MANAGER'S DISCUSSION
Your Fund's Objective:
The Franklin Principal Maturity Trust's primary objective is to manage a
portfolio of securities with the goal of returning $10.00 per share to investors
on or shortly before May 31, 2001, while providing high monthly income. No
assurances can be made that the fund will achieve this goal.
July 15, 1996
Dear Shareholder:
We're pleased to bring you the Franklin Principal Maturity Trust's semi-annual
report for the period ended May 31, 1996. Despite a generally rising interest
rate environment, the fund generated a cumulative total return of +5.24%, based
on the change in its market price on the New York Stock Exchange for the six
months ended May 31, 1996.
As you may know, the year-long interest rate decline reversed direction in
February 1996, following U.S. Department of Commerce reports that showed
unexpectedly strong employment growth. Interest rates generally rose through the
remainder of the reporting period.
A large portion of the fund's total net assets (47%) is invested in zero coupon,
U.S. government-agency bonds maturing on or around May 31, 2001.
Although these bonds are guaranteed by the U.S. government as to payment of
principal and interest, and will mature at par value, they are very sensitive to
interim movements in interest rates. As the economy began to expand and interest
rates rose, government bond prices declined.
By favorably positioning the fund in cyclical issues, both our stock and bond
holdings benefited from the improving economy. Our bond holdings in Haynes
International Inc. and Ladish, for example, allowed us to capitalize on the
growing strength of the aerospace industry, which continued to improve through
the end of the reporting period. We recorded another strong performance from our
investment in Mesa Capital bonds (energy sector). Mesa generated strong returns
during the period due, in part, to higher energy prices and a proposed
additional equity investment in the company from an outside investor.
On the equity side, three stocks that performed well during the period were Lone
Star Industries, Inc., a cement manufacturer; Carson Pirie Scott & Co., a
department store chain in the Midwest; and Emcor Group, Inc., the largest
mechanical/electrical contractor in North America.
Overall, we sought to maximize gains on an improving economy and hedge against
losses in our interest rate-sensitive issues. We remain heavily invested in
bonds of the U.S. government and its related agencies, while common stocks and
corporate bonds -- the two areas that generated the largest gains during the
period -made up nearly 49% of our total net assets on May 31, 1996.
Although interest rates experienced upward pressures in the first half of the
year, we anticipate continued, modest economic growth over the short- to
intermediate-term. A stable economy, coupled with moderate inflationary figures,
should lead to a more favorable interest rate environment.
We appreciate your continued support of Franklin Principal Maturity Trust and
look forward to serving your needs in the years to come.
Sincerely,
Charles B. Johnson
President
Franklin Principal Maturity Trust
Top Ten Holdings
As of May 31, 1996
% of Net
Holding Assets
U.S. Treasury Strips (Zero Coupon) 33.63%
REFCO Strips (Zero Coupon) 15.82%
Government Trust Strip, Israel, Series aF
(Zero Coupon) 10.65%
Carson Pirie Scott & Co. 6.08%
Lone Star Industries, Inc. 5.19%
FICO (Zero Coupon) 04106101 4.92%
FICO (Zero Coupon) 03107101 4.29%
Haynes International, Inc. 3.58%
Harvard Industries, Inc., Plk 3.44%
Rexene Corporation 3.33%
For a complete list of portfolio holdings, please see
page 5 of this report.
Performance Summary
The Franklin Principal Maturity Trust's share price on the New York Stock
Exchange (NYSE) increased $0.125, from $7.50 on November 30, 1995, to $7.625 on
May 31, 1996. The Trust's net asset value per share increased $0.42, from $8.54
on November 30, 1995, to $8.96 on May 31, 1996.
The Trust distributed income dividends of 27.0 cents ($0.270) per share during
the reporting period. Based on an annualization of the current monthly dividend
of 4.5 cents ($0.045) per share and the NYSE closing share price of $7.625 on
May 31, 1996, the Trust's distribution rate was 7.08%. Dividends will vary based
on the earnings of the portfolio, and past distributions are not predictive of
future trends.
The Franklin Principal Maturity Trust reported cumulative total returns of
+5.24% and +15.47% respectively, for the six-month and one-year periods ended
May 31, 1996. Total return reflects the change in the Trust's share price on the
NYSE and assumes reinvestment of dividends and capital gains at market price on
the reinvestment date. Based on the change in net asset value (as opposed to
market price), six-month and one-year total returns for the same period were
+8.61% and +18.33%, respectively. These figures assume reinvestment of dividends
and capital gains at market price on the reinvestment date. Past performance is
not predictive of future trends.
We urge you to view your investment in Franklin Principal Maturity Trust with a
long-term investment perspective. As the chart below shows, the Trust reported a
cumulative total return of +83.46%, based on net asset value, since its
inception on January 19, 1989.
Franklin Principal Maturity Trust
Periods ended May 31, 1996
Since
Inception
1-Year 5-Year (1/19/89)
Cumulative Total Return1
Based on change
in net asset value 18.33% 70.10% 83.46%
Based on change
in market price 15.47% 43.93% 45.19%
Average Annual
Total Return1
Based on change
in net asset value 18.33% 11.21% 8.58%
Based on change
in market price 15.47% 7.55% 5.19%
Distribution Rate:2 7.08%
1. Total Return calculations represent the change in value of an investment over
the periods indicated and assume reinvestment of all distributions at market
price on the reinvestment date. Past performance is not predictive of future
results.
2. Distribution Rate is based on the annualization of the Trust's current 4.5
cents per share monthly dividend and the New York Stock Exchange closing price
of $7.625 on May 31, 1996.
FRANKLIN PRINCIPAL MATURITY TRUST
Statement of Investments in Securities and Net Assets, May 31, 1996 (unaudited)
<TABLE>
<CAPTION>
Shares,
Warrants Value
& Rights (Note 1)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Common Stocks, Warrants & Rights 23.9%.......................................
Aerospace/Defense 2.2%
2,144,000 gLadish Co., Inc. ............................................................. $ 3,752,000
895 a,bLadish Co., Inc., warrants.................................................... 223,829
3,000 aSabreliner Corp., warrants ................................................... 15,000
-------------
3,990,829
-------------
Automobile/Auto Parts 1.5%
105,000 aHarvard Industries, Inc., Class B............................................. 1,732,500
156,601 aPullman Co. .................................................................. 959,181
-------------
2,691,681
-------------
Chemicals 3.3%
519,000 aRexene Corp. ................................................................. 6,098,250
-------------
Commercial Services 2.0%
227,991 aEmcor Group, Inc. ............................................................ 3,719,103
-------------
Electronics .2%
27,620 aAmpex Group, Inc.............................................................. 372,870
-------------
Forest/Paper Products .2%
407,221 aWTD Industries, Inc........................................................... 305,416
-------------
Home Building 1.4%
245,194 a,bNVR, Inc. .................................................................... 2,605,186
24,000 a,bNVR, Inc., warrants .......................................................... 45,000
-------------
2,650,186
-------------
Industrial 5.4%
286,075 Lone Star Industries, Inc. ................................................... 9,511,994
274,444 a,c,gTriangle Wire & Cable Corp. .................................................. 411,666
-------------
9,923,660
-------------
Machine/Construction
3,000 aTerex Corp., rights .......................................................... --
-------------
Real Estate
65,393 aXRC Corp. .................................................................... 3,924
-------------
Retail 6.1%
401,510 aCarson Pirie Scott & Co. ..................................................... 11,141,903
456 aHills Stores Co. ............................................................. 5,529
-------------
11,147,432
-------------
Technology/Information Systems .9%
438,407 aMemorex Telex, NV, ADR ....................................................... 630,210
48,081 aWang Laboratories, Inc. ...................................................... 1,039,752
-------------
1,669,962
-------------
Utilities .7%
248,077 aEl Paso Electric Co. ......................................................... $ 1,348,919
-------------
Total Common Stocks, Warrants & Rights (Cost $34,747,357) .............. 43,922,232
-------------
Preferred Stocks 6.3%
Automobile/Auto Parts 3.4%
239,369 Harvard Industries, Inc., 14.25% pfd., PIK ................................... 6,313,357
-------------
Cable Television 2.7%
50,711 cCablevision Systems Corp., Series L, 11.125% pfd., PIK ....................... 4,918,967
-------------
Financial Services .2%
20,000 Nortel, Inc., pfd., Series B ................................................. 280,000
-------------
Total Preferred Stocks (Cost $11,655,481) .............................. 11,512,324
-------------
Convertible Preferred Stocks .1%
19,498 aHills Stores Co., cvt. pfd., Series A (Cost $392,397) ........................ 243,725
-------------
Face
Amount
---------- Corporate Bonds 25.3%
Aerospace/Defense 5.0%
$ 11,042 bLadish Co., Inc., units, 12.00%, 12/22/00 .................................... 9,966
6,500,000 Haynes International, Inc., senior sub. notes, 13.50%, 08/15/99 .............. 6,565,000
3,000,000 Sabreliner Corp., senior notes, 12.50%, 04/15/03 ............................. 2,625,000
-------------
9,199,966
-------------
Automotive .5%
1,500,000 cExide Corp., senior sub. notes, 2.90%,12/15/05 ............................... 877,500
-------------
Chemicals/Fertilizers 1.5%
3,100,000 Lanesborough Corp., senior notes, 10.00%, 04/15/00 ........................... 2,650,500
-------------
Financial 2.3%
4,000,000 cAcadia Partners, senior sub. notes, 13.00%, 10/01/97 ......................... 4,100,000
-------------
Food Retailing .8%
2,528,000 Almac, Inc., senior sub. notes, PIK, 11.50%, 11/19/04 ........................ 290,720
170,000 Doane Products Co., senior notes, 10.625%, 03/01/06 .......................... 172,975
7,500,000 dVictory Markets, Inc., notes, 12.50%, 03/15/00 ............................... 1,050,000
-------------
1,513,695
-------------
Forest/Paper Products 2.9%
5,000,000 Rapp International Finance Co., guaranteed, secured notes, 13.25%, 12/15/05 .. 5,350,000
-------------
Gaming & Leisure .5%
2,000,000 dHarrah's Jazz Co., first mortgage, 14.25%, 11/15/01 .......................... 920,000
-------------
Industrial 3.0%
$ 700,000 AAF-McQuay, Inc., senior notes, 8.875%, 02/15/03 ............................. $ 668,500
5,000,000 Great Dane Holdings, Inc., senior notes, 14.50%, 01/01/06 .................... 4,900,000
9,000 Lone Star Industries, Inc., senior notes, 10.00%, 07/31/03 ................... 9,113
-------------
5,577,613
-------------
Oil/Gas 1.0%
1,000,000 Plains Resources, Inc., senior sub. notes, 10.25%, 03/15/06 .................. 1,010,000
1,000,000 TransAmerican Refining Corp., first mortgage, Series 2, 16.50% coupon to
08/15/98, 16.00% thereafter, 02/15/02 ....................................... 905,000
-------------
1,915,000
-------------
Retail 1.2%
2,000,000 Levitz Furniture, senior sub. notes, 9.625%, 07/15/03 ........................ 1,340,000
2,000,000 dRickel Home Centers, units, 13.50%, 12/15/01 ................................. 770,000
-------------
2,110,000
-------------
Semiconductors 1.3%
2,500,000 cXilinx, Inc., sub. notes, 5.25%, 11/01/02 .................................... 2,403,125
-------------
Tobacco 2.0%
574,000 cLiggett Group, senior secured notes, Series C, 19.75%, 02/01/99 .............. 556,780
3,750,000 Liggett Group, S.F., senior secured notes, 11.50%, 02/01/99 .................. 3,131,250
-------------
3,688,030
-------------
Utilities 2.1%
430,000 El Paso Electric, first mortgage, Series A, 7.25%, 02/01/99 .................. 425,163
477,000 El Paso Electric, first mortgage, Series B, 7.75%, 05/01/01 .................. 466,864
405,000 El Paso Electric, first mortgage, Series C, 8.25%, 02/01/03 .................. 395,888
2,500,000 El Paso Electric, first mortgage, Series E, 9.40%, 05/01/11 .................. 2,503,125
-------------
3,791,040
-------------
Total Corporate Bonds (Cost $52,012,543) ............................... 44,096,469
-------------
Foreign Government Bonds 1.2%
4,350,000 eESCOM, E168, utility deb. (South Africa), 11.00%, 06/01/08 ................... 733,136
2,158,000 Republic of Ecuador, deb. notes, 3.00%, 02/27/15 ............................. 919,347
1,100,000 Republic of Ecuador, deb. notes, 7.25%, 02/28/25 ............................. 610,500
-------------
Total Foreign Government Bonds (Cost $2,166,283) ....................... 2,262,983
-------------
Zero Coupon Bonds 81.1%
10,850,000 FICO Strips, 03/07/01 ........................................................ 7,861,008
12,520,000 FICO Strips, 04/06/01 ........................................................ 9,018,706
5,211,000 FICO Strips, 05/02/01 ........................................................ 3,734,567
1,116,000 FICO Strips, 05/11/01 ........................................................ 798,400
5,253,000 FICO Strips, 05/30/01 ........................................................ 3,744,164
$ 7,348,000 FNMA Strips, 02/01/01 ........................................................ $ 5,364,539
8,100,000 GTC Trust Certificates-Israel, Series 1D, 05/15/01 ........................... 5,809,934
27,226,000 fGTC Trust Certificates-Israel, Series 2F, 05/15/01 ........................... 19,528,552
5,000 a,dMcCrory Corp., deb., 0.00%, 12/31/96.......................................... 2,250,000
40,000,000 REFCO Strips, 04/15/01 ....................................................... 29,009,673
85,249,000 fU.S. Treasury Strips, 05/15/01 ............................................... 61,673,558
-------------
Total Zero Coupon Bonds (Cost $148,743,597) ............................ 148,793,101
-------------
Total Long Term Investments (Cost $249,717,658)......................... 250,830,834
-------------
hReceivables from Repurchase Agreements 2.6%
4,746,278 Joint Repurchase Agreement, 5.329%, 06/03/96, (Maturity Value $4,722,172)
(Cost $4,720,076)
B.A. Securities, Inc., (Maturity Value $652,422)
Collateral: U.S. Treasury Notes, 5.625% - 7.25%, 11/15/96 - 06/30/97
Bear Stearns & Co., Inc., (Maturity Value $652,422)
Collateral: U.S. Treasury Bills, 11/21/96
U.S. Treasury Notes, 5.625% - 9.25%, 08/15/98 - 02/28/01
B.T. Securities Corp., (Maturity Value $652,422)
Collateral: U.S. Treasury Notes, 6.375%, 05/15/99
Daiwa Securities America, Inc., (Maturity Value $652,422)
Collateral: U.S. Treasury Notes, 5.375% - 6.875%, 11/30/97 - 04/30/01
Donaldson, Lufkin & Jenrette Securities Corp., (Maturity Value $807,640)
Collateral: U.S. Treasury Notes, 5.625% - 8.50%, 03/31/97 - 02/29/00
Nikko Securities Co. International, Inc., (Maturity Value $652,422)
Collateral: U.S. Treasury Notes, 4.75% - 8.25%, 08/31/97 - 08/31/00
SBC Capital Markets, Inc., (Maturity Value $652,422)
Collateral: U.S. Treasury Notes, 5.625% - 6.875%, 10/31/97 - 07/31/99 ..... 4,720,076
-------------
Total Investments (Cost $254,437,734) 139.3% ...................... 255,550,910
Liabilities in Excess of Other Assets (39.3)% ..................... (72,154,078)
-------------
Net Assets 100.0% ................................................. $183,396,832
=============
At May 31, 1996, the net unrealized appreciation based on the cost of
investments for income tax purposes of $254,483,363 was as follows:
Aggregate gross unrealized appreciation for all investments
in which there was an excess of value over tax cost ....................... $ 18,616,872
Aggregate gross unrealized depreciation for all investments
in which there was an excess of tax cost over value ....................... (17,549,325)
-------------
Net unrealized appreciation ................................................ $ 1,067,547
=============
</TABLE>
PORTFOLIO ABREVIATIONS:
FICO - Financing Corp.
FNMA - Federal National Mortgage Association
GTC - Government Trust Certificates
REFCO - Resolution Funding Corp.
PIK - Payment-in-Kind
S.F. - Sinking Fund
aNon-income producing.
bSee Note 6 regarding restricted securities.
cPurchased in a private placement transaction; resale may only be to qualified
institutional buyers.
dSee Note 9 regarding credit risk and defaulted securities.
eFace amount is stated in foreign currency and value is stated in U.S. dollars.
fA portion of these securities is designated as collateral for reverse
repurchase agreement transactions.
gSee Note 10 regarding holdings of 5% voting securities.
hFace amount for repurchase agreements is for the underlying collateral. See
Note 2(f) regarding joint repurchase agreement.
The accompanying notes are an integral part of these financial statements.
FRANKLIN PRINCIPAL MATURITY TRUST
Financial Statements
Statement of Assets and Liabilities
May 31, 1996 (unaudited) Assets:
Investments in securities, at value
(identified cost $249,717,658) $250,830,834
Receivables from repurchase
agreements, at value and cost 4,720,076
Receivables
Interest and dividends 1,804,523
Investment securities sold 2,569,328
--------------
Total assets 259,924,761
--------------
Liabilities
Payables:
Investment securities purchased 463,656
Reverse repurchase agreements (Note 2) 74,653,035
Distributions to shareholders 920,817
Accrued interest (Note 2) 339,049
Management fees 91,908
Shareholder servicing costs 12,482
Accrued expenses and other liabilities 46,982
--------------
Total liabilities 76,527,929
--------------
Net assets, at value $183,396,832
==============
Net assets consist of:
Undistributed net investment income $ 773,197
Net unrealized appreciation on invest-
ments and translation of assets and
liabilities denominated in foreign
currencies 1,106,773
Net realized loss from investments and
foreign currency transactions (3,840,982)
Capital shares 185,357,844
--------------
Net assets, at value $183,396,832
==============
Net asset per share
($183,396,832 / 20,462,600 shares
of beneficial interest outstanding) $8.96
==============
Statement of Operations
for the six months ended May 31, 1996 (unaudited)
Investment income:
Interest (Note 2) $8,394,438
Dividends 189,680
--------------
Total income $ 8,584,118
Expenses:
Management fees (Note 4) 538,534
Shareholder servicing costs 45,864
Professional fees 46,418
Reports to shareholders 12,665
Custodian fees 8,742
Trustees' fees and expenses 8,038
Other 42,896
--------------
Operating expenses 703,157
Interest expense (Note 2) 2,110,305
--------------
Total expenses 2,813,462
--------------
Net investment income 5,770,656
--------------
Realized and unrealized gain
(loss) from investments and
foreign currency:
Net realized loss from:
Investments (108,464)
Foreign currency transactions (4,058)
Net unrealized appreciation
(depreciation) on:
Investments 8,464,659
Translation of assets and
liabilities denominated
in foreign currencies (6,088)
--------------
Net realized and unrealized
gain on investments
and foreign currencies 8,346,049
--------------
Net increase in net assets
resulting from operations $14,116,705
==============
The accompanying notes are an integral part of these financial statements.
FRANKLIN PRINCIPAL MATURITY TRUST
Financial Statements (cont.)
Statements of Changes in Net Assets
for the six months ended May 31, 1996 (unaudited)
and the year ended November 30, 1995
Six Months Year Ended
Ended November 30,
May 31, 1996 1995
--------- ---------
Increase (decrease)
in net assets:
Operations:
Net investment income $ 5,770,656 $ 10,464,321
Net realized loss from
investments and foreign
currency transactions (112,522) (3,339,040)
Net unrealized appre-
ciation on investments
and translation of
assets and liabilities
denominated in foreign
currencies 8,458,571 22,265,305
--------- ---------
Net increase
in net assets
resulting from
operations 14,116,705 29,390,586
Distributions to
shareholders from
undistributed net
investment income (5,524,902) (12,093,398)
--------- ---------
Net increase
in net assets 8,591,803 17,297,188
Net assets:
Beginning of period 174,805,029 157,507,841
--------- ---------
End of period (including
undistributed net
investment income of
$773,197 - 5/31/96 and
$533,928 -11/30/95) $183,396,832 $174,805,029
========= =========
Statement of Cash Flows
for the six months ended May 31, 1996 (unaudited)
Interest and dividends received $7,892,794
Interest expense paid (1,706,479)
Operating expenses paid (703,503)
--------------
Cash provided - operations 5,482,812
--------------
Investment purchases (465,566,528)
Investment sales 462,878,739
--------------
Cash used - investments (2,687,789)
--------------
Net increase in reverse repurchase
agreement transactions 3,568,846
Distributions to shareholders (6,363,869)
--------------
Cash used - financing activities (2,795,023)
--------------
Net increase in cash --
Cash at beginning of period --
--------------
Cash at end of period $ --
==============
The accompanying notes are an integral part of these financial statements.
FRANKLIN PRINCIPAL MATURITY TRUST
Notes to Financial Statements (unaudited)
NOTE 1 - ORGANIZATION
Franklin Principal Maturity Trust (the Fund) was organized as a Massachusetts
business trust on November 22, 1988, and is registered as a diversified,
closed-end management investment company under the Investment Company Act of
1940, as amended. The Fund seeks to provide investors with high current income
consistent with preservation of capital.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
a. Security Valuation: Portfolio securities listed on a securities exchange or
on the NASDAQ for which market quotations are readily available are valued at
the last sale price or, if there is no sale price, within the range of the most
recent quoted bid and asked prices. Other securities are valued based on a
variety of factors, including yield, risk, maturity, trade activity and recent
developments related to these securities. The Fund may utilize a pricing
service, bank or broker/dealer experienced in such matters to perform any of the
pricing functions, under procedures approved by the Board of Trustees (the
Board). Securities for which market quotations are not available are valued in
accordance with procedures established by the Board.
The value of a foreign security is determined as of the close of trading on the
foreign exchange on which it is traded or as of the close of trading on the New
York Stock Exchange, if that is earlier, and that value is then converted into
its U.S. dollar equivalent at the foreign exchange rate in effect at noon, New
York time, on the day the value of the foreign security is determined. If no
sale is reported at that time, the mean between the current bid and asked price
is used. Occasionally, events which affect the values of foreign securities and
foreign exchange rates may occur between the times at which they are determined
and the close of the exchange and will, therefore, not be reflected in the
computation of the Fund's net asset value, unless material. If events which
materially affect the value of these securities occur during such period, these
securities will be valued in accordance with procedures established by the
Board.
The fair value of securities restricted as to resale are determined following
procedures established by the Board.
b. Investment Income, Expenses and Distributions: Dividend income and
distributions to shareholders is recorded on the ex-dividend date. Interest
income and estimated expenses are accrued daily. Bond discount and premium are
amortized as required by the Internal Revenue Code.
Net realized capital gains or losses differ for financial statement and tax
purposes primarily due to differing wash sale and foreign currency transactions.
Net investment income differs for financial statement and tax purposes primarily
due to differing treatments of defaulted securities and foreign currency
transactions - see Note 9.
c. Security Transactions: Security transactions are accounted for on the date
the securities are purchased or sold (trade date). Realized gains and losses on
security transactions are determined on the basis of specific identification.
d. Income Taxes: The Fund intends to continue to qualify for the tax treatment
applicable to regulated investment companies under the Internal Revenue Code and
to make the requisite distributions to shareholders which will be sufficient to
relieve it from income and excise taxes.
e. Foreign Currency Translation: The accounting records of the Fund are
maintained in U.S. dollars. All assets and liabilities denominated in foreign
currencies are translated into U.S. dollars at the rate of exchange of the
currencies against U.S. dollars on the date of the valuation. Purchases and
sales of securities, income and expenses are translated at the rate of exchange
quoted on the day that the transactions are recorded. Differences between income
and expense amounts recorded and collected or paid are recognized when reported
by the custodian bank.
The Fund does not isolate that portion of the results of operations resulting
from changes in foreign exchange rates on investments from fluctuations arising
form changes in market prices of securities held. Such fluctuations are included
with the net realized and unrealized gain or loss from investments.
e. Foreign Currency Translation (cont):
Realized foreign exchange gains or losses arise from sales and maturities of
short-term securities, sales of foreign currencies, gains or losses realized
between the trade and settlement dates on security transactions, the difference
between the amounts of dividends and interest, and foreign withholding taxes
recorded on the Fund's books and the U.S. dollar equivalent of the amounts
actually received or paid. Net unrealized appreciation or depreciation on
translation of assets and liabilities denominated in foreign currencies arises
from changes in the value of assets and liabilities other than investments in
securities at the end of the reporting period, resulting from changes in
exchange rates.
f. Repurchase Agreements: The Fund may enter into a joint repurchase agreement
whereby its uninvested cash balance is deposited into a joint cash account to be
used to invest in one or more repurchase agreements with government securities
dealer recognized by the Federal Reserve Board and/or member banks of the
Federal Reserve System. The value and face amount of the joint repurchase
agreement are allocated to the Fund based on its pro-rata interest. A repurchase
agreement is accounted for as a loan by the Fund to the seller, collateralized
by underlying U.S. government securities, which are delivered to the Fund's
custodian. The market value, including accrued interest, of the initial
collateralization is required to be at least 102% of the dollar amount invested
by the Fund, with the value of the underlying securities marked to market daily
to maintain coverage of at least 100%. At May 31, 1996, all outstanding
repurchase agreements held by the Fund had been entered into on that date.
g. Reverse Repurchase Agreements: During the period ended May 31, 1996, the Fund
entered into reverse repurchase agreements with certain brokers. Under a reverse
repurchase agreement, the Fund sells securities and agrees to repurchase them at
a mutually agreed-upon date and price. Such a transaction is accounted for as a
borrowing by the Fund, collateralized by securities for which the Fund retains
possession. The difference between the selling price and the repurchase price is
accounted for as interest expense. At May 31, 1996, the outstanding reverse
repurchase agreements, which were entered into on May 1, 1996, and
collateralized by zero coupon bonds issued by the U.S. government or its
agencies, mature within 61 days and are as follows:
<TABLE>
<CAPTION>
Amount of Weighted Weighted Cost of Value of
Counterparty Agreements Average Rate Average Maturity Collateral Collateral
- -------- -------- -------- ---------- -------- --------
<S> <C> <C> <C> <C> <C>
Bear Stearns $74,653,035 5.45% 34 days $64,297,432 $81,202,110
</TABLE>
The Fund has entered into various interest swap agreements in order to convert
its interest exposure on a portion of the reverse repurchase agreements from a
current short-term rate to a long-term fixed rate. See Note 2h.
h. Interest Rate Swap Agreements: During the period ended May 31, 1996, the Fund
entered into various interest rate swap agreements. As part of the Fund's asset
and liability management, these agreements are used as a hedge for the interest
rate exposure on its reverse repurchase agreements - see Note 2g. The fund is
exposed to credit risk in the event of non-performance by the counterparty to
the interest rate swap agreements. Notional principal amounts specified in these
agreements often are used to express the volume of these transactions, but the
amounts potential subject to such credit risk are limited to the accrued
interest. To minimize the risk, the Fund's policy required all counterparties to
have a minimum credit rating of A. At May 31, 1996, the Fund had no outstanding
interest rate swaps.
i. Accounting Estimates: The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the amounts of income
and expense during the reporting period. Actual results could differ from those
estimates.
NOTE 3 - DISTRIBUTIONS AND CAPITAL LOSS CARRYOVERS
At November 30, 1995, for tax purposes, the Fund had capital loss carryovers as
follows:
Expiring in:2002...................... 342,927
2003...................... 3,346,388
For tax purposes, the aggregated cost of securities and unrealized appreciation
is lower for financial reporting purposes at May 31, 1996 by $45,629.
NOTE 4 - TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES
Under the terms of a management agreement, Franklin Advisers, Inc. (Advisers)
provides investment advice, administrative services, office space and facilities
to the Fund, and receives fees computed weekly and payable monthly at 0.60% of
the Fund's average weekly net assets from June 1, 1993 through May 31, 1997.
After May 31, 1997, the Fund will pay fees of 0.45% of its average weekly net
assets from June 1, 1997 until May 31, 2001 (the anticipated termination of the
Fund). Fees incurred by the Fund aggregated $538,534 for the period ended May
31, 1996. Certain officers and trustees of the Trust are also officers and/or
directors of Advisers, a wholly-owned subsidiary of Franklin Resources, Inc.
NOTE 5 - TRUST SHARES
As a result of its initial public offering, 20,355,000 shares of beneficial
interest were sold at a price of $10.00 per share. The Fund received proceeds
from the sale of $189,301,500, after underwriting discounts of $.70 per share.
At May 31, 1996, the Fund has an unlimited number of shares at $.01 par value
authorized.
NOTE 6 - RESTRICTED SECURITIES
A restricted security is a security which has not been registered with the
Securities and Exchange Commission pursuant to the Securities Act of 1933 (1933
Act). The Fund may purchase restricted securities through a private offering
which cannot be sold without prior registration under the 1933 Act unless such
sale is pursuant to an exemption therefrom. Subsequent costs of registration of
such securities are borne by the issuer. A secondary market exists for certain
privately placed securities. The Fund values these restricted securities as
disclosed in Note 2. At May 31, 1996, the Fund held the following restricted
securities representing 1.57% of net assets:
<TABLE>
<CAPTION>
Shares/Units/Warrants Security Acquisition Date Cost Value
- --------------- -------------------------------- ------------- ------- --------
<S> <C> <C> <C> <C>
11,042 Ladish, Co., Inc., units..................... 05/30/96 11,042 9,966
895 Ladish Co., Inc, warrants.................... 02/22/96 223,829 223,829
245,194 NVR, Inc. ................................... 02/24/89 - 05/02/94 2,888,893 2,605,186
24,000 NVR, Inc., warrants.......................... 09/29/93 102,000 45,000
</TABLE>
NOTE 7 - PURCHASES AND SALES OF SECURITIES
Purchases and sales of securities (excluding purchases and sales of short-term
securities) for the period ended May 31, 1996 aggregated $30,283,834 and
$41,445,409, respectively.
NOTE 8 - STATEMENT OF CASH FLOWS
The Fund's financial statements for the year ended May 31, 1996 include a
Statement of Cash Flows in compliance with SFAS 102. Cash provided from
operations differs from net investment income because of amortization of bond
discount and premium, bonds paid-in-kind, year-end income and expense accrual
changes amounting to $287,844.
NOTE 9 - CREDIT RISK AND DEFAULTED SECURITIES
Although the Fund has a diversified portfolio, 23.8% of its portfolio is
invested in lower rated and comparable quality unrated high yield securities.
Investments in higher yield securities are accompanied by a greater degree of
credit risk and such lower quality securities tend to be more sensitive to
economic conditions than higher rated securities. The risk of loss due to
default by the issuer may be significantly greater for the holders of high
yielding securities, because such securities are generally unsecured and are
often subordinated to other creditors of the issuer. At May 31, 1996, the Fund
held four defaulted securities with a value aggregating $4,990,000 representing
2.72% of the Fund's net assets. For information as to specific securities, see
the accompanying Statement of Investments in Securities and Net Assets.
For financial reporting purposes, it is the Fund's accounting practice to
discontinue accrual of income and provide an estimate for probable losses due to
unpaid interest income on defaulted bonds for the current reporting period.
NOTE 10 - HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES
Investments of 5% or more of an issuer's outstanding voting securities held by
the Fund, are defined in the Investment Company Act of 1940 as affiliated
companies. The Fund had investments in such affiliated companies at May 31,
1996, which amounted to $4,163,666. See the accompanying Statement of
Investments in Securities and Net Assets for specific information on such
securities.
NOTE 11 - FINANCIAL HIGHLIGHTS
Selected data for each share of beneficial interest outstanding throughout each
period are as follows:
<TABLE>
<CAPTION>
Year ended November 30,
1996** 1995 1994 1993 1992 1991
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value at beginning of period........... $8.54 $7.70 $9.62 $8.09 $8.06 $7.36
------ ------ ------ ------ ------ ------
Net investment income........................... 0.282 0.520 0.540 0.517 0.456 0.736
Net realized and unrealized gain (loss)
on securities................................... 0.408 0.911 (1.766) 1.568 0.214 0.757
------ ------ ------ ------ ------ ------
Total from investment operations................. 0.690 1.431 (1.226) 2.085 0.670 1.493
------ ------ ------ ------ ------ ------
Less distributions:
From net investment income...................... (0.270) (0.591) (0.590) (0.517) (0.456) (0.729)
From paid-in capital............................ -- -- -- -- (0.184) (0.064)
In excess of net investment income.............. -- -- -- (0.038) -- --
From capital gains.............................. -- -- (0.104) -- -- --
------ ------ ------ ------ ------ ------
Total distributions.............................. (0.270) (0.591) (0.694) (0.555) (0.640) (0.793)
------ ------ ------ ------ ------ ------
Net asset value at end of period................. $8.96 $8.54 $7.70 $9.62 $8.09 $8.06
====== ====== ====== ====== ====== ======
Total Return+.................................... 5.24% 14.21% (8.50%) 21.17% 4.88% 10.30%
Ratios/Supplemental Data
Net assets at end of period (in 000's)........... $183,397 $174,805 $157,508 $196,895 $165,637 $164,934
Ratio of expenses to average net assets.......... 3.13%* 3.32% 2.60% 2.98% 3.27% 4.06%
Ratio of net investment income to
average net assets.............................. 6.43%* 6.33% 5.86% 5.74% 5.51% 9.41%
Portfolio turnover rate.......................... 12.15% 30.57% 45.19% 70.91% 61.69% 49.91%
Closing market price per share at end of period++. $7.625 $7.50 $7.125 $8.50 $7.50 $7.75
</TABLE>
*Annualized.
**For the six months ended May 31, 1996.
+Total return measures the change in the market price of an investment over the
periods indicated. It is not annualized. It assumes reinvestment of dividends
and capital gains, at market price.
++Based on last sale on the New York Stock Exchange.
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