<PAGE>
PREFERRED INCOME FUND
INCORPORATED
Dear Shareholder:
The Preferred Income Fund has stayed on track very well in the first three
quarters of fiscal 1996 despite the weak bond market. The return on net asset
value ("NAV") was 4.3% over the first nine months, and the Fund's dividend rate
was increased in May. Furthermore, the market price of the shares recently hit a
new high for the past twelve months as the discount from NAV narrowed.
Rapidly rising interest rates underscore the value of the Fund's hedging
strategy. On August 31, 1996 the Fund's NAV was essentially unchanged from
mid-February when the bond market started its fall. The decline in the value of
the Fund's holdings of preferred stocks caused by rising interest rates was
offset by gains on our hedges. Normally we would expect the NAV to decline
moderately under these conditions because the "safety net" of our hedges was
initially set slightly below the market (i.e., our put options on Treasury bond
futures were "out-of-the-money"). However, we also benefited from our preferred
stock holdings generally outperforming the Treasury bonds on which our hedges
are based.
Preferred stocks took a "breather" in the latest quarter as the market
absorbed the liquidation of a large institutional portfolio. Nonetheless, we
still see "creeping scarcity" of traditional preferreds eligible for the
intercorporate Dividends Received Deduction. As discussed in our previous
letters, there is a strong tax motivation for issuers to retire such preferreds.
In the last few months, the discount of the market price of the Fund's
shares from their NAV has generally narrowed, from around 15% earlier this year.
The strong NAV performance of the Fund and the increased dividend rate have
probably helped. We have also made a serious effort to draw the Fund's
accomplishments to the attention of securities analysts and investment
publications. At this moment, the discount is approximately 11%, although it can
be erratic from week to week.
The Fund will probably be able to make a special year-end distribution this
December. To date, realized capital gains have exceeded losses available to
offset them, due in part to the success of our hedges. To the extent that any
year-end distribution is attributable to capital gains, it will not qualify for
the Dividends Received Deduction available to corporate investors. Of course,
the year is not over, and the situation could change.
The Preferred Income Fund is intended to be an alternative to bond funds
for investors who want less exposure to fluctuating interest rates than is
normally associated with fixed income investments. It's working!
Sincerely,
/s/ Robert T. Flaherty
Robert T. Flaherty
Chairman of the Board
September 25, 1996
<PAGE>
<TABLE>
- ----------------------------------------------------------------------------------------------------
Preferred Income Fund Incorporated
SUMMARY OF INVESTMENTS
AUGUST 31, 1996 (UNAUDITED)
- ----------------------------------
<CAPTION>
PERCENT
VALUE OF TOTAL
(000'S) NET ASSETS
-------- ----------
<S> <C> <C>
ADJUSTABLE RATE PREFERRED STOCK
Utilities............................................................. $ 20,062 9.5%
Banking............................................................... 47,020 22.4
-------- -----
Total Adjustable Rate............................................ 67,082 31.9
-------- -----
FIXED RATE PREFERRED STOCK
Utilities............................................................. 73,574 35.0
Banking............................................................... 31,740 15.1
Financial Services.................................................... 12,207 5.8
Industrial............................................................ 7,749 3.7
Insurance............................................................. 3,545 1.6
-------- -----
Total Fixed Rate................................................. 128,815 61.2
-------- -----
TOTAL PREFERRED STOCK...................................................... 195,897 93.1
OTHER SECURITIES........................................................... 8,780 4.2
COMMERCIAL PAPER........................................................... 548 0.3
PURCHASED PUT OPTIONS...................................................... 3,626 1.7
-------- -----
TOTAL INVESTMENTS.......................................................... 208,851 99.3
OTHER ASSETS AND LIABILITIES (NET)......................................... 1,531 0.7
-------- -----
TOTAL NET ASSETS................................................. $210,382 100.0%
======== =====
</TABLE>
<TABLE>
FINANCIAL DATA
PER SHARE OF COMMON STOCK (UNAUDITED)
- -------------------------------------
<CAPTION>
DIVIDEND
DIVIDEND NET ASSET NYSE REINVESTMENT
PAID VALUE CLOSING PRICE PRICE (1)
-------- --------- ------------- ------------
<S> <C> <C> <C> <C>
December 29, 1995.............................. $0.087 $15.54 $13.500 $13.48
January 31, 1996............................... 0.087 15.61 13.625 13.74
February 29, 1996.............................. 0.087 15.33 13.625 13.65
March 29, 1996................................. 0.087 15.45 13.125 13.22
April 30, 1996................................. 0.087 15.43 13.250 13.20
May 31, 1996................................... 0.092 15.63 13.875 13.80
June 28, 1996.................................. 0.092 15.64 14.000 14.03
July 31, 1996.................................. 0.092 15.58 14.125 14.09
August 30, 1996................................ 0.092 15.54 14.500 14.53
<FN>
- ---------------
(1) Whenever the net asset value per share of the Fund's common stock is less
than or equal to the market price per share on the payment date, new shares
issued will be valued at the higher of net asset value or 95% of the then
current market price. Otherwise, the reinvestment shares of common stock
will be purchased in the open market.
</TABLE>
2
<PAGE>
<TABLE>
- -----------------------------------------------------------------------------------------------------------------------
Preferred Income Fund Incorporated
STATEMENT OF CHANGES IN NET ASSETS(1)
NINE MONTHS ENDED AUGUST 31, 1996 (UNAUDITED)
---------------------------------------------
<S> <C>
OPERATIONS:
Net investment income................................................................................. $ 10,200,816
Net realized gain on investments sold................................................................. 10,545,004
Net unrealized depreciation of investments during the period.......................................... (13,584,688)
------------
Net increase in net assets from operations........................................................ 7,161,132
DISTRIBUTIONS:
Dividends paid from net investment income to Money Market Cumulative
Preferred[Trademark] Stock Shareholders............................................................. (1,931,557)
Dividends paid from net investment income to Common Stock Shareholders................................ (7,900,373)
------------
Net decrease in net assets........................................................................ (2,670,798)
NET ASSETS:
Beginning of period................................................................................... 213,053,235
------------
End of period......................................................................................... $210,382,437
============
</TABLE>
<TABLE>
FINANCIAL HIGHLIGHTS(1)
NINE MONTHS ENDED AUGUST 31, 1996 (UNAUDITED)
FOR A COMMON SHARE OUTSTANDING THROUGHOUT THE PERIOD.
-----------------------------------------------------
<S> <C>
OPERATING PERFORMANCE:
Net asset value, beginning of period.................................................................. $ 15.80
------------
Net investment income................................................................................. 1.04
Net realized gain and unrealized depreciation on investments.......................................... (0.31)
------------
Net increase in net asset value resulting from investment operations.................................. 0.73
DISTRIBUTIONS:
Dividends declared to Money Market Cumulative Preferred[Trademark] Stock Shareholders................. (0.20)
Dividends paid from net investment income............................................................. (0.80)
Change in accumulated undeclared dividends on Money Market Cumulative Preferred[Trademark] Stock...... 0.01
------------
Total from distributions.............................................................................. (0.99)
------------
Net asset value, end of period........................................................................ $ 15.54
=============
Market value, end of period........................................................................... $ 14.500
=============
Net assets, end of period............................................................................. $210,382,437
=============
Common shares outstanding, end of period.............................................................. 9,838,571
=============
RATIOS TO AVERAGE NET ASSETS AVAILABLE TO COMMON STOCK SHAREHOLDERS/SUPPLEMENTAL DATA:
Net investment income................................................................................. 7.33%*
Operating expenses.................................................................................... 1.52%*
Portfolio turnover rate............................................................................... 76%
<FN>
- ---------------
(1) These tables summarize the nine months ended August 31, 1996 and should be
read in conjunction with the Fund's audited financial statements, including
footnotes, in its Annual Report dated November 30, 1995.
* Annualized.
</TABLE>
3
<PAGE>
DIRECTORS
Martin Brody
Donald F. Crumrine, CFA
Robert T. Flaherty, CFA
Morgan Gust
Robert F. Wulf
OFFICERS
Robert T. Flaherty, CFA
Chairman of the Board
and President
Donald F. Crumrine, CFA
Vice President
and Secretary
Robert M. Ettinger, CFA
Vice President
Peter C. Stimes, CFA
Vice President
and Treasurer
Carl D. Johns
Assistant Treasurer
INVESTMENT ADVISER
Flaherty & Crumrine Incorporated
QUESTIONS CONCERNING YOUR SHARES OF PREFERRED
INCOME FUND?
- If your shares are held in a Brokerage Account, contact your Broker.
- If you have physical possession of your shares in certificate
form, contact the Fund's Transfer Agent & Shareholder Servicing
Agent --
First Data Investor Services Group, Inc.
(FDISG)
P.O. Box 1376
Boston, MA 02104
1-800-331-1710
THIS REPORT IS SENT TO SHAREHOLDERS OF PREFERRED INCOME FUND
INCORPORATED FOR THEIR INFORMATION. IT IS NOT A PROSPECTUS, CIRCULAR
OR REPRESENTATION INTENDED FOR USE IN THE PURCHASE OR SALE OF SHARES
OF THE FUND OR OF ANY SECURITIES MENTIONED IN THIS REPORT.
[LOGO]
Quarterly
Report
August 31, 1996
