<PAGE>
2002 TARGET TERM TRUST INC. ANNUAL REPORT
January 15, 1999
- ---------------------------------------------------------------
2002 TARGET TERM
TRUST INC.
TRUST PROFILE
- - GOAL:
Return $15 per share to investors on or about 11/30/02,
while providing high monthly income
- - PORTFOLIO MANAGER/SUBADVISER:
Sharmin Mossavar-Rahmani, Goldman Sachs Funds Management, L.P.
- - TOTAL NET ASSETS:
$118.6 million as of November 30, 1998
- - DIVIDEND PAYMENTS: Monthly
- -----------------------------------------------------------------
Dear Shareholder,
We are pleased to present you with the annual report for 2002 Target Term
Trust Inc. (the "Trust" for the fiscal year ended November 30, 1998.
MARKET OVERVIEW
- -------------------------------------------------------------------------------
"Flight to quality" remained the dominant theme in the bond markets during
the fiscal year ended November 30, 1998, as investors sought the safety and
liquidity of U.S. Treasury securities, especially short- to intermediate-term
debt.
Turmoil hit the capital markets in August when Russia devalued its currency
and effectively defaulted on its internal debt. The ensuing sell-off in the
global equity and emerging debt markets spurred the flight to U.S. Treasurys
to an even higher pitch. Return OF capital, not return on capital, became the
dominant theme in the markets. All sectors of the bond market suffered as
risk premiums soared.
The global sell-off continued to disrupt the financial markets in September.
The Federal Reserve responded by lowering the Fed Funds rate (the rate for
overnight loans) from 5.50% to 5.25%. Barely two weeks into October, the Fed
again lowered the Fed Funds rate and also lowered the discount rate (the rate
commercial banks pay to borrow from the Federal Reserve). The market took
this action as a sign of the Fed's resolve to keep the economy growing in its
effort to avoid a recession. Investors reacted positively -- the stock market
rose and shorter-maturity Treasurys rallied.
The Fed lowered both rates again in November, and several European central
banks followed suit in preparation for the January 1, 1999 debut of the euro
currency. The third rate reduction in as many months boosted corporate bonds
and mortgage-backed securities as market psychology and liquidity improved.
PORTFOLIO REVIEW
- -------------------------------------------------------------------------------
PERFORMANCE
For the fiscal year ended November 30, 1998, the Trust (NYSE: TTR) returned
6.99% based on changes in its net asset value (assuming that dividends were
reinvested at the net asset value on the payable dates) and 10.23% based on
changes in its share price on the New York Stock Exchange (assuming dividends
were reinvested under the Dividend Reinvestment Plan). For the fiscal year,
the Trust lagged the 9.86% total return of its benchmark (a U.S. Treasury
note maturing on August 15, 2002, with a coupon of 6.375%). The primary
reason for the Trust's underperformance during the fiscal year was a widening
of non-Treasury spreads in response to worldwide financial turmoil.
On November 30, 1998 the Trust's net asset value per share was $15.19, while
its share price on the New York Stock Exchange was $14.13. During the fiscal
year ended November 30, 1998, the Trust paid dividends from net investment
income totaling $0.86 per share, or about 7.18 cents per share per month.
Based on the dividend paid in November and the Trust's market price on
November 30,
1
<PAGE>
1998, the Trust's annualized market yield was 6.10%.
HIGHLIGHTS(1)
COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS) -- CMOs represented 59.2% of the
portfolio as of November 30, 1998 versus 71.8% on November 30, 1997. The
Trust's allocation to CMOs declined modestly over the fiscal year as we
identified greater total return opportunities in alternative sectors, for
example, pass-through securities.
ADJUSTABLE RATE MORTGAGE SECURITIES (ARMs) -- The Trust's allocation to ARMs
remained relatively unchanged during the fiscal year. As of November 30,
1998, the Trust was 13.4% invested in ARM securities, compared to 13.6% on
November 30, 1997.
MORTGAGE PASS-THROUGH SECURITIES -- The Trust's position in mortgage
pass-through securities increased significantly over the fiscal year, from
6.9% on November 30, 1997 to 21.6% on November 30, 1998. Although we were
initially cautious on pass-throughs because of their tight spreads and
vulnerability to prepayment risk, we increased the Trust's exposure to the
sector after spreads widened in response to declining interest rates and the
global flight to Treasurys.
ASSET-BACKED SECURITIES (ABS) -- As of November 30, 1998, the Trust was 3.5%
invested in ABS, compared to 7.4% on November 30, 1997. Early in the period,
ABS performed well as investors demonstrated renewed interest in the sector.
However, spreads widened and we reduced our ABS position during the months
following the Russian ruble devaluation.
OUTLOOK
- -------------------------------------------------------------------------------
ARMs
Our outlook for the ARM sector has become cautiously optimistic, as both
fundamental and technical influences have turned more positive. From a
fundamental standpoint, long-term interest rates have risen and the yield
curve has steepened; as a result, ARM-to-fixed rate refinancing incentives
are now less compelling. From a technical standpoint, the overall tone of the
market has firmed as well -- hedge fund selling has abated, while supply
pressure from new mortgage origination activity has been concentrated
primarily in fixed-rate rather than adjustable-rate collateral.
CMOs
CMO spreads have narrowed as volatility has subsided and investors have
returned to the sector. We expect that relative value opportunities should
continue to improve as spreads stabilize and liquidity returns to the sector.
MORTGAGE PASS-THROUGH SECURITIES
Within the pass-through market, the technical environment has become more
favorable as wider spreads have attracted a variety of investors and
originator selling has diminished. Refinancing is also less of a concern,
with interest rates currently more than 40 basis points above their lows. We
are optimistic on the sector (particularly over longer investment horizons),
as we believe current spreads should more than compensate for short-term
volatility.
ABS
Although further spread volatility is possible, the strong fundamental
backdrop and improving technical situation bode well for ABS spreads over the
next several months.
- -------------------------------------
EDGAR REPRESENTATION OF GRAPHIC DATA:
<TABLE>
<CAPTION>
2002 TARGET TERM TRUST INC.
Sector Allocation(1)
<S> <C>
CMO's 59.2%
ARM's 13.4%
Mortgage Pass-Throughs 21.6%
ABS 3.5%
Repurchase Agreements 2.3%
</TABLE>
- -------------------------------------
(1) Unless otherwise noted, all portfolio weightings represent percentages of
portfolio assets as of November 30, 1998. The Trust's portfolio is
actively managed and all weightings are subject to change.
2
<PAGE>
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 REVIEW of a mutual fund in the PaineWebber Family of Funds(2),
please contact your Investment Executive.
Sincerely,
/s/Margo Alexander /s/Sharmin Mossavar-Rahmani
MARGO ALEXANDER SHARMIN MOSSAVAR-RAHMANI
President Chief Investment Officer
Mitchell Hutchins Domestic Fixed Income,
Asset Management Inc. Goldman Sachs Funds Management, L.P.
This letter is intended to assist shareholders in understanding how the Trust
performed during the fiscal year ended November 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.
(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.
3
<PAGE>
2002 TARGET TERM TRUST INC.
PORTFOLIO OF INVESTMENTS NOVEMBER 30, 1998
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
(000) MATURITY DATES INTEREST RATES VALUE
- ------------- -------------------- ----------------- -------------
<C> <S> <C> <C> <C>
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION CERTIFICATES--16.73%
$ 5,979+ GNMA.......................... 01/15/24 to 10/15/28 6.500% $ 6,041,587
8,995+ GNMA.......................... 10/15/22 to 12/15/23 7.000 9,214,111
3,265+ GNMA.......................... 01/15/23 to 07/15/23 7.500 3,372,705
1,117 GNMA.......................... 01/15/10 to 07/15/12 8.500 1,166,569
43 GNMA.......................... 09/15/18 9.000 45,377
-------------
Total Government National Mortgage Association
Certificates (cost--$19,506,455)............. 19,840,349
-------------
FEDERAL HOME LOAN MORTGAGE CORPORATION CERTIFICATES--11.47%
1,604+ FHLMC......................... 12/01/13 6.000 1,599,165
1,977+ FHLMC......................... 09/01/28 7.000 2,018,379
6,025+ FHLMC......................... 08/01/27 7.500 6,190,085
2,672+ FHLMC ARM..................... 08/01/19 7.518 2,775,169
1,000 FHLMC TBA..................... TBA 7.000 1,020,625
-------------
Total Federal Home Loan Mortgage Corporation
Certificates (cost--$13,528,260)............. 13,603,423
-------------
FEDERAL NATIONAL MORTGAGE ASSOCIATION CERTIFICATES--12.51%
2,452+ FNMA ARM...................... 11/01/26 6.218 2,473,503
2,732+ FNMA ARM...................... 01/01/25 6.886 2,834,714
2,274+ FNMA ARM...................... 08/01/22 7.515 2,316,284
4,047+ FNMA ARM...................... 01/01/21 7.710 4,135,553
3,000 FNMA TBA...................... TBA 7.000 3,067,500
-------------
Total Federal National Mortgage Association
Certificates (cost--$14,915,773)............. 14,827,554
-------------
COLLATERALIZED MORTGAGE OBLIGATIONS--73.37%
2,448 FHLMC Series 1629, Class QC... 12/15/23 10.000* 2,429,415
2,100 FHLMC Series 164, Class B2,
B3, B9 & B11................ 07/15/21 9.500 2,273,574
1,725 FNMA REMIC, Series 1988-12,
Class A..................... 02/25/18 10.000 1,862,683
462 FNMA Series 1993-138, Class
SM.......................... 12/25/21 9.988* 505,701
1,827+ FNMA Series 1994-11, Class
B........................... 06/25/18 4.625 1,808,011
958 Citicorp Mortgage Securities
Incorporated, Series 1994-6,
Class A4.................... 03/25/09 5.750 936,045
3,480 CMC Securities Corporation,
Series 1992-A, Class A12.... 10/25/22 7.400 3,520,190
3,759+ CMC Securities Corporation,
Series 1992-B, Class B11.... 11/25/23 7.375 3,807,611
3,197 CMC Securities Corporation,
Series 1993-C, Class C3..... 04/25/08 9.552 3,290,856
11,377 CMC Securities Corporation,
Series 1993-E, Class S10.... 11/25/08 6.500 11,390,952
7,395 Collateralized Mortgage
Obligation Trust, Series 64,
Class Z..................... 11/20/20 9.000 7,662,788
4,931 Countrywide Funding
Corporation, Series 1993-10,
Class A9.................... 01/25/24 6.688* 4,935,274
5,781 Countrywide Funding
Corporation, Series 1993-2,
Class A5A................... 10/25/08 6.500 5,817,048
4,679 Countrywide Mortgage Backed
Securities Incorporated,
Series 1994-B, Class A7..... 02/25/09 6.588* 4,691,088
5,179 Countrywide Mortgage Backed
Securities Incorporated,
Series 1994-C, Class A9..... 03/25/24 6.500 5,165,584
10,889 First Boston Mortgage
Securities Corporation,
Series 1993-1A, Class 1A.... 04/25/06 7.401* 11,263,184
6,308 Housing Securities
Incorporated, Series 1994-1,
Class A13................... 03/25/09 6.500 6,278,015
3,878 Residential Funding Mortgage
Securities Incorporated,
Series 1994-S1, Class A13... 01/25/21 6.888* 3,904,409
3,792 Securitized Asset Sales
Incorporated, Series 1994-5,
Class AM.................... 07/25/24 7.000 3,806,615
1,627 Structured Asset Securities
Corporation, Series 1995-3A,
Class 1A1................... 01/28/24 7.000 1,642,715
-------------
Total Collateralized Mortgage Obligations
(cost--$83,672,097).......................... 86,991,758
-------------
</TABLE>
4
<PAGE>
2002 TARGET TERM TRUST INC.
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
(000) MATURITY DATES INTEREST RATES VALUE
- ------------- -------------------- ----------------- -------------
<C> <S> <C> <C> <C>
ADJUSTABLE RATE COLLATERALIZED MORTGAGE OBLIGATIONS*--5.43%
$ 1,499 Housing Securities
Incorporated, Series 1992-5,
Class A..................... 06/15/22 7.470% $ 1,495,290
1,559 Resolution Trust Corporation,
Series 1992-16, Class A4.... 08/25/22 7.572 1,553,309
1,020 Ryland Mortgage Securities
Corporation, Series 1, Class
A2.......................... 08/25/23 7.595 1,015,920
2,338 Salomon Brothers Mortgage
Securities VII, Series
1994-20, Class A............ 08/01/24 8.205 2,368,858
-------------
Total Adjustable Rate Collateralized Mortgage
Obligations (cost--$6,474,462)............... 6,433,377
-------------
STRIPPED COLLATERALIZED MORTGAGE OBLIGATIONS--4.63%
30 FNMA REMIC Trust, Series
1991-G-15, Class S***....... 06/25/21 27.244(1) 415,639
1,828 FNMA REMIC Trust, Series
1991-G-35, Class N**........ 10/25/21 7.557(1) 1,568,227
15 FNMA REMIC Trust, Series
1992-G-44, Class GA***...... 05/25/03 14.600(1) 213,886
4,791 FNMA REMIC Trust, Series
1993-101, Class A***........ 06/25/08 7.000 293,646
2,059 FNMA REMIC, Series 151, Class
2***........................ 07/25/22 9.500 478,710
8 Structured Asset Securities
Corporation, Series 1992-M1,
Class A3***................. 11/25/07 11.000(1) 2,149,497
8 Structured Asset Securities
Corporation, Series 1992-M1,
Class A4***................. 11/25/07 11.000(1) 369,018
-------------
Total Stripped Collateralized Mortgage
Obligations (cost--$6,584,450)............... 5,488,623
-------------
ASSET BACKED SECURITIES--4.64%
658 Fasco Grantor Trust........... 11/15/01 6.650 665,067
1,601 Mid-State Trust IV, Series 4,
Class A..................... 04/01/30 8.330 1,742,395
1,112 Salomon Brothers Mortgage
Securities VII, Series
1996-3, Class 1A2........... 06/25/26 5.758* 1,112,410
2,000 The Money Store Home Equity
Trust....................... 01/15/39 6.945 1,975,000
-------------
Total Asset Backed Securities
(cost--$5,457,854)........................... 5,494,872
-------------
REPURCHASE AGREEMENT--3.05%
3,617 Repurchase Agreement dated
11/30/98 with State Street
Bank & Trust Company,
collateralized by $3,675,000
Federal Farm Credit Bank
Notes, 5.200% due 10/20/00
(value--$3,692,614)
proceeds: $3,617,517
(cost--$3,617,000).......... 12/01/98 5.150 3,617,000
-------------
Total Investments
(cost--$153,756,351)--131.83%................ 156,296,956
Liabilities in excess of other
assets--(31.83)%.............................. (37,733,955)
-------------
Net Assets--100.00%........................... $ 118,563,001
-------------
-------------
</TABLE>
- -----------------
ARM Adjustable Rate Mortgage Security--The interest rate shown is the current
rate as of November 30, 1998.
TBA (To Be Assigned) Securities are purchased on a forward commitment basis
with an approximate (generally +/- 1.0%) principal amount and generally
stated maturity date. The actual principal amount and maturity date will be
determined upon settlement when the specific mortgage pools are assigned.
REMIC Real Estate Mortgage Investment Conduit
* Floating Rate Securities. The interest rate shown is the current rate as
of November 30, 1998.
** Principal Only Security. This security entitles the holder to receive
principal payments from an underlying pool of mortgages. High prepayments
return principal faster than expected and cause the yield to increase. Low
prepayments return principal more slowly than expected and cause the yield
to decrease.
*** Interest Only Security. This security entitles the holder to receive
interest payments from an underlying pool of mortgages. The risk
associated with this security is related to the speed of principal
paydowns. High prepayments would result in a smaller amount of interest
being received and cause the yield to decrease. Low prepayments would
result in a greater amount of interest being received and cause the yield
to increase.
+ Entire or partial principal amount pledged as collateral for reverse
repurchase agreements (with Morgan Stanley Incorporated, maturing December
1, 1998) and/or futures transactions.
(1) Interest rate represents the annualized yield at date of purchase.
5
<PAGE>
2002 TARGET TERM TRUST INC.
FUTURES CONTRACTS
<TABLE>
<CAPTION>
NUMBER OF EXPIRATION UNREALIZED
CONTRACTS CONTRACT TO RECEIVE IN EXCHANGE FOR DATE APPRECIATION
- ------------- ------------------------------ --------------- -------------- -----------
<C> <S> <C> <C> <C>
448 5 year United States Treasury
Notes....................... $ 50,679,345 March 1999 $ 294,655
-----------
-----------
</TABLE>
SECURITY SOLD SHORT "AGAINST THE BOX"
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
(000) VALUE
- ----------- ----------
<C> <S> <C>
$ 3,000 FHLMC TBA 7.500%
(proceeds--$3,085,313)...... $3,082,500
----------
----------
</TABLE>
See accompanying notes to financial statements
6
<PAGE>
2002 TARGET TERM TRUST INC.
STATEMENT OF ASSETS AND LIABILITIES NOVEMBER 30, 1998
<TABLE>
<S> <C>
ASSETS
Investments in securities, at value (cost--$153,756,351).... $156,296,956
Receivable for investments sold............................. 3,369,942
Interest receivable......................................... 1,174,121
Variation margin receivable................................. 312,073
Other assets................................................ 6,522
------------
Total assets................................................ 161,159,614
------------
LIABILITIES
Payable for reverse repurchase agreements................... 34,543,000
Payable for investments purchased........................... 4,090,385
Security sold short, at value (proceeds -- $3,085,313)...... 3,082,500
Payable to custodian........................................ 413,304
Payable for interest on reverse repurchase agreements....... 131,401
Payable to investment adviser and administrator............. 68,398
Accrued expenses and other liabilities...................... 267,625
------------
Total liabilities........................................... 42,596,613
------------
NET ASSETS
Capital Stock--$0.001 par value; total authorized
200,000,000 shares; 7,802,867 shares issued and
outstanding............................................... 113,737,358
Undistributed net investment income......................... 6,703,720
Accumulated net realized loss from investments and futures
transactions.............................................. (4,716,150)
Net unrealized appreciation of investments, security sold
short and futures......................................... 2,838,073
------------
Net assets.................................................. $118,563,001
------------
------------
Net asset value per share................................... $15.19
------------
------------
</TABLE>
See accompanying notes to financial statements
7
<PAGE>
2002 TARGET TERM TRUST INC.
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE
YEAR ENDED
NOVEMBER 30,
1998
------------
<S> <C>
INVESTMENT INCOME:
Interest.................................................... $11,486,186
------------
EXPENSES:
Interest expense............................................ 2,131,479
Investment advisory and administration...................... 833,003
Excise tax.................................................. 200,171
Legal and audit............................................. 96,464
Reports and notices to shareholders......................... 78,914
Custody and accounting...................................... 73,785
Transfer agency............................................. 22,438
Directors' fees............................................. 10,500
Amortization of organizational expenses..................... 3,771
Other expenses.............................................. 83,747
------------
3,534,272
------------
Net investment income....................................... 7,951,914
------------
REALIZED AND UNREALIZED GAINS (LOSSES) FROM INVESTMENT
ACTIVITIES:
Net realized gains from:
Investment transactions................................. 531,169
Futures transactions.................................... 43,471
Net change in unrealized appreciation/depreciation of:
Investments............................................. (1,024,689)
Futures................................................. 571,018
------------
NET REALIZED AND UNREALIZED GAIN FROM INVESTMENT
ACTIVITIES................................................ 120,969
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 8,072,883
------------
------------
</TABLE>
See accompanying notes to financial statements
8
<PAGE>
2002 TARGET TERM TRUST INC.
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
NOVEMBER 30,
------------------------------
1998 1997
------------- -------------
<S> <C> <C>
FROM OPERATIONS:
Net investment income................... $ 7,951,914 $ 8,228,574
Net realized gains from investments and
futures transactions.................. 574,640 1,244,464
Net change in unrealized
appreciation/depreciation of
investments and futures............... (453,671) (1,782,546)
------------- -------------
Net increase in net assets resulting
from operations....................... 8,072,883 7,690,492
------------- -------------
DIVIDENDS TO SHAREHOLDERS FROM:
Net investment income................... (6,722,949) (6,726,756)
------------- -------------
CAPITAL STOCK TRANSACTIONS:
Cost of shares repurchased.............. -- (1,027,037)
------------- -------------
Net increase (decrease) in net assets... 1,349,934 (63,301)
NET ASSETS:
Beginning of year....................... 117,213,067 117,276,368
------------- -------------
End of year (including undistributed net
investment income of $6,703,720 and
$5,252,965, respectively)............. $ 118,563,001 $ 117,213,067
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to financial statements
9
<PAGE>
2002 TARGET TERM TRUST INC.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE
YEAR ENDED
NOVEMBER 30,
1998
--------------
<S> <C>
CASH FLOWS PROVIDED FROM OPERATING ACTIVITIES:
Interest received........................................... $ 12,553,681
Operating expenses paid..................................... (885,323)
Interest paid............................................... (2,195,014)
Purchase of short-term portfolio investments, net........... (537,000)
Purchase of long-term portfolio investments................. (133,115,977)
Sale of long-term portfolio investments..................... 142,619,849
Variation margin received on futures contracts.............. 239,733
--------------
Net cash provided from operating activities................. 18,679,949
--------------
CASH FLOWS USED FOR FINANCING ACTIVITIES:
Dividends paid to shareholders.............................. (6,722,949)
Decrease in reverse repurchase agreements................... (11,957,000)
--------------
Net cash used for financing activities...................... (18,679,949)
--------------
Net change in cash.......................................... 0
Cash at beginning of year................................... 0
--------------
Cash at end of year......................................... $ 0
--------------
--------------
RECONCILIATION OF NET INCREASE IN NET ASSETS RESULTING FROM
OPERATIONS TO NET CASH PROVIDED FROM OPERATING ACTIVITIES:
Net increase in net assets resulting from operations........ $ 8,072,883
--------------
Decrease in investments, at value........................... 6,747,483
Increase in receivable for investments sold................. (3,365,628)
Increase in interest receivable............................. (26,853)
Increase in variation margin receivable..................... (312,073)
Decrease in other assets.................................... 2,046
Increase in payable for investments purchased............... 4,090,385
Amortization of organizational expenses..................... 3,771
Increase in security sold short, at value................... 3,082,500
Decrease in payable for interest on reverse repurchase
agreements................................................ (63,535)
Increase in payable to investment adviser and
administrator............................................. 622
Decrease in variation margin payable........................ (62,683)
Increase in accrued expenses and other liabilities.......... 511,031
--------------
10,607,066
--------------
Net cash provided from operating activities................. $ 18,679,949
--------------
--------------
</TABLE>
See accompanying notes to financial statements
10
<PAGE>
NOTES TO FINANCIAL STATEMENTS
ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
2002 Target Term Trust Inc. (the "Trust") was incorporated in Maryland on
October 16, 1992 and is registered with the Securities and Exchange Commission
under the Investment Company Act of 1940, as amended, as a closed-end
diversified management investment company. The Trust's investment objective is
to manage a portfolio of high quality fixed-income and adjustable-rate
securities in order to return $15 per share (the initial public offering price)
to investors on or about November 30, 2002, while providing high monthly income.
The Trust is expected to terminate on or about November 30, 2002. Organizational
costs have been fully amortized on a straight line basis over a period of sixty
months from the date the Trust commenced operations.
The preparation of financial statements in accordance with generally accepted
accounting principles requires Trust 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 ("PaineWebber") and investment adviser
and administrator of the Trust, or Goldman Sachs Funds Management, L.P.
("Goldman Sachs"), a limited partnership indirectly controlled by Goldman Sachs
Group L.P. and sub-advisor of the Trust. When market quotations are not readily
available, securities are valued 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 Trust's board of
trustees ("board"). The amortized cost method of valuation, which approximates
market value, generally is used to value short-term debt instruments with sixty
days or less remaining to maturity, unless the board determines that this does
not represent fair value.
REPURCHASE AGREEMENTS--The Trust's custodian takes possession of the
collateral pledged for investments in repurchase agreements. The underlying
collateral is valued daily on a mark-to-market basis to ensure that the value,
including accrued interest, is at least equal to the repurchase price. In the
event of default of the obligation to repurchase, the Trust has the right to
liquidate the collateral and apply the proceeds in satisfaction of the
obligation. Under certain circumstances in the event of default or bankruptcy by
the other party to the agreement, realization
and/or retention of the collateral may be subject to legal proceedings.
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. Premiums are amortized and discounts are accreted
as adjustments to interest income and identified cost of investments.
FUTURES CONTRACTS--Upon entering into a financial futures contract, the Trust
is required to pledge to a broker an amount of cash and/or U.S. Government
securities equal to a certain percentage of the contract amount. This amount is
known as the "initial margin." Subsequent payments, known as "variation margin,"
are made or received by the Trust
11
<PAGE>
NOTES TO FINANCIAL STATEMENTS
each day, depending on the daily fluctuations in the value of the underlying
financial futures contracts. Such variation margin is recorded for financial
statement purposes on a daily basis as unrealized gain or loss until the
financial futures contract is closed, at which time the net gain or loss is
reclassified to realized.
Using financial futures contracts involves various market risks. The maximum
amount at risk from the purchase of a futures contract is the contract value.
The Trust primarily used financial futures contracts for hedging purposes as
well as to manage the average duration of the Trust's portfolio and not for
leverage. However, imperfect correlations between futures contracts and the
portfolio securities being hedged, or market disruptions, normally do not permit
full control of these risks at all times.
REVERSE REPURCHASE AGREEMENTS--The Trust enters into reverse repurchase
agreements with qualified, third party broker-dealers as determined by, and
under the direction of, the Trust's board of directors. Interest on the value of
reverse repurchase agreements issued and outstanding is based upon competitive
market rates at the time of issuance. At the time the Trust enters into a
reverse repurchase agreement, it establishes and maintains a segregated account
with the Trust's custodian containing liquid securities having a value not less
than the repurchase price, including accrued interest, of the reverse repurchase
agreement.
The average monthly balance of reverse repurchase agreements outstanding
during the year ended November 30, 1998 was $37,397,417 at a weighted average
interest rate of 5.69%.
DOLLAR ROLLS--The Trust may enter into transactions in which the Trust sells
securities for delivery in the current month and simultaneously contracts to
repurchase substantially similar (same type, coupon and maturity) securities on
a specified future date (the "roll period"). During the roll period the Trust
forgoes principal and interest paid on the securities. The Trust is compensated
by the interest earned on the cash proceeds of the initial sale and by fee
income or a lower repurchase price.
SHORT SALES "AGAINST THE BOX"--The Trust may engage in short sales of
securities it owns (short sales "against the box"). To make delivery to the
purchaser in a short sale, the executing broker borrows the securities being
sold short on behalf of the Trust, and the Trust is obligated to replace the
securities borrowed at a date in the future. When the Trust sells short, it
establishes a margin account with the broker effecting the short sale, and
deposits collateral with the broker. In addition, the Trust maintains with its
custodian, in a segregated account, the securities that could be used to cover
the short sale. The Trust will incur transaction costs, including interest
expense, in connection with opening, maintaining and closing short sales against
the box.
The Trust might make a short sale "against the box" in order to hedge against
market risks when Mitchell Hutchins or Goldman Sachs believes that the price of
a security may decline, thereby causing a decline in the value of a security
owned by the Trust. In such case, any loss in the Trust's long position during
the short sale should be reduced by a corresponding gain in the short position.
Conversely, any gain in the long position during the short sale should be
reduced by a corresponding loss in the short position. The extent to which gains
or losses in the long position are reduced will depend upon the amount of the
securities sold short relative to the amount of securities the Trust owns either
directly or indirectly.
DIVIDENDS AND DISTRIBUTIONS--Dividends and distributions are recorded on the
ex-dividend date. The amount of dividends and distributions is determined in
accordance with federal income tax regulations which may differ from
12
<PAGE>
NOTES TO FINANCIAL STATEMENTS
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.
On or about November 30, 2002, the Trust will liquidate its assets and will
declare and make a termination distribution to its shareholders in an aggregate
amount equal to the net proceeds of such liquidation after payment of the
Trust's expenses and liabilities, including amounts on any outstanding
borrowings by the Trust.
CONCENTRATION OF RISK
The ability of the issuers of the debt securities, including mortgage- and
asset-backed securities, held by the Trust to meet their obligations may be
affected by economic developments, including those particular to a specific
issuer, industry or region. Mortgage- and asset-backed securities may decrease
in value as a result of increases in interest rates and may benefit less than
other fixed-income securities from declining interest rates because of the risk
of prepayments.
INVESTMENT ADVISER AND ADMINISTRATOR
The Trust has entered into an Investment Advisory and Administration Contract
("Advisory Contract") with Mitchell Hutchins. The Advisory Contract provides
Mitchell Hutchins with an investment advisory fee and an administration fee,
each computed weekly and payable monthly, at an annual rate of 0.50% and 0.20%,
respectively, of the Trust's average weekly net assets.
Under a separate contract with Mitchell Hutchins ("Sub-Advisory Contract"),
Goldman Sachs serves as the Trust's Sub-Adviser. Under the Sub-Advisory
Contract, Mitchell Hutchins (not the Trust) will pay the Sub-Adviser a fee,
computed weekly and payable monthly, in an amount equal to one-half of the
investment advisory fee received by Mitchell Hutchins from the Trust.
INVESTMENTS IN SECURITIES
For federal income tax purposes, the cost of securities owned at November 30,
1998, was substantially the same as the cost of securities for financial
statement purposes.
At November 30, 1998, the components of net unrealized appreciation of
investments were as follows:
<TABLE>
<S> <C>
Gross appreciation (from investments having an excess of
value over cost).......................................... $4,582,004
Gross depreciation (from investments having an excess of
cost over value).......................................... (2,041,399)
---------
Net unrealized appreciation of investments.................. $2,540,605
---------
---------
</TABLE>
For the year ended November 30, 1998, total aggregate purchases and sales of
portfolio securities excluding short-term securities, were $137,206,362 and
$142,900,165, respectively.
FEDERAL TAX STATUS
It is the Trust's intention to continue to meet the requirements of the
Internal Revenue Code applicable to regulated investment companies and to
distribute sufficient amounts of its taxable income to shareholders. Therefore,
no federal income tax provision is required. As part of the Trust's investment
objective to return $15.00 per share to investors on or about November 30, 2002,
the Trust intends to retain a portion of its taxable income and will pay any
applicable federal excise tax.
13
<PAGE>
NOTES TO FINANCIAL STATEMENTS
At November 30, 1998, the Trust had a net capital loss carryforward of
$4,421,495. The loss carryforward is available as a reduction, to the extent
provided in the regulations, of future net realized capital gains, and will
expire on or about November 30, 2002 or the liquidation of the Fund. To the
extent that such losses are used to offset future net realized capital gains as
provided in the regulations, it is probable that these gains will not be
distributed.
To reflect reclassifications, arising from permanent "book/tax" differences
for the year ended November 30, 1998, undistributed net investment income was
increased by $221,790, accumulated net realized gains/losses from investments
and futures transactions was decreased by $71,547 and capital stock decreased by
$150,243.
CAPITAL STOCK
There are 200,000,000 shares of $0.001 par value common stock authorized. Of
the 7,802,867 shares outstanding as of November 30, 1998, Mitchell Hutchins
owned 8,148 shares.
The Trust did not repurchase any shares of common stock for the year ended
November 30, 1998.
For the period July 10, 1995 (commencement of repurchase program) through
November 30, 1998, the Trust repurchased 2,873,600 shares of common stock at an
average market price per share of $12.57 and a weighted average discount from
net asset value of 10.88%. At November 30, 1998, paid-in-capital is net the cost
of $37,317,935 of capital stock reacquired.
14
<PAGE>
2002 TARGET TERM TRUST INC.
FINANCIAL HIGHLIGHTS
Selected data for a share of common stock outstanding throughout each year is
presented below:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED NOVEMBER 30,
------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- --------- ---------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of year...... $ 15.02 $ 14.88 $ 14.37 $ 12.70 $ 14.68
-------- -------- -------- --------- ---------
Net investment income................... 1.02 1.06 1.13* 1.02* 0.93
Net realized and unrealized gains
(losses) from investments and
futures................................ 0.01 (0.08) (0.05)* 1.36* (1.90)
-------- -------- -------- --------- ---------
Net increase (decrease) in net asset
value resulting from investment
operations............................. 1.03 0.98 1.08 2.38 (0.97)
-------- -------- -------- --------- ---------
Dividends from net investment income.... (0.86) (0.86) (0.86) (0.90) (0.96)
Distributions from short-term capital
gains.................................. -- -- -- -- (0.05)
-------- -------- -------- --------- ---------
Total dividends and distributions to
shareholders........................... (0.86) (0.86) (0.86) (0.90) (1.01)
-------- -------- -------- --------- ---------
Net increase in net asset value
resulting from repurchase of common
stock.................................. -- 0.02 0.29 0.19 --
-------- -------- -------- --------- ---------
Net asset value, end of year............ $ 15.19 $ 15.02 $ 14.88 $ 14.37 $ 12.70
-------- -------- -------- --------- ---------
-------- -------- -------- --------- ---------
Market value, end of year............... $ 14.13 $ 13.63 $ 12.63 $ 12.50 $ 11.25
-------- -------- -------- --------- ---------
-------- -------- -------- --------- ---------
Total investment return(1).............. 10.23% 15.23% 8.07% 19.85% (12.79)%
-------- -------- -------- --------- ---------
-------- -------- -------- --------- ---------
Ratios/Supplemental data:
Net assets, end of year (000's)......... $118,563 $117,213 $117,276 $136,754 $136,562
Expenses to average net assets+......... 2.97% 3.36% 3.13% 3.42% 2.72%
Net investment income to average net
assets................................. 6.68% 7.13% 7.74% 7.44% 6.82%
Portfolio turnover rate................. 86% 64% 127% 103% 108%
Asset coverage++........................ $4,334 $3,521 $3,261 $4,013 $3,023
</TABLE>
- -----------------
* Calculated using average daily shares outstanding for the period
+ These ratios include 1.79%, 2.25%, 1.93%, 2.50%, and 1.82% related to
interest expense for the years ended November 30, 1998, 1997, 1996, 1995 and
1994, respectively, which represents the cost of leverage to the Trust.
++ Per $1,000 of reverse repurchase agreements and dollar roll transactions
outstanding
(1) Total investment return is calculated assuming a purchase of common stock at
the current market price on the first day of each year reported and a sale at
the current market price on the last day of each year reported and assuming
reinvestment of dividends and distributions at prices obtained under the
Trust's Dividend Reinvestment Plan. Investment returns do not reflect
brokerage commissions.
15
<PAGE>
2002 TARGET TERM TRUST INC.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
2002 Target Term Trust Inc.
We have audited the accompanying statement of assets and liabilities,
including the portfolio of investments, of 2002 Target Term Trust Inc. (the
"Trust") as of November 30, 1998, and the related statements of operations and
cash flows for the year then ended, the statement of changes in net assets for
each of the two years in the period then ended, and the financial highlights for
each of the periods indicated therein. These financial statements and financial
highlights are the responsibility of the Trust's management. Our responsibility
is to express an opinion on these financial statements and financial highlights
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements and financial highlights. Our procedures included confirmation of
securities owned as of November 30, 1998, by correspondence with the custodian
and brokers. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of 2002
Target Term Trust Inc. at November 30, 1998, and 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 indicated periods, in conformity with generally accepted accounting
principles.
[ERNST & YOUNG SIGNATURE]
New York, New York
January 20, 1999
16
<PAGE>
2002 TARGET TERM TRUST INC.
TAX INFORMATION (UNAUDITED)
We are required by Subchapter M of the Internal Revenue Code of 1986, as
amended, to advise you within 60 days of the Trust's fiscal year end (November
30, 1998), as to the federal tax status of distributions received by
stockholders during such fiscal year. Accordingly, we are advising you that all
distributions paid during the period by the Trust were derived from net
investment income and are taxable as ordinary income.
Dividends received by tax-exempt recipients (e.g., IRAs and Keoghs) need not
be reported as taxable income. Some retirement trusts (e.g., corporate, Keogh
and 403(b)(7) plans) may need this information for their annual information
reporting.
Because the Trust'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. Shareholders are advised to consult their own tax
advisers with respect to the tax consequences of their investment in the Trust.
17
<PAGE>
2002 TARGET TERM TRUST INC.
GENERAL INFORMATION (UNAUDITED)
THE TRUST
2002 Target Term Trust Inc. (the "Trust") is a diversified closed-end
management investment company whose shares trade on the New York Stock Exchange
("NYSE"). The Trust's investment objective is to manage a portfolio of high
quality fixed-income and adjustable-rate securities in order to return $15 per
share (the initial public offering price) to investors on or about November 30,
2002, while providing high monthly income. The Trust's investment adviser and
administrator is Mitchell Hutchins Asset Management Inc., a wholly owned asset
management subsidiary of PaineWebber Incorporated, which has over $57 billion in
assets under management as of December 31, 1998. Goldman Sachs Funds Management,
L.P., is sub-adviser to the Trust.
SHAREHOLDER INFORMATION
The Trust's NYSE trading symbol is "TTR." Weekly comparative net asset value
and market price information about the Trust 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 Trust's board of directors amended the Trust's bylaws to require that the
Trust 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 the Trust's 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 Trust's 1999 annual meeting.
The amended bylaws require that the Trust 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 Trust's proxy statement for the previous year's annual
meeting was first released to shareholders. For a special shareholder meeting,
the Trust must receive notice within seven 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 Trust must receive notice of that nomination or proposal no
later than October 1, 1999.
YEAR 2000 RISKS
Like other funds and financial and business organizations around the world,
the Trust 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 the Trust's 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 Trust'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 Trust.
DISTRIBUTION POLICY
The Trust'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
18
<PAGE>
2002 TARGET TERM TRUST INC.
GENERAL INFORMATION (UNAUDITED) (CONCLUDED)
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 Trust'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 Trust 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 Trust. 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. See "Tax Information."
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.
19
<PAGE>
- -------------------------------------------------------------------------------
DIRECTORS
E. Garrett Bewkes, Jr. Mary C. Farrell
CHAIRMAN
Meyer Feldberg
Margo N. Alexander
George W. Gowen
Richard Q. Armstrong
Frederic V. Malek
Richard R. Burt
Carl W. Schafer
PRINCIPAL OFFICERS
Margo N. Alexander Dianne E. O'Donnell
PRESIDENT VICE PRESIDENT AND SECRETARY
Victoria E. Schonfeld Paul H. Schubert
VICE PRESIDENT VICE PRESIDENT AND TREASURER
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 TRUST MAY PURCHASE SHARES OF
ITS COMMON STOCK IN THE OPEN MARKET AT MARKET PRICES.
THIS REPORT IS SENT TO THE SHAREHOLDERS OF THE TRUST FOR THEIR INFORMATION.
IT IS NOT A PROSPECTUS, CIRCULAR OR REPRESENTATION INTENDED FOR THE USE IN
THE PURCHASE OR SALE OF SHARES OF THE TRUST OR OF ANY SECURITIES MENTIONED IN
THIS REPORT.
<PAGE>
2002 TARGET
TERM TRUST INC.
ANNUAL REPORT
NOVEMBER 30, 1998
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- -c- 1999 PaineWebber Incorporated
Member SIPC
