Rule 497(c)
Registration No. 33-60019
EQUITABLE REAL ESTATE HYPERION
MORTGAGE OPPORTUNITY FUND, INC.
SERIES A-1995
520 Madison Avenue
New York, New York 10022
Prospectus
September 12, 1995
Series A-1995 (the "Fund") is a series of Equitable Real Estate Hyperion
Mortgage Opportunity Fund, Inc. (the "Company"), a non-diversified, open-end
management investment company whose investment objective is to seek to provide
high total return from (i) both short and long term capital gains and (ii) a
high level of current income. The Fund seeks to achieve its investment objective
by investing, under normal circumstances, in a portfolio consisting primarily of
commercial mortgage-backed securities ("Commercial Mortgage-Backed Securities").
The Fund will invest only in securities which at the time of purchase are
investment grade quality. Commercial Mortgage-Backed Securities are securities
that directly or indirectly represent participations in, or are secured by and
payable from, a pool of mortgage loans secured by commercial real estate
property. The securities in which the Fund invests, and not the shares of the
Fund, may be secured by commercial real estate property. There is no assurance
that the Fund will be able to achieve its investment objective.
The investment adviser of the Fund is Equitable Real Estate Hyperion
Capital Advisors, L.L.C. (the "Adviser"). Hyperion Distributors, Inc. is the
distributor (the "Distributor") of shares of the Fund. The Adviser is a
registered investment adviser and the Distributor is a registered broker dealer
and a member of the National Association of Securities Dealers, Inc.
This Prospectus sets forth concisely the information concerning the Fund
that a prospective investor ought to know before investing. The Company has
filed with the Securities and Exchange Commission a Statement of Additional
Information, with respect to the Fund dated September 12, 1995, which contains
more detailed information about the Fund and is incorporated into this
Prospectus by reference. An investor may obtain a copy of the Statement of
Additional Information without charge by contacting the Distributor (see back
cover for address and phone number). Investors should read this Prospectus and
retain it for future reference.
Shares of the Fund are neither insured nor guaranteed by the U.S.
Government. Shares of the Fund are not deposits or obligations of, or guaranteed
or endorsed by, any bank, and the shares are not federally insured by the
Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other
agency.
THESE ARE SPECULATIVE SECURITIES
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
Table of Contents
Prospectus Summary................................. 2
Expense Summary.................................... 3
The Fund........................................... 3
Investment Objective and Policies.................. 3
Risk Considerations................................ 10
Purchases and Redemptions of Shares................ 20
Performance Information............................ 22
Management of the Fund............................. 22
Distributions and Tax Matters...................... 23
Other Information Concerning Shares of the Fund.... 25
Transfer Agent, Custodian and Accounting Agent..... 26
Counsel and Independent Accountants................ 27
Application Forms.................................. 29
HYPERION DISTRIBUTORS, INC.
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information appearing in this Prospectus.
The Fund: Series A-1995 (the "Fund") is a series of Equitable Real Estate
Hyperion Mortgage Opportunity Fund, Inc. (the "Company"), a newly-formed,
non-diversified, open-end management investment company.
Investment Objective: The Fund's investment objective is to seek to provide high
total return from (i) both short and long term capital gains and (ii) a high
level of current income. The Fund seeks to achieve its investment objective by
investing, under normal circumstances, in a portfolio consisting primarily of
commercial mortgage-backed securities ("Commercial Mortgage-Backed Securities").
The Fund will invest only in securities which at the time of purchase are
investment grade quality. See "Investment Objective and Policies." The value of
the Fund's securities may fluctuate, in some cases significantly, in response to
interest rate changes. See "Risk Considerations." There is no assurance that the
Fund will achieve its investment objective. The investment objective of the Fund
and its investment restrictions described in the Statement of Additional
Information are fundamental and may not be changed without shareholder approval.
Management and Fees: Equitable Real Estate Hyperion Capital Advisors, L.L.C.
(the "Adviser") serves as the Fund's investment adviser and administrator and is
compensated for its advisory and administrative services at an annual rate of
.35% and .20% of the Fund's average daily net assets, respectively. The Fund is
currently the only open-end investment company advisory client of the Adviser.
Hyperion Distributors, Inc. (the "Distributor") will act as Distributor for the
Fund's shares.
How to Purchase Shares: Shares of the Fund may be purchased at the net asset
value per share next determined after receipt of an order by the Fund's
Distributor or transfer agent in proper form with accompanying check or other
bank wire payment arrangements satisfactory to the Fund. The minimum initial
investment is $100,000. The minimum for subsequent investments is $5,000. Such
minimum initial and subsequent investments may be waived for employees of the
Adviser, Hyperion Capital Management, Inc. and Equitable Real Estate Investment
Management, Inc. See "Purchases and Redemptions of Shares."
Risk Considerations: Investors should consider the risks associated with
investing in Commercial Mortgage-Backed Securities and other mortgage-backed
securities which may involve the risks of delinquent payments of interest and
principal, early prepayments and potential unrecoverable principal loss from the
sale of foreclosed property. Additionally, investors should consider the risk of
the Fund's concentration in Commercial Mortgage-Backed Securities versus the
safety that comes with a less concentrated investment portfolio and should
compare yields available for more diversified portfolios before making an
investment decision. The Fund may invest in repurchase agreements, reverse
repurchase agreements and dollar rolls, when-issued purchases and forward
commitments, calls and puts, options and futures contracts and may engage in
short sales and other hedging transactions. The Fund may not invest more than
15% of its net assets in illiquid securities. For the risks associated with
these investments see "Investment Objective and Policies" and "Risk
Considerations." Investors should also consider that currently the Fund is the
Adviser's only open-end investment company advisory client.
How to Sell Shares: Shares of the Fund may be redeemed by the shareholder at any
time at the net asset value per share next determined after the redemption
request is received by the Fund in proper order. A shareholder will be charged a
fee for a wire redemption (currently $8.00) equal to the fee charged for such
redemption by the Fund's Custodian. See "Purchases and Redemptions of Shares."
Dividends and Reinvestment: Each dividend and capital gains distribution, if
any, declared by the Fund on its outstanding shares will, unless a shareholder
elects otherwise, be paid on the payment date in additional shares of the Fund
having an aggregate net asset value as of the ex-dividend date of such dividend
or distribution equal to the cash amount of such distribution. An election may
be changed by notifying the Fund in writing at any time prior to the record date
for a particular dividend or distribution. There are no sales or other charges
in connection with the reinvestment of dividends and capital gains
distributions. There is no fixed dividend rate, and there can be no assurance
that the Fund will pay any dividends or realize any capital gains. However, the
Fund currently intends to pay dividends, if any, on a monthly basis and capital
gains, if any, annually. See "Distributions and Tax Matters."
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EXPENSE SUMMARY
Estimated Annual Fund Operating Expenses
(as a percentage of average net assets)
Investment Advisory Fees............................................ 0.35%
12b-1 Fees.......................................................... None
Other Expenses (after reimbursement)................................ 0.35%
(including Administration Fees..............................0.20%)
Annual Total Fund Operating Expenses................................ 0.70%
Example:
A shareholder of the Fund would pay the following expenses on a $1,000
investment in the Fund assuming a 5% annual return reinvested in shares of the
Fund and redemption at the end of each time period:
Year 1........................... $ 7
Year 3........................... $ 22
The purpose of the expense table provided above is to assist investors in
understanding the various costs and expenses that a shareholder will bear
directly or indirectly. For a further discussion of these fees see "Management
of the Fund." The Adviser has voluntarily agreed to waive all or a portion of
its Investment Advisory Fee or Administration Fee, and to voluntarily reimburse
the Fund's other operating expenses to the extent necessary to maintain the
Annual Total Fund Operating Expenses at not more than 0.70% of the Fund's
average net assets. Absent such waivers and reimbursements, Other Expenses are
anticipated to be 0.45% and Annual Total Fund Operating Expenses are anticipated
to be 0.80%. The expenses reflected above are estimates of the expenses the Fund
will incur during its first fiscal year. A shareholder will be charged a fee for
a wire redemption (currently $8.00) equal to the fee charged for such redemption
by the Fund's Custodian. The "Example" set forth above should not be considered
a representation of past or future expenses; actual expenses may be greater or
less than those shown.
THE FUND
The Fund, a non-diversified, open-end management investment company, is a series
of Equitable Real Estate Hyperion Mortgage Opportunity Fund, Inc., organized as
a corporation under the laws of the State of Maryland on May 30, 1995. The Fund
offers to buy back (redeem) shares from shareholders at any time at the Fund's
then current net asset value. Shares of the Fund are continuously sold by
Hyperion Distributors, Inc., the Fund's distributor (the "Distributor"). The
minimum initial investment is $100,000. The minimum additional investment is
$5,000. The minimum initial and subsequent investments may be waived for
employees of the Adviser, Hyperion Capital Management, Inc. and Equitable Real
Estate Investment Management, Inc.
INVESTMENT OBJECTIVE AND POLICIES
Investment Objective
The investment objective of the Fund is to seek to provide high total return
from (i) both short and long term capital gains and (ii) a high level of current
income. The investment objective of the Fund is fundamental and may not be
changed without approval by the shareholders of the Fund. The Fund expects there
will be fluctuations in its net asset value per share. The Fund's investment
policies indicated below (unlike its investment objective) are not fundamental
and may be changed by the Fund's Board of Directors without shareholder
approval.
Investment Policies
The Fund seeks to achieve its investment objective by investing, under normal
circumstances, in a portfolio consisting primarily of Commercial Mortgage-Backed
Securities. Under normal market conditions, the Fund will have at least 65% of
its total assets invested in mortgage-backed securities. Mortgage-backed
securities directly or indirectly represent participations in, or are secured by
and payable from, a pool of mortgage loans pledged by real estate property to
secure the payment of such debt. Subject to the preceding policy, the other debt
securities in which the Fund may invest include, without limitation, obligations
of the U.S. Government and its agencies, collateralized mortgage obligations
("CMOs"),
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asset backed securities, other mortgage pass-through certificates, debt
securities of real estate investment trusts and certain corporate debt
securities.
The Fund may also employ various hedging techniques, including interest rate
transactions, that will affect the Fund's average duration. (See "Risk
Considerations -- Hedging Transactions.") In addition, the Fund may use various
techniques and investments to increase or decrease its exposure to changing
security prices, interest rates or other factors that affect security values.
These techniques and investments may involve derivative transactions such as
buying and selling options and futures contracts, selling securities short and
investments in mortgage-backed securities. The Fund may use these practices to
adjust the risk and return characteristics of the Fund's portfolio. However,
these techniques or investments may result in a loss, regardless of whether the
intent was to reduce risk or increase return, with unexpected changes in market
conditions or if the counterparty to the transaction does not perform as
promised. Additionally, these techniques or investments may increase the
volatility of the Fund and may involve a small investment of cash relative to
the magnitude of the risk assumed.
The Adviser, depending upon market conditions, will seek to manage the Fund's
assets such that the interest rate sensitivity of such assets will be equivalent
to 80% to 120% of U.S. Treasury securities having a maturity of ten years. The
Fund will only purchase securities if they are of investment grade quality at
the time of purchase (i.e. rated within the four highest ratings categories by a
nationally-recognized statistical rating organization, e.g. BBB and above, by
Standard & Poor's Corporation ("S&P"), Baa and above by Moody's Investor
Services Inc. ("Moody's"), BBB and above by Fitch Investors Services, Inc.
("Fitch") or BBB and above by Duff & Phelps Credit Rating Co. ("Duff & Phelps"),
collectively known as the "Rating Agencies"). There can, of course, be no
assurance that the investment objective of the Fund will be achieved. Like all
investors in interest bearing securities, the Fund is exposed to the risk that
the prices of individual securities held by the portfolio may fluctuate, in some
cases significantly, in response to changes in credit conditions and prevailing
levels of interest rates. See "Risk Considerations."
The following is a discussion of the various investments eligible to be
purchased by the Fund and the investment techniques anticipated to be employed
by the Fund.
(1) Commercial Mortgage-Backed Securities -- Commercial Mortgage-Backed
Securities are generally multi-class debt or pass-through securities backed by a
mortgage loan or pool of mortgage loans secured by commercial property, such as
industrial and warehouse properties, office buildings, retail centers and
shopping malls, multi-family properties and cooperative apartments, hotels and
motels, nursing homes, hospitals, senior living centers, manufactured living
communities and mobile home parks. Assets underlying Commercial Mortgage-Backed
Securities may relate to many properties, only a few properties, or to a single
property. Each commercial mortgage loan that underlies Commercial Mortgage-
Backed Securities has certain distinct characteristics.
Commercial mortgage loans are often not amortizing or not fully amortizing. At
their maturity date, repayment of the remaining principal balance or "balloon"
is due and is repaid through the attainment of an additional loan, the sale of
the property or contribution of additional capital. Unlike most single family
residential mortgages, commercial real property loans often contain provisions
which substantially reduce the likelihood that they will be prepaid. The
provisions generally impose significant prepayment penalties on loans and, in
some cases, there may be prohibitions on principal prepayments for several years
following origination. This difference in prepayment exposure is significant due
to extraordinarily high levels of refinancing of traditional residential
mortgages experienced over the past years when mortgage rates reached a 25-year
low. Changing real estate markets may adversely impact both the value of the
underlying collateral and the borrower's ability to meet contractual
obligations, either of which may lead to delinquencies, defaults, modifications
or foreclosure that in turn may lead to the realization of credit losses in the
Commercial Mortgage-Backed Security. See "Risk Considerations."
Commercial Mortgage-Backed Securities have been issued in public and private
transactions by a variety of public and private issuers. Non-governmental
entities that have issued or sponsored Commercial Mortgage-Backed Securities
offerings include owners of commercial properties, originators of and investors
in mortgage loans, savings and loan associations, mortgage banks, commercial
banks, insurance companies, investment banks and special purpose subsidiaries of
the foregoing. The Fund may from time to time purchase Commercial
Mortgage-Backed Securities directly from issuers in negotiated or non-negotiated
transactions or from a holder of such Commercial Mortgage-Backed Securities in
the secondary market.
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Commercial mortgage securitizations generally are senior/subordinated
structures. The senior class investors are deemed to be protected against
potential losses on the underlying mortgage loans by the subordinated class
investors who take the first loss if there are defaults on the underlying
commercial mortgage loans. Other protections, which may benefit all of the
classes including the subordinated classes, may include issuer guarantees,
reserve funds, additional subordinated securities, cross-collateralization,
over-collateralization and the equity investor in the underlying properties.
By adjusting the priority of interest and principal payments on each class of a
given Commercial Mortgage-Backed Security, issuers are able to create senior
investment grade securities and lower rated or unrated subordinated securities
tailored to meet the needs of sophisticated institutional investors. In general,
subordinated classes of Commercial Mortgage-Backed Securities are entitled to
receive repayment of principal only after all required principal payments have
been made to more senior classes and have subordinate rights as to receipt of
interest distributions. Such subordinated classes are subject to a substantially
greater risk of nonpayment than are senior classes of Commercial Mortgage-Backed
Securities. Even within a class of subordinated securities, most Commercial
Mortgage-Backed Securities are structured with a hierarchy of levels (or "loss
positions"). Loss positions are the order in which nonrecoverable losses of
principal are applied to the securities within a given structure. For instance,
a first loss subordinated security will absorb any principal losses before any
higher loss subordinate position. This type of structure allows a number of
classes of securities to be created with varying degrees of credit exposure,
prepayment exposure and potential total return. The Fund will invest in
subordinated class securities but will not invest in first loss subordinated
securities or non-rated securities regardless of implied ratings.
The Fund also intends to invest in investment grade senior classes of Commercial
Mortgage-Backed Securities. As discussed above, from a credit perspective, they
are structured to absorb any credit-related losses after losses have been
absorbed by the subordinated classes. The following table sets forth an example
of the prioritization of the payments to each class as well as the order of
absorption of credit losses, if any, on the underlying mortgage loans. The table
provides a general example of the current Commercial Mortgage-Backed Securities
Structures; however, the actual ratings, cash flows and loss absorption
priorities of the Commercial Mortgage-Backed Securities in which the Fund will
invest may differ.
General Examples Of Commercial Mortgage-Backed Securities Structures
Typical
Class Rating
Senior A-1............................................... "AAA"
Senior A-2............................................... "AA"
Subordinated B-1......................................... "A","BBB"
(The Fund will not invest in the following classes.)
Subordinated B-2......................................... "BB"
Subordinated B-3......................................... "B"
Subordinated B-4......................................... Unrated
Reserve Fund/Letter of Credit............................ N/A
Equity Holder............................................ N/A
Excess
Principal Loss
Cash Flow Absorption
Class Priority Priority
Senior A-1............................................. 1st 8
Senior A-2............................................. 2nd 7
Subordinated B-1....................................... 3rd, 4th 6
(The Fund will not invest in the following classes.)
Subordinated B-2....................................... 5th 5
Subordinated B-3....................................... 6th 4
Subordinated B-4....................................... 7th 3
Reserve Fund/Letter of Credit.......................... N/A 2
Equity Holder.......................................... N/A 1
The Fund will only invest in those classes listed above with credit quality
ratings at the time of investment of BBB or higher. See "Risk Considerations."
The rating assigned to a given issue and class of Commercial Mortgage-Backed
Securities is a product of many factors, including, but not limited to, the
structure of the security, the level of subordination, the quality and adequacy
of the collateral, projected losses from the collateral and the past performance
of the originators and servicing companies. The rating of any Commercial
Mortgage-Backed Security is determined to a substantial degree by the debt
service coverage ratio (i.e., the ratio of current net operating income from the
commercial properties, in the aggregate, to the current debt service obligations
on the properties) and the loan-to-value ("LTV") ratio of the pooled properties.
The amount of the securities issued in any one rating category is determined by
the rating agencies after a rigorous credit rating process which includes
analysis of the issuer, servicer and property manager, as well as verification
of the LTV and debt service coverage ratios. LTV ratios may be particularly
important in the case of commercial mortgages because most commercial
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mortgage loans generally provide that the lender's sole remedy in the event of a
default is against the mortgaged property, and the lender is not permitted to
pursue remedies with respect to other assets of the borrower.
(2) U.S. Government Agency Mortgage-Backed Certificates -- These are obligations
issued or guaranteed by the United States Government or one of its agencies or
instrumentalities, such as the Government National Mortgage Association ("Ginnie
Mae" or "GNMA"), the Federal National Mortgage Association ("Fannie Mae" or
"FNMA") and the Federal Home Loan Mortgage Corporation ("Freddie Mac" or
"FHLMC"). FNMA and FHLMC obligations are not backed by the full faith and credit
of the U.S. Government as GNMA certificates are, but FHLMC securities are
supported by the instrumentality's limited right to borrow from the U.S.
Treasury, and obligations of FNMA are supported only by the discretionary
authority of the U.S. Government to purchase the agency's obligations. No
assurance can be given that the U.S. Government will provide financial support
in the future to U.S. Government agencies, authorities or instrumentalities that
are not supported by the full faith and credit of the United States. U.S.
Government Agency Mortgage-Backed Certificates provide for the pass-through to
investors of their pro-rata share of monthly payments (including any
prepayments) made by the individual borrowers on the pooled mortgage loans, net
of any fees paid to the guarantor of such securities and the servicer of the
underlying mortgage loans. Each of GNMA, FNMA and FHLMC guarantees timely
distributions of interest to certificate holders. GNMA and FNMA guarantee timely
distributions of scheduled principal. FHLMC has in the past guaranteed only the
ultimate collection of principal of the underlying mortgage loan; however, FHLMC
now issues Mortgage-Backed Securities ("FHLMC Gold PCs") which also guarantee
timely payment of scheduled monthly principal reductions.
(3) U.S. Government Securities -- These include issues of the U.S. Treasury,
such as bills, certificates of indebtedness, notes and bonds, and obligations of
agencies and instrumentalities of the U.S. Government. U.S. Treasury Securities
are backed by the full faith and credit of the U.S. Government, while other U.S.
Government Securities are generally not.
(4) Collateralized Mortgage Obligations -- Collateralized mortgage obligations
("CMOs") are debt obligations or multi-class pass-through certificates issued by
agencies or instrumentalities of the U.S. Government or by private originators
or investors in mortgage loans. They are backed by Mortgage Pass-Through
Securities or pools of whole loans (all such assets, the "Mortgage Assets") and
are evidenced by a series of bonds or certificates issued in multiple classes or
"tranches." The principal and interest on the underlying Mortgage Assets may be
allocated among the several classes of a series of CMOs in many ways.
CMOs may be issued by agencies or instrumentalities of the U.S. Government, or
by private originators of, or investors in, mortgage loans, including savings
and loan associations, mortgage bankers, commercial banks, investment banks and
special purpose subsidiaries of the foregoing. CMOs that are issued by a private
governmental agency or instrumentality are generally structured with one or more
of the types of credit enhancements described below under "Risk
Considerations-Credit Support." CMOs that are issued by private sector entities
and are backed by assets lacking a guarantee of an entity having the credit
status of a governmental agency or instrumentality are generally structured with
one or more of the types of credit enhancement described under "Credit Support."
In addition, CMOs issued by private sector entities may be illiquid. See "Risk
Considerations-Less Marketable and Illiquid Securities." An issuer of CMOs may
elect to be treated, for federal income tax purposes, as a Real Estate Mortgage
Investment Conduit ("REMIC"). An issuer of CMOs issued after 1991 generally must
elect to be treated as a REMIC or it will be taxable as a corporation under
rules regarding taxable mortgage pools.
In a CMO, a series of bonds or certificates are issued in multiple classes. Each
class of CMOs, often referred to as a "tranche," may be issued with a specific
fixed or floating coupon rate and has a stated maturity or final scheduled
distribution date. Principal prepayments on the underlying Mortgage Assets may
cause the CMOs to be retired substantially earlier than their stated maturities
or final scheduled distribution dates. Interest is paid or accrues on CMOs on a
monthly, quarterly or semi-annual basis. The principal of, and interest on, the
Mortgage Assets may be allocated among the several classes of a CMO in many
ways. The general goal in allocating cash flows on Mortgage Assets to the
various classes of a CMO is to create certain tranches on which the expected
cash flows have a higher degree of predictability than the underlying Mortgage
Assets. As a general matter, the more predictable the cash flow is on a
particular CMO tranche, the lower the anticipated yield will be on that tranche
at the time of issuance relative to prevailing market yields on certain other
Mortgage-Backed Securities. As part of the process of creating more predictable
cash flows on certain tranches of a CMO, one or more tranches generally must be
created that absorb most of the changes in the cash flows on the underlying
Mortgage Assets. The yields on these tranches are generally higher than
prevailing market yields on Mortgage-Backed
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Securities with similar average lives. Because of the uncertainty of the cash
flows on these tranches, the market prices of and yields on these tranches are
more volatile. The Fund may purchase CMOs that have been sold in public
offerings registered under the Securities Act of 1933 or in private placements.
CMOs acquired in private placements will be subject to certain restrictions on
resale and accordingly will have limited marketability.
Subordinated CMOs. The Fund intends to invest in subordinated tranches of CMOs.
Subordinated tranches of CMOs are multiple class securities with one or more
classes subordinate to other classes as to the payment of principal thereof and
interest thereon, with defaults on the underlying assets being borne first by
the holders of the most subordinated class. The Fund will not invest in first
loss classes of subordinated CMOs. Subordinated tranches are entitled to receive
repayment of principal only after all required principal payments have been made
on more senior tranches and also have subordinate rights as to receipt of
interest distributions. Such subordinated tranches are subject to greater risk
of non-payment than are more senior tranches or CMOs backed by third party
credit enhancement which may have limited marketability. See "Risk
Considerations."
CMOs Backed by Mortgages on Multi-Family Dwelling. The Fund also intends to
invest in CMOs backed by mortgages on multi-family dwellings. Multi-family
dwellings are residential properties consisting of five or more units.
Investment in CMOs backed by mortgages on multi-family dwellings involves
different investment considerations than investment in Mortgage-Backed
Securities backed by single-family homes due to such factors as the investment
character of the underlying asset and regulatory requirements. CMOs backed by
multi-family dwelling mortgages are subject to risks generally not associated
with mortgages on single family homes, including vacancy rates, increases in
operating expenses, regulatory requirements and environmental liability issues.
In addition, such CMOs may have limited marketability. See "Risk
Considerations."
"Planned Amortization Class" Bonds. Also included within the category of CMOs
are "Planned Amortization Class" ("PAC") Bonds. PAC Bonds are a type of CMO
tranche or series designed to provide relatively predictable payments of
principal provided that, among other things, the actual prepayment experience on
the underlying mortgage loans falls within a predefined range. Because of these
features, PAC Bonds generally are less subject to the risks of prepayment than
are other types of Mortgage-Backed Securities. However, if the actual prepayment
experience on the underlying mortgage loans is at a rate faster or slower than
the predefined range or if deviations from other assumptions occur, principal
payments on the PAC Bond may be earlier or later than predicted.
(5) U.S. Government Agency Multi-Class Pass-Through Securities -- Unlike CMOs,
U.S. Government Agency Multi-Class Pass-Through Securities, which include FNMA
Guaranteed REMIC Pass-Through Certificates and FHLMC Multi-Class Mortgage
Participation Certificates, are ownership interests in a pool of Mortgage
Assets. Unless the context indicates otherwise, all references herein to CMOs
include multi-class pass-through securities.
(6) Asset-Backed Securities -- The securitization techniques used to develop
Mortgage-Backed Securities are now being applied to a broad range of assets.
Through the use of trusts and special purpose corporations, various types of
assets, primarily automobile and credit card receivables, are being securitized
in pass-through structures similar to the mortgage pass-through structure or in
a pay-through structure similar to the CMO Structure. The Fund may invest in
these and other types of Asset-Backed Securities that may be developed in the
future. These investments will be disclosed to shareholders in the Fund's
annual, semi-annual and other reports.
In general, the collateral supporting Asset-Backed Securities is of shorter
maturity than mortgage loans and historically has been less likely to experience
substantial prepayments. Furthermore, the effect of prepayments on securities
that have shorter maturities, such as Asset-Backed Securities, is much smaller
than the effect of prepayments on securities having longer maturities, such as
Mortgage-Backed Securities. As with Mortgage-Backed Securities, Asset-Backed
Securities are often backed by a pool of assets representing the obligations of
a number of different parties and use similar credit enhancement techniques.
To the extent that it invests in Asset-Backed Securities, the Fund will place
primary emphasis on securities rated AAA/Aaa or AA/Aa by any of the Rating
Agencies. However, the Fund may invest in Asset-Backed Securities that at the
time of investment have ratings as low as A/A by any of the Rating Agencies.
Securities rated A/A are considered more susceptible to the adverse effects of
changes in economic conditions or to impairment in the future than are higher
rated securities.
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Asset-Backed Securities present certain risks that are not presented by
Mortgage-Backed Securities. Primarily, these securities do not have the benefit
of the same type of security interest in the related collateral. Credit card
receivables are generally unsecured and the debtors are entitled to the
protection of a number of state and federal consumer credit laws, many of which
give such debtors the right to avoid payments of certain amounts owned on the
credit cards, thereby reducing the balance due. Most issuers of automobile
receivables permit the servicers to retain possession of the underlying
obligations. If the servicer were to sell these obligations to another party,
there is a risk that the purchaser would acquire an interest superior to that of
the holders of the related automobile receivable. In addition, because of the
large number of vehicles involved in a typical issuance and technical
requirements under state laws, the trustee for the holders of the automobile
receivables may not have a proper security interest in all of the obligations
backing such receivables. Therefore, there is the possibility that recoveries on
repossessed collateral may not, in some cases, be available to support payments
on the securities.
(7) Adjustable Rate Mortgage Securities ("ARMS") -- The Fund intends to invest
in ARMS which can be U.S. Government Agency Mortgage-Backed Securities, Agency
Mortgage-Backed Securities (which are securities backed by U.S. Government
Agency Mortgage-Backed Securities), or privately-issued Mortgage-Backed
Securities (which represent an interest in, or are collateralized by, a pool of
mortgage loans with variable rates of interest). Holding ARMS allows the Fund to
participate in increases in interest rates through periodic adjustments in the
interest rates underlying the mortgages, resulting in both higher current yields
and lower price fluctuations. However, the Fund will not benefit from such
increases if rates rise to the point where they would cause increases in the
interest rates on the mortgages underlying ARMS to exceed the maximum allowable
annual or lifetime reset limits. In addition, in periods of declining interest
rates ARMS will experience declining yields.
Adjustable rate mortgages generally provide that the mortgage interest rate may
not be adjusted above or below a specified applicable lifetime maximum or
minimum rate. In addition, certain adjustable rate mortgages provide for
limitations on the maximum amount by which the mortgage interest rate may adjust
for any single adjustment period. Other adjustable rate mortgages provide
instead for limitations on changes in the required monthly payment. In the event
that a monthly payment is not sufficient to pay the interest accruing on such an
adjustable rate mortgage, any such excess interest is added to the principal
balance of the mortgage loan, which is repaid through future monthly payments.
In the event that a monthly payment exceeds the sum of the interest accrued at
the applicable mortgage interest rate and the principal payment necessary to
amortize the outstanding principal balance over the remaining term of the loan,
the excess further reduces the principal balance of the adjustable rate
mortgages in the same manner as a prepayment. See "Risk Considerations."
(8) High Coupon Agency Mortgage-Backed Securities -- The Fund intends to invest
in High Coupon Agency Mortgage-Backed Securities which provide the holder with a
coupon that is higher at the time of purchase than the then prevailing market
rate yield. Such securities are purchased at a price greater than their par
value because the coupon is higher than the market rate. The Adviser believes
that High Coupon Agency Mortgage-Backed Securities offer greater price stability
than other Agency Mortgage-Backed Securities. Because of shorter duration, the
prices of High Coupon Agency Mortgage-Backed Securities generally do not tend to
rise as rapidly as those of traditional fixed rate securities in declining
interest rate environments and also tend to decline more slowly in increasing
interest rate environments until the point at which prevailing mortgage interest
rates are equal to the rates on the underlying mortgage loans. Because the Fund
may purchase High Coupon Agency Mortgage-Backed Securities at a premium, a
prepayment rate that is faster than expected will reduce both market value and
income from that which was anticipated and may result in a loss of a portion of
the amount invested, while a prepayment rate that is slower than expected will
have the opposite effect of increasing income and market value. High Coupon
Agency Mortgage-Backed Securities have a greater probability of prepayment than
lower coupon agency mortgage-backed securities and the risk of prepayment is
greater in a declining interest rate environment.
(9) Debt Securities Issued by Real Estate Investment Trusts -- The Fund intends
to invest in debt securities issued by real estate investment trusts ("REITs")
("REIT Debt Securities"). REITs are pooled investment vehicles which invest
primarily in income producing real estate or real estate related loans or
interests. Generally, REITs can be classified as equity REITs, mortgage REITs,
or hybrid REITs. Equity REITs invest the majority of their assets directly in
real property and derive income primarily from the collection of rents. Equity
REITs can also realize capital gains by selling properties that have appreciated
in value. Mortgage REITs invest the majority of their assets in real estate
mortgages and derive
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income from the collection of interest payments. Hybrid REITs combine the
characteristics of both equity REITs and mortgage REITs.
REIT Debt Securities, for the most part, are general and unsecured obligations.
These securities typically have corporate bond features such as semi-annual
interest coupons, no amortization and strong prepayment protection.
Additionally, real estate related unsecured debt generally contains covenants
restricting the level of secured and total debt and requires a minimum debt
service coverage ratio and net worth level. The Fund will only purchase
unsecured debt that has an investment grade rating of A or higher. Debt
covenants for A-rated unsecured debt generally restrict debts to 50% of total
capitalization and secured debt to 35% of total capitalization. See "Risk
Considerations."
(10) Whole Loans -- Under normal market conditions, the Fund does not anticipate
investing in Whole Loans, however; under certain conditions, the Board of
Directors of the Fund may determine that it is advisable to invest in Whole
Loans. A Whole Loan is a loan to a single obligor on a single asset. Whole Loans
are nonrecourse to the borrower and therefore repayment of a Whole Loan will be
dependent solely on the cash flow derived from, and the market or liquidation
value of, the underlying property. Other assets of the borrower, if any, would
generally not be available for payment of the Whole Loan. Commercial real estate
lending can be affected significantly by the condition of the property and by
supply and demand in the market for the type of property securing a Whole Loan.
Market values may vary as a result of economic events or governmental
regulations outside the control of the borrower or issuer, which events may
impact the future cash flow of the property. See "Risk Considerations." Whole
Loans may be considered illiquid securities. For a discussion of illiquid and
less marketable securities, see "Risk Considerations -- Less Marketable and
Illiquid Securities" herein.
Investment Restrictions
The Fund has adopted the following fundamental investment restrictions which may
not be changed unless approved by a majority of the outstanding shares of the
Fund that would be affected by such change. The Fund is subject to further
investment restrictions that are set forth in the Statement of Additional
Information. The Fund may not:
1. Borrow Money. This restriction shall not apply to (i) borrowing from banks
for temporary or emergency (not leveraging) purposes, including the meeting
of redemption requests that might otherwise require the untimely disposition
of securities, in an amount up to 15% of the value of the Fund's total assets
(including the amount borrowed) valued at market less liabilities (not
including the amount borrowed) at the time the borrowing was made and (ii)
hedging techniques described in the Prospectus which may be deemed to be
borrowings. While borrowings (excluding items in (ii) above) exceed 5% of the
value of the Fund's total assets, the Fund will not make any investments.
Interest paid on borrowings will reduce net income.
2. Pledge, hypothecate, mortgage or otherwise encumber its assets, except in an
amount up to 15% of the value of its total assets and only to secure
borrowings for temporary or emergency purposes.
3. Purchase securities subject to restrictions on disposition under the
Securities Act of 1933 ("restricted securities"). Subject to state law
limitations, the Fund will not invest more than an aggregate of 15% of its
net assets in repurchase agreements maturing in more than seven days and
securities that are not readily marketable.
4. Invest in securities of other investment companies, except that (i) the Fund
may purchase unit investment trust securities where such unit investment
trusts meet the investment objective of the Fund and then only up to 5% of
the Fund's net assets, except as they may be acquired as part of a merger,
consolidation or acquisition of assets and (ii) as permitted by Section 12(d)
of the Investment Company Act of 1940 (the "1940 Act").
Portfolio Turnover
Purchases and sales are made for the Fund whenever necessary, in the Adviser's
opinion, to meet the Fund's objective. Portfolio turnover may involve the
payment by the Fund of dealer spreads or underwriting commissions, and other
transaction costs, on the sale of securities, as well as on the reinvestment of
the proceeds in other securities. The greater the portfolio turnover the greater
the transaction costs to the Fund which will increase the Fund's total operating
expenses. In order to qualify as a regulated investment company, less than 30%
of the Fund's gross income must be derived from the sale or other disposition of
stock, securities or certain other investments held for less than three months.
Although increased portfolio turnover may increase the likelihood of additional
capital gains for the Fund, the Fund expects to satisfy the 30% income test. The
Adviser expects that the annual turnover of the portfolio should not exceed
100%.
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RISK CONSIDERATIONS
Commercial Mortgage-Backed Securities -- Investments in Commercial
Mortgage-Backed Securities involve the credit risk of delinquency and default.
Delinquency refers to interruptions in the payment of interest and principal.
Default refers to the potential for unrecoverable principal loss from the sale
of foreclosed property. These risks include the risks inherent in the commercial
mortgage loans which support such Commercial Mortgage-Backed Securities and the
risks associated with direct ownership of real estate. This may be especially
true in the case of Commercial Mortgage-Backed Securities secured by, or
evidencing an interest in, a relatively small or less diverse pool of commercial
mortgage loans. The factors contributing to these risks include the effects of
general and local economic conditions on real estate values, the conditions of
specific industry segments, the ability of tenants to make lease payments and
the ability of a property to attract and retain tenants, which in turn may be
affected by local conditions such as oversupply of space or a reduction of
available space, the ability of the owner to provide adequate maintenance and
insurance, changes in management of the underlying commercial property, energy
costs, government regulations with respect to environmental, zoning, rent
control, bankruptcy and other matters, real estate and other taxes, and
prepayments of the underlying commercial mortgage loans (although such
prepayments generally occur less frequently than prepayments on residential
mortgage loans).
While the credit quality of the securities in which the Fund invests will
reflect the perceived appropriateness of future cash flows to meet operating
expenses, the underlying commercial properties may not be able to continue to
generate income to meet their operating expenses (mainly debt services, lease
payments, capital expenditures and tenant improvements) as a result of any of
the factors mentioned above. Consequently, the obligors under commercial
mortgages may be unable to make payments of principal and interest in a timely
fashion, increasing the risk of default on a related Commercial Mortgage-Backed
Security. In addition, the repayment of the commercial mortgage loans underlying
Commercial Mortgage-Backed Securities will typically depend upon the future
availability of financing and the stability of real estate property values.
Most commercial mortgage loans are nonrecourse obligations of the borrower,
meaning that the sole remedy of the lender in the event of a default is to
foreclose upon the collateral. As a result, in the event of default by a
borrower, recourse may be had only against the specific property pledged to
secure the loan and not against the borrower's other assets. If borrowers are
not able or willing to refinance or dispose of the property to pay the principal
balance due at maturity, payments on the subordinated classes of the related
Commercial Mortgage-Backed Securities are likely to be adversely affected. The
ultimate extent of the loss, if any, to the subordinated classes may only be
determined after a foreclosure of the mortgage encumbering the property and if
the mortgagee takes title to the property upon liquidation of the property.
Factors such as the title to the property, its physical condition, and financial
performance, as well as governmental disclosure requirements with respect to the
condition of the property, may make a third party unwilling to purchase the
property at a foreclosure sale or for a price sufficient to satisfy the
obligations with respect to the related Commercial Mortgage-Backed Securities.
The condition of a property may deteriorate during foreclosure proceedings.
Certain obligors on underlying mortgages may become subject to bankruptcy
proceedings, in which case the amount and timing of amounts due under the
related Commercial Mortgage-Backed Securities may be materially adversely
affected.
In general, any losses on a given property, the lien on which is included in a
Commercial Mortgage-Backed Security, will be absorbed first by the equity holder
of the property, then by a cash reserve fund or letter of credit, if any, and
then by the "first loss" subordinated security holder to the extent of its
principal balance. Because the Fund intends to invest in both senior classes and
subordinated classes of Commercial Mortgage-Backed Securities, in the event of
default, the equity support, the reserve fund and any debt classes junior to
those in which the Fund invests will bear losses prior to the Fund. However,
there can be no assurance that the Fund will be able to recover all of its
investments in the securities it purchases. In addition, if the underlying
mortgage portfolio has been overvalued by the originator, or if the values
subsequently decline, the Fund may bear significant losses.
General Characteristics of Agency Mortgage-Backed Securities -- The investment
characteristics of Agency Mortgage-Backed Securities differ from traditional
debt securities because the volatility of Agency Mortgage-Backed Securities is
affected by changes in both prepayment rates and interest rates. Interest
payments and principal repayments on Agency Mortgage-Backed Securities are made
more frequently (usually monthly), and principal may be prepaid at any time
because the underlying mortgage loans or other assets generally may be prepaid
at any time. As a result, if the Fund purchases Agency Mortgage-Backed
Securities at a premium, a prepayment rate that is faster than expected will
reduce both the market value and income from that which was anticipated, while a
prepayment rate that is slower than expected
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will have the opposite effect of increasing income and market value. Conversely,
if the Fund purchases Agency Mortgage-Backed Securities at a discount, faster
than expected prepayments will increase, while slower than expected prepayments
will reduce, income and market value. The Adviser will seek to reduce prepayment
and interest rate risks (and increase potential benefits) by investing in a
variety of such securities and by using hedging techniques.
Prepayments on a pool of mortgage loans are influenced by a variety of economic,
geographic, social and other factors, including changes in mortgagors' housing
needs, job transfers, unemployment, death, mortgagors' net equity in the
mortgaged properties and servicing decisions. Generally, prepayments on fixed
rate mortgage loans will increase during a period of falling mortgage interest
rates and decrease during a period of rising mortgage interest rates.
Accordingly, amounts available for reinvestment by the Fund are likely to be
greater during a period of declining mortgage interest rates and, if general
interest rates also decline, are likely to be reinvested at lower interest rates
than the Portfolio was earning on the Agency Mortgage-Backed Securities that
were prepaid.
All of the Agency Mortgage-Backed Securities in which the Fund invests are
traded in over-the-counter markets rather than on exchanges. The size of spreads
between bid and asked prices in over-the-counter markets for Agency Mortgage-
Backed Securities depends upon a number of factors, including the outstanding
principal amount of the particular security, the number of dealers making
markets in the security, the length of time that a particular type of security
has been trading in the market and the perceived volatility of the price of the
security. Some of the Agency Mortgage-Backed Securities in which the Fund
invests, in particular U.S. Government Agency Mortgage-Backed Securities backed
by fixed rate mortgages having interest rates above current market rates ("High
Coupon Agency Mortgage-Backed Securities"), may trade with a wider spread
between the bid and asked quotations than do other fixed-income securities, such
as U.S. Government Securities or U.S. Government Agency Mortgage-Backed
Securities backed by fixed-rate mortgages having current market interest rates.
The spread between the bid and asked quotations is taken into account, among
other things, in the determination of the value of each security held by the
Fund and, therefore, in the determination of the net asset value per share of
the Fund. See "Determination of Net Asset Value; Valuation of Portfolio
Securities" in the Statement of Additional Information. If the Fund is forced on
short notice to sell a security for which the spread between bid and asked
quotations is wide, as a result of requests for redemption of a large number of
shares or for some other reason, the Fund might not be able to obtain the same
price for such security as it would if it were able to take a longer period of
time to seek the most efficient execution of its proposed sale.
Adjustable Rate Mortgage Securities ("ARMS") -- Unlike investments in pools of
fixed-income mortgages which decline in value during periods of rising interest
rates, investments in ARMS allow the Fund to participate in increases in
interest rates through periodic adjustments in the interest rates on the
underlying mortgages, resulting in both higher current yields and lower price
fluctuations. However, the Fund will not benefit from increases in interest
rates if interest rates rise to the point where they would cause increases in
the interest rates on the adjustable rate mortgages underlying its ARMS to
exceed the maximum allowable annual or lifetime reset limits, which are
described more fully below, for particular mortgages.
Adjustable rate mortgages eligible for inclusion in a mortgage pool usually
provide for a fixed initial mortgage interest rate for either the first three,
six, twelve or thirteen scheduled monthly payments. Thereafter, the interest
rates are subject to periodic adjustment, based, subject to the applicable
limitations discussed below, on changes in an applicable index.
Adjustable rate mortgages provide that the mortgage interest rate may not be
adjusted above some applicable lifetime maximum rate or below some applicable
lifetime minimum rate. In addition, certain adjustable rate mortgages provide
for limitations on the maximum amount by which the mortgage interest rate may
adjust for any single adjustment period. Other adjustable rate mortgages provide
instead for limitations on changes in the required monthly payment. In the event
that a monthly payment is not sufficient to pay the interest accruing on an
adjustable rate mortgage, any such excess interest is added to the principal
balance of the mortgage loan, which is repaid through future monthly payments.
In the event that a monthly payment exceeds the sum of the interest accrued at
the applicable mortgage interest rate and the principal payment necessary to
amortize the outstanding principal balance over the remaining term of the loan,
the excess further reduces the principal balance of the adjustable rate mortgage
in the same manner as a partial prepayment.
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The index applicable to adjustable rate mortgages will normally be either the
One Year Treasury Index, the Cost of Funds Index or the London Interbank Offered
Rate ("LIBOR"), which are discussed further in the Fund's Statement of
Additional Information.
CMOs (Agency/Private Label) -- Each class of CMOs, often referred to as a
"tranche," may be issued with a specific fixed or floating coupon rate and has a
stated maturity or final distribution date. Principal prepayments on the
Mortgage Assets may cause CMOs to be retired substantially earlier than their
stated maturities or final distribution dates. Interest is paid or accrued on
CMOs on a monthly, quarterly or semi-annual basis. The principal of, and
interest on, the Mortgage Assets may be allocated among the several classes of a
series of a CMO in many ways. The general goal sought to be achieved in
allocating cash flows on Mortgage Assets to the various classes of a series of
CMOs is to create certain tranches on which the expected cash flows have a
higher degree of predictability than the underlying Mortgage Assets. As a
general matter, the more predictable the cash flows are on a CMO tranche, the
lower the anticipated yield will be on that tranche at the time of issuance
relative to prevailing market yields on Agency Mortgage-Backed Securities. As
part of the process of creating more predictable cash flows on most of the
tranches in a series of CMOs, one or more tranches generally must be created
that absorb most of the volatility in the cash flows on the underlying Mortgage
Assets. The yields on these tranches are generally higher than prevailing market
yields on Agency Mortgage-Backed Securities with similar average lives. Because
of the uncertainty of the cash flows on these tranches, and the sensitivity
thereof to changes in prepayment rates on the underlying Mortgage Assets, the
market prices of, and yields on, these tranches tend to be highly volatile.
Subordinated Tranches of CMOs. The Fund may invest to a significant degree in
subordinated tranches of CMOs. Subordinated tranches of CMOs are entitled to
receive repayment of principal only after all required principal payments have
been made to more senior tranches and also have subordinate rights as to receipt
of interest distributions. Such subordinated tranches are subject to a greater
risk of nonpayment than are senior tranches or CMOs backed by third party credit
enhancement. In addition, an active secondary market for such securities is not
as well developed as the market for certain other Mortgage-Backed Securities.
Accordingly, such subordinated CMOs may have limited marketability and there can
be no assurance that a more efficient secondary market will develop.
CMOs Backed by Mortgages on Multi-Family Dwellings. The Fund may invest to a
significant degree in CMOs backed by mortgages on multi-family dwellings. Such
mortgages are subject to risks generally not associated with mortgages on single
family homes, including vacancy rates, increases in operating expenses,
regulatory requirements and environmental liability concerns. In addition, such
securities may have limited marketability and there can be no assurance that a
more efficient secondary market will develop. Multi-family dwellings can be
affected significantly by supply and demand in the market for the type of
property securing the loan and therefore may be subject to adverse economic
conditions. Market values may vary as a result of economic events or
governmental regulations outside the control of the borrower or lender, such as
rent control laws, which impact the future cash flow of the property. Mortgages
on multi-family and commercial real estate properties often are structured so
that a substantial portion of the loan principal is to be repaid at maturity.
Repayment of such principal may depend on the ability of the borrower to obtain
new financing. CMOs backed by mortgages on multi-family dwelling may be backed
by fewer mortgages involving fewer borrowers than is the case for
Mortgage-Backed Securities backed by mortgages on single-family homes.
Accordingly, the event of a single default or insolvency of a single borrower
may have a greater adverse impact than would be the case for Mortgage-Backed
Securities backed by mortgages on single-family homes. Mortgages on multi-family
dwellings are often nonrecourse to the borrower.
Credit Support. Mortgage-Backed Securities and Asset-Backed Securities are often
backed by a pool of assets representing the obligations of a number of different
parties. To lessen the effect of failures by obligors on underlying assets to
make payments, such securities may contain elements of credit support. Such
credit support falls into two categories: (i) liquidity protection and (ii)
protection against losses resulting from ultimate default by an obligor on the
underlying assets. Liquidity protection refers to the provision of advances,
generally by the entity administering the pool of assets, to ensure that the
pass-through of payments due on the underlying pool occurs in a timely fashion.
Protection against losses resulting from ultimate default enhances the
likelihood of ultimate payment of the obligations on at least a portion of the
assets in the pool. Such protection may be provided through guarantees,
insurance policies or letters of credit obtained by the issuer or sponsor from
third parties, through various means of structuring the transaction or through a
combination of
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such approaches. The Fund will not pay any additional fees for such credit
support, although the existence of credit support may increase the price of a
security.
The ratings of Mortgage-Backed Securities and Asset-Backed Securities for which
third-party credit enhancement provides liquidity protection or protection
against losses from default are generally dependent upon the continued
creditworthiness of the provider of the credit enhancement. The ratings of such
securities could be subject to reduction in the event of deterioration in the
creditworthiness of the credit enhancement provider even in cases where the
delinquency and loss experience on the underlying pool of assets is better than
expected.
Examples of credit support arising out of the structure of the transaction
include "senior-subordinated securities" (multiple class securities with one or
more classes subordinate to other classes as to the payment of principal thereof
and interest thereon, with the result that defaults on the underlying assets are
borne first by the holders of the subordinated class), creation of "reserve
funds" (where cash or investments, sometimes funded from a portion of the
payments on the underlying assets, are held in reserve against future losses)
and "over-collateralization" (where the scheduled payments on, or the principal
amount of, the underlying assets exceed those required to make payment on the
securities and pay any servicing or other fees). The degree of credit support
provided for each issue is generally based on historical information with
respect to the level of credit risk associated with the underlying assets.
Delinquency or loss in excess of that which is anticipated could adversely
affect the return on an investment in such a security.
Whole Loans -- The timely payment of interest and principal on a Whole Loan is
secured by an income producing property and, therefore, is dependent upon
performance and payments by the lessees under the related leases and the
successful operation of the underlying property, rather than its liquidation
value. If the net operating income from the underlying property is reduced (for
example, if rental or occupancy rates decline or real estate tax rates or other
operating expenses increase), the borrower's ability to repay the Whole Loan may
be impaired. Furthermore, the liquidation value of the property may be adversely
affected by risks generally incidental to interests in real property, including
changes in general or local economic conditions and/or specific industry
segments; declines in real estate values; declines in rental or occupancy rates;
increases in interest rates, real estate tax rates and other operating expenses
including energy costs; changes in governmental rules, regulations and fiscal
policies, including environmental legislation; acts of God; and other factors
which are beyond the borrower's, the issuer's, or the property manager's
control. Whole Loans may be considered illiquid securities. See "Risk
Considerations-Less Marketable and Illiquid Securities" herein. Additionally,
the borrower may be obligated to cause standard hazard insurance to be
maintained with respect to an underlying property. Insurance with respect to
extraordinary hazards such as earthquakes is not always required, and insurance
may not be available (or is available only at prohibitively expensive rates)
with respect to many other risks, including those listed above. In addition,
there is no assurance that any loss incurred will not exceed the limits of
policies obtained.
In addition, the borrower's ability to make payments in respect of a Whole Loan
largely depends on the ability of tenants to perform on their rental obligations
under existing leases and the ability of the borrower to continue to lease a
substantial portion of the property upon terms which do not adversely affect the
property's cash flow. As the leases expire or lessees default, the demand for,
and supply of, rental space in general from time to time may affect the
property's occupancy rate and the rental rates obtained and concessions, if any,
granted on new leases or re-leases of space, which may cause fluctuations in the
cash flow from the operation of the property. Such fluctuations may affect the
amount and timing of payments on the Whole Loan.
Furthermore, Whole Loans with balloon payments involve a greater degree of risk
of payment because the ability of a borrower to make a balloon payment will
depend upon its ability to either refinance the loan or to sell the related
property. The ability and desire of the borrower to accomplish either of these
goals will be affected by a number of factors, including the level of available
mortgage rates at the time of sale or refinancing, the borrower's equity in the
property, the physical and financial condition and operating history of the
property, tax laws, prevailing general economic and market conditions and the
availability of credit for commercial real estate projects, generally. In
addition, the value of commercial properties depends, in part, on the fitness of
such properties for a particular purpose. Thus, no assurance can be given that
other parties will find such property sufficient for the purpose for which it is
currently being used.
REIT Debt Securities -- Investing in REIT Debt Securities involves certain
unique risks in addition to those risks associated with investing in the real
estate industry in general which include, among other things, possible declines
in the value of real estate; risks related to general and local economic
conditions; possible lack of availability of mortgage funds;
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over-building; extended vacancies of properties; increases in competition,
property taxes and operating expenses; changes in zoning laws; costs resulting
from the clean-up of, and liability to third parties for damages resulting from,
environmental problems; casualty or condemnation losses; uninsured damages from
flood, earthquakes or other natural disasters; limitations on and variations in
rents; dependency on property management skill; the appeal of properties to
tenants; and changes in interest rates. Equity REITs may be affected by changes
in the value of the underlying property owned by the REITs while mortgage REITs
may be affected by the quality of any credit extended. REITs are dependent upon
management skills, are not diversified, and are subject to the risks of
financing projects. The Fund may invest in the debt securities of new or
unseasoned REIT issuers and it, therefore, may be difficult or impossible for
the Adviser to ascertain the value of each of such REITs' underlying assets,
management capabilities and growth prospects. In addition, REITs are subject to
heavy cash flow dependency, default by borrowers, self-liquidation, and the
possibilities of failing to qualify for the exemption from tax or distributed
income under the Internal Revenue Code of 1986, as amended (the "Code") and
failing to maintain their exemptions from the 1940 Act. REITs whose underlying
assets include long-term health care properties, such as nursing, retirement and
assisted-living homes, may be affected by federal regulations concerning the
health care industry.
REITs (especially mortgage REITs) and REIT Debt Securities are subject to
interest rate risks. When interest rates decline, the value of a REIT's
investment in fixed rate obligations usually rises. Conversely, when interest
rates rise, the value of a REIT's investment in fixed rate obligations can be
expected to decline. In contrast, as interest rates on adjustable rate mortgage
loans are reset periodically, yields on a REIT's investment in such loans will
gradually align themselves to reflect changes in market interest rates, causing
the value of such investments to fluctuate less dramatically in response to
interest rate fluctuations than would investments in fixed rate obligations.
Less Marketable and Illiquid Securities -- The Fund may not invest more than 15%
of its net assets in securities for which the secondary trading market is not as
well developed as the markets for certain Mortgage-Backed Securities or that are
otherwise considered less marketable or illiquid. Liquidity relates to the
ability of the Fund to readily dispose of securities and the price to be paid
therefor, but does not generally relate to credit risk or the likelihood of
receipt of cash at maturity. Securities which have limited marketability or
which may be regarded as illiquid under current guidelines of the staff of the
Securities and Exchange Commission may include certain subordinated CMO
tranches, certain CMOs backed by mortgages on multi-family dwellings, Whole
Loans, certain hedging instruments, including interest rate collars, caps and
floors, forward commitments, over-the-counter options, mortgage swaps and
futures and options on Mortgage-Backed Securities. Securities may be less
marketable or illiquid because of the absence of registration under the
Securities Act of 1933, contractual restrictions on transfer, the small size of
the issue (relative to issues of comparable securities) or, particularly in the
case of recently developed securities, undeveloped or partially developed
trading markets. Investment in illiquid securities may expose the Fund to
greater risks or costs. The Fund may not be able to sell less marketable or
illiquid instruments when the Adviser considers it desirable to do so or may
have to sell them at a price lower than could be obtained if they were more
marketable. These factors may have an adverse impact on net asset value. Less
marketable and illiquid securities may be more difficult to value due to the
unavailability of reliable market quotations. Also, the sale of less marketable
securities may require more time and result in higher brokerage charges or
dealer discounts and other selling expenses than does the sale of more
marketable securities.
Investment Grade Securities -- The ratings assigned to securities by a Rating
Agency reflect such Agency's assessment of the issuer's creditworthiness,
ability to make timely repayments of principal and interest and the nature and
quality of the collateral underlying the obligation. Securities rated in the
fourth highest rating category by a Rating Agency are investment grade but have
certain speculative characteristics. For example, securities rated BBB by S&P
are regarded as having an adequate capacity to pay interest and repay principal.
Such securities normally exhibit adequate parameters, but adverse economic
conditions or changing circumstances are more likely to lead to a weakened
capacity to pay interest and repay principal than for debt in higher rated
categories. Moody's states that securities rated Baa are considered medium grade
obligations. Interest payments and principal security appear adequate for the
present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such securities
lack outstanding investment characteristics and in fact have speculative
characteristics as well. Securities rated BBB by Fitch are considered to be
investment grade and of satisfactory credit quality. Securities rated BBB by
Duff & Phelps have below average protection but are still considered investment
grade securities. The Fund's investment in securities rated at the time of
investment in the second, third or fourth highest rating category by a Rating
Agency incrementally increases the risk of nonpayment and of significant delay
in payment on such securities. Nonpayment or delay could have an adverse impact
14
<PAGE>
on the net income and dividends of the Fund. The Fund may retain in its
portfolio securities whose ratings have been downgraded to below the fourth
highest rating category by a Rating Agency, although the Fund anticipates that
not more than 5% of its total assets, if any, will consist of securities whose
ratings have been so downgraded. Rating downgrades may adversely affect the
value of a security and may have an adverse effect on the net asset value of the
Fund.
Repurchase Agreements -- The Fund may invest temporarily, without limitation, in
repurchase agreements, which are agreements pursuant to which securities are
acquired by the Fund from a third party with the commitment that they will be
repurchased by the seller at a fixed price on an agreed date. These agreements
may be made with respect to any of the portfolio securities in which the Fund is
authorized to invest. Repurchase agreements may be characterized as loans by the
Fund to the other party to the agreement that are secured by the underlying
securities. Repurchase agreements facilitate portfolio management and allow the
Fund to earn additional revenue. The Fund may enter into repurchase agreements
with (i) member banks of the Federal Reserve System having total assets in
excess of $500 million and (ii) securities dealers, provided that such banks or
dealers meet the creditworthiness standards established by the Fund's Board of
Directors ("Qualified Institutions"). The Adviser will monitor the continued
creditworthiness of Qualified Institutions, subject to the oversight of the
Fund's Board of Directors. The resale price reflects the purchase price plus an
agreed upon market rate of interest which is unrelated to the coupon rate or
date of maturity of the purchased security. The collateral will be
marked-to-market daily. Such agreements permit the Fund to keep all its assets
earning interest while retaining overnight flexibility in pursuit of investments
of a longer-term nature.
The use of repurchase agreements involves certain risks. For example, if the
seller of securities under a repurchase agreement defaults on its obligation to
repurchase the underlying securities, as a result of its bankruptcy or
otherwise, the Fund will seek to dispose of such securities, which action could
involve costs or delays. If the seller becomes insolvent and subject to
liquidation or reorganization under applicable bankruptcy or other laws, the
Fund's ability to dispose of the underlying securities may be restricted. Also,
it is possible that the Fund may not be able to substantiate its interest in the
underlying securities. To minimize this risk, the securities underlying the
repurchase agreement will be held by a custodian at all times in an amount at
least equal to the repurchase price, including accrued interest. If the seller
fails to repurchase the securities, the Fund may suffer a loss to the extent
proceeds from the sale of the underlying securities are less than the repurchase
price.
Lending of Securities -- The Fund may lend its portfolio securities to Qualified
Institutions. By lending its portfolio securities, the Fund attempts to increase
its income through the receipt of interest on the loan. Any gain or loss in the
market price of the securities loaned that may occur during the term of the loan
will be for the account of the Fund.
The Fund will not lend portfolio securities if, as a result, the aggregate of
such loans exceeds 33 1/3% of the value of the Fund's total assets (including
such loans). The lending of portfolio securities involves certain risks arising
out of an extension of credit. All relevant facts and circumstances, including
the creditworthiness of the Qualified Institution, will be monitored by the
Adviser, and will be considered in making decisions with respect to lending of
securities, subject to review by the Fund's Board of Directors. The Fund may pay
reasonable negotiated fees in connection with loaned securities, so long as such
fees are set forth in a written contract and their reasonableness is determined
by the Fund's Board of Directors.
Borrowing -- The Fund is authorized to borrow for temporary or emergency
purposes such as the meeting of redemption requests that might otherwise require
the untimely disposition of securities or for hedging purposes. The Fund will
only borrow when the Adviser believes that such borrowings will benefit the
Fund.
Hedging Transactions -- The Fund may enter into various hedging transactions,
such as interest rate swaps and the purchase or sale of interest rate collars,
caps and floors, to preserve a return or spread on a particular investment
within the portfolio or its entire portfolio and to manage the effective
maturity or interest rate sensitivity of its portfolio. Hedging transactions may
also be used to attempt to protect against possible declines in the market value
of the Fund's assets resulting from downward trends in the debt securities
markets (generally due to a rise in interest rates), to protect any unrealized
gains in the value of the Fund's portfolio securities, to facilitate the sale of
such securities or to establish a position in the securities markets as a
temporary substitute for purchasing particular securities. Any or all of these
techniques may be used at any time. There is no particular strategy that
requires use of one technique rather than another. Use of any particular hedging
transaction is a function of market conditions. Further hedging transactions may
be used by the Fund in the future as they are developed or deemed by the Board
of Directors of the Fund to be appropriate and in the best
15
<PAGE>
interest of investors in the Fund. The Fund intends to use these transactions as
a hedge against market fluctuations and not as speculative investments. The Fund
may also purchase and sell (or write) options on securities or indices of
securities and may purchase or sell futures contracts or options on futures
contracts, as described below.
The Fund may employ a variety of hedging transactions as described below and
there can be no assurance that any such transaction used will succeed. The
principal risks relating to the use of hedging transactions are: (a) possible
imperfect correlation between changes in the value of the hedging instrument and
the changes in the market value of the underlying securities; (b) possible lack
of a liquid secondary market for closing out or offsetting a hedging position;
(c) losses on hedging positions resulting from general movements in securities
prices or interest rate movements not anticipated by the Adviser, and (d) the
possibility that the Fund could be obligated to pay variation margin on a
hedging position at a time when it would be disadvantageous to do so. While the
use of hedging transactions should tend to minimize the risk of loss resulting
from a decline in the value of hedged portfolio securities, these transactions
will tend to limit any potential that could result from an increase in the value
of these securities. Such transactions also are subject to the risk that, if the
Adviser is incorrect in its forecast of interest rates, market values or other
economic factors affecting such a transaction, the Fund would have been better
off if it had not entered into the transaction.
Reverse Repurchase Agreements and Dollar Roll Agreements. The Fund may enter
into reverse repurchase agreements and dollar roll agreements with the same
parties with whom it may enter into repurchase agreements. Under a reverse
repurchase agreement or a dollar roll agreement, the Fund sells securities and
agrees to repurchase them, or substantially similar securities in the case of a
dollar roll agreement, at a mutually agreed upon date and price. Under generally
accepted accounting principles, reverse repurchase agreements and dollar roll
agreements are generally regarded as a form of borrowing. At the time the Fund
enters into a reverse repurchase agreement or a dollar roll agreement, it will
establish and maintain a segregated account with its custodian containing
securities from its portfolio having a value not less than the repurchase price
(including accrued interest). The Fund's ability to enter into reverse
repurchase agreements and dollar roll agreements is not limited except by the
requirement to maintain assets in segregated accounts. Reverse repurchase
agreements and dollar roll agreements involve the risk that the market value of
the securities retained in lieu of their sale by the Fund may decline below the
price of the securities the portfolio has sold but is obligated to repurchase.
In the event the buyer of securities under a reverse repurchase agreement or a
dollar roll agreement files for bankruptcy or becomes insolvent, such buyer or
its trustee or receiver may receive an extension of time to determine whether to
enforce the Fund's obligation to repurchase the securities, and the Fund's use
of the proceeds of the reverse repurchase agreement or the dollar roll agreement
may effectively be restricted pending such decision. Investors should be aware
that the Fund will enter into reverse repurchase agreements, which may be
considered to be a form of borrowing and, therefore, involve the use of
leverage. The use of leverage involves special risks in that, while providing
increased opportunities for income, the use of leverage also means that any
losses will be magnified. The use of reverse repurchase agreements also involves
certain fees and costs to the Fund.
When-Issued Purchases and Forward Commitments. The Fund may purchase securities
on a "when-issued" basis and may purchase or sell securities on a "forward
commitment" basis. When such transactions are negotiated, the price is fixed at
the time the commitment is made, but delivery and payment for the securities
take place at a later date, which can be a month or more after the date of the
transaction. At the time the Fund makes the commitment to purchase securities on
a when-issued or forward commitment basis, it will record the transaction and
thereafter reflect the value of such securities in determining its net asset
value. At the time the Fund enters into a transaction on a when-issued or
forward commitment basis, a segregated account consisting of cash or high grade
liquid debt securities equal to the value of the when-issued or forward
commitment securities will be established and maintained with the Fund's
Custodian and will be marked-to-market daily. On the delivery date, the Fund
will meet its obligations from securities that are then maturing or sales of the
securities held in the segregated asset account and/or from then available cash
flow. When-issued securities and forward commitments may be sold prior to the
settlement date which can result in a gain or loss due to market fluctuation
subsequent to the time when the commitment was originally made. There is always
a risk that the securities may not be delivered and that the Fund may incur a
loss or will have lost the opportunity to invest the amount set aside for such
transaction in the segregated asset account. Settlements in the ordinary course,
which may take substantially more than three business days for mortgage-related
securities, are not treated by the Fund as when-issued or forward commitment
transactions and, accordingly, are not subject to the foregoing limitations even
though some of the risks described above may be present in such transactions.
16
<PAGE>
Short Sales. The Fund may also make short sales of securities as a form of
hedging to offset potential declines in long positions in similar securities. A
short sale is a transaction in which the Fund sells a security it does not own
in anticipation that the market price of that security will decline.
When the Fund makes a short sale, it must borrow the security sold short and
deliver it to the broker-dealer through which it made the short sale as
collateral for its obligation to deliver the security upon conclusion of the
sale. Such borrowings may expose the Fund to increased risks or costs. The Fund
may have to pay a fee to borrow particular securities and is obligated to return
any payments received on such borrowed securities.
The Fund's obligation to replace the borrowed security will be secured by
collateral deposited with the broker-dealer, usually cash, U.S. Government
securities or other highly liquid securities. The Fund will also be required to
deposit similar collateral with its Custodian to the extent, if any, necessary
so that the value of both collateral deposits in the aggregate is at all times
equal to at least 100% of the current market value of the security sold short.
The Fund is due to receive only interest payments on the deposited collateral
during the term of the borrowing.
If the price of the security sold short increases between the time of the short
sale and the time the Fund replaces the borrowed security, the Fund will incur a
loss; conversely, if the price declines, the Fund will realize a capital gain.
Any gain will be decreased, and any loss increased, by the transaction costs
described above. Although the Fund's gain is limited to the price at which it
sold the security short, its potential loss is theoretically unlimited.
The Fund will not make a short sale if, after giving effect to such sale, the
market value of all securities sold short exceeds 20% of the value of its total
assets or the Fund's aggregate short sales of a particular class of securities
exceeds 25% of the outstanding securities of that class. The Fund may also make
short sales "against the box" without regard to such limitations. In this type
of short sale, at the time of the sale, the Fund owns or has the immediate and
unconditional right to acquire at no additional cost the identical securities.
Calls and Puts on Securities and Related Options. The Fund may engage in various
put and call transactions. The Fund may hedge through the use of call options
("calls") on U.S. Treasury securities and Mortgage-Backed Securities that are
traded on U.S. and foreign securities exchanges and in the over-the-counter
markets. The Fund may purchase and sell calls on these securities or indices
thereof. Sales of calls will be "covered" while the call is outstanding (i.e.,
the seller owns the securities subject to the call or other securities
acceptable for applicable escrow requirements). Some contracts are "cash
settled" (i.e., the seller pays the difference between the call and market price
in cash when the market price is higher). Cash-settled calls also may be
covered. The Fund does not intend to sell any cash-settled calls that are not
covered. If a call sold by the Fund is exercised, the Fund forgoes any possible
profit from an increase in the market price of the underlying security over the
exercise price.
The Fund may hedge through the use of put options ("puts") that relate to U.S.
Treasury securities and Mortgage-Backed Securities (whether or not it holds such
securities in its portfolio) or on indices of securities. The Fund may purchase
puts on these securities and may also sell puts on these securities or indices
if such puts are secured by segregated liquid assets. The Fund will not sell
puts if, as a result, more than 50% of the Fund's assets would be required to be
segregated liquid assets. In selling puts, there is a risk that the Fund may be
required to buy the underlying security at a disadvantageous price.
A put option gives the purchaser of the option the right to sell and the writer,
if the purchaser exercises his right, the obligation to buy the underlying
security at the exercise price during the option period. A call option gives the
purchaser of the option the right to buy and the writer, if the purchaser
exercises his right, the obligation to sell the underlying security at the
exercise price during the option period. The Fund is authorized to purchase and
sell exchange listed options and over-the-counter options ("OTC Options").
Listed options are issued by the Options Clearing Corporation ("OCC") which
guarantees the performance of the obligations of the parties to such options.
The purchaser of an option risks losing his entire investment in a short period
of time. If an option is not sold while it has remaining value, or if during the
life of an option the underlying security does not appreciate, in the case of a
call option, or depreciate, in the case of a put option, the purchaser of such
option may lose his entire investment. On the other hand, given the same market
conditions, if the potential purchaser of a call option purchases the underlying
security directly instead of purchasing a call option or if the potential
purchaser of a put option decides not to purchase the put option, but to sell
the underlying security, such potential option purchaser might have less of a
loss. An option purchaser does not
17
<PAGE>
have the choice of "waiting out" an unexpected decrease or increase in the price
of the underlying fixed income security beyond the expiration date of the
option. The more that an option is out-of-the-money and the shorter its
remaining term to expiration, the greater the risk that a purchaser of the
option will lose all or part of his investment. Further, except where the value
of the remaining life of an option may be realized in the secondary market, for
an option purchase to be profitable the market price of the underlying interest
must exceed or be below the exercise price by more than the premium and
transaction costs paid in connection with the purchase of the option and its
sale or exercise.
The writer of an option assumes an obligation to deliver or purchase the
underlying interest represented by the option upon the assignment to him of an
exercise notice. The writer is subject to being assigned an exercise notice at
any time after he has written the option until the option expires or until he
has closed out his position by the offsetting purchase of an identical option.
The Fund's ability to close out its position as a writer or purchaser of an
exchange-listed option is dependent upon the existence of a liquid secondary
market on option exchanges. Among the possible reasons for the absence of a
liquid secondary market on an exchange are: (i) insufficient trading interest in
certain options; (ii) restrictions on transactions imposed by an exchange; (iii)
trading halts, suspensions or other restrictions imposed with respect to
particular classes or series of options or underlying securities; (iv)
interruption of the normal operations on an exchange; (v) inadequacy of the
facilities of an exchange or OCC to handle current trading volume; or (vi) a
decision by one or more exchanges to discontinue the trading of options (or a
particular class or series of options) in which event the secondary market on
that exchange (or in that class or series of options) would cease to exist,
although outstanding options on that exchange that had been listed by the OCC as
a result of trades on that exchange would generally continue to be exercisable
in accordance with their terms. OTC Options are purchased from or sold to
dealers or financial institutions which have entered into direct agreement with
the Fund. With OTC Options, such variables as expiration date, exercise price
and premium will be agreed upon between the Fund and the transacting dealer,
without the intermediation of a third party such as the OCC. If the transacting
dealer fails to make or take delivery of the securities underlying an option it
has written, in accordance with the terms of that option as written, the Fund
would lose the premium paid for the option as well as any anticipated benefit of
the transaction. OTC Options and their underlying securities are considered
illiquid. The Fund will engage in OTC Option transactions only with primary U.S.
Government securities dealers recognized by the Federal Reserve Bank of New
York.
The hours of trading for options on debt securities may not conform to the hours
during which the underlying securities are traded. To the extent that the option
markets close before the markets for the underlying securities, significant
price and rate movements can take place in the underlying markets that cannot be
reflected in the option markets.
Futures Contracts and Related Options. The Fund may buy or sell financial
futures contracts or purchase options on such futures as a hedge against
anticipated interest rate changes. A futures contract sale creates an obligation
by the Fund, as seller, to deliver the specified type of financial instrument
called for in the contract at a specified future time for a specified price or,
in "cash settlement" futures contracts, to pay to (or receive from) the buyer in
cash the difference between the price in the futures contract and the market
price of the instrument on the specified date, if the market price is higher (or
lower, as the case may be). Options on futures contracts are similar to options
on securities except that an option on a futures contract gives the purchaser
the right for the premium paid to assume a position in a futures contract (a
long position if the option is a call and a short position if the option is a
put).
The Fund's use of futures and options on futures will in all cases be consistent
with applicable regulatory requirements and in particular the rules and
regulations of the Commodity Futures Trading Commission ("CFTC") with which the
Fund must comply in order not to be deemed a commodity pool operator within the
meaning and intent of the Commodity Exchange Act and the regulations promulgated
thereunder.
Typically, an investment in a futures contract requires the Fund to deposit with
the applicable exchange or other specified financial intermediary as security
for its obligations an amount of cash or other specified debt securities which
initially is 1% to 5% of the face amount of the contract and which thereafter
fluctuates on a periodic basis as the value of the contract fluctuates. An
investment in options involves payment of a premium for the option without any
further obligation on the part of the Fund.
Regulations of the CFTC applicable to the Fund currently require that all of the
Fund's futures and options on futures transactions constitute bona fide hedging
transactions or be undertaken incidental to the Fund's activities in the
securities
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<PAGE>
markets. In accordance with CFTC regulations, the Fund may not purchase or sell
futures contracts or options thereon if immediately thereafter the sum of the
amounts of initial margin deposits on the Fund's existing futures positions and
premiums paid for options on futures would exceed 5% of the fair market value of
the Fund's total assets. The Adviser reserves the right to comply with such
different standard as may be established by CFTC rules and regulations with
respect to the purchase or sale of futures contracts or options thereon.
The variable degree of correlation between price movements of futures contracts
and price movements in the position being hedged creates the possibility that
losses on the hedge may be greater than gains in the value of the Fund's
position. In addition, futures and futures option markets may not be liquid in
all circumstances. As a result, in volatile markets, the Fund may not be able to
close out a transaction without incurring losses substantially greater than the
initial deposit. Although the contemplated use of these contracts should tend to
minimize the risk of loss due to a decline in the value of the hedge position,
at the same time they tend to limit any potential gain which might result from
an increase in the value of such position. The ability of the Fund to hedge
successfully will depend on the Adviser's ability to forecast pertinent market
movements, which cannot be assured. Finally, the daily deposit requirements in
futures contracts create an ongoing greater potential financial risk than do
options purchased by the Fund, where the exposure is limited to the cost of the
initial premium. Losses due to hedging transactions will reduce net asset value.
Income earned by the Fund from its hedging activities generally will be treated
as capital gains.
Eurodollar Futures Contracts and Related Options. The Fund may make investments
in Eurodollar futures contracts and options thereon for hedging purposes only
and, in each case, in accordance with the rules and regulations of the CFTC.
Eurodollar futures contracts and options thereon are essentially U.S.
dollar-denominated futures contracts or options thereon which are linked to
LIBOR. Eurodollar futures contracts enable purchasers to obtain a fixed rate for
the lending of funds and sellers to obtain a fixed rate for borrowings. The Fund
intends to use Eurodollar futures contracts and options thereon to hedge against
changes in LIBOR, to which many interest rate swaps, short term borrowings and
floating rate securities are linked. When the Fund enters into a futures
contract, it makes a deposit of initial margin and thereafter will be required
to pay or entitled to receive variation margin in an amount equal to the change
in the value of the contract from the preceding day.
Interest Rate Transactions. Interest rate swaps involve the exchange with
another party of commitments to pay or receive interest (e.g., an exchange of
floating rate payments for fixed rate payments). The purchase of an interest
rate cap entitles the purchaser, to the extent that a specified index exceeds a
predetermined interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate cap. The purchase of
an interest rate floor entitles the purchaser, to the extent that a specified
index falls below a predetermined interest rate, to receive payments of interest
on a notional principal amount from the party selling such interest rate floor.
An interest rate collar combines the elements of purchasing a cap and selling a
floor. The collar protects against an interest rate rise above the maximum
amount but gives up the benefits of an interest rate decline below the minimum
amount. The net amount of the excess, if any, of the Fund's obligations over its
entitlements with respect to each interest rate swap will be accrued on a daily
basis and an amount of cash or liquid securities having an aggregate net asset
value at least equal to the accrued excess will be maintained in a segregated
account by the Fund's Custodian. If there is a default by the other party to
such a transaction, the Fund will have contractual remedies pursuant to the
agreements related to the transactions.
The Fund may enter into interest rate transactions to preserve a return or
spread on a particular investment or portion of its portfolio, to protect
against any increase in the price of securities the Fund anticipates purchasing
at a later date, to effectively fix the rate of interest that it pays on one or
more borrowings or series of borrowings or to manage the effective maturity or
interest rate sensitivity of its portfolio. The Fund would use these
transactions as a hedge and not as a speculative investment. Interest rate
transactions are subject to risks comparable to those described above with
respect to other hedging strategies.
The Fund may enter into interest rate swaps, caps, collars and floors on either
an asset-based or liability-based basis, depending on whether it is hedging its
assets or its liabilities, and will usually enter into interest rate swaps on a
net basis, i.e., the two payment streams are netted out, with the Fund receiving
or paying, as the case may be, only the net amount of the two payments. Inasmuch
as these interest rate transactions are entered into for good faith hedging
purposes, and inasmuch as segregated accounts will be established with respect
to such transactions, the Adviser and the Fund believe such obligations do not
constitute senior securities and, accordingly, will not treat them as being
subject to its borrowing restrictions. The net amount of the excess, if any, of
the Fund's obligations over its entitlements with respect to each
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<PAGE>
interest rate swap will be accrued on a daily basis and an amount of cash, U.S.
Government securities or other liquid high grade debt obligations having an
aggregate net asset value at least equal to the accrued excess will be
maintained in a segregated account by the Fund's Custodian. The Fund also will
establish and maintain such segregated accounts with respect to its total
obligations under any interest rate swaps that are not entered into on a net
basis and with respect to any interest rate caps, collars and floors that are
written by the Fund.
The Fund will enter into interest rate transactions only with banks and
recognized securities dealers believed by the Adviser to present minimal credit
risks in accordance with guidelines established by the Fund's Board of
Directors. If there is a default by the other party to such a transaction, the
Fund will have to rely on its contractual remedies (which may be limited by
bankruptcy, insolvency or similar laws) pursuant to the agreements related to
the transaction.
Subordinated Securities -- Credit enhancement in the form of subordination
provides for the issuance of a senior class of certificates which are generally
rated at least AA/Aa by any of the Rating Agencies and one or more classes of
subordinated certificates which bear ratings lower than the senior certificates
or are non-rated. Holders of either the senior or the subordinated certificates
will ordinarily be entitled to a pro rata share of distributions of principal
and interest. However, in the event that delinquencies and defaults on the
underlying mortgage loans cause a shortfall in the distributions to the senior
certificates, distributions otherwise payable to the subordinated certificates
will be distributed to the senior certificates to the extent required. The
characteristics of the mortgage loans and other credit enhancement features will
determine the size of the subordinated interest required to obtain the desired
rating on the senior securities.
The Fund may invest in subordinated certificates. To compensate for the greater
risk of loss on, and illiquidity of, the subordinated certificates, the yields
on subordinated certificates are generally substantially higher than those
available on senior certificates. To the extent that actual delinquency and loss
experience is greater than anticipated, the return on the subordinated
certificates will be adversely affected and, in extreme cases, a portion of the
principal could be lost; to the extent that such experience is more favorable
than anticipated, the return on the subordinated certificates will be increased.
Non-Diversification -- As a non-diversified investment company, the Fund is not
subject to any statutory restriction under the 1940 Act with respect to
investing its assets in one or relatively few issuers. Non-diversification may
present greater risks for the Fund than in the case of a diversified company.
However, the Fund intends to qualify as a "regulated investment company" under
Subchapter M of the Code. The Fund will be restricted in that at the close of
each quarter of the taxable year, at least 50% of the value of its total assets
must be represented by cash, U.S. Government securities, investment company
securities and other securities limited in respect of any one issuer to not more
than 5% in value of the total assets of the Fund and to not more than 10% of the
outstanding voting securities of such issuer. In addition, at the close of each
quarter of any taxable year, not more than 25% in value of the Fund's total
assets may be invested in securities (other than U.S. Government securities or
the securities of other regulated investment companies) of one issuer or of two
or more issuers which the Fund controls and which are engaged in the same or
similar or related trades or businesses. The limitations described in this
paragraph regarding qualification under Subchapter M of the Code as a "regulated
investment company" are not fundamental policies and may be revised to the
extent applicable federal income tax requirements are revised. (See
"Distribution and Tax Matters" herein).
PURCHASES AND REDEMPTIONS OF SHARES
Distributor
Hyperion Distributors, Inc. (the "Distributor") serves as the exclusive
distributor of the shares of the Fund pursuant to its Distribution Agreement
with the Fund. Investors may open accounts in the Fund only through the
exclusive Distributor for the Fund. Under the Distribution Agreement, the
Distributor, for nominal consideration and as agent for the Fund, will solicit
orders for the purchase of Fund shares, provided that any subscriptions and
orders will not be binding on the Fund until accepted by the Fund as principal.
The Adviser pays the expenses incurred in the distribution of the Fund's shares.
Purchases and Sales of Shares
The Fund's shares are sold on a continuous basis and may be purchased upon
receipt of a purchase order by the Distributor at the current net asset value of
such shares which is computed daily. The minimum initial investment in the Fund
is $100,000. The minimum additional investment is $5,000. The minimum initial
and subsequent investments may be
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<PAGE>
waived for employees of the Adviser, Hyperion Capital Management, Inc. and
Equitable Real Estate Investment Management, Inc. Shares of the Fund may be
purchased at the public offering price, which is the net asset value next
determined after the purchase order is transmitted to and accepted by the
Distributor. Payment may be made by check, but shares are issued only upon
receipt of full payment. No exchange privilege is currently available between
the Fund and any other Fund.
METHOD THROUGH INITIAL (MINIMUM) INVESTMENT
By
Mail:
State Street Bank Complete application and mail with check made
payable to "Equitable Real Estate Hyperion
Mortgage Opportunity Fund, Inc." to: [the
Fund, c/o State Street Bank]
By
Wire:
State Street Bank $100,000
Call (617) 985-7183 to obtain a Shareholder
Account Number. Then contact your bank and
request it to wire federal funds as specified
below. You must provide all information
requested below. Investors making initial
investments by wire must promptly complete a
Purchase Application and mail it to State
Street Bank and Trust Company, Attn: Equitable
Real Estate Hyperion Mortgage Opportunity
Fund, Inc. at the address on the back cover.
The application may also be sent via
facsimile.
Wire federal funds to: State Street Bank & Trust Co., ABA #011000028, Account
Number 99039513, for Equitable Real Estate Hyperion Mortgage Opportunity Fund,
Inc. Include your name, Shareholder Account Number and social security number.
METHOD ADDITIONAL (MINIMUM) INVESTMENT
By
Mail:
Mail check made payable to "Equitable Real Estate
Hyperion Mortgage Opportunity Fund, Inc."
Include account number on check
By
Wire:
$5,000
Contact your bank and request it to wire federal
funds as specified below. You must provide all
information requested below.
Wire fe
Number
Inc. In
The Distributor, at its expense, may from time to time provide promotional
incentives to dealers who sell shares of the Fund. In some instances, these
incentives may be offered only to certain dealers who have sold or may sell
significant numbers of shares of the Fund. Shares of the Fund may be purchased
at the public offering price through a securities broker or bank or other
financial institution (a "Dealer") which has a sales or agency agreement with
the Distributor.
Redemptions
A shareholder may redeem all or any portion of the shares in its account at any
time at the net asset value next determined after a redemption request in proper
form is received and accepted by the Distributor. The proceeds of an effective
redemption request will be paid within seven days. In some cases the Fund may
require the furnishing of additional documents. A shareholder will be charged a
fee for a wire redemption (currently $8) equal to the fee charged for such
redemption by the Fund's Custodian.
The Fund will not make redemption proceeds available until a shareholder's check
(including a certified or cashier's check) received for purchase of those shares
being redeemed has been cleared by the bank on which it is drawn, which could
take up to fifteen days. A Fund shareholder may avoid any delay in redemption
proceeds being available by purchasing shares by federal funds wire.
The Fund has the right at its option and currently intends to redeem all of the
shares in any account in which there are fewer than a specified minimum number
of shares (currently 50 shares or 20 for an IRA). Written notice of at least 60
days will be given to a shareholder before any such redemption is effected, but
no redemption will occur if the shareholder increases the number of shares to
the specified number of shares by the end of the notice period.
The value of shares redeemed may be more or less than the shareholder's cost,
depending on the Fund's performance during the period the shareholder owned its
shares. Redemptions of shares are taxable events on which the shareholder may
recognize a gain or a loss. The Fund will not make redemptions in kind.
Distribution Options
A shareholder may elect to receive dividends and capital gain distributions in
either cash or additional shares of the Fund. Unless otherwise specified in
writing by a shareholder, all dividends and capital gain distributions will be
reinvested in additional shares. For further information on distributions, see
"Distributions and Taxes."
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PERFORMANCE INFORMATION
Performance information concerning the Fund may from time to time be used in
advertisements, shareholder reports or other communications to shareholders. The
Fund may provide period and average annualized "total return." The "total
return" refers to the change in the value of an investment over a stated period,
reflects any change in net asset value per share, and includes the value of any
shares purchasable with any dividends or capital gains distributions declared
during such period. Period total rates of return may be annualized. An
annualized total return is a compounded total rate of return which assumes that
the period total rate of return is generated over a number of 52-week periods,
and that all dividends and capital gain distributions are reinvested.
The Fund may provide annualized "yield" quotations. The "yield" of the Fund
refers to the income generated by an investment over a 30-day or one month
period (which period shall be stated in any advertisement or communications with
a shareholder). This income is then annualized, that is, the amount of income
generated by the investment over the period is assumed to be generated over a
52-week period and is shown as a percentage of investment. A yield quotation,
unlike a total return quotation, does not reflect changes in net asset value.
Because yield accounting methods differ from the methods used for other
accounting purposes, the Fund's yield may not equal its "distribution rate,"
which reflects all dividends paid (including returns of capital, if any), or the
income reported in the Fund's financial statements.
From time to time the Fund may also use comparative performance information in
such an advertisement or communication, including data from Lipper Analytical
Services, Inc., Bank Rate Monitor and other industry publications. The Fund may
also compare its performance to the current interest rate paid on a ten year
U.S. Treasury Note.
See the Statement of Additional Information of the Fund for further information
concerning the calculation of yield and any total rate of return quotations.
MANAGEMENT OF THE FUND
The Fund's Board of Directors which is responsible for the overall management
and supervision of the Fund has employed Equitable Real Estate Hyperion Capital
Advisors, L.L.C. to serve as investment adviser of the Fund. For information
about the Directors and Officers of the Fund, see "Management of the Fund" in
the Statement of Additional Information.
Investment Adviser
The Adviser provides advice to the Fund pursuant to an Investment Advisory
Agreement (the "Advisory Agreement"). Subject to such policies as the Board of
Directors of the Fund may determine, the Adviser makes investment decisions for
the Fund. For its services under the Advisory Agreement, the Adviser receives
from the Fund a fee accrued daily and paid monthly at an annual rate equal to
0.35% of the Fund's average daily net assets.
The Adviser is a limited liability corporation formed under the Delaware Limited
Liability Company Act and provides investment advisory, administrative,
financial and clerical services to clients whose principal investment objective
is to invest in Commercial Mortgage-Backed Securities. The Adviser is owned
equally by Equitable Real Estate Investment Management, Inc. and Hyperion
Capital Management, Inc. The Fund is currently the only open-end investment
company advisory client of the Adviser. The Fund's primary day-to-day investment
management decisions will be made by an investment committee, and no person(s)
is primarily responsible for making recommendations to that committee.
Information regarding the Fund's performance is set forth in the Fund's Annual
Report, which will be available without charge, upon request, from the Fund.
Hyperion Capital Management, Inc. ("HCM") is a wholly-owned subsidiary of
Hyperion Partners. Hyperion Partners primarily seeks investments in the
financial services, housing and real estate industries and assists in the
development of the properties in which it invests. The sole general partner of
Hyperion Partners is Hyperion Ventures, L.P., a Delaware limited partnership
("Hyperion Ventures"). Corporations owned principally by Lewis S. Ranieri,
Salvatore A. Ranieri and Scott A. Shay are the general partners of Hyperion
Ventures. Lewis S. Ranieri, a former Vice-Chairman of Salomon Brothers Inc., is
the Chairman of the Board of HCM and a Director of the Fund. Messrs. Salvatore
Ranieri and Shay are principally engaged in the management of the affairs of
Hyperion Ventures and its affiliated entities. As of April 30, 1995, HCM acts as
investment manager for clients with assets in excess of $4 billion. The business
address of HCM is 520 Madison Avenue, New York, New York 10022.
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Equitable Real Estate Investment Management, Inc. ("EREIM"), a subsidiary of The
Equitable Life Assurance Society of the United States ("Equitable"), is a full
service investment adviser with experience in investing and managing commercial
real estate assets for institutional lenders and owners. As of December 31,
1994, EREIM managed approximately $35 billion in real estate and mortgage
investments for its clients, which include pensions funds, international
investors, insurance companies and other financial institutions. EREIM also is
one of the nation's leading advisors to pension funds regarding investments in
U.S. real estate. As of December 31, 1994, EREIM managed approximately $11.0
billion in tax-exempt equity assets.
EREIM is headquartered in Atlanta, Georgia and has 14 regional offices located
throughout the United States. Through its network of regional offices, EREIM
manages more than 228 million square feet of retail, office, industrial and
apartment properties nationwide. The firm's regional operations are full service
offices with accounting, valuation and leasing professionals, asset and property
managers, and acquisition and disposition specialists. EREIM's regional office
system is designed to allow the company to monitor buy-sell opportunities
closely and act quickly on opportunities.
The Adviser provides persons satisfactory to the Fund's Board of Directors to
serve as officers of the Fund. Such officers, as well as certain other employees
and directors of the Fund, may be directors and officers of EREIM or HCM. The
Statement of Additional Information contains general background information
regarding each director and principal officer of the Fund. In addition, the
Adviser provides the Fund with the unique expertise of its two owners. With
respect to the Adviser, EREIM's personnel provide investment research,
acquisition and asset management services to assist the Adviser in underwriting,
due diligence and portfolio management activities with respect to the commercial
real estate collateral underlying the Fund's investments and provides the
Adviser with personnel to perform real estate evaluation services used in
developing credit evaluation and pricing models. HCM provides personnel to the
Adviser to provide quantitative research, trading, portfolio management,
administration, compliance and finance services to the Adviser in connection
with its underwriting, due diligence and portfolio management activities with
respect to the securities in which the Fund may invest. Further, HCM personnel
provide quantitative modeling services to the Adviser to assist in developing
credit evaluation and pricing models.
Certain affiliates of the Adviser engage in real estate-related activities,
including but not limited to acting as the servicer of a pool of Commercial
Mortgage-Backed Securities; underwriting and issuing Commercial Mortgage-Backed
Securities; serving as market-maker of Commercial Mortgage-Backed Securities;
originating loans that underlie Commercial Mortgage-Backed Securities; acting as
the borrower of a mortgage that underlies Commercial Mortgage-Backed Securities;
and purchasing Commercial Mortgage-Backed Securities for their own accounts or
accounts over which they have control. Because the 1940 Act prohibits certain
affiliated transactions involving the Fund and certain affiliates of the Fund,
in the absence of exemptive relief, the Fund may be prohibited from purchasing
Commercial Mortgage-Backed Securities with respect to which an affiliate of the
Adviser acted in one or more of the above capacities. The Adviser does not
anticipate that this restriction will have any significant adverse effect on its
ability to manage the Fund. However, the Adviser may seek exemptive relief to
permit the Fund to engage in certain transactions involving affiliates under
conditions designed to eliminate or minimize any potential conflict of interest.
Administrator
Pursuant to an Administrative Services Agreement, the Adviser supervises the
overall administration of the Fund, including, among other responsibilities, the
negotiation of contracts and fees with, and the monitoring of performance and
billings of, the independent contractors and agents of the Fund; the preparation
and filing of all documents required for compliance by the Fund with applicable
laws and regulations; and arranging for the maintenance of books and records of
the Fund. The Adviser provides persons satisfactory to the Board of Directors of
the Fund to serve as certain officers of the Fund. Such officers may be
directors, officers or employees of the Adviser or its affiliates. For its
administrative services to the Fund, the Adviser receives a fee from the Fund at
a rate equal, on an annual basis, to 0.20% of the average daily net assets of
the Fund.
DISTRIBUTIONS AND TAX MATTERS
The Fund intends to qualify and to be treated as a regulated investment company
for federal income tax purposes. Accordingly, the Fund should not be subject to
federal income tax on the portion of its investment company taxable income
(including any net capital gain) it distributes to shareholders in a timely
manner. In addition, to the extent the Fund
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distributes to shareholders in a timely manner at least 98% of its taxable
income (including any net capital gain) it should not be subject to the 4%
excise tax on certain undistributed income of "regulated investment companies."
Distributions to Shareholders
The Fund intends to declare daily and distribute monthly distributions to its
shareholders of net investment income. The Fund reserves the right to include
net short-term gains, if any, in such monthly distributions. Long term capital
gains and undistributed net short term gains, if any, will be distributed once
annually. "Net investment income," as used above, includes all dividends,
interest and other income earned by the Fund, net of the Fund's expenses.
Notices will be provided in accordance with Section 19 of the 1940 Act.
A shareholder may elect to receive dividends and capital gain distributions in
either cash or additional shares of the Fund. Unless otherwise specified in
writing by a shareholder, all dividends and capital gain distributions will be
paid on the payment date in additional shares of the kind having an aggregate
net asset value as of the ex-dividend date of such dividend or distribution
equal to the cash amount of such distribution. An election may be changed by
notifying the Fund in writing at any time prior to the record date for a
particular dividend or distribution. There are no sales or other charges in
connection with the reinvestment of dividends and capital gains distributions.
There is no fixed dividend rate, and there can be no assurance that the Fund
will pay any dividend or realize any capital gains distributions.
Notwithstanding the above, the Fund currently intends to pay dividends, if any,
on a monthly basis and capital gains, if any, annually.
Distributions to shareholders attributable to the Fund's interest income and net
short term capital gains are taxable as ordinary dividend income whether paid in
cash or reinvested in additional shares. It is not anticipated that any of such
dividends will qualify for the dividends received deduction for corporate
shareholders. Capital gain dividends, which are designated as distributions of
net capital gain (i.e., the excess of net long term capital gain over net short
term capital loss, if any), are taxable as long term capital gains, whether paid
in cash or additional shares, regardless of how long the shares have been held.
Net capital gains of taxpayers who are individuals are currently taxed at a
maximum rate of 28%. Net capital gains of corporate taxpayers are currently
taxed at the same rate as is applicable to ordinary income. The deduction of
capital losses by the Fund, and the deduction of capital losses by shareholders
with respect to shares in the Fund, is subject to limitations. Investors should
consider the tax implications of buying shares shortly before the record date of
a distribution because distributions of ordinary income or net capital gain will
be taxable even though the net asset value of shares of the Fund is reduced by
the distribution.
Dividends and distributions are generally taxable to the shareholders at the
time the dividend or distribution is made (even if reinvested in additional
shares). Any dividend declared by the Fund in October, November or December of
any calendar year, however, which is payable to shareholders of record on a
specified date in such a month and which is not paid on or before December 31 of
such year, will be treated as received by the shareholders as of December 31 of
such year, provided that the dividend is paid during January of the following
year.
The amount and character of the taxable income or tax loss of the Fund will
depend upon the application of a number of complex and/or uncertain aspects of
federal income tax law. In particular, certain securities issued or acquired by
the Fund (including regular interests in REMICs within the meaning of Section
860D of the Code) may be treated as having original issue discount ("OID") for
federal income tax purposes. A security will be treated as having OID if its
stated redemption price at maturity exceeds its issue price by more than a
statutory de minimis amount. In the case of any security treated as having OID,
the Fund would be required to accrue a portion of the OID daily as interest
income even though it would not actually receive the cash payment of such income
until a later period. A similar problem may arise with respect to residual
interests in a REMIC.
A "market discount bond" is a security purchased at a market discount, subject
to a statutory de minimis exception. For this purpose, a purchase at a market
discount includes a purchase at or after the original issue at a price below the
stated redemption price at maturity. A portion of the securities to be acquired
by the Fund may be acquired at a market discount. Any gain from the disposition
of a security that was originated after July 18, 1984 and acquired by the Fund
at a market discount will be treated as ordinary income to the extent the gain
does not exceed the accrued market discount. Holders of market discount
securities are required to include as ordinary income any partial principal
payment on the loan, to the extent such payment does not exceed the accrued
market discount on such security, even if the holder eventually disposes of the
security prior to maturity at a loss.
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Back-up Withholding. Under certain provisions of the Code, some shareholders may
be subject to a 31% "back-up withholding" on reportable dividends, capital gains
distributions and redemption payments. Generally, shareholders subject to
back-up withholding will be those for whom a taxpayer identification number is
not on file with the Fund or who, to the Fund's knowledge, have furnished an
incorrect number. When establishing an account, an investor must certify under
penalty of perjury that such number is correct and that he or she is not
otherwise subject to back-up withholding. An individual's taxpayer
identification number is his or her Social Security number.
Back-up withholding is not an additional tax and may be credited against a
taxpayer's federal income tax provided the shareholder provides the necessary
information.
Investment Expenses. Investment expenses incurred by the Fund are expected to be
allowable deductions for individual shareholders only to the extent such
expenses, together with other miscellaneous itemized deductions of the
shareholder, exceed 2% of the shareholder's adjusted gross income.
Other Taxation. Dividends and capital gains distributions may also be subject to
state, local and foreign taxes.
Shareholders who are not U.S. citizens or residents should be aware that
distributions from the Fund will generally be subject to a withholding tax of
30%, or a lower treaty rate, and should consult their own tax advisers to
determine whether investment in the Fund is appropriate. Distributions may also
be subject to state and local taxation and shareholders should consult their own
tax advisers in this regard.
Entities that generally qualify for an exemption from federal income tax, such
as many pension trusts, are nevertheless taxed on "unrelated business taxable
income." A tax-exempt entity's dividend income from the Fund and gain from the
sale of shares in the Fund or the Fund's sale of securities is not expected to
constitute unrelated business income to such tax-exempt entity unless the
acquisition of the share itself is debt-financed or constitutes dealer property
in the hands of the tax-exempt entity.
Before investing in the Fund, the trustee or investment manager of an employee
benefit plan (e.g., a pension or profit sharing retirement plan) should consider
among other things (a) whether the investment is prudent under the Employee
Retirement Income Security Act of 1974 ("ERISA"), taking into account the needs
of the plan and all of the facts and circumstances of the investment in the
Fund; (b) whether the investment satisfies the diversification requirement of
Section 404(a)(1)(C) of ERISA; and (c) whether the assets of the Fund are deemed
"plan assets" under ERISA and the Department of Labor regulations regarding the
definition of "plan assets."
Prospective tax-exempt investors are urged to consult their own tax advisers
prior to investing in the Fund.
The Fund will send written notice to its shareholders regarding the tax status
of all distributions made during each year.
OTHER INFORMATION CONCERNING SHARES OF THE FUND
Net Asset Value
The Fund determines the net asset value of each of its shares on each day that
the Adviser is open for business (a "Pricing Day"). A list of those days appears
in the Statement of Additional Information. This determination is made once
during each Pricing Day as of 4:00 p.m. New York time, by deducting the amount
of the Fund's liabilities from the value of its assets and dividing the
difference by the number of shares of the Fund outstanding.
The Fund values each of its securities based on a variety of factors including
the current bid and asked price. See "Determination of Net Asset Value;
Valuation of Portfolio Securities" in the Statement of Additional Information.
The Fund values any securities for which market quotations are not readily
available at their fair value as determined in good faith, utilizing procedures
approved by the Board of Directors of the Fund on the basis of valuations
provided by dealers. Debt securities having a remaining maturity of sixty days
or less when purchased and debt securities originally purchased with maturities
in excess of sixty days but which currently have maturities of sixty days or
less are valued at cost adjusted for amortization of premiums and accretion of
discounts.
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Expenses
The Fund pays all of its expenses, including the compensation of its respective
Directors who are not "interested persons" (as defined in the 1940 Act) of the
Adviser; governmental fees; interest charges; taxes; membership dues in the
Investment Company Institute allocable to the Fund; fees and expenses of
independent auditors, of legal counsel and of any transfer agent, custodian,
registrar or dividend disbursing agent of the Fund; insurance premiums;
amortization of organizational expenses; and expenses of calculating the net
asset value of the shares of the Fund.
The Fund will also pay all expenses of issuing and redeeming shares and
servicing shareholder accounts; expenses of preparing, printing and mailing
prospectuses, reports, notices, proxy statements and reports to shareholders and
to governmental officers and commissions; expenses of shareholder and Board of
Directors' meetings; and expenses relating to the registration and qualification
of shares of the Fund. The Adviser will pay all expenses of distributing shares
and all expenses of printing and mailing prospectuses and sales literature to
prospective investors.
The Fund will also pay the expenses connected with the execution, recording and
settlement of security transactions; fees and expenses of the Fund's Custodian
including safekeeping of funds and securities and maintaining required books and
accounts; expenses of preparing and mailing reports to investors and to
governmental officers and commissions; expenses of meetings of investors; and
the advisory and administrative fees payable to the Adviser under the Advisory
Agreement and the Administrative Services Agreement, respectively.
Description of Shares, Voting Rights and Liabilities
Equitable Real Estate Hyperion Mortgage Opportunity Fund, Inc. was incorporated
in Maryland on May 30, 1995. The authorized capital stock consists of twenty
billion shares of common stock having a par value of one-tenth of one cent
($.001) per share. The Fund is currently the only series. The Articles of
Incorporation provide for the creation of separate classes of outstanding common
stock.
Each share of a series represents an interest in the series represented by each
other share in the series. Shares have no preference, preemptive, conversion or
similar rights. Shares when issued are fully paid and non-assessable, except as
set forth below. Shareholders are entitled to one vote for each share held on
matters on which they are entitled to vote. The Fund is not required to and has
no current intention to hold annual meetings of shareholders, although the Fund
will hold special meetings of shareholders when in the judgment of the Board of
Directors it is necessary or desirable to submit matters for a shareholder vote.
Shareholders also have under certain circumstances (e.g., upon application and
submission of certain specified documents to the Board of Directors by a
specified number of shareholders) the right to remove one or more Directors of
the Fund. Shareholders also have the right to remove one or more Directors
without a meeting by a declaration in writing by a specified number of
shareholders. Upon liquidation or dissolution of the Fund, shareholders would be
entitled to share pro rata in the net assets of the respective series available
for distribution to shareholders.
On August 1, 1995, Equitable Real Estate Hyperion Capital Advisors, L.L.C.
purchased $100,000 of the Fund's shares at an initial subscription price of
$10.00 per share. Based on the foregoing share ownership, the vote of the
Adviser may be determinative of the outcome of any matters submitted to the vote
of the shareholders of the Fund.
Annual and other meetings may be required with respect to such additional
matters relating to the Fund as may be required by the 1940 Act, any
registration of the Fund with the Securities and Exchange Commission or any
state, or as the Directors may consider necessary or desirable. Each Director
serves until the next meeting of the shareholders called for the purpose of
considering the election or reelection of such Director or of a successor to
such Director, and until the election and qualification of his or her successor,
elected at such a meeting, or until such Director sooner dies, resigns, retires
or is removed by the vote of the shareholders.
For further information with respect to the Fund and the shares offered hereby,
reference is made to the Fund's registration statement filed with the Securities
and Exchange Commission, including the exhibits thereto. The Registration
Statement and the exhibits thereto may be examined at the Commission and copies
thereof may be obtained upon payment of certain duplicating fees.
TRANSFER AGENT, CUSTODIAN AND ACCOUNTING AGENT
The Fund has entered into a Transfer Agency and Service Agreement with State
Street Bank and Trust Company ("State Street") which acts as transfer and
accounting agent for the Trust (the "Transfer and Accounting Agent"). The
Transfer
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and Accounting Agent maintains an account for each shareholder of the Fund,
performs other transfer agency functions and acts as dividend disbursing agent
for the Fund. Pursuant to a Custodian Agreement, State Street also acts as the
custodian of the Fund's assets. The Custodian's responsibilities include
safeguarding and controlling the Fund's cash and securities, handling the
receipt and delivery of securities, determining income and collecting interest
on the Fund's investments, maintaining books of original entry for Fund
accounting and other required books and accounts, and calculating the daily net
asset value of shares of the Fund. Securities held by the Fund may be deposited
into certain securities depositaries. The Custodian does not determine the
investment policies of the Fund or decide which securities the Fund will buy or
sell. The Fund may, however, invest in securities of the Custodian and may deal
with the Custodian as principal in securities transactions. For its services,
the Custodian will receive such compensation as may from time to time be agreed
upon by it and the Fund.
The Fund's Statement of Additional Information, dated September 12, 1995,
contains more detailed information about the Fund, including information related
to (i) the Fund's investment policies and restrictions, (ii) the Directors,
officers and administrator of the Fund, (iii) securities transactions, (iv) the
Fund's shares, including rights and liabilities of shareholders, (v) additional
performance information, including the method used to calculate yield and total
rate of return quotations of the Fund, (vi) the determination of the net asset
value of shares of the Fund, and (vii) an audited balance sheet dated as of
August 29, 1995.
COUNSEL AND INDEPENDENT ACCOUNTANTS
Legal matters in connection with the issuance of shares of stock of the Fund are
passed upon by Messrs. Battle Fowler LLP, 75 East 55th Street, New York, New
York 10022. Price Waterhouse LLP, 1177 Avenue of the Americas, New York, New
York 10036, have been selected as independent accountants for the Fund.
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EQUITABLE REAL ESTATE HYPERION
MORTGAGE OPPORTUNITY FUND, INC.
SERIES A-1995
520 Madison Avenue
New York, New York 10022
(212) 980-8400
Statement of Additional Information
September 12, 1995
This Statement of Additional Information sets forth information which may
be of interest to investors but which is not necessarily included in the Fund's
Prospectus, dated September 12, 1995 (the "Prospectus"), through which shares of
the Fund are offered. This Statement of Additional Information should be read in
conjunction with the Prospectus, a copy of which may be obtained by an investor
without charge by contacting Hyperion Distributors, Inc., which is the
distributor of shares of the Fund at [1-(800) Hyperion].
The Statement of Additional Information is NOT a prospectus and is
authorized for distribution to prospective investors only if preceded or
accompanied by the Prospectus.
Table of Contents
1. The Fund.......................................... 1
2. Investment Objective, Policies, Risks and
Restrictions.................................... 1
3. Performance Information........................... 4
4. Determination of Net Asset Value; Valuation of
Portfolio Securities............................ 5
5. Tax Status........................................ 5
6. Management of the Fund............................ 6
7. Counsel and Independent Accountants............... 9
8. Portfolio Transactions............................ 9
9. How to Purchase and Redeem Shares................. 10
10. Description of Shares, Voting Rights and
Liabilities..................................... 10
11. Description of Ratings............................ 10
12. Financial Statements.............................. 10
1. THE FUND
Series A-1995 (the "Fund") is a series of Equitable Real Estate Hyperion
Mortgage Opportunity Fund, Inc. (the "Company"), a non-diversified, open-end
management investment company. Equitable Real Estate Hyperion Mortgage
Opportunity Fund, Inc. was organized as a corporation under the laws of the
State of Maryland on May 30, 1995. The Adviser manages the investments of the
Fund from day to day in accordance with the Fund's investment objective and
policies. The selection of investments for the Fund and the way they are managed
depend on the conditions and trends in the economy and the financial
marketplaces.
Equitable Real Estate Hyperion Capital Advisors, L.L.C., the adviser and
administrator of the Fund (the "Adviser" and "Administrator"), manages the Fund
and supervises the overall administration of the Fund. The Board of Directors of
the Fund provides broad supervision over the affairs of the Fund. Shares of the
Fund are continuously sold by Hyperion Distributors, Inc., the Fund's
distributor (the "Distributor").
2. INVESTMENT OBJECTIVE, POLICIES, RISKS AND RESTRICTIONS
Investment Objective
The investment objective of the Fund is to seek to provide high total return
from (i) both short and long term capital gains and (ii) a high level of current
income. There can, of course, be no assurance that the Fund will achieve its
investment objective. The investment objective of the Fund is fundamental and
may not be changed without approval by its shareholders.
<PAGE>
Investment Policies
The Fund seeks to achieve its investment objective by investing, under normal
circumstances, in a portfolio consisting primarily of a variety of different
types of commercial mortgage backed securities ("Commercial Mortgage-Backed
Securities"). The Fund will invest only in securities which at the time of
purchase are investment grade quality.
The following is a discussion of the various investments of and techniques
employed by the Fund and is intended only as a supplement to the information
contained in the Prospectus and should be read only in conjunction with the
Prospectus. Terms defined in the Prospectus and not defined herein have the same
meanings herein as in the Prospectus.
Description of the Fund's Investment Securities
U.S. Government Agency Mortgage-Backed Securities
Ginnie Mae Certificates. The Government National Mortgage Association ("Ginnie
Mae") is a wholly-owned corporate instrumentality of the United States within
the Department of Housing and Urban Development. The National Housing Act of
1934, as amended (the "Housing Act"), authorizes Ginnie Mae to guarantee the
timely payment of the principal of and interest on certificates that are based
on and backed by a pool of mortgage loans insured by the Federal Housing
Administration under the Housing Act, or Title V of the Housing Act of 1949
("FHA Loans"), or guaranteed by the Department of Veterans Affairs under the
Servicemen's Readjustment Act of 1944, as amended ("VA Loans"), or by pools of
other eligible mortgage loans. The Housing Act provides that the full faith and
credit of the United States Government is pledged to the payment of all amounts
that may be required to be paid under any guaranty. In order to meet its
obligations under such guaranty, Ginnie Mae is authorized to borrow from the
United States Treasury with no limitations as to amount.
The Ginnie Mae Certificates in which the Fund will invest will represent a pro
rata interest in one or more pools of the following types of mortgage loans: (i)
fixed rate level payment mortgage loans; (ii) fixed rate graduated payment
mortgage loans; (iii) fixed rate growing equity mortgage loans; (iv) fixed rate
mortgage loans secured by manufactured (mobile) homes, (v) mortgage loans on
multi-family residential properties under construction; (vi) mortgage loans on
completed multi-family projects; (vii) fixed rate mortgage loans as to which
escrowed funds are used to reduce the borrower's monthly payments during the
early years of the mortgage loans ("buydown" mortgage loans); (viii) mortgage
loans that provide for adjustments in payments based on periodic changes in
interest rates or in other payment terms of the mortgage loans; and (ix)
mortgage-backed serial notes. All of these mortgage loans will be FHA Loans or
VA Loans and, except as otherwise specified above, will be fully-amortizing
loans secured by first liens on one to four family housing units.
Fannie Mae Certificates. The Federal National Mortgage Association ("Fannie Mae"
or "FNMA") is a federally chartered and privately owned corporation organized
and existing under the Federal National Mortgage Association Charter Act of
1938. The obligations of FNMA are not backed by the full faith and credit of the
United States Government.
Each Fannie Mae Certificate will represent a pro rata interest in one or more
pools of FHA Loans, VA Loans or conventional mortgage loans (i.e., mortgage
loans that are not insured or guaranteed by any governmental agency) of the
following types: (i) fixed rate level payment mortgage loans; (ii) fixed rate
growing equity mortgage loans; (iii) fixed rate graduated payment mortgage
loans; (iv) variable rate California mortgage loans; (v) other adjustable rate
mortgage loans; and (vi) fixed rate and adjustable mortgage loans secured by
multi-family projects.
Freddie Mac Certificates. The Federal Home Loan Mortgage Corporation ("Freddie
Mac") is a corporate instrumentality of the United States created pursuant to
the Emergency Home Finance Act of 1970, as amended (the "FHLMC Act"). The
obligations of Freddie Mac are obligations solely of Freddie Mac and are not
backed by the full faith and credit of the United States Government. Freddie Mac
Certificates represent a pro rata interest in a group of mortgage loans (a
"Freddie Mac Certificate group") purchased by Freddie Mac. The mortgage loans
underlying the Freddie Mac Certificates will consist of fixed rate or adjustable
rate mortgage loans with original terms to maturity of between ten and thirty
years, substantially all of which are secured by first liens on one- to
four-family residential properties or multi-family projects. Each mortgage loan
must meet the applicable standards set forth in the FHLMC Act. A Freddie Mac
Certificate group may include whole loans, participation interests in whole
loans and undivided interests in whole loans and participations comprising
another Freddie Mac Certificate group.
2
<PAGE>
Private Pass-Throughs. Pass-Throughs are Mortgage-Backed Securities that are
structured similarly to government agency pass-through securities such as Ginnie
Mae, Fannie Mae and Freddie Mac Certificates, but are issued by private sector
originators of or investors in mortgage loans. Private Pass-Throughs can
represent an interest in any of the variety of types of mortgage loans that can
back an issue of Mortgage-Backed Securities. Since Private Pass-Throughs
typically lack a guarantee by an entity having the credit status of a
governmental agency or instrumentality, they are generally structured with one
or more forms of credit enhancement. All of the Private Pass-Throughs purchased
by the Fund will have been sold in public offerings registered under the
Securities Act of 1933 and will, accordingly, not be subject to restrictions on
resale generally imposed upon privately-placed securities.
Adjustable Rate Mortgages -- Interest Rate Indices. The One Year Treasury Index
is the figure derived from the average weekly quoted yield on U.S. Treasury
Securities adjusted to a constant maturity of one year. The Cost of Funds Index
reflects the monthly weighted average cost of funds of savings and loan
associations and savings banks whose home offices are located in Arizona,
California and Nevada (the "FHLB Eleventh District") that are member
institutions of the Federal Home Loan Bank of San Francisco (the "FHLB of San
Francisco"), as computed from statistics tabulated and published by the FHLB of
San Francisco. The FHLB of San Francisco normally announces the Cost of Funds
Index on the last working day of the month following the month in which the cost
of funds was incurred.
A number of factors affect the performance of the Cost of Funds Index and may
cause the Cost of Funds Index to move in a manner different from indices based
upon specific interest rates, such as the One Year Treasury Index. Because of
the various origination dates and maturities of the liabilities of member
institutions of the FHLB Eleventh District upon which the Cost of Funds Index is
based, among other things, at any time the Cost of Funds Index may not reflect
the average prevailing market interest rates on new liabilities of similar
maturities. There can be no assurance that the Cost of Funds Index will
necessarily move in the same direction or at the same rate as prevailing
interest rates since as longer term deposits or borrowings mature and are
renewed at market interest rates, the Cost of Funds Index will rise or fall
depending upon the differential between the prior and the new rates on such
deposits and borrowings. In addition, dislocations in the thrift industry in
recent years have caused and may continue to cause the cost of funds of thrift
institutions to change for reasons unrelated to changes in general interest rate
levels. Furthermore, any movement in the Cost of Funds Index as compared to
other indices based upon specific interest rates may be affected by changes
instituted by the FHLB of San Francisco in the method used to calculate the Cost
of Funds Index. To the extent that the Cost of Funds Index may reflect interest
changes on a more delayed basis than other indices, in a period of rising
interest rates, any increase may produce a higher yield later than would be
produced by such other indices, and in a period of declining interest rates, the
Cost of Funds Index may remain higher than other market interest rates. This may
result in a higher level of principal prepayments on mortgage loans which adjust
in accordance with the Cost of Funds Index than mortgage loans which adjust in
accordance with other indices.
LIBOR, the London interbank offered rate, is the interest rate that the most
creditworthy international banks dealing in U.S. dollar-denominated deposits and
loans charge each other for large dollar-denominated loans. LIBOR is also
usually the base rate for large dollar-denominated loans in the international
market. LIBOR is generally quoted for loans having rate adjustments at one,
three, six or twelve month intervals.
Investment Restrictions
The Fund has adopted the following investment restrictions which may not be
changed without approval by holders of a "majority of the outstanding voting
securities" of the Fund that would be affected by such a change. A "majority of
the outstanding voting securities" as used herein means the vote of the lesser
of (i) 67% or more of the outstanding "voting securities" of the Fund present at
a meeting, if the holders of more than 50% of the outstanding "voting
securities" of the Fund are present or represented by proxy, or (ii) more than
50% of the outstanding "voting securities" of the Fund. The term "voting
securities" as used in this paragraph has the same meaning as in the 1940 Act.
The Fund may not:
1. Invest 25% or more of the value of the total assets of the Fund in
securities of issuers engaged in any one industry (excluding real estate and
related industries and U.S. Government securities as defined in the 1940
Act).
2. Borrow Money. This restriction shall not apply to (i) borrowing from banks
for temporary or emergency (not leveraging) purposes, including the meeting
of redemption requests that might otherwise require the untimely disposition
of
3
<PAGE>
securities, in an amount up to 15% of the value of the Fund's total assets
(including the amount borrowed) valued at market less liabilities (not
including the amount borrowed) at the time the borrowing was made and (ii)
hedging techniques described in the Prospectus which may be deemed to be
borrowing. While borrowings (excluding items in (ii) above) exceed 5% of the
value of the Fund's total assets, the Fund will not make any investments.
Interest paid on borrowings will reduce net income.
3. Pledge, hypothecate, mortgage or otherwise encumber its assets, except in an
amount up to 15% of the value of its total assets and only to secure
borrowings for temporary or emergency purposes.
4. Underwrite the securities of other issuers, except insofar as the Fund may
be deemed an underwriter under the Securities Act of 1933 in disposing of a
portfolio security.
5. Purchase securities subject to restrictions on disposition under the
Securities Act of 1933 ("restricted securities"). Subject to state law
limitations, the Fund will not invest more than an aggregate of 15% of its
net assets in a repurchase agreement maturing in more than seven days and
securities that are not readily marketable.
6. Invest in securities of other investment companies, except that (i) the Fund
may purchase unit investment trust securities where such unit investment
trusts meet the investment objective of the Fund and then only up to 5% of
the Fund's net assets, except as they may be acquired as part of a merger,
consolidation or acquisition of assets and (ii) as permitted by Section
12(d) of the 1940 Act.
7. Issue senior securities, except insofar as the Fund may be deemed to have
issued a senior security in connection with any permitted borrowing.
8. Make loans of money or property to any person, except through loans of
portfolio securities to Qualified Institutions, the purchase of debt
obligations in which the Fund may invest consistently with the Fund's
investment objective and policies and investment restrictions or the
temporary investment in repurchase agreements with Qualified Institutions.
The Fund may not lend portfolio securities, if, as a result, the aggregate
of such loans exceeds 33 1/3% of the value of the Fund's total assets
(including such loans).
9. Invest for the purpose of exercising control over management of any company.
10. Purchase real estate or interests therein (including limited partnership
interests but excluding Mortgage-Backed Securities, Stripped Mortgage-Backed
Securities and similar instruments and REIT Debt Securities) or interests in
oil, gas or mineral leases.
11. Purchase or sell commodities or commodity contracts except for hedging
purposes.
12. Make any short sale of securities except for short sales against the box and
short sales made in connection with hedging transactions.
13. Purchase or retain any securities issued by an issuer, any of whose officers
or directors, trustees or security holders is an officer or director of the
Fund, or is an officer or director of the Adviser, if after the purchase of
the securities of such issuer by the Fund one or more of such persons who
individually owns beneficially more than 1/2 of 1% of the shares or
securities, or both, all taken at market value, of such issuer, together own
beneficially more than 5% of such shares or securities, or both, all taken
at market value.
Percentage and Rating Restrictions. If a percentage restriction or a rating
restriction on investment or utilization of assets set forth above or referred
to in the Prospectus is adhered to at the time an investment is made or assets
are so utilized, a later change in percentage resulting from changes in the
value of the securities held by the Fund or a later change in the rating of a
security held by the Fund will not be considered a violation of policy.
However, if more than 15% of the net assets of the Fund are invested in
securities that are not readily marketable or redeemable, the Fund will take
steps to reduce the amount of such securities held by the Fund as soon as
reasonably practicable.
3. PERFORMANCE INFORMATION
The material relating to the purchase and redemption of shares in the Prospectus
is herein incorporated by reference.
4
<PAGE>
4. DETERMINATION OF NET ASSET VALUE; VALUATION OF PORTFOLIO SECURITIES
The net asset value of each share of the Fund is determined on each day on which
the Adviser is open for business (a "Pricing Day"). As of the date of this
Statement of Additional Information, the Adviser is open for business every
weekday except for the following holidays (as observed): New Year's Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. This determination of the net asset value of
shares is made once during each Pricing Day as of 4:00 p.m., New York time, by
dividing the value of the Fund's net assets (i.e., the value of its assets less
its liabilities, including expenses payable or accrued) by the number of Fund
shares outstanding in the Fund at the time the determination is made.
Pricing of Securities. A determination of value used in calculating net asset
value must be a fair value determination made in good faith by or on behalf of
the Fund's Board of Directors in accordance with procedures established by such
Board. While no single standard for determining fair value exists, as a general
rule, the current fair value of a security would appear to be the amount which
the Fund could expect to receive upon its current sale. Some, but not
necessarily all, of the general factors which may be considered in determining
fair value include: (i) the fundamental analytical data relating to the
investments; (ii) the nature and duration of restrictions on disposition of the
securities; and (iii) an evaluation of the forces which influence the market in
which these securities are purchased and sold. Without limiting or including all
of the specific factors which may be considered in determining fair value, some
of the specific factors include: type of security, financial statements of the
issuer, cost at date of purchase, size of holding, discount from market value,
value of unrestricted securities of the same class at the time of purchase,
special reports prepared by analysts, information as to any transaction or
offers with respect to the security, existence of merger proposals or tender
offers affecting the securities, price and extent of public trading in similar
securities of the issuer or comparable companies, and other relevant matters.
5. TAX STATUS
The Fund intends to qualify and elect to be treated as a regulated investment
company for federal income tax purposes for its fiscal year ended July 31, 1996,
and it intends to do so for future fiscal years. In order to so qualify, the
Fund must, among other things, (a) derive in each taxable year at least 90% of
its gross income from dividends, interest, payments with respect to loans of
securities, gains from the sale or other disposition of securities or other
income derived with respect to its business of investing in such securities
(including, but not limited to, gains from options, futures or forward
contracts); (b) derive in each taxable year less than 30% of its gross income
from gains from the sale or other disposition of securities, options, futures or
forward contracts held for less than three months; and (c) diversify its
holdings so that, at the end of each fiscal quarter, (i) at least 50% of the
value of the Fund's assets is represented by cash, U.S. Government securities
(as defined in the 1940 Act), securities of other regulated investment
companies, and other securities which, with respect to any one issuer, do not
represent more than 5% of the value of the Fund's assets nor more than 10% of
the voting securities of such issuer, and (ii) not more than 25% of the value of
the Fund's assets is invested in the securities of any issuer (other than U.S.
Government securities as defined in the 1940 Act or the securities of other
regulated investment companies) or of two or more issuers which the Fund
controls and which are engaged in the same or related trades or businesses. If
the Fund qualifies as a regulated investment company and satisfies a minimum
distribution requirement, the Fund will not be subject to federal income tax to
the extent that it distributes its income to its shareholders. The minimum
distribution requirement is satisfied if the Fund distributes as an ordinary
income dividend at least 90% of its investment company taxable income (generally
net investment income and the excess of net short-term capital gain over net
long-term capital loss and computed without regard to the deduction for
dividends paid) for the taxable year.
The Fund may be subject to a nondeductible 4% excise tax which will be imposed
if, and to the extent that, the Fund does not distribute by the end of each
calendar year (or is not subjected to regular corporate tax in such year on) an
amount equal to the sum of (a) 98% of the Fund's ordinary income for such
calendar year; (b) 98% of the excess of capital gains over capital losses for
the one-year period ending on October 31 of each year; and (c) the undistributed
income and gains from the preceding years (if any) pursuant to the calculations
in (a) and (b). A distribution will be treated as having been paid on December
31 if it is declared by the Fund in October, November or December with a record
date in such month and is paid by the Fund in January of the following year.
Such distribution will be treated as received by the shareholders in the
calendar year in which the distribution is declared.
5
<PAGE>
The Fund intends to engage in various hedging transactions. Under various
provisions of the Internal Revenue Code of 1986, as amended (the "Code"), the
result of such transactions may be to change the character of recognized gains
and losses, accelerate the recognition of certain gains and losses, and defer
the recognition of certain losses.
The Fund's taxable income will in most cases be determined on the basis of
reports made to the Fund by the issuers of the securities in which the Fund
invests. The tax treatment of certain securities in which the Fund may invest is
not free from doubt and it is possible that an Internal Revenue Service
examination of the issuers of such securities or of the Fund could result in
adjustments to the income of the Fund. An upward adjustment by the Internal
Revenue Service to the income of the Fund may result in the failure of the Fund
to satisfy the minimum distribution requirement described above.
The Fund's fiscal year end is July 31.
6. MANAGEMENT OF THE FUND
The directors and officers of the Fund and their principal occupations during
the past five years are set forth below. Their titles may have varied during
this period. Asterisks indicate that those directors are "interested persons"
(as defined in the 1940 Act) of the Fund. Except for Mr. Petersen, whose address
is 500 East 85th Street, New York, New York 10028, Mr. Shirk, whose address is
823 Longleaf Drive, N.E., Atlanta, Georgia 30342, Mr. Moulthrop, whose address
is 1074 Millcreek Manor, Atlanta, Georgia 30342, Mr. Walsh, whose address is 15
East 91st Street, New York, New York 10128, and Messrs. Tibbetts, Smith, Thomas,
Bartlett and Wright, whose address is 1150 Lake Hearn Drive, N.E., Atlanta,
Georgia 30342, the address of each director and officer is 520 Madison Avenue,
New York, New York 10022.
Officers and Directors of the Fund
<TABLE>
<S> <C>
LEWIS S. RANIERI* Chairman and Chief Executive Officer of Ranieri & Co., Inc. (since 1988); in addition,
Director President of LSR Hyperion Corp., a general partner of the limited partnership that is the
general partner of Hyperion Partners L.P. ("Hyperion Partners") (since 1988). Director and
Chairman of the Board of Hyperion Capital Management, Inc. (since 1989); Chairman of Bank
United of Texas FSB (since 1988) and Hyperion Credit Service Corp. (since 1992); Director and
President of Hyperion Funding 1993 Corp., the general partner of the limited partnership that
is the general partnership that is the general partner of Hyperion 1993 Fund L.P.; and, also
Chairman and President of various other direct and indirect subsidiaries of Hyperion Partners.
Formerly Vice Chairman of Salomon Brother Inc. (until 1987). Age 48.
HARRY E. PETERSEN, JR. Director and/or Trustee of several investment companies advised by Hyperion Capital
Director Management, Inc. (1992-Present). Director of Lexington Corporate Properties, Inc. (1993-
Present). Senior Advisor to Potomac Capital (1995-Present). Advisory Board of Polytechnic
University (1995-Present). Consultant to Advisers Capital Management, Inc. (1992-Present).
Consultant to Ewing Capital, Inc. (1993-Present). Formerly Consultant on public and private
pension funds (1991-1993). President of Lepercq Realty Advisors (1988-1990). Age 70.
LEO M. WALSH, JR. Director and/or Trustee of several investment companies advised by Hyperion Capital
Director Management, Inc. (1989-Present). Financial Consultant for Medco Containment Services Inc.
(1994-Present). Financial Consultant for Synetic Inc., a manufacturer of porous plastic
materials for health care uses (1989-1994). Formerly President, WW Acquisition Corp. (1989-
1990); Senior Executive Vice President and Chief Operating Officer of The Equitable Life
Assurance Society of the United States ("The Equitable") (1986-1988); Director of The
Equitable and Chairman of Equitable Investment Corporation, a holding company for The
Equitable's investment oriented subsidiaries (1983-1988); Chairman and Chief Executive Officer
of EQUICOR-Equitable HCA Corporation (1987-1988). Age 62.
DOUGLAS A. TIBBETTS* President and Chief Operating Officer of Equitable Real Estate Investment Management, Inc.
Director since 1989. Director and member of various advisory committees of professional real estate
organizations such as National Realty Committee, Society of Industrial & Office Realtors, and
NAIOP. Currently serves as Practitioner/Lecturer at The University of Georgia, Terry College
of Business. Director of various Equitable related companies including: Equitable Real Estate,
Column Financial, Compass Retail, and COMPASS Management and Leasing. Formerly Senior Vice
President in charge of the Dallas office (1982-1988). Age 50.
6
<PAGE>
RICHARD D. SHIRK President and Chief Executive Officer of Blue Cross and Blue Shield since April 1992. Chairman
Director of the Georgia U.S.O.C. Steering Committee and Board Member of Central Atlanta Progress,
Georgia Chamber of Commerce, Georgia Coalition for Health, Metropolitan Atlanta Chapter of the
American Red Cross, Board of Trustee member of Seven Seas Series Mutual Fund, Member of
Atlanta Chamber of Commerce Board of Advisers and Buckhead Coalition. Formerly, Senior Officer
of Equicor (1987-1989) and Senior Vice President of the Central Region for CIGNA (1990-1992).
Age 49.
W. BRUCE MOULTHROP Member of the Real Estate Advisory Committee for New York State Teachers' Retirement System
Director since 1990 and serving on the Board of Directors for Mitchell's Formalwear Company since 1984.
Formerly, Senior Executive Vice President of Equitable Real Estate Investment Management, Inc.
(1984-1990). Age 57.
EDWARD G. SMITH* Senior Executive Vice President of Equitable Real Estate Investment Management, Inc. since
Director, Chairman 1988. Member of The Equitable Management and Investment Committees (1993-Present). Formerly,
Executive Vice President heading property development, management and administration for The
Equitable (1986-1988). Age 45.
KENNETH C. WEISS* Chief Executive Officer of the Adviser since March 1995. President and Chief Executive Officer
Director, President of Hyperion Capital Management, Inc. (February 1992-Present). Chairman of the Board,
Director/Trustee and/or officer of several investment companies advised by Hyperion Capital
Management, Inc. (February 1992-Present). Formerly Director of First Boston Asset Management
(1988-February 1992). Director of First Boston Corporation (until 1988). Age 43.
LOUIS C. LUCIDO* Managing Director and Chief Operating Officer of Hyperion Capital Management, Inc. (February
Director, Secretary 1992-Present). Formerly Senior Vice President and Director of Progressive Capital Management
(June 1991-February 1992); Senior Vice President and Manager at Donaldson, Lufkin and Jenrette
(1988-January 1991); Vice President of Smith Barney, Harris Upham & Co. Incorporated (1987-May
1988); Vice President at Merrill Lynch, Pierce, Fenner & Smith (1981-1987). Age 46.
CLIFFORD E. LAI Managing Director and Chief Investment Officer, Hyperion Capital Management, Inc. (March
Senior Vice President 1993-Present). Formerly Managing Director and Chief Investment Strategist for Fixed Income,
First Boston Asset Management (1989-1993); Vice President, Morgan Stanley & Co. (1987-1989).
Age 42.
M. ANDREW THOMAS Executive Vice President of Equitable Real Estate Investment Management, Inc. Senior Vice
Director, Senior Vice President President, Investors, Inc. since 1995. Formerly with Equitable Real Estate's New Business area
responsible for the new mortgage origination (1990-1992); managed $250 million equity
portfolio for corporate pension client (1988-1992). Age 34.
ROBERT BARTLETT Vice President of Equitable Real Estate Investment Management, Inc. since 1988, responsible
Vice President for developing and implementing mortgage investment marketing strategy with pension funds and
other institutional investors. Co-developed the company's CMBS program and its marketing
implementation. Formerly portfolio manager for Gatehouse Apartments of Florida Fund
(1994-1995) and assistant portfolio manager (1990-1992); assistant portfolio manager for
European Fund I (1993-1995). Age 42.
JOHN N. DUNLEVY Director of Hyperion Capital Management, Inc. (July 1992-Present). Formerly, Director and
Vice President Portfolio Manager, Teachers Insurance & Annuity Association (1988-1992); Assistant Vice
President, Sumitomo Bank Ltd. (1985-1988). Age 36.
KURT L. WRIGHT Senior Vice President of Equitable Real Estate Investment Management, Inc. since 1995.
Vice President Portfolio manager for Buckhead Strategic Fund which invests in distressed commercial mortgages
since 1994 and oversees all commercial mortgage backed securities investing for third-party
clients. Formerly with Equitable's Investment Research, where he performed studies of real
estate markets and investment strategies (1990-1993); Senior Analyst at Prudential Realty
Group on PRISA portfolio (1988-1990); Editorial Board Real Estate Capital Markets Report
(1993-1995) and Research Committee-National Council Real Estate Investment Fiduciaries
(1990-Present). Age 36.
7
<PAGE>
JOSEPH W. SULLIVAN Vice President of Hyperion Capital Management, Inc. (August 1995-Present). Formerly, Vice
Treasurer President in Merrill Lynch & Co.'s Investment Banking Division; Treasurer and Chief Financial
Officer of several Merrill Lynch subsidiaries. Responsible for all financial reporting,
accounting, ministerial and administrative services (1990-1995); Assistant Vice President of
Standard & Poor's Debt Rating Group (1988-1990); Assistant Vice President and Operations
Controller of Shearson Lehman Hutton, Inc., engaged in the identification, analysis and
financial administration of public and private real estate investment programs (1983-1987). A
Licensed Certified Public Accountant since 1981. Age 38.
JOSEPH TROPEANO Vice President and Compliance Officer of Hyperion Capital Management, Inc. (December
Assistant Secretary 1993-Present). Formerly Senior Compliance Examiner and Staff Accountant with the investment
management section of the Securities & Exchange Commission's northeast regional office
(1988-1993). With Merrill Lynch from 1980 to 1988. Age 34.
THOMAS J. VINCE Fund Administrator of Hyperion Capital Management, Inc. (February 1994-Present). Formerly
Assistant Treasurer Assistant Treasurer with Lexington Management Corporation (1993-1994); Mutual Fund Manager
with ABD Securities Corporation (1990-1993); Senior Fund Accountant with Furman Selz, Mager,
Dietz & Birney, Inc. (1988-1990). Age 44.
JOSEPH V. ZOLOFRA Senior Tax Manager of Hyperion Capital Management, Inc. (1993-Present). Formerly Tax Manager
Assistant Treasurer of Ernst & Young Financial Services Office (1988-1993); Tax Manager and Director of Tax
Accounting Services Center of Touche Ross (1985-1988); Senior Tax Consultant (1982-1985). Age
36.
</TABLE>
<TABLE>
DIRECTORS' COMPENSATION TABLE
(Estimated for the year ended July 31, 1996)
<CAPTION>
Pension or Retirement
Aggregate Compensation Benefits Accrued as Part Estimated Annual
Name of Person from Fund of Fund Expenses Benefits upon Retirement
<S> <C> <C> <C>
Lewis S. Ranieri None None None
Harry E. Petersen, Jr. $7,500 None None
Leo M. Walsh, Jr. $7,500 None None
Edward Smith None None None
Kenneth C. Weiss None None None
Louis C. Lucido None None None
Richard D. Shirk $7,500 None None
W. Bruce Moulthrop $7,500 None None
Total Compensation from
Fund and Fund Complex
Name of Person Paid to Directors
Lewis S. Ranieri None
Harry E. Petersen, Jr. $15,000
Leo M. Walsh, Jr. $15,000
Edward Smith None
Kenneth C. Weiss None
Louis C. Lucido None
Richard D. Shirk $15,000
W. Bruce Moulthrop $15,000
</TABLE>
Each Director, who is not an interested person of the Fund, receives a base
annual fee of $7,500 which is paid
by the Fund.
Adviser
Equitable Real Estate Hyperion Capital Advisors, L.L.C. (the "Adviser") manages
the Fund pursuant to an Investment Advisory Agreement (the "Advisory
Agreement"). Subject to such policies as the Board of Directors of the Fund may
determine, the Adviser makes investment decisions for the Fund. The Adviser
furnishes at its own expense all facilities and personnel necessary in
connection with providing these services. The Advisory Agreement will continue
in effect if such continuance is specifically approved at least annually by the
Fund's Board of Directors or by a majority vote of the Fund and by a majority of
the Fund's Directors who are not parties to the Advisory Agreement or interested
persons of any such party, at a meeting called for the purpose of voting on the
Advisory Agreement.
The Advisory Agreement provides that the Adviser may render services to others.
The Advisory Agreement is terminable without penalty on not more than 60 days'
nor less than 30 days' written notice by the Fund when authorized either by
majority vote of the directors and of the other investors in the Fund (with the
vote of each being in proportion to the amount of its investment) or by a vote
of majority of the Fund's Board of Directors, or by the Adviser, and will
automatically terminate in the event of its assignment. The Advisory Agreement
provides that neither the Adviser nor its personnel shall be liable for any
error of judgment or mistake of law or for any loss arising out of any
investment or for any act or
8
<PAGE>
omission in its services to the Fund, except for wilful misfeasance, bad faith
or gross negligence or reckless disregard of its or their obligations and duties
under the Advisory Agreement.
The Fund's Prospectus contains additional information regarding the Adviser and
a description of fees payable to the Adviser for services under the Advisory
Agreement.
Administrator
Pursuant to the Administrative Services Agreement, the Adviser provides the Fund
with general office facilities and supervises the overall administration of the
Fund; including, among other responsibilities, the negotiation of contracts and
fees with, and the monitoring of performance and billings of, the independent
contractors and agents of the Fund; the preparation and filing of all documents
required for compliance by the Fund with applicable laws and regulations; and
arranging for the maintenance of books and records of the Fund. The
Administrator provides persons satisfactory to the Board of Directors of the
Fund to serve as officers of the Fund. Such officers may be directors, officers
or employees of the Administrator or its affiliates. The Fund's Prospectus
contains a description of the fees payable to the Administrator under the
Administrative Services Agreement. The Administrative Services Agreement
terminates automatically if it is assigned and may be terminated without penalty
by majority vote of the shareholders of the Fund in the case of the Fund or by
either party on not more than 60 days' nor less than 30 days' written notice.
Transfer Agent, Custodian and Accounting Agent
The Fund has entered into a Transfer Agency and Service Agreement with State
Street Bank & Trust Company ("State Street") which acts as transfer and
accounting agent for the Fund. Pursuant to a Custodian Agreement, State Street
also acts as the custodian of the Funds's assets. For its services, the
Custodian will receive compensation as may from time to time be agreed upon by
it and the Fund. The Fund's transfer and accounting agent and custodian do not
assist in, and are not responsible for, investment decisions involving assets of
the Fund.
7. COUNSEL AND INDEPENDENT ACCOUNTANTS
Legal matters in connection with the issuance of shares of stock of the Fund are
passed upon by Messrs. Battle Fowler LLP, Price Waterhouse LLP are the
independent accountants for the Fund, providing audit services, tax return
preparation, and assistance and consultation with respect to the preparation of
filings with the Securities and Exchange Commission.
8. PORTFOLIO TRANSACTIONS
The Fund's purchases and sales of securities usually are principal transactions.
Securities are normally purchased directly from the issuer or from an
underwriter or market maker for the securities. There usually are no brokerage
commissions paid for such purchases and, therefore, the Fund does not anticipate
paying brokerage commissions on its securities purchases, although it may pay
such commissions on futures transactions. Any transaction for which the Fund
pays a brokerage commission will be effected at the best price and execution
available. Purchases from underwriters of securities include a commission or
concession paid by the issuer to the underwriter, and purchases from dealers
serving as market makers include the spread between the bid and asked price.
Allocation of transactions, including their frequency, to various dealers is
determined by the Adviser in its best judgment and in a manner deemed to be in
the best interest of the investors in the Fund rather than by any formula. The
primary consideration is prompt execution of orders in an effective manner at
the most favorable price.
Investment decisions for the Fund will be made independently from those for any
other account or investment company that is or may in the future become managed
by the Adviser or its affiliates. If, however, the Fund and other investment
companies or accounts managed by the Adviser are contemporaneously engaged in
the purchase or sale of the same security, the transactions may be averaged as
to price and allocated equitably to each account. In some cases, this policy
might adversely affect the price paid or received by the Fund or the size of the
position obtainable for the Fund. In addition, when purchases or sales of the
same security for the Fund and for other investment companies managed by the
Adviser occur contemporaneously, the purchase or sale orders may be aggregated
in order to obtain any price advantages available to large denomination
purchases or sales. Furthermore, in certain circumstances affiliates of the
Adviser whose investment portfolios are managed internally, rather than by the
Adviser, might seek to purchase or sell the same type of investments at the same
time as the Portfolio. Such an event might also adversely affect the Fund.
9
<PAGE>
9. HOW TO PURCHASE AND REDEEM SHARES
The material relating to the purchase and redemption of shares in the Prospectus
is herein incorporated by reference.
10. DESCRIPTION OF SHARES, VOTING RIGHTS AND LIABILITIES
The authorized capital stock of the Company, which was incorporated on May 30,
1995 in the State of Maryland, consists of twenty billion shares of stock having
a par value of one tenth of one cent ($.001) per share. The Board of Directors
is authorized to divide the shares into separate series of stock, one for each
of the portfolios that may be created. Each share of any series of shares when
issued will have equal dividend, distribution and liquidation rights within the
series for which it was issued and each fractional share has those rights in
proportion to the percentage that the fractional share represents of a whole
share. Shares of all series have identical voting rights, except where, by law,
certain matters must be approved by a majority of the shares of the unaffected
series. Shares will be voted in the aggregate. There are no conversion or
preemptive rights in connection with any shares of the Fund. All shares, when
issued in accordance with the terms of the offering, will be fully paid and
nonassessable. Shares are redeemable at net asset value, at the option of the
shareholder. On August 1, 1995, Equitable Real Estate Hyperion Capital Advisers,
L.L.C. purchased $100,000 of the Fund's shares at an initial subscription price
of $10 per share.
Under the Company's Articles of Incorporation, the Fund has the right to redeem
for cash shares of stock owned by any shareholder to the extent and at such
times as the Board of Directors determines to be necessary or appropriate to
prevent an undue concentration of stock ownership which should cause the Fund to
become a "personal holding company" for Federal income tax purposes. In this
regard, the Fund may also exercise its right to reject purchase orders.
The shares of the Fund have non-cumulative voting rights, which means that the
holders of more than 50% of the shares outstanding voting for the election of
directors can elect 100% of the directors if the holders choose to do so, and,
in that event, the holders of the remaining shares will not be able to elect any
person or persons to the Board of Directors. The Fund will not issue
certificates evidencing Fund shares.
As a general matter, the Fund will not hold annual or other meetings of the
Fund's shareholders. This is because the By-Laws of the Company provide for any
meetings only (a) for the election of directors, (b) approval of revised
investment advisory contracts with respect to a particular class or series of
stock, (c) approval of revisions to the Fund's distribution agreement with
respect to a particular class or series of stock, and (d) upon the written
request of holders of shares entitled to cast not less than 25% of all those
votes entitled to be cast at such meeting. Annual and other meetings may be
required with respect to such additional matters relating to the Fund as may be
required by the Act, including the removal of Company directors(s) and
communication among shareholders, any registration of the Fund with the
Securities and Exchange Commission or any state, or as the Directors may
consider necessary or desirable. Each Director serves until the next meeting of
the shareholders called for the purpose of considering the election or
reelection of such Director or of a successor to such Director, and until the
election and qualification of his or her successor, elected at such meeting, or
until such Director sooner dies, resigns, retires or is removed by the vote of
the shareholders.
11. DESCRIPTION OF RATINGS
See Appendix A.
12. FINANCIAL STATEMENTS
The financial statements included herein have been audited by Price Waterhouse
LLP, independent accountants, as stated in their reports appearing herein, and
are included in reliance upon the report of such firm given upon their
authority, as experts in accounting and auditing.
10
<PAGE>
Report of Independent Accountants
To the Shareholder and Board of Directors of
Equitable Real Estate Hyperion Mortgage Opportunity Fund, Inc.
In our opinion, the accompanying statement of assets and liabilities presents
fairly, in all material respects, the financial position of Equitable Real
Estate Hyperion Mortgage Opportunity Fund, Inc. (the "Fund") at August 29, 1995,
in conformity with generally accepted accounting principles. This financial
statement is the responsibility of the Fund's management; our responsibility is
to express an opinion on this financial statement based on our audit. We
conducted our audit of this financial statement in accordance with generally
accepted auditing standards which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statement is 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
audit provides a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
1177 Avenue of the Americas
New York, New York
August 31, 1995
11
<PAGE>
<TABLE>
EQUITABLE REAL ESTATE HYPERION MORTGAGE OPPORTUNITY FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
August 29, 1995
<S> <C>
Assets:
Cash.............................................................................. $100,000
Deferred organization expenses (Note 2)........................................... 100,000
Total Assets................................................................. 200,000
Liabilities:
Organization expenses (Note 2).................................................... 100,000
Commitments....................................................................... --
Total Liabilities............................................................ 100,000
Net Assets (10,000 shares of $.001 par value shares of common stock issued and
outstanding; 20,000,000,000 shares authorized)....................................... $100,000
Net asset value per share.............................................................. $100,000
</TABLE>
12
<PAGE>
NOTES TO FINANCIAL STATEMENT
NOTE 1
The Equitable Real Estate Hyperion Mortgage Opportunity Fund, Inc. (the "Fund")
was incorporated as a Maryland corporation on May 30, 1995 and has had no
operations to date other than matters relating to its organization and
registration as a non-diversified, open-end management investment company under
the Investment Company Act of 1940, as amended, and the sale and issuance to
Equitable Real Estate Hyperion Capital Advisors, L.L.C. (the "Investment
Adviser") of 10,000 shares of its common stock for an aggregate purchase price
of $100,000. The books and records of the Fund will be maintained in U.S.
Dollars.
NOTE 2
Organization expenses relating to the Fund incurred and to be incurred by the
Investment Adviser will be reimbursed by the Fund. Such expenses, estimated at
$100,000, will be deferred and amortized on a straight-line basis for a five
year period beginning at the commencement of operations of the Fund. In the
event that, at any time during the five year period beginning with the date of
the commencement of operations, the initial shares acquired by the Investment
Adviser prior to such date are redeemed, by any holder thereof, the redemption
proceeds payable in respect of such shares will be reduced by the pro rata share
(based on the proportionate share of the initial shares redeemed to the total
number of original shares outstanding at the time of redemption) of the then
unamortized deferred organization expenses as of the date of such redemption. In
the event that the Fund liquidates before the deferred organization expenses are
fully amortized, the Investment Adviser shall bear such unamortized deferred
organization expenses.
NOTE 3
The Fund intends to enter into an advisory agreement with the Investment
Adviser, a Delaware Limited Liability Company equally owned by Equitable Real
Estate Investment Management, Inc. and Hyperion Capital Management, Inc.,
pursuant to which the Investment Adviser will, among other things, supervise the
Fund's investment program, and provide investment advisory services to the Fund,
and will be responsible for the management of the Fund's portfolio in accordance
with the Fund's investment policies, and for making decisions to buy, sell, or
hold particular securities, and monitor the performance of the Fund's service
providers.
The Investment Adviser will also serve as the Fund's administrator (the
"Administrator") pursuant to an administration agreement to be entered into
between the Fund and the Administrator.
The Fund will pay the Investment Adviser a monthly fee for its management
services at an annual rate of 0.35% of the Fund's average daily net assets. The
Fund will pay the Administrator a monthly fee for its administration services at
an annual rate of 0.20% of the Fund's average daily net assets.
The Fund intends to enter into a distribution agreement with Hyperion
Distributors, Inc. (the "Distributor"). The Distributor will serve as the
exclusive distributor of the shares of the Fund pursuant to its distribution
agreement with the Fund. Investors may open accounts in the Fund only through
the exclusive distributor for the Fund. Under the distribution agreement, the
Distributor, for nominal consideration of one dollar, and as the agent for the
Fund, will solicit orders for the purchase of Fund shares, provided that any
subscriptions and orders will not be binding on the Fund until accepted by the
Fund as principal. The Investment Adviser pays the expenses incurred in the
distribution of the Fund's shares. Certain officers and/or directors of the Fund
are officers and/or directors of the Investment Adviser.
13
<PAGE>
APPENDIX A
Description of Moody's Investors Service, Inc.'s
Four Highest Debt Ratings:
Aaa: Securities which are rated Aaa are judged to be the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt-edge." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Aa: Securities which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuations of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in Aaa
securities.
A: Securities which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa: Securities which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present, but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such securities lack outstanding investment characteristics and
in fact have speculative characteristics as well.
Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through B (i.e., two categories below Baa) in its bond
rating system. The modifier 1 indicates that the security ranks in the higher
end of its generic rating category, the modifier 2 indicates a mid-range
ranking, and the modifier 3 indicates that the issue ranks in the lower end of
its generic rating category.
Description of Standard & Poor Corporation's
Four Highest Debt Ratings:
AAA: Securities rated AAA have the highest rating assigned by S&P to a debt
obligation. Capacity to pay interest and repay principal is extremely strong.
AA: Securities rated AA have a very strong capacity to pay interest; and repay
principal and differ from the higher rated issues only in small degree.
A: Securities rated A have a strong capacity to pay interest and repay principal
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than bonds in higher rated categories.
BBB: Securities rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
securities in this category than for securities in higher rated categories.
Plus (+) or Minus (-): The ratings from AA to CCC (i.e., three categories below
BBB) may be modified by the addition of a plus or minus sign to show relative
standing within the major rating categories. NR: Securities may lack a S&P
rating because no public rating has been requested, because there is
insufficient information on which to base a rating, or because S&P does not rate
a particular type of obligation as a matter of policy.
Description of Fitch Investors Service, Inc.'s
Four Highest Debt Ratings:
AAA: Securities in this category are considered to be investment grade and of
the highest credit quality. The obligor has an exceptionally strong ability to
pay interest and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
AA: Securities in this category are considered to be investment grade and of
very high credit quality. The obligor's ability to pay interest and repay
principal is very strong, although not quite as strong as securities rated
"AAA." As securities
A-1
<PAGE>
rated in the "AAA" and "AA" categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issuers is generally
rated "F-l+."
A: Securities in this category are considered to be investment grade and of high
credit quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than securities with higher ratings.
BBB: Securities in this category are considered to be investment grade and of
satisfactory quality. The obligor's ability to pay interest and repay principal
is considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these bonds,
and therefore, impair timely payment.
Plus (+) or Minus (-): The ratings from AA to C (i.e. five categories below BBB)
may be modified by the addition of a plus or minus sign to indicate the relative
position of a credit within the rating category.
NR: Indicates that Fitch does not rate the specific issue. Conditional: A
conditional rating is premised on the successful completion of a project or the
occurrence of a specific event.
Description of Duff & Phelps Credit Rating Co.'s
Four Highest Debt Ratings:
AAA: Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
AA: High credit quality. Protection factors are strong. Risk is modest but may
vary slightly from time to time because of economic conditions.
A: Protection factors are average but adequate. However, risk factors are more
variable and greater in periods of economic stress.
BBB: Below-average protection factors but within the definition of investment
grade securities but still considered sufficient for prudent investment.
Considerable variability in risk during economic cycles.
Plus (+) or Minus (-): The ratings from AA to C (i.e. five categories below BBB)
may be modified by the addition of a plus or minus sign to indicate the relative
position of a credit within the rating category.
Notes with Respect to All Ratings:
Securities which are unrated expose the investor to risks with respect to
capacity to pay interest or repay principal that are similar to the risks of
lower-rated securities. The Fund is dependent on Fund management's judgment,
analysis and experience in the evaluation of such securities.
Investors should note that the assignment of a rating to a security by a rating
service may not reflect the effect of recent developments on the issuer's
ability to make interest and principal payments.
A-2
<PAGE>
Fax all three completed documents to: Fund Treasurer (212) 593-4906 and
mail original documents to Fund Treasurer, c/o Hyperion Distributors, Inc.
Equitable Real Estate Hyperion Mortgage Opportunity Fund, Inc. ACCOUNT
REGISTRATION FORM
1. ACCOUNT REGISTRATION Account Number Assigned
Name Of Institution/Individual/Trustee Telephone Number
Street Address Or Post Office Box Taxpayer Identification Number
City To The Attention Of
State Zip Fax Number
2. TYPE OF ORGANIZATION
Corporation Sole Proprietorship Partnership
Trust Other
3. ACCOUNT TYPE
Regular HR-10 Pension Defined-Contribution
IRA IRA/SEP TSA/403B
4. CONFIRMATION/STATEMENT MAILING ADDRESS DUPLICATE: CONFIRMATION/STATEMENT
Name Of Institution/Mailing Contact Name Of Institution/Mailing Contact
Street Address Or Post Office Box Street Address Or Post Office Box
City City
State Zip State Zip
5. PURCHASE OF SHARES AND DIVIDEND OPTIONS
The minimal initial investment is $100,000 and minimum subsequent investments
are $5,000.
Initial Investment $
All dividends and capital gains distributions will be reinvested unless
otherwise indicated.
Pay dividends and capital gains in cash
6. BANK INFORMATION
Name of Bank
Street City State Zip Code
Registration of Bank Account Your Bank Account Number Your Bank ABA Number
7. TAX CERTIFICATION -- The undersigned hereby certifies under penalties of
perjury that: (1) the number shown on this application is the Applicant's
correct tax identification number and (2) the Applicant is not subject to
back-up withholding, either because: Applicant has not been notified by the
Internal Revenue Service (IRS) that it is subject to back-up withholding due to
its under reporting of interest or dividends; or the IRS has notified Applicant
that it is no longer subject to back-up withholding. Please Note: If the IRS has
notified Applicant that it is subject to back-up withholding because of under
reporting, and it has not terminated that notice, please strike out part (2)
above before signing.
We are a tax-exempt organization.
8. TAX FILINGS -- Any tax filings must be made by the institutional shareholder.
Tax filings will not be made by Equitable Real Estate Hyperion Capital Advisors,
L.L.C., State Street Bank and Trust Company or the Fund on behalf of the
institutional shareholder.
9. SIGNATURES -- The undersigned hereby certifies that:
I/we have full authority and legal capacity to purchase fund shares.
I/we have received the current prospectus of the fund and agree to be bound by
its terms.
If Joint Account both owners must sign
Signature Print Name & Title Date
Signature Print Name & Title Date
<PAGE>
EQUITABLE REAL ESTATE HYPERION MORTGAGE
OPPORTUNITY FUND, INC. SERIES A-1995
SUBSCRIPTION ADDENDUM TO ACCOUNT REGISTRATION FORM
Board of Directors
Equitable Real Estate Hyperion Mortgage
Opportunity Fund, Inc., Series A-1995
520 Madison Avenue
New York, New York 10022
Gentlemen:
The undersigned hereby subscribes for shares of the Common
Stock, of Equitable Real Estate Hyperion Mortgage Opportunity Fund, Inc., Series
A-1995, a Maryland corporation (the "Corporation") and a non-diversified,
open-end management investment company registered under the Investment Company
Act of 1940, as amended, at $ per share for an aggregate purchase price of
$ .
The undersigned hereby represents and agrees for the purpose of certain
state institutional investor exemptions that it is one of the following
categories of institutional investors: a bank, savings institution or insurance
company (initial box if applicable). Other category of institution (please
describe):
The undersigned is unable to qualify as an "institutional investor". The
following is a description of the nature of the its' business:
Very truly yours, (Name of Investor)
By:
Name:
Title:
Subscription Accepted:
Equitable Real Estate Hyperion Mortgage
Opportunity Fund, Inc., Series A-1995
By:
Date:
<PAGE>
HYPERION CAPITAL MANAGEMENT, INC.
TRADE AUTHORIZATION FORM
FUND: Equitable Real Estate Hyperion Mortgage Opportunity Fund, Inc.
Tax ID/Shareholder
Account Number
Shareholder Name
Shareholder Address
Trade Date Trade Price
Trade Type: Purchase Redemption
Trade Amount (Dollars)
WIRE INSTRUCTIONS:
Purchase Wire Information: Redemption Wire Instructions:
Special Instructions Yes No
ABA No. 011000028 ABA No.
State Street Bank & Trust Co. Bank
Boston, Massachusetts 02101
BNF=AC-99037350 "Mutual Funds BNF=
F/B/O Hyperion, FD 7L15
OBI=Equitable Real Estate Hyperion OBI=
Mortgage Opportunity Fund/Shareholder
Name/Shareholder Account #
Authorized Signature
<PAGE>
Investment Adviser and Administrator
Equitable Real Estate Hyperion Capital Advisors, L.L.C.
520 Madison Avenue
New York, New York 10022
Distributor
Hyperion Distributors, Inc.
520 Madison Avenue
New York, New York 10022
(212) 980-8400
Transfer Agent, Custodian and Accounting Agent
State Street Bank and Trust Company
1776 Heritage Drive
Boston, Massachusetts 02171
