<PAGE>
- --------------------------------------------------------------------------------
THE
MORGAN STANLEY
HIGH YIELD
FUND, INC.
- --------------------------------------------------------------------------------
ANNUAL REPORT
DECEMBER 31, 1998
MORGAN STANLEY DEAN WITTER INVESTMENT
MANAGEMENT INC.
INVESTMENT ADVISER
THE MORGAN STANLEY HIGH YIELD FUND, INC.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
DIRECTORS AND OFFICERS
Barton M. Biggs
CHAIRMAN OF THE BOARD
OF DIRECTORS
Michael F. Klein
PRESIDENT AND DIRECTOR
Peter J. Chase
DIRECTOR
John W. Croghan
DIRECTOR
David B. Gill
DIRECTOR
Graham E. Jones
DIRECTOR
John A. Levin
DIRECTOR
William G. Morton, Jr.
DIRECTOR
Stefanie V. Chang
VICE PRESIDENT
Harold J. Schaaff, Jr.
VICE PRESIDENT
Joseph P. Stadler
VICE PRESIDENT
Valerie Y. Lewis
SECRETARY
Joanna M. Haigney
TREASURER
Belinda A. Brady
ASSISTANT TREASURER
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
INVESTMENT ADVISER
Morgan Stanley Dean Witter Investment Management Inc.
1221 Avenue of the Americas
New York, New York 10020
- --------------------------------------------------------------------------------
ADMINISTRATOR
The Chase Manhattan Bank
73 Tremont Street
Boston, Massachusetts 02108
- --------------------------------------------------------------------------------
CUSTODIANS
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
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INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP
1177 Avenue of the Americas
New York, New York 10036
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- --------------------------------------------------------------------------------
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.
<PAGE>
LETTER TO SHAREHOLDERS
- ---------
For the year ended december 31, 1998, the Morgan Stanley High Yield Fund, Inc.
(the "Fund") had a total return, based on net asset value per share, of 4.12%
compared to 0.58% 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, 1998, the Fund's total return based on net asset value per
share, was 72.68% compared to 49.88% for the Index. On December 31, 1998, the
closing price of the Fund's shares on the New York Stock Exchange was
$15 3/8, representing a 12.9% premium to the Fund's net asset value per share.
The high yield market underperformed high quality bonds in 1998 by over 500
basis points. Global financial turmoil highlighted by the default of Russia and
the subsequent flight to quality caused spreads to widen dramatically in the
third quarter. For the year, the weakness in the third quarter outweighed strong
returns for the asset class in the first and fourth quarters.
Technical factors and fear were primarily responsible for the spread widening
that occurred in the third quarter. However, for the year, default rates also
rose meaningfully, which put pressure on specific industries. Leveraged
investors including many hedge funds were forced to sell to satisfy margin
calls. At the same time, dealers were under pressure to keep inventories low
and net cash flows into mutual funds turned negative. Consistent with the
other non-Treasury sectors of the bond market, high yield bonds rebounded
strongly in the fourth quarter. An accommodative Fed reduced fears of a
credit crunch allowing liquidity to return to this market as well. Technical
conditions improved dramatically: mutual fund cash flows were strong, demand for
the large number of new issues has been overwhelming, and the deleveraging so
prevalent in the previous quarter appears to be over. A strong equity market
and improving conditions in the emerging markets also enhanced the confidence of
high yield investors in late December and early January. Uncertainty arose
again, however, as Brazil's financial crisis heightened.
Results relative to the Index were negatively impacted by exposure to non-U. S.
issues and an overweighting in the telecommunications sector. Positive
contributions to our relative performance included a higher average credit
rating than the Index, an underweight position in cyclical and commodity sectors
such as metals, paper, energy and utilities and superior security selection
across several sectors. In addition, our focus on larger capitalization public
companies, which is a key tenet of our investment philosophy, helped support
the domestic portion of the Fund.
Current sector allocation, which is driven primarily by bottom up security
selection, can be described as follows.
The Fund remains the most overweighted in the telecommunications and emerging
markets sectors where we continue to find value. The Fund is also
overweighted in the healthcare, retail and gaming sectors. We have less than
the Index's exposure in the media and consumer sector as well as in the
commodity and cyclical sectors. We are also finding value in securities of
selected Western European issuers. As a result of our valuation discipline,
the Fund continues to maintain an average credit quality that is higher than
that of the Index, while the interest rate sensitivity is close to that of
the Index.
Even after the recent rebound, yield spreads on high yield bonds now exceed 500
basis points over Treasuries-levels not seen since the early 1990's. During
that historical period, default rates were very high (reaching 10% in 1990 and
1991), interest coverage ratios were less than 2.0 times, and there was serious
concern over the health of the banking system. Today, default rates are less
than 3%, coverage ratios average 2.5 times, and the U.S. financial system is
better capitalized. Also, the rating agency upgrade to downgrade ratio is
better today than it was in the late 80's, and the percentage of equity in the
capital structures of high yield issuers is significantly higher. Finally, cash
flow continues to improve for many of the issuers we follow. In summary,
prices in the high yield market continue to discount worst case outcomes/default
rates that are historically very high at a time when the fundamental credit
quality of most high yield issuers is quite strong and the financial system is
very healthy. Consequently, we believe that high yield bonds may offer
compelling value, and we continue to find attractive bottom up investment
opportunities using our valuation criteria.
Sincerely,
/s/ Michael F. Klein
Michael F. Klein
PRESIDENT AND DIRECTOR
January 1999
THE INFORMATION CONTAINED IN THIS OVERVIEW REGARDING SPECIFIC SECURITIES IS FOR
INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE CONSTRUED AS A RECOMMENDATION TO
PURCHASE OR SELL THE SECURITIES MENTIONED.
2
<PAGE>
The Morgan Stanley High Yield Fund, Inc.
Investment Summary as of December 31, 1998 (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 11.15% 11.15% 4.12% 4.12% 0.58% 0.58%
Five Year 86.34 13.26 72.68 11.54 48.02 8.16
Since Inception* 94.91 14.02 72.68 11.34 49.88 8.28
</TABLE>
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
- --------------------------------------------------------------------------------
RETURNS AND PER SHARE INFORMATION
[GRAPH]
<TABLE>
<CAPTION>
Year Ended December 31,
1993* 1994 1995 1996 1997 1998
----- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value Per Share. . . . . . . . $ 14.10 $ 11.96 $ 13.63 $ 14.45 $ 15.19 $ 13.62
Market Value Per Share . . . . . . . . . $ 14.75 $ 11.38 $ 12.88 $ 14.63 $ 16.06 $ 15.38
Premium/(Discount) . . . . . . . . . . . 4.6% -4.8% -5.5% 1.3% 5.7% 12.9%
Income Dividends . . . . . . . . . . . . -- $ 1.37 $ 1.27 $ 1.42 $ 1.36 $ 1.42
Capital Gains Distributions. . . . . . . -- -- -- -- $ 0.48 $ 0.83
Fund Total Return (2). . . . . . . . . . 0.00% -5.53% 26.07% 17.52% 18.48% 4.12%
Index Total Return (1)(3). . . . . . . . 1.26% -0.98% 17.39% 12.40% 12.65% 0.58%
</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>
The Morgan Stanley High Yield Fund, Inc.
Portfolio Summary as of December 31, 1998
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
DIVERSIFICATION OF TOTAL INVESTMENTS
[CHART]
<TABLE>
<S> <C>
Debt Instruments (95.8%)
Equity Securities (2.3%)
Short-Term Investments (1.9%)
</TABLE>
- --------------------------------------------------------------------------------
SECTORS
[CHART]
<TABLE>
<S> <C>
Asset Backed Securities (5.6%)
Broadcast -- Radio &
Television (11.5%)
Diversified (3.5%)
Financial Services (4.3%)
Foreign Government Bonds (4.4%)
Gaming & Lodging (4.0%)
Health Care Supplies &
Services (6.7%)
Multi - Industry (13.7%)
Telecommunications (20.2%)
Utilities (3.0%)
Other (23.1%)
</TABLE>
- --------------------------------------------------------------------------------
TEN LARGEST HOLDINGS*
<TABLE>
<CAPTION>
PERCENT OF
TOTAL
INVESTMENTS
-----------
<S> <C>
1. DR Securitized Lease Trust 3.9%
2. Nextel Communications, Inc. 3.4
3. Columbia/HCA Healthcare 3.1
4. Tenet Healthcare Corp. 2.8
5. Jet Equipment Trust 2.3
6. Lenfest Communications, Inc. 2.0%
7. TV Azteca 'B' 10.50%, 2/15/07 1.9
8. CSC Holdings, Inc. 1.9
9. Station Casinos, Inc. 1.8
10. Republic of Argentina. 1.8
----
24.9%
----
----
</TABLE>
* Excludes short-term investments.
4
<PAGE>
FINANCIAL STATEMENTS
- -------
STATEMENT OF NET ASSETS
(SHOWING PERCENTAGE OF TOTAL VALUE OF INVESTMENTS)
- -------
DECEMBER 31, 1998
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- -------------------------------------------------------------------------------
<S> <C> <C>
CORPORATE BONDS AND NOTES (83.3%)
- -------------------------------------------------------------------------------
AEROSPACE & DEFENSE (2.6%)
Jet Equipment Trust
'C1' 11.79%, 6/15/13 $ 1,500 $ 1,969
(b) 'D-95' 11.44%, 11/1/14 1,100 1,433
(b) Satelites Mexicanos 'B'
10.125%, 11/1/04 565 463
------------
3,865
------------
- -------------------------------------------------------------------------------
AUTOMOTIVE (0.8%)
(b) Hayes Lemmerz International, Inc.
8.25%, 12/15/08 1,220 1,217
------------
- -------------------------------------------------------------------------------
BANKING (1.1%)
(b,d,e) SB Treasury Co. LLC
9.40%, 12/29/49 1,010 957
Western Financial Bank
8.875%, 8/1/07 885 637
------------
1,594
------------
- -------------------------------------------------------------------------------
BROADCAST --- RADIO & TELEVISION (11.5%)
(b,e) Chancellor Media Corp.
9.00%, 10/1/08 1,080 1,139
Chancellor Media Corp. 'B'
8.125%, 12/15/07 1,370 1,367
(b) HMV Media Group plc
10.875%, 5/15/08 GBP 1,035 1,601
(d) Intermedia Communications, Inc. 'B'
0.00%, 7/15/07 $ 3,000 2,070
Lenfest Communications, Inc.
(b) 7.625%, 2/15/08 800 839
(e) 8.375%, 11/1/05 2,010 2,171
(b) Metromedia Fiber Network
10.00%, 11/15/08 790 814
(d) RCN Corp.
0.00%, 10/15/07 3,000 1,695
Rogers Cablesystems
10.125%, 9/1/12 650 718
Rogers Cablesystems 'B'
10.00%, 3/15/05 1,505 1,686
(e) TV Azteca 'B'
10.50%, 2/15/07 3,460 2,837
------------
16,937
------------
- -------------------------------------------------------------------------------
BUILDING MATERIALS & COMPONENTS (1.7%)
(e) American Standard Cos., Inc.
7.375%, 2/1/08 1,370 1,376
(b) Building Materials Corp.
8.00%, 12/1/08 1,115 1,112
------------
2,488
------------
- -------------------------------------------------------------------------------
BUSINESS SERVICES (1.1%)
(e) Outdoor Systems, Inc.
8.875%, 6/15/07 $ 1,480 $1,576
------------
- -------------------------------------------------------------------------------
COAL, GAS & OIL (2.3%)
(b,d) Husky Oil, Ltd.
8.90%, 8/15/28 885 879
(b) RAS Laffan Liquid Natural Gas
8.294%, 3/15/14 950 794
(b) Snyder Oil Corp.
8.75%, 6/15/07 1,750 1,698
------------
3,371
------------
- -------------------------------------------------------------------------------
DIVERSIFIED (3.5%)
(b) CEX Holdings, Inc.
9.625%, 6/1/08 1,065 964
CSC Holdings, Inc.
7.875%, 12/15/07 575 610
(e) 9.875%, 5/15/06 1,955 2,150
ISP Holdings, Inc. 'B'
9.00%, 10/15/03 1,350 1,424
------------
5,148
------------
- -------------------------------------------------------------------------------
ELECTRONICS (0.1%)
(b) AST Research Inc.
7.45%, 10/1/02 175 154
------------
- -------------------------------------------------------------------------------
ENERGY (0.5%)
Quezon Power Ltd.
8.86%, 6/15/17 1,000 745
------------
- -------------------------------------------------------------------------------
ENVIRONMENTAL CONTROLS (1.2%)
(d) Norcal Waste Systems, Inc.
13.50%, 11/15/05 1,600 1,728
------------
- -------------------------------------------------------------------------------
FINANCE (1.2%)
(d) PTC International Finance B.V.
0.00%, 7/1/07 2,470 1,717
------------
- -------------------------------------------------------------------------------
FINANCIAL SERVICES (3.2%)
CB Richard Ellis Services
8.875%, 6/1/06 700 679
Geberit International
10.125%, 4/15/07 DEM 1,700 1,160
Globalstar LP
11.375%, 2/15/04 $ 850 638
Indah Kiat Finance
(b) 10.00%, 7/1/07 420 227
(e) 10.00%, 7/1/07 1,530 826
Iridium LLC/Capital Corp. 'A'
13.00%, 7/15/05 1,285 1,176
------------
4,706
------------
- -------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- -------------------------------------------------------------------------------
<S> <C> <C>
FOOD (0.8%)
Smithfield Foods, Inc.
7.625%, 2/15/08 $ 1,175 $ 1,181
------------
- -------------------------------------------------------------------------------
FOREST PRODUCTS & PAPER (0.3%)
APP Fin II Mauritius Ltd.
12.00%, 2/15/04 865 411
------------
- -------------------------------------------------------------------------------
GAMING & LODGING (4.0%)
(e) Grand Casinos
10.125%, 12/1/03 1,495 1,630
Hilton Hotels
7.95%, 4/15/07 1,510 1,564
(e) Station Casinos, Inc.
10.125%, 3/15/06 2,555 2,695
------------
5,889
------------
- -------------------------------------------------------------------------------
HEALTH CARE SUPPLIES & SERVICES (6.7%)
Columbia/HCA Healthcare
(e) 6.91%, 6/15/05 2,650 2,597
(e) 7.00%, 7/1/07 2,025 1,961
Fresenius Medical Capital Trust II
7.875%, 2/1/08 1,195 1,189
Tenet Healthcare Corp.
(b) 8.125%, 12/1/08 1,000 1,025
(e) 8.625%, 1/15/07 2,955 3,103
------------
9,875
------------
- -------------------------------------------------------------------------------
METALS (2.0%)
Algoma Steel, Inc.
12.375%, 7/15/05 340 248
Grupo Minero Mexico 'A'
8.25%, 4/1/08 590 508
Impress Metal Packaging
(b) 9.875%, 5/29/07 DEM 2,750 1,821
(b) 9.875%, 5/29/07 400 265
(b) NSM Steel, Inc.
12.25%, 2/1/08 $ 825 116
------------
2,958
------------
- -------------------------------------------------------------------------------
MULTI - INDUSTRY (13.7%)
(b)Adelphia Communications
8.375%, 2/1/08 300 312
Adelphia Communications 'B'
8.375%, 2/1/08 800 832
9.875%, 3/1/07 200 222
AMSC Acquisition Co., Inc. 'B'
12.25%, 4/1/08 1,725 1,069
(b)Axia, Inc.
10.75%, 7/15/08 585 594
(b)CA FM Lease Trust
8.50%, 7/15/17 1,422 1,578
(b)Cathay International Ltd.
13.00%, 4/15/08 $ 525 $ 197
Glencore Nickel Property Ltd.
9.00%, 12/1/14 935 748
Global Crossing Holdings Ltd.
9.625%, 5/15/08 1,790 1,879
Harrahs Operating Co., Inc.
7.875%, 12/5/05 660 662
(e)Multicanal
10.50%, 2/1/07 1,705 1,578
(b)Multicanal 'C'
10.50%, 4/15/18 725 605
(b)Murrin Murrin Holdings
Property Ltd.
9.375%, 8/31/07 1,075 957
Musicland Group, Inc.
9.00%, 6/15/03 325 312
Musicland Group, Inc. 'B'
9.875%, 3/15/08 1,600 1,560
Norampac, Inc.
9.50%, 2/1/08 800 816
(b)Nortek, Inc.
8.875%, 8/1/08 750 763
Park Place Entertainment
7.875%, 12/15/05 1,195 1,198
(b)RBS Participacoes
11.00%, 4/1/07 850 527
(b)Reliance Industries Ltd.
9.375%, 6/24/26 445 399
(e)SD Warren Co. 'B'
12.00%, 12/15/04 2,235 2,436
(b)Sirona Dental Systems
9.125%, 7/15/08 DEM 1,650 995
------------
20,239
------------
- -------------------------------------------------------------------------------
REAL ESTATE (1.6%)
(e)HMH Properties 'A'
7.875%, 8/1/05 $ 2,380 2,341
------------
- -------------------------------------------------------------------------------
RETAIL -- GENERAL (0.6%)
Southland Corp.
5.00%, 12/15/03 930 818
------------
- -------------------------------------------------------------------------------
TELECOMMUNICATIONS (19.0%)
(b)American Cellular Corp.
10.50%, 5/15/08 775 760
(b)Centennial Cellular
10.75%, 12/15/08 695 698
Comcast Cellular Holdings 'B'
9.50%, 5/1/07 245 261
(d)Dial Call Communications 'B'
0.00%, 12/15/05 560 559
Dobson Communications Corp.
11.75%, 4/15/07 720 734
- -------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- -------------------------------------------------------------------------------
<S> <C> <C>
TELECOMMUNICATIONS (19.0%) (CONTINUED)
(d)Dolphin Telecommunications plc
0.00%, 6/1/08 ECU 1,520 $ 580
Espirit Telecom Group 'DM'
11.50%, 12/15/07 DEM 1,300 796
Flag Ltd.
8.25%, 1/30/08 $ 900 886
(b)Globopar 1996-B, Class C
10.625%, 12/5/08 650 419
IXC Communications, Inc.
9.00%, 4/15/08 1,295 1,289
(e)Level 3 Communications, Inc.
9.125%, 5/1/08 1,300 1,284
Nextel Communications, Inc.
(d) 0.00%, 8/15/04 1,575 1,528
(d) 0.00%, 9/15/07 5,520 3,533
NEXTLINK Communications, Inc.
(d)0.00%, 4/15/08 2,500 1,437
(b)10.75%, 11/15/08 225 230
(b,d)NTL, Inc.
0.00%, 4/1/08 2,325 1,441
(d)Occidente y Caribe
0.00%, 3/15/04 3,125 2,273
(e)Philippine Long Distance Telephone
9.25%, 6/30/06 1,725 1,639
Primus Telecommunications
Group 'B'
9.875%, 5/15/08 1,000 955
(e)Qwest Communications
International, Inc.
10.875%, 4/1/07 710 817
(d)Qwest Communications
International, Inc. 'B'
0.00%, 2/1/08 1,000 755
Rogers Communications, Inc.
8.875%, 7/15/07 750 776
(e)9.125%, 1/15/06 800 832
RSL Communications plc
(e)9.125%, 3/1/08 1,165 1,060
(b)12.00%, 11/1/08 900 945
RSL Communications, Ltd.
(d)0.00%, 3/15/08 DEM 2,700 893
12.25%, 11/15/06 $ 88 93
(b)Viatel, Inc.
0.00%, 4/15/08 980 556
------------
28,029
------------
- -------------------------------------------------------------------------------
TRANSPORTATION (0.8%)
Hermes Europe Railtel B.V.
(b) 10.375%, 1/15/09 250 251
11.50%, 8/15/07 945 997
------------
1,248
------------
- -------------------------------------------------------------------------------
UTILITIES (3.0%)
AES Corp.
8.50%, 11/1/07 $ 1,430 $ 1,451
(e)Korea Electric Power Corp.
7.75%, 4/1/13 1,810 1,527
Niagara Mohawk Power 'G'
7.75%, 10/1/08 433 473
(d)Niagara Mohawk Power 'H'
0.00%, 7/1/10 1,245 959
------------
4,410
------------
- -------------------------------------------------------------------------------
TOTAL CORPORATE BONDS AND NOTES
(Cost $125,729) 122,645
------------
- -------------------------------------------------------------------------------
ASSET-BACKED SECURITIES (5.6%)
- -------------------------------------------------------------------------------
Aircraft Lease Portfolio
Securitization Ltd.
1996-1 P1D 12.75%, 6/15/06 1,594 1,594
DR Securitized Lease Trust
1993-K1 A1 6.66%, 8/15/10 2,056 1,951
1994-K1 A1 7.60%, 8/15/07 3,271 3,258
1994-K2 A2 9.35%, 8/15/19 500 521
(b)First Home Mortgage Acceptance
Corp., 1996-B, Class C
7.929%, 11/1/18 1,312 997
------------
8,321
------------
- -------------------------------------------------------------------------------
TOTAL ASSET-BACKED SECURITIES
(Cost $7,708) 8,321
------------
- -------------------------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS (2.5%)
- -------------------------------------------------------------------------------
DLJ Mortgage Acceptance Corp.
1997-CF2 S
0.357%, 10/15/30 32,622 734
GMAC IO 1996-C1 CL X2 REMIC
2.590%, 3/15/21 6,330 443
Long Beach Auto 1997-1, 'B'
14.22%, 10/26/03 1,499 1,490
(b)OHA Auto Grantor Trust 1997-1, 'B'
11.00%, 1/15/04 1,045 1,015
------------
3,682
------------
- -------------------------------------------------------------------------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS
(Cost $4,004) 3,682
------------
- --------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
7
<PAGE>
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- -------------------------------------------------------------------------------
<S> <C> <C>
FOREIGN GOVERNMENT BONDS (4.4%)
- -------------------------------------------------------------------------------
ARGENTINA (1.8%)
(d)Republic of Argentina 'L'
6.188%, 3/31/05 $ 1,791 $ 1,531
(d)Republic of Argentina Pre 4
Bocon PIK
5.198%, 9/1/02 1,031 1,122
------------
2,653
------------
- -------------------------------------------------------------------------------
INDONESIA (0.7%)
(b,e)Pindo Deli Finance (Mauritius)
10.75%, 10/1/07 1,955 1,017
------------
- -------------------------------------------------------------------------------
KOREA (1.5%)
Korea Development Bank
6.625%, 11/21/03 2,460 2,189
------------
- -------------------------------------------------------------------------------
MEXICO (0.4%)
United Mexican States Par Bond 'W-A'
6.25%, 12/31/19 770 601
------------
- -------------------------------------------------------------------------------
TOTAL FOREIGN GOVERNMENT BONDS
(Cost $7,163) 6,460
------------
- -------------------------------------------------------------------------------
SHARES
- -------------------------------------------------------------------------------
PREFERRED STOCK (2.0%)
- -------------------------------------------------------------------------------
FINANCIAL SERVICES (1.1%)
Sinclair Capital 11.625% 15,290 1,628
------------
- -------------------------------------------------------------------------------
TELECOMMUNICATIONS (0.9%)
(a)IXC Communications, Inc. 'B' 1,246 1,271
(a,f)Viatel, Inc., Series 'A' 10.00% 505 3
------------
1,274
------------
- -------------------------------------------------------------------------------
TOTAL PREFERRED STOCK
(Cost $2,621) 2,902
------------
- -------------------------------------------------------------------------------
NO. OF
WARRANTS
- -------------------------------------------------------------------------------
WARRANTS (0.3%)
- -------------------------------------------------------------------------------
METALS (0.0%)
(a,b)NSM Steel, Inc., expiring 2/1/08 522,301 --@
------------
- -------------------------------------------------------------------------------
TELECOMMUNICATIONS (0.3%)
(a,b)American Mobile Satellite
Corp., expiring 4/1/08 1,725 1
(a,b)Globalstar Telecom, expiring 2/15/04 1,000 55
(a,b)Iridium World Communications, Inc.,
expiring 7/15/05 840 127
(a,b)Nextel Communications,
expiring 4/25/99 2,500 $ --@
(a,b)Occidente y Caribe, expiring 3/15/04 12,500 219
------------
402
------------
- -------------------------------------------------------------------------------
TOTAL WARRANTS
(Cost $--@) 402
------------
- -------------------------------------------------------------------------------
FACE
AMOUNT
(000)
- -------------------------------------------------------------------------------
SHORT-TERM INVESTMENTS (1.9%)
- -------------------------------------------------------------------------------
REPURCHASE AGREEMENT
Chase Securities, Inc., 4.45%,
dated 12/31/98, due 1/4/99, to
be repurchased at $2,857,
collateralized by $1,925 United
States Treasury Bonds, 9.875%,
due 11/15/15, valued at $2,919
(Cost $2,856) $ 2,856 2,856
------------
- -------------------------------------------------------------------------------
TOTAL INVESTMENTS (100.0%)
(Cost $150,081) 147,268
------------
- -------------------------------------------------------------------------------
OTHER ASSETS
Cash 47
Interest Receivable 3,263
Receivable for Investments Sold 458
Receivable for Daily Variation
on Futures Contracts 2
Other Assets 7 3,777
------------ ------------
- -------------------------------------------------------------------------------
LIABILITIES
Payable For:
Reverse Repurchase Agreements (21,930)
Dividends Declared (8,647)
Investments Purchased (250)
Investment Advisory Fees (76)
Directors' Fees and Expenses (44)
Shareholder Reporting Expenses (41)
Net Unrealized Loss on Foreign
Currency Exchange Contracts (41)
Professional Fees (38)
Administrative Fees (14)
Custodian Fees (4)
Other Liabilities (20) (31,105)
------------ ------------
- -------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
8
<PAGE>
<TABLE>
<CAPTION>
AMOUNT
(000)
- -------------------------------------------------------------------------------
<S> <C>
NET ASSETS (100%)
Applicable to 8,803,010, issued and
outstanding $0.01 par value shares
(100,000,000 shares authorized) $119,940
------------
------------
- -------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE $ 13.62
------------
------------
- --------------------------------------------------------------------------------
AT DECEMBER 31, 1998, NET ASSETS CONSISTED OF:
- -------------------------------------------------------------------------------
Common Stock $ 88
Capital Surplus 123,530
Distributions in Excess of Net Investment
Income (198)
Accumulated Net Realized Loss (597)
Unrealized Depreciation on Investments
and Foreign Currency Translations (2,883)
- -------------------------------------------------------------------------------
TOTAL NET ASSETS $119,940
------------
------------
- -------------------------------------------------------------------------------
(a) -- Non-income producing
(b) -- 144A Security - certain conditions for public sale may
exist.
(c) -- Variable/floating rate security -- rate disclosed is as of
December 31, 1998.
(d) -- Step Bond -- coupon rate increases in increments to maturity.
Rate disclosed is as of December 31, 1998. Maturity date disclosed is
the ultimate maturity.
(e) -- Denotes all or a portion of securities subject to repurchase
under Reverse Repurchase Agreements as of December 31, 1998 --
see note A-4 to financial statements.
(f) -- Security valued at fair value -- See note A-1 to financial
statements.
@ -- Value is less than U.S.$500.
PIK -- Payment-in-Kind. Income may be paid in additional securities or cash
at the discretion of the issuer.
- -------------------------------------------------------------------------------
DECEMBER 31, 1998 EXCHANGE RATES:
- -------------------------------------------------------------------------------
ECU European Currency Unit 0.852 = U.S. $1.00
DEM German Mark 1.666 = U.S. $1.00
GBP Great British Pound 0.602 = U.S. $1.00
- -------------------------------------------------------------------------------
FUTURES CONTRACTS:
At December 31, 1998, the following futures contracts were open:
NET
NUMBER AGGREGATE UNREALIZED
OF FACE VALUE EXPIRATION LOSS
CONTRACTS (000) DATE (000)
--------- ---------- ---------- ----------
Long:
Long Gilt 6 U.S.$ 1,186 Mar-99 U.S.$(32)
----- --------
----- --------
- -------------------------------------------------------------------------------
</TABLE>
FOREIGN CURRENCY EXCHANGE CONTRACT INFORMATION:
Under the terms of foreign currency exchange contracts open at December 31,
1998, 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 495 $ 297 12/07/98 $ 302 $ 302 $ 5
ECU 425 500 01/25/99 $ 496 496 (4)
DEM 5,500 3,305 01/27/99 $3,314 3,314 9
DEM 2,920 1,755 01/29/99 $1,718 1,718 (37)
DEM 495 297 02/08/99 $ 297 297 --
DEM 1,210 728 02/22/99 $ 729 729 1
GBP 875 1,453 03/03/99 $1,438 1,438 (15)
------ ------ -----
$8,335 $8,294 $(41)
------ ------ -----
------ ------ -----
</TABLE>
The accompanying notes are an integral part of these financial statements.
9
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1998
STATEMENT OF OPERATIONS (000)
- ----------------------------------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
Dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 356
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,388
- ----------------------------------------------------------------------------------------------------------------
Total Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,744
- ----------------------------------------------------------------------------------------------------------------
EXPENSES
Interest Expense on Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,480
Investment Advisory Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 920
Administrative Fees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176
Custodian Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76
Shareholder Reporting Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76
Professional Fees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
Transfer Agent Fees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Directors' Fees and Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Other Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
- ----------------------------------------------------------------------------------------------------------------
Total Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,927
- ----------------------------------------------------------------------------------------------------------------
Net Investment Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,817
- ----------------------------------------------------------------------------------------------------------------
NET REALIZED GAIN (LOSS)
Investment Securities Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,390
Foreign Currency Transactions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (129)
Futures Contracts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
- ----------------------------------------------------------------------------------------------------------------
Net Realized Gain. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,280
- ----------------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION
Depreciation on Investments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (11,854)
Depreciation on Foreign Currency Translations. . . . . . . . . . . . . . . . . . . . . . . . (212)
- ----------------------------------------------------------------------------------------------------------------
Change in Unrealized Appreciation/Depreciation . . . . . . . . . . . . . . . . . . . . . . (12,066)
- ----------------------------------------------------------------------------------------------------------------
Net Realized Gain and Change in Unrealized Appreciation/Depreciation . . . . . . . . . . . . . . (5,786)
- ----------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS . . . . . . . . . . . . . . . . . . . . $ 6,031
- ----------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997
STATEMENT OF CHANGES IN NET ASSETS (000) (000)
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
Operations:
Net Investment Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 11,817 $ 11,927
Net Realized Gain. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,280 7,981
Change in Unrealized Appreciation/Depreciation . . . . . . . . . . . . . . . (12,066) 2,600
- ----------------------------------------------------------------------------------------------------------------
Net Increase in Net Assets Resulting from Operations . . . . . . . . . . . . 6,031 22,508
- ----------------------------------------------------------------------------------------------------------------
Distributions:
Net Investment Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . (12,267) (11,879)
In Excess of Net Investment Income . . . . . . . . . . . . . . . . . . . . . (198) -
Net Realized Gain. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6,732) (4,182)
In Excess of Net Realized Gain . . . . . . . . . . . . . . . . . . . . . . . (597) -
- ----------------------------------------------------------------------------------------------------------------
Total Distributions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (19,794) (16,061)
- ----------------------------------------------------------------------------------------------------------------
Capital Share Transactions:
Reinvestment of Distributions (42,301 and 18,040 shares, respectively) . . . 653 273
- ----------------------------------------------------------------------------------------------------------------
Net Increase in Net Assets Resulting from Capital Share Transactions . . . . 653 273
- ----------------------------------------------------------------------------------------------------------------
Total Increase (Decrease). . . . . . . . . . . . . . . . . . . . . . . . . . (13,110) 6,720
Net Assets:
Beginning of Period. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133,050 126,330
- ----------------------------------------------------------------------------------------------------------------
End of Period (including (distribution in excess of net investment income) /
undistributed net investment income of $(198) and $199, respectively). . . $119,940 $133,050
- ----------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
10
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1998
STATEMENT OF CASH FLOWS (000)
- ----------------------------------------------------------------------------------------------------------------
<S> <C>
CASH FLOWS FROM INVESTING AND OPERATING ACTIVITIES:
Proceeds from Sales of Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 136,583
Purchases of Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (114,503)
Net Increase in Short-Term Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . 863
Investment Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,015
Interest Expense Paid. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,921)
Operating Expenses Paid. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,436)
- ----------------------------------------------------------------------------------------------------------------
Net Cash Provided by Investing and Operating Activities. . . . . . . . . . . . . . . . . . . 31,601
- ----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash Paid for Reverse Repurchase Agreements. . . . . . . . . . . . . . . . . . . . . . . . . (15,448)
Cash Distributions Paid (net of reinvestment of U.S.$653). . . . . . . . . . . . . . . . . . (16,182)
- ----------------------------------------------------------------------------------------------------------------
Net Cash used for Financing Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . (31,630)
- ----------------------------------------------------------------------------------------------------------------
Net Decrease in Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (29)
CASH AT BEGINNING OF PERIOD. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76
- ----------------------------------------------------------------------------------------------------------------
CASH AT END OF PERIOD. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 47
- ----------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------
RECONCILIATION OF NET INVESTMENT INCOME TO NET CASH PROVIDED BY INVESTING AND
OPERATING ACTIVITIES:
- ----------------------------------------------------------------------------------------------------------------
Net Investment Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 11,817
Proceeds from Sales of Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136,583
Purchases of Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (114,503)
Net Increase in Short-Term Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . 863
Net Increase in Receivables Related to Operations. . . . . . . . . . . . . . . . . . . . . . (246)
Net Decrease in Payables Related to Operations . . . . . . . . . . . . . . . . . . . . . . . (436)
Accretion/Amortization of Discounts and Premiums . . . . . . . . . . . . . . . . . . . . . . (2,477)
- ----------------------------------------------------------------------------------------------------------------
Net Cash Provided by Investing and Operating Activities. . . . . . . . . . . . . . . . . . . $ 31,601
- ----------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
11
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
SELECTED PER SHARE DATA -------------------------------------------------------------
AND RATIOS: 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD . . . . . . . . . . $ 15.19 $ 14.45 $ 13.63 $ 11.96 $ 14.10
- ---------------------------------------------------------------------------------------------------------------------
Offering Costs . . . . . . . . . . . . . . . . . . . . . -- -- -- -- (0.01)
- ---------------------------------------------------------------------------------------------------------------------
Net Investment Income. . . . . . . . . . . . . . . . . . 1.34 1.37 1.35 1.34 1.32
Net Realized and Unrealized Gain (Loss) on Investments . (0.66) 1.21 0.89 1.60 (2.08)
- ---------------------------------------------------------------------------------------------------------------------
Total from Investment Operations . . . . . . . . . . 0.68 2.58 2.24 2.94 (0.76)
- ---------------------------------------------------------------------------------------------------------------------
Distributions:
Net Investment Income. . . . . . . . . . . . . . . . . (1.40) (1.36) (1.42) (1.27) (1.36)
In Excess of Net Investment Income . . . . . . . . . . (0.02) -- -- -- (0.01)
Net Realized Gain. . . . . . . . . . . . . . . . . . . (0.76) (0.48) -- -- --
In Excess of Net Realized Gain . . . . . . . . . . . . (0.07) -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Total Distributions. . . . . . . . . . . . . . . . . (2.25) (1.84) (1.42) (1.27) (1.37)
- ---------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD . . . . . . . . . . . . . $ 13.62 $ 15.19 $ 14.45 $ 13.63 $ 11.96
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
PER SHARE MARKET VALUE, END OF PERIOD. . . . . . . . . . $ 15.38 $ 14.63 $ 14.63 $ 12.88 $ 11.38
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN: . . . . . . . . . . . . . . . .
Market Value . . . . . . . . . . . . . . . . . . . . . 11.15% 23.79% 25.92% 25.21% (14.11)%
Net Asset Value (1). . . . . . . . . . . . . . . . . . 4.12% 18.48% 17.52% 26.07% (5.53)%
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
RATIOS, SUPPLEMENTAL DATA: . . . . . . . . . . . . . . .
NET ASSETS, END OF PERIOD (THOUSANDS). . . . . . . . . . $119,940 $133,050 $126,330 $118,863 $104,260
- ---------------------------------------------------------------------------------------------------------------------
Ratio of Expenses before Interest Expense to Average
Net Assets . . . . . . . . . . . . . . . . . . . . . . 1.10% 1.06% 1.12% 1.11% 1.12%
Ratio of Expenses After Interest Expense to Average
Net Assets . . . . . . . . . . . . . . . . . . . . . . 2.23% 2.76% 2.46% 2.79% 2.78%
Ratio of Net Investment Income to Average Net Assets . . 9.00% 8.98% 9.82% 10.29% 10.18%
Portfolio Turnover Rate. . . . . . . . . . . . . . . . . 78% 94% 136% 84% 32%
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
(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.
12
<PAGE>
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
- ---------
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: 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. Reverse repurchase
agreements also involve credit risk with the counter party to the extent
that the value of securities subject to repurchase exceed the Fund's
liability under the reverse repurchase agreement. Securities subject to
repurchase under reverse repurchase agreements are designated as such in
the Statement of Net Assets.
At December 31, 1998, the Fund had reverse repurchase agreements
outstanding as follows:
<TABLE>
<CAPTION>
MATURITY IN
LESS THAN
365 DAYS
-----------
<S> <C>
Value of Securities Subject to
Repurchase . . . . . . . . . . . . . . . . . . . . .$32,096,000
Liability Under Reverse
Repurchase Agreement . . . . . . . . . . . . . . . .$21,930,000
Weighted Average Interest Rate . . . . . . . . . . . . 6.38%
</TABLE>
The average weekly balance of reverse repurchase agreements outstanding
during the year ended December 31, 1998 was approximately $22,178,000 at a
weighted average interest rate of 6.38%.
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
13
<PAGE>
changes in the foreign exchange 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 may use derivatives to achieve its investment objectives. The Fund may
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 may use derivatives for
non-hedging as well as hedging purposes.
Following is a description of derivative instruments and their associated risks
that the Fund may utilize:
6. FOREIGN CURRENCY EXCHANGE CONTRACTS: The Fund may enter into 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 commit-
ments to pay and receive interest based on a notional principal amount. Net
periodic
14
<PAGE>
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 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 generally
will expose the Fund to credit risks of the underlying instruments as well
as of the issuer of the Structured Security. 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-dividend 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 Dean Witter Investment 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
0.70% of the Fund's average weekly net assets.
C. The Chase Manhattan Bank, through its corporate 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
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of 0.08% 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 also acts as custodian for the Fund.
Custodian 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. During the year ended December 31, 1998, the Fund made purchases and sales
totaling, approximately $114,753,000 and $133,073,000, 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, 1998, the Federal income tax cost basis
of securities was $150,081,000 and, accordingly, net unrealized depreciation for
Federal income tax purposes was $2,813,000 of which $5,570,000 related to
appreciated securities and $8,383,000 related to depreciated securities. For
the year ended December 31, 1998, the Fund intends to elect to defer to January
1, 1999 for U.S. Federal income tax purposes, post-October capital losses of
$596,832.
E. At December 31, 1998, 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.
F. 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, 1998 totaled approximately $44,000 and are included in Payable for
Directors' Fees and Expenses on the Statement of Net Assets.
G. During December 1998, the Board declared distributions of $0.198 and $0.788
per share, derived from net investment income and net realized gains,
respectively, payable on January 8, 1999, to shareholders of record on December
31, 1998.
- --------------------------------------------------------------------------------
FEDERAL INCOME TAX INFORMATION (UNAUDITED):
For the year ended December 31, 1998, the Fund designates $5,516,000 as
long-term capital gain at the 20% tax bracket. In addition, for the year ended
December 31, 1998, the percentage of dividends, as reported on Form 1099-DIV,
that qualify for the 70% dividend received deduction for corporate shareholders
was 3%.
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REPORT OF INDEPENDENT AUDITORS
- --------
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, 1998, the results of its operations and its cash flows for the year then
ended, the changes in its net assets for each of the two years in the period
then ended and the financial highlights for each of the five years in the period
then ended, in conformity with generally accepted accounting principles. These
financial statements and financial highlights (hereafter referred to as
"financial statements") are the responsibility of the Fund's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these financial statements in accordance
with generally accepted auditing standards which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits, which included confirmation of securities at
December 31, 1998 by correspondence with the custodian and brokers, provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
1177 Avenue of the Americas
New York, New York 10036
February 8, 1999
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<PAGE>
YEAR 2000 DISCLOSURE (UNAUDITED):
The investment advisory services provided to the Fund by the Adviser depend on
the smooth operation of its computer systems. Many computer and software systems
in use today cannot recognize the year 2000, but revert to 1900 or some other
date, due to the manner in which dates were encoded and calculated. That failure
could have a negative impact on the handling of securities trades, pricing and
account services. The Adviser has been actively working on necessary changes to
its own computer systems to deal with the year 2000 problem and expects that its
systems will be adapted before that date. There can be no assurance, however,
that the Adviser will be successful. In addition, other unaffiliated service
providers may be faced with similar problems. The Adviser is monitoring their
remedial efforts, but, there can be no assurance that they and the services they
provide will not be adversely affected.
In addition, it is possible that the markets for securities in which the Fund
invests may be detrimentally affected by computer failures throughout the
financial services industry beginning January 1, 2000. Improperly functioning
trading systems may result in settlement problems and liquidity issues. In
addition, corporate and governmental data processing errors may result in
production problems for individual companies and overall economic uncertainties.
Earnings of individual issuers will be affected by remediation costs, which may
be substantial and may be reported inconsistently in U.S. and foreign financial
statements. Accordingly, the Fund's investments may be adversely affected.
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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
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