<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC. ANNUAL REPORT
November 16, 1998
Dear Shareholder,
We are pleased to present you with the annual report for the Investment
Grade Municipal Income Fund Inc. (the "Fund") for the fiscal year ended
September 30, 1998.
GENERAL MARKET OVERVIEW
- --------------------------------------------------------------------------------
[Picture]
Over the Fund's fiscal year, the U.S. bond markets reflected the widening
reach of the Asian crisis. During the last few months of global turmoil,
Russian, Asian and Latin American economies faltered and their stock markets
fell. Corporate America also felt the impact of scaled-back profit
expectations.
As capital retreated from stocks and foreign markets the security of U.S.
Treasury bonds attracted investors from around the world. As a result, the
30-year Treasury bond yield fell to 4.98% in September, its lowest point in
thirty years. Municipals registered more modest gains as institutional investors
began buying them.
PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
PERFORMANCE
[Picture]
For the fiscal year ended September 30, 1998, the Fund (symbol: PPM) returned
7.40% based on changes in the Fund's net asset value and 12.21% based on changes
in its share price on the New York Stock Exchange.
At September 30, 1998 the Fund's net asset value per share was $17.09, while
its share price on the New York Stock Exchange was $15.94. During the fiscal
year ended September 30, 1998, the Fund paid common shareholders dividends from
net investment income totaling $0.90 per share of common stock, or about 7.5
cents per share per month. Based on the dividend paid in September and the
Fund's market price on September 30, 1998, the Fund's market yield was 5.65%
annualized.
HIGHLIGHTS
Through our economic, credit, quantitative and market research, we
identified bonds in attractive spots along the yield curve. We continue to
uncover value across sectors and credits as well.
In this declining rate environment, the Fund's higher-coupon bonds continued
to meet income distribution targets. Through the latter part of the fiscal year
the Fund's credit-quality profile remained largely unchanged, with more than
half the portfolio in bonds rated Aaa. The top five sectors also remained
unchanged. We picked up incremental yield and maintained duration targets by
purchasing NY State Dormitory Authority (City University) Baa-rated bonds
(0.4%).(1) Another investment during the period was our purchase of BBB-rated
and California Statewide Industrial Development Revenue for Irvine Corporation
(1.2%). Through this investment we were able to capture the yield of a BBB-rated
debt from an issuer that we consider one of the few underrated ones around.
- -----------------
(1) All weightings represent percentages of portfolio assets as of September
30, 1998. The Fund is actively managed and all holdings are subject to
change.
- --------------------------------------------------------------------------------
Investment Grade Municpal Income Fund Inc.
Fund Profile
[ARROW] Goal:
High Current income exempt from Federal income tax, consistent
with preservation of capital.
[ARROW] Portfolio Managers:
Elbridge T. Gerry, III,
Cynthia N. Bow,
Mitchell Hutchins
Asset Management
Inc.
[ARROW] Total Net Assets:
$257.0 million as of
September 30, 1998
[ARROW] Dividend Payments:
Monthly
1
<PAGE>
ANNUAL REPORT
OUTLOOK
- --------------------------------------------------------------------------------
We remain cautiously optimistic on the municipal markets: municipal bonds
are historically cheap compared to taxable bonds, suggesting that municipals
have greater relative upside potential. We believe the Fund is well
positioned to benefit from any gains in the municipal market, and we do not
foresee any significant portfolio changes in the near term.
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.
For a quarterly Fund Profile on the Investment Grade Municipal Income
Fund Inc. or another fund in the PaineWebber Family of Funds,(2) please
contact your investment executive.
Sincerely,
/s/ MARGO ALEXANDER /s/ ELBRIDGE T. GERRY, III
- -------------------------------------- -------------------------------------
MARGO ALEXANDER ELBRIDGE T. GERRY, III
President Senior Vice President
Mitchell Hutchins Asset Management Inc. Mitchell Hutchins Asset Management Inc.
Portfolio Manager, Investment Grade
Municipal Income Fund Inc.
/s/ CYNTHIA N. BOW
- --------------------------------------
CYNTHIA N. BOW
Vice President
Mitchell Hutchins Asset Management Inc.
Portfolio Manager, Investment Grade Municipal
Income Fund Inc.
This letter is intended to assist shareholders in understanding how the Fund
performed during the fiscal year ended September 30, 1998, and reflects our
views at the time of writing this report. Of course, these views may change in
response to changing circumstances. We encourage you to consult your investment
executive regarding your personal investment program.
- ----------
(1) All weightings represent percentages of portfolio assets as of September
30, 1998. The Fund is actively managed and all holdings are subject to
change.
(2) Mutual funds are sold by prospectus only. The prospectuses for the funds
contain more complete information regarding risks, charges and expenses,
and should be read carefully before investing.
- --------------------------------------------------------------------------------
INVESTMENT GRADE
MUNICIPAL INCOME
FUBD INC.
[BAR GRAPH]
Top Five Sectors,
September 30, 1998(1)
Water 17.7%
Power 16.9%
Healthcare 11.1%
General Obligations 9.3%
Sales Tax 7.5%
[PIE CHART]
Gredit Quality
September 30, 1998(1)
AAA/Aaa 51.3%
AA/Aa 29.7%
A/A 13.4%
BBB/Baa 5.6%
2
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
<TABLE>
<CAPTION>
Principal Moody's S&P
Amount Rating Rating Maturity Interest
(000) (unaudited) (unaudited) Dates Rates Value
----- ----------- ----------- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Long-Term Municipal Bonds--98.51%
Alaska--2.82%
$ 6,540 Valdez Marine Terminal British
Petroleum Company
Sohio Pipeline Project.............. Aa2 AA 12/01/25 7.000% $ 7,236,772
-----------
California--2.66%
3,500 California Public Works Board
California State University Library
Projects Series A
(Pre-refunded with U.S. Government
Securities to 09/01/00 @ 102)........ Aaa AAA 09/01/16 6.250 3,751,860
3,000 California Statewide Communities
Development Authority
Irvine Apartment Communities
Series A-3........................... Baa2 BBB 05/17/10 5.100* 3,090,090
-----------
6,841,950
-----------
Colorado--3.40%
5,950 Arapahoe County Capital Improvement
Trust Fund Highway Revenue (Pre-
refunded with U.S. Government
Securities to 08/31/05 @103)......... Aaa NR 08/31/26 7.000 7,187,064
1,500 Denver City & County
Excise Tax Revenue Bonds
(MBIA Insured)....................... Aaa AAA 09/01/14 6.500 1,537,965
-----------
8,725,029
-----------
Connecticut--3.61%
8,590 Connecticut Housing Finance
Authority Series A & B............... Aa2 AA 05/15/14 to 11/15/23 6.200 to 6.750 9,287,755
Georgia--0.21%
500 Municipal Electric Authority of
Georgia Series B..................... A3 A 01/01/16 6.375 544,560
Illinois--12.61%
1,000 Illinois Educational Facilities
Authority Northwestern University
(Pre-refunded with U.S. Government
Securities to 12/01/01 @ 102)........ NR AA+ 12/01/21 6.900 1,113,470
1,890 Illinois Toll & Highway Authority
Series A (FGIC-Insured).............. Aaa AAA 01/01/16 6.200 2,066,564
2,650 University of Illinois Auxiliary
Facilities........................... Aa3 AA- 04/01/22 5.750 2,777,571
7,380 Chicago Gas Supply Revenue People's Gas Aa3 AA- 03/01/15 6.875 8,142,870
4,000 Chicago Water Works (Pre-refunded with
U.S. Government Securities to
11/15/99 @ 100)...................... A1 AA- 11/15/19 6.000 4,112,320
250 Metropolitan Pier & Exposition ........ A1 AA- 06/15/27 6.500 277,403
11,350 Metropolitan Pier & Exposition
Authority (Pre-refunded with
U.S. Government Securities to
06/15/03 @ 102)...................... Aaa AA- 06/15/27 6.500 12,833,331
1,000 Naperville Electric Revenue............ Aa2 NR 05/01/12 5.700 1,085,050
-----------
32,408,579
-----------
Indiana--10.96%
5,320 Indiana Transportation Finance
Authority Airport Facilities Series A
(Pre-refunded with U.S. Government
Securities to 11/01/02 @ 102)........ Aaa A 11/01/16 6.250 5,900,678
</TABLE>
3
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
<TABLE>
<CAPTION>
Principal Moody's S&P
Amount Rating Rating Maturity Interest
(000) (unaudited) (unaudited) Dates Rates Value
----- ----------- ----------- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Long-Term Municipal Bonds (continued)
Indiana (concluded)
$ 1,430 Indiana Transportation Finance Authority
Airport Facilities Series A..................... A1 A 11/01/16 6.250% $ 1,564,792
6,000 Indianapolis Gas Utility Revenue Series A
(Pre-refunded with U.S. Government Securities
to 06/01/02 @ 102) (FGIC Insured)............... Aaa AAA 06/01/23 6.200 6,603,900
2,000 Indianapolis Local Public Improvement Bond Bank... Aa AA- 07/01/10 6.000 2,197,240
4,000 Marion County Hospital Authority
Methodist Hospital of Indiana (Escrowed
to maturity)..................................... Aa3 AAA 09/01/13 6.500 4,211,520
5,725 Petersburg County Pollution Control Revenue
Indianapolis Power & Light Company.............. Aa2 AA- 12/01/24 6.625 6,500,451
1,000 Purdue University Series B (Pre-refunded with
U.S. Government Securities to 01/01/05 @ 103)... Aa2 AA- 07/01/15 6.700 1,173,850
-----------
28,152,431
-----------
Kentucky--3.34%
7,750 Boone County Pollution Control Revenue
Dayton Power & Light Company.................... Aa3 AA- 11/15/22 6.500 8,570,570
Massachusetts--7.39%
8,500 Massachusetts Bay Transportation Authority
Series C (Pre-refunded with U.S. Government
Securities to 03/01/02 @ 102)................... Aa3 A 03/01/23 6.100 9,279,110
2,750 Massachusetts Water Resources Authority Series A
(Pre-refunded with U.S. Government
Securities to 12/01/01 @ 102)................... Aaa AAA 12/01/19 6.500 3,029,950
6,000 Massachusetts Water Resources Authority Series A
(Pre-refunded with U.S. Government
Securities to 07/15/02 @ 102)................... Aaa AAA 07/15/21 6.500 6,686,220
-----------
18,995,280
-----------
Nevada--2.89%
6,750 Clark County Pollution Control Revenue
Nevada Power Company (FGIC Insured)............. Aaa AAA 06/01/19 6.600 7,432,898
-----------
New York--12.79%
35 New York City General Obligation
Subseries C-1 & Series H........................ A3 A- 08/01/17 7.000 38,936
600 New York City General Obligation Series H......... A3 A- 02/01/16 7.000 660,366
4,400 New York City General Obligation Series H
(Pre-refunded with U.S. Government Securities to
02/01/02 @ 101 1/2)............................. NR A- 02/01/16 7.000 4,908,420
1,115 New York City General Obligation Subseries C-1
(Pre-refunded with U.S. Government Securities to
08/01/02 @ 101 1/2)............................. Aaa A- 08/01/17 7.000 1,259,839
1,000 New York State Dormitory Authority Revenue
Series 2 2nd City University Series 2........... Baa1 BBB+ 07/01/28 5.000 986,200
</TABLE>
4
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
<TABLE>
<CAPTION>
Principal Moody's S&P
Amount Rating Rating Maturity Interest
(000) (unaudited) (unaudited) Dates Rates Value
----- ----------- ----------- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Long-Term Municipal Bonds (continued)
New York (concluded)
$ 6,000 New York State Local Government Assistance
Corporation Series B (Pre-refunded with
U.S. Government Securities to 04/01/02 @ 102)....... Aaa A+ 04/01/21 6.250% $ 6,612,240
5,350 New York State Local Government Assistance
Corporation Series D (Pre-refunded with
U.S. Government Securities to 04/01/02 @ 102)....... Aaa AAA 04/01/21 6.750 5,983,119
1,500 New York State Medical Care Facilities
Hospital & Nursing Homes (FHA Insured).............. NR AAA 02/15/31 6.600 1,654,740
1,375 New York City Municipal Water Finance Authority
Water & Sewer System Series A (Pre-refunded with
U.S. Government Securities to 06/15/01 @ 100)....... A1 A- 06/15/21 6.250 1,467,771
8,695 New York City Municipal Water Finance Authority
Water & Sewer System Series A....................... A1 A- 06/15/17 to 06/15/21 6.000 to 6.250 9,288,418
-----------
32,860,049
-----------
North Carolina--2.20%
2,700 North Carolina Eastern Municipal Power Agency
Series A............................................ Baa1 BBB 01/01/21 6.400 2,885,652
920 North Carolina Municipal Power Agency
Catawba Electric Revenue (Pre-refunded with
U.S. Government Securities to 01/01/03 @ 102)....... A3 A- 01/01/17 6.250 1,022,589
1,630 North Carolina Municipal Power Agency
Catawba Electric Revenue............................ A3 A- 01/01/17 6.250 1,757,564
-----------
5,665,805
-----------
Pennsylvania--1.00%
2,500 Pennsylvania State Turnpike Commission
Turnpike Revenue Series N (FGIC Insured)............ Aaa AAA 12/01/19 5.500 2,564,750
-----------
Rhode Island--2.55%
6,175 Rhode Island Housing Finance Authority
Homeownership Opportunity Series 10-A............... Aa2 AA+ 04/01/27 6.500 6,550,749
-----------
South Carolina--4.88%
5,035 South Carolina Public Service Authority
Santee Cooper Series D (Pre-refunded with U.S.
Government Securities to 07/01/02 @ 102)............ Aaa AAA 07/01/31 6.625 5,632,101
6,290 Richland County Pollution Control Revenue
Union Camp Corp. Project Series C................... A1 A- 11/01/20 6.550 6,905,665
-----------
12,537,766
-----------
Texas--13.30%
5,000 Texas Health Facilities Development Corporation
All Saints Episcopal Hospital (MBIA Insured)........ Aaa AAA 08/15/22 6.250 5,526,650
4,000 Coastal Bend Health Facilities
Incarnate Word Health Services (AMBAC Insured)...... Aaa AAA 01/01/17 6.300 4,389,120
4,750 Harris County Subordinated Lien Revenue............... Aa2 AA 08/01/14 6.750 5,193,603
</TABLE>
5
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
<TABLE>
<CAPTION>
Principal Moody's S&P
Amount Rating Rating Maturity Interest
(000) (unaudited) (unaudited) Dates Rates Value
----- ----------- ----------- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Long-Term Municipal Bonds (concluded)
Texas (concluded)
$ 915 Harris County Toll Road Authority Senior Lien
(AMBAC Insured).................................... Aaa AAA 08/15/17 6.500% $ 1,011,651
1,000 Houston Water & Sewer System Series B
(Pre-refunded with U.S. Government
Securities to 12/01/01 @ 102)...................... A A 12/01/14 6.375 1,099,950
6,575 Houston Water & Sewer System Series C
(Pre-refunded with U.S. Government
Securities to 12/01/01 @ 102) (AMBAC Insured)...... Aaa AAA 12/01/17 6.375 7,133,982
2,350 Port Corpus Christi Industrial Development Revenue
Valero Energy Corporation Series C................. Baa3 BBB- 04/01/18 5.400 2,373,876
------------
6,750 Sabine River Authority Pollution Control Revenue
Texas Utilities Electric Company (FGIC Insured).... Aaa AAA 10/01/22 6.550 7,453,687
------------
34,182,519
------------
Virginia--4.37%
4,500 Virginia Beach Development Authority
Sentara Bayside Hospital........................... Aa2 AA 11/01/21 6.300 4,868,910
5,815 Virginia Transportation Board Revenue
Route 28 Project................................... Aa AA 04/01/18 6.500 6,364,983
------------
11,233,893
------------
Washington--4.68%
6,625 Metropolitan Seattle Sewer Series T
(Pre-refunded with U.S. Government Securities to
01/01/00 @ 102).................................... Aaa AA- 01/01/31 6.875 7,017,597
4,500 Metropolitan Seattle Sewer Series W (MBIA Insured)... Aaa AAA 01/01/33 6.300 5,010,525
------------
12,028,122
------------
Wisconsin--2.85%
6,750 Wisconsin Health and Educational Facilities
Authority--Sisters of Sorrowful Mother Health
Care System (MBIA Insured)......................... Aaa AAA 06/01/20 6.250 7,329,083
------------
Total Investments (cost--$230,451,408)--98.51%................ 253,148,560
Other assets in excess of liabilities--1.49%.................. 3,833,990
------------
Net Assets--100.00%........................................... $256,982,550
------------
------------
</TABLE>
- ------------------------
AMBAC--American Municipal Bond Assurance Corporation
FGIC--Financial Guaranty Insurance Company
FHA--Federal Housing Authority
MBIA--Municipal Bond Investors Assurance
* Variable rate demand note is payable on demand. The interest rate shown is
the current rate at September 30, 1998. The maturitiy date reflects
earliest date bond can be put back to issuer.
See accompanying notes to financial statements
6
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
STATEMENT OF ASSETS AND LIABILITIES SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
Assets
<S> <C>
Investments in securities, at value (cost--$230,451,408)............................ $253,148,560
Interest receivable................................................................. 4,376,326
Other assets........................................................................ 344
------------
Total assets........................................................................ 257,525,230
------------
Liabilities
Payable to investment adviser and administrator..................................... 163,081
Payable to custodian................................................................ 135,622
Dividends payable to preferred shareholders......................................... 76,175
Accrued expenses and other liabilities.............................................. 167,802
------------
Total liabilities................................................................... 542,680
------------
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................................................. 955,136
Accumulated net realized loss from investment transactions.......................... (343,878)
Net unrealized appreciation of investments.......................................... 22,697,152
------------
Net assets applicable to common shareholders........................................ 176,982,550
------------
Total net assets.................................................................... $256,982,550
============
Net asset value per common share ($176,982,550 applicable to 10,356,667
common shares outstanding)........................................................ $ 17.09
============
</TABLE>
See accompanying notes to financial statements
7
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
For the Year
Ended
September 30, 1998
------------------
<S> <C>
Investment income:
Interest............................................................... $14,810,966
-----------
Expenses:
Investment advisory and administration................................. 2,294,471
Auction Preferred Shares expenses...................................... 227,211
Custody and accounting................................................. 155,427
Legal and audit........................................................ 53,870
Reports and notices to shareholders.................................... 45,747
Transfer agency and service fees....................................... 30,919
Directors' fees........................................................ 10,500
Amortization of organizational expenses................................ 3,898
Other expenses......................................................... 12,834
-----------
2,834,877
Less: Fee waivers from adviser......................................... (318,675)
-----------
Net expenses........................................................... 2,516,202
-----------
Net investment income.................................................. 12,294,764
-----------
Realized and unrealized gains from investment activities:
Net realized gains from investment transactions........................ --
Net change in unrealized appreciation/depreciation of investments...... 3,080,854
-----------
Net realized and unrealized gain from investment activities............ 3,080,854
-----------
Net increase in net assets resulting from operations................... $15,375,618
===========
</TABLE>
See accompanying notes to financial statements
8
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Years Ended
September 30,
-------------------
1998 1997
---- ----
<S> <C> <C>
From operations:
Net investment income............................................................... $ 12,294,764 $ 12,320,828
Net realized gains from investment transactions..................................... -- 106,492
Net change in unrealized appreciation/depreciation of investments................... 3,080,854 6,678,013
------------ ------------
Net increase in net assets resulting from operations................................ 15,375,618 19,105,333
------------ ------------
Dividends to shareholders from:
Net investment income--common stockholders.......................................... (9,321,000) (9,321,000)
Net investment income--preferred stockholders....................................... (2,838,610) (2,821,607)
------------ ------------
Total dividends to stockholders..................................................... (12,159,610) (12,142,607)
------------ ------------
Net increase in net assets.......................................................... 3,216,008 6,962,726
Net assets:
Beginning of year................................................................... 253,766,542 246,803,816
------------ ------------
End of year (including undistributed net investment income of
$955,136 and $819,982, respectively).............................................. $ 256,982,550 $253,766,542
============= ============
</TABLE>
See accompanying notes to financial statements
9
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
For the Year
Ended
September 30, 1998
-----------------
<S> <C>
Cash flows provided (used) by operating activities:
Interest received............................................................... $14,617,599
Expenses paid (net of fee waivers).............................................. (2,424,057)
Sale of short-term portfolio investments, net................................... 9,800,000
Purchase of long-term portfolio investments..................................... (9,916,080)
-----------
Net cash provided by operating activities....................................... 12,077,462
-----------
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............. (2,816,684)
-----------
Net cash used for financing activities.......................................... (12,137,684)
-----------
Net decrease in cash............................................................ (60,222)
Cash at beginning of year....................................................... 60,222
-----------
Cash at end of year............................................................. $ 0
===========
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............................ $15,375,618
Increase in investments, at value............................................... (3,215,181)
Increase in interest receivable................................................. (175,120)
Amortization of deferred organizational expenses................................ 3,898
Increase in other assets........................................................ (344)
Increase in payable to investment adviser and administrator..................... 1,858
Increase in accrued expenses and other liabilities.............................. 86,733
-----------
Total adjustments............................................................... (3,298,156)
-----------
Net cash provided by operating activities $12,077,462
===========
</TABLE>
See accompanying notes to financial statements
10
<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 fully amortized on the straight line method over
a period of 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 asset management
subsidiary of PaineWebber Incorporated and 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 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.
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
11
<PAGE>
NOTES TO FINANCIAL STATEMENTS
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, 1998, Mitchell Hutchins voluntarily waived $318,675 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, 1998 was substantially the same as the cost of securities for financial
statement purposes.
At September 30, 1998, the components of the net unrealized appreciation of
investments were as follows:
Gross appreciation (from investments having an excess
of value over cost).................................... $22,697,152
Gross depreciation (from investments having an excess
of cost over value).................................... --
-----------
Net unrealized appreciation of investments............... $22,697,152
===========
For the year ended September 30, 1998, total aggregate purchases and sales
of portfolio securities, excluding short-term securities, were $9,916,080 and
$0, respectively.
FEDERAL TAX STATUS
The Fund intends to distribute substantially all of its tax-exempt income
and any taxable income and to comply with the 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, 1998, the Fund had a net capital loss carryforward of
$343,878 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.
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, 8,007 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 3 months for APS Series B. Dividend rates ranged from 3.31% to
3.85% for the year ended September 30, 1998.
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.
12
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
FINANCIAL HIGHLIGHTS
Selected data for a share of common stock outstanding throughout each year
is presented below:
<TABLE>
<CAPTION>
For the Years Ended September 30,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of year ............... $16.78 $16.11 $15.73 $14.72 $17.04
-------- -------- -------- -------- --------
Net investment income ............................ 1.19 1.19 1.21 1.18 1.17
Net realized and unrealized gains
(losses) from investments ...................... 0.29 0.65 0.35 1.03 (2.28)
-------- -------- -------- -------- --------
Net increase (decrease) from investment
operations...................................... 1.48 1.84 1.56 2.21 (1.11)
-------- -------- -------- -------- --------
Dividends from net investment income:
Common stockholders ............................ (0.90) (0.90) (0.90) (0.90) (0.98)
Common share equivalent of dividends
paid to preferred stockholders ............... (0.27) (0.27) (0.28) (0.30) (0.21)
Distributions from net realized gains
from investment transactions ................... -- -- -- -- (0.02)
-------- -------- -------- -------- --------
Total dividends and distributions
to stockholders ................................ (1.17) (1.17) (1.18) (1.20) (1.21)
-------- -------- -------- -------- --------
Net asset value, end of year ..................... $17.09 $16.78 $16.11 $15.73 $14.72
======== ======== ======== ======== ========
Per share market value, end of year .............. $15.94 $15.06 $13.63 $13.00 $12.38
======== ======== ======== ======== ========
Total investment return (1) ...................... 12.21% 17.76% 12.03% 12.63% (15.21)%
======== ======== ======== ======== ========
Ratios to average net assets attributable
to common shares:
Total expenses, net of waivers from adviser .... 1.44% 1.44% 1.34% 1.69% 1.70%
Total expenses, before waivers from adviser .... 1.62% 1.77% 1.71% 1.82% 1.70%
Net investment income before
preferred stock dividends .................... 7.03% 7.27% 7.61% 7.87% 7.32%
Preferred stock dividends ...................... 1.62% 1.66% 1.73% 2.02% 1.33%
Net investment income available to
common stockholders .......................... 5.41% 5.61% 5.88% 5.85% 5.99%
Supplemental data:
Net assets, end of year (000's) ................ $256,983 $253,767 $246,804 $242,906 $232,406
Portfolio turnover rate ........................ 0% 3% 0% 7% 0%
Asset coverage per share of preferred
stock, end of year ........................... $160,614 $158,604 $154,252 $151,816 $145,254
</TABLE>
(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 year 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 does not reflect brokerage commissions.
13
<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 Inc. (the "Fund") at September 30,
1998, 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 five years in the
period then ended, 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, 1998 by
correspondence with the custodian, provide a reasonable basis for the
opinion expressed above.
PricewaterhouseCoopers LLP
1177 Avenue of the Americas
New York, New York 10036
November 19, 1998
14
<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, 1998), 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 1998. 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 1999. Stockholders are advised to consult their
own tax advisers with respect to the tax consequences of their investment in the
Fund.
15
<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 asset
management subsidiary of PaineWebber Incorporated, which has over $55 billion in
assets under management as of October 31, 1998.
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.
The Fund's board of directors amended the Fund's bylaws to require that the
Fund receive notice of board nominations or proposals that any shareholder
wishes to be considered at an annual or special shareholder meeting. This notice
will give Fund management an opportunity to inform shareholders of and respond
to those nominations and proposals. The amendment will be effective for meetings
that occur after the Fund's 1999 annual meeting.
The amended bylaws require that the Fund receive notice of a nomination or
proposal for an annual meeting at least 120 days in advance of the anniversary
of the date that the Fund's proxy statement for the previous year's annual
meeting was first released to shareholders. For a special shareholder meeting,
the Fund must receive notice within seven business days of the date on which
notice of the special meeting is first given to shareholders. In order to make a
nomination or proposal to be considered at the 2000 annual meeting of
shareholders, the Fund must receive notice of that nomination or proposal no
later than August 3, 1999.
An annual meeting of shareholders of the Fund was held on January 15, 1998.
At the meeting, Margo N. Alexander, Richard Q. Armstrong, E. Garrett Bewkes,
Jr., Richard R. Burt, Mary C. Farrell, Meyer Feldberg, George W. Gowen,
Frederick V. Malek and Carl W. Schafer were elected to serve as directors until
the next annual meeting of shareholders, or until their successors are elected
and qualified; and PricewaterhouseCoopers LLP was ratified as independent
accountants for the Fund for fiscal year ended September 30, 1998.
16
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
GENERAL INFORMATION (continued)
COMMON STOCK AND APS SHARES VOTING AS A SINGLE CLASS:
PROPOSAL 1
Shares
Shares Withhold
To vote for or against the election of: for Voted Authority
----------- ------------
Richard Q. Armstrong ..................... 9,912,778.137 205,929.540
E. Garrett Bewkes, Jr. ................... 9,984,876.137 223,845.540
Richard R. Burt .......................... 9,911,978.137 206,739.540
Mary C. Farrell .......................... 9,909,404.137 209,313.540
George W. Gowen .......................... 9,906,585.137 212,132.540
Frederick V. Malek ....................... 9,904,358.137 214,359.540
Carl W. Schafer .......................... 9,911,374.137 207,343.540
*Mr.Torrell subsequently resigned from the Board in March 1998.
PROPOSAL 2
Shares
Shares Withhold Shares
For Voted Authority Against
--------- --------- -------
Ratification of the selection of
PricewaterhouseCoopers LLP as
independent accountants
for the fiscal year ending
September 30, 1998 ................ 9,910,362.694 101,070.000 107,284.983
AUCTION PREFERRED SHARES:
PROPOSAL 1
Shares
Shares Withhold
To vote for or against the election of: for Voted Authority
--------- ---------
Margo N. Alexander .......................... 1,587.000 9.000
Meyer Feldberg .............................. 1,587.000 9.000
(Broker non-votes and abstentions are
included within the "Shares Withhold
Authority" Totals)
17
<PAGE>
INVESTMENT GRADE MUNICIPAL INCOME FUND INC.
GENERAL INFORMATION (concluded)
YEAR 2000 RISKS
Like other funds and financial and business organizations around the world,
the Fund could be adversely affected if the computer systems used by its
investment adviser, other service providers and entities with computer systems
that are linked to Fund records do not properly process and calculate
date-related information and data from and after January 1, 2000. This is
commonly known as the "Year 2000 Issue."
Mitchell Hutchins is taking steps that it believes are reasonably designed
to address the Year 2000 Issue with respect to the computer systems that it
uses, and to obtain satisfactory assurances that each of the Fund's other major
service providers is taking comparable steps. However, there can be no assurance
that these steps will be sufficient to avoid any adverse impact on the Fund.
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. The ability of such
stockholders to participate in the Plan may change if their shares are
transferred into the name of another broker or nominee.
A stockholder may elect not to participate in the Plan or may terminate
participation in the Plan at any time without penalty, and stockholders who have
previously terminated participation in the Plan may rejoin it at any time.
Changes in elections must be made in writing to the Fund's transfer agent and
should include the stockholder's name and address as they appear on that share
certificate or in the transfer agent's records. An election to terminate
participation in the Plan, until such election is changed, will be deemed an
election by a stockholder to take all subsequent distributions in cash. An
election will be effective only for distributions declared and having a record
date at least ten days after the date on which the election is received.
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
number of shares of common stock purchased with each dividend will be equal to
the result obtained by dividing the amount of the dividend payable to a
particular stockholder by the average price per share (including applicable
brokerage commissions) that the transfer agent was able to obtain in the open
market. The Fund will not issue any new shares of common stock in connection
with the Plan. There is no charge to participants for reinvesting dividends or
other distributions. The transfer agent's fees for handling the reinvestment of
distributions will be paid by the Fund. However, each participant pays a pro
rata share of brokerage commissions incurred with respect to the transfer
agent's open market purchases of common stock in connection with the
reinvestment of distributions. The automatic reinvestment of dividends and other
distributions in shares of common stock does not relieve participants of any
income tax that may be payable on such distributions.
Additional information regarding the Plan may be obtained from, and all
correspondence concerning the Plan should be directed to, the transfer agent at
PNC Bank, National Association, c/o PFPC Inc., P.O. Box 8950, Wilmington,
Delaware 19899.
18
<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
PRINCIPAL OFFICERS
Margo N. Alexander
President
Victoria E. Schonfeld
Vice President
Dianne E. O'Donnell
Vice President and Secretary
Dennis L. McCauley
Vice President
Paul H. Schubert
Vice President and Treasurer
Elbridge T. Gerry III
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 shares of
its common stock in the open market at market prices.
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 of any securities mentioned in
this report.
<PAGE>
INVESTMENT
GRADE MUNICIPAL
INCOME FUND INC.
ANNUAL REPORT
SEPTEMBER 30, 1998
- --------------------------------------------------------------------------------
PaineWebber
(C)1998 PaineWebber Incorporated
Member SIPC
