HIGH INCOME ADVANTAGE TRUST III
N-30D, 1996-09-25
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<PAGE>   1
 
HIGH INCOME ADVANTAGE TRUST III       Two World Trade Center, New York, New York
                                                                           10048
LETTER TO THE SHAREHOLDERS July 31, 1996
 
DEAR SHAREHOLDER:
 
After rebounding sharply during 1995, the U.S. Treasury market retreated in the
first half of 1996, as signs of an economic recovery fanned inflation fears. The
high-yield market, in contrast, held up relatively well during the first half of
1996, even as prevailing interest rates moved up sharply. While signs of an
economic recovery has led to a sharp increase in interest rates, this recovery
also bodes well for the future prospects of many corporate issuers in the
high-yield marketplace and helps erase some of the recession fears that had
plagued the high-yield market in late 1995. Overall, the high-yield market is
off to a relatively good start thus far in 1996, following up on the strong year
the market had in 1995.
 
PERFORMANCE
 
Against this backdrop, High Income Advantage Trust III produced a total return
of 9.19 percent for the six months ended July 31, 1996, based on its closing
market price on the New York Stock Exchange (NYSE) of $7.00 per share. Based on
its net asset value (NAV) of $6.33 per share, the Trust's total return for the
same period was 4.30 percent. As of July 31, 1996, the Trust had net assets in
excess of $81 million. Over the past six months, the Trust continued to
distribute regular income dividends at a rate of $0.06 per share per month. For
the full six-month period, income dividends totaled approximately $0.36 per
share.
 
INVESTMENT STRATEGY
 
The Trust's investment strategy remained essentially unchanged over the past six
months, with a continued emphasis on discounted B-rated issues, given their
attractive long-term total return potential. In today's market, many of these
issues can be purchased below par providing significant future appreciation
potential and an attractive yield spread over comparable Treasuries (in the 11
percent to 12 percent range). In light of the rebounding economy, we feel quite
comfortable with the earnings outlook for most of our B-rated issuers.
Recognizing that the economy may slow somewhat in 1996's second half however, we
have tried to limit
<PAGE>   2
 
HIGH INCOME ADVANTAGE TRUST III
LETTER TO THE SHAREHOLDERS July 31, 1996, continued
 
the portfolio's volatility by focusing primarily on growth type, recession
resistant industry sectors such as cable, media, food and beverage and
telecommunications.
 
MARKET OUTLOOK
 
Given our outlook for continued, albeit moderate economic growth, we find that
many of today's B-rated issues offer excellent long-term return potential. Over
the near term, there could be continued volatility in the financial markets as
investors assess the economy's strength, possible Federal Reserve Board actions
and the upcoming Presidential election. However, despite any potential
short-term weakness, we consider today's high-yield market to be an attractive
long-term opportunity for investors.
 
We would like to remind you that the Trustees have approved a procedure whereby
the Trust, when appropriate, may repurchase shares in the open market or in
privately negotiated transactions at a price not above market value or net asset
value, whichever is lower at the time of purchase.
 
We appreciate your continued support of High Income Advantage Trust III and look
forward to continuing to serve your investment needs and objectives.
 
Very truly yours,
 
/s/ CHARLES A. FIUMEFREDDO
CHARLES A. FIUMEFREDDO
Chairman of the Board
<PAGE>   3
 
HIGH INCOME ADVANTAGE TRUST III
RESULTS OF ANNUAL MEETING (unaudited)
 
                             *         *         *
 
On June 27, 1996, an annual meeting of the Trust's shareholders was held for the
purpose of voting on three separate matters, the results of which were as
follows:
 
(1) ELECTION OF TRUSTEES:
 
<TABLE>
         <S>                                                                   <C>
         Edward J. Garn
         For.................................................................  8,918,567
         Against.............................................................     89,905
         John R. Haire
         For.................................................................  8,911,189
         Against.............................................................     97,283
         Michael E. Nugent
         For.................................................................  8,918,847
         Against.............................................................     89,625
         Philip J. Purcell
         For.................................................................  8,915,067
         Against.............................................................     93,405
</TABLE>
 
  The following Trustees were not standing for reelection at this meeting:
   Michael Bozic, Charles A. Fiumefreddo, Dr. Manuel H. Johnson,
   Paul Kolton and John L. Schroeder
 
(2) CONTINUANCE OF THE CURRENTLY EFFECTIVE INVESTMENT MANAGEMENT AGREEMENT:
 
<TABLE>
         <S>                                                                   <C>
         For.................................................................  8,714,826
         Against.............................................................     71,376
         Abstain.............................................................    222,270
</TABLE>
 
(3) RATIFICATION OF PRICE WATERHOUSE LLP AS INDEPENDENT ACCOUNTANTS:
 
<TABLE>
         <S>                                                                   <C>
         For.................................................................  8,811,627
         Against.............................................................     41,682
         Abstain.............................................................    155,163
</TABLE>
<PAGE>   4
 
HIGH INCOME ADVANTAGE TRUST III
PORTFOLIO OF INVESTMENTS July 31, 1996 (unaudited)
 
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT IN                                              COUPON      MATURITY
THOUSANDS                                               RATE         DATE           VALUE
- --------------------------------------------------------------------------------------------
<C>          <S>                                       <C>         <C>           <C>
             CORPORATE BONDS (88.8%)
             Aerospace (2.6%)
$  2,500     Sabreliner Corp. (Series B)...........     12.50 %     04/15/03     $ 2,087,500
                                                                                   ---------
             Automotive (3.5%)
     400     APS, Inc. - 144A*.....................     11.875      01/15/06         418,000
   3,250     Envirotest Systems, Inc. .............      9.625      04/01/03       2,470,000
                                                                                   ---------
                                                                                   2,888,000
                                                                                   ---------
             Broadcast Media (3.2%)
     750     Adams Outdoor Advertising - 144A*.....     10.75       03/15/06         772,500
   1,000     Paxson Communications Corp. ..........     11.625      10/01/02       1,045,000
     750     Spanish Broadcasting System, Inc. ....      7.50       06/15/02         757,500
                                                                                   ---------
                                                                                   2,575,000
                                                                                   ---------
             Business Services (3.5%)
     750     Anacomp, Inc. ........................     13.00+      06/04/02         735,000
   2,000     Xerox Corp. ..........................     15.00       06/10/97       2,145,520
                                                                                   ---------
                                                                                   2,880,520
                                                                                   ---------
             Cable & Telecommunications (11.3%)
   1,098     Adelphia Communications Corp. (Series
             B)....................................      9.50+      02/15/04         905,762
     800     American Communications Services,
             Inc...................................    12.75++      04/01/06         410,000
   2,000     AT&T Capital Corp. ...................     15.00       05/05/97       2,128,060
     750     Charter Communication South East
             L.P. - 144A*..........................     11.25       03/15/06         742,500
     750     Falcon Holdings Group L.P. ...........     11.00+      09/15/03         705,000
   7,000     In-Flight Phone Corp. (Series B)......    14.00++      05/15/02       2,625,000
   1,000     Peoples Telephone Co., Inc. ..........     12.25       07/15/02         975,000
     750     Rifkin Acquisition Partners L.P. .....     11.125      01/15/06         750,000
                                                                                   ---------
                                                                                   9,241,322
                                                                                   ---------
             Computer Equipment (2.3%)
     750     Unisys Corp. .........................     15.00       07/01/97         791,250
   1,000     Unisys Corp. (Conv.)..................      8.25       03/15/06       1,076,250
                                                                                   ---------
                                                                                   1,867,500
                                                                                   ---------
             Consumer Products (1.2%)
   1,000     J.B. Williams Holdings, Inc. .........     12.00       03/01/04       1,007,500
                                                                                   ---------
             Containers (2.0%)
   1,500     Ivex Holdings Corp. (Series B)........    13.25++      03/15/05         945,000
     750     Mail-Well Corp. ......................     10.50       02/15/04         723,750
                                                                                   ---------
                                                                                   1,668,750
                                                                                   ---------
             Electrical & Alarm Systems (2.8%)
   2,750     Mosler, Inc. .........................     11.00       04/15/03       2,320,312
                                                                                   ---------
             Entertainment/Gaming & Lodging (8.0%)
     750     AMF Group Inc. - 144A*................     10.875      03/15/06         748,125
     750     Lady Luck Gaming Finance Corp. .......     11.875      03/01/01         748,125
</TABLE>
 
        SEE NOTES TO FINANCIAL STATEMENTS
<PAGE>   5
 
HIGH INCOME ADVANTAGE TRUST III
PORTFOLIO OF INVESTMENTS July 31, 1996 (unaudited) continued
 
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT IN                                              COUPON      MATURITY
THOUSANDS                                               RATE         DATE           VALUE
- ---------------------------------------------------------------------------------------------
<C>          <S>                                       <C>         <C>           <C>
$  2,000     Motels of America, Inc. (Series B)....     12.00 %     04/15/04     $ 1,920,000
     800     Players International, Inc. ..........     10.875      04/15/05         808,000
     750     Plitt Theaters, Inc. (Canada).........     10.875      06/15/04         763,125
   6,722     Spectravision, Inc. (a)...............     11.65       12/01/02         776,377
     800     Station Casinos, Inc. (Series B)......      9.625      06/01/03         763,000
                                                                                   ---------
                                                                                   6,526,752
                                                                                   ---------
             Foods & Beverages (10.5%)
   4,200     Envirodyne Industries, Inc. ..........     10.25       12/01/01       3,654,000
   2,000     Seven Up/RC Bottling Co. Southern
             California, Inc. (b)..................     11.50       08/01/99       1,342,500
   8,000     Specialty Foods Acquisition Corp.
             (Series B)............................    13.00++      08/15/05       3,520,000
                                                                                   ---------
                                                                                   8,516,500
                                                                                   ---------
             Healthcare (0.9%)
     750     Unilab Corp. .........................     11.00       04/01/06         693,750
                                                                                   ---------
             Manufacturing (7.8%)
   1,700     Alpine Group, Inc. (Series B).........     12.25       07/15/03       1,725,500
   1,000     Berry Plastics Corp. .................     12.25       04/15/04       1,060,000
     750     Cabot Safety Corp. ...................     12.50       07/15/05         826,875
     750     Exide Electronics Group, Inc. (Series
             B)....................................     11.50       03/15/06         761,250
   1,000     International Wire Group..............     11.75       06/01/05       1,000,000
   1,000     Uniroyal Technology Corp. ............     11.75       06/01/03         950,000
                                                                                   ---------
                                                                                   6,323,625
                                                                                   ---------
             Manufacturing - Diversified (6.4%)
     800     Foamex L.P. ..........................     11.875      10/01/04         826,000
     800     Interlake Corp. ......................     12.125      03/01/02         804,000
   1,000     J.B. Poindexter & Co., Inc. ..........     12.50       05/15/04         900,000
   1,000     Jordan Industries, Inc. ..............     10.375      08/01/03         955,000
   2,400     Jordan Industries, Inc. ..............    11.75++      08/01/05       1,728,000
                                                                                   ---------
                                                                                   5,213,000
                                                                                   ---------
             Oil & Gas (1.1%)
   1,000     Empire Gas Corp. .....................      7.00       07/15/04         875,000
                                                                                   ---------
             Publishing (4.5%)
   1,500     Affiliated Newspapers Investments,
             Inc...................................    13.25++      07/01/06       1,087,500
     800     American Media Operations, Inc. ......     11.625      11/15/04         824,000
   1,875     United States Banknote Corp. .........     10.375      06/01/02       1,757,812
                                                                                   ---------
                                                                                   3,669,312
                                                                                   ---------
             Restaurants (8.1%)
   4,750     American Restaurant Group Holdings,
             Inc. .................................    14.00++      12/15/05       1,757,500
     750     Boston Chicken Inc. (Conv.)...........      4.50       02/01/04         778,125
     750     Carrols Corp. ........................     11.50       08/15/03         768,750
   4,950     Flagstar Corp. .......................     11.25       11/01/04       3,267,000
                                                                                   ---------
                                                                                   6,571,375
                                                                                   ---------
</TABLE>
 
        SEE NOTES TO FINANCIAL STATEMENTS
<PAGE>   6
 
HIGH INCOME ADVANTAGE TRUST III
PORTFOLIO OF INVESTMENTS July 31, 1996 (unaudited) continued
 
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT IN                                              COUPON      MATURITY
THOUSANDS                                               RATE         DATE           VALUE
- ---------------------------------------------------------------------------------------------
<C>          <S>                                       <C>         <C>           <C>
             Retail (2.5%)
$    800     Cort Furniture Rental Corp. ..........     12.00 %     09/01/00     $   840,000
   1,500     County Seat Stores Co. ...............     12.00       10/01/02       1,215,000
                                                                                   ---------
                                                                                   2,055,000
                                                                                   ---------
             Retail - Food Chains (3.0%)
     750     Jitney-Jungle Stores..................     12.00       03/01/06         776,250
     800     Pathmark Stores, Inc. ................      9.625      05/01/03         754,000
   1,000     Ralphs Grocery Co. ...................     11.00       06/15/05         952,500
                                                                                   ---------
                                                                                   2,482,750
                                                                                   ---------
             Textiles - Apparel Manufacturers (3.6%)
      57     Farley, Inc. (Conv.)..................      0.00       01/01/12           5,982
   3,048     JPS Textile Group, Inc. ..............     10.85       06/01/99       1,935,480
   1,155     U.S. Leather, Inc. ...................     10.25       07/31/03         958,650
                                                                                   ---------
                                                                                   2,900,112
                                                                                   ---------
             TOTAL CORPORATE BONDS
             (Identified Cost $80,908,944)..................................      72,363,580
                                                                                   ---------
<CAPTION>
NUMBER OF
 SHARES                                                                             VALUE
- ---------------------------------------------------------------------------------------------
<C>          <S>                                                                   <C>
             COMMON STOCKS (c) (1.1%)
             Computer Equipment (0.1%)
  95,553     Memorex Telex NV (ADR) (Netherlands) (d).......................         119,441
                                                                                   ---------
             Entertainment/Gaming & Lodging (0.2%)
   2,000     Motels of America, Inc. - 144A*................................         140,000
                                                                                   ---------
             Foods & Beverages (0.1%)
  90,000     Specialty Foods Acquisition Corp. (Restricted) - 144A*.........         112,500
                                                                                   ---------
             Publishing (0.1%)
   4,000     Affiliated Newspapers Investments, Inc. (Class B)..............         120,000
                                                                                   ---------
             Restaurants (0.1%)
   4,750     American Restaurant Group Holdings, Inc. - 144A*...............          47,500
                                                                                   ---------
             Retail (0.5%)
  10,758     CORT Business Services Corp. ..................................         204,402
  11,400     Thrifty Payless Holdings, Inc. (Class B).......................         159,600
                                                                                   ---------
                                                                                     364,002
                                                                                   ---------
             TOTAL COMMON STOCKS
             (Identified Cost $3,007,041)...................................         903,443
                                                                                   ---------
             PREFERRED STOCKS (2.1%)
             Entertainment/Gaming & Lodging (2.1%)
  80,000     Fitzgeralds Gaming Corp. (Units)+++............................       1,680,000
                                                                                   ---------
</TABLE>
 
        SEE NOTES TO FINANCIAL STATEMENTS
<PAGE>   7
 
HIGH INCOME ADVANTAGE TRUST III
PORTFOLIO OF INVESTMENTS July 31, 1996 (unaudited) continued
 
<TABLE>
<CAPTION>
 
NUMBER OF
 SHARES                                                                             VALUE
- --------------------------------------------------------------------------------------------
<C>          <S>                                                                 <C>
             Utilities - Electric (0.0%)
 373,201     TGX Corp. (Series A) (c) (d)...................................     $     3,732
                                                                                   ---------
             TOTAL PREFERRED STOCKS
             (Identified Cost $4,718,250)...................................       1,683,732
                                                                                   ---------
</TABLE>
 
<TABLE>
<CAPTION>
 
NUMBER OF                                                        EXPIRATION
WARRANTS                                                           DATE           VALUE
- ------------------------------------------------------------------------------------------
<C>         <S>                                                  <C>           <C>
            WARRANTS (c) (0.2%)
            Aerospace (0.0%)
   2,500    Sabreliner Corp. (Restricted) - 144A*............     04/15/03          25,000
                                                                                 ---------
            Cable & Telecommunications (0.1%)
   5,500    In-Flight Phone Corp. - 144A*....................     08/31/02          55,054
                                                                                 ---------
            Containers (0.0%)
   2,000    Crown Packaging Holdings, Ltd.
            (Canada) - 144A*.................................     11/01/03              --
                                                                                 ---------
            Entertainment/Gaming & Lodging (0.0%)
   3,263    Casino America, Inc. ............................     11/15/96              --
   1,250    Fitzgeralds Gaming Corp. - 144A*.................     03/15/99              --
                                                                                 ---------
                                                                                        --
                                                                                 ---------
            Manufacturing (0.1%)
     750    Exide Electronics Group, Inc. - 144A*............     03/15/06          15,000
  10,000    Uniroyal Technology Corp. .......................     06/01/03          13,750
                                                                                 ---------
                                                                                    28,750
                                                                                 ---------
            Oil & Gas (0.0%)
   2,760    Empire Gas Corp. ................................     07/15/04          27,600
                                                                                 ---------
            Retail (0.0%)
   2,000    County Seat Holdings Co. ........................     10/15/98          20,000
                                                                                 ---------
            Retail - Food Chains (0.0%)
   8,608    Grand Union Co. (Series 1) (d)...................     06/15/00           2,694
  17,216    Grand Union Co. (Series 2) (d)...................     06/15/00             276
                                                                                 ---------
                                                                                     2,970
                                                                                 ---------
            TOTAL WARRANTS
            (Identified Cost $568,873)....................................         159,374
                                                                                 ---------
</TABLE>
 
        SEE NOTES TO FINANCIAL STATEMENTS
<PAGE>   8
 
HIGH INCOME ADVANTAGE TRUST III
PORTFOLIO OF INVESTMENTS July 31, 1996 (unaudited) continued
 
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT IN                                               COUPON      MATURITY
THOUSANDS                                                RATE         DATE           VALUE
- ---------------------------------------------------------------------------------------------
<C>           <S>                                       <C>         <C>           <C>
              SHORT-TERM INVESTMENTS (5.8%)
              COMMERCIAL PAPER (e) (4.3%)
              Automotive - Finance
 $ 3,500      Ford Motor Credit Co. ................      5.35 %     08/07/96     $ 3,496,879
                                                                                    ---------
              REPURCHASE AGREEMENT (1.5%)
   1,231      The Bank of New York (dated 07/31/96;
              proceeds $1,230,912; collateralized by
              $1,459,345 Federal Home Loan Mortgage
              Corp. 7.00% due 04/01/24 valued at
              $1,255,329) (Identified Cost
              $1,230,715)...........................      5.75       08/01/96       1,230,715
                                                                                    ---------
              TOTAL SHORT-TERM INVESTMENTS
              (Identified Cost $4,727,594)...................................       4,727,594
                                                                                    ---------
              TOTAL INVESTMENTS
              (Identified Cost $93,930,702) (f).......................  98.0%      79,837,723
 
              OTHER ASSETS IN EXCESS OF LIABILITIES....................   2.0       1,619,277
                                                                         ----       ---------
              NET ASSETS.............................................  100.0%     $81,457,000
                                                                       ======     ===========
</TABLE>
 
- ---------------------
 
<TABLE>
<S>    <C>
ADR    American Depository Receipt.
 *     Resale is restricted to qualified institutional investors.
 +++   Consists of one or more class of securities traded together as a unit;
       generally bonds with attached stocks/warrants.
 +     Payment-in-kind security.
 ++    Currently a zero coupon bond and will pay interest at the rate shown at a
       future specified date.
(a)    Non-income producing security, issuer in bankruptcy.
(b)    Non-income producing security, bond in default.
(c)    Non-income producing security.
(d)    Acquired through exchange offer.
(e)    Security was purchased on a discount basis. The interest rate shown has been
       adjusted to reflect a money market equivalent yield.
(f)    The aggregate cost for federal income tax purposes approximates identified
       cost. The aggregate gross unrealized appreciation was $2,144,427 and the
       aggregate gross unrealized depreciation was $16,237,406, resulting in net
       unrealized depreciation of $14,092,979.
</TABLE>
 
        SEE NOTES TO FINANCIAL STATEMENTS
<PAGE>   9
 
HIGH INCOME ADVANTAGE TRUST III
FINANCIAL STATEMENTS
 
<TABLE>
<S>                                                                       <C>
STATEMENT OF ASSETS AND LIABILITIES
July 31, 1996 (unaudited)
ASSETS:
Investments in securities, at value
 (identified cost $93,930,702)........................................    $ 79,837,723
Receivable for:
    Investments sold..................................................       2,006,250
    Interest..........................................................       1,725,874
Prepaid expenses......................................................           5,365
                                                                            ----------
    TOTAL ASSETS......................................................      83,575,212
                                                                            ----------
LIABILITIES:
Payable for:
    Investments purchased.............................................       2,000,000
    Investment management fee.........................................          55,240
Accrued expenses......................................................          62,972
                                                                            ----------
    TOTAL LIABILITIES.................................................       2,118,212
                                                                            ----------
NET ASSETS:
Paid-in-capital.......................................................     121,076,287
Net unrealized depreciation...........................................     (14,092,979)
Accumulated undistributed net investment income.......................       1,536,812
Accumulated net realized loss.........................................     (27,063,120)
                                                                            ----------
    NET ASSETS........................................................    $ 81,457,000
                                                                            ==========
NET ASSET VALUE PER SHARE,
 12,876,779 shares outstanding
 (unlimited shares authorized of $.01 par value)......................           $6.33
                                                                                  ====
</TABLE>
 
        SEE NOTES TO FINANCIAL STATEMENTS
<PAGE>   10
 
HIGH INCOME ADVANTAGE TRUST III
FINANCIAL STATEMENTS, continued
 
<TABLE>
<S>                                                                        <C>
STATEMENT OF OPERATIONS
For the six months ended July 31, 1996 (unaudited)
NET INVESTMENT INCOME:
INTEREST INCOME........................................................    $ 5,567,661
                                                                             ---------
EXPENSES
Investment management fee..............................................        306,003
Professional fees......................................................         37,969
Transfer agent fees and expenses.......................................         23,022
Shareholder reports and notices........................................         12,740
Registration fees......................................................         12,240
Custodian fees.........................................................         12,100
Trustees' fees and expenses............................................          6,380
Other..................................................................          2,303
                                                                             ---------
    TOTAL EXPENSES.....................................................        412,757
                                                                             ---------
    NET INVESTMENT INCOME..............................................      5,154,904
                                                                             ---------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain......................................................        763,663
Net change in unrealized depreciation..................................     (2,102,826)
                                                                             ---------
    NET LOSS...........................................................     (1,339,163)
                                                                             ---------
NET INCREASE...........................................................    $ 3,815,741
                                                                             =========
</TABLE>
 
        SEE NOTES TO FINANCIAL STATEMENTS
<PAGE>   11
 
HIGH INCOME ADVANTAGE TRUST III
FINANCIAL STATEMENTS, continued
 
<TABLE>
<CAPTION>
STATEMENT OF CHANGES IN NET ASSETS
                                                                          FOR THE YEAR
                                                         FOR THE SIX          ENDED
                                                        MONTHS ENDED       JANUARY 31,
                                                        JULY 31, 1996         1996
- ---------------------------------------------------------------------------------------
                                                         (unaudited)
<S>                                                     <C>               <C>
INCREASE (DECREASE) IN NET ASSETS:
OPERATIONS:
Net investment income...............................     $ 5,154,904       $ 9,613,457
Net realized gain (loss)............................         763,663        (2,246,851)
Net change in unrealized depreciation...............      (2,102,826)        5,416,939
                                                          ----------        ----------
    NET INCREASE....................................       3,815,741        12,783,545
Dividends from net investment income................      (4,635,640)       (9,271,281)
                                                          ----------        ----------
    TOTAL INCREASE (DECREASE).......................        (819,899)        3,512,264
NET ASSETS:
Beginning of period.................................      82,276,899        78,764,635
                                                          ----------        ----------
    END OF PERIOD
    (Including undistributed net investment income of
    $1,536,812 and $1,017,548, respectively)........     $81,457,000       $82,276,899
                                                          ==========        ==========
</TABLE>
 
        SEE NOTES TO FINANCIAL STATEMENTS
<PAGE>   12
 
HIGH INCOME ADVANTAGE TRUST III
NOTES TO FINANCIAL STATEMENTS July 31, 1996 (unaudited)
 
1. ORGANIZATION AND ACCOUNTING POLICIES
 
High Income Advantage Trust III (the "Trust") is registered under the Investment
Company Act of 1940, as amended, as a diversified, closed-end management
investment company. The Trust's primary investment objective is to earn a high
level of current income and, as a secondary objective, capital appreciation, but
only when consistent with its primary objective. The Trust seeks to achieve its
objective by investing primarily in lower-rated fixed income securities. The
Trust was organized as a Massachusetts business trust on November 23, 1988 and
commenced operations on February 28, 1989.
 
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts and disclosures. Actual results could differ from
those estimates. The following is a summary of significant accounting policies:
 
A. VALUATION OF INVESTMENTS -- (1) an equity security listed or traded on the
New York or American Stock Exchange is valued at its latest sale price on that
exchange prior to the time when assets are valued; if there were no sales that
day, the security is valued at the latest bid price; (2) all other portfolio
securities for which over-the-counter market quotations are readily available
are valued at the latest available bid price prior to the time of valuation; (3)
when market quotations are not readily available, portfolio securities are
valued at their fair value as determined in good faith under procedures
established by and under the general supervision of the Trustees; (4) certain of
the Trust's portfolio securities may be valued by an outside pricing service
approved by the Trustees. The pricing service utilizes a matrix system
incorporating security quality, maturity and coupon as the evaluation model
parameters, and/or research and evaluations by its staff, including review of
broker-dealer market price quotations, if available, in determining what it
believes is the fair valuation of the portfolio securities valued by such
pricing service; and (5) short-term debt securities having a maturity date of
more than sixty days at time of purchase are valued on a mark-to-market basis
until sixty days prior to maturity and thereafter at amortized cost based on
their value on the 61st day. Short-term debt securities having a maturity date
of sixty days or less at the time of purchase are valued at amortized cost.
 
B. ACCOUNTING FOR INVESTMENTS -- Security transactions are accounted for on the
trade date (date the order to buy or sell is executed). Realized gains and
losses on security transactions are determined by the identified cost method.
Discounts are accreted over the life of the respective securities. Interest
income is accrued daily except where collection is not expected.
<PAGE>   13
 
HIGH INCOME ADVANTAGE TRUST III
NOTES TO FINANCIAL STATEMENTS July 31, 1996 (unaudited) continued
 
C. FEDERAL INCOME TAX STATUS -- It is the Trust's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute all of its taxable income to its shareholders.
Accordingly, no federal income tax provision is required.
 
D. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS -- The Trust records dividends
and distributions to its shareholders on the record date. The amount of
dividends and distributions from net investment income and net realized capital
gains are determined in accordance with federal income tax regulations which may
differ from generally accepted accounting principles. These "book/tax"
differences are either considered temporary or permanent in nature. To the
extent these differences are permanent in nature, such amounts are reclassified
within the capital accounts based on their federal tax-basis treatment;
temporary differences do not require reclassification. Dividends and
distributions which exceed net investment income and net realized capital gains
for financial reporting purposes but not for tax purposes are reported as
dividends in excess of net investment income or distributions in excess of net
realized capital gains. To the extent they exceed net investment income and net
realized capital gains for tax purposes, they are reported as distributions of
paid-in-capital.
 
2. INVESTMENT MANAGEMENT AGREEMENT
 
Pursuant to an Investment Management Agreement with Dean Witter InterCapital
Inc. (the "Investment Manager"), the Trust pays the Investment Manager a
management fee, calculated weekly and payable monthly, by applying the following
annual rates to the Trust's weekly net assets: 0.75% to the portion of weekly
net assets not exceeding $250 million; 0.60% to the portion of weekly net assets
exceeding $250 million but not exceeding $500 million; 0.50% to the portion of
weekly net assets exceeding $500 million but not exceeding $750 million; 0.40%
to the portion of weekly net assets exceeding $750 million but not exceeding $1
billion; and 0.30% to the portion of weekly net assets exceeding $1 billion.
 
Under the terms of the Agreement, in addition to managing the Trust's
investments, the Investment Manager maintains certain of the Trust's books and
records and furnishes, at its own expense, office space, facilities, equipment,
clerical, bookkeeping and certain legal services and pays the salaries of all
personnel, including officers of the Trust who are employees of the Investment
Manager. The Investment Manager also bears the cost of telephone services, heat,
light, power and other utilities provided to the Trust.
<PAGE>   14
 
HIGH INCOME ADVANTAGE TRUST III
NOTES TO FINANCIAL STATEMENTS July 31, 1996 (unaudited) continued
 
3. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES
 
The cost of purchases and proceeds from sales of portfolio securities, excluding
short-term investments, for the six months ended July 31, 1996 aggregated
$48,010,204 and $53,702,958, respectively.
 
Dean Witter Trust Company, an affiliate of the Investment Manager, is the
Trust's transfer agent. At July 31, 1996, the Trust had transfer agent fees and
expenses payable of approximately $7,000.
 
4. SHARES OF BENEFICIAL INTEREST
 
<TABLE>
<CAPTION>
                                                                                                                    CAPITAL
                                                                                                                    PAID IN
                                                                                                                   EXCESS OF
                                                                                      SHARES       PAR VALUE       PAR VALUE
                                                                                    ----------     ----------     ------------
<S>                                                                                 <C>            <C>            <C>
Balance, January 31, 1995, January 31, 1996 and July 31, 1996...................    12,876,779      $ 128,768     $120,947,519
                                                                                     =========        =======      ===========
</TABLE>
 
5. DIVIDENDS
 
The Trust declared the following dividends from net investment income:
 
<TABLE>
<CAPTION>
    DECLARATION         AMOUNT             RECORD                PAYABLE
       DATE            PER SHARE            DATE                  DATE
- -------------------    ---------     ------------------    -------------------
<S>                    <C>           <C>                   <C>
   July 30, 1996         $0.06         August 9, 1996        August 23, 1996
  August 27, 1996        $0.06       September 6, 1996     September 20, 1996
</TABLE>
 
6. FEDERAL INCOME TAX STATUS
 
At January 31, 1995, the Trust had an approximate net capital loss carryover
which may be used to offset future capital gains to the extent provided by
regulations as follows:
 
<TABLE>
<CAPTION>
            AVAILABLE THROUGH JANUARY 31
               (AMOUNTS IN THOUSANDS)
- ----------------------------------------------------
 2000       2002       2003        2004       TOTAL
- -------    ------     -------     ------     -------
<S>        <C>        <C>         <C>        <C>
$9,648     $3,256     $10,665     $4,232     $27,801
 =====      =====      ======      =====      ======
</TABLE>
<PAGE>   15
 
HIGH INCOME ADVANTAGE TRUST III
FINANCIAL HIGHLIGHTS
 
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
<TABLE>
<CAPTION>
                                                                       FOR THE SIX
                                                                       MONTHS ENDED     FOR THE YEAR ENDED JANUARY 31
                                                                         JULY 31,       -----------------------------
                                                                           1996             1996             1995
- ---------------------------------------------------------------------------------------------------------------------
                                                                       (unaudited)
<S>                                                                    <C>              <C>              <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period...............................        $ 6.39             $ 6.12           $ 7.57
                                                                           ------               ----             ----
Net investment income..............................................          0.40               0.75             0.75
Net realized and unrealized gain (loss)............................         (0.10)              0.24            (1.43)
                                                                           ------               ----             ----
Total from investment operations...................................          0.30               0.99            (0.68)
                                                                           ------               ----             ----
Less dividends from net investment income..........................         (0.36)             (0.72)           (0.77)
                                                                           ------               ----             ----
Net asset value, end of period.....................................        $ 6.33             $ 6.39           $ 6.12
                                                                           ------               ----             ----
Market value, end of period........................................        $ 7.00             $ 6.75           $ 6.50
                                                                           ======               ====             ====
TOTAL INVESTMENT RETURN+...........................................          9.19%(1)          15.31%           (6.30)%
RATIOS TO AVERAGE NET ASSETS:
Expenses...........................................................          1.01%(2)           1.00%            1.02%
Net investment income..............................................         12.63%(2)          11.80%           11.04%
SUPPLEMENTAL DATA:
Net assets, end of period, in thousands............................       $81,457            $82,277          $78,765
Portfolio turnover rate............................................            61%(1)             78%              82%
 
<CAPTION>
                                                                               FOR THE YEAR ENDED JANUARY 31
                                                                      -----------------------------------------------
                                                                           1994              1993             1992
- ---------------------------------------------------------------------------------------------------------------------
<S>                                                                    <C>            <C>              <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period...............................        $ 6.70           $ 6.83           $ 5.18
                                                                             ----            -----             ----
Net investment income..............................................          0.81             0.91             0.84
Net realized and unrealized gain (loss)............................          0.91            (0.13)            1.58
                                                                             ----            -----             ----
Total from investment operations...................................          1.72             0.78             2.42
                                                                             ----            -----             ----
Less dividends from net investment income..........................         (0.85)           (0.91)           (0.77)
                                                                             ----            -----             ----
Net asset value, end of period.....................................        $ 7.57           $ 6.70           $ 6.83
                                                                             ----            -----             ----
Market value, end of period........................................        $ 7.75           $6.875           $ 6.50
                                                                             ====            =====             ====
TOTAL INVESTMENT RETURN+...........................................         26.21%           20.77%           60.31%
RATIOS TO AVERAGE NET ASSETS:
Expenses...........................................................          0.99%            1.06%            1.17%
Net investment income..............................................         11.40%           13.22%           13.53%
SUPPLEMENTAL DATA:
Net assets, end of period, in thousands............................       $97,466          $86,305          $89,084
Portfolio turnover rate............................................           231%             118%             137%
</TABLE>
 
- ---------------------
 +  Total investment return is based upon the current market value on the last
    day of each period reported. Dividends are assumed to be reinvested at the
    prices obtained under the Trust's dividend reinvestment plan. Total
    investment return does not reflect brokerage commissions.
(1)  Not annualized.
(2)  Annualized.
 
                       SEE NOTES TO FINANCIAL STATEMENTS
<PAGE>   16
TRUSTEES
- ----------------------------------------------
Michael Bozic
Charles A. Fiumefreddo
Edwin J. Garn
John R. Haire
Dr. Manuel H. Johnson
Michael E. Nugent
Philip J. Purcell
John L. Schroeder

OFFICERS
- ----------------------------------------------
Charles A. Fiumefreddo
Chairman and Chief Executive Officer

Sheldon Curtis
Vice President, Secretary and General Counsel

Peter M. Avelar
Vice President

Thomas F. Caloia
Treasurer

TRANSFER AGENT
- ----------------------------------------------
Dean Witter Trust Company
Harborside Financial Center -- Plaza Two
Jersey City, New Jersey 07311

INDEPENDENT ACCOUNTANTS
- ----------------------------------------------
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York 10036

INVESTMENT MANAGER
- ----------------------------------------------
Dean Witter InterCapital Inc.
Two World Trade Center
New York, New York 10048




The financial statements included herein have been taken from the records of
the Fund without examination by the independent accountants and accordingly
they do not express an opinion thereon.



HIGH
INCOME
ADVANTAGE
TRUST III


Semiannual Report
July 31, 1996


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