INCOME
OPPORTUNITIES
FUND 2000, INC.
FUND LOGO
Semi-Annual Report
June 30, 1997
This report, including the financial information herein, is
transmitted to the shareholders of Income Opportunities Fund 2000,
Inc. for their information. It is not a prospectus, circular or
representation intended for use in the purchase of shares of the
Fund or any securities mentioned in the report. Past performance
results shown in this report should not be considered a
representation of future performance. Statements and other
information herein are as dated and are subject to change.
The Fund has leveraged its Common Stock to provide Common Stock
shareholders with a potentially higher rate of return. Leverage
creates risk for Common Stock shareholders, including the likelihood
of greater volatility of net asset value and market price of Common
Stock shares, and the risk that fluctuations in short-term interest
rates may reduce the Common Stock's yield.
<PAGE>
Income Opportunities
Fund 2000, Inc.
Box 9011
Princeton, NJ
08543-9011
Printed on post-consumer recycled paper
INCOME OPPORTUNITIES FUND 2000, INC.
The Benefits and
Risks of
Leveraging
Income Opportunities Fund 2000, Inc. is authorized to borrow funds
and utilize leverage in amounts not exceeding 33 1/3% of its total
assets (including the amount borrowed). The Fund's ability to
leverage creates an opportunity for increased net income, but, at
the same time, creates special risks. The Fund will only borrow or
use leverage when the Investment Adviser believes that it will
benefit the Fund. To the extent that the income derived from
securities purchased with borrowed funds exceeds the cost of
borrowing, the Fund's net income will be greater than if borrowing
had not been used.
Conversely, if the income from the securities purchased with
borrowed funds is not sufficient to cover the cost of borrowing, the
net income of the Fund will be less than if borrowing had not been
used, reducing the amount available for distribution to shareholders.
In this case, the Fund may nevertheless maintain its leveraged
position in order to avoid capital losses on securities
purchased with the leverage.
<PAGE>
DEAR SHAREHOLDER
For the six months ended June 30, 1997, Income Opportunities Fund
2000, Inc. earned $0.303 per share income dividends, which included
earned and unpaid dividends of $0.053. This represents a net
annualized yield of 6.16%, based on a month-end net asset value of
$9.91 per share. Over the same period, the Fund's total investment
return was +3.17%, based on a change in per share net asset value
from $9.87 to $9.91, and assuming reinvestment of $0.250 per share
income dividends.
Investment Activities
Federal Reserve Board (FRB) Chairman Alan Greenspan indicated that
the acceptable, or noninflationary, level of economic growth is in
the range of 2%--2.5%. With first-quarter 1997 gross domestic
product (GDP) reported at 5.8%, three of the last four quarters were
substantially above the targeted range. Although recent economic
data indicates more moderate growth for the second quarter of 1997,
it seems inevitable that economic growth for 1997 will end up at the
upper range of the band.
GDP growth is largely contingent on consumer spending, and real
consumer spending rose 6.4% in the first quarter of 1997, the
fastest pace in nine years. By comparison, consumer spending in 1996
was 2.6%. Behind consumer spending is the rise in consumer
confidence to its highest level since 1969. In turn, this reflects
the lowest unemployment rate (4.8%) in nearly 24 years and the
unprecedented strength of the stock market which continues to set
new record highs.
Interestingly, this environment has not yet led to a period of
inflation. Inflation is at a 31-year low. Despite a tight labor
market, the employment cost index rose just 0.6% in the first
quarter of 1997 and is up just 2.9% from one year ago. This is near
the slowest compensation growth rate in 50 years. Similarly, the
Consumer Price Index and the Producer Price Index rose just 2.5% and
0.1%, respectively, for the past 12 months.
Strong economic growth with no inflation is the best of both worlds.
Although we may be on the threshold of a new paradigm regarding the
level of noninflationary growth, there are risks ahead that could
trigger inflation. The FRB must keep a vigilant eye on aggregate
consumer demand and the tight labor markets, which could lead to
demand pull or cost push inflation. So far, the FRB seems committed
to keeping the current economic expansion going, which is now in its
seventh year, while maintaining a tough posture on inflation.
Interest rates fluctuated during the six-month period ended June 30,
1997, but ended the period essentially unchanged from the start of
the year. All across the maturity curve--one year--30 years--
interest rates moved higher by just 15 basis points (0.15%) to 20
basis points. Interestingly, short-term interest rates--three-month
and six-month securities--were actually lower by a few basis points
reflecting eased investor concerns that the FRB would raise interest
rates to slow the economy.
<PAGE>
Portfolio Strategy
In our December 31, 1996 annual shareholder letter, we mentioned
that our taxable earnings were in excess of the dividend payout and
that, barring an interest rate hike by the FRB, a dividend increase
would be warranted in 1997. At the Fund's July 9, 1997 board
meeting, a dividend increase of 35 basis points was approved
bringing the dividend to a 6.35% annual dividend based on the
original offering price of $10.00. With the FRB leaving interest
rates unchanged at its July 1, and July 2, 1997 Federal Open Market
Committee meeting, the increase is likely to hold throughout 1997.
Another added feature of the Fund is the 25 basis point (0.25%)
management fee reduction scheduled for this December. The portfolio
yield increased for several reasons. Borrowing costs remained stable
allowing for the leverage to contribute to income. (For a complete
explanation of the benefits and risks of leveraging, see page 1 of
this report to shareholders.) Prepayment speeds have slowed,
increasing the yield on many of the collaterized mortgage obligation
positions. In addition, we collected sizable prepayment penalties on
some commercial mortgage-backed securities. Portfolio yield aside,
our primary investment strategy remains to return to a $10.00 per
share net asset value by year-end 2000. As such we continue to shift
into securities that offer an attractive yield and a more definite
cash flow structure that reduces prepayment and extension risks. At
this time, in the current interest rate environment, the portfolio
is on track to reach its net asset value target at the Fund's
termination date.
In Conclusion
We thank you for your continued investment in Income Opportunities
Fund 2000, Inc., and we look forward to reviewing our outlook and
strategy with you again in our next report to shareholders.
Sincerely,
(Arthur Zeikel)
Arthur Zeikel
President
(Gregory Mark Maunz)
Gregory Mark Maunz
Vice President and
Portfolio Manager
<PAGE>
July 25, 1997
Officers and
Directors
Arthur Zeikel, President and Director
Joe Grills, Director
Walter Mintz, Director
Robert S. Salomon Jr., Director
Melvin R. Seiden, Director
Stephen B. Swensrud, Director
Terry K. Glenn, Executive Vice President
Joseph T. Monagle Jr., Senior Vice President
Donald C. Burke, Vice President
Jeffrey B. Hewson, Vice President
Gregory Mark Maunz, Vice President
Gerald M. Richard, Treasurer
Ira P. Shapiro, Secretary
Custodian and Transfer Agent
The Bank of New York
90 Washington Street
New York, NY 10286
NYSE Symbol
IFT
<TABLE>
SCHEDULE OF INVESTMENTS
<CAPTION>
S&P Moody's Face Value Percent of
Rating Rating Amount Issue Cost (Note 1a) Net Assets
<S> <S> <S> <C> <S> <C> <C> <C>
Adjustable Rate* A BBB+++++ $ 1,170,632 Resolution Trust Corp., REMIC (5)
Mortgage-Backed 91-M4-B, 7.75% due 2/25/2020 $ 1,187,409 $ 1,175,388 1.1%
Obligations**-- Ryland Trust, REMIC (5):
London Interbank AA Aa2 7,000,000 92-9-B, 7.785% due 7/25/2022 7,065,584 7,035,000 6.4
Offered Rate AA Aa2 7,000,000 92-10-B, 7.698% due 8/25/2022 7,068,677 7,025,156 6.4
Indexed Sears Mortgage Securities Corp.,
Obligations REMIC (5):
AAA A1 2,937,422 91-M-A2, 6.937% due 11/25/2021 2,953,423 2,963,124 2.7
AA Aaa 1,855,160 92-18-A2, 7.318% due 9/25/2022 1,894,706 1,908,206 1.7
NR+++ A1 2,020,790 92-2-A1, 7.752% due 12/25/2024 2,054,241 2,066,257 1.9
Total Investments in Adjustable Rate
Mortgage-Backed Obligations 22,224,040 22,173,131 20.2
<PAGE>
Fixed Rate AAA++++ Aaa 3,851,684 American Southwest Financial Securities
Mortgage-Backed Corp.,95-C1-A1A, 7.30% due 10/17/2001 3,917,843 3,909,459 3.6
Obligations** AA AA++ 5,766,000 Blackrock Capital Finance L.P., 96-C2-B,
7.747% due 11/15/2026++++++ (a) 5,822,715 5,838,075 5.3
AAA++ Aaa 15,000,000 Debartolo Corp., A2, 7.48% due
5/15/2001++++++ 15,469,162 15,393,750 14.1
NR+++ NR+++ 386,352 Federal Home Loan Mortgage Association,
Pool #80294, 5% due 10/01/2000 372,769 370,952 0.3
NR+++ NR+++ 6,686,000 Federal Home Loan Mortgage Association,
REMIC (5) 1589-D, 6.25% due 8/15/2021
(c)(1) 6,691,608 6,552,280 6.0
Federal National Mortgage Association,
Pool:
NR+++ NR+++ 501,036 #199718, 5.50% due 8/01/2000 (1) 489,372 485,073 0.4
NR+++ NR+++ 662,994 #227383, 5.50% due 9/01/2000 (1) 646,730 641,871 0.6
NR+++ NR+++ 351,522 #50932, 5.50% due 11/01/2000 (1) 342,515 340,323 0.3
NR+++ NR+++ 6,614,833 #50917, 6% due 11/01/2000 (1) 6,544,551 6,524,144 6.0
NR+++ NR+++ 416,468 #241824, 5.50% due 12/01/2000 405,731 403,200 0.4
NR+++ NR+++ 12,000,000 #160160, 7.778% due 7/01/2001 (1) 12,774,618 12,444,375 11.4
NR+++ NR+++ 3,772,298 #73046, 7.60% due 10/01/2001 (1) 3,734,575 3,831,240 3.5
NR+++ NR+++ 5,469,561 #73059, 8.375% due 12/01/2001 (1) 5,735,107 5,739,621 5.2
NR+++ NR+++ 3,173,124 #73181, 7.14% due 9/01/2002 (1) 3,153,292 3,202,872 2.9
Federal National Mortgage Association,
REMIC (5)(1):
NR+++ NR+++ 4,135,022 92-122-PG, 7.50% due 12/01/1998 (a) 4,159,843 4,167,316 3.8
NR+++ NR+++ 4,472,673 94-M2-A, 6.625% due 2/25/2001 4,292,466 4,433,537 4.0
NR+++ NR+++ 14,094,037 G-92-39-Z, 7% due 10/25/2016 (b) 14,140,911 13,961,835 12.7
NR+++ NR+++ 5,000,000 97-7-PK, 6.50% due 10/18/2017 (b) 5,004,710 4,956,250 4.5
NR+++ AAA++ 5,000,000 Paine Webber Mortgage Acceptance Corp.,
CMO (4) 96-M1-A1, 6.80% due
1/02/2012++++++ (b) 5,049,020 5,025,000 4.6
Resolution Trust Corporation, REMIC (5):
AA AA+++++ 4,408,071 93-C2-B, 7.75% due 7/01/2000 (b) 4,544,554 4,441,131 4.1
AAA AA+++ 1,049,593 92-C5-B, 6.90% due 5/25/2002 (a) 1,054,353 1,046,969 1.0
AA AA+++ 1,175,592 92-CHF-B, 7.15% due 12/25/2020 (a) 1,188,167 1,177,245 1.1
A+++++ A2 2,097,669 92-C7-B, 7.15% due 6/25/2023 (a) 2,118,915 2,106,847 1.9
AA-++++ A2 585,844 92-C6-B, 7.70% due 7/25/2024 (a) 598,827 589,231 0.5
AA++ Aa2 5,000,000 Town & Country Funding Corporation,
CMO (4), 5.85% due 8/15/1998 4,988,200 4,946,094 4.5
AAA AAA++++ 11,025,000 Vornado Finance Corp., CMO (4), 6.36%
due 12/01/2000 9,980,621 10,863,076 9.9
Total Investments in Fixed Rate
Mortgage-Backed Obligations 123,221,175 123,391,766 112.6
Derivative Federal National Mortgage Association,
Mortgage-Backed REMIC (5):
Obligations**-- NR+++ NR+++ 6,747,910 93-221-JD, 6% due 11/25/2006 (a) 654,200 594,660 0.5
Interest NR+++ NR+++ 5,278,328 94-23-PN, 6% due 7/25/2017 (a) 793,032 723,708 0.7
Only (2) NR+++ Aaa 47,841,472 Fund America Investors Corporation II,
CMO (4) 93-E-SIO, 0.50% due 9/25/2023 638,817 334,842 0.3
AAA++++ Aaa 18,510,541 Mortgage Capital Fund Inc., REMIC (5)
94-MC1-I1, 1.044% due 6/25/2019 575,858 135,127 0.1
------------ ------------ ------
2,661,907 1,788,337 1.6
<PAGE>
Derivative Federal Home Loan Mortgage Corporation,
Mortgage-Backed REMIC (5):
Obligations**-- NR+++ NR+++ 4,158,144 1557-S, 3.083% due 8/15/1998 3,852,781 3,995,717 3.6
Inverse NR+++ NR+++ 86,094 1330-I, 8.82% due 9/15/1999 81,359 81,870 0.1
Floaters (3) NR+++ NR+++ 3,395,032 1743-S, 5.40% due 8/15/2001 2,850,766 3,131,917 2.9
NR+++ NR+++ 9,150,000 Federal National Mortgage Association,
REMIC (5) 93-227-S, 3.698% due
12/25/2000 6,567,281 7,731,750 7.1
------------ ------------ ------
13,352,187 14,941,254 13.7
Total Investments in Derivative
Mortgage-Backed Obligations 16,014,094 16,729,591 15.3
Total Investments in Mortgage-Backed
Obligations 161,459,309 162,294,488 148.1
Total Investments $161,459,309 162,294,488 148.1
============
Liabilities in Excess of Other Assets (52,706,851) (48.1)
------------ ------
Net Assets $109,587,637 100.0%
============ ======
<FN>
Average life estimates are made using realistic prepayment
assumptions. Actual maturities could differ from those estimates.
Corresponding average life estimates for bonds are as follows:
(a)0-2 years.
(b)2-4 years.
(c)4-6 years.
*Adjustable Rate Mortgage-Backed Obligations have coupon rates which
reset periodically to reflect changes in a referenced interest rate.
**Mortgage-Backed Obligations are subject to principal paydowns as a
result of prepayments or refinancing of the underlying mortgage
instruments. As a result, the average life may be substantially less
than the original maturity.
(1)All or a portion of the security represents collateral in
connection with Reverse Repurchase Agreements (Note 5).
(2)Securities which receive some or all of the interest portion of
the underlying collateral and little or no principal. Interest only
securities have either a nominal or a notional amount of principal.
(3)Instruments with variable or floating interest rates that move in
the opposite direction of short-term interest rates.
(4)Collateralized Mortgage Obligation.
(5)Real Estate Mortgage Investment Conduits (REMICs) are identified
by the year created, series issued and the particular tranche.
+++Not Rated.
++Rating of issue is by Fitch Investors Service.
++++Rating of issue is by Duff & Phelps.
++++++The security may be offered and sold to "qualified
institutional buyers" under Rule 144A of the Securities Act of 1933.
See Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
As of June 30, 1997
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$161,459,309) (Note 1a) $162,294,488
Receivables:
Interest $ 1,087,078
Principal paydowns 183,520 1,270,598
------------
Deferred organization expenses (Note 1e) 9,753
Prepaid expenses and other assets 6,223
------------
Total assets 163,581,062
------------
Liabilities: Payables:
Reverse repurchase agreements (Note 5) 53,079,000
Interest expense (Note 5) 456,223
Investment adviser (Note 2) 47,725
Securities purchased 24,913 53,607,861
------------
Accrued expenses and other liabilities 385,564
------------
Total liabilities 53,993,425
------------
Net Assets: Net assets $109,587,637
============
Capital: Capital stock, $0.10 par value, 200,000,000 shares authorized $ 1,105,773
Paid-in capital in excess of par 106,408,040
Undistributed investment income--net 3,669,093
Accumulated realized capital losses on investments--net (Note 6) (2,430,448)
Unrealized appreciation on investments--net 835,179
------------
Net assets--Equivalent to $9.91 per share based on 11,057,727
shares outstanding (market price--$9.1875) $109,587,637
============
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENT OF OPERATIONS
For the Six Months Ended June 30, 1997
<S> <S> <C> <C>
Investment Income Interest and amortization of premium and discount earned $ 5,406,522
(Note 1d): Other income 223,281
------------
Total income 5,629,803
------------
<PAGE>
Expenses: Interest expense (Note 5) $ 1,504,239
Investment advisory fees (Note 2) 296,570
Professional fees 40,268
Accounting services (Note 2) 35,296
Directors' fees and expenses 19,298
Printing and shareholder reports 15,827
Transfer agent fees 11,422
Custodian fees 7,602
Amortization of organization expenses (Note 1e) 4,659
Pricing fees 292
Other 21,877
------------
Total expenses 1,957,350
------------
Investment income--net 3,672,453
------------
Realized & Realized gain on investments--net 301,546
Unrealized Gain Change in unrealized appreciation on investments--net (883,043)
(Loss) on ------------
Investments Net Increase in Net Assets Resulting from Operations $ 3,090,956
(Notes 1b, 1d & 3): ============
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the Six For the
Months Ended Year Ended
June 30, December 31,
Increase (Decrease) in Net Assets: 1997 1996
<S> <S> <C> <C>
Operations: Investment income--net $ 3,672,453 $ 7,339,940
Realized gain on investments--net 301,546 3,632,680
Change in unrealized appreciation on investments--net (883,043) (4,956,250)
------------ ------------
Net increase in net assets resulting from operations 3,090,956 6,016,370
------------ ------------
Dividends to Investment income--net (2,769,797) (6,532,946)
Shareholders ------------ ------------
(Note 1f): Net decrease in net assets resulting from dividends to
shareholders (2,769,797) (6,532,946)
------------ ------------
Capital Stock Net decrease in net assets derived from capital stock
Transactions transactions (1,583,324) (7,962,117)
(Note 4): ------------ ------------
<PAGE>
Net Assets: Total decrease in net assets (1,262,165) (8,478,693)
Beginning of period 110,849,802 119,328,495
------------ ------------
End of period* $109,587,637 $110,849,802
============ ============
<FN>
*Undistributed investment income--net $ 3,669,093 $ 2,766,437
============ ============
See Notes to Financial Statements.
</TABLE>
<TABLE>
STATEMENT OF CASH FLOWS
<CAPTION>
For the Six Months Ended June 30, 1997
<S> <S> <C>
Cash Provided by Net increase in net assets resulting from operations $ 3,090,956
Operating Adjustments to reconcile net increase in net assets resulting from
Activities: operations to net cash provided by operating
Decrease in receivables 106,882
Decrease in other liabilities (323,581)
Realized and unrealized loss on investments--net 581,497
Amortization of premium and discount--net 579,601
------------
Net cash provided by operating activities 4,035,355
------------
Cash Used for Proceeds from principal payments and sales of long-term securities 12,272,008
Investing Purchases of long-term securities (15,848,408)
Activities: Purchases of short-term investments. (82,477,000)
Proceeds from sales and maturities of short-term investments 83,730,500
------------
Net cash used for investing activities (2,322,900)
------------
Cash Used for Cash receipts from borrowings 12,778,500
Financing Cash payments on borrowings (9,480,500)
Activities: Dividends paid to shareholders (3,332,637)
Cash payments on capital shares repurchased (1,678,032)
------------
Net cash used for financing activities (1,712,669)
------------
Cash: Net decrease in cash (214)
Cash at beginning of period 214
------------
Cash at end of period $ --
============
<PAGE>
Cash Flow Cash paid for interest $ 2,069,785
Information: ============
See Notes to Financial Statements.
</TABLE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
The following per share data and ratios For the
have been derived from information provided Six Months
in the financial statements. Ended For the Year Ended
June 30, December 31,
Increase (Decrease) in Net Asset Value: 1997++ 1996++ 1995 1994 1993
<S> <S> <C> <C> <C> <C> <C>
Per Share Net asset value, beginning of period $ 9.87 $ 9.83 $ 8.51 $ 10.00 $ 9.64
Operating -------- -------- -------- -------- --------
Performance: Investment income--net .33 .63 .60 .64 .69
Realized and unrealized gain (loss) on
investments--net (.04) (.03) 1.27 (1.50) .36
-------- -------- -------- -------- --------
Total from investment operations .29 .60 1.87 (.86) 1.05
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net (.25) (.56) (.55) (.63) (.63)
Realized gain on investments--net -- -- -- --++++ (.06)
-------- -------- -------- -------- --------
Total dividends and distributions to Common
Stock shareholders (.25) (.56) (.55) (.63) (.69)
-------- -------- -------- -------- --------
Net asset value, end of period $ 9.91 $ 9.87 $ 9.83 $ 8.51 $ 10.00
======== ======== ======== ======== ========
Market price per share, end of period $ 9.1875 $ 9.00 $ 8.75 $ 7.375 $ 9.25
======== ======== ======== ======== ========
Total Investment Based on market price per share 4.89%+++ 9.63% 26.77% (13.91%) (.64%)
Return:** ======== ======== ======== ======== ========
Based on net asset value per share 3.17%+++ 7.02% 23.42% (8.11%) 11.43%
======== ======== ======== ======== ========
Ratios to Average Expenses, net of reimbursement and excluding
Net Assets: interest expense. .84%* .81% .89% .90% .85%
======== ======== ======== ======== ========
Expenses, net of interest expense .84%* .81% .89% .90% .95%
======== ======== ======== ======== ========
Expenses 3.63%* 3.36% 3.90% 3.05% 2.46%
======== ======== ======== ======== ========
Investment income--net 6.81%* 6.46% 6.34% 6.79% 6.84%
======== ======== ======== ======== ========
<PAGE>
Supplemental Net assets, end of period (in thousands) $109,588 $110,850 $119,328 $109,879 $135,050
Data: ======== ======== ======== ======== ========
Portfolio turnover 4.75% 112.79% 32.78% 109.96% 129.32%
======== ======== ======== ======== ========
Leverage: Amount of borrowings, end of period
(in thousands) $ 53,079 $ 49,781 $ 53,070 $ 55,195 $ 67,842
======== ======== ======== ======== ========
Average amount of borrowings outstanding
during the period (in thousands) $ 53,236 $ 51,951 $ 56,355 $ 61,771 $ 54,105
======== ======== ======== ======== ========
Average amount of borrowings outstanding per
share during the period $ 4.79 $ 4.44 $ 4.50 $ 4.68 $ 4.00
======== ======== ======== ======== ========
<FN>
*Annualized.
**Total investment returns based on market value, which can be
significantly greater or lesser than the net asset value, may result
in substantially different returns. Total investment returns exclude
the effects of sales loads.
+++Aggregate total investment return.
++Based on average shares outstanding during the period.
++++Amount is less than $.01 per share.
See Notes to Financial Statements.
</TABLE>
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Income Opportunities Fund 2000, Inc. (the "Fund") is registered
under the Investment Company Act of 1940 as a diversified, closed-
end management investment company. These unaudited financial
statements reflect all adjustments which are, in the opinion of
management, necessary to a fair statement of the results of the
interim period presented. All such adjustments are of a normal
recurring nature. The Fund determines and makes available for
publication the net asset value of its Common Stock on a weekly
basis. The Fund's Common Stock is listed on the New York Stock
Exchange under the symbol IFT. The following is a summary of
significant accounting policies followed by the Fund.
<PAGE>
(a) Valuation of investments--Corporate debt securities, mortgage-
backed securities, municipal securities, asset-backed securities and
other debt securities are valued on the basis of valuations provided
by dealers or by a pricing service approved by the Fund's Board of
Directors. Securities having a remaining maturity of sixty days or
less are valued at amortized cost, which approximates market value.
Any securities or other assets for which current market quotations
are not readily available are valued at their fair value as
determined in good faith by and under the direction of the Fund's
Board of Directors. Any securities denominated in a currency other
than US dollars will be translated into US dollars on the valuation
date.
(b) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt market. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell
interest rate futures contracts and options on such futures
contracts for the purpose of hedging the market risk on existing
securities or the intended purchase of securities. Futures contracts
are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a
contract, the Fund deposits and maintains as collateral such initial
margin as required by the exchange on which the transaction is
effected. Pursuant to the contract, the Fund agrees to receive from
or pay to the broker an amount of cash equal to the daily fluctuation
in value of the contract. Such receipts or payments are known as
variation margin and are recorded by the Fund as unrealized
gains or losses. When the contract is closed, the Fund records a
realized gain or loss equal to the difference between the value of
the contract at the time it was opened and the value at the time it
was closed.
* Options--The Fund is authorized to purchase and write call and put
options. When the Fund writes an option, an amount equal to the
premium received by the Fund is reflected as an asset and an
equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option
written.
When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
<PAGE>
Written and purchased options are non-income producing investments.
* Interest rate transactions--The Fund is authorized to enter into
interest rate swaps and purchase or sell interest rate caps and
floors. In an interest rate swap, the Fund exchanges with another
party their respective commitments to pay or receive interest on a
specified notional principal amount. The purchase of an interest
rate cap (or floor) entitles the purchaser, to the extent that a
specified index exceeds (or falls below) a predetermined interest
rate, to receive payments of interest equal to the difference
between the index and the predetermined rate on a notional principal
amount from the party selling such interest rate cap (or floor).
(c) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(d) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Discounts and market premiums are amortized into interest
income. Realized gains and losses on security transactions are
determined on the identified cost basis.
(e) Deferred organization expenses--Deferred organization ex-penses
are amortized on a straight-line basis over a five-year period.
(f) Dividends and distributions--Dividends from net investment
income are declared and paid monthly. Distributions of capital gains
are recorded on the ex-dividend dates. The Fund may at times pay out
less than the entire amount of taxable net investment income earned
in any particular period and may at times pay out such accumulated
undistributed income in addition to taxable net investment income
earned in other periods in order to permit the Fund to maintain a
more stable level of distribution.
2. Investment Advisory Agreement and Transactions
with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund
Asset Management, L.P. ("FAM"). The general partner of FAM is
Princeton Services, Inc. ("PSI"), an indirect wholly-owned
subsidiary of Merrill Lynch & Co., Inc. ("ML & Co."), which is the
limited partner.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee at an annual rate of 0.55% of
the Fund's average weekly net assets from December 1, 1994 to
December 1, 1997, and 0.30% of average weekly net assets from
December 1, 1997 through termination of the Fund.
<PAGE>
During the six months ended June 30, 1997, the Fund paid Merrill
Lynch Security Pricing Service, an affiliate of Merrill Lynch,
Pierce, Fenner & Smith Inc. ("MLPF&S"), $315 for security price
quotations to compute the net asset value of the Fund.
Accounting services are provided to the Fund by FAM at cost.
Certain officers and/or directors of the Fund are officers and/or
directors of FAM, PSI, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the six months ended June 30, 1997 were $7,745,244 and
$12,454,817, respectively.
Net realized and unrealized gains as of June 30, 1997 were as
follows:
Realized Unrealized
Gains Gains
Long-term investments $ 301,546 $ 835,179
---------- ----------
Total $ 301,546 $ 835,179
========== ==========
As of June 30, 1997, net unrealized appreciation for Federal income
tax purposes aggregated $835,179, of which $2,821,402 related to
appreciated securities and $1,986,223 related to depreciated
securities. The aggregate cost of investments at June 30, 1997 for
Federal income tax purposes was $161,459,309.
4. Capital Stock Transactions:
The Fund is authorized to issue 200,000,000 shares of capital stock,
par value $.10 per share. At June 30, 1997, total paid-in capital
amounted to $107,513,813.
During the six months ended June 30, 1997, the Fund repurchased
173,000 shares of capital stock, at an average market price of
$9.15, all of which have been retired.
5. Reverse Repurchase Agreements:
Under a reverse repurchase agreement, the Fund sells securities and
agrees to repurchase them at a mutually agreed upon date and price.
At the time the Fund enters into a reverse repurchase agreement, it
may establish a segregated account with the custodian containing
cash, cash equivalents or liquid high grade debt securities having a
value at least equal to the repurchase price.
<PAGE>
As of June 30, 1997, the Fund had entered into reverse repurchase
agreements in the amount of $53,079,000. For the six months ended
June 30, 1997, the maximum amount entered into was $57,463,500, the
average outstanding was approximately $53,236,000, and the daily
weighted average interest rate was 5.72%.
6. Capital Loss Carryforward:
At December 31, 1996, the Fund had a net capital loss carryforward
of approximately $2,697,000, of which $2,492,000 expires in 2002 and
$205,000 expires in 2003. This amount will be available to offset
like amounts of any future taxable gains.
7. Subsequent Event:
On July 9, 1997, the Fund's Board of Directors declared an ordinary
income dividend to Common Stock shareholders in the amount of
$.0529167 per share, payable on July 31, 1997 to shareholders of
record as of July 21, 1997.
