<PAGE>
THE PREFERRED INCOME FUND
Dear Shareholder:
The Preferred Income Fund continues on a steady course despite tumultuous
economic and political conditions around the world. Total return on net asset
value, including both income and principal change, was 0.8% for the quarter
ended August 31, 1998 and 6.7% for the first three quarters of fiscal 1998.
Tumbling common stock prices in this country and near economic collapse in
Russia and parts of Asia have resulted in a classic "flight to safety." The
yields of U.S. Treasury bonds have fallen, causing their prices to rise strongly
while, at the same time, the markets for junk bonds and emerging market debt are
in shambles. Better quality domestic corporate bonds and preferreds, in which
the Fund invests, have been caught in the middle, sharing neither the prosperity
of Treasuries nor the misery of distressed markets.
Our strategy of hedging by purchasing put options on Treasury bond futures
was up to the challenge of these difficult markets. We expect the Fund to lose
money on its hedges when the prices of long term Treasury bonds rise. However,
the maximum loss on purchased put options is limited to the comparatively small
amount paid for the options, which kept our hedge losses under control. Thus,
even though the Fund's preferred stock holdings did not match the strength in
Treasuries, we were still able to produce positive returns after hedging. "All's
well that ends well."
A chaotic investment climate usually helps patient investors once the smoke
clears. We believe select hybrid preferreds now present exceptional
opportunities, even for corporate investors that normally favor traditional
preferreds eligible for the Dividend Received Deduction. In response, we have
roughly doubled the Fund's position in hybrids over the course of the current
fiscal year to approximately 45% of the portfolio.
Adjustable rate preferreds (ARPs) have been a welcome source of cash for
adding to hybrids. In part, this has been due to redemptions of ARPs by issuers
at prices that we were happy to get. ARPs now account for roughly 17% of the
Fund's portfolio, down from approximately 32% at the start of the current fiscal
year and a high of 42% less than two years ago.
The Fund has realized substantial capital gains in the current fiscal year,
as shown in the "Statement of Changes In Net Assets" contained in this report.
This makes a special year-end distribution quite likely, although we are living
in a volatile world where things can change quickly.
Sincerely yours,
/s/ Robert T. Flaherty
------------------------------
Robert T. Flaherty
Chairman of the Board
September 11, 1998
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
SUMMARY OF INVESTMENTS
AUGUST 31, 1998 (UNAUDITED)
- ----------------------------------
<TABLE>
<CAPTION>
PERCENT OF
VALUE TOTAL NET
(000'S) ASSETS
-------- ----------
<S> <C> <C>
ADJUSTABLE RATE PREFERRED STOCKS
Utilities........................................... $ 14,213 6.4%
Banking............................................. 23,287 10.5
-------- -----
Total Adjustable Rate.......................... 37,500 16.9
-------- -----
FIXED RATE PREFERRED STOCKS AND SECURITIES
Utilities........................................... 69,184 31.3
Banking............................................. 41,184 18.6
Financial Services.................................. 31,185 14.1
Industrial.......................................... 11,303 5.1
Insurance........................................... 22,841 10.3
-------- -----
Total Fixed Rate............................... 175,697 79.4
-------- -----
TOTAL PREFERRED STOCKS AND SECURITIES.................... 213,197 96.3
COMMON STOCKS
Utilities........................................... 5,121 2.3
COMMERCIAL PAPER......................................... 1,992 0.9
PURCHASED PUT OPTIONS.................................... 316 0.1
-------- -----
TOTAL INVESTMENTS........................................ 220,626 99.6
OTHER ASSETS AND LIABILITIES (NET)....................... 914 0.4
-------- -----
TOTAL NET ASSETS............................... $221,540 100.0%
======== =====
</TABLE>
FINANCIAL DATA
PER SHARE OF COMMON STOCK (UNAUDITED)
- -------------------------------------
<TABLE>
<CAPTION>
DIVIDEND
DIVIDEND NET ASSET NYSE REINVESTMENT
PAID VALUE CLOSING PRICE Price (1)
-------- --------- ------------- ------------
<S> <C> <C> <C> <C>
December 31, 1997............. $0.460 $16.43 $16.1250 $16.40
January 31, 1998.............. 0.081 16.53 15.9375 15.98
February 28, 1998............. 0.081 16.55 15.8125 15.80
March 31, 1998................ 0.081 16.63 15.8125 15.82
April 30, 1998................ 0.081 16.64 15.6250 15.68
May 31, 1998.................. 0.081 16.77 15.9375 15.98
June 30, 1998................. 0.081 16.84 16.2500 16.00
July 31, 1998................. 0.081 16.65 15.8125 15.74
August 31, 1998............... 0.081 16.64 15.8750 15.89
</TABLE>
- ---------------
(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.
2
<PAGE>
- --------------------------------------------------------------------------------
Preferred Income Fund Incorporated
STATEMENT OF CHANGES IN NET ASSETS(1)
NINE MONTHS ENDED AUGUST 31, 1998 (UNAUDITED)
---------------------------------------------
<TABLE>
<S> <C>
OPERATIONS:
Net investment income................................... $ 9,274,821
Net realized gain on investments sold................... 7,309,785
Net unrealized depreciation of investments during the
period................................................. (4,355,361)
------------
Net increase in net assets from operations.......... 12,229,245
DISTRIBUTIONS:
Dividends paid from net investment income to MMP*
Shareholders........................................... (1,731,860)
Distributions paid from net realized capital gains to
MMP* Shareholders(3)................................... (46,436)
Dividends paid from net investment income to Common
Stock Shareholders(2).................................. (7,985,967)
Distributions paid from net realized capital gains to
Common Stock Shareholders(3)........................... (2,915,169)
------------
Net decrease in net assets.......................... (450,187)
NET ASSETS:
Beginning of period..................................... 221,990,154
------------
End of period........................................... $221,539,967
============
</TABLE>
FINANCIAL HIGHLIGHTS(1)
NINE MONTHS ENDED AUGUST 31, 1998 (UNAUDITED)
FOR A COMMON SHARE OUTSTANDING THROUGHOUT THE PERIOD.
-----------------------------------------------------
<TABLE>
<S> <C>
OPERATING PERFORMANCE:
Net asset value, beginning of period.................... $ 16.71
----------
Net investment income................................... 0.94
Net realized gain and unrealized depreciation on
investments............................................ 0.30
----------
Net increase in net asset value resulting from
investment operations.................................. 1.25
DISTRIBUTIONS:
Dividends declared to MMP* Shareholders................. (0.18)
Distributions paid from net realized capital gains to
MMP* Shareholders(3)................................... (0.00)#
Dividends paid from net investment income to Common
Stock Shareholders(2).................................. (0.81)
Distributions paid from net realized capital gains to
Common Stock Shareholders(3)........................... (0.30)
Change in accumulated undeclared dividends on MMP*
Shareholders........................................... (0.02)
----------
Total distributions..................................... (1.31)
----------
Net asset value, end of period.......................... $ 16.64
==========
Market value, end of period............................. $ 15.875
==========
Common shares outstanding, end of period................ $9,838,571
==========
RATIOS TO AVERAGE NET ASSETS AVAILABLE TO COMMON STOCK
SHAREHOLDERS:
Net investment income................................... 5.93**
Operating expenses...................................... 1.36%**
SUPPLEMENTAL DATA:
Portfolio turnover rate................................. 74%
- ------------------------------------------------------------
Ratio of operating expenses to Total Average Net Assets
including MMP*............................................ 1.01%**
</TABLE>
(1) These tables summarize the nine months ended August 31, 1998 and should be
read in conjunction with the Fund's audited financial statements, including
footnotes, in its Annual Report dated November 30, 1997.
(2) Includes dividends earned, but not paid out, in prior fiscal year.
(3) Paid from capital gains realized, but not paid out, in prior fiscal year.
* Money Market Cumulative Preferred(TM) Stock.
** Annualized.
# Amount represents less than $0.01 per share.
3
<PAGE>
DIRECTORS
Martin Brody
Donald F. Crumrine, CFA
Robert T. Flaherty, CFA
David Gale
Morgan Gust
Robert F. Wulf, CFA
OFFICERS
Robert T. Flaherty, CFA [LOGO]
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 Quarterly
e-mail: [email protected] Report
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.
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 August 31, 1998
OF SHARES OF THE FUND OR OF ANY
SECURITIES MENTIONED IN THIS REPORT.
