<PAGE>
THE MORGAN STANLEY HIGH YIELD FUND, INC.
- --------------------------------------------------------------------------------
DIRECTORS AND OFFICERS
Barton M. Biggs William G. Morton, Jr.
CHAIRMAN OF THE BOARD DIRECTOR
OF DIRECTORS
Michael F. Klein Stefanie V. Chang
PRESIDENT AND DIRECTOR VICE PRESIDENT
Peter J. Chase Harold J. Schaaff, Jr.
DIRECTOR VICE PRESIDENT
John W. Croghan Joseph P. Stadler
DIRECTOR VICE PRESIDENT
David B. Gill Valerie Y. Lewis
DIRECTOR SECRETARY
Graham E. Jones Joanna M. Haigney
DIRECTOR TREASURER
John A. Levin Belinda A. Brady
DIRECTOR ASSISTANT TREASURER
- --------------------------------------------------------------------------------
INVESTMENT ADVISER
Morgan Stanley Asset Management Inc.
1221 Avenue of the Americas
New York, New York 10020
- --------------------------------------------------------------------------------
ADMINISTRATOR
The Chase Manhattan Bank
73 Tremont Street
Boston, Massachusetts 02108
- --------------------------------------------------------------------------------
CUSTODIANS
Morgan Stanley Trust Company
One Pierrepont Plaza
Brooklyn, New York 11201
The Chase Manhattan Bank
3 Chase MetroTech Center
Brooklyn, New York 11245
- --------------------------------------------------------------------------------
SHAREHOLDER SERVICING AGENT
American Stock Transfer & Trust Company
40 Wall Street
New York, New York 10005
(800) 278-4353
- --------------------------------------------------------------------------------
LEGAL COUNSEL
Rogers & Wells LLP
200 Park Avenue
New York, New York 10166
- --------------------------------------------------------------------------------
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York 10036
- --------------------------------------------------------------------------------
For additional Fund information, including the Fund's net asset value per share
and information regarding the investments comprising the Fund's portfolio,
please call 1-800-221-6726.
- --------------------------------------------------------------------------------
THE
MORGAN STANLEY
HIGH YIELD
FUND, INC.
- --------------------------------------------------------------------------------
ANNUAL REPORT
DECEMBER 31, 1997
MORGAN STANLEY ASSET MANAGEMENT INC.
INVESTMENT ADVISER
<PAGE>
LETTER TO SHAREHOLDERS
- --------------------------------------------------------------------------------
For the year ended December 31, 1997, the Morgan Stanley High Yield Fund, Inc.
(the "Fund") had a total return, based on net asset value per share, of 18.48%
compared to 12.65% for the CS First Boston High Yield Index (the "Index"). For
the period since the Fund's commencement of operations on November 30, 1993
through December 31, 1997, the Fund's total return based on net asset value per
share, was 65.85% compared to 49.02% for the Index. On December 31, 1997, the
closing price of the Fund's shares on the New York Stock Exchange was $16.06,
representing a 5.7% premium to the Fund's net asset value per share.
The high yield bond market had another good year in 1997. The Salomon Brothers
high yield market index returned 13.2% compared to the 9.6% return registered by
the Salomon Brothers Broad index. Declining long-term interest rates and a
strong stock market provided a favorable backdrop to high yield market.
Ten year Treasury rates declined 67 basis points and thirty year rates declined
72 basis points from the beginning to the end of the year. However short-term
interest rates rose resulting in a relatively flat yield curve. The Federal
Reserve boosted short term rates in March because of the fear of future
inflation given the strong economy and tight labor market. These fears have not
materialized so far however and the market retreat in March was short lived.
Inflation reports continue to be excellent and the problems in Asia will only
help keep inflation down.
The strong stock market also supported the high yield market. The S&P 500's 33%
rise increased investors' confidence that earnings will continue upwards and
that companies will have ready access to capital. Portfolio holdings such as
Qwest and Outdoor Systems benefited from IPOs and equity issuance.
The merger and acquisition activity also continued at a high pace. Stock for
stock transactions and mergers into high grade companies effectively delevered
many high yield companies and boosted bond prices. Portfolio holdings Brooks
Fiber and recently Teleport were beneficiaries in this category.
The telecommunications sector was by far the best performer during 1997. The
sector benefited from acquisition activity and from the fact that many of the
securities in the industry tend to have a high duration, so declining rates
helped performance also. This was by far our most heavily weighted sector.
We also did a good job avoiding many landmines in 1997. The supermarket
industry, generally a popular one in the market, had several high profile credit
problems which we avoided. Subprime finance companies and auto suppliers were
also sectors that experienced problems that we successfully avoided.
Emerging markets is another area of importance to our portfolio. We started the
year with nearly a twenty percent weighting in emerging markets debt. This area
performed spectacularly and as spreads narrowed dramatically we cut our position
by approximately a third. Our timing was fortunate in that this was accomplished
shortly before the Asian crisis. Although we had little exposure to Asia at the
time, Latin credits were also hammered during the rout. Latin bonds rebounded
fairly quickly as opposed to the Asians, but volatility still is evident in
these markets. We have increased our exposure to the Asians as we believe the
IMF bailouts will enable the sovereigns and some of the major corporates to
avoid default.
We are well positioned for 1998. We currently have little exposure to cyclical
credits. We maintain a high allocation to the telecommunications sector where
fundamentals continue to appear very positive. The emerging markets sector is
where we hope for more aggressive returns, but we acknowledge the potential
risks. We attempt to mitigate this risk by investing primarily in what we
consider world class companies or those that have very strong sponsorship and in
sovereign issues where we believe there is significant value.
Sincerely,
/s/ Michael F. Klein
Michael F. Klein
PRESIDENT AND DIRECTOR
/s/ Robert Angevine
Robert Angevine
PORTFOLIO MANAGER
January 1998
2
<PAGE>
MORGAN STANLEY HIGH YIELD FUND, INC.
INVESTMENT SUMMARY AS OF DECEMBER 31, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
HISTORICAL TOTAL RETURN (%)
INFORMATION ------------------------------------------------------------------------------------
MARKET VALUE(1) NET ASSET VALUE(2) INDEX(3)
------------------------ ------------------------ ------------------------
AVERAGE AVERAGE AVERAGE
CUMULATIVE ANNUAL CUMULATIVE ANNUAL CUMULATIVE ANNUAL
---------- ------- ---------- ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
One Year 23.79% 23.79% 18.48% 18.48% 12.65% 12.65%
Since Inception* 75.37 14.73 65.85 13.17 49.02 10.26
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
RETURNS AND PER SHARE INFORMATION
[CHART]
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31:
1993* 1994 1995 1996 1997
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Net Asset Value Per Share. . . . . . $ 14.10 $ 11.96 $ 13.63 $ 14.45 $ 15.19
Market Value Per Share . . . . . . . $ 14.75 $ 11.38 $ 12.88 $ 14.63 $ 16.06
Premium/(Discount) . . . . . . . . . 4.6% -4.8% -5.5% 1.3% 5.7%
Income Dividends . . . . . . . . . . -- $ 1.37 $ 1.27 $ 1.42 $ 1.36
Capital Gains Distributions. . . . . -- -- -- $ 0.48
Fund Total Return (2). . . . . . . . 0.00% -5.53% 26.07% 17.52% 18.48%
Index Total Return (1)(3). . . . . . 1.26% -0.98% 17.39% 12.40% 12.65%
</TABLE>
(1) Assumes dividends and distributions, if any, were reinvested.
(2) Total investment return based on net asset value per share reflects the
effects of changes in net asset value on the performance of the Fund during
each period, and assumes dividends and distributions, if any, were
reinvested. These percentages are not an indication of the performance of a
shareholder's investment in the Fund based on market value due to
differences between the market price of the stock and the net asset value
per share of the Fund.
(3) The CS First Boston High Yield Index is an unmanaged index of high yield
corporate bonds.
* The Fund commenced operations on November 30, 1993.
3
<PAGE>
MORGAN STANLEY HIGH YIELD FUND, INC.
PORTFOLIO SUMMARY AS OF DECEMBER 31, 1997
- --------------------------------------------------------------------------------
DIVERSIFICATION OF TOTAL INVESTMENTS
<TABLE>
[CHART]
<S> <C>
Debt Securities 91.5%
Equity Securities 6.4%
Short-Term Investments 2.1%
</TABLE>
- --------------------------------------------------------------------------------
SECTORS (UNAUDITED)
<TABLE>
[CHART]
<S> <C>
Other 30.7%
Asset-Backed Securities 5.2%
Broadcast -- Radio & Television 14.2%
Collateralized Mortgage Obligation 3.5%
Diversified 4.5%
Energy 4.5%
Foreign Government Bonds 5.7%
Gaming & Lodging 3.3%
Metals 3.6%
Multi-Industry 9.3%
Telecommunications 15.5%
</TABLE>
- --------------------------------------------------------------------------------
TEN LARGEST HOLDINGS*
<TABLE>
<CAPTION>
PERCENT OF
TOTAL
INVESTMENTS
-----------
<S> <C>
1. Time Warner, Inc. Series 'M' 10.25% 4.0%
2. DR Securitized Lease Trust 3.4
3. Brooks Fiber Properties 3.1
4. Teleport Communications 0.00%, 7/1/07 2.6
5. ISP Holdings, Inc. 'B' 9.00%, 10/15/03 2.4
6. Norcal Waste Systems Inc. 13.50%, 11/15/05 2.4%
7. Republic of Argentina 2.3
8. Viacom, Inc. 8.00%, 7/7/06 2.2
9. IXC Communications, Inc. 2.2
10. Southland Corp. 5.00%, 12/15/03 2.0
----
26.6%
----
----
</TABLE>
* Excludes short-term investments.
4
<PAGE>
FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS
(SHOWING PERCENTAGE OF TOTAL VALUE OF INVESTMENTS)
- --------------------------------------------------------------------------------
DECEMBER 31, 1997
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
CORPORATE BONDS AND NOTES (77.1%)
- --------------------------------------------------------------------------------
AEROSPACE & DEFENSE (2.0%)
Jet Equipment Trust 144A
'D-95' 11.44%, 11/1/14 $ 1,100 $ 1,469
'C1' 11.79%, 6/15/13 1,500 2,020
-------
3,489
-------
- --------------------------------------------------------------------------------
BANKING (1.6%)
Korea Development Bank
7.375%, 9/17/04 590 475
Western Financial Bank
8.875%, 8/1/07 2,385 2,367
-------
2,842
-------
- --------------------------------------------------------------------------------
BROADCAST -- RADIO & TELEVISION (14.2%)
Cablevision Systems Corp.
7.875%, 12/15/07 575 587
(d) 9.875%, 5/15/06 2,650 2,912
Comcast Cellular Holdings 'B'
9.50%, 5/1/07 2,480 2,585
Comcast Corp.
1.125%, 4/15/07 1,350 889
Fox/Liberty Networks LLC 144A
(c) 0.00%, 8/15/07 3,390 2,170
8.875%, 8/15/07 845 846
Lenfest Communications
8.375%, 11/1/05 1,060 1,093
(d) Paramount Communications
8.25%, 8/1/22 2,600 2,622
Rogers Cablesystems
10.125%, 9/1/12 650 712
(d) Rogers Cablesystems 'B'
10.00%, 3/15/05 2,210 2,442
Sinclair Broadcast Group
9.00%, 7/15/07 1,370 1,397
TV Azteca 'B'
10.50%, 2/15/07 2,470 2,553
(d) Viacom, Inc.
8.00%, 7/7/06 3,840 3,845
-------
24,653
-------
- --------------------------------------------------------------------------------
BUSINESS SERVICES (1.8%)
(d) Outdoor Systems Inc.
8.875%, 6/15/07 2,955 3,080
-------
- --------------------------------------------------------------------------------
CHEMICALS (1.0%)
(b) Huntsman Corp. 144A
9.094%, 7/1/07 1,650 1,724
-------
- --------------------------------------------------------------------------------
COAL, GAS & OIL (2.0%)
(d) Snyder Oil Corp.
8.75%, 6/15/07 3,350 3,409
-------
- --------------------------------------------------------------------------------
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
COMPUTERS (1.8%)
(d) Advanced Micro Devices, Inc.
11.00%, 8/1/03 $ 2,970 $ 3,193
-------
- --------------------------------------------------------------------------------
DIVERSIFIED (0.5%)
KMart Corp.
(d) 7.75%, 10/1/12 725 705
8.375%, 7/1/22 185 182
-------
887
-------
- --------------------------------------------------------------------------------
ENERGY (4.5%)
National Power Corp.
7.875%, 12/15/06 1,825 1,605
(d) Nuevo Energy Co.
9.50%, 4/15/06 2,760 2,946
Quezon Power Ltd.
8.86%, 6/15/17 2,900 2,479
(c) Transamerican Energy 144A
0.00%, 6/15/02 945 747
-------
7,777
-------
- --------------------------------------------------------------------------------
ENVIRONMENTAL CONTROLS (2.4%)
(c) Norcal Waste Systems Inc.
13.50%, 11/15/05 3,575 4,156
-------
- --------------------------------------------------------------------------------
FINANCIAL SERVICES (2.3%)
Geberit International
10.125%, 4/15/07 DEM 1,700 1,025
ITT Promedia 144A
9.125%, 9/15/07 2,950 1,722
(c) PTC International Finance BV 144A
0.00%, 7/1/07 $1,820 1,174
-------
3,921
-------
- --------------------------------------------------------------------------------
FOOD (1.2%)
Fleming Companies, Inc. 144A
10.50%, 12/1/04 1,455 1,522
10.625%, 7/31/07 460 486
-------
2,008
-------
- --------------------------------------------------------------------------------
FOOD SERVICE & LODGING (1.1%)
(d) Host Marriott Travel
9.50%, 5/15/05 1,835 1,945
-------
- --------------------------------------------------------------------------------
FOREST PRODUCTS & PAPER (1.2%)
APP Fin II Mauritius Ltd.
12.00%, 2/15/04 2,490 2,098
-------
- --------------------------------------------------------------------------------
GAMING & LODGING (3.3%)
(d) Grand Casinos
10.125%, 12/1/03 2,495 2,695
Louisiana Casino Cruise
11.50%, 12/1/98 318 322
- --------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
GAMING & LODGING (CONTINUED)
(d) Station Casinos, Inc.
10.125%, 3/15/06 $ 2,485 $ 2,615
-------
5,632
-------
- --------------------------------------------------------------------------------
HEALTH CARE SUPPLIES & SERVICES (1.7%)
Kinetic Concepts Inc. 144A
9.625%, 11/1/07 500 507
(d) Tenet Healthcare Corp.
8.625%, 1/15/07 2,405 2,480
-------
2,987
-------
- --------------------------------------------------------------------------------
METALS (3.6%)
Hylsa 144A
9.25%, 9/15/07 1,900 1,864
Impress Metal Packaging
9.875%, 5/29/07 DEM 2,750 1,586
Murrin Murrin Holdings Pty 144A
9.375%, 8/31/07 $ 2,785 2,775
-------
6,225
-------
- --------------------------------------------------------------------------------
MULTI-INDUSTRY (9.3%)
Ameriserve Food Co.
10.125%, 7/15/07 795 826
(c,d) Brooks Fiber Properties
0.00%, 3/1/06 5,395 4,478
0.00%, 11/1/06 1,095 876
CA FM Lease Trust 144A
8.50%, 7/15/17 1,470 1,549
(d) ISP Holdings, Inc. 'B'
9.00%, 10/15/03 4,065 4,219
Multicanal
10.50%, 2/1/07 1,705 1,688
(d) SD Warren Co. 'B'
12.00%, 12/15/04 2,235 2,497
-------
16,133
-------
- --------------------------------------------------------------------------------
REAL ESTATE (1.8%)
(d) HMC Acquisition Properties
9.00%, 12/15/07 2,050 2,137
Residential Reins 97A A2 144A
11.45%, 12/15/98 1,000 1,024
-------
3,161
-------
- --------------------------------------------------------------------------------
RETAIL -- GENERAL (2.0%)
(d) Southland Corp.
5.00%, 12/15/03 4,000 3,500
-------
- --------------------------------------------------------------------------------
SOAP & TOILETRIES (1.8%)
Revlon Worldwide 'B' Zero
Coupon, 3/15/01 4,560 3,146
-------
- --------------------------------------------------------------------------------
TELECOMMUNICATIONS (14.1%)
(c,d) Dial Call Communications
0.00%, 4/15/04 2,500 2,387
-------
- --------------------------------------------------------------------------------
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
Telecommunications (continued)
(c) Dial Call Communications 'B'
0.00%, 12/15/05 $ 1,000 $ 915
Espirit Telecom Group 'DM'
11.50%, 12/15/07 DEM 2,000 1,148
Globalstar LP
11.375%, 2/15/04 $ 1,925 1,958
Iridium LLC/Capital Corp. 'A'
13.00%, 7/15/05 840 882
(d) IXC Communications, Inc.
12.50%, 10/1/05 1,745 2,007
(c,d) Nextel Communications, Inc.
0.00%, 8/15/04 3,475 3,084
(c) Occidente y Caribe
0.00%, 3/15/04 3,125 2,344
(d) Qwest Communications International
10.875%, 4/1/07 775 876
Rogers Communications, Inc.
8.875%, 7/15/07 750 751
(d) 9.125%, 1/15/06 800 813
(c) TCI Satellite Entertainment 144A
0.00%, 2/15/07 4,295 2,867
(c,d) Teleport Communications
0.00%, 7/1/07 5,480 4,480
-------
24,512
-------
- --------------------------------------------------------------------------------
TRANSPORTATION (0.3%)
Hermes Europe Railtel BV 144A
11.50%, 8/15/07 480 530
-------
- --------------------------------------------------------------------------------
UTILITIES (1.6%)
Cleveland Electric
8.375%, 12/1/11 440 450
(d) 8.375%, 8/1/12 1,050 1,075
Midland Funding Corp. I 'C-94'
10.33%, 7/23/02 1,122 1,202
-------
2,727
-------
- --------------------------------------------------------------------------------
TOTAL CORPORATE BONDS AND NOTES
(Cost $127,628) 133,735
-------
- --------------------------------------------------------------------------------
ASSET-BACKED SECURITIES (5.2%)
Aircraft Lease Portfolio Securitization
Ltd. 1996-1 P1D 12.75%, 6/15/06 1,770 1,912
DR Securitized Lease Trust
1993-K1 A1 6.66%, 8/15/10 2,164 2,004
1994-K1 A1 7.60%, 8/15/07 3,517 3,455
1994-K2 A2 9.35%, 8/15/19 500 521
First Home Mortgage Acceptance
Corp., 1996-B, Class C 144A 7.929%, 11/1/18 1,319 1,181
-------
- --------------------------------------------------------------------------------
TOTAL ASSET-BACKED SECURITIES
(Cost $8,191) 9,073
-------
- --------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
COLLATERALIZED MORTGAGE OBLIGATIONS (3.5%)
DLJ Mortgage Acceptance Corp.
1997-CF2 S 144A
0.357%, 10/15/30 $ 32,950 $ 876
GMAC IO 1996-C1 CL X2 REMIC
1.904%, 3/15/21 6,604 591
Long Beach Auto 1997-1, 'B' 144A
14.22%, 10/26/03 3,039 3,040
OHA Auto Grantor Trust 1997-1, 'B'
144A 11.00%, 9/15/03 1,609 1,613
PNC Mortgage Services Corp.,
1995-2 B4 7.50%, 9/25/25 1
-------
- --------------------------------------------------------------------------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS
(Cost $6,238) 6,120
-------
- --------------------------------------------------------------------------------
FOREIGN GOVERNMENT BONDS (5.7%)
- --------------------------------------------------------------------------------
ARGENTINA (2.3%)
(b,c) Republic of Argentina 'L' Par Bond
5.50%, 3/31/23 3,625 2,663
(c) Republic of Argentina Bearer Bond
6.688%, 3/31/05 14 13
(b,c) Republic of Argentina Pre 4 Bocon PIK
0.00%, 9/1/02 1,100 1,285
-------
3,961
-------
- --------------------------------------------------------------------------------
COLOMBIA (0.5%)
(c) Republic of Colombia
8.70%, 2/15/16 925 899
-------
- --------------------------------------------------------------------------------
MAURITIUS (0.7%)
Pindo Deli Finance Mauritius 144A
10.75%, 10/1/07 1,560 1,271
-------
- --------------------------------------------------------------------------------
MEXICO (1.6%)
United Mexican States Par Bond 'W-A'
6.25%, 12/31/19 2,520 2,105
United Mexican States Par Bond 'W-B'
6.25%, 12/31/19 750 626
-------
2,731
-------
- --------------------------------------------------------------------------------
VENEZUELA (0.6%)
Republic of Venezuela Debt Conversion Bond
9.25%, 9/15/27 1,070 962
-------
- --------------------------------------------------------------------------------
TOTAL FOREIGN GOVERNMENT BONDS
(Cost $9,297) 9,824
-------
- --------------------------------------------------------------------------------
<CAPTION>
Value
Shares (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
COMMON STOCKS (0.2%)
- --------------------------------------------------------------------------------
TELECOMMUNICATIONS (0.2%)
(a) Nextel Communications, Inc. 'A'
(Cost $216) 13,377 $ 348
-------
- --------------------------------------------------------------------------------
PREFERRED STOCK (6.0%)
- --------------------------------------------------------------------------------
DIVERSIFIED (4.0%)
Time Warner, Inc. Series 'M' 10.25% 6,102 6,873
-------
- --------------------------------------------------------------------------------
FINANCIAL SERVICES (1.0%)
Sinclair Capital 11.625% 15,290 1,682
-------
- --------------------------------------------------------------------------------
TELECOMMUNICATIONS (1.0%)
IXC Communications, Inc. 144A PIK 12.50% 1,545 1,777
-------
- --------------------------------------------------------------------------------
TOTAL PREFERRED STOCK
(Cost $9,093) 10,332
-------
- --------------------------------------------------------------------------------
<CAPTION>
No. of
Warrants
- --------------------------------------------------------------------------------
<S> <C> <C>
WARRANTS (0.2%)
AEROSPACE & DEFENSE (0.0%)
(a) Sabreliner Corp. , expiring 4/15/03 2,000
-------
- --------------------------------------------------------------------------------
GAMING & LODGING (0.0%)
(a) Louisiana Casino Cruises, expiring 12/1/98 1,108 --
-------
- --------------------------------------------------------------------------------
TELECOMMUNICATIONS (0.2%)
(a) Globalstar Telecom 144A, expiring 2/15/04 1,925 211
(a) Iridium World Communications, Inc. 144A,
expiring 7/15/05 840 101
(a) Nextel Communications, expiring 4/25/99 2,500 --
(a) Occidente y Caribe 144A, expiring 3/15/04 12,500
-------
312
-------
- --------------------------------------------------------------------------------
TOTAL WARRANTS
(Cost $40) 312
-------
- --------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
7
<PAGE>
<TABLE>
<CAPTION>
Face
Amount Value
(000) (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
SHORT-TERM INVESTMENTS (2.1%)
Repurchase Agreement
Chase Securities, Inc., 5.95%, dated
12/31/97, due 1/2/98, to be
repurchased at $3,720,
collateralized by $3,760 United
States Treasury Notes, 5.625%, due
2/15/06, valued at $3,799
(Cost $3,719) $ 3,719 $ 3,719
---------
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS (100.0%)
(Cost $164,422) 173,463
---------
- --------------------------------------------------------------------------------
OTHER ASSETS
Cash 76
Interest Receivable 3,011
Net Unrealized Gain on Foreign
Currency Exchange Contracts 135
Receivable for Investments Sold 71
Deferred Organization Costs 11
Receivable for Closed Foreign Currency
Exchange Contracts 9
Other Assets 13 3,326
- --------------------------------------------------------------------------------
LIABILITIES
Payable For:
Reverse Repurchase Agreements (37,819)
Dividends Declared (5,688)
Investment Advisory Fees (81)
Professional Fees (39)
Director's Fees and Expenses (38)
Shareholder Reporting Expenses (35)
Administrative Fees (16)
Custodian Fees (7)
Other Liabilities (16) (43,739)
- --------------------------------------------------------------------------------
NET ASSETS
Applicable to 8,760,708, issued and
outstanding U.S.$0.01 par value shares
(100,000,000 shares authorized) $ 133,050
---------
- --------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE $ 15.19
---------
- --------------------------------------------------------------------------------
<CAPTION>
Amount
(000)
- --------------------------------------------------------------------------------
<S> <C>
AT DECEMBER 31, 1997, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
Common Stock $ 88
Capital Surplus 122,877
Undistributed Net Investment Income 199
Accumulated Net Realized Gain 703
Unrealized Appreciation on Investments and
Foreign Currency Translations 9,183
- --------------------------------------------------------------------------------
TOTAL NET ASSETS $ 133,050
---------
- --------------------------------------------------------------------------------
</TABLE>
(a) -- Non-income producing
(b) -- Variable/floating rate security -- rate disclosed is as of December
31, 1997.
(c) -- Step Bond -- coupon rate increases in increments to maturity. Rate
disclosed is as of December 31, 1997. Maturity date disclosed is the
ultimate maturity.
(d) -- Denotes all or a portion of securities subject to repurchase under
Reverse Repurchase Agreements as of December 31, 1997 -- see note A-4
to financial statements.
144A -- Certain conditions for public sale may exist.
PIK -- Payment-in-Kind. Income may be paid in additional securities or cash
at the discretion of the issuer.
December 31, 1997 exchange rate -- German Mark (DEM) 1.799 = U.S.$1.00
Foreign Currency Exchange Contract Information:
Under the terms of foreign currency exchange contracts open at December 31,
1997, the Fund is obligated to deliver or is to receive foreign currency in
exchange for U.S. dollars as indicated below:
<TABLE>
<CAPTION>
Net
Currency In Unrealized
to Exchange Gain
Deliver Value Settlement For Value (Loss)
(000) (000) Date (000) (000) (000)
- ------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
DEM 1,980 $1,102 01/20/98 $ 1,141 $1,141 $39
2,920 1,629 02/27/98 1,681 1,681 52
$ 145 145 02/27/98 DEM 255 142 (3)
DEM 2,000 1,117 03/18/98 $ 1,135 1,135 18
3,355 1,873 03/23/98 1,902 1,902 29
------ ------ ----
$5,866 $6,001 $135
------ ------ ----
------ ------ ----
</TABLE>
The accompanying notes are an integral part of these financial statements.
8
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED
STATEMENT OF OPERATIONS DECEMBER 31, 1997
(000)
- --------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
Dividends. . . . . . . . . . . . . . . . . . . . . . . . . $ 528
Interest . . . . . . . . . . . . . . . . . . . . . . . . . 15,066
- --------------------------------------------------------------------------------
Total Income . . . . . . . . . . . . . . . . . . . . . 15,594
- --------------------------------------------------------------------------------
EXPENSES
Interest Expense on Borrowings . . . . . . . . . . . . . . 2,258
Investment Advisory Fees . . . . . . . . . . . . . . . . . 929
Administrative Fees . . . . . . . . . . . . . . . . . . . 177
Shareholder Reporting Expenses . . . . . . . . . . . . . . 94
Professional Fees . . . . . . . . . . . . . . . . . . . . 65
Custodian Fees . . . . . . . . . . . . . . . . . . . . . . 38
Directors' Fees and Expenses . . . . . . . . . . . . . . . 33
Transfer Agent Fees . . . . . . . . . . . . . . . . . . . 31
Amortization of Organization Costs . . . . . . . . . . . . 12
Other Expenses . . . . . . . . . . . . . . . . . . . . . . 30
- --------------------------------------------------------------------------------
Total Expenses . . . . . . . . . . . . . . . . . . . . 3,667
- --------------------------------------------------------------------------------
Net Investment Income . . . . . . . . . . . . . . . . 11,927
- --------------------------------------------------------------------------------
NET REALIZED GAIN (LOSS)
Investment Securities Sold . . . . . . . . . . . . . . . . 7,899
Foreign Currency Transactions . . . . . . . . . . . . . . 82
- --------------------------------------------------------------------------------
Net Realized Gain . . . . . . . . . . . . . . . . . . . 7,981
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION
Appreciation on Investments . . . . . . . . . . . . . . . 2,458
Appreciation on Foreign Currency Translations . . . . . . 142
- --------------------------------------------------------------------------------
Change in Unrealized Appreciation/Depreciation . . . . 2,600
- --------------------------------------------------------------------------------
Net Realized Gain and Change in Unrealized
Appreciation/Depreciation . . . . . . . . . . . . . . . . 10,581
- --------------------------------------------------------------------------------
Net Increase in Net Assets Resulting from Operations . . . $22,508
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996
STATEMENT OF CHANGES IN NET ASSETS (000) (000)
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
Operations:
Net Investment Income. . . . . . . . . . . . . . . . . . . . $ 11,927 $ 11,804
Net Realized Gain. . . . . . . . . . . . . . . . . . . . . . 7,981 3,064
Change in Unrealized Appreciation/Depreciation . . . . . . . 2,600 4,689
- ---------------------------------------------------------------------------------------------------------
Net Increase in Net Assets Resulting from Operations . . . . 22,508 19,557
- ---------------------------------------------------------------------------------------------------------
Distributions:
Net Investment Income. . . . . . . . . . . . . . . . . . . . (11,879) (12,391)
In Excess of Net Investment Income . . . . . . . . . . . . . - (7)
Net Realized Gain. . . . . . . . . . . . . . . . . . . . . . (4,182) -
- ---------------------------------------------------------------------------------------------------------
Total Distributions. . . . . . . . . . . . . . . . . . . . . (16,061) (12,398)
- ---------------------------------------------------------------------------------------------------------
Capital Share Transactions:
Reinvestment of Distributions
(18,040 and 22,124 shares, respectively) . . . . . . . . . 273 308
- ---------------------------------------------------------------------------------------------------------
Total Increase . . . . . . . . . . . . . . . . . . . . . . . 6,720 7,467
Net Assets:
Beginning of Period. . . . . . . . . . . . . . . . . . . . . 126,330 118,863
- ---------------------------------------------------------------------------------------------------------
End of Period (including undistributed net investment income
(distributions in excess of) of U.S.$199 and U.S.$(7),
respectively.) . . . . . . . . . . . . . . . . . . . . . . $133,050 $126,330
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
9
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1997
STATEMENT OF CASH FLOWS (000)
- --------------------------------------------------------------------------------
<S> <C>
CASH FLOWS FROM INVESTING AND OPERATING ACTIVITIES:
Proceeds from Sales of Investments . . . . . . . . . . . . $ 146,468
Purchases of Investments . . . . . . . . . . . . . . . . . (152,015)
Net Increase in Short-Term Investments . . . . . . . . . . (3,719)
Investment Income. . . . . . . . . . . . . . . . . . . . . 11,394
Interest Expense Paid. . . . . . . . . . . . . . . . . . . (1,935)
Operating Expenses Paid. . . . . . . . . . . . . . . . . . (1,382)
- --------------------------------------------------------------------------------
Net Cash Provided by Investing and Operating Activities. . (1,189)
- --------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under Reverse Repurchase Agreements . . . . . . 12,390
Distributions Paid (net of reinvestment of U.S.$273) . . . (11,198)
- --------------------------------------------------------------------------------
Net Cash Provided by Financing Activities. . . . . . . . . 1,192
- --------------------------------------------------------------------------------
Net Increase in Cash . . . . . . . . . . . . . . . . . . . 3
CASH AT BEGINNING OF PERIOD. . . . . . . . . . . . . . . . . 73
- --------------------------------------------------------------------------------
CASH AT END OF PERIOD. . . . . . . . . . . . . . . . . . . . $76
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Reconciliation of Net Investment Income to Net Cash Provided
by Investing and Operating Activities:
- --------------------------------------------------------------------------------
Net Investment Income. . . . . . . . . . . . . . . . . . . $ 11,927
Proceeds from Sales of Investments . . . . . . . . . . . . 146,468
Purchases of Investments . . . . . . . . . . . . . . . . . (152,015)
Net Increase in Short-Term Investments . . . . . . . . . . (3,719)
Net Increase in Receivables Related to Operations. . . . . (606)
Net Increase in Payables Related to Operations . . . . . . 343
Amortization of Organization Costs . . . . . . . . . . . . 12
Accretion/Amortization of Discounts and Premiums . . . . . (3,599)
- --------------------------------------------------------------------------------
Net Cash Provided by Investing and Operating Activities. . $ (1,189)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
10
<PAGE>
<TABLE>
<CAPTION>
PERIOD FROM
NOVEMBER 30,
YEAR ENDED DECEMBER 31, 1993* TO
----------------------- DECEMBER 31,
SELECTED PER SHARE DATA AND RATIOS: 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD . . . . . . . . . $ 14.45 $ 13.63 $ 11.96 $ 14.10 $ 14.10
- ---------------------------------------------------------------------------------------------------------------------------------
OFFERING COSTS . . . . . . . . . . . . . . . . . . . . - - - (0.01) (0.05)
- ---------------------------------------------------------------------------------------------------------------------------------
Net Investment Income. . . . . . . . . . . . . . . . . 1.37 1.35 1.34 1.32 0.04
Net Realized and Unrealized Gain (Loss)
on Investments . . . . . . . . . . . . . . . . . . . 1.21 0.89 1.60 (2.08) 0.01
- ---------------------------------------------------------------------------------------------------------------------------------
Total from Investment Operations . . . . . . . . . . 2.58 2.24 2.94 (0.76) 0.05
- ---------------------------------------------------------------------------------------------------------------------------------
Distributions:
Net Investment Income. . . . . . . . . . . . . . . . (1.36) (1.42) (1.27) (1.36) -
In Excess of Net Investment Income . . . . . . . . . - - - (0.01) -
Net Realized Gain. . . . . . . . . . . . . . . . . . (0.48) - - - -
- ---------------------------------------------------------------------------------------------------------------------------------
Total Distributions . . . . . . . . . . . . . . . (1.84) (1.42) (1.27) (1.37) -
- ---------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Period . . . . . . . . . . . . $15.19 $14.45 $13.63 $11.96 $14.10
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
Per Share Market Value, End of Period . . . . . . . . $16.06 $14.63 $12.88 $11.38 $14.75
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:
Market Value . . . . . . . . . . . . . . . . . . . . 23.79% 25.92% 25.21% (14.11)% 4.61%
Net Asset Value (1). . . . . . . . . . . . . . . . . 18.48% 17.52% 26.07% (5.53)% 0.00%
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
RATIOS, SUPPLEMENTAL DATA:
- ---------------------------------------------------------------------------------------------------------------------------------
Net Assets, End of Period (Thousands) . . . . . . . . $133,050 $126,330 $118,863 $104,260 $122,781
- ---------------------------------------------------------------------------------------------------------------------------------
Ratio of Expenses before Interest Expense to
Average Net Assets . . . . . . . . . . . . . . . . . 1.06% 1.12% 1.11% 1.12% 1.46%**
Ratio of Expenses After Interest Expense to
Average Net Assets . . . . . . . . . . . . . . . . . 2.76% 2.46% 2.79% 2.78% 1.46%**
Ratio of Net Investment Income to Average
Net Assets . . . . . . . . . . . . . . . . . . . . . 8.98% 9.82% 10.29% 10.18% 3.76%**
Portfolio Turnover Rate. . . . . . . . . . . . . . . . 94% 136% 84% 32% 0%
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Commencement of operations
** Annualized
(1) Total investment return based on net asset value per share reflects the
effects of changes in net asset value on the performance of the Fund during
each period, and assumes dividends and distributions, if any, were
reinvested. This percentage is not an indication of the performance of a
shareholder's investment in the Fund based on market value due to
differences between the market price of the stock and the net asset value
per share of the Fund.
The accompanying notes are an integral part of the financial statements.
11
<PAGE>
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
- -----------
The Morgan Stanley High Yield Fund, Inc. (the "Fund") was incorporated on
September 23, 1993 and is registered as a non-diversified, closed-end management
investment company under the Investment Company Act of 1940, as amended. The
Fund's primary objective is to produce high current income and as a secondary
objective, to seek capital appreciation, through investments primarily in high
yield securities.
A. The following significant accounting policies are in conformity with
generally accepted accounting principles for investment companies. Such policies
are consistently followed by the Fund in the preparation of its financial
statements. Generally accepted accounting principles may require management to
make estimates and assumptions that affect the reported amounts and disclosures
in the financial statements. Actual results may differ from those estimates.
1. SECURITY VALUATION: In valuing the Fund's assets, all listed securities for
which market quotations are readily available are valued at the last sales
price on the valuation date, or if there was no sale on such date, at the
mean between the current bid and asked prices. Securities which are traded
over-the-counter are valued at the average of the mean of the current bid
and asked prices obtained from reputable brokers. Bonds and other fixed
income securities may be valued on the basis of prices provided by
independent pricing services when such prices are believed to reflect the
fair market value of such securities. Short-term securities which mature in
60 days or less are valued at amortized cost. All other securities and
assets for which market values are not readily available (including
investments which are subject to limitations as to their sale) are valued
at fair value as determined in good faith under procedures approved by the
Board of Directors (the "Board"), although the actual calculations may be
done by others.
2. U.S. FEDERAL INCOME TAXES: It is the Fund's intention to continue to
qualify as a regulated investment company and distribute all of its taxable
income. Accordingly, no provision for U.S. Federal income taxes is required
in the financial statements.
3. REPURCHASE AGREEMENTS: In connection with transactions in repurchase
agreements, a bank as custodian for the Fund takes possession of the
underlying securities, with a market value at least equal to the amount of
the repurchase transaction, including principal and accrued interest. To
the extent that any repurchase transaction exceeds one business day, the
value of the collateral is marked-to-market on a daily basis to determine
the adequacy of the collateral. In the event of default on the obligation
to repurchase, the Fund has the right to liquidate the collateral and apply
the proceeds in satisfaction of the obligation. In the event of default or
bankruptcy by the counterparty to the agreement, realization and/or
retention of the collateral or proceeds may be subject to legal
proceedings.
4. REVERSE REPURCHASE AGREEMENTS: In order to leverage the Fund, the Fund may
enter into reverse repurchase agreements with institutions that the Fund's
investment adviser has determined are creditworthy. Under a reverse
repurchase agreement, the Fund sells securities and agrees to repurchase
them at a mutually agreed upon date and price. Reverse repurchase
agreements involve the risk that the market value of the securities
purchased with the proceeds from the sale of securities received by the
Fund may decline below the price of the securities the Fund is obligated to
repurchase. Securities subject to repurchase under reverse repurchase
agreements are designated as such in the Statement of Net Assets.
At December 31, 1997, the Fund had reverse repurchase agreements
outstanding as follows:
<TABLE>
<CAPTION>
MATURITY IN
30 TO 90
DAYS
------------
<S> <C>
Value of Securities Subject to
Repurchase . . . . . . . . . . . . . . . . . . . . . . $ 51,250,591
Liability Under Reverse
Repurchase Agreement . . . . . . . . . . . . . . . . . $ 37,819,000
Weighted Average Interest Rate. . . . . . . . . . . . . 6.74%
</TABLE>
The average weekly balance of reverse repurchase agreements outstanding
during the year ended December 31, 1997 was approximately $33,098,000 at a
weighted average interest rate of 6.72%.
5. FOREIGN CURRENCY TRANSLATION: The books and records of the Fund are
maintained in U.S. dollars. Foreign currency amounts are translated into
U.S. dollars at the mean of the bid and asked prices of such currencies
against U.S. dollars last quoted by a major bank as follows:
- investments, other assets and liabilities at the prevailing rates of
exchange on the valuation date;
- investment transactions and investment income at the prevailing rates
of exchange on the dates of such transactions.
Although the net assets of the Fund are presented at the foreign exchange
rates and market values at the close of the period, the Fund does not
isolate that portion of the results of operations arising as a result of
changes in the foreign ex-
12
<PAGE>
change rates from the fluctuations arising from changes in the market
prices of the securities held at period end. Similarly, the Fund does not
isolate the effect of changes in foreign exchange rates from the
fluctuations arising from changes in the market prices of securities sold
during the period. Accordingly, realized and unrealized foreign currency
gains (losses) are included in the reported net realized and unrealized
gains (losses) on investment transactions and balances.
Net realized gains (losses) on foreign currency transactions represent net
foreign exchange gains (losses) from sales and maturities of foreign
currency exchange contracts, disposition of foreign currencies, currency
gains or losses realized between the trade and settlement dates on
securities transactions, and the difference between the amount of
investment income and foreign withholding taxes recorded on the Fund's
books and the U.S. dollar equivalent amounts actually received or paid. Net
unrealized currency gains (losses) from valuing foreign currency
denominated assets and liabilities at period end exchange rates are
reflected as a component of unrealized appreciation (depreciation) on
investments and foreign currency translations in the Statement of Net
Assets. The change in net unrealized currency gains (losses) for the period
is reflected in the Statement of Operations.
The Fund intends to use derivatives more actively than it has in the past. The
Fund intends to engage in transactions in futures contracts on foreign
currencies, stock indices, as well as in options, swaps and structured notes.
Consistent with the Fund's investment objectives and policies, the Fund intends
to use derivatives for non-hedging as well as hedging purposes.
Following is a description of derivative instruments and their associated risks
that the Fund intends to utilize:
6. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS: The Fund may enter into
forward foreign currency exchange contracts generally to attempt to protect
securities and related receivables and payables against changes in future
foreign exchange rates and, in certain situations, to gain exposure to a
foreign currency. A foreign currency exchange contract is an agreement
between two parties to buy or sell currency at a set price on a future
date. The market value of the contract will fluctuate with changes in
currency exchange rates. The contract is marked-to-market daily and the
change in market value is recorded by the Fund as unrealized gain or loss.
The Fund records realized gains or losses when the contract is closed 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. Risk may arise upon
entering into these contracts from the potential inability of
counterparties to meet the terms of their contracts and is generally
limited to the amount of unrealized gain on the contracts, if any, at the
date of default. Risks may also arise from unanticipated movements in the
value of a foreign currency relative to the U.S. dollar.
7. WHEN-ISSUED/DELAYED DELIVERY SECURITIES: The Fund may purchase securities
on a when-issued or delayed delivery basis. Securities purchased on a
when-issued or delayed delivery basis are purchased for delivery beyond the
normal settlement date at a stated price and yield, and no income accrues
to the Fund on such securities prior to delivery. When the Fund enters into
a purchase transaction on a when-issued or delayed delivery basis, it
either establishes a segregated account in which it maintains liquid assets
in an amount at least equal in value to the Fund's commitments to purchase
such securities or denotes such assets on the Fund's Custody account as
segregated. Purchasing securities on a when-issued or delayed delivery
basis may involve a risk that the market price at the time of delivery may
be lower than the agreed-upon purchase price, in which case there could be
an unrealized loss at the time of delivery.
8. FORWARD COMMITMENTS AND WHEN-ISSUED/DELAYED DELIVERY SECURITIES: The Fund
may make forward commitments to purchase or sell securities. Payment and
delivery for securities which have been purchased or sold on a forward
commitment basis can take place a month or more (not to exceed 120 days)
after the date of the transaction. Additionally, the Fund may purchase
securities on a when-issued or delayed delivery basis. Securities purchased
on a when-issued or delayed delivery basis are purchased for delivery
beyond the normal settlement date at a stated price and yield, and no
income accrues to the Fund on such securities prior to delivery. When the
Fund enters into a purchase transaction on a when-issued or delayed
delivery basis, it either establishes a segregated account in which it
maintains liquid assets in an amount at least equal in value to the Fund's
commitments to purchase such securities or denotes such securities on the
custody statement for its regular custody account. Purchasing securities on
a forward commitment or when-issued or delayed-delivery basis may involve a
risk that the market price at the time of delivery may be lower than the
agreed upon purchase price, in which case there could be an unrealized loss
at the time of delivery.
9. SWAP AGREEMENTS: The Fund may enter into swap agreements to exchange the
return generated by one security, instrument or basket of instruments for
the return generated by another security, instrument or basket of
instruments. The following summarizes swaps which may be entered into by
the Fund:
INTEREST RATE SWAPS: Interest rate swaps involve the exchange of
commitments to pay and receive interest based on a notional principal
amount. Net periodic interest payments to be received or paid are accrued
daily and are recorded in the Statement of Operations as an adjustment to
interest income. Interest rate swaps are marked-to-market daily based upon
quotations from market makers and the change, if any, is
13
<PAGE>
recorded as unrealized appreciation or depreciation in the Statement of
Operations.
TOTAL RETURN SWAPS: Total return swaps involve commitments to pay interest
in exchange for a market-linked return based on a notional amount. To the
extent the total return of the security, instrument or basket of
instruments underlying the transaction exceeds or falls short of the
offsetting interest obligation, the Fund will receive a payment from or
make a payment to the counterparty, respectively. Total return swaps are
marked-to-market daily based upon quotations from market makers and the
change, if any, is recorded as unrealized gains or losses in the Statement
of Operations. Periodic payments received or made at the end of each
measurement period, but prior to termination, are recorded as realized
gains or losses in the Statement of Operations.
Realized gains or losses on maturity or termination of interest rate and
total return swaps are presented in the Statement of Operations. Because
there is no organized market for these swap agreements, the value reported
in the Statement of Net Assets may differ from that which would be realized
in the event the Fund terminated its position in the agreement. Risks may
arise upon entering into these agreements from the potential inability of
the counterparties to meet the terms of the agreements and are generally
limited to the amount of net interest payments to be received and/or
favorable movements in the value of the underlying security, instrument or
basket of instruments, if any, at the date of default.
10. STRUCTURED SECURITIES: The Fund may invest in interests in entities
organized and operated solely for the purpose of restructuring the
investment characteristics of sovereign debt obligations. This type of
restructuring involves the deposit with or purchase by an entity of
specified instruments and the issuance by that entity of one or more
classes of securities ("Structured Securities") backed by, or representing
interests in, the underlying instruments. Structured Securities, invested
in by the Fund, generally will have credit risk equivalent to that of the
underlying instruments. Structured Securities are typically sold in private
placement transactions with no active trading market. Investments in
structured securities may be more volatile than their underlying
instruments, however, any loss is limited to the amount of the original
investment.
11. OVER-THE-COUNTER TRADING: Derivative instruments that may be purchased or
sold by the Fund are expected to regularly consist of instruments not
traded on an exchange. The risk of nonperformance by the obligor on such an
instrument may be greater, and the ease with which the Fund can dispose of
or enter into closing transactions with respect to such an instrument may
be less, than in the case of an exchange-traded instrument. In addition,
significant disparities may exist between bid and asked prices for
derivative instruments that are not traded on an exchange. Derivative
instruments not traded on exchanges are also not subject to the same type
of government regulation as exchange traded instruments, and many of the
protections afforded to participants in a regulated environment may not be
available in connection with such transactions.
12. OTHER: Security transactions are accounted for on the date the securities
are purchased or sold. Realized gains and losses on the sale of investment
securities are determined on the specific identified cost basis. Interest
income is recognized on the accrual basis except where collection is in
doubt. Discounts and premiums on investments purchased are accreted or
amortized in accordance with the effective yield method over their
respective lives. Dividend income and distributions to shareholders are
recorded on the ex-date.
The amount and character of income and capital gain distributions to be
paid are determined in accordance with Federal income tax regulations which
may differ from generally accepted accounting principles. These differences
are primarily due to differing book and tax treatments of the timing of the
recognition of losses on securities and non-deductible expenses.
Permanent book and tax basis differences relating to shareholder
distributions may result in reclassifications to undistributed net
investment income (loss), accumulated net realized gain (loss) and capital
surplus.
Adjustments for permanent book-tax differences, if any, are not reflected
in ending undistributed net investment income (loss) for the purpose of
calculating net investment income (loss) per share in the financial
highlights.
B. Morgan Stanley Asset Management Inc. ("the Adviser") provides investment
advisory services to the Fund under the terms of an Investment Advisory
Agreement (the "Agreement"). Under the Agreement, the Adviser is paid a fee
computed weekly and payable monthly at an annual rate of .70% of the Fund's
average weekly net assets.
C. The Chase Manhattan Bank, through its affiliate Chase Global Funds Services
Company (the "Administrator"), provides administrative services to the Fund
under an Administration Agreement. Under the Administration Agreement, the
Administrator is paid a fee computed weekly and payable monthly at an annual
rate of .08% of the Fund's average weekly net assets, plus $65,000 per annum. In
addition, the Fund is charged certain out-of-pocket expenses by the
Administrator. The Chase Manhattan Bank acts as custodian for the Fund's assets
held in the United States under a Domestic Custody Agreement. Cus-
14
<PAGE>
todian fees are computed and payable monthly based on assets under custody plus
an amount for each transaction effected, including reimbursement for certain
out-of-pocket expenses.
D. Morgan Stanley Trust Company (the "International Custodian"), an affiliate
of the Adviser, acts as custodian for the Fund's assets held outside the United
States in accordance with an International Custody Agreement. International
Custodian fees are payable monthly based on Fund assets under custody plus an
amount for each transaction effected, including reimbursement for certain
out-of-pocket expenses. During the year ended December 31, 1997, the Fund did
not incur any fees to the International Custodian.
E. During the year ended December 31, 1997, the Fund made purchases and sales
totaling, approximately $152,015,000 and $145,650,000, respectively, of
investment securities other than long-term U.S. Government securities and
short-term investments. There were no purchases and sales of long-term U.S.
Government securities. At December 31, 1997, the Federal income tax cost basis
of securities was $164,430,000 and, accordingly, net unrealized appreciation for
Federal income tax purposes was $9,033,000 of which $10,730,000 related to
appreciated securities and $1,697,000 related to depreciated securities.
F. In connection with its organization, the Fund incurred $60,000 of
organization costs. The organization costs are being amortized on a
straight-line basis over a five year period beginning November 30, 1993, the
date the Fund commenced operations.
G. At December 31, 1997, a substantial portion of the Fund's total investments
consist of high yield securities rated below investment grade. Investments in
high-yield securities are accompanied by a greater degree of credit risk and the
risk tends to be more sensitive to economic conditions than higher-rated
securities. These investments are often traded by one market maker who may also
be utilized by the Fund to provide pricing information used to value such
securities. The amounts which will be realized upon disposition of the
securities may differ from the value reflected on the statement of net assets
and the differences could be material.
H. Each Director of the Fund who is not an officer of the Fund or an
affiliated person as defined under the Investment Company Act of 1940, as
amended, may elect to participate in the Directors' Deferred Compensation Plan
(the "Plan"). Under the Plan, such Directors may elect to defer payment of a
percentage of their total fees earned as a Director of the Fund. These deferred
portions are treated, based on an election by the Director, as if they were
either invested in the Fund's shares or invested in U.S. Treasury Bills, as
defined under the Plan. The deferred fees payable, under the Plan, at December
31, 1997 totaled approximately $30,000 and are included in Payable for
Directors' Fees and Expenses on the Statement of Net Assets.
I. During December 1997, the Board declared a monthly distribution of $0.17
per share, derived from net investment income and $0.48 per share, derived from
net realized gains, payable on January 9, 1998, to shareholders of record on
December 31, 1997.
FEDERAL INCOME TAX INFORMATION (UNAUDITED):
For the year ended December 31, 1997, the Fund designates $1,025,000 as
long-term capital gain at the 28% tax bracket and $1,067,000 at the 20% tax
bracket. In addition, for the year ended December 31, 1997, the percentage of
dividends, as reported on Form 1099-DIV, that qualify for the 70% dividend
receive deduction for corporate shareholders was 4%.
15
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
- ---------
To the Shareholders and Board of Directors of
The Morgan Stanley High Yield Fund, Inc.
In our opinion, the accompanying statement of net assets 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 The Morgan Stanley High Yield Fund, Inc. (the "Fund") at December
31, 1997, 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 four years in the period
then ended and for the period November 30, 1993 (commencement of operations)
through December 31, 1993, in conformity with generally accepted accounting
principles. These financial statements and financial highlights (hereafter
referred to as "financial statements") are the responsibility of the Fund's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities at December 31, 1997 by correspondence with the
custodians and brokers and the application of alternative auditing procedures
where confirmations from brokers were not received, provide a reasonable basis
for the opinion expressed above.
PRICE WATERHOUSE LLP
1177 Avenue of the Americas
New York, New York 10036
February 18, 1998
16
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DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN
Pursuant to the Dividend Reinvestment and Cash Purchase Plan (the "Plan"),
each shareholder may elect by providing written instructions to American Stock
Transfer & Trust Company (the "Plan Agent") to have all distributions
automatically reinvested in Fund Shares. Participants in the Plan have the
option of making additional voluntary cash payments to the Plan Agent, annually,
in any amount from $100 to $3,000, for investment in Fund shares.
Dividend and capital gain distributions will be reinvested on the
reinvestment date in full and fractional shares. If the market price per share
equals or exceeds net asset value per share on the reinvestment date, the Fund
will issue shares to participants at net asset value. If net asset value is less
than 95% of the market price on the reinvestment date, shares will be issued at
95% of the market price. If net asset value exceeds the market price on the
reinvestment date, participants will receive shares valued at market price. The
Fund may purchase shares of its Common Stock in the open market in connection
with dividend reinvestment requirements at the discretion of the Board of
Directors. Should the Fund declare a dividend or capital gain distribution
payable only in cash, the Plan Agent will purchase Fund shares for participants
in the open market as agent for the participants.
The Plan Agent's fees for the reinvestment of dividends and distributions
will be paid by the Fund. However, each participant's account will be charged a
pro rata share of brokerage commissions incurred on any open market purchases
effected on such participant's behalf. A participant will also pay brokerage
commissions incurred on purchases made by voluntary cash payments. Although
shareholders in the Plan may receive no cash distributions, participation in the
Plan will not relieve participants of any income tax which may be payable on
such dividends or distributions.
In the case of shareholders, such as banks, brokers or nominees, which hold
shares for others who are the beneficial owners, the Plan Agent will administer
the Plan on the basis of the number of shares certified from time to time by the
shareholder as representing the total amount registered in the shareholder's
name and held for the account of beneficial owners who are participating in the
Plan.
Participants who wish to withdraw from the Plan should notify the Plan
Agent in writing. There is no penalty for non-participation or withdrawal from
the Plan, and shareholders who have previously withdrawn from the Plan may
rejoin at any time. Requests for additional information or any correspondence
concerning the Plan should be directed to the Plan Agent at:
The Morgan Stanley High Yield Fund, Inc.
American Stock Transfer & Trust Company
Dividend Reinvestment and Cash Purchase Plan
40 Wall Street
New York, NY 10005
1-800-278-4353
17
