<PAGE>
ANNUAL REPORT--NOVEMBER 14, 1996
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER,
We are pleased to present you with the
annual report for Investment Grade Municipal
Income Fund Inc. (the "Fund") for the year ended
September 30, 1996.
GENERAL MARKET OVERVIEW
After exceptional performance during most
of 1995, 1996 to date has been difficult for
fixed income investors. Accelerating economic
growth, reflected in strong employment, retail
sales and investment spending numbers, as well as
a surprisingly robust housing sector, combined to
convince the market that, contrary to initial
expectations, the Federal Reserve Board (the
"Fed") would not move to ease interest rates. The
change in sentiment was clearly reflected in the
30-year U.S. Treasury bond, the benchmark of bond
market performance, as its yield increased from
5.95% on December 29, 1995, to 6.75% by August
31, 1996 (when bond yields increase, bond prices
decrease). These events established a pattern for
the remainder of the period, as ongoing economic
reports portraying the economy as growing too
rapidly continued to unsettle a jittery bond
market. August proved the exception, bringing a
glimmer of hope to the market; this was
short-lived, however, as disappointing economic
reports emerged over the last few trading days of
the month.
THE MUNICIPAL MARKET
While concerns over a flat tax early in the
fiscal year cast a shadow over the municipal
market, over the past few months the presidential
campaign rendered these fears nearly nonexistent.
Neither candidate focused heavily upon the topic
of tax restructuring, at least not to the extent
that it substantially impacted the municipal bond
market.
Adding to the positive municipal
environment in recent months was the fact that
municipals outperformed Treasuries, rising 60
basis points to hit their high yields in
mid-June, then rallying by 25 basis points as of
August 31, 1996. Also contributing to their
attractiveness was the continued slowdown in the
supply of new municipal issues; with fewer bonds
being issued, demand increased relative to
supply, thereby elevating the price of
<PAGE>
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PORTFOLIO REVIEW
existing bonds. As of September 30, 1996,
high-quality, long-term municipal bonds were
yielding an average of 80% of comparable maturity
Treasury bonds.
Going forward, we anticipate that any
remaining flat tax concerns will continue to
subside and expect that any tax reform proposals
will not seriously impact municipals. We believe
that municipal bonds will continue to enjoy
tax-exemption, while other asset classes will
still be subject to taxes. Moreover, we expect
that municipal bonds will continue to stay on an
even keel relative to Treasuries, and that new
issue supply should continue to remain low and
demand for supply constant.
PORTFOLIO REVIEW
The Fund's total return for the 12 months
ended September 30, 1996, based on the Fund's
common stock net asset value was 8.33%, while the
Fund's total return for the same time period
based on the Fund's common stock market value was
12.03%. As of September 30, 1996, the Fund's net
asset value per share was $16.11, and its share
price on the New York Stock Exchange was $13.63
The Fund paid dividends from net investment
income to common shareholders, which totalled
$0.90 per share of common stock during the 12
months ended September 30, 1996. The Fund has
paid a monthly dividend of $0.0750 per share of
common stock since July 1995. Given the current
interest rate environment, we anticipate that the
monthly dividend will remain unchanged for the
remainder of 1996.
The Fund's dividends benefited from
declining short-term interest rates during the 12
months ended September 30, 1996. As short-term
rates decreased, the benefit derived from the
Fund's Auction Preferred Shares ("APS")
increased. As you know, the Fund's dividends have
benefited in the past from the use of leverage
through the issuance of APS. That is, by
investing the proceeds of the APS offering in
longer-term municipal bonds, the Fund has been
able to earn a spread--the difference between
short- and long-term interest rates--over the
rate paid on the APS, which is a short-term rate.
The amount of the spread, after paying the costs
attributable to
2
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PORTFOLIO REVIEW
the APS, increases the dividends payable to
individual shareholders. As always, our goal is
to provide the best use of leverage for the Fund
to individual shareholders.
As of September 30, 1996, the Fund was
fully invested in long-term municipal securities
with an average maturity of 21.1 years and was
fully diversified. Using the higher of Moody's
Investors Service, Inc. or Standard & Poor's
ratings, the rating mix in the portfolio as of
September 30, 1996 (as a percentage of portfolio
investments) was as follows:
EDGAR REPRESENTATION OF DATA POINTS USED IN
PRINTED GRAPHIC
<TABLE>
<S> <C>
AAA or Aaa 34.3%
AA or Aa 31.6%
A or A 25.9%
BBB or Baa 5.2%
SP1 or MIG1 1.8%
A1 or P1 1.2%
</TABLE>
The largest percentages of the Fund's net
assets as of September 30, 1996, were invested in
securities of Illinois, 14.8%; New York, 13.4%;
and Texas, 12.5%. As of September 30, 1996 three
of the largest sector holdings were Water
Revenue, 17.7%; Power Revenue, 16.9%; and
Hospital Revenue, 13.8%.
Going forward, we see opportunities in
select spots on the yield curve, specifically
issues in the fifteen to twenty year maturity
range. We intend to diversify across the yield
curve and the credit spectrum and increase the
structural variety of bonds included in the
portfolio. These three diversification strategies
should offer greater return potential without
increasing risk.
3
<PAGE>
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PORTFOLIO REVIEW
One final note--in October, 1996, Cynthia
Bow assumed co-portfolio management
responsibilities for the Fund, joining existing
portfolio manager and Senior Vice President in
charge of all municipal investments, Elbridge
(Ebby) T. Gerry III. Ms. Bow, who has been with
Mitchell Hutchins since 1982, is a vice president
and portfolio manager. She is also a vice
president of two investment companies for which
Mitchell Hutchins or PaineWebber serves as
investment adviser.
Our ultimate objective in managing your
investments is to help you successfully meet your
financial goals. We thank you for your continued
support, and welcome any comments or questions
you may have.
Sincerely,
[SIGNATURE] [SIGNATURE]
MARGO ALEXANDER ELBRIDGE T. GERRY III
President, Senior Vice President,
Mitchell Hutchins Asset Management Mitchell Hutchins Asset Management
Inc. Inc.
Portfolio Manager,
Investment Grade Municipal Income Fund
Inc.
[SIGNATURE]
CYNTHIA BOW
Portfolio Manager,
Investment Grade Municipal
Income Fund Inc.
4
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
PORTFOLIO OF INVESTMENTS SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
PRINCIPAL MOODY'S
AMOUNT RATING S&P RATING
(000) (UNAUDITED) (UNAUDITED) MATURITY DATES INTEREST RATES VALUE
- --------- ----------- ----------- -------------------- -------------- ------------
<C> <S> <C> <C> <C> <C> <C>
LONG-TERM MUNICIPAL BONDS - 95.32%
ALASKA - 2.89%
$ 6,540 Valdez Marine Terminal
British Petroleum Co.
Sohio Pipeline Project...... Aa3 AA 12/01/25 7.000% $ 7,123,957
------------
CALIFORNIA - 1.45%
3,500 California Public Works Board
California State
University.................. A A 09/01/16 6.250 3,575,985
------------
COLORADO - 0.64%
1,500 Denver City & County
Excise Tax Revenue Bonds
(MBIA Insured).............. Aaa AAA 09/01/14 6.500 1,570,695
------------
CONNECTICUT - 4.04%
9,650 Connecticut Housing Finance
Authority................... Aa AA 05/15/14 to 11/15/23 6.200 to 6.750 9,979,248
------------
GEORGIA - 0.21%
500 Municipal Electric Authority
of Georgia.................. A A 01/01/16 6.375 510,050
------------
ILLINOIS - 14.79%
1,000 Illinois Educational
Facilities
Authority--Northwestern
University (Pre-refunded
with U.S. Government
Securities to 12/01/01 @
$102)....................... A AA 12/01/21 6.900 1,117,040
3,000 Illinois Health Facilities
Authority--Glen Oaks
Hospital.................... Baa1 BBB 11/15/19 7.000 3,077,460
3,000 Illinois Health Facilities
Authority--Hinsdale
Hospital.................... Baa1 BBB 11/15/19 7.000 3,079,530
1,890 Illinois Toll & Highway
Authority (FGIC Insured).... Aaa AAA 01/01/16 6.200 1,967,717
7,380 Chicago Gas Supply People's
Gas......................... Aa3 AA- 03/01/15 6.875 7,917,116
4,000 Chicago Water Works........... A1 AA- 11/15/19 6.000 4,008,680
11,600 Metropolitan Pier & Exposition
Authority................... A AAA 06/15/27 6.500 12,739,816
2,650 University of Illinois........ Aa AA- 04/01/22 5.750 2,601,346
------------
36,508,705
------------
INDIANA - 10.77%
6,750 Indiana Transportation
Financing Authority......... A BBB 11/01/16 6.250 6,891,075
6,000 Indianapolis Gas Utility
(FGIC Insured).............. Aaa AAA 06/01/23 6.200 6,206,280
2,000 Indianapolis Local Public
Improvement Bond Bank....... Aa AA- 07/01/10 6.000 2,082,620
4,000 Marion County Hospital
Authority--Methodist
Hospital of Indiana......... Aa AA- 09/01/13 6.500 4,195,600
5,725 Petersburg County Pollution
Control--Indianapolis Power
& Light Company............. Aa2 AA- 12/01/24 6.625 6,109,262
1,000 Purdue University............. Aa AA- 07/01/15 6.700 1,087,320
------------
26,572,157
------------
</TABLE>
5
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
<TABLE>
<CAPTION>
PRINCIPAL MOODY'S
AMOUNT RATING S&P RATING
(000) (UNAUDITED) (UNAUDITED) MATURITY DATES INTEREST RATES VALUE
- --------- ----------- ----------- -------------------- -------------- ------------
<C> <S> <C> <C> <C> <C> <C>
LONG-TERM MUNICIPAL BONDS - (CONTINUED)
KENTUCKY - 3.28%
$ 7,750 Boone County Pollution
Control--Dayton Power &
Light Co.................... Aa3 AA- 11/15/22 6.500% $ 8,100,455
------------
MASSACHUSETTS - 7.42%
8,500 Massachusetts Bay
Transportation Authority.... A1 A+ 03/01/23 6.100 8,646,370
6,000 Massachusetts Water Resources
Authority (Pre-refunded with
U.S. Government Securities
to 07/15/02 @ $102)......... Aaa AAA 07/15/21 6.500 6,636,420
2,750 Massachusetts Water Resources
Authority (Pre-refunded with
U.S. Government Securities
to 12/01/01 @ $102)......... Aaa AAA 12/01/19 6.500 3,025,880
------------
18,308,670
------------
NEVADA - 2.97%
6,750 Clark County Pollution Control
Nevada Power (FGIC
Insured).................... Aaa AAA 06/01/19 6.600 7,323,075
------------
NEW YORK - 12.30%
6,000 New York State Local
Government Assistance
Corp........................ A A 04/01/21 6.250 6,180,720
5,350 New York State Local
Government Assistance Corp.
(Pre-refunded with U.S.
Government Securities to
04/01/02 @ $102)............ Aaa AAA 04/01/21 6.750 5,967,551
1,500 New York State Medical Care
Facilities (FHA Insured).... Aa AAA 02/15/31 6.600 1,583,685
6,150 New York City General
Obligation.................. Baa1 BBB+ 02/01/16 to 08/01/17 7.000 6,524,032
10,070 New York City Municipal Water
Finance..................... A A- 06/15/17 to 06/15/21 6.000 to 6.250 10,092,588
------------
30,348,576
------------
NORTH CAROLINA - 2.14%
2,700 North Carolina Eastern
Municipal Power Agency...... A BBB+ 01/01/21 6.400 2,711,664
2,550 North Carolina Municipal Power
Agency--Catawba Electric
Revenue..................... A A- 01/01/17 6.250 2,561,093
------------
5,272,757
------------
PENNSYLVANIA - 0.48%
1,190 Philadelphia Hospitals and
Higher Educational
Facilities Authority
Chestnut Hill Hospital...... Baa1 A- 11/15/22 6.500 1,189,738
------------
RHODE ISLAND - 2.56%
6,175 Rhode Island Housing
Finance..................... Aa AA+ 04/01/27 6.500 6,313,876
------------
</TABLE>
6
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
<TABLE>
<CAPTION>
PRINCIPAL MOODY'S
AMOUNT RATING S&P RATING
(000) (UNAUDITED) (UNAUDITED) MATURITY DATES INTEREST RATES VALUE
- --------- ----------- ----------- -------------------- -------------- ------------
<C> <S> <C> <C> <C> <C> <C>
LONG-TERM MUNICIPAL BONDS - (CONCLUDED)
SOUTH CAROLINA - 4.95%
$ 5,035 South Carolina Public Service
Authority--Santee Cooper
(Pre-refunded with U.S.
Government Securities to
07/01/02 @ $102)............ Aaa AAA 07/01/31 6.625% $ 5,599,272
6,290 Richland County Pollution
Control--Union Camp Project
Series C.................... A1 A- 11/01/20 6.550 6,626,767
------------
12,226,039
------------
TEXAS - 12.46%
5,000 Texas Health Facilities
Development Corp.--All
Saints Episcopal Hospital
(MBIA Insured).............. Aaa AAA 08/15/22 6.250 5,192,600
4,000 Coastal Bend Health Facilities
Incarnate Word Health System
(AMBAC Insured)............. Aaa AAA 01/01/17 6.300 4,185,280
4,750 Harris County Subordinated
Lien Revenue................ Aa AA 08/01/14 6.750 5,156,220
915 Harris County Toll Road
Authority
Senior Lien (AMBAC
Insured).................... Aaa AAA 08/15/17 6.500 984,165
1,000 Houston Water & Sewer
System...................... A A 12/01/14 6.375 1,037,550
6,575 Houston Water & Sewer System
(AMBAC Insured)............. Aaa AAA 12/01/17 6.375 6,883,696
6,750 Sabine River Authority
Pollution Control (FGIC
Insured).................... Aaa AAA 10/01/22 6.550 7,317,540
------------
30,757,051
------------
VIRGINIA - 4.35%
4,500 Virginia Beach Development
Authority--Sentara Bayside
Hospital.................... Aa AA 11/01/21 6.300 4,579,290
5,815 Virginia Transportation Board
Revenue--Route 28 Project... Aa AA 04/01/18 6.500 6,168,552
------------
10,747,842
------------
WASHINGTON - 4.81%
4,500 Metropolitan Seattle Sewer
(MBIA Insured).............. Aaa AAA 01/01/33 6.300 4,678,290
6,625 Metropolitan Seattle Sewer
(Pre-refunded with U.S.
Government Securities to
01/01/00 @ $102)............ Aaa AAA 01/01/31 6.875 7,201,772
------------
11,880,062
------------
WISCONSIN - 2.81%
6,750 Wisconsin Health and
Educational Facilities
Authority--Sisters of
Sorrowful Mother Health Care
System (MBIA Insured)....... Aaa AAA 06/01/20 6.250 6,947,843
------------
TOTAL LONG-TERM MUNICIPAL BONDS
(cost--$222,318,496)..................... 235,256,781
------------
</TABLE>
7
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
<TABLE>
<CAPTION>
PRINCIPAL MOODY'S
AMOUNT RATING S&P RATING
(000) (UNAUDITED) (UNAUDITED) MATURITY DATES INTEREST RATES VALUE
- --------- ----------- ----------- -------------------- -------------- ------------
<C> <S> <C> <C> <C> <C> <C>
SHORT-TERM MUNICIPAL NOTES - 3.00%
ARIZONA - 0.24%
$ 600 Phoenix General Obligation
Bonds*...................... VMIG1 A-1+ 10/01/96 3.950% $ 600,000
------------
FLORIDA - 0.37%
900 Hillsborough County Pollution
Control*.................... VMIG1 A-1+ 10/01/96 3.900 900,000
------------
NEW YORK - 1.13%
200 New York City Series A*....... VMIG1 A-1+ 10/01/96 3.950 200,000
1,600 New York City Series B*....... VMIG1 A-1+ 10/01/96 3.700 to 3.950 1,600,000
700 New York City Series E*....... VMIG1 A-1+ 10/01/96 3.900 700,000
300 New York State Energy Research
and Development Authority
Pollution Control
Revenue*.................... VMIG1 A-1+ 10/01/96 3.800 300,000
------------
2,800,000
------------
WYOMING - 1.26%
3,100 Lincoln County Pollution
Control*.................... P-1 A-1+ 10/01/96 4.000 3,100,000
------------
TOTAL SHORT-TERM MUNICIPAL NOTES
(cost--$7,400,000)....................... 7,400,000
------------
TOTAL INVESTMENTS
(cost--$229,718,496)--98.32%............. 242,656,781
Other assets in excess of
liabilities--1.68%......................... 4,147,035
------------
NET ASSETS--100.00%........................ $246,803,816
------------
------------
</TABLE>
- ------------------------------
* Variable rate demand notes are payable on demand. The maturity dates shown are
the next interest rate reset dates; the interest rates shown are the current
rates as of September 30, 1996.
AMBAC -- American Municipal Bond Assurance Corporation
FGIC -- Financial Guaranty Insurance Company
FHA -- Federal Housing Authority
MBIA -- Municipal Bond Investors Assurance
See accompanying notes to financial statements
8
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
STATEMENT OF ASSETS AND LIABILITIES SEPTEMBER 30, 1996
<TABLE>
<S> <C>
ASSETS
Investments in securities, at value (cost--$229,718,496)............................................ $242,656,781
Cash................................................................................................ 72,058
Interest receivable................................................................................. 4,372,719
Deferred organizational expenses.................................................................... 42,270
------------
Total assets........................................................................................ 247,143,828
------------
LIABILITIES
Payable to investment adviser and administrator..................................................... 130,285
Dividends payable to preferred shareholders......................................................... 126,322
Accrued expenses and other liabilities.............................................................. 83,405
------------
Total liabilities................................................................................... 340,012
------------
NET ASSETS
Auction Preferred Shares Series A & B--1,600 non-participating shares authorized,
issued and outstanding; $0.001 par value; $50,000 liquidation value............................... 80,000,000
------------
Common Stock--$0.001 par value; total authorized shares--199,998,400; 10,356,667 shares
issued and outstanding............................................................................ 153,674,140
Undistributed net investment income................................................................. 641,761
Accumulated net realized losses from investment transactions........................................ (450,370)
Net unrealized appreciation of investments.......................................................... 12,938,285
------------
Net assets applicable to common shareholders........................................................ 166,803,816
------------
Total net assets.................................................................................... $246,803,816
------------
------------
Net asset value per common share ($166,803,816 applicable to 10,356,667 common shares
outstanding)...................................................................................... $16.11
------------
------------
</TABLE>
See accompanying notes to financial statements
9
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
STATEMENT OF OPERATIONS FOR THE YEAR ENDED SEPTEMBER 30, 1996
<TABLE>
<S> <C>
INVESTMENT INCOME:
Interest............................................................................................ $14,796,367
-----------
EXPENSES:
Investment advisory and administration.............................................................. 2,208,189
Auction Preferred Shares expenses................................................................... 274,029
Custody and accounting.............................................................................. 110,842
Legal and audit..................................................................................... 68,902
Reports and notices to shareholders................................................................. 67,787
Amortization of organizational expenses............................................................. 38,372
Transfer agency and service fees.................................................................... 22,861
Directors' fees..................................................................................... 12,250
Other expenses...................................................................................... 23,922
-----------
2,827,154
Less: Fee waivers from adviser...................................................................... (613,386)
-----------
Net expenses........................................................................................ 2,213,768
-----------
NET INVESTMENT INCOME............................................................................... 12,582,599
-----------
REALIZED AND UNREALIZED GAINS FROM INVESTMENT ACTIVITIES:
Net realized gains from investment transactions..................................................... --
Net change in unrealized appreciation/depreciation of investments................................... 3,503,278
-----------
NET REALIZED AND UNREALIZED GAINS FROM INVESTMENT ACTIVITIES........................................ 3,503,278
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS................................................ $16,085,877
-----------
-----------
</TABLE>
See accompanying notes to financial statements
10
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
FOR THE YEARS
ENDED SEPTEMBER 30,
--------------------------
1996 1995
------------ ------------
<S> <C> <C>
FROM OPERATIONS:
Net investment income........................................................... $ 12,582,599 $ 12,211,758
Net realized losses from investment transactions................................ -- (447,179)
Net change in unrealized appreciation/depreciation of investments............... 3,503,278 11,192,984
------------ ------------
Net increase in net assets resulting from operations............................ 16,085,877 22,957,563
------------ ------------
DIVIDENDS FROM:
Net investment income--common stockholders...................................... (9,321,000) (9,323,071)
Net investment income--preferred stockholders................................... (2,866,596) (3,134,892)
------------ ------------
Total dividends to stockholders................................................. (12,187,596) (12,457,963)
------------ ------------
Net increase in net assets...................................................... 3,898,281 10,499,600
NET ASSETS:
Beginning of year............................................................... 242,905,535 232,405,935
------------ ------------
End of year (including undistributed net investment income of $641,761 and
$246,758, respectively)....................................................... $246,803,816 $242,905,535
------------ ------------
------------ ------------
</TABLE>
See accompanying notes to financial statements
11
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED SEPTEMBER 30, 1996
<TABLE>
<S> <C>
CASH FLOWS PROVIDED (USED) BY OPERATING ACTIVITIES:
Interest received................................................................................... $14,770,735
Expenses paid (net of fee waivers).................................................................. (2,284,936)
Purchase of short-term portfolio investments, net................................................... (300,000)
-----------
Net cash provided by operating activities........................................................... 12,185,799
-----------
CASH FLOWS USED FOR FINANCING ACTIVITIES:
Dividends paid from net investment income to common stockholders.................................... (9,321,000)
Dividends paid from net investment income to preferred stockholders................................. (2,869,456)
-----------
Net cash used for financing activities.............................................................. (12,190,456)
-----------
NET DECREASE IN CASH................................................................................ (4,657)
CASH AT BEGINNING OF YEAR........................................................................... 76,715
-----------
CASH AT END OF YEAR................................................................................. $ 72,058
-----------
-----------
RECONCILIATION OF NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS TO NET CASH PROVIDED BY
OPERATING ACTIVITIES:
Net increase in net assets resulting from operations................................................ $16,085,877
-----------
Increase in investments, at value................................................................... (3,831,243)
Decrease in interest receivable..................................................................... 2,333
Amortization of deferred organizational expenses.................................................... 38,372
Increase in payable to investment adviser and administrator......................................... 442
Decrease in accrued expenses and other liabilities.................................................. (109,982)
-----------
Total adjustments................................................................................... (3,900,078)
-----------
Net cash provided by operating activities........................................................... $12,185,799
-----------
-----------
</TABLE>
See accompanying notes to financial statements
12
<PAGE>
NOTES TO FINANCIAL STATEMENTS
ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Investment Grade Municipal Income Fund Inc. (the "Fund") was
incorporated in Maryland on August 6, 1992, and is registered with
the Securities and Exchange Commission as a closed-end diversified
management investment company. Organizational costs have been
deferred and are being amortized on the straight line method over a
period not to exceed 60 months from the date the Fund commenced
operations.
The preparation of financial statements in accordance with
generally accepted accounting principles requires Fund management
to make estimates and assumptions that affect the reported amounts
and disclosures in the financial statements. Actual results could
differ from those estimates. The following is a summary of
significant accounting policies:
VALUATION OF INVESTMENTS - Where market quotations are readily
available, portfolio securities are valued thereon, provided such
quotations adequately reflect the fair value of the securities, in
the judgment of Mitchell Hutchins Asset Management Inc. ("Mitchell
Hutchins"), a wholly owned subsidiary of PaineWebber Incorporated,
investment adviser and administrator of the Fund. When market
quotations are not readily available, securities are valued based
upon appraisals received from a pricing service which utilizes a
computerized matrix pricing system, or based upon appraisals
derived from information concerning those securities or similar
securities received from recognized dealers in those securities.
All other securities are valued at fair value as determined in good
faith by or under the direction of the Fund's board of directors.
The amortized cost method of valuation, which approximates market
value, is used to value certain debt obligations with 60 days or
less remaining to maturity, unless the Fund's board of directors
determines that this does not represent fair value.
INVESTMENT TRANSACTIONS AND INVESTMENT INCOME - Investment
transactions are recorded on the trade date. Realized gains and
losses from investment transactions are calculated using the
identified cost method. Interest income is recorded on an accrual
basis. Discounts are accreted and premiums are amortized as
adjustments to interest income and the identified cost of
securities.
DIVIDENDS AND DISTRIBUTIONS - The Fund intends to pay monthly cash
dividends to common stockholders at a level rate that over time
will result in the distribution of all of the Fund's net investment
income remaining after the payment of dividends on any outstanding
preferred stock. Dividends and distributions to common stockholders
are recorded on the ex-dividend date. Dividends to preferred
stockholders are accrued daily. Dividends from net investment
income and distributions from realized capital gains from
investment transactions are determined in accordance with federal
income tax regulations which may differ from generally accepted
accounting principles. These "book/tax" differences are either
considered temporary or permanent in nature. To the extent these
differences are permanent in nature, such amounts are reclassified
within the capital accounts based on their federal tax-basis
treatment; temporary differences do not require reclassification.
13
<PAGE>
CONCENTRATION OF RISK
The Fund follows an investment policy of investing primarily in
municipal obligations of various states. Economic changes affecting
those states and certain of their public bodies and municipalities
may affect the ability of the issuers within those states to pay
interest on, or repay principal of, municipal obligations held by
the Fund.
INVESTMENT ADVISER AND ADMINISTRATOR
The Fund's board of directors has approved an investment advisory
and administration contract ("Advisory Contract") with Mitchell
Hutchins, under which Mitchell Hutchins serves as investment
adviser and administrator of the Fund. In accordance with the
Advisory Contract, Mitchell Hutchins receives compensation from the
Fund, computed weekly and paid monthly, at the annual rate of 0.90%
of the Fund's average weekly net assets. For the year ended
September 30, 1996, Mitchell Hutchins voluntarily waived $613,386
in investment advisory and administration fees from the Fund.
INVESTMENTS IN SECURITIES
For federal income tax purposes, the cost of securities owned at
September 30, 1996, was substantially the same as the cost of
securities for financial statement purposes.
At September 30, 1996, the components of the net unrealized
appreciation of investments were as follows:
<TABLE>
<S> <C>
Gross appreciation (from investments having an
excess of value over cost)...................... $12,938,285
Gross depreciation (from investments having an
excess of cost over value)...................... --
----------
Net unrealized appreciation of investments....... $12,938,285
----------
----------
</TABLE>
FEDERAL TAX STATUS
The Fund intends to distribute substantially all of its tax-exempt
income and any taxable income and to comply with the other
requirements of the Internal Revenue Code applicable to regulated
investment companies. Accordingly, no provision for income taxes is
required. In addition, by distributing during each calendar year
substantially all of its net investment income, capital gains and
certain other amounts, if any, the Fund intends not to be subject
to a federal excise tax.
At September 30, 1996, the Fund had a net capital loss carryforward
of $450,370 which is available as a reduction, to the extent
provided in the regulations, of future net realized capital gains,
and will expire by September 30, 2004. To the extent that such
losses are used to offset future capital gains, it is probable that
the gains so offset will not be distributed.
14
<PAGE>
CAPITAL STOCK
COMMON STOCK--There are 199,998,400 shares of $0.001 par value
common stock authorized. Of the 10,356,667 common shares
outstanding, 7,124 shares are owned by Mitchell Hutchins.
AUCTION PREFERRED SHARES--The Fund has issued 800 shares of Auction
Preferred Shares Series A and 800 shares of Auction Preferred
Shares Series B, which are referred to herein collectively as the
"APS." All shares of each series of APS have a liquidation
preference of $50,000 per share plus an amount equal to accumulated
but unpaid dividends upon liquidation.
Dividends, which are cumulative, are generally reset every 28 days
for APS Series A and 90 days for APS Series B. Dividend rates
ranged from 3.25% to 4.05% for the year ended September 30, 1996.
The Fund is subject to certain restrictions relating to the APS.
Failure to comply with these restrictions could preclude the Fund
from declaring any distributions to common shareholders or
repurchasing common shares and/or could trigger the mandatory
redemption of APS at liquidation value.
The APS are entitled to one vote per share and, unless otherwise
required by law, will vote with holders of common stock as a single
class, except that the preferred shares will vote separately as a
class on certain matters, as required by law. The holders of the
preferred shares have the right to elect two directors of the Fund.
15
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
FINANCIAL HIGHLIGHTS
SELECTED DATA FOR A SHARE OF COMMON STOCK OUTSTANDING THROUGHOUT EACH PERIOD IS
PRESENTED BELOW:
<TABLE>
<CAPTION>
FOR THE
PERIOD
NOVEMBER 6,
FOR THE YEARS ENDED 1992+
SEPTEMBER 30, THROUGH
------------------------------- SEPTEMBER 30,
1996 1995 1994 1993
--------- --------- --------- -------------
<S> <C> <C> <C> <C>
Net asset value, beginning of period.................................. $ 15.73 $ 14.72 $ 17.04 $ 15.00
--------- --------- --------- -------------
Net investment income................................................. 1.21 1.18 1.17 0.94
Net realized and unrealized gains (losses) from investments........... 0.35 1.03 (2.28) 2.13
--------- --------- --------- -------------
Net increase (decrease) from investment operations.................... 1.56 2.21 (1.11) 3.07
--------- --------- --------- -------------
Dividends from net investment income to:
Common stockholders................................................. (0.90) (0.90) (0.98) (0.73)
Common share equivalent of dividends paid to preferred
stockholders....................................................... (0.28) (0.30) (0.21) (0.14)
Distributions from net realized gains from investment transactions.... -- -- (0.02) --
--------- --------- --------- -------------
Total dividends and distributions to stockholders..................... (1.18) (1.20) (1.21) (0.87)
--------- --------- --------- -------------
Underwriting and offering costs incurred with the preferred stock
offering charged to common stock.................................... -- -- -- (0.16)
--------- --------- --------- -------------
Net asset value, end of period........................................ $ 16.11 $ 15.73 $ 14.72 $ 17.04
--------- --------- --------- -------------
--------- --------- --------- -------------
Per share market value, end of period................................. $ 13.63 $ 13.00 $ 12.38 $ 15.63
--------- --------- --------- -------------
--------- --------- --------- -------------
Total investment return(1)............................................ 12.03% 12.63% (15.21)% 9.10%
--------- --------- --------- -------------
--------- --------- --------- -------------
Ratios to average net assets attributable to common shares:
Total expenses, net of waivers from adviser......................... 1.34% 1.69% 1.70% 1.55%*
Total expenses, before waivers from adviser......................... 1.71% 1.82% 1.70% 1.55%*
Net investment income before preferred stock dividends.............. 7.61% 7.87% 7.32% 6.55%*
Preferred stock dividends........................................... 1.73% 2.02% 1.33% 0.95%*
Net investment income available to common stockholders.............. 5.88% 5.85% 5.99% 5.60%*
Supplemental data:
Net assets, end of period (000's)................................... $ 246,804 $ 242,906 $ 232,406 $ 256,466
Portfolio turnover rate............................................. 0% 7% 0% 6%
Asset coverage per share of preferred stock, end of period.......... $ 154,252 $ 151,816 $ 145,254 $ 160,291
</TABLE>
- ------------------------------
+ Commencement of operations
* Annualized
(1) Total investment return is calculated assuming a purchase of common stock at
the current market price on the first day and a sale at the current market
price on the last day of each period reported and assuming reinvestment of
dividends and other distributions to common stockholders at prices obtained
under the Fund's Dividend Reinvestment Plan. Total investment return for
periods of less than one year has not been annualized. Total investment
return does not reflect brokerage commissions.
16
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors of
Investment Grade Municipal Income Fund Inc.
In our opinion, the accompanying statement of assets and
liabilities, including the portfolio of investments, and the
related statements of operations, of changes in net assets and of
cash flows and the financial highlights present fairly, in all
material respects, the financial position of Investment Grade
Municipal Income Fund (the "Fund") at September 30, 1996, the
results of its operations and its cash flows for the year then
ended, the changes in its net assets for each of the two years in
the period then ended and the financial highlights for each of the
three years in the period then ended and for the period November 6,
1992 (commencement of operations) through September 30, 1993, in
conformity with generally accepted accounting principles. These
financial statements and financial highlights (hereafter referred
to as "financial statements") are the responsibility of the Fund's
management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits
of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe
that our audits, which included confirmation of securities at
September 30, 1996 by correspondence with the custodian, provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
1177 Avenue of the Americas
New York, New York 10036
November 20, 1996
17
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
TAX INFORMATION
We are required by Subchapter M of the Internal Revenue Code of
1986, as amended, to advise you within 60 days of the Fund's fiscal
year end (September 30, 1996), as to the federal tax status of
distributions received by stockholders during such fiscal year.
Accordingly, we are advising you that all dividends paid during the
fiscal year were federal tax-exempt interest dividends.
The Fund did not invest in any securities which paid interest
subject to the federal alternative minimum tax for individual
taxpayers during its fiscal year. Therefore, none of the dividends
paid by the Fund were subject to such tax.
Because the Fund's fiscal year is not the calendar year, another
notification will be sent in respect of calendar year 1996. The
second notification, which reflects the amount to be used by
calendar year taxpayers on their federal income tax returns, will
be made in conjunction with Form 1099 DIV and will be mailed in
January 1997. Stockholders are advised to consult their own tax
advisers with respect to the tax consequences of their investment
in the Fund.
18
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
GENERAL INFORMATION
THE FUND
Investment Grade Municipal Income Fund Inc. (the "Fund") is a
diversified closed-end management investment company whose shares
trade on the New York Stock Exchange, Inc. ("NYSE"). The Fund's
investment objective is to achieve a high level of current income
that is exempt from federal income tax, consistent with the
preservation of capital. The Fund's investment adviser and
administrator is Mitchell Hutchins Asset Management Inc., a wholly
owned subsidiary of PaineWebber Incorporated, which has over $43
billion in assets under management as of October 31, 1996.
SHAREHOLDER INFORMATION
The Fund's NYSE trading symbol is "PPM." Weekly comparative net
asset value and market price information about the Fund is
published each Monday in THE WALL STREET JOURNAL, each Sunday in
THE NEW YORK TIMES and each week in BARRON'S, as well as in
numerous other newspapers.
A special meeting of shareholders was held on April 11, 1996, at
which the following proposals were approved:
PROPOSAL 1
To vote for or against the election of the Board of Directors:
<TABLE>
<CAPTION>
SHARES
SHARES WITHHOLD
VOTED FOR AUTHORITY
---------- ----------------
<S> <C> <C>
Richard Q. Armstrong............................................. 5,249,349 246,892
E. Garrett Bewkes, Jr. .......................................... 5,254,074 242,167
Richard R. Burt.................................................. 5,251,723 244,518
Mary C. Farrell.................................................. 5,251,707 244,534
George W. Gowen.................................................. 5,247,939 248,302
Frederic V. Malek................................................ 5,240,340 255,901
Carl W. Schafer.................................................. 5,250,879 245,362
John R. Torrell III.............................................. 5,243,236 253,005
</TABLE>
PROPOSAL 2
AUCTION PREFERRED SHARES:
To vote for or against the election of its Board of Directors:
<TABLE>
<CAPTION>
SHARES SHARES
VOTED FOR WITHHOLD AUTHORITY
----------- -----------------------
<S> <C> <C>
Margo N. Alexander................................................. 1,133 0
Meyer Feldberg..................................................... 1,133 0
</TABLE>
(BROKER NON-VOTES AND ABSTENTIONS ARE INCLUDED WITHIN THE "SHARES
WITHHOLD AUTHORITY" AND "SHARES ABSTAIN" TOTALS.)
19
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
PROPOSAL 3
To vote for or against the following changes to the Fund's
fundamental investment restrictions and policies:
<TABLE>
<CAPTION>
SHARES
SHARES VOTED SHARES
VOTED FOR AGAINST ABSTAIN
--------- --------- ---------
<S> <C> <C> <C>
Modification of fundamental restriction on portfolio
diversification:................................................ 4,632,020 163,316 200,905
Modification of fundamental restriction on concentration:......... 4,626,823 164,008 205,407
Modification of fundamental restriction on senior securities and
borrowing:...................................................... 4,610,630 157,752 227,860
Modification of fundamental restriction on making loans:.......... 4,600,746 196,505 198,990
Modification of fundamental restriction on underwriting
securities:..................................................... 4,620,216 169,867 206,158
Modification of fundamental restriction on real estate
investments:.................................................... 4,626,862 150,567 218,812
Modification of fundamental restriction on investing in
commodities:.................................................... 4,597,135 185,784 213,322
Elimination of fundamental restriction on margin transactions:.... 4,580,577 212,896 202,768
Elimination of fundamental restriction on short sales:............ 4,581,495 197,652 217,095
Elimination of fundamental restriction on investments in oil, gas
and mineral leases and programs:................................ 4,631,334 171,924 192,984
</TABLE>
DISTRIBUTION POLICY
The Fund's Board of Directors has established a Dividend
Reinvestment Plan (the "Plan") under which all common stockholders
whose shares are registered in their own names, or in the name of
PaineWebber or its nominee, will have all dividends and other
distributions on their shares of common stock automatically
reinvested in additional shares of common stock, unless such common
stockholders elect to receive cash. Common stockholders who elect
to hold their shares in the name of another broker or nominee
should contact such broker or nominee to determine whether, or how,
they may participate in the Plan. Additional shares of common stock
acquired under the Plan will be purchased in the open market, on
the NYSE, at prices that may be higher or lower than the net asset
value per share of the common stock at the time of the purchase.
The Fund will not issue any new shares of common stock in
connection with the Plan.
20
<PAGE>
DIRECTORS
E. Garrett Bewkes, Jr., CHAIRMAN
Margo N. Alexander
Richard Q. Armstrong
Richard R. Burt
Mary C. Farrell
Meyer Feldberg
George W. Gowen
Frederic V. Malek
Carl W. Schafer
John R. Torell III
PRINCIPAL OFFICERS
Margo N. Alexander
PRESIDENT
Julian F. Sluyters
VICE PRESIDENT AND TREASURER
Dianne E. O'Donnell
VICE PRESIDENT AND SECRETARY
Victoria E. Schonfeld
VICE PRESIDENT
Elbridge T. Gerry III
VICE PRESIDENT
Cynthia Bow
VICE PRESIDENT
INVESTMENT ADVISER AND ADMINISTRATOR
Mitchell Hutchins Asset Management Inc.
1285 Avenue of the Americas
New York, New York 10019
Notice is hereby given in accordance with Section 23(c) of the Investment
Company Act of 1940 that from time to time the Fund may purchase at market
prices shares of its common
stock in the open market.
This report is sent to the shareholders of the Fund for their information.
It is not a prospectus, circular or representation intended for the use in
the purchase or sale of shares of the Fund or any securities mentioned in
this report.
[LOGO]
-C-1996 PaineWebber Incorporated
Member SIPC
-----------------------------------------------
I N V E S T M E N T
G R A D E
M U N I C I P A L
I N C O M E
F U N D I N C.
SEPTEMBER 30, 1996
ANNUAL REPORT
