February 25, 1998
Dear Shareholder:
Enclosed are the mid-year financial statements for the Western Asset Trust
Intermediate Portfolio, covering the period July 1 - December 31, 1997.
Now in its fourth year of operation, the fund continues to enjoy positive
investment results relative to its benchmark for this period and since
inception. Total assets have risen to over $250 million, with more than 28
participants.
The principal factors behind the fund's recent good performance, when it
returned 5.1% (net of all fees) versus the Lehman Brothers Government/Corporate
Intermediate Index's 4.9% return, were its longer than market duration posture,
which was rewarded by declining interest rates and its barbelled exposure to
maturities, which benefited from a pronounced flattening of the yield curve.
Please fee free to call if you have any questions.
Sincerely,
/s/ W. Curtis Livingston
________________________
W. Curtis Livingston
President
Enclosure
<PAGE>
WESTERN ASSET TRUST, INC.
INTERMEDIATE PORTFOLIO
REPORT TO SHAREHOLDERS
FOR THE SIX MONTHS ENDED DECEMBER 31, 1997
<PAGE>
WESTERN ASSET TRUST, INC.
INTERMEDIATE PORTFOLIO
STATEMENT OF NET ASSETS
December 31, 1997
(Amounts in Thousands)
(Unaudited)
<PAGE>
<TABLE>
<CAPTION>
<S><C>
% of Maturity
Net Assets Rate Date Par Value
- --------------------------------------------------------------------------------------------------------------------------
CORPORATE BONDS AND NOTES 13.32%
Banking and Finance 5.76%
Ford Motor Credit 6.55% 09/10/02 $4,000 $4,049
Heller Financial, Inc. 6.50% 11/01/01 4,400 4,410
Heller Financial, Inc. 6.66% 07/11/02 1,700 1,725
Lehman Brothers Holdings, Inc. 8.63% 02/26/99 400 412
NationsBank Capital Trust III 6.308% 01/15/27 1,300 1,289
National Westminister Bancorp 9.375% 11/15/03 290 333
Travelers Group, Inc. 7.30% 05/15/02 1,600 1,651
United States Leasing International 8.75% 12/01/01 500 543
United States Leasing International 6.625% 05/15/03 1,750 1,774
----------
16,187
Entertainment 1.68%
Time Warner Inc. 7.25% 10/15/17 4,650 4,735
Food, Beverage and Tobacco 2.33%
Philip Morris Companies, Inc. 7.00% 07/15/05 2,000 2,039
Philip Morris Companies, Inc. 6.95% 06/01/06 4,350 4,505
----------
6,544
Industrial 3.55%
Columbia/HCA Healthcare 8.85% 01/01/07 5,020 5,466
TCI Communications Inc. 8.00% 08/01/05 4,200 4,501
----------
9,967
Total Corporate Bonds and Notes
(Identified Cost - $20,422) 37,432
- --------------------------------------------------------------------------------------------------------------------------
U.S. GOVERNMENT AND AGENCY OBLIGATIONS 31.73%
Fixed-rate Securities 27.32%
United States Treasury Bonds 6.625% 02/15/27 5,000 5,428
United States Treasury Notes 5.875% 03/31/99 150 150
United States Treasury Notes 5.875% 08/31/02 35,010 35,202
United States Treasury Notes 6.25% 09/30/02 5,000 5,102
</TABLE>
2
<PAGE>
WESTERN ASSET TRUST, INC.
INTERMEDIATE PORTFOLIO
STATEMENT OF NET ASSETS
December 31, 1997
(Amounts in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
<S><C>
% of Maturity
Net Assets Rate Date Par Value
- --------------------------------------------------------------------------------------------------------------------------
United States Treasury Notes 5.75% 08/15/03 $3,850 $3,852
United States Treasury Notes 7.875% 11/15/04 3,300 3,689
United States Treasury Notes 6.625% 05/15/07 11,660 12,341
United States Treasury Notes 6.125% 08/15/07 10,730 11,027
----------
76,791
Indexed Securities 4.41%
Fannie Mae 5.122% 03/13/02 12,720 12,397(E)
Total U.S. Government and Agency Obligations
(Identified Cost - $88,797) 89,188
- --------------------------------------------------------------------------------------------------------------------------
U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITIES 7.99%
Fixed-rate Securities 5.29%
Fannie Mae 8.50% 02/01/08 792 823
Fannie Mae 6.50% 06/01/14 1,596 1,585
Fannie Mae 8.00% 12/01/14 949 977
Fannie Mae 7.00% 01/01/26 826 835
Fannie Mae 7.00% 03/01/27 200 202
Fannie Mae 7.00% 03/01/27 958 967
Fannie Mae 7.00% 03/01/27 990 997
Fannie Mae 7.00% 03/01/27 992 999
Fannie Mae 7.00% 03/01/27 1,000 1,007
Fannie Mae 7.00% 03/01/27 1,002 1,010
Freddie Mac 8.50% 07/01/06 152 156
Freddie Mac 7.76% 05/01/12 330 332
Freddie Mac 6.50% 06/01/13 475 474
Freddie Mac 6.50% 06/01/14 775 772
Freddie Mac 6.50% 11/01/15 415 412
Freddie Mac 7.50% 04/01/17 391 404
Freddie Mac 9.30% 04/15/19 1,185 1,271
Freddie Mac 7.00% 04/01/27 984 991
</TABLE>
3
<PAGE>
WESTERN ASSET TRUST, INC.
INTERMEDIATE PORTFOLIO
STATEMENT OF NET ASSETS
December 31, 1997
(Amounts in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
<S><C>
% of Maturity
Net Assets Rate Date Par Value
- --------------------------------------------------------------------------------------------------------------------------
Government National Mortgage Association 9.50% 09/15/05 $307 $325
Government National Mortgage Association 9.00% 06/15/06 329 344
----------
14,883
Variable-rate Securities 2.59%
Fannie Mae 6.191% 03/01/18 201 201(C)
Freddie Mac 6.612% 01/01/19 111 112(C)
Government National Mortgage Association 7.00% 08/20/21 549 564(C)
Government National Mortgage Association 7.375% 05/20/22 1,438 1,483(C)
Government National Mortgage Association 7.375% 06/02/22 1,825 1,882(C)
Government National Mortgage Association 7.375% 06/20/22 1,011 1,042(C)
Government National Mortgage Association 7.00% 07/20/22 1,536 1,578(C)
Government National Mortgage Association 7.00% 08/20/22 401 412(C)
----------
7,274
Stripped Securities 0.11%
Fannie Mae 0% 05/25/22 195 144(D,2)
Fannie Mae 0% 05/25/22 91 87(D,2)
Freddie Mac 10.00% 03/01/21 231 66(D,1)
----------
297
Total U.S. Government Agency Mortgage-backed Securities
(Identified Cost - $22,014) 22,454
- --------------------------------------------------------------------------------------------------------------------------
ASSET-BACKED SECURITIES 18.11%
Fixed-rate Securities 13.51%
Aesop Funding II LLC 6.40% 10/20/03 1,100 1,106
Bridgestone/Firestone Master Trust 6.17% 07/01/03 3,800 3,808
Chevy Chase Home Loan Trust 7.15% 05/15/15 1,190 1,222
Chevy Chase 1997-A 7.65% 12/20/07 2,889 2,919
Cityscape Home Equity Loan Trust 7.40% 09/25/28 3,064 3,093(F)
CS First Boston Mortgage Services 6.62% 09/25/09 4,000 4,020
FASCO Auto Trust 9.05% 03/17/03 57 58(F)
Fleet Finance Home Equity Trust 6.70% 10/16/06 391 391
</TABLE>
4
<PAGE>
WESTERN ASSET TRUST, INC.
INTERMEDIATE PORTFOLIO
STATEMENT OF NET ASSETS
December 31, 1997
(Amounts in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
<S><C>
% of Maturity
Net Assets Rate Date Par Value
- --------------------------------------------------------------------------------------------------------------------------
Guaranteed Export Certificates 6.13% 06/15/04 $1,529 $1,532
Irwin Home Equity 6.77% 07/15/06 1,647 1,652
Lehman FHA Title 1 Loan Trust 7.71% 08/25/17 1,922 1,956
Long Beach 97-1 A 6.85% 02/15/03 4,435 4,449(F)
Mego Mortgage FHA Title I Loan Trust 6.55% 09/25/07 405 404
Mego Mortgage FHA Title I Loan Trust 7.17% 05/25/23 1,700 1,719
Mego Mortgage FHA Title I Loan Trust 7.275% 09/25/16 1,121 1,135
Merrill Lynch Mortgage Investors, Inc. 9.65% 09/15/10 1,750 1,869
Merrill Lynch Mortgage Investors, Inc. 9.70% 06/15/08 849 880
Preferred Credit Corporation 7.15% 05/25/10 2,100 2,124
Union Acceptance Corp 6.375% 10/08/03 2,800 2,806
World Omni Automobile Lease Securitization Trust 6.05% 11/25/01 799 799
----------
37,942
Indexed Securities 3.89%
Advanta Credit Card Master Trust 5.784% 08/01/03 6,000 5,998(E)
Keycorp Student Loan 96-A CTFS 6.155% 11/27/28 3,000 2,967(E)
Lehman Home Equity Loan Trust 6.168% 12/15/27 1,963 1,961(E)
----------
10,926
Stripped Securities 0.73%
Bay View Auto Trust 3.15% 12/15/04 17,812 411(D,1)
Option One CTS Arm Trust 3.049% 03/15/01 2,997 86(D,1)
Union Acceptance Corp. 2.75% 05/10/04 59,776 1,548(D,1)
----------
2,046
Total Asset-backed Securities
(Identified Cost -$50,416) 50,913
- --------------------------------------------------------------------------------------------------------------------------
MORTGAGE-BACKED SECURITIES 10.98%
Fixed-rate Securities 7.79%
Agricultural Mortgage (Farmer Mac) 7.92% 01/25/12 2,000 2,110
Asset Securitization Corp. 6.72% 11/12/26 2,776 2,823
Citicorp Mortgage Securities, Inc. 9.00% 07/25/02 1,498 1,492
Donaldson, Lufkin & Jenerette Mortgage Acceptance Corp. 6.86% 11/12/21 1,773 1,808
GMAC Commercial Mortgage Securities, Inc. 6.853% 09/15/06 3,800 3,880
</TABLE>
5
<PAGE>
WESTERN ASSET TRUST, INC.
INTERMEDIATE PORTFOLIO
STATEMENT OF NET ASSETS
December 31, 1997
(Amounts in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
<S><C>
% of Maturity
Net Assets Rate Date Par Value
- --------------------------------------------------------------------------------------------------------------------------
Merrill Lynch Mortgage Investors, Inc. 6.69% 11/21/28 $1,895 $1,918
Metropolitan Asset Funding, Inc. 6.05% 11/20/01 895 890
Metropolitan Asset Funding, Inc. 6.95% 04/20/08 2,157 2,155
Nomura Asset Securities Corporation 7.07% 04/13/36 1,818 1,875
Resolution Trust Corporation 8.40% 07/25/24 451 450
Structured Asset Securities Corp. 6.60% 10/25/24 301 299
Structured Asset Securities Corp. 7.75% 02/25/28 2,150 2,170
----------
21,870
Variable-rate Securities 2.84%
CPS Auto Grantor Trust 6.30% 08/15/02 1,380 1,385(C)
Housing Securities Inc. 5.987% 11/25/26 693 682(C,F)
Resolution Trust Corporation 5.916% 07/25/20 64 63(C)
Resolution Trust Corporation 8.753% 03/25/21 1,686 1,715(C)
Resolution Trust Corporation 7.016% 06/25/24 600 605(C)
Resolution Trust Corporation 6.062% 01/25/27 1,684 1,654(C)
Resolution Trust Corporation 7.969% 09/25/29 114 114(C)
Resolution Trust Corporation 8.284% 09/25/29 776 782(C)
Resolution Trust Corporation 7.365% 12/25/29 924 922(C)
Securitized Asset Sales, Inc. 7.002% 08/25/33 72 72(C)
----------
7,994
Indexed Securities 0.13%
Resolution Trust Corporation 7.875% 09/25/21 372 363(E,F)
Stripped Securities 0.22%
CMC Securities Corp. 0% 02/25/09 545 408(D,2)
Securitized Asset Sales, Inc. 0% 12/25/10 300 217(D,2)
----------
625
Total Mortgage-backed Securities
(Identified Cost - $30,580) 30,852
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
6
<PAGE>
WESTERN ASSET TRUST, INC.
INTERMEDIATE PORTFOLIO
STATEMENT OF NET ASSETS
December 31, 1997
(Amounts in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
<S><C>
% of Maturity
Net Assets Rate Date Par Value
- --------------------------------------------------------------------------------------------------------------------------
YANKEE BONDS 4.96%
Fixed-rate Securities
Export Import Bank Korea 6.50% 05/15/00 $880 $764(B)
Hydro Quebec 7.74% 02/26/99 350 357(B)
Petrozuata Finance 7.63% 04/01/09 4,760 5,030(B,F)
Province de Quebec 8.625% 01/19/05 1,000 1,150(B)
YPF Sociedad Anonima 7.00% 10/26/02 2,839 2,852(B)
YPF Sociedad Anonima 7.50% 10/26/02 3,722 3,781(B)
Total Yankee Bonds
(Identified Cost - $13,697) 13,934
- --------------------------------------------------------------------------------------------------------------------------
COMMON STOCK AND EQUITY INTERESTS 3.11%
Black Rock 1999 Term Trust, Inc. 10 shrs 94
Black Rock 2001 Term Trust, Inc. 1,002 shrs 8,643
Total Common Stocks and Equity Interests
(Identified Cost - $8,166) 8,737
- --------------------------------------------------------------------------------------------------------------------------
SHORT-TERM INVESTMENTS 9.01%
Corporate 5.08%
Associates Corporation, North America 8.125% 01/15/98 $340 340
Ford Motor Credit Company 6.42% 02/04/98 300 300
General Electric Capital Corporation 7.65% 02/23/98 240 241
General Motors Acceptance Corp. 6.00% 12/29/97 210 210
JP Morgan & Co. 6.25% 12/07/98 10,000 9,998
Norwest Corporation 5.75% 11/16/98 100 100
USF&G Corporation 7.00% 05/15/98 3,000 3,009
----------
14,198
Mortgage-backed Securities 0.37%
CRIIMI MAE Financial Corporation 6.77% 05/30/98 1,049 1,042
U.S. Government Obligations 0.19%
United States Treasury Bills 5.23% 03/05/98 250 248
United States Treasury Bills 5.04% 03/05/98 300 297
----------
545
</TABLE>
7
<PAGE>
WESTERN ASSET TRUST, INC.
INTERMEDIATE PORTFOLIO
STATEMENT OF NET ASSETS
December 31, 1997
(Amounts in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
<S><C>
% of Maturity
Net Assets Rate Date Par Value
- --------------------------------------------------------------------------------------------------------------------------
Repurchase Agreement 3.37%
Merrill Lynch Securities, Inc.
6.60% dated 12/31/97, to be repurchased at $9,465 on 1/2/98
(Collateral: $9,595 Fannie Mae Medium-term Notes,
6.58% due 12/17/07, value $9,680) $9,462 $9,462
Actual
Contracts
---------------
Options Purchased N.M.
Eurodollar Futures, June 98 Call, Strike Price $94.25 201 72
Total Short-Term Investments
(Identified Cost - $25,311) 25,319
- --------------------------------------------------------------------------------------------------------------------------
Total Investments 99.20% 278,827
Other Assets Less Liabilities 0.80% 2,243
----------
Net assets consisting of:
Accumulated paid-in-capital applicable to
2,626 shares outstanding
Undistributed net investment income
Undistributed net realized gain on investments
Unrealized appreciation of investments
Net assets 100.00% $281,070
----------
Net asset value per share $107.01
----------
</TABLE>
8
<PAGE>
WESTERN ASSET TRUST, INC.
INTERMEDIATE PORTFOLIO
STATEMENT OF NET ASSETS
December 31, 1997
(Amounts in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
<S><C>
Actual Appreciation/
Expiration Contracts (Depreciation)
------------ -----------------------------------
Options Written
Eurodollar Future Call, Strike Price $94.75 June 98 160 $7
Futures Purchased
U.S. Treasury Note Future March 98 61 23
</TABLE>
- ----------------------------------------------------------------
A Zero-Coupon Bond - A bond with no periodic interest payments which is sold
at such a discount as to produce a current yield to maturity.
B Yankee Bond Dollar denominated bond issued in the U.S. by foreign entities.
C The coupon rates shown on variable rate securities are the rates at
December 31, 1997. These rates vary with the weighted average coupon of
the underlying loans
D Stripped Security - Security with interest-only or principal-only payment
streams, denoted by superscript 1 or 2, respectively. For interest-only
securities, the amount shown as principal is the notional balance used to
calculate the amount of interest due.
E Indexed Security - The rate of interest earned on this type of security is
tied to the London Interbank Offered Rate (LIBOR), the Global Telecom
Basket (GTB) index or the one year Treasury Bill rate. The coupon rate is
the rate as of December 31, 1997.
F Rule 144a Security - A security purchased pursuant to Rule 144a under the
securities Act of 1933 which may not be resold subject to that rule except
to qualified buyers.
N.M. Not Meaningful
9
<PAGE>
WESTERN ASSET TRUST, INC.
INTERMEDIATE PORTFOLIO
STATEMENT OF OPERATIONS
For the Six Months Ended December 31, 1997
(Amounts in Thousands)
(Unaudited)
Investment Income:
Interest $7,359
Dividends 203
---------
$7,562
Expenses:
Advisory fee 416
Administrative fee 59
Transfer agent and
shareholder servicing expense 1
Custodian fees 50
Legal and audit fees 14
Reports to shareholders 3
Registration fees 36
Directors' fees 9
Organization expenses 6
Other expenses 30
---------
624
Less fees waived (89)
---------
Total expenses, net of waivers 535
---------
Net Investment Income 7,027
Net Realized and Unrealized Gain (Loss) on Investments:
Realized gain on investments, options
and futures 2,197
Change in unrealized appreciation
of investments, options and futures 2,499
---------
Net Realized and Unrealized Gain (Loss) on Investments 4,696
---------
Change in Net Assets Resulting from Operations $11,723
---------
STATEMENT OF CHANGES IN NET ASSETS
(Amounts in Thousands)
For the Six For the Year
Months Ended Ended
December 31, 1997 June 30, 1997
----------------- -------------
(Unaudited)
Change in Net Assets:
Net investment income $7,027 $10,304
Net realized gain (loss) on investments,
options and futures 2,197 1,450
Change in unrealized appreciation
of investments, options and futures 2,499 1,322
--------- ----------
Change in net assets resulting
from operations 11,723 130,076
Distributions to shareholders from:
Net investment income (10,136) (8,020)
Net realized gain on investments (2,146) (993)
Change in net assets from
Fund share transactions 57,132 154,355
-----------------------------
Changes in net assets 56,573 158,418
Net Assets:
Beginning of period 224,497 66,079
---------- ----------
End of period (including
undistributed net investment
income of $56 and $3,165,
respectively) $281,070 $224,497
---------- ----------
10
<PAGE>
WESTERN ASSET TRUST, INC.
INTERMEDIATE PORTFOLIO
FINANCIAL HIGHLIGHTS
Contained below is per share operating performance data for a share of common
stock outstanding throughout each period shown, total investment return, ratios
to average net assets and other supplemental data. This information has been
derived from information in the financial statements.
<TABLE>
<CAPTION>
<S><C>
FOR THE SIX FOR THE YEARS ENDED JUNE 30,
MONTHS ENDED --------------------------------
DECEMBER 31, 1997 1997 1996 1995
----------------- --------- --------- ---------
(UNAUDITED)
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $107.19 $104.83 $107.36 $100.00
Net investment income (A) 3.10 5.49 5.41 3.86
Net realized and unrealized gain (loss)
on investments, options and futures 2.29 3.00 (0.06) 6.02
------- ------------------------------
Total from investment operations 5.39 8.49 5.35 9.88
------- ------------------------------
Distributions to shareholders from:
Net investment income (4.59) (5.42) (5.35) (2.47)
Net realized gain on investments (0.98) (0.71) (2.53) (0.05)
------- ------------------------------
Total distributions (5.57) (6.13) (7.88) (2.52)
------- ------------------------------
Net asset value, end of period $107.01 $107.19 $104.83 $107.36
======= ==============================
Total return 5.10%(B) 8.32% 5.15% 10.08%
RATIOS / SUPPLEMENTAL DATA:
Ratios to average net assets
Expenses (A) 0.45%(C) 0.45% 0.50% 0.50%
Net investment income (A) 5.87%(C) 6.33% 6.28% 6.11%
Portfolio turnover rate 411.23%(C) 419.26% 841.29% 764.45%
Net assets, end of period
(in thousands) $281,070 $224,497 $66,079 $20,313
</TABLE>
- ----------------------------------------------------------------
(A) Net of advisory fees waived pursuant to a voluntary expense limitation of
0.50% to August 5, 1996 and 0.45% thereafter. In the absence of this
limitation, the ratio of expenses to average net assets would have been
0.52% for the six months ended December 31, 1997, 0.55% for the year
ended June 30, 1997, 1.03% for the year ended June 30, 1996 and 1.60% for
the year ended June 30, 1995.
(B) Not annualized
(C) Annualized
See notes to financial statements.
11
<PAGE>
WESTERN ASSET TRUST, INC.
INTERMEDIATE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES:
The Western Asset Trust, Inc. ("Corporation") is registered under the Investment
Company Act of 1940, as amended. The Western Asset Trust Intermediate Portfolio
("Fund"), formerly known as Western Asset Trust Intermediate Duration Portfolio,
a diversified, open-end management investment company, is one of the portfolios
established by the Corporation. The Fund was organized on May 16, 1990 and had
no operations prior to July 1, 1994, other than those related to organizational
matters.
SECURITY VALUATION
Portfolio securities are valued based upon market quotations. When market
quotations are not readily available, securities are valued based on prices
received from recognized broker-dealers in the same or similar securities. The
amortized cost method of valuation is used for debt obligations with 60 days or
less remaining to maturity.
OPTIONS AND FUTURES
The current market value of a traded option is the last sale price or, in the
absence of a sale, the mean between the closing bid and asked price. Futures
contracts are marked-to-market on a daily basis. As a contract's value
fluctuates, payments known as variation margin are made to or received from the
futures commission merchant.
DISTRIBUTIONS TO SHAREHOLDERS
Net investment income for dividend purposes is recorded on the accrual basis and
consists of interest and dividend income less expenses. Bond premium and
original issue discount are amortized for financial reporting and tax purposes
using the effective interest method over the period to maturity of the security
and serve to reduce or increase interest income.
Distributions are determined on a tax basis and may differ from net investment
income and realized capital gains for financial reporting purposes.
12
<PAGE>
NOTES TO FINANCIAL STATEMENTS - CONTINUED
SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
SECURITY TRANSACTIONS
Security transactions are recorded on the trade date. Realized gains and losses
from security transactions are reported on an identified cost basis.
DEFERRED ORGANIZATION EXPENSE
Deferred organization expenses of $54 are being amortized on a straight-line
basis through June 1999.
USE OF ESTIMATES
The preparation of the financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts and disclosures in the financial
statements. Actual results could differ from these estimates.
FEDERAL INCOME TAXES
No provision for federal income or excise taxes is required since the Fund
intends to continue to qualify as a regulated investment company and distribute
all of its taxable income to its shareholders.
2. FINANCIAL INSTRUMENTS:
As part of the Fund's investment program, the Fund utilizes repurchase
agreements, options and futures contracts. The nature and risk of these
financial instruments and the reasons for using them are set forth more fully in
the Corporation's Prospectus and Statement of Additional Information.
REPURCHASE AGREEMENTS
All repurchase agreements are fully collateralized by obligations issued by the
U.S. Government or its agencies and such collateral is in the possession of the
Fund's custodian. Risks arise from the possible delay in recovery or potential
loss of rights in the collateral should the issuer of the repurchase agreement
fail financially.
13
<PAGE>
NOTES TO FINANCIAL STATEMENTS - CONTINUED
FINANCIAL INSTRUMENTS - CONTINUED
OPTION TRANSACTIONS
A call option gives the option holder the right to purchase the underlying
security at a specified price until a specified date. A put option gives the
option holder the right to sell the underlying security at a specified price
until a specified date. Risks arise from the possible illiquidity of the options
market and from movements in security values. Call and put options written by
the Fund and related premiums received during the period were as follows:
<TABLE>
<CAPTION>
<S><C>
CALLS PUTS
----------------------------------------------------------
CONTRACTS PREMIUMS CONTRACTS PREMIUMS
----------------------------------------------------------------------- ---------------------------
Options outstanding at June 30, 1997 - $ - 43 $31
Options written 1,350 721 38 12
Options closed (1,024) (693) (81) (43)
Options expired (166) (9) - -
Options exercised - - - -
----------------------------------------------------------------------- ---------------------------
Options outstanding at December 31, 1997 (160) $19 - $ -
======================================================================= ===========================
</TABLE>
FUTURES
The Fund may enter into futures contracts in connection with its interest rate
management strategy. Risks arise from the possible illiquidity of the futures
market and from the possibility that a change in the value of a contract may not
correlate with changes in interest rates. The open long and short futures
positions and related appreciation or depreciation at December 31, 1997 are
described at the end of the "Statement of Net Assets", page 8.
14
<PAGE>
NOTES TO FINANCIAL STATEMENTS - CONTINUED
3. PORTFOLIO TRANSACTIONS:
Purchases and sales of portfolio securities (excluding short-term, U.S.
Government securities, written and purchased options and futures contracts) for
the six months ended December 31, 1997, aggregated $89,317 and $100,831,
respectively. Purchases and sales of U.S. Government securities aggregated
$438,036 and $376,045, respectively for the same period.
At December 31, 1997, the cost of securities for federal income tax purposes was
$275,535. Aggregate gross unrealized appreciation for all securities in which
there was an excess of value over tax cost was $3,635 and aggregate gross
unrealized depreciation for all securities in which there was an excess of tax
cost over value was $343.
4. FUND SHARE TRANSACTIONS:
At December 31, 1997, there were 5,000,000 shares of common stock of the
corporation authorized at $.001 par value. Transactions in Fund shares were as
follows:
<TABLE>
<CAPTION>
<S><C>
FOR THE SIX MONTHS ENDED FOR THE YEAR ENDED
--------------------------------------------------------
DECEMBER 31, 1997 JUNE 30, 1997
------------------------- --------------------------
SHARES AMOUNT SHARES AMOUNT
--------------------------------------------------------------- --------------------------
Sold 630 $ 67,867 1,492 $ 157,504
Reinvestment of distributions 111 11,926 85 8,937
Repurchased (209) (22,661) (113) (12,086)
--------------------------------------------------------------- ------------------------------
Net increase 532 $57,132 1,464 $154,355
=============================================================== ==============================
</TABLE>
15
<PAGE>
NOTES TO FINANCIAL STATEMENTS - CONTINUED
5. TRANSACTIONS WITH AFFILIATES:
The Fund has an administration agreement with Legg Mason Fund Adviser, Inc.
("Administrator"), a corporate affiliate of Legg Mason Wood Walker, Incorporated
("Legg Mason"), a member of the New York Stock Exchange and the distributor for
the Fund. Under this agreement, the Administrator provides the Fund with
administrative services for which the Fund pays a fee at an annual rate of 0.05%
of average daily net assets of the Fund. At December 31, 1997, $11 was due to
the Administrator.
Western Asset Management Company ("Adviser"), a corporate affiliate of the
Administrator and Legg Mason, serves as investment adviser to the Fund. The
Adviser is responsible for the actual investment activity of the Fund, for which
the Fund pays a fee at an annual rate of 0.50% of average daily net assets of
the Fund. The Adviser has voluntarily agreed to indefinitely limit its fee to
0.35% of average daily net assets and to further waive its fees and reimburse
the Fund to the extent necessary to limit the total expenses to an annual rate
of 0.45% of the Fund's average daily net assets. Pursuant to this agreement,
advisory fees of $89 were waived for the six months ended December 31, 1997, and
$51 was due to the Adviser at December 31, 1997.
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