<PAGE> 1
COLONIAL INTERMEDIATE HIGH INCOME FUND
5,010,532 SHARES OF BENEFICIAL INTEREST
ISSUABLE UPON EXERCISE OF
RIGHTS TO SUBSCRIBE FOR SUCH SHARES
------------------------
Colonial Intermediate High Income Fund (the "Fund") is issuing to its
shareholders of record ("Record Date Shareholders"), as of the close of business
on May 26, 1998 (the "Record Date"), transferable rights ("Rights") entitling
the holders thereof to subscribe for up to 5,010,532 shares of beneficial
interest, no par value, of the Fund (the "Shares") at the rate of one Share for
every three Rights held (the "Offer"). Fractional shares will not be issued upon
the exercise of Rights. Record Date Shareholders will receive one Right for each
whole share held on the Record Date. Record Date Shareholders issued fewer than
three Rights are entitled to subscribe for one Share pursuant to the primary
subscription (as described herein). The Rights entitle each Record Date
Shareholder to subscribe, subject to certain limitations and subject to
allotment, for any Shares not acquired by exercise of the Rights. The Rights are
transferable and the Rights will be listed for trading on the New York Stock
Exchange (the "Exchange") under the symbol "CIF RT," subject to notice of
issuance. The Fund's shares trade on the Exchange under the symbol "CIF." The
Shares issued pursuant to the Offer will be listed on the Exchange, subject to
notice of issuance. See "The Offer." Record Date Shareholders, where the context
requires, shall also include beneficial owners whose shares are held of record
by Cede & Co. ("Cede"), nominee for The Depository Trust Company ("DTC"), or by
any other depository or nominee. THE SUBSCRIPTION PRICE PER SHARE (THE
"SUBSCRIPTION PRICE") WILL BE $6.75.
THE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME, ON JUNE 19, 1998
UNLESS EXTENDED AS DESCRIBED HEREIN (THE "EXPIRATION DATE").
AN IMMEDIATE DILUTION, WHICH COULD BE SUBSTANTIAL, OF THE AGGREGATE NET
ASSET VALUE OF THE SHARES OWNED BY RECORD DATE SHAREHOLDERS WHO DO NOT FULLY
EXERCISE THEIR RIGHTS MAY BE EXPERIENCED AS A RESULT OF THE OFFER BECAUSE THE
SUBSCRIPTION PRICE PER SHARE MAY BE LESS THAN THE FUND'S NET ASSET VALUE PER
SHARE ON THE EXPIRATION DATE, AND THE NUMBER OF SHARES OUTSTANDING AFTER THE
OFFER IS LIKELY TO INCREASE IN A GREATER PERCENTAGE THAN THE INCREASE IN THE
SIZE OF THE FUND'S ASSETS. IN ADDITION, AS A RESULT OF THE OFFER, RECORD DATE
SHAREHOLDERS WHO DO NOT FULLY EXERCISE THEIR RIGHTS SHOULD EXPECT THAT THEY
WILL, AT THE COMPLETION OF THE OFFER, OWN A SMALLER PROPORTIONAL INTEREST IN THE
FUND THAN WOULD OTHERWISE BE THE CASE. SEE "RISK FACTORS AND SPECIAL
CONSIDERATIONS--DILUTION" AND "THE OFFER." EXCEPT AS DESCRIBED HEREIN, RECORD
DATE SHAREHOLDERS AND HOLDERS OF RIGHTS ACQUIRED DURING THE SUBSCRIPTION PERIOD
WILL HAVE NO RIGHT TO RESCIND THEIR SUBSCRIPTIONS AFTER RECEIPT OF THEIR PAYMENT
FOR SHARES BY THE SUBSCRIPTION AGENT (AS DEFINED HEREIN).
The Fund is a diversified, closed-end management investment company with a
leveraged capital structure. The Fund's investment objective is to seek high
current income and total return by investing primarily in lower-rated corporate
debt securities. Under normal market conditions, the Fund invests primarily in a
professionally managed, diversified portfolio of debt securities rated in the
lower categories by established rating agencies (consisting principally of
securities rated "BBB" or lower by Standard & Poor's Ratings Group ("S&P") or
"Baa" or lower by Moody's Investors Service, Inc. ("Moody's," and together with
S&P, the "Rating Agencies")), or nonrated securities deemed by Colonial
Management Associates, Inc. (the "Adviser") to be of comparable quality.
Securities rated "BB" or lower by S&P or "Ba" or lower by Moody's are commonly
referred to as "high yield," high risk securities or "junk bonds." LOWER RATED
SECURITIES ENTAIL RISKS THAT ARE DIFFERENT AND MORE PRONOUNCED THAN THOSE
INVOLVED IN HIGHER RATED SECURITIES. AN INVESTMENT IN THE FUND IS NOT
APPROPRIATE FOR ALL INVESTORS, AND NO ASSURANCE CAN BE GIVEN THAT THE FUND WILL
ACHIEVE ITS INVESTMENT OBJECTIVE. SEE "RISK FACTORS AND SPECIAL CONSIDERATIONS."
The Fund's use of leverage creates the opportunity for greater total returns but
at the same time involves certain substantial risks. See "The Fund" and "Risk
Factors and Special Considerations--Risk of Leverage." The Adviser has served as
the Fund's investment adviser since the Fund's inception in 1988. Since the
Adviser's fee is based on the average weekly net assets of the Fund, the Adviser
will benefit from any increase in the Fund's net assets resulting from the
Offer. See "The Adviser."
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR
ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
================================================================================
<TABLE>
<S> <C> <C> <C>
SUBSCRIPTION PRICE SALES LOAD(1) PROCEEDS TO FUND(2)(3)
- -----------------------------------------------------------------------------------------------------------------
Per Share............................ $6.75 $0.25 $6.50
- -----------------------------------------------------------------------------------------------------------------
Total Maximum........................ $33,821,091 $1,268,291 $32,552,800
=================================================================================================================
</TABLE>
(footnotes on following page)
------------------------
PAINEWEBBER INCORPORATED
------------------------
THE DATE OF THIS PROSPECTUS IS MAY 19, 1998
<PAGE> 2
(continued from cover page)
Prior to the Expiration Date, PaineWebber Incorporated (the "Dealer
Manager") may offer Shares acquired through its purchase and exercise of Rights
at prices it sets from time to time. Because the Dealer Manager will determine
the price, it may realize profits or losses independent of any fees referred to
under "The Offer--Distribution Arrangements."
This Prospectus sets forth concisely the information about the Fund that a
prospective investor ought to know before investing. Investors are advised to
read this Prospectus and to retain it for future reference. Additional
information about the Fund is contained in the May 19, 1998 Statement of
Additional Information (the "SAI") which has been filed with the Securities and
Exchange Commission (the "Commission") and is obtainable free of charge by
calling the Adviser at 1-800-426-3750. The SAI is incorporated by reference in
(which means it is considered to be a part of) this Prospectus. See page 40 of
this Prospectus for a table of contents of the SAI.
All questions and inquiries relating to the Offer should be directed to
Shareholder Communications Corporation (the "Information Agent") at (800)
733-8481, ext. 486. The Fund's address is One Financial Center, Boston,
Massachusetts 02111, and its telephone number is (617) 426-3750.
The Fund announced its intention to make the Offer after the close of
trading on the Exchange on April 15, 1998. The net asset values per Share at the
close of business on April 10, 1998 (the last trading date on which the Fund
publicly reported its net asset value prior to the announcement of the Offer)
and on May 15, 1998 (the last trading date prior to the date of this Prospectus
on which the Fund publicly reported its net asset value) were $7.52 and $7.43,
respectively, and the last reported sales prices of a Share on the Exchange on
those dates were $7.688 and $7.625, respectively.
------------------------
(1) In connection with the Offer, the Fund has agreed to pay PaineWebber
Incorporated (the "Dealer Manager") a fee for its financial advisory,
marketing and soliciting services equal to 3.75% of the aggregate
Subscription Price for Shares issued pursuant to the Offer. The Dealer
Manager will reallow to broker-dealers included in the selling group to be
formed and managed by the Dealer Manager ("Selling Group Members")
solicitation fees equal to 2.50% of the Subscription Price per Share for
each Share issued pursuant to the Offer as a result of their soliciting
efforts. In addition, the Dealer Manager will reallow to other
broker-dealers that have executed and delivered a soliciting dealer
agreement and have solicited the exercise of Rights solicitation fees equal
to 0.50% of the Subscription Price per Share for each Share issued pursuant
to the exercise of Rights as a result of their soliciting efforts, subject
to a maximum fee based upon the number of Shares held by each broker-dealer
through DTC on the Record Date. The Fund and the Adviser have agreed to
indemnify the Dealer Manager and each Selling Group Member and soliciting
dealer against certain liabilities under the Securities Act of 1933, as
amended.
(2) Before deduction of offering expenses incurred by the Fund, estimated at
$500,000, which includes up to $100,000 that may be paid to the Dealer
Manager as partial reimbursement for its expenses relating to the Offer.
(3) Funds received by check prior to the final due date of this Offer will be
deposited into a segregated interest-bearing account (which interest will
accrue to the benefit of the Fund) pending proration and distribution of the
Shares.
-----------------------------
Certain numbers in this Prospectus have been rounded for ease of
presentation and, as a result, may not total precisely.
IN CONNECTION WITH THIS OFFERING, THE DEALER MANAGER MAY EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE RIGHTS AND THE
SHARES AT LEVELS ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET.
SUCH TRANSACTIONS MAY BE EFFECTED ON THE NEW YORK STOCK EXCHANGE, ON NASDAQ OR
OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
2
<PAGE> 3
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PROSPECTUS SUMMARY
The following is qualified in its entirety by the more detailed information
included elsewhere in this Prospectus.
PURPOSE OF THE OFFER
The Board of Trustees of Colonial Intermediate High Income Fund (the
"Fund") has determined that it may be in the best interests of the Fund and its
shareholders to increase the number of outstanding shares of the Fund and to
increase the assets of the Fund available for investment.
In reaching its decision, the Board of Trustees of the Fund was advised by
the Fund's investment adviser, Colonial Management Associates, Inc. (the
"Adviser"), that an increase in the assets of the Fund would permit the Fund to
pursue attractive investment opportunities in the "high yield," high risk
securities market, while retaining portfolio investments that the Adviser
believes should continue to be held. The Adviser believes the Offer may result
in greater portfolio diversification opportunities and enhance its ability to
buy and sell larger blocks of securities on potentially better terms.
The Fund maintains a leveraged capital structure when it believes such a
capital structure is of potential benefit to shareholders. The Fund utilizes
leverage seeking to enhance returns to shareholders by borrowing capital at a
lower interest rate than that which the Fund earns on its investments. The Board
of Trustees believes that increasing the Fund's assets will provide the Fund
with additional flexibility in connection with the Fund's leverage, including
enhancing its ability to increase the Fund's existing leverage, while reducing
the overall effective cost of the leverage. For a discussion of the anticipated
impact of the Offer on the Fund's leverage, please refer to "Investment Policies
and Limitations" and "Risk Factors and Special Considerations--Risk of
Leverage."
In addition, the Board of Trustees believes that increasing the size of the
Fund may lower the Fund's expenses as a proportion of average net assets because
the Fund's fixed costs can be spread over a larger asset base. The Board of
Trustees also believes that a larger number of outstanding shares and a larger
number of beneficial owners of shares could increase the level of market
interest in the Fund and the liquidity of Fund shares on the New York Stock
Exchange (the "Exchange"). The distribution to shareholders of transferable
Rights which themselves may have a realizable value will also afford
nonparticipating shareholders the potential of receiving a cash payment upon
sale of such Rights, receipt of which may be viewed as partial compensation for
the dilution of their interest in the Fund that may result from the Offer.
The Board of Trustees also considered the impact of the Offer on the Fund's
current distributions. Based on the Adviser's assessment of current market
conditions in the lower rated debt market and available leverage opportunities,
the Board of Trustees believes the Offer will not result in a decrease in the
Fund's current level of dividends per share. For a further discussion of the
anticipated impact of the Offer on the Fund's dividends, please refer to "Risk
Factors and Special Considerations--Dividends and Distributions."
TERMS OF THE OFFER
The Fund is issuing to its shareholders of record ("Record Date
Shareholders") as of the close of business on May 26, 1998 (the "Record Date")
transferable rights ("Rights") entitling the holders thereof to subscribe for up
to 5,010,532 shares of beneficial interest, no par value (the "Shares"), of the
Fund (the "Offer"). Each such Record Date Shareholder is being issued one Right
for each whole share owned on the Record Date. The Rights entitle the holders
thereof to subscribe for one Share for every three Rights held (1-for-3).
Fractional shares will not be issued upon the exercise of Rights. Record Date
Shareholders issued fewer than three Rights are entitled to subscribe for one
Share pursuant to the primary subscription (as described below). Rights may be
exercised at any time during the subscription period (the "Subscription
Period"), which commences on May 26, 1998 and ends at 5:00 p.m., New York City
time, on June 19, 1998, unless extended by the Fund (the "Expiration Date"). The
Rights are evidenced by Subscription Certificates ("Subscription Certificates")
that will be mailed to Record Date Shareholders promptly following the Record
Date, except as discussed below under "Foreign Shareholders."
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3
<PAGE> 4
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Record Date Shareholders, where the context requires, shall also include
beneficial owners whose shares are held of record by Cede & Co. ("Cede"),
nominee for The Depository Trust Company ("DTC"), or by any other depository or
nominee. In the case of shares held of record by Cede or any other depository or
nominee, beneficial owners for whom Cede or any other depository or nominee is
the holder of record will be deemed to be the holders of the Rights that are
issued to Cede or such other depository or nominee on their behalf.
A Record Date Shareholder's right to acquire during the Subscription Period
at the Subscription Price one Share for every three Rights held is hereinafter
referred to as the "Primary Subscription." The Rights are transferable and
persons who become holders of Rights who are not Record Date Shareholders
("Rights Holders") may also purchase Shares in the Primary Subscription. All
Rights may be exercised until 5:00 p.m., New York City time, on the Expiration
Date. (Record Date Shareholders and Rights Holders purchasing Shares in the
Primary Subscription and those Record Date Shareholders who purchase Shares
pursuant to the Over-Subscription Privilege described below are hereinafter
referred to as "Exercising Rights Holders.")
The first dividend to be paid on Shares acquired upon exercise of Rights
will be the first monthly dividend, the record date for which occurs after the
issuance of such Shares. It is the Fund's present policy to pay dividends on the
last Friday on or before the 15th day of each month to shareholders of record on
the last Business Day (as defined herein) of the month prior to the payment
date. Except as described below, it is expected that the first dividend to be
paid on Shares issued pursuant to the Offer will be paid on or about August 14,
1998. To accommodate settlement of the Offer, the June 1998 record date for
dividends may be accelerated so that the issuance of Shares by the Fund in
connection with the Offer and the receipt of proceeds of such issuance by the
Fund, subject to certain exceptions, occurs shortly after the June 1998 record
date for dividends.
Prior to the Expiration Date, the Dealer Manager may offer Shares acquired
through the purchase and exercise of Rights at prices it sets from time to time.
To the extent such Shares are issued prior to a dividend record date of the Fund
that precedes the Expiration Date, such Shares will be paid the dividend
declared to the same extent as other shares outstanding on such dividend record
date, and thus, the issuance of such Shares may have a dilutive effect on the
income per share available for such dividend.
OVER-SUBSCRIPTION PRIVILEGE
Record Date Shareholders who fully exercise all Rights issued to them
(other than those Rights which cannot be exercised because they represent the
right to acquire less than one Share) are entitled to subscribe for those Shares
which were not otherwise subscribed for by others in the Primary Subscription
(the "Over-Subscription Privilege"). If sufficient Shares are available, all
Record Date Shareholder over-subscription requests will be honored in full. If
Record Date Shareholder requests for Shares pursuant to the Over-Subscription
Privilege exceed Shares available, the available Shares will be allocated pro
rata among those who over-subscribe based on the number of Rights originally
issued to them by the Fund. See "The Offer--Over-Subscription Privilege."
Banks, brokers, trustees and other nominee holders of Rights will be
required to certify to the Subscription Agent (as defined herein), before any
Over-Subscription Privilege may be exercised with respect to any particular
beneficial owner, as to the aggregate number of Rights exercised pursuant to the
Primary Subscription and the number of Shares subscribed for pursuant to the
Over-Subscription Privilege by such beneficial owner and that such beneficial
owner's Primary Subscription was exercised in full. Nominee Holder
Over-Subscription Forms and Beneficial Owner Certificate Forms will be
distributed to banks, brokers, trustees and other nominee holders with the
Subscription Certificates.
The Fund will not offer or sell in connection with the Offer any Shares
that are not subscribed for pursuant to the Primary Subscription or the
Over-Subscription Privilege.
SUBSCRIPTION PRICE
The Subscription Price per Share (the "Subscription Price") for the Shares
to be issued pursuant to the Offer will be $6.75.
- -------------------------------------------------------------------------------
4
<PAGE> 5
- -------------------------------------------------------------------------------
METHOD FOR EXERCISING RIGHTS
Rights are evidenced by Subscription Certificates that, except as described
below under "Foreign Shareholders," will be mailed promptly following the Record
Date to Record Date Shareholders or, if a shareholder's shares are held by Cede,
as nominee for DTC, or any other depository or nominee on its behalf, to Cede or
such depository or nominee. Rights may be exercised by completing and signing
the Subscription Certificate that accompanies this Prospectus and mailing it in
the envelope provided, or otherwise delivering the completed and signed
Subscription Certificate to the Subscription Agent, together with payment in
full for the Shares to be purchased at the Subscription Price by the Expiration
Date. Rights may also be exercised by contacting your broker, bank or trust
company, which can arrange, on your behalf, to guarantee delivery of payment and
delivery of a properly completed and executed Subscription Certificate pursuant
to a Notice of Guaranteed Delivery ("Notice of Guaranteed Delivery") by the
close of business on the third Business Day after the Expiration Date. A fee may
be charged for this service. Fractional shares will not be issued. Completed
Subscription Certificates must be received by the Subscription Agent prior to
5:00 p.m., New York City time, on the Expiration Date at one of the addresses
set forth herein (unless the guaranteed delivery procedures are complied with as
described below under the heading "The Offer--Payment for Shares").
SALE OF RIGHTS
The Rights are transferable until the Expiration Date. The Rights will be
listed for trading on the Exchange, subject to notice of issuance. The Fund will
use its best efforts to ensure that an adequate trading market for the Rights
will exist, although no assurance can be given that a market for the Rights will
develop. Trading in the Rights on the Exchange may be conducted until the close
of trading on the Exchange on June 18, 1998, the last Business Day (as defined
below) prior to the Expiration Date. The Fund expects that a market for the
Rights will develop and that the value of the Rights, if any, will be affected
by the market price. Rights may be sold by individual holders through brokerage
channels or may be submitted to the Subscription Agent for sale by or to the
Dealer Manager. Any Rights to be submitted by the Subscription Agent to the
Dealer Manager for purchase or sale must be received by the Subscription Agent
at or prior to 5:00 p.m., New York City time, on June 17, 1998, two Business
Days prior to the Expiration Date, due to normal settlement procedures. It is
anticipated the Rights will trade on the Exchange commencing on a when-issued
basis on or about May 20, 1998 until approximately May 28, 1998 and on a regular
way basis thereafter until and including June 18, 1998, the last Business Day
prior to the Expiration Date. If the Subscription Agent receives Rights for sale
in a timely manner, it will either sell the Rights to the Dealer Manager or the
Dealer Manager will use its best efforts to sell the Rights. The Dealer Manager
will also either purchase or attempt to sell any Rights submitted to it by the
Subscription Agent that a Record Date Shareholder is unable to exercise because
such Rights represent the right to subscribe for less than one Share. Any
commissions will be paid by the selling Record Date Shareholder. Neither the
Fund nor the Subscription Agent for the Dealer Manager will be responsible for
Rights that cannot be sold nor will they guarantee any minimum sale price for
the Rights. "Business Day" means a day on which the Exchange is open for trading
and which is not a Saturday or Sunday or a holiday, including New Year's Day,
Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Columbus Day, Thanksgiving Day, Christmas Day or
any other day on which banks in New York City are authorized or obligated by law
or executive order to close. Record Date Shareholders are urged to obtain a
recent trading price for the Rights on the Exchange from their broker, bank,
financial adviser or the financial press. Exercising Rights Holders' inquiries
should be directed to the Information Agent.
OFFERING FEES AND EXPENSES
The Fund has agreed to pay the Dealer Manager a fee for its financial
advisory, marketing and soliciting services equal to 3.75% of the aggregate
Subscription Price for Shares issued pursuant to the Offer. The Dealer Manager
will reallow to broker-dealers included in the selling group to be formed and
managed by the Dealer Manager ("Selling Group Members"), solicitation fees equal
to 2.50% of the Subscription Price per Share for each Share issued pursuant to
the Offer as a result of their soliciting efforts. In addition, the Dealer
Manager will reallow to other broker-dealers that have executed and delivered a
soliciting dealer agreement and have solicited the exercise of Rights
solicitation fees equal to 0.50% of the Subscription Price per Share
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5
<PAGE> 6
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for each Share issued pursuant to the exercise of Rights as a result of their
soliciting efforts, subject to a maximum fee based upon the number of shares
held by each broker-dealer through DTC on the Record Date. Fees will be paid to
the broker-dealer designated on the applicable portion of the Subscription
Certificates or, in the absence of such designation, to the Dealer Manager. See
"The Offer--Distribution Arrangements." Other offering expenses incurred by the
Fund are estimated at $500,000, which includes up to $100,000 that may be paid
to the Dealer Manager as partial reimbursement for its expenses relating to the
Offer.
FOREIGN SHAREHOLDERS
Subscription Certificates will not be mailed to Record Date Shareholders
whose record addresses are outside the United States (the term "United States"
includes the states, the District of Columbia and the territories and
possessions of the United States) ("Foreign Record Date Shareholders"). Foreign
Record Date Shareholders will be sent written notice of the Offer. The Rights to
which such Subscription Certificates relate will be held by the Subscription
Agent for such Foreign Record Date Shareholders' accounts until instructions are
received to exercise the Rights. If no instructions have been received by 5:00
p.m., New York City time, on June 16, 1998, three Business Days prior to the
Expiration Date, the Rights of those Foreign Record Date Shareholders will be
transferred by the Subscription Agent to the Dealer Manager, who will either
purchase the Rights or use its best efforts to sell the Rights. The net
proceeds, if any, from the sale of those Rights by or to the Dealer Manager will
be remitted to the Foreign Record Date Shareholders.
USE OF PROCEEDS
Based on the Subscription Price of $6.75 per Share, the net proceeds of the
Offer to the Fund, assuming all 5,010,532 Shares offered hereby are sold, are
estimated to be approximately $32,052,800, after deducting offering expenses
payable by the Fund estimated at approximately $500,000. The Adviser anticipates
that investment of such proceeds in accordance with the Fund's investment
objective and policies will take up to 30 days from their receipt by the Fund,
depending on market conditions and the availability of appropriate securities
for purchase, but in no event does the Adviser anticipate that such investment
will take longer than six months. Pending such investment in accordance with the
Fund's investment objective and policies, the proceeds will be held in U.S.
Government securities (which term includes obligations of the United States
Government, its agencies or instrumentalities) and other high-quality short-term
money market instruments.
INFORMATION AGENT
Any questions or request for assistance concerning the method of
subscribing for Shares or for additional copies of this Prospectus or
Subscription Certificates or Notices of Guaranteed Delivery may be directed to
the Information Agent at its telephone number and address listed below.
Information Agent for the Offer is:
Shareholder Communications Corporation
17 State Street, 27th Floor
New York, New York 10004
(800) 733-8481, ext. 486
Shareholders may also contact their brokers or nominees for information
with respect to the Offer.
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6
<PAGE> 7
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IMPORTANT DATES TO REMEMBER
<TABLE>
<CAPTION>
EVENT DATE
----- ----
<S> <C>
Record Date........................................... May 26, 1998
Subscription Period................................... May 26, 1998 to
June 19, 1998(a)
Expiration Date....................................... June 19, 1998(a)
Subscription Certificates and Payment for Shares
Due(b).............................................. June 19, 1998(a)
Notice of Guaranteed Delivery Due(b).................. June 19, 1998(a)
Payment for Guarantees of Delivery Due................ June 24, 1998(a)
Confirmation to Participants.......................... July 1, 1998(a)
</TABLE>
- ---------------
(a) Unless the Offer is extended.
(b) A shareholder exercising Rights must deliver by June 19, 1998 either (i) a
Subscription Certificate and payment for Shares or (ii) a Notice of
Guaranteed Delivery.
INFORMATION REGARDING THE FUND
The Fund has been engaged in business as a diversified, closed-end
management investment company since 1988. The Fund's investment objective is to
seek high current income and total return by investing primarily in lower-rated
corporate debt securities. An investment in the Fund may not be appropriate for
all investors, and no assurance can be given that the Fund's investment
objective will be achieved.
Under normal conditions, the Fund invests primarily in a professionally
managed, diversified portfolio of debt securities rated in the lower categories
by established rating agencies (consisting principally of securities rated "BBB"
or lower by Standard & Poor's Ratings Group ("S&P") or "Baa" or lower by Moody's
Investors Service, Inc. ("Moody's," and together with S&P, the "Rating
Agencies")) or nonrated securities deemed by the Adviser to be of comparable
quality. Securities rated "BB" or lower by S&P or "Ba" or lower by Moody's are
commonly referred to as "high yield," high risk securities or "junk bonds." Such
securities are generally regarded by the Rating Agencies as significantly more
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligation and more likely to default than
higher quality debt securities. In addition to investing in such lower rated
debt securities, the Fund may engage in, among other activities, certain options
activities, investments in equity securities and higher rated debt securities,
the use of futures contracts and options thereon and repurchase agreements. The
Fund may also invest in foreign and restricted securities. See "Investment
Policies and Limitations" and the Statement of Additional Information. Lower
rated and comparable nonrated securities and foreign securities may be subject
to a greater degree of risk than higher rated and domestic securities,
respectively. See "Risk Factors and Special Considerations."
The Fund completed an initial public offering of 11,000,000 shares in July
1988, raising approximately $102.3 million. Concurrently with its initial public
offering, the Fund issued $37.4 million aggregate principal amount of Senior
Extendible Notes (the "Senior Extendible Notes"). During the fiscal year ended
October 31, 1996 the Fund redeemed all of its outstanding Senior Extendible
Notes.
The Fund entered into a credit agreement dated as of June 12, 1996 with
Bank of America Illinois pursuant to which the Fund issued a term note (the
"Original Term Note") to Bank of America Illinois in the aggregate principal
amount of $27,400,000, due in full on June 14, 1999 and bearing interest at the
fixed annual rate of 7.33%. On May 19, 1998, the Fund entered into an Amended
and Restated Credit Agreement (the "Credit Agreement") with Bank of America
National Trust and Savings Association, successor by merger to Bank of America
Illinois ("Bank of America"), pursuant to which the Fund issued a new term note
(the "Term Note") to Bank of America in the aggregate principal amount of
$44,900,000. The $27,400,000 borrowing (the "First Loan") under the Original
Term Note remains outstanding under the Term Note with the same maturity and
interest rate. In addition, on May 19, 1998, the Fund borrowed under the Term
Note the aggregate principal amount of $6,900,000 (the "Second Loan") from Bank
of America, which amount is due in full on May 19, 2001 and bears interest at
the fixed annual rate of 6.36%. The combined weighted
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7
<PAGE> 8
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average interest rate of the $34,300,000 aggregate principal amount outstanding
under the Term Note is 7.13%. The Credit Agreement permits the Fund to borrow up
to the remaining amount of the Term Note at any time prior to September 30,
1998. The Credit Agreement requires the Fund to comply with certain asset
coverage, liquidity and investment limitations. See "Description of Term Note."
As a result of the Second Loan, the Fund increased the percentage of its
assets representing leverage from approximately 20% to approximately 24%. Based
on current market conditions, the Fund's Board of Trustees has authorized the
Fund to increase its borrowings to the maximum aggregate principal amount of the
Term Note at or following the completion of the Offer in order that the
percentage of the Fund's assets, including the proceeds from the Offer,
representing leverage may be maintained at or about 25% following completion of
the Offer. Due to possible changes in market conditions, there are no assurances
that the Fund will borrow additional amounts under the Term Note or that any
additional borrowings under the Term Note will be obtained by the Fund at
favorable interest rates. The Fund reserves the right at any time, if it
believes that market conditions are appropriate, further to increase its level
of debt or other senior securities to maintain or increase the Fund's current
level of leverage to the extent permitted under the Investment Company Act of
1940, as amended (the "1940 Act"), and any relevant agreements between the Fund
and third parties, including the Credit Agreement referred to above. The
inability to increase, or delays in increasing the Fund's leverage could,
depending on market conditions, adversely affect the Fund's earnings and net
asset value. See "Risk Factors and Special Considerations--Risk of Leverage."
The Fund's outstanding shares are listed and traded on the Exchange. The
average weekly trading volumes of the Fund's shares on the Exchange for the
Fund's fiscal years ended October 31, 1996 and 1997 and for the six months ended
April 30, 1998 were 117,262 shares, 114,140 shares and 120,650 shares,
respectively. As of April 30, 1998, the Fund had 14,971,645 shares outstanding
and net assets of approximately $111.3 million.
INFORMATION REGARDING THE ADVISER
Colonial Management Associates, Inc., an investment adviser registered
under the Investment Advisers Act of 1940, as amended, has served as investment
adviser to the Fund since its inception. The Adviser is a wholly owned
subsidiary of The Colonial Group, Inc. ("TCG"), and both TCG and the Adviser are
indirect subsidiaries of Liberty Mutual Insurance Company, an underwriter of
workers' compensation insurance and a property and casualty insurer in the U.S.
The Adviser has been an investment adviser since 1931. As of the date of this
Prospectus, the Adviser serves as investment adviser for 39 open-end and 5
closed-end management investment companies.
Andrea S. Feingold, Vice President and head of the Corporate Group of the
Adviser, has managed the Fund since 1993. Ms. Feingold joined the Adviser in
1991 as an Investment Analyst.
The Fund pays the Adviser a monthly fee at the annual rate of 0.65% of the
Fund's average weekly net assets. Since the Adviser's fee is based on the
average weekly net assets of the Fund, the Adviser will benefit from any
increase in the Fund's net assets resulting from the Offer. See "The Adviser."
RISK FACTORS AND SPECIAL CONSIDERATIONS
The following summarizes certain matters that should be considered, among
others, in connection with the Offer and investment in the Fund generally.
Dilution. An immediate dilution of the aggregate net asset value of the
shares owned by Record Date Shareholders who do not fully exercise their Rights
may be experienced as a result of the Offer because the Subscription Price per
Share may be less than the Fund's net asset value per share on the Expiration
Date, and the number of shares outstanding after the Offer is likely to increase
in a greater percentage than the increase in the size of the Fund's assets. In
addition, as a result of the Offer, Record Date Shareholders who do not fully
exercise their Rights should expect that they will, at the completion of the
Offer, own a smaller proportional interest in the Fund than would otherwise be
the case. Although it is not possible to state precisely the amount of any such
decrease in net asset value, because it is not known at this time what the net
asset value per share will be at the Expiration Date or what proportion of the
Shares will be subscribed, such
- --------------------------------------------------------------------------------
8
<PAGE> 9
- --------------------------------------------------------------------------------
dilution could be substantial. For example, assuming that all Rights are
exercised at the Subscription Price of $6.75, which is 9.2% below the Fund's net
asset value of $7.43 per share as of May 15, 1998, the Fund's net asset value
per share (after payment of the Dealer Manager and soliciting fees and estimated
offering expenses) would be reduced by approximately $0.26 per share (or 3.5%).
The distribution to shareholders of transferable Rights which themselves may
have a realizable value will afford nonparticipating shareholders the potential
of receiving a cash payment upon sale of such Rights, receipt of which may be
viewed as partial compensation for the possible dilution of their interest in
the Fund. No assurance can be given that a market for the Rights will develop or
as to the value, if any, that such Rights will have.
Risk of Leverage. Leverage creates the opportunity for greater total
returns, but at the same time involves certain risks. Any investment income or
gains earned with respect to the amounts borrowed pursuant to the Credit
Agreement or other forms of leverage, which is in excess of interest due
thereon, will augment the Fund's income attributable to its shares of beneficial
interest. Conversely, if the investment performance with respect to the amounts
borrowed pursuant to the Credit Agreement or other forms of leverage fails to
cover the interest on such borrowings, the value of the Fund's shares may
decrease more quickly than would otherwise be the case and dividends thereon
would be reduced or eliminated. This is the speculative effect of leverage.
As a result of the Second Loan, the Fund increased the percentage of its
assets representing leverage from approximately 20% to approximately 24%. Based
on current market conditions, the Fund's Board of Trustees has authorized the
Fund to increase its borrowings to the maximum aggregate principal amount of the
Term Note at or following the completion of the Offer in order that the
percentage of the Fund's assets, including the proceeds from the Offer,
representing leverage may be maintained at or about 25% following completion of
the Offer. Due to possible changes in market conditions, there are no assurances
that the Fund will borrow additional amounts under the Term Note or that any
additional borrowings under the Term Note will be obtained by the Fund at
favorable interest rates. The Fund reserves the right at any time, if it
believes that market conditions are appropriate, further to increase its level
of debt or other senior securities to maintain or increase the Fund's level of
leverage to the extent permitted under the 1940 Act and any relevant agreements
between the Fund and third parties, including the Credit Agreement. The
inability to increase, or delays in increasing the Fund's leverage could,
depending on market conditions, adversely affect the Fund's earnings and net
asset value. See "Risk Factors and Special Considerations--Risk of Leverage."
Because the Credit Agreement obligations are senior to the Fund's shares in
any liquidation of the Fund, such obligations would have to be paid in full
before any payments would be made with respect to the shares. In addition, the
risk of adverse changes in net asset value is increased by the Fund's leveraged
structure. See "Risk Factors and Special Considerations."
Discount from Net Asset Value. Shares of closed-end funds frequently trade
at a market price that is less than the value of the net assets attributable
thereto. The possibility that Shares of the Fund will trade at a discount from
net asset value is a risk separate and distinct from the risk that the Fund's
net asset value will decrease. It should be noted, however, that in some cases,
shares of closed-end funds trade at a premium to net asset value. The Fund's
shares have traded in the market above, at and below net asset value at various
times since the commencement of the Fund's operations. See "Trading and Net
Asset Value Information." In addition, the net asset value of the Fund will
change with changes in the value of its portfolio securities.
Lower-Rated Investments. Debt securities offering the high current income
sought by the Fund will ordinarily be in the lower rating categories of
recognized rating agencies or will be nonrated. Such securities are generally
regarded by the Rating Agencies as significantly more speculative with respect
to capacity to pay interest and repay principal in accordance with the terms of
the obligation and more likely to default than higher quality debt securities.
The values of such securities tend to reflect individual corporate developments
to a greater extent than higher rated securities, which tend to react more to
changes in the general market level of interest rates. Relative to other debt
securities, the values of lower rated debt securities may be more volatile
because: (i) an economic downturn may more significantly impact their potential
for default, or
- --------------------------------------------------------------------------------
9
<PAGE> 10
(ii) the secondary market for such securities may at times be less liquid or
respond more adversely to negative publicity or investor perceptions, making it
more difficult to value or dispose of the securities. In addition, the trading
market for lower rated securities is generally less liquid than the market for
higher rated securities. As of April 30, 1998, approximately 97.15% of the
market value of the Fund's total investments was represented by debt securities
regarded by the Rating Agencies as below investment grade (that is, rated below
BBB by S&P or below Baa by Moody's) or unrated securities deemed by the Adviser
to be below investment grade.
For a more detailed discussion of the risks and special considerations with
respect to lower rated securities, see "Risk Factors and Special
Considerations--Lower-Rated Investments."
Dividends and Distributions. It is the Fund's present policy, which may be
changed by the Board of Trustees, to pay dividends of investment company taxable
income on a monthly basis to holders of shares and to distribute any net
short-term capital gains and net capital gains annually. Based on the Adviser's
assessment of current market conditions in the lower rated debt market and
available leverage opportunities, the Board of Trustees believes the Offer will
not result in a decrease in the Fund's current level of dividends per share.
However, there can be no assurance that the Fund will be able to maintain its
current level of dividends per share, and the Board of Trustees may, in its sole
discretion, change the Fund's current level of dividends per share in response
to market or other conditions.
For a more detailed discussion of the risks and special considerations with
respect to dividends and distributions, see "Risk Factors and Special
Considerations--Dividends and Distributions."
Other Matters. There are additional matters which should be considered in
connection with an investment in the Fund, including provisions of the Fund's
Agreement and Declaration of Trust, limitations on the ability of the Fund to
declare dividends or other distributions contained in the 1940 Act and in the
Credit Agreement, and the possible conversion of the Fund to an open-end
investment company. See "Risk Factors and Special Considerations" and "Share
Repurchases; Conversion to Open-End Status."
Investors should carefully consider their ability to assume the foregoing
risks before making an investment in the Fund. An investment in shares of the
Fund is not appropriate for all investors. See "Risk Factors and Special
Considerations."
10
<PAGE> 11
FEE TABLE
<TABLE>
<S> <C>
Shareholder Transaction Expenses
Sales Load (as a percentage of the Subscription Price per
Share)(1)................................................. 3.75%
Annual Expenses (as a percentage of average weekly net
assets attributable to shares)(2)
Management Fees(3).......................................... 0.65%
Interest and Amortization of Deferred Debt Issuance
Expense................................................... 1.40%
Other Expenses.............................................. 0.19%
-----
Total Annual Expenses............................. 2.24%
=====
</TABLE>
EXAMPLE:
<TABLE>
<CAPTION>
CUMULATIVE EXPENSES PAID FOR THE PERIOD OF:
--------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a
$1,000 investment, assuming a 5% annual return
throughout the periods.......................... $59 $105 $153 $285
</TABLE>
- ---------------
(1) The Fund has agreed to pay the Dealer Manager a fee for its financial
advisory, marketing and soliciting services equal to 3.75% of the aggregate
Subscription Price for Shares issued pursuant to the Offer. The Dealer
Manager will reallow to broker-dealers included in the selling group to be
formed and managed by the Dealer Manager ("Selling Group Members")
solicitation fees equal to 2.50% of the Subscription Price per Share for
each Share issued pursuant to the Offer as a result of their soliciting
efforts. In addition, the Dealer Manager will reallow, to other
broker-dealers that have executed and delivered a soliciting dealer
agreement and have solicited the exercise of Rights, solicitation fees equal
to 0.50% of the Subscription Price per Share for each Share issued pursuant
to the exercise of Rights as a result of their soliciting efforts, subject
to a maximum fee based upon the number of shares held by each broker-dealer
through DTC on the Record Date. The Fund has also agreed to reimburse the
Dealer Manager for its expenses relating to the Offer up to an aggregate of
$100,000. In addition, the Fund has agreed to pay fees to the Subscription
Agent (as defined herein) and the Information Agent (as defined herein),
estimated to be $35,000 and $27,000, respectively, for their services
related to the Offer, excluding reimbursement for their out-of-pocket
expenses. These fees and expenses will be borne by the Fund and indirectly
by all of the Fund's shareholders, including those shareholders who do not
exercise their Rights.
(2) Amounts are based on estimated amounts for the Fund's current fiscal year
after giving effect to anticipated net proceeds of the Offer, assuming that
all of the Rights are exercised.
(3) The Fund pays the Adviser a monthly fee at an annual rate of 0.65% of the
Fund's average weekly net assets. See "The Adviser."
THE FOREGOING FEE TABLE AND EXAMPLE ARE INTENDED TO ASSIST INVESTORS IN
UNDERSTANDING THE COSTS AND EXPENSES THAT AN INVESTOR IN THE FUND WILL BEAR
DIRECTLY OR INDIRECTLY.
The Example set forth above assumes reinvestment of all dividends and
distributions at net asset value, payment of a 3.75% sales load and an annual
expense ratio of 2.24%. The table above and the assumption in the Example of a
5% annual return are required by Commission regulations applicable to all
management investment companies. THE EXAMPLE SHOULD NOT BE CONSIDERED AS A
REPRESENTATION OF PAST OR FUTURE EXPENSES OR ANNUAL RATES OF RETURN. ACTUAL
EXPENSES OR ANNUAL RATES OF RETURN MAY BE MORE OR LESS THAN THOSE ASSUMED FOR
PURPOSES OF THE EXAMPLE. In addition, while the Example assumes reinvestment of
all dividends and distributions at net asset value, participants in the Fund's
Dividend Reinvestment Plan may receive shares purchased or issued at a price or
value different from net asset value. See "Dividends and Distributions; Dividend
Reinvestment Plan."
11
<PAGE> 12
FINANCIAL HIGHLIGHTS(a)
The table below sets forth certain specified information for a share of
beneficial interest of the Fund outstanding throughout each period presented.
The financial highlights for each period presented have been audited by Price
Waterhouse LLP, the Fund's independent accountants, whose unqualified report is
included in the Fund's October 31, 1997 Annual Report and is incorporated by
reference in the Statement of Additional Information. The financial highlights
should be read in conjunction with the financial statements and notes thereto
included in the Fund's October 31, 1997 Annual Report which is available upon
request from the Information Agent for the Offer, Shareholder Communications
Corporation.
<TABLE>
<CAPTION>
FOR THE FISCAL YEARS ENDED OCTOBER 31,
-----------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993 1992 1991 1990 1989
-------- ------- ------- ------- ------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value --
beginning of period.... $ 6.890 $ 6.620 $ 6.280 $ 6.920 $ 6.430 $ 6.290 $ 4.880 $ 8.260 $ 9.220
-------- ------- ------- ------- ------- ------- ------- ------- --------
Net investment income... 0.699(c) 0.699 0.696 0.693 0.709 0.773 0.800 1.072 1.223
Net realized and
unrealized gain
(loss)................. 0.383 0.258 0.340 (0.587) 0.497 0.142 1.385 (3.332) (0.983)
-------- ------- ------- ------- ------- ------- ------- ------- --------
Total from investment
operations......... 1.082 0.957 1.036 0.106 1.206 0.915 2.185 (2.260) (0.240)
-------- ------- ------- ------- ------- ------- ------- ------- --------
Distributions:
From net investment
income............... (0.702) (0.687) (0.696) (0.746) (0.716) (0.775) (0.775) (1.106) (1.200)
From paid-in capital... -- -- -- -- -- -- -- (0.014)(d) --
-------- ------- ------- ------- ------- ------- ------- ------- --------
Total
distributions...... (0.702) (0.687) (0.696) (0.746) (0.716) (0.775) (0.775) (1.120) (1.200)
-------- ------- ------- ------- ------- ------- ------- ------- --------
Net asset value -- end
of period.............. $ 7.270 $ 6.890 $ 6.620 $ 6.280 $ 6.920 $ 6.430 $ 6.290 $ 4.880 $ 8.260
======== ======= ======= ======= ======= ======= ======= ======= ========
Per share market value:
End of Period.......... $ 7.562 $ 7.125 $ 6.875 $ 5.750 $ 6.625 $ 6.250 $ 6.000 $ 4.500 $ 7.375
======== ======= ======= ======= ======= ======= ======= ======= ========
Total return based on
market value(e)........ 16.97% 14.62% 33.00% ( 2.80)% 17.89% 17.39% 54.29% (27.10)% (11.20)%
======== ======= ======= ======= ======= ======= ======= ======= ========
Net assets, end of
period(f).............. $107,774 $99,925 $93,984 $87,519 $95,164 $87,149 $83,613 $64,872 $107,769
======== ======= ======= ======= ======= ======= ======= ======= ========
Ratio of operating
expenses to average net
assets................. 0.89%(c) 0.98%(c) 0.95%(c) 0.97% 1.00% 1.00% 1.38% 1.31% 1.24%
Ratio of interest and
amortization of
deferred debt issuance
expenses to average net
assets................. 1.96% 2.07% 1.94% 1.91% 2.66% 3.24% 3.80% 4.23% 3.26%
Ratio of net investment
income to average net
assets................. 9.63%(c) 10.11%(c) 10.76%(c) 10.40% 10.62% 11.98% 14.40% 15.86% 13.48%
Portfolio turnover
rate................... 92% 92% 92% 160% 135% 78% 30% 12% 23%
<CAPTION>
JULY 29, 1988
(COMMENCEMENT
OF OPERATIONS)
TO OCTOBER 31,
1988
----
<S> <C>
Net asset value --
beginning of period.... $ 9.262(b)
--------
Net investment income... 0.257
Net realized and
unrealized gain
(loss)................. (0.054)
--------
Total from investment
operations......... 0.203
--------
Distributions:
From net investment
income............... (0.245)
From paid-in capital... --
--------
Total
distributions...... (0.245)
--------
Net asset value -- end
of period.............. $ 9.220
========
Per share market value:
End of Period.......... $ 9.500
========
Total return based on
market value(e)........ (2.50)%
========
Net assets, end of
period(f).............. $116,613
========
Ratio of operating
expenses to average net
assets................. 1.04%(g)
Ratio of interest and
amortization of
deferred debt issuance
expenses to average net
assets................. 3.26%(g)
Ratio of net investment
income to average net
assets................. 11.06%(g)
Portfolio turnover
rate................... 34%(g)
</TABLE>
- ---------------
(a) Per share data are calculated based on average shares outstanding during the
period.
(b) Net of initial offering and underwriting costs, which amounted to $0.038 per
share.
(c) The benefits derived from custody credits and directed brokerage
arrangements had an impact of 0.01% and $0.001 per share in 1997 only. Prior
years' ratios are net of benefits received, if any.
(d) Because of differences between book and tax basis accounting, there was no
return of capital for federal income tax purposes.
(e) Total return at market value assuming all distributions reinvested and
excluding brokerage commissions.
(f) Dollars in thousands.
(g) Annualized.
12
<PAGE> 13
CAPITALIZATION
AT APRIL 30, 1998
<TABLE>
<CAPTION>
AMOUNT OUTSTANDING AMOUNT HELD
EXCLUSIVE OF AMOUNT BY THE FUND
HELD BY THE FUND OR FOR ITS
TITLE OF CLASS AMOUNT AUTHORIZED OR FOR ITS ACCOUNT ACCOUNT
- -------------- ----------------- ------------------- -----------
<S> <C> <C> <C>
Shares of Beneficial Interest, no par Unlimited 14,971,645 shares -0- shares
value...................................
Term Note................................. -- $27,400,000(1) N/A
</TABLE>
INFORMATION REGARDING SENIOR SECURITIES
The following table shows certain information regarding each class of
senior security of the Fund as of the end of each fiscal year of the Fund since
its inception.
<TABLE>
<CAPTION>
AT TOTAL AMOUNT ASSET COVERAGE
OCTOBER 31 OUTSTANDING PER UNIT(2)
---------- ------------ --------------
<S> <C> <C> <C>
Senior Extendible Notes(1)............................. 1988 $37,400,000 $3,120
1989 37,400,000 2,880
1990 27,400,000 2,370
1991 27,400,000 3,050
1992 27,400,000 3,180
1993 27,400,000 3,470
1994 27,400,000 3,190
1995 27,400,000 3,430
1996 0 --
Term Note(1)........................................... 1996 $27,400,000 $3,650
1997 27,400,000 3,930
</TABLE>
- ---------------
(1) On July 15, 1996, the Fund redeemed the remaining $27,400,000 principal
amount of its Senior Extendible Notes, which carried an annual interest rate
through July 15, 1996 of 6.21%, for $28,250,770. The Fund thereafter entered
into a credit agreement dated as of June 12, 1996 with Bank of America
Illinois, pursuant to which the Fund issued a term note (the "Original Term
Note") to Bank of America Illinois in the aggregate principal amount of
$27,400,000, due in full on June 14, 1999 and bearing interest at a fixed
annual rate of 7.33%. On May 19, 1998, the Fund entered into an Amended and
Restated Credit Agreement (the "Credit Agreement") with Bank of America
National Trust and Savings Association, successor by merger to Bank of
America Illinois ("Bank of America"), pursuant to which the Fund issued a
new term note (the "Term Note") to Bank of America in the aggregate
principal amount of $44,900,000. The $27,400,000 borrowing (the "First
Loan") under the Original Term Note remains outstanding under the Term Note
with the same maturity and interest rate. In addition, on May 19, 1998, the
Fund borrowed under the Term Note the aggregate principal amount of
$6,900,000 (the "Second Loan") from Bank of America, which amount is due in
full on May 19, 2001 and bears interest at the fixed annual rate of 6.36%.
The combined weighted average interest rate of the $34,300,000 aggregate
principal amount outstanding under the Term Note is 7.13%. The Credit
Agreement permits the Fund to borrow up to the remaining amount of the Term
Note at any time prior to September 30, 1998. See "Description of Term
Note."
(2) Amount shown is per $1,000 of Senior Extendible Note or Term Note, as the
case may be. Calculated by subtracting the Fund's total liabilities from the
Fund's total assets and dividing such amount by the quotient of (a) the
principal amount of outstanding Senior Extendible Notes or the Term Note, as
the case may be, divided by (b) $1,000.
13
<PAGE> 14
TRADING AND NET ASSET VALUE INFORMATION
In the past, the Fund's shares have traded at various times at either a
premium or a discount in relation to net asset value. Although the Fund's shares
recently have been trading at a premium above net asset value, there can be no
assurance that this premium will continue after the Offer or that the shares
will not again trade at a discount. Shares of other closed-end investment
companies frequently trade at a discount from net asset value. See "Risk Factors
and Special Considerations."
The following table shows the high and low sales prices of the Fund's
shares on the New York Stock Exchange Composite Tape, quarterly trading volume
on the Exchange, the high and low net asset value per share and the high and low
premium or discount at which the Fund's shares were trading for each fiscal
quarter during the two most recent fiscal years and for the fiscal quarters
ended January 31, 1998 and April 30, 1998.
<TABLE>
<CAPTION>
PREMIUM/
(DISCOUNT)
TO NET ASSET
MARKET PRICE QUARTERLY NET ASSET VALUE VALUE(%)
---------------- TRADING ---------------- ------------
QUARTER ENDED HIGH LOW VOLUME HIGH LOW HIGH LOW
- ------------- ---- --- --------- ---- --- ---- ---
(THOUSANDS
OF SHARES)
<S> <C> <C> <C> <C> <C> <C> <C>
January 31, 1996................ $7.125 $6.750 1,519.0 $6.79 $6.60 8.0% 0.9%
April 30, 1996.................. 7.250 6.875 1,662.0 6.89 6.70 7.1% 1.6%
July 31, 1996................... 7.000 6.625 1,710.2 6.75 6.68 4.3% (1.0%)
October 31, 1996................ 7.250 6.875 1,105.5 6.96 6.74 4.9% 0.5%
January 31, 1997................ 7.375 7.125 1,846.1 7.09 6.90 5.5% 0.5%
April 30, 1997.................. 7.500 7.125 1,677.2 7.20 6.85 6.7% 0.5%
July 31, 1997................... 7.750 7.375 1,618.5 7.30 6.98 7.7% 3.6%
October 31, 1997................ 7.938 7.375 1,501.4 7.44 7.25 6.8% 0.9%
January 31, 1998................ 7.938 7.340 1,424.6 7.49 7.28 7.1% 0.0%
April 30, 1998.................. 8.188 7.563 1,586.2 7.52 7.41 9.2% 0.7%
</TABLE>
The net asset values per share of the Fund at the close of business on
April 10, 1998 (the last trading date on which the Fund publicly reported its
net asset value prior to the announcement of the Offer) and on May 15, 1998 (the
last trading date prior to the date of this Prospectus on which the Fund
publicly reported its net asset value) were $7.52 and 7.43, respectively, and
the last reported sales prices of a share of the Fund on the Exchange on those
dates were $7.688 and $7.625, respectively.
14
<PAGE> 15
THE FUND
The Fund is a diversified, closed-end management investment company with a
leveraged capital structure. The Fund's investment objective is to seek high
current income and total return by investing primarily in lower-rated corporate
debt securities. Under normal market conditions, the Fund invests primarily in a
professionally managed, diversified portfolio of debt securities rated in the
lower categories by the Rating Agencies (consisting principally of securities
rated "BBB"/"Baa" or lower by the Rating Agencies(1)) or nonrated debt
securities deemed by the Adviser to be of comparable quality. Securities rated
"BB"/"Ba" or lower are commonly referred to as "high yield," high risk
securities or "junk bonds." The Fund's investments are subject to restrictions
on investments contained in the Credit Agreement. See "Description of Term
Note--Restrictive Covenants." Such securities are generally regarded by the
Rating Agencies as significantly more speculative with respect to capacity to
pay interest and repay principal in accordance with the terms of the obligation
and more likely to default than higher quality debt securities. In addition to
investing in lower rated securities, the Fund may engage in, among other
activities, certain options activities, investments in equity securities and
higher rated debt securities, the use of futures contracts and options thereon
and repurchase agreements. The Fund may also invest in foreign and restricted
securities. See "Investment Policies and Limitations" and the Statement of
Additional Information. Lower rated and comparable nonrated securities and
foreign securities may be subject to a greater degree of risk than higher rated
and domestic securities, respectively. See "Risk Factors and Special
Considerations."
The capital structure of the Fund has been designed to take advantage of
the historical spread in yields between lower rated securities and
representative U.S. Treasury securities, compared with the average default loss
on such lower rated securities. In addition, through investment leverage,
investors in the Fund receive increased yields to the extent that the rate of
return (i.e., the current interest yield on the Fund's portfolio reduced by the
actual default loss rate experienced on that portfolio) earned on the Fund's
assets exceeds, after expenses of Fund management, the interest rate on the Term
Note. Conversely, to the extent that the rate of return on the portfolio does
not exceed the interest rate on the Term Note, yields to investors in the shares
will be reduced.
The Fund is a closed-end investment company. Closed-end investment
companies differ from open-end investment companies (commonly referred to as
"mutual funds") in that closed-end investment companies have a fixed capital
base, whereas open-end companies issue securities redeemable at net asset value
at any time at the option of the shareholder and typically engage in a
continuous offering of their shares. Accordingly, open-end investment companies
are subject to periodic asset in-flows and out-flows that can complicate
portfolio management. Closed-end investment companies do not face the prospect
of having to liquidate portfolio holdings to satisfy redemptions at the option
of shareholders or having to maintain cash positions to meet the possibility of
such redemptions. The Fund will, however, be required to have sufficient cash or
cash equivalents to meet interest payments on the Term Note and to fund certain
redemptions of the Term Note in certain circumstances. See "Description of Term
Note" and "Description of Shares of Beneficial Interest."
The Fund was organized as a Massachusetts business trust under the laws of
The Commonwealth of Massachusetts on May 24, 1988 and has registered with the
Commission under the 1940 Act. The Fund's principal office is located at One
Financial Center, Boston, Massachusetts 02111. The Fund's Adviser is Colonial
Management Associates, Inc., an investment management firm registered with the
Commission under the Investment Advisers Act of 1940, as amended. See "The
Adviser."
- ---------------
1 Throughout this Prospectus, references to ratings by the Rating Agencies will
indicate the S&P rating followed by the Moody's rating in the format shown.
15
<PAGE> 16
THE OFFER
PURPOSE OF THE OFFER
The Board of Trustees of the Fund has determined that it may be in the best
interests of the Fund and its shareholders to increase the number of outstanding
shares of the Fund and to increase the assets of the Fund available for
investment.
In reaching its decision, the Board of Trustees of the Fund was advised by
the Fund's investment adviser, Colonial Management Associates, Inc. (the
"Adviser"), that an increase in the assets of the Fund would permit the Fund to
pursue attractive investment opportunities in the "high yield," high risk
securities market, while retaining portfolio investments that the Adviser
believes should continue to be held. The Adviser believes the Offer may result
in greater portfolio diversification opportunities and enhance its ability to
buy and sell larger blocks of securities on potentially better terms.
The Fund maintains a leveraged capital structure when it believes such a
capital structure is of potential benefit to shareholders. The Fund utilizes
leverage seeking to enhance returns to shareholders by borrowing capital at a
lower interest rate than that which the Fund earns on its investments. The Board
of Trustees believes that increasing the Fund's assets will provide the Fund
with additional flexibility in connection with the Fund's leverage, including
enhancing its ability to increase the Fund's existing leverage, while reducing
the overall effective cost of the leverage. For a discussion of the anticipated
impact of the Offer on the Fund's leverage, please refer to "Investment Policies
and Limitations" and "Risk Factors and Special Considerations--Risk of
Leverage."
In addition, the Board of Trustees believes that increasing the size of the
Fund may lower the Fund's expenses as a proportion of average net assets because
the Fund's fixed costs can be spread over a larger asset base. The Board of
Trustees also believes that a larger number of outstanding shares and a larger
number of beneficial owners of shares could increase the level of market
interest in the Fund and the liquidity of Fund shares on the New York Stock
Exchange (the "Exchange"). The distribution to shareholders of transferable
Rights which themselves may have a realizable value will also afford
nonparticipating shareholders the potential of receiving a cash payment upon
sale of such Rights, receipt of which may be viewed as partial compensation for
the dilution of their interest in the Fund that may result from the Offer.
The Board of Trustees also considered the impact of the Offer on the Fund's
current distributions. Based on the Adviser's assessment of current market
conditions in the lower rated debt market and available leverage opportunities,
the Board of Trustees believes the Offer will not result in a decrease in the
Fund's current level of dividends per share. For a further discussion of the
anticipated impact of the Offer on the Fund's dividends, please refer to "Risk
Factors and Special Considerations--Dividends and Distributions."
The Adviser will benefit from the Offer because the Adviser's fee is based
on the average weekly net assets of the Fund. See "The Adviser."
The Fund may, in the future and at its discretion, choose to make
additional rights offerings from time to time for a number of shares and on
terms which may or may not be similar to the Offer. Any such future rights
offering will be made in accordance with the 1940 Act.
TERMS OF THE OFFER
The Fund is issuing to its Record Date Shareholders, as of the close of
business on the Record Date, Rights entitling the holders thereof to subscribe
for up to 5,010,532 Shares of the Fund. Each such Record Date Shareholder is
being issued one Right for each whole share owned on the Record Date. The Rights
entitle the holders thereof to subscribe for one Share for every three Rights
held (1-for-3). Fractional shares will not be issued upon the exercise of
Rights. Record Date Shareholders issued fewer than three Rights are entitled to
subscribe for one Share pursuant to the Primary Subscription. Rights may be
exercised at any time during the Subscription Period, which commences on May 26,
1998 and ends at 5:00 p.m., New York City time, on June 19, 1998, unless
extended by the Fund (the "Expiration Date"). The Rights are evidenced by
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<PAGE> 17
Subscription Certificates that will be mailed to Record Date Shareholders
promptly following the Record Date, except as discussed below under "Foreign
Shareholders."
Shares not subscribed for in the Primary Subscription will be offered, by
means of the Over-Subscription Privilege, to those Record Date Shareholders who
have exercised all Rights issued to them and who wish to acquire more than the
number of Shares they are entitled to purchase pursuant to the exercise of their
Rights (other than those Rights which cannot be exercised because they represent
the right to acquire less than one Share). Shares acquired pursuant to the
Over-Subscription Privilege are subject to allotment, as more fully discussed
below under "Over-Subscription Privilege." For purposes of determining the
maximum number of Shares a shareholder may acquire pursuant to the Offer,
shareholders whose shares are held of record by Cede, as nominee for DTC, or by
any other depository or nominee will be deemed to be the holders of the Rights
that are issued to Cede or such other depository or nominee on their behalf.
There is no minimum number of Rights which must be exercised in order for
the Offer to close.
The first dividend to be paid on Shares acquired upon exercise of Rights
will be the first monthly dividend, the record date for which occurs after the
issuance of such Shares. It is the Fund's present policy to pay dividends on the
last Friday on or before the 15th day of each month to shareholders of record on
the last Business Day (as defined herein) of the month prior to the payment
date. Except as described below, it is expected that the first dividend to be
paid on Shares issued pursuant to the Offer will be paid on or about August 14,
1998. To accommodate settlement of the Offer, the June 1998 record date for
dividends may be accelerated so that the issuance of Shares by the Fund in
connection with the Offer and the receipt of proceeds of such issuance by the
Fund, subject to certain exceptions, occurs shortly after the June 1998 record
date for dividends.
Prior to the Expiration Date, the Dealer Manager may offer Shares acquired
through the purchase and exercise of Rights at prices it sets from time to time.
To the extent such Shares are issued prior to a dividend record date of the Fund
that precedes the Expiration Date, such Shares will be paid the dividend
declared to the same extent as other shares outstanding on such dividend record
date, and thus, the issuance of such Shares may have a dilutive effect on the
income per share available for such dividend.
OVER-SUBSCRIPTION PRIVILEGE
Shares not subscribed for by Exercising Rights Holders (the "Excess
Shares") will be offered, by means of the Over-Subscription Privilege, to the
Record Date Shareholders who have exercised all exercisable Rights issued to
them (other than those Rights which cannot be exercised because they represent
the right to acquire less than one Share) and who wish to acquire more than the
number of Shares for which the Rights issued to them are exercisable. Record
Date Shareholders should indicate, on the Subscription Certificate which they
submit with respect to the exercise of the Rights issued to them, how many
Excess Shares they are willing to acquire pursuant to the Over-Subscription
Privilege. If sufficient Excess Shares remain, all Record Date Shareholder
over-subscription requests will be honored in full. If Record Date Shareholder
requests for Shares pursuant to the Over-Subscription Privilege exceed the
Excess Shares available, the available Excess Shares will be allocated pro rata
among Record Date Shareholders who over-subscribe based on the number of Rights
originally issued to such Record Date Shareholders.
Banks, brokers, trustees and other nominee holders of Rights will be
required to certify to the Subscription Agent (as defined herein), before any
Over-Subscription Privilege may be exercised with respect to any particular
beneficial owner, as to the aggregate number of Rights exercised pursuant to the
Primary Subscription and the number of Shares subscribed for pursuant to the
Over-Subscription Privilege by such beneficial owner and that such beneficial
owner's Primary Subscription was exercised in full. Nominee Holder
Over-Subscription Forms and Beneficial Owner Certification Forms will be
distributed to banks, brokers, trustees and other nominee holders with the
Subscription Certificates.
The Fund will not offer or sell in connection with the Offer any Shares
that are not subscribed for pursuant to the Primary Subscription or the
Over-Subscription Privilege.
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<PAGE> 18
SUBSCRIPTION PRICE
The Subscription Price per Share (the "Subscription Price") for the Shares
to be issued pursuant to the Offer will be $6.75.
The Fund announced the Offer after the close of trading on the Exchange on
April 15, 1998. The net asset values per share at the close of business on April
10, 1998 (the last trading date on which the Fund publicly reported its net
asset value prior to the announcement) and on May 15, 1998 (the last trading
date prior to the date of this Prospectus on which the Fund publicly reported
its net asset value) were $7.52 and $7.43, respectively, and the last reported
sales prices of a share of the Fund on the Exchange on those dates were $7.688
and $7.625, respectively.
EXPIRATION OF THE OFFER
The Offer will expire at 5:00 p.m., New York City time, on June 19, 1998,
unless extended by the Fund. The Rights will expire on the Expiration Date and
thereafter may not be exercised. Any extension of the Offer will be followed as
promptly as practicable by announcement thereof. Such announcement will be
issued no later than 9:00 a.m., New York City time, on the next Business Day
following the previously scheduled Expiration Date. Without limiting the manner
in which the Fund may choose to make such announcement, the Fund will not,
unless otherwise required by law, have any obligation to publish, advertise or
otherwise communicate any such announcement other than by making a release to
the Dow Jones News Service or such other means of announcement as the Fund deems
appropriate.
SUBSCRIPTION AGENT
The subscription agent is First Data Investor Services Group, Inc. (the
"Subscription Agent"). The Subscription Agent will receive for its
administrative, processing, invoicing and other services as subscription agent a
fee estimated to be approximately $35,000, excluding reimbursement for its
out-of-pocket expenses related to the Offer. The Subscription Agent is also the
Fund's transfer agent, dividend-paying agent and registrar for the shares.
Questions regarding the Subscription Certificates should be directed to
Shareholder Communications Corporation at (800) 733-8481, ext. 486 (toll free);
shareholders may also consult their brokers or nominees. Completed Subscription
Certificates must be sent together with proper payment of the Subscription Price
for all Shares subscribed for in the Primary Subscription and the
Over-Subscription Privilege (for Record Date Shareholders) to the Subscription
Agent by one of the methods described below. Alternatively, Notices of
Guaranteed Delivery may be sent by facsimile to (781) 794-6333 to be received by
the Subscription Agent prior to 5:00 p.m., New York City time, on the Expiration
Date. Facsimiles should be confirmed by telephone at (781) 794-6388. The Fund
will accept only properly completed and executed Subscription Certificates
actually received at any of the addresses listed below, prior to 5:00 p.m., New
York City time, on the Expiration Date or by the close of business on the third
Business Day after the Expiration Date following timely receipt of a Notice of
Guaranteed Delivery. See "Payment for Shares" below.
<TABLE>
<S> <C>
(1) BY FIRST CLASS MAIL: First Data Investor Services Group, Inc.
c/o BankBoston N.A.
Corporate Reorganization
P.O. Box 9049
Boston, Massachusetts 02205-9838
(2) BY OVERNIGHT COURIER: First Data Investor Services Group, Inc.
c/o BankBoston N.A.
Corporate Reorganization
70 Campanelli Drive
Braintree, Massachusetts 02184
(3) BY HAND: First Data Investor Services Group, Inc.
c/o BankBoston N.A.
Securities Transfer & Reporting Services, Inc.
55 Broadway, Third Floor
New York, NY 10006
</TABLE>
DELIVERY TO AN ADDRESS OTHER THAN ONE OF THE ADDRESSES LISTED ABOVE WILL NOT
CONSTITUTE VALID DELIVERY.
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<PAGE> 19
METHOD FOR EXERCISING RIGHTS
Rights are evidenced by Subscription Certificates that, except as described
below under "Foreign Shareholders," will be mailed promptly following the Record
Date to Record Date Shareholders or, if a shareholder's shares are held by Cede
or any other depository or nominee on their behalf, to Cede or such depository
or nominee. Rights may be exercised by completing and signing the Subscription
Certificate that accompanies this Prospectus and mailing it in the envelope
provided, or otherwise delivering the completed and signed Subscription
Certificate to the Subscription Agent, together with payment in full for the
Shares to be purchased at the Subscription Price by the Expiration Date. Rights
may also be exercised by contacting your broker, bank or trust company, which
can arrange, on your behalf, to guarantee delivery of payment and delivery of a
properly completed and executed Subscription Certificate pursuant to a Notice of
Guaranteed Delivery by the close of business on June 24, 1998, the third
Business Day after the Expiration Date. A fee may be charged for this service.
Fractional shares will not be issued upon the exercise of Rights. Record Date
Shareholders issued fewer than three Rights are entitled to subscribe for one
Share pursuant to the Primary Subscription. Completed Subscription Certificates
must be received by the Subscription Agent prior to 5:00 p.m., New York City
time, on the Expiration Date at one of the addresses set forth above (unless the
guaranteed delivery procedures are complied with as described below under
"Payment for Shares").
Shareholders Who Are Record Owners. Shareholders who are record owners can
choose between either option to exercise their Rights as described below under
"Payment for Shares." If time is of the essence, option (2) under "Payment for
Shares" below will permit delivery of the Subscription Certificate and payment
after the Expiration Date.
Shareholders Whose Shares Are Held by a Nominee. Shareholders whose shares
are held by a nominee, such as a bank, broker or trustee, must contact that
nominee to exercise their Rights. In such case, the nominee will complete the
Subscription Certificate on behalf of the shareholder and arrange for proper
payment by one of the methods described below under "Payment for Shares."
Nominees. Nominees who hold shares for the account of others should notify
the beneficial owners of such shares as soon as possible to ascertain such
beneficial owners' intentions and to obtain instructions with respect to the
Rights. If the beneficial owner so instructs, the nominee should complete the
Subscription Certificate and submit it to the Subscription Agent with the proper
payment as described below under "Payment for Shares."
INFORMATION AGENT
Any questions or requests for assistance concerning the method of
subscribing for Shares or for additional copies of this Prospectus or
Subscription Certificates or Notices of Guaranteed Delivery may be directed to
the Information Agent at its telephone number and address listed below:
Information Agent for the Offer is:
Shareholder Communications Corporation
17 State Street, 27th Floor
New York, New York 10004
800-733-8481, ext. 486
Shareholders may also contact their brokers or nominees for information
with respect to the Offer. The Information Agent will receive a fee estimated to
be $27,000, excluding reimbursement for its out-of-pocket expenses related to
the Offer.
PAYMENT FOR SHARES
Shareholders who wish to acquire Shares pursuant to the Offer may choose
between the following methods of payment:
(1) An Exercising Rights Holder may send the Subscription Certificate
together with payment for the Shares acquired in the Primary Subscription
and any additional Shares subscribed for pursuant to the
19
<PAGE> 20
Over-Subscription Privilege (for Record Date Shareholders) to the
Subscription Agent based on the Subscription Price of $6.75 per Share. A
subscription will be accepted when payment, together with a properly
completed and executed Subscription Certificate, is received by the
Subscription Agent's office at one of the addresses set forth above no
later than 5:00 p.m., New York City time, on the Expiration Date. The
Subscription Agent will deposit all checks and money orders received by it
for the purchase of Shares into a segregated interest-bearing account (the
interest from which will accrue to the benefit of the Fund) pending
proration and distribution of Shares. A PAYMENT PURSUANT TO THIS METHOD
MUST BE IN U.S. DOLLARS BY MONEY ORDER OR CHECK DRAWN ON A BANK OR BRANCH
LOCATED IN THE UNITED STATES, MUST BE PAYABLE TO COLONIAL INTERMEDIATE HIGH
INCOME FUND AND MUST ACCOMPANY A PROPERLY COMPLETED AND EXECUTED
SUBSCRIPTION CERTIFICATE FOR SUCH SUBSCRIPTION CERTIFICATE TO BE ACCEPTED.
EXERCISE BY THIS METHOD IS SUBJECT TO ACTUAL COLLECTION OF CHECKS BY 5:00
P.M., NEW YORK CITY TIME, ON THE EXPIRATION DATE. BECAUSE UNCERTIFIED
PERSONAL CHECKS MAY TAKE AT LEAST FIVE BUSINESS DAYS TO CLEAR, SHAREHOLDERS
ARE STRONGLY URGED TO PAY, OR ARRANGE FOR PAYMENT, BY MEANS OF A CERTIFIED
OR CASHIER'S CHECK OR MONEY ORDER.
(2) Alternatively, an Exercising Rights Holder may acquire Shares, and
a subscription will be accepted by the Subscription Agent if, prior to 5:00
p.m., New York City time, on the Expiration Date, the Subscription Agent
has received a Notice of Guaranteed Delivery by facsimile (telecopy) or
otherwise from a financial institution that is a member of the Securities
Transfer Agents Medallion Program, the Stock Exchange Medallion Program or
the New York Stock Exchange Medallion Signature Program guaranteeing
delivery of (i) payment of the Subscription Price of $6.75 per share for
the Shares subscribed for in the Primary Subscription and any additional
Shares subscribed for pursuant to the Over-Subscription Privilege (for
Record Date Shareholders), and (ii) a properly completed and executed
Subscription Certificate. The Subscription Agent will not honor a Notice of
Guaranteed Delivery unless a properly completed and executed Subscription
Certificate and full payment for the Shares is received by the Subscription
Agent by the close of business on June 24, 1998, the third Business Day
after the Expiration Date.
On a date within eight Business Days following the Expiration Date (the
"Confirmation Date"), the Subscription Agent will send to each Exercising Rights
Holder (or, if shares are held by Cede or any other depository or nominee, to
Cede or such other depository or nominee) a confirmation showing (i) the number
of Shares purchased pursuant to the Primary Subscription and (ii) the number of
Shares, if any, acquired pursuant to the Over-Subscription Privilege (for Record
Date Shareholders). All payments by an Exercising Rights Holder must be in U.S.
dollars by money order or check drawn on a bank or branch located in the United
States and payable to COLONIAL INTERMEDIATE HIGH INCOME FUND.
The Subscription Agent will deposit all checks received by it prior to the
final payment date into a segregated interest-bearing account (which interest
will accrue to the benefit of the Fund) pending proration and distribution of
the Shares.
WHICHEVER OF THE TWO METHODS DESCRIBED ABOVE IS USED, ISSUANCE OF THE
SHARES PURCHASED IS SUBJECT TO COLLECTION OF CHECKS AND ACTUAL PAYMENT. IF A
HOLDER OF RIGHTS WHO SUBSCRIBES FOR SHARES PURSUANT TO THE PRIMARY SUBSCRIPTION
OR OVER-SUBSCRIPTION PRIVILEGE (FOR RECORD DATE SHAREHOLDERS) DOES NOT MAKE
PAYMENT OF ANY AMOUNTS DUE BY THE TENTH BUSINESS DAY AFTER THE CONFIRMATION
DATE, THE SUBSCRIPTION AGENT RESERVES THE RIGHT TO TAKE ANY OR ALL OF THE
FOLLOWING ACTIONS: (i) FIND OTHER RECORD DATE SHAREHOLDERS TO PURCHASE SUCH
SUBSCRIBED AND UNPAID FOR SHARES; (ii) APPLY ANY PAYMENT ACTUALLY RECEIVED BY IT
TOWARD THE PURCHASE OF THE GREATEST WHOLE NUMBER OF SHARES WHICH COULD BE
ACQUIRED BY SUCH HOLDER UPON EXERCISE OF THE PRIMARY SUBSCRIPTION AND/OR
OVER-SUBSCRIPTION PRIVILEGE, AND/OR (iii) EXERCISE ANY AND ALL OTHER RIGHTS OR
REMEDIES TO WHICH IT MAY BE ENTITLED, INCLUDING, WITHOUT LIMITATION, THE RIGHT
TO SET OFF AGAINST PAYMENTS ACTUALLY RECEIVED BY IT WITH RESPECT TO SUCH
SUBSCRIBED SHARES.
20
<PAGE> 21
THE METHOD OF DELIVERY OF SUBSCRIPTION CERTIFICATES AND PAYMENT OF THE
SUBSCRIPTION PRICE TO THE FUND WILL BE AT THE ELECTION AND RISK OF THE
EXERCISING RIGHTS HOLDERS, BUT IF SENT BY MAIL IT IS RECOMMENDED THAT SUCH
CERTIFICATES AND PAYMENTS BE SENT BY REGISTERED MAIL, PROPERLY INSURED, WITH
RETURN RECEIPT REQUESTED, AND THAT A SUFFICIENT NUMBER OF DAYS BE ALLOWED TO
ENSURE DELIVERY TO THE SUBSCRIPTION AGENT AND CLEARANCE OF PAYMENT PRIOR TO 5:00
P.M., NEW YORK CITY TIME, ON THE EXPIRATION DATE. BECAUSE UNCERTIFIED PERSONAL
CHECKS MAY TAKE AT LEAST FIVE BUSINESS DAYS TO CLEAR, YOU ARE STRONGLY URGED TO
PAY, OR ARRANGE FOR PAYMENT, BY MEANS OF CERTIFIED OR CASHIER'S CHECK OR MONEY
ORDER.
All questions concerning the timeliness, validity, form and eligibility of
any exercise of Rights will be determined by the Fund, whose determinations will
be final and binding. The Fund in its sole discretion may waive any defect or
irregularity, or permit a defect or irregularity to be corrected within such
time as it may determine, or reject the purported exercise of any Right.
Subscriptions will not be deemed to have been received or accepted until all
irregularities have been waived or cured within such time as the Subscription
Agent determines in its sole discretion.
The Subscription Agent will not be under any duty to give notification of
any defect or irregularity in connection with the submission of Subscription
Certificates or incur any liability for failure to give such notification.
EXERCISING RIGHTS HOLDERS WILL HAVE NO RIGHT TO RESCIND THEIR SUBSCRIPTION
AFTER RECEIPT OF THEIR PAYMENT FOR SHARES BY THE SUBSCRIPTION AGENT, EXCEPT AS
PROVIDED BELOW UNDER "NOTICE OF NET ASSET VALUE DECLINE."
SALE OF RIGHTS
The Rights are transferable until the Expiration Date. The Rights will be
listed for trading on the Exchange, subject to notice of issuance. The Fund will
use its best efforts to ensure that an adequate trading market for the Rights
will exist, although no assurance can be given that a market for the Rights will
develop. It is anticipated that the Rights will trade on the Exchange on a
when-issued basis commencing on or about May 20, 1998 until approximately May
28, 1998 and on a regular way basis thereafter until and including June 18,
1998, the last Business Day prior to the Expiration Date.
Sales through Subscription Agent and Dealer Manager. Record Date
Shareholders who do not wish to exercise any or all of their Rights may instruct
the Subscription Agent to sell any unexercised Rights through or to the Dealer
Manager. Subscription Certificates representing the Rights to be sold by or to
the Dealer Manager must be received by the Subscription Agent on or before June
17, 1998 (or if the Offer is extended, until two Business Days prior to the
Expiration Date). Upon the timely receipt by the Subscription Agent of
appropriate instructions to sell Rights, the Subscription Agent will request the
Dealer Manager either to purchase or to use its best efforts to complete the
sale and the Subscription Agent will remit the proceeds of sale, net of
commissions, to the selling Record Date Shareholder. Any commissions on sales of
Rights will be paid by the selling Record Date Shareholder. If the Rights can be
sold, sales of such Rights will be deemed to have been effected at the
weighted-average price received by the Dealer Manager on the day such Rights are
sold. The sale price of any Rights sold to the Dealer Manager will be based upon
the then current market price for the Rights, less amounts comparable to the
usual and customary brokerage fees. The Dealer Manager will also attempt to sell
all Rights which remain unclaimed as a result of Subscription Certificates being
returned by the postal authorities to the Subscription Agent as undeliverable as
of the fourth Business Day prior to the Expiration Date. Such sales will be made
net of commissions on behalf of the nonclaiming Record Date Shareholders. The
Subscription Agent will hold the proceeds from those sales for the benefit of
such nonclaiming Record Date Shareholders until such proceeds are either claimed
or escheat. There can be no assurance that the Dealer Manager will purchase or
be able to complete the sale of any such Rights, and neither the Fund nor the
Dealer Manager has guaranteed any minimum sales price for the Rights.
Other Transfers. The Rights evidenced by a Subscription Certificate may be
transferred in whole by endorsing the Subscription Certificate for transfer in
accordance with the accompanying instructions. A
21
<PAGE> 22
portion of the Rights evidenced by a single Subscription Certificate (but not
fractional Rights) may be transferred by delivering to the Subscription Agent a
Subscription Certificate properly endorsed for transfer, with instructions to
register such portion of the Rights evidenced thereby in the name of the
transferee and to issue a new Subscription Certificate to the transferee
evidencing such transferred Rights. In such event, a new Subscription
Certificate evidencing the balance of the Rights, if any, will be issued to the
Record Date Shareholder or, if the Record Date Shareholder so instructs, to an
additional transferee. The signature on the Subscription Certificate must
correspond with the name as written upon the face of the Subscription
Certificate in every particular, without alteration or enlargement, or any
change whatever. A signature guarantee must be provided by an eligible financial
institution as defined in Rule 17Ad-15 of the Securities Exchange Act of 1934,
as amended (the "1934 Act"), subject to the standards and procedures adopted by
the Fund.
Record Date Shareholders wishing to transfer all or a portion of their
Rights should allow at least five Business Days prior to the Expiration Date for
(i) the transfer instructions to be received and processed by the Subscription
Agent; (ii) a new Subscription Certificate to be issued and transmitted to the
transferee or transferees with respect to transferred Rights, and to the
transferor with respect to retained Rights, if any; and (iii) the Rights
evidenced by such new Subscription Certificate to be exercised or sold by the
recipients thereof. Neither the Fund nor the Subscription Agent nor the Dealer
Manager shall have any liability to a transferee or transferor of Rights if
Subscription Certificates are not received in time for exercise or sale prior to
the Expiration Date.
Except for the fees charged by the Subscription Agent and Dealer Manager
(which will be paid by the Fund), all commissions, fees and other expenses
(including brokerage commissions and transfer taxes) incurred or charged in
connection with the purchase, sale or exercise of Rights will be for the account
of the transferor of the Rights, and none of such commissions, fees or expenses
will be paid by the Fund, the Subscription Agent or the Dealer Manager.
The Fund anticipates that the Rights will be eligible for transfer through,
and that the exercise of the Primary Subscription (but not the Over-Subscription
Privilege) may be effected through, the facilities of The Depository Trust
Company ("DTC"; Rights exercised through DTC are referred to as "DTC Exercised
Rights"). Record Date Shareholders of DTC Exercised Rights may exercise the
Over-Subscription Privilege in respect of such DTC Exercised Rights by properly
executing and delivering to the Subscription Agent, at or prior to 5:00 p.m.,
New York City time, on the Expiration Date, a Nominee Holder Over-Subscription
Exercise Form or a substantially similar form satisfactory to the Subscription
Agent, together with payment of the Subscription Price for the number of Shares
for which the Over-Subscription Privilege is to be exercised.
DISTRIBUTION ARRANGEMENTS
PaineWebber Incorporated, which is a broker-dealer and member of the
National Association of Securities Dealers, Inc., will act as the Dealer Manager
for the Offer. Under the terms and subject to the conditions contained in the
Dealer Manager Agreement dated on or about the date hereof (the "Dealer Manager
Agreement"), the Dealer Manager will provide financial advisory and marketing
services in connection with the Offer and will solicit the exercise of Rights
and participation in the Over-Subscription Privilege. The Offer is not
contingent upon any number of Rights being exercised. The Fund has agreed to pay
the Dealer Manager a fee for its financial advisory, marketing and soliciting
services equal to 3.75% of the aggregate Subscription Price for Shares issued
pursuant to the Offer. The Dealer Manager will reallow to Selling Group Members
solicitation fees equal to 2.50% of the Subscription Price per Share for each
Share issued pursuant to the Offer as a result of their soliciting efforts. In
addition, the Dealer Manager will reallow to other broker-dealers that have
executed and delivered a soliciting dealer agreement and have solicited the
exercise of Rights, solicitation fees equal to 0.50% of the Subscription Price
per Share for each Share issued pursuant to the exercise of Rights as a result
of their soliciting efforts, subject to a maximum fee based upon the number of
shares held by each broker-dealer through DTC on the Record Date. Fees will be
paid to the broker-dealer designated on the applicable portion of the
Subscription Certificates or, in the absence of such designation, to the Dealer
Manager.
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<PAGE> 23
In addition, the Fund may reimburse the Dealer Manager up to an aggregate
of $100,000 for its reasonable expenses incurred in connection with the Offer.
The Fund and the Adviser have each agreed to indemnify the Dealer Manager or
contribute to losses arising out of certain liabilities including liabilities
under the Securities Act of 1933, as amended (the "Securities Act"). The Dealer
Manager Agreement also provides that the Dealer Manager will not be subject to
any liability to the Fund in rendering the services contemplated by such
Agreement except for any act of bad faith, willful misconduct or gross
negligence of the Dealer Manager or reckless disregard by the Dealer Manager of
its obligations and duties under such Agreement.
The Fund has agreed not to offer or sell, or enter into any agreement to
sell, any equity or equity related securities of the Fund or securities
convertible into such securities for a period of 180 days after the date of the
Dealer Manager Agreement, except for the Shares to be issued upon exercise of
the rights offered hereby and shares issued in reinvestment of dividends or
distributions.
DELIVERY OF SHARE CERTIFICATES
Except as described herein, certificates representing Shares acquired in
the Primary Subscription and representing Shares acquired pursuant to the
Over-Subscription Privilege will be mailed promptly after the expiration of the
Offer once full payment for such Shares has been received and cleared.
Participants in the Fund's Dividend Reinvestment Plan (the "Plan") will have any
Shares acquired in the Primary Subscription and pursuant to the
Over-Subscription Privilege credited to their shareholder dividend reinvestment
accounts in the Plan. Participants in the Plan wishing to exercise Rights for
the Shares held in their accounts in the Plan must exercise such Rights in
accordance with the procedures set forth above. Shareholders whose shares are
held of record by Cede or by any other depository or nominee on their behalf or
their broker-dealer's behalf will have any Shares acquired in the Primary
Subscription credited to the account of Cede or such other depository or
nominee. Shares acquired pursuant to the Over-Subscription Privilege will be
certificated and certificates representing such Shares will be sent directly to
Cede or such other depository or nominee. Stock certificates will not be issued
for Shares credited to Plan accounts.
FOREIGN SHAREHOLDERS
Subscription Certificates will not be mailed to Record Date Shareholders
whose record addresses are outside the United States (the term "United States"
includes the states, the District of Columbia, and the territories and
possessions of the United States) ("Foreign Record Date Shareholders"). Foreign
Record Date Shareholders will be sent written notice of the Offer. The Rights to
which such Subscription Certificates relate will be held by the Subscription
Agent for such Foreign Record Date Shareholders' accounts until instructions are
received to exercise the Rights. If no instructions have been received by 5:00
p.m., New York City time, on June 16, 1998, which is three Business Days prior
to the Expiration Date, the Rights of those Foreign Record Date Shareholders
will be transferred by the Subscription Agent to the Dealer Manager, who will
either purchase the rights or use its best efforts to sell the Rights. The net
proceeds, if any, from the sale of those Rights by or to the Dealer Manager will
be remitted to Foreign Record Date Shareholders.
FEDERAL INCOME TAX CONSEQUENCES OF THE OFFER
The U.S. federal income tax consequences to holders of shares with respect
to the Offer will be as follows:
1. The distribution of Rights to Record Date Shareholders will not
result in taxable income to such holders nor will such holders realize
taxable income as a result of the exercise of the Rights. No loss will be
realized if the Rights expire without exercise.
2. The basis of a Right will be (a) to a holder of shares to whom the
Right is issued and who exercises or sells the Right (i) if the fair market
value of the Right immediately after issuance is less than 15% of the fair
market value of the shares with regard to which it is issued, zero (unless
the holder elects with respect to all Rights so received, by filing a
statement with his timely filed federal income tax return for the year in
which the Rights are received, to allocate the basis of the shares between
the Right and the shares based on their respective fair market values
immediately after the Right is issued), and (ii) if the fair market value
of the Right immediately after issuance is 15% or more of the fair market
value of the
23
<PAGE> 24
shares with regard to which it is issued, a portion of the basis in the
shares based upon their respective fair market values immediately after the
Right is issued, and (b) to a holder of shares to whom the Right is issued
and who allows the Right to expire, zero.
3. The holding period of a Right received by a Record Date
Shareholder includes the holding period of the share with regard to which
the Right is issued. If the Right is exercised, the holding period of the
Share acquired begins on the date the Right is exercised.
4. A Record Date Shareholder's basis for determining gain or loss
upon the sale of a Share acquired upon the exercise of a Right will be
equal to the sum of the Record Date Shareholder's basis in the Right, if
any, and the Subscription Price per Share. A Record Date Shareholder's gain
or loss recognized upon a sale of a Share acquired upon the exercise of a
Right will be capital gain or loss if the Share was held at the time of
sale as a capital asset and will be long-term capital gain or loss if the
Share is held for more than one year. See "Taxes--Federal Income Tax
Treatment of Holders of Shares" in the Statement of Additional Information
for more information regarding the capital gains tax rates applicable to
capital gains or losses recognized upon the sale of shares.
The Fund is required to withhold and remit to the U.S. Treasury 31% of
reportable payments paid on an account if the holder of the account provides the
Fund with either an incorrect taxpayer identification number or no number at
all, or fails to certify that he or she is not subject to such withholding.
The foregoing is a general summary of the material U.S. federal income tax
consequences of the Offer under the provisions of the U.S. Internal Revenue Code
of 1986, as amended (the "Code"), and Treasury regulations presently in effect
that are generally applicable to Record Date Shareholders that are United States
persons within the meaning of the Code and any other Record Date Shareholder who
would be subject to U.S. federal income tax upon the sale or exchange of the
Shares acquired upon the exercise of the Rights, and does not cover foreign,
state or local taxes. The Code and such regulations are subject to change by
legislative or administrative action, which may be retroactive. Exercising
Rights Holders should consult their tax advisers regarding specific questions as
to foreign, federal, state or local taxes. See "Federal Taxation."
NOTICE OF NET ASSET VALUE DECLINE
The Fund has, as required by the Commission's registration form, undertaken
to suspend the Offer until it amends this Prospectus if, subsequent to the
effective date of the Fund's Registration Statement, the Fund's net asset value
declines more than 10% from its net asset value as of that date. Accordingly,
the Expiration Date would be extended and the Fund would notify Record Date
Shareholders of any such decline and permit Exercising Rights Holders to cancel
their exercise of Rights.
EMPLOYEE PLAN CONSIDERATIONS
Shareholders that are tax-deferral arrangements, such as plans qualified
under Code section 401(a) (including corporate savings plans, 401(k) plans, and
Keogh plans of self-employed individuals), individual retirement accounts under
Code section 408 ("IRAs"), Roth IRAs under Code section 408A, and custodial
accounts under Code section 403(b) (collectively, "Retirement Plans"), should be
aware that additional contributions of cash to the Retirement Plan (other than
rollover contributions or trustee-to-trustee transfers from another Retirement
Plan) in order to exercise Rights would be treated as contributions to the
Retirement Plan and, when taken together with contributions previously made, may
result in, among other things, excise taxes for excess or nondeductible
contributions. In the case of Retirement Plans qualified under Code section
401(a) and certain other Retirement Plans, additional cash contributions could
cause the maximum contribution limitations of Code section 415 or other
qualification rules to be violated.
Retirement Plans and other tax exempt entities, including governmental
plans, should also be aware that if they borrow in order to finance their
exercise of Rights, they may become subject to the tax on unrelated business
taxable income ("UBTI") under Code section 511. If any portion of an IRA or a
Roth IRA is used as security for a loan, the portion so used is also treated as
distributed to the IRA or Roth IRA depositor, which may result in current income
taxation and penalty taxes.
24
<PAGE> 25
The Employee Retirement Income Security Act of 1974, as amended ("ERISA"),
contains fiduciary responsibility requirements, and ERISA and the Code contain
prohibited transaction rules that may apply to the exercise of Rights by
Retirement Plans. Retirement Plans that are not subject to ERISA (such as
governmental plans) may be subject to state law restrictions that could affect
the decision to exercise or transfer Rights. Due to the complexity of these
rules and the penalties for noncompliance, shareholders that are Retirement
Plans should consult with their counsel and other advisers regarding the
consequences of their exercise of Rights under ERISA, the Code, and, where
applicable, state law.
IMPORTANT DATES TO REMEMBER
<TABLE>
<CAPTION>
EVENT DATE
----- ----
<S> <C>
Record Date................................................. May 26, 1998
Subscription Period......................................... May 26, 1998 to
June 19, 1998
Expiration Date............................................. June 19, 1998(a)
Subscription Certificates and Payment for Shares Due(b)..... June 19, 1998(a)
Notice of Guaranteed Delivery Due(b)........................ June 19, 1998(a)
Payment for Guarantees of Delivery Due...................... June 24, 1998(a)
Confirmation to Participants................................ July 1, 1998(a)
</TABLE>
- ---------------
(a) Unless the Offer is extended.
(b) A shareholder exercising Rights must deliver by June 19, 1998 either (i) a
Subscription Certificate and payment for Shares or (ii) a Notice of
Guaranteed Delivery.
USE OF PROCEEDS
Based on the Subscription Price of $6.75 per Share, the net proceeds of the
Offer to the Fund, assuming all 5,010,532 Shares offered hereby are sold, are
estimated to be approximately $32,052,800, after deducting offering expenses
payable by the Fund estimated at approximately $500,000. The Adviser anticipates
that investment of such proceeds in accordance with the Fund's investment
objective and policies will take up to thirty days from their receipt by the
Fund, depending on market conditions and the availability of appropriate
securities for purchase, but in no event will such investment take longer than
six months. Pending such investment in accordance with the Fund's investment
objective and policies, the proceeds will be held in U.S. Government securities
(which term includes obligations of the United States Government, its agencies
or instrumentalities) and other high-quality short-term money market
instruments.
INVESTMENT POLICIES AND LIMITATIONS
The investment objective of the Fund is to seek high current income and
total return by investing primarily in lower-rated corporate debt securities.
INVESTMENT STRATEGY
It is the Fund's policy that, under normal market conditions, up to 80% of
its total assets will be invested in debt securities rated in the lower
categories by recognized rating agencies or nonrated debt securities deemed by
the Adviser to be of comparable quality. The Fund's portfolio investments have
consisted and generally will continue to consist principally of debt securities,
including fixed-income securities, rated "BBB"/"Baa" or lower by the Rating
Agencies.
The Fund may invest up to 100% of its assets in higher rated securities,
if, in the opinion of the Adviser, such investments are in the best interests of
the Fund because of narrow yield spreads between lower and higher rated
securities. The Fund may invest in debt securities of any maturity, but under
normal conditions, the average maturity of the Fund's investments is expected to
be between 3 and 10 years. The Fund will not invest more than 25% of its total
assets in a single industry and not more than 25% of its total assets in
securities issued or guaranteed by foreign governments or foreign companies.
Debt Securities. The Fund may invest in debt securities of any maturity
that pay fixed, floating or adjustable interest rates. The values of debt
securities generally fluctuate inversely with changes in interest
25
<PAGE> 26
rates. This is less likely to be true for adjustable or floating rate
securities, since interest rate changes are more likely to be reflected in
changes in the rates paid on the securities. However, reductions in interest
rates also may translate into lower distributions paid by the Fund.
The Fund also may invest in debt securities (i) that do not pay interest
but instead are issued at a significant discount to their maturity values
(referred to as zero coupon securities), (ii) that pay interest, at the issuer's
option, in additional securities instead of cash (referred to as pay-in-kind
securities) or (iii) that pay interest at predetermined rates that increase over
time (referred to as step coupon bonds). Because zero coupon securities,
pay-in-kind securities and step coupon bonds may not pay cash interest on a
current basis, but the Fund nevertheless must accrue and distribute to investors
the income deemed to be earned on a current basis, the Fund may have to sell
other investments to raise the cash needed to make income distributions.
Common Stocks. The Fund may invest up to 20% of its total assets in common
stocks, usually as a result of warrants associated with debt instruments
purchased by the Fund, but also under certain circumstances to seek capital
appreciation.
Lower Rated Debt Securities. Lower rated debt securities are debt
securities which are not considered to be investment grade (that is, they are
rated below "BBB" by S&P or below "Baa" by Moody's, or are unrated but
considered by the Adviser to be of comparable credit quality). Securities rated
"BB" or lower by S&P or "Ba" or lower by Moody's are commonly referred to as
"high yield," high risk securities or "junk bonds." For a description of S&P's
and Moody's rating systems, see Appendix A to this Prospectus. Lower rated debt
securities are generally considered significantly more speculative and likely to
default than higher quality debt securities. Because of the increased risk of
default, lower rated debt securities generally have higher interest rates than
higher quality securities.
The Fund may purchase bonds in the lowest rating categories (C for Moody's
and D for S&P) and comparable unrated securities. However, the Fund will only
purchase securities rated Ca or lower by Moody's or CC or lower by S&P if the
Adviser believes the quality of such securities is higher than indicated by the
rating.
The values of lower rated securities are less likely than those of higher
quality debt securities to fluctuate inversely with changes in interest rates.
This is because increases in interest rates often are associated with an
improving economy, which may translate into an improved ability of the issuers
of lower-rated securities to pay off their bonds (lowering the risk of default).
Relative to other debt securities, the values of lower rated debt securities may
be more volatile because: (i) an economic downturn may more significantly impact
their potential for default, or (ii) the secondary market for such securities
may at times be less liquid or respond more adversely to negative publicity or
investor perceptions, making it more difficult to value or dispose of the
securities. The likelihood that these securities will help the Fund achieve its
investment objective is more dependent on the Adviser's own credit analysis.
The credit ratings of all bonds held by the Fund at October 31, 1997 are
set forth below. This information reflects the composition of the Fund's assets
at October 31, 1997 and is not necessarily representative of the Fund holdings
currently or at any time in the future.
<TABLE>
<CAPTION>
RATED BY
S&P
--------
<S> <C>
Investment Grade............................................ 2.6%
BB.......................................................... 9.7%
B........................................................... 74.7%
CCC......................................................... 5.6%
CC.......................................................... 0.0%
C........................................................... 0.0%
D........................................................... 0.0%
Nonrated.................................................... 1.5%
-----
Subtotal............................................... 94.1%
U.S. Governments, equities and others....................... 5.9%
-----
Total.................................................. 100.0%
=====
</TABLE>
26
<PAGE> 27
Foreign Investments. Investments in foreign securities have special risks
related to political, economic and legal conditions outside the U.S. As a
result, the prices of foreign securities may fluctuate substantially more than
the prices of securities of issuers based in the U.S. Special risks associated
with foreign securities include the possibility of unfavorable movements in
currency exchange rates, the existence of less liquid markets, the
unavailability of reliable information about issuers, the existence (or
potential imposition) of exchange control regulations (including currency
blockage), and political and economic instability, among others. In addition,
transactions in foreign securities may be more costly because of currency
conversion costs and higher brokerage and custodial costs. See "Miscellaneous
Investment Practices--Foreign Investments" and "Miscellaneous Investment
Practices--Foreign Currency Transactions" in the Statement of Additional
Information for more information about foreign investments.
Emerging Markets. The Fund may invest in foreign securities issued or
guaranteed by companies or governments located in countries whose economies or
securities markets are not yet highly developed. Special risks associated with
these investments (in addition to those of foreign investments generally) may
include, among others, greater political uncertainties, an economy's dependence
on revenues from particular commodities or on international aid or development
assistance, extreme or volatile debt burdens or inflation rates, highly limited
numbers of potential buyers for such securities, heightened volatility of
security prices, restrictions on repatriation of capital invested abroad and
delays and disruptions in securities settlement procedures.
Foreign Currency Transactions. In connection with its investments in
foreign securities, the Fund may purchase and sell (i) foreign currencies on a
spot or forward basis, (ii) foreign currency futures contracts and (iii) options
on foreign currencies and foreign currency futures. Such transactions will be
entered into (a) to lock in a particular foreign exchange rate pending
settlement of a purchase or sale of a foreign security or pending the receipt of
interest, principal or dividend payments on a foreign security held by the Fund,
or (b) to hedge against a decline in the value, in U.S. dollars or in another
currency, of a foreign currency in which securities held by the Fund are
denominated. The Fund will not attempt, nor would it be able, to eliminate all
foreign currency risk. Further, although hedging may lessen the risk of loss if
the hedged currency's value declines, it limits the potential gain from currency
value increases. See "Miscellaneous Investment Practices--Foreign Currency
Transactions" in the Statement of Additional Information for more information
relating to the Fund's obligations in entering into foreign currency
transactions.
Temporary/Defensive Investments. Temporarily available cash may be
invested in certificates of deposit, bankers' acceptances, high quality
commercial paper, Treasury bills, repurchase agreements and U.S. government
securities. Some or all of the Fund's assets also may be invested in such
investments during periods of unusual market conditions. Under a repurchase
agreement, the Fund buys a security from a bank or dealer, which is obligated to
buy it back at a fixed price and time. The security is held in a separate
account at the Fund's custodian and constitutes the Fund's collateral for the
bank's or dealer's repurchase obligation. Additional collateral will be added so
that the obligation will at all times be fully collateralized. However, if the
bank or dealer defaults or enters bankruptcy, the Fund may experience costs and
delays in liquidating the collateral, and may experience a loss if it is unable
to demonstrate its rights to the collateral in a bankruptcy proceeding.
Interest Rate Futures and Options. For hedging purposes, the Fund may (1)
buy or sell interest rate futures and (2) buy put and call options on such
futures. The total market value of securities to be delivered or acquired
pursuant to such contracts will not exceed 5% of the Fund's net assets. A
futures contract creates an obligation by the seller to deliver and the buyer to
take a delivery of the type of instrument at the time and in the amount
specified in the contract. Although futures contracts call for the delivery (or
acceptance) of the specified instrument, the contracts are usually closed out
before the settlement date through the purchase (or sale) of an offsetting
contract. If the price of the initial sale of the futures contract exceeds (or
is less than) the price of the offsetting purchase, the Fund realizes a gain (or
loss).
"When-Issued" and "Delayed Delivery" Securities. The Fund may acquire
securities on a "when-issued" or "delayed delivery" basis by contracting to
purchase securities for a fixed price on a date beyond the customary settlement
time with no interest accruing until settlement. If made through a dealer, the
contract is
27
<PAGE> 28
dependent on the dealer completing the sale. The dealer's failure could deprive
the Fund of an advantageous yield or price. These contracts involve the risk
that the value of the underlying security may change prior to settlement. The
Fund may realize short-term gains or losses if the contracts are sold.
Other. The Fund may not achieve its investment objective. The Fund may
trade portfolio securities for short-term profits to take advantage of price
differentials. High portfolio turnover may result in higher transaction costs
and higher levels of realized capital gains. The Fund's investment objective and
nonfundamental investment policies may be changed without shareholder approval.
Additional information concerning certain of the securities and investment
techniques and strategies described above or in which the Fund also engages is
contained in the Statement of Additional Information.
Additional Leverage. The Fund has reserved the right to borrow money to
the extent such borrowing would not result in a violation of the Asset Coverage
Requirements (as defined under "Risk Factors and Special Considerations--Risk of
Leverage") and would not otherwise violate Section 18 of the 1940 Act. The Fund
may borrow to the extent then permitted by the Credit Agreement and the 1940 Act
through the public or private issuance of debt securities and/or from lenders of
all types, such as banks, savings and loan associations, insurance companies and
similar financial institutions. To the extent permitted by the Credit Agreement
and the 1940 Act, the Fund may also borrow additional amounts as it redeems the
Term Note. See "Description of Term Note--Restrictive Covenants."
As a result of the Second Loan, the Fund increased the percentage of its
assets representing leverage from approximately 20% to approximately 24%. Based
on current market conditions, the Fund's Board of Trustees has authorized the
Fund to increase its borrowings to the maximum aggregate principal amount of the
Term Note at or following the completion of the Offer in order that the
percentage of the Fund's assets, including the proceeds from the Offer,
representing leverage may be maintained at or about 25% following completion of
the Offer. Due to possible changes in market conditions, there are no assurances
that the Fund will borrow additional amounts under the Term Note or that any
additional borrowings under the Term Note will be obtained by the Fund at
favorable interest rates. The Fund reserves the right at any time, if it
believes that market conditions are appropriate, further to increase its level
of debt or other senior securities to maintain or increase the Fund's current
level of leverage to the extent permitted under the 1940 Act and any relevant
agreements between the Fund and third parties, including the Credit Agreement.
The inability to increase, or delays in increasing the Fund's leverage could,
depending on market conditions, adversely affect the Fund's earnings and net
asset value. See "Risk Factors and Special Considerations" for a discussion of
certain risks associated with borrowings by the Fund.
28
<PAGE> 29
RISK FACTORS AND SPECIAL CONSIDERATIONS
An investment in the Fund is subject to a number of risks and special
considerations, including the following:
DILUTION
An immediate dilution of the aggregate net asset value of the shares owned
by Record Date Shareholders who do not fully exercise their Rights may be
experienced as a result of the Offer because the Subscription Price per Share
may be less than the Fund's net asset value per share on the Expiration Date,
and the number of shares outstanding after the Offer is likely to increase in a
greater percentage than the increase in the size of the Fund's assets. In
addition, as a result of the Offer, Record Date Shareholders who do not fully
exercise their Rights should expect that they will, at the completion of the
Offer, own a smaller proportional interest in the Fund than would otherwise be
the case. Although it is not possible to state precisely the amount of any such
decrease in net asset value, because it is not known at this time what the net
asset value per share will be at the Expiration Date or what proportion of the
Shares will be subscribed, such dilution could be substantial. For example,
assuming that all Rights are exercised at the Subscription Price of $6.75, which
is 9.2% below the Fund's net asset value of $7.43 per share as of May 15, 1998,
the Fund's net asset value per share (after payment of the Dealer Manager and
soliciting fees and estimated offering expenses) would be reduced by
approximately $0.26 per share (or 3.5%). The distribution to shareholders of
transferable Rights which themselves may have a realizable value will afford
nonparticipating shareholders the potential of receiving a cash payment upon the
sale of such Rights, receipt of which may be viewed as partial compensation for
the possible dilution of their interest in the Fund. No assurance can be given
that a market for the Rights will develop or as to the value, if any, that such
Rights will have.
RISK OF LEVERAGE
The Fund's leveraged capital structure creates special risks not associated
with unleveraged funds having similar investment objectives and policies,
including a higher volatility of the net asset value of the shares and
potentially more volatility in the market value of the shares. For a description
of the Term Note, see "Description of Term Note." Any investment income or gains
earned by the Fund on amounts borrowed under the Term Note or other forms of
leverage that is in excess of interest and dividends due thereon will cause the
value of and dividends, if any, on the Fund's shares to rise more quickly than
would otherwise be the case. Conversely, if the investment performance by the
Fund on amounts borrowed under the Term Note or other forms of leverage fails to
cover the interest and dividends on such leverage, the value of the shares may
decrease more quickly than would otherwise be the case and dividends thereon
will be reduced or eliminated. This is the speculative effect of "leverage."
Since any decline in the net asset value of the Fund's investments will be
borne entirely by holders of the shares, the effect of leverage in a declining
market would result in a greater decrease in net asset value to holders of the
shares than if the Fund were not leveraged, which would likely be reflected in a
greater decline in the market price for the shares. In an extreme case, if the
Fund's current investment income were not sufficient to meet interest payments
on the Term Note or other forms of leverage, it could be necessary for the Fund
to liquidate certain of its investments, thereby reducing the net asset value
attributable to the shares. In addition, a decline in the net asset value of the
Fund's investments may affect the ability of the Fund to make dividend payments
on its shares and such failure to pay dividends or make distributions may result
in the Fund ceasing to qualify as a regulated investment company under the Code.
The Term Note or other forms of leverage may constitute a substantial lien and
burden on the shares by reason of their prior claim against the income of the
Fund and against the net assets of the Fund in liquidation.
As a result of the Second Loan, the Fund increased the percentage of its
assets representing leverage from approximately 20% to approximately 24%. Based
on current market conditions, the Fund's Board of Trustees has authorized the
Fund to increase its borrowings to the maximum aggregate principal amount of the
Term Note at or following the completion of the Offer in order that the
percentage of the Fund's assets, including the proceeds from the Offer,
representing leverage may be maintained at or about 25% following completion of
the Offer. Due to possible changes in market conditions, there are no assurances
that the Fund
29
<PAGE> 30
will borrow additional amounts under the Term Note or that any additional
borrowings under the Term Note will be obtained by the Fund at favorable
interest rates. The Fund reserves the right at any time, if it believes that
market conditions are appropriate, to increase its level of debt or other senior
securities to maintain or increase the Fund's current level of leverage to the
extent permitted by the 1940 Act and any relevant agreements between the Fund
and third parties, including the Credit Agreement. The inability to increase, or
delays in increasing the Fund's leverage could, depending on market conditions,
adversely affect the Fund's earnings and net asset value.
The 1940 Act generally imposes on registered closed-end investment
companies, such as the Fund, a 300% "asset coverage" test for "senior securities
representing indebtedness" and a 200% "asset coverage" test for "senior
securities representing stock" (the "Asset Coverage Requirements"). The 1940 Act
generally restricts distributions to holders of common stock and preferred stock
of a registered closed-end investment company while any senior security
representing indebtedness is outstanding and restricts distributions to the
holders of common stock while any senior security representing stock is
outstanding, unless such coverage requirements are satisfied. The Fund's shares
of beneficial interest constitute common stock for this purpose. Furthermore,
the 1940 Act generally limits registered closed-end investment companies from
issuing more than one class of senior securities representing indebtedness and
more than one class of senior securities representing stock, subject to various
exceptions.
The following table illustrates the effect of leverage (using senior
securities--i.e., $34.3 million borrowed in two loans under the Term Note) on
the return of a holder of the shares, assuming net assets of approximately $111
million, the assumed return on the portfolio set forth in such table and fixed
annual rates of 7.33% and 6.36%, respectively, payable on the $27.4 million
aggregate principal amount of the First Loan and the $6.9 million aggregate
principal amount of the Second Loan under the Term Note:
<TABLE>
<S> <C> <C> <C> <C> <C>
Assumed Return on Portfolio
(Net of Expenses Except
Interest)........................ -10% -5% 0% 5% 10%
Corresponding Return to
Shareholder...................... -15.30% -8.76% -2.21% 4.34% 10.89%
</TABLE>
The purpose of the foregoing table is to assist the investor in
understanding the effects of leverage. The figures in the table are hypothetical
and the actual returns to a holder of the shares may be greater or less than
those appearing in the table.
DISCOUNT FROM NET ASSET VALUE
Shares of closed-end funds frequently trade at a market price which is less
than the value of the net assets attributable thereto. The possibility that
shares of the Fund will trade at a discount from net asset value is a risk
separate and distinct from the risk that the Fund's net asset value will
decrease. It should be noted, however, that in some cases, shares of closed-end
funds may trade at a premium to net asset value. The Fund's shares have traded
at various times in the market above, at and below net asset value since the
commencement of the Fund's operations. See "Trading and Net Asset Value
Information." In addition, the net asset value of the Fund will change with
changes in the value of its portfolio securities. Because the Fund invests
primarily in fixed-income securities, the net asset value of the shares of the
Fund can be expected to change as general levels of interest rates fluctuate.
When interest rates decline, the value of a fixed-income portfolio can be
expected to rise. Conversely, when interest rates rise, the value of a
fixed-income portfolio can be expected to decline. In addition, in a period of
rising interest rates, increasing defaults by issuers of lower rated debt
obligations could exacerbate such decline in the Fund's net asset value,
although in some circumstances an interest rate increase may be associated with
an improving economy, which may translate into an improved ability of the
issuers of lower rated debt securities to make their payment obligations. The
Fund cannot predict whether its shares will trade at, below or above net asset
value.
LOWER-RATED INVESTMENTS
The Fund is designed for long-term investors who can accept the risks
entailed in seeking a high level of current income available from investments in
long-term, high yielding, lower quality debt securities. Consistent with a
long-term investment approach, investors in the Fund should not rely on the Fund
for their
30
<PAGE> 31
short-term financial needs. The principal value of the lower quality securities
in which the Fund invests will be affected by interest rate levels, general
economic conditions, specific industry conditions and the creditworthiness of
the individual issuer. Although the Fund seeks to reduce risk by portfolio
diversification, extensive credit analysis, and attention to trends in the
economy, industries and financial markets, such efforts will not eliminate risk.
Debt securities offering the high current income sought by the Fund will
ordinarily be in the lower rating categories of recognized rating agencies or
will be unrated. The values of such securities tend to reflect individual
corporate developments or adverse economic changes to a greater extent than
higher rated securities, which tend to react more to fluctuations in the general
market level of interest rates. Periods of economic uncertainty and changes
generally result in increased volatility in the market prices and yields of
lower rated securities and thus in the Fund's net asset value. Further, these
securities are generally regarded by the Rating Agencies as significantly more
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligation and more likely to default than
securities in the higher rating categories; the Fund may incur additional
expenses to the extent it is required to seek recovery upon a default in the
payment of principal of or interest on its portfolio holdings. The lower rated
securities held by the Fund are frequently subordinated to the prior payment of
senior indebtedness and are traded in markets that may be relatively less liquid
than the market for higher rated securities. Changes by recognized rating
services in their ratings of any debt security and in the ability of an issuer
to make payments of interest and principal may also affect the value of the
Fund's investments. Changes in the value of portfolio securities will not
necessarily affect cash income derived from such securities, but will affect the
Fund's net asset value. The Fund will rely on the Adviser's judgment, analysis
and experience in evaluating the creditworthiness of an issuer. In this
evaluation, the Adviser will take into consideration, among other things, the
issuer's financial resources, its sensitivity to economic conditions and trends,
its operating history, the quality of the issuer's management and regulatory
matters.
The values of lower rated securities are less likely than higher quality
debt securities to fluctuate inversely with changes in interest rates. This is
because increases in interest rates may be associated with an improving economy,
which may translate into an improved ability of the issuers of lower rated
securities to pay off their bonds (lowering the risk of default). Relative to
other debt securities, the values of lower rated debt securities may be more
volatile because: (i) an economic downturn may more significantly impact their
potential for default, or (ii) the secondary market for such securities may at
times be less liquid or respond more adversely to negative publicity or investor
perceptions, making it more difficult to value or dispose of the securities. In
addition, the trading market for lower rated securities is generally less liquid
than the market for higher rated securities. As of April 30, 1998, approximately
97.15% of the market value of the Fund's total investments was represented by
debt securities regarded by the Rating Agencies as below investment grade (that
is, rated below BBB by S&P or below Baa by Moody's) or unrated securities deemed
by the Adviser to be below investment grade. In addition, in a period of rising
interest rates, increasing defaults by issuers of such debt obligations could
exacerbate any decline in the Fund's net asset value. If an issuer of a security
containing a redemption or call provision exercises either provision in a
declining interest rate market, the Fund would be likely to replace the security
with a lower-yielding investment, which could result in a decreased return for
shareholders.
The market for lower rated securities has expanded rapidly in recent years.
This expanded market has not yet completely weathered an economic downturn. A
further economic downturn or an increase in interest rates could have a negative
effect on the lower rated debt market and on the market value of such securities
held by the Fund, as well as on the ability of the issuers of such securities to
repay principal and interest on their borrowings.
The credit ratings issued by credit rating services may not fully reflect
the true risks of an investment. For example, credit ratings typically evaluate
the safety of principal and interest payments, not market value risk, of lower
rated securities. Also, credit rating agencies may fail to change on a timely
basis a credit rating to reflect changes in economic or company conditions that
affect a security's market value. Although the Adviser considers ratings of
recognized rating services such as Moody's and S&P, the Adviser primarily relies
on its own credit analysis, which includes a study of the issuer's existing
debt, capital structure, ability to service debt
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and to pay dividends, the issuer's sensitivity to economic conditions, its
operating history and the current trend of earnings. The Adviser continually
monitors the investments in the Fund's portfolio and carefully evaluates whether
to dispose of or retain lower rated securities whose credit ratings have
changed.
DIVIDENDS AND DISTRIBUTIONS
It is the Fund's present policy, which may be changed by the Board of
Trustees, to pay dividends on a monthly basis to holders of the shares of
investment company taxable income and to distribute any net short-term capital
gains and net capital gains annually. See "Dividends and Distributions; Dividend
Reinvestment Plan." However, there can be no assurance that the Fund will be
able to maintain its current level of dividends per share, and the Fund may
change the Fund's current level of dividends per share in response to market or
other conditions. The Fund currently has accumulated undistributed net
investment income upon which it has paid taxes. Based on the Adviser's
assessment of current market conditions in the lower rated debt market and
available leverage opportunities, the Board of Trustees believes the Offer will
not result in a decrease in the Fund's current level of dividends per share. See
"Financial Highlights" and "The Offer--Purpose of the Offer."
The Fund will not be permitted to declare dividends or other distributions
with respect to the shares or purchase shares unless at the time thereof the
Fund meets certain asset coverage requirements, including those imposed by the
1940 Act. Failure to pay dividends or other distributions could result in the
Fund ceasing to qualify as a regulated investment company under the Code. See
"Federal Taxation" and "Description of Shares of Beneficial Interest--Dividends
and Distributions." In the event the Fund fails to satisfy certain asset
coverage requirements, the Fund may be required to effect mandatory partial or
complete redemption of the Term Note. Redemption of the Term Note would reduce
the Fund's leverage and could negatively affect potential returns with respect
to the Shares.
Given the above-described investment risks inherent in the Fund, investment
in shares of the Fund should not be considered a complete investment program and
is not appropriate for all investors. Investors should carefully consider their
ability to assume these risks before making an investment in the Fund.
THE ADVISER
THE ADVISER
The Adviser is Colonial Management Associates, Inc., a Massachusetts
corporation having its principal offices at One Financial Center, Boston,
Massachusetts 02111. The Adviser is a wholly owned subsidiary of The Colonial
Group, Inc. ("TCG"), and both TCG and the Adviser are indirect subsidiaries of
Liberty Mutual Insurance Company, an underwriter of workers' compensation
insurance and a property and casualty insurer in the U.S. The Adviser has been
an investment adviser since 1931. As of the date of this Prospectus, the Adviser
serves as investment adviser for 39 open-end and 5 closed-end management
investment companies.
Andrea S. Feingold, Vice President and head of the Corporate Group of the
Adviser, has managed the Fund since November 1993. Ms. Feingold joined the
Adviser in 1991 as an Investment Analyst.
MANAGEMENT AGREEMENT
The Management Agreement between the Adviser and the Fund (the "Management
Agreement") provides that, subject to the direction of the Board of Trustees of
the Fund and the applicable provisions of the 1940 Act, the Adviser is
responsible for the actual management of the Fund's portfolio. The
responsibility for making decisions to buy, sell or hold a particular investment
rests with the Adviser, subject to review by the Board of Trustees of the Fund
and compliance with the applicable provisions of the 1940 Act.
The Adviser provides the Fund with accounting, bookkeeping and pricing
services and other services and office facilities (the expenses of which are
borne by the Fund as specified below), except to the extent these services are
provided by an administrator or an accounting firm hired by the Fund.
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Under the Management Agreement with the Fund, the Adviser receives a
monthly advisory fee at the annual rate of 0.65% of the average weekly net
assets of the Fund. Since the Adviser's fee is based on the average weekly net
assets of the Fund, the Adviser will benefit from any increase in the Fund's net
assets resulting from the Offer. It is not possible to state precisely the
amount of additional compensation the Adviser will receive as a result of the
Offer because it is not known how many Shares will be subscribed for and because
the proceeds of the Offer will be invested in additional portfolio securities
which will fluctuate in value. However, based on the estimated proceeds from the
Offer, assuming all the Rights are exercised in full for the Subscription Price
of $6.75 per Share, the Adviser would receive additional annual advisory fees of
approximately $208,000 as a result of the increase in average weekly net assets
under management over the Fund's current net assets under management, assuming
no fluctuations in the value of Fund portfolio securities.
The Adviser places all orders for the purchase and sale of portfolio
securities. In selecting broker-dealers, the Adviser may consider research and
brokerage services furnished by such broker-dealers to the Adviser and its
affiliates. In recognition of the research and brokerage services provided, the
Adviser may cause the Fund to pay the selected broker-dealer a higher commission
than would have been charged by another broker-dealer not providing such
services. Subject to seeking best execution, the Adviser may consider sales of
shares of certain other Colonial funds in selecting broker-dealers for portfolio
security transactions.
YEAR 2000 COMPLIANCE
The Adviser is actively coordinating, managing and monitoring Year 2000
readiness for the Fund. A central program office at the Adviser is working
within the Adviser and with vendors who provide services, software and systems
to the Fund to help ensure that date-related information and data can be
properly processed and calculated on and after January 1, 2000. Many Fund
service providers and vendors, including the Adviser, are in the process of
making Year 2000 modifications to their services, software and systems and
believe that such modifications will be completed on a timely basis prior to
January 1, 2000. The cost of these modifications will not affect the Fund.
However, no assurances can be given that all modifications required to ensure
proper data processing and calculation on and after January 1, 2000 will be
timely made or that services to the Fund will not be adversely affected.
DETERMINATION OF NET ASSET VALUE
Net asset value of the shares will be determined as of the close of regular
trading on the Exchange (generally 4:00 p.m. New York City time) on the last
Business Day of each week (generally Friday), and at such other times as the
Fund may authorize. Net asset value is determined by dividing the value of the
net assets of the Fund (for the purpose of determining the net asset value per
share, the value of the Fund's net assets shall be deemed to equal the value of
the Fund's assets less the Fund's liabilities (including the outstanding
principal amount of the Term Note and accrued but unpaid interest on the Term
Note)) by the total number of shares outstanding. Portfolio securities for which
market quotations are readily available are valued at current market value.
Short term investments maturing in 60 days or less are valued at amortized cost
when the Adviser determines, pursuant to procedures adopted by the Board of
Trustees, that such cost approximates current market value. All other securities
and assets are valued at their fair value following procedures adopted by the
Board of Trustees.
SHARE REPURCHASES; CONVERSION TO OPEN-END STATUS
REPURCHASE OF SHARES
Shares of closed-end investment companies frequently trade at a discount
from net asset value. The Board of Trustees regularly monitors the relationship
between the Fund's market price and net asset value. If shares of the Fund were
to trade at a substantial discount to net asset value for an extended period of
time, the Board may consider the repurchase of its shares on the open market or
the making of tender offers for such shares. Since commencement of the Fund's
operations, no such open market purchases or tender offers have
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been made, and no assurances can be given that such actions will be taken in the
future. The Fund may borrow money to finance the repurchase of shares, subject
to compliance with the Asset Coverage Requirements, Section 18 of the 1940 Act
and the other limitations described under "Investment Policies and
Limitations--Investment Strategy--Additional Leverage." Shares may not be
repurchased, however, (i) if applicable asset coverage requirements under the
1940 Act (i.e., 300% with respect to the Term Note and 200% with respect to
preferred stock, if any) are not met or would not be met following such
repurchase, (ii) when payments of principal of or interest on the Term Note are
in default or (iii) if otherwise prohibited by applicable law.
There can be no assurance that repurchases or tenders, if they were to
occur, would result in the shares trading at a price which is equal to their net
asset value. The Fund anticipates that the market price of the shares will
usually vary from net asset value. The market price of the shares will be
determined, among other things, by the relative demand for and supply of the
shares in the market, the Fund's investment performance, the Fund's dividends
and yield and investor perception of the Fund's overall attractiveness as an
investment as compared with other investment alternatives. It should be
recognized that any such acquisitions of shares would decrease the total assets
of the Fund and therefore have the effect of increasing the Fund's expense
ratio. Furthermore, any interest on borrowings to finance share repurchase
transactions would reduce the Fund's net income.
CONVERSION TO OPEN-END STATUS
The Fund's Board of Trustees may from time to time consider submitting to
the holders of the shares at any time a proposal to convert the Fund to an
open-end investment company and in connection therewith to redeem or otherwise
retire the Term Note, as would be required upon such conversion by the 1940 Act.
In determining whether to exercise its discretion to submit this issue to
shareholders, the Board of Trustees would consider all factors then relevant,
including the relationship of the market price of the shares to net asset value,
the extent to which the Fund's capital structure is leveraged and the
possibility of re-leveraging, the spread, if any, between yields on lower rated
securities in the Fund's portfolio and interest and dividend charges on senior
securities and general market and economic conditions. In addition to any vote
required by Massachusetts law, conversion of the Fund to an open-end investment
company would require the affirmative vote of two-thirds of the shares entitled
to be voted on the matter. This two-thirds vote requirement is higher than the
vote required under the 1940 Act. Shareholders of an open-end investment company
may require the company to redeem their shares at any time (except in certain
circumstances as authorized by or under the 1940 Act) at their net asset value,
less such redemption charges, if any, as might be in effect at the time of
redemption. If the Fund converted to an open-end investment company, it could be
required to liquidate portfolio securities to meet requests for redemption, and
the shares would no longer be listed on the Exchange. In the event the Fund
converts to open-end status, the Fund would only be able to borrow through bank
borrowings within certain limits and would not be allowed to have preferred
stock. No assurance can be given that the Board will, at any time in the future,
decide to submit a proposal to convert to open-end status to the shareholders of
the Fund.
DIVIDENDS AND DISTRIBUTIONS; DIVIDEND REINVESTMENT PLAN
It is the Fund's present policy, which may be changed by the Board of
Trustees, to pay dividends of investment company taxable income (but not
including short-term capital gains or "net capital gains," defined as the excess
of net long-term capital gains over net short-term capital losses) on a monthly
basis to holders of shares, and to distribute any net short-term capital gains
and net capital gains annually. Under present law, if the Fund were to retain
ordinary income or net capital gains, taxes would be imposed with respect to
those amounts. There can be no assurance that the Fund will be able to maintain
its current level of dividends, and the Fund may change the Fund's current level
of dividends in response to market or other conditions. See "Risk Factors and
Special Considerations--Dividends and Distributions." See also "Federal
Taxation," "Description of Term Note--Restrictive Covenants" and "Description of
Shares of Beneficial Interest--Dividends and Distributions" for a discussion of
certain possible restrictions on the Fund's ability to declare dividends on the
Shares.
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Pursuant to the Fund's Dividend Reinvestment Plan (the "Plan"), all
shareholders whose shares are registered in their own names will have all
distributions reinvested automatically in additional shares of the Fund by First
Data Investor Services Group, Inc., as agent under the Plan (acting in such
capacity, the "Plan Agent"), unless a shareholder elects to receive cash. An
election to receive cash may be revoked or reinstated at the option of the
shareholder. Shareholders whose shares are held in the name of a broker or
nominee will have distributions reinvested automatically by the broker or
nominee in additional shares under the Plan, unless the service is not provided
by the broker or nominee, or unless the shareholder elects to receive
distributions in cash. If the service is not available, such distributions will
be paid in cash. Shareholders whose shares are held in the name of a broker or
nominee should contact the broker or nominee for details. All distributions to
investors who elect not to participate (or whose brokers or nominees elect not
to participate) in the Plan will be paid by check mailed directly to the record
holder by the Plan Agent, as dividend paying agent.
The Plan Agent will furnish each person who buys Shares in the Offer with
written information relating to the Plan. Included in such information will be
procedures for electing to receive distributions in cash (or, in the case of
shares held in the name of a broker or nominee who does not participate in the
Plan, procedures for having such shares registered in the name of the
shareholder so that such shareholder may participate in the Plan).
If the Trustees of the Fund declare a dividend or capital gains
distribution payable either in shares or in cash, as holders of shares may have
elected, then nonparticipants in the Plan will receive cash and participants in
the Plan will receive the equivalent in shares valued as set forth below.
Whenever a market price is equal to or exceeds net asset value at the time
shares are valued for the purpose of determining the number of shares equivalent
to the cash dividend or capital gains distribution, participants will be issued
shares at the net asset value most recently determined as provided under
"Determination of Net Asset Value" in this Prospectus and in the Statement of
Additional Information, or, if higher, at 95% of the market price. If the net
asset value of the shares at such time exceeds the market price of shares at
such time, or if the Fund should declare a dividend or capital gains
distribution payable only in cash, the Plan Agent will, as agent for the
participants, buy shares in the open market, on the Exchange or elsewhere, for
the participants' accounts. If, before the Plan Agent has completed its
purchases, the market price exceeds the net asset value of the shares, the
average per share purchase price paid by the Plan Agent may exceed the net asset
value of the shares, resulting in the acquisition of fewer shares than if the
dividend or capital gains distribution had been paid in shares issued by the
Fund. The Plan Agent will apply all cash received as a dividend or capital gains
distribution to purchase shares in the open market as soon as practicable after
the payment date of such dividend or capital gains distribution, but in no event
later than 30 days after such date, except where necessary to comply with
applicable provisions of the federal securities laws.
The Plan Agent maintains all shareholder accounts in the Plan and furnishes
written confirmations of all transactions in such accounts, including
information needed by shareholders for personal and tax records. Shares in the
account of each Plan participant will be held by the Plan Agent in
noncertificated form in the name of the participant, and each shareholder's
proxy will include those shares purchased pursuant to the Plan.
There is no charge to participants for reinvesting dividends or capital
gains distributions. The Plan Agent's fees for handling the reinvestment of
dividends and capital gains distributions will be paid by the Fund. There will
be no brokerage charges with respect to shares issued directly by the Fund as a
result of dividends or capital gains distributions payable either in shares or
in cash. However, each participant will pay a pro rata share of brokerage
commissions incurred with respect to the Plan Agent's open market purchases in
connection with the reinvestment of dividends and capital gains distributions.
The automatic reinvestment of dividends and capital gains distributions
pursuant to the Plan will not relieve participants of any income tax which may
be payable on such dividends or distributions.
Experience under the Plan may indicate that changes are desirable.
Accordingly, the Fund reserves the right to amend or terminate the Plan as
applied to any dividend or capital gains distribution paid after written notice
of the change sent to participants in the Plan at least 30 days before the
record date for such dividend or
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capital gains distribution. All correspondence concerning the Plan should be
directed to the Plan Agent at P.O. Box 1376, Boston, Massachusetts 02104.
FEDERAL TAXATION
The following discussion offers only a brief outline of certain material
federal income tax consequences of investing in shares of the Fund and is based
on the federal income tax laws in effect on the date hereof. Such tax laws are
subject to change by legislative, judicial or administrative action, possibly
with retroactive effect. Investors should consult their own tax advisers for
more detailed information and for information regarding the impact of state,
local and foreign taxes upon such an investment. See the Statement of Additional
Information for further discussion of federal income tax aspects of an
investment in the Fund.
The Fund has qualified and intends to continue to qualify as a "regulated
investment company" for federal income tax purposes and to meet all other
requirements necessary for it to be relieved of federal taxes on income and
gains it distributes to shareholders. In order to maintain its status as a
regulated investment company, the Fund will distribute substantially all of its
ordinary income and capital gain net income on a current basis.
Fund distributions will be taxable to shareholders as ordinary income to
the extent derived from the Fund's investment income and net short-term capital
gains (that is, net capital gains from securities held for not more than a
year). Distributions designated by the Fund as deriving from net capital gains
on securities held for more than one year but not more than 18 months and from
net gains on securities held for more than 18 months will be taxable to
shareholders as such, regardless of how long such shareholder has held the
shares. Pursuant to the Taxpayer Relief Act of 1997, long-term capital gains are
subject to a maximum tax rate of either 28% or 20% depending on the Fund's
holding period for the portfolio assets generating such gains. Distributions
will be taxable as described above whether received in cash or in shares through
the reinvestment of distributions.
Generally, gain recognized by a shareholder on the sale of Fund shares held
for more than one year will be taxable as long-term capital gain subject to a
maximum tax rate of 28% if such shares were held for more than one year but not
more than 18 months or 20% if such shares were held for more than 18 months. See
"Taxes--Federal Income Tax Treatment of Holders of Shares" in the Statement of
Additional Information for more information regarding the capital gains tax
rates applicable to capital gains or losses recognized upon the sale of shares.
If a shareholder holds shares primarily for sale to customers in the ordinary
course of business rather than for investment, any gain recognized on the sale
of those shares would be taxable as ordinary income.
Early in each calendar year the Plan Agent will notify each shareholder of
the amount and tax status of distributions paid to such shareholder for the
preceding year.
DESCRIPTION OF SHARES OF BENEFICIAL INTEREST
GENERAL
The Fund has an unlimited number of authorized shares of beneficial
interest, no par value. As of April 30, 1998, 14,971,645 shares were
outstanding. The Board of Trustees has the authority under the Agreement and
Declaration of Trust to, and reserves the right to, issue shares from time to
time. See "Description of Term Note--Restrictive Covenants" for certain
restrictions. The shares issued are, or upon issuance will be, fully paid and
nonassessable (although shareholders could, in certain circumstances, be liable
for the obligations of the Fund to the extent set forth under "Shareholder
Liability" in the Statement of Additional Information) and will have no
preemptive rights or conversion rights. The Fund's shares are listed on the
Exchange under the symbol "CIF."
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DIVIDENDS AND DISTRIBUTIONS
The Fund may not declare dividends or distributions or purchase or redeem
any shares if, at the time of the declaration, purchase or redemption, as
applicable (and after giving effect thereto), asset coverage with respect to the
Fund's senior securities representing indebtedness, including the Term Note,
would be less than 300% (or such higher percentage as may in the future be
required by law) or asset coverage with respect to any senior securities of a
class which is stock would be less than 200% (or such higher percentage as may
in the future be required by law). See "Description of Term Note--Restrictive
Covenants" for certain definitions relating to the foregoing restrictions. Under
the Credit Agreement (as defined herein), the declaration of dividends or other
distributions on or the purchase or the redemption of shares will be prohibited
at any time payments of principal of or interest on the Term Note are in
default.
LIQUIDATION RIGHTS
Upon a liquidation, dissolution or winding up of the Fund (whether
voluntary or involuntary), the holders of the shares will be entitled to
participate equally in the remaining assets of the Fund. Neither a sale, lease
or exchange of all or substantially all of the property and assets of the Fund
nor a consolidation or merger of the Fund with or into any other corporation or
business trust will be deemed to be a liquidation, dissolution or winding up of
the Fund.
VOTING
Holders of shares have voting rights of one vote per share. The Fund is
required by the rules of the Exchange to hold annual meetings of shareholders.
The most recent annual meeting of shareholders was held on April 29, 1998. The
next annual meeting of shareholders is expected to be scheduled for April 28,
1999.
CERTAIN PROVISIONS OF THE AGREEMENT AND DECLARATION OF TRUST
The Board of Trustees is divided into three classes, each having a term of
three years. Each year the term of one class expires. This may make more
difficult a change in the Fund's management, and could have the effect of
depriving shareholders of an opportunity to sell their shares at a premium over
prevailing market prices by discouraging a third party from seeking to obtain
control of the Fund in a tender offer or similar transaction. In addition, the
Agreement and Declaration of Trust provides that the affirmative vote or consent
of two-thirds of the outstanding shares of the Fund is required to authorize the
conversion of the Fund from a closed-end to an open-end investment company. This
two-thirds vote requirement is higher than the vote required under the 1940 Act.
DESCRIPTION OF TERM NOTE
GENERAL
The Fund entered into a credit agreement dated as of June 12, 1996 with
Bank of America Illinois pursuant to which the Fund issued a term note (the
"Original Term Note") to Bank of America Illinois in the aggregate principal
amount of $27,400,000, due in full on June 14, 1999 and bearing interest at the
fixed annual rate of 7.33%. On May 19, 1998, the Fund entered into an Amended
and Restated Credit Agreement (the "Credit Agreement") with Bank of America
National Trust and Savings Association, successor by merger to Bank of America
Illinois ("Bank of America"), pursuant to which the Fund issued a new term note
(the "Term Note") to Bank of America in the aggregate principal amount of
$44,900,000. The $27,400,000 borrowing (the "First Loan") under the Original
Term Note remains outstanding under the Term Note with the same maturity and
interest rate. In addition, on May 19, 1998, the Fund borrowed under the Term
Note the aggregate principal amount of $6,900,000 (the "Second Loan") from Bank
of America, which amount is due in full on May 19, 2001 and bears interest at
the fixed annual rate of 6.36%. The combined weighted average interest rate of
the $34,300,000 aggregate principal amount outstanding under the Term Note is
7.13%. The Credit Agreement permits the Fund to borrow up to the remaining
amount of the Term Note at any time prior to September 30, 1998. The issuance of
any subsequent senior securities will be subject to compliance with the 1940
Act, including Section 18 thereof. Any such subsequent senior securities may
have certain terms, including, but not limited to, those relating to interest
rate, redemptions, repurchases and maturity which differ from the credit terms
of the Term Note. The following summary of the principal terms
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of the Term Note and certain terms of the Credit Agreement is qualified in its
entirety by reference to all provisions of the Credit Agreement, including the
definitions therein of certain terms. A copy of the Credit Agreement will be
filed as an exhibit to the Fund's Registration Statement on Form N-2, of which
this Prospectus forms a part.
INTEREST
The First Loan bears interest at the rate of 7.33% per annum from June 14,
1996 through and including June 14, 1999. Interest on the First Loan is payable
on June 13 and December 13 of each year, commencing December 13, 1996. The First
Loan will mature on June 14, 1999 if not repaid or redeemed prior to that date.
The Second Loan bears interest at the rate of 6.36% per annum from May 19, 1998
through and including May 19, 2001. Interest on the Second Loan is payable on
May 19 and November 19 of each year, commencing November 19, 1998. The Second
Loan will mature on May 19, 2001 if not repaid or redeemed prior to that date.
REDEMPTION
The First Loan or the Second Loan is redeemable by the Fund prior to
maturity upon the payment of certain prepayment penalties, as set forth in the
Credit Agreement. The Term Note or any loan thereunder may also be declared
immediately due and payable by Bank of America or, in certain circumstances, may
become immediately due and payable without such declaration. All redemptions of
the Term Note or any loan thereunder by the Fund will be at a price of 100% of
the principal amount thereof, plus accrued interest to the date of redemption,
plus applicable prepayment penalties, if any.
RANKING OF TERM NOTE
The Term Note will rank pari passu with all other existing and future
senior indebtedness of the Fund and is senior to the shares. "Senior
indebtedness" means the principal of and interest on and other amounts due on or
in connection with any existing or future unsecured indebtedness of the Fund.
RESTRICTIVE COVENANTS
Under the 1940 Act and the Credit Agreement, the Fund may not declare
dividends or other distributions on the shares or purchase any shares if, at the
time of the declaration or purchase, as applicable (and after giving effect
thereto), asset coverage with respect to the Fund's senior securities
representing indebtedness, including the Term Note, would be less than 300% (or
such higher percentage as may in the future be required by law). Under the Code,
the Fund must, among other things, distribute at least 90% of its investment
company taxable income each year in order to maintain its qualification for tax
treatment as a regulated investment company. The foregoing limitations on
dividends, distributions and purchases may under certain circumstances impair
the Fund's ability to maintain such qualification. See "Federal Taxation" and
the Statement of Additional Information. The Credit Agreement also restricts the
Fund from investing more than 5% of the total assets of the Fund in a single
issuer and requires the Fund to retain certain levels of cash and "cash
equivalents" in its portfolio at all times.
The asset coverage of a class of senior securities representing
indebtedness, such as the Term Note, is defined as the ratio of (i) the total
assets of the Fund, less all liabilities and indebtedness not represented by
senior securities, to (ii) the aggregate amount of senior securities
representing indebtedness of the Fund. The asset coverage of a class of senior
securities representing stock (see "Description of Shares of Beneficial
Interest--Dividends and Distributions") is defined as the ratio of (i) the total
assets of the Fund, less all liabilities and indebtedness not represented by
senior securities, to (ii) the aggregate amount of senior securities
representing indebtedness of the Fund, plus the aggregate of the liquidation
preference of the senior securities representing stock. "Senior securities
representing indebtedness" generally means any bond, debenture, note or similar
obligation or instrument constituting a security (other than stock) and
evidencing indebtedness. For purposes of determining asset coverage for senior
securities representing indebtedness in connection with the payment of dividends
or other distributions on or purchases or redemptions of stock, the
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term "senior security" does not include any promissory note or other evidence of
indebtedness issued in consideration of any loan, extension or renewal thereof,
made by a bank or other person and privately arranged, and not intended to be
publicly distributed. The term "senior security" also does not include any such
promissory note or other evidence in any case where such a loan is for temporary
purposes only and in an amount not exceeding 5% of the value of the total assets
of the Fund at the time when the loan is made; a loan is presumed under the 1940
Act to be for temporary purposes if it is repaid within 60 days and is not
extended or renewed; otherwise it is presumed not to be for temporary purposes.
For purposes of determining whether the 300% and 200% asset coverage
requirements described above apply in connection with dividends or distributions
on or purchases or redemptions of the shares and for purposes of determining
conformance with Asset Coverage Requirements, such asset coverages may be
calculated on the basis of values calculated as of a time within 48 hours (not
including Sundays or holidays) next preceding the time of the applicable
determination. The foregoing definitions reflect the provisions of the 1940 Act
as in effect on the date hereof and are subject to change to the extent
necessary to reflect changes in the 1940 Act, if any.
The Credit Agreement contains a covenant limiting the Fund's ability to
incur, assume, guarantee or otherwise become liable with respect to any
indebtedness for money borrowed or issue preferred stock other than the Term
Note, a limited amount of unsecured indebtedness to the Fund's Custodian and
reverse repurchase agreements permitted by the Fund's investment restrictions.
See the Statement of Additional Information.
CUSTODIAN, TRANSFER AGENT, DIVIDEND
DISBURSING AGENT AND REGISTRAR
The Fund's securities and cash are held by The Chase Manhattan Bank, whose
principal business address is 4 Chase MetroTech Center, Brooklyn, New York
11245, as custodian (the "Custodian") under a custodian contract.
First Data Investor Services Group, Inc. serves as dividend disbursing
agent, as agent under the Plan and as transfer agent and registrar for the
shares.
LEGAL OPINIONS
The validity of the Shares offered hereby will be passed upon for the Fund
by Ropes & Gray, Boston, Massachusetts, which serves as counsel to the Fund.
Certain matters will be passed on for the Dealer Manager by Skadden, Arps,
Slate, Meagher & Flom (Illinois), Chicago, Illinois.
REPORTS TO SHAREHOLDERS
The Fund will send unaudited semiannual and audited annual reports to its
shareholders, including a list of investments held.
EXPERTS
The Financial Statements incorporated by reference in the Statement of
Additional Information have been so incorporated in reliance on the report of
Price Waterhouse LLP, independent accountants, given on the authority of said
firm as experts in auditing and accounting. The address of Price Waterhouse LLP
is 160 Federal Street, Boston, Massachusetts 02110.
FURTHER INFORMATION
The Fund has filed with the Commission, Washington, D.C. 20549, a
Registration Statement under the Securities Act with respect to the Shares
offered hereby. Further information concerning these securities and the Fund may
be found in the Registration Statement, of which this Prospectus constitutes a
part, on file with the Commission. The Registration Statement may be inspected
without charge at the Commission's office in Washington, D.C., and copies of all
or any part thereof may be obtained from such office after payment of the fees
prescribed by the Commission.
39
<PAGE> 40
The Fund is subject to the informational requirements of the 1934 Act and
the 1940 Act, and in accordance therewith files reports and other information
with the Commission. Such reports, proxy and information statements and other
information can be inspected and copied at the public reference facilities
maintained by the Commission at 450 Fifth Street, Washington, D.C. 20549 and the
Commission's regional offices, including offices at Seven World Trade Center,
New York, New York 10048. Copies of such material can be obtained from the
Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. Such reports and other information
concerning the Fund may also be inspected at the offices of the Exchange. The
Commission maintains a Web site (http://www.sec.gov) that contains the Statement
of Additional Information, material incorporated by reference into this
Prospectus and the Statement of Additional Information, and reports, proxy and
information statements and other information regarding registrants that file
electronically with the Commission. In addition, reports, proxy and information
statements and other information concerning the Fund can be inspected at the
offices of the Exchange, 20 Broad Street, New York, New York 10005.
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Definitions................................................. 2
Investment Objective and Policies........................... 2
Fundamental Investment Policies............................. 2
Other Investment Policies................................... 3
Fund Charges and Expenses................................... 3
Management of the Fund...................................... 7
Custodian................................................... 7
Independent Accountants..................................... 8
Incorporation of Financial Statements by Reference.......... 8
Determination of Net Asset Value............................ 8
Portfolio Transactions...................................... 9
Miscellaneous Investment Practices.......................... 10
Taxes....................................................... 23
Shareholder Liability....................................... 27
</TABLE>
40
<PAGE> 41
APPENDIX A
BOND RATINGS
THE FOLLOWING RATING SERVICES DESCRIBE RATED SECURITIES AS FOLLOWS:
MOODY'S INVESTORS SERVICE, INC.
BONDS
AAA--Bonds which are rated 'Aaa' are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an exceptionally
stable margin, and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
AA--Bonds which are rated 'Aa' are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in 'Aaa' securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risk appear somewhat larger than the 'Aaa'
securities.
A--Bonds which are rated 'A' possess many favorable investment attributes
and are to be considered as upper-medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment sometime in the future.
BAA--Bonds which are rated 'Baa' are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
BA--Bonds which are rated 'Ba' are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B--Bonds which are rated 'B' generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
CAA--Bonds which are rated 'Caa' are of poor standing. Such issues may be
in default, or there may be present elements of danger with respect to principal
or interest.
CA--Bonds which are rated 'Ca' represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C--Bonds which are rated 'C' are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
STANDARD & POOR'S
BONDS
AAA--Debt rated 'AAA' has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA--Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
41
<PAGE> 42
A--Debt rated 'A' has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB--Debt rated 'BBB' is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
BB-B-CCC-CC-C--Debt rated 'BB', 'B', 'CCC', 'CC' and 'C' is regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. 'BB'
indicates the lowest degree of speculation and 'C' the highest. While such debt
will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major exposures to adverse conditions.
BB--Debt rated 'BB' has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The 'BB'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'BBB-' rating.
B--Debt rated 'B' has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The 'B' rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
'BB' or 'BB-' rating.
CCC--Debt rated 'CCC' has a currently identifiable vulnerability to default
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The 'CCC' rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
'B' or 'B-' rating.
CC--The rating 'CC' typically is applied to debt subordinated to senior
debt that is assigned an actual or implied 'CCC' rating.
C--The rating 'C' typically is applied to debt subordinated to senior debt
which is assigned an actual or implied 'CCC' debt rating. The 'C' rating may be
used to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
D--Bonds rated 'D' are in payment default. The 'D' rating category is used
when interest payments or principal payments are not made on the date due even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period. The 'D' rating also will be used
on the filing of a bankruptcy petition if debt service payments are jeopardized.
42
<PAGE> 43
================================================================================
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE FUND OR THE DEALER MANAGER. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE FUND SINCE
THE DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY
TIME SUBSEQUENT TO ITS DATE. HOWEVER, IF ANY MATERIAL CHANGE OCCURS WHILE THIS
PROSPECTUS IS REQUIRED BY LAW TO BE DELIVERED, THIS PROSPECTUS WILL BE AMENDED
OR SUPPLEMENTED ACCORDINGLY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO
SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY SECURITIES OTHER THAN THE
REGISTERED SECURITIES TO WHICH IT RELATES. THIS PROSPECTUS DOES NOT CONSTITUTE
AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY IN ANY CIRCUMSTANCES IN
WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
------------------------
TABLE OF CONTENTS
PROSPECTUS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary...................................................... 3
Fee Table............................................................... 11
Financial Highlights.................................................... 12
Capitalization at April 30, 1998........................................ 13
Information Regarding Senior Securities................................. 13
Trading and Net Asset Value Information................................. 14
The Fund................................................................ 15
The Offer............................................................... 16
Use of Proceeds......................................................... 25
Investment Policies and Limitations..................................... 25
Risk Factors and Special Considerations................................. 29
The Adviser............................................................. 32
Determination of Net Asset Value........................................ 33
Share Repurchases; Conversion to Open-End Status........................ 33
Dividends and Distributions; Dividend Reinvestment Plan................. 34
Federal Taxation........................................................ 36
Description of Shares of Beneficial Interest............................ 36
Description of Term Note................................................ 37
Custodian, Transfer Agent, Dividend Disbursing Agent and Registrar...... 39
Legal Opinions.......................................................... 39
Reports to Shareholders................................................. 39
Experts................................................................. 39
Further Information..................................................... 39
Table of Contents of Statement of Additional Information................ 40
Appendix A.............................................................. 41
</TABLE>
================================================================================
================================================================================
5,010,532 SHARES OF BENEFICIAL
INTEREST ISSUABLE UPON
EXERCISE OF RIGHTS TO
SUBSCRIBE FOR SUCH SHARES
COLONIAL INTERMEDIATE
HIGH INCOME FUND
SHARES OF BENEFICIAL INTEREST
------------------------------
PROSPECTUS
------------------------------
PAINEWEBBER INCORPORATED
------------------------
MAY 19, 1998
================================================================================
IH-01/326F-0598
<PAGE> 44
COLONIAL INTERMEDIATE HIGH INCOME FUND
STATEMENT OF ADDITIONAL INFORMATION
This Statement of Additional Information ("SAI") contains information which
may be useful to investors but which is not included in the Prospectus of
Colonial Intermediate High Income Fund (the "Fund"). This SAI is not a
prospectus and is only authorized for distribution when accompanied or preceded
by the Prospectus of the Fund dated May 19, 1998. This SAI should be read
together with the Prospectus. Investors may obtain a free copy of the Prospectus
dated May 19, 1998 and the Annual Report dated October 31, 1997 from the
Information Agent for the Offer, Shareholder Communications Corporation, 17
State Street, 27th Floor, New York, New York 10004, Telephone (800) 733-8481,
ext. 486.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Definitions................................................. 2
Investment Objective and Policies........................... 2
Fundamental Investment Policies............................. 2
Other Investment Policies................................... 3
Fund Charges and Expenses................................... 3
Management of the Fund...................................... 7
Custodian................................................... 7
Independent Accountants..................................... 8
Incorporation of Financial Statements by Reference.......... 8
Determination of Net Asset Value............................ 8
Portfolio Transactions...................................... 9
Miscellaneous Investment Practices.......................... 10
Taxes....................................................... 23
Shareholder Liability....................................... 27
</TABLE>
IH-16/327F-0598
<PAGE> 45
COLONIAL INTERMEDIATE HIGH INCOME FUND
STATEMENT OF ADDITIONAL INFORMATION
DEFINITIONS
<TABLE>
<S> <C>
"Fund" Colonial Intermediate High Income Fund
"Adviser" Colonial Management Associates, Inc., the Fund's investment
adviser
"First Data" First Data Investor Services Group, Inc., the Fund's
transfer agent, dividend disbursing agent, plan agent and
registrar
</TABLE>
INVESTMENT OBJECTIVE AND POLICIES
The Fund's Prospectus describes its investment objective and investment
policies. This SAI includes additional information concerning, among other
things, the investment policies of the Fund and information about certain
securities and investment techniques that are described or referred to in the
Prospectus or in which the Fund expects to engage. Except as indicated under
"Fundamental Investment Policies," the Fund's investment policies are not
fundamental and the Trustees may change the policies without shareholder
approval.
FUNDAMENTAL INVESTMENT POLICIES
The Investment Company Act of 1940, as amended (the "Act"), provides that a
"vote of a majority of the outstanding voting securities" means the affirmative
vote of the lesser of (1) more than 50% of the outstanding shares of the Fund,
or (2) 67% or more of the shares present at a meeting if more than 50% of the
outstanding shares are represented at the meeting in person or by proxy. The
following fundamental investment policies cannot be changed without such a vote.
Total assets and net assets are determined at current value for purposes of
compliance with investment restrictions and policies. All percentage limitations
will apply at the time of investment and are not violated unless an excess or
deficiency occurs as a result of such investment. For the purpose of the Act's
diversification requirement, an issuer is the entity whose revenues support the
security.
The Fund may:
1. Issue senior securities or borrow money to the extent permitted by
the Act;
2. Only own real estate acquired as a result of owning securities;
3. Purchase and sell interest rate futures contracts, foreign
currency forward or futures contracts, futures contracts on
indexes of securities, and options relating to any of the
foregoing;
4. Underwrite securities issued by others only when disposing of
portfolio securities;
5. Make loans through lending of securities, through the purchase of
debt instruments or similar evidences of indebtedness typically
sold to financial institutions and through repurchase agreements;
and
6. Not concentrate more than 25% of its total assets in any one
industry, or with respect to 75% of total assets purchase any
security (other than obligations of the U.S. Government and cash
items including receivables) if as a result more than 5% of its
total assets would then be invested in securities of a single
issuer or purchase the voting securities of an issuer if, as a
result of such purchase, the Fund would own more than 10% of the
outstanding voting shares of such issuer.
2
<PAGE> 46
OTHER INVESTMENT POLICIES
The following non-fundamental policies may be changed without shareholder
approval:
The Fund may not:
1. Purchase securities on margin, but it may receive short-term
credit to clear securities transactions and may make initial or
maintenance margin deposits in connection with futures
transactions;
2. Have a short securities position, unless the Fund owns, or owns
rights (exercisable without payment) to acquire, an equal amount
of such securities;
3. Own securities of any company if the Fund knows that officers and
Trustees of the Fund or officers or directors of the Adviser who
individually own more than 0.5% of such securities together own
more than 5% of such securities; and
4. Invest in interests in oil, gas or other mineral exploration or
development programs, including leases.
FUND CHARGES AND EXPENSES
Under the Fund's management agreement, the Fund pays the Adviser a monthly
fee based on the average weekly net assets of the Fund at the annual rate of
0.65%.
RECENT FEES PAID TO THE ADVISER AND FIRST DATA (dollars in thousands)
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31
----------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Management fee................................. $680 $631 $588
Bookkeeping fee................................ 46 43 41
Transfer agent fee............................. 51 53 59
</TABLE>
BROKERAGE COMMISSIONS
The Fund did not pay any brokerage commissions for the fiscal years ended
October 31, 1997, 1996 and 1995.
TRUSTEES AND OFFICERS
The Trustees and officers of the Fund, their addresses, their ages and
their principal occupations for at least the past five years are set forth
below.
<TABLE>
<CAPTION>
NAME AND ADDRESS AGE POSITION WITH FUND PRINCIPAL OCCUPATION
- ---------------- --- ------------------ --------------------
<S> <C> <C> <C>
Robert J. Birnbaum................... 70 Trustee Retired (formerly Special Counsel,
313 Bedford Road Dechert Price & Rhoads from
Ridgewood, NJ 07450 September, 1988 to December, 1993).
Tom Bleasdale........................ 67 Trustee Retired (formerly Chairman of the
11 Carriage Way Board and Chief Executive Officer,
Danvers, MA 01923 Shore Bank & Trust Company from
1992-1993), is a Director of Empire
Company Limited since June, 1995.
Lora S. Collins...................... 62 Trustee Attorney (formerly Attorney, Kramer,
1175 Hill Road Levin, Naftalis & Frankel from
Southold, NY 11971 September, 1986 to November, 1996).
James E. Grinnell.................... 68 Trustee Private Investor since November,
22 Harbor Avenue 1988.
Marblehead, MA 01945
Richard W. Lowry..................... 61 Trustee Private Investor since August, 1987.
10701 Charleston Drive
Vero Beach, FL 32963
</TABLE>
3
<PAGE> 47
<TABLE>
<CAPTION>
NAME AND ADDRESS AGE POSITION WITH FUND PRINCIPAL OCCUPATION
---------------- --- ------------------ --------------------
<S> <C> <C> <C>
William E. Mayer*.................... 57 Trustee Partner, Development Capital, LLC
500 Park Avenue, 5th Floor (formerly Dean, College of Business
New York, NY 10022 and Management, University of
Maryland from October, 1992 to
November, 1996, Dean, Simon Graduate
School of Business, University of
Rochester from October, 1991 to July,
1992).
James L. Moody, Jr................... 66 Trustee Retired (formerly Chairman of the
16 Running Tide Road Board, Hannaford Bros. Co. from May,
Cape Elizabeth, ME 04107 1984 to May, 1997, and Chief
Executive Officer, Hannaford Bros.
Co. from May, 1973 to May, 1992).
John J. Neuhauser.................... 55 Trustee Dean, Boston College School of
140 Commonwealth Avenue Management since 1977.
Chestnut Hill, MA 02167
Robert L. Sullivan................... 70 Trustee Retired Partner, KPMG Peat Marwick
7121 Natelli Woods Lane LLP.
Bethesda, MD 20817
Harold W. Cogger..................... 62 President President of Colonial Funds (defined
below) since March, 1996 (formerly
Vice President from July, 1993 to
March, 1996); is Director since
March, 1984 and Chairman of the Board
since March, 1996 of the Adviser
(formerly President from July, 1993,
to December, 1996, Chief Executive
Officer from March, 1995 to December,
1996 and Executive Vice President
from October, 1989 to July, 1993);
Director since October, 1991 and
Chairman of the Board since March,
1996 of TCG (formerly President from
October, 1994 to December, 1996 and
Chief Executive Officer from March,
1995 to December, 1996); Executive
Vice President and Director since
March, 1995, Liberty Financial;
Director since November, 1996 of
Stein Roe & Farnham Incorporated.
J. Kevin Connaughton................. 33 Controller and Chief Controller and Chief Accounting
Accounting Officer Officer of Colonial Funds since
February, 1998; Vice President of the
Adviser since February, 1998
(formerly Senior Tax Manager, Coopers
& Lybrand, LLP from April, 1996 to
January, 1998; Vice President, 440
Financial Group/First Data Investor
Services Group from March, 1994 to
April, 1996; Vice President, The
Boston Company (subsidiary of Mellon
Bank) from December, 1993 to March,
1994; Assistant Vice President and
Tax Manager, Mellon Bank from March,
1992 to December, 1993).
</TABLE>
4
<PAGE> 48
<TABLE>
<CAPTION>
NAME AND ADDRESS AGE POSITION WITH FUND PRINCIPAL OCCUPATION
---------------- --- ------------------ --------------------
<S> <C> <C> <C>
Timothy J. Jacoby.................... 45 Treasurer and Chief Treasurer and Chief Financial Officer
Financial Officer of Colonial Funds since October, 1996
(formerly Controller and Chief
Accounting Officer from October, 1997
to February, 1998); Senior Vice
President of the Adviser since
September, 1996 (formerly Senior Vice
President, Fidelity Accounting and
Custody Services from September, 1993
to September, 1996 and Assistant
Treasurer to the Fidelity Group of
Funds from August, 1990 to September,
1993).
Davey S. Scoon....................... 51 Vice President Vice President of Colonial Funds
since June, 1993; Executive Vice
President since July, 1993 and
Director since March, 1985 of the
Adviser (formerly Senior Vice
President and Treasurer of the
Adviser from March, 1985 to July,
1993); Executive Vice President and
Chief Operating Officer, TCG since
March, 1995 (formerly Vice
President -- Finance and
Administration of TCG from November,
1985 to March, 1995).
Nancy L. Conlin...................... 44 Secretary Secretary of Colonial Funds since
April, 1998 (formerly Assistant
Secretary from July, 1994 to April,
1998); Director, Senior Vice
President, General Counsel, Clerk and
Secretary of the Adviser since April,
1998 (formerly Vice President,
Counsel, Assistant Secretary and
Assistant Clerk from July, 1994 to
April, 1998), Vice
President -- Legal, General Counsel
and Clerk of TCG since April, 1998
(formerly Assistant Clerk from July,
1994 to April, 1998).
</TABLE>
- ---------------
* A Trustee who is an "interested person" (as defined in the Act) of the Fund or
the Adviser.
The business address of the officers of the Fund is One Financial Center,
Boston, Massachusetts 02111.
The Trustees serve as trustees of all Colonial Funds, for which each
Trustee will receive an annual retainer of $45,000 and attendance fees of $7,500
for each regular joint meeting and $1,000 for each special joint meeting.
Committee chairs receive an annual retainer of $5,000. Committee members receive
an annual retainer of $1,000 and $1,000 for each special meeting attended.
Two-thirds of the Trustee fees are allocated among the Colonial Funds based on
each Fund's relative net assets, and one-third of the fees are divided equally
among the Colonial Funds.
TRUSTEES' FEES
For the fiscal year ended October 31, 1997, and the calendar year ended
December 31, 1997, the Trustees received the following compensation for serving
as Trustees(a):
<TABLE>
<CAPTION>
TOTAL COMPENSATION FROM FUND AND
AGGREGATE COMPENSATION FROM FUND COMPLEX PAID TO THE TRUSTEES FOR
FUND FOR THE YEAR ENDED THE CALENDAR YEAR ENDED
TRUSTEE OCTOBER 31, 1997 DECEMBER 31, 1997(B)
------- --------------------------- -------------------------------------
<S> <C> <C>
Robert J. Birnbaum..................... $1,042 $ 93,949
Tom Bleasdale.......................... 1,191(c) 106,432(d)
Lora S. Collins........................ 1,045 93,949
James E. Grinnell...................... 1,076(e) 94,698(f)
</TABLE>
5
<PAGE> 49
<TABLE>
<CAPTION>
TOTAL COMPENSATION FROM FUND AND
AGGREGATE COMPENSATION FROM FUND COMPLEX PAID TO THE TRUSTEES FOR
FUND FOR THE YEAR ENDED THE CALENDAR YEAR ENDED
TRUSTEE OCTOBER 31, 1997 DECEMBER 31, 1997(B)
------- --------------------------- -------------------------------------
<S> <C> <C>
William D. Ireland, Jr.(g)............. 1,133 101,445
Richard W. Lowry....................... 1,050 94,698
William E. Mayer....................... 994 89,949
James L. Moody, Jr..................... 1,097(h) 98,447(i)
John J. Neuhauser...................... 1,053 94,948
George L. Shinn(g)..................... 1,159 103,443
Robert L. Sullivan..................... 1,114 99,945
Sinclair Weeks, Jr.(g)................. 1,132 101,445
</TABLE>
- ---------------
<TABLE>
<S> <C>
(a) The Fund does not currently provide pension or retirement
plan benefits to the Trustees.
(b) At December 31, 1997, the Colonial Funds complex consisted
of 39 open-end and 5 closed-end management investment
company portfolios (together, the "Colonial Funds").
(c) Includes $697 payable in later years as deferred
compensation.
(d) Includes $57,454 payable in later years as deferred
compensation.
(e) Includes $28 payable in later years as deferred
compensation.
(f) Includes $4,797 payable in later years as deferred
compensation.
(g) Effective April 24, 1998, Messrs. Ireland, Shinn and Weeks
retired as Trustees of the Fund.
(h) Includes $1,097 payable in later years as deferred
compensation.
(i) Total compensation of $98,447 for the calendar year ended
December 31, 1997 will be payable in later years as deferred
compensation.
</TABLE>
The following table sets forth the amount of compensation paid to Messrs.
Birnbaum, Grinnell and Lowry in their capacities as Trustees or Directors of the
Liberty All-Star Equity Fund and of the Liberty All-Star Growth Fund, Inc.
(formerly known as The Charles Allmon Trust, Inc.) (together, the "Liberty
Funds") for service during the calendar year ended December 31, 1997:
<TABLE>
<CAPTION>
TOTAL COMPENSATION FROM
LIBERTY FUNDS FOR THE CALENDAR
TRUSTEE YEAR ENDED DECEMBER 31, 1997(J)
------- -------------------------------
<S> <C>
Robert J. Birnbaum................................. $26,800
James E. Grinnell.................................. 26,800
Richard W. Lowry................................... 26,800
</TABLE>
- ---------------
(j) The Liberty Funds are advised by Liberty Asset Management Company ("LAMCO").
LAMCO is an indirect wholly owned subsidiary of Liberty Financial Companies,
Inc. ("Liberty Financial") (an intermediate parent of the Adviser).
OWNERSHIP OF THE FUND
At April 30, 1998, the officers and Trustees of the Fund as a group owned
less than 1% of the outstanding shares of the Fund.
At April 30, 1998, The Depository Trust Company (Cede & Co.), 7 Hanover
Square, New York, New York 10004, owned of record 13,016,987 shares representing
86.94% of the Fund's outstanding shares.
6
<PAGE> 50
MANAGEMENT OF THE FUND
The Adviser is the investment adviser to each of the Colonial Funds (except
for Colonial Municipal Money Market Fund, Colonial Global Utilities Fund,
Newport Tiger Fund, Colonial Newport Tiger Cub Fund, Newport Japan Opportunities
Fund and Newport Greater China Fund, for each of which the Adviser serves as
Administrator). The Adviser is a subsidiary of The Colonial Group, Inc. ("TCG"),
One Financial Center, Boston, Massachusetts 02111. TCG is a direct subsidiary of
Liberty Financial Companies, Inc. ("Liberty Financial"), which in turn is a
direct subsidiary of LFC Holdings, Inc., which in turn is a direct subsidiary of
Liberty Mutual Equity Corporation, which in turn is a wholly-owned subsidiary of
Liberty Mutual Insurance Company ("Liberty Mutual"). Liberty Mutual is an
underwriter of workers' compensation insurance and a property and casualty
insurer in the U.S. Liberty Financial's address is 600 Atlantic Avenue, Boston,
Massachusetts 02210. Liberty Mutual's address is 175 Berkeley Street, Boston,
Massachusetts 02117.
Under a Management Agreement (the "Agreement"), the Adviser has agreed to
furnish the Fund with investment research and recommendations, and office space,
equipment and other facilities at the Adviser's expense. For these services and
facilities, the Fund pays a monthly fee equal, on an annual basis, to 0.65% of
the average weekly net assets of the Fund (which, for the purposes of
determining such fee, shall mean the average weekly value of the total assets of
the Fund, minus the sum of accrued liabilities of the Fund). The Fund pays
operating costs, including auditing, legal, administration, custodian, Trustees,
shareholder services and transfer and dividend paying agent and registrar fees
and expenses.
Under the Agreement, any liability of the Adviser to the Fund and its
shareholders is limited to situations involving the Adviser's own willful
misfeasance, bad faith, gross negligence or reckless disregard of duties.
The Agreement may be terminated at any time on 60 days' notice by the
Adviser or by the Trustees of the Fund or by vote of a majority of the
outstanding voting securities of the Fund. The Agreement will automatically
terminate upon any assignment thereof and will continue in effect after two
years from the date of its execution only so long as such continuance is
approved at least annually (i) by the Trustees of the Fund or by vote of a
majority of the outstanding voting securities of the Fund and (ii) by vote of a
majority of the Trustees who are not interested persons (as such term is defined
in the Act) of the Adviser or the Fund, cast in person at a meeting called for
the purpose of voting on such approval.
The Adviser also provides the Fund with bookkeeping and pricing services,
and for these services, the Fund pays the Adviser a monthly fee of $2,250 for
the first $50 million of Fund assets, plus a monthly percentage fee at the
following annual rates: .035% on the next $950 million; .025% on the next $1
billion; .015% on the next $1 billion; and .001% on the excess over $3 billion
of the average net assets of the Fund for such month.
The Adviser also acts as investment adviser to the other Colonial Funds
(described under "Fund Charges and Expenses--Trustees' Fees"). Various officers
and Trustees of the Fund also serve as officers, directors or trustees of other
Funds advised by the Adviser and of other corporate or fiduciary clients of the
Adviser. The other investment companies and clients advised by the Adviser may
sometimes invest in securities and options in which the Fund will also invest.
If the Fund, such other investment companies and such clients desire to buy or
sell the same portfolio securities or options at about the same time, the
purchases and sales will normally be made as nearly as practicable on a pro rata
basis in proportion to the amounts desired to be purchased or sold by each.
Although in some cases these practices may have a detrimental effect on the
price or volume of the securities or options as far as the Fund is concerned, in
most cases it is believed that these practices should produce better executions.
CUSTODIAN
The Chase Manhattan Bank (the "Custodian") is the Fund's custodian. The
Custodian is responsible for safeguarding the Fund's cash and securities,
receiving and delivering securities and collecting the Fund's interest and
dividends. The Custodian's address is 4 Chase MetroTech Center, Brooklyn, New
York 11245.
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INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP are the Fund's independent accountants providing audit
and tax return preparation services and assistance and consultation in
connection with the review of various Securities and Exchange Commission
filings. The address of Price Waterhouse LLP is 160 Federal Street, Boston,
Massachusetts 02110. The financial statements incorporated by reference in this
SAI have been so incorporated, and the financial highlights included in the
Prospectus have been so included, in reliance upon the report of Price
Waterhouse LLP given on the authority of said firm as experts in accounting and
auditing.
The financial statements and Report of Independent Accountants appearing in
the October 31, 1997 Annual Report are incorporated in this SAI by reference.
INCORPORATION OF FINANCIAL STATEMENTS BY REFERENCE
The Fund's Annual Report, which includes financial statements for the
fiscal year ended October 31, 1997 and which either accompanies the Prospectus
or has previously been provided to persons to whom the Prospectus has been sent,
is incorporated herein by reference with respect to all information other than
the information set forth in the Letter to Shareholders included therein. Any
statement contained in the Fund's Annual Report that was incorporated herein
shall be deemed modified or superseded for purposes of the Prospectus or this
SAI to the extent a statement contained in the Prospectus or this SAI varies
from such statement. Any such statement so modified or superseded shall not,
except as so modified or superseded, be deemed to constitute a part of the
Prospectus or this SAI. The Information Agent for the Offer will furnish,
without charge, a copy of its Annual Report, upon request to Shareholder
Communications Corporation, 17 State Street, 27th Floor, New York, New York
10004, telephone (800) 733-8481, ext. 486, Monday through Friday from 9:00 a.m.
to 5:00 p.m.
DETERMINATION OF NET ASSET VALUE
Net asset value ("NAV") of the Fund's shares will be determined as of the
close of regular trading on the Exchange (generally 4:00 p.m. New York City
time) on the last Business Day of each week (generally Friday), and at such
other times as the Fund may authorize. It will be determined by dividing the
value of the net assets of the Fund (for the purpose of determining the net
asset value per share, the value of the Fund's net assets shall be deemed to
equal the value of the Fund's assets less the Fund's liabilities (including the
outstanding principal amount of the Term Note and unpaid interest on the Term
Note)) by the total number of shares outstanding. Portfolio securities for which
market quotations are readily available are valued at current market value.
Short term investments maturing in 60 days or less are valued at amortized cost
when the Adviser determines, pursuant to procedures adopted by the Board of
Trustees, that such cost approximates current market value. All other securities
and assets are valued at their fair value following procedures adopted by the
Board of Trustees.
Debt securities generally are valued by a pricing service which determines
valuations based upon market transactions for normal, institutional-size trading
units of similar securities. However, in circumstances where such prices are not
available or where the Adviser deems it appropriate to do so, an
over-the-counter or exchange bid quotation is used. Securities listed on an
exchange or on NASDAQ are valued at the last sale price. Listed securities for
which there were no sales during the day and unlisted securities are valued at
the last quoted bid price. Options are valued at the last sale price or, in the
absence of a sale, the mean between the last quoted bid and offering prices.
Short-term obligations with a maturity of 60 days or less are valued at
amortized cost pursuant to procedures adopted by the Trustees. The values of
foreign securities quoted in foreign currencies are translated into U.S. dollars
at the exchange rate for that day. Portfolio positions for which there are no
such valuations and other assets are valued at fair value as determined by the
Adviser in good faith under the direction of the Fund's Trustees.
Generally, trading in certain securities (such as foreign securities) is
substantially completed each day at various times prior to the close of regular
trading on the Exchange. Trading on certain foreign securities markets may not
take place on all business days in New York, and trading on some foreign
securities markets
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takes place on days which are not business days in New York and on which the
Fund's NAV is not calculated. The values of these securities used in determining
the NAV are computed as of such times. Also, because of the amount of time
required to collect and process trading information as to large numbers of
securities, the values of certain securities (such as convertible bonds, U.S.
government securities and tax-exempt securities) are determined based on market
quotations collected earlier in the day at the latest practicable time prior to
the close of regular trading on the Exchange. Occasionally, events affecting the
value of such securities may occur between such times and the close of the
Exchange which will not be reflected in the computation of the Fund's NAV. If
events materially affecting the value of such securities occur during such
period, then these securities will be valued at their fair value following
procedures approved by the Fund's Trustees.
PORTFOLIO TRANSACTIONS
The Adviser is responsible for decisions to buy and sell securities and
other portfolio holdings for the Fund, the selection of brokers and dealers to
effect the transactions and the negotiation of brokerage commissions, if any.
Fixed-income securities are generally traded on a "net" basis with dealers
acting as principals for their own accounts without a stated commission,
although the price of the security will likely include a profit to the dealer.
In underwritten offerings, securities are usually purchased at a fixed price
which includes an amount of compensation to the underwriter, generally referred
to as the underwriter's concession or discount. On occasion, certain money
market instruments may be purchased directly from an issuer, in which case no
commissions or discounts are paid.
In placing orders for portfolio securities of the Fund, the Adviser is
required to give primary consideration to obtaining the most favorable price and
efficient execution. This means that the Adviser will seek to execute each
transaction at a price and commission, if any, which provides the most favorable
total cost or proceeds reasonably attainable under the circumstances. In seeking
the most favorable price and execution, the Adviser, having in mind the Fund's
best interests, will consider all factors it deems relevant, including, by way
of illustration, price, the size of the transaction, the nature of the market
for the security, the amount of commission, the timing of the transaction taking
into account market prices and trends, the reputation, experience and financial
stability of the broker-dealer involved and the quality of service rendered by
the broker-dealer in other transactions. Though the Adviser generally seeks
reasonably competitive spreads or commissions, the Fund will not necessarily be
paying the lowest spread or commission available. Within the framework of the
policy of obtaining the most favorable price and efficient execution, the
Adviser will consider research and investment services provided by brokers and
dealers who effect or are parties to portfolio transactions with the Fund, the
Adviser or the Adviser's other clients. Such research and investment services
are those which brokerage houses customarily provide to institutional investors
and include statistical and economic data and research reports on particular
issuers and industries. Such services are used by the Adviser in connection with
all of its investment activities, and some of such services obtained in
connection with the execution of transactions for the Fund may be used in
managing other investment accounts. Conversely, brokers furnishing such services
may be selected for the execution of transactions for such other accounts, and
the services furnished by such brokers may be used by the Adviser in providing
investment management for the Fund. Commission rates are established pursuant to
negotiations based on the quality and quantity of execution services provided by
the broker or dealer in light of generally prevailing rates. The management fee
paid by the Fund will not be reduced because the Adviser and/or other clients
receive such services. The allocation of orders and the commission rates paid by
the Fund will be reviewed periodically by the Board of Trustees.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, as
amended (the "1934 Act"), the Adviser may cause the Fund to pay a broker-dealer
which provides "brokerage and research services" (as defined in the 1934 Act) to
the Adviser, an amount of disclosed commission for effecting a securities
transaction for the Fund in excess of the commission which another broker-dealer
would have charged for effecting that transaction.
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For the fiscal years ended October 31, 1995, 1996 and 1997, the Fund paid
no brokerage commissions for the execution of portfolio transactions. The rate
of portfolio turnover for each of the fiscal years ended October 31, 1995, 1996
and 1997 was 92%.
MISCELLANEOUS INVESTMENT PRACTICES
SHORT-TERM TRADING
In seeking the Fund's objective, the Adviser will buy or sell portfolio
securities whenever the Adviser believes it appropriate to do so. In deciding
whether to sell a portfolio security, the Adviser does not consider how long the
Fund has owned the security. From time to time the Fund will buy securities
intending to seek short-term trading profits. A change in the securities held by
the Fund is known as "portfolio turnover" and generally involves some expense to
the Fund. This expense may include brokerage commissions or dealer markups and
other transaction costs on both the sale of securities and the reinvestment of
the proceeds in other securities. If sales of portfolio securities cause the
Fund to realize net short-term capital gains, such gains will be taxable as
ordinary income. As a result of the Fund's investment policies, under certain
market conditions the Fund's portfolio turnover rate may be higher than that of
other investment companies. Portfolio turnover rate for a fiscal year is the
ratio of the lesser of purchases or sales of portfolio securities to the monthly
average of the value of portfolio securities -- excluding securities whose
maturities at acquisition were one year or less. The Fund's portfolio turnover
rate is not a limiting factor when the Adviser considers a change in the Fund's
portfolio.
LOWER-RATED SECURITIES
The Fund may invest all or any portion of its assets in lower-rated
securities (commonly known as "high yield," high risk securities or "junk
bonds"). The lower ratings of certain securities held by the Fund reflect a
greater possibility that adverse changes in the financial condition of the
issuer or in general economic conditions, or both, or an unanticipated rise in
interest rates, may impair the ability of the issuer to make payments of
interest and principal. The inability (or perceived inability) of issuers to
make timely payments of interest and principal would likely make the values of
securities held by the Fund more volatile and could limit the Fund's ability to
sell its securities at prices approximating the values the Fund had placed on
such securities. In the absence of a liquid trading market for securities held
by it, the Fund at times may be unable to establish the fair value for such
securities.
Securities ratings are based largely on the issuer's historical financial
condition and the rating agencies' analysis at the time of rating. Consequently,
the rating assigned to any particular security is not necessarily a reflection
of the issuer's current financial condition, which may be better or worse than
the rating would indicate. In addition, the rating assigned to a security by
Moody's Investors Service, Inc. or Standard & Poor's Ratings Group (or by any
other nationally recognized securities rating organization) does not reflect an
assessment of the volatility of the security's market value or the liquidity of
an investment in the security. See Appendix A to the Prospectus for a
description of security ratings.
Like those of other fixed-income securities, the values of lower-rated
securities fluctuate in response to changes in interest rates. A decrease in
interest rates will generally result in an increase in the value of the Fund's
assets. Conversely, during periods of rising interest rates, the value of the
Fund's assets will generally decline. The values of lower-rated securities may
often be affected to a greater extent by changes in general economic conditions
and business conditions affecting the issuers of such securities and their
industries. Negative publicity or investor perceptions may also adversely affect
the values of lower-rated securities. Changes by recognized rating services in
their ratings of any fixed-income security and changes in the ability of an
issuer to make payments of interest and principal may also affect the value of
these investments. Changes in the value of portfolio securities generally will
not affect income derived from these securities, but will affect the Fund's net
asset value. The Fund will not necessarily dispose of a security when its rating
is reduced below its rating at the time of purchase. However, the Adviser will
monitor the investment to determine whether its retention will assist in meeting
the Fund's investment objective.
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<PAGE> 54
Issuers of lower-rated securities are often highly leveraged, so that their
ability to service their debt obligations during an economic downturn or during
sustained periods of rising interest rates may be impaired. Such issuers may not
have more traditional methods of financing available to them and may be unable
to repay outstanding obligations at maturity by refinancing. The risk of loss
due to default in payment of interest or repayment of principal by such issuers
is significantly greater because such securities frequently are unsecured and
subordinated to the prior payment of senior indebtedness.
At times, a substantial portion of the Fund's assets may be invested in
securities as to which the Fund, by itself or together with other Funds and
accounts managed by the Adviser and its affiliates, holds all or a major portion
of the securities outstanding. Although the Adviser generally considers such
securities to be liquid because of the availability of an institutional market
for such securities, it is possible that, under adverse market or economic
conditions or in the event of adverse changes in the financial condition of the
issuer, the Fund could find it more difficult to sell these securities when the
Adviser believes it advisable to do so or may be able to sell the securities
only at prices lower than if they were more widely held. Under these
circumstances, it may also be more difficult to determine the fair value of such
securities for purposes of computing the Fund's net asset value. In order to
enforce its rights in the event of a default under such securities, the Fund may
be required to participate in various legal proceedings or take possession of
and manage assets securing the issuer's obligations on such securities. This
could increase the Fund's operating expenses and adversely affect the Fund's net
asset value.
Certain securities held by the Fund may permit the issuer at its option to
"call," or redeem, its securities. If an issuer were to redeem securities held
by the Fund during a time of declining interest rates, the Fund might not be
able to reinvest the proceeds in securities providing the same investment return
as the securities redeemed. The Fund may invest without limit in such bonds.
Zero-coupon bonds are issued at a significant discount from their principal
amount in lieu of paying interest periodically. Payment-in-kind bonds allow the
issuer, at its option, to make current interest payments on the bonds either in
cash or in additional bonds. Because zero coupon and payment-in-kind bonds do
not pay current interest in cash, their value is subject to greater fluctuation
in response to changes in market interest rates than bonds that pay interest
currently. Both zero coupon and payment-in-kind bonds allow an issuer to avoid
the need to generate cash to meet current interest payments. Accordingly, such
bonds may involve greater credit risks than bonds paying interest currently in
cash. The Fund is required to accrue interest income on such investments and to
distribute such amounts at least annually to shareholders even though such bonds
do not pay current interest in cash. Thus, it may be necessary at times for the
Fund to liquidate investments in order to satisfy its dividend distribution
requirements.
To the extent the Fund invests in securities in the lower rating
categories, the achievement of the Fund's goals is more dependent on the
Adviser's investment analysis than would be the case if the Fund were investing
in securities in the higher rating categories.
PRIVATE PLACEMENTS
The Fund may invest in securities that are purchased in private placements
and, accordingly, are subject to restrictions on resale as a matter of contract
or under federal securities laws. Because there may be relatively few potential
purchasers for such investments, especially under adverse market or economic
conditions or in the event of adverse changes in the financial condition of the
issuer, the Fund could find it more difficult to sell such securities when the
Adviser believes it advisable to do so or may be able to sell such securities
only at prices lower than if such securities were more widely held. At times, it
may also be more difficult to determine the fair value of such securities for
purposes of computing the Fund's net asset value.
STEP COUPON BONDS (STEPS)
The Fund may invest in debt securities which do not pay interest for a
stated period of time and then pay interest at a series of different rates for a
series of periods. In addition to the risks associated with the credit rating of
the issuers, these securities are subject to the volatility risk of zero coupon
bonds for the period when no interest is paid.
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TENDER OPTION BONDS
A tender option bond is a municipal security (generally held pursuant to a
custodial arrangement) having a relatively long maturity and bearing interest at
a fixed rate substantially higher than prevailing short-term tax-exempt rates
that has been coupled with the agreement of a third party, such as a bank,
broker-dealer or other financial institution, pursuant to which such institution
grants the security holders the option, at periodic intervals, to tender their
securities to the institution and receive the face value thereof. As
consideration for providing the option, the financial institution receives
periodic fees equal to the difference between the municipal security's fixed
coupon rate and the rate, as determined by a remarketing or similar agent at or
near the commencement of such period, that would cause the securities, coupled
with the tender option, to trade at par on the date of such determination. Thus,
after payment of this fee, the security holder effectively holds a demand
obligation that bears interest at the prevailing short-term tax-exempt rate. The
Adviser will consider on an ongoing basis the creditworthiness of the issuer of
the underlying municipal securities, of any custodian, and of the third-party
provider of the tender option. In certain instances and for certain tender
option bonds, the option may be terminable in the event of a default in payment
of principal or interest on the underlying municipal securities and for other
reasons.
PAY-IN-KIND (PIK) SECURITIES
The Fund may invest in securities which pay interest either in cash or
additional securities at the issuer's option. These securities are generally
high yield securities and in addition to the other risks associated with
investing in high yield securities are subject to the risks that the interest
payments, which consist of additional securities, will also be subject to the
risks of high yield securities.
MONEY MARKET INSTRUMENTS
The Fund may invest in short-term money market instruments as follows:
Government obligations are issued by the U.S. or foreign governments, their
subdivisions, agencies and instrumentalities. Supranational obligations are
issued by supranational entities and are generally designed to promote economic
improvements. Certificates of deposit are issued against deposits in a
commercial bank with a defined return and maturity. Banker's acceptances are
used to finance the import, export or storage of goods and are "accepted" when
guaranteed at maturity by a bank. Commercial paper is promissory notes issued by
businesses to finance short-term needs (including those with floating or
variable interest rates, or including a frequent interval put feature).
Short-term corporate obligations are bonds and notes (with one year or less to
maturity at the time of purchase) issued by businesses to finance long-term
needs.
SECURITIES LOANS
The Fund may make secured loans of its portfolio securities, on either a
short-term or long-term basis, thereby realizing additional income. The risks in
lending portfolio securities, as with other extensions of credit, consist of
possible delay in recovery of the securities or possible loss of rights in the
collateral should the borrower fail financially. As a matter of policy,
securities loans are made to broker-dealers pursuant to agreements requiring
that the loans be continuously secured by collateral consisting of cash or
short-term debt obligations at least equal at all times to the value of the
securities on loan, "marked-to-market" daily. The borrower pays to the Fund an
amount equal to any dividends or interest received on securities loaned. The
Fund retains all or a portion of the interest received on investment of the cash
collateral or receives a fee from the borrower. Although voting rights, or
rights to consent, with respect to the loaned securities may pass to the
borrower, the Fund retains the right to call the loans at any time on reasonable
notice, and it will do so to enable the Fund to exercise voting rights on any
matters materially affecting the investment. The Fund may also call such loans
in order to sell the securities.
FORWARD COMMITMENTS
The Fund may enter into contracts to purchase securities for a fixed price
at a future date beyond customary settlement time ("forward commitments") if the
Fund sets aside, on the books and records of its custodian, liquid assets in an
amount sufficient to meet the purchase price, or if the Fund enters into
offsetting
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contracts for the forward sale of other securities it owns. In the case of
to-be-announced ("TBA") purchase commitments, the unit price and the estimated
principal amount are established when the Fund enters into a contract, with the
actual principal amount being within a specified range of the estimate. Forward
commitments may be considered securities in themselves, and involve a risk of
loss if the value of the security to be purchased declines prior to the
settlement date, which risk is in addition to the risk of decline in the value
of the Fund's other assets. Where such purchases are made through dealers, the
Fund relies on the dealer to consummate the sale. The dealer's failure to do so
may result in the loss to the Fund of an advantageous yield or price. Although
the Fund will generally enter into forward commitments with the intention of
acquiring securities for its portfolio or for delivery pursuant to options
contracts it has entered into, the Fund may dispose of a commitment prior to
settlement if the Adviser deems it appropriate to do so. The Fund may realize
short-term profits or losses on the sale of forward commitments.
The Fund may enter into TBA sale commitments to hedge its portfolio
positions or to sell securities it owns under delayed delivery arrangements.
Proceeds of TBA sale commitments are not received until the contractual
settlement date. During the time a TBA sale commitment is outstanding,
equivalent deliverable securities, or an offsetting TBA purchase commitment
deliverable on or before the sale commitment date, are held as "cover" for the
transaction. Unsettled TBA sale commitments are valued at current market value
of the underlying securities. If the TBA sale commitment is closed through the
acquisition of an offsetting purchase commitment, the Fund realizes a gain or
loss on the commitment without regard to any unrealized gain or loss on the
underlying security. If the Fund delivers securities under the commitment, the
Fund realizes a gain or loss from the sale of the securities based upon the unit
price established at the date the commitment was entered into.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements. A repurchase agreement is a
contract under which the Fund acquires a security for a relatively short period
(usually not more than one week), subject to the obligation of the seller to
repurchase and the Fund to resell such security at a fixed time and price
(representing the Fund's cost plus interest). It is the Fund's present intention
to enter into repurchase agreements only with commercial banks and registered
broker-dealers and only with respect to obligations of the U.S. government or
its agencies or instrumentalities. Repurchase agreements may also be viewed as
loans made by the Fund which are collateralized by the securities subject to
repurchase. The Adviser will monitor such transactions to ensure that the value
of the underlying securities will be at least equal at all times to the total
amount of the repurchase obligation, including the interest factor. If the
seller defaults, the Fund could realize a loss on the sale of the underlying
security to the extent that the proceeds of sale, including accrued interest,
are less than the resale price provided in the agreement, including interest. In
addition, if the seller should be involved in bankruptcy or insolvency
proceedings, the Fund may incur delay and costs in selling the underlying
security or may suffer a loss of principal and interest if the Fund is treated
as an unsecured creditor and required to return the underlying collateral to the
seller's estate.
Pursuant to an exemptive order issued by the Securities and Exchange
Commission, the Fund may transfer uninvested cash balances into a joint account,
along with cash of other Colonial Funds and certain other accounts. These
balances may be invested in one or more repurchase agreements and/or short-term
money market instruments.
OPTIONS ON SECURITIES
WRITING COVERED OPTIONS. The Fund may write covered call options and
covered put options on optionable securities held in its portfolio, when in the
opinion of the Adviser such transactions are consistent with the Fund's
investment objective and policies. Call options written by the Fund give the
purchaser the right to buy the underlying securities from the Fund at a stated
exercise price; put options give the purchaser the right to sell the underlying
securities to the Fund at a stated price.
The Fund may write only covered options, which means that, so long as the
Fund is obligated as the writer of a call option, it will own the underlying
securities subject to the option (or comparable securities satisfying the cover
requirements of securities exchanges). In the case of put options, the Fund will
hold cash
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and/or high-grade short-term debt obligations equal to the price to be paid if
the option is exercised. In addition, the Fund will be considered to have
covered a put or call option if and to the extent that it holds an option that
offsets some or all of the risk of the option it has written. The Fund may write
combinations of covered puts and calls on the same underlying security.
The Fund will receive a premium from writing a put or call option, which
increases the Fund's return on the underlying security in the event the option
expires unexercised or is closed out at a profit. The amount of the premium
reflects, among other things, the relationship between the exercise price and
the current market value of the underlying security, the volatility of the
underlying security, the amount of time remaining until expiration, current
interest rates and the effect of supply and demand in the options market and in
the market for the underlying security. By writing a call option, the Fund
limits its opportunity to profit from any increase in the market value of the
underlying security above the exercise price of the option but continues to bear
the risk of a decline in the value of the underlying security. By writing a put
option, the Fund assumes the risk that it may be required to purchase the
underlying security for an exercise price higher than its then-current market
value, resulting in a potential capital loss unless the security subsequently
appreciates in value.
The Fund may terminate an option that it has written prior to its
expiration by entering into a closing purchase transaction in which it purchases
an offsetting option. The Fund realizes a profit or loss from a closing
transaction if the cost of the transaction (option premium plus transaction
costs) is less or more than the premium received from writing the option. If the
Fund writes a call option but does not own the underlying security, and when it
writes a put option, the Fund may be required to deposit cash or securities with
its broker as "margin," or collateral, for its obligation to buy or sell the
underlying security. As the value of the underlying security varies, the Fund
may have to deposit additional margin with the broker. Margin requirements are
complex and are fixed by individual brokers, subject to minimum requirements
currently imposed by the Federal Reserve Board and by stock exchanges and other
self-regulatory organizations.
PURCHASING PUT OPTIONS. The Fund may purchase put options to protect its
portfolio holdings in an underlying security against a decline in market value.
Such protection is provided during the life of the put option since the Fund, as
holder of the option, is able to sell the underlying security at the put
exercise price regardless of any decline in the underlying security's market
price. In order for a put option to be profitable, the market price of the
underlying security must decline sufficiently below the exercise price to cover
the premium and transaction costs. By using put options in this manner, the Fund
will reduce any profit it might otherwise have realized from appreciation of the
underlying security by the premium paid for the put option and by transaction
costs.
PURCHASING CALL OPTIONS. The Fund may purchase call options to hedge
against an increase in the price of securities that the Fund wants ultimately to
buy. Such hedge protection is provided during the life of the call option since
the Fund, as holder of the call option, is able to buy the underlying security
at the exercise price regardless of any increase in the underlying security's
market price. In order for a call option to be profitable, the market price of
the underlying security must rise sufficiently above the exercise price to cover
the premium and transaction costs.
RISK FACTORS IN OPTIONS TRANSACTIONS
The successful use of the Fund's options strategies depends on the ability
of the Adviser to forecast interest rate and market movements correctly. For
example, if the Fund were to write a call option based on the Adviser's
expectation that the price of the underlying security would fall, but the price
were to rise instead, the Fund could be required to sell the security upon
exercise at a price below the current market price. Similarly, if the Fund were
to write a put option based on the Adviser's expectation that the price of the
underlying security would rise, but the price were to fall instead, the Fund
could be required to purchase the security upon exercise at a price higher than
the current market price.
When the Fund purchases an option, it runs the risk that it will lose its
entire investment in the option in a relatively short period of time, unless the
Fund exercises the option or enters into a closing sale transaction before the
option's expiration. If the price of the underlying security does not rise (in
the case of a call) or fall (in the case of a put) to an extent sufficient to
cover the option premium and transaction costs, the Fund will
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lose part or all of its investment in the option. This contrasts with an
investment by the Fund in the underlying security, since the Fund will not
realize a loss if the security's price does not change.
The effective use of options also depends on the Fund's ability to
terminate option positions at times when the Adviser deems it desirable to do
so. There is no assurance that the Fund will be able to effect closing
transactions at any particular time or at an acceptable price.
If a secondary market in options were to become unavailable, the Fund could
no longer engage in closing transactions. Lack of investor interest might
adversely affect the liquidity of the market for particular options or series of
options. A market may discontinue trading of a particular option or options
generally. In addition, a market could become temporarily unavailable if unusual
events -- such as volume in excess of trading or clearing capability -- were to
interrupt its normal operations.
A market may at times find it necessary to impose restrictions on
particular types of options transactions, such as opening transactions. For
example, if an underlying security ceases to meet qualifications imposed by the
market or the Options Clearing Corporation, new series of options on that
security will no longer be opened to replace expiring series, and opening
transactions in existing series may be prohibited. If an options market were to
become unavailable, the Fund as a holder of an option would be able to realize
profits or limit losses only by exercising the option, and the Fund, as option
writer, would remain obligated under the option until expiration or exercise.
Disruptions in the markets for the securities underlying options purchased
or sold by the Fund could result in losses on the options. If trading is
interrupted in an underlying security, the trading of options on that security
is normally halted as well. As a result, the Fund as purchaser or writer of an
option will be unable to close out its positions until options trading resumes,
and it may be faced with considerable losses if trading in the security reopens
at a substantially different price. In addition, the Options Clearing
Corporation or other options markets may impose exercise restrictions. If a
prohibition on exercise is imposed at the time when trading in the option has
also been halted, the Fund as purchaser or writer of an option will be locked
into its position until one of the two restrictions has been lifted. If the
Options Clearing Corporation were to determine that the available supply of an
underlying security appears insufficient to permit delivery by the writers of
all outstanding calls in the event of exercise, it may prohibit indefinitely the
exercise of put options. The Fund, as holder of such a put option, could lose
its entire investment if the prohibition remained in effect until the put
option's expiration.
Foreign-traded options are subject to many of the same risks presented by
foreign securities. In addition, because of time differences between the United
States and various foreign countries, and because different holidays are
observed in different countries, foreign options markets may be open for trading
during hours or on days when U.S. markets are closed. As a result, option
premiums may not reflect the current prices of the underlying interest in the
United States.
FUTURES CONTRACTS AND RELATED OPTIONS
Subject to applicable law, the Fund may invest without limit in the types
of futures contracts and related options identified in the Prospectus for
hedging and non-hedging purposes, such as to manage the effective duration of
the Fund's portfolio or as a substitute for direct investment. A financial
futures contract sale creates an obligation by the seller to deliver the type of
financial instrument called for in the contract in a specified delivery month
for a stated price. A financial futures contract purchase creates an obligation
by the purchaser to take delivery of the type of financial instrument called for
in the contract in a specified delivery month at a stated price. The
determination is made in accordance with the rules of the exchange on which the
futures contract sale or purchase was made. Futures contracts are traded in the
United States only on commodity exchanges or boards of trade -- known as
"contract markets" -- approved for such trading by the Commodity Futures Trading
Commission (the "CFTC"), and must be executed through a futures commission
merchant or brokerage firm which is a member of the relevant contract market.
Although futures contracts (other than index futures) by their terms call
for actual delivery or acceptance of commodities or securities, in most cases
the contracts are closed out before the settlement date without the making or
taking of delivery. Closing out a futures contract sale is effected by
purchasing a futures contract for
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the same aggregate amount of the specific type of financial instrument or
commodity with the same delivery date. If the price of the initial sale of the
futures contract exceeds the price of the offsetting purchase, the seller is
paid the difference and realizes a gain. Conversely, if the price of the
offsetting purchase exceeds the price of the initial sale, the seller realizes a
loss. If the Fund is unable to enter into a closing transaction, the amount of
the Fund's potential loss is unlimited. The closing out of a futures contract
purchase is effected by the purchaser's entering into a futures contract sale.
If the offsetting sale price exceeds the purchase price, the purchaser realizes
a gain, and if the purchase price exceeds the offsetting sale price, the
purchaser realizes a loss. In general, 40% of the gain or loss arising from the
closing out of a futures contract traded on an exchange approved by the CFTC is
treated as short-term gain or loss, and 60% is treated as long-term gain or
loss.
Unlike when the Fund purchases or sells a security, no price is paid or
received by the Fund upon the purchase or sale of a futures contract. Upon
entering into a contract, the Fund is required to deposit with its custodian in
a segregated account in the name of the futures broker an amount of liquid
assets. This amount is known as "initial margin." The nature of initial margin
in futures transactions is different from that of margin in security
transactions in that futures contract margin does not involve the borrowing of
funds to finance the transactions. Rather, initial margin is similar to a
performance bond or good faith deposit which is returned to the Fund upon
termination of the futures contract, assuming all contractual obligations have
been satisfied. Futures contracts also involve brokerage costs.
Subsequent payments, called "variation margin" or "maintenance margin," to
and from the broker (or the custodian) are made on a daily basis as the price of
the underlying security or commodity fluctuates, making the long and short
positions in the futures contract more or less valuable, a process known as
"marking to the market." For example, when the Fund has purchased a futures
contract on a security and the price of the underlying security has risen, that
position will have increased in value and the Fund will receive from the broker
a variation margin payment based on that increase in value. Conversely, when the
Fund has purchased a security futures contract and the price of the underlying
security has declined, the position would be less valuable and the Fund would be
required to make a variation margin payment to the broker.
The Fund may elect to close some or all of its futures positions at any
time prior to their expiration in order to reduce or eliminate a position then
currently held by the Fund. The Fund may close its positions by taking opposite
positions which will operate to terminate the Fund's position in the futures
contracts. Final determinations of variation margin are then made, additional
cash is required to be paid by or released to the Fund, and the Fund realizes a
loss or a gain. Such closing transactions involve additional commission costs.
The Fund does not intend to purchase or sell futures or related options for
other than hedging purposes if, as a result, the sum of the initial margin
deposits on the Fund's existing futures and related options positions and
premiums paid for outstanding options on futures contracts would exceed 5% of
the Fund's net assets.
OPTIONS ON FUTURES CONTRACTS. The Fund may purchase and write call and put
options on futures contracts and it may buy or sell and enter into closing
transactions with respect to such options to terminate existing positions.
Options on futures contracts give the purchaser the right, in return for the
premium paid, to assume a position in a futures contract at the specified option
exercise price at any time during the period of the option. The Fund may use
options on futures contracts in lieu of writing or buying options directly on
the underlying securities or purchasing and selling the underlying futures
contracts. For example, to hedge against a possible decrease in the value of its
portfolio securities, the Fund may purchase put options or write call options on
futures contracts rather than selling futures contracts. Similarly, the Fund may
purchase call options or write put options on futures contracts as a substitute
for the purchase of futures contracts to hedge against a possible increase in
the price of securities which the Fund expects to purchase. Such options
generally operate in the same manner as options purchased or written directly on
the underlying investments.
As with options on securities, the holder or writer of an option may
terminate his position by selling or purchasing an offsetting option. There is
no guarantee that such closing transactions can be effected.
The Fund will be required to deposit initial margin and maintenance margin
with respect to put and call options on futures contracts written by it pursuant
to brokers' requirements, similar to those described above in connection with
the discussion of futures contracts.
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RISKS OF TRANSACTIONS IN FUTURES CONTRACTS AND RELATED OPTIONS. Successful
use of futures contracts by the Fund is subject to the Adviser's ability to
predict movements in various factors affecting securities markets, including
interest rates. Compared to the purchase or sale of futures contracts, the
purchase of call or put options on futures contracts involves less potential
risk to the Fund because the maximum amount at risk is the premium paid for the
options (plus transaction costs). However, there may be circumstances when the
purchase of a call or put option on a futures contract would result in a loss to
the Fund when the purchase or sale of a futures contract would not, such as when
there is no movement in the prices of the hedged investments. The writing of an
option on a futures contract involves risks similar to those risks relating to
the sale of futures contracts.
The use of options and futures strategies also involves the risk of
imperfect correlation among movements in the prices of the securities underlying
the futures and options purchased and sold by the Fund, of the options and
futures contracts themselves, and, in the case of hedging transactions, of the
securities which are the subject of a hedge.
There is no assurance that higher than normal trading activity or other
unforeseen events might not, at times, render certain market clearing facilities
inadequate, and thereby result in the institution by exchanges of special
procedures which may interfere with the timely execution of customer orders.
To reduce or eliminate a position held by the Fund, the Fund may seek to
close out such position. The ability to establish and close out positions will
be subject to the development and maintenance of a liquid secondary market. It
is not certain that this market will develop or continue to exist for a
particular futures contract or option. Reasons for the absence of a liquid
secondary market on an exchange include the following: (i) there may be
insufficient trading interest in certain contracts or options, (ii) restrictions
may be imposed by an exchange on opening transactions or closing transactions or
both, (iii) trading halts, suspensions or other restrictions may be imposed with
respect to particular classes or series of contracts or options, or underlying
securities, (iv) unusual or unforeseen circumstances may interrupt normal
operations on an exchange, (v) the facilities of an exchange or a clearing
corporation may not at all times be adequate to handle current trading volume,
or (vi) one or more exchanges could, for economic or other reasons, decide or be
compelled at some future date to discontinue the trading of contracts or options
(or a particular class or series of contracts or options), in which event the
secondary market on that exchange for such contracts or options (or in the class
or series of contracts or options) would cease to exist, although outstanding
contracts or options on the exchange that had been issued by a clearing
corporation as a result of trades on that exchange would continue to be
exercisable in accordance with their terms.
U.S. TREASURY SECURITY FUTURES CONTRACTS AND OPTIONS. U.S. Treasury
security futures contracts require the seller to deliver, or the purchaser to
take delivery of, the type of U.S. Treasury security called for in the contract
at a specified date and price. Options on U.S. Treasury security futures
contracts give the purchaser the right, in return for the premium paid, to
assume a position in a U.S. Treasury security futures contract at the specified
option exercise price at any time during the period of the option.
Successful use of U.S. Treasury security futures contracts by the Fund is
subject to the Adviser's ability to predict movements in the direction of
interest rates and other factors affecting markets for debt securities. For
example, if the Fund has sold U.S. Treasury security futures contracts in order
to hedge against the possibility of an increase in interest rates which would
adversely affect securities held in its portfolio, and the prices of the Fund's
securities increase instead as a result of a decline in interest rates, the Fund
would be likely to lose part or all of the benefit of the increased value of its
securities which it has hedged because it will have offsetting losses in its
futures positions. In addition, in such situations, if the Fund has insufficient
cash, it may have to sell securities to meet daily maintenance margin
requirements at a time when it may be disadvantageous to do so.
There is also a risk that price movements in U.S. Treasury security futures
contracts and related options will not correlate closely with price movements in
markets for particular securities. For example, if the Fund has hedged against a
decline in the values of high yield corporate securities held by it by selling
Treasury security futures and the values of Treasury securities subsequently
increase while the values of its high yield
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corporate securities decrease, the Fund would incur losses on both the Treasury
security futures contracts written by it and the high yield corporate securities
held in its portfolio.
INDEX FUTURES CONTRACTS. An index futures contract is a contract to buy or
sell units of an index at a specified future date at a price agreed upon when
the contract is made. Entering into a contract to buy units of an index is
commonly referred to as buying or purchasing a contract or holding a long
position in the index. Entering into a contract to sell units of an index is
commonly referred to as selling a contract or holding a short position. A unit
is the current value of the index. The Fund may enter into stock index futures
contracts, debt index futures contracts, or other index futures contracts
appropriate to its objective. The Fund may also purchase and sell options on
index futures contracts.
There are several risks in connection with the use by the Fund of index
futures. One risk arises because of the imperfect correlation between movements
in the prices of the index futures and movements in the prices of securities
which are the subject of the hedge. The Adviser will, however, attempt to reduce
this risk by buying or selling, to the extent possible, futures on indices the
movements of which will, in its judgment, have a significant correlation with
movements in the prices of the securities sought to be hedged.
Successful use of index futures by the Fund is also subject to the
Adviser's ability to predict movements in the direction of the market. For
example, it is possible that, where the Fund has sold futures to hedge its
portfolio against a decline in the market, the index on which the futures are
written may advance and the value of securities held in the Fund's portfolio may
decline. If this occurred, the Fund would lose money on the futures and also
experience a decline in value in its portfolio securities. It is also possible
that, if the Fund has hedged against the possibility of a decline in the market
adversely affecting securities held in its portfolio and securities prices
increase instead, the Fund will lose part or all of the benefit of the increased
value of those securities it has hedged because it will have offsetting losses
in its futures positions. In addition, in such situations, if the Fund has
insufficient cash, it may have to sell securities to meet daily variation margin
requirements at a time when it is disadvantageous to do so.
In addition to the possibility that there may be an imperfect correlation,
or no correlation at all, between movements in the index futures and the portion
of the portfolio being hedged, the prices of index futures may not correlate
perfectly with movements in the underlying index due to certain market
distortions. First, all participants in the futures market are subject to margin
deposit and maintenance requirements. Rather than meeting additional margin
deposit requirements, investors may close futures contracts through offsetting
transactions which could distort the normal relationship between the index and
futures markets. Second, margin requirements in the futures market are less
onerous than margin requirements in the securities market, and as a result the
futures market may attract more speculators than the securities market does.
Increased participation by speculators in the futures market may also cause
temporary price distortions. Due to the possibility of price distortions in the
futures market and also because of the imperfect correlation between movements
in the index and movements in the prices of index futures, even a correct
forecast of general market trends by the Adviser may still not result in a
profitable position over a short time period.
OPTIONS ON INDEX FUTURES. Options on index futures are similar to options
on securities except that options on index futures give the purchaser the right,
in return for the premium paid, to assume a position in an index futures
contract (a long position if the option is a call and a short position if the
option is a put) at a specified exercise price at any time during the period of
the option. Upon exercise of the option, the delivery of the futures position by
the writer of the option to the holder of the option will be accompanied by
delivery of the accumulated balance in the writer's futures margin account which
represents the amount by which the market price of the index futures contract,
at exercise, exceeds (in the case of a call) or is less than (in the case of a
put) the exercise price of the option on the index future. If an option is
exercised on the last trading day prior to its expiration date, the settlement
will be made entirely in cash equal to the difference between the exercise price
of the option and the closing level of the index on which the future is based on
the expiration date. Purchasers of options who fail to exercise their options
prior to the exercise date suffer a loss of the premium paid.
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OPTIONS ON INDICES
As an alternative to purchasing call and put options on index futures, the
Fund may purchase and sell call and put options on the underlying indices
themselves. Such options would be used in a manner identical to the use of
options on index futures.
INDEX WARRANTS
The Fund may purchase put warrants and call warrants whose values vary
depending on the change in the value of one or more specified securities indices
("index warrants"). Index warrants are generally issued by banks or other
financial institutions and give the holder the right, at any time during the
term of the warrant, to receive upon exercise of the warrant a cash payment from
the issuer based on the value of the underlying index at the time of exercise.
In general, if the value of the underlying index rises above the exercise price
of the index warrant, the holder of a call warrant will be entitled to receive a
cash payment from the issuer upon exercise based on the difference between the
value of the index and the exercise price of the warrant. If the value of the
underlying index falls, the holder of a put warrant will be entitled to receive
a cash payment from the issuer upon exercise based on the difference between the
exercise price of the warrant and the value of the index. The holder of a
warrant would not be entitled to any payments from the issuer at any time when,
in the case of a call warrant, the exercise price is greater than the value of
the underlying index, or, in the case of a put warrant, the exercise price is
less than the value of the underlying index. If the Fund were not to exercise an
index warrant prior to its expiration, then the Fund would lose the amount of
the purchase price paid by it for the warrant.
The Fund will normally use index warrants in a manner similar to its use of
options on securities indices. The risks of the Fund's use of index warrants are
generally similar to those relating to its use of index options. Unlike most
index options, however, index warrants are issued in limited amounts and are not
obligations of a regulated clearing agency, but are backed only by the credit of
the bank or other institution which issues the warrant. Also, index warrants
generally have longer terms than index options. Although the Fund will normally
invest only in exchange-listed warrants, index warrants are not likely to be as
liquid as certain index options backed by a recognized clearing agency. In
addition, the terms of index warrants may limit the Fund's ability to exercise
the warrants at such time, or in such quantities, as the Fund would otherwise
wish to do.
FOREIGN INVESTMENTS
The Fund may invest in securities of foreign issuers that are not actively
traded in U.S. markets. These foreign investments involve certain special risks
described below.
Foreign securities are normally denominated and traded in foreign
currencies. As a result, the value of the Fund's foreign investments and the
value of its shares may be affected favorably or unfavorably by changes in
currency exchange rates relative to the U.S. dollar. There may be less
information publicly available about a foreign issuer than about a U.S. issuer,
and foreign issuers are not generally subject to accounting, auditing and
financial reporting standards and practices comparable to those in the United
States. The securities of some foreign issuers are less liquid and at times more
volatile than securities of comparable U.S. issuers. Foreign brokerage
commissions and other fees are also generally higher than in the United States.
Foreign settlement procedures and trade regulations may involve certain risks
(such as delay in payment or delivery of securities or in the recovery of the
Fund's assets held abroad) and expenses not present in the settlement of
investments in U.S. markets.
In addition, the Fund's investments in foreign securities may be subject to
the risk of nationalization or expropriation of assets, imposition of currency
exchange controls or restrictions on the repatriation of foreign currency,
confiscatory taxation, political or financial instability and diplomatic
developments which could affect the value of the Fund's investments in certain
foreign countries. Dividends or interest on, or proceeds from the sale of,
foreign securities may be subject to foreign withholding taxes, and special U.S.
tax considerations may apply.
Legal remedies available to investors in certain foreign countries may be
more limited than those available with respect to investments in the United
States or in other foreign countries. The laws of some
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foreign countries may limit the Fund's ability to invest in securities of
certain issuers organized under the laws of those foreign countries.
The risks described above, including the risks of nationalization or
expropriation of assets, are typically increased in connection with investments
in "emerging markets." For example, political and economic structures in these
countries may be in their infancy and developing rapidly, and such countries may
be in their infancy and developing rapidly, and such countries may lack the
social, political and economic stability characteristic of more developed
countries. Certain of these countries have in the past failed to recognize
private property rights and have at times nationalized and expropriated the
assets of private companies. High rates of inflation or currency devaluations
may adversely affect the economies and securities markets of such countries.
Investments in emerging markets may be considered speculative.
In addition, unanticipated political or social developments may affect the
value of the Fund's investments in emerging markets and the availability to the
Fund of additional investments in these markets. The small size, limited trading
volume and relative inexperience of the securities markets in these countries
may make the Fund's investments in securities traded in emerging markets
illiquid and more volatile than investments in securities traded in more
developed countries, and the Fund may be required to establish special custodial
or other arrangements before making investments in securities traded in emerging
markets. There may be little financial or accounting information available with
respect to issuers of emerging market securities, and it may be difficult as a
result to assess the value of prospects of an investment in such securities.
Certain of the foregoing risks may also apply to some extent to securities
of U.S. issuers that are denominated in foreign currencies or that are traded in
foreign markets, or securities of U.S. issuers having significant foreign
operations.
FOREIGN CURRENCY TRANSACTIONS
The Fund may engage without limit in currency exchange transactions,
including purchasing and selling foreign currency, foreign currency options,
foreign currency forward contracts and foreign currency futures contracts and
related options, to protect against uncertainty in the level of future currency
exchange rates. In addition, the Fund may write covered call and put options on
foreign currencies for the purpose of increasing its current return.
Generally, the Fund may engage in both "transaction hedging" and "position
hedging." When it engages in transaction hedging, the Fund enters into foreign
currency transactions with respect to specific receivables or payables,
generally arising in connection with the purchase or sale of portfolio
securities. The Fund will engage in transaction hedging when it desires to "lock
in" the U.S. dollar price of a security it has agreed to purchase or sell, or
the U.S. dollar equivalent of a dividend or interest payment in a foreign
currency. By transaction hedging the Fund will attempt to protect itself against
a possible loss resulting from an adverse change in the relationship between the
U.S. dollar and the applicable foreign currency during the period between the
date on which the security is purchased or sold, or on which the dividend or
interest payment is earned, and the date on which such payments are made or
received.
The Fund may purchase or sell a foreign currency on a spot (or cash) basis
at the prevailing spot rate in connection with the settlement of transactions in
portfolio securities denominated in that foreign currency. If conditions
warrant, for transaction hedging purposes the Fund may also enter into contracts
to purchase or sell foreign currencies at a future date ("forward contracts")
and purchase and sell foreign currency futures contracts. A foreign currency
forward contract is a negotiated agreement to exchange currency at a future time
at a rate or rates that may be higher or lower than the spot rate. Foreign
currency futures contracts are standardized exchange-traded contracts and have
margin requirements. In addition, for transaction hedging purposes the Fund may
also purchase or sell exchange-listed and over-the-counter call and put options
on foreign currency futures contracts and on foreign currencies. The Fund may
also enter into contracts to purchase or sell foreign currencies at a future
date ("forward contracts") and purchase and sell foreign currency futures
contracts.
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For transaction hedging purposes the Fund may also purchase exchange-listed
and over-the-counter call and put options on foreign currency futures contracts
and on foreign currencies. A put option on a futures contract gives the Fund the
right to assume a short position in the futures contract until the expiration of
the option. A put option on a currency gives the Fund the right to sell the
currency at an exercise price until the expiration of the option. A call option
on a futures contract gives the Fund the right to assume a long position in the
futures contract until the expiration of the option. A call option on a currency
gives the Fund the right to purchase the currency at the exercise price until
the expiration of the option.
The Fund may engage in position hedging to protect against a decline in the
value relative to the U.S. dollar of the currencies in which its portfolio
securities are denominated or quoted (or an increase in the value of the
currency in which the securities the Fund intends to buy are denominated, when
the Fund holds cash or short-term investments). For position hedging purposes,
the Fund may purchase or sell foreign currency futures contracts, foreign
currency forward contracts and options on foreign currency futures contracts and
on foreign currencies on exchanges or in over-the-counter markets. In connection
with position hedging, the Fund may also purchase or sell foreign currency on a
spot basis.
It is impossible to forecast with precision the market value of portfolio
securities at the expiration or maturity of a forward or futures contract.
Accordingly, it may be necessary for the Fund to purchase additional foreign
currency on the spot market (and bear the expense of such purchase) if the
market value of the security or securities being hedged is less than the amount
of foreign currency the Fund is obligated to deliver and a decision is made to
sell the security or securities and make delivery of the foreign currency.
Conversely, it may be necessary to sell on the spot market some of the foreign
currency received upon the sale of the portfolio security or securities if the
market value of such security or securities exceeds the amount of foreign
currency the Fund is obligated to deliver.
Transaction and position hedging do not eliminate fluctuations in the
underlying prices of the securities which the Fund owns or intends to purchase
or sell. They simply establish a rate of exchange which one can achieve at some
future point in time. Additionally, although these techniques tend to minimize
the risk of loss due to a decline in the value of the hedged currency, they tend
to limit any potential gain which might result from the increase in value of
such currency.
The Fund may seek to increase its current return or to offset some of the
costs of hedging against fluctuations in current exchange rates by writing
covered call options and covered put options on foreign currencies. The Fund
receives a premium from writing a call or put option, which increases the Fund's
current return if the option expires unexercised or is closed out at a net
profit. The Fund may terminate an option that it has written prior to its
expiration by entering into a closing purchase transaction in which it purchases
an option having the same terms as the option written. See "Risk Factors in
Options Transactions" above.
The Fund's currency hedging transactions may call for the delivery of one
foreign currency in exchange for another foreign currency and may at times not
involve currencies in which its portfolio securities are then denominated. The
Adviser will engage in such "cross hedging" activities when it believes that
such transactions provide significant hedging opportunities for the Fund. Cross
hedging transactions by the Fund involve the risk of imperfect correlation
between changes in the values of the currencies to which such transactions
relate and changes in the value of the currency or other asset or liability
which is the subject of the hedge.
The value of any currency, including U.S. dollars and foreign currencies,
may be affected by complex political and economic factors applicable to the
issuing country. In addition, the exchange rates of foreign currencies (and
therefore the values of foreign currency options, forward contracts and futures
contracts) may be affected significantly, fixed, or supported directly or
indirectly by U.S. and foreign government actions. Government intervention may
increase risks involved in purchasing or selling foreign currency options,
forward contracts and futures contracts, since exchange rates may not be free to
fluctuate in response to other market forces.
The value of a foreign currency option, forward contract or futures
contract reflects the value of an exchange rate, which in turn reflects relative
values of two currencies, the U.S. dollar and the foreign currency
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in question. Because foreign currency transactions occurring in the interbank
market involve substantially larger amounts than those that may be involved in
the exercise of foreign currency options, forward contracts and futures
contracts, investors may be disadvantaged by having to deal in an odd-lot market
for the underlying foreign currencies in connection with options at prices that
are less favorable than for round lots. Foreign governmental restrictions or
taxes could result in adverse changes in the cost of acquiring or disposing of
foreign currencies.
There is no systematic reporting of last sale information for foreign
currencies and there is no regulatory requirement that quotations available
through dealers or other market sources be firm or revised on a timely basis.
Available quotation information is generally representative of very large
round-lot transactions in the interbank market and thus may not reflect exchange
rates for smaller odd-lot transactions (less than $1 million) where rates may be
less favorable. The interbank market in foreign currencies is a global, around-
the-clock market. To the extent that options markets are closed while the
markets for the underlying currencies remain open, significant price and rate
movements may take place in the underlying markets that cannot be reflected in
the options markets.
The decision as to whether and to what extent the Fund will engage in
foreign currency exchange transactions will depend on a number of factors,
including prevailing market conditions, the composition of the Fund's portfolio
and the availability of suitable transactions. Accordingly, there can be no
assurance that the Fund will engage in foreign currency exchange transactions at
any given time or from time to time.
CURRENCY FORWARD AND FUTURES CONTRACTS. A forward foreign currency
contract involves an obligation to purchase or sell a specific currency at a
future date, which may be any fixed number of days from the date of the contract
as agreed by the parties, at a price set at the time of the contract. In the
case of a cancelable forward contract, the holder has the unilateral right to
cancel the contract at maturity by paying a specified fee. The contracts are
traded in the interbank market conducted directly between currency traders
(usually large commercial banks) and their customers. A forward contract
generally has no deposit requirement, and no commissions are charged at any
stage for trades. A foreign currency futures contract is a standardized contract
for the future delivery of a specified amount of a foreign currency at a price
set at the time of the contract. Foreign currency futures contracts traded in
the United States are designed by and traded on exchanges regulated by the CFTC,
such as the New York Mercantile Exchange.
Forward foreign currency exchange contracts differ from foreign currency
futures contracts in certain respects. For example, the maturity date of a
forward contract may be any fixed number of days from the date of the contract
agreed upon by the parties, rather than a predetermined date in a given month.
Forward contracts may be in any amounts agreed upon by the parties rather than
predetermined amounts. Also, forward foreign exchange contracts are traded
directly between currency traders so that no intermediary is required. A forward
contract generally requires no margin or other deposit.
At the maturity of a forward or futures contract, the Fund may either
accept or make delivery of the currency specified in the contract, or at or
prior to maturity enter into a closing transaction involving the purchase or
sale of an offsetting contract. Closing transactions with respect to forward
contracts are usually effected with the currency trader who is a party to the
original forward contract. Closing transactions with respect to futures
contracts are effected on a commodities exchange; a clearing corporation
associated with the exchange assumes responsibility for closing out such
contracts.
Positions in the foreign currency futures contracts may be closed out only
on an exchange or board of trade which provides a secondary market in such
contracts. Although the Fund intends to purchase or sell foreign currency
futures contracts only on exchanges or boards of trade where there appears to be
an active secondary market, there is no assurance that a secondary market on an
exchange or board of trade will exist for any particular contract or at any
particular time. In such event, it may not be possible to close a futures
position and, in the event of adverse price movements, the Fund would continue
to be required to make daily cash payments of variation margin.
FOREIGN CURRENCY OPTIONS. In general, options on foreign currencies
operate similarly to options on securities and are subject to many of the risks
described above. Foreign currency options are traded primarily
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in the over-the-counter market, although options on foreign currencies are also
listed on several exchanges. Options are traded not only on the currencies of
individual nations, but also on the European Currency Unit ("ECU"). The ECU is
composed of amounts of a number of currencies, and is the official medium of
exchange of the European Community's European Monetary System.
The Fund will only purchase or write foreign currency options when the
Adviser believes that a liquid secondary market exists for such options. There
can be no assurance that a liquid secondary market will exist for a particular
option at any specific time. Options on foreign currencies are affected by all
of those factors which influence foreign exchange rates and investments
generally.
SETTLEMENT PROCEDURES. Settlement procedures relating to the Fund's
investments in foreign securities and to the Fund's foreign currency exchange
transactions may be more complex than settlements with respect to investments in
debt or equity securities of U.S. issuers, and may involve certain risks not
present in the Fund's domestic investments. For example, settlement of
transactions involving foreign securities or foreign currencies may occur within
a foreign country, and the Fund may be required to accept or make delivery of
the underlying securities or currency in conformity with any applicable U.S. or
foreign restrictions or regulations, and may be required to pay any fees, taxes
or charges associated with such delivery. Such investments may also involve the
risk that an entity involved in the settlement may not meet its obligations.
FOREIGN CURRENCY CONVERSION. Although foreign exchange dealers do not
charge a fee for currency conversion, they do realize a profit based on the
difference (the "spread") between prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to the
Fund at one rate, while offering a lesser rate of exchange should the Fund
desire to resell that currency to the dealer.
RULE 144A SECURITIES
The Fund may purchase securities that have been privately placed but that
are eligible for purchase and sale under Rule 144A under the Securities Act of
1933 (the "1933 Act"). That Rule permits certain qualified institutional buyers,
such as the Fund, to trade in privately placed securities that have not been
registered for sale under the 1933 Act. In some instances, these investments may
be less liquid (and consequently harder to value) than securities that were
issued in a public offering.
TAXES
The following discussion offers only a brief outline of the federal income
tax consequences of investing in the Fund's shares. Potential investors should
consult their own tax advisers for more detailed information regarding the
impact of federal, state, local and foreign taxes upon such an investment.
FEDERAL INCOME TAX TREATMENT OF THE FUND
The Fund has elected and has qualified and intends to continue to qualify
to be treated as a regulated investment company under the Internal Revenue Code.
To qualify as a regulated investment company, the Fund must, among other things,
(a) derive in each taxable year at least 90% of its gross income from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of stock, securities or foreign currencies, or other income
derived with respect to its business of investing in stocks, securities or
currencies (including, but not limited to, gains from options, futures and
forward contracts); and (b) diversify its holdings so that, at the end of each
quarter of each taxable year, (i) at least 50% of the market value of the Fund's
assets is represented by cash, cash items, U.S. Government securities,
securities of other regulated investment companies and other securities, with
such other securities of any one issuer limited for the purposes of this
calculation to an amount not greater than 5% of the value of the Fund's total
assets and 10% of the outstanding voting securities of such issuer and (ii) not
more than 25% of the value of its total assets is invested in the securities of
any one issuer (other than U.S. Government securities or the securities of other
regulated investment companies).
As a regulated investment company, in any fiscal year with respect to which
the Fund distributes at least 90% of its investment company taxable income
(which includes, among other items, dividends and interest but
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excludes net long-term capital gains in excess of net short-term capital
losses), the Fund (but not its shareholders) generally will be relieved of U.S.
federal income tax on its net investment income and net capital gains (i.e., net
long-term capital gains in excess of the sum of net short-term capital losses
and capital loss carryovers from prior years, if any) that it distributes to
shareholders. To the extent the Fund retains its net capital gains for
investment, it will be subject under current tax rates to a federal income tax
at a maximum effective rate of 35% on the amount retained. See "Federal Income
Tax Treatment of Holders of Shares" below. Amounts not distributed on a timely
basis in accordance with a calendar year distribution requirement are subject to
a nondeductible 4% excise tax payable by the Fund. To avoid this tax, the Fund
must distribute, or be deemed to have distributed, during each calendar year an
amount equal to the sum of (1) at least 98% of its ordinary income (not taking
into account any capital gains or losses) for the calendar year, (2) at least
98% of its capital gains in excess of its capital losses (adjusted for certain
ordinary losses) for the twelve-month period ending on October 31 of the
calendar year, and (3) all ordinary income and capital gains for previous years
that were not distributed during such years. See "Risk Factors and Special
Considerations--Dividends and Distributions" in the Prospectus.
If in any taxable year the Fund fails to qualify as a regulated investment
company under the Internal Revenue Code, the Fund will be taxed in the same
manner as an ordinary corporation, and distributions to its shareholders will
not be deductible by the Fund in computing its taxable income. In addition, in
the event of the failure to qualify, the Fund's distributions, to the extent
derived from the Fund's current or accumulated earnings and profits, will
constitute dividends (eligible for the corporate dividends-received deduction,
subject to certain requirements) which are taxable to shareholders as ordinary
income, even though the gains generating those distributions might otherwise (at
least in part) have been treated in the shareholders' hands as long-term capital
gains. If the Fund fails to qualify as a regulated investment company or fails
to satisfy the 90% distribution requirement for any year, it generally must pay
out its earnings and profits attributable to non-regulated investment company
years less an interest charge to the U.S. Treasury on 50% of such earnings and
profits before it can again qualify as a regulated investment company.
If the Fund does not meet the asset coverage requirements of the Act, it
will be required to suspend distributions to the holders of shares until the
asset coverage is restored. See "Description of Shares of Beneficial
Interest--Dividends and Distributions" in the Prospectus. Such a suspension of
distributions might prevent the Fund from distributing 90% of its investment
company taxable income, as is required in order to qualify for taxation as a
regulated investment company, or cause the Fund to incur a tax liability or a
non-deductible 4% excise tax on its undistributed taxable income (including
gain), or both.
Upon any failure to meet the asset coverage requirements of the Act, the
Fund intends to repurchase or redeem the Term Note in order to maintain or
restore the requisite asset coverage and avoid failing to remain qualified as a
regulated investment company. The determination to repurchase or redeem the Term
Note will be made in the sole discretion of the Fund. Furthermore, the Fund will
be required to make mandatory partial redemptions of the Term Note that in the
event its failure to maintain Act Asset Coverage is not cured in a timely
manner. See "Description of Term Note--Restrictive Covenants" in the Prospectus.
Use of the Fund's cash to repurchase or redeem the Term Note may adversely
affect the Fund's ability to distribute annually at least 90% of its investment
company taxable income, which distribution is required to qualify for taxation
as a regulated investment company. In order to fund repurchases or redemptions
of the Term Note, the Fund may have to sell assets (including assets that the
Fund otherwise would have continued to hold) and any income generated by such
sales will be included in the Fund's income that is subject to the distribution
requirements described above. Depending on the size of the Fund's assets
relative to its outstanding senior securities, redemption of the Term Note might
restore asset coverage. Payment of distributions after restoration of asset
coverage could requalify (or avoid a disqualification of) the Fund as a
regulated investment company, depending upon the facts and circumstances.
The Fund's portfolio may include zero coupon bonds. Zero coupon bonds are
original issue discount bonds which pay no current interest. Original issue
discount is the excess (if any) of the stated redemption price at maturity of a
debt instrument over the issue price of the instrument. Original issue discount
on a taxable obligation is required to be currently included in the income of
the holder of the obligation generally
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<PAGE> 68
on a constant interest rate basis resembling the economic accrual of interest.
The tax basis of the holder of an original issue discount debt instrument is
increased by the amount of original issue discount thereon properly included in
the holder's gross income as determined for federal income tax purposes. Current
inclusion in gross income of original issue discount on a taxable debt
instrument is required, even though no cash is received at the time the original
issue discount is required to be included in gross income. Because such income
may not be matched by a corresponding receipt of cash by the Fund, the Fund may
be required to borrow money or dispose of other securities to be able to make
required distributions to the holders of shares.
The Fund's transactions in foreign currencies, forward contracts, options
and futures contracts (including options and futures contracts on foreign
currencies) will be subject to special provisions of the Internal Revenue Code
(including constructive sale, mark-to-market, straddle, wash sale and short sale
rules) that, among other things, may affect the character of gains and losses
realized by the Fund (i.e., may affect whether gains or losses are ordinary or
capital), accelerate recognition of income to the Fund, defer Fund losses, and
affect the determination of whether capital gains and losses are characterized
as long-term or short-term capital gains or losses. These rules could therefore
affect the character, amount and timing of distributions to shareholders. These
provisions also may require the Fund to mark-to-market certain types of the
positions in its portfolio (i.e, treat them as if they were disposed of at their
fair market value at the close of the taxable year) which may cause the Fund to
recognize income or gain without receiving cash with which to make distributions
in amounts necessary to satisfy the 90% and 98% distribution requirements for
avoiding income and excise taxes. The Fund will monitor its transactions and
will make the appropriate tax elections and appropriate entries in its books and
records when it acquires any foreign currency, option, futures contract, forward
contract, or hedged investment in order to mitigate the effect of these rules
and prevent disqualification of the Fund as a regulated investment company and
minimize the imposition of income and excise taxes.
The Fund may acquire stock of a "passive foreign investment company" (a
"PFIC"). A PFIC is a foreign corporation that, in general, meets either of the
following tests: (1) at least 75% of its gross income is passive income or (2)
an average of at least 50% of its assets produce, or are held for the production
of, passive income. Under certain circumstances, the Fund will be subject to
federal income tax on a portion of any "excess distribution" received on shares
of PFIC stock or of any gain from the disposition of such stock (collectively,
"PFIC income"), plus interest thereon, even if the Fund distributes the PFIC
income as a taxable dividend to its shareholders. The balance of the PFIC income
will be included in the Fund's taxable income and, accordingly, will not be
taxable to the extent that income is distributed to its shareholders. If the
Fund invests in a PFIC and elects to treat the PFIC as a "qualified electing
fund," then in lieu of the foregoing tax and interest obligation, the Fund will
be required to include in income each year its pro rata share of the qualified
electing fund's annual ordinary earnings and net capital gains, even if such
amounts are not distributed to the Fund. These amounts likely would have to be
distributed to satisfy the requirements for avoiding income and excise taxes. In
most instances it will be very difficult, if not impossible, to make this
election because of certain requirements.
As an alternative to making the above-described election to treat the PFIC
as a qualified electing fund, the Fund may make an election to annually
mark-to-market certain publicly traded PFIC stock (a "PFIC Mark-to-Market
Election"). "Marking-to-Market," in this context, means recognizing as ordinary
income (and, to a limited extent, loss) each year an amount equal to the
difference between the Fund's adjusted tax basis in such PFIC stock and its fair
market value. The PFIC Mark-to-Market Election applies to the taxable year for
which made and to all subsequent taxable years, unless the PFIC stock ceases to
be publicly traded or the Internal Revenue Service consents to revocation of the
election. By making the PFIC Mark-to-Market Election, the Fund could ameliorate
the adverse tax consequences arising from its ownership of PFIC stock, but in
any particular year may be required to recognize income in excess of the
distributions it receives from the PFIC and proceeds from the dispositions of
PFIC stock.
FEDERAL INCOME TAX TREATMENT OF HOLDERS OF SHARES
For any period during which the Fund qualifies as a regulated investment
company for federal income tax purposes, dividends paid out of the Fund's net
investment income and short-term capital gains to holders of shares will be
taxable as ordinary income. It is expected that dividends paid to by corporate
shareholders will
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not be eligible for the dividends received deduction. Distributions of net
capital gains designated by the Fund as "capital gain dividends," if any, are
taxable as long-term capital gains, regardless of how long the shareholder has
held the Fund's shares. See the discussion below for a summary of the capital
gains rates applicable to capital gain dividends. Capital gain dividends are not
eligible for the corporate dividends received deduction. Dividends and
distributions of capital gain dividends will be taxable to shareholders as if
actually distributed, even if they are reinvested in additional shares of the
Fund. Shareholders receiving distributions in the form of newly issued shares
will have a cost basis in each share received equal to the fair market value of
a share of the Fund on the distribution date.
Generally, dividends paid by the Fund are treated as received in the
taxable year in which the distribution is made; however, any dividend declared
by the Fund in October, November or December of any calendar year, payable to
shareholders of record on a specified date in any such month and actually paid
during January of the following year, will be treated as received on December 31
of the year in which declared.
Any distribution by the Fund to a holder of shares not made out of the
Fund's current or accumulated earnings and profits will be treated as a return
of capital to such holder of shares, will reduce the basis of each share or
shares with respect to which it is distributed and will be subject to tax as
capital gain to the extent that the distribution exceeds the basis of the share
or shares with respect to which it is distributed. Potential investors should
carefully consider the tax implications of buying shares just prior to a
distribution, as the price of shares purchased at this time may reflect the
amount of the forthcoming distribution which will, except in unusual
circumstances, be taxable when received.
In the event the Fund retains any net capital gains, it may designate such
retained amounts as undistributed capital gains in a notice to its shareholders.
In the event such a designation is made, the Fund will be subject to tax at a
35% rate on the undistributed amounts and shareholders subject to U.S. federal
income tax will be required to include in income, as long-term capital gains,
their proportionate share of such undistributed amounts, but will be allowed a
credit or refund, as the case may be, for their proportionate share of the 35%
tax paid by the Fund. If the designation is made, for U.S. federal income tax
purposes, the tax basis of shares owned by a shareholder will be increased by an
amount equal to the difference between (i) the amount included in such
shareholder's income as long-term capital gains and (ii) such shareholder's
proportionate share of the tax paid by the Fund.
After the close of each taxable year, the Fund will notify its shareholders
of the amounts of dividends and capital gain dividends paid (or deemed paid) in
such taxable year, and undistributed capital gains designated for that year. The
information regarding capital gain dividends and undistributed capital gains
will designate the portion thereof subject to the different maximum rates of tax
applicable to non-corporate taxpayers' net capital gain as discussed below.
The Internal Revenue Code allows certain miscellaneous itemized deductions
by individuals, including deductions of investment expenses, only to the extent
the aggregate of such deductions exceeds 2% of an individual's adjusted gross
income as determined for federal income tax purposes. The Internal Revenue Code
and the regulations promulgated thereunder treat such expenses incurred by a
regulated investment company as being indirectly incurred by its shareholders.
Shareholder expenses indirectly incurred through publicly offered regulated
investment companies are exempted from the application of the 2% floor. Thus,
the limitation will not apply with respect to indirect deductions through the
Fund. Shareholders of the Fund that are corporations are not subject to the 2%
floor with respect to their expenses indirectly incurred through the Fund.
If the Fund suffers a net taxable loss in any taxable year, its
shareholders will not be permitted to utilize that loss in their tax returns.
Generally, gain recognized by a shareholder on the sale of shares held for
more than one year will be taxable as long-term capital gain. If a shareholder
holds shares primarily for sale to customers in the ordinary course of business
rather than for investment, any gain recognized on the sale of those shares
would be taxable as ordinary income. Any loss realized on a sale or exchange
will be disallowed to the extent the shares disposed of are replaced within a
period of 61 days beginning 30 days before and ending 30 days after the date on
which
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shares are disposed. In such a case, the basis of the shares acquired will be
adjusted to reflect the disallowed loss. Any loss recognized by a shareholder on
a disposition of Fund shares held by the shareholder for six months or less will
be treated as a long-term capital loss to the extent of any distributions of
capital gain dividends received or treated as having been received by the
shareholder with respect to such shares. Shareholders who acquire shares on
multiple dates should consult their tax advisers to determine how to allocate
the cost of shares for basis purposes.
Under the Taxpayer Relief Act of 1997 (the "1997 Tax Act"), the maximum tax
rate applicable to net capital gains recognized by individuals and other
non-corporate taxpayers is (i) the same as the maximum ordinary income tax rate
for capital assets held for one year or less, (ii) 28% for capital assets held
for more than one year but not more than 18 months and (iii) 20% for capital
assets held for more than 18 months. Shareholders should consult their own tax
advisors regarding the availability and effect of a certain tax election to
mark-to-market shares of the Fund held on January 1, 2001. Capital gains or
losses recognized by corporate shareholders are subject to tax at the ordinary
income tax rates applicable to corporations. The new tax rates for capital gains
under the 1997 Tax Act described above will apply to distributions of capital
gain dividends by the Fund (if, as expected, the Fund designates capital gain
dividends as 28% rate gain distributions or 20% rate gain distributions, in
accordance with its holding periods for the securities that generated such
capital gain dividends) as well as to sales and exchanges of shares in the Fund.
With respect to capital losses recognized on dispositions of shares held six
months or less where such losses are treated as long term capital losses to the
extent of prior capital gain dividends received on such shares, it is unclear
how such capital losses offset the capital gains referred to above. Holders of
shares should consult their own tax advisers as to the application of the new
capital gains rates to their particular circumstances.
In general, federal withholding taxes at a 30% rate or a lower rate
established by treaty will apply to distributions to shareholders (except to
those distributions designated by the Fund as capital gain dividends) that are
nonresident aliens or foreign partnerships, trusts or corporations to the extent
that such income is not "effectively connected" with a U.S. trade or business
carried on by such shareholders.
The U.S. Treasury Department and the Internal Revenue Service recently
issued Treasury regulations, generally effective for payments made after
December 31, 1999, concerning the withholding of tax and reporting for certain
amounts paid to nonresident aliens and foreign corporations (the "Final
Withholding Regulations"). Among other things, the Final Withholding Regulations
may require shareholders that are not United States persons within the meaning
of the Internal Revenue Code to furnish new certification of their foreign
status after December 31, 1999. Investors should consult their tax advisers
concerning the applicability and effect of the Final Withholding Regulations on
an investment in shares of the Fund.
BACKUP WITHHOLDING
The Fund may be required to withhold for U.S. federal income taxes 31% of
all taxable distributions paid to shareholders who (i) fail to provide the Fund
with their correct taxpayer identification number, (ii) fail to make required
certifications or (iii) have been notified or with respect to whom the Fund has
been notified by the U.S. Internal Revenue Service that distributions to such
shareholder are subject to backup withholding. Corporate shareholders and
certain other shareholders specified in the Internal Revenue Code are exempt
from such backup withholding. Backup withholding is not an additional tax. Any
amounts withheld may be credited against the shareholder's U.S. federal income
tax liability.
OTHER TAXATION
Investors are advised to consult their own tax advisers with respect to the
application to their own circumstances of the above-described general taxation
rules and with respect to the federal, state, local or foreign tax consequences
to them of an investment in shares of the Fund.
SHAREHOLDER LIABILITY
Under Massachusetts law, shareholders could, under certain circumstances,
be held personally liable for the obligations of the Fund. However, the
Agreement and Declaration of Trust of the Fund (the "Declara-
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tion") disclaims shareholder liability for acts or obligations of the Fund and
requires that a notice of such disclaimer be given in each agreement, obligation
or instrument entered into or executed by the Fund or the Trustees. The
Declaration provides for indemnification out of Fund property for all loss and
expense of any shareholder held personally liable for the obligations of the
Fund. Thus, the risk of a shareholder's incurring financial loss on account of
shareholder liability is limited to circumstances (which are considered remote)
in which the Fund would be unable to meet its obligations and the disclaimer was
inoperative.
28
