<PAGE>
THE PREFERRED INCOME OPPORTUNITY FUND
Dear Shareholder:
The Preferred Income Opportunity 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 1.1% for the
quarter ended August 31, 1998 and 7.7% 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 44% 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 12% of the
Fund's portfolio, down from approximately 24% at the start of the current fiscal
year and a high of 32% 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 Opportunity Fund Incorporated
SUMMARY OF INVESTMENTS
AUGUST 31, 1998 (UNAUDITED)
- ---------------------------------------------
<TABLE>
<CAPTION>
PERCENT
VALUE OF TOTAL
(000'S) NET ASSETS
-------- ----------
<S> <C> <C>
ADJUSTABLE RATE PREFERRED STOCKS
Utilities.............................................. $ 17,004 7.7%
Banking................................................ 10,944 4.9
-------- -----
Total Adjustable Rate............................. 27,948 12.6
-------- -----
FIXED RATE PREFERRED STOCKS AND SECURITIES
Utilities.............................................. 79,445 35.8
Banking................................................ 34,433 15.5
Financial Services..................................... 33,417 15.0
Industrial............................................. 12,099 5.4
Insurance.............................................. 20,571 9.3
-------- -----
Total Fixed Rate.................................. 179,965 81.0
-------- -----
TOTAL PREFERRED STOCKS AND SECURITIES....................... 207,913 93.6
COMMON STOCKS
Utilities.............................................. 9,742 4.4
REPURCHASE AGREEMENT........................................ 2,692 1.2
PURCHASED PUT OPTIONS....................................... 303 0.1
-------- -----
TOTAL INVESTMENTS........................................... 220,650 99.3
OTHER ASSETS AND LIABILITIES (NET).......................... 1,607 0.7
-------- -----
TOTAL NET ASSETS.................................. $222,257 100.0%
======== =====
</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.............................. $0.325 $13.46 $13.0000 $13.40
January 31, 1998............................... 0.068 13.52 12.8750 12.95
February 28, 1998.............................. 0.068 13.52 12.8750 12.96
March 31, 1998................................. 0.068 13.62 12.8125 12.92
April 30, 1998................................. 0.068 13.59 12.6250 12.75
May 31, 1998................................... 0.068 13.70 12.8125 12.92
June 30, 1998.................................. 0.068 13.80 13.1250 13.11
July 31, 1998.................................. 0.068 13.59 12.8750 12.86
August 31, 1998................................ 0.068 13.64 12.8750 12.92
</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 Opportunity Fund Incorporated
STATEMENT OF CHANGES IN NET ASSETS(1)
NINE MONTHS ENDED AUGUST 31, 1998 (UNAUDITED)
------------------------------------------------------------------
<TABLE>
<S> <C>
OPERATIONS:
Net investment income................................... $ 9,422,161
Net realized gain on investments sold................... 8,379,829
Net unrealized depreciation of investments during the
period................................................. (4,591,569)
------------
Net increase in net assets from operations.......... 13,210,421
DISTRIBUTIONS:
Dividends paid from net investment income to MMP*
Shareholders........................................... (2,461,229)
Distributions paid from net realized capital gains to
MMP* Shareholders(3)................................... (32,478)
Dividends paid from net investment income to Common
Stock Shareholders(2).................................. (7,646,437)
Distributions paid from net realized capital gains to
Common Stock Shareholders(3)........................... (2,044,031)
------------
Net increase in net assets.......................... 1,026,246
NET ASSETS:
Beginning of period..................................... 221,230,471
------------
End of period........................................... $222,256,717
============
</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.................... $ 13.53
-----------
Net investment income................................... 0.84
Net realized gain and unrealized depreciation on
investments............................................ 0.34
-----------
Net increase in net asset value resulting from
investment operations.................................. 1.18
DISTRIBUTIONS:
Dividends declared to MMP* Shareholders................. (0.22)
Distributions paid from net realized capital gains to
MMP* Shareholders(3)................................... (0.00)#
Dividends paid from net investment income to Common
Stock Shareholders(2).................................. (0.68)
Distributions paid from net realized capital gains to
Common Stock Shareholders(3)........................... (0.18)
Change in accumulated undeclared dividends on MMP*
shareholders........................................... 0.01
-----------
Total distributions..................................... (1.07)
-----------
Net asset value, end of period.......................... $ 13.64
===========
Market value, end of period............................. $ 12.875
===========
Common shares outstanding, end of period................ 11,151,287
===========
RATIOS TO AVERAGE NET ASSETS AVAILABLE TO COMMON STOCK
SHAREHOLDERS:
Net investment income................................... 6.22%**
Operating expenses...................................... 1.48%**
SUPPLEMENTAL DATA:
Portfolio turnover rate................................. 82%
- ------------------------------------------------------------
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
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
e-mail: [email protected]
QUESTIONS CONCERNING YOUR SHARES OF PREFERRED
INCOME OPPORTUNITY 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 OPPORTUNITY
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.
[PREFERRED INCOME OPPORTUNITY LOGO]
Quarterly
Report
August 31, 1998
