PROSPECTUS May 21, 2003
$525,000,000
[LOGO] PIMCO
ADVISORS
Nicholas-Applegate Convertible & Income Fund
4,200 Shares, Series A
4,200 Shares, Series B
4,200 Shares, Series C
4,200 Shares, Series D
4,200 Shares, Series E
Auction Preferred Shares
Liquidation Preference $25,000 Per Share
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Investment Objective. The Fund is a recently organized, diversified,
closed-end management investment company. The Fund's investment objective is to
provide total return through a combination of capital appreciation and high
current income.
Portfolio Contents. Under normal circumstances, the Fund will invest at least
80% of its total assets in a diversified portfolio of convertible securities
and non-convertible income-producing securities. The Fund may invest up to 20%
of its total assets in other types of securities. The portion of the Fund's
assets invested in convertible securities, on the one hand, and non-convertible
income-producing securities, on the other, will vary from time to time
consistent with the Fund's investment objective, although the Fund will
normally invest at least 50% of its total assets in convertible securities. In
making allocation decisions, the Fund's portfolio manager will consider factors
such as changes in equity prices, changes in interest rates and other economic
and market factors. The Fund may invest without limit in securities that are
below investment grade quality and expects that ordinarily the portfolio
manager's strategies will result in the Fund investing primarily in these
securities. Securities of below investment grade quality are regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal, and are commonly referred to as "high yield"
securities or "junk bonds." They involve greater risk of loss, are subject to
greater price volatility and are less liquid, especially during periods of
economic uncertainty or change, than higher rated securities. Due to the risks
involved in investing in high yield securities, an investment in the Fund
should be considered speculative. There can be no assurance that the Fund will
achieve its investment objective.
Certain capitalized terms used in this Prospectus are defined in the Glossary
that appears at the end of this Prospectus.
Before buying any preferred shares you should read the discussion of the
material risks of investing in the Fund in "Risks" beginning on page 29.
Certain of these risks are summarized in "Prospectus summary--Special Risk
Considerations" beginning on page 6.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this Prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
Proceeds to
Price to Public Sales Load Fund(1)
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Per Share $ 25,000 $ 250 $ 24,750
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Total $525,000,000 $5,250,000 $519,750,000
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(1) Plus accumulated dividends if any, from the date the Auction Preferred
Shares are issued, but before offering expenses payable by the Fund
estimated to be $525,000.
Auction Preferred Shares, Series A, Auction Preferred Shares, Series B, Auction
Preferred Shares, Series C, Auction Preferred Shares, Series D, and Auction
Preferred Shares, Series E (together, "APS") are being offered by the
underwriters subject to the condition that the APS be rated "Aaa" by Moody's
Investors Service, Inc. ("Moody's") as of the time of delivery of the APS to
the underwriters, and subject to certain other conditions. The underwriters
reserve the right to withdraw, cancel or modify the offering in whole or in
part. It is expected that the APS will be delivered to the nominee of The
Depository Trust Company on or about May 23, 2003.
UBS Warburg
Merrill Lynch & Co.
Prudential Securities
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(continued from previous page)
Investors in APS will be entitled to receive cash dividends at an annual rate
that may vary for the successive dividend periods for such shares. The dividend
rate on the Series A APS for the initial period from and including the date of
issue to, but excluding, June 3, 2003 will be 1.30% per year. The dividend rate
on the Series B APS for the initial period from and including the date of issue
to, but excluding, June 4, 2003 will be 1.30% per year. The dividend rate on
the Series C APS for the initial period from and including the date of issue
to, but excluding, June 5, 2003 will be 1.30% per year. The dividend rate on
the Series D APS for the initial period from and including the date of issue
to, but excluding, June 6, 2003 will be 1.30% per year. The dividend rate on
the Series E APS for the initial period from and including the date of issue
to, but excluding, June 9, 2003 will be 1.30% per year. For each subsequent
period, the Auction Agent will determine the dividend rate for a particular
period by an auction conducted in accordance with the procedures described in
this Prospectus and, in further detail, in Appendix A to the Statement of
Additional Information (each, an "Auction").
The APS, which have no history of public trading, will not be listed on an
exchange or automated quotation system. Broker-Dealers may maintain a secondary
trading market in the APS outside of Auctions; however, they have no obligation
to do so, and there can be no assurance that a secondary market for the APS
will develop or, if it does develop, that it will provide holders with a liquid
trading market (i.e., trading will depend on the presence of willing buyers and
sellers and the trading price will be subject to variables to be determined at
the time of the trade by such Broker-Dealers). A general increase in the level
of interest rates may have an adverse effect on the secondary market price of
the APS, and a selling shareholder that sells APS between Auctions may receive
a price per share of less than $25,000. The Fund may redeem APS as described
under "Description of APS--Redemption."
When issued and outstanding, the APS will add leverage to an investment in the
Fund's common shares. The APS will be senior in liquidation and distribution
rights to the Fund's outstanding common shares. The Fund's common shares are
traded on the New York Stock Exchange under the symbol "NCV." This offering is
conditioned upon the APS receiving a rating of "Aaa" from Moody's.
You should read this Prospectus, which contains important information about the
Fund, before deciding whether to invest, and retain it for future reference. A
Statement of Additional Information, dated May 21, 2003, containing additional
information about the Fund, has been filed with the Securities and Exchange
Commission and is incorporated by reference in its entirety into this
Prospectus, which means that it is part of the Prospectus for legal purposes.
You can review the table of contents of the Statement of Additional Information
on page 72 of this Prospectus. You may request a free copy of the Statement of
Additional Information by calling (877) 819-2224 or by writing to the Fund, or
obtain a copy (and other information regarding the Fund) from the Securities
and Exchange Commission's web site (http://www.sec.gov).
The APS do not represent a deposit or obligation of, and are not guaranteed or
endorsed by, any bank or other insured depository institution, and are not
federally insured by the Federal Deposit Insurance Corporation, the Federal
Reserve Board or any other government agency.
You should rely only on the information contained or incorporated by reference
in this Prospectus. The Fund has not, and the underwriters have not, authorized
anyone to provide you with different information. If anyone provides you with
different or inconsistent information, you should not rely on it. The Fund is
not, and the underwriters are not, making an offer of the APS in any state
where the offer is not permitted. You should not assume that the information
contained in this Prospectus is accurate as of any date other than the date on
the front of this Prospectus. The Fund's business, financial condition, results
of operations and prospects may have changed since that date.
TABLE OF CONTENTS
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Prospectus summary............................ 1
Financial highlights.......................... 16
The Fund...................................... 17
Use of proceeds............................... 17
Capitalization................................ 17
Portfolio composition......................... 18
The Fund's investment objective and strategies 18
Risks......................................... 29
How the Fund manages risk..................... 36
Rating agency guidelines...................... 37
Description of APS............................ 39
Management of the Fund........................ 60
Net asset value............................... 63
Tax matters................................... 64
Description of capital structure................... 66
Anti-takeover and other provisions in the
Declaration of Trust............................. 67
Repurchase of Common Shares; conversion to open-
end fund......................................... 69
Underwriting....................................... 70
Shareholder servicing agent, custodian and transfer
agents........................................... 70
Legal matters...................................... 71
Table of contents for the Statement of Additional
Information...................................... 72
Glossary........................................... 73
Appendix A--Description of Securities Ratings...... A-1
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Prospectus summary
This is only a summary. This summary may not contain all of the information
that you should consider before investing in the APS. You should review the
more detailed information contained in this Prospectus and in the Statement of
Additional Information. Certain capitalized terms used in this Prospectus are
defined in the Glossary that appears at the end of this Prospectus.
THE FUND
Nicholas-Applegate Convertible & Income Fund (the "Fund") is a recently
organized, diversified, closed-end management investment company registered
under the Investment Company Act of 1940, as amended (the "1940 Act"). See "The
Fund." The Fund's common shares ("Common Shares") are traded on the New York
Stock Exchange under the symbol "NCV." As of May 13, 2003, the Fund had
65,351,981 Common Shares outstanding and net assets of $970,953,019.
THE OFFERING
The Fund is offering an aggregate of 4,200 Series A APS, 4,200 Series B APS,
4,200 Series C APS, 4,200 Series D APS and 4,200 Series E APS, each at a
purchase price of $25,000 per share plus accumulated dividends, if any, from
the date of original issue. The APS are being offered through a group of
underwriters led by UBS Warburg LLC (collectively, the "Underwriters"). See
"Underwriting." This offering is conditioned upon the APS receiving a credit
quality rating of "Aaa" from Moody's. The Fund will invest the net proceeds of
this offering in accordance with the Fund's investment objective and policies
as summarized under "The Fund's investment objective and strategies." It is
presently anticipated that the Fund will be able to invest substantially all of
the net proceeds in convertible securities and non-convertible income-producing
securities that meet its investment objective and policies within three months
after the completion of this offering. Pending such investment, it is
anticipated that the proceeds will be invested in high grade, short-term
securities, credit-linked trust certificates, and/or high yield securities
index futures contracts or similar derivative instruments designed to give the
Fund market exposure while the Fund's portfolio manager selects specific
securities.
The APS will entitle their holders to receive cash dividends at an annual rate
that may vary for successive Dividend Periods. In general, except as described
under "Description of APS--Dividends," each Dividend Period will be seven days.
The Auction Agent will determine the Applicable Rate for a particular period by
an Auction conducted on the Business Day immediately prior to the start of that
Dividend Period.
The APS are not listed on an exchange. Instead, investors may buy or sell APS
at an Auction that normally is held weekly, by submitting orders to
Broker-Dealers that have entered into an agreement with the Auction Agent or to
certain other Broker-Dealers. Deutsche Bank Trust Company Americas, the Auction
Agent, reviews orders from Broker-Dealers on behalf of Existing Holders that
wish to sell or hold at the auction rate, or hold only at a specified
Applicable Rate, and on behalf of Potential Holders that wish to buy, APS. The
Auction Agent then determines the lowest Applicable Rate that will result in
all of the outstanding APS continuing to be held. The first Auction Date for
Series A APS will be June 2, 2003, for Series B APS will be June 3, 2003, for
Series C APS will be June 4, 2003, for Series D APS will be June 5, 2003 and
for Series E APS will be June 6, 2003, each being the Business Day before the
Initial Dividend Payment Date for the Initial Dividend Period for the relevant
series of APS (June 3 , 2003, for Series A, June 4, 2003 for Series B, June 5,
2003 for Series C, June 6, 2003 for Series D and June 9, 2003 for Series E).
The Auction day for Series A APS generally will be Monday, for Series B APS
generally will be Tuesday, for Series C APS generally will be Wednesday, for
Series D APS generally will be Thursday and for Series E APS generally will be
Friday, unless the then-current Dividend Period is a Special Dividend Period,
or the day that normally would be the Auction Date or the first day of the
subsequent Dividend Period is not a Business Day.
1
INVESTMENT OBJECTIVE AND STRATEGIES
Investment Objective
The Fund's investment objective is to provide total return through a
combination of capital appreciation and high current income. The Fund attempts
to achieve this objective by investing in a diversified portfolio of
convertible securities and non-convertible income-producing securities
described under "Portfolio Contents" below. As described below, in seeking to
achieve its investment objective, the Fund expects ordinarily to invest
primarily in "high yield" securities or "junk bonds." The Fund cannot assure
you that it will achieve its investment objective.
Portfolio Management Strategies
In selecting investments for the Fund, Nicholas-Applegate Capital Management
LLC ("NACM"), the Fund's portfolio manager, attempts to identify issuers that
successfully adapt to change. NACM uses traditional credit analysis combined
with a disciplined, fundamental, bottom-up research process that facilitates
the early identification of issuers demonstrating an ability to improve their
fundamental characteristics. See "Independent Credit Analysis" below. NACM
attempts to identify potential investments that it expects will exceed minimum
credit statistics and exhibit the highest visibility of future expected
operating performance. NACM's sell discipline is clearly defined and designed
to drive the Fund's portfolio continually toward strength, taking into account
factors such as a change in credit fundamentals, a decline in attractiveness
relative to other securities and a decline in industry fundamentals.
In selecting convertible securities for investment by the Fund, NACM evaluates
each convertible security's investment characteristics as an income-producing
security, using the techniques described above, as well as its potential for
capital appreciation, using techniques that focus on the security's equity
characteristics. NACM seeks to capture approximately 70-80% of any increase in
the market price of the underlying equities (upside potential) and 50% or less
of any decrease in the market price of the underlying equities (downside
exposure). In analyzing specific companies for possible investment, NACM
ordinarily looks for several of the following characteristics: above-average
per share earnings growth; high return on invested capital; a healthy balance
sheet; sound financial and accounting policies and overall financial strength;
strong competitive advantages; effective research and product development and
marketing; development of new technologies; efficient service; pricing
flexibility; strong management; and general operating characteristics that will
enable the companies to compete successfully in their respective markets. NACM
will consider selling a particular convertible security when any of those
factors materially changes.
Independent Credit Analysis
NACM relies heavily on its own analysis of the credit quality and risks
associated with individual securities considered for the Fund, rather than
relying exclusively on Rating Agencies or third-party research. The team
managing the Fund utilizes this information in an attempt to minimize credit
risk and identify issuers, industries or sectors that are undervalued or that
offer attractive capital appreciation potential or high current income relative
to NACM's assessment of their credit characteristics.
Portfolio Contents
Under normal circumstances, the Fund will invest at least 80% of its total
assets in a diversified portfolio of convertible securities and non-convertible
income-producing securities. The portion of the Fund's assets invested in
convertible securities, on the one hand, and non-convertible income-producing
securities, on the other, will vary from time to time consistent with the
Fund's investment objective, although the Fund will normally invest at least
50% of its total assets in convertible securities. In making allocation
decisions, NACM will consider factors such as changes in equity prices, changes
in interest
2
rates and other economic and market factors. The Fund may invest without limit
in convertible securities and non-convertible income-producing securities that
are below investment grade quality, and expects that ordinarily NACM's
portfolio strategies will result in the Fund investing primarily in these
securities. The Fund invests in securities with a broad range of maturities.
The weighted average maturity of the Fund will typically range from five to ten
years, although the weighted average maturity of obligations held by the Fund
may be shorter or longer at any time or from time to time depending on market
conditions. The Fund may invest up to 20% of its total assets in other types of
securities. The Fund may invest in securities of companies with smaller market
capitalizations. The principal types of securities in which the Fund will
invest are described below. For more detailed descriptions, see "The Fund's
investment objective and strategies--Portfolio Contents and Other Information."
Convertible Securities
The Fund may invest without limit in convertible securities, and these
securities will ordinarily constitute a principal component of the Fund's
investment program. Under normal circumstances, the Fund will invest at least
50% of its total assets in convertible securities. Convertible securities are
bonds, debentures, notes, preferred stocks or other securities that may be
converted or exchanged (by the holder or by the issuer) into shares of the
underlying common stock (or cash or securities of equivalent value) at a stated
exchange ratio or predetermined price (the "conversion price"). A convertible
security is designed to provide current income and also the potential for
capital appreciation through the conversion feature, which enables the holder
to benefit from increases in the market price of the underlying common stock. A
convertible security may be called for redemption or conversion by the issuer
after a particular date and under certain circumstances (including a specified
price) established upon issue. Depending upon the relationship of the
conversion price to the market value of the underlying security, a convertible
security may trade more like an equity security than a debt instrument. See
"The Fund's investment objective and strategies--Portfolio Contents and Other
Information--Convertible Securities."
Synthetic Convertible Securities
The Fund also may invest without limit in "synthetic" convertible securities,
which will be selected based on the similarity of their economic
characteristics to those of a traditional convertible security due to the
combination of separate securities that possess the two principal
characteristics of a traditional convertible security, i.e., an
income-producing security ("income-producing component") and the right to
acquire an equity security ("convertible component"). The income-producing
component is achieved by investing in non-convertible, income-producing
securities such as bonds, preferred stocks and money market instruments. The
convertible component is achieved by investing in warrants or options to buy
common stock at a certain exercise price, or options on a stock index. A simple
example of a synthetic convertible security is the combination of a traditional
corporate bond with a warrant to purchase equity securities of the issuer of
the bond. The Fund may also purchase synthetic securities created by other
parties, typically investment banks, including convertible structured notes.
The income-producing and convertible components of a synthetic convertible
security may be issued separately by different issuers and at different times.
The Fund's holdings of synthetic convertible securities are considered
convertible securities for purposes of the Fund's policy to invest at least 50%
of its total assets in convertible securities and 80% of its total assets in a
diversified portfolio of convertible securities and non-convertible
income-producing securities. See "The Fund's investment objective and
strategies--Portfolio Contents and Other Information--Synthetic Convertible
Securities."
Non-Convertible Income-Producing Securities
The Fund will also invest in non-convertible income-producing securities,
including, but not limited to, corporate bonds, debentures, notes and other
similar types of corporate debt instruments, as well as non-convertible
preferred stocks, bank loans and loan participations, commercial paper, real
estate investment trusts ("REITs") and commercial and other mortgage-related
and asset-backed securities,
3
payment-in-kind securities, credit-linked trust certificates and other
securities issued by special purpose or structured vehicles, zero-coupon bonds,
bank certificates of deposit, fixed time deposits, bankers' acceptances and
U.S. Government securities. The Fund's investments in non-convertible
income-producing securities may have fixed or variable principal payments and
all types of interest rate and dividend payment and reset terms, including
fixed rate, adjustable rate, zero-coupon, contingent, deferred, payment-in-kind
and auction-rate features. See "The Fund's investment objective and
strategies--Portfolio Contents and Other Information--Non-Convertible
Income-Producing Securities."
High Yield Securities
The Fund may invest without limit in convertible securities and non-convertible
income-producing securities that are below investment grade quality, and
expects that ordinarily NACM's portfolio strategies will result in the Fund
investing primarily in these securities. Below investment grade securities are
securities rated, at the time of investment, below the four highest grades
(i.e., rated Ba or lower by Moody's or BB or lower by Standard & Poor's
("S&P")) or securities that are unrated but judged to be of comparable quality
by NACM. Below investment grade securities are sometimes referred to as "high
yield" securities or "junk bonds." The Fund may invest in high yield securities
of any rating, including securities given the lowest non-default rating (C by
Moody's or S&P, as described in Appendix A) or unrated securities judged to be
of comparable quality by NACM. Securities of below investment grade quality are
regarded as having predominantly speculative characteristics with respect to
capacity to pay interest and repay principal. Securities in the lowest
investment grade category (i.e., rated Baa by Moody's or BBB by S&P) also may
be considered to possess some speculative characteristics. The Fund may
purchase distressed securities that are in default or the issuers of which are
in bankruptcy. See "The Fund's investment objective and strategies--Portfolio
Contents and Other Information--High Yield Securities."
Foreign (Non-U.S.) Investments
The Fund may invest up to 20% of its total assets in U.S. dollar-denominated
securities of foreign issuers based in developed countries. For this purpose,
foreign securities include, but are not limited to, foreign convertible
securities and non-convertible income-producing securities, foreign equity
securities (including preferred securities of foreign issuers), foreign bank
obligations, and obligations of foreign governments or their subdivisions,
agencies and instrumentalities, international agencies and supranational
entities. For this purpose, foreign securities do not include American
Depository Receipts ("ADRs") or securities guaranteed by a United States
person, but may include foreign securities in the form of Global Depository
Receipts ("GDRs") or other securities representing underlying shares of foreign
issuers. See "The Fund's investment objective and strategies--Portfolio
Contents and Other Information--Foreign (Non-U.S.) Investments and Currencies."
Rule 144A Securities
The Fund may invest without limit in securities that have not been registered
for public sale, but that are eligible for purchase and sale pursuant to Rule
144A under the Securities Act of 1933, as amended. Rule 144A permits certain
qualified institutional buyers, such as the Fund, to trade in privately placed
securities that have not been registered for sale under that Act. Rule 144A
Securities may be deemed illiquid and thus may be subject to the Fund's
limitation to invest not more than 5% of its total assets in securities which
are illiquid at the time of investment, although the Fund may determine that
certain Rule 144A Securities are liquid in accordance with procedures adopted
by the Board of Trustees.
LEVERAGE
The Fund expects to utilize financial leverage on an ongoing basis for
investment purposes. After completion of the offering of the APS, the Fund
anticipates its total leverage from the issuance of APS will be approximately
35%. This amount may change, but total leverage will not exceed 50% of the
Fund's total assets. Although the Fund may in the future offer other Preferred
Shares, the Fund does not
4
currently intend to offer Preferred Shares other than Series A APS, Series B
APS, Series C APS, Series D APS and Series E APS. The Fund may also leverage
the portfolio by borrowing money, issuing debt securities, and utilizing
reverse repurchase agreements and other derivative instruments, although these
forms of leverage will generally be used as a substitute for, rather than in
addition to, the leverage obtained through the issuance of the APS.
The Fund generally will not utilize leverage if it anticipates that it would
result in a lower return to Common Shareholders over time. Use of financial
leverage creates an opportunity for increased income for Common Shareholders
but, at the same time, creates the possibility for greater loss (including the
likelihood of greater volatility of net asset value and market price of the
shares and of dividends), and there can be no assurance that a leveraging
strategy will be successful during any period in which it is employed. Because
the fees paid to the Manager and NACM will be calculated on the basis of the
Fund's managed assets, the fees will be higher when leverage (including the
APS) is utilized, giving the Manager and NACM an incentive to utilize leverage.
See "Risks--Leverage Risk."
INVESTMENT MANAGER
PIMCO Advisors Fund Management LLC (the "Manager") serves as the investment
manager of the Fund. Subject to the supervision of the Board of Trustees, the
Manager is responsible for managing, either directly or through others selected
by it, the investment activities of the Fund and the Fund's business affairs
and other administrative matters. The Manager will receive an annual fee,
payable monthly, in an amount equal to 0.70% of the Fund's average daily total
managed assets. "Total managed assets" means the total assets of the Fund
(including any assets attributable to the APS or other forms of leverage that
may be outstanding) minus accrued liabilities (other than liabilities
representing leverage). The Manager is located at 1345 Avenue of the Americas,
New York, New York 10105. Organized in 2000 as a subsidiary successor in the
restructuring of a business originally organized in 1987, the Manager provides
investment management and advisory services to several closed-end and open-end
investment company clients. As of March 31, 2003, the Manager had approximately
$18.4 billion in assets under management. Allianz Dresdner Asset Management of
America L.P. is the direct parent company of PIMCO Advisors Retail Holdings
LLC, of which the Manager is a wholly-owned subsidiary. As of March 31, 2003,
Allianz Dresdner Asset Management of America L.P. and its subsidiary
partnerships, including NACM, had approximately $392 billion in assets under
management.
The Manager has retained its affiliate, NACM, as a sub-adviser to manage the
Fund's portfolio investments. See "--Portfolio Manager" below.
PORTFOLIO MANAGER
NACM serves as the Fund's sub-adviser responsible for managing the Fund's
portfolio investments, and is sometimes referred to herein as the "portfolio
manager." Subject to the supervision of the Manager, NACM has full investment
discretion and makes all determinations with respect to the investment of the
Fund's assets.
NACM is located at 600 West Broadway, 30th Floor, San Diego, California 92101.
Founded in 1984, NACM currently manages discretionary assets for numerous
clients, including investment companies, employee benefit plans, corporations,
public retirement systems and unions, university endowments, foundations, and
other institutional investors and individuals. As of March 31, 2003, NACM had
approximately $16 billion in assets under management.
The Manager (and not the Fund) will pay a portion of the fees it receives to
NACM in return for NACM's services.
5
SPECIAL RISK CONSIDERATIONS
Risks of investing in APS include:
Auction Risk
You may not be able to sell your APS at an Auction if the Auction fails; that
is, if there are more APS offered for sale than there are buyers for those
shares. As a result, your investment in APS may be illiquid. Neither the
Broker-Dealers nor the Fund are obligated to purchase APS in an Auction or
otherwise, nor is the Fund required to redeem APS in the event of a failed
Auction.
Ratings and Asset Coverage Risk
A Rating Agency could downgrade the APS, which could affect their liquidity and
value. In addition, the Fund may be forced to redeem your APS to meet
regulatory or Rating Agency requirements. The Fund may also voluntarily redeem
APS under certain circumstances.
Secondary Market Risk
You could receive less than the price you paid for your APS if you sell them
outside of an Auction, especially when market interest rates are rising.
Although the Broker-Dealers may maintain a secondary trading market in the APS
outside of Auctions, they are not obligated to do so, and no secondary market
may develop or exist at any time for the APS.
General risks of investing in the Fund include:
Limited Operating History
The Fund is a recently organized, diversified, closed-end management investment
company which has been operational for less than two months.
Market Discount Risk
Shares of closed-end management investment companies like the Fund frequently
trade at a discount from their net asset value.
Convertible Securities Risk
The Fund may invest without limit in convertible securities, and these
securities will ordinarily constitute a principal component of the Fund's
investment program. Under normal circumstances, the Fund will invest at least
50% of its total assets in convertible securities. Convertible securities
generally offer lower interest or dividend yields than non-convertible
securities of similar quality. The market values of convertible securities tend
to decline as interest rates increase and, conversely, to increase as interest
rates decline. However, a convertible security's market value tends to reflect
the market price of the common stock of the issuing company when that stock
price approaches or is greater than the convertible security's "conversion
price." The conversion price is defined as the predetermined price at which the
convertible security could be exchanged for the associated stock. As the market
price of the underlying common stock declines, the price of the convertible
security tends to be influenced more by the yield of the convertible security.
Thus, it may not decline in price to the same extent as the underlying common
stock. In the event of a liquidation of the issuing company, holders of
convertible securities would be paid before the company's common stockholders
but after holders of any senior debt obligations of the company. Consequently,
the issuer's convertible securities generally entail less risk than its common
stock but more risk than its debt obligations. See "Risks--Convertible
Securities Risk."
Synthetic Convertible Securities Risk
The Fund may invest without limit in synthetic convertible securities. The
value of a synthetic convertible security will respond differently to market
fluctuations than a traditional convertible security because a
6
synthetic convertible is composed of two or more separate securities or
instruments, each with its own market value. Because the convertible component
is typically achieved by investing in warrants or options to buy common stock
at a certain exercise price, or options on a stock index, synthetic convertible
securities are subject to the risks associated with derivatives. See
"Risks--Convertible Securities Risk" and "Risks--Derivatives Risk." In
addition, if the value of the underlying common stock or the level of the index
involved in the convertible component falls below the exercise price of the
warrant or option, the warrant or option may lose all value. See
"Risks--Synthetic Convertible Securities Risk."
Credit Risk/High Yield Risk
Credit risk is the risk that one or more securities in the Fund's portfolio
will decline in price, or fail to pay interest or principal when due, because
the issuer of the obligation or the issuer of a reference security experiences
a decline in its financial status. Any default by an issuer of a debt
obligation could have a negative impact on the Fund's ability to pay dividends
on the APS and could result in the redemption of some or all of the APS. The
Fund may invest without limit in securities that are below investment grade
quality, and expects that ordinarily NACM's portfolio strategies will result in
the Fund investing primarily in these securities. Securities of below
investment grade quality (commonly referred to as "high yield" securities or
"junk bonds") are predominantly speculative with respect to the issuer's
capacity to pay interest and repay principal when due, and therefore involve a
greater risk of default. The prices of these lower grade obligations are more
sensitive to negative developments, such as a decline in the issuer's revenues
or a general economic downturn, than are the prices of higher grade securities.
The Fund may purchase distressed securities that are in default or the issuers
of which are in bankruptcy. Securities in the lowest investment grade category
also may be considered to possess some speculative characteristics by certain
Rating Agencies. See "The Fund's investment objective and strategies--Portfolio
Contents and Other Information--High Yield Securities," "Risks--Credit Risk"
and "Risks--High Yield Risk" for additional information. Due to the risks
involved in investing in high yield securities, an investment in the Fund
should be considered speculative.
Interest Rate Risk
Generally, when market interest rates fall, the prices of convertible and
non-convertible income-producing obligations rise, and vice versa. Interest
rate risk is the risk that the securities in the Fund's portfolio will decline
in value because of increases in market interest rates. Because market interest
rates are currently near their lowest levels in many years, there is a greater
risk that the Fund's portfolio will decline in value. The prices of longer-term
obligations generally fluctuate more than prices of shorter-term obligations as
interest rates change. Because the weighted average maturity of the Fund's
securities typically will range from five to ten years, the Fund's net asset
value will tend to fluctuate more in response to changes in market interest
rates than if the Fund invested mainly in short-term obligations. If interest
rates rise, the value of the Fund's investment portfolio may decline, reducing
asset coverage on the APS. See "Risks--Interest Rate Risk" for additional
information.
Issuer Risk
The value of securities in the Fund's portfolio may decline for a number of
reasons which directly relate to the issuer, such as management performance,
financial leverage and reduced demand for the issuer's goods and services.
Equity Securities Risk
The Fund will often have substantial exposure to equity securities by virtue of
the equity component of the convertible securities in which the Fund invests.
The Fund may also hold equity securities in its portfolio upon conversion of a
convertible security or through direct investments in preferred stocks. The
market price of equity securities may go up or down, sometimes rapidly or
unpredictably. Equity
7
securities may decline in value due to factors affecting equity securities
markets generally, particular industries represented in those markets or the
issuer itself, including the historical and prospective earnings of the issuer
and the value of its assets. Equity securities generally have greater price
volatility than debt and other income-producing securities.
Leverage Risk
The Fund utilizes financial leverage for investment purposes. Leverage risk
includes the risk associated with the issuance of the APS to leverage the
Fund's Common Shares. The Fund may also leverage the portfolio by borrowing
money, issuing debt securities, and utilizing reverse repurchase agreements and
other derivative instruments, although these forms of leverage will generally
be used as a substitute for, rather than in addition to, the leverage obtained
through the issuance of the APS. If the dividend rate on the APS and interest
rates (if applicable) on other forms of leverage, as reset periodically, exceed
the net rate of return on the Fund's portfolio, the leverage will result in a
lower net asset value than if the Fund were not leveraged, and the Fund's
ability to pay dividends and to meet its asset coverage requirements on the APS
would be reduced.
Because the fees received by the Manager and NACM are based on the total
managed assets of the Fund, the fees will be higher when leverage (including
the APS) is utilized, giving the Manager and NACM an incentive to utilize
leverage.
Liquidity Risk
The Fund may invest up to 5% of its total assets in securities which are
illiquid at the time of investment (determined using the Securities and
Exchange Commission's standard applicable to open-end investment companies,
i.e., securities that cannot be disposed of within seven days in the ordinary
course of business at approximately the value at which the Fund has valued the
securities). Illiquid securities may trade at a discount from comparable, more
liquid investments, and may be subject to wide fluctuations in market value.
Also, the Fund may not be able to dispose of illiquid securities when that
would be beneficial at a favorable time or price.
Foreign (Non-U.S.) Investment Risk
The Fund's investments in U.S. dollar-denominated securities of foreign issuers
involve special risks. For example, the value of these investments may decline
in response to unfavorable political or legal developments, unreliable or
untimely information, or economic and financial instability. Foreign settlement
procedures also may involve additional risks.
Smaller Company Risk
The general risks associated with corporate income-producing and equity
securities are particularly pronounced for securities issued by companies with
smaller market capitalizations. These companies may have limited product lines,
markets or financial resources, or they may depend on a few key employees. As a
result, they may be subject to greater levels of credit, market and issuer
risk. Securities of smaller companies may trade less frequently and in lesser
volume than more widely held securities and their values may fluctuate more
sharply than other securities. Companies with medium-sized market
capitalizations may have risks similar to those of smaller companies.
Derivatives Risk
The Fund may utilize derivative instruments for investment purposes, as well as
to leverage its portfolio, generally as a substitute for, rather than in
addition to, the issuance of the APS. Such derivative instruments may include
derivatives used as a component of a synthetic convertible security or to gain
exposure to high yield securities and other securities in which the Fund may
invest (pending investment of the proceeds of this offering and the Fund's
common share offering). Such derivative instruments
8
include, but are not limited to, warrants, options on common stock or stock
indexes and futures contracts. The Fund may also have exposure to derivatives,
such as credit default swaps and interest rate swaps, through investments in
credit-linked trust certificates or other securities issued by special purpose
or structured vehicles. Derivatives are subject to a number of risks described
elsewhere in this Prospectus, such as liquidity risk, equity securities risk,
issuer risk, credit risk, interest rate risk, leveraging risk, management risk
and, if applicable, smaller company risk. They also involve the risk of
mispricing or improper valuation, the risk of ambiguous documentation, and the
risk that changes in the value of the derivative may not correlate perfectly
with an underlying asset, interest rate or index. Suitable derivative
transactions may not be available in all circumstances and there can be no
assurance that the Fund will engage in these transactions when that would be
beneficial.
Counterparty Risk
The Fund will be subject to credit risk with respect to the counterparties to
derivative contracts entered into directly by the Fund or held by special
purpose or structured vehicles in which the Fund invests. If a counterparty
becomes bankrupt or otherwise fails to perform its obligations under a
derivative contract due to financial difficulties, the Fund may experience
significant delays in obtaining any recovery under the derivative contract in a
bankruptcy or other reorganization proceeding. The Fund may obtain only a
limited recovery or may obtain no recovery in such circumstances.
REITs and Mortgage-Related Risk
Investing in REITs involves certain unique risks in addition to investing in
the real estate industry in general. REITs are subject to interest rate risks
(especially mortgage REITs) and the risk of default by lessees or borrowers. An
equity REIT may be affected by changes in the value of the underlying
properties owned by the REIT. A mortgage REIT may be affected by the ability of
the issuers of its portfolio mortgages to repay their obligations. REITs whose
underlying assets are concentrated in properties used by a particular industry
are also subject to risks associated with such industry. REITs may have limited
financial resources, their securities may trade less frequently and in a
limited volume and may be subject to more abrupt or erratic price movements
than larger company securities.
In addition to REITs, the Fund may invest in a variety of other
mortgage-related securities, including commercial mortgage securities and other
mortgage-backed instruments. Rising interest rates tend to extend the duration
of mortgage-related securities, making them more sensitive to changes in
interest rates, and may reduce the market value of the securities. In addition,
mortgage-related securities are subject to prepayment risk--the risk that
borrowers may pay off their mortgages sooner than expected, particularly when
interest rates decline. This can reduce the Fund's returns because the Fund may
have to reinvest that money at lower prevailing interest rates. The Fund's
investments in other asset-backed securities are subject to risks similar to
those associated with mortgage-backed securities, as well as additional risks
associated with the nature of the assets and the servicing of those assets.
Reinvestment Risk
Income from the Fund's portfolio will decline if and when the Fund invests the
proceeds from matured, traded or called obligations at market interest rates
that are below the portfolio's current earnings rate. This could impact the
Fund's net asset value and reduce asset coverage on the APS.
Inflation/Deflation Risk
Inflation risk is the risk that the value of assets or income from the Fund's
investments will be worth less in the future as inflation decreases the value
of payments at future dates. As inflation increases, the real value of the APS
and distributions, as well as the value of the Fund's portfolio, could decline.
Deflation risk is the risk that prices throughout the economy decline over
time--the opposite of inflation. Deflation may have an adverse affect on the
creditworthiness of issuers and may make issuer default more likely, which may
result in a decline in the value of the Fund's portfolio. Deflation may also
result in a decline in the dividend rate of the APS.
9
Management Risk
The Fund is subject to management risk because it is an actively managed
portfolio. NACM and the portfolio management team will apply investment
techniques and risk analyses in making investment decisions for the Fund, but
there can be no guarantee that these will produce the desired results.
Anti-Takeover Provisions
The Fund's Amended and Restated Agreement and Declaration of Trust (the
"Declaration") and Amended Bylaws include provisions that could limit the
ability of other entities or persons to acquire control of the Fund, convert
the Fund to open-end status or to change the composition of the Board of
Trustees. Preferred Shareholders will have voting rights in addition to and
separate from the voting rights of the Common Shareholders in certain
situations. See "Anti-takeover and other provisions in the Declaration of
Trust." Preferred Shareholders, on the one hand, and Common Shareholders, on
the other, may have interests that conflict in these situations.
Certain Affiliations
Because certain broker-dealers may be considered affiliated persons of the
Fund, the Manager and/or NACM, the Fund's ability to utilize such
broker-dealers is subject to restrictions and, in some cases, is prohibited.
This could limit the Fund's ability to engage in securities transactions and
take advantage of market opportunities.
Market Disruption and Geopolitical Risk
The war with Iraq, its aftermath and the continuing occupation of Iraq are
likely to have a substantial impact on the U.S. and world economies and
securities markets. The nature, scope and duration of the war and occupation
and such impact cannot be predicted with any certainty. Terrorist attacks on
the World Trade Center and the Pentagon on September 11, 2001 closed some of
the U.S. securities markets for a four-day period and similar events cannot be
ruled out. The war and occupation, terrorism and related geopolitical risks
have led, and may in the future lead, to increased short-term market volatility
and may have adverse long-term effects on U.S. and world economies and markets
generally. Those events could also have an acute effect on individual issuers
or related groups of issuers. These risks could also adversely affect
individual issuers and securities markets, interest rates, Auctions, secondary
trading, ratings, credit risk, inflation and other factors relating to the APS.
For additional information about the risks of investing in the APS and in the
Fund, see "Risks."
DIVIDENDS ON APS
The APS will entitle their holders to receive cash dividends at a rate per
annum that may vary for the successive Dividend Periods for such shares. In
general, except as described below, each Dividend Period for each series of APS
subsequent to the Initial Dividend Period will be seven days in length. The
Applicable Rate for a particular Dividend Period will be determined by an
Auction conducted on the Business Day next preceding the start of such Dividend
Period. For hypothetical examples of how the Applicable Rate will be
determined, see "Description of APS--Auction Procedures--Determination of
Sufficient Clearing Bids, Winning Bid Rates and Applicable Rate."
Through their Broker-Dealers, Beneficial Owners and Potential Beneficial Owners
of APS may participate in Auctions, although, except in the case of Special
Dividend Periods of longer than 91 days, Beneficial Owners desiring to continue
to hold all of their APS regardless of the Applicable Rate resulting from
Auctions need not participate. For an explanation of Auctions and the method of
determining the Applicable Rate, see "Description of APS--The Auction."
Except as described herein, investors in APS will not receive certificates
representing ownership of their shares. Ownership of APS will be maintained in
book-entry form by the Securities Depository or its
10
nominee for the account of the investor's Agent Member. The investor's Agent
Member, in turn, will maintain records of such investor's beneficial ownership
of APS. Accordingly, references herein to an investor's investment in or
purchase, sale or ownership of APS are to purchases, sales or ownership of
those shares by Beneficial Owners.
After the Initial Dividend Period, each Subsequent Dividend Period for each
series of APS will generally consist of seven days (a "7-Day Dividend Period");
provided, however, that prior to any Auction, the Fund may elect, subject to
certain limitations described herein, upon giving notice to holders thereof, a
Special Dividend Period for any or all series. A "Special Dividend Period" is a
Dividend Period consisting of a specified number of days, evenly divisible by
seven and not fewer than 14 nor more than 364 (a "Short Term Dividend Period")
or a Dividend Period consisting of a specified period of one whole year or more
but not greater than five years (a "Long Term Dividend Period"). Dividends on
the APS offered hereby are cumulative from the Date of Original Issue and are
payable when, as and if declared by the Board of Trustees of the Fund, out of
funds legally available therefor, commencing on the Initial Dividend Payment
Date. In the case of Dividend Periods that are not Special Dividend Periods,
dividends will be payable generally on each succeeding Tuesday for Series A
APS, on each succeeding Wednesday for Series B APS, on each succeeding Thursday
for Series C APS, on each succeeding Friday for Series D APS and on each
succeeding Monday for Series E APS, subject to certain exceptions.
Dividends for the APS will be paid through the Securities Depository on each
Dividend Payment Date. The Securities Depository's normal procedures provide
for it to distribute dividends in same-day funds to Agent Members, who are in
turn expected to distribute such dividends to the person for whom they are
acting as agent in accordance with the instructions of such person. See
"Description of APS--Dividends."
For each Subsequent Dividend Period, the cash dividend rate on each series of
APS will be the Applicable Rate that the Auction Agent advises the Fund has
resulted from an Auction. See "Description of APS--Dividends." The first
Auction for each series of the APS is scheduled to be held on the ending date
for the Initial Dividend Period as set forth above.
The Amended Bylaws provide that until the Fund gives a Request for Special
Dividend Period and the related Notice of Special Dividend Period, only 7-Day
Dividend Periods will be applicable to each series of APS. While the Fund does
not currently intend to give a Request for Special Dividend Period with respect
to any series of APS, it may so elect in the future subject to, and on, the
conditions discussed under "Description of the APS--Dividends--Notification of
Dividend Period."
A Special Dividend Period will not be effective for a series of APS unless
Sufficient Clearing Bids exist at the Auction in respect of such Special
Dividend Period. If Sufficient Clearing Bids do not exist at such Auction, the
Dividend Period commencing on the Business Day succeeding such Auction will be
a 7-Day Dividend Period, and the holders of the APS outstanding immediately
prior to such Auction will be required to continue to hold some or all of such
shares for such Dividend Period. In addition, the Fund may not give a Notice of
Special Dividend Period with respect to the APS, or if the Fund has given a
Notice of Special Dividend Period for the APS, the Fund will be required to
give a Notice of Revocation in respect thereof, if (i) either the 1940 Act APS
Asset Coverage is not satisfied or the Fund fails to maintain Moody's Eligible
Assets with an aggregate Discounted Value at least equal to the APS Basic
Maintenance Amount, in each case on each of the two Valuation Dates immediately
preceding the Business Day prior to the related Auction Date for the APS, or
(ii) sufficient funds for the payment of dividends payable on the immediately
succeeding Dividend Payment Date have not been irrevocably deposited with the
Auction Agent by the close of business on the third Business Day preceding the
related Auction Date. In such event, the next succeeding Dividend Period will
be a 7-Day Dividend Period.
11
DETERMINATION OF MAXIMUM APPLICABLE RATES
Except during a Non-Payment Period, the Applicable Rate for any Dividend Period
for APS will not be more than the Maximum Applicable Rate applicable to such
shares. The Maximum Applicable Rate for each series of APS will depend on the
credit rating assigned to such series and on the duration of the Dividend
Period. The Maximum Applicable Rate will be the Applicable Percentage of the
Reference Rate. The Reference Rate is the applicable "AA" Financial Composite
Commercial Paper Rate (for a dividend period of fewer than 184 days) or the
applicable Treasury Index Rate (for a dividend period of 184 days or more). The
Applicable Percentage is subject to upward but not downward adjustment in the
discretion of the Board of Trustees after consultation with the Broker-Dealers.
The Applicable Percentage is determined as follows:
Moody's Credit Rating Applicable Percentage
-------------------------------------------
Aa3 or higher 150%
A3 to A1 200%
Baa3 to Baa1 225%
Below Baa3 275%
There is no minimum Applicable Rate in respect of any Dividend Period. The
Applicable Rate for any Dividend Period commencing during any Non-Payment
Period, and the rate used to calculate the late charge described under
"Description of APS--Dividends--Non-Payment Period; Late Charge," initially
will be 300% of the Reference Rate.
AUCTION PROCEDURES
Separate Auctions will be conducted for each series of APS. Unless otherwise
permitted by the Fund, Beneficial Owners and Potential Beneficial Owners of APS
may only participate in Auctions through their Broker-Dealers. Broker-Dealers
will submit the Orders of their respective customers who are Beneficial Owners
and Potential Beneficial Owners to the Auction Agent, designating themselves as
Existing Holders in respect of shares subject to Orders submitted or deemed
submitted to them by Beneficial Owners and as Potential Holders in respect of
shares subject to Orders submitted to them by Potential Beneficial Owners. On
or prior to each Auction Date for the APS (the Business Day next preceding the
first day of each Dividend Period), each Beneficial Owner may submit Orders to
its Broker-Dealer as follows:
.. Hold Order--indicating its desire to hold the APS without regard to the
Applicable Rate for the next Dividend Period for such shares.
.. Bid--indicating its desire to hold the APS, provided that the Applicable
Rate for the next Dividend Period for such shares is not less than the rate
per annum specified in such Bid.
.. Sell Order--indicating its desire to sell the APS without regard to the
Applicable Rate for the next Dividend Period for such shares.
A Beneficial Owner may submit different types of Orders to its Broker-Dealer
with respect to the APS then held by such Beneficial Owner, provided that the
total number of APS covered by such Orders does not exceed the number of APS
held by such Beneficial Owner. If, however, a Beneficial Owner offers through
its Broker-Dealer to purchase additional APS in such Auction, such Beneficial
Owner, for purposes of such offer to purchase additional shares, will be
treated as a Potential Beneficial Owner as described below. Bids by Beneficial
Owners through their Broker-Dealers with rates per annum higher than the
Maximum Applicable Rate will be treated as Sell Orders. A Hold Order (in the
case of an
12
Auction relating to a Dividend Period of 91 days or less) or a Sell Order (in
the case of an Auction relating to a Special Dividend Period of longer than 91
days) shall be deemed to have been submitted on behalf of a Beneficial Owner if
an Order with respect to the APS then held by such Beneficial Owner is not
submitted on behalf of such Beneficial Owner for any reason, including the
failure of a Broker-Dealer to submit such Beneficial Owner's Order to the
Auction Agent.
Potential Beneficial Owners of APS may submit Bids through their Broker-Dealers
in which they offer to purchase APS, provided that the Applicable Rate for the
next Dividend Period for such shares is not less than the rate per annum
specified in such Bid. A Bid by a Potential Beneficial Owner with a rate per
annum higher than the Maximum Applicable Rate will not be considered.
Neither the Fund nor the Auction Agent will be responsible for a
Broker-Dealer's failure to act in accordance with the instructions of
Beneficial Owners or Potential Beneficial Owners or failure to comply with any
of the foregoing.
A Broker-Dealer also may hold APS for its own account as a Beneficial Owner. A
Broker-Dealer thus may submit Orders to the Auction Agent as a Beneficial Owner
or a Potential Beneficial Owner and therefore participate in an Auction as an
Existing Holder or Potential Holder on behalf of both itself and its customers.
Any Order placed with the Auction Agent by a Broker-Dealer as or on behalf of a
Beneficial Owner or a Potential Beneficial Owner will be treated in the same
manner as an Order placed with a Broker-Dealer by a Beneficial Owner or a
Potential Beneficial Owner. Similarly, any failure by a Broker-Dealer to submit
to the Auction Agent an Order in respect of any APS held by it or its customers
who are Beneficial Owners will be treated in the same manner as a Beneficial
Owner's failure to submit to its Broker-Dealer an Order in respect of APS held
by it, as described above. Inasmuch as a Broker-Dealer participates in an
Auction as an Existing Holder or a Potential Holder only to represent the
interests of a Beneficial Owner or Potential Beneficial Owner, whether it be a
customer or itself, all discussion herein relating to the consequences of an
Auction for Existing Holders and Potential Holders also applies to the
underlying beneficial ownership interests represented thereby.
If Sufficient Clearing Bids exist in an Auction for a series of APS (that is,
in general, the number of APS subject to Bids by Potential Holders with rates
equal to or lower than the Maximum Applicable Rate is at least equal to the
number of APS subject to Sell Orders by Existing Holders), the Applicable Rate
will be the lowest rate per annum specified in the Submitted Bids which, taking
into account such rate per annum and all lower rates per annum bid by Existing
Holders and Potential Holders, would result in Existing Holders and Potential
Holders owning all of the APS available for purchase in the Auction. If
Sufficient Clearing Bids do not exist, the Dividend Period next following the
Auction automatically will be a 7-Day Dividend Period and the Applicable Rate
will be the Maximum Applicable Rate, and in such event, Existing Holders that
have submitted Sell Orders will not be able to sell in the Auction all, and may
not be able to sell any, APS subject to such Sell Orders. Thus, in certain
circumstances, Existing Holders and, thus, the Beneficial Owners they represent
may not have liquidity of investment. If all Existing Holders submit (or are
deemed to have submitted) Hold Orders in an Auction, the Dividend Period next
following the Auction automatically shall be the same length as the immediately
preceding Dividend Period, and the Applicable Rate will be 80% of the Reference
Rate (as defined under "Determination of Maximum Applicable Rates" above) in
effect on the date of the Auction. The Auction Procedures include a pro rata
allocation of shares for purchase and sale, which may result in an Existing
Holder selling or holding, or a Potential Holder purchasing, a number of APS
that is less than the number of APS specified in its Order. To the extent the
allocation has this result, a Broker-Dealer will be required to make
appropriate pro rata allocations among its customers and itself.
13
A Sell Order by an Existing Holder will constitute an irrevocable offer to sell
the APS subject thereto, and a Bid placed by an Existing Holder also will
constitute an irrevocable offer to sell the APS subject thereto if the rate per
annum specified in the Bid is higher than the Applicable Rate determined in the
Auction, in each case at a price per share equal to $25,000. A Bid placed by a
Potential Holder will constitute an irrevocable offer to purchase the APS
subject thereto at a price per share equal to $25,000 if the rate per annum
specified in such Bid is less than or equal to the Applicable Rate determined
in the Auction. Settlement of purchases and sales will be made on the next
Business Day (also a Dividend Payment Date) after the Auction Date through the
Securities Depository. Purchasers will make payment through their Agent Members
in same-day funds to the Securities Depository against delivery by book-entry
to their Agent Members. The Securities Depository will make payment to the
sellers' Agent Members in accordance with the Securities Depository's normal
procedures, which now provide for payment in same-day funds. See "Description
of APS--The Auction."
ASSET MAINTENANCE
Under the Amended Bylaws, the Fund must maintain (i) Moody's Eligible Assets
having, in the aggregate, a Discounted Value at least equal to the APS Basic
Maintenance Amount and (ii) 1940 Act APS Asset Coverage of at least 200%. See
"Description of APS--Asset Maintenance."
In the event that the Fund does not maintain (or cure a failure to maintain)
these coverage tests, some or all of the APS will be subject to mandatory
redemption. See "Description of APS--Redemption--Mandatory Redemption."
The Fund estimates that, based on the composition of its portfolio at May 13,
2003, 1940 Act APS Asset Coverage with respect to APS would be approximately
284% immediately after the issuance of the APS offered hereby in an amount
representing approximately 35% of the Fund's capital (including the capital
attributable to the APS). This asset coverage will change from time to time.
The Discount Factors and guidelines for calculating the Discounted Value of the
Fund's portfolio for purposes of determining whether the APS Basic Maintenance
Amount has been satisfied have been established by Moody's in connection with
the Fund's expected receipt of a rating of "Aaa" on the APS on their Date of
Original Issue. See "Rating agency guidelines."
MANDATORY REDEMPTION
If the APS Basic Maintenance Amount or the 1940 Act APS Asset Coverage is not
maintained or restored as specified herein, the APS will be subject to
mandatory redemption, out of funds legally available therefor, at the Mandatory
Redemption Price of $25,000 per share plus an amount equal to dividends thereon
(whether or not earned or declared) accumulated but unpaid to the date fixed
for redemption. Any such redemption will be limited to the minimum number of
APS necessary to restore the APS Basic Maintenance Amount or the 1940 Act APS
Asset Coverage, as the case may be. The Fund's ability to make such a mandatory
redemption may be restricted by the provisions of the 1940 Act. See
"Description of APS--Redemption--Mandatory Redemption."
OPTIONAL REDEMPTION
The APS are redeemable at the option of the Fund, in whole or in part, on any
Dividend Payment Date (except during the Initial Dividend Period or a Non-Call
Period) at the Optional Redemption Price of $25,000 per share, plus an amount
equal to dividends thereon (whether or not earned or declared) accumulated but
unpaid to the date fixed for redemption plus the premium, if any, resulting
from the designation of a Premium Call Period. See "Description of
APS--Redemption--Optional Redemption."
14
LIQUIDATION PREFERENCE
The liquidation preference of the APS will be $25,000 per share, plus an amount
equal to accumulated but unpaid dividends (whether or not earned or declared).
See "Description of APS--Liquidation Rights."
RATING
It is a condition to their issuance that the APS be issued with a credit
quality rating of "Aaa" from Moody's. The Fund may at some future time seek to
have the APS rated by an additional Rating Agency or a Substitute Rating
Agency. See "Rating agency guidelines."
VOTING RIGHTS
The 1940 Act requires that the holders of APS and any other Preferred Shares,
voting as a separate class, have the right to elect at least two Trustees at
all times and to elect a majority of the Trustees at any time when two years'
dividends on the APS or any other Preferred Shares are unpaid. The holders of
APS and any other Preferred Shares will vote as a separate class on certain
other matters as required under the Declaration and Amended Bylaws and under
the 1940 Act. See "Description of APS--Voting Rights," "Description of capital
structure" and "Anti-takeover and other provisions in the Declaration of Trust."
TAX CONSIDERATIONS
The distributions with respect to any series of APS (other than distributions
in redemption of APS subject to Section 302(b) of the Internal Revenue Code of
1986, as amended (the "Code")) will constitute dividends to the extent of the
Fund's current or accumulated earnings and profits, as calculated for federal
income tax purposes. Such dividends generally will be taxable as ordinary
income to holders. Distributions of net capital gains (i.e., the excess of net
long-term capital gains over net short-term capital losses) that are designated
by the Fund as capital gain dividends will be treated as long-term capital
gains in the hands of holders receiving such distributions. The Internal
Revenue Service (the "IRS") currently requires that a regulated investment
company that has two or more classes of stock allocate to each such class
proportionate amounts of each type of its income (such as ordinary income and
capital gains) based upon the percentage of total dividends distributed to each
class for the tax year. Accordingly, the Fund intends each year to allocate
capital gain dividends between and among its Common Shares and each series of
the APS in proportion to the total dividends paid to each class during or with
respect to such year. Ordinary income dividends and dividends qualifying for
the dividends received deduction, if any, will similarly be allocated between
and among classes. See "Tax matters."
15
--------------------------------------------------------------------------------
Financial highlights (unaudited)
The financial highlights table set forth below is intended to help you
understand the Fund's recent financial performance. Information contained in
the table below under the headings "Per Share Operating Performance" and
"Ratios/Supplemental Data" shows the unaudited operating performance of the
Fund from the commencement of the Fund's investment operations on March 31,
2003 through April 30, 2003. Because the Fund is recently organized and
commenced investment operations on March 31, 2003, the table covers
approximately five weeks of operations, during which a substantial portion of
the Fund's portfolio was held in temporary investments pending investment in
securities that meet the Fund's investment objective and policies. Accordingly,
the information presented may not provide a meaningful picture of the Fund's
operating performance.
For the Period from
March 31, 2003(1) through
April 30, 2003
(Unaudited)
------------------------------------------------------------------------------------------------------
Per Share Operating Performance:
Net Asset Value, Beginning of Period..................................... $ 14.33(2)
Income from Investment Operations:.......................................
Net Investment Income................................................ 0.08
Net Realized and Unrealized Gain on Investments...................... 0.35
--------
Net Increase in Net Assets from Investment Operations............. 0.43
Common Stock Offering Expenses Charged to Paid-in-Capital in Excess of
Par...................................................................... (0.02)
--------
Net Asset Value, End of Period........................................... $ 14.74
========
Market Price, End of Period.............................................. $ 15.08
========
Total Investment Return.................................................. 0.5%(3)
Ratios/Supplemental Data:
Net Assets, End of Period (in thousands)................................. $884,734
Ratio of Expenses to Average Net Assets.................................. 0.75%(4)
Ratio of Net Investment Income to Average Net Assets..................... 6.90%(4)
Portfolio Turnover....................................................... 6%
(1) Date of commencement of operations.
(2) Initial public offering price of $15.00 per Common Share less underwriting
discount of $0.675 per share.
(3) Total Investment Return is calculated assuming a purchase of Common Shares
at the current market price on the first day and a sale at the current
market price on the last day of the period reported. Total Investment
Return does not reflect brokerage commissions. Total Investment Return for
a period of less than one year is not annualized.
(4) Annualized.
--------------------------------------------------------------------------------
16
--------------------------------------------------------------------------------
The Fund
The Fund is a recently organized, diversified, closed-end management investment
company registered under the 1940 Act. The Fund was organized as a
Massachusetts business trust on January 17, 2003, pursuant to the Declaration,
which is governed by the laws of The Commonwealth of Massachusetts. The Fund's
principal office is located at 1345 Avenue of the Americas, New York, New York
10105, and its telephone number is (800) 331-1710.
The Fund commenced operations on March 31, 2003, upon the closing of an initial
public offering of 60,000,000 of its Common Shares. The net proceeds of such
offering were approximately $858,350,000 after the payment of organizational
and offering expenses. In connection with the initial public offering of the
Fund's Common Shares, the underwriters were granted an option to purchase up to
an additional 9,000,000 Common Shares to cover over-allotments. On April 29,
2003, and May 9, 2003, respectively, the underwriters purchased, at a price of
$15.00 per Common Share (less an underwriting discount of $0.675 per share), an
additional 3,500,000 and 1,845,000 Common Shares of the Fund pursuant to the
over-allotment option.
Use of proceeds
The net proceeds of the offering of APS will be approximately $519,225,000
after payment of the estimated offering costs. The Fund will invest the net
proceeds of the offering in accordance with the Fund's investment objective and
policies as stated below. It is presently anticipated that the Fund will be
able to invest substantially all of the net proceeds in convertible securities
and non-convertible income-producing securities within three months after the
completion of this offering. Pending such investment, it is anticipated that
the proceeds will be invested in high grade, short-term securities,
credit-linked trust certificates, and/or high yield securities index futures
contracts or similar derivative instruments designed to give the Fund market
exposure while NACM selects specific securities.
Capitalization
The following table sets forth the unaudited capitalization of the Fund as of
May 13, 2003, and as adjusted to give effect to the issuance of the APS offered
hereby (including estimated offering expenses and sales load of $5,775,000).
Actual As Adjusted
---------------------------------------------------------------------------------------------
Auction Preferred Shares, par value $0.00001 per share (no shares
issued; 21,000 shares issued, as adjusted, at $25,000 per share
liquidation preference)........................................ $ 0 $525,000,000
============ ============
Common Shares, par value $0.00001 per share, 65,351,981 shares
outstanding.................................................... $935,017,128 $929,242,128
Undistributed net investment income.............................. $ 8,525,593 $ 8,525,593
Net realized gain/loss on investment transactions................ $ (94,656) $ (94,656)
Net unrealized appreciation/(depreciation) on investments........ $ 27,504,954 $ 27,504,954
------------ ------------
Net assets applicable to Common Shares........................... $970,953,019 $965,178,019
============ ============
--------------------------------------------------------------------------------
17
--------------------------------------------------------------------------------
Portfolio composition
As of May 13, 2003, approximately 98.1% of the market value of the Fund's
portfolio was invested in long-term investments, approximately 0.0% of the
market value of the Fund's portfolio was invested in short-term investments and
approximately 1.9% of the market value of the Fund's portfolio was invested in
cash. The following table sets forth certain information with respect to the
composition of the Fund's investment portfolio as of May 13, 2003, based on the
highest rating assigned.
Value
S&P(1) Moody's(1) Number of Issues (in Thousands) Percent
-----------------------------------------------------------------------------
AAA Aaa 2 $172,304 18.0%
AA Aa 0 0 0.0
A A 3 23,666 2.5
BBB Baa 12 99,744 10.4
BB Ba 16 120,465 12.6
B B 56 380,182 39.8
CCC Caa 7 52,559 5.5
CC Ca 1 2,723 0.3
C C 0 0 0.0
NR(2) NR(2) 15 85,405 9.0
Cash 18,380 1.9
--- -------- -----
Total 112 955,428 100.0%
=== ======== =====
(1) Ratings: Using the higher of S&P's or Moody's ratings on the Fund's
portfolio securities. S&P rating categories may be modified further by a
plus (+) or minus (-) in AA, A, BBB, BB, B and CCC ratings. Moody's rating
categories may be modified further by a 1, 2, or 3 in Aa, A, Baa, Ba, B and
Caa ratings.
(2) Refers to securities that have not been rated by Moody's or S&P but have
been assessed by NACM as being of comparable credit quality to rated
securities in which the Fund may invest. See "The Fund's investment
objective and strategies."
The Fund's investment objective and strategies
INVESTMENT OBJECTIVE
The Fund's investment objective is to provide total return through a
combination of capital appreciation and high current income. The Fund attempts
to achieve its investment objective by investing in a diversified portfolio of
convertible securities and non-convertible income-producing securities
described under "--Portfolio Contents and Other Information" below. In seeking
to achieve its investment objective, the Fund expects to invest primarily in
"high yield" securities or "junk bonds." The Fund cannot assure you that it
will achieve its investment objective.
PORTFOLIO MANAGEMENT STRATEGIES
In selecting investments for the Fund, NACM attempts to identify issuers that
successfully adapt to change. NACM uses traditional credit analysis combined
with a disciplined, fundamental bottom-up research process that facilitates the
early identification of issuers demonstrating an ability to improve their
fundamental characteristics. See "--Independent Credit Analysis" below. NACM
attempts to identify potential investments that it expects will exceed minimum
credit statistics and exhibit the highest visibility of future expected
operating performance. NACM's sell discipline is clearly defined and designed
to drive the Fund's portfolio continually toward strength. A series of sell
alerts triggering
--------------------------------------------------------------------------------
18
The Fund's investment objective and strategies
--------------------------------------------------------------------------------
further verification research, such as changes in credit fundamentals, declines
in relative attractiveness to other issues and declines in industry
fundamentals, are utilized, and NACM will consider selling a particular
security if any of the original reasons for purchase materially changes.
In selecting convertible securities for investment by the Fund, NACM evaluates
each convertible security's investment characteristics as an income-producing
security, using the techniques described above, as well as its potential for
capital appreciation, using techniques that focus on the security's equity
characteristics. NACM seeks to capture approximately 70-80% of any increase in
the market price of the underlying equities (upside potential) and 50% or less
of any decrease in the market price of the underlying equities (downside
exposure). In analyzing specific companies for possible investment, NACM
ordinarily looks for several of the following characteristics: above-average
per share earnings growth; high return on invested capital; a healthy balance
sheet; sound financial and accounting policies and overall financial strength;
strong competitive advantages; effective research and product development and
marketing; development of new technologies; efficient service; pricing
flexibility; strong management; and general operating characteristics that will
enable the companies to compete successfully in their respective markets. NACM
will consider selling a particular convertible security when any of those
factors materially changes.
Credit Quality
The Fund may invest without limit in securities that are below investment grade
quality, including unrated securities judged to be of comparable quality by
NACM, and expects that ordinarily NACM's portfolio strategies will result in
the Fund investing primarily in these securities. The Fund may invest in
issuers of any credit quality (including securities in the lowest ratings
categories). The Fund may purchase distressed securities that are in default or
the issuers of which are in bankruptcy. As described under "Portfolio Contents
and Other Information--High Yield Securities" below, securities of below
investment grade quality are regarded as having predominantly speculative
characteristics with respect to capacity to pay interest and repay principal,
and are commonly referred to as "high yield" securities or "junk bonds."
Securities in the lowest investment grade category also may be considered to
possess some speculative characteristics.
Independent Credit Analysis
NACM relies heavily on its own analysis of the credit quality and risks
associated with individual securities considered for the Fund, rather than
relying exclusively on rating agencies or third-party research. NACM has a
devoted team of professionals that conducts fundamental credit research and
analysis of individual issuers, industries and sectors and uses analytical
tools to assess and monitor credit risk. The team managing the Fund utilizes
this information in an attempt to minimize credit risk and identify issuers,
industries or sectors that are undervalued or that offer attractive capital
appreciation potential or current income relative to NACM's assessment of their
credit characteristics.
PORTFOLIO CONTENTS AND OTHER INFORMATION
Under normal circumstances, the Fund will invest at least 80% of its total
assets in a diversified portfolio of convertible securities and non-convertible
income-producing securities. The portion of the Fund's assets invested in
convertible securities, on the one hand, and non-convertible income-producing
securities, on the other, will vary from time to time consistent with the
Fund's investment objective, although the Fund will normally invest at least
50% of its total assets in convertible securities. In making allocation
decisions, NACM will consider factors such as changes in equity prices, changes
in interest rates and other economic and market factors. The Fund invests in
securities with a broad range of maturities. The weighted average maturity of
the Fund will typically range from five to ten years,
--------------------------------------------------------------------------------
19
The Fund's investment objective and strategies
--------------------------------------------------------------------------------
although the weighted average maturity of obligations held by the Fund may be
shorter or longer at any time or from time to time depending on market
conditions.
The Fund may invest up to 20% of its total assets in securities other than
convertible securities and non-convertible income-producing securities. The
Fund may invest up to 5% of its total assets in illiquid securities (which is
determined using the Securities and Exchange Commission's standard applicable
to open-end investment companies, i.e., securities that cannot be disposed of
within seven days in the ordinary course of business at approximately the value
at which the Fund has valued the securities). The Fund may invest in securities
of companies with smaller market capitalizations.
The Fund cannot change its investment objective without the approval of the
holders of a "majority of the outstanding" Common Shares and any Preferred
Shares (including the APS) voting together as a single class, and of the
holders of a "majority of the outstanding" Preferred Shares (including the APS)
voting as a separate class. A "majority of the outstanding" shares (whether
voting together as a single class or voting as a separate class) means (i) 67%
or more of such shares present at a meeting, if the holders of more than 50% of
those shares are present or represented by proxy, or (ii) more than 50% of such
shares, whichever is less. See "Description of APS--Voting Rights" for
additional information with respect to the voting rights of holders of APS.
In addition to the issuance of the APS, the Fund may also leverage the
portfolio by borrowing money, issuing debt securities, and utilizing reverse
repurchase agreements and other derivative instruments, although these forms of
leverage will generally be used as a substitute for, rather than in addition
to, the leverage obtained through the issuance of the APS. See
"Risks--Leverage."
Upon NACM's recommendation, for temporary defensive purposes and in order to
keep the Fund's cash fully invested, including during the period in which the
net proceeds of this offering are being invested, the Fund may deviate from its
investment objective and policies and invest some or all of its net assets in
investments such as high grade, short-term debt securities. The Fund may not
achieve its investment objective when it does so.
It is the policy of the Fund not to engage in trading for short-term profits
although portfolio turnover rate is not considered a limiting factor in the
execution of investment decisions for the Fund. Frequent changes in the Fund's
investments (i.e., portfolio turnover), which are more likely in periods of
volatile market movements, involve some expense to the Fund, including
brokerage commissions or dealer mark-ups and other transaction costs, and may
increase the amount of capital gains (and, in particular, short-term gains)
realized by the Fund, on which shareholders may pay tax. Please see "Investment
Objective and Policies--Portfolio Trading and Turnover Rate" in the Statement
of Additional Information for more information regarding portfolio turnover.
The following provides additional information regarding the types of securities
and other instruments in which the Fund will ordinarily invest. A more detailed
discussion of these and other instruments and investment techniques that may be
used by the Fund is provided under "Investment Objective and Policies" in the
Statement of Additional Information. The ability of the Fund to use some of the
strategies discussed below and in the Statement of Additional Information, such
as derivatives, is limited by Rating Agency guidelines. See "Rating agency
guidelines" below.
Convertible Securities
The Fund may invest without limit in convertible securities, and these
securities will ordinarily constitute a principal component of the Fund's
investment program. Convertible securities are bonds, debentures, notes,
preferred stocks or other securities that may be converted or exchanged (by the
holder or by the
--------------------------------------------------------------------------------
20
The Fund's investment objective and strategies
--------------------------------------------------------------------------------
issuer) into shares of the underlying common stock (or cash or securities of
equivalent value) at a stated exchange ratio or predetermined price (the
"conversion price"). A convertible security is designed to provide current
income and also the potential for capital appreciation through the conversion
feature, which enables the holder to benefit from increases in the market price
of the underlying common stock. A convertible security may be called for
redemption or conversion by the issuer after a particular date and under
certain circumstances (including a specified price) established upon issue. If
a convertible security held by the Fund is called for redemption or conversion,
the Fund could be required to tender it for redemption, convert it into the
underlying common stock or sell it to a third party. Convertible securities
have general characteristics similar to both debt securities and equity
securities. Although to a lesser extent than with debt obligations, the market
value of convertible securities tends to decline as interest rates increase
and, conversely, tends to increase as interest rates decline. In addition,
because of the conversion feature, the market value of convertible securities
tends to vary with fluctuations in the market value of the underlying common
stocks and, therefore, it will also react to variations in the general market
for equity securities. Depending upon the relationship of the conversion price
to the market value of the underlying security, a convertible security may
trade more like an equity security than a debt instrument.
Convertible securities are designed to provide for a stable stream of income
with generally higher yields than common stocks. There can be no assurance of
current income because the issuers of the convertible securities may default on
their obligations. Convertible securities, however, generally offer lower
interest or dividend yields than non-convertible securities of similar credit
quality because of the potential for capital appreciation.
Synthetic Convertible Securities
The Fund also may invest without limit in "synthetic" convertible securities,
which will be selected based on the similarity of their economic
characteristics to those of a traditional convertible security due to the
combination of separate securities that possess the two principal
characteristics of a traditional convertible security, i.e., an
income-producing security ("income-producing component") and the right to
acquire an equity security ("convertible component"). The income-producing
component is achieved by investing in non-convertible, income-producing
securities such as bonds, preferred stocks and money market instruments. The
convertible component is achieved by investing in warrants or options to buy
common stock at a certain exercise price, or options on a stock index. A simple
example of a synthetic convertible security is the combination of a traditional
corporate bond with a warrant to purchase equity securities of the issuer of
the bond. The Fund may also purchase synthetic securities created by other
parties, typically investment banks or other financial institutions, including
convertible structured notes. The income-producing and convertible components
of a synthetic convertible security may be issued separately by different
issuers and at different times. Unlike a traditional convertible security,
which is a single security having a unitary market value, a synthetic
convertible comprises two or more separate securities, each with its own market
value. Therefore, the market value of a synthetic convertible security is the
sum of the values of its debt component and its convertibility component. For
this reason, the values of a synthetic convertible and a traditional
convertible security may respond differently to market fluctuations. The Fund's
holdings of synthetic convertible securities are considered convertible
securities for purposes of the Fund's policy to invest at least 50% of its
total assets in convertible securities and 80% of its total assets in a
diversified portfolio of convertible securities and non-convertible
income-producing securities.
Non-Convertible Income-Producing Securities
The Fund will also invest in non-convertible income-producing securities,
including, but not limited to, corporate bonds, debentures, notes and other
similar types of corporate debt instruments, as well as non-convertible
preferred stocks, bank loans and loan participations, commercial paper, REITs
and
--------------------------------------------------------------------------------
21
The Fund's investment objective and strategies
--------------------------------------------------------------------------------
commercial and other mortgage-related and asset-backed securities,
payment-in-kind securities, credit-linked trust certificates and other
securities issued by special purpose or structured vehicles, zero-coupon bonds,
bank certificates of deposit, fixed time deposits, bankers' acceptances and
U.S. Government securities. The Fund's investments in non-convertible
income-producing securities may have fixed or variable principal payments and
all types of interest rate and dividend payment and reset terms, including
fixed rate, adjustable rate, zero-coupon, contingent, deferred, payment-in-kind
and auction-rate features.
High Yield Securities
As noted above, the Fund may invest without limit in securities rated lower
than Baa by Moody's or BBB by S&P (including securities in the lowest ratings
categories (C by Moody's or S&P)), or in unrated securities judged to be of
comparable quality by NACM, and expects that ordinarily NACM's portfolio
strategies will result in the Fund investing primarily in these securities.
These securities are sometimes referred to as "high yield" securities or "junk
bonds." Investing in high yield securities involves greater risks (in
particular, greater risk of default) and special risks in addition to the risks
associated with investments in investment grade obligations. While offering a
greater potential opportunity for capital appreciation and higher yields, high
yield securities typically entail greater potential price volatility and may be
less liquid than higher-rated securities. High yield securities may be regarded
as predominantly speculative with respect to the issuer's continuing ability to
meet principal and interest payments. They also may be more susceptible to real
or perceived adverse economic and competitive industry conditions than
higher-rated securities. The Fund may purchase distressed securities that are
in default or the issuers of which are in bankruptcy. Securities in the lowest
investment grade category also may be considered to possess some speculative
characteristics.
The market values of high yield securities tend to reflect individual
developments of the issuer to a greater extent than do higher-quality
securities, which tend to react mainly to fluctuations in the general level of
interest rates. In addition, lower-quality securities tend to be more sensitive
to economic conditions.
Credit Ratings and Unrated Securities
Rating agencies are private services that provide ratings of the credit quality
of debt obligations, including convertible securities. Appendix A to this
Prospectus describes the various ratings assigned to debt obligations by
Moody's and S&P. Ratings assigned by a Rating Agency are not absolute standards
of credit quality and do not evaluate market risks. Rating agencies may fail to
make timely changes in credit ratings and an issuer's current financial
condition may be better or worse than a rating indicates. The Fund will not
necessarily sell a security when its rating is reduced below its rating at the
time of purchase. As described above under "Portfolio Management
Strategies--Independent Credit Analysis," NACM does not rely solely on credit
ratings, and develops its own analysis of issuer credit quality. The ratings of
a security may change over time. Moody's and S&P monitor and evaluate the
ratings assigned to securities on an ongoing basis. As a result, instruments
held by the Fund could receive a higher rating (which would tend to increase
their value) or a lower rating (which would tend to decrease their value)
during the period in which they are held.
The Fund may purchase unrated securities (which are not rated by a Rating
Agency). Unrated securities may be less liquid than comparable rated securities
and involve the risk that NACM may not accurately evaluate the security's
comparative credit rating. Analysis of creditworthiness may be more complex for
issuers of high yield securities than for issuers of higher-quality
obligations. The Fund expects that ordinarily NACM's portfolio strategies will
result in the Fund investing primarily in high yield and/or unrated securities.
Therefore, the Fund's success in achieving its investment objective may depend
more heavily on NACM's creditworthiness analysis than if the Fund invested
exclusively in higher-quality and rated securities.
--------------------------------------------------------------------------------
22
The Fund's investment objective and strategies
--------------------------------------------------------------------------------
Foreign (Non-U.S.) Investments and Currencies
The Fund may invest up to 20% of its total assets in U.S. dollar-denominated
securities of foreign issuers based in developed countries. For this purpose,
foreign securities include, but are not limited to, foreign convertible
securities and non-convertible income-producing securities, foreign equity
securities (including preferred securities of foreign issuers), foreign bank
obligations, and obligations of foreign governments or their subdivisions,
agencies and instrumentalities, international agencies and supranational
entities. For this purpose, foreign securities do not include ADRs or
securities guaranteed by a United States person, but may include foreign
securities in the form of GDRs or other securities representing underlying
shares of foreign issuers. See "Risks--Foreign (Non-U.S.) Investment Risk."
The U.S. dollar-denominated foreign securities in which the Fund may invest
include Eurodollar obligations and "Yankee Dollar" obligations. Eurodollar
obligations are U.S. dollar-denominated certificates of deposit and time
deposits issued outside the U.S. capital markets by foreign branches of U.S.
banks and by foreign banks. Yankee Dollar obligations are U.S.
dollar-denominated obligations issued in the U.S. capital markets by foreign
banks. Eurodollar and Yankee Dollar obligations are generally subject to the
same risks that apply to domestic debt issues, notably credit risk, market risk
and liquidity risk. Additionally, Eurodollar (and to a limited extent, Yankee
Dollar) obligations are subject to certain sovereign risks. One such risk is
the possibility that a sovereign country might prevent capital, in the form of
U.S. dollars, from flowing across its borders. Other risks include adverse
political and economic developments; the extent and quality of government
regulation of financial markets and institutions; the imposition of foreign
withholding taxes; and the expropriation or nationalization of foreign issuers.
The Fund also may invest in sovereign debt issued by foreign governments, their
agencies or instrumentalities, or other government-related entities. As a
holder of sovereign debt, the Fund may be requested to participate in the
rescheduling of such debt and to extend further loans to governmental entities.
In addition, there are generally no bankruptcy proceedings similar to those in
the United States by which defaulted sovereign debt may be collected. The Fund
also may invest in Brady Bonds, which are securities created through the
exchange of existing commercial bank loans to sovereign entities for new
obligations in connection with a debt restructuring. Investments in Brady Bonds
may be viewed as speculative. Brady Bonds acquired by the Fund may be subject
to restructuring arrangements or to requests for new credit, which may cause
the Fund to realize a loss of interest or principal on any of its portfolio
holdings.
Please see "Investment Objective and Policies--Foreign (Non-U.S.) Securities"
in the Statement of Additional Information for a more detailed description of
the types of foreign investments in which the Fund may invest and their related
risks.
Rule 144A Securities
The Fund may invest without limit in Rule 144A Securities. Rule 144A under the
Securities Act of 1933, as amended, provides a non-exclusive safe harbor
exemption from the registration requirements of the Act for the resale of
certain "restricted" securities to certain qualified institutional buyers, such
as the Fund. Rule 144A Securities may be deemed illiquid and thus may be
subject to the Fund's limitation to invest not more than 5% of its total assets
in securities which are illiquid at the time of investment, although the Fund
may determine that certain Rule 144A Securities are liquid in accordance with
procedures adopted by the Board of Trustees.
Corporate Bonds
The Fund may invest in a wide variety of bonds of varying maturities issued by
U.S. and foreign corporations and other business entities. Bonds are fixed or
variable rate debt obligations, including bills,
--------------------------------------------------------------------------------
23
The Fund's investment objective and strategies
--------------------------------------------------------------------------------
notes, debentures, money market instruments and similar instruments and
securities. Bonds generally are used by corporations as well as governments and
other issuers to borrow money from investors. The issuer pays the investor a
fixed or variable rate of interest and normally must repay the amount borrowed
on or before maturity. Certain bonds are "perpetual" in that they have no
maturity date.
Preferred Stocks
The Fund may invest in preferred stocks. The Fund's investments in preferred
stocks typically will be convertible securities, although the Fund may also
invest in non-convertible preferred stocks. Preferred stock represents an
equity interest in a company that generally entitles the holder to receive, in
preference to the holders of other stocks such as common stocks, dividends and
a fixed share of the proceeds resulting from liquidation of the company. Some
preferred stocks entitle their holders to receive additional liquidation
proceeds on the same basis as holders of a company's common stock, and thus
also represent an ownership interest in the company. Some preferred stocks
offer a fixed rate of return with no maturity date. Because they never mature,
these preferred stocks act like long-term bonds and can be more volatile than
other types of preferred stocks and may have heightened sensitivity to changes
in interest rates. Other preferred stocks have a variable dividend, generally
determined on a quarterly or other periodic basis, either according to a
formula based upon a specified premium or discount to the yield on particular
U.S. Treasury securities or based on an auction process, involving bids
submitted by holders and prospective purchasers of such stocks. Because
preferred stocks represent an equity ownership interest in a company, their
value usually will react more strongly than bonds and other debt instruments to
actual or perceived changes in a company's financial condition or prospects, or
to fluctuations in the equity markets.
Investments in Equity Securities
Consistent with its investment objective, the Fund may hold or have exposure to
equity securities. The Fund will often have substantial exposure to equity
securities by virtue of the equity component of the convertible securities in
which the Fund invests. The Fund may also hold equity securities in its
portfolio upon conversion of a convertible security or through direct
investments in preferred stocks. Equity securities, such as common stock,
generally represent an ownership interest in a company. Although equity
securities have historically generated higher average returns than debt
securities, equity securities have also experienced significantly more
volatility in those returns. An adverse event, such as an unfavorable earnings
report, may depress the value of a particular equity security held by the Fund.
Also, the price of equity securities, particularly common stocks, are sensitive
to general movements in the stock market. A drop in the stock market may
depress the price of equity securities held by the Fund.
U.S. Government Securities
The Fund may invest in U.S. Government securities, which are obligations of, or
guaranteed by, the U.S. Government, its agencies or government-sponsored
enterprises. U.S. Government securities include a variety of securities that
differ in their interest rates, maturities and dates of issue. Securities
issued or guaranteed by agencies or instrumentalities of the U.S. Government
may or may not be supported by the full faith and credit of the United States
or by the right of the issuer to borrow from the U.S. Treasury.
Derivatives
The Fund may utilize derivative instruments for investment purposes, as well as
to leverage its portfolio, generally as a substitute for, rather than in
addition to, the APS. Generally, derivatives are financial contracts whose
value depends upon, or is derived from, the value of any underlying asset,
reference rate or index, and may relate to, among others, individual
securities, interest rates and related indexes. The Fund may use derivatives as
a component of a synthetic convertible security or to gain exposure to high
yield securities and other securities in which the Fund may invest (pending
investment of the proceeds of
--------------------------------------------------------------------------------
24
The Fund's investment objective and strategies
--------------------------------------------------------------------------------
this offering). Such derivative instruments include, but are not limited to,
warrants, options on common stock or stock indexes, futures contracts and swap
agreements. In connection with its investments in synthetic convertible
securities, the Fund may purchase warrants, call options on common stock and
call options on stock indexes. A warrant is a certificate that gives the holder
of the warrant the right to buy, at a specified time or specified times, from
the issuer of the warrant, the common stock of the issuer at a specified price.
A call option is a contract that gives the holder of the option, in return for
a premium, the right to buy from the writer of the option the common stock
underlying the option (or the cash value of the index) at a specified exercise
price at any time during the term of the option. The Fund may also have
exposure to derivatives, such as credit default swaps and interest rate swaps,
through investments in credit-linked trust certificates and related
instruments. The Fund's use of derivative instruments involves risks different
from, or possibly greater than, the risks associated with investment directly
in securities and other more traditional investments. See "Risks--Derivatives
Risk." Please see "Investment Objective and Policies--Derivative Instruments"
in the Statement of Additional Information for additional information about
these and other derivative instruments that the Fund may use and the risks
associated with such instruments. There is no assurance that these derivative
strategies will be available at any time or that NACM will determine to use
them for the Fund or, if used, that the strategies will be successful. In
addition, the Fund is subject to certain restrictions on its use of derivative
strategies imposed by guidelines of Moody's, which issues ratings for the APS.
Credit-Linked Trust Certificates
Among the income-producing securities in which the Fund may invest are
credit-linked trust certificates, which are investments in a limited purpose
trust or other vehicle formed under State law which, in turn, invests in a
basket of derivative instruments, such as credit default swaps, interest rate
swaps and other securities, in order to provide exposure to the high yield or
another fixed income market.
Subject to the investment limitations described in this Prospectus, the Fund
may invest in credit-linked trust certificates during the period when the net
proceeds of the Common Share offering and this offering are being invested, and
during such period the high yield exposure will be broadly diversified.
Thereafter, the Fund may invest up to 5% of its total assets in these
instruments.
Like an investment in a bond, investments in these credit-linked trust
certificates represent the right to receive periodic income payments (in the
form of distributions) and payment of principal at the end of the term of the
certificate. However, these payments are conditioned on the trust's receipt of
payments from, and the trust's potential obligations to, the counterparties to
the derivative instruments and other securities in which the trust invests. For
instance, the trust may sell one or more credit default swaps, under which the
trust would receive a stream of payments over the term of the swap agreements
provided that no event of default has occurred with respect to the referenced
debt obligation upon which the swap is based. If a default occurs, the stream
of payments may stop and the trust would be obligated to pay to the
counterparty the par (or other agreed upon value) of the referenced debt
obligation. This, in turn, would reduce the amount of income and principal that
the Fund would receive as an investor in the trust. Please see "Investment
Objective and Policies--Derivative Instruments" in the Statement of Additional
Information for additional information about credit default swaps. The Fund's
investments in these instruments are indirectly subject to the risks associated
with derivative instruments, including, among others, credit risk, default or
similar event risk, interest rate risk, leverage risk and management risk. It
is expected that the trusts which issue credit-linked trust certificates will
constitute "private" investment companies, exempt from registration under the
1940 Act. Therefore, the certificates will be subject to the risks described
under "Other Investment Companies" below, and will not be subject to applicable
investment limitations and other regulation imposed by the 1940 Act (although
the Fund will remain subject to such limitations and regulation, including with
respect to its investments in the
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The Fund's investment objective and strategies
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certificates). Although the trusts are typically private investment companies,
they are generally not actively managed such as a "hedge fund" might be. It is
also expected that the certificates will be exempt from registration under the
Securities Act of 1933. Accordingly, there may be no established trading market
for the certificates and they may constitute illiquid investments. See
"Risks--Liquidity Risk." If market quotations are not readily available for the
certificates, they will be valued by the Fund at fair value as determined by
the Board of Trustees or persons acting at its direction. See "Net asset
value." The Fund may lose its entire investment in a credit-linked trust
certificate. The Fund intends to invest in credit-linked trust certificates
mainly as a cash management tool in order to gain exposure to the high yield
markets and/or to remain fully invested when more traditional income-producing
securities are not available, including during the period when the net proceeds
of the Common Share offering and this offering are being invested.
Zero-Coupon Bonds, Step-Ups and Payment-In-Kind Securities
Zero-coupon bonds pay interest only at maturity rather than at intervals during
the life of the security. Like zero-coupon bonds, "step up" bonds pay no
interest initially but eventually begin to pay a coupon rate prior to maturity,
which rate may increase at stated intervals during the life of the security.
Payment-in-kind securities ("PIKs") are debt obligations that pay "interest" in
the form of other debt obligations, instead of in cash. Each of these
instruments is normally issued and traded at a deep discount from face value.
Zero-coupon bonds, step-ups and PIKs allow an issuer to avoid or delay the need
to generate cash to meet current interest payments and, as a result, may
involve greater credit risk than bonds that pay interest currently or in cash.
The Fund would be required to distribute the income on these instruments as it
accrues, even though the Fund will not receive the income on a current basis or
in cash. Thus, the Fund may have to sell other investments, including when it
may not be advisable to do so, to make income distributions to its shareholders.
Other Investment Companies
The Fund may invest in securities of other open- or closed-end investment
companies to the extent that such investments are consistent with the Fund's
investment objective and policies and permissible under the 1940 Act. The Fund
may invest in other investment companies either during periods when it has
large amounts of uninvested cash, such as the period shortly after the Fund
receives the proceeds of the offering of its Common Shares or Preferred Shares,
during periods when there is a shortage of attractive convertible securities
and non-convertible income-producing securities available in the market, or
when NACM believes share prices of other investment companies offer attractive
values. The Fund may invest in investment companies that are advised by NACM or
its affiliates to the extent permitted by applicable law and/or pursuant to
exemptive relief from the Securities and Exchange Commission. As a stockholder
in an investment company, the Fund will bear its ratable share of that
investment company's expenses, and would remain subject to payment of the
Fund's management fees and other expenses with respect to assets so invested.
Common Shareholders would therefore be subject to duplicative expenses to the
extent the Fund invests in other investment companies. NACM will take expenses
into account when evaluating the investment merits of an investment in an
investment company relative to available investments in convertible securities
and non-convertible income-producing securities. In addition, the securities of
other investment companies may also be leveraged and will therefore be subject
to the same leverage risks described herein. The net asset value and market
value of leveraged shares will be more volatile and the yield to shareholders
will tend to fluctuate more than the yield generated by unleveraged shares.
Commercial Paper
Commercial paper represents short-term unsecured promissory notes issued in
bearer form by corporations such as banks or bank holding companies and finance
companies. The rate of return on commercial paper may be linked or indexed to
the level of exchange rates between the U.S. dollar and a foreign currency or
currencies.
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The Fund's investment objective and strategies
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Bank Obligations
The Fund may invest in certain bank obligations, including certificates of
deposit, bankers' acceptances and fixed time deposits. Certificates of deposit
are negotiable certificates issued against funds deposited in a commercial bank
for a definite period of time and earning a specified return. Bankers'
acceptances are negotiable drafts or bills of exchange, normally drawn by an
importer or exporter to pay for specific merchandise, which are "accepted" by a
bank, meaning, in effect, that the bank unconditionally agrees to pay the face
value of the instrument on maturity. Fixed time deposits are bank obligations
payable at a stated maturity date and bearing interest at a fixed rate. Fixed
time deposits may be withdrawn on demand by the investor, but may be subject to
early withdrawal penalties which vary depending upon market conditions and the
remaining maturity of the obligation.
Loan Participations and Assignments
The Fund may invest in fixed- and floating-rate loans issued by banks and other
corporations, which investments generally will be in the form of loan
participations and assignments of portions of such loans. Participations and
assignments involve credit risk, interest rate risk, liquidity risk and the
risks of being a lender. If the Fund purchases a participation, it may only be
able to enforce its rights through the lender, and may assume the credit risk
of both the lender and the borrower. Given the current structure of the markets
for loan participations and assignments, the Fund expects to treat these
securities as illiquid.
REITs and Other Mortgage-Related and Asset-Backed Securities
The Fund may invest REITs, which primarily invest in income-producing real
estate or real estate related loans or interests. REITs are generally
classified as equity REITs, mortgage REITs or a combination of equity and
mortgage 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 income from the collection of interest
payments. REITs are not taxed on income distributed to shareholders provided
they comply with the applicable requirements of the Code. The Fund will
indirectly bear its proportionate share of any management and other expenses
paid by REITs in which it invests in addition to the expenses paid by the Fund.
Debt securities issued by REITs are, for the most part, general and unsecured
obligations and are subject to risks associated with REITs.
Other mortgage-related securities include debt instruments which provide
periodic payments consisting of interest and/or principal that are derived from
or related to payments of interest and/or principal on underlying mortgages.
Additional payments on mortgage-related securities may be made out of
unscheduled prepayments of principal resulting from the sale of the underlying
property, refinancing or foreclosure, net of fees or costs that may be incurred.
The Fund may invest in commercial mortgage-related securities issued by
corporations. These are securities that represent an interest in, or are
secured by, mortgage loans secured by commercial property, such as industrial
and warehouse properties, office buildings, retail space and shopping malls,
multifamily properties and cooperative apartments, hotels and motels, nursing
homes, hospitals, and senior living centers. They may pay fixed or adjustable
rates of interest. The commercial mortgage loans that underlie commercial
mortgage-related securities have certain distinct risk characteristics.
Commercial mortgage loans generally lack standardized terms, which may
complicate their structure. Commercial properties themselves tend to be unique
and difficult to value. Commercial mortgage loans tend to have shorter
maturities than residential mortgage loans, and may not be fully amortizing,
meaning that they may have a significant principal balance, or "balloon"
payment, due on maturity. In addition, commercial properties, particularly
industrial and warehouse properties, are subject to environmental risks and the
burdens and costs of compliance with environmental laws and regulations.
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The Fund's investment objective and strategies
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Other mortgage-related securities in which the Fund may invest include mortgage
pass-through securities, collateralized mortgage obligations ("CMOs"), mortgage
dollar rolls, CMO residuals (other than residual interests in real estate
mortgage investment conduits), stripped mortgage-backed securities ("SMBSs")
and other securities that directly or indirectly represent a participation in,
or are secured by and payable from, mortgage loans on real property.
The Fund may invest in other types of asset-backed securities that are offered
in the marketplace, including Enhanced Equipment Trust Certificates ("EETCs").
Although any entity may issue EETCs, to date, U.S. airlines are the primary
issuers. An airline EETC is an obligation secured directly by aircraft or
aircraft engines as collateral. EETCs tend to be less liquid than corporate
bonds. Other asset-backed securities may be collateralized by the fees earned
by service providers. The value of asset-backed securities may be substantially
dependent on the servicing of the underlying asset pools and are therefore
subject to risks associated with the negligence of, or defalcation by, their
servicers. In certain circumstances, the mishandling of related documentation
may also affect the rights of the security holders in and to the underlying
collateral. The insolvency of entities that generate receivables or that
utilize the assets may result in added costs and delays in addition to losses
associated with a decline in the value of the underlying assets.
Please see "Investment Objective and Policies--Real Estate Investment Trusts
("REITs")" and "Investment Objective and Policies--Mortgage-Related and Other
Asset-Backed Securities" in the Statement of Additional Information, and
"Risks--REITs and Mortgage-Related Risk" in this Prospectus for a more detailed
description of the types of mortgage-related and other asset-backed securities
in which the Fund may invest and their related risks.
Variable and Floating Rate Securities
Variable and floating rate securities provide for a periodic adjustment in the
interest rate paid on the obligations. The Fund may invest in floating rate
debt instruments ("floaters") and engage in credit spread trades. While
floaters provide a certain degree of protection against rising interest rates,
the Fund will participate in any decline in interest rates as well. A credit
spread trade is an investment position relating to a difference in the prices
or interest rates of two bonds or other securities, where the value of the
investment position is determined by changes in the difference between such
prices or interest rates, as the case may be, of the respective securities.
When Issued, Delayed Delivery and Forward Commitment Transactions
The Fund may purchase securities which it is eligible to purchase on a
when-issued basis, may purchase and sell such securities for delayed delivery
and may make contracts to purchase such securities for a fixed price at a
future date beyond normal settlement time (forward commitments). When-issued
transactions, delayed delivery purchases and forward commitments involve a risk
of loss if the value of the securities declines prior to the settlement date.
The risk is in addition to the risk that the Fund's other assets will decline
in value. Therefore, these transactions may result in a form of leverage and
increase the Fund's overall investment exposure. Typically, no income accrues
on securities the Fund has committed to purchase prior to the time delivery of
the securities is made, although the Fund may earn income on securities it has
segregated to cover these positions.
Reverse Repurchase Agreements
The Fund may utilize reverse repurchase agreements to leverage its portfolio,
generally as a substitute for, rather than in addition to, the leverage
obtained through the issuance of the APS. In a reverse repurchase agreement,
the Fund sells securities to a bank or broker-dealer and agrees to repurchase
the securities at a mutually agreed date and price. Generally, the effect of
such a transaction is that the Fund can recover
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The Fund's investment objective and strategies
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and reinvest all or most of the cash invested in the portfolio securities
involved during the term of the reverse repurchase agreement and still be
entitled to the returns associated with those portfolio securities. Such
transactions are advantageous if the interest cost to the Fund of the reverse
repurchase transaction is less than the returns it obtains on investments
purchased with the cash.
Unless the Fund covers its positions in reverse repurchase agreements (by
segregating liquid assets at least equal in amount to the forward purchase
commitment), its obligations under the agreements will be subject to the Fund's
limitations on borrowings. Reverse repurchase agreements involve leverage risk
and also the risk that the market value of the securities that the Fund is
obligated to repurchase under the agreement may decline below the repurchase
price. In the event the buyer of securities under a reverse repurchase
agreement files for bankruptcy or becomes insolvent, the Fund's use of the
proceeds of the agreement may be restricted pending a determination by the
other party, or its trustee or receiver, whether to enforce the Fund's
obligation to repurchase the securities.
Lending of Portfolio Securities
For the purpose of achieving income, the Fund may lend its portfolio securities
to brokers, dealers, and other financial institutions provided a number of
conditions are satisfied, including that the loan is fully collateralized.
Please see "Investment Objective and Policies--Securities Loans" in the
Statement of Additional Information for details. When the Fund lends portfolio
securities, its investment performance will continue to reflect changes in the
value of the securities loaned, and the Fund will also receive a fee or
interest on the collateral. Securities lending involves the risk of loss of
rights in the collateral or delay in recovery of the collateral if the borrower
fails to return the security loaned or becomes insolvent. The Fund may pay
lending fees to the party arranging the loan.
Please see "Investment Objective and Policies" in the Statement of Additional
Information for additional information regarding the investments of the Fund
and their related risks.
Risks
Risk is inherent in all investing. Investing in any investment company security
involves risk, including the risk that you may receive little or no return on
your investment or even that you may lose part or all of your investment.
Therefore, before purchasing APS, you should consider carefully the following
risks that you assume when you invest in the Fund.
AUCTION RISK
You may not be able to sell your APS at an Auction if the Auction fails; that
is, if there are more APS offered for sale than there are buyers for those
shares. If Sufficient Clearing Bids do not exist in an Auction, the Applicable
Rate will be the Maximum Applicable Rate, and in such event, owners of APS
wishing to sell will not be able to sell all, and may not be able to sell any,
of such shares in the Auction. As a result, your investment in APS may be
illiquid. Neither the Broker-Dealers nor the Fund are obligated to purchase APS
in an Auction or otherwise, nor is the Fund required to redeem APS in the event
of a failed Auction. Also, if you place bid orders (orders to retain APS) at an
Auction only at a specified rate, and that bid rate exceeds the Applicable Rate
set at the Auction, you will not retain your APS. If you elect to retain APS
without specifying a rate below which you would not wish to continue to hold
those APS, and the Auction sets a below-market rate, you may receive a lower
rate of return on your APS than the market rate. See "Description of APS--The
Auction" and "Description of APS--Auction Procedures."
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Risks
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RATINGS AND ASSET COVERAGE RISK
While Moody's is expected to assign a rating of "Aaa" to the APS, the ratings
would not eliminate or necessarily mitigate the risks of investing in the APS.
A Rating Agency could downgrade the APS, which may make your shares less liquid
at an Auction or in any secondary market. In addition, the Fund may be forced
to redeem your APS to meet regulatory or Rating Agency requirements. The Fund
may also voluntarily redeem APS under certain circumstances. See "Description
of APS--Redemption." The Fund may not redeem APS if such a redemption would
cause the Fund to fail to meet regulatory or Rating Agency asset coverage
requirements, and the Fund may not declare, pay or set apart for payment any
dividend or other distribution if immediately thereafter the Fund would fail to
meet regulatory asset coverage requirements. In addition, as a condition to its
receipt of an "Aaa" rating on the APS, the Fund has agreed to certain
investment limitations, which may restrict the Fund from making investments
that NACM believes would benefit the Fund. See "Rating agency guidelines" for
descriptions of the significance and limitations of the ratings on the APS and
of the asset maintenance and other tests the Fund must meet.
SECONDARY MARKET RISK
The Broker-Dealers may maintain a secondary trading market in the APS outside
of Auctions; however, they have no obligation to do so, and there can be no
assurance that a secondary market for the APS will develop or, if it does
develop, that it will provide holders with a liquid trading market (i.e.,
trading will depend on the presence of willing buyers and sellers and the
trading price is subject to variables to be determined at the time of the trade
by the Broker-Dealers). The APS will not be registered on any stock exchange or
on any automated quotation system. If you try to sell your APS between
Auctions, you may not be able to sell any or all of your shares, or you may
receive a purchase price of less than $25,000 per share. An increase in the
level of interest rates, particularly during any Long Term Dividend Period,
likely will have an adverse effect on the secondary market price of the APS.
LIMITED OPERATING HISTORY
The Fund is a recently organized, diversified, closed-end management investment
company which has been operational for less than two months.
CONVERTIBLE SECURITIES RISK
The Fund may invest without limit in convertible securities, and these
securities will ordinarily constitute a principal component of the Fund's
investment program. Convertible securities generally offer lower interest or
dividend yields than non-convertible securities of similar quality. The market
values of convertible securities tend to decline as interest rates increase
and, conversely, to increase as interest rates decline. However, the
convertible security's market value tends to reflect the market price of the
common stock of the issuing company when that stock price is greater than the
convertible's "conversion price." The conversion price is defined as the
predetermined price at which the convertible could be exchanged for the
associated stock. As the market price of the underlying common stock declines,
the price of the convertible security tends to be influenced more by the yield
of the convertible security. Thus, it may not decline in price to the same
extent as the underlying common stock, and convertible securities generally
have less potential for gain or loss than common stocks. However, securities
that are convertible other than at the option of the holder generally do not
limit the potential for loss to the same extent as securities convertible at
the option of the holder. In the event of a liquidation of the issuing company,
holders of convertible securities would be paid before the company's common
stockholders but after holders of any senior debt obligations of the company.
Consequently, the issuer's convertible securities generally entail less risk
than its common stock but more risk than its debt obligations. Convertible
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Risks
--------------------------------------------------------------------------------
securities are often rated below investment grade or not rated because they
fall below debt obligations and just above common equity in order of preference
or priority on the issuer's balance sheet. See "--High Yield Risk."
SYNTHETIC CONVERTIBLE SECURITIES RISK
The Fund may invest without limit in synthetic convertible securities. The
value of a synthetic convertible security will respond differently to market
fluctuations than a convertible security because a synthetic convertible is
composed of two or more separate securities, each with its own market value.
Because the convertible component is achieved by investing in warrants or
options to buy common stock at a certain exercise price, or options on a stock
index, synthetic convertible securities are subject to the risks associated
with derivatives. See "--Convertible Securities Risk" and "--Derivatives Risk."
In addition, if the value of the underlying common stock or the level of the
index involved in the convertible component falls below the exercise price of
the warrant or option, the warrant or option may lose all value.
CREDIT RISK
The Fund could lose money if the issuer of a convertible security or
non-convertible income-producing security, or the counterparty to an option
contract, swap contract, loan of portfolio securities or other obligation, is,
or is perceived to be, unable or unwilling to make timely principal and/or
interest payments, or to otherwise honor its obligations. Such defaults could
have a negative impact on the Fund's ability to pay dividends on the APS and
could result in the redemption of some or all of the APS.
HIGH YIELD RISK
In general, lower rated securities carry a greater degree of risk that the
issuer will lose its ability to make interest and principal payments, which
could have a negative impact on the Fund's net asset value or dividends. The
Fund may invest without limit in securities that are rated below investment
grade quality (i.e., below a rating of Baa or BBB by Moody's or S&P,
respectively), or that are unrated but judged to be of comparable quality by
NACM, and expects that ordinarily NACM's portfolio strategies will result in
the Fund investing primarily in these securities. Securities rated below
investment grade quality are regarded as having predominantly speculative
characteristics with respect to capacity to pay interest and repay principal,
and are commonly referred to as "high yield" securities or "junk bonds." The
prices of these lower grade securities are more sensitive to negative
developments, such as a decline in the issuer's revenues or a general economic
downturn, than are the prices of higher grade securities. In addition, the
secondary market on which high yield securities are traded may be less liquid
than the market for investment grade securities, meaning these securities are
subject to greater liquidity risk than investment grade securities. Securities
in the lowest investment grade category also may be considered to possess some
speculative characteristics by certain Rating Agencies.
INTEREST RATE RISK
Interest rate risk is the risk that convertible securities and non-convertible
income-producing securities (and the Fund's net assets) will decline in value
because of changes in interest rates. Generally, income-producing securities
will decrease in value when interest rates rise and increase in value when
interest rates decline. This means that the Fund's net asset value will
fluctuate with interest rate changes and the corresponding changes in the value
of the Fund's holdings. Because market interest rates are currently near their
lowest levels in many years, there is a greater risk that the Fund's portfolio
will decline in value. The Fund's use of leverage will tend to increase
interest rate risk.
The APS pay dividends based on short-term interest rates. The Fund will use the
proceeds from the issuance of APS to buy convertible securities and
non-convertible, income producing securities, which
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Risks
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generally pay interest based on longer-term yields. The yields on the
securities purchased by the Fund are typically, although not always, higher
than short-term interest rates. If short-term interest rates rise, the dividend
rate on the APS may rise so that the amount of dividends payable to APS
shareholders exceeds the income from the portfolio securities purchased with
the proceeds from the APS. Because income from the Fund's entire investment
portfolio (not just the portion of the portfolio purchased with the proceeds of
the APS offering) is available to pay APS dividends, however, APS dividend
rates would need to greatly exceed the Fund's net portfolio income before the
Fund's ability to pay APS dividends would be jeopardized. If long-term rates
rise, the value of the Fund's investment portfolio will decline, reducing the
amount of assets serving as asset coverage for the APS.
ISSUER RISK
The value of securities in the Fund's portfolio may decline for a number of
reasons which directly relate to the issuer, such as management performance,
financial leverage and reduced demand for the issuer's goods and services.
EQUITY SECURITIES RISK
The Fund will often have substantial exposure to equity securities by virtue of
the equity component of the convertible securities in which the Fund invests.
The Fund may also hold equity securities in its portfolio upon conversion of a
convertible security or through direct investments in preferred stocks. The
market price of equity securities may go up or down, sometimes rapidly or
unpredictably. Equity securities may decline in value due to factors affecting
equity securities markets generally, particular industries represented in those
markets or the issuer itself, including the historical and prospective earnings
of the issuer and the value of its assets. The values of equity securities may
decline due to general market conditions which are not specifically related to
a particular company, such as real or perceived adverse economic conditions,
changes in the general outlook for corporate earnings, changes in interest or
currency rates or adverse investor sentiment generally. They may also decline
due to factors which affect a particular industry or industries, such as labor
shortages or increased production costs and competitive conditions within an
industry. Equity securities generally have greater price volatility than debt
and other income-producing securities.
LEVERAGE RISK
The Fund expects to utilize financial leverage on an ongoing basis for
investment purposes. Leverage risk includes the risk associated with the
issuance of APS to leverage the Common Shares. If the dividend rate on the APS
and interest rates (if applicable) on other forms of leverage, as reset
periodically, exceeds the net rate of return on the Fund's portfolio, the
leverage will result in a lower net asset value than if the Fund were not
leveraged, and the Fund's ability to pay dividends and meet its asset coverage
requirements on the APS would be reduced. Because the longer-term instruments
included in the Fund's portfolio will typically pay fixed rates of interest
while the dividend rate on the APS will be adjusted periodically, this could
occur even when both long-term and short-term interest rates rise. Similarly,
any decline in the net asset value of the Fund's investments could result in
the Fund being in danger of failing to meet its asset coverage requirements or
of losing its expected "Aaa" rating on the APS. In an extreme case, the Fund's
current investment income might not be sufficient to meet the dividend
requirements on the APS. In order to counteract such an event, the Fund might
need to liquidate investments in order to fund a redemption of some or all of
the APS. Liquidation at times of low securities prices may result in a capital
loss to the Fund. There is no assurance that the Fund's leveraging strategy
will be successful.
While the Fund may from time to time consider reducing leverage in response to
actual or anticipated changes in interest rates in an effort to mitigate the
increased volatility of current income and net asset
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Risks
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value associated with leverage, there can be no assurance that the Fund will
actually reduce leverage in the future or that any reduction, if undertaken,
will be effective. Changes in the future direction of interest rates are very
difficult to predict accurately. If the Fund were to reduce leverage based on a
prediction about future changes to interest rates, and that prediction turned
out to be incorrect, the reduction in leverage would likely operate to reduce
the Fund's net asset value relative to the circumstance where the Fund had not
reduced leverage. The Fund may decide that this risk outweighs the likelihood
of achieving the desired reduction to volatility in income and net asset value
if the prediction were to turn out to be correct, and determine not to reduce
leverage as described above.
The Fund may also leverage the portfolio by borrowing money, issuing debt
securities, and utilizing reverse repurchase agreement and other derivative
instruments, although these forms of leverage will generally be used as a
substitute for, rather than in addition to, the leverage obtained through the
issuance of the APS. Any APS or other borrowings will have seniority over the
Common Shares.
Because the fees received by the manager and NACM are based on the total
managed assets of the Fund, the fees will be higher when leverage is utilized
through the issuance of APS or through other leveraging strategies, giving the
manager and NACM an incentive to utilize such leverage.
LIQUIDITY RISK
The Fund may invest up to 5% of its total assets in securities which are
illiquid at the time of investment. The term "illiquid securities" for this
purpose is determined using the Securities and Exchange Commission's standard
applicable to open-end investment companies, i.e., securities that cannot be
disposed of within seven days in the ordinary course of business at
approximately the value at which the Fund has valued the securities. Illiquid
securities may be subject to wide fluctuations in market value. The Fund may be
subject to significant delays in disposing of illiquid securities. Accordingly,
the Fund may be forced to sell these securities at less than fair market value
or may not be able to sell them when NACM believes it is desirable to do so.
Illiquid securities also may entail registration expenses and other transaction
costs that are higher than those for liquid securities. Restricted securities,
i.e., securities subject to legal or contractual restrictions on resale, may
also be illiquid. However, some restricted securities (such as securities
issued pursuant to Rule 144A under the Securities Act of 1933 and certain
commercial paper) may be treated as liquid for these purposes.
FOREIGN (NON-U.S.) INVESTMENT RISK
The Fund may invest up to 20% of its total assets in U.S. dollar-denominated
securities of foreign issuers based in developed countries. The Fund's
investments in foreign issuers involve special risks. There may be less
information publicly available about a foreign issuer than about a U.S. issuer,
and foreign issuers are not generally subject to accounting, auditing and
financial reporting standards and practices comparable to those in the United
States. The securities of some foreign issuers are less liquid and at times
more volatile than securities of comparable U.S. issuers. Foreign brokerage
costs, custodial expenses and other fees are also generally higher than for
securities traded in the United States. With respect to certain foreign
countries, there is also a possibility of expropriation of assets, confiscatory
taxation, political or financial instability and diplomatic developments which
could affect the value of investments in those countries. In addition, income
received by the Fund from sources within foreign countries may be reduced by
withholding and other taxes imposed by such countries.
SMALLER COMPANY RISK
The general risks associated with corporate income-producing and equity
securities are particularly pronounced for securities issued by companies with
smaller market capitalizations. These companies may
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33
Risks
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have limited product lines, markets or financial resources, or they may depend
on a few key employees. As a result, they may be subject to greater levels of
credit, market and issuer risk. Securities of smaller companies may trade less
frequently and in lesser volume than more widely held securities and their
values may fluctuate more sharply than other securities. Companies with
medium-sized market capitalizations may have risks similar to those of smaller
companies.
DERIVATIVES RISK
Derivatives are financial contracts whose value depends on, or is derived from,
the value of an underlying asset, reference rate or index (or relationship
between two indexes). The Fund may utilize derivative instruments for
investment purposes as well as to leverage its portfolio, generally as a
substitute for, rather than in addition to, the issuance of the APS. These may
include derivatives used as a component of a synthetic convertible security or
to gain exposure to high yield securities and other securities in which the
Fund may invest (pending investment of the proceeds of this offering). Such
derivative instruments include, but are not limited to, warrants, options on
common stock or stock indexes, futures contracts and swap agreements. The Fund
will invest in warrants and options only to the extent that the convertible
components of the synthetic convertible securities in which it invests consist
of a warrant, call option on common stock or call option on a stock index. The
Fund may also have exposure to derivatives, such as credit default swaps and
interest rate swaps, through investments in credit-linked trust certificates
and other securities issued by special purpose or structured vehicles. The
Fund's use of derivative instruments involves risks different from, and
possibly greater than, the risks associated with investing directly in
securities and other traditional investments. Derivatives are subject to a
number of risks described elsewhere in this Prospectus, such as liquidity risk,
equity securities risk, issuer risk, credit risk, interest rate risk,
leveraging risk, management risk and, if applicable, smaller companies risk.
They also involve the risk of mispricing or improper valuation, the risk of
ambiguous documentation, and the risk that changes in the value of the
derivative may not correlate perfectly with the underlying asset, rate or
index. Also, suitable derivative transactions may not be available in all
circumstances and there can be no assurance that the Fund will engage in these
transactions when that would be beneficial. The use of derivatives also may
increase the amount of taxes payable by shareholders.
COUNTERPARTY RISK
The Fund will be subject to credit risk with respect to the counterparties to
the derivative contracts entered into directly by the Fund or held by special
purpose or structured vehicles in which the Fund invests. If a counterparty
becomes bankrupt or otherwise fails to perform its obligations under a
derivative contract due to financial difficulties, the Fund may experience
significant delays in obtaining any recovery under the derivative contract in a
bankruptcy or other reorganization proceeding. The Fund may obtain only a
limited recovery or may obtain no recovery in such circumstances.
REINVESTMENT RISK
Reinvestment risk is the risk that income from the Fund's portfolio will
decline if and when the Fund invests the proceeds from matured, traded or
called obligations at market interest rates that are below the portfolio's
current earnings rate. A decline in income could affect the Fund's net asset
value or reduce asset coverage on the APS.
REITS AND MORTGAGE-RELATED RISK
Investing in REITs involves certain unique risks in addition to those risks
associated with investing in the real estate industry in general. An equity
REIT may be affected by changes in the value of the underlying properties owned
by the REIT. A mortgage REIT may be affected by changes in interest rates and
the
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34
Risks
--------------------------------------------------------------------------------
ability of the issuers of its portfolio mortgages to repay their obligations.
REITs are dependent upon the skills of their managers and are not diversified.
REITs are generally dependent upon maintaining cash flows to repay borrowings
and to make distributions to shareholders and are subject to the risk of
default by lessees or borrowers. REITs whose underlying assets are concentrated
in properties used by a particular industry, such as health care, are also
subject to risks associated with such industry.
REITs (especially mortgage REITs) are also subject to interest rate risks. When
interest rates decline, the value of a REIT's investment in fixed rate
obligations can be expected to rise. Conversely, when interest rates rise, the
value of a REIT's investment in fixed rate obligations can be expected to
decline. If the REIT invests in adjustable rate mortgage loans the interest
rates on which are reset periodically, yields on a REIT's investments in such
loans will gradually align themselves to reflect changes in market interest
rates. This causes the value of such investments to fluctuate less dramatically
in response to interest rate fluctuations than would investments in fixed rate
obligations.
REITs may have limited financial resources, may trade less frequently and in a
limited volume and may be subject to more abrupt or erratic price movements
than larger company securities. Historically, REITs have been more volatile in
price than the larger capitalization stocks included in Standard & Poor's 500
Stock Index.
In addition to REITs, the Fund may invest in a variety of other
mortgage-related securities, including commercial mortgage securities and other
mortgage-backed instruments. Rising interest rates tend to extend the duration
of mortgage-related securities, making them more sensitive to changes in
interest rates. As a result, in a period of rising interest rates,
mortgage-related securities held by the Fund may exhibit additional volatility.
This is known as extension risk. In addition, mortgage-related securities are
subject to prepayment risk--the risk that borrowers may pay off their mortgages
sooner than expected, particularly when interest rates decline. This can reduce
the Fund's returns because the Fund may have to reinvest that money at lower
prevailing interest rates. The Fund's investments in other asset-backed
securities are subject to risks similar to those associated with
mortgage-related securities, as well as additional risks associated with the
nature of the assets and the servicing of those assets.
INFLATION/DEFLATION RISK
Inflation risk is the risk that the value of assets or income from the Fund's
investments will be worth less in the future as inflation decreases the value
of money. As inflation increases, the real, or inflation-adjusted, value of the
APS and distributions may decline, and the dividend payments on the APS, if
any, or interest payments on Fund borrowings, if any, may increase. Deflation
risk is the risk that prices throughout the economy decline over time--the
opposite of inflation. Deflation may have an adverse affect on the
creditworthiness of issuers and may make issuer default more likely, which may
result in a decline in the value of the Fund's portfolio. Deflation may also
result in a decline in the dividend rate of the APS.
MANAGEMENT RISK
The Fund is subject to management risk because it is an actively managed
investment portfolio. NACM and the individual portfolio manager will apply
investment techniques and risk analyses in making investment decisions for the
Fund, but there can be no guarantee that these will produce the desired results.
ANTI-TAKEOVER PROVISIONS
The Declaration and Amended Bylaws include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund, to convert the Fund to open-end status or to change the
composition of the Board of Trustees. See "Anti-takeover and other provisions
in the Declaration of Trust."
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35
Risks
--------------------------------------------------------------------------------
MARKET DISRUPTION AND GEOPOLITICAL RISK
The war with Iraq, its aftermath and the continuing occupation of Iraq are
likely to have a substantial impact on the U.S. and world economies and
securities markets. The nature, scope and duration of the war and occupation
and such impact cannot be predicted with any certainty. Terrorist attacks on
the World Trade Center and the Pentagon on September 11, 2001 closed some of
the U.S. securities markets for a four-day period and similar events cannot be
ruled out. The war and occupation, terrorism and related geopolitical risks
have led, and may in the future lead, to increased short-term market volatility
and may have adverse long-term effects on U.S. and world economies and markets
generally. Those events could also have an acute effect on individual issuers
or related groups of issuers. These risks could also adversely affect
individual issuers and securities markets, interest rates, Auctions, secondary
trading, ratings, credit risk, inflation and other factors relating to the APS.
CERTAIN AFFILIATIONS
Certain broker-dealers may be considered to be affiliated persons of the Fund,
the Manager and/or NACM due to their possible affiliations with Allianz AG, the
ultimate parent of the Manager and NACM. Absent an exemption from the
Securities and Exchange Commission or other regulatory relief, the Fund is
generally precluded from effecting certain principal transactions with
affiliated brokers, and its ability to purchase securities being underwritten
by an affiliated broker or a syndicate including an affiliated broker, or to
utilize affiliated brokers for agency transactions, is subject to restrictions.
This could limit the Fund's ability to engage in securities transactions and
take advantage of market opportunities. In addition, unless and until the
underwriting syndicate is broken in connection with the initial public offering
of the APS, the Fund will be precluded from effecting principal transactions
with brokers who are members of the syndicate.
How the Fund manages risk
INVESTMENT LIMITATIONS
The Fund has adopted certain investment limitations designed to limit
investment risk and maintain portfolio diversification. These limitations (two
of which are listed below) are fundamental and may not be changed without the
approval of the holders of a majority of the outstanding Common Shares and any
Preferred Shares (including the APS) voting together as a single class, and the
approval of the holders of a majority of any Preferred Shares (including the
APS) voting as a separate class. The Fund may not:
.. Concentrate its investments in a particular "industry," as that term is used
in the 1940 Act, and as interpreted, modified or otherwise permitted by
regulatory authority having jurisdiction, from time to time; and
.. With respect to 75% of the Fund's total assets, purchase the securities of
any issuer, except securities issued or guaranteed by the U.S. Government or
any of its agencies or instrumentalities or securities of other investment
companies, if, as a result, (i) more than 5% of the Fund's total assets
would be invested in the securities of that issuer or (ii) the Fund would
hold more than 10% of the outstanding voting securities of that issuer.
The Fund would be deemed to "concentrate" its investments in a particular
industry if it invested 25% or more of its total assets in that industry. The
Fund's industry concentration policy does not preclude it from focusing
investments in issuers in a group of related industrial sectors (such as
different types of utilities).
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36
How the Fund manages risk
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The Fund is subject to asset coverage and other guidelines which are more
limiting than the investment restrictions set forth above and other
restrictions set forth in the Statement of Additional Information in order to
obtain and maintain a rating of "Aaa" from Moody's on the APS and may become
subject to additional guidelines in the future. The Fund does not anticipate
that such guidelines will have a material adverse effect on the Fund's ability
to achieve its investment objective. See "Rating agency guidelines" below in
this Prospectus and "Investment Objective and Policies" and "Investment
Restrictions" in the Statement of Additional Information for information about
these guidelines and a complete list of the fundamental investment policies of
the Fund.
MANAGEMENT OF INVESTMENT PORTFOLIO AND CAPITAL STRUCTURE TO LIMIT LEVERAGE RISK
The Fund may take certain actions if short-term interest rates increase or
market conditions otherwise change (or the Fund anticipates such an increase or
change) and the Fund's leverage begins (or is expected) to adversely affect
Common Shareholders. In order to attempt to offset such a negative impact of
leverage on Common Shareholders, the Fund may shorten the average weighted
maturity of its investment portfolio (which will typically range from five to
ten years) by investing in short-term, high grade securities or may extend the
Dividend Period of outstanding Preferred Shares (including the APS). The Fund
also may attempt to reduce leverage by repurchasing or otherwise retiring
Preferred Shares (subject to any restrictions discussed under "Description of
APS--Redemption") or by reducing any holdings in other instruments that create
leverage. As explained above under "Risks--Leverage Risk," the success of any
such attempt to limit leverage risk depends on NACM's ability to accurately
predict interest rate or other market changes. Because of the difficulty of
making such predictions, the Fund may not be successful in managing its
interest rate exposure in the manner described above.
If market conditions suggest that additional leverage would be beneficial, the
Fund may issue additional Preferred Shares or utilize other forms of leverage,
such as by borrowing money, issuing debt securities, utilizing reverse
repurchase agreements and other derivative instruments, although these forms of
leverage will generally be used as a substitute for, rather than in addition
to, the leverage obtained through the issuance of the APS.
Rating agency guidelines
The Fund is required under Moody's guidelines to maintain assets having in the
aggregate a Discounted Value at least equal to the APS Basic Maintenance
Amount. Moody's has established guidelines for determining Discounted Value. To
the extent any particular portfolio holding does not satisfy Moody's
guidelines, all or a portion of such holding's value will not be included in
the calculation of Discounted Value (as defined by Moody's). Such ineligible
securities may include, for example, certain privately placed debt securities
(other than Rule 144A Securities) and debt securities of certain non-U.S.
issuers. Accordingly, although the Fund may invest in such securities to the
extent not prohibited (which may vary depending upon the rating,
diversification and other characteristics of the eligible assets included in
the portfolio), it is not anticipated that in the normal course of business
they would constitute a significant portion of the Fund's portfolio. The
Moody's guidelines also impose limitations on the Fund's investments.
The Fund is also required under the 1940 Act and Moody's guidelines to
maintain, with respect to shares of APS, asset coverage (as that term is used
in the 1940 Act) of at least 200% with respect to senior securities that are
shares of beneficial interest, including APS (or such other asset coverage as
may
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37
Rating agency guidelines
--------------------------------------------------------------------------------
in the future be specified in or under the 1940 Act as the minimum asset
coverage for senior securities that are shares of beneficial interest of a
closed-end investment company as a condition of declaring dividends on its
common shares) ( "1940 Act APS Asset Coverage").
In the event the Fund does not timely cure a failure to maintain (a) a
Discounted Value of its portfolio equal to the APS Basic Maintenance Amount or
(b) the 1940 Act APS Asset Coverage, in each case in accordance with the
requirements of the Rating Agency or Agencies then rating the shares of APS,
the Fund will be required by the Amended Bylaws to redeem shares of APS as
described under "Description of APS--Redemption--Mandatory Redemption."
The Moody's guidelines restrict the Fund's use of some types of investment
strategies. For example, the guidelines, among other restrictions, limit the
Fund's use of futures, options and other derivative transactions for hedging,
leveraging or investment purposes, restrict the use of forward commitments and
similar transactions and limit the percentage of the Fund's assets that may be
invested in any one issuer or type or class of issuer.
The Moody's guidelines also prohibit the Fund from taking certain types of
actions unless it has received written confirmation from Moody's that such
actions would not impair the ratings then assigned to the APS. These include
restrictions on borrowing money, engaging in short sales, lending portfolio
securities, issuing any class or series of shares ranking prior to or on a
parity with the APS with respect to the payment of dividends or the
distribution of assets upon dissolution, liquidation or winding up of the Fund
or merging or consolidating into or with any other entity.
The restrictions in the Moody's guidelines may limit the Fund's ability to make
investments that NACM believes would benefit the Fund. The descriptions of the
Moody's guidelines in this section and in "Description of APS--Asset
Maintenance" are summaries only and are not complete. The Moody's guidelines
are set forth in their entirety in the Amended Bylaws, which have been filed as
an exhibit to the Registration Statement of which this Prospectus is a part.
The Fund may, but is not required to, adopt any modifications to the guidelines
that may hereafter be established by Moody's. Failure to adopt any such
modifications, however, may result in a change in the ratings described above
or a withdrawal of ratings altogether. In addition, any Rating Agency providing
a rating for the APS may, at any time, change or withdraw any such rating. The
Board may, without shareholder approval, amend, alter or repeal certain of the
definitions and related provisions which have been adopted by the Fund in the
Amended Bylaws pursuant to the Rating Agency guidelines if such Rating Agency
or Agencies advises the Fund in writing that any such amendment, alteration or
repeal would not adversely affect the ratings then assigned by such Rating
Agency or Agencies to the APS.
As described by Moody's, a preferred stock rating is an assessment of the
capacity and willingness of an issuer to pay preferred stock obligations. The
ratings on the APS are not recommendations to purchase, hold or sell those
shares, inasmuch as the ratings do not comment as to market price or
suitability for a particular investor. The Rating Agency guidelines described
above also do not address the likelihood that an owner of APS will be able to
sell such shares in an Auction or otherwise. The ratings are based on current
information furnished to Moody's by the Fund and/or the Manager and its
affiliates and information obtained from other sources. The ratings may be
changed, suspended or withdrawn as a result of changes in, or the
unavailability of, such information. The Common Shares have not been rated by a
Rating Agency.
A Rating Agency's guidelines will apply to the APS only so long as such Rating
Agency is rating such shares. The Fund will pay certain fees to Moody's for
rating the APS. The Fund may at some future time seek to have the APS rated by
an additional Rating Agency or a Substitute Rating Agency.
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38
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Description of APS
The following is a brief description of the terms of the APS. This description
does not purport to be complete and is subject to, and qualified in its
entirety by reference to, the Declaration and Amended Bylaws, including the
provisions thereof establishing the APS. The Declaration and the Amended Bylaws
establishing the terms of the APS have been filed as exhibits to the
Registration Statement of which this Prospectus is a part
Each series of APS will be Preferred Shares that entitle their holders to
receive dividends when, as and if declared by the Board of Trustees, out of
funds legally available therefor, at a rate per annum that may vary for the
successive Dividend Periods for each such series. After the Initial Dividend
Period, each Subsequent Dividend Period for each series of APS generally will
be a 7-Day Dividend Period; provided, however, that the Fund may elect, subject
to certain limitations described herein, upon giving notice to the Auction
Agent and each Broker-Dealer, a Special Dividend Period. The Applicable Rate
for a particular Dividend Period for a series of APS will be determined by an
Auction conducted on the Business Day before the start of such Dividend Period.
Beneficial Owners and Potential Beneficial Owners of APS may participate in
Auctions therefor, although, except in the case of Special Dividend Periods of
longer than 91 days, Beneficial Owners desiring to continue to hold all of
their APS regardless of the Applicable Rate resulting from Auctions need not
participate. For an explanation of Auctions and the method of determining the
Applicable Rate, see "--The Auction."
The nominee of the Securities Depository is expected to be the sole holder of
record of each series of APS. Accordingly, each purchaser of APS must rely on
(i) the procedures of the Securities Depository and, if such purchaser is not a
member of the Securities Depository, such purchaser's Agent Member, to receive
dividends, distributions and notices and to exercise voting rights (if and when
applicable) and (ii) the records of the Securities Depository and, if such
purchaser is not a member of the Securities Depository, such purchaser's Agent
Member, to evidence its beneficial ownership of the APS.
When issued and sold, the APS of each series will have a liquidation preference
of $25,000 per share plus an amount equal to accumulated but unpaid dividends
(whether or not earned or declared) and will be fully paid and, except as
discussed under "Anti-takeover and other provisions in the Declaration of
Trust," non-assessable. See "--Liquidation Rights." The APS will not be
convertible into Common Shares or other shares of beneficial interest of the
Fund, and the holders thereof will have no pre-emptive rights. The APS will not
be subject to any sinking fund but will be subject to redemption at the option
of the Fund at the Optional Redemption Price on any Dividend Payment Date for
such series (except during the Initial Dividend Period and during a Non-Call
Period) and, in certain circumstances, will be subject to mandatory redemption
by the Fund at the Mandatory Redemption Price described herein. See
"--Redemption."
In addition to serving as the Auction Agent in connection with the Auction
Procedures described below, Deutsche Bank Trust Company Americas will be the
transfer agent, registrar, dividend paying agent and redemption agent for each
series of APS. The Auction Agent, however, will serve merely as the agent of
the Fund, acting in accordance with the Fund's instructions, and will not be
responsible for any evaluation or verification of any matters certified to it.
Except in an Auction, the Fund will have the right (to the extent permitted by
applicable law) to purchase or otherwise acquire any APS so long as the Fund is
current in the payment of dividends on APS and on any other shares of
beneficial interest of the Fund ranking on a parity with the APS with respect
to the payment of dividends or upon liquidation.
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39
Description of APS
--------------------------------------------------------------------------------
THE AUCTION
General
Holders of the APS of each series will be entitled to receive cumulative cash
dividends on their shares when, as and if declared by the Board of Trustees,
out of the funds legally available therefor, on the Initial Dividend Payment
Date with respect to the Initial Dividend Period for each series and,
thereafter, on each Dividend Payment Date with respect to a Subsequent Dividend
Period for each series (generally a period of seven days subject to certain
exceptions set forth under "--Dividends--General") at the rate per annum equal
to the Applicable Rate for each such Dividend Period.
The provisions of the Amended Bylaws establishing the terms of the APS offered
hereby provide that the Applicable Rate for each Dividend Period after the
Initial Dividend Period for each series will be equal to the rate per annum
that the Auction Agent advises has resulted on the Business Day preceding the
first day of such Dividend Period due to implementation of the Auction
Procedures set forth in the Amended Bylaws in which persons determine to hold
or offer to purchase or sell the APS. The Auction Procedures are attached as
Appendix A to the Statement of Additional Information. Each periodic operation
of such procedures with respect to the APS is referred to herein as an
"Auction." If, however, the Fund should fail to pay or duly provide for the
full amount of any dividend on or the redemption price of the APS called for
redemption, the Applicable Rate for the APS will be determined as set forth
under "--Dividends--Non-Payment Period; Late Charge."
Auction Agency Agreement
The Fund will enter into the Auction Agency Agreement with the Auction Agent,
which provides, among other things, that the Auction Agent will follow the
Auction Procedures for the purpose of determining the Applicable Rate for each
series of APS. The Fund will pay the Auction Agent compensation for its
services under the Auction Agency Agreement.
The Auction Agent will act as agent for the Fund in connection with Auctions.
In the absence of bad faith or negligence on its part, the Auction Agent will
not be liable for any action taken, suffered or omitted, or for any error of
judgment made, by it in the performance of its duties under the Auction Agency
Agreement and will not be liable for any error of judgment made in good faith
unless the Auction Agent shall have been negligent in ascertaining the
pertinent facts. Pursuant to the Auction Agency Agreement, the Fund is required
to indemnify the Auction Agent for certain losses and liabilities incurred by
the Auction Agent without negligence or bad faith on its part in connection
with the performance of its duties under such agreement.
The Auction Agent may terminate the Auction Agency Agreement upon notice to the
Fund, which termination may be no earlier than 60 days following delivery of
such notice. If the Auction Agent resigns, the Fund will attempt to appoint
another qualified institution to act as a successor Auction Agent. The Fund may
terminate the Auction Agency Agreement, provided that prior to such termination
the Fund shall have entered into such an agreement with respect thereto with a
successor Auction Agent.
Broker-Dealer Agreements
The Auctions require the participation of one or more broker-dealers. The
Auction Agent will enter into agreements (collectively, the "Broker-Dealer
Agreements") with one or more broker-dealers, or other entities permitted by
law to perform the functions required of a Broker-Dealer in the Auction
Procedures (collectively, the "Broker-Dealers"), selected by the Fund, which
provide for the participation of such Broker-Dealers in Auctions and pursuant
to which such Broker-Dealers agree to follow the Auction
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40
Description of APS
--------------------------------------------------------------------------------
Procedures. A Broker-Dealer Agreement may be terminated by the Auction Agent or
a Broker-Dealer on five days' notice to the other party, provided that the
Broker-Dealer Agreement with UBS Warburg LLC may not be terminated without the
prior written consent of the Fund, which consent may not be unreasonably
withheld.
Securities Depository
The Depository Trust Company (the "Securities Depository") initially will act
as the Securities Depository for the Agent Members with respect to the APS. All
of the shares of each series of APS initially will be registered in the name of
Cede & Co., as nominee of the Securities Depository. Such shares will be
subject to the provisions restricting transfers of the APS contained in the
Amended Bylaws. Cede & Co. initially will be the holder of record of all APS,
and Beneficial Owners will not be entitled to
receive certificates representing their ownership interest in such shares. See
Appendix A (Auction Procedures) to the Statement of Additional Information. The
Securities Depository will maintain lists of its participants and will maintain
the positions (ownership interests) of the APS held by each Agent Member,
whether as the Beneficial Owner thereof for its own account or as nominee for
the Beneficial Owner thereof. Payments made by the Fund to holders of APS will
be duly made by making payments to the nominee of the Securities Depository.
AUCTION PROCEDURES
The following is a brief summary of the procedures to be used in conducting
Auctions. This summary is qualified in its entirety by reference to the Auction
Procedures set forth in Appendix A to the Statement of Additional Information.
The Settlement Procedures to be used with respect to Auctions are set forth in
Appendix B to the Statement of Additional Information.
Auction Date
An Auction to determine the Applicable Rate for the APS offered hereby for each
Dividend Period for such shares (other than the Initial Dividend Period
therefor) will be held on the last Business Day preceding the first day of such
Dividend Period, which first day is also the Dividend Payment Date for the
preceding Dividend Period (the date of each Auction being referred to herein as
an "Auction Date"). The initial Auction Date will be June 2, 2003 for Series A
APS, June 3, 2003 for Series B APS, June 4, 2003 for Series C APS, June 5, 2003
for Series D APS and June 6, 2003 for Series E APS. Auctions for the APS for
Dividend Periods after the Initial Dividend Period normally will be held every
Monday after the preceding Dividend Payment Date for Series A APS, every such
Tuesday for Series B APS, every such Wednesday for Series C APS, every such
Thursday for Series D APS and every such Friday for Series E APS; and each
subsequent Dividend Period normally will begin on the following Tuesday for
Series A APS, on the following Wednesday for Series B APS, on the following
Thursday for Series C APS, on the following Friday for Series D APS and on the
following Monday for Series E APS (also a Dividend Payment Date). The Auction
Date and the first day of the related Dividend Period for a series of APS (both
of which must be Business Days) need not be consecutive calendar days. See
"--Dividends" for information concerning the circumstances under which a
Dividend Payment Date may fall on a date other than the days specified above,
which may affect the Auction Date.
Orders by Beneficial Owners, Potential Beneficial Owners, Existing Holders and
Potential Holders
On or prior to the Submission Deadline on each Auction Date for a series of APS:
(a) each Beneficial Owner may submit to its Broker-Dealer by telephone a:
(i) "Hold Order"-- indicating the number of outstanding APS, if any, such
Beneficial Owner desires to continue to hold without regard to the
Applicable Rate for the next Dividend Period for such shares;
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41
Description of APS
--------------------------------------------------------------------------------
(ii) "Bid"--indicating the number of outstanding APS, if any, such
Beneficial Owner desires to continue to hold, provided that the
Applicable Rate for the next Dividend Period for such shares is not
less than the rate per annum then specified by such Beneficial Owner;
and/or
(iii) "Sell Order"--indicating the number of outstanding APS, if any, such
Beneficial Owner offers to sell without regard to the Applicable Rate
for the next Dividend Period for such shares; and
(b) Broker-Dealers will contact customers who are Potential Beneficial
Owners of APS to determine whether such Potential Beneficial Owners
desire to submit Bids indicating the number of APS which they offer to
purchase provided that the Applicable Rate for the next Dividend Period
is not less than the rates per annum specified in such Bids.
The communication by a Beneficial Owner or Potential Beneficial Owner to a
Broker-Dealer and the communication by a Broker-Dealer, whether or not acting
for its own account, to the Auction Agent of the foregoing information is
hereinafter referred to as an "Order" and collectively as "Orders." A
Beneficial Owner or a Potential Beneficial Owner placing an Order, including a
Broker-Dealer acting in such capacity for its own account, is hereinafter
referred to as a "Bidder" and collectively as "Bidders." Any Order submitted by
a Beneficial Owner or a Potential Beneficial Owner to its Broker-Dealer, or by
a Broker-Dealer to the Auction Agent, prior to the Submission Deadline on any
Auction Date shall be irrevocable.
In an Auction, a Beneficial Owner may submit different types of Orders with
respect to APS then held by such Beneficial Owner, as well as Bids for
additional APS. If, however, a Beneficial Owner offers through its
Broker-Dealer to purchase additional APS in such Auction, such Beneficial
Owner, for purposes of such offer to purchase additional shares, will be
treated as a Potential Beneficial Owner as described below. For information
concerning the priority given to different types of Orders placed by Beneficial
Owners, see "--Submission of Orders by Broker-Dealers to Auction Agent" below.
The "Maximum Applicable Rate," on any date on which the Applicable Rate is
determined for a series of APS, will be the Applicable Percentage of the
Reference Rate. The Applicable Percentage will be subject to upward but not
downward adjustment in the discretion of the Board of Trustees after
consultation with the Broker-Dealers, provided that immediately following any
such increase the Fund would be in compliance with the APS Basic Maintenance
Amount. The Auction Agent will round each applicable Maximum Applicable Rate to
the nearest one-thousandth (0.001) of one percent per annum, with any such
number ending in five ten-thousandths of one percent being rounded upwards to
the nearest one-thousandth (0.001) of one percent. The Auction Agent will not
round the applicable Reference Rate as part of its calculation of the Maximum
Applicable Rate.
The Maximum Applicable Rate for a series of APS will depend on the credit
rating assigned to such series. The "Applicable Percentage" will be determined
based on the credit rating assigned on such date to such shares by Moody's (or,
if Moody's shall not make such rating available, the equivalent of such rating
by a Substitute Rating Agency), such Applicable Percentage as so determined
further subject to adjustments by the Board of Trustees as described in the
preceding paragraph, as follows:
Moody's Credit Rating Applicable Percentage
-------------------------------------------
"Aa3" or higher 150%
"A3" to "A1" 200%
"Baa3" to "Baa1" 225%
Below "Baa3" 275%
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42
Description of APS
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There is no minimum Applicable Rate in respect of any Dividend Period. The Fund
will take all reasonable action necessary to enable Moody's to provide a rating
for each series of APS. If Moody's does not make such a rating available, UBS
Warburg LLC or its affiliates and successors, after consultation with the Fund,
will select another Rating Agency to act as a Substitute Rating Agency.
Any Bid by a Beneficial Owner specifying a rate per annum higher than the
Maximum Applicable Rate will be treated as a Sell Order, and any Bid by a
Potential Beneficial Owner specifying a rate per annum higher than the Maximum
Applicable Rate will not be considered. See "--Determination of Sufficient
Clearing Bids, Winning Bid Rate and Applicable Rate" and "--Acceptance and
Rejection of Submitted Bids and Submitted Sell Orders and Allocation of Shares."
A Broker-Dealer also may hold APS in its own account as a Beneficial Owner. A
Broker-Dealer thus may submit Orders to the Auction Agent as a Beneficial Owner
or a Potential Beneficial Owner and therefore participate in an Auction as an
Existing Holder or Potential Holder on behalf of both itself and its customers.
Any Order placed with the Auction Agent by a Broker-Dealer as or on behalf of a
Beneficial Owner or a Potential Beneficial Owner will be treated in the same
manner as an Order placed with a Broker-Dealer by a Beneficial Owner or a
Potential Beneficial Owner. Similarly, any failure by a Broker-Dealer to submit
to the Auction Agent an Order in respect of any APS held by it or its customers
who are Beneficial Owners will be treated in the same manner as a Beneficial
Owner's failure to submit to its Broker-Dealer an Order in respect of APS held
by it, as described in the next paragraph. If a Broker-Dealer participates in
an Auction as an Existing Holder or a Potential Holder only to represent the
interests of a Beneficial Owner or Potential Beneficial Owner, whether it be
its customers or itself, all discussion herein relating to the consequences of
an Auction for Existing Holders and Potential Holders also applies to the
underlying beneficial ownership interests represented thereby. For information
concerning the priority given to different types of Orders placed by Existing
Holders, see "--Submission of Orders by Broker-Dealers to Auction Agent." Each
purchase or sale in an Auction will be settled on the Business Day next
succeeding the Auction Date at a price per share equal to $25,000. See
"--Notification of Results; Settlement."
If one or more Orders covering in the aggregate all of the outstanding APS held
by a Beneficial Owner are not submitted to the Auction Agent prior to the
Submission Deadline, either because a Broker-Dealer failed to contact such
Beneficial Owner or otherwise, the Auction Agent will deem a Hold Order (in the
case of any Auction other than an Auction relating to a Special Dividend Period
longer than 91 days) or a Sell Order (in the case of an Auction relating to a
Special Dividend Period of longer than 91 days) to have been submitted on
behalf of such Beneficial Owner covering the number of outstanding APS held by
such Beneficial Owner and not subject to Orders submitted to the Auction Agent.
If all of the outstanding APS are subject to Submitted Hold Orders, the
Dividend Period next succeeding the Auction automatically will be the same
length as the immediately preceding Dividend Period, and the Applicable Rate
for the next Dividend Period for all the APS will be 80% of the Reference Rate
on the date of the applicable Auction.
For the purposes of an Auction, the APS for which the Fund shall have given
notice of redemption and deposited moneys therefor with the Auction Agent in
trust or segregated in an account at the Fund's custodian bank for the benefit
of the Auction Agent, as set forth under "--Redemption," will not be considered
as outstanding and will not be included in such Auction. The Fund may not
submit an Order in any Auction.
Neither the Fund nor the Auction Agent will be responsible for a
Broker-Dealer's failure to act in accordance with the instructions of
Beneficial Owners or Potential Beneficial Owners or failure to comply with the
foregoing.
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43
Description of APS
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Submission of Orders by Broker-Dealers to Auction Agent
Prior to 1:00 p.m., New York City time, on each Auction Date or such other time
on the Auction Date as may be specified by the Auction Agent (the "Submission
Deadline"), each Broker-Dealer will submit to the Auction Agent in writing or
through the Auction Agent's auction processing system all Orders obtained by it
for the Auction for a series of APS to be conducted on such Auction Date,
designating itself (unless otherwise permitted by the Fund) as the Existing
Holder or Potential Holder in respect of the APS subject to such Orders. Any
Order submitted by a Beneficial Owner or a Potential Beneficial Owner to its
Broker-Dealer, or by a Broker-Dealer to the Auction Agent, prior to the
Submission Deadline for any Auction Date, shall be irrevocable.
If the rate per annum specified in any Bid contains more than three figures to
the right of the decimal point, the Auction Agent will round such rate per
annum up to the next highest one-thousandth (0.001) of one percent. If one or
more Orders of an Existing Holder are submitted to the Auction Agent and such
Orders cover in the aggregate more than the number of outstanding shares of APS
held by such Existing Holder, such Orders will be considered valid in the
following order of priority:
(i) any Hold Order will be considered valid up to and including the number
of outstanding APS held by such Existing Holder, provided that if more
than one Hold Order is submitted by such Existing Holder and the number
of APS subject to such Hold Orders exceeds the number of outstanding APS
held by such Existing Holder, the number of APS subject to each of such
Hold Orders will be reduced pro rata so that such Hold Orders, in the
aggregate, will cover exactly the number of outstanding APS held by such
Existing Holder;
(ii) any Bids will be considered valid, in the ascending order of their
respective rates per annum if more than one Bid is submitted by such
Existing Holder, up to and including the excess of the number of
outstanding APS held by such Existing Holder over the number of
outstanding APS subject to any Hold Order referred to in clause (i)
above (and if more than one Bid submitted by such Existing Holder
specifies the same rate per annum and together they cover more than the
remaining number of shares that can be the subject of valid Bids after
application of clause (i) above and of the foregoing portion of this
clause (ii) to any Bid or Bids specifying a lower rate or rates per
annum, the number of shares subject to each of such Bids will be reduced
pro rata so that such Bids, in the aggregate, cover exactly such
remaining number of outstanding shares); and the number of outstanding
shares, if any, subject to Bids not valid under this clause (ii) shall
be treated as the subject of a Bid by a Potential Holder; and
(iii) any Sell Order will be considered valid up to and including the excess
of the number of outstanding APS held by such Existing Holder over the
sum of the number of APS subject to Hold Orders referred to in clause
(i) above and the number of APS subject to valid Bids by such Existing
Holder referred to in clause (ii) above; provided that, if more than one
Sell Order is submitted by any Existing Holder and the number of APS
subject to such Sell Orders is greater than such excess, the number of
APS subject to each of such Sell Orders will be reduced pro rata so that
such Sell Orders, in the aggregate, will cover exactly the number of APS
equal to such excess.
If more than one Bid of any Potential Holder is submitted in any Auction, each
Bid submitted in such Auction will be considered a separate Bid with the rate
per annum and number of APS therein specified.
Determination of Sufficient Clearing Bids, Winning Bid Rate and Applicable Rate
Not earlier than the Submission Deadline for each Auction, the Auction Agent
will assemble all Orders submitted or deemed submitted to it by the
Broker-Dealers (each such "Hold Order," "Bid" or "Sell
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44
Description of APS
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Order" as submitted or deemed submitted by a Broker-Dealer hereinafter being
referred to as a "Submitted Hold Order," a "Submitted Bid" or a "Submitted Sell
Order," as the case may be, or as a "Submitted Order") and will determine the
excess of the number of outstanding APS over the number of outstanding APS
subject to Submitted Hold Orders (such excess being referred to as the
"Available APS") and whether Sufficient Clearing Bids have been made in such
Auction. Sufficient Clearing Bids will have been made if the number of
outstanding APS that are the subject of Submitted Bids of Potential Holders
with rates per annum not higher than the Maximum Applicable Rate equals or
exceeds the number of outstanding shares that are the subject of Submitted Sell
Orders (including the number of shares subject to Bids of Existing Holders
specifying rates per annum higher than the Maximum Applicable Rate). If
Sufficient Clearing Bids have been made, the Auction Agent will determine the
lowest rate per annum specified in the Submitted Bids (the "Winning Bid Rate")
which would result in the number of shares subject to Submitted Bids specifying
such rate per annum or a lower rate per annum being at least equal to the
Available APS. If Sufficient Clearing Bids have been made, the Winning Bid Rate
will be the Applicable Rate for the next Dividend Period for the APS then
outstanding. If Sufficient Clearing Bids have not been made (other than because
all outstanding APS are the subject of Submitted Hold Orders), the Dividend
Period next following the Auction automatically will be a 7-Day Dividend
Period, and the Applicable Rate for such Dividend Period will be equal to the
Maximum Applicable Rate.
If Sufficient Clearing Bids have not been made, Beneficial Owners that have
Submitted Sell Orders will not be able to sell in the Auction all, and may not
be able to sell any, of their APS subject to such Submitted Sell Orders. See
"--Acceptance and Rejection of Submitted Bids and Submitted Sell Orders and
Allocation of Shares." Thus, under some circumstances, Beneficial Owners may
not have liquidity of investment.
The following is a simple example of how a typical Auction might work. Assume
that the Fund has 1,000 outstanding APS of a series and three Existing Holders
of those shares. The three Existing Holders and three Potential Holders submit
their Orders through Broker-Dealers at the Auction:
Existing Holder A. Owns 500 APS, wants to sell all 500 Bid of 2.1% rate for all 500
APS if Applicable Rate is less than 2.1% APS
Existing Holder B. Owns 300 APS, wants to hold Hold Order--will take
the auction rate
Existing Holder C. Owns 200 APS, wants to sell all 200 Bid of 1.9% rate for all
APS if Applicable Rate is less than 1.9% 200 shares
Potential Holder D Wants to buy 200 APS if Applicable Places Order to buy 200 APS
Rate is 2.0% or above at or above 2.0%
Potential Holder E Wants to buy 300 APS if Applicable Places Order to buy 300 APS
Rate is 1.9% or above at or above 1.9%
Potential Holder F Wants to buy 200 APS if Applicable Places Order to buy 200 APS
Rate is 2.1% or above at or above 2.1%
In this example, the lowest dividend rate that will result in all 1,000 APS
continuing to be held is 2.0% (the offer by Potential Holder D). Therefore, the
Winning Bid Rate and the Applicable Rate will be 2.0%. Existing Holders B and C
will continue to own their APS. Existing Holder A will sell its APS because A's
Bid rate was higher than the Winning Bid Rate. Potential Holder D will buy 200
APS and Potential Holder E will buy 300 APS because their Bid rates were at or
below the Winning Bid Rate. Potential Holder F will not buy any APS because its
Bid rate was above the Winning Bid Rate.
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45
Description of APS
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The examples above are entirely hypothetical and are not meant to be an
indication of how any particular Auction might be conducted or the dividend
rates that may be payable on any series of APS at any time or from time to
time. These are simple examples that do not purport to reflect all applicable
conditions and requirements of an Auction, and are qualified in their entirety
by reference to the Auction Procedures set forth in Appendix A to the Statement
of Additional Information.
Acceptance and Rejection of Submitted Bids and Submitted Sell Orders and
Allocation of Shares
Based on the determinations described under "--Determination of Sufficient
Clearing Bids, Winning Bid Rate and Applicable Rate" and subject to the
discretion of the Auction Agent to round as described below, Submitted Bids and
Submitted Sell Orders will be accepted or rejected in the order of priority set
forth in the Auction Procedures with the result that Existing Holders and
Potential Holders of a series of APS will sell, continue to hold and/or
purchase APS as set forth below. Existing Holders that submit or are deemed to
have submitted Hold Orders will continue to hold the APS subject to such Hold
Orders.
If Sufficient Clearing Bids have been made:
(a) each Existing Holder that placed a Submitted Bid specifying a rate per
annum higher than the Winning Bid Rate or a Submitted Sell Order will
sell the outstanding APS subject to such Submitted Bid or Submitted Sell
Order;
(b) each Existing Holder that placed a Submitted Bid specifying a rate per
annum lower than the Winning Bid Rate will continue to hold the
outstanding APS subject to such Submitted Bid;
(c) each Potential Holder that placed a Submitted Bid specifying a rate per
annum lower than the Winning Bid Rate will purchase the number of APS
subject to such Submitted Bid;
(d) each Existing Holder that placed a Submitted Bid specifying a rate per
annum equal to the Winning Bid Rate will continue to hold the
outstanding shares of APS subject to such Submitted Bids, unless the
number of outstanding APS subject to all such Submitted Bids of Existing
Holders is greater than the excess of the Available APS over the number
of APS accounted for in clauses (b) and (c) above, in which event each
Existing Holder with such a Submitted Bid will sell a number of
outstanding APS determined on a pro rata basis based on the number of
outstanding APS subject to all such Submitted Bids of such Existing
Holders; and
(e) each Potential Holder that placed a Submitted Bid specifying a rate per
annum equal to the Winning Bid Rate will purchase any Available APS not
accounted for in clause (b), (c) or (d) above on a pro rata basis based
on the APS subject to all such Submitted Bids of Potential Holders.
If Sufficient Clearing Bids have not been made (other than because all
outstanding APS are the subject of Submitted Hold Orders):
(a) each Existing Holder that placed a Submitted Bid specifying a rate per
annum equal to or lower than the Maximum Applicable Rate will continue
to hold the outstanding APS subject to such Submitted Bid;
(b) each Potential Holder that placed a Submitted Bid specifying a rate per
annum equal to or lower than the Maximum Applicable Rate will purchase
the number of APS subject to such Submitted Bid; and
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46
Description of APS
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(c) each Existing Holder that placed a Submitted Bid specifying a rate per
annum higher than the Maximum Applicable Rate or a Submitted Sell Order
will sell a number of outstanding APS determined on a pro rata basis
based on the outstanding APS subject to all such Submitted Bids and
Submitted Sell Orders.
If as a result of the Auction Procedures described above any Existing Holder
would be entitled or required to sell, or any Potential Holder would be
entitled or required to purchase, a fraction of APS, then the Auction Agent, in
such manner as it shall determine in its sole discretion, will round up or down
the number of APS being sold or purchased on such Auction Date so that each
share sold or purchased by each Existing Holder or Potential Holder will be a
whole APS. If any Potential Holder would be entitled or required to purchase
less than a whole APS, then the Auction Agent, in such manner as it shall
determine in its sole discretion, will allocate APS for purchase among
Potential Holders so that only whole APS are purchased by any such Potential
Holder, even if such allocation results in one or more of such Potential
Holders not purchasing any APS.
Notification of Results; Settlement
The Auction Agent will advise each Broker-Dealer who submitted a Bid or Sell
Order in an Auction whether such Bid or Sell Order was accepted or rejected in
whole or in part and of the Applicable Rate for the next Dividend Period for
the related APS by telephone or through the Auction Agent's auction processing
system at approximately 3:00 p.m., New York City time, on the Auction Date for
such Auction. Each such Broker-Dealer that submitted an Order for the account
of a customer then will advise such customer whether such Bid or Sell Order was
accepted or rejected, will confirm purchases and sales with each customer
purchasing or selling APS as a result of the Auction and will advise each
customer purchasing or selling APS to give instructions to its Agent Member of
the Securities Depository to pay the purchase price against delivery of such
shares or to deliver such shares against payment therefor as appropriate. If a
customer selling APS as a result of an Auction fails to instruct its Agent
Member to deliver such shares, the Broker-Dealer that submitted such customer's
Bid or Sell Order will instruct such Agent Member to deliver such shares
against payment therefor. Each Broker-Dealer that submitted a Hold Order in an
Auction on behalf of a customer also will advise such customer of the
Applicable Rate for the next Dividend Period for the APS. The Auction Agent
will record each transfer of APS on the record book of Existing Holders to be
maintained by the Auction Agent.
In accordance with the Securities Depository's normal procedures, on the day
after each Auction Date, the transactions described above will be executed
through the Securities Depository, and the accounts of the respective Agent
Members at the Securities Depository will be debited and credited as necessary
to effect the purchases and sales of APS as determined in such Auction.
Purchasers will make payment through their Agent Members in same-day funds to
the Securities Depository against delivery through their Agent Members; the
Securities Depository will make payment in accordance with its normal
procedures, which now provide for payment in same-day funds. If the procedures
of the Securities Depository applicable to APS shall be changed to provide for
payment in next-day funds, then purchasers may be required to make payment in
next-day funds. If the certificates for the APS are not held by the Securities
Depository or its nominee, payment will be made in same-day funds to the
Auction Agent against delivery of such certificates.
If any Existing Holder selling APS in an Auction fails to deliver such shares,
the Broker-Dealer of any person that was to have purchased APS in such Auction
may deliver to such person a number of whole APS that is less than the number
of shares that otherwise was to be purchased by such person. In such event, the
number of APS to be so delivered will be determined by such Broker-Dealer.
Delivery of such lesser number of shares will constitute good delivery. Each
Broker-Dealer Agreement also will provide
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47
Description of APS
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that neither the Fund nor the Auction Agent will have responsibility or
liability with respect to the failure of Beneficial Owners or Potential
Beneficial Owners or their respective Agent Members to deliver APS or to pay
for APS purchased or sold pursuant to an Auction or otherwise.
BROKER-DEALERS
General
The Auction Agent after each Auction will pay a service charge from funds
provided by the Fund to each Broker-Dealer on the basis of the purchase price
of APS placed by such Broker-Dealer at such Auction. The service charge (i) for
any 7-Day Dividend Period shall be payable at the annual rate of 0.25% of the
purchase price of the APS placed by such Broker-Dealer in any such Auction and
(ii) for any Special Dividend Period shall be determined by mutual consent of
the Fund and any such Broker-Dealer or Broker-Dealers and shall be based upon a
selling concession that would be applicable to an underwriting of fixed or
variable rate preferred shares with a similar final maturity or variable rate
dividend period, respectively, at the commencement of the Dividend Period with
respect to such Auction. For the purposes of the preceding sentence, the APS
will be placed by a Broker-Dealer if such shares were (i) the subject of Hold
Orders deemed to have been made by Beneficial Owners that were acquired by such
Beneficial Owners through such Broker-Dealer or (ii) the subject of the
following Orders submitted by such Broker-Dealer: (A) a Submitted Bid of a
Beneficial Owner that resulted in such Beneficial Owner continuing to hold such
shares as a result of the Auction, (B) a Submitted Bid of a Potential
Beneficial Owner that resulted in such Potential Beneficial Owner purchasing
such shares as a result of the Auction or (C) a Submitted Hold Order.
The Broker-Dealer Agreements provide that a Broker-Dealer may submit Orders in
Auctions for its own account, unless the Fund notifies all Broker-Dealers that
they no longer may do so; provided that Broker-Dealers may continue to submit
Hold Orders and Sell Orders. If a Broker-Dealer submits an Order for its own
account in any Auction of APS, it may have knowledge of Orders placed through
it in that Auction and therefore have an advantage over other Bidders, but such
Broker-Dealer would not have knowledge of Orders submitted by other
Broker-Dealers in that Auction.
Secondary Market Trading and Transfers of APS
The Broker-Dealers may maintain a secondary trading market in the APS outside
of Auctions; however, they have no obligation to do so, and may discontinue
such activity at any time. There can be no assurance that a secondary market
for the APS will develop or, if it does develop, that it will provide holders
with a liquid trading market (i.e., trading will depend on the presence of
willing buyers and sellers and the trading price is subject to variables to be
determined at the time of the trade by the Broker-Dealers). The APS will not be
registered on any stock exchange or on any automated quotation system. An
increase in the level of interest rates, particularly during any Long Term
Dividend Period for a series of APS, likely will have an adverse effect on the
secondary market price of such APS, and a selling shareholder may sell APS
between Auctions at a price per share of less than $25,000.
A Beneficial Owner or an Existing Holder may sell, transfer or otherwise
dispose of APS only in whole shares and only (1) pursuant to a Bid or Sell
Order placed with the Auction Agent in accordance with the Auction Procedures,
(2) to a Broker-Dealer or (3) to such other persons as may be permitted by the
Fund; provided, however, that (a) a sale, transfer or other disposition of
shares of APS from a customer of a Broker-Dealer who is listed on the records
of that Broker-Dealer as the holder of such shares to that Broker-Dealer or
another customer of that Broker-Dealer shall not be deemed to be a sale,
transfer or other disposition for purposes of the foregoing if such
Broker-Dealer remains the Existing Holder of the shares so sold, transferred or
disposed of immediately after such sale, transfer or disposition and (b) in
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48
Description of APS
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the case of all transfers other than pursuant to Auctions, such Beneficial
Owner or Existing Holder, its Broker-Dealer, if applicable, or its Agent Member
advises the Auction Agent of such transfer.
DIVIDENDS
General
The holders of APS of each series will be entitled to receive, when, as and if
declared by the Board of Trustees, out of funds legally available therefor,
cumulative cash dividends on their shares, at the Applicable Rate determined as
set forth below under "--Determination of Dividend Rate," payable on the dates
set forth below. Dividends on the APS so declared and payable will be paid in
preference to and in priority over any dividends so declared and payable on the
Common Shares.
Dividends on each series of APS will accumulate from the date on which the Fund
originally issues the APS (the "Date of Original Issue") and will be payable on
the APS on the dates described below. Dividends on a series of APS with respect
to the Initial Dividend Period shall be payable on the Initial Dividend Payment
Date for that series. Following the Initial Dividend Payment Date, dividends on
each series of APS will be payable, at the option of the Fund, either (i) with
respect to any 7-Day Dividend Period and any Short Term Dividend Period of 35
or fewer days, on the day next succeeding the last day thereof or (ii) with
respect to any Short Term Dividend Period of more than 35 days and with respect
to any Long Term Dividend Period, monthly on the first Business Day of each
calendar month during such Short Term Dividend Period or Long Term Dividend
Period and on the day next succeeding the last day thereof (each such date
referred to in clause (i) or (ii) being referred to herein as a "Normal
Dividend Payment Date"), except that if such Normal Dividend Payment Date is
not a Business Day, the Dividend Payment Date will be the first Business Day
next succeeding such Normal Dividend Payment Date. Although any particular
Dividend Payment Date may not occur on the originally scheduled date because of
the exceptions discussed above, the next succeeding Dividend Payment Date,
subject to such exceptions, will nonetheless occur on the next following
originally scheduled date. If for any reason a Dividend Period for a series of
APS is scheduled to begin on the same day and end on the same day as a Dividend
Period for another series of APS, then the last day of the Dividend Period for
such other series of APS shall be the second Business Day next succeeding such
scheduled day unless the Fund obtains the opinion of tax counsel referred to
below. Subject to the limitation in the next sentence, if for any reason a
Dividend Payment Date cannot be fixed as described above, then the Board of
Trustees will fix the Dividend Payment Date. However, no Dividend Period of any
series of APS shall be co-extensive with the Dividend Period of any other
series of APS unless the Fund has received an opinion of tax counsel that
having such co-extensive periods will not affect the deductibility, for federal
income tax purposes, of dividends paid on the different series of APS. The
Board of Trustees before authorizing a dividend may change a Dividend Payment
Date if such change does not adversely affect the contract rights of the
holders of APS set forth in the Declaration or Amended Bylaws. The Initial
Dividend Period, 7-Day Dividend Periods and Special Dividend Periods are
sometimes referred to herein as "Dividend Periods." Each dividend payment date
determined as provided above is hereinafter referred to as a "Dividend Payment
Date."
Prior to each Dividend Payment Date, the Fund is required to deposit with the
Auction Agent sufficient funds for the payment of declared dividends. The Fund
does not intend to establish any reserves for the payment of dividends.
Each dividend will be paid to the record holder of the APS as of 12:00 noon,
New York City time, on the Business Day preceding the Dividend Payment Date,
which holder is expected to be the nominee of the Securities Depository. See
"--The Auction--Securities Depository." The Securities Depository will credit
the accounts of the Agent Members of the Existing Holders in accordance with
the Securities
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49
Description of APS
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Depository's normal procedures, which provide for payment in same-day funds.
The Agent Member of an Existing Holder will be responsible for holding or
disbursing such payments on the applicable Dividend Payment Date to such
Existing Holder in accordance with the instructions of such Existing Holder.
Dividends in arrears for any past Dividend Period may be declared and paid at
any time, without reference to any regular Dividend Payment Date, to the record
holder of the APS on a date, not exceeding fifteen days prior to the payment
date therefor, as may be fixed by the Board of Trustees. Any dividend payment
made on the APS first shall be credited against the earliest declared but
unpaid dividends accumulated with respect to such shares.
Holders of the APS will not be entitled to any dividends, whether payable in
cash, property or stock, in excess of full cumulative dividends except as
described under "--Non-Payment Period; Late Charge" below. No interest will be
payable in respect of any dividend payment or payments on the APS which may be
in arrears.
The amount of cash dividends per share of APS of each series payable (if
declared) on the Initial Dividend Payment Date, each Dividend Payment Date of
each 7-Day Dividend Period and each Dividend Payment Date of each Short Term
Dividend Period will be computed by multiplying the Applicable Rate for such
Dividend Period by a fraction, the numerator of which will be the number of
days in such Dividend Period or part thereof that such share was outstanding
and for which dividends are payable on such Dividend Payment Date and the
denominator of which will be 365, multiplying the amount so obtained by
$25,000, and rounding the amount so obtained to the nearest cent. During any
Long Term Dividend Period, the amount of cash dividends per share of APS
payable (if declared) on any Dividend Payment Date will be computed by
multiplying the Applicable Rate for such Dividend Period by a fraction, the
numerator of which will be such number of days in such part of such Dividend
Period that such share was outstanding and for which dividends are payable on
such Dividend Payment Date and the denominator of which will be 360,
multiplying the amount so obtained by $25,000, and rounding the amount so
obtained to the nearest cent.
Notification of Dividend Period
The Fund, at its sole option and to the extent permitted by law, by telephonic
and written notice (a "Request for Special Dividend Period") to the Auction
Agent and to each Broker-Dealer, may request that the next succeeding Dividend
Period for a series of APS be a number of days (other than seven), evenly
divisible by seven, and not fewer than fourteen nor more than 364 in the case
of a Short Term Dividend Period or one whole year or more but not greater than
five years in the case of a Long Term Dividend Period, specified in such
notice, provided that the Fund may not give a Request for Special Dividend
Period for a Dividend Period of greater than 28 days (and any such request will
be null and void) unless, for any Auction occurring after the initial Auction,
Sufficient Clearing Bids were made in the last occurring Auction and unless
full cumulative dividends and any amounts due with respect to redemptions
payable prior to such date have been paid in full. Such Request for Special
Dividend Period, in the case of a Short Term Dividend Period, shall be given on
or prior to the second Business Day but not more than seven Business Days prior
to an Auction Date for the APS of that series and, in the case of a Long Term
Dividend Period, shall be given on or prior to the second Business Day but not
more than 28 days prior to an Auction Date for the APS of that series. Upon
receiving such Request for Special Dividend Period, the Broker-Dealers jointly
shall determine the Optional Redemption Price of the APS of that series during
such Special Dividend Period and the Specific Redemption Provisions and shall
give the Fund and the Auction Agent written notice (a "Response") of such
determination by no later than the second Business Day prior to such Auction
Date. In making such determination, the Broker-Dealers will consider (i)
existing short-term and long-term market rates and indices of such short-term
and long-term rates, (ii) existing market supply and demand for short-term and
long-term securities, (iii) existing yield
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50
Description of APS
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curves for short-term and long-term securities comparable to the APS, (iv)
industry and financial conditions which may affect the APS of that series, (v)
the investment objective of the Fund and (vi) the Dividend Periods and dividend
rates at which current and potential beneficial holders of the APS would remain
or become beneficial holders.
After providing the Request for Special Dividend Period to the Auction Agent
and each Broker-Dealer as set forth above, the Fund, by no later than the
second Business Day prior to such Auction Date, may give a notice (a "Notice of
Special Dividend Period") to the Auction, Agent, the Securities Depository and
each Broker-Dealer, which notice will specify (i) the duration of the Special
Dividend Period, (ii) the Optional Redemption Price, if any, as specified in
the related Response and (iii) the Specific Redemption Provisions, if any, as
specified in the related Response. The Fund has agreed to provide a copy of
such Notice of Special Dividend Period to Moody's and any Substitute Rating
Agency. The Fund will not give a Notice of Special Dividend Period and, if such
Notice of Special Dividend Period was given, already, will give telephonic and
written notice of its revocation (a "Notice of Revocation") to the Auction
Agent, each Broker-Dealer and the Securities Depository on or prior to the
Business Day prior to the relevant Auction Date if (x) either the 1940 Act APS
Asset Coverage is not satisfied or the Fund fails to maintain Moody's Eligible
Assets with an aggregate Discounted Value at least equal to the APS Basic
Maintenance Amount, on each of the two Valuation Dates immediately preceding
the Business Day prior to the relevant Auction Date on an actual basis and on a
pro forma basis giving effect to the proposed Special Dividend Period (using as
a pro forma dividend rate with respect to such Special Dividend Period the
dividend rate which the Broker-Dealers shall advise the Fund is an
approximately equal rate for securities similar to the APS with an equal
dividend period) or (y) sufficient funds for the payment of dividends payable
on the immediately succeeding Dividend Payment Date have not been irrevocably
deposited with the Auction Agent by the close of business on the third Business
Day preceding the Auction Date immediately preceding such Dividend Payment
Date. The Fund also shall provide a copy of such Notice of Revocation to
Moody's and any Substitute Rating Agency. If the Fund is prohibited from giving
a Notice of Special Dividend Period as a result of the factors enumerated in
clause (x) or (y) above or if the Fund gives a Notice of Revocation with
respect to a Notice of Special Dividend Period for any series of the APS, the
next succeeding Dividend Period for that series will be a 7-Day Dividend
Period. In addition, in the event Sufficient Clearing Bids are not made in an
Auction, or if an Auction is not held for any reason, the next succeeding
Dividend Period will be a 7-Day Dividend Period, and the Fund may not again
give a Notice of Special Dividend Period (and any such attempted notice will be
null and void) until Sufficient Clearing Bids have been made in an Auction with
respect to a 7-Day Dividend Period. If an Auction is not held because an
unforeseen event or unforeseen events cause a day that otherwise would have
been a Dividend Payment Date or an Auction Date not to be a Business Day, then
the length of the Dividend Period relating to such Dividend Payment Date shall
be extended by seven days (or a multiple thereof if necessary because of such
unforeseen event or events) (an "Extension Period"), the Applicable Rate for
such Extension Period shall be the Applicable Rate for the Dividend Period so
extended and the Dividend Payment Date for such Dividend Period shall be the
first Business Day next succeeding the end of such Extension Period. Solely for
purposes of (1) the foregoing sentence, (2) the proviso in clause (i) of the
definition of "Non-Payment Period" under "--Non-Payment Period; Late Charge"
below and (3) the second parenthetical in the fifth sentence of the same
paragraph in which "Non-Payment Period" is defined, any day on which banks in
New York City generally are closed, for any reason, while the New York Stock
Exchange remains open for trading and any day which otherwise would be a
Business Day as defined in the Amended Bylaws on which the Auction Agent is
closed for business, for any reason, shall not be considered a Business Day.
Determination of Dividend Rate
The dividend rate on a series of APS during the period from and including the
Date of Original Issue for the APS to but excluding the Initial Dividend
Payment Date for that series of APS (the "Initial Dividend
--------------------------------------------------------------------------------
51
Description of APS
--------------------------------------------------------------------------------
Period") will be the rate per annum set forth on the inside cover page hereof.
Commencing on the Initial Dividend Payment Date for a series of APS, the
Applicable Rate on that series of APS for each Subsequent Dividend Period,
which Subsequent Dividend Period shall be a period commencing on and including
a Dividend Payment Date and ending on and including the calendar day prior to
the next Dividend Payment Date (or last Dividend Payment Date in a Dividend
Period if there is more than one Dividend Payment Date), shall be equal to the
rate per annum that results from the Auction with respect to such Subsequent
Dividend Period. Cash dividends shall be calculated as set forth above under
"--Dividends--General."
Generally speaking, the APS will pay dividends at the Winning Bid Rate,
although dividends for Dividend Periods commencing during any Non-Payment
Period will be paid at the Non-Payment Period Rate (as described below);
dividends will be paid at the Maximum Applicable Rate if Sufficient Clearing
Bids do not exist; and dividends will be paid at a rate equal to 80% of the
Reference Rate if all outstanding APS are the subject of Submitted Hold Orders.
Non-Payment Period; Late Charge
A "Non-Payment Period" for a series of APS will commence if the Fund fails to
(i) declare, prior to the close of business on the second Business Day
preceding any Dividend Payment Date, for payment on or (to the extent permitted
as described below) within three Business Days after such Dividend Payment Date
to the persons who held such shares as of 12:00 noon, New York City time, on
the Business Day preceding such Dividend Payment Date, the full amount of any
dividend on the APS payable on such Dividend Payment Date, provided, however,
that if the Fund is not able to make such declaration in compliance with the
foregoing because an unforeseen event or unforeseen events causes or cause a
day that otherwise would have been a Business Day not to be a Business Day,
then the Fund may make such declaration on the Business Day immediately
preceding the Dividend Payment Date, if possible, or, if not possible, on the
Dividend Payment Date, and in such case the Fund shall not be deemed to have
failed to declare a dividend otherwise required to be declared, or (ii)
deposit, irrevocably in trust, in same-day funds, with the Auction Agent by
12:00 noon, New York City time, (A) on such Dividend Payment Date the full
amount of any cash dividend on such shares payable (if declared) on such
Dividend Payment Date or (B) on any redemption date for any APS called for
redemption, the Mandatory Redemption Price per share of such APS or, in the
case of an optional redemption, the Optional Redemption Price per share. Such
Non-Payment Period will consist of the period commencing on and including the
aforementioned Dividend Payment Date or redemption date, as the case may be,
and ending on and including the Business Day on which, by 12:00 noon, New York
City time, all unpaid cash dividends and unpaid redemption prices shall have
been so deposited or otherwise shall have been made available to the applicable
holders in same-day funds, provided that a Non-Payment Period for the APS will
not end unless the Fund shall have given at least five days' but no more than
30 days' written notice of such deposit or availability to the Auction Agent,
the Securities Depository and all holders of the APS of such series.
Notwithstanding the foregoing, the failure by the Fund to deposit funds as
provided for by clauses (ii)(A) or (ii )(B) above within three Business Days
after any Dividend Payment Date or redemption date, as the case may be, in each
case to the extent contemplated below, shall not constitute a "Non-Payment
Period." The Applicable Rate for each Dividend Period for the APS of any
series, commencing during a Non-Payment Period, will be equal to the
Non-Payment Period Rate; and each Dividend Period commencing after the first
day of, and during, but not after the end of, a Non-Payment Period shall be a
7-Day Dividend Period. Any dividend on the APS due on any Dividend Payment Date
for such shares (if, prior to the close of business on the second Business Day
preceding such Dividend Payment Date, the Fund has declared such dividend
payable on such Dividend Payment Date to the persons who held such shares as of
12:00 noon, New York City time, on the Business Day preceding such Dividend
Payment Date) or redemption price with respect to such shares not paid to such
persons when due may be paid to such persons in the same form of funds by 12:00
noon, New York City time, on any of the first three
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52
Description of APS
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Business Days after such Dividend Payment Date or due date, as the case may be,
provided that such amount is accompanied by a late charge calculated for such
period of non-payment at the Non-Payment Period Rate applied to the amount of
such non-payment based on the actual number of days comprising such period
(excluding any days that would have been Business Days but for the occurrence
of any unforeseen event or unforeseen events that caused such days not to be
Business Days) divided by 365 and in such case such period shall not constitute
a Non-Payment Period; provided, however, that the Fund shall not be required to
pay any late charge if it declares a dividend on the Dividend Payment Date or
the Business Day immediately preceding such Dividend Payment Date in accordance
with clause (i) of the definition of "Non-Payment Period" and deposits payment
for such dividend as contemplated by clause (ii)(A) of the definition of
"Non-Payment Period" on or before the second Business Day succeeding the day on
which the dividend was declared. In the case of a willful failure of the Fund
to pay a dividend on a Dividend Payment Date or to redeem any APS on the date
set for such redemption, the preceding sentence shall not apply and the
Applicable Rate for the Dividend Period commencing during the Non-Payment
Period resulting from such failure shall be the Non-Payment Period Rate. For
purposes of the foregoing, payment to a person in same-day funds on any
Business Day at any time will be considered equivalent to payment to that
person in New York Clearing House (next-day) funds at the same time on the
preceding Business Day, and any payment made after 12:00 noon, New York City
time, on any Business Day shall be considered to have been made instead in the
same form of funds and to the same person before 12:00 noon, New York City
time, on the next Business Day. The "Non-Payment Period Rate" initially will be
300% of the applicable Reference Rate, provided that the Board of Trustees of
the Fund shall have the authority to adjust, modify, alter or change from time
to time the initial Non-Payment Period Rate if the Board of Trustees of the
Fund determines and Moody's (or any Substitute Rating Agency in lieu of Moody's
in the event Moody's shall not rate the APS) advises the Fund in writing that
such adjustment, modification, alteration or change will not adversely affect
its then current rating on the APS.
Restrictions on Dividends and Other Payments
Under the 1940 Act, the Fund may not declare dividends or make other
distributions on Common Shares or purchase any such shares if, at the time of
the declaration, distribution or purchase, as applicable (and after giving
effect thereto), asset coverage (as defined in the 1940 Act) with respect to
the outstanding APS would be less than 200% (or such other percentage as in the
future may be required by law). The foregoing limitations on dividends, other
distributions and purchases in certain circumstances may impair the Fund's
ability to maintain its qualification as a regulated investment company under
the Code. See "Tax matters." Upon any failure to pay dividends on the APS for
two years or more, the holders of the APS will acquire certain additional
voting rights. See "--Voting Rights" below.
For so long as any APS are outstanding, the Fund will not declare, pay or set
apart for payment any dividend or other distribution (other than a dividend or
distribution paid in shares of, or options, warrants or rights to subscribe for
or purchase, Common Shares or other shares, if any, ranking junior to the APS
as to dividends or upon liquidation) in respect of Common Shares or any other
shares of the Fund ranking junior to or on a parity with the APS as to
dividends or upon liquidation, or call for redemption, redeem, purchase or
otherwise acquire for consideration any Common Shares or any other such junior
shares (except by conversion into or exchange for shares of beneficial interest
of the Fund ranking junior to APS as to dividends and upon liquidation) or any
such parity shares (except by conversion into or exchange for shares of
beneficial interest of the Fund ranking junior to or on a parity with APS as to
dividends and upon liquidation), unless:
.. immediately after such transaction, the Fund would have Moody's Eligible
Assets with an aggregate Discounted Value equal to or greater than the APS
Basic Maintenance Amount, and the 1940 Act APS Asset Coverage would be
satisfied (see "--Asset Maintenance" and "--Redemption" below);
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53
Description of APS
--------------------------------------------------------------------------------
.. full cumulative dividends on the APS due on or prior to the date of the
transaction have been declared and paid or shall have been declared and
sufficient funds for the payment thereof deposited with the Auction Agent;
and
.. the Fund has redeemed the full number of APS required to be redeemed by any
provision for mandatory redemption contained in the Amended Bylaws.
ASSET MAINTENANCE
The Fund will be required to satisfy two separate asset maintenance
requirements under the terms of the Amended Bylaws. These requirements are
summarized below.
1940 Act APS Asset Coverage
The Fund will be required under the Amended Bylaws to maintain, with respect to
the APS, as of the last Business Day of each month in which any APS are
outstanding, asset coverage (as defined in the 1940 Act) of at least 200% with
respect to senior securities which are shares of beneficial interest in the
Fund, including the APS (or such other asset coverage as in the future may be
specified in or under the 1940 Act as the minimum asset coverage for senior
securities which are shares of beneficial interest of a closed-end investment
company as a condition of paying dividends on its common stock) ("1940 Act APS
Asset Coverage"). If the Fund fails to maintain 1940 Act APS Asset Coverage and
such failure is not cured as of the last Business Day of the following month
(the "1940 Act Cure Date"), the Fund will be required under certain
circumstances to redeem certain of the APS. See "--Redemption" below.
The 1940 Act APS Asset Coverage immediately following the issuance of APS
offered hereby (after giving effect to the deduction of the sales load and
offering expenses for the APS), computed using the Fund's net assets as of May
13, 2003, and assuming the APS had been issued as of such date, will be as
follows:
Value of the Fund assets less liabilities = = 284%
not constituting senior securities $1,490,178,019
----------------------------------------- --------------
Senior securities representing indebtedness $525,000,000
plus liquidation value of the APS
APS Basic Maintenance Amount
So long as any APS are outstanding and any Rating Agency so requires, the Fund
will be required under the Amended Bylaws to maintain as of the last Business
Day of each week commencing with the Date of Original Issue (a "Valuation
Date") Moody's Eligible Assets having an aggregate Discounted Value at least
equal to the APS Basic Maintenance Amount. If the Fund fails to meet such
requirement as of any Valuation Date and such failure is not cured on or before
the sixth Business Day after such Valuation Date (the "APS Basic Maintenance
Cure Date"), the Fund will be required in certain circumstances to redeem
certain of the APS. Upon any failure to maintain the required Discounted Value,
the Fund will use its best efforts to alter the composition of its portfolio to
retain a Discounted Value at least equal to the APS Basic Maintenance Amount on
or prior to the APS Basic Maintenance Cure Date. See "--Redemption."
The "APS Basic Maintenance Amount," as of any Valuation Date, means the dollar
amount equal to the sum of (i)(A) the product of the number of APS outstanding
on such date multiplied by $25,000, plus any redemption premium applicable to
APS then subject to redemption; (B) the aggregate amount of dividends that will
have accumulated at the respective Applicable Rates (whether or not earned or
declared) to (but not including) the first respective Dividend Payment Dates
for each series of APS
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54
Description of APS
--------------------------------------------------------------------------------
outstanding that follow such Valuation Date (plus the aggregate amount of
dividends, whether or not earned or declared, that will have accumulated in
respect of other outstanding Preferred Shares to, but not including, the first
respective dividend payment dates for such other shares that follow such
Valuation Date); (C) the aggregate amount of dividends that would accumulate on
shares of each series of APS outstanding from such first respective Dividend
Payment Date therefor through the 49th day after such Valuation Date, at the
Maximum Applicable Rate (calculated as if such Valuation Date were the Auction
Date for the Dividend Period commencing on such Dividend Payment Date) for a
7-Day Dividend Period of shares of such series to commence on such Dividend
Payment Date, multiplied by the Volatility Factor (except that (1) if such
Valuation Date occurs during a Non-Payment Period, the dividend for purposes of
calculation would accumulate at the then current Non-Payment Period Rate and
(2) for those days during the period described in this clause (C) in respect of
which the Applicable Rate in effect immediately prior to such Dividend Payment
Date will remain in effect, the dividend for purposes of calculation would
accumulate at such Applicable Rate in respect of those days); (D) the amount of
anticipated expenses of the Fund for the 90 days subsequent to such Valuation
Date; and (E) any current liabilities as of such Valuation Date to the extent
not reflected in any of (i)(A) through (i)(D) (including, without limitation,
any payables for portfolio securities of the Fund purchased as of such
Valuation Date and any liabilities incurred for the purpose of clearing
securities transactions) less (ii) the value (i.e., the face value of cash,
short-term securities rated MIG-1, VMIG-1 or P-1, and short-term securities
that are the direct obligation of the U.S. government, provided in each case
that such securities mature on or prior to the date upon which any of (i)(A)
through (i)(E) become payable, otherwise the Discounted Value) of any of the
Fund's assets irrevocably deposited by the Fund for the payment of any of
(i)(A) through (i)(E).
For purposes of determining whether the Fund has Moody's Eligible Assets with
an aggregate Discounted Value that equals or exceeds the APS Basic Maintenance
Amount, the Discounted Value of Moody's Eligible Assets that the Fund is
obligated to deliver or receive pursuant to an outstanding futures contract or
option shall be as follows: (i) assets subject to call options written by the
Fund that are either exchange-traded and "readily reversible" or that expire
within 49 days after the date as of which such valuation is made shall be
valued at the lesser of (A) Discounted Value and (B) the exercise price of the
call option written by the Fund; (ii) assets subject to call options written by
the Fund not meeting the requirements of clause (i) of this sentence shall have
no value; (iii) assets subject to put options written by the Fund shall be
valued at the lesser of (A) the exercise price and (B) the Discounted Value of
the assets subject to the option; (iv) futures contracts shall be valued at the
lesser of (A) settlement price and (B) the Discounted Value of the assets
subject to the futures contract, provided that, if a contract matures within 49
days after the date as of which such valuation is made, where the Fund is the
seller the contract may be valued at the settlement price and where the Fund is
the buyer the contract may be valued at the Discounted Value of the assets
subject to the futures contract; and (v) where delivery may be made to the Fund
with any security of a class of securities, the Fund shall assume that it will
take delivery of the security with the lowest Discounted Value.
In addition, for purposes of determining whether the Fund has Moody's Eligible
Assets with an aggregate Discounted Value that equals or exceeds the APS Basic
Maintenance Amount, the following amounts shall be subtracted from the
aggregate Discounted Value of the Moody's Eligible Assets held by the Fund to
the extent the relevant asset is a Moody's Eligible Asset: (i) 10% of the
exercise price of a written call option; (ii) the exercise price of any written
put option; (iii) where the Fund is the seller under a financial futures
contract, 10% of the settlement price of the financial futures contract; (iv)
where the Fund is the purchaser under a financial futures contract, any amounts
payable by the Fund under such financial futures contract; (v) the settlement
price of the underlying financial futures contract if the Fund writes put
options on a financial futures contract; and (vi) 105% of the Market Value of
the underlying financial futures contracts if the Fund writes call options on a
financial futures contract and does not
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55
Description of APS
--------------------------------------------------------------------------------
own the underlying contract. The Discounted Value of all forward commitments to
which the Fund is a party and of all securities deliverable to the Fund
pursuant to such forward commitments shall be zero.
The Discount Factors and guidelines for determining the market value of the
Fund's portfolio holdings have been based on criteria established in connection
with rating the APS. These factors include, but are not limited to, the
sensitivity of the market value of the relevant asset to changes in interest
rates, the liquidity and depth of the market for the relevant asset, the credit
quality of the relevant asset (for example, the lower the rating of a debt
obligation, the higher the related Discount Factor) and the frequency with
which the relevant asset is marked to market. In no event shall the Discounted
Value of any asset of the Fund exceed its unpaid principal balance or face
amount as of the date of calculation. The Discount Factor relating to any asset
of the Fund and the APS Basic Maintenance Amount, the assets eligible for
inclusion in the calculation of the Discounted Value of the Fund's portfolio
and certain definitions and methods of calculation relating thereto may be
changed from time to time by the Fund, without shareholder approval, if Moody's
or any Substitute Rating Agency advises the Fund in writing that such change
will not adversely affect its then current rating in the APS.
On or before the third Business Day after a Valuation Date on which the Fund
fails to maintain Moody's Eligible Assets with an aggregate Discounted Value
equal to or greater than the APS Basic Maintenance Amount, the Fund is required
to deliver to the Auction Agent and Moody's a report with respect to the
calculation of the APS Basic Maintenance Amount and the value of its portfolio
holdings (an "APS Basic Maintenance Report") as of the date of such failure.
Additionally, on or before the third Business Day after the first day of a
Special Dividend Period, the Fund will deliver an APS Basic Maintenance Report
to Moody's and the Auction Agent. The Fund also will deliver an APS Basic
Maintenance Report as of the last Business Day of the last month of each fiscal
quarter of the Fund on or before the third Business Day after such day. Within
ten Business Days after delivery of such report relating to the last Business
Day of the last month of each fiscal quarter of the Fund, the Fund's
independent accountants will confirm in writing to the Auction Agent and
Moody's the mathematical accuracy of the calculations made by the Fund in its
most recent APS Basic Maintenance Report (and in another APS Basic Maintenance
Report, randomly selected by the Fund's independent accountants, that was
delivered during such fiscal quarter). Also, on or before 5:00 p.m., New York
City time, on the first Business Day after any Common Shares are repurchased by
the Fund, the Fund will complete and deliver to Moody's an APS Basic
Maintenance Report as of the close of business on such date that Common Shares
are repurchased. If any such letter prepared by the Fund's independent
accountants shows that an error was made in the most recent APS Basic
Maintenance Report, the calculation or determination made by the Fund's
independent accountants will be conclusive and binding on the Fund.
REDEMPTION
Optional Redemption
To the extent permitted under the 1940 Act and under Massachusetts law, upon
giving notice of redemption, as provided below, the Fund, at its option, may
redeem the APS, in whole or in part, out of funds legally available therefor,
at the Optional Redemption Price per share on any Dividend Payment Date;
provided that no APS may be redeemed at the option of the Fund during (a) the
Initial Dividend Period with respect to the APS or (b) a Non-Call Period to
which such shares are subject. "Optional Redemption Price" means $25,000 per
share plus an amount equal to accumulated but unpaid dividends (whether or not
earned or declared) to the date fixed for redemption plus any applicable
redemption premium attributable to the designation of a Premium Call Period.
Mandatory Redemption
Under the Fund's Amended Bylaws, the Fund will be required to redeem, out of
funds legally available therefor, at the Mandatory Redemption Price per share,
the APS to the extent permitted under the 1940
--------------------------------------------------------------------------------
56
Description of APS
--------------------------------------------------------------------------------
Act and Massachusetts law, on a date fixed by the Board of Trustees, if the
Fund fails to maintain Moody's Eligible Assets with an aggregate Discounted
Value equal to or greater than the APS Basic Maintenance Amount or to satisfy
the 1940 Act APS Asset Coverage and such failure is not cured on or before the
APS Basic Maintenance Cure Date or the 1940 Act Cure Date (herein collectively
referred to as a "Cure Date"), as the case may be. "Mandatory Redemption Price"
for each series of APS means $25,000 per APS plus an amount equal to
accumulated but unpaid dividends (whether or not earned or declared) to (but
not including) the date fixed for redemption. The number of APS to be redeemed
will be equal to the lesser of (a) the minimum number of APS the redemption of
which, if deemed to have occurred immediately prior to the opening of business
on the Cure Date, together with all Preferred Shares subject to redemption or
retirement, would result in the Fund having Moody's Eligible Assets with an
aggregate Discounted Value equal to or greater than the APS Basic Maintenance
Amount or satisfaction of the 1940 Act APS Asset Coverage, as the case may be,
on such Cure Date (provided that, if there is no such minimum number of shares
the redemption of which would have such result, all APS and other Preferred
Shares then outstanding will be redeemed), and (b) the maximum number of APS,
together with all other Preferred Shares subject to redemption or retirement,
that can be redeemed out of funds expected to be legally available therefor on
such redemption date. In determining the number of APS required to be redeemed
in accordance with the foregoing, the Fund shall allocate the number required
to be redeemed which would result in the Fund having Moody's Eligible Assets
with an aggregate Discounted Value equal to or greater than the APS Basic
Maintenance Amount or satisfaction of the 1940 Act APS Asset Coverage, as the
case may be, pro rata among APS of all series and other Preferred Shares
subject to redemption pursuant to provisions similar to those set forth below;
provided that APS that may not be redeemed at the option of the Fund due to the
designation of a Non-Call Period applicable to such shares (A) will be subject
to mandatory redemption only to the extent that other shares are not available
to satisfy the number of shares required to be redeemed and (B) will be
selected for redemption in an ascending order of outstanding number of days
remaining in the Non-Call Period (with shares with the lowest number of days to
be redeemed first) and by lot in the event of shares having an equal number of
days in such Non-Call Period. The Fund is required to effect such a mandatory
redemption not later than 35 days after such Cure Date, except that if the Fund
does not have funds legally available for the redemption of all of the required
number of APS which are subject to mandatory redemption or the Fund otherwise
is unable to effect such redemption on or prior to 35 days after such Cure
Date, the Fund will redeem those APS which it was unable to redeem on the
earliest practicable date on which it is able to effect such redemption out of
funds legally available therefor.
General
If the APS are to be redeemed, a notice of redemption will be mailed to each
record holder of such APS (initially Cede & Co. as nominee of the Securities
Depository) and to the Auction Agent not less than 17 nor more than 30 days
prior to the date fixed for the redemption thereof. Each notice of redemption
will include a statement setting forth: (i) the redemption date, (ii) the
aggregate number of APS to be redeemed, (iii) the redemption price, (iv) the
place or places where APS are to be surrendered for payment of the redemption
price, (v) a statement that dividends on the shares to be redeemed will cease
to accumulate on such redemption date, and (vi) the provision of the Amended
Bylaws pursuant to which such shares are being redeemed. No defect in the
notice of redemption or in the mailing or publication thereof will affect the
validity of the redemption proceedings, except as required by applicable law.
If less than all of the outstanding APS of a series are to be redeemed, the
shares of that series to be redeemed will, unless otherwise required for the
Amended Bylaws, be selected by lot or such other method as the Fund deems fair
and equitable, and the results thereof will be communicated to the Auction
Agent. The Auction Agent will give notice to the Securities Depository, whose
nominee will be
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57
Description of APS
--------------------------------------------------------------------------------
the record holder of all APS, and the Securities Depository will determine the
number of shares to be redeemed from the account of the Agent Member of each
Existing Holder. Each Agent Member will determine the number of shares to be
redeemed from the account of each Existing Holder for which it acts as agent.
An Agent Member may select for redemption shares from the accounts of some
Existing Holders without selecting for redemption any shares from the accounts
of other Existing Holders. Notwithstanding the foregoing, if neither the
Securities Depository nor its nominee is the record holder of all of the APS
series, the particular shares to be redeemed shall be selected by the Fund by
lot or by such other method as the Fund deems fair and equitable.
If the Fund gives notice of redemption, and concurrently or thereafter deposits
in trust with the Auction Agent, or segregates in an account at the Fund's
custodian bank for the benefit of the Auction Agent, Deposit Securities (with a
right of substitution) having an aggregate Discounted Value equal to the
redemption payment for the APS as to which notice of redemption has been given,
with irrevocable instructions and authority to pay the redemption price to the
record holders thereof, then upon the date of such deposit or, if no such
deposit is made, upon such date fixed for redemption (unless the Fund defaults
in making payment of the redemption price), all rights (including, without
limitation, voting rights) of the holders of such shares called for redemption
will cease and terminate, except the right of such holders to receive the
redemption price thereof, but without interest, and such shares no longer will
be deemed to be outstanding. The Fund will be entitled to receive, from time to
time, the interest, if any, earned on such Deposit Securities deposited with
the Auction Agent, and the holders of any shares so redeemed will have no claim
to any such interest. Any funds so deposited which are unclaimed at the end of
one year from such redemption date will be repaid, upon demand, to the Fund,
after which the holders of the APS of such series so called for redemption may
look only to the Fund for the redemption payment.
So long as any APS are held of record by the nominee of the Securities
Depository (initially Cede & Co.), the redemption price for such shares will be
paid on the redemption date to the nominee of the Securities Depository. The
Securities Depository's normal procedures now provide for it to distribute the
amount of the redemption price to Agent Members who, in turn, are expected to
distribute such funds to the persons for whom they are acting as agent.
Notwithstanding the provisions for redemption described above, no APS shall be
subject to optional redemption (i) unless all dividends in arrears on the
outstanding APS, and all shares of beneficial interest of the Fund ranking on a
parity with the APS with respect to the payment of dividends or upon
liquidation, have been or are being contemporaneously paid or declared and set
aside for payment and (ii) if redemption thereof would result in the Fund's
failure to maintain Moody's Eligible Assets with an aggregate Discounted Value
equal to or greater than the APS Basic Maintenance Amount.
LIQUIDATION RIGHTS
Upon any liquidation, dissolution or winding up of the Fund, whether voluntary
or involuntary, the holders of APS of each series will be entitled to receive,
out of the assets of the Fund available for distribution to shareholders,
before any distribution or payment is made upon any Common Shares or any other
shares of beneficial interest of the Fund ranking junior in right of payment
upon liquidation to APS, $25,000 per share together with the amount of any
dividends accumulated but unpaid (whether or not earned or declared) thereon to
the date of distribution. If such assets of the Fund are insufficient to make
the full liquidation payment on outstanding APS and liquidation payments on any
other outstanding class or series of Preferred Shares of the Fund ranking on a
parity with the APS as to payment upon liquidation, then such assets will be
distributed among the holders of APS and the holders of shares of such other
class or series ratably in proportion to the respective preferential amounts to
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58
Description of APS
--------------------------------------------------------------------------------
which they are entitled. After payment of the full amount of liquidation
distribution to which they are entitled, the holders of APS will not be
entitled to any further participation in any distribution of assets by the
Fund. A consolidation, merger or share exchange of the Fund with or into any
other entity or entities or a sale, whether for cash, shares of stock,
securities or properties, of all or substantially all or any part of the assets
of the Fund shall not be deemed or construed to be a liquidation, dissolution
or winding up of the Fund.
VOTING RIGHTS
Except as otherwise indicated in this Prospectus and except as otherwise
required by applicable law, holders of APS will be entitled to one vote per
share on each matter submitted to a vote of shareholders and will vote together
with holders of Common Shares and other Preferred Shares as a single class.
In connection with the election of the Fund's Trustees, holders of the APS and
any other Preferred Shares, voting as a separate class, shall be entitled at
all times to elect two of the Fund's Trustees, and the remaining Trustees will
be elected by holders of Common Shares and APS and any other Preferred Shares,
voting together as a single class. In addition, if at any time dividends
(whether or not earned or declared) on any outstanding Preferred Shares of the
Fund, including APS, are due and unpaid in an amount equal to at least two full
years of dividends, and sufficient cash or specified securities have not been
deposited with the Auction Agent for the payment of such dividends, or if at
any time holders of any shares of Preferred Shares are entitled, together with
the holders of the APS, to elect a majority of the Trustees of the Fund under
the 1940 Act, then the number of Trustees constituting the Board of Trustees
automatically shall be increased by the smallest number that, when added to the
two Trustees elected exclusively by the holders of APS and any other Preferred
Shares as described above, would constitute a majority of the Board of Trustees
as so increased, and at a special meeting of shareholders which will be called
and held as soon as practicable thereafter, and at all subsequent meetings at
which Trustees are to be elected until all dividends in arrears have been paid
or otherwise provided for, the holders of the APS and any other Preferred
Shares, voting as a separate class, will be entitled to elect the smallest
number of additional Trustees that, together with the two Trustees that such
holders in any event will be entitled to elect, constitutes a majority of the
total number of Trustees of the Fund as so increased. The terms of office of
the persons who are Trustees at the time of that election will continue, unless
otherwise terminated pursuant to the Declaration or Amended Bylaws. If the Fund
thereafter shall pay, or declare and set apart for payment in full, all
dividends payable on all outstanding APS and any other Preferred Shares for all
past Dividend Periods, the additional voting rights of the holders of APS and
any other Preferred Shares as described above shall cease, and the terms of
office of all of the additional Trustees elected by the holders of APS and any
other Preferred Shares (but not of the Trustees with respect to whose election
the holders of Common Shares were entitled to vote or the two Trustees the
holders of APS and any other Preferred Shares have the right to elect in any
event) will terminate automatically.
Unless a higher percentage is provided for under the Declaration or the Amended
Bylaws or applicable law, the affirmative vote of a majority of the votes
entitled to be cast by holders of outstanding APS and any other Preferred
Shares, voting together as a single class, will be required to (i) authorize,
create or issue any class or series of shares ranking prior to the APS or any
other series of Preferred Shares with respect to the payment of dividends or
the distribution of assets on liquidation; provided, however, that no vote is
required to authorize the issuance of another series of APS or another class of
Preferred Shares which are substantially identical in all respects to the APS;
or (ii) amend, alter or repeal the provisions of the Declaration or the Amended
Bylaws, whether by merger, consolidation or otherwise, so as to adversely
affect any of the contract rights expressly set forth in the Declaration or the
Amended Bylaws of holders of APS or any other Preferred Shares. To the extent
permitted under the 1940 Act, in the event shares of more than one series of
Preferred Shares are outstanding, the Fund shall not approve any of the
--------------------------------------------------------------------------------
59
Description of APS
--------------------------------------------------------------------------------
actions set forth in clause (i) or (ii) which adversely affects the contract
rights expressly set forth in the Declaration or the Amended Bylaws of a holder
of shares of a series of APS differently than those of a holder of shares of
any other series of APS without the affirmative vote of at least a majority of
votes entitled to be cast by holders of the APS of each series adversely
affected and outstanding at such time (each such adversely affected series
voting separately as a class). The Board of Trustees, however, without
shareholder approval, may amend, alter or repeal any or all of the various
Rating Agency guidelines described herein if Moody's (or any Substitute Rating
Agency) advises the Fund in writing that any such amendment, alteration or
repeal would not adversely affect the rating then assigned to the APS by such
Rating Agency. Unless a higher percentage is provided for under the Declaration
or the Amended Bylaws, the affirmative vote of a majority of the votes entitled
to be cast by holders of outstanding APS and any other Preferred Shares, voting
as a single class, will be required to approve any plan of reorganization
(including bankruptcy proceedings) adversely affecting such shares or any
action requiring a vote of security holders under Section 13(a) of the 1940 Act
including, among other things, changes in the investment restrictions described
as fundamental policies under "Investment Restrictions" in the Statement of
Additional Information. The class (and, where applicable, series) vote of
holders of APS and any other Preferred Shares described above in each case will
be in addition to a separate vote of the requisite percentage of Common Shares
and APS and any other Preferred Shares, voting together as a single class,
necessary to authorize the action in question.
The foregoing voting provisions will not apply with respect to APS if, at or
prior to the time when a vote is required, such shares have been (i) redeemed
or (ii) called for redemption and sufficient funds have been deposited in trust
to effect such redemption.
Management of the Fund
TRUSTEES AND OFFICERS
The Board of Trustees is responsible for the management of the Fund, including
supervision of the duties performed by the Manager and NACM. There are
presently three Trustees of the Fund, none of whom is currently treated by the
Fund as an "interested person" (as defined in the 1940 Act). The names and
business addresses of the Trustees and officers of the Fund and their principal
occupations and other affiliations during the past five years are set forth
under "Management of the Fund" in the Statement of Additional Information.
INVESTMENT MANAGER
PIMCO Advisors Fund Management LLC serves as the investment manager of the
Fund. Subject to the supervision of the Board of Trustees, the Manager is
responsible for managing, either directly or through others selected by it, the
investment activities of the Fund and the Fund's business affairs and other
administrative matters. The Manager is located at 1345 Avenue of the Americas,
New York, New York 10105.
Organized in 2000 as a subsidiary successor in the restructuring of a business
originally organized in 1987, the Manager provides investment management and
advisory services to several closed-end and open-end investment company
clients. As of March 31, 2003, the Manager had approximately $18.4 billion in
assets under management. Allianz Dresdner Asset Management of America L.P. is
the direct parent company of PIMCO Advisors Retail Holdings LLC, of which the
Manager is a wholly-owned subsidiary. As of March 31, 2003, Allianz Dresdner
Asset Management of America L.P. and its subsidiary partnerships, including
NACM, had approximately $392 billion in assets under management.
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60
Management of the Fund
--------------------------------------------------------------------------------
The Manager has retained its affiliate, NACM, to manage the Fund's investments.
See "--Portfolio Manager" below. The Manager and NACM are each majority-owned
indirect subsidiaries of Allianz AG, a publicly traded German insurance and
financial services company.
PORTFOLIO MANAGER
NACM serves as the portfolio manager for the Fund pursuant to a sub-advisory
agreement between the Manager and NACM. Subject to this agreement and the
supervision of the Manager, NACM has full investment discretion and makes all
determinations with respect to the investment of the Fund's assets.
NACM is located at 600 West Broadway, 30th Floor, San Diego, California 92101.
Founded in 1984, NACM currently manages discretionary assets for numerous
clients, including investment companies, employee benefit plans, corporations,
public retirement systems and unions, university endowments, foundations, and
other institutional investors and individuals. As of March 31, 2003, NACM had
approximately $16 billion in assets under management.
For its services pursuant to the sub-advisory agreement, the Manager (and not
the Fund) will pay to NACM a monthly fee equal to (i) fifty percent (50%) of
the management fees payable by the Fund to the Manager for such month with
respect to the first $300 million of the Fund's average daily total managed
assets and (ii) seventy-five percent (75%) of the management fees payable by
the Fund to the Manager for such month with respect to the Fund's average daily
total managed assets in excess of $300 million; provided, however, that the
amounts payable under (i) and (ii) above shall be reduced to reflect that NACM
will bear 50% and 75%, respectively, of any Service or Incentive Fees payable
by the Manager for such month with respect to the specified total managed
assets. For these purposes, "Service or Incentive Fees" for any period equals
the sum of any Shareholder Servicing Fees payable by the Manager to UBS Warburg
LLC (as described under "Shareholder servicing agent, custodian and transfer
agents") for such period and any incentive fees payable by the Manager to other
underwriters (in connection with the Fund's initial public offering of the
Common Shares) for such period.
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61
Management of the Fund
--------------------------------------------------------------------------------
The following six individuals are part of the Convertibles/High Yield team at
NACM and constitute the team that has primary responsibility for the day-to-day
portfolio management of the Fund, with Mr. Forsyth serving as the head of the
team:
Since Recent Professional Experience
------------------------------------------------------------------------------------------
Douglas Forsyth, CFA 2003 Mr. Forsyth is a Senior Portfolio Manager and Member of
(Inception) the Executive Committee at NACM. He joined NACM in
1994 after three years of investment management
experience at AEGON USA. Mr. Forsyth holds a B.B.A.
from the University of Iowa.
William L. Stickney 2003 Mr. Stickney is a portfolio manager at NACM. He joined
(Inception) NACM in 1999 after an aggregate of ten years of
investment experience with ABN AMRO, Inc., Cowen &
Company and Wayne Hummer & Company. Mr. Stickney
holds a B.S. from Miami University and is an M.M.
candidate at Northwestern University, J.L. Kellogg School
of Management.
Michael E. Yee 2003 Mr. Yee is a portfolio manager at NACM. He joined
(Inception) NACM in 1995 and has been a portfolio manager since
1998. Mr. Yee holds a B.S. from the University of
California, San Diego and an M.B.A. from San Diego
State University.
Justin Kass 2003 Mr. Kass is an investment analyst at NACM. He joined
(Inception) NACM in 2000 after serving as an intern on the
Convertibles/High Yield team and has four years of
investment experience. Mr. Kass holds a B.S. from the
University of California, Davis and an M.B.A. from the
Anderson School at the University of California, Los
Angeles.
Elizabeth Lemesevski 2003 Ms. Lemesevski is an investment analyst at NACM. She
(Inception) joined NACM in 2001 after an aggregate of nine years of
investment and research experience with T.A. McKay &
Co., Citibank and CoreStates Philadelphia International
Bank. Ms. Lemesevski holds a B.S. from Rutgers
University and an M.B.A. from Fordham University.
Nicole Larrabee 2003 Ms. Larrabee is a trading assistant/analyst at NACM. She
(Inception) joined NACM in 2000 after an aggregate of four years of
investment and research experience with Salomon Smith
Barney (Schroders), Lehman Brothers, Inc., Heflin and
Co., LLC, Sun Alliance Holdings, Ltd. and Cantor
Fitzgerald and Co., Inc. Ms. Larrabee holds a B.S. from
the University of Arizona.
INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an investment management agreement between the Manager and the Fund
(the "Investment Management Agreement"), the Fund has agreed to pay the Manager
an annual management fee payable
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62
Management of the Fund
--------------------------------------------------------------------------------
on a monthly basis at the annual rate of 0.70% of the Fund's average daily
total managed assets (including net assets attributable to Preferred Shares,
including the APS) for the services and facilities it provides.
In addition to the fees of the Manager, the Fund pays all other costs and
expenses of its operations, including compensation of its Trustees (other than
those affiliated with the Manager), custodial expenses, shareholder servicing
expenses, transfer agency and dividend disbursing expenses, legal fees,
expenses of independent auditors, expenses of repurchasing shares, expenses of
issuing the APS and any other Preferred Shares, expenses of preparing, printing
and distributing prospectuses, shareholder reports, notices, proxy statements
and reports to governmental agencies, and taxes, if any.
Because the fees received by the Manager and NACM are based on the total
managed assets of the Fund (including assets attributable to the APS and any
other forms of leverage created that may be outstanding), the Manager and NACM
each have a financial incentive for the Fund to issue APS and utilize other
forms of leverage, which may create a conflict of interest between the
Manager/NACM and the holders of the Fund's Common Shares.
Net asset value
The net asset value ("NAV") of the Fund equals the total value of the Fund's
portfolio investments and other assets, less any liabilities. For purposes of
calculating NAV, portfolio securities and other assets for which market quotes
are available are stated at market value. Market value is generally determined
on the basis of the last reported sales price (or the NASDAQ Official Closing
Price for NASDAQ-reported securities), or if no sales are reported, based on
quotes obtained from a quotation reporting system, established market makers or
pricing services. Certain securities or investments for which market quotations
are not readily available may be valued, pursuant to guidelines established by
the Board of Trustees, with reference to other securities or indexes. For
instance, a pricing service may recommend a fair market value based on prices
of comparable securities. Short-term investments having a maturity of 60 days
or less are generally valued at amortized cost. Other securities for which
market quotes are not readily available are valued at fair value as determined
in good faith by the Board of Trustees or persons acting at its direction.
The NAV of the Fund will be determined as of the close of regular trading on
the New York Stock Exchange (normally 4:00 p.m., Eastern time) (the "NYSE
Close") on each day the New York Stock Exchange is open. For purposes of
calculating the NAV, the Fund normally uses pricing data for domestic equity
securities received shortly after the NYSE Close and does not normally take
into account trading, clearances or settlements that take place after the NYSE
Close. Domestic securities and foreign securities are normally priced using
data reflecting the earlier closing of the principal markets for those
securities. Information that becomes known to the Fund or its agent after the
Fund's NAV has been calculated on a particular day will not be used to
retroactively adjust the price of a security or the Fund's NAV determined
earlier that day.
Investments initially valued in currencies other than the U.S. dollar are
converted to U.S. dollars using exchange rates obtained from pricing services.
As a result, the NAV of the Fund's shares may be affected by changes in the
value of currencies in relation to the U.S. dollar. The value of securities
traded in markets outside the United States or denominated in currencies other
than the U.S. dollar may be affected significantly on a day that the New York
Stock Exchange is closed.
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63
Net asset value
--------------------------------------------------------------------------------
In unusual circumstances, instead of valuing securities in the usual manner,
the Fund may value securities at fair value as determined in good faith by the
Board of Trustees, generally based upon recommendations provided by NACM. The
Fund may also be required to use fair valuation as a result of events occurring
after the close of the relevant market but prior to the NYSE Close.
Tax matters
FEDERAL INCOME TAX MATTERS
The following federal income tax discussion is based on the advice of Ropes &
Gray LLP, counsel to the Fund, and reflects provisions of the Code, existing
U.S. Treasury regulations, rulings published by the IRS, and other applicable
authority, as of the date of this Prospectus. These authorities are subject to
change by legislative or administrative action, possibly with retroactive
effect. The following discussion is only a summary of some of the important tax
considerations generally applicable to investments in the Fund. For more
detailed information regarding tax considerations, see the Statement of
Additional Information. There may be other tax considerations applicable to
particular investors. In addition, income earned through an investment in the
Fund may be subject to state, local and foreign taxes.
The Fund intends to qualify each year for taxation as a regulated investment
company eligible for treatment under the provisions of Subchapter M of the
Code. If the Fund so qualifies and satisfies certain distribution requirements,
the Fund will not be subject to federal income tax on income distributed in a
timely manner to its shareholders in the form of dividends or capital gain
distributions.
In order for any portion of any distributions to holders of APS to be eligible
to be treated as capital gain dividends, the APS must be treated as equity for
federal income tax purposes. Based in part on certain representations made by
the Fund to Ropes & Gray LLP relating to the lack of any present intention to
redeem or purchase APS at any time in the future, it is the opinion of Ropes &
Gray LLP that the APS will constitute equity for federal income tax purposes.
This opinion relies in part on a published ruling of the IRS stating that
certain auction rate preferred stock similar in many material respects to the
APS represents equity. The opinion of Ropes & Gray LLP represents only its best
legal judgment and is not binding on the IRS or the courts. If the IRS were to
assert successfully that variable rate preferred stock such as the APS should
be treated as debt for federal income tax purposes, distributions on APS
(including distributions designated by the Fund as capital gain dividends)
would be taxable as ordinary income (as opposed to capital gains). Ropes & Gray
LLP has advised the Fund that, should the IRS pursue in court the position that
the APS should be treated as debt for federal income tax purposes, the IRS
would be unlikely to prevail.
To satisfy the distribution requirements applicable to regulated investment
companies, amounts paid as dividends by the Fund to its shareholders, including
holders of APS, must qualify for the dividends-paid deduction. If the Fund
realizes a long-term capital gain, it will be required to allocate such gain
between and among the Common Shares and any Preferred Shares issued by the Fund
in proportion to the total dividends paid to each class during the year in
which the income is realized. In certain circumstances, the IRS could take the
position that dividends paid on the APS constitute preferential dividends under
Section 562(c) of the Code, and thus do not qualify for the dividends-paid
deduction.
If at any time when APS are outstanding the Fund does not meet applicable asset
coverage requirements, it will be required to suspend distributions to Common
Shareholders until the requisite asset coverage is restored. Any such
suspension may cause the Fund to pay a 4% federal excise tax (imposed on
regulated
--------------------------------------------------------------------------------
64
Tax matters
--------------------------------------------------------------------------------
investment companies that fail to distribute for a given calendar year,
generally, at least 98% of their net investment income and capital gain net
income) and income tax on undistributed income or gains, and may, in certain
circumstances, prevent the Fund from qualifying for treatment as a regulated
investment company. The Fund may redeem APS in an effort to comply with the
distribution requirement applicable to regulated investment companies and to
avoid income and excise taxes. The Fund may have to dispose of portfolio
securities to generate cash for such redemption, which may result in
transaction expenses and gain at the Fund level and in further distributions.
The Fund's investments in certain debt obligations may cause the Fund to
recognize taxable income in excess of the cash generated by such obligations.
Thus, the Fund could be required at times to liquidate other investments in
order to satisfy its distribution requirements.
For federal income tax purposes, distributions of investment income are taxable
as ordinary income. Whether distributions of capital gains are taxed as
ordinary income or capital gains is determined by how long the Fund owned the
investments that generated such capital gains, rather than how long a
shareholder has owned his or her shares. Distributions are taxable to
shareholders even if they are paid from income or gains earned by the Fund
before a shareholder's investment. Distributions of gains from the sale of
investments that the Fund owned for more than one year will be taxable as
capital gains. Distributions of gains from the sale of investments that the
Fund owned for one year or less will be taxable as ordinary income.
Distributions are taxable whether shareholders receive them in cash or reinvest
them in additional shares through the Dividend Reinvestment Plan for Common
Shares. Any gain or loss resulting from the sale or exchange of Fund shares
generally will be capital gain or loss (assuming the shares are held as a
capital asset), and such gain or loss will be long-term if such shares are held
for more than one year at the time of such sale or exchange.
The Fund's investments in foreign securities may be subject to foreign
withholding taxes. In that case, the Fund's yield on those securities would be
decreased. Shareholders will not be entitled to claim a credit or deduction
with respect to foreign taxes paid by the Fund. In addition, the Fund's
investments in foreign securities or foreign currencies may increase or
accelerate the Fund's recognition of ordinary income and may affect the timing
or amount of the Fund's distributions.
Under current law, the backup withholding rate is 30% for amounts paid during
2003 if the Fund is required to apply backup withholding to taxable
distributions payable to a shareholder. Please see "Tax Matters" in the
Statement of Additional Information for additional information about (and
possible changes to) the new backup withholding tax rates.
If, in connection with the designation of a Special Dividend Period, (i) the
Fund provides in a Notice of Special Dividend Period that the Fund may redeem
all or part of a series of APS and that upon such redemption the holders of
that series of APS may receive a premium in addition to receipt of a redemption
price per share equal to the sum of $25,000 plus an amount equal to the
accumulated but unpaid dividends thereon during the whole or any part of the
Special Dividend Period, (ii) based on all the facts and circumstances at the
time of the designation of the Special Dividend Period the Fund is more likely
than not to redeem such series of APS during the Special Dividend Period, and
(iii) the premium to be paid upon redemption during such Special Dividend
Period exceeds a specified de minimis amount, it is possible that the holders
of such series will be required to accrue the premium as a dividend (to the
extent of the Fund's earnings and profits).
The Bush Administration has announced, and Congress is currently considering, a
proposal to reduce or eliminate the tax on dividends. Many of the details of
the proposal have not been specified, and the prospects for this proposal are
unclear. Accordingly, it is not possible to evaluate how this proposal
--------------------------------------------------------------------------------
65
Tax matters
--------------------------------------------------------------------------------
might affect the tax discussion above. The elimination of the taxation of
corporation distributions may reduce the value of, and thus the return on,
previously issued debt obligations and similar securities which are part of the
Fund's investment portfolio. This change could reduce the Fund's net asset
value and distributions made by the Fund.
This section relates only to federal income tax consequences of investing in
the Fund; the consequences under other tax laws may differ. You should consult
your tax advisor as to the possible application of foreign, state and local
income tax laws to Fund dividends and capital distributions. Please see "Tax
Matters" in the Statement of Additional Information for additional information
regarding the tax aspects of investing in the Fund.
Description of capital structure
The Fund is an unincorporated business trust established under the laws of The
Commonwealth of Massachusetts by the Declaration. The Declaration provides that
the Trustees of the Fund may authorize separate classes of shares of beneficial
interest. The Trustees have authorized an unlimited number of Common Shares and
Preferred Shares. Preferred Shares (such as the APS) may be issued in one or
more series, with such par value and with such rights as determined by the
Board of Trustees, by action of the Board of Trustees without the approval of
the Common Shareholders. For a description of the APS, see "Description of APS"
above. The following table shows the amount of (i) shares authorized and (ii)
shares outstanding, for each class of authorized securities of the Fund as of
May 13, 2003:
Amount Amount
Title of Class Authorized Outstanding
---------------------------------------
Common Shares. Unlimited 65,351,981
APS
Series A... 4,200(1) 0
Series B... 4,200(1) 0
Series C... 4,200(1) 0
Series D... 4,200(1) 0
Series E... 4,200(1) 0
(1) Assumes the authorization of 21,000 APS by the Board of Trustees prior
to issuance of the APS.
Holders of Common Shares are entitled to share equally in dividends declared by
the Board of Trustees payable to holders of Common Shares and in the net assets
of the Fund available for distribution to holders of Common Shares after
payment of the preferential amounts payable to holders of any outstanding
Preferred Shares. Neither holders of Common Shares nor holders of Preferred
Shares have pre-emptive or conversion rights or have the right to cause the
Fund to redeem their shares. Upon liquidation of the Fund, after paying or
adequately providing for the payment of all liabilities of the Fund and the
liquidation preference with respect to any outstanding Preferred Shares, and
upon receipt of such releases, indemnities and refunding agreements as they
deem necessary for their protection, the Trustees may distribute the remaining
assets of the Fund among the holders of the Fund's Common Shares.
Pursuant to the Fund's Dividend Reinvestment Plan, all Common Shareholders
whose shares are registered in their own names will have all dividends,
including any capital gain dividends, reinvested automatically in additional
Common Shares by PFPC, Inc., as agent for the Common Shareholders, unless the
shareholder elects to receive cash. The Fund and PFPC, Inc. reserve the right
to amend or terminate the Dividend Reinvestment Plan.
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66
Description of capital structure
--------------------------------------------------------------------------------
Holders of Common Shares are entitled to one vote for each share held and will
vote with the holders of any outstanding APS or other Preferred Shares on each
matter submitted to a vote of holders of Common Shares, except as described
under "Description of APS--Voting Rights" and except as otherwise required by
the Declaration, the Amended Bylaws or applicable law.
Shareholders of each class are entitled to one vote for each share held. Except
as provided under "Description of APS--Voting Rights" and except as otherwise
required by the Declaration, the Amended Bylaws or applicable law, holders of
APS are (voting as a separate class) entitled to elect two Trustees, and the
remaining Trustees shall be elected by holders of Common Shares and APS, voting
as a single class.
So long as any APS or any other Preferred Shares are outstanding, holders of
Common Shares will not be entitled to receive any dividends of or other
distributions from the Fund, unless at the time of such declaration, (1) all
accrued dividends on APS and any other Preferred Shares or accrued interest on
borrowings (if any) has been paid and (2) the value of the Fund's total assets
(determined after deducting the amount of such dividend or other distribution),
less all liabilities and indebtedness of the Fund not represented by senior
securities, is at least 300% of the aggregate amount of senior securities
representing indebtedness and at least 200% of the aggregate amount of senior
securities representing indebtedness plus the aggregate liquidation value of
the outstanding Preferred Shares (expected to equal the aggregate original
purchase price of the outstanding Preferred Shares plus the redemption premium,
if any, together with any accrued and unpaid dividends thereon, whether or not
earned or declared and on a cumulative basis). In addition to the requirements
of the 1940 Act, the Fund is required to comply with other asset coverage
requirements as a condition of the Fund obtaining a rating of the APS from a
Rating Agency. These requirements include an asset coverage test more stringent
than under the 1940 Act. See "Description of APS--Dividends--Restrictions on
Dividends and Other Payments."
The Fund will send unaudited reports at least semi-annually and audited
financial statements annually to all of its shareholders.
Common Shares of the Fund commenced trading on the NYSE on March 31, 2003. As
of May 13, 2003, the net asset value per Common Share was $14.86, and the
closing price per Common Share on the New York Stock Exchange was $15.00.
OTHER ISSUES RELATING TO THE APS
Under the 1940 Act, the Fund is permitted to have outstanding more than one
series of Preferred Shares as long as no single series has priority over
another series as to the distribution of assets of the Fund or the payment of
dividends. Neither holders of Common Shares nor holders of Preferred Shares
have pre-emptive rights to purchase any APS or any other Preferred Shares that
might be issued. It is anticipated that the net asset value per share of the
APS will equal its original purchase price per share plus accumulated dividends
per share.
Anti-takeover and other provisions in the Declaration of Trust
The Declaration includes provisions that could limit the ability of other
entities or persons to acquire control of the Fund or to convert the Fund to
open-end status. The Fund's Trustees are divided into three classes. At each
annual meeting of shareholders, the term of one class will expire and each
Trustee
--------------------------------------------------------------------------------
67
Anti-takeover and other provisions in the Declaration of Trust
--------------------------------------------------------------------------------
elected to that class will hold office for a term of three years. The
classification of the Board of Trustees in this manner could delay for an
additional year the replacement of a majority of the Board of Trustees. In
addition, the Declaration provides that a Trustee may be removed only for cause
and only (i) by action of at least seventy-five percent (75%) of the
outstanding shares of the classes or series of shares entitled to vote for the
election of such Trustee or (ii) by at least seventy-five percent (75%) of the
remaining Trustees.
As described below, the Declaration grants special approval rights with respect
to certain matters to members of the Board who qualify as "Continuing
Trustees," which term means a Trustee who either (i) has been a member of the
Board for a period of at least thirty-six months (or since the commencement of
the Fund's operations, if less than thirty-six months) or (ii) was nominated to
serve as a member of the Board of Trustees by a majority of the Continuing
Trustees then members of the Board.
The Declaration requires the affirmative vote or consent of at least
seventy-five percent (75%) of the Board of Trustees and holders of at least
seventy-five percent (75%) of the Fund's shares (including Common and Preferred
Shares) to authorize certain Fund transactions not in the ordinary course of
business, including a merger or consolidation or a sale or transfer of Fund
assets, unless the transaction is authorized by both a majority of the Trustees
and seventy-five percent (75%) of the Continuing Trustees (in which case no
shareholder authorization would be required by the Declaration, but may be
required in certain cases under the 1940 Act). The Declaration also requires
the affirmative vote or consent of holders of at least seventy-five percent
(75%) of each class of the Fund's shares entitled to vote on the matter to
authorize a conversion of the Fund from a closed-end to an open-end investment
company, unless the conversion is authorized by both a majority of the Trustees
and seventy-five percent (75%) of the Continuing Trustees (in which case
shareholders would have only the minimum voting rights required by the 1940 Act
with respect to the conversion). Also, the Declaration provides that the Fund
may be terminated at any time by vote or consent of at least seventy-five
percent (75%) of the Fund's shares or, alternatively, by vote or consent of
both a majority of the Trustees and seventy-five percent (75%) of the
Continuing Trustees. See "Anti-Takeover and Other Provisions in the Declaration
of Trust" in the Statement of Additional Information for a more detailed
summary of these provisions.
The Trustees may from time to time grant other voting rights to shareholders
with respect to these and other matters in the Fund's Amended Bylaws, certain
of which are required by the 1940 Act. For example, the Amended Bylaws grant
holders of the APS and any other Preferred Shares special voting rights with
respect to certain matters described in the preceding paragraph. See
"Description of APS-- Voting Rights."
The overall effect of these provisions is to render more difficult the
accomplishment of a merger, conversion of the Fund to open-end status or the
assumption of control by a third party. They provide, however, the advantage of
potentially requiring persons seeking control of the Fund to negotiate with its
management regarding the price to be paid and facilitating the continuity of
the Fund's investment objective and policies. The provisions of the Declaration
described above could have the effect of discouraging a third party from
seeking to obtain control of the Fund in a tender offer or similar transaction.
The Board of Trustees of the Fund has considered the foregoing anti-takeover
provisions and concluded that they are in the best interests of the Fund and
its Common Shareholders.
The foregoing is intended only as a summary and is qualified in its entirety by
reference to the full text of the Declaration and the Fund's Amended Bylaws,
both of which are on file with the Securities and Exchange Commission.
--------------------------------------------------------------------------------
68
Anti-takeover and other provisions in the Declaration of Trust
--------------------------------------------------------------------------------
Under Massachusetts law, shareholders could, in certain circumstances, be held
personally liable for the obligations of the Fund. However, the Declaration
contains an express disclaimer of shareholder liability for debts or
obligations of the Fund and requires that notice of such limited liability be
given in each agreement, obligation or instrument entered into or executed by
the Fund or the Trustees. The Declaration further provides for indemnification
out of the assets and property of the Fund for all loss and expense of any
shareholder held personally liable for the obligations of the Fund. Thus, the
risk of a shareholder incurring financial loss on account of shareholder
liability is limited to circumstances in which the Fund would be unable to meet
its obligations. The Fund believes that the likelihood of such circumstances is
remote.
Repurchase of Common Shares; conversion to open-end fund
The Fund is a closed-end investment company and, as such, its shareholders will
not have the right to cause the Fund to redeem their shares. Shares of a
closed-end investment company may frequently trade at prices lower than net
asset value. The Fund's Board of Trustees regularly monitors the relationship
between the market price and net asset value of the Common Shares. If the
Common Shares were to trade at a substantial discount to net asset value for an
extended period of time, the Board may consider the repurchase of the Common
Shares on the open market or in private transactions, the making of a tender
offer for such shares or the conversion of the Fund to an open-end investment
company. The Fund cannot assure you that its Board of Trustees will decide to
take or propose any of these actions, or that share repurchases or tender
offers will actually reduce market discount.
If the Fund were to convert to an open-end company, it would be required to
redeem all Preferred Shares (including the APS) then outstanding (requiring in
turn that it liquidate a portion of its investment portfolio), and the Common
Shares would no longer be listed on the New York Stock Exchange. In contrast to
a closed-end investment company, shareholders of an open-end investment company
may require the company to redeem their shares at any time (except in certain
circumstances as authorized by or under the 1940 Act) at their net asset value,
less any redemption charge that is in effect at the time of redemption.
Before deciding whether to take any action to convert the Fund to an open-end
investment company, the Board would consider all relevant factors, including
the extent and duration of the discount, the liquidity of the Fund's portfolio,
the impact of any action that might be taken on the Fund or its shareholders,
and market considerations. Based on these considerations, even if the Fund's
shares should trade at a discount, the Board of Trustees may determine that, in
the interest of the Fund and its shareholders, no action should be taken. See
the Statement of Additional Information under "Repurchase of Common Shares;
Conversion to Open-End Fund" for a further discussion of possible action to
reduce or eliminate such discount to net asset value.
--------------------------------------------------------------------------------
69
--------------------------------------------------------------------------------
Underwriting
The Underwriters named below, acting through UBS Warburg LLC, 299 Park Avenue,
New York, New York, as lead manager, and Merrill Lynch, Pierce, Fenner & Smith
Incorporated and Prudential Securities Incorporated as their representatives
(together with the lead manager, the "Representatives"), have severally agreed,
subject to the terms and conditions of an underwriting agreement with the Fund
and the Manager (the "Underwriting Agreement"), to purchase from the Fund the
number of APS set forth opposite their respective names. The Underwriters are
committed to purchase and pay for all of such APS if any are purchased.
Underwriters Number of APS
--------------------------------------------------------------------------
UBS Warburg LLC............................................. 12,600
Merrill Lynch, Pierce, Fenner & Smith Incorporated.......... 5,250
Prudential Securities Incorporated.......................... 3,150
------
Total.................................................... 21,000
======
The Underwriters have advised the Fund that they propose initially to offer the
APS to the public at the public offering price set forth on the cover page of
this Prospectus, and to certain dealers at such price less a concession not in
excess of $137.50 per share. The Underwriters may allow, and such dealers may
reallow, a discount not in excess of $100.00 per share to other dealers. After
the initial public offering, the public offering price, concession and discount
may be changed. Investors must pay for any APS purchased in the initial public
offering on or before May 23, 2003.
The Underwriters will act in Auctions as Broker-Dealers as set forth under
"Description of APS--The Auction--Broker-Dealer Agreements" and will be
entitled to fees for services as Broker-Dealers, as set forth under
"Description of APS--Broker-Dealers." The Underwriters also may provide
information to be used in ascertaining the Reference Rate.
The Fund anticipates that the Representatives and certain other Underwriters
may from time to time act as brokers and dealers in connection with the
execution of the Fund's portfolio transactions after they have ceased to be
principal underwriters of the Fund under the 1940 Act and, subject to certain
conditions, may act as such brokers while they are principal underwriters.
In connection with this offering, certain of the Underwriters or selected
dealers may distribute Prospectuses electronically.
The Fund and the Manager have agreed to indemnify the Underwriters against
certain liabilities including liabilities under the Securities Act of 1933, as
amended.
Shareholder servicing agent, custodian and transfer agents
The Manager (and not the Fund) has agreed to pay from its own assets to UBS
Warburg LLC a shareholder servicing fee (the "Shareholder Servicing Fee") at an
annual rate of 0.10% of the average daily total managed assets (including net
assets attributable to Preferred Shares, including the APS, and other forms of
leverage) of the Fund pursuant to a shareholder servicing agreement between the
Manager and UBS Warburg LLC (the "Shareholder Servicing Agreement"). Pursuant
to the Shareholder Servicing Agreement, UBS Warburg LLC will: (i) undertake to
make public information pertaining to the Fund on
--------------------------------------------------------------------------------
70
Shareholder servicing agent, custodian and transfer agents
--------------------------------------------------------------------------------
an ongoing basis and to communicate to investors and prospective investors the
Fund's features and benefits (including periodic seminars or conference calls,
responses to questions from current or prospective shareholders and specific
shareholder contact where appropriate); (ii) make available to investors and
prospective investors market price, net asset value, yield and other
information regarding the Fund, if reasonably obtainable, for the purpose of
maintaining the visibility of the Fund in the investor community; (iii) at the
request of the Manager, provide certain economic research and statistical
information and reports, if reasonably obtainable, on behalf of the Fund, and
consult with representatives and Trustees of the Fund in connection therewith,
which information and reports shall include (a) statistical and financial
market information with respect to the Fund's market performance and (b)
comparative information regarding the Fund and other closed-end management
investment companies with respect to (1) the net asset value of their
respective shares, (2) the respective market performance of the Fund and such
other companies and (3) other relevant performance indicators; and (iv) at the
request of the Manager, provide information to and consult with the Board of
Trustees with respect to applicable modifications to dividend policies or
capital structure, repositioning or restructuring of the Fund, conversion of
the Fund to an open-end investment company or a Fund liquidation or merger;
provided, however, that under the terms of the Shareholder Servicing Agreement,
UBS Warburg LLC is not obligated to render any opinions, valuations or
recommendations of any kind or to perform any such similar services. Under the
terms of the Shareholder Servicing Agreement, UBS Warburg LLC is relieved from
liability to the Manager or the Fund for any act or omission in the course of
its performances under the Shareholder Servicing Agreement in the absence of
gross negligence or willful misconduct. The Shareholder Servicing Agreement
will remain in effect until March 31, 2005, and will continue thereafter unless
terminated by either the Manager or UBS Warburg LLC.
The custodian of the assets of the Fund is Brown Brothers Harriman & Co., 40
Water Street, Boston, Massachusetts 02109. The Custodian performs custodial and
fund accounting services.
Deutsche Bank Trust Company Americas, 280 Park Avenue, 9th Floor, New York, New
York 10017, serves as Auction Agent, transfer agent, registrar, dividend paying
agent and redemption agent for the APS. PFPC Inc., 400 Bellevue Parkway,
Wilmington, Delaware 19809, serves as the transfer agent, registrar and
dividend disbursement agent for the Common Shares, as well as agent for the
Fund's Dividend Reinvestment Plan for Common Shares.
Legal matters
Certain legal matters in connection with the APS will be passed upon for the
Fund by Ropes & Gray LLP, Boston, Massachusetts, and for the Underwriters by
Skadden, Arps, Slate, Meagher & Flom (Illinois), Chicago, Illinois, and its
affiliated entities.
--------------------------------------------------------------------------------
71
--------------------------------------------------------------------------------
Table of contents for the
Statement of Additional Information
Use of Proceeds............................................. 3
Investment Objective and Policies........................... 3
Investment Restrictions..................................... 38
Management of the Fund...................................... 41
Investment Manager and Portfolio Manager.................... 51
Portfolio Transactions...................................... 56
Distributions............................................... 58
Description of Shares....................................... 58
Anti-Takeover and Other Provisions in the Declaration of
Trust..................................................... 59
Repurchase of Common Shares; Conversion to Open-End Fund.... 61
Tax Matters................................................. 63
Performance Related and Comparative Information............. 71
Custodian, Transfer Agents and Dividend Paying Agent........ 71
Independent Accountants..................................... 72
Counsel..................................................... 72
Registration Statement...................................... 72
Financial Statements........................................ 73
Appendix A--Auction Procedures.............................. A-1
Appendix B--Settlement Procedures........................... B-1
Appendix C--Description of Securities Ratings............... C-1
--------------------------------------------------------------------------------
72
--------------------------------------------------------------------------------
Glossary
"'AA' Financial Composite Commercial Paper Rate" on any date means (i) (A) the
Interest Equivalent of the 7-day rate (in the case of a Dividend Period which
is a 7-Day Dividend Period or shorter), the 30-day rate (for Special Dividend
Periods greater than 7 days but fewer than or equal to 31 days), the 60-day
rate (for Dividend Periods greater than 31 days but fewer than or equal to 61
days) and the 90-day rate (for Dividend Periods greater than 61 days but fewer
than or equal to 91 days) on commercial paper on behalf of issuers whose
corporate bonds are rated AA by S&P, or the equivalent of such rating by
another Rating Agency, as announced by the Federal Reserve Bank of New York for
the close of business on the Business Day immediately preceding such date; and
(B) for Dividend Periods greater than 91 days but fewer than 184 days, the rate
described in clause (ii) below; or (ii) if the Federal Reserve Bank of New York
does not make available such a rate, or with respect to Dividend Periods
greater than 91 days but fewer than 184 days, then the arithmetic average of
the Interest Equivalent of such rates on commercial paper placed on behalf of
such issuers, as quoted on a discount basis or otherwise by the Commercial
Paper Dealers to the Auction Agent for the close of business on the Business
Day immediately preceding such date (rounded to the next highest one-thousandth
(0.001) of 1%). If any Commercial Paper Dealer does not quote a rate required
to determine the "AA" Financial Composite Commercial Paper Rate, such rate
shall be determined on the basis of the quotations (or quotation) furnished by
the remaining Commercial Paper Dealers (or Dealer), if any, or, if there are no
such Commercial Paper Dealers, by the Auction Agent. For purposes of this
definition, (A) "Commercial Paper Dealers" shall mean (1) UBS Warburg LLC,
Merrill Lynch, Pierce, Fenner & Smith Incorporated, Prudential Securities
Incorporated, Goldman Sachs & Co., and such other commercial paper dealer or
dealers as the Fund may from time to time appoint; (2) in lieu of any thereof,
its respective affiliate or successor; and (3) in the event that any of the
foregoing shall cease to quote rates for commercial paper of issuers of the
sort described above, in substitution therefor, a nationally recognized dealer
in commercial paper of such issuers then making such quotations selected by the
Fund, and (B) "Interest Equivalent" of a rate stated on a discount basis for
commercial paper of a given number of days' maturity shall mean a number equal
to the quotient (rounded upward to the next higher one-thousandth (0.001) of
1%) of (1) such rate expressed as a decimal, divided by (2) the difference
between (x) 1.00 and (y) a fraction, the numerator of which shall be the
product of such rate expressed as a decimal, multiplied by the number of days
in which such commercial paper shall mature and the denominator of which shall
be 360.
"ADRs" means American Depository Receipts.
"Affiliate" means any person known to the Auction Agent to be controlled by, in
control of, or under common control with, the Fund.
"Agent Member" means a member of or a participant in the Securities Depository
that will act on behalf of a Beneficial Owner of one or more APS or on behalf
of a Potential Beneficial Owner.
"Amended Bylaws" means the Second Amended and Restated Bylaws of the Fund as
amended May 20, 2003, specifying, in part, the powers, preferences and rights
of the APS.
"Applicable Percentage" has the meaning specified under "Description of
APS--Auction Procedures--Orders by Beneficial Owners, Potential Beneficial
Owners, Existing Holders and Potential Holders" in this Prospectus.
"Applicable Rate" means the rate per annum at which cash dividends are payable
on APS for any Dividend Period.
--------------------------------------------------------------------------------
73
Glossary
--------------------------------------------------------------------------------
"Approved Price" means the "fair value" as determined by the Fund in accordance
with the valuation procedures adopted from time to time by the Board of
Trustees of the Fund and for which the Fund receives a marked-to-market price
(which, for the purpose of clarity, shall not mean Market Value) from an
independent source at least semi-annually.
"APS" means the Auction Preferred Shares with par value $0.00001 per share and
a liquidation preference of $25,000 per share plus an amount equal to
accumulated but unpaid dividends thereon (whether or not earned or declared) of
the Fund.
"APS Basic Maintenance Amount" has the meaning specified under "Description of
APS--Asset Maintenance--APS Basic Maintenance Amount" in this Prospectus.
"APS Basic Maintenance Cure Date" has the meaning specified under "Description
of APS--Asset Maintenance--APS Basic Maintenance Amount" in this Prospectus.
"APS Basic Maintenance Report" has the meaning specified under "Description of
APS--Asset Maintenance--APS Basic Maintenance Amount" in this Prospectus.
"Auction" means a periodic operation of the Auction Procedures.
"Auction Agency Agreement" means the agreement entered into between the Fund
and the Auction Agent which provides, among other things, that the Auction
Agent will follow the Auction Procedures for the purpose of determining the
Applicable Rate.
"Auction Agent" means Deutsche Bank Trust Company Americas unless and until
another commercial bank, trust company or other financial institution appointed
by a resolution of the Board of Trustees of the Fund or a duly authorized
committee thereof enters into an agreement with the Fund to follow the Auction
Procedures for the purpose of determining the Applicable Rate and to act as
transfer agent, registrar, dividend paying agent and redemption agent for the
APS.
"Auction Date" has the meaning specified under "Description of APS--Auction
Procedures--Auction Date" in this Prospectus.
"Auction Procedures" means the procedures for conducting Auctions, as set forth
Appendix A to the Statement of Additional Information.
"Available APS" has the meaning specified under "Description of APS--Auction
Procedures--Determination of Sufficient Clearing Bids, Winning Bid Rate and
Applicable Rate" in this Prospectus.
"Bank Loans" means direct purchases of, assignments of, participations in and
other interests in (a) any bank loan or (b) any loan made by an investment
bank, investment fund or other financial institution, provided that such loan
under this clause (b) is similar to those typically made, syndicated, purchased
or participated by a commercial bank or institutional loan investor in the
ordinary course of business.
"Beneficial Owner" means a customer of a Broker-Dealer who is listed on the
records of that Broker-Dealer (or, if applicable, the Auction Agent) as a
holder of APS or a Broker-Dealer that holds APS for its own account.
"Bid" has the meaning specified under "Description of APS--Auction
Procedures--Orders by Beneficial Owners, Potential Beneficial Owners, Existing
Holders and Potential Holders" in this Prospectus.
--------------------------------------------------------------------------------
74
Glossary
--------------------------------------------------------------------------------
"Bidder" has the meaning specified under "Description of APS--Auction
Procedures--Orders by Beneficial Owners, Potential Beneficial Owners, Existing
Holders and Potential Holders" in this Prospectus.
"Board of Trustees" or "Board" means the Board of Trustees of the Fund.
"Broker-Dealer" has the meaning specified under "Description of APS--The
Auction--Broker-Dealer Agreements" in this Prospectus.
"Broker-Dealer Agreement" has the meaning specified under "Description of
APS--The Auction--Broker-Dealer Agreements" in this Prospectus.
"Business Day" means a day on which the New York Stock Exchange is open for
trading and which is not a Saturday, Sunday or other day on which banks in New
York City are authorized or obligated by law to close.
"Code" means the Internal Revenue Code of 1986, as amended.
"Commercial Paper Dealers" has the meaning set forth in the definition of "'AA'
Financial Composite Commercial Paper Rate."
"Common Shareholders" means the holders of Common Shares.
"Common Shares" means the common shares of beneficial interest, par value
$0.00001 per share, of the Fund.
"Cure Date" has the meaning specified under "Description of
APS--Redemption--Mandatory Redemption" in this Prospectus.
"Date of Original Issue" means, with respect to any share of APS, the date on
which the Fund first issues such share.
"Declaration" has the meaning specified under "Prospectus summary--Special Risk
Considerations--Anti-Takeover Provisions" in this Prospectus.
"Deposit Securities" means cash and portfolio securities rated at least A2
(having a remaining maturity of 12 months or less), P-1, VMIG-1 or MIG-1 by
Moody's or A (having a remaining maturity of 12 months or less), A-1+ or SP-1+
by S&P.
"Discount Factor" means a Moody's Discount Factor.
"Discounted Value" of any asset of the Fund means the quotient of the Market
Value of an Eligible Asset divided by the Moody's Discount Factor, provided
that with respect to an Eligible Asset that is currently callable, the
Discounted Value will be equal to the quotient as calculated above or the call
price, whichever is lower, and that with respect to an Eligible Asset that is
prepayable, the Discounted Value will be equal to the quotient as calculated
above or the face value, whichever is lower.
"Dividend Payment Date" has the meaning specified under "Description of
APS--Dividends--General" in this Prospectus.
--------------------------------------------------------------------------------
75
Glossary
--------------------------------------------------------------------------------
"Dividend Period" has the meaning specified under "Description of
APS--Dividends--General" in this Prospectus.
"Eligible Asset" means a Moody's Eligible Asset (if Moody's is then rating the
APS) and/or any asset included in the calculations used by any Rating Agency
then rating the APS for purposes of determining such Rating Agency's rating on
the APS, as applicable.
"Existing Holder" means a Broker-Dealer or any such other person as may be
permitted by the Fund that is listed as the holder of record of APS in the
records of the Auction Agent.
"Extension Period" has the meaning specified under "Description of
APS--Dividends--Notification of Dividend Period" in this Prospectus.
"FHLB, FNMA and FFCB Debentures" has the meaning set forth in paragraph (ix) of
the definition of "Moody's Eligible Assets."
"Fitch" means Fitch, Inc. doing business as Fitch Ratings, or its successors.
"Fund" means Nicholas-Applegate Convertible & Income Fund, a Massachusetts
business trust that is the issuer of the APS.
"GDRs" means Global Depository Receipts.
"Hold Order" has the meaning specified under "Description of APS--Auction
Procedures--Orders by Beneficial Owners, Potential Beneficial Owners, Existing
Holders and Potential Holders" in this Prospectus.
"Initial Dividend Payment Date" means, with respect to a series of APS, the
initial dividend payment date as determined by the Board of Trustees or
pursuant to their delegated authority with respect to such series.
"Initial Dividend Period" means, for each series of APS, the period from and
including the Date of Original Issue to but excluding the Initial Dividend
Payment Date.
"Interest Equivalent" has the meaning set forth in the definition of "'AA'
Financial Composite Commercial Paper Rate."
"Investment Management Agreement" has the meaning set forth under "Management
of the Fund--Investment Management Agreement" in this Prospectus.
"IRS" means the United States Internal Revenue Service.
"Lien" means any material lien, mortgage, pledge, security interest or security
agreement of any kind.
"Long Term Dividend Period" has the meaning specified under "Prospectus
summary--Dividends on APS" in this Prospectus.
"Manager" means PIMCO Advisors Fund Management LLC.
--------------------------------------------------------------------------------
76
Glossary
--------------------------------------------------------------------------------
"Mandatory Redemption Price" has the meaning specified under "Description of
APS--Redemption--Mandatory Redemption" in this Prospectus.
"Market Value" of any asset of the Fund shall be the market value thereof
determined by a Pricing Service. The Market Value of any asset shall include
any interest accrued thereon. A Pricing Service shall value portfolio
securities at the quoted bid prices or the mean between the quoted bid and
asked prices or the yield equivalent when quotations are not readily available.
Securities for which quotations are not readily available shall be valued at
fair value as determined by a Pricing Service using methods which include
consideration of: yields or prices of securities of comparable quality, type of
issue, coupon, maturity and rating; indications as to value from dealers; and
general market conditions. A Pricing Service may employ electronic data
processing techniques and/or a matrix system to determine valuations. In the
event a Pricing Service is unable to value a security, the security shall be
valued at the lower of two bid quotations obtained by the Fund from dealers who
are members of the National Association of Securities Dealers, Inc. and who
make a market in the security, at least one of which shall be in writing. If
two bid quotations are not readily available for any securities, such
securities shall be valued in good faith at fair value pursuant to procedures
approved by the Board of Trustees of the Fund. Futures contracts and options
are valued at the closing prices for such instruments established by the
exchange or board of trade on which they are traded, or if market quotations
are not readily available, are valued at fair value in good faith pursuant to
procedures approved by the Trustees. All other assets will be valued at fair
value on a consistent basis using methods determined in good faith by the
Trustees.
"Maximum Applicable Rate" has the meaning specified under "Description of
APS--Auction Procedures--Orders by Beneficial Owners, Potential Beneficial
Owners, Existing Holders and Potential Holders" in this Prospectus.
"Moody's" means Moody's Investors Service, Inc. or its successors.
"Moody's Discount Factor" means, for purposes of determining the Discounted
Value of any Moody's Eligible Asset, the percentage determined as follows:
(i) Convertible securities (including convertible preferred stock): The
percentage determined by reference to the sector groupings of the issuer
of the convertible security with reference to the rating of such
security, in accordance with the table set forth below.
Discount Factors(2)
Rating(1) -------------------------------------------
Utility Industrial Financial Transportation
----------------------------------------------------------------
Aaa 162% 256% 233% 250%
Aa 167 261 238 265
A 172 266 243 275
Baa 188 282 259 285
Ba 195 290 265 290
B 199 293 270 295
Unrated 300 300 300 300
(1) Unless conclusions regarding liquidity risk as well as estimates of
both the probability and severity of default for applicable Fund assets
can be derived from other sources as well as combined with a number of
sources, unrated fixed-income and convertible securities (which are
securities that are not rated by any of Moody's, S&P or Fitch) are
limited to 10% of discounted Moody's Eligible Assets for purposes of
calculations related to the APS Basic Maintenance Amount. If a
convertible security is not rated by any of Moody's, S&P or Fitch, the
Fund will use the applicable percentage set forth in the row entitled
"Unrated" in the table above. Ratings assigned by S&P and/or Fitch are
generally accepted at face value. However, adjustments to face value
may be made to particular categories of credits for which the S&P
and/or Fitch rating does not seem to approximate a Moody's rating
equivalent.
--------------------------------------------------------------------------------
77
Glossary
--------------------------------------------------------------------------------
(2) Discount factors are for 7-week exposure period.
Upon conversion to common stock, the Discount Factors applicable to common
stock will apply:
Common Stocks Utility Industrial Financial
---------------------------------------------------
7 week exposure period 170% 264% 241%
(ii) Corporate debt securities (non-convertible): The percentage determined
by reference to the rating on such asset with reference to the remaining
term to maturity of such asset, in accordance with the table set forth
below.
Moody's Rating Category
---------------------------------------
Term to Maturity of Corporate Debt Security Aaa Aa A Baa Ba B Unrated(1)
------------------------------------------------------------------------------------
1 year or less............................. 109% 112% 115% 118% 137% 150% 250%
2 years or less (but longer than 1 year)... 115 118 122 125 146 160 250
3 years or less (but longer than 2 years).. 120 123 127 131 153 168 250
4 years or less (but longer than 3 years).. 126 129 133 138 161 176 250
5 years or less (but longer than 4 years).. 132 135 139 144 168 185 250
7 years or less (but longer than 5 years).. 139 143 147 152 179 197 250
10 years or less (but longer than 7 years). 145 150 155 160 189 208 250
15 years or less (but longer than 10 years) 150 155 160 165 196 216 250
20 years or less (but longer than 15 years) 150 155 160 165 196 228 250
30 years or less (but longer than 20 years) 150 155 160 165 196 229 250
Greater than 30 years...................... 165 173 181 189 205 240 250
(1) Unless conclusions regarding liquidity risk as well as estimates of
both the probability and severity of default for applicable Fund assets
can be derived from other sources as well as combined with a number of
sources, unrated fixed-income and convertible securities (which are
securities that are not rated by any of Moody's, S&P or Fitch) are
limited to 10% of Moody's Eligible Assets for purposes of calculations
related to the APS Basic Maintenance Amount. If a corporate debt
security is not rated by any of Moody's, S&P or Fitch, the Fund will
use the applicable percentage set forth under the column entitled
"Unrated" in the table above. Ratings assigned by S&P and/or Fitch are
generally accepted at face value. However, adjustments to face value
may be made to particular categories of credits for which the S&P
and/or Fitch rating does not seem to approximate a Moody's rating
equivalent.
The Moody's Discount Factors presented in the immediately preceding table
will also apply to Moody's Eligible Assets that are FHLB, FNMA and FFCB
Debentures and to rated TRACERs, whereby the ratings in the table will be
applied to the underlying securities and the Market Value of each underlying
security will be its proportionate amount of the Market Value of the TRACER.
The Moody's Discount Factors presented in the immediately preceding table
will also apply to corporate debt securities that do not pay interest in
U.S. dollars or euros, provided that the Moody's Discount Factor determined
from the table shall be multiplied by a factor of 110% for purposes of
calculating the Discounted Value of such securities.
(iii) Preferred stock (other than convertible preferred stock, which is
subject to paragraph (i) above): The Moody's Discount Factor for
preferred stock shall be (A) for preferred stocks issued by a utility,
155%; (B) for preferred stocks of industrial and financial issuers,
209%; and (C) for auction rate preferred stocks, 350%.
(iv) Short-term instruments: The Moody's Discount Factor applied to
short-term portfolio securities, including without limitation short-term
corporate debt securities, Short Term Money Market Instruments and
short-term municipal debt obligations, will be (A) 100%, so long as
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Glossary
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such portfolio securities mature or have a demand feature at par
exercisable within the Moody's Exposure Period; (B) 115%, so long as
such portfolio securities do not mature within the Moody's Exposure
Period, or have a demand feature at par not exercisable within the
Moody's Exposure Period; and (C) 125%, if such securities are not rated
by Moody's, so long as such portfolio securities are rated at least
A-1+/AA or SP-1+/AA by S&P or Fitch and mature or have a demand feature
at par exercisable within the Moody's Exposure Period. A Moody's
Discount Factor of 100% will be applied to cash.
(v) U.S. Government Securities and U.S. Treasury Strips: The percentage
determined by reference to the remaining term to maturity of such asset,
in accordance with the table set forth below.
U.S. Government Securities U.S. Treasury Strips
Remaining Term to Maturity Discount Factor Discount Factor
-------------------------------------------------------------------------------------------
1 year or less............................. 107% 107%
2 years or less (but longer than 1 year)... 113 115
3 years or less (but longer than 2 years).. 118 121
4 years or less (but longer than 3 years).. 123 128
5 years or less (but longer than 4 years).. 128 135
7 years or less (but longer than 5 years).. 135 147
10 years or less (but longer than 7 years). 141 163
15 years or less (but longer than 10 years) 146 191
20 years or less (but longer than 15 years) 154 218
30 years or less (but longer than 20 years) 154 244
(vi) Rule 144A Securities: The Moody's Discount Factor applied to Rule 144A
Securities for Rule 144A Securities whose terms include rights to
registration under the Securities Act of 1933 within one year and Rule
144A Securities which do not have registration rights within one year
will be 120% and 130%, respectively, of the Moody's Discount Factor
which would apply were the securities registered under the Securities
Act of 1933.
(vii) Bank Loans: The Moody's Discount Factor applied to senior Bank Loans
("Senior Loans") shall be the percentage specified in the table below
opposite such Moody's Loan Category:
Moody's Loan Category Discount Factor
-------------------------------------
A.......... 118%
B.......... 137
C.......... 161
D.......... 222
E.......... 222
(viii) Asset-backed and Mortgage-backed securities: The Moody's Discount
Factor applied to asset-backed securities shall be 131%. The Moody's
Discount Factor applied to collateralized mortgage obligations, planned
amortization class bonds and targeted amortization class bonds shall be
determined by reference to the weighted average life of the security
and whether cash flow is retained (i.e., controlled by a trustee) or
excluded (i.e., not controlled by a trustee), in accordance with the
table set forth below.
Remaining Term to Maturity Cash Flow Retained Cash Flow Excluded
---------------------------------------------------------------------------------
3 years or less............................ 133% 141%
7 years or less (but longer than 3 years).. 142 151
10 years or less (but longer than 7 years). 158 168
20 years or less (but longer than 10 years) 174 185
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79
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The Moody's Discount Factor applied to residential mortgage pass-throughs
(including private-placement mortgage pass-throughs) shall be determined by
reference to the coupon paid by such security and whether cash flow is
retained (i.e., controlled by a trustee) or excluded (i.e., not controlled
by a trustee), in accordance with the table set forth below.
Coupon Cash Flow Retained Cash Flow Excluded
------------------------------------------------
5%........ 166% 173%
6......... 162 169
7......... 158 165
8......... 154 161
9......... 151 157
10........ 148 154
11........ 144 154
12........ 142 151
13........ 139 148
adjustable 165 172
The Moody's Discount Factor applied to fixed-rate pass-throughs that are not
rated by Moody's and are serviced by a servicer approved by Moody's shall be
determined by reference to the table in the following paragraph (relating to
whole loans).
The Moody's Discount Factor applied to whole loans shall be determined by
reference to the coupon paid by such security and whether cash flow is
retained (i.e., controlled by a trustee) or excluded (i.e., not controlled
by a trustee), in accordance with the table set forth below.
Coupon Cash Flow Retained Cash Flow Excluded
------------------------------------------------
5%........ 172% 179%
6......... 167 174
7......... 163 170
8......... 159 165
9......... 155 161
10........ 151 158
11........ 148 157
12........ 145 154
13........ 142 151
adjustable 170 177
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(ix) Municipal debt obligations: The Moody's Discount Factor applied to
municipal debt obligations shall be the percentage determined by
reference to the rating on such asset and the shortest Exposure Period
set forth opposite such rating that is the same length as or is longer
than the Moody's Exposure Period, in accordance with the table set forth
below:
Exposure Period Aaa(1) Aa1 A1 Baa1 Other(2) (V)MIG-1(3) SP-1+(4) Unrated(5)
------------------------------------------------------------------------------------------
7 weeks.................... 151% 159% 166% 173% 187% 136% 148% 225%
8 weeks or less but greater
than seven weeks......... 154 161 168 176 190 137 149 231
9 weeks or less but greater
than eight weeks......... 158 163 170 177 192 138 150 240
(1) Moody's rating.
(2) Municipal debt obligations not rated by Moody's but rated BBB by S&P or
Fitch.
(3) Municipal debt obligations rated MIG-1 or VMIG-1, which do not mature
or have a demand feature at par exercisable in 30 days and which do not
have a long-term rating.
(4) Municipal debt obligations not rated by Moody's but rated SP-1+ by S&P
or Fitch, which do not mature or have a demand feature at par
exercisable in 30 days and which do not have a long-term rating.
(5) Municipal debt obligations rated less than Baa3 or not rated by Moody's
and less than BBB by S&P or Fitch or not rated by S&P or Fitch, shall
not to exceed 10% of Moody's Eligible Assets for purposes of
calculations related to the APS Basic Maintenance Amount. Unless
conclusions regarding liquidity risk as well as estimates of both the
probability and severity of default for applicable Fund assets can be
derived from other sources as well as combined with a number of
sources, unrated fixed-income and convertible securities (which are
securities that are not rated by any of Moody's, S&P or Fitch) are
limited to 10% of discounted Moody's Eligible Assets for purposes of
calculations related to the APS Basic Maintenance Amount. If a
municipal debt obligation is not rated by any of Moody's, S&P or Fitch,
the Fund will use the applicable percentage set forth under the column
entitled "Unrated" in the table above. Ratings assigned by S&P or Fitch
are generally accepted at face value. However, adjustments to face
value may be made to particular categories of credits for which the S&P
and/or Fitch rating does not seem to approximate a Moody's rating
equivalent.
(x) Structured Notes: The Moody's Discount Factor applied to Structured
Notes will be (A) in the case of a corporate issuer, the Moody's
Discount Factor determined in accordance with paragraph (ii) under this
definition, whereby the rating on the issuer of the Structured Note will
be the rating on the Structured Note for purposes of determining the
Moody's Discount Factor in the table in paragraph (ii); and (B) in the
case of an issuer that is the U.S. Government or an agency or
instrumentality thereof, the Moody's Discount Factor determined in
accordance with paragraph (v) under this definition.
The Moody's Discount Factor for any Moody's Eligible Asset other than the
securities set forth above will be the percentage provided in writing by
Moody's.
"Moody's Eligible Assets" means
(i) cash (including interest and dividends due on assets rated (A) Baa3 or
higher by Moody's if the payment date is within five Business Days of
the Valuation Date, (B) A2 or higher if the payment date is within
thirty days of the Valuation Date, and (C) A1 or higher if the payment
date is within the Moody's Exposure Period) and receivables for Moody's
Eligible Assets sold if the receivable is due within five Business Days
of the Valuation Date, and if the trades which generated such
receivables are (A) settled through clearing house firms or (B) (1) with
counterparties having a Moody's long-term debt rating of at least Baa3
or (2) with counterparties having a Moody's Short Term Money Market
Instrument rating of at least P-1;
(ii) Short Term Money Market Instruments so long as (A) such securities are
rated at least P-1, (B) in the case of demand deposits, time deposits
and overnight funds, the supporting entity is rated
--------------------------------------------------------------------------------
81
Glossary
--------------------------------------------------------------------------------
at least A2, or (C) in all other cases, the supporting entity (1) is
rated A2 and the security matures within one month, (2) is rated A1 and
the security matures within three months or (3) is rated at least Aa3
and the security matures within six months; provided, however, that for
purposes of this definition, such instruments (other than commercial
paper rated by S&P or Fitch and not rated by Moody's) need not meet any
otherwise applicable S&P or Fitch rating criteria;
(iii) U.S. Government Securities and U.S. Treasury Strips;
(iv) Rule 144A Securities;
(v) Senior Loans and other Bank Loans approved by Moody's;
(vi) Corporate debt securities if (A) such securities are rated B3 or higher
by Moody's; (B) such securities provide for the periodic payment of
interest in cash in U.S. dollars or euros, except that such securities
that do not pay interest in U.S. dollars or euros shall be considered
Moody's Eligible Assets if they are rated by Moody's,S&P or Fitch; (C)
for securities which provide for conversion or exchange into equity
capital at some time over their lives, the issuer must be rated at least
B3 by Moody's and the discount factor will be 250%; (D) for debt
securities rated Ba1 and below, no more than 10% of the original amount
of such issue may constitute Moody's Eligible Assets; (E) such
securities have been registered under the Securities Act of 1933 or are
restricted as to resale under federal securities laws but are eligible
for resale pursuant to Rule 144A under the Securities Act of 1933 as
determined by the Fund's investment manager or portfolio manager acting
pursuant to procedures approved by the Board of Trustees, except that
such securities that are not subject to U.S. federal securities laws
shall be considered Moody's Eligible Assets if they are publicly traded;
and (F) such securities are not subject to extended settlement.
Notwithstanding the foregoing limitations, (x) corporate debt securities
not rated at least B3 by Moody's or not rated by Moody's shall be
considered to be Moody's Eligible Assets only to the extent the Market
Value of such corporate debt securities does not exceed 10% of the
aggregate Market Value of all Moody's Eligible Assets; provided,
however, that if the Market Value of such corporate debt securities
exceeds 10% of the aggregate Market Value of all Moody's Eligible
Assets, a portion of such corporate debt securities (selected by the
Fund) shall not be considered Moody's Eligible Assets, so that the
Market Value of such corporate debt securities (excluding such portion)
does not exceed 10% of the aggregate Market Value of all Moody's
Eligible Assets; and (y) corporate debt securities rated by none of
Moody's, S&P or Fitch shall be considered to be Moody's Eligible Assets
only to the extent such securities are issued by entities which (i) have
not filed for bankruptcy within the past three years, (ii) are current
on all principal and interest in their fixed income obligations, (iii)
are current on all preferred stock dividends, and (iv) possess a
current, unqualified auditor's report without qualified, explanatory
language.
(vii) Convertible securities (including convertible preferred stock),
provided that (A) the issuer of common stock must have a Moody's senior
unsecured debt of Caa or better, or an S&P or Fitch rating of CCC or
better, (B) the common stocks must be traded on the New York Stock
Exchange, the American Stock Exchange, or the NASDAQ, (C) dividends
must be paid in U.S. dollars, (D) the portfolio of convertible bonds
must be diversified as set forth in the table set forth below, (E) the
company shall not hold shares exceeding the average weekly trading
volume during the preceding month, and (F) synthetic convertibles are
excluded from asset eligibility.
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82
Glossary
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Convertible Bonds
Diversification Guidelines
--------------------------
Maximum Single Maximum Single Maximum Single
Type Issuer (%)(1) Industry (%) State (%)(1)
-----------------------------------------------------------------------
Utility................... 4 50 7(2)
Other..................... 6 20 n/a
(1) Percentage represent a portion of the aggregate market value and number
of outstanding shares of the convertible stock portfolio.
(2) Utility companies operating in more than one state should be
diversified according to the state in which they generate the largest
part of their revenues. Publicly available information on utility
company revenues by state is available from the Uniform Statistical
Report (USR) or the Federal Energy Regulation Commission (FERC).
(viii) Preferred stocks if (A) dividends on such preferred stock are
cumulative, (B) such securities provide for the periodic payment of
dividends thereon in cash in U.S. dollars or euros and do not provide
for conversion or exchange into, or have warrants attached entitling
the holder to receive, equity capital at any time over the respective
lives of such securities, (C) the issuer of such a preferred stock has
common stock listed on either the New York Stock Exchange or the
American Stock Exchange or the NASDAQ, (D) the issuer of such a
preferred stock has a senior debt rating from Moody's of Baa1 or higher
or a preferred stock rating from Moody's of Baa3 or higher and (E) such
preferred stock has paid consistent cash dividends in U.S. dollars or
euros over the last three years or has a minimum rating of A1 (if the
issuer of such preferred stock has other preferred issues outstanding
that have been paying dividends consistently for the last three years,
then a preferred stock without such a dividend history would also be
eligible); provided, however, that convertible preferred stock shall be
treated as convertible securities in accordance with paragraph (vii)
above. In addition, the preferred stocks must have the following
diversification requirements: (X) the preferred stock issue must be
greater than $50 million and (Y) the minimum holding by the Fund of
each issue of preferred stock is $500,000 and the maximum holding of
preferred stock of each issue is $5 million. In addition, preferred
stocks issued by transportation companies will not be considered
Moody's Eligible Assets;
(ix)Asset-backed and mortgage-backed securities:
(A) Asset-backed securities if (1) such securities are rated at least Aa3
by Moody's or at least AA by S&P or Fitch, (2) the securities are
part of an issue that is $250 million or greater, or the issuer of
such securities has a total of $500 million or greater of
asset-backed securities outstanding at the time of purchase of the
securities by the Fund and (3) the expected average life of the
securities is not greater than 4 years;
(B) Collateralized mortgage obligations ("CMOs"), including CMOs with
interest rates that float at a multiple of the change in the
underlying index according to a pre-set formula, provided that any
CMO held by the Fund (1) has been rated Aaa by Moody's or AAA by S&P
or Fitch, (2) does not have a coupon which floats inversely, (3) is
not portioned as an interest-only or principal-only strip and (4) is
part of an issuance that had an original issue size of at least $100
million;
(C) Planned amortization class bonds ("PACs") and targeted amortization
class bonds ("TACs") provided that such PACs or TACs are (1) backed
by certificates of either the Federal National Mortgage Association
("FNMA"), the Government National Mortgage
--------------------------------------------------------------------------------
83
Glossary
--------------------------------------------------------------------------------
Association ("GNMA") or the Federal Home Loan Mortgage Corporation
("FHLMC") representing ownership in single-family first lien mortgage
loans with original terms of 30 years, (2) part of an issuance that
had an original issue size of at least $10 million, (3) part of PAC
or TAC classes that have payment priority over other PAC or TAC
classes, (4) if TACs, TACs that do not support PAC classes, and (5)
if TACs, not considered reverse TACs (i.e., do not protect against
extension risk);
(D) Consolidated senior debt obligations of Federal Home Loan Banks
("FHLBs"), senior long-term debt of the FNMA, and consolidated
systemwide bonds and FCS Financial Assistance Corporation Bonds of
Federal Farm Credit Banks ("FFCBs") (collectively, "FHLB, FNMA and
FFCB Debentures"), provided that such FHLB, FNMA and FFCB Debentures
are (1) direct issuance corporate debt rated Aaa by Moody's, (2)
senior debt obligations backed by the FHLBs, FFCBs or FNMA, (3) part
of an issue entirely denominated in U.S. dollars and (4) not callable
or exchangeable debt issues;
(E) Mortgage pass-throughs rated at least Aa by Moody's and pass-throughs
issued prior to 1987 (if rated AA by S&P or Fitch and based on
fixed-rate mortgage loans) by Travelers Mortgage Services, Citicorp
Homeowners, Citibank, N.A., Sears Mortgage Security or RFC--Salomon
Brothers Mortgage Securities, Inc., provided that (1) certificates
must evidence a proportional, undivided interest in specified pools
of fixed or adjustable rate mortgage loans, secured by a valid first
lien, on one- to four-family residential properties and (2) the
securities are publicly registered (not issued by FNMA, GNMA or
FHLMC);
(F) Private-placement mortgage pass-throughs provided that (1)
certificates represent a proportional undivided interest in specified
pools of fixed-rate mortgage loans, secured by a valid first lien, on
one- to four-family residential properties, (2) documentation is held
by a trustee or independent custodian, (3) pools of mortgage loans
are serviced by servicers that have been approved by FNMA or FHLMC
and funds shall be advanced to meet deficiencies to the extent
provided in the pooling and servicing agreements creating such
certificates, and (4) pools have been rated Aa or better by Moody's;
and
(G) Whole loans (e.g., direct investments in mortgages) provided that (1)
at least 65% of such loans (a) have seasoning of no less than 6
months, (b) are secured by single-family detached residences, (c) are
owner-occupied primary residences, (d) are secured by a first-lien,
fully-documented mortgage, (e) are neither currently delinquent (30
days or more) nor delinquent during the preceding year, (f) have
loan-to-value ratios of 80% or below, (g) carry normal hazard
insurance and title insurance, as well as special hazard insurance,
if applicable, (h) have original terms to maturity not greater than
30 years, with at least one year remaining to maturity, (i) have a
minimum of $10,000 remaining principal balance, (j) for loans
underwritten after January 1, 1978, FNMA and/or FHLMC forms are used
for fixed-rate loans, and (k) such loans are whole loans and not
participations; (2) for loans that do not satisfy the requirements
set forth in the foregoing clause (1), (a) non-owner occupied
properties represent no greater than 15% of the aggregate of either
the adjustable-rate pool or the fixed-rate pool, (b) multi-family
properties (those with five or more units) represent no greater than
15% of the aggregate of either the adjustable-rate pool or the
fixed-rate pool, (c) condominiums represent no greater than 10% of
the aggregate of either the adjustable-rate pool or the fixed-rate
pool, and any condominium project must be 80% occupied at the time
the loan is originated, (d) properties with loan-to-value ratios
exceeding 80% represent no greater than 25% of the aggregate of
either the
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84
Glossary
--------------------------------------------------------------------------------
adjustable-rate pool or the fixed-rate pool and the portion of the
mortgage on any such property that exceeds a loan-to-value ratio of
80% is insured with Primary Mortgage Insurance from an insurer rated
at least Baa3 by Moody's and (e) loan balances in excess of the
current FHLMC limit plus $75,000 represent no greater than 25% of the
aggregate of either the adjustable-rate pool or the fixed-rate pool,
loan balances in excess of $350,000 represent no greater than 10% of
the aggregate of either the adjustable-rate pool or the fixed-rate
pool, and loan balances in excess of $1,000,000 represent no greater
than 5% of the aggregate of either the adjustable-rate pool or the
fixed-rate pool; (3) no greater than 5% of the pool of loans is
concentrated in any one zip code; (4) the pool of loans contains at
least 100 loans or $2 million in loans per servicer; (5) for
adjustable-rate mortgages ("ARMs"), (a) any ARM is indexed to the
National Cost of Funds index, the 11th District Cost of Funds index,
the 1-year Treasury or the 6-month Treasury, (b) the margin over the
given index is between 0.15% and 0.25% for either cost-of-funds index
and between 0.175% and 0.325% for Treasuries, (c) the maximum yearly
interest rate increase is 2%, (d) the maximum life-time interest rate
increase is 6.25% and (e) ARMs may include Federal Housing
Administration and Department of Veterans Affairs loans; and (6) for
"teaser" loans, (a) the initial discount from the current ARM market
rate is no greater than 2%, (b) the loan is underwritten at the
market rate for ARMs, not the "teaser" rate, and (c) the loan is
seasoned six months beyond the "teaser" period.
(x) Any municipal debt obligation that (A) pays interest in cash, (B) does
not have a Moody's rating, as applicable, suspended by Moody's, and (C)
is part of an issue of municipal debt obligations of at least
$5,000,000, except for municipal debt obligations rated below A by
Moody's, in which case the minimum issue size is $10,000,000;
(xi) Structured Notes and rated TRACERs; and
(xii) Financial contracts, as such term is defined in Section 3(c)(2)(B)(ii)
of the 1940 Act, not otherwise provided for in this definition but only
upon receipt by the Fund of a letter from Moody's specifying any
conditions on including such financial contract in Moody's Eligible
Assets and assuring the Fund that including such financial contract in
the manner so specified would not affect the credit rating assigned by
Moody's to the APS.
In addition, portfolio holdings as described below must be within the following
diversification and issue size requirements in order to be included in Moody's
Eligible Assets:
Maximum Single Maximum Single Minimum Issue Size
Ratings(1) Issuer(2)(3) Industry(3)(4) ($ in million)(5)
------------------------------------------------------------
Aaa........ 100% 100% $100
Aa......... 20 60 100
A.......... 10 40 100
Baa........ 6 20 100
Ba......... 4 12 50(6)
B1-B2...... 3 8 50(6)
B3 or below 2 5 50(6)
(1) Refers to the preferred stock and senior debt rating of the portfolio
holding.
(2) Companies subject to common ownership of 25% or more are considered as one
issuer.
(3) Percentages represent a portion of the aggregate Market Value of corporate
debt securities.
(4) Industries are determined according to Moody's Industry Classifications, as
defined herein.
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85
Glossary
--------------------------------------------------------------------------------
(5) Except for preferred stock, which has a minimum issue size of $50 million.
(6) Portfolio holdings from issues ranging from $50 million to $100 million are
limited to 20% of the Fund's total assets.
Where the Fund sells an asset and agrees to repurchase such asset in the
future, the Discounted Value of such asset will constitute a Moody's Eligible
Asset and the amount the Fund is required to pay upon repurchase of such asset
will count as a liability for the purposes of the APS Basic Maintenance Amount.
Where the Fund purchases an asset and agrees to sell it to a third party in the
future, cash receivable by the Fund thereby will constitute a Moody's Eligible
Asset if the long-term debt of such other party is rated at least A2 by Moody's
and such agreement has a term of 30 days or less; otherwise the Discounted
Value of such purchased asset will constitute a Moody's Eligible Asset. For the
purposes of calculation of Moody's Eligible Assets, portfolio securities which
have been called for redemption by the issuer thereof shall be valued at the
lower of Market Value or the call price of such portfolio securities.
Notwithstanding the foregoing, an asset will not be considered a Moody's
Eligible Asset to the extent that it (i) has been irrevocably deposited for the
payment of (i)(A) through (i)(E) under the definition of APS Basic Maintenance
Amount or to the extent it is subject to any Liens, except for (A) Liens which
are being contested in good faith by appropriate proceedings and which Moody's
has indicated to the Fund will not affect the status of such asset as a Moody's
Eligible Asset, (B) Liens for taxes that are not then due and payable or that
can be paid thereafter without penalty, (C) Liens to secure payment for
services rendered or cash advanced to the Fund by its investment manager or
portfolio manager, the Fund's custodian, transfer agent or registrar or the
Auction Agent and (D) Liens arising by virtue of any repurchase agreement, or
(ii) has been segregated against obligations of the Fund in connection with an
outstanding derivative transaction.
"Moody's Exposure Period" means the period commencing on a given Valuation Date
and ending 49 days thereafter.
"Moody's Industry Classification" means, for the purposes of determining
Moody's Eligible Assets, each of the following industry classifications (or
such other classifications as Moody's may from time to time approve for
application to the APS):
1. Aerospace and Defense: Major Contractor, Subsystems, Research, Aircraft
Manufacturing, Arms, Ammunition
2. Automobile: Automobile Equipment, Auto-Manufacturing, Auto Parts
Manufacturing, Personal Use Trailers, Motor Homes, Dealers
3. Banking: Bank Holding, Savings and Loans, Consumer Credit, Small Loan,
Agency, Factoring, Receivables
4. Beverage, Food and Tobacco: Beer and Ale, Distillers, Wines and Liquors,
Distributors, Soft Drink Syrup, Bottlers, Bakery, Mill Sugar, Canned
Foods, Corn Refiners, Dairy Products, Meat Products, Poultry Products,
Snacks, Packaged Foods, Candy, Gum, Seafood, Frozen Food, Cigarettes,
Cigars, Leaf/Snuff, Vegetable Oil
5. Buildings and Real Estate: Brick, Cement, Climate Controls, Contracting,
Engineering, Construction, Hardware, Forest Products (building-related
only), Plumbing, Roofing, Wallboard, Real Estate, Real Estate
Development, REITs, Land Development
--------------------------------------------------------------------------------
86
Glossary
--------------------------------------------------------------------------------
6. Chemicals, Plastics and Rubber: Chemicals (non-agricultural), Industrial
Gases, Sulfur, Plastics, Plastic Products, Abrasives, Coatings, Paints,
Varnish, Fabricating
7. Containers, Packaging and Glass: Glass, Fiberglass, Containers made of:
Glass, Metal, Paper, Plastic, Wood or Fiberglass
8. Personal and Non-Durable Consumer Products (Manufacturing Only): Soaps,
Perfumes, Cosmetics, Toiletries, Cleaning Supplies, School Supplies
9. Diversified/Conglomerate Manufacturing
10. Diversified/Conglomerate Service
11. Diversified Natural Resources, Precious Metals and Minerals:
Fabricating, Distribution
12. Ecological: Pollution Control, Waste Removal, Waste Treatment and Waste
Disposal
13. Electronics: Computer Hardware, Electric Equipment, Components,
Controllers, Motors, Household Appliances, Information Service
Communicating Systems, Radios, TVs, Tape Machines, Speakers, Printers,
Drivers, Technology
14. Finance: Investment Brokerage, Leasing, Syndication, Securities
15. Farming and Agriculture: Livestock, Grains, Produce, Agriculture
Chemicals, Agricultural Equipment, Fertilizers
16. Grocery: Grocery Stores, Convenience Food Stores
17. Healthcare, Education and Childcare: Ethical Drugs, Proprietary Drugs,
Research, Health Care Centers, Nursing Homes, HMOs, Hospitals, Hospital
Supplies, Medical Equipment
18. Home and Office Furnishings, Housewares, and Durable Consumer Products:
Carpets, Floor Coverings, Furniture, Cooking, Ranges
19. Hotels, Motels, Inns and Gaming
20. Insurance: Life, Property and Casualty, Broker, Agent, Surety
21. Leisure, Amusement, Motion Pictures, Entertainment: Boating, Bowling,
Billiards, Musical Instruments, Fishing, Photo Equipment, Records,
Tapes, Sports, Outdoor Equipment (Camping), Tourism, Resorts, Games, Toy
Manufacturing, Motion Picture Production Theaters, Motion Picture
Distribution
22. Machinery (Non-Agricultural, Non-Construction, Non-Electronic):
Industrial, Machine Tools, Steam Generators
23. Mining, Steel, Iron and Non-Precious Metals: Coal, Copper, Lead,
Uranium, Zinc, Aluminum, Stainless Steel, Integrated Steel, Ore
Production, Refractories, Steel Mill Machinery, Mini-Mills, Fabricating,
Distribution and Sales of the foregoing
--------------------------------------------------------------------------------
87
Glossary
--------------------------------------------------------------------------------
24. Oil and Gas: Crude Producer, Retailer, Well Supply, Service and Drilling
25. Printing, Publishing, and Broadcasting: Graphic Arts, Paper, Paper
Products, Business Forms, Magazines, Books, Periodicals, Newspapers,
Textbooks, Radio, T.V., Cable Broadcasting Equipment
26. Cargo Transport: Rail, Shipping, Railroads, Rail-car Builders, Ship
Builders, Containers, Container Builders, Parts, Overnight Mail,
Trucking, Truck Manufacturing, Trailer Manufacturing, Air Cargo,
Transport
27. Retail Stores: Apparel, Toy, Variety, Drugs, Department, Mail Order
Catalog, Showroom
28. Telecommunications: Local, Long Distance, Independent, Telephone,
Telegraph, Satellite, Equipment, Research, Cellular
29. Textiles and Leather: Producer, Synthetic Fiber, Apparel Manufacturer,
Leather Shoes
30. Personal Transportation: Air, Bus, Rail, Car Rental
31. Utilities: Electric, Water, Hydro Power, Gas
32. Diversified Sovereigns: Semi-sovereigns, Canadian Provinces,
Supra-national Agencies
The Fund will use its discretion in determining which industry classification
is applicable to a particular investment in consultation with the Fund's
independent accountant and Moody's, to the extent the Fund considers necessary.
"Moody's Loan Category" means the following five categories (and, for purposes
of this categorization, the Market Value of a Moody's Eligible Asset trading at
par is equal to $1.00):
(i) "Moody's Loan Category A" means Performing Senior Loans which have a
Market Value or an Approved Price greater than or equal to $0.90.
(ii) "Moody's Loan Category B" means: (A) Performing Senior Loans which have
a Market Value or an Approved Price of greater than or equal to $0.80
but less than $0.90; and (B) non-Performing Senior Loans which have a
Market Value or an Approved Price greater than or equal to $0.85.
(iii) "Moody's Loan Category C" means: (A) Performing Senior Loans which have
a Market Value or an Approved Price of greater than or equal to $0.70
but less than $0.80; and (B) non-Performing Senior Loans which have a
Market Value or an Approved Price of greater than or equal to $0.75 but
less than $0.85.
(iv) "Moody's Loan Category D" means Senior Loans which have a Market Value
or an Approved Price less than $0.75.
(v) "Moody's Loan Category E" means non-Senior Loans which have a Market
Value or an Approved Price.
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Notwithstanding any other provision contained above, for purposes of
determining whether a Moody's Eligible Asset falls within a specific Moody's
Loan Category, to the extent that any Moody's Eligible Asset would fall in more
than one of the Moody's Loan Categories, such Moody's Eligible Asset shall be
deemed to fall into the Moody's Loan Category with the lowest applicable
Moody's Discount Factor.
"NACM" means Nicholas-Applegate Capital Management LLC.
"NAV" has the meaning specified under "Net asset value" in this Prospectus.
"1940 Act" means the Investment Company Act of 1940, and the regulations
thereunder, each as amended from time to time.
"1940 Act APS Asset Coverage" has the meaning specified under "Rating agency
guidelines" in this Prospectus.
"1940 Act Cure Date" has the meaning specified under "Description of APS--Asset
Maintenance--1940 Act APS Asset Coverage" in this Prospectus.
"Non-Call Period" has the meaning set forth in the definition of "Specific
Redemption Provisions" below.
"Non-Payment Period" has the meaning specified under "Description of
APS--Dividends--Non-Payment Period; Late Charge" in this Prospectus.
"Non-Payment Period Rate" has the meaning specified under "Description of
APS--Dividends--Non-Payment Period; Late Charge" in this Prospectus.
"Normal Dividend Payment Date" has the meaning specified under "Description of
APS--Dividends--General" in this Prospectus.
"Notice of Revocation" has the meaning specified under "Description of
APS--Dividends--Notification of Dividend Period" in this Prospectus.
"Notice of Special Dividend Period" has the meaning specified under
"Description of APS Dividends--Notification of Dividend Period" in this
Prospectus.
"NYSE Close" has the meaning set forth under "Net asset value" in this
Prospectus.
"Optional Redemption Price" has the meaning specified under "Description of
APS--Redemption--Optional Redemption" in this Prospectus.
"Order" has the meaning specified under "Description of APS--Auction
Procedures--Orders by Beneficial Owners, Potential Beneficial Owners, Existing
Holders and Potential Holders" in this Prospectus.
"Performing" means with respect to any asset that is a Bank Loan or other debt,
the issuer of such investment is not in default of any payment obligations in
respect thereof.
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"Potential Beneficial Owner" means a customer of a Broker-Dealer or a
Broker-Dealer that is not a Beneficial Owner of APS but that wishes to purchase
such shares, or that is a Beneficial Owner that wishes to purchase additional
APS.
"Potential Holder" means any Broker-Dealer or any such other person as may be
permitted by the Fund, including any Existing Holder, who may be interested in
acquiring APS (or, in the case of an Existing Holder, additional APS).
"Preferred Shares" means preferred shares of beneficial interest of the Fund,
and includes the APS.
"Premium Call Period" has the meaning set forth under the definition of
"Specific Redemption Provisions" below.
"Pricing Service" means any pricing service designated by the Board of Trustees
of the Fund and approved by Moody's for purposes of determining whether the
Fund has Eligible Assets with an aggregate Discounted Value that equals or
exceeds the APS Basic Maintenance Amount.
"Rating Agency" means a nationally recognized statistical rating organization.
"Reference Rate" means the applicable "AA" Financial Composite Commercial Paper
Rate (for a Dividend Period of fewer than 184 days) or the applicable Treasury
Index Rate (for a Dividend Period of 184 days or more).
"REITs" means real estate investment trusts.
"Representatives" has the meaning specified under "Underwriting" in this
Prospectus.
"Request for Special Dividend Period" has the meaning specified under
"Description of APS--Dividends--Notification of Dividend Period" in this
Prospectus.
"Response" has the meaning specified under "Description of
APS--Dividends--Notification of Dividend Period" in this Prospectus.
"Rule 144A Securities" means securities which are restricted as to resale under
federal securities laws but are eligible for resale pursuant to Rule 144A under
the Securities Act of 1933 as determined by the Fund's investment manager or
portfolio manager acting pursuant to procedures approved by the Board of
Trustees of the Fund.
"S&P" means Standard & Poor's, a division of The McGraw-Hill Companies, Inc.,
or its successors.
"Securities Depository" means The Depository Trust Company and its successors
and assigns or any successor securities depository selected by the Fund that
agrees to follow the procedures required to be followed by such securities
depository in connection with the APS.
"Sell Order" has the meaning specified under "Description of APS--Auction
Procedures--Orders by Beneficial Owners, Potential Beneficial Owners, Existing
Holders and Potential Holders" in this Prospectus.
"Senior Loans" has the meaning set forth in paragraph (vii) of the definition
of "Moody's Discount Factor."
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"7-Day Dividend Period" has the meaning specified under "Prospectus
summary--Dividends on APS" in this Prospectus.
"Shareholder Servicing Agreement" has the meaning specified under "Shareholder
servicing agent, custodian and transfer agents" in this Prospectus.
"Short Term Dividend Period" has the meaning specified under "Prospectus
summary--Dividends on APS" in this Prospectus.
"Short Term Money Market Instruments" means the following types of instruments
if, on the date of purchase or other acquisition thereof by the Fund, the
remaining term to maturity thereof is not in excess of 180 days (or 270 days
for instruments rated at least Aaa for purposes of determining Moody's Eligible
Assets):
(i) commercial paper rated either F-1 by Fitch or A-1 by S&P if such
commercial paper matures in 30 days or P-1 by Moody's and either F-1+ by
Fitch or A-1+ by S&P if such commercial paper matures in over 30 days;
(ii) demand or time deposits in, and banker's acceptances and certificates of
deposit of, (A) a depository institution or trust company incorporated
under the laws of the United States of America or any state thereof or
the District of Columbia or (B) a United States branch office or agency
of a foreign depository institution (provided that such branch office or
agency is subject to banking regulation under the laws of the United
States, any state thereof or the District of Columbia);
(iii) overnight funds;
(iv) U.S. Government Securities; and
(v) Eurodollar demand or time deposits in, or certificates of deposit of,
the head office or the London branch office of a depository institution
or trust company if the certificates of deposit, if any, and the
long-term unsecured debt obligations (other than such obligations the
ratings of which are based on the credit of a person or entity other
than such depository institution or trust company) of such depository
institution or trust company that have (1) credit ratings on each
Valuation Date of at least P-1 from Moody's and either F-1+ from Fitch
or A-1+ from S&P, in the case of commercial paper or certificates of
deposit, and (2) credit ratings on each Valuation Date of at least Aa3
from Moody's and either AA from Fitch or AA- from S&P, in the case of
long-term unsecured debt obligations; provided, however, that in the
case of any such investment that matures in no more than one Business
Day from the date of purchase or other acquisition by the Fund, all of
the foregoing requirements shall be applicable except that the required
long-term unsecured debt credit rating of such depository institution or
trust company from Moody's, Fitch and S&P shall be at least A2, A-2 and
A, respectively; and provided further, however, that the foregoing
credit rating requirements shall be deemed to be met with respect to a
depository institution or trust company if (1) such depository
institution or trust company is the principal depository institution in
a holding company system, (2) the certificates of deposit, if any, of
such depository institution or trust company are not rated on any
Valuation Date below P-1 by Moody's, F-1+ by Fitch or A-1+ by S&P and
there is no long-term rating, and (3) the holding company shall meet all
of the foregoing credit rating requirements (including the preceding
proviso in the case of investments that mature in no more
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than one Business Day from the date of purchase or other acquisition by
the Fund); and provided further, that the interest receivable by the
Fund shall not be subject to any withholding or similar taxes.
"Special Dividend Period" has the meaning specified under "Prospectus
summary--Dividends on APS" in this Prospectus.
"Specific Redemption Provisions" means, with respect to a Special Dividend
Period either, or both, of (i) a period (a "Non-Call Period") determined by the
Board of Trustees of the Fund, after consultation with the Auction Agent and
the Broker-Dealers, during which the APS subject to such Special Dividend
Period shall not be subject to redemption at the option of the Fund and (ii) a
period (a "Premium Call Period"), consisting of a number of whole years and
determined by the Board of Trustees of the Fund, after consultation with the
Auction Agent and the Broker-Dealers, during each year of which the APS subject
to such Special Dividend Period shall be redeemable at the Fund's option at a
price per share equal to $25,000, plus accumulated but unpaid dividends
(whether or not earned or declared) to (but not including) the date fixed for
redemption, plus a premium expressed as a percentage or percentages of $25,000,
as determined by the Board of Trustees of the Fund after consultation with the
Auction Agent and the Broker-Dealers.
"Structured Notes" means privately negotiated debt obligations where the
principal and/or interest is determined by reference to the performance of a
benchmark asset or market (an "embedded index"), such as selected securities or
an index of securities, or the differential performance of two assets or
markets, such as indices reflecting bonds.
"Submission Deadline" has the meaning specified under "Description of
APS--Auction Procedures--Submission of Orders by Broker-Dealers to Auction
Agent" in this Prospectus.
"Submitted Bid" has the meaning specified under "Description of APS--Auction
Procedures--Determination of Sufficient Clearing Bids, Winning Bid Rate and
Applicable Rate" in this Prospectus.
"Submitted Hold Order" has the meaning specified under "Description of
APS--Auction Procedures--Determination of Sufficient Clearing Bids, Winning Bid
Rate and Applicable Rate" in this Prospectus.
"Submitted Order" has the meaning specified under "Description of APS--Auction
Procedures--Determination of Sufficient Clearing Bids, Winning Bid Rate and
Applicable Rate" in this Prospectus.
"Submitted Sell Order" has the meaning specified under "Description of
APS--Auction Procedures--Determination of Sufficient Clearing Bids, Winning Bid
Rate and Applicable Rate" in this Prospectus.
"Subsequent Dividend Period" means each Dividend Period after the Initial
Dividend Period.
"Substitute Rating Agency" means a Rating Agency selected by UBS Warburg LLC or
its affiliates and successors, after consultation with the Fund, to act as the
substitute Rating Agency to determine the credit ratings of the APS.
"Sufficient Clearing Bids" has the meaning set forth in Subsection 11.10(d)(i)
of the Auction Procedures.
"TRACERs" means traded custody receipts representing direct ownership in a
portfolio of underlying securities.
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"Treasury Bill" means a direct obligation of the U.S. Government having a
maturity at the time of issuance of 364 days or less.
"Treasury Bonds" means United States Treasury Bonds or Notes.
"Treasury Index Rate" means the average yield to maturity for actively traded
marketable U.S. Treasury fixed interest rate securities having the same number
of 30-day periods to maturity as the length of the applicable Dividend Period,
determined, to the extent necessary, by linear interpolation based upon the
yield for such securities having the next shorter and next longer number of
30-day periods to maturity treating all Dividend Periods with a length greater
than the longest maturity for such securities as having a length equal to such
longest maturity, in all cases based upon data set forth in the most recent
weekly statistical release published by the Board of Governors of the Federal
Reserve System (currently in H.15 (519)); provided, however, if the most recent
such statistical release shall not have been published during the 15 days
preceding the date of computation, the foregoing computations shall be based
upon the average of comparable data as quoted to the Fund by at least three
recognized dealers in U.S. Government Securities selected by the Fund.
"Underwriters" has the meaning specified under "Prospectus summary--The
Offering" in this Prospectus.
"Underwriting Agreement" has the meaning specified under "Underwriting" in this
Prospectus.
"U.S. Government Securities" means direct obligations of the United States or
of its agencies or instrumentalities that are entitled to the full faith and
credit of the United States and that, other than Treasury Bills, provide for
the periodic payment of interest and the full payment of principal at maturity
or call for redemption.
"U.S. Treasury Securities" means direct obligations of the United States
Treasury that are entitled to the full faith and credit of the United States.
"U.S. Treasury Strips" means securities based on U.S. Treasury Securities
created through the Separate Trading of Registered Interest and Principal of
Securities program.
"Valuation Date" has the meaning specified under "Description of APS--Asset
Maintenance--APS Basic Maintenance Amount" in this Prospectus.
"Volatility Factor" means 1.89.
"Winning Bid Rate" has the meaning specified under "Description of APS--Auction
Procedures--Determination of Sufficient Clearing Bids, Winning Bid Rate and
Applicable Rate" in this Prospectus.
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Appendix A
DESCRIPTION OF SECURITIES RATINGS
The Fund's investments may range in quality from securities rated in the lowest
category to securities rated in the highest category (as rated by Moody's or
S&P or, if unrated, determined by NACM to be of comparable quality). The
percentage of a Fund's assets invested in securities in a particular rating
category will vary. The following terms are generally used to describe the
credit quality of debt securities:
High Quality Debt Securities are those rated in one of the two highest rating
categories (the highest category for commercial paper) or, if unrated, deemed
comparable by NACM.
Investment Grade Debt Securities are those rated in one of the four highest
rating categories or, if unrated, deemed comparable by NACM.
Below Investment Grade, High Yield Securities ("Junk Bonds") are those rated
lower than Baa by Moody's or BBB by S&P and comparable securities. They are
deemed predominantly speculative with respect to the issuer's ability to repay
principal and interest.
Following is a description of Moody's and S&P's rating categories applicable to
debt securities.
Moody's Investors Service, Inc.
Corporate and Municipal Bond Ratings
Aaa: Bonds which are rated Aaa are judged to be of 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: Bonds 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 fluctuation of
protective elements may be of greater amplitude or there may be other elements
present that make the long-term risks appear somewhat larger than with Aaa
securities.
A: Bonds 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
that suggest a susceptibility to impairment sometime in the future.
Baa: Bonds 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 bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
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A-1
Appendix A
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B: Bonds which are rated B generally lack characteristics of a desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca: Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Moody's bond ratings, where specified, are applicable to financial contracts,
senior bank obligations and insurance company senior policyholder and claims
obligations with an original maturity in excess of one year. Obligations
relying upon support mechanisms such as letter-of-credit and bonds of indemnity
are excluded unless explicitly rated. Obligations of a branch of a bank are
considered to be domiciled in the country in which the branch is located.
Unless noted as an exception, Moody's rating on a bank's ability to repay
senior obligations extends only to branches located in countries which carry a
Moody's Sovereign Rating for Bank Deposits. Such branch obligations are rated
at the lower of the bank's rating or Moody's Sovereign Rating for the Bank
Deposits for the country in which the branch is located. When the currency in
which an obligation is denominated is not the same as the currency of the
country in which the obligation is domiciled, Moody's ratings do not
incorporate an opinion as to whether payment of the obligation will be affected
by the actions of the government controlling the currency of denomination. In
addition, risk associated with bilateral conflicts between an investor's home
country and either the issuer's home country or the country where an issuer
branch is located are not incorporated into Moody's ratings.
Moody's makes no representation that rated bank obligations or insurance
company obligations are exempt from registration under the U.S. Securities Act
of 1933 or issued in conformity with any other applicable law or regulation.
Nor does Moody's represent any specific bank or insurance company obligation is
legally enforceable or a valid senior obligation of a rated issuer.
Moody's applies numerical modifiers, 1, 2, and 3, in each generic rating
classified from Aa through Caa in its corporate 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.
Corporate Short-Term Debt Ratings
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be investment
grade, to indicate the relative repayment ability of rated issuers:
PRIME-1: Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1 repayment
ability will often be evidenced by many of the following characteristics:
leading market positions in well-established industries; high rates of return on
--------------------------------------------------------------------------------
A-2
Appendix A
--------------------------------------------------------------------------------
funds employed; conservative capitalization structure with moderate reliance on
debt and ample asset protection; broad margins in earnings coverage of fixed
financial charges and high internal cash generation; and well-established
access to a range of financial markets and assured sources of alternate
liquidity.
PRIME-2: Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
PRIME-3: Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt
protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
NOT PRIME: Issuers rated Not Prime do not fall within any of the Prime rating
categories.
Standard & Poor's
Issue Credit Rating Definitions
A Standard & Poor's issue credit rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations, or a specific financial program
(including ratings on medium term note programs and commercial paper programs).
It takes into consideration the creditworthiness of guarantors, insurers, or
other forms of credit enhancement on the obligation and takes into account the
currency in which the obligation is denominated. The issue credit rating is not
a recommendation to purchase, sell, or hold a financial obligation, inasmuch as
it does not comment as to market price or suitability for a particular investor.
Issue credit ratings are based on current information furnished by the obligors
or obtained by Standard & Poor's from other sources it considers reliable.
Standard & Poor's does not perform an audit in connection with any credit
rating and may, on occasion, rely on unaudited financial information. Credit
ratings may be changed, suspended, or withdrawn as a result of changes in, or
unavailability of, such information, or based on other circumstances.
Issue credit ratings can be either long-term or short-term. Short-term ratings
are generally assigned to those obligations considered short term in the
relevant market. In the U.S., for example, that means obligations with an
original maturity of no more than 365 days--including commercial paper.
Short-term ratings are also used to indicate the creditworthiness of an obligor
with respect to put features on long-term obligations. The result is a dual
rating, in which the short-term rating addresses the put feature, in addition
to the usual long-term rating. Medium-term notes are assigned long-term ratings.
Issue credit ratings are based, in varying degrees, on the following
considerations: likelihood of payment--capacity and willingness of the obligor
to meet its financial commitment on an obligation in accordance with the terms
of the obligation; nature of and provisions of the obligation; protection
afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization, or other arrangement under the laws of bankruptcy
and other laws affecting creditors' rights.
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--------------------------------------------------------------------------------
The issue rating definitions are expressed in terms of default risk. As such,
they pertain to senior obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to reflect the lower priority in
bankruptcy, as noted above. (Such differentiation applies when an entity has
both senior and subordinated obligations, secured and unsecured obligations, or
operating company and holding company obligations.) Accordingly, in the case of
junior debt, the rating may not conform exactly with the category definition.
Corporate and Municipal Bond Ratings
Investment Grade
AAA: An obligation rated AAA has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA: An obligation rated AA differs from the highest rated obligations only in
small degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
A: An obligation rated A is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in higher
rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB: An obligation rated BBB exhibits adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity of the obligor to meet its financial commitment on the
obligation.
Speculative Grade
Obligations rated BB, B, CCC, CC, and C are regarded as having predominantly
speculative characteristics with respect to capacity to pay interest and repay
principal. BB indicates the least degree of speculation and C the highest.
While such debt will likely have some quality and protective characteristics,
these are outweighed by large uncertainties or major exposures to adverse
conditions.
BB: An obligation rated BB is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B: An obligation rated B is more vulnerable to nonpayment than obligations
rated BB, but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
CCC: An obligation rated CCC is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC: An obligation rated CC is currently highly vulnerable to nonpayment.
C: A subordinated debt or preferred stock obligation rated C is CURRENTLY
HIGHLY VULNERABLE to nonpayment. The C rating may be used to cover a situation
where a bankruptcy petition has been filed or similar action taken, but
payments on this obligation are being continued. A C also will be assigned to a
preferred stock issue in arrears on dividends or sinking fund payments, but
that is currently paying.
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Appendix A
--------------------------------------------------------------------------------
CI: The rating CI is reserved for income bonds on which no interest is being
paid.
D: An obligation rated D is in payment default. The D rating category is used
when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poor's believes that
such payments will be made during such grace period. The D rating also will be
used upon the filing of a bankruptcy petition or the taking of a similar action
if payments on an obligation are jeopardized.
Plus (+) or Minus (-): The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Provisional ratings: The letter "p" indicates that the rating is provisional. A
provisional rating assumes the successful completion of the project being
financed by the debt being rated and indicates that payment of debt service
requirements is largely or entirely dependent upon the successful and timely
completion of the project. This rating, however, while addressing credit
quality subsequent to completion of the project, makes no comment on the
likelihood of, or the risk of default upon failure of, such completion. The
investor should exercise his own judgment with respect to such likelihood and
risk.
r: This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk--such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
The absence of an "r" symbol should not be taken as an indication that an
obligation will exhibit no volatility or variability in total return.
N.R.: This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that Standard & Poor's
does not rate a particular obligation as a matter of policy.
Debt obligations of issuers outside the United States and its territories are
rated on the same basis as domestic corporate and municipal issues. The ratings
measure the creditworthiness of the obligor but do not take into account
currency exchange and related uncertainties.
Commercial Paper Rating Definitions
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more
than 365 days. Ratings are graded into several categories, ranging from A for
the highest quality obligations to D for the lowest. These categories are as
follows:
A-1: A short-term obligation rated A-1 is rated in the highest category by
Standard & Poor's. The obligor's capacity to meet its financial commitment on
the obligation is strong. Within this category, certain obligations are
designated with a plus sign (+). This indicates that the obligor's capacity to
meet its financial commitment on these obligations is extremely strong.
A-2: A short-term obligation rated A-2 is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to
meet its financial commitment on the obligation is satisfactory.
A-3: A short-term obligation rated A-3 exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
--------------------------------------------------------------------------------
A-5
Appendix A
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B: A short-term obligation rated B is regarded as having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet its
financial commitment on the obligation.
C: A short-term obligation rated C is currently vulnerable to nonpayment and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation.
D: A short-term obligation rated D is in payment default. The D rating category
is used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poor's believes that
such payments will be made during such grace period. The D rating also will be
used upon the filing of a bankruptcy petition or the taking of a similar action
if payments on an obligation are jeopardized.
A commercial paper rating is not a recommendation to purchase, sell or hold a
security inasmuch as it does not comment as to market price or suitability for
a particular investor. The ratings are based on current information furnished
to Standard & Poor's by the issuer or obtained from other sources it considers
reliable. Standard & Poor's does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended, or withdrawn as a result of changes in or
unavailability of such information.
--------------------------------------------------------------------------------
A-6
[LOGO] PIMCO
ADVISORS
NICHOLAS-APPLEGATE CONVERTIBLE & INCOME FUND
STATEMENT OF ADDITIONAL INFORMATION
May 21, 2003
Nicholas-Applegate Convertible & Income Fund (the "Fund") is a recently
organized, diversified closed-end management investment company.
This Statement of Additional Information relating to auction preferred
shares of the Fund ("APS") is not a prospectus, and should be read in
conjunction with the Fund's prospectus relating to the APS dated May 21, 2003
(the "Prospectus"). This Statement of Additional Information does not include
all information that a prospective investor should consider before purchasing
APS, and investors should obtain and read the Prospectus prior to purchasing
such shares. A copy of the Prospectus may be obtained without charge by calling
(877) 819-2224. You may also obtain a copy of the Prospectus on the web site
(http://www.sec.gov) of the Securities and Exchange Commission ("SEC").
Capitalized terms used but not defined in this Statement of Additional
Information have the meanings ascribed to them in the Prospectus.
-1-
TABLE OF CONTENTS
USE OF PROCEEDS.........................................................3
INVESTMENT OBJECTIVE AND POLICIES.......................................3
INVESTMENT RESTRICTIONS................................................38
MANAGEMENT OF THE FUND.................................................41
INVESTMENT MANAGER AND PORTFOLIO MANAGER...............................51
PORTFOLIO TRANSACTIONS.................................................56
DISTRIBUTIONS..........................................................58
DESCRIPTION OF SHARES..................................................58
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST.........59
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND...............61
TAX MATTERS............................................................63
PERFORMANCE RELATED AND COMPARATIVE INFORMATION........................71
CUSTODIAN, TRANSFER AGENTS AND DIVIDEND PAYING AGENT...................71
INDEPENDENT ACCOUNTANTS................................................72
COUNSEL................................................................72
REGISTRATION STATEMENT.................................................72
FINANCIAL STATEMENTS...................................................73
APPENDIX A - AUCTION PROCEDURES.......................................A-1
APPENDIX B - SETTLEMENT PROCEDURES................................... B-1
APPENDIX C - DESCRIPTION OF SECURITIES RATINGS....................... C-1
This Statement of Additional Information is dated May 21, 2003.
-2-
USE OF PROCEEDS
The net proceeds of the offering of APS of the Fund will be approximately
$519,225,000 after payment of offering costs and the sales load.
Pending investment in convertible securities, non-convertible
income-producing securities and other securities that meet the Fund's investment
objective and policies, it is anticipated that the net proceeds of the offering
will be invested in high grade, short-term securities, credit-linked trust
certificates, and/or high yield securities index futures contracts or similar
derivative instruments designed to give the Fund market exposure while specific
securities are selected.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective and general investment policies of the Fund are
described in the Prospectus. Additional information concerning the
characteristics of certain of the Fund's investments is set forth below.
CONVERTIBLE SECURITIES
The Fund may invest without limit in convertible securities, and these
securities will ordinarily constitute a principal component of the Fund's
investment program. Convertible securities are bonds, debentures, notes,
preferred stocks or other securities that may be converted or exchanged (by the
holder or by the issuer) into shares of the underlying common stock (or cash or
securities of equivalent value) at a stated exchange ratio or predetermined
price (the "conversion price"). A convertible security is designed to provide
current income and also the potential for capital appreciation through the
conversion feature, which enables the holder to benefit from increases in the
market price of the underlying common stock. A convertible security may be
called for redemption or conversion by the issuer after a particular date and
under certain circumstances (including a specified price) established upon
issue. If a convertible security held by the Fund is called for redemption or
conversion, the Fund could be required to tender it for redemption, convert it
into the underlying common stock, or sell it to a third party, which may have an
adverse effect on the Fund's ability to achieve its investment objective.
Convertible securities have general characteristics similar to both debt and
equity securities.
A convertible security generally entitles the holder to receive interest
paid or accrued until the convertible security matures or is redeemed, converted
or exchanged. Convertible securities rank senior to common stock in a
corporation's capital structure and, therefore, generally entail less risk than
the corporation's common stock, although the extent to which such risk is
reduced depends in large measure upon the degree to which the convertible
security sells above its value as a debt obligation. Before conversion,
convertible securities have characteristics similar to non-convertible debt
obligations and are designed to provide for a stable stream of income with
generally higher yields than common stocks. However, there can be no assurance
of current income because the issuers of the convertible securities may default
on their obligations. Convertible securities are subordinate in rank to any
senior debt obligations of the issuer, and, therefore, an issuer's convertible
securities entail more risk than its debt obligations. Moreover, convertible
securities are often rated below investment grade or not rated because they fall
below debt obligations and just above common equity in order of preference or
priority on an issuer's balance sheet. See "--High Yield Securities" below.
-3-
Convertible securities generally offer lower interest or dividend yields
than non-convertible securities of similar credit quality because of the
potential for capital appreciation. The common stock underlying convertible
securities may be issued by a different entity than the issuer of the
convertible securities.
The value of convertible securities is influenced by both the yield of
non-convertible securities of comparable issuers and by the value of the
underlying common stock. The value of a convertible security viewed without
regard to its conversion feature (i.e., strictly on the basis of its yield) is
sometimes referred to as its "investment value." The investment value of the
convertible security typically will fluctuate based on the credit quality of the
issuer and will fluctuate inversely with changes in prevailing interest rates.
However, at the same time, the convertible security will be influenced by its
"conversion value," which is the market value of the underlying common stock
that would be obtained if the convertible security were converted. Conversion
value fluctuates directly with the price of the underlying common stock, and
will therefore be subject to risks relating to the activities of the issuer
and/or general market and economic conditions. Depending upon the relationship
of the conversion price to the market value of the underlying security, a
convertible security may trade more like an equity security than a debt
instrument.
If, because of a low price of the common stock, the conversion value is
substantially below the investment value of the convertible security, the price
of the convertible security is governed principally by its investment value. If
the conversion value of a convertible security increases to a point that
approximates or exceeds its investment value, the value of the security will be
principally influenced by its conversion value. A convertible security will sell
at a premium over its conversion value to the extent investors place value on
the right to acquire the underlying common stock while holding an
income-producing security.
SYNTHETIC CONVERTIBLE SECURITIES
Nicholas-Applegate Capital Management LLC ("NACM"), the Fund's portfolio
manager, may also create a "synthetic" convertible security by combining
separate securities that possess the two principal characteristics of a
traditional convertible security, i.e., an income-producing security
("income-producing component") and the right to acquire an equity security
("convertible component"). The income-producing component is achieved by
investing in non-convertible, income-producing securities such as bonds,
preferred stocks and money market instruments. The convertible component is
achieved by investing in warrants or options to buy common stock at a certain
exercise price, or options on a stock index. Unlike a traditional convertible
security, which is a single security having a unitary market value, a synthetic
convertible comprises two or more separate securities, each with its own market
value. Therefore, the "market value" of a synthetic convertible security is the
sum of the values of its income-producing component and its convertible
component. For this reason, the values of a synthetic convertible security and a
traditional convertible security may respond differently to market fluctuations.
More flexibility is possible in the assembly of a synthetic convertible
security than in the purchase of a convertible security. Although synthetic
convertible securities may be selected where the two components are issued by a
single issuer, thus making the synthetic convertible security similar to the
traditional convertible security, the character of a synthetic convertible
security allows the combination of components representing distinct issuers,
when NACM believes that
-4-
such a combination would better promote the Fund's investment objective. A
synthetic convertible security also is a more flexible investment in that its
two components may be purchased separately. For example, the Fund may purchase a
warrant for inclusion in a synthetic convertible security but temporarily hold
short-term investments while postponing the purchase of a corresponding bond
pending development of more favorable market conditions.
A holder of a synthetic convertible security faces the risk of a decline in
the price of the security or the level of the index involved in the convertible
component, causing a decline in the value of the call option or warrant
purchased to create the synthetic convertible security. Should the price of the
stock fall below the exercise price and remain there throughout the exercise
period, the entire amount paid for the call option or warrant would be lost.
Because a synthetic convertible security includes the income-producing component
as well, the holder of a synthetic convertible security also faces the risk that
interest rates will rise, causing a decline in the value of the income-producing
instrument.
The Fund may also purchase synthetic convertible securities created by
other parties, including convertible structured notes. Convertible structured
notes are income-producing debentures linked to equity, and are typically issued
by investment banks. Convertible structured notes have the attributes of a
convertible security; however, the investment bank that issues the convertible
note, rather than the issuer of the underlying common stock into which the note
is convertible, assumes credit risk associated with the investment.
The Fund's holdings of synthetic convertible securities are considered
convertible securities for purposes of the Fund's policy to invest at least 50%
of its assets in convertible securities and 80% of its total assets in a
diversified portfolio of convertible and non-convertible income-producing
securities.
HIGH YIELD SECURITIES
As described under "The Fund's investment objective and strategies" in the
Prospectus, the Fund may invest without limit in securities rated lower than Baa
by Moody's Investors Service, Inc. ("Moody's") or BBB by Standard & Poor's
("S&P"), or in securities that are unrated but judged to be of comparable
quality by NACM, and expects that ordinarily NACM's portfolio strategies will
result in the Fund investing primarily in these securities. These securities are
sometimes referred to as "high yield" securities or "junk bonds."
Investments in high yield securities generally provide greater income and
increased opportunity for capital appreciation than investments in higher
quality securities, but they also typically entail greater price volatility and
principal and income risk, including the possibility of issuer default and
bankruptcy. High yield securities are regarded as predominantly speculative with
respect to the issuer's continuing ability to meet principal and interest
payments. Securities in the lowest investment grade category also may be
considered to possess some speculative characteristics by certain rating
agencies. In addition, analysis of the creditworthiness of issuers of high yield
securities may be more complex than for issuers of higher quality securities.
High yield securities may be more susceptible to real or perceived adverse
economic and competitive industry conditions than investment grade securities. A
projection of an economic downturn or of a period of rising interest rates, for
example, could cause a decline in high yield
-5-
security prices because the advent of a recession could lessen the ability of an
issuer to make principal and interest payments on its debt obligations. If an
issuer of high yield securities defaults, in addition to risking payment of all
or a portion of interest and principal, the Fund may incur additional expenses
to seek recovery. The market prices of high yield securities structured as
zero-coupon, step-up or payment-in-kind securities will normally be affected to
a greater extent by interest rate changes, and therefore tend to be more
volatile than the prices of securities that pay interest currently and in cash.
NACM seeks to reduce these risks through diversification, credit analysis and
attention to current developments and trends in both the economy and financial
markets.
The secondary market on which high yield securities are traded may be less
liquid than the market for investment grade securities. Less liquidity in the
secondary trading market could adversely affect the price at which the Fund
could sell a high yield security, and could adversely affect the net asset value
of the shares. Adverse publicity and investor perceptions, whether or not based
on fundamental analysis, may decrease the values and liquidity of high yield
securities, especially in a thinly traded market. When secondary markets for
high yield securities are less liquid than the market for investment grade
securities, it may be more difficult to value the securities because such
valuation may require more research, and elements of judgment may play a greater
role in the valuation because there is less reliable, objective data available.
During periods of thin trading in these markets, the spread between bid and
asked prices is likely to increase significantly and the Fund may have greater
difficulty selling its portfolio securities. The Fund will be more dependent on
NACM's research and analysis when investing in high yield securities. NACM seeks
to minimize the risks of investing through in-depth credit analysis and
attention to current developments in interest rates and market conditions.
A general description of the ratings of securities by Moody's, S&P and
Fitch is set forth in Appendix C to this Statement of Additional Information.
The ratings of Moody's and S&P represent their opinions as to the quality of the
securities they rate. It should be emphasized, however, that ratings are general
and are not absolute standards of quality. Consequently, in the case of debt
obligations, certain debt obligations with the same maturity, coupon and rating
may have different yields while debt obligations with the same maturity and
coupon with different ratings may have the same yield. For these reasons, the
use of credit ratings as the sole method of evaluating high yield securities can
involve certain risks. For example, credit ratings evaluate the safety of
principal and interest payments, not the market value risk of high yield
securities. Also, credit rating agencies may fail to change credit ratings in a
timely fashion to reflect events since the security was last rated. NACM does
not rely solely on credit ratings when selecting securities for the Fund, and
develops its own independent analysis of issuer credit quality.
The Fund's credit quality policies apply only at the time a security is
purchased, and the Fund is not required to dispose of a security in the event
that a rating agency or NACM downgrades its assessment of the credit
characteristics of a particular issue. In determining whether to retain or sell
such a security, NACM may consider such factors as NACM's assessment of the
credit quality of the issuer of such security, the price at which such security
could be sold and the rating, if any, assigned to such security by other rating
agencies. However, analysis of creditworthiness may be more complex for issuers
of high yield securities than for issuers of higher quality debt securities.
-6-
FOREIGN (NON-U.S.) SECURITIES
The Fund may invest up to 20% of its total assets in U.S.
dollar-denominated securities of foreign issuers based in developed countries.
For this purpose, foreign securities include, but are not limited to, foreign
convertible securities and non-convertible income-producing securities, foreign
equity securities (including preferred securities of foreign issuers), foreign
bank obligations, and obligations of foreign governments or their subdivisions,
agencies and instrumentalities, international agencies and supranational
entities. American Depository Receipts ("ADRs") or securities guaranteed by a
United States person are not treated as securities of foreign issuers for
purposes of the 20% limitation above, although Global Depository Receipts
("GDRs") or other securities representing underlying shares of foreign issuers
are so treated.
ADRs are U.S. dollar-denominated receipts issued generally by domestic
banks and represent the deposit with the bank of a security of a foreign issuer.
GDRs may be offered privately in the United States and also trade in public or
private markets in other countries. ADRs and GDRs may be issued as sponsored or
unsponsored programs. In sponsored programs, an issuer has made arrangements to
have its securities trade in the form of ADRs or GDRs. In unsponsored programs,
the issuer may not be directly involved in the creation of the program. Although
regulatory requirements with respect to sponsored and unsponsored programs are
generally similar, in some cases it may be easier to obtain financial
information from an issuer that has participated in the creation of a sponsored
program.
Other foreign securities in which the Fund may invest include Eurodollar
obligations and "Yankee Dollar" obligations. Eurodollar obligations are U.S.
dollar-denominated certificates of deposit and time deposits issued outside the
U.S. capital markets by foreign branches of U.S. banks and by foreign banks.
Yankee Dollar obligations are U.S. dollar-denominated obligations issued in the
U.S. capital markets by foreign banks. Eurodollar and Yankee Dollar obligations
are generally subject to the same risks that apply to domestic debt issues,
notably credit risk, market risk and liquidity risk. Additionally, Eurodollar
(and, to a limited extent, Yankee Dollar) obligations are subject to certain
sovereign risks. One such risk is the possibility that a sovereign country might
prevent capital, in the form of U.S. dollars, from flowing across its borders.
Other risks include adverse political and economic developments; the extent and
quality of government regulation of financial markets and institutions; the
imposition of foreign withholding taxes; and the expropriation or
nationalization of foreign issuers.
The Fund also may invest in Brady Bonds. Brady Bonds are securities created
through the exchange of existing commercial bank loans to sovereign entities for
new obligations in connection with debt restructurings under a debt
restructuring plan introduced by former U.S. Secretary of the Treasury, Nicholas
F. Brady (the "Brady Plan"). Brady Plan debt restructurings have been
implemented in a number of countries, including: Argentina, Bolivia, Brazil,
Bulgaria, Costa Rica, the Dominican Republic, Ecuador, Jordan, Mexico, Niger,
Nigeria, Panama, Peru, the Philippines, Poland, Uruguay, and Venezuela.
Brady Bonds may be collateralized or uncollateralized, are issued in
various currencies (although the Fund may invest only in U.S. dollar-denominated
securities) and are actively traded in the over-the-counter secondary market.
Brady Bonds are not considered to be U.S.
-7-
Government securities. U.S. dollar-denominated, collateralized Brady Bonds,
which may be fixed rate par bonds or floating rate discount bonds, are generally
collateralized in full as to principal by U.S. Treasury zero-coupon bonds having
the same maturity as the Brady Bonds. Interest payments on these Brady Bonds
generally are collateralized on a one-year or longer rolling-forward basis by
cash or securities in an amount that, in the case of fixed rate bonds, is equal
to at least one year of interest payments or, in the case of floating rate
bonds, initially is equal to at least one year's interest payments based on the
applicable interest rate at that time and is adjusted at regular intervals
thereafter. Certain Brady Bonds are entitled to "value recovery payments" in
certain circumstances, which in effect constitute supplemental interest payments
but generally are not collateralized. Brady Bonds are often viewed as having
three or four valuation components: (i) the collateralized repayment of
principal at final maturity; (ii) the collateralized interest payments; (iii)
the uncollateralized interest payments; and (iv) any uncollateralized repayment
of principal at maturity (the uncollateralized amounts constitute the "residual
risk").
Most Mexican Brady Bonds issued to date have principal repayments at final
maturity fully collateralized by U.S. Treasury zero-coupon bonds (or comparable
collateral denominated in other currencies) and interest coupon payments
collateralized on an 18-month rolling-forward basis by funds held in escrow by
an agent for the bondholders. A significant portion of the Venezuelan Brady
Bonds and the Argentine Brady Bonds issued to date have repayments at final
maturity collateralized by U.S. Treasury zero-coupon bonds (or comparable
collateral denominated in other currencies) and/or interest coupon payments
collateralized on a 14-month (for Venezuela) or 12-month (for Argentina)
rolling-forward basis by securities held by the Federal Reserve Bank of New York
as collateral agent.
Brady Bonds involve various risk factors including residual risk and the
history of defaults with respect to commercial bank loans by public and private
entities of countries issuing Brady Bonds. There can be no assurance that Brady
Bonds in which the Fund may invest will not be subject to restructuring
arrangements or to requests for new credit, which may cause the Fund to suffer a
loss of interest or principal on any of its holdings.
Investing in the securities of foreign issuers involves special risks and
considerations not typically associated with investing in U.S. companies. These
include differences in accounting, auditing and financial reporting standards,
generally higher commission rates on foreign portfolio transactions, the
possibility of expropriation or confiscatory taxation, adverse changes in
investment or exchange control regulations (which may include suspension of the
ability to transfer currency from a country), political instability which can
affect U.S. investments in foreign countries and potential restrictions on the
flow of international capital. In addition, foreign securities and dividends and
interest payable on those securities may be subject to foreign taxes, including
taxes withheld from payments on those securities. Foreign securities often trade
with less frequency and volume than domestic securities and therefore may
exhibit greater price volatility.
Sovereign Debt. Investment in sovereign debt can involve a high degree of
risk. The governmental entity that controls the repayment of sovereign debt may
not be able or willing to repay the principal and/or interest when due in
accordance with the terms of the debt. A governmental entity's willingness or
ability to repay principal and interest due in a timely
-8-
manner may be affected by, among other factors, its cash flow situation, the
extent of its foreign reserves, the availability of sufficient foreign exchange
on the date a payment is due, the relative size of the debt service burden to
the economy as a whole, the governmental entity's policy toward the
International Monetary Fund, and the political constraints to which a
governmental entity may be subject. Governmental entities may also depend on
expected disbursements from foreign governments, multilateral agencies and
others to reduce principal and interest arrearages on their debt. The commitment
on the part of these governments, agencies and others to make such disbursements
may be conditioned on a governmental entity's implementation of economic reforms
and/or economic performance and the timely service of such debtor's obligations.
Failure to implement such reforms, achieve such levels of economic performance
or repay principal or interest when due may result in the cancellation of such
third parties' commitments to lend funds to the governmental entity, which may
further impair such debtor's ability or willingness to service its debts in a
timely manner. Consequently, governmental entities may default on their
sovereign debt. Holders of sovereign debt (including the Fund) may be requested
to participate in the rescheduling of such debt and to extend further loans to
governmental entities. There is no bankruptcy proceeding by which sovereign debt
on which governmental entities have defaulted may be collected in whole or in
part.
CORPORATE BONDS
The Fund may invest in a wide variety of bonds and related debt obligations
of varying maturities issued by U.S. and foreign corporations (including banks)
and other business entities. Bonds are fixed or variable rate debt obligations,
including bills, notes, debentures, money market instruments and similar
instruments and securities. Bonds generally are used by corporations and other
issuers to borrow money from investors. The issuer pays the investor a fixed or
variable rate of interest and normally must repay the amount borrowed on or
before maturity. Certain bonds are "perpetual" in that they have no maturity
date. The Fund may invest up to 20% of its total assets in U.S.
dollar-denominated securities of foreign issuers based in developed countries,
including corporate debt securities of foreign issuers in accordance with the
Fund's investment objective and policies as described in the Prospectus. See
"--Foreign (Non-U.S.) Securities" above. The Fund may also invest without limit
in corporate bonds that are below investment grade quality. See "--High Yield
Securities" above.
The Fund's investments in corporate bonds are subject to a number of risks
described in the Prospectus and elaborated upon elsewhere in this section of the
Statement of Additional Information, including interest rate risk, credit risk,
high yield risk, issuer risk, foreign (non-U.S.) investment risk, inflation
risk, liquidity risk, smaller company risk and management risk.
COMMERCIAL PAPER
Commercial paper represents short-term unsecured promissory notes issued in
bearer form by corporations such as banks or bank holding companies and finance
companies. The Fund may invest in commercial paper of any credit quality
consistent with the Fund's investment objective and policies, including unrated
commercial paper for which NACM has made a credit quality assessment. See
Appendix C to this Statement of Additional Information for a description of the
ratings assigned by Moody's, S&P and Fitch to securities, including commercial
paper. The rate of return on commercial paper may be linked or indexed to the
level of exchange rates between the U.S. dollar and a foreign currency or
currencies.
-9-
PREFERRED STOCK
Preferred stock represents an equity interest in a company that generally
entitles the holder to receive, in preference to the holders of other stocks
such as common stocks, dividends and a fixed share of the proceeds resulting
from a liquidation of the company. Some preferred stocks also entitle their
holders to receive additional liquidation proceeds on the same basis as holders
of a company's common stock, and thus also represent an ownership interest in
that company. The Fund's investments in preferred stocks typically will be
convertible securities, although the Fund may also invest in non-convertible
preferred stocks.
As described below, the Fund may invest in preferred stocks that pay fixed
or adjustable rates of return. The value of a company's preferred stock may fall
as a result of factors relating directly to that company's products or services.
A preferred stock's value may also fall because of factors affecting not just
the company, but companies in the same industry or in a number of different
industries, such as increases in production costs. The value of preferred stock
may also be affected by changes in financial markets that are relatively
unrelated to the company or its industry, such as changes in interest rates or
currency exchange rates. In addition, a company's preferred stock generally pays
dividends only after the company makes required payments to holders of its bonds
and other debt. For this reason, the value of the preferred stock will usually
react more strongly than bonds and other debt to actual or perceived changes in
the company's financial condition or prospects. Preferred stocks of smaller
companies may be more vulnerable to adverse developments than those of larger
companies.
Fixed Rate Preferred Stocks. Some fixed rate preferred stocks in which the
Fund may invest, known as perpetual preferred stocks, offer a fixed return with
no maturity date. Because they never mature, perpetual preferred stocks act like
long-term bonds and can be more volatile than other types of preferred stocks
that have a maturity date and may have heightened sensitivity to changes in
interest rates. The Fund may also invest in sinking fund preferred stocks. These
preferred stocks also offer a fixed return, but have a maturity date and are
retired or redeemed on a predetermined schedule. The shorter duration of sinking
fund preferred stocks makes them perform somewhat like intermediate-term bonds
and they typically have lower yields than perpetual preferred stocks.
Adjustable Rate and Auction Preferred Stocks. Typically, the dividend rate
on an adjustable rate preferred stock is determined prospectively each quarter
by applying an adjustment formula established at the time of issuance of the
stock. Although adjustment formulas vary among issues, they typically involve a
fixed premium or discount relative to rates on specified debt securities issued
by the U.S. Treasury. Typically, an adjustment formula will provide for a fixed
premium or discount adjustment relative to the highest base yield of three
specified U.S. Treasury securities: the 90-day Treasury bill, the 10-year
Treasury note and the 20-year Treasury bond. The premium or discount adjustment
to be added to or subtracted from this highest U.S. Treasury base rate yield is
fixed at the time of issue and cannot be changed without the approval of the
holders of the stock. The dividend rate on other preferred stocks in which the
Fund may invest, commonly known as auction preferred stocks, is adjusted at
intervals that may be more frequent than quarterly, such as every 49 days, based
on bids submitted by holders and prospective purchasers of such stocks and may
be subject to stated maximum and minimum dividend rates. The issues of most
adjustable rate and auction preferred stocks
-10-
currently outstanding are perpetual, but are redeemable after a specified date
at the option of the issuer. Certain issues supported by the credit of a
high-rated financial institution provide for mandatory redemption prior to
expiration of the credit arrangement. No redemption can occur if full cumulative
dividends are not paid. Although the dividend rates on adjustable and auction
preferred stocks are generally adjusted or reset frequently, the market values
of these preferred stocks may still fluctuate in response to changes in interest
rates. Market values of adjustable preferred stocks also may substantially
fluctuate if interest rates increase or decrease once the maximum or minimum
dividend rate for a particular stock is approached.
INVESTMENTS IN EQUITY SECURITIES
Consistent with its investment objective, the Fund may hold or have
exposure to equity securities. The Fund will often have substantial exposure to
equity securities by virtue of the equity component of the convertible
securities in which the Fund invests. The Fund may also hold equity securities
in its portfolio upon conversion of a convertible security or through direct
investment in preferred stocks. Equity securities, such as common stock,
generally represent an ownership interest in a company. Although equity
securities have historically generated higher average returns than debt
securities, equity securities have also experienced significantly more
volatility in those returns. An adverse event, such as an unfavorable earnings
report, may depress the value of a particular equity security held by the Fund.
Also, the price of an equity security, particularly a common stock, is sensitive
to general movements in the stock market. A drop in the stock market may depress
the price of equity securities held by the Fund or to which the Fund is
otherwise exposed.
DERIVATIVE INSTRUMENTS
In pursuing its investment objective, the Fund may purchase and sell
(write) both put options and call options on securities, swap agreements, and
securities indexes, and enter into interest rate, securities and index futures
contracts and purchase and sell options on such futures contracts ("futures
options") to add leverage to the portfolio or as part of its overall investment
strategy. The Fund also may enter into swap agreements with respect to interest
rates, securities indexes and other assets and measures of risk or return. If
other types of financial instruments, including other types of options, futures
contracts or futures options are traded in the future, the Fund may also use
those instruments, provided that the Trustees determine that their use is
consistent with the Fund's investment objective.
The value of some derivative instruments in which the Fund may invest may
be particularly sensitive to changes in prevailing interest rates, and, like the
other investments of the Fund, the ability of the Fund to successfully utilize
these instruments may depend in part upon the ability of NACM to forecast
interest rates and other economic factors correctly. If NACM incorrectly
forecasts such factors and has taken positions in derivative instruments
contrary to prevailing market trends, the Fund could be exposed to the risk of
loss.
The Fund might not employ any of the strategies described below, and no
assurance can be given that any strategy used will succeed. If NACM incorrectly
forecasts interest rates, market values or other economic factors in utilizing a
derivatives strategy for the Fund, the Fund might have been in a better position
if it had not entered into the transaction at all. Also, suitable derivative
transactions may not be available in all circumstances. The use of these
strategies
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involves certain special risks, including a possible imperfect correlation, or
even no correlation, between price movements of derivative instruments and price
movements of related investments. While some strategies involving derivative
instruments can reduce the risk of loss, they can also reduce the opportunity
for gain or even result in losses by offsetting favorable price movements in
related investments or otherwise, due to the possible inability of the Fund to
purchase or sell a portfolio security at a time that otherwise would be
favorable or the possible need to sell a portfolio security at a disadvantageous
time because the Fund is required to maintain asset coverage or offsetting
positions in connection with transactions in derivative instruments, and the
possible inability of the Fund to close out or to liquidate its derivatives
positions. Income earned by the Fund from many derivative strategies will be
treated as capital gain and, if not offset by net realized capital loss, will be
distributed to shareholders in taxable distributions.
Warrants to Purchase Securities. The Fund may invest in warrants to
purchase debt securities or equity securities. A warrant to purchase equity
securities is a right to purchase common stock at a specific price (usually at a
premium above the market value of the underlying common stock at time of
issuance) during a specified period of time. Such a warrant may have a life
ranging from less than a year to twenty years or longer, but the warrant becomes
worthless unless it is exercised or sold before expiration. In addition, if the
market price of the common stock does not exceed an equity security warrant's
exercise price during the life of the warrant, the warrant will expire
worthless. Equity security warrants have no voting rights, pay no dividends and
have no rights with respect to the assets of the corporation issuing them. The
percentage increase or decrease in the value of an equity security warrant may
be greater than the percentage increase or decrease in the value of the
underlying common stock.
Debt obligations with warrants attached to purchase equity securities have
many characteristics of convertible securities and their prices may, to some
degree, reflect the performance of the underlying stock. Debt obligations also
may be issued with warrants attached to purchase additional debt securities at
the same coupon rate. A decline in interest rates would permit the Fund to buy
additional bonds at the favorable rate or to sell such warrants at a profit. If
interest rates rise, these warrants would generally expire with no value.
Options on Securities and Indexes. The Fund may purchase and sell both put
and call options on securities or indexes in standardized contracts traded on
domestic or other securities exchanges, boards of trade, or similar entities, or
quoted on NASDAQ or on an over-the-counter market, and agreements, sometimes
called cash puts, which may accompany the purchase of a new issue of debt
obligations from a dealer. The Fund may also use options on swap agreements (see
"Swap Agreements" below).
An option on a security (or an index) is a contract that gives the holder
of the option, in return for a premium, the right to buy from (in the case of a
call) or sell to (in the case of a put) the writer of the option the security
underlying the option (or the cash value of the index) at a specified exercise
price at any time during the term of the option. The writer of an option on a
security has the obligation upon exercise of the option to deliver the
underlying security upon payment of the exercise price or to pay the exercise
price upon delivery of the underlying security. Upon exercise, the writer of an
option on an index is obligated to pay the difference between the cash value of
the index and the exercise price multiplied by the specified multiplier
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for the index option. (An index is designed to reflect features of a particular
securities market, a specific group of financial instruments or securities, or
certain economic indicators.)
The Fund will write call options and put options only if they are
"covered." In the case of a call option on a debt obligation or other security,
the option is "covered" if the Fund owns the security underlying the call or has
an absolute and immediate right to acquire that security without additional cash
consideration (or, if additional cash consideration is required, cash or other
assets determined to be liquid by NACM in accordance with procedures established
by the Board of Trustees, in such amount are segregated by its custodian) upon
conversion or exchange of other securities held by the Fund. For a call option
on an index, the option is covered if the Fund maintains with its custodian
assets determined to be liquid by NACM in accordance with procedures established
by the Board of Trustees, in an amount equal to the contract value of the index.
A call option is also covered if the Fund holds a call on the same security or
index as the call written where the exercise price of the call held is (i) equal
to or less than the exercise price of the call written, or (ii) greater than the
exercise price of the call written, provided the difference is maintained by the
Fund in segregated assets determined to be liquid by NACM in accordance with
procedures established by the Board of Trustees. A put option on a security or
an index is "covered" if the Fund segregates assets determined to be liquid by
NACM in accordance with procedures established by the Board of Trustees equal to
the exercise price. A put option is also covered if the Fund holds a put on the
same security or index as the put written where the exercise price of the put
held is (i) equal to or greater than the exercise price of the put written, or
(ii) less than the exercise price of the put written, provided the difference is
maintained by the Fund in segregated assets determined to be liquid by NACM in
accordance with procedures established by the Board of Trustees.
If an option written by the Fund expires unexercised, the Fund realizes on
the expiration date a capital gain equal to the premium received by the Fund at
the time the option was written. If an option purchased by the Fund expires
unexercised, the Fund realizes a capital loss equal to the premium paid. Prior
to the earlier of exercise or expiration, an exchange-traded option may be
closed out by an offsetting purchase or sale of an option of the same series
(type, exchange, underlying security or index, exercise price, and expiration).
There can be no assurance, however, that a closing purchase or sale transaction
can be effected when the Fund desires.
The Fund may sell put or call options it has previously purchased, which
could result in a net gain or loss depending on whether the amount realized on
the sale is more or less than the premium and other transaction costs paid on
the put or call option which is sold. Prior to exercise or expiration, an option
may be closed out by an offsetting purchase or sale of an option of the same
series. The Fund will realize a capital gain from a closing purchase transaction
if the cost of the closing option is less than the premium received from writing
the option, or, if it is more, the Fund will realize a capital loss. If the
premium received from a closing sale transaction is more than the premium paid
to purchase the option, the Fund will realize a capital gain or, if it is less,
the Fund will realize a capital loss. The principal factors affecting the market
value of a put or a call option include supply and demand, interest rates, the
current market price of the underlying security or index in relation to the
exercise price of the option, the volatility of the underlying security or
index, and the time remaining until the expiration date.
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The premium paid for a put or call option purchased by the Fund is an asset
of the Fund. The premium received for an option written by the Fund is recorded
as a deferred credit. The value of an option purchased or written is marked to
market daily and is valued at the closing price on the exchange on which it is
traded or, if not traded on an exchange or no closing price is available, at the
mean between the last bid and asked prices.
The Fund may write covered straddles consisting of a combination of a call
and a put written on the same underlying security. A straddle will be covered
when sufficient assets are deposited to meet the Fund's immediate obligations.
The Fund may use the same liquid assets to cover both the call and put options
where the exercise price of the call and put are the same, or the exercise price
of the call is higher than that of the put. In such cases, the Fund will also
segregate liquid assets equivalent to the amount, if any, by which the put is
"in the money."
Risks Associated with Options on Securities and Indexes. There are several
risks associated with transactions in options on securities and on indexes. For
example, there are significant differences between the securities and options
markets that could result in an imperfect correlation between these markets,
causing a given transaction not to achieve its objectives. A decision as to
whether, when and how to use options involves the exercise of skill and
judgment, and even a well-conceived transaction may be unsuccessful to some
degree because of market behavior or unexpected events.
During the option period, the covered call writer has, in return for the
premium on the option, given up the opportunity to profit from a price increase
in the underlying security above the exercise price, but, as long as its
obligation as a writer continues, has retained the risk of loss should the price
of the underlying security decline. The writer of an option has no control over
the time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying security at the exercise price. If a put
or call option purchased by the Fund is not sold when it has remaining value,
and if the market price of the underlying security remains equal to or greater
than the exercise price (in the case of a put), or remains less than or equal to
the exercise price (in the case of a call), the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it has purchased. Except
to the extent that a call option on an index written
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by the Fund is covered by an option on the same index purchased by the Fund,
movements in the index may result in a loss to the Fund; however, such losses
may be mitigated by changes in the value of the Fund's securities during the
period the option was outstanding.
Futures Contracts and Options on Futures Contracts. The Fund may invest in
interest rate futures contracts and options thereon ("futures options"). The
Fund may also purchase and sell futures contracts on high yield and other
securities (to the extent they are available) and U.S. Government and agency
securities as well as on indexes of high yield and other securities, as well as
purchase put and call options on such futures contracts.
A futures contract provides for the future sale by one party and purchase
by another party of a specified quantity of the security or other financial
instrument at a specified price and time. A futures contract on an index is an
agreement pursuant to which two parties agree to take or make delivery of an
amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract was originally written. Although the value of an index might be a
function of the value of certain specified securities, physical delivery of
these securities is not always made. A public market exists in futures contracts
covering a number of indexes as well as financial instruments, including,
without limitation: U.S. Treasury bonds; U.S. Treasury notes; GNMA Certificates;
three-month U.S. Treasury bills; 90-day commercial paper; bank certificates of
deposit; and Eurodollar certificates of deposit. It is expected that other
futures contracts will be developed and traded in the future.
The Fund may purchase and write call and put futures options. Futures
options possess many of the same characteristics as options on securities and
indexes (discussed above). A futures option gives the holder the right, in
return for the premium paid, to assume a long position (call) or short position
(put) in a futures contract at a specified exercise price at any time during the
period of the option. Upon exercise of a call option, the holder acquires a long
position in the futures contract and the writer is assigned the opposite short
position. In the case of a put option, the opposite is true.
To comply with applicable rules of the Commodity Futures Trading Commission
("CFTC") under which the Fund avoids being deemed a "commodity pool" or a
"commodity pool operator," the Fund intends generally to limit its use of
futures contracts and futures options to "bona fide hedging" transactions, as
such term is defined in applicable regulations, interpretations and practice.
For example, the Fund might use futures contracts to hedge against anticipated
changes in interest rates that might adversely affect either the value of the
Fund's debt obligations or the price of the debt obligations that the Fund
intends to purchase. The Fund's hedging activities may include sales of futures
contracts as an offset against the effect of expected increases in interest
rates, and purchases of futures contracts as an offset against the effect of
expected declines in interest rates. Although other techniques could be used to
reduce the Fund's exposure to interest rate fluctuations, the Fund may be able
to hedge its exposure more effectively and perhaps at a lower cost by using
futures contracts and futures options.
The Fund may enter into futures contracts and futures options that are
standardized and traded on a U.S. or other exchange, board of trade, or similar
entity, or quoted on an automated quotation system, and the Fund may also enter
into OTC options on futures contracts.
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When a purchase or sale of a futures contract is made by the Fund, the Fund
is required to deposit with its custodian (or broker, if legally permitted) a
specified amount of assets determined to be liquid by NACM in accordance with
procedures established by the Board of Trustees ("initial margin"). The margin
required for a futures contract is set by the exchange on which the contract is
traded and may be modified during the term of the contract. The initial margin
is in the nature of a performance bond or good faith deposit on the futures
contract that is returned to the Fund upon termination of the contract, assuming
all contractual obligations have been satisfied. The Fund expects to earn
taxable interest income on its initial margin deposits. A futures contract held
by the Fund is valued daily at the official settlement price of the exchange on
which it is traded. Each day the Fund pays or receives cash, called "variation
margin," equal to the daily change in value of the futures contract. This
process is known as "marking to market." Variation margin does not represent a
borrowing or loan by the Fund but is instead a settlement between the Fund and
the broker of the amount one would owe the other if the futures contract
expired. In computing daily net asset value, the Fund will mark to market its
open futures positions.
The Fund is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures contract (and the
related initial margin requirements), the current market value of the option,
and other futures positions held by the Fund.
Although some futures contracts call for making or taking delivery of the
underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts
(involving the same exchange, underlying security or index, and delivery month).
If an offsetting purchase price is less than the original sale price, the Fund
realizes a capital gain, or if it is more, the Fund realizes a capital loss.
Conversely, if an offsetting sale price is more than the original purchase
price, the Fund realizes a capital gain, or if it is less, the Fund realizes a
capital loss. The transaction costs must also be included in these calculations.
The Fund may write covered straddles consisting of a call and a put written
on the same underlying futures contract. A straddle will be covered when
sufficient assets are deposited to meet the Fund's immediate obligations. The
Fund may use the same liquid assets to cover both the call and put options where
the exercise price of the call and put are the same, or the exercise price of
the call is higher than that of the put. In such cases, the Fund will also
segregate liquid assets equivalent to the amount, if any, by which the put is
"in the money."
Limitations on Use of Futures and Futures Options. As noted above, the Fund
generally intends to enter into positions in futures contracts and related
options only for "bona fide hedging" purposes. With respect to positions in
futures and related options that do not constitute bona fide hedging positions,
the Fund will not enter into a futures contract or futures option contract if,
immediately thereafter, the aggregate initial margin deposits relating to such
positions plus premiums paid by it for open futures option positions, less the
amount by which any such options are "in the money," would exceed 5% of the
Fund's liquidation value, after taking into account unrealized profits and
unrealized losses on any such contracts into which the Fund has entered. A call
option is "in the money" if the value of the futures contract that is the
subject of
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the option exceeds the exercise price. A put option is "in the money" if the
exercise price exceeds the value of the futures contract that is the subject of
the option.
When purchasing a futures contract, the Fund will maintain with its
custodian (and mark to market on a daily basis) assets determined to be liquid
by NACM in accordance with procedures established by the Board of Trustees,
that, when added to the amounts deposited with a futures commission merchant as
margin, are equal to the market value of the futures contract. Alternatively,
the Fund may "cover" its position by purchasing a put option on the same futures
contract with a strike price as high as or higher than the price of the contract
held by the Fund.
When selling a futures contract, the Fund will maintain with its custodian
(and mark to market on a daily basis) assets determined to be liquid by NACM in
accordance with procedures established by the Board of Trustees, that are equal
to the market value of the instruments underlying the contract. Alternatively,
the Fund may "cover" its position by owning the instruments underlying the
contract (or, in the case of an index futures contract, a portfolio with a
volatility substantially similar to that of the index on which the futures
contract is based), or by holding a call option permitting the Fund to purchase
the same futures contract at a price no higher than the price of the contract
written by the Fund (or at a higher price if the difference is maintained in
liquid assets with the Fund's custodian).
When selling a call option on a futures contract, the Fund will maintain
with its custodian (and mark to market on a daily basis) assets determined to be
liquid by NACM in accordance with procedures established by the Board of
Trustees, that, when added to the amounts deposited with a futures commission
merchant as margin, equal the total market value of the futures contract
underlying the call option. Alternatively, the Fund may cover its position by
entering into a long position in the same futures contract at a price no higher
than the strike price of the call option, by owning the instruments underlying
the futures contract, or by holding a separate call option permitting the Fund
to purchase the same futures contract at a price not higher than the strike
price of the call option sold by the Fund.
When selling a put option on a futures contract, the Fund will maintain
with its custodian (and mark to market on a daily basis) assets determined to be
liquid by NACM in accordance with procedures established by the Board of
Trustees, that equal the purchase price of the futures contract, less any margin
on deposit. Alternatively, the Fund may cover the position either by entering
into a short position in the same futures contract, or by owning a separate put
option permitting it to sell the same futures contract so long as the strike
price of the purchased put option is the same as or higher than the strike price
of the put option sold by the Fund.
To the extent that securities with maturities greater than one year are
used to segregate assets to cover the Fund's obligations under futures contracts
and related options, such use will not eliminate the leverage risk arising from
such use, which may tend to exaggerate the effect on net asset value of any
increase or decrease in the market value of the Fund's portfolio, and may
require liquidation of portfolio positions when it is not advantageous to do so.
The requirements for qualification as a regulated investment company also
may limit the extent to which the Fund may enter into futures, futures options
or forward contracts. See "Tax Matters."
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Risks Associated with Futures and Futures Options. There are several risks
associated with the use of futures contracts and futures options as hedging
techniques. A purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract. There can be no guarantee
that there will be a correlation between price movements in the hedging vehicle
and in the Fund securities being hedged. In addition, there are significant
differences between the securities and futures markets that could result in an
imperfect correlation between the markets, causing a given hedge not to achieve
its objectives. The degree of imperfection of correlation depends on
circumstances such as variations in speculative market demand for futures and
futures options on securities, including technical influences in futures trading
and futures options, and differences between the financial instruments being
hedged and the instruments underlying the standard contracts available for
trading in such respects as interest rate levels, maturities, and
creditworthiness of issuers. A decision as to whether to hedge involves the
exercise of skill and judgment, and even a well-conceived hedge may be
unsuccessful to some degree because of market behavior or unexpected interest
rate trends.
Futures contracts on U.S. Government securities historically have reacted
to an increase or decrease in interest rates in a manner similar to that in
which the underlying U.S. Government securities reacted. To the extent, however,
that the Fund enters into such futures contracts, the value of such futures will
not vary in direct proportion to the value of the Fund's holdings of debt
obligations. Thus, the anticipated spread between the price of the futures
contract and the hedged security may be distorted due to differences in the
nature of the markets. The spread also may be distorted by differences in
initial and variation margin requirements, the liquidity of such markets and the
participation of speculators in such markets.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of the current trading
session. Once the daily limit has been reached in a futures contract subject to
the limit, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may work to prevent
the liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial losses.
There can be no assurance that a liquid market will exist at a time when
the Fund seeks to close out a futures contract or a futures option position, and
the Fund would remain obligated to meet margin requirements until the position
is closed. In addition, many of the contracts discussed above are relatively new
instruments without a significant trading history. As a result, there can be no
assurance that an active secondary market will develop or continue to exist.
Additional Risks of Options on Securities, Futures Contracts and Options on
Futures Contracts. Options on securities, futures contracts and options on
futures contracts may be traded on foreign exchanges. Such transactions may not
be regulated as effectively as similar transactions in the United States, may
not involve a clearing mechanism and related guarantees, and are subject to the
risk of governmental actions affecting trading in, or the prices of, foreign
securities. Some foreign exchanges may be principal markets so that no common
clearing
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facility exists and a trader may look only to the broker for performance of the
contract. The value of such positions also could be adversely affected by (i)
other complex foreign political, legal and economic factors, (ii) lesser
availability than in the United States of data on which to make trading
decisions, (iii) delays in the Fund's ability to act upon economic events
occurring in foreign markets during non-business hours in the United States,
(iv) the imposition of different exercise and settlement terms and procedures
and margin requirements than in the United States and (v) lesser trading volume.
The Fund's use of such instruments may cause the Fund to realize higher amounts
of short-term capital gains (generally taxed to shareholders at ordinary income
tax rates) than if the Fund had not used such instruments.
Swap Agreements. The Fund may enter into swap agreements with respect to
interest rates, indexes of securities and other assets or measures of risk or
return. The Fund may also enter into options on swap agreements ("swaptions").
These transactions are entered into in an attempt to obtain a particular return
when it is considered desirable to do so, possibly at a lower cost to the Fund
than if the Fund had invested directly in an instrument that yielded that
desired return. Swap agreements are two-party contracts entered into primarily
by institutional investors for periods ranging from a few weeks to more than one
year. In a standard "swap" transaction, two parties agree to exchange the
returns (or differentials in rates of return) earned or realized on particular
predetermined investments or instruments, which may be adjusted for an interest
factor. The gross returns to be exchanged or "swapped" between the parties are
generally calculated with respect to a "notional amount," i.e., the return on or
increase in value of a particular dollar amount invested at a particular
interest rate or in a "basket" of securities representing a particular index.
Forms of swap agreements include interest rate caps, under which, in return for
a premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or "cap"; interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall below a specified rate, or "floor"; and
interest rate collars, under which a party sells a cap and purchases a floor or
vice versa in an attempt to protect itself against interest rate movements
exceeding given minimum or maximum levels. The Fund may use interest rate caps,
floors and collars in connection with its leveraging strategies. See "--Certain
Interest Rate Transactions" below. A swaption is a contract that gives a
counterparty the right (but not the obligation) to enter into a new swap
agreement or to shorten, extend, cancel or otherwise modify an existing swap
agreement, at some designated future time on specified terms. The Fund may write
(sell) and purchase put and call swaptions.
The Fund may have exposure to credit default swaps through investments in
credit-linked trust certificates. In connection with such investments, the Fund
would be in the position of a seller of a credit default swap contract because
the trust that issues the certificates would be selling one or more credit
default swap contracts. The seller of a credit default swap contract is required
to pay the par (or other agreed-upon) value of a referenced debt obligation to
the counterparty in the event of a default or similar triggering event by a
third party, such as a U.S. or foreign corporate issuer, on the debt obligation.
In return, the trust issuing the certificates receives from the counterparty a
periodic stream of payments over the term of the contract provided that no event
of default or similar triggering event has occurred. The trust in turn passes
the stream of payments along to the holders of the certificates it has issued.
If no default or other triggering event occurs, the trust, and thus the Fund,
would keep the stream of payments and would have no payment obligations. In
connection with its investments in credit-linked trust
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certificates, the Fund is therefore subject to credit risk relating to the
counterparty to any credit default swap contract entered into by the trust and
also the issuer and/or any guarantor of any referenced debt obligation.
Most swap agreements entered into by the Fund would calculate the
obligations of the parties to the agreement on a "net basis." Consequently, the
Fund's current obligations (or rights) under a swap agreement will generally be
equal only to the net amount to be paid or received under the agreement based on
the relative values of the positions held by each party to the agreement (the
"net amount"). The Fund's current obligations under a swap agreement will be
accrued daily (offset against any amounts owed to the Fund). The Fund may use
swap agreements to add leverage to the portfolio. The Fund may (but is not
required to) cover any accrued but unpaid net amounts owed to a swap
counterparty through the segregation of assets determined to be liquid by NACM
in accordance with procedures established by the Board of Trustees. Obligations
under swap agreements so covered will not be construed to be "senior securities"
for purposes of the Fund's investment restriction concerning senior securities
and borrowings.
Whether the Fund's use of swap agreements or swaptions will be successful
in furthering its investment objective will depend on NACM's ability to predict
correctly whether certain types of investments are likely to produce greater
returns than other investments. Because they are two-party contracts and because
they may have terms of greater than seven days, swap agreements may be
considered to be illiquid. Moreover, the Fund bears the risk of loss of the
amount expected to be received under a swap agreement in the event of the
default or bankruptcy of a swap agreement counterparty. The Fund will enter into
swap agreements only with counterparties that meet certain standards of
creditworthiness. The swaps market is a relatively new market and is largely
unregulated. It is possible that developments in the swaps market, including
potential government regulation, could adversely affect the Fund's ability to
terminate existing swap agreements or to realize amounts to be received under
such agreements.
Depending on the terms of the particular option agreement, the Fund will
generally incur a greater degree of risk when it writes a swaption than it will
incur when it purchases a swaption. When the Fund purchases a swaption, it risks
losing only the amount of the premium it has paid should it decide to let the
option expire unexercised. However, when the Fund writes a swaption, upon
exercise of the option the Fund will become obligated according to the terms of
the underlying agreement.
Certain swap agreements are exempt from most provisions of the Commodity
Exchange Act ("CEA") and, therefore, are not regulated as futures or commodity
option transactions under the CEA.
Certain Interest Rate Transactions. As described above, the Fund may enter
into interest rate swaps and caps. Interest rate swaps involve the Fund's
agreement with the swap counterparty to pay a fixed rate payment in exchange for
the counterparty paying the Fund a variable rate payment that may be structured
so as to approximate the Fund's variable rate payment obligation on the APS or
any other preferred shares of beneficial interest that the Fund may issue or any
variable rate borrowing. The payment obligation would be based on the notional
amount of the swap. The Fund may use an interest rate cap, which would require
the
-20-
Fund to pay a premium to the cap counterparty and would entitle the Fund, to the
extent that a specified variable rate index exceeds a predetermined fixed rate,
to receive from the counterparty payment of the difference based on the notional
amount. The Fund may use interest rate swaps or caps with the intent to reduce
or eliminate the risk that an increase in short-term interest rates could have
on the performance of the common shares of the Fund ("Common Shares") as a
result of the Fund's investments and capital structure, and may also use these
instruments for other hedging purposes.
BANK OBLIGATIONS
Bank obligations in which the Fund may invest include certificates of
deposit, bankers' acceptances, and fixed time deposits. Certificates of deposit
are negotiable certificates that are issued against funds deposited in a
commercial bank for a definite period of time and that earn a specified return.
Bankers' acceptances are negotiable drafts or bills of exchange, normally drawn
by an importer or exporter to pay for specific merchandise, which are "accepted"
by a bank, meaning, in effect, that the bank unconditionally agrees to pay the
face value of the instrument on maturity. Fixed time deposits are bank
obligations payable at a stated maturity date and bearing interest at a fixed
rate. Fixed time deposits may be withdrawn on demand by the investor, but may be
subject to early withdrawal penalties which vary depending upon market
conditions and the remaining maturity of the obligation. There are generally no
contractual restrictions on the right to transfer a beneficial interest in a
fixed time deposit to a third party, although there is no market for such
deposits. The Fund may also hold funds on deposit with its custodian bank in an
interest-bearing account for temporary purposes.
The Fund may invest up to 20% of its total assets in U.S.
dollar-denominated obligations of foreign banks. Obligations of foreign banks
involve certain risks associated with investing in foreign securities described
under "--Foreign (Non-U.S.) Securities" above, including the possibilities that
their liquidity could be impaired because of future political and economic
developments, that their obligations may be less marketable than comparable
obligations of U.S. banks, that a foreign jurisdiction might impose withholding
taxes on interest income payable on those obligations, that foreign deposits may
be seized or nationalized, that foreign governmental restrictions such as
exchange controls may be adopted which might adversely affect the payment of
principal and interest on those obligations and that the selection of those
obligations may be more difficult because there may be less publicly available
information concerning foreign banks or the accounting, auditing and financial
reporting standards, practices and requirements applicable to foreign banks may
differ from those applicable to U.S. banks. Foreign banks are not generally
subject to examination by any U.S. Government agency or instrumentality.
LOAN PARTICIPATIONS AND ASSIGNMENTS
The Fund may purchase participations in commercial loans. Such indebtedness
may be secured or unsecured. Loan participations typically represent direct
participations in a loan to a corporate borrower, and generally are offered by
banks or other financial institutions or lending syndicates. The Fund may
participate in such syndications, or can buy part of a loan, becoming a part
lender. When purchasing loan participations, the Fund assumes the credit risk
associated with the corporate borrower and may assume the credit risk associated
with an interposed bank or other financial intermediary. The participation
interests in which the Fund intends to invest may not be rated by any nationally
recognized rating service. Given the current structure of the
-21-
markets for loan participations and assignments, the Fund expects to treat these
securities as illiquid.
A loan is often administered by an agent bank acting as agent for all
holders. The agent bank administers the terms of the loan, as specified in the
loan agreement. In addition, the agent bank is normally responsible for the
collection of principal and interest payments from the corporate borrower and
the apportionment of these payments to the credit of all institutions which are
parties to the loan agreement. Unless, under the terms of the loan or other
indebtedness, the Fund has direct recourse against the corporate borrower, the
Fund may have to rely on the agent bank or other financial intermediary to apply
appropriate credit remedies against a corporate borrower.
A financial institution's employment as agent bank might be terminated in
the event that it fails to observe a requisite standard of care or becomes
insolvent. A successor agent bank would generally be appointed to replace the
terminated agent bank, and assets held by the agent bank under the loan
agreement should remain available to holders of such indebtedness. However, if
assets held by the agent bank for the benefit of the Fund were determined to be
subject to the claims of the agent bank's general creditors, the Fund might
incur certain costs and delays in realizing payment on a loan or loan
participation and could suffer a loss of principal and/or interest. In
situations involving other interposed financial institutions (e.g., an insurance
company or government agency) similar risks may arise.
Purchasers of loans and other forms of direct indebtedness depend primarily
upon the creditworthiness of the corporate borrower for payment of principal and
interest. If the Fund does not receive scheduled interest or principal payments
on such indebtedness, the Fund's share price and yield could be adversely
affected. Loans that are fully secured offer the Fund more protection than an
unsecured loan in the event of non-payment of scheduled interest or principal.
However, there is no assurance that the liquidation of collateral from a secured
loan would satisfy the corporate borrower's obligation, or that the collateral
can be liquidated.
The Fund may invest in loan participations with credit quality comparable
to that of issuers of its securities investments. Indebtedness of companies
whose creditworthiness is poor involves substantially greater risks, and may be
highly speculative. Some companies may never pay off their indebtedness, or may
pay only a small fraction of the amount owed. Consequently, when investing in
indebtedness of companies with poor credit, the Fund bears a substantial risk of
losing the entire amount invested.
The Fund limits the amount of its total assets that it will invest in any
one issuer or in issuers within the same industry (see "Investment
Restrictions"). For purposes of these limits, the Fund generally will treat the
corporate borrower as the "issuer" of indebtedness held by the Fund. In the case
of loan participations where a bank or other lending institution serves as a
financial intermediary between the Fund and the corporate borrower, if the
participation does not shift to the Fund the direct debtor-creditor relationship
with the corporate borrower, SEC interpretations require the Fund to treat both
the lending bank or other lending institution and the corporate borrower as
"issuers" for the purposes of determining whether the Fund has invested more
than 5% of its total assets in a single issuer. Treating a financial
intermediary as an issuer of indebtedness may restrict the Fund's ability to
invest in indebtedness related to a single
-22-
financial intermediary, or a group of intermediaries engaged in the same
industry, even if the underlying borrowers represent many different companies
and industries.
Loans and other types of direct indebtedness may not be readily marketable
and may be subject to restrictions on resale. In some cases, negotiations
involved in disposing of indebtedness may require weeks to complete.
Consequently, some indebtedness may be difficult or impossible to dispose of
readily at what NACM believes to be a fair price. In addition, valuation of
illiquid indebtedness involves a greater degree of judgment in determining the
Fund's net asset value than if that value were based on available market
quotations, and could result in significant variations in the Fund's daily share
price. At the same time, some loan interests are traded among certain financial
institutions and accordingly may be deemed liquid. As the market for different
types of indebtedness develops, the liquidity of these instruments is expected
to improve. In addition, the Fund currently intends to treat indebtedness for
which there is no readily available market as illiquid for purposes of the
Fund's limitation on illiquid investments. Investments in loan participations
are considered to be debt obligations for purposes of the Fund's investment
restriction relating to the lending of funds or assets.
Investments in loans through a direct assignment of the financial
institution's interests with respect to the loan may involve additional risks to
the Fund. For example, if a loan is foreclosed, the Fund could become part owner
of any collateral, and would bear the costs and liabilities associated with
owning and disposing of the collateral. In addition, it is conceivable that,
under emerging legal theories of lender liability, the Fund could be held liable
as co-lender. It is unclear whether loans and other forms of direct indebtedness
offer securities law protections against fraud and misrepresentation. In the
absence of definitive regulatory guidance, the Fund relies on NACM's research in
an attempt to avoid situations where fraud or misrepresentations could adversely
affect the Fund.
ZERO-COUPON BONDS, STEP-UPS AND PAYMENT-IN-KIND SECURITIES
Zero-coupon securities are debt obligations that do not entitle the holder
to any periodic payments of interest either for the entire life of the
obligation or for an initial period after the issuance of the obligations. Like
zero-coupon bonds, "step-up" bonds pay no interest initially but eventually
begin to pay a coupon rate prior to maturity, which rate may increase at stated
intervals during the life of the security. Payment-in-kind securities ("PIKs")
pay dividends or interest in the form of additional securities of the issuer,
rather than in cash. Each of these instruments is typically issued and traded at
a deep discount from its face amount. The amount of the discount varies
depending on such factors as the time remaining until maturity of the
securities, prevailing interest rates, the liquidity of the security and the
perceived credit quality of the issuer. The market prices of zero-coupon bonds,
step-ups and PIKs generally are more volatile than the market prices of debt
instruments that pay interest currently and in cash and are likely to respond to
changes in interest rates to a greater degree than do other types of securities
having similar maturities and credit quality. In order to satisfy a requirement
for qualification as a "regulated investment company" under the Internal Revenue
Code of 1986, as amended (the "Code"), an investment company, such as the Fund,
must distribute each year at least 90% of its net investment income, including
the original issue discount accrued on zero-coupon bonds, step-ups and PIKs.
Because the Fund will not on a current basis receive cash payments from the
issuer of these securities in respect of any accrued original issue discount, in
some years the
-23-
Fund may have to distribute cash obtained from selling other portfolio holdings
of the Fund. In some circumstances, such sales might be necessary in order to
satisfy cash distribution requirements even though investment considerations
might otherwise make it undesirable for the Fund to sell securities at such
time. Under many market conditions, investments in zero-coupon bonds, step-ups
and PIKs may be illiquid, making it difficult for the Fund to dispose of them or
determine their current value.
REAL ESTATE INVESTMENT FUNDS ("REITs")
REITs are pooled investment vehicles which invest primarily in
income-producing real estate or real estate related loans or interests. REITs
are generally classified as equity REITs, mortgage REITs or a combination of
equity and mortgage 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 income from the collection of interest
payments. REITs are not taxed on income distributed to shareholders provided
they comply with the applicable requirements of the Code. The Fund will
indirectly bear its proportionate share of any management and other expenses
paid by REITs in which it invests in addition to the expenses paid by the Fund.
Debt securities issued by REITs are, for the most part, general and unsecured
obligations and are subject to risks associated with REITs.
Investing in REITs involves certain unique risks in addition to those risks
associated with investing in the real estate industry in general. An equity REIT
may be affected by changes in the value of the underlying properties owned by
the REIT. A mortgage REIT may be affected by changes in interest rates and the
ability of the issuers of its portfolio mortgages to repay their obligations.
REITs are dependent upon the skills of their managers and are not diversified.
REITs are generally dependent upon maintaining cash flows to repay borrowings
and to make distributions to shareholders and are subject to the risk of default
by lessees or borrowers. REITs whose underlying assets are concentrated in
properties used by a particular industry, such as health care, are also subject
to risks associated with such industry.
REITs (especially mortgage REITs) are also subject to interest rate risks.
When interest rates decline, the value of a REIT's investment in fixed rate
obligations can be expected to rise. Conversely, when interest rates rise, the
value of a REIT's investment in fixed rate obligations can be expected to
decline. If the REIT invests in adjustable rate mortgage loans the interest
rates on which are reset periodically, yields on a REIT's investments in such
loans will gradually align themselves to reflect changes in market interest
rates. This causes the value of such investments to fluctuate less dramatically
in response to interest rate fluctuations than would investments in fixed rate
obligations.
REITs may have limited financial resources, may trade less frequently and
in a limited volume and may be subject to more abrupt or erratic price movements
than larger company securities. Historically REITs have been more volatile in
price than the larger capitalization stocks included in Standard & Poor's 500
Stock Index.
-24-
MORTGAGE-RELATED AND OTHER ASSET-BACKED SECURITIES
The Fund may invest in mortgage-related securities, and in other
asset-backed securities (unrelated to mortgage loans) that are offered to
investors currently or in the future. Mortgage-related securities are interests
in pools of residential or commercial mortgage loans, including mortgage loans
made by savings and loan institutions, mortgage bankers, commercial banks and
others. Pools of mortgage loans are assembled as securities for sale to
investors by various governmental, government-related and private organizations.
The value of some mortgage-related or asset-backed securities in which the Fund
may invest may be particularly sensitive to changes in prevailing interest
rates, and, like other debt obligations, the ability of the Fund to successfully
utilize these instruments may depend in part upon the ability of NACM to
forecast interest rates and other economic factors correctly. See "--Mortgage
Pass-Through Securities" below. Certain debt obligations are also secured with
collateral consisting of mortgage-related securities. See "--Collateralized
Mortgage Obligations ("CMOs")" below.
Commercial Mortgage-Backed Securities. Commercial mortgage-backed
securities include securities that reflect an interest in, and are secured by,
mortgage loans on commercial real property. The market for commercial
mortgage-backed securities developed more recently and in terms of total
outstanding principal amount of issues is relatively small compared to the
market for residential single-family mortgage-backed securities. Many of the
risks of investing in commercial mortgage-backed securities reflect the risks of
investing in the real estate securing the underlying mortgage loans. These risks
reflect the effects of local and other economic conditions on real estate
markets, the ability of tenants to make loan payments, and the ability of a
property to attract and retain tenants. Commercial mortgage-backed securities
may be less liquid and exhibit greater price volatility than other types of
mortgage- or asset-backed securities.
Mortgage Pass-Through Securities. Mortgage pass-through securities are
securities representing interests in "pools" of mortgage loans secured by
residential or commercial real property. Interests in pools of mortgage-related
securities differ from other forms of debt obligations, which normally provide
for periodic payment of interest in fixed amounts with principal payments at
maturity or specified call dates. Instead, these securities provide a monthly
payment which consists of both interest and principal payments. In effect, these
payments are a "pass-through" of the monthly payments made by the individual
borrowers on their residential or commercial mortgage loans, net of any fees
paid to the issuer or guarantor of such securities. Additional payments are
caused by repayments of principal resulting from the sale of the underlying
property, refinancing or foreclosure, net of fees or costs which may be
incurred. Some mortgage-related securities (such as securities issued by the
Government National Mortgage Association (the "GNMA")) are described as
"modified pass-through." These securities entitle the holder to receive all
interest and principal payments owed on the mortgage pool, net of certain fees,
at the scheduled payment dates regardless of whether or not the mortgagor
actually makes the payment.
The rate of prepayments on underlying mortgages will affect the price and
volatility of a mortgage-related security, and may have the effect of shortening
or extending the effective maturity of the security beyond what was anticipated
at the time of purchase. Early repayment of principal on some mortgage-related
securities (arising from prepayments of principal due to the sale of the
underlying property, refinancing, or foreclosure, net of fees and costs which
may
-25-
be incurred) may expose the Fund to a lower rate of return upon reinvestment of
principal. Also, if a security subject to prepayment has been purchased at a
premium, the value of the premium would be lost in the event of prepayment. Like
other debt obligations, when interest rates rise, the value of a
mortgage-related security generally will decline; however, when interest rates
are declining, the value of mortgage-related securities with prepayment features
may not increase as much as other debt obligations. To the extent that
unanticipated rates of prepayment on underlying mortgages increase the effective
maturity of a mortgage-related security, the volatility of such security can be
expected to increase.
Payment of principal and interest on some mortgage pass-through securities
(but not the market value of the securities themselves) may be guaranteed by the
full faith and credit of the U.S. Government (in the case of securities
guaranteed by the GNMA) or guaranteed by agencies or instrumentalities of the
U.S. Government (in the case of securities guaranteed by the Federal National
Mortgage Association (the "FNMA") or the Federal Home Loan Mortgage Corporation
(the "FHLMC"). The principal governmental guarantor of mortgage-related
securities is the GNMA. GNMA is a wholly-owned U.S. Government corporation
within the Department of Housing and Urban Development. GNMA is authorized to
guarantee, with the full faith and credit of the U.S. Government, the timely
payment of principal and interest on securities issued by institutions approved
by GNMA (such as savings and loan institutions, commercial banks and mortgage
bankers) and backed by pools of mortgages insured by the Federal Housing
Administration (the "FHA"), or guaranteed by the Department of Veterans Affairs
(the "VA").
Government-related guarantors (i.e., not backed by the full faith and
credit of the U.S. Government) include the FNMA and the FHLMC. FNMA is a
government-sponsored corporation owned entirely by private stockholders. It is
subject to general regulation by the Secretary of Housing and Urban Development.
FNMA purchases conventional (i.e., not insured or guaranteed by any government
agency) residential mortgages from a list of approved sellers/servicers which
include state and federally chartered savings and loan associations, mutual
savings banks, commercial banks, and credit unions and mortgage bankers.
Pass-through securities issued by FNMA are guaranteed as to timely payment of
principal and interest by FNMA but are not backed by the full faith and credit
of the U.S. Government. Instead, they are supported only by the discretionary
authority of the U.S. Government to purchase the agency's obligations.
FHLMC was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. It is a
government-sponsored corporation formerly owned by the twelve Federal Home Loan
Banks and now owned entirely by private stockholders. FHLMC issues Participation
Certificates ("PCs") which represent interests in conventional mortgages from
FHLMC's national portfolio. FHLMC guarantees the timely payment of interest and
ultimate collection of principal, but PCs are not backed by the full faith and
credit of the U.S. Government. Instead, they are supported only by the
discretionary authority of the U.S. Government to purchase the agency's
obligations.
Commercial banks, savings and loan institutions, private mortgage insurance
companies, mortgage bankers and other secondary market issuers also create
pass-through pools of conventional residential mortgage loans. Such issuers may,
in addition, be the originators and/or servicers of the underlying mortgage
loans as well as the guarantors of the mortgage-related
-26-
securities. Pools created by such non-governmental issuers generally offer a
higher rate of interest than government and government-related pools because
there are no direct or indirect government or agency guarantees of payments in
such pools. However, timely payment of interest and principal of these pools may
be supported by various forms of insurance or guarantees, including individual
loan, title, pool and hazard insurance and letters of credit. The insurance and
guarantees are issued by governmental entities, private insurers and the
mortgage poolers. There can be no assurance that the private insurers or
guarantors can meet their obligations under the insurance policies or guarantee
arrangements. Although the market for such securities is becoming increasingly
liquid, securities issued by certain private organizations may not be readily
marketable. The Fund will not purchase mortgage-related securities or any other
assets which in NACM's opinion are illiquid if, as a result, more than 5% of the
value of the Fund's total assets (taken at market value at the time of
investment) will be invested in illiquid securities.
Mortgage-related securities that are issued or guaranteed by the U.S.
Government, its agencies or instrumentalities, are not subject to the Fund's
industry concentration restrictions (see "Investment Restrictions") by virtue of
the exclusion from that test available to all U.S. Government securities. In the
case of privately issued mortgage-related securities, the Fund takes the
position that mortgage-related securities do not represent interests in any
particular "industry" or group of industries. The assets underlying such
securities may be represented by a portfolio of first lien residential mortgages
(including both whole mortgage loans and mortgage participation interests) or
portfolios of mortgage pass-through securities issued or guaranteed by GNMA,
FNMA or FHLMC. Mortgage loans underlying a mortgage-related security may in turn
be insured or guaranteed by the FHA or the VA. In the case of private issue
mortgage-related securities whose underlying assets are neither U.S. Government
securities nor U.S. Government-insured mortgages, to the extent that real
properties securing such assets may be located in the same geographical region,
the security may be subject to a greater risk of default than other comparable
securities in the event of adverse economic, political or business developments
that may affect such region and, ultimately, the ability of residential
homeowners to make payments of principal and interest on the underlying
mortgages.
Collateralized Mortgage Obligations ("CMOs"). A CMO is a hybrid between a
mortgage-backed bond and a mortgage pass-through security. Similar to a bond,
interest and prepaid principal is paid, in most cases, semi-annually. CMOs may
be collateralized by whole mortgage loans, but are more typically collateralized
by portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or
FNMA, and their income streams.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal
received from the pool of underlying mortgages, including prepayments, is first
returned to investors holding the shortest maturity class. Investors holding the
longer maturity classes receive principal only after the first class has been
retired. An investor is partially guarded against a sooner than desired return
of principal because of the sequential payments.
-27-
In a typical CMO transaction, a corporation ("issuer") issues multiple
series (e.g., A, B, C, Z) of CMO bonds (the "Bonds"). Proceeds of the Bond
offering are used to purchase mortgages or mortgage pass-through certificates
(the "Collateral"). The Collateral is pledged to a third party trustee as
security for the Bonds. Principal and interest payments from the Collateral are
used to pay principal on the Bonds in the order A, B, C, Z. The Series A, B and
C Bonds all bear current interest. Interest on the Series Z Bond is accrued and
added to principal and a like amount is paid as principal on the Series A, B or
C Bond currently being paid off. When the Series A, B and C Bonds are paid in
full, interest and principal on the Series Z Bond begin to be paid currently.
With some CMOs, the issuer serves as a conduit to allow loan originators
(primarily builders or savings and loan associations) to borrow against their
loan portfolios.
CMOs that are issued or guaranteed by the U.S. Government or by any of its
agencies or instrumentalities will be considered U.S. Government securities by
the Fund, while other CMOs, even if collateralized by U.S. Government
securities, will have the same status as other privately issued securities for
purposes of applying the Fund's diversification tests.
FHLMC Collateralized Mortgage Obligations. FHLMC CMOs are debt obligations
of FHLMC issued in multiple classes having different maturity dates which are
secured by the pledge of a pool of conventional mortgage loans purchased by
FHLMC. Unlike FHLMC PCs, payments of principal and interest on the CMOs are made
semi-annually, as opposed to monthly. The amount of principal payable on each
semi-annual payment date is determined in accordance with FHLMC's mandatory
sinking fund schedule, which in turn, is equal to approximately 100% of FHA
prepayment experience applied to the mortgage collateral pool. All sinking fund
payments in the CMOs are allocated to the retirement of the individual classes
of bonds in the order of their stated maturities. Payments of principal on the
mortgage loans in the collateral pool in excess of the amount of FHLMC's minimum
sinking fund obligation for any payment date are paid to the holders of the CMOs
as additional sinking fund payments. Because of the "pass-through" nature of all
principal payments received on the collateral pool in excess of FHLMC's minimum
sinking fund requirement, the rate at which principal of the CMOs is actually
repaid is likely to be such that each class of bonds will be retired in advance
of its scheduled maturity date.
If collection of principal (including prepayments) on the mortgage loans
during any semi-annual payment period is not sufficient to meet FHLMC's minimum
sinking fund obligation on the next sinking fund payment date, FHLMC agrees to
make up the deficiency from its general funds.
Criteria for the mortgage loans in the pool backing the FHLMC CMOs are
identical to those of FHLMC PCs. FHLMC has the right to substitute collateral in
the event of delinquencies and/or defaults.
Other Mortgage-Related Securities. Other mortgage-related securities
include securities other than those described above that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage loans
on real property, including CMO residuals or stripped mortgage-backed
securities. Other mortgage-related securities may be equity or debt securities
issued by agencies or instrumentalities of the U.S. Government or by private
-28-
originators of, or investors in, mortgage loans, including savings and loan
associations, homebuilders, mortgage banks, commercial banks, investment banks,
partnerships, trusts and special purpose entities of the foregoing.
CMO Residuals. CMO residuals are mortgage securities 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,
homebuilders, mortgage banks, commercial banks, investment banks and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
particular, the yield to maturity on CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
IO class of stripped mortgage-backed securities. See "--Stripped Mortgage-Backed
Securities" below. In addition, if a series of a CMO includes a class that bears
interest at an adjustable rate, the yield to maturity on the related CMO
residual will also be extremely sensitive to changes in the level of the index
upon which interest rate adjustments are based. As described below with respect
to stripped mortgage-backed securities, in certain circumstances the Fund may
fail to recoup some or all of its initial investment in a CMO residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has developed fairly recently and CMO residuals currently may
not have the liquidity of other more established securities trading in other
markets. Transactions in CMO residuals are generally completed only after
careful review of the characteristics of the securities in question. In
addition, CMO residuals may, or pursuant to an exemption therefrom, may not,
have been registered under the Securities Act of 1933, as amended (the "1933
Act"). CMO residuals, whether or not registered under the 1933 Act, may be
subject to certain restrictions on transferability, and may be deemed "illiquid"
and subject to the Fund's limitations on investment in illiquid securities. As
used in this Statement of Additional Information, the term CMO residual does not
include residual interests in real estate mortgage investment conduits.
Stripped Mortgage-Backed Securities. Stripped mortgage-backed securities
("SMBS") are derivative multi-class mortgage securities. SMBS 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 banks, commercial banks, investment banks and special purpose entities
of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the interest
and most of the principal from the mortgage assets,
-29-
while the other class will receive most of the interest and the remainder of the
principal. In the most extreme case, one class will receive all of the interest
(the "IO" class), while the other class will receive all of the principal (the
"PO" class). The yield to maturity on an IO class is extremely sensitive to the
rate of principal payments (including prepayments) on the related underlying
mortgage assets, and a rapid rate of principal payments may have a material
adverse effect on the Fund's yield to maturity from these securities. If the
underlying mortgage assets experience greater than anticipated prepayments of
principal, the Fund may fail to recoup some or all of its initial investment in
these securities even if the security is in one of the highest rating
categories.
Although SMBS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were developed fairly recently. As a result, established trading markets have
not yet developed and, accordingly, these securities may be deemed "illiquid"
and subject to the Fund's limitations on investment in illiquid securities.
Other Asset-Backed Securities. Similarly, NACM expects that other
asset-backed securities (unrelated to mortgage loans) will be offered to
investors in the future and may be purchased by the Fund. Several types of
asset-backed securities have already been offered to investors, including
Enhanced Equipment Trust Certificates ("EETCs") and Certificates for Automobile
Receivables(SM) ("CARS(SM)").
Although any entity may issue EETCs, to date, U.S. airlines are the primary
issuers. An airline EETC is an obligation secured directly by aircraft or
aircraft engines as collateral. Airline EETCs generally have credit enhancement
in the form of overcollateralization and cross-subordination (i.e., multiple
tranches and multiple aircraft as collateral). They also generally have a
dedicated liquidity facility provided by a third-party insurer to insure that
coupon payments are made on a timely basis until collateral is liquidated in the
event of a default by the lessor of the collateral. Aircraft EETCs issued by
registered U.S. carriers also benefit from a special section of the U.S.
Bankruptcy Code, which allows the aircraft to be sold by the trust holding the
collateral to repay note holders without participating in bankruptcy
proceedings. EETCs tend to be less liquid than corporate bonds.
CARS(SM) represent undivided fractional interests in a trust whose assets
consist of a pool of motor vehicle retail installment sales contracts and
security interests in the vehicles securing the contracts. Payments of principal
and interest on CARS(SM) are passed through monthly to certificate holders, and
are guaranteed up to certain amounts and for a certain time period by a letter
of credit issued by a financial institution unaffiliated with the trustee or
originator of the trust. An investor's return on CARS(SM) may be affected by
early prepayment of principal on the underlying vehicle sales contracts. If the
letter of credit is exhausted, the trust may be prevented from realizing the
full amount due on a sales contract because of state law requirements and
restrictions relating to foreclosure sales of vehicles and the obtaining of
deficiency judgments following such sales or because of depreciation, damage or
loss of a vehicle, the application of federal and state bankruptcy and
insolvency laws, or other factors. As a result, certificate holders may
experience delays in payments or losses if the letter of credit is exhausted.
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Consistent with the Fund's investment objective and policies, NACM also may
invest in other types of asset-backed securities. Other asset-backed securities
may be collateralized by the fees earned by service providers. The value of
asset-backed securities may be substantially dependent on the servicing of the
underlying asset pools and are therefore subject to risks associated with the
negligence by, or defalcation of, their servicers. In certain circumstances, the
mishandling of related documentation may also affect the rights of the security
holders in and to the underlying collateral. The insolvency of entities that
generate receivables or that utilize the assets may result in added costs and
delays in addition to losses associated with a decline in the value of the
underlying assets.
OTHER INVESTMENT COMPANIES
The Fund may invest in securities of open-or closed-end investment
companies to the extent that such investments are consistent with the Fund's
investment objective and policies and permissible under the 1940 Act. In
general, under the 1940 Act, an investment company such as the Fund may not (i)
invest more than 10% of its total assets in securities of other registered
investment companies, (ii) own more than 3% of the outstanding voting securities
of any one registered investment company, or (iii) invest more than 5% of its
total assets in the securities of any single registered investment company. The
Fund may invest in other investment companies either during periods when it has
large amounts of uninvested cash, such as the period shortly after the Fund
receives the proceeds of the offering of its Common Shares or APS, during
periods when there is a shortage of attractive convertible securities and
non-convertible income-producing securities available in the market, or when
NACM believes share prices of other investment companies offer attractive
values. The Fund may invest in investment companies that are advised by NACM or
its affiliates to the extent permitted by applicable law and/or pursuant to
exemptive relief from the SEC. As a stockholder in an investment company, the
Fund will bear its ratable share of that investment company's expenses and would
remain subject to payment of the Fund's management fees with respect to assets
so invested. Holders of the Common Shares (the "Common Shareholders") would
therefore be subject to duplicative expenses to the extent the Fund invests in
other investment companies. NACM will take expenses into account when evaluating
the investment merits of an investment in an investment company relative to
available convertible securities and non-convertible income-producing
securities. In addition, the securities of other investment companies may also
be leveraged and will therefore be subject to the same leverage risks described
in the Prospectus and herein. As described in the Prospectus in the section
entitled "Risks--Leverage Risk," the net asset value and market value of
leveraged shares will be more volatile and the yield to shareholders will tend
to fluctuate more than the yield generated by unleveraged shares.
VARIABLE AND FLOATING RATE SECURITIES
Variable and floating rate securities provide for a periodic adjustment in
the interest rate paid on the obligations. The terms of such obligations must
provide that interest rates are adjusted periodically based upon an interest
rate adjustment index as provided in the respective obligations. The adjustment
intervals may be regular, and range from daily up to annually, or may be event
based, such as based on a change in the prime rate.
The Fund may invest in floating rate debt instruments ("floaters") and
engage in credit spread trades. The interest rate on a floater is a variable
rate that is tied to another interest rate,
-31-
such as a corporate bond index or Treasury bill rate. The interest rate on a
floater resets periodically, typically every six months. While, because of the
interest rate reset feature, floaters provide the Fund with a certain degree of
protection against rising interest rates, the Fund will participate in any
declines in interest rates as well. A credit spread trade is an investment
position relating to a difference in the prices or interest rates of two bonds
or other securities, where the value of the investment position is determined by
movements in the difference between the prices or interest rates, as the case
may be, of the respective securities or currencies.
The Fund may also invest in inverse floating rate debt instruments
("inverse floaters"). The interest rate on an inverse floater resets in the
opposite direction from the market rate of interest to which the inverse floater
is indexed. An inverse floating rate security may exhibit greater price
volatility than a fixed rate obligation of similar credit quality.
EVENT-LINKED BONDS
The Fund may invest in "event-linked bonds." Event-linked bonds, which are
sometimes referred to as "catastrophe bonds," are debt obligations for which the
return of principal and payment of interest is contingent on the non-occurrence
of a specific "trigger" event, such as a hurricane or an earthquake. They may be
issued by government agencies, insurance companies, reinsurers, special purpose
corporations or other on-shore or off-shore entities. If a trigger event causes
losses exceeding a specific amount in the geographic region and time period
specified in a bond, the Fund may lose a portion or all of its principal
invested in the bond. If no trigger event occurs, the Fund will recover its
principal plus interest. For some event-linked bonds, the trigger event or
losses may be based on company-wide losses, index-portfolio losses, industry
indexes or readings of scientific instruments rather than specified actual
losses. Often event-linked bonds provide for extensions of maturity that are
mandatory, or optional at the discretion of the issuer, in order to process and
audit loss claims in those cases when a trigger event has, or possibly has,
occurred. In addition to the specified trigger events, event-linked bonds may
also expose the Fund to certain unanticipated risks including but not limited to
issuer (credit) default, adverse regulatory or jurisdictional interpretations
and adverse tax consequences.
Event-linked bonds are a relatively new type of financial instrument. As
such, there is no significant trading history of these securities, and there can
be no assurance that a liquid market in these instruments will develop. Lack of
a liquid market may impose the risk of higher transaction costs and the
possibility that the Fund may be forced to liquidate positions when it would not
be advantageous to do so. Event-linked bonds are typically rated.
U.S. GOVERNMENT SECURITIES
U.S. Government securities are obligations of, or guaranteed by, the U.S.
Government, its agencies or instrumentalities. The U.S. Government does not
guarantee the net asset value of the Fund's shares. Some U.S. Government
securities, such as Treasury bills, notes and bonds, and securities guaranteed
by the GNMA, are supported by the full faith and credit of the United States;
others, such as those of the Federal Home Loan Banks, are supported by the right
of the issuer to borrow from the U.S. Treasury; others, such as those of the
FNMA, are supported by the discretionary authority of the U.S. Government to
purchase the agency's obligations; and still others, such as those of the
Student Loan Marketing Association, are supported only by the credit of the
instrumentality. U.S. Government securities include securities that have no
coupons, or
-32-
have been stripped of their unmatured interest coupons, individual interest
coupons from such securities that trade separately, and evidences of receipt of
such securities. Such securities may pay no cash income, and are purchased at a
deep discount from their value at maturity. See "--Zero-Coupon Bonds, Step-Ups
and Payment-In-Kind Securities" above. Custodial receipts issued in connection
with so-called trademark zero-coupon securities, such as CATs and TIGRs, are not
issued by the U.S. Treasury, and are therefore not U.S. Government securities,
although the underlying bond represented by such receipt is a debt obligation of
the U.S. Treasury. Other zero-coupon Treasury securities (e.g., STRIPs and
CUBEs) are direct obligations of the U.S. Government.
WHEN-ISSUED, DELAYED DELIVERY AND FORWARD COMMITMENT TRANSACTIONS
The Fund may purchase or sell securities on a when-issued, delayed
delivery, or forward commitment basis. When such purchases are outstanding, the
Fund will segregate until the settlement date assets determined to be liquid by
NACM in accordance with procedures established by the Board of Trustees, in an
amount sufficient to meet the purchase price. Typically, no income accrues on
securities the Fund has committed to purchase prior to the time delivery of the
securities is made, although the Fund may earn income on securities it has
segregated.
When purchasing a security on a when-issued, delayed delivery, or forward
commitment basis, the Fund assumes the rights and risks of ownership of the
security, including the risk of price and yield fluctuations, and takes such
fluctuations into account when determining its net asset value. Because the Fund
is not required to pay for the security until the delivery date, these risks are
in addition to the risks associated with the Fund's other investments. If the
Fund remains substantially fully invested at a time when when-issued, delayed
delivery, or forward commitment purchases are outstanding, the purchases may
result in a form of leverage.
When the Fund has sold a security on a when-issued, delayed delivery, or
forward commitment basis, the Fund does not participate in future gains or
losses with respect to the security. If the other party to a transaction fails
to deliver or pay for the securities, the Fund could miss a favorable price or
yield opportunity or could suffer a loss. The Fund may dispose of or renegotiate
a transaction after it is entered into, and may sell when-issued, delayed
delivery or forward commitment securities before they are delivered, which may
result in a capital gain or loss. There is no percentage limitation on the
extent to which the Fund may purchase or sell securities on a when-issued,
delayed delivery, or forward commitment basis.
BORROWING AND RELATED STRATEGIES
The Fund may borrow money or issue other senior securities representing
indebtedness (hereinafter referred to collectively as borrowings) to the extent
permitted under the 1940 Act as interpreted, modified or otherwise permitted by
regulatory authority having jurisdiction, from time to time. The Fund may from
time to time borrow for investment purposes or to add leverage to the portfolio.
However, borrowing for leveraging purposes will generally be used as a
substitute for, rather than in addition to, any leverage obtained through the
issuance of the APS. The Fund may also borrow in order to repurchase its shares
or as a temporary measure for extraordinary or emergency purposes, including for
the payment of dividends or the settlement of securities transactions which
otherwise might require untimely dispositions of Fund securities.
-33-
Borrowings may include the issuance of notes, commercial paper or other
evidences of indebtedness. The Fund may secure any borrowings by mortgaging,
pledging or otherwise granting a security interest in the Fund's assets. The
terms of any borrowings will be subject to the provisions of any credit
agreements related to the borrowings and, to the extent that the Fund seeks a
rating for the borrowings, any additional guidelines imposed by any rating
agency that is rating the borrowings. Credit agreement provisions and rating
agency guidelines may impose asset coverage or portfolio composition
requirements that are more stringent than those imposed on the Fund by the 1940
Act. Any credit agreement to which the Fund may become subject may include
customary limits on the Fund's ability to (i) incur additional debt or issue
preferred shares of beneficial interest (such as the APS) without approval of
the lenders, (ii) incur liens or pledge portfolio securities, (iii) incur
obligations under derivative instruments, and (iv) change its investment
objective or fundamental investment restrictions without the approval of
lenders. The rights of lenders to receive payments of interest on and repayments
of principal of any borrowings made by the Fund under any commercial paper
program, liquidity facility, credit facility or other evidence of indebtedness
may be senior to the rights of holders of preferred shares of beneficial
interest (including the APS) ("Preferred Shareholders") with respect to the
payment of dividends or upon liquidation.
Under the 1940 Act, the Fund generally is not permitted to engage in
borrowings unless immediately after a borrowing the value of the Fund's total
assets less liabilities (other than the borrowing) is at least 300% of the
principal amount of such borrowing (i.e., such principal amount may not exceed
33 1/3% of the Fund's total assets). In addition, the Fund is not permitted to
declare any cash dividend or other distribution on Common Shares unless, at the
time of such declaration, the value of the Fund's total assets, less liabilities
other than borrowing, is at least 300% of such principal amount. If the Fund
borrows, it intends, to the extent possible, to prepay all or a portion of the
principal amount of the borrowing to the extent necessary in order to maintain
the required asset coverage. Failure to maintain certain asset coverage
requirements could result in an event of default and entitle the Preferred
Shareholders to elect a majority of the Trustees of the Fund.
As described elsewhere in this section, the Fund also may enter into
certain transactions involving derivative instruments, although the Fund's
exposure to certain derivative instruments will be limited by the Fund's 5%
limit on illiquid investments to the extent they are determined to be illiquid.
The Fund may enter into these transactions, as well as utilize reverse
repurchase agreements (see below), in order to add leverage to the portfolio.
See "The Fund's investment objective and strategies," and "Risks - Leverage
Risk" in the Prospectus. The Fund may (but is not required to) cover its
commitment under these instruments by the segregation of assets determined to be
liquid by NACM in accordance with procedures adopted by the Trustees, equal in
value to the amount of the Fund's commitment, or by entering into offsetting
transactions or owning positions covering its obligations. In that case, the
instruments will not be considered "senior securities" under the 1940 Act for
purposes of the asset coverage requirements otherwise applicable to borrowings
by the Fund or the Fund's issuance of APS.
Any borrowing in which the Fund engages will tend to exaggerate the effect
on net asset value of any increase or decrease in the market value of the Fund's
portfolio. Money borrowed will be subject to interest costs which may or may not
be recovered by appreciation of the securities purchased. The Fund also may be
required to maintain minimum average balances in
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connection with such borrowing or to pay a commitment or other fee to maintain a
line of credit; either of these requirements would increase the cost of
borrowing over the stated interest rate.
REVERSE REPURCHASE AGREEMENTS
The Fund may utilize reverse repurchase agreements, generally as a
substitute for, rather than in addition to, the leverage obtained through the
issuance of APS. In a reverse repurchase agreement, the Fund sells securities to
a bank or broker-dealer and agrees to repurchase the securities at a mutually
agreed date and price. Generally, the effect of such a transaction is that the
Fund can recover and reinvest all or most of the cash invested in the portfolio
securities involved during the term of the reverse repurchase agreement and
still be entitled to the returns associated with those portfolio securities.
Such transactions are advantageous if the interest cost to the Fund of the
reverse repurchase transaction is less than the returns it obtains on
investments purchased with the cash.
Reverse repurchase agreements involve leverage risk and also the risk that
the market value of the securities that the Fund is obligated to repurchase
under the agreement may decline below the repurchase price. In the event the
buyer of securities under a reverse repurchase agreement files for bankruptcy or
becomes insolvent, the Fund's use of the proceeds of the agreement may be
restricted pending a determination by the other party, or its trustee or
receiver, whether to enforce the Fund's obligation to repurchase the securities.
The Fund may (but is not required to) segregate assets determined to be
liquid by NACM in accordance with procedures established by the Board of
Trustees, equal (on a daily mark-to-market basis) to its obligations under
reverse repurchase agreements. To the extent that positions in reverse
repurchase agreements are not so covered, such transactions would be subject to
the Fund's limitations on borrowings, which would, among other things, restrict
the aggregate of such transactions (plus any other borrowings) to one-third of
the Fund's total assets.
SHORT SALES
The Fund may make short sales of securities as part of its overall
portfolio management strategy and to offset potential declines in long positions
in securities in the Fund's portfolio. 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 on a security, 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. The Fund may have to pay a fee to borrow particular securities and is
often obligated to pay over any accrued interest and dividends on such borrowed
securities.
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. The successful use of short selling may be adversely
affected by imperfect correlation between movements in the price of the security
sold short and the securities being hedged.
-35-
To the extent that the Fund engages in short sales, it will provide
collateral to the broker-dealer. A short sale is "against the box" to the extent
that the Fund contemporaneously owns, or has the right to obtain at no added
cost, securities identical to those sold short. The Fund may also engage in
so-called "naked" short sales (i.e., short sales that are not "against the
box"), in which case the Fund's losses could theoretically be unlimited, in
cases where the Fund is unable for whatever reason to close out its short
position. The Fund has the flexibility to engage in short selling to the extent
permitted by the 1940 Act and rules and interpretations thereunder.
ILLIQUID SECURITIES
The Fund may invest up to 5% of its total assets in securities which are
illiquid at the time of investment. The term "illiquid securities" for this
purpose is determined using the SEC's standard applicable to open-end investment
companies, i.e., securities that cannot be disposed of within seven days in the
ordinary course of business at approximately the amount at which the Fund has
valued the securities. Illiquid securities are considered to include, among
other things, written over-the-counter options, securities or other liquid
assets being used as cover for such options, certain loan participation
interests, fixed time deposits which are not subject to prepayment or provide
for withdrawal penalties upon prepayment (other than overnight deposits), and
other securities whose disposition is restricted under the federal securities
laws (other than securities issued pursuant to Rule 144A under the 1933 Act and
certain commercial paper that NACM has determined to be liquid under procedures
approved by the Board of Trustees).
Illiquid securities may include privately placed securities, which are sold
directly to a small number of investors, usually institutions. Unlike public
offerings, such securities are not registered under the federal securities laws.
Although certain of these securities may be readily sold, others may be
illiquid, and their sale may involve substantial delays and additional costs.
PORTFOLIO TRADING AND TURNOVER RATE
Portfolio trading may be undertaken to accomplish the investment objective
of the Fund in relation to actual and anticipated movements in interest rates
and for other reasons. In addition, a security may be sold and another of
comparable quality purchased at approximately the same time to take advantage of
what NACM believes to be a temporary price disparity between the two securities.
Temporary price disparities between two comparable securities may result from
supply and demand imbalances where, for example, a temporary oversupply of
certain securities may cause a temporarily low price for such security, as
compared with other securities of like quality and characteristics. The Fund may
also engage in short-term trading consistent with its investment objective.
Securities may be sold in anticipation of a market decline (a rise in interest
rates) or purchased in anticipation of a market rise (a decline in interest
rates) and later sold, or to recognize a gain.
A change in the securities held by the Fund is known as "portfolio
turnover." NACM manages the Fund without regard generally to restrictions on
portfolio turnover. The use of certain derivative instruments with relatively
short maturities may tend to exaggerate the portfolio turnover rate for the
Fund. High portfolio turnover (e.g., greater than 100%) involves correspondingly
greater expenses to the Fund, including brokerage commissions or dealer mark-ups
and other transaction costs on the sale of securities and reinvestments in other
securities.
-36-
Trading in debt obligations does not generally involve the payment of brokerage
commissions, but does involve indirect transaction costs. The use of futures
contracts may involve the payment of commissions to futures commission
merchants. The higher the rate of portfolio turnover of the Fund, the higher the
transaction costs borne by the Fund generally will be. Transactions in the
Fund's portfolio securities may result in realization of taxable capital gains
(including short-term capital gains which are generally taxed to shareholders at
ordinary income tax rates). The trading costs and tax effects associated with
portfolio turnover may adversely affect the Fund's performance.
The portfolio turnover rate of the Fund is calculated by dividing (a) the
lesser of purchases or sales of portfolio securities for the particular fiscal
year by (b) the monthly average of the value of the portfolio securities owned
by the Fund during the particular fiscal year. In calculating the rate of
portfolio turnover, there is excluded from both (a) and (b) all securities,
including options, whose maturities or expiration dates at the time of
acquisition were one year or less.
SECURITIES LOANS
Subject to the Fund's "Investment Restrictions" listed below, the Fund may
make secured loans of its portfolio securities to brokers, dealers and other
financial institutions amounting to no more than one-third of its total assets.
The risks in lending portfolio securities, as with other extensions of credit,
consist of possible delay in recovery of the securities or possible loss of
rights in the collateral should the borrower fail financially. However, such
loans will be made only to broker-dealers that are believed by NACM to be of
relatively high credit standing. Securities loans are made to broker-dealers
pursuant to agreements requiring that loans be continuously secured by
collateral consisting of U.S. Government securities, cash or cash equivalents
(negotiable certificates of deposit, bankers' acceptances or letters of credit)
maintained on a daily mark-to-market basis in an amount at least equal at all
times to the market value of the securities lent. The borrower pays to the Fund,
as the lender, an amount equal to any dividends or interest received on the
securities lent. The Fund may invest only the cash collateral received in
interest-bearing, short-term securities or receive a fee from the borrower. In
the case of cash collateral, the Fund typically pays a rebate to the lender.
Although voting rights or rights to consent with respect to the loaned
securities pass to the borrower, the Fund, as the lender, retains the right to
call the loans and obtain the return of the securities loaned at any time on
reasonable notice, and it will do so in order that the securities may be voted
by the Fund if the holders of such securities are asked to vote upon or consent
to matters materially affecting the investment. The Fund may also call such
loans in order to sell the securities involved. When engaged in securities
lending, the Fund's performance will continue to reflect changes in the value of
the securities loaned and will also reflect the receipt of either interest,
through investment of cash collateral by the Fund in permissible investments, or
a fee, if the collateral is U.S. Government securities.
PARTICIPATION ON CREDITORS COMMITTEES
The Fund may from time to time participate on committees formed by
creditors to negotiate with the management of financially troubled issuers of
securities held by the Fund. Such participation may subject the Fund to expenses
such as legal fees and may make the Fund an "insider" of the issuer for purposes
of the federal securities laws, and therefore may restrict
-37-
the Fund's ability to trade in or acquire additional positions in a particular
security when it might otherwise desire to do so. Participation by the Fund on
such committees also may expose the Fund to potential liabilities under the
federal bankruptcy laws or other laws governing the rights of creditors and
debtors. The Fund would participate on such committees only when NACM believes
that such participation is necessary or desirable to enforce the Fund's rights
as a creditor or to protect the value of securities held by the Fund.
SHORT-TERM INVESTMENTS / TEMPORARY DEFENSIVE STRATEGIES
Upon NACM's recommendation, for temporary defensive purposes and in order
to keep the Fund's cash fully invested, including the period during which the
net proceeds of the offering are being invested, the Fund may invest up to 100%
of its net assets in investments (other than convertible securities and
non-convertible income-producing securities in which the Fund ordinarily
invests), such as high grade, short-term debt instruments. Such investments may
prevent the Fund from achieving its investment objective.
INVESTMENT RESTRICTIONS
FUNDAMENTAL INVESTMENT RESTRICTIONS
Except as described below, the Fund, as a fundamental policy, may not,
without the approval of the holders of a majority of the outstanding Common
Shares and any outstanding preferred shares of beneficial interest of the Fund
(including the APS) voting together as a single class, and of the holders of a
majority of any outstanding preferred shares of beneficial interest of the Fund
(including the APS) voting as a separate class:
(1) Concentrate its investments in a particular "industry," as that
term is used in the Investment Company Act of 1940, as amended, and as
interpreted, modified, or otherwise permitted by regulatory authority
having jurisdiction, from time to time.
(2) With respect to 75% of the Fund's total assets, purchase the
securities of any issuer, except securities issued or guaranteed by the
U.S. Government or any of its agencies or instrumentalities or securities
issued by other investment companies, if, as a result, (i) more than 5% of
the Fund's total assets would be invested in the securities of that issuer,
or (ii) the Fund would hold more than 10% of the outstanding voting
securities of that issuer.
(3) Purchase or sell real estate, although it may purchase securities
secured by real estate or interests therein, or securities issued by
companies which invest in real estate, or interests therein.
(4) Purchase or sell commodities or commodities contracts or oil, gas
or mineral programs. This restriction shall not prohibit the Fund, subject
to restrictions described in the Prospectus and elsewhere in this Statement
of Additional Information, from purchasing, selling or entering into
futures contracts, options on futures contracts, forward contracts, or any
interest rate, securities-related or other hedging instrument, including
swap agreements and other derivative instruments, subject to compliance
with any applicable provisions of the federal securities or commodities
laws.
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(5) Borrow money or issue any senior security, except to the extent
permitted under the Investment Company Act of 1940, as amended, and as
interpreted, modified, or otherwise permitted by regulatory authority
having jurisdiction, from time to time.
(6) Make loans, except to the extent permitted under the Investment
Company Act of 1940, as amended, and as interpreted, modified, or otherwise
permitted by regulatory authority having jurisdiction, from time to time.
(7) Act as an underwriter of securities of other issuers, except to
the extent that in connection with the disposition of portfolio securities,
it may be deemed to be an underwriter under the federal securities laws.
Currently under the 1940 Act, the Fund generally is not permitted to engage
in borrowings unless immediately after a borrowing the value of the Fund's total
assets less liabilities (other than the borrowing) is at least 300% of the
principal amount of such borrowing (i.e., such principal amount may not exceed
33 1/3% of the Fund's total assets). In addition, the Fund is not permitted to
declare any cash dividend or other distribution on Common Shares unless, at the
time of such declaration, the value of the Fund's total assets, less liabilities
other than borrowing, is at least 300% of such principal amount.
Currently under the 1940 Act, the Fund may generally not lend money or
property to any person, directly or indirectly, if such person controls or is
under common control with the Fund, except for a loan from the Fund to a company
which owns all of the outstanding securities of the Fund, except directors' and
qualifying shares.
For purposes of the foregoing, "majority of the outstanding," when used
with respect to particular shares of the Fund (whether voting together as a
single class or voting as separate classes), means (i) 67% or more of such
shares present at a meeting, if the holders of more than 50% of such shares are
present or represented by proxy, or (ii) more than 50% of such shares, whichever
is less.
Unless otherwise indicated, all limitations applicable to the Fund's
investments (as stated above and elsewhere in this Statement of Additional
Information) apply only at the time a transaction is entered into. Any
subsequent change in a rating assigned by any rating service to a security (or,
if unrated, deemed by NACM to be of comparable quality), or change in the
percentage of the Fund's total assets invested in certain securities or other
instruments, or change in the average maturity or duration of the Fund's
investment portfolio, resulting from market fluctuations or other changes in the
Fund's total assets, will not require the Fund to dispose of an investment until
NACM determines that it is practicable to sell or close out the investment
without undue market or tax consequences to the Fund. In the event that rating
agencies assign different ratings to the same security, NACM will determine
which rating it believes best reflects the security's quality and risk at that
time, which may be the higher of the several assigned ratings.
Under the 1940 Act, a "senior security" does not include any promissory
note or evidence of indebtedness where such loan is for temporary purposes only
and in an amount not exceeding
-39-
5% of the value of the total assets of the issuer at the time the loan is made.
A loan is presumed to be for temporary purposes if it is repaid within sixty
days and is not extended or renewed.
The Fund would be deemed to "concentrate" in a particular industry if it
invested 25% or more of its total assets in that industry. The Fund's industry
concentration policy does not preclude it from focusing investments in issuers
in a group of related industrial sectors (such as different types of utilities).
The Fund may not change its policy to invest at least 80% of its total
assets in a diversified portfolio of convertible securities and non-convertible
income-producing securities unless it provides shareholders with notice of such
change if and to the extent required by the 1940 Act and the rules thereunder.
To the extent the Fund covers its commitment under a derivative instrument
by the segregation of assets determined by NACM to be liquid in accordance with
procedures adopted by the Trustees, equal in value to the amount of the Fund's
commitment, such instrument will not be considered a "senior security" for
purposes of the asset coverage requirements otherwise applicable to borrowings
by the Fund or the Fund's issuance of the APS. For instance, the Fund may cover
its position in a reverse repurchase agreement by segregating liquid assets at
least equal in amount to its forward purchase commitment.
The Fund interprets its policies with respect to borrowing and lending to
permit such activities as may be lawful for the Fund, to the full extent
permitted by the 1940 Act or by exemption from the provisions therefrom pursuant
to exemptive order of the SEC.
It is a condition of the issuance of the APS that they be issued with a
credit quality rating of "Aaa" from Moody's. In order to obtain and maintain the
required rating, the Fund will be required to comply with investment quality,
diversification and other guidelines established by Moody's. Such guidelines
will likely be more restrictive than the restrictions set forth above. The Fund
does not anticipate that such guidelines would have a material adverse effect on
the Fund's ability to achieve its investment objective. Moody's receives fees in
connection with their ratings issuances.
-40-
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The business of the Fund is managed under the direction of the Fund's Board
of Trustees. Subject to the provisions of the Fund's Amended and Restated
Agreement and Declaration of Trust (the "Declaration"), its Second Amended and
Restated Bylaws and Massachusetts law, the Trustees have all powers necessary
and convenient to carry out this responsibility, including the election and
removal of the Fund's officers.
The Trustees and officers of the Fund, their ages, the position they hold
with the Fund, their terms of office and length of time served, a description of
their principal occupations during the past five years, the number of portfolios
in the fund complex that the Trustee oversees and any other directorships held
by the Trustee are listed in the two tables immediately following. Except as
shown, each Trustee's and officer's principal occupation and business experience
for the last five years have been with the employer(s) indicated, although in
some cases the Trustee may have held different positions with such employer(s).
Unless otherwise indicated, the business address of the persons listed below is
c/o PIMCO Advisors Fund Management LLC, 1345 Avenue of the Americas, New York,
New York 10105.
-41-
Independent Trustees*
NUMBER OF
TERM OF PORTFOLIOS IN
OFFICE AND FUND COMPLEX OTHER
NAME, ADDRESS POSITION(s) LENGTH OF PRINCIPAL OCCUPATION(s) DURING THE PAST 5 OVERSEEN BY DIRECTORSHIPS
AND AGE HELD WITH FUND TIME SERVED YEARS TRUSTEE HELD BY TRUSTEE
Paul Belica Trustee Since Trustee, Fixed Income SHares, PIMCO 15 None.
Age 81 inception Corporate Opportunity Fund, PIMCO Corporate
(February, Income Fund, PIMCO High Income Fund, PIMCO
2003). Municipal Income Fund, PIMCO California
Municipal Income Fund, PIMCO New York
Municipal Income Fund, PIMCO Municipal
Income Fund II, PIMCO California Municipal
Income Fund II, PIMCO New York Municipal
Income Fund II, PIMCO Municipal Income Fund
III, PIMCO California Municipal Income Fund
III, PIMCO New York Municipal Income Fund
III, and Nicholas-Applegate Convertible &
Income Fund; Manager, Stratigos Fund, LLC,
Whistler Fund, LLC, Xanthus Fund, LLC and
Wynstone Fund, LLC; Director, Student Loan
Finance Corp., Education Loans, Inc., Goal
Funding, Inc., Goal Funding II, Inc.;
formerly, Advisor, Salomon Smith Barney
Inc.; Director, Central European Value Fund,
Inc., Deck House Inc., The Czech Republic
Fund, Inc., Surety Loan Funding, Inc.
Robert E. Connor Trustee Since Trustee, Fixed Income SHares, PIMCO 16 None.
Age 68 inception Corporate Opportunity Fund, PIMCO Corporate
(February, Income Fund, PIMCO High Income Fund, PIMCO
2003). Municipal Income Fund, PIMCO California
Municipal Income Fund, PIMCO New York
Municipal Income Fund, PIMCO Municipal
Income Fund II, PIMCO California Municipal
Income Fund II, PIMCO New York Municipal
Income Fund II, PIMCO Municipal Income
Fund III, PIMCO California Municipal
Income Fund III, PIMCO New York Municipal
Income Fund III, and Nicholas-Applegate
Convertible & Income Fund; Director,
Municipal Advantage Fund, Inc.; Corporate
Affairs Consultant; formerly, Senior
Vice President, Corporate Office,
Salomon Smith Barney Inc.
-42-
NUMBER OF
TERM OF PORTFOLIOS IN
OFFICE AND FUND COMPLEX OTHER
NAME, ADDRESS POSITION(s) LENGTH OF PRINCIPAL OCCUPATION(s) DURING THE PAST 5 OVERSEEN BY DIRECTORSHIPS
AND AGE HELD WITH FUND TIME SERVED YEARS TRUSTEE HELD BY TRUSTEE
John J. Trustee Since President and Director, J.J. Dalessandro II 13 None.
Dalessandro II* inception Ltd., registered broker-dealer and member of
Age 65 (February, the New York Stock Exchange; Trustee, PIMCO
2003). Corporate Opportunity Fund, PIMCO Corporate
Income Fund, PIMCO High Income Fund, PIMCO
Municipal Income Fund, PIMCO California
Municipal Income Fund, PIMCO New York
Municipal Income Fund, PIMCO Municipal
Income Fund II, PIMCO California Municipal
Income Fund II, PIMCO New York Municipal
Income Fund II, PIMCO Municipal Income Fund
III, PIMCO California Municipal Income Fund
III, PIMCO New York Municipal Income Fund
III, and Nicholas-Applegate Convertible &
Income Fund.
----------
* Mr. Dalessandro is treated by the Fund as not being an "interested person" (as
defined in Section 2(a)(19) of the 1940 Act) of the Fund, PIMCO Advisors Fund
Management LLC, NACM or the Underwriters, despite his affiliation with J.J.
Dalessandro II Ltd., a member of the New York Stock Exchange, Inc. (the
"Exchange") that operates as a floor broker and effects portfolio transactions
for other brokers, generally members of the Exchange, and one unrelated
investment adviser.
-43-
Interested Trustees
Currently no Trustees are treated as "interested persons" (as defined in
Section 2(a)(19) of the 1940 Act) of the Fund.
In accordance with the Fund's staggered board (see "Anti-Takeover and Other
Provisions in the Declaration of Trust"), the Common Shareholders of the Fund
will elect Trustees to fill the vacancies of Trustees whose terms expire at each
annual meeting of Common Shareholders, unless any Preferred Shareholders
(including holders of the APS) are outstanding, in which event such Preferred
Shareholders, voting as a separate class, will elect two Trustees, and the
remaining Trustee(s) shall be elected by Common Shareholders and the Preferred
Shareholders voting together as a single class. Any Preferred Shareholders
(including holders of the APS) will be entitled to elect a majority of the
Fund's Trustees under certain circumstances.
-44-
Officers
TERM OF OFFICE
POSITION(s) HELD AND LENGTH OF
NAME, ADDRESS AND AGE WITH FUND TIME SERVED PRINCIPAL OCCUPATION(s) DURING THE PAST 5 YEARS
Stephen J. Treadway Chairman Since inception Managing Director, Allianz Dresdner Asset Management of America
2187 Atlantic Street (February, L.P.; Managing Director and Chief Executive Officer, PIMCO
Stamford, CT 06902 2003). Advisors Fund Management LLC; Managing Director and Chief
Age 55 Executive Officer, PIMCO Advisors Distributors LLC ("PAD");
Trustee and Chairman, PIMCO Funds: Multi-Manager Series;
Trustee, Chairman and President, OCC Accumulation Trust; Trustee
and Chairman, PIMCO Corporate Income Fund, PIMCO Municipal
Income Fund, PIMCO California Municipal Income Fund, PIMCO New
York Municipal Income Fund, PIMCO Municipal Income Fund II,
PIMCO California Municipal Income Fund II, PIMCO New York
Municipal Income Fund II and Municipal Advantage Fund, Inc.;
Chairman, PIMCO High Income Fund, PIMCO Municipal Income Fund
III, PIMCO California Municipal Income Fund III and PIMCO New
York Municipal Income Fund III; member of the Board of
Management of Allianz Dresdner Asset Management GmbH.
Brian S. Shlissel President and Since Senior Vice President, PIMCO Advisors Fund Management LLC;
Age 38 Chief Executive inception Executive Vice President and Treasurer, OCC Accumulation Trust;
Officer (February, President and Chief Executive Officer, Fixed Income SHares,
2003). PIMCO Corporate Opportunity Fund, PIMCO Corporate Income Fund,
PIMCO High Income Fund, PIMCO Municipal Income Fund, PIMCO
California Municipal Income Fund, PIMCO New York Municipal
Income Fund, PIMCO Municipal Income Fund II, PIMCO California
Municipal Income Fund II, PIMCO New York Municipal Income Fund
II, PIMCO Municipal Income Fund III, PIMCO California Municipal
Income Fund III, PIMCO New York Municipal Income Fund III and
Municipal Advantage Fund, Inc.; formerly, Vice President,
Mitchell Hutchins Asset Management Inc.
Lawrence G. Altadonna Treasurer, Since Vice President, PIMCO Advisors Fund Management LLC; Treasurer
Age 36 Principal inception and Principal Financial and Accounting Officer, PIMCO Corporate
Financial and (February, Opportunity Fund, PIMCO Corporate Income Fund, PIMCO High Income
Accounting 2003). Fund, PIMCO Municipal Income Fund, PIMCO California Municipal
Officer Income Fund, PIMCO New York Municipal Income Fund, PIMCO
Municipal Income Fund II, PIMCO California Municipal Income Fund
II, PIMCO New York Municipal Income Fund II, PIMCO Municipal
Income Fund III, PIMCO California Municipal Income Fund III,
PIMCO New York Municipal Income Fund III and Municipal Advantage
Fund, Inc.; Treasurer, Fixed Income SHares; Assistant Treasurer,
OCC Accumulation Trust; formerly, Director of Fund
Administration, Prudential Investments.
Newton B. Schott, Jr. Vice President, Since Managing Director, Chief Administrative Officer, Secretary and
2187 Atlantic Street Secretary inception General Counsel, PAD; Managing Director, Chief Legal Officer and
Stamford, CT 06902 (February, Secretary, PIMCO Advisors Fund Management LLC; President, Chief
Age 60 2003). Executive Officer and Secretary, PIMCO Funds: Multi-Manager
Series; Vice President and Secretary, PIMCO Corporate
Opportunity Fund, PIMCO Corporate Income Fund, PIMCO High Income
Fund, PIMCO Municipal Income Fund, PIMCO California Municipal
Income Fund, PIMCO New York Municipal Income Fund, PIMCO
Municipal Income Fund II, PIMCO California Municipal Income Fund
II, PIMCO New York Municipal Income Fund II, PIMCO Municipal
Income Fund III, PIMCO California Municipal Income Fund III,
PIMCO New York Municipal Income Fund III and Municipal Advantage
Fund, Inc.; Secretary, Fixed Income SHares.
Douglas Forsyth Vice President Since Senior Portfolio Manager and Member of the Executive Committee
600 West Broadway inception of NACM.
San Diego, CA 92101 (February,
Age 34 2003).
-45-
For interested Trustees and officers, positions held with affiliated
persons or principal underwriters of the Fund are listed in the following table:
POSITIONS HELD WITH AFFILIATED PERSONS OR
NAME PRINCIPAL UNDERWRITERS OF THE FUND
Stephen J. Treadway See above.
Brian S. Shlissel See above.
Lawrence G. Altadonna See above.
Newton B. Schott, Jr. See above.
Douglas Forsyth See above.
COMMITTEES OF THE BOARD OF TRUSTEES
Audit Oversight Committee
Provides oversight with respect to the internal and external accounting and
auditing procedures of the Fund and, among other things, considers the selection
of independent public accountants for the Fund and the scope of the audit,
approves all significant services proposed to be performed by those accountants
on behalf of the Fund, and considers other services provided by those
accountants to the Fund, PIMCO Advisors Fund Management LLC (the "Manager") and
NACM and the possible effect of those services on the independence of those
accountants. Messrs. Belica and Connor, each of whom is an independent Trustee,
serve on this committee.
Nominating Committee
Responsible for reviewing and recommending qualified candidates to the
Board in the event that a position is vacated or created. The Nominating
Committee will review and consider nominees recommended by shareholders to serve
as Trustee, provided any such recommendation is submitted in writing to the
Fund, c/o Newton B. Schott, Jr., Secretary, at the address of the principal
executive offices of the Fund. The Nominating Committee has full discretion to
reject nominees recommended by shareholders, and there is no assurance that any
such person so recommended and considered by a committee will be nominated for
election to the Board. Messrs. Belica and Connor, each of whom is an independent
Trustee, serve on this committee.
Valuation Committee
Reviews procedures for the valuation of securities and periodically reviews
information from the Manager and NACM regarding fair value and liquidity
determination made pursuant to the Board-approved procedures, and makes related
recommendations to the full Board and assists the full Board in resolving
particular valuation matters. Messrs. Belica and Connor, each of whom is an
independent Trustee, serve on this committee.
-46-
Compensation Committee
The Compensation Committee periodically reviews and sets compensation
payable to the Trustees of the Fund who are not directors, officers, partners or
employees of the Manager, NACM or any entity controlling, controlled by or under
common control with the Manager or NACM. Messrs. Belica and Connor, each of whom
is an independent Trustee, serve on this committee.
During the last fiscal year, none of the above committees of the Board of
Trustees held any meetings.
SECURITIES OWNERSHIP
For each Trustee, the following table discloses the dollar range of equity
securities beneficially owned by the Trustee in the Fund and, on an aggregate
basis, in any registered investment companies overseen by the Trustee within the
Fund's family of investment companies as of December 31, 2002:
AGGREGATE DOLLAR RANGE OF EQUITY SECURITIES IN ALL
DOLLAR RANGE OF EQUITY REGISTERED INVESTMENT COMPANIES OVERSEEN BY TRUSTEE
NAME OF TRUSTEE SECURITIES IN THE FUND IN FAMILY OF INVESTMENT COMPANIES
Paul Belica None. > $100,000
Robert E. Connor None. None.
John J. Dalessandro II None. None.
For independent Trustees and their immediate family members, the following
table provides information regarding each class of securities owned beneficially
in an investment adviser or principal underwriter of the Fund, or a person
(other than a registered investment company) directly or indirectly controlling,
controlled by, or under common control with an investment adviser or principal
underwriter of the Fund as of December 31, 2002:
NAME OF TRUSTEE NAME OF OWNERS AND VALUE OF PERCENT OF
RELATIONSHIPS TO TRUSTEE COMPANY TITLE OF CLASS SECURITIES CLASS
Paul Belica None.
Robert E. Connor None.
John J. Dalessandro II None.
As of May 5, 2003, the Fund's officers and Trustees as a group owned less
than 1% of the Fund's outstanding Common Shares. Other than Common Shares, there
were no other equity securities of the Fund outstanding on such date.
-47-
As of May 5, 2003, the following persons owned of record the number of
Common Shares noted below, representing the indicated percentage of the Fund's
outstanding equity securities as of such date. Many of these shares are believed
to be held only as nominee. To the knowledge of the Fund, no other person owned
of record or beneficially 5% or more of the Fund's outstanding equity securities
on such date.
PERCENTAGE OF THE FUND'S
NUMBER OF OUTSTANDING SHARES AS OF
SHAREHOLDER COMMON SHARES MAY 5, 2003
First Clearing Corporation 4,517,711 7.11%
10700 Wheat First Drive
Suite 900
Glen Allen, VA 23060
Citigroup Global Markets Inc. 5,353,178 8.43%
333 West 34th Street
4th Floor
New York, NY 10001
Legg Mason Wood Walker 3,872,321 6.10%
Incorporated
100 Light Street
Baltimore, MD 21202
Merrill Lynch 8,337,350 13.13%
101 Hudson Street
Jersey City, NJ 07302-3997
Prudential Securities 6,927,452 10.91%
Incorporated
c/o ADP Proxy Services
51 Mercedes Way
Edgewood, NY 11717
RBC Dain Rauscher Inc. 4,167,451 6.56%
510 Marquette Ave South
Minneapolis, MN 55402
UBS Painewebber Inc. 16,431,695 25.87%
1000 Harbor Blvd
Weehawken, NJ 07087
COMPENSATION
Messrs. Belica, Connor and Dalessandro also serve as Trustees of PIMCO
Municipal Income Fund, PIMCO California Municipal Income Fund, PIMCO New York
Municipal Income Fund, PIMCO Municipal Income Fund II, PIMCO California
Municipal Income Fund II, PIMCO New York Municipal Income Fund II, PIMCO
Municipal Income Fund III, PIMCO California Municipal Income Fund III and PIMCO
New York Municipal Income Fund III (together, the "Municipal Funds"), PIMCO
Corporate Opportunity Fund, PIMCO Corporate Income Fund and PIMCO High Income
Fund, twelve closed-end funds for which the Manager
-48-
serves as investment manager and Pacific Investment Management Company LLC
("PIMCO"), an affiliate of the Manager, serves as portfolio manager. In addition
to the Fund, the Municipal Funds, PIMCO Corporate Opportunity Fund, PIMCO
Corporate Income Fund, and PIMCO High Income Fund, Mr. Belica is a director or
trustee, as the case may be, of one open-end investment company (comprising two
separate investment portfolios) advised by the Manager, and Mr. Connor is a
director or trustee, as the case may be, of one open-end investment company
(comprising two separate investment portfolios) and one closed-end investment
company advised by the Manager. To the best of the Fund's knowledge, none of the
"independent" Trustees has ever been a director, officer, or employee of, or a
consultant to, the Manager, NACM, any one or more of the Underwriters or any one
or more affiliates of any of the foregoing, except that Mr. Connor provides
occasional editorial consulting services as an independent contractor to an
administrative unit of Smith Barney, a subsidiary of Citigroup, Inc. As
indicated above, certain of the officers and Trustees of the Fund are affiliated
with the Manager and/or NACM.
The Municipal Funds, PIMCO Corporate Income Fund, PIMCO Corporate
Opportunity Fund, PIMCO High Income Fund, and the Fund (together, the "PIMCO
Closed-End Funds") are expected to hold joint meetings of their Boards of
Trustees whenever possible. Each Trustee, other than any Trustee who is a
director, officer, partner or employee of the Manager, NACM, PIMCO or any entity
controlling, controlled by or under common control with the Manager, NACM or
PIMCO, receives $26,000 for each joint meeting for the first four joint meetings
in each year and $13,000 for each additional joint meeting in such year if the
meetings are attended in person. Trustees receive $6,500 per joint meeting if
the meetings are attended telephonically. Members of the Audit Oversight
Committee will receive $500 per fund per joint meeting of the PIMCO Closed-End
Funds' Audit Oversight Committees if the meeting takes place on a day other than
the day of a regularly scheduled Board meeting. Trustees will also be reimbursed
for meeting-related expenses.
The PIMCO Closed-End Funds will allocate the Trustees' compensation and
other costs of their joint meetings pro rata based on each PIMCO Closed-End
Fund's net assets, including assets attributable to any APS.
It is estimated that the Trustees will receive the amounts set forth in the
following table from the Fund for its initial fiscal year ending February 29,
2004. For the calendar year ended December 31, 2002, the Trustees received the
compensation set forth in the following table for serving as trustees of other
funds in the "Fund Complex." Each officer and Trustee who is a director,
officer, partner or employee of the Manager, NACM or any entity controlling,
controlled by or under common control with the Manager or NACM serves without
any compensation from the Fund.
-49-
Total Compensation
Estimated Compensation from the Fund Complex Paid
from the Fund for the to the Trustees for the
Fiscal Year Ending Calendar Year Ending
Name of Trustee February 29, 2004* December 31, 2002**
----------------------- ----------------------- --------------------------
Paul Belica $ 20,000 $ 78,400
Robert E. Connor $ 20,000 $ 87,170
John J. Dalessandro II $ 20,000 $ 76,400
----------
* Since the Fund has not completed its first full fiscal year, compensation
is estimated based upon future payments to be made by the Fund during the
current fiscal year and upon estimated relative net assets of the PIMCO
Closed-End Funds.
** In addition to the PIMCO Closed-End Funds, during the year ended
December 31, 2002, Mr. Belica served as a trustee of one open-end investment
company (comprising two separate investment portfolios) advised by the Manager,
and Mr. Connor served as a director or trustee of one open-end investment
company (comprising two separate investment portfolios) and one closed-end
investment company advised by the Manager. These investment companies are
considered to be in the same "Fund Complex" as the Fund, and the amounts listed
in this column include compensation received by Mr. Belica and Mr. Connor from
these investment companies and the PIMCO Closed-End Funds for services provided
as trustees or directors as the case may be.
The Fund has no employees. Its officers are compensated by the Manager
and/or NACM.
CODES OF ETHICS
The Fund, the Manager and NACM have each adopted a separate code of ethics
governing personal trading activities of, as applicable, all Trustees and
officers of the Fund, and directors, officers and employees of the Manager and
NACM, who, in connection with their regular functions, play a role in the
recommendation of any purchase or sale of a security by the Fund or obtain
information pertaining to such purchase or sale or who have the power to
influence the management or policies of the Fund, the Manager or NACM, as
applicable. Such persons are prohibited from effecting certain transactions,
allowed to effect certain exempt transactions (including with respect to
securities that may be purchased or held by the Fund), and are required to
preclear certain security transactions with the applicable compliance officer or
his designee and to report certain transactions on a regular basis. The Fund,
the Manager and NACM have each developed procedures for administration of their
respective codes. Text-only versions of the codes of ethics can be viewed online
or downloaded from the EDGAR Database on the SEC's internet web site at
http://www.sec.gov. You may also review and copy those documents by visiting the
SEC's Public Reference Room in Washington, DC. Information on the operation of
the Public Reference Room may be obtained by calling the SEC at 1-202-942-8090.
In addition, copies of the codes of ethics may be obtained, after mailing the
appropriate duplicating fee, by writing to the SEC's Public Reference Section,
450 5th Street, N.W., Washington, DC 20549-0102 or by e-mail request at
publicinfo@sec.gov.
-50-
INVESTMENT MANAGER AND PORTFOLIO MANAGER
INVESTMENT MANAGER
The Manager serves as investment manager to the Fund pursuant to an
investment management agreement (the "Investment Management Agreement") between
it and the Fund. The Manager, a Delaware limited liability company organized in
2000 as a subsidiary successor in the restructuring of a business originally
organized in 1987, is wholly-owned by PIMCO Advisors Retail Holdings LLC, a
wholly-owned subsidiary of Allianz Dresdner Asset Management of America L.P.
("ADAM of America"). ADAM of America was organized as a limited partnership
under Delaware law in 1987. ADAM of America's sole general partner is
Allianz-Paclife Partners LLC. Allianz-Paclife Partners LLC is a Delaware limited
liability company with three members, ADAM U.S. Holding LLC, a Delaware limited
liability company, Pacific Asset Management LLC, a Delaware limited liability
company, and Pacific Life Insurance Company ("Pacific Life"), a California stock
life insurance company. Pacific Asset Management LLC is a wholly-owned
subsidiary of Pacific Life, which is a wholly-owned subsidiary of Pacific Mutual
Holding Company. Pacific Life also owns an indirect minority equity interest in
ADAM of America. The sole member of ADAM U.S. Holding LLC is Allianz Dresdner
Asset Management of America LLC. Allianz Dresdner Asset Management of America
LLC has two members, Allianz of America, Inc. ("Allianz of America"), a Delaware
corporation which owns a 99.9% non-managing interest, and Allianz Dresdner Asset
Management of America Holding Inc., a Delaware corporation which owns a 0.01%
managing interest. Allianz of America is a wholly-owned subsidiary of Allianz
Aktiengesellschaft ("Allianz AG"). Allianz Dresdner Asset Management of America
Holding Inc. is a wholly-owned subsidiary of ADAM GmbH, which is a wholly-owned
subsidiary of Allianz AG. Allianz AG indirectly holds a controlling interest in
ADAM of America. Allianz AG is a European-based, multinational insurance and
financial services holding company. Allianz AG's address is Koeniginstrasse 28,
D-80802, Munich, Germany. Pacific Life's address is 700 Newport Center Drive,
Newport Beach, California 92660. ADAM of America's address is 888 San Clemente
Drive, Suite 100, Newport Beach, California 92660.
The general partner of ADAM of America has substantially delegated its
management and control of ADAM of America to an Executive Committee. The
Executive Committee of ADAM of America is comprised of William S. Thompson, Jr.
and David C. Flattum.
The Manager is located at 1345 Avenue of the Americas, New York, New York
10105. As of March 31, 2003, the Manager had approximately $18.4 billion in
assets under management. As of March 31, 2003, ADAM of America and its
subsidiary partnerships, including NACM, had approximately $392 billion in
assets under management.
In connection with the acquisition of ADAM of America by Allianz of America
in May of 2000, the Pacific Life interest in ADAM of America was converted into
an interest in 3,722 Class E Units in ADAM of America. The Class E Units are
entitled to distributions based largely on the performance of Pacific Investment
Management Company, a subsidiary of ADAM of America, and for periods after
January 31, 2003, the distributions are capped at a maximum of $98 million
(annualized) for 2003, $96 million for 2004, $94 million for 2005, $92 million
for 2006 and $90 million in 2007 and thereafter. Pursuant to a Continuing
Investment Agreement
-51-
dated May 5, 2000, as amended and restated March 10, 2003, Allianz of America,
Pacific Asset Management LLC and Pacific Life are party to a call and put
arrangement regarding the Class E Units. Under the restated agreement, the
quarterly put and/or call options are limited in amount to a maximum of $250
million per quarter through March 2004. In any month subsequent to March 2004,
Pacific Life and Allianz of America can put or call, respectively, all Allianz
of America's units owned directly or indirectly by Pacific Life. The repurchase
price for the Class E Units is calculated based on the financial performance of
Pacific Investment Management Company over the preceding four calendar quarters
prior to repurchase, but the amount can increase or decrease in value by a
maximum of 2% per year from the per unit amount as defined in the Continuing
Investment Agreement, calculated as of December 31 of the preceding calendar
year. The initial per unit amount as of December 31, 2002 was approximately
$551,900 per unit ($2.054 billion in aggregate). The per unit amount is also
subject to a cap and a floor of $600,000 and $500,000 per unit, respectively.
As of the date of this Statement of Additional Information, significant
institutional shareholders of Allianz AG currently include Munchener
Ruckversicherungs-Gesellschaft AG ("Munich Re") and HypoVereinsbank. Allianz AG
in turn owns more than 95% of Dresdner Bank AG. Certain broker-dealers that
might be controlled by or affiliated with these entities or Dresdner Bank AG,
including Dresdner Klienwort Wasserstein, Dresdner Kleinwort Benson and
Grantchester Securities, Inc., may be considered to be affiliated persons of the
Manager and NACM. (Broker-dealer affiliates of such significant institutional
shareholders are sometimes referred to herein as "Affiliated Brokers.") Absent
an SEC exemption or other relief, the Fund generally is precluded from effecting
principal transactions with the Affiliated Brokers, and its ability to purchase
securities being underwritten by an Affiliated Broker or a syndicate including
an Affiliated Broker is subject to restrictions. Similarly, the Fund's ability
to utilize the Affiliated Brokers for agency transactions is subject to the
restrictions of Rule 17e-1 under the 1940 Act. NACM does not believe that the
restrictions on transactions with the Affiliated Brokers described above will
materially adversely affect its ability to provide services to the Fund, the
Fund's ability to take advantage of market opportunities, or the Fund's overall
performance.
The Manager, subject to the supervision of the Board of Trustees, is
responsible for managing, either directly or through others selected by the
Manager, the investments of the Fund. The Manager also furnishes to the Board of
Trustees periodic reports on the investment performance of the Fund. As more
fully discussed below, the Manager has retained NACM to serve as the Fund's
portfolio manager.
Under the terms of the Investment Management Agreement, subject to such
policies as the Trustees of the Fund may determine, the Manager, at its expense,
furnishes continuously an investment program for the Fund and makes investment
decisions on behalf of the Fund and places all orders for the purchase and sale
of portfolio securities subject always to the Fund's investment objective,
policies and restrictions; provided that, so long as NACM serves as the
portfolio manager for the Fund, the Manager's obligation under the Investment
Management Agreement with respect to the Fund is, subject always to the control
of the Trustees, to determine and review with NACM the investment policies of
the Fund.
-52-
Subject to the control of the Trustees, the Manager also manages,
supervises and conducts the other affairs and business of the Fund, furnishes
office space and equipment, provides bookkeeping and certain clerical services
(excluding determination of the net asset value of the Fund, shareholder
accounting services and the accounting services for the Fund) and pays all
salaries, fees and expenses of officers and Trustees of the Fund who are
affiliated with the Manager. As indicated under "Portfolio
Transactions--Brokerage and Research Services," the Fund's portfolio
transactions may be placed with broker-dealers which furnish the Manager and
NACM, without cost, certain research, statistical and quotation services of
value to them or their respective affiliates in advising the Fund or their other
clients. In so doing, the Fund may incur greater brokerage commissions and other
transactions costs than it might otherwise pay.
Pursuant to the Investment Management Agreement, the Fund has agreed to pay
the Manager an annual management fee, payable on a monthly basis, at the annual
rate of 0.70% of the Fund's average daily total managed assets for the services
and facilities it provides. "Total managed assets" means the total assets of the
Fund (including any assets attributable to APS or other forms of leverage that
may be outstanding) minus accrued liabilities (other than liabilities
representing leverage). All fees and expenses are accrued daily and deducted
before payment of dividends to investors.
Except as otherwise described in the Prospectus, the Fund pays, in addition
to the investment management fee described above, all expenses not assumed by
the Manager, including, without limitation, fees and expenses of Trustees who
are not "interested persons" of the Manager or the Fund, interest charges,
taxes, brokerage commissions, expenses of issue of shares, fees and expenses of
registering and qualifying the Fund and its classes of shares for distribution
under federal and state laws and regulations, charges of custodians, auditing
and legal expenses, expenses of determining net asset value of the Fund, reports
to shareholders, expenses of meetings of shareholders, expenses of printing and
mailing prospectuses, proxy statements and proxies to existing shareholders, and
its proportionate share of insurance premiums and professional association dues
or assessments. The Fund is also responsible for such nonrecurring expenses as
may arise, including litigation in which the Fund may be a party, and other
expenses as determined by the Trustees. The Fund may have an obligation to
indemnify its officers and Trustees with respect to such litigation.
PORTFOLIO MANAGER
NACM serves as portfolio manager for the Fund pursuant to a portfolio
management agreement (the "Portfolio Management Agreement") between NACM and the
Manager. Under the Portfolio Management Agreement, subject always to the control
of the Trustees and the supervision of the Manager, NACM's obligation is to
furnish continuously an investment program for the Fund, to make investment
decisions on behalf of the Fund and to place all orders for the purchase and
sale of portfolio securities and all other investments for the Fund.
Under the Portfolio Management Agreement, the Manager (and not the Fund)
has agreed to pay NACM a monthly fee equal to (i) fifty percent (50%) of the
management fees payable by the Fund to the Manager for such month with respect
to the first $300 million of the Fund's average daily total managed assets and
(ii) seventy-five percent (75%) of the management fees payable by the Fund to
the Manager for such month with respect to the Fund's average daily
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total managed assets in excess of $300 million; provided, however, that the
amounts payable under (i) and (ii) above shall be reduced to reflect that NACM
will bear 50% and 75%, respectively, of any Service or Incentive Fees payable by
the Manager for such month with respect to the specified total managed assets.
For these purposes, "Service or Incentive Fees" for any period equals the sum of
any Shareholder Servicing Fees payable by the Manager to UBS Warburg LLC (as
described under "Shareholder servicing agent, custodian and transfer agent" in
the Prospectus) for such period and any incentive fees payable by the Manager to
other qualifying underwriters of the initial public offering of the Fund's
Common Shares for such period.
NACM is an investment management firm organized as a Delaware limited
liability company (formerly Nicholas-Applegate Capital Management, a California
limited partnership). NACM is wholly owned by Nicholas-Applegate Holdings LLC, a
Delaware limited liability company, which is a wholly owned subsidiary of
Allianz Dresdner Asset Management U.S. Equities LLC ("ADAM Equities"), a
Delaware limited liability company. ADAM Equities is a wholly owned subsidiary
of ADAM of America.
NACM was organized in 1984 to manage discretionary accounts investing
primarily in publicly traded equity securities and securities convertible into
or exercisable for publicly traded equity securities, with the goal of capital
appreciation. As of March 31, 2003, NACM had approximately $16 billion in
assets under management. NACM is located at 600 West Broadway, 30th Floor, San
Diego, California 92101.
CERTAIN TERMS OF THE INVESTMENT MANAGEMENT AND PORTFOLIO MANAGEMENT AGREEMENTS
The Investment Management Agreement and the Portfolio Management Agreement
were each approved by the Trustees of the Fund (including all of the Trustees
who are not "interested persons" of the Manager or NACM). The Investment
Management Agreement and Portfolio Management Agreement will each continue in
force with respect to the Fund for two years from their respective dates, and
from year to year thereafter, but only so long as their continuance is approved
at least annually by (i) vote, cast in person at a meeting called for that
purpose, of a majority of those Trustees who are not "interested persons" of the
Manager, NACM or the Fund, and (ii) the majority vote of either the full Board
of Trustees or the vote of a majority of the outstanding shares of all classes
of the Fund. Each of the Investment Management Agreement and Portfolio
Management Agreement automatically terminates on assignment. The Investment
Management Agreement may be terminated on not less than 60 days' notice by the
Manager to the Fund or by the Fund to the Manager. The Portfolio Management
Agreement may be terminated on not less than 60 days' notice by the Manager to
NACM or by NACM to the Manager, or by the Fund at any time by notice to the
Manager and NACM.
The Investment Management Agreement and the Portfolio Management Agreement
each provide that the Manager or NACM, as applicable, shall not be subject to
any liability in connection with the performance of its services thereunder in
the absence of willful misfeasance, bad faith, gross negligence or reckless
disregard of its obligations and duties.
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BASIS FOR APPROVAL OF THE INVESTMENT MANAGEMENT AND PORTFOLIO MANAGEMENT
AGREEMENTS
In determining to approve the Investment Management Agreement and the
Portfolio Management Agreement, the Trustees met with the relevant investment
advisory personnel from the Manager and NACM and considered information relating
to the education, experience and number of investment professionals and other
personnel who would provide services under the applicable agreement. See
"Management of the Fund" in the Prospectus and this Statement of Additional
Information. The Trustees also took into account the time and attention to be
devoted by senior management to the Fund and the other funds in the complex. The
Trustees evaluated the level of skill required to manage the Fund and concluded
that the human resources to be available at the Manager and NACM were
appropriate to fulfill effectively the duties of the Manager and NACM on behalf
of the Fund under the applicable agreement. The Trustees also considered the
business reputation of the Manager and NACM, their financial resources and
professional liability insurance coverage and concluded that they would be able
to meet any reasonably foreseeable obligations under the applicable agreement.
The Trustees received information concerning the investment philosophy and
investment process to be applied by NACM in managing the Fund. In this
connection, the Trustees considered NACM's in-house research capabilities as
well as other resources available to NACM's personnel, including research
services available to NACM as a result of securities transactions effected for
the Fund and other investment advisory clients. The Trustees concluded that
NACM's investment process, research capabilities and philosophy were well suited
to the Fund, given the Fund's investment objective and policies.
The Trustees considered the scope of the services provided by the Manager
and NACM to the Fund under the Investment Management Agreement and Portfolio
Management Agreement, respectively, relative to services provided by third
parties to other mutual funds. The Trustees noted that the Manager's and NACM's
standard of care was comparable to that found in most investment company
advisory agreements. See "--Certain Terms of the Investment Management and
Portfolio Management Agreements" above. The Trustees concluded that the scope of
the Manager's and NACM's services to be provided to the Fund was consistent with
the Fund's operational requirements, including, in addition to its investment
objective, compliance with the Fund's investment restrictions, tax and reporting
requirements and related shareholder services.
The Trustees considered the quality of the services to be provided by the
Manager and NACM to the Fund. The Trustees also evaluated the procedures of the
Manager and NACM designed to fulfill the their fiduciary duty to the Fund with
respect to possible conflicts of interest, including their codes of ethics
(regulating the personal trading of their officers and employees) (see
"Management of the Fund--Codes of Ethics" above), the procedures by which NACM
allocates trades among its various investment advisory clients, the integrity of
the systems in place to ensure compliance with the foregoing and the record of
NACM in these matters. The Trustees also received information concerning
standards of the Manager and NACM with respect to the execution of portfolio
transactions. See "Portfolio Transactions" below.
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In approving the agreements, the Trustees also gave substantial
consideration to the fees payable under the agreements. The Trustees reviewed
information concerning fees paid to investment advisers of similar funds. The
Trustees also considered the fees of the Fund as a percentage of assets at
different asset levels and possible economies of scale to the Manager. The
Trustees evaluated the Manager's profitability with respect to the Fund,
concluding that such profitability was not inconsistent with levels of
profitability that had been determined by courts not to be "excessive." In
evaluating the Fund's advisory fees, the Trustees also took into account the
complexity of investment management for the Fund relative to other types of
funds.
PORTFOLIO TRANSACTIONS
INVESTMENT DECISIONS AND PORTFOLIO TRANSACTIONS
Investment decisions for the Fund and for the other investment advisory
clients of the Manager and NACM are made with a view to achieving their
respective investment objectives. Investment decisions are the product of many
factors in addition to basic suitability for the particular client involved
(including the Fund). Some securities considered for investments by the Fund may
also be appropriate for other clients served by the Manager and NACM. Thus, a
particular security may be bought or sold for certain clients even though it
could have been bought or sold for other clients at the same time. If a purchase
or sale of securities consistent with the investment policies of the Fund and
one or more of these clients served by the Manager or NACM is considered at or
about the same time, transactions in such securities will be allocated among the
Fund and clients in a manner deemed fair and reasonable by the Manager or NACM,
as applicable. The Manager or NACM may aggregate orders for the Fund with
simultaneous transactions entered into on behalf of its other clients so long as
price and transaction expenses are averaged either for that transaction or for
the day. Likewise, a particular security may be bought for one or more clients
when one or more clients are selling the security. In some instances, one client
may sell a particular security to another client. It also sometimes happens that
two or more clients simultaneously purchase or sell the same security, in which
event each day's transactions in such security are, insofar as possible,
averaged as to price and allocated between such clients in a manner which the
Manager or NACM believes is equitable to each and in accordance with the amount
being purchased or sold by each. There may be circumstances when purchases or
sales of portfolio securities for one or more clients will have an adverse
effect on other clients.
BROKERAGE AND RESEARCH SERVICES
There is generally no stated commission in the case of debt securities,
which are traded in the over-the-counter markets, but the price paid by the Fund
usually includes an undisclosed dealer commission or mark-up. In underwritten
offerings, the price paid by the Fund includes a disclosed, fixed commission or
discount retained by the underwriter or dealer. Transactions on U.S. stock
exchanges and other agency transactions involve the payment by the Fund of
negotiated brokerage commissions. Such commissions vary among different brokers.
Also, a particular broker may charge different commissions according to such
factors as the difficulty and size of the transaction.
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Subject to the supervision of the Manager, NACM places all orders for the
purchase and sale of portfolio securities, options, futures contracts and other
instruments for the Fund and buys and sells such securities, options, futures
contracts and other instruments for the Fund through a substantial number of
brokers and dealers. In so doing, NACM uses its best efforts to obtain for the
Fund the most favorable price and execution available, except to the extent it
may be permitted to pay higher brokerage commissions as described below. In
seeking the most favorable price and execution, NACM, having in mind the Fund's
best interests, considers all factors it deems relevant, including, by way of
illustration, price, the size of the transaction, the nature of the market for
the security, the amount of the commission, the timing of the transaction taking
into account market prices and trends, the reputation, experience and financial
stability of the broker-dealer involved and the quality of service rendered by
the broker-dealer in other transactions.
Subject to the supervision of the Manager, NACM places orders for the
purchase and sale of portfolio investments for the Fund's account with brokers
or dealers selected by it in its discretion. In effecting purchases and sales of
portfolio securities for the account of the Fund, NACM will seek the best price
and execution of the Fund's orders. In doing so, the Fund may pay higher
commission rates than the lowest available when NACM believes it is reasonable
to do so in light of the value of the brokerage and research services provided
by the broker effecting the transaction, as discussed below.
It has for many years been a common practice in the investment advisory
business for advisers of investment companies and other institutional investors
to receive research services from broker-dealers which execute portfolio
transactions for the clients of such advisers. Consistent with this practice,
NACM may receive research services from many broker-dealers with which NACM
places the Fund's portfolio transactions. NACM may also receive research or
research credits from brokers which are generated from underwriting commissions
when purchasing new issues of debt securities or other assets for the Fund.
These services, which in some cases may also be purchased for cash, include such
matters as general economic and security market reviews, industry and company
reviews, evaluations of securities and recommendations as to the purchase and
sale of securities. Some of these services are of value to NACM in advising
various of its clients (including the Fund), although not all of these services
are necessarily useful and of value in managing the Fund. Neither the management
fee paid by the Fund to the Manager nor the portfolio management fee paid by the
Manager to NACM is reduced because NACM and its affiliates receive such
services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, NACM
may cause the Fund to pay a broker-dealer which provides "brokerage and research
services" (as defined in such Act) to NACM an amount of disclosed commission for
effecting a securities transaction for the Fund in excess of the commission
which another broker-dealer would have charged for effecting that transaction.
The Fund may use broker-dealers that are affiliates (or affiliates of
affiliates) of the Fund, the Manager and/or NACM, subject to certain
restrictions discussed above under "Investment Manager and Portfolio
Manager--Investment Manager."
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References to NACM in this section would apply equally to the Manager if
the Manager were to assume portfolio management responsibilities for the Fund
and place orders for the purchase and sale of the Fund's portfolio investments.
DISTRIBUTIONS
See "Description of APS - Dividends" and "Description of capital structure"
in the Prospectus for information relating to distributions made to Fund
shareholders.
For tax purposes, the Fund is currently required to allocate net capital
gain and other taxable income, if any, between and among Common Shares, the
Series A APS, the Series B APS, the Series C APS, the Series D APS, and the
Series E APS in proportion to total distributions paid to each class for the
year in which such net capital gain or other taxable income is realized.
While any APS are outstanding, the Fund may not declare any cash dividend
or other distribution on its Common Shares unless at the time of such
declaration (1) all accumulated dividends on the APS have been paid and (2) the
net asset value of the Fund's portfolio (determined after deducting the amount
of such dividend or other distribution) is at least 200% of the liquidation
value of any outstanding APS. This latter limitation on the Fund's ability to
make distributions on its Common Shares could cause the Fund to incur income and
excise tax and, under certain circumstances, impair the ability of the Fund to
maintain its qualification for taxation as a regulated investment company. See
"Tax Matters."
The Board of Trustees has declared a dividend of $0.125 per Common Share
payable on June 2, 2003.
DESCRIPTION OF SHARES
COMMON SHARES
The Fund's Declaration authorizes the issuance of an unlimited number of
Common Shares. The Common Shares currently outstanding have been issued with a
par value of $0.00001 per share. All Common Shares of the Fund have equal rights
as to the payment of dividends and the distribution of assets upon liquidation
of the Fund. The Common Shares currently outstanding have been fully paid and,
subject to matters discussed in "Anti-Takeover and Other Provisions in the
Declaration of Trust--Shareholder Liability" below, are non-assessable, and have
no pre-emptive or conversion rights or rights to cumulative voting. At any time
when the Fund's APS or any other preferred shares of beneficial interest are
outstanding, Common Shareholders will not be entitled to receive any
distributions from the Fund unless all accrued dividends on APS and any other
preferred shares of beneficial interest have been paid, and unless asset
coverage (as defined in the 1940 Act) with respect to APS and any other
preferred shares of beneficial interest would be at least 200% after giving
effect to such distributions. See "--Auction Preferred Shares" below and
"Description of APS - Dividends - Restrictions on Dividends and Other Payments"
and "Description of capital structure" in the Prospectus.
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The Common Shares are listed on the New York Stock Exchange. The Fund
intends to hold annual meetings of shareholders so long as the Common Shares are
listed on a national securities exchange and such meetings are required as a
condition to such listing.
Shares of closed-end investment companies may frequently trade at prices
lower than net asset value. Shares of closed-end investment companies have
during some periods traded at prices higher than net asset value and during
other periods traded at prices lower than net asset value. There can be no
assurance that Common Shares or shares of other similar funds will trade at a
price higher than net asset value in the future. Net asset value will be reduced
immediately following any offering of APS by the costs of that offering paid by
the Fund. Net asset value generally increases when interest rates decline, and
decreases when interest rates rise, and these changes are likely to be greater
in the case of a fund, such as the Fund, having a leveraged capital structure.
Whether investors will realize gains or losses upon the sale of Common Shares
will not depend upon the Fund's net asset value but will depend entirely upon
whether the market price of the Common Shares at the time of sale is above or
below the original purchase price for the shares. Since the market price of the
Fund's Common Shares will be determined by factors beyond the control of the
Fund, the Fund cannot predict whether the Common Shares will trade at, below, or
above net asset value or at, below or above the initial public offering price.
Accordingly, the Common Shares are designed primarily for long-term investors,
and investors in the Common Shares should not view the Fund as a vehicle for
trading purposes. See "Repurchase of Common Shares; Conversion to Open-End
Fund."
AUCTION PREFERRED SHARES
See "Description of APS" and "Description of capital structure" in the
Prospectus for information relating to the APS.
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST
SHAREHOLDER LIABILITY
Under Massachusetts law, shareholders could, under certain circumstances,
be held personally liable for the obligations of the Fund. However, the
Declaration contains an express disclaimer of shareholder liability for acts or
obligations of the Fund and requires that notice of such disclaimer be given in
each agreement, obligation or instrument entered into or executed by the Fund or
the Trustees. The Declaration also provides for indemnification out of the
Fund's property for all loss and expense of any shareholder held personally
liable on account of being or having been a shareholder. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which such disclaimer is inoperative or the Fund is
unable to meet its obligations, and thus should be considered remote.
ANTI-TAKEOVER PROVISIONS
As described below, the Declaration includes provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Trustees, and could
have the effect of depriving shareholders of opportunities to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund.
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The Fund's Trustees are divided into three classes (Class I, Class II and
Class III), having initial terms of one, two and three years, respectively. At
each annual meeting of shareholders, the term of one class will expire and each
Trustee elected to that class will hold office for a term of three years. The
classification of the Board of Trustees in this manner could delay for an
additional year the replacement of a majority of the Board of Trustees. In
addition, the Declaration provides that a Trustee may be removed only for cause
and only (i) by action of at least seventy-five percent (75%) of the outstanding
shares of the classes or series of shares entitled to vote for the election of
such Trustee, or (ii) by at least seventy-five percent (75%) of the remaining
Trustees.
Except as provided in the next paragraph, the affirmative vote or consent
of at least seventy-five percent (75%) of the Board of Trustees and at least
seventy-five percent (75%) of the shares of the Fund outstanding and entitled to
vote thereon are required to authorize any of the following transactions (each a
"Material Transaction"): (1) a merger, consolidation or share exchange of the
Fund or any series or class of shares of the Fund with or into any other person
or company, or of any such person or company with or into the Fund or any such
series or class of shares; (2) the issuance or transfer by the Fund or any
series or class of shares (in one or a series of transactions in any
twelve-month period) of any securities of the Fund or such series or class to
any other person or entity for cash, securities or other property (or
combination thereof) having an aggregate fair market value of $1,000,000 or
more, excluding sales of securities of the Fund or such series or class in
connection with a public offering, issuances of securities of the Fund or such
series or class pursuant to a dividend reinvestment plan adopted by the Fund and
issuances of securities of the Fund or such series or class upon the exercise of
any stock subscription rights distributed by the Fund; or (3) a sale, lease,
exchange, mortgage, pledge, transfer or other disposition by the Fund or any
series or class of shares (in one or a series of transactions in any
twelve-month period) to or with any person of any assets of the Fund or such
series or class having an aggregate fair market value of $1,000,000 or more,
except for transactions in securities effected by the Fund or such series or
class in the ordinary course of its business. The same affirmative votes are
required with respect to any shareholder proposal as to specific investment
decisions made or to be made with respect to the Fund's assets or the assets of
any series or class of shares of the Fund.
Notwithstanding the approval requirements specified in the preceding
paragraph, the Declaration requires no vote or consent of the Fund's
shareholders to authorize a Material Transaction if the transaction is approved
by a vote of both a majority of the Board of Trustees and seventy-five percent
(75%) of the Continuing Trustees (as defined below), so long as all other
conditions and requirements, if any, provided for in the Fund's Bylaws and
applicable law (including any shareholder voting rights under the 1940 Act) have
been satisfied.
In addition, the Declaration provides that the Fund may be terminated at
any time by vote or consent of at least seventy-five percent (75%) of the Fund's
shares or, alternatively, by vote or consent of both a majority of the Board of
Trustees and seventy-five percent (75%) of the Continuing Trustees (as defined
below).
In certain circumstances, the Declaration also imposes shareholder voting
requirements that are more demanding than those required under the 1940 Act in
order to authorize a
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conversion of the Fund from a closed-end to an open-end investment company. See
"Repurchase of Common Shares; Conversion to Open-End Fund" below.
As noted, the voting provisions described above could have the effect of
depriving Common Shareholders of an opportunity to sell their Common Shares at a
premium over prevailing market prices by discouraging a third party from seeking
to obtain control of the Fund in a tender offer or similar transaction. In the
view of the Fund's Board of Trustees, however, these provisions offer several
possible advantages, including: (1) requiring persons seeking control of the
Fund to negotiate with its management regarding the price to be paid for the
amount of Common Shares required to obtain control; (2) promoting continuity and
stability; and (3) enhancing the Fund's ability to pursue long-term strategies
that are consistent with its investment objective and management policies. The
Board of Trustees has determined that the voting requirements described above,
which are generally greater than the minimum requirements under the 1940 Act,
are in the best interests of the Fund's Common Shareholders generally.
A "Continuing Trustee," as used in the discussion above, is any member of
the Fund's Board of Trustees who either (i) has been a member of the Board for a
period of at least thirty-six months (or since the commencement of the Fund's
operations, if less than thirty-six months) or (ii) was nominated to serve as a
member of the Board of Trustees by a majority of the Continuing Trustees then
members of the Board.
The foregoing is intended only as a summary and is qualified in its
entirety by reference to the full text of the Declaration and the Fund's Bylaws,
both of which have been filed as exhibits to the Fund's registration statement
on file with the SEC.
LIABILITY OF TRUSTEES
The Declaration provides that the obligations of the Fund are not binding
upon the Trustees of the Fund individually, but only upon the assets and
property of the Fund, and that the Trustees shall not be liable for errors of
judgment or mistakes of fact or law. Nothing in the Declaration, however,
protects a Trustee against any liability to which he would otherwise be subject
by reason of willful misfeasance, bad faith, gross negligence or reckless
disregard of the duties involved in the conduct of his office.
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its shareholders
will not have the right to cause the Fund to redeem their shares. Instead, the
Fund's Common Shares will trade in the open market at a price that will be a
function of several factors, including dividend levels (which are in turn
affected by expenses), net asset value, call protection, price, dividend
stability, relative demand for and supply of such shares in the market, general
market and economic conditions and other factors. Shares of a closed-end
investment company may frequently trade at prices lower than net asset value.
The Fund's Board of Trustees regularly monitors the relationship between the
market price and net asset value of the Common Shares. If the Common Shares were
to trade at a substantial discount to net asset value for an extended period of
time, the Board may consider the repurchase of its Common Shares on the open
market
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or in private transactions, or the making of a tender offer for such shares.
There can be no assurance, however, that the Board of Trustees will decide to
take or propose any of these actions, or that share repurchases or tender
offers, if undertaken, will reduce market discount. The Fund has no present
intention to repurchase its Common Shares and would do so only in the
circumstances described in this section.
Notwithstanding the foregoing, at any time when the Fund's APS are
outstanding, the Fund may not purchase, redeem or otherwise acquire any of its
Common Shares unless (1) all accrued dividends on APS have been paid and (2) at
the time of such purchase, redemption or acquisition, the net asset value of the
Fund's portfolio (determined after deducting the acquisition price of the Common
Shares) is at least 200% of the liquidation value of the outstanding APS
(expected to equal the original purchase price per share plus any accrued and
unpaid dividends thereon).
Subject to its investment limitations, the Fund may borrow to finance the
repurchase of shares or to make a tender offer. Interest on any borrowings to
finance share repurchase transactions or the accumulation of cash by the Fund in
anticipation of share repurchases or tenders will reduce the Fund's net income.
Any share repurchase, tender offer or borrowing that might be approved by the
Board of Trustees would have to comply with the Securities Exchange Act of 1934,
as amended, and the 1940 Act and the rules and regulations thereunder.
The Fund's Board of Trustees may also from time to time consider submitting
to the holders of the shares of beneficial interest of the Fund a proposal to
convert the Fund to an open-end investment company. In determining whether to
exercise its sole discretion to submit this issue to shareholders, the Board of
Trustees would consider all factors then relevant, including the relationship of
the market price of the Common Shares to net asset value, the extent to which
the Fund's capital structure is leveraged and the possibility of re-leveraging,
the spread, if any, between the yields on securities in the Fund's portfolio and
interest and dividend charges on APS issued by the Fund and general market and
economic conditions.
The Declaration requires the affirmative vote or consent of holders of at
least seventy-five percent (75%) of each class of the Fund's shares entitled to
vote on the matter to authorize a conversion of the Fund from a closed-end to an
open-end investment company, unless the conversion is authorized by both a
majority of the Board of Trustees and seventy-five percent (75%) of the
Continuing Trustees (as defined above under "Anti-Takeover and Other Provisions
in the Declaration of Trust--Anti-Takeover Provisions"). This seventy-five
percent (75%) shareholder approval requirement is higher than is required under
the 1940 Act. In the event that a conversion is approved by the Trustees and the
Continuing Trustees as described above, the minimum shareholder vote required
under the 1940 Act would be necessary to authorize the conversion. Currently,
the 1940 Act would require approval of the holders of a "majority of the
outstanding" Common Shares and, if issued, APS voting together as a single
class, and the holders of a "majority of the outstanding" APS voting as a
separate class, in order to authorize a conversion.
If the Fund converted to an open-end company, it would be required to
redeem all APS then outstanding (requiring in turn that it liquidate a portion
of its investment portfolio), and the Fund's Common Shares likely would no
longer be listed on the New York Stock Exchange.
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Shareholders of an open-end investment company may require the company to redeem
their shares on any business day (except in certain circumstances as authorized
by or under the 1940 Act) at their net asset value, less such redemption charge,
if any, as might be in effect at the time of redemption. In order to avoid
maintaining large cash positions or liquidating favorable investments to meet
redemptions, open-end companies typically engage in a continuous offering of
their shares. Open-end companies are thus subject to periodic asset in-flows and
out-flows that can complicate portfolio management.
The repurchase by the Fund of its shares at prices below net asset value
will result in an increase in the net asset value of those shares that remain
outstanding. However, there can be no assurance that share repurchases or
tenders at or below net asset value will result in the Fund's shares trading at
a price equal to their net asset value. Nevertheless, the fact that the Fund's
shares may be the subject of repurchase or tender offers at net asset value from
time to time, or that the Fund may be converted to an open-end company, may
reduce any spread between market price and net asset value that might otherwise
exist.
In addition, a purchase by the Fund of its Common Shares will decrease the
Fund's total assets. This would likely have the effect of increasing the Fund's
expense ratio. Any purchase by the Fund of its Common Shares at a time when APS
are outstanding will increase the leverage applicable to the outstanding Common
Shares then remaining. See the Prospectus under "Risks--Leverage Risk."
Before deciding whether to take any action if the Fund's Common Shares
trade below net asset value, the Board of Trustees would consider all relevant
factors, including the extent and duration of the discount, the liquidity of the
Fund's portfolio, the impact of any action that might be taken on the Fund or
its shareholders and market considerations. Based on these considerations, even
if the Fund's shares should trade at a discount, the Board of Trustees may
determine that, in the interest of the Fund and its shareholders, no action
should be taken.
TAX MATTERS
Taxation of the Fund. The Fund intends to qualify each year as a regulated
investment company under Subchapter M of the Code. In order to qualify for the
special tax treatment accorded regulated investment companies and their
shareholders, the Fund must, among other things:
(a) derive at least 90% of its gross income from dividends, interest,
payments with respect to certain securities loans, and gains from the sale
of stock, securities or foreign currencies, or other income (including but
not limited to gains from options, futures, or forward contracts) derived
with respect to its business of investing in such stock, securities, or
currencies;
(b) distribute with respect to each taxable year at least 90% of the
sum of its net tax-exempt income, taxable ordinary income and the excess,
if any, of net short-term capital gains over net long-term capital losses
for such year; and
(c) diversify its holdings so that, at the end of each quarter of the
Fund's taxable year, (i) at least 50% of the market value of the Fund's
total assets is represented by cash
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and cash items, U.S. Government securities, securities of other regulated
investment companies, and other securities limited in respect of any one
issuer to a value not greater than 5% of the value of the Fund's total
assets and not more than 10% of the outstanding voting securities of such
issuer, and (ii) not more than 25% of the value of the Fund's total assets
is invested in the securities (other than those of the U.S. Government or
other regulated investment companies) of any one issuer or of two or more
issuers which the Fund controls and which are engaged in the same, similar,
or related trades or businesses.
If the Fund qualifies as a regulated investment company that is accorded
special tax treatment, the Fund will not be subject to federal income tax on
income distributed in a timely manner to its shareholders in the form of
dividends (including Capital Gain Dividends, as defined below).
If the Fund failed to qualify as a regulated investment company accorded
special tax treatment in any taxable year, the Fund would be subject to tax on
its taxable income at corporate rates, and all distributions from earnings and
profits, including any distributions of net tax-exempt income and net long-term
capital gains, would be taxable to shareholders as ordinary income. Some portion
of such distributions may be eligible for the dividends received deduction in
the case of corporate shareholders. In addition, the Fund could be required to
recognize unrealized gains, pay substantial taxes and interest and make
substantial distributions before requalifying as a regulated investment company
that is accorded special tax treatment.
The Fund intends to distribute at least annually to its shareholders all or
substantially all of its investment company taxable income and may distribute
its net capital gain. The Fund may also retain for investment its net capital
gain. If the Fund does retain any net capital gain or any investment company
taxable income, it will be subject to tax at regular corporate rates on the
amount retained. If the Fund retains any net capital gain, it may designate the
retained amount as undistributed capital gains in a notice to its shareholders
who, if subject to federal income tax on long-term capital gains, (i) will be
required to include in income for federal income tax purposes, as long-term
capital gain, their shares of such undistributed amount, and (ii) will be
entitled to credit their proportionate shares of the tax paid by the Fund on
such undistributed amount against their federal income tax liabilities, if any,
and to claim refunds to the extent the credit exceeds such liabilities. For
federal income tax purposes, the tax basis of shares owned by a shareholder of
the Fund will be increased by an amount equal under current law to the
difference between the amount of undistributed capital gains included in the
shareholder's gross income and the tax deemed paid by the shareholder under
clause (ii) of the preceding sentence.
Treasury regulations permit a regulated investment company, in determining
its investment company taxable income and net capital gain, to elect to treat
all or part of any net capital loss, any net long-term capital loss or any net
foreign currency loss incurred after October 31 as if it had been incurred in
the succeeding year.
If the Fund fails to distribute in a calendar year at least an amount equal
to the sum of 98% of its ordinary income for such year and 98% of its capital
gain net income for the one-year period ending October 31 of such year, plus any
retained amount from the prior year, the Fund will be subject to a
non-deductible 4% excise tax on the undistributed amounts. For these purposes,
the Fund will be treated as having distributed any amount for which it is
subject to income tax. A dividend paid to shareholders in January of a year
generally is deemed to have
-64-
been paid by the Fund on December 31 of the preceding year, if the dividend was
declared and payable to shareholders of record on a date in October, November or
December of that preceding year. The Fund intends generally to make
distributions sufficient to avoid imposition of the 4% excise tax, although
there can be no assurance that it will be able to do so.
Fund Distributions. Distributions from the Fund will be taxable to
shareholders as ordinary income to the extent derived from investment income and
net short-term capital gains. Distributions of net capital gains (that is, the
excess of net gains from the sale of capital assets held more than one year over
net losses from the sale of capital assets held for not more than one year)
properly designated as capital gain dividends ("Capital Gain Dividends") will be
taxable to shareholders as long-term capital gain, regardless of how long a
shareholder has held the shares in the Fund.
Dividends of net investment income received by corporate shareholders of
the Fund will qualify for the 70% dividends received deduction generally
available to corporations to the extent of the amount of qualifying dividends
received by the Fund from domestic corporations for the taxable year. A dividend
received by the Fund will not be treated as a qualifying dividend (1) if the
stock on which the dividend is paid is considered to be "debt-financed"
(generally, acquired with borrowed funds), (2) if it has been received with
respect to any share of stock that the Fund has held for less than 46 days (91
days in the case of certain preferred stock) during the 90-day period beginning
on the date which is 45 days before the date on which such share becomes
ex-dividend with respect to such dividend (during the 180-day period beginning
90 days before such date in the case of certain preferred stock) or (3) to the
extent that the Fund is under an obligation (pursuant to a short sale or
otherwise) to make related payments with respect to positions in substantially
similar or related property. Moreover, the dividends received deduction may be
disallowed or reduced (1) if the corporate shareholder fails to satisfy the
foregoing requirements with respect to its shares of the Fund or (2) by
application of the Code.
The Internal Revenue Service currently requires that a regulated investment
company that has two or more classes of stock allocate to each such class
proportionate amounts of each type of its income (such as ordinary income and
capital gains) based upon the percentage of total dividends distributed to each
class for the tax year. Accordingly, the Fund intends each year to allocate
Capital Gain Dividends between and among its Common Shares, Series A APS, Series
B APS, Series C APS, Series D APS, and Series E APS in proportion to the total
dividends paid to each such class with respect to such tax year. Dividends
qualifying and not qualifying for the dividends received deduction will
similarly be allocated between and among these classes.
Return of Capital Distributions. If the Fund makes a distribution to a
shareholder in excess of the Fund's current and accumulated earnings and profits
in any taxable year, the excess distribution will be treated as a return of
capital to the extent of such shareholder's tax basis in its shares, and
thereafter as capital gain. A return of capital is not taxable, but it reduces a
shareholder's tax basis in its shares, thus reducing any loss or increasing any
gain on a subsequent taxable disposition by the shareholder of its shares. Where
one or more such distributions occur in any taxable year of the Fund, the
available earnings and profits will be allocated, first, to the distributions
made to the holders of any outstanding preferred shares of beneficial interest
of the Fund (including the APS), and only thereafter to distributions made to
holders of Common Shares. As a result, the holders of any outstanding preferred
shares of
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beneficial interest of the Fund (including the APS) will receive a
disproportionate share of the distributions treated as dividends, and the
holders of the Common Shares will receive a disproportionate share of the
distributions treated as a return of capital.
Dividends and distributions on the Fund's shares are generally subject to
federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, even though such dividends and distributions
may economically represent a return of a particular shareholder's investment.
Such distributions are likely to occur in respect of shares purchased at a time
when the Fund's net asset value reflects gains that are either unrealized, or
realized but not distributed. Such realized gains may be required to be
distributed even when the Fund's net asset value also reflects unrealized
losses. Distributions are taxable to a shareholder even if they are paid from
income or gains earned by the Fund prior to the shareholder's investment (and
thus included in the price paid by the shareholders).
Securities Issued or Purchased at a Discount. The Fund's investment in
securities issued at a discount and certain other obligations will (and
investments in securities purchased at a market discount may) require the Fund
to accrue and distribute income not yet received. In order to generate
sufficient cash to make the requisite distributions, the Fund may be required to
sell securities in its portfolio that it otherwise would have continued to hold.
Capital Loss Carryover. Distributions from capital gains are generally made
after applying any available capital loss carryovers.
Sale or Redemption of Shares. The sale, exchange or redemption of Fund
shares may give rise to a gain or loss. In general, any gain or loss realized
upon a taxable disposition of shares will be treated as long-term capital gain
or loss if the shares have been held for more than 12 months. Otherwise, the
gain or loss on the taxable disposition of Fund shares will be treated as
short-term capital gain or loss. However, any loss realized upon a taxable
disposition of shares held for six months or less will be treated as long-term,
rather than short-term, to the extent of any long-term capital gain
distributions received (or deemed received) by the shareholder with respect to
the shares. All or a portion of any loss realized upon a taxable disposition of
Fund shares will be disallowed if other substantially identical shares of the
Fund are purchased within 30 days before or after the disposition. In such a
case, the basis of the newly purchased shares will be adjusted to reflect the
disallowed loss.
From time to time the Fund may make a tender offer for its Common Shares.
It is expected that the terms of any such offer will require a tendering
shareholder to tender all Common Shares and dispose of all APS held, or
considered under certain attribution rules of the Code to be held, by such
shareholder. Shareholders who tender all Common Shares and dispose of all APS
held, or considered to be held, by them will be treated as having sold their
shares and generally will realize a capital gain or loss. If a shareholder
tenders fewer than all of its Common Shares, or retains a substantial portion of
its APS, such shareholder may be treated as having received a taxable dividend
upon the tender of its Common Shares. In such a case, there is a remote risk
that non-tendering shareholders will be treated as having received taxable
distributions from the Fund. Likewise, if the Fund repurchases some but not all
of the APS held by a Preferred Shareholder and such shareholder is treated as
having received a taxable dividend upon such redemption, there is a remote risk
that Common Shareholders and Preferred
-66-
Shareholders whose shares are not repurchased will be treated as having received
taxable distributions from the Fund. To the extent that the Fund recognizes net
gains on the liquidation of portfolio securities to meet such tenders of Common
Shares, the Fund will be required to make additional distributions to its Common
Shareholders.
Original Issue Discount and Payment-in-Kind Securities. Current federal tax
law requires the holder of a U.S. Treasury or other fixed income zero-coupon
security to accrue as income each year a portion of the discount at which the
security was issued, even though the holder receives no interest payment in cash
on the security during the year. In addition, payment-in-kind securities will
give rise to income which is required to be distributed and is taxable even
though the Fund holding the security receives no interest payment in cash on the
security during the year.
Some of the debt obligations (with a fixed maturity date of more than one
year from the date of issuance) that may be acquired by the Fund may be treated
as debt obligations that are issued originally at a discount. Generally, the
amount of the original issue discount ("OID") is treated as interest income and
is included in income over the term of the debt security, even though payment of
that amount is not received until a later time, usually when the debt security
matures.
Some of the debt obligations (with a fixed maturity date of more than one
year from the date of issuance) that may be acquired by the Fund in the
secondary market may be treated as having market discount. Generally, any gain
recognized on the disposition of, and any partial payment of principal on, a
debt security having market discount is treated as ordinary income to the extent
the gain, or principal payment, does not exceed the "accrued market discount" on
such debt security. Market discount generally accrues in equal daily
installments. The Fund may make one or more of the elections applicable to debt
obligations having market discount, which could affect the character and timing
of recognition of income.
Some debt obligations (with a fixed maturity date of one year or less from
the date of issuance) that may be acquired by the Fund may be treated as having
acquisition discount, or OID in the case of certain types of debt obligations.
Generally, the Fund will be required to include the acquisition discount, or
OID, in income over the term of the debt security, even though payment of that
amount is not received until a later time, usually when the debt security
matures. The Fund may make one or more of the elections applicable to debt
obligations having acquisition discount, or OID, which could affect the
character and timing of recognition of income.
If the Fund holds the foregoing kinds of securities, it may be required to
pay out as an income distribution each year an amount which is greater than the
total amount of cash interest the Fund actually received. Such distributions may
be made from the cash assets of the Fund or by liquidation of portfolio
securities, if necessary. The Fund may realize gains or losses from such
liquidations. In the event the Fund realizes net capital gains from such
transactions, its shareholders may receive a larger capital gain distribution
than they would in the absence of such transactions.
-67-
Higher-Risk Securities. The Fund may invest to a significant extent in debt
obligations that are in the lowest rating categories or are unrated, including
debt obligations of issuers not currently paying interest or who are in default.
Investments in debt obligations that are at risk of or in default present
special tax issues for the Fund. Tax rules are not entirely clear about issues
such as when the Fund may cease to accrue interest, original issue discount or
market discount, when and to what extent deductions may be taken for bad debts
or worthless securities and how payments received on obligations in default
should be allocated between principal and income. These and other related issues
will be addressed by the Fund when, as and if it invests in such securities, in
order to seek to ensure that it distributes sufficient income to preserve its
status as a regulated investment company and does not become subject to U.S.
federal income or excise tax.
Issuer Deductibility of Interest. A portion of the interest paid or accrued
on certain high yield discount obligations owned by the Fund may not (and
interest paid on debt obligations, if any, that are considered for tax purposes
to be payable in the equity of the issuer or a related party will not) be
deductible to the issuer. This may affect the cash flow of the issuer. If a
portion of the interest paid or accrued on certain high yield discount
obligations is not deductible, that portion will be treated as a dividend for
purposes of the corporate dividends received deduction. In such cases, if the
issuer of the high yield discount obligations is a domestic corporation,
dividend payments by the Fund may be eligible for the dividends received
deduction to the extent of the deemed dividend portion of such accrued interest.
Certain Investments in REITs. The Fund may invest in REITs that hold
residual interests in real estate mortgage investment conduits ("REMICs"). Under
Treasury regulations that have not yet been issued, but may apply retroactively,
a portion of the Fund's income from a REIT that is attributable to the REIT's
residual interest in a REMIC (referred to in the Code as an "excess inclusion")
will be subject to federal income tax in all events. These regulations are also
expected to provide that excess inclusion income of a regulated investment
company, such as the Fund, will be allocated to shareholders of the regulated
investment company in proportion to the dividends received by such shareholders,
with the same consequences as if the shareholders held the related REMIC
residual interest directly.
In general, excess inclusion income allocated to shareholders (i) cannot be
offset by net operating losses (subject to a limited exception for certain
thrift institutions), (ii) will constitute unrelated business taxable income to
entities (including a qualified pension plan, an individual retirement account,
a 401(k) plan, a Keogh plan or other tax-exempt entity) subject to tax on
unrelated business income, thereby potentially requiring such an entity that is
allocated excess inclusion income, and otherwise might not be required to file a
tax return, to file a tax return and pay tax on such income, and (iii) in the
case of a non-U.S. shareholder, will not qualify for any reduction in U.S.
federal withholding tax (discussed below). Under current law, if a charitable
remainder trust (defined in section 664 of the Code) realizes any unrelated
business taxable income for a taxable year, it will lose its tax-exempt status
for the year. The Bush Administration has proposed imposing a 100% tax on a
charitable remainder trust's unrelated business income in lieu of removing the
trust's income tax exemption. In addition, if at any time during any taxable
year a "disqualified organization" (as defined in the Code) is a record holder
of a share in a regulated investment company, then the regulated investment
company will be subject to a tax equal to that portion of its excess inclusion
income for the taxable year that is allocable to the disqualified organization,
multiplied by the highest federal income tax rate
-68-
imposed on corporations. The Fund does not intend to invest in REITS in which a
substantial portion of the assets will consist of residual interests in REMICs.
Options, Futures Contracts and Swap Agreements. The Fund's transactions in
options, futures contracts, hedging transactions, swap agreements, and straddles
will be subject to special tax rules (including mark-to-market, constructive
sale, straddle, wash sale and short sale rules), the effect of which may be to
accelerate income to the Fund, defer losses to the Fund, cause adjustments in
the holding periods of the Fund's securities, convert long-term capital gains
into short-term capital gains and convert short-term capital losses into
long-term capital losses. These rules could therefore affect the amount, timing
and character of distributions to shareholders.
Certain of the Fund's hedging activities, if any are used, are likely to
produce a difference between its book income and its taxable income. If the
Fund's book income exceeds its taxable income, the distribution (if any) of such
excess generally will be treated as (i) a dividend to the extent of the Fund's
remaining earnings and profits (including earnings and profits arising from
tax-exempt income), (ii) thereafter, as a return of capital to the extent of the
recipient's basis in its shares, and (iii) thereafter, as gain from the sale or
exchange of a capital asset. If the Fund's book income is less than taxable
income, the Fund could be required to make distributions exceeding book income
to qualify as a regulated investment company that is accorded special tax
treatment.
Foreign Taxation. Income received by the Fund from sources within foreign
countries may be subject to withholding and other taxes imposed by such
countries. Tax conventions between certain countries and the U.S. may reduce or
eliminate such taxes. Shareholders generally will not be entitled to claim a
credit or deduction with respect to foreign taxes.
Passive Foreign Investment Companies. Equity investments by the Fund in
certain "passive foreign investment companies" ("PFICs") could potentially
subject the Fund to a U.S. federal income tax (including interest charges) on
distributions received from the company or on proceeds received from the
disposition of shares in the company, which tax cannot be eliminated by making
distributions to Fund shareholders. However, the Fund may elect to avoid the
imposition of that tax. For example, the Fund may elect to treat a PFIC as a
"qualified electing fund" (a "QEF election"), in which case the Fund will be
required to include its share of the company's income and net capital gains
annually, regardless of whether it receives any distribution from the company.
The Fund also may make an election to mark the gains (and to a limited extent
losses) in such holdings "to the market" as though it had sold and repurchased
its holdings in those PFICs on the last day of the Fund's taxable year. Such
gains and losses are treated as ordinary income and loss. The QEF and
mark-to-market elections may accelerate the recognition of income (without the
receipt of cash) and increase the amount required to be distributed by the Fund
to avoid taxation. Making either of these elections therefore may require the
Fund to liquidate other investments (including when it is not advantageous to do
so) to meet its distribution requirement, which also may accelerate the
recognition of gain and affect the Fund's total return.
Shares Purchased Through Tax-Qualified Plans. Special tax rules apply to
investments through defined contribution plans and other tax-qualified plans.
Shareholders should consult
-69-
their tax advisers to determine the suitability of shares of the Fund as an
investment through such plans and the precise effect of an investment on their
particular tax situation.
Non-U.S. Shareholders. Under U.S. federal tax law, dividends other than
Capital Gain Dividends paid on shares beneficially held by a person who is not a
U.S. person (a "foreign person") within the meaning of the Code, are, in
general, subject to withholding of U.S. federal income tax at a rate of 30% of
the gross dividend, which rate may, in some cases, be reduced by an applicable
tax treaty. Dividends are subject to withholding even if they are funded by
income or gains (such as portfolio interest, short-term capital gains, or
foreign-source dividend and interest income) that, if paid to a foreign person
directly, would not be subject to withholding. However, Capital Gain Dividends
will not be subject to withholding of U.S. federal income tax. If a beneficial
holder who is a foreign person has a trade or business in the United States, and
the dividends are effectively connected with the conduct by the beneficial
holder of a trade or business in the United States, the dividend will be subject
to U.S. federal net income taxation at regular income tax rates.
Under U.S. federal tax law, a beneficial holder of shares who is a foreign
person is not, in general, subject to U.S. federal income tax on gains (and is
not allowed a deduction for losses) realized on the sale of such shares unless
(i) such gain is effectively connected with the conduct of a trade or business
carried on by such holder within the United States or (ii) in the case of an
individual holder, the holder is present in the United States for a period or
periods aggregating 183 days or more during the year of the sale and certain
other conditions are met.
If you are eligible for the benefits of a tax treaty, any effectively
connected income or gain will generally be subject to U.S. federal income tax on
a net basis only if it is also attributable to a permanent establishment
maintained by you in the United States.
A beneficial holder of shares who is a foreign person may be subject to
state and local tax and to the U.S. federal estate tax in addition to the
federal tax on income referred to above.
Backup Withholding. The Fund generally is required to withhold and remit to
the U.S. Treasury a percentage of the taxable dividends and other distributions
paid to any individual shareholder who fails to properly furnish the Fund with a
correct taxpayer identification number ("TIN"), who has under-reported dividend
or interest income, or who fails to certify to the Fund that he or she is not
subject to such withholding. The backup withholding tax rate is (i) 30% for
amounts paid during 2003, (ii) 29% for amounts paid during 2004 and 2005, and
(iii) 28% for amounts paid during 2006 through 2010. The backup withholding rate
will be 31% for amounts paid after December 31, 2010, unless Congress enacts tax
legislation providing otherwise. The Bush Administration has announced a
proposal to accelerate reductions in tax rates, which may change the backup
withholding rate as well.
In order for a foreign investor to qualify for exemption from the back-up
withholding tax rates under income tax treaties, the foreign investor must
comply with special certification and filing requirements. Foreign investors in
the Fund should consult their tax advisers in this regard.
Recent Tax Shelter Reporting Regulations. Under recently enacted Treasury
regulations, if a shareholder realizes a loss on disposition of Fund shares of
$2 million or more for an
-70-
individual shareholder or $10 million or more for a corporate shareholder, the
shareholder must file with the Internal Revenue Service a disclosure statement
on Form 8886. Direct shareholders of portfolio securities are in many cases
excepted from this reporting requirement, but under current guidance,
shareholders of a regulated investment company are not excepted. Future guidance
may extend the current exception from this reporting requirement to shareholders
of most or all regulated investment companies.
Recent Tax Proposal. The Bush Administration has announced, and Congress is
currently considering, a proposal to reduce or eliminate the tax on dividends.
Many of the details of the proposal have not been specified, and the prospects
for this proposal are unclear. Accordingly, it is not possible to evaluate how
this proposal might affect the tax discussion above. The elimination of the
taxation of corporate distributions may reduce the value of, and thus the return
on, previously issued debt obligations and similar securities which are part of
the Fund's investment portfolio. This change could reduce the Fund's net asset
value and distributions made by the Fund.
General. The federal income tax discussion set forth above is for general
information only. Prospective investors should consult their tax advisers
regarding the specific federal tax consequences of purchasing, holding, and
disposing of shares of the Fund, as well as the effects of state, local and
foreign tax law and any proposed tax law changes.
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
The Fund may quote certain performance-related information and may compare
certain aspects of its portfolio and structure to other substantially similar
closed-end funds as categorized by Lipper, Inc. ("Lipper"), Morningstar Inc. or
other independent services. Comparison of the Fund to an alternative investment
should be made with consideration of differences in features and expected
performance. The Fund may obtain data from sources or reporting services, such
as Bloomberg Financial ("Bloomberg") and Lipper, that the Fund believes to be
generally accurate.
The Fund, in its advertisements, may refer to pending legislation from time
to time and the possible impact of such legislation on investors, investment
strategy and related matters. At any time in the future, yields and total return
may be higher or lower than past yields and there can be no assurance that any
historical results will continue.
Past performance is not indicative of future results. At the time holders
of APS sell their shares, they may be worth more or less than their original
investment.
For the period from March 31, 2003 (the commencement of the Fund's
operations) through April 30, 2003, the Fund's net increase in net assets
resulting from investment operations was $26,284,437.
CUSTODIAN, TRANSFER AGENTS AND DIVIDEND PAYING AGENT
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts
02109, a financial institution that performs custody-related and other services,
serves as custodian for assets of the Fund. The custodian performs custodial and
fund accounting services.
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PFPC Inc., 400 Bellevue Parkway, Wilmington, Delaware 19809, serves as the
transfer agent, registrar and dividend disbursement agent for the Common Shares,
as well as agent for the Dividend Reinvestment Plan relating to the Common
Shares.
Deutsche Bank Trust Company Americas, 280 Park Avenue, 9th Floor, New York,
New York 10017, serves as auction agent, transfer agent, registrar, dividend
paying agent and redemption agent for the APS.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York
10036, serves as independent accountants for the Fund. PricewaterhouseCoopers
LLP provides audit services, tax return preparation and assistance and
consultation in connection with review of SEC filings to the Fund.
COUNSEL
Ropes & Gray LLP, One International Place, Boston, MA 02110, passes upon
certain legal matters in connection with shares offered by the Fund, and also
acts as counsel to the Fund.
REGISTRATION STATEMENT
A Registration Statement on Form N-2, including any amendments thereto,
relating to the shares of the Fund offered hereby, has been filed by the Fund
with the SEC, Washington, D.C. The Prospectus and this Statement of Additional
Information do not contain all of the information set forth in the Registration
Statement, including any exhibits and schedules thereto. For further information
with respect to the Fund and the shares offered or to be offered hereby,
reference is made to the Fund's Registration Statement. Statements contained in
the Prospectus and this Statement of Additional Information as to the contents
of any contract or other document referred to are not necessarily complete and
in each instance reference is made to the copy of such contract or other
document filed as an exhibit to the Registration Statement, each such statement
being qualified in all respects by such reference. Copies of the Registration
Statement may be inspected without charge at the SEC's principal office in
Washington, D.C., and copies of all or any part thereof may be obtained from the
SEC upon the payment of certain fees prescribed by the SEC.
-72-
FINANCIAL STATEMENTS
The Statement of Net Assets of the Fund dated as of March 19, 2003,
including the Notes thereto, and the report of PricewaterhouseCoopers LLP
thereon dated March 21, 2003, as included in the Fund's Statement of Additional
Information dated March 26, 2003, relating to the Common Shares, is hereby
incorporated by reference into this Statement of Additional Information, which
means that such Statement of Net Assets and the Notes thereto are considered to
be a part of this Statement of Additional Information. The Statement of
Additional Information for the Common Shares was filed electronically with the
SEC on March 28, 2003 (Accession No. 0000927016-03-001450).
-73-
NICHOLAS-APPLEGATE CONVERTIBLE & INCOME FUND
STATEMENT OF ASSETS AND LIABILITIES
April 30, 2003
(unaudited)
ASSETS:
Investments, at value (cost - $857,855,706).................. $ 879,292,176
Cash......................................................... 12,354,827
Interest and dividends receivable............................ 16,308,137
Prepaid expenses 7,623
----------------
Total Assets............................................ 907,962,763
----------------
LIABILITIES:
Payable for investments purchased............................ 21,650,265
Common stock offering costs payable.......................... 1,027,482
Investment management fee payable............................ 513,221
Accrued expenses............................................. 37,355
----------------
Total Liabilities....................................... 23,228,323
----------------
Net Assets........................................... $ 884,734,440
================
COMPOSITION OF NET ASSETS:
Par value ($0.00001 per share, applicable to 60,006,981
shares issued and outstanding)............................... $ 600
Paid-in-capital in excess of par............................. 858,449,403
Undistributed net investment income.......................... 5,062,525
Net realized loss on investments............................. (214,558)
Net unrealized appreciation of investments................... 21,436,470
----------------
Net assets........................................... $ 884,734,440
================
Shares Outstanding........................................... 60,006,981
----------------
Net Asset Value Per Share.................................... $ 14.74
================
See accompanying notes to financial statements.
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NICHOLAS-APPLEGATE CONVERTIBLE & INCOME FUND
STATEMENT OF OPERATIONS
For the period March 31, 2003* through April 30, 2003
(unaudited)
INVESTMENT INCOME:
Interest..................................................... $ 4,382,155
Dividends.................................................... 1,231,082
----------------
5,613,237
----------------
EXPENSES:
Investment management fees................................... 513,221
Custodian fees............................................... 19,375
Audit and tax service fees................................... 4,650
Reports to shareholders...................................... 4,650
Trustees' fees............................................... 3,100
Transfer agent fees.......................................... 2,542
Legal fees................................................... 2,108
Miscellaneous................................................ 1,066
----------------
Total expenses.......................................... 550,712
----------------
Net investment income................................ 5,062,525
----------------
REALIZED AND UNREALIZED GAIN (LOSS):
Net realized loss on investments........................... (214,558)
Net unrealized appreciation of investments................. 21,436,470
----------------
Net realized and unrealized gain on investments...... 21,221,912
----------------
Net increase in net assets resulting from investment
operations.................................................. $ 26,284,437
================
STATEMENT OF CHANGES IN NET ASSETS
For the period March 31, 2003* through April 30, 2003
(unaudited)
INVESTMENT OPERATIONS:
Net investment income...................................... $ 5,062,525
Net realized loss on investments........................... (214,558)
Net unrealized appreciation of investments................. 21,436,470
----------------
Net increase in net assets resulting from
investment operations.................................. 26,284,437
----------------
CAPITAL SHARE TRANSACTIONS:
Net proceeds from the sale of common stock................. 859,500,000
Common stock offering expenses charged to
paid-in-capital in excess of par.......................... (1,150,000)
----------------
Total capital share transactions........................ 858,350,000
----------------
Total increase in net assets............................ 884,634,437
NET ASSETS:
Beginning of period........................................ 100,003
----------------
End of period (including undistributed net investment
income of $5,062,525) $ 884,734,440
================
Shares Issued:............................................... 60,000,000
----------------
----------
* Commencement of operations
See accompanying notes to financial statements.
-75-
NICHOLAS-APPLEGATE CONVERTIBLE & INCOME FUND
FINANCIAL HIGHLIGHTS
(unaudited)
For a share of common stock outstanding for the period March 31, 2003*
through April 30, 2003:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period**......................... $ 14.33
INVESTMENT OPERATIONS:
Net investment income.......................................... 0.08
Net realized and unrealized gain on investments................ 0.35
---------
Net increase in net assets from investment operations.......... 0.43
Common stock offering expenses charged to paid-in capital
in excess of par.............................................. (0.02)
---------
Net asset value, end of period................................. $ 14.74
=========
Market price, end of period.................................... $ 15.08
=========
Total Investment Return (1).................................... 0.5%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)................................ $ 884,734
Ratio of expenses to average net assets (2).................... 0.75%
Ratio of net investment income to average net assets (2)....... 6.90%
Portfolio Turnover............................................. 6%
* Commencement of operations.
** Initial public offering price of $15.00 per share less underwriting discount
of $0.675 per share.
(1) Total investment return is calculated assuming a purchase of common stock at
the current market price on the first day and a sale at the current market price
on the last day of the period reported. Total investment return does not reflect
brokerage commissions. Total investment return for a period of less than one
year is not annualized.
(2) Annualized.
See accompanying notes to financial statements.
-76-
NICHOLAS-APPLEGATE CONVERTIBLE & INCOME FUND
NOTES TO FINANCIAL STATEMENTS
April 30, 2003
(unaudited)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Nicholas-Applegate Convertible & Income Fund (the "Fund") was organized as a
Massachusetts business trust on January 17, 2003. Prior to commencing operations
on March 31, 2003, the Fund had no operations other than matters relating to its
organization and registration as a diversified, closed-end management investment
company under the Investment Company Act of 1940, as amended, and the sale and
issuance of 6,981 shares of beneficial interest at an aggregate purchase price
of $100,003 to Allianz Dresdner Asset Management of America, L.P. ("ADAM").
PIMCO Advisors Fund Management LLC (the "Investment Manager") serves as the
Fund's investment manager and is an indirect wholly-owned subsidiary of ADAM
which is an indirect, majority-owned subsidiary of Allianz AG, a publicly traded
insurance and financial services company.
The Fund issued 60,000,000 shares of common stock, in its initial public
offering. These shares were all issued at $15.00 per share before an
underwriting discount of $0.675 per share. Offering costs of $1,150,000
(representing $0.02 per share) were offset against the proceeds of the offering
and have been charged to paid-in capital in excess of par.
The preparation of the financial statements in accordance with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
and disclosures in the financial statements. Actual results could differ from
these estimates. In the normal course of business, the Fund enters into
contracts that contain a variety of representations which provide general
indemnifications. The Fund's maximum exposure under these arrangements is
unknown as this would involve future claims that may be made against the Fund
that have not yet occurred. However, the Fund expects the risk of loss to be
remote.
The following is a summary of significant accounting policies followed by the
Fund.
(a) VALUATION OF INVESTMENTS
Portfolio securities and other assets for which market quotations are
readily available are valued each day at market value. Market value is generally
determined on the basis of the last reported sales price, or if no sales are
reported, based on quotes obtained from a quotation reporting system,
established market makers, or independent pricing services approved by the Board
of Trustees. Any security or other asset for which market quotations are not
readily available is valued at fair value as determined in good faith under
procedures established by the Board of Trustees. The Fund invests substantially
all of its assets in a diversified portfolio of corporate convertible debt
obligations of varying maturities and other income-producing securities.
Short-term debt securities having a remaining maturity of sixty days or less are
valued at amortized cost or amortized value, which approximates market value.
(b) INVESTMENT TRANSACTIONS AND INVESTMENT INCOME
Investment transactions are accounted for on the trade date. Realized gains
and losses on investments are determined on the identified cost basis. Interest
income is recorded on an accrual basis. Discounts or premiums on debt securities
purchased are accreted or amortized to interest income over the lives of the
respective securities using the effective interest method.
-77-
NICHOLAS-APPLEGATE CONVERTIBLE & INCOME FUND
NOTES TO FINANCIAL STATEMENTS
April 30, 2003
(unaudited) (concluded)
2. INVESTMENT MANAGER AND SUB-ADVISER
Pursuant to the Investment Management Agreement, the Fund pays the Investment
Manager an annual management fee, payable monthly, at the annual rate of 0.70%
of the Fund's average daily total managed assets. Total managed assets refer to
the total assets of the Fund (including assets attributable to any Preferred
Shares or other forms of leverage that may be outstanding) minus accrued
liabilities (other than liabilities representing leverage). The Investment
Manager has retained its affiliate, Nicholas-Applegate Capital Management LLC
("NACM"), to manage the Fund's investments. For its services, the Investment
Manager (not the Fund) will pay NACM a monthly fee equal to (i) 50% of the
management fee payable by the Fund to the Investment Manager for such month with
respect to the first $300 million of the Fund's average daily total managed
assets and (ii) 75% of the management fee payable by the Fund to the Investment
Manager for such month with respect to the Fund's average daily total managed
assets in excess of $300 million; provided however, that the amounts payable
under (i) and (ii) above shall be reduced to reflect that NACM will bear 50% and
75%, respectively, of any "Service or Incentive Fees" payable by the Investment
Manager for such month with respect to the specified total managed assets. For
these purposes, Service or Incentive Fees for any period equals the sum of any
shareholder servicing fees payable by the Investment Manager to UBS Warburg LLC,
the lead underwriter of the Fund's shares and incentive fees payable by the
Investment Manager to other underwriters for such period.
3. FEDERAL INCOME TAXES
The Fund intends to comply with the requirements of the Internal Revenue Code of
1986, as amended, applicable to regulated investment companies. Accordingly, no
provision for U.S. federal income taxes is required. In addition, by
distributing substantially all of its ordinary income and long-term capital
gains, if any, during each calendar year, the Fund intends not to be subject to
U. S. federal excise tax.
4. INVESTMENT IN SECURITIES
For the period ended April 30, 2003, purchases and sales of investments, other
than short-term securities, were $906,209,755 and $48,471,283, respectively.
5. CAPITAL
The Fund has an unlimited amount of common shares with a $0.00001 par value of
common stock authorized.
6. SUBSEQUENT EVENTS
In connection with the initial public offering of the Fund's common shares, the
underwriters were granted an option to purchase up to an additional 9,000,000
Common Shares. On April 29, 2003 and on May 9, 2003, the underwriters purchased,
at a price of $15.00 per common share (before underwriters discount of $0.675),
an additional 3,500,000 and 1,845,000 common shares, respectively, of the Fund
pursuant to the over-allotment option.
On May 13, 2003, a dividend of $0.125 per share was declared to common
shareholders payable June 2, 2003 to shareholders of record on May 23, 2003.
-78-
NICHOLAS-APPLEGATE CONVERTIBLE & INCOME FUND
SCHEDULE OF INVESTMENTS
APRIL 30, 2003
(unaudited)
PRINCIPAL
AMOUNT (000) CUSIP # VALUE *
------------------------------------------------------------------------------------------------------------------
CORPORATE BONDS & NOTES - 39.3%
COMMERCIAL SERVICES-1.7%
$ 12,200 911363AH2 United Rentals, Inc., 9.00%, 4/1/09.................................. $ 11,590,000
3,000 911365AF1 United Rentals North America, Inc., 10.75%, 4/15/08.................. 3,240,000
-------------
14,830,000
-------------
ELECTRONICS-1.8%
9,000 00130HAQ8 AES Corp., 9.50%, 6/1/09............................................. 8,865,000
1,250 33938EAF4 Flextronics International, Inc., 9.875%, 7/1/10...................... 1,400,000
4,500 45245EAE9 Imax Corp., 7.875%,12/1/05........................................... 4,027,500
1,100 86183PAD4 Stoneridge, Inc., 11.50%, 5/01/12.................................... 1,200,375
-------------
15,492,875
-------------
ENERGY-1.1%
13,000 131347AW6 Calpine Corp., 8.50%, 2/15/11........................................ 9,490,000
-------------
ENTERTAINMENT-2.0%
3,000 01859PAG9 Alliance Gaming 10.00%, 8/1/07....................................... 3,135,000
11,000 040228AG3 Argosy Gaming 10.75%, 6/1/09......................................... 12,155,000
2,000 740540AF6 Premier Parks, Inc., 9.75%, 6/15/07.................................. 2,075,000
-------------
17,365,000
-------------
FINANCIAL SERVICES-9.3%
75,460 48121TAA7 JPMorganChase & Co., 8.75%, 11/15/07................................. 81,402,475
-------------
HEALTHCARE-2.4%
5,000 020813AF8 Alpharma, Inc., 8.625%, 5/1/11....................................... 5,175,000
8,000 087851AM3 Beverly Enterprises, Inc., 9.00%, 2/15/06............................ 7,120,000
7,340 302244AC2 Extendicare Health Services, Inc., 9.35%, 12/15/07................... 5,945,400
1,000 89579VAB1 Triad Hospitals Holdings, Inc., 9.875%, 12/1/09...................... 1,110,000
2,000 925610AB3 Vicar Operating, Inc., 9.875%, 12/1/09............................... 2,210,000
-------------
21,560,400
-------------
HOME FURNISHINGS-0.6%
5,350 795757AB9 Salton, Inc., 10.75%, 12/15/05....................................... 5,564,000
-------------
LEISURE-3.3%
10,250 05873KAF5 Bally Total Fitness Holdings Corp., 9.875%, 10/15/07, Ser. D......... 9,276,250
8,500 562567AB3 Mandalay Resort Group, Inc., 10.25%, 8/1/07.......................... 9,392,500
9,900 780153AL6 Royal Caribbean Cruises, Inc., 8.75%, 02/02/11....................... 10,048,500
-------------
28,717,250
-------------
MULTI-MEDIA-4.7%
7,250 16117PAT7 Charter Communications, Inc., 10.75%, 10/1/09........................ 4,893,750
5,960 126304AE4 CSC Holdings, Inc., 9.875%, 2/15/13.................................. 6,243,100
8,115 126304AP9 CSC Holdings, Inc., 7.625%, 4/1/11, Ser. B........................... 8,541,037
5,000 25459HAA3 DirecTV Holdings, Inc., 8.375% , 3/15/13............................. 5,600,000
6,600 27876GAL2 Echostar DBS Corp., 10.375%, 10/1/07................................. 7,392,000
3,000 540211AC3 Lodgenet Entertainment Corp., 10.25%, 12/15/06....................... 3,030,000
5,000 92852EAA3 Vivendi Universal SA., 9.25%, 4/15/10............................... 5,612,500
-------------
41,312,387
-------------
OIL & GAS-1.4%
14,500 835415AJ9 Sonat, Inc., 7.625%, 7/15/11......................................... 12,615,000
-------------
RETAIL-0.5%
2,500 436141AJ4 Hollywood Entertainment Corp., 9.625%, 3/15/11....................... 2,700,000
1,750 767754AW4 Rite Aid Corp., 11.25%, 7/1/08....................................... 1,898,750
-------------
4,598,750
-------------
SEMICONDUCTORS-1.1%
9,625 031652AE0 Amkor Technology, Inc., 10.50%, 5/1/09............................... 10,106,250
-------------
-79-
NICHOLAS-APPLEGATE CONVERTIBLE & INCOME FUND
SCHEDULE OF INVESTMENTS
APRIL 30, 2003
(unaudited) (continued)
PRINCIPAL
AMOUNT (000) CUSIP # VALUE *
------------------------------------------------------------------------------------------------------------------
CORPORATE BONDS & NOTES (concluded)
TELECOMMUNICATIONS-6.8%
$ 13,500 029912AH5 American Tower Corp., 9.375%, 2/1/09................................. $ 13,365,000
2,000 228227AC8 Crown Castle International, Inc., 9.00%, 5/15/11..................... 1,910,000
3,500 228227AJ3 Crown Castle International, Inc., 10.75%, 8/1/11..................... 3,605,000
11,970 65332VAQ6 Nextel Communications, Inc., 12.00%, 11/1/08......................... 12,867,750
4,700 65333FAH0 Nextel Partners, Inc., 11.00%, 3/15/10............................... 4,935,000
5,500 69371YAB7 Pac-West Telecommunications, Inc., 13.50%, 2/1/09.................... 2,722,500
7,500 887321AA5 Time Warner Telecom, Inc., 9.75%, 7/15/08............................ 6,300,000
3,000 887319AB7 Time Warner Telecom, Inc., 10.125%, 2/1/11........................... 2,505,000
12,000 656569AA8 Nortel Networks Ltd., 6.125%, 2/15/06................................ 11,625,000
-------------
59,835,250
-------------
TEXTILES - 1.2%
3,500 235773AB4 Dan River, Inc., 12.75%, 4/15/09..................................... 3,412,500
6,426 458665AD8 Interface, Inc., 9.50%, 11/15/05..................................... 5,205,060
2,000 458665AG1 Interface, Inc., 10.375%, 2/01/10.................................... 1,840,000
-------------
10,457,560
-------------
WASTE DISPOSAL - 1.4%
11,500 01958XAQ0 Allied Waste, Inc., 10.00%, 8/1/09, Ser. B........................... 12,290,625
-------------
Total Corporate Bonds & Notes (cost-$333,219,124) 345,637,822
-------------
CONVERTIBLE BONDS & NOTES - 19.5%
ADVERTISING-0.1%
233 374276AE3 Getty Images, Inc., 5.00%, 3/15/07................................... 227,757
354 512815AF8 Lamar Advertising Co., 5.25%, 9/15/06................................ 361,080
-------------
588,837
-------------
AEROSPACE-1.0%
7,499 502424AB0 L-3 Communications Holdings, Inc., 5.25%, 6/1/09..................... 9,186,275
-------------
AUTOMOTIVE-0.2%
2,208 83545GAE2 Sonic Automotive, Inc., 5.25%, 5/07/09............................... 1,965,120
-------------
BUSINESS SERVICES-1.1%
7,481 008190AF7 Affiliated Computer Services, Inc., 3.50%, 2/15/06. 9,435,411
-------------
COMMERCIAL SERVICES-0.7%
6,366 981443AA2 Quebecor World Color Press, Inc., 6.00%, 10/1/07..................... 6,533,108
-------------
DIVERSIFIED MANUFACTURING-1.1%
191 902118BD9 Tyco International Group SA, 2.75%, 1/15/18.......................... 194,581
9,324 902118BE7 Tyco International Group SA, 3.125%, 1/15/23......................... 9,498,825
-------------
9,693,406
-------------
ELECTRONICS-1.8%
7,289 232572AE7 Cymer, Inc., 3.50%, 2/15/09.......................................... 7,216,110
5,500 80004CAB7 Sandisk Corp., 4.50%, 11/15/06....................................... 8,518,125
-------------
15,734,235
-------------
ENERGY-0.1%
550 131347BA3 Calpine Corp., 4.00%, 12/26/06....................................... 455,812
-------------
FOOD SERVICES-1.0%
7,000 713755AA4 Performance Food Group, Co., 5.50%, 10/16/08......................... 9,003,750
-------------
INTERNET-0.0%
233 871503AB4 Symantec Corp., 3.00%, 11/1/06....................................... 341,054
-------------
MINING-0.9%
5,804 35671DAF2 Freeport-McMoRan Cooper & Gold, Inc., 8.25%, 1/31/06................. 8,009,520
-------------
MULTI-MEDIA-2.1%
8,645 278762AG4 Echostar Communications Corp., 5.75%, 5/15/08........................ 9,109,669
8,629 530715AR2 Liberty Media Corp., 3.25%, 3/15/31.................................. 8,995,733
-------------
18,105,402
-------------
OIL & GAS-0.0%
176 792228AC2 St. Mary Land & Exploration Corp., 5.75%, 3/15/22.................... 237,380
-------------
-80-
NICHOLAS-APPLEGATE CONVERTIBLE & INCOME FUND
SCHEDULE OF INVESTMENTS
APRIL 30, 2003
(unaudited) (continued)
PRINCIPAL
AMOUNT (000) CUSIP # VALUE *
------------------------------------------------------------------------------------------------------------------
CONVERTIBLE BONDS & NOTES (concluded)
PHARMACEUTICALS-2.2%
$ 7,010 03071PAD4 AmerisourceBergen Corp., 5.00%, 12/1/07.............................. $ 9,244,437
276 156708AC3 Cephaleon, Inc., 5.25%, 5/01/06...................................... 274,965
130 375558AC7 Gilead Sciences, Inc., 2.00%, 12/15/07............................... 158,275
4,756 375558AB9 Gilead Sciences, Inc., 5.00%, 12/15/07............................... 9,214,750
90 808905AB9 Scios, Inc., 5.50%, 8/15/09.......................................... 108,788
310 88163VAB5 Teva Pharmaceutical Finance LLC, 1.50%, 10/15/05..................... 359,600
-------------
19,360,815
-------------
REAL ESTATE-1.0%
8,318 268766BR2 EOP Operating LP, 7.25%, 11/15/08.................................... 8,723,502
-------------
RETAIL-1.1%
7,022 364760AJ7 Gap, Inc., 5.75%, 3/15/09............................................ 9,233,930
-------------
SEMICONDUCTORS-0.9%
2,240 031652AH3 Amkor Technology, Inc., 5.00%, 3/15/07............................... 1,904,000
6,500 031652AN0 Amkor Technology, Inc., 5.75%, 6/1/06................................ 5,776,875
252 232806AE9 Cypress Semiconductor Corp., 4.00%, 2/1/05........................... 232,470
336 512807AE8 Lam Research Corp., 4.00%, 6/1/06.................................... 318,780
-------------
8,232,125
-------------
SOFTWARE-1.7%
328 319963AD6 First Data Corp., 2.00%, 3/1/08...................................... 367,770
7,295 40425PAC1 HNC Software, Inc., 5.25%, 9/1/08.................................... 8,799,594
5,275 64123LAB7 Network Associates, Inc., 5.25%, 8/15/06............................. 5,631,063
-------------
14,798,427
-------------
TELECOMMUNICATIONS-1.5%
4,000 029912AF9 American Tower Corp., 5.00%, 2/15/10................................. 3,400,000
436 65332VBC6 Nextel Communications, Inc., 6.00%, 6/1/11........................... 446,355
11,070 656568AB8 Nortel Networks Corp., 4.25%, 9/1/08................................. 9,284,963
375 918076AA8 Utstarcom, Inc., 0.875%, 3/1/08...................................... 431,250
-------------
13,562,568
-------------
WASTE DISPOSAL - 1.0%
7,255 941053AB6 Waste Connections, Inc., 5.50%, 4/15/06.............................. 8,252,563
-------------
Total Convertible Bonds & Notes (cost-$167,160,143) 171,453,240
-------------
SHARES
-------------
CONVERTIBLE PREFERRED STOCKS - 21.6%
AEROSPACE-2.1%
88,501 666807409 Northrop Grumman Corp., 7.25%, 11/16/04.............................. 9,049,227
169,899 755111606 Raytheon, Co., 8.25%, 5/15/04........................................ 9,176,245
-------------
18,225,472
-------------
AUTOMOTIVE-0.2%
48,079 345395206 Ford Motor Co Capital Trust II., 6.50%, 01/15/32..................... 2,109,226
-------------
BANKING-2.2%
114,920 845905306 Sovereign Capital Trust II, 7.50%, 1/15/30........................... 9,624,550
169,734 939322848 Washington Mutual, Inc., 5.375%, 5/3/41.............................. 9,738,488
-------------
19,363,038
-------------
COMMERCIAL SERVICES-2.6%
355,222 151313889 Cendant Corp., 7.75%, 8/17/04........................................ 13,551,719
144,780 98411F202 Xerox Corp., 7.50%, 11/27/21......................................... 9,609,773
-------------
23,161,492
-------------
ELECTRONICS-1.0%
806,625 834182206 Solectron Corp., 7.25%, 11/15/04..................................... 8,872,875
-------------
FINANCIAL SERVICES-2.2%
273,180 14040H204 Capital One Financial Corp., 6.25%, 5/17/05.......................... 10,102,196
171,311 744320201 Prudential Financial, Inc., 6.75%, 11/15/04.......................... 9,379,277
-------------
19,481,473
-------------
-81
NICHOLAS-APPLEGATE CONVERTIBLE & INCOME FUND
SCHEDULE OF INVESTMENTS
APRIL 30, 2003
(unaudited) (concluded)
SHARES CUSIP # VALUE *
------------------------------------------------------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS - (concluded)
HEALTHCARE-1.1%
111,664 03674B203 Anthem Inc., 6.00%, 11/15/04......................................... $ 9,379,776
-------------
INSURANCE-1.0%
5,487 4408209 ACE Ltd., 8.25%, 5/16/03............................................. 351,113
306,571 G7127P118 Platinum, Inc., 7.00%, 11/15/05...................................... 8,804,719
-------------
9,155,832
-------------
MULTI-MEDIA-1.6%
554,470 29477R103 Equity Securities Trust II, 6.50%, 11/15/04.......................... 13,639,962
181 75040P603 Radio One, Inc., 6.50%, 7/15/05...................................... 188,466
-------------
13,828,428
-------------
OIL & GAS-2.6%
163,560 165167602 Chesapeake Energy Corp., 6.00%, 12/31/49............................. 8,914,020
200,000 28336L208 El Paso Corp., 9.00%, 8/16/05........................................ 5,924,000
290,140 91821D107 VEC Trust I, 7.75%, 8/18/03.......................................... 8,190,652
-------------
23,028,672
-------------
PAPER PRODUCTS-1.1%
194,203 81211K209 Sealed Air Corp., 4.29%, 4/1/18...................................... 9,438,266
-------------
RAILROADS-1.1%
180,859 907824403 Union Pacific Capital Trust, 6.25%, 4/1/28........................... 9,314,239
-------------
TELECOMMUNICATIONS-1.7%
27,874 219350204 Corning, Inc., 7.00%, 8/16/05........................................ 8,160,114
1 656568300 Nortel Networks Corp., 7.00%, 8/15/05................................ 48,414
1,232,567 852061605 Sprint Corp. (FON Group), 7.125%, 8/17/04............................ 7,099,586
-------------
15,308,114
-------------
UTILITIES-1.1%
171,605 302571401 FPL Group, Inc., 8.00%, 02/16/06..................................... 9,300,991
-------------
Total Convertible Preferred Stocks (cost-$184,452,377) 189,967,894
-------------
PRINCIPAL
AMOUNT
(000)
-------------
U.S. GOVERNMENT SECURITIES-19.6%
$ 143,000 912810DR6 United States Treasury Notes,
9.375%-10.75%, 8/15/05-2/15/06, (cost-$173,024,062)................. 172,233,220
-------------
Total Investments (cost-$857,855,706) - 100% $ 879,292,176
-------------
* Long-Term debt securities are valued by an independent pricing service
authorized by the Board of Trustees.
See accompanying notes to financial statements.
-82-
APPENDIX A
AUCTION PROCEDURES
The following procedures will be set forth in provisions of the Second
Amended and Restated Bylaws relating to the APS, and will be incorporated by
reference into the Auction Agency Agreement and each Broker-Dealer Agreement.
The terms not defined below are defined in the Prospectus or the Second Amended
and Restated Bylaws. Nothing contained in this Appendix A constitutes a
representation by the Fund that in each Auction each party referred to herein
actually will perform the procedures described herein to be performed by each
party.
ARTICLE 11
* * *
11.10 Auction Procedures.
(a) Certain Definitions. As used in this Section 11.10, the following
terms shall have the following meanings, unless the context otherwise
requires:
(i) "APS" means the APS being auctioned pursuant to this Section
11.10.
(ii) "Auction Date" means the first Business Day preceding the
first day of a Dividend Period.
(iii) "Available APS" has the meaning specified in Section
11.10(d)(i)(A) below.
(iv) "Bid" has the meaning specified in Section 11.10(b)(i)(B)
below.
(v) "Bidder" has the meaning specified in Section 11.10(b)(i)(B)
below.
(vi) "Hold Order" has the meaning specified in Section
11.10(b)(i)(B) below.
(vii) "Maximum Applicable Rate" for any Dividend Period will be
the Applicable Percentage of the Reference Rate. The Auction Agent
will round each applicable Maximum Applicable Rate to the nearest
one-thousandth (0.001) of one percent per annum, with any such number
ending in five ten-thousandths of one percent being rounded upwards to
the nearest one-thousandth (0.001) of one percent. The Auction Agent
will not round the applicable Reference Rate as part of its
calculation of the Maximum Applicable Rate. The "Applicable
Percentage" shall be the percentage determined based on the credit
ratings assigned on such date by Moody's as follows:
A-1
Moody's Applicable
Credit Rating Percentage
------------- ----------
Aa3 or above 150%
A3 to A1 200%
Baa3 to Baa1 225%
Below Baa3 275%
The Applicable Percentage as so determined shall be further
subject to upward but not downward adjustment in the discretion of the
Board of Trustees of the Trust after consultation with the
Broker-Dealers, provided that immediately following any such increase
the Trust would be in compliance with the APS Basic Maintenance
Amount. The Trust shall take all reasonable action necessary to enable
Moody's to provide a rating for each series of APS. If Moody's shall
not make such a rating available, UBS Warburg LLC or its affiliates
and successors, after consultation with the Trust, shall select
another Rating Agency to act as a Substitute Rating Agency.
(viii) "Order" has the meaning specified in Section
11.10(b)(i)(B) below.
(ix) "Sell Order" has the meaning specified in Section
11.10(b)(i)(B) below.
(x) "Submission Deadline" means 1:00 p.m., New York City time, on
any Auction Date or such other time on any Auction Date as may be
specified by the Auction Agent from time to time as the time by which
each Broker-Dealer must submit to the Auction Agent in writing all
Orders obtained by it for the Auction to be conducted on such Auction
Date.
(xi) "Submitted Bid" has the meaning specified in Section
11.10(d)(i) below.
(xii) "Submitted Hold Order" has the meaning specified in Section
11.10(d)(i) below.
(xiii) "Submitted Order" has the meaning specified in Section
11.10(d)(i) below.
(xiv) "Submitted Sell Order" has the meaning specified in Section
11.10(d)(i) below.
(xv) "Sufficient Clearing Bids" has the meaning specified in
Section 11.10(d)(i) below.
(xvi) "Winning Bid Rate" has the meaning specified in Section
11.10(d)(i)(C) below.
(b) Orders by Beneficial Owners, Potential Beneficial Owners, Existing
Holders and Potential Holders.
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(i) Unless otherwise permitted by the Trust, Beneficial Owners
and Potential Beneficial Owners may only participate in Auctions
through their Broker-Dealers. Broker-Dealers will submit the Orders of
their respective customers who are Beneficial Owners and Potential
Beneficial Owners to the Auction Agent, designating themselves as
Existing Holders in respect of shares subject to Orders submitted or
deemed submitted to them by Beneficial Owners and as Potential Holders
in respect of shares subject to Orders submitted to them by Potential
Beneficial Owners. A Broker-Dealer may also hold APS in its own
account as a Beneficial Owner. A Broker-Dealer may thus submit Orders
to the Auction Agent as a Beneficial Owner or a Potential Beneficial
Owner and therefore participate in an Auction as an Existing Holder or
Potential Holder on behalf of both itself and its customers. On or
prior to the Submission Deadline on each Auction Date:
(A) each Beneficial Owner may submit to its Broker-Dealer
information as to:
(1) the number of Outstanding APS, if any, held by such
Beneficial Owner which such Beneficial Owner desires to
continue to hold without regard to the Applicable Rate for
the next succeeding Dividend Period for such shares;
(2) the number of Outstanding APS, if any, held by such
Beneficial Owner which such Beneficial Owner desires to
continue to hold, provided that the Applicable Rate for the
next succeeding Dividend Period for such shares shall not be
less than the rate per annum specified by such Beneficial
Owner; and/or
(3) the number of Outstanding APS, if any, held by such
Beneficial Owner which such Beneficial Owner offers to sell
without regard to the Applicable Rate for the next
succeeding Dividend Period; and
(B) each Broker-Dealer, using a list of Potential Beneficial
Owners that shall be maintained in good faith in a commercially
reasonable manner for the purpose of conducting a competitive
Auction, shall contact Potential Beneficial Owners, including
Persons that are not Beneficial Owners, on such list to determine
the number of Outstanding APS, if any, which each such Potential
Beneficial Owner offers to purchase, provided that the Applicable
Rate for the next succeeding Dividend Period shall not be less
than the rate per annum specified by such Potential Beneficial
Owner.
For the purposes hereof, the communication by a Beneficial
Owner or Potential Beneficial Owner to a Broker-Dealer, or the
communication by a Broker-Dealer acting for its own account to
the Auction Agent, of information referred to in clause (A) or
(B) of this Section 11.10(b)(i) is
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hereinafter referred to as an "Order" and each Beneficial Owner
and each Potential Beneficial Owner placing an Order, including a
Broker-Dealer acting in such capacity for its own account, is
hereinafter referred to as a "Bidder"; an Order containing the
information referred to in clause (A)(1) of this Section
11.10(b)(i) is hereinafter referred to as a "Hold Order"; an
Order containing the information referred to in clause (A)(2) or
(B) of this Section 11.10(b)(i) is hereinafter referred to as a
"Bid"; and an Order containing the information referred to in
clause (A)(3) of this Section 11.10(b)(i) is hereinafter referred
to as a "Sell Order." Inasmuch as a Broker-Dealer participates in
an Auction as an Existing Holder or a Potential Holder only to
represent the interests of a Beneficial Owner or Potential
Beneficial Owner, whether it be its customers or itself, all
discussion herein relating to the consequences of an Auction for
Existing Holders and Potential Holders also applies to the
underlying beneficial ownership interests represented.
(ii) (A) A Bid by an Existing Holder shall constitute an
irrevocable offer to sell:
(1) the number of Outstanding APS specified in such Bid
if the Applicable Rate determined on such Auction Date shall
be less than the rate per annum specified in such Bid; or
(2) such number or a lesser number of Outstanding APS
to be determined as set forth in Section 11.10(e)(i)(D) if
the Applicable Rate determined on such Auction Date shall be
equal to the rate per annum specified therein; or
(3) a lesser number of Outstanding APS to be determined
as set forth in Section 11.10(e)(ii)(C) if such specified
rate per annum shall be higher than the Maximum Applicable
Rate and Sufficient Clearing Bids do not exist.
(B) A Sell Order by an Existing Holder shall constitute an
irrevocable offer to sell:
(1) the number of Outstanding APS specified in such
Sell Order; or
(2) such number or a lesser number of Outstanding APS
to be determined as set forth in Section 11.10(e)(ii)(C) if
Sufficient Clearing Bids do not exist.
(C) A Bid by a Potential Holder shall constitute an
irrevocable offer to purchase:
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(1) the number of Outstanding APS specified in such Bid
if the Applicable Rate determined on such Auction Date shall
be higher than the rate per annum specified in such Bid; or
(2) such number or a lesser number of Outstanding APS
to be determined as set forth in Section 11.10(e)(i)(E) if
the Applicable Rate determined on such Auction Date shall be
equal to the rate per annum specified therein.
(c) Submission of Orders by Broker-Dealers to Auction Agent.
(i) Each Broker-Dealer shall submit in writing or through the
Auction Agent's auction processing system to the Auction Agent prior
to the Submission Deadline on each Auction Date all Orders obtained by
such Broker-Dealer, designating itself (unless otherwise permitted by
the Trust) as an Existing Holder in respect of shares subject to
Orders submitted or deemed submitted to it by Beneficial Owners and as
a Potential Holder in respect of shares subject to Orders submitted to
it by Potential Beneficial Owners, and specifying with respect to each
Order:
(A) the name of the Bidder placing such Order (which shall
be the Broker-Dealer unless otherwise permitted by the Trust);
(B) the aggregate number of Outstanding APS that are the
subject of such Order;
(C) to the extent that such Bidder is an Existing Holder:
(1) the number of Outstanding APS, if any, subject to
any Hold Order placed by such Existing Holder;
(2) the number of Outstanding APS, if any, subject to
any Bid placed by such Existing Holder and the rate per
annum specified in such Bid; and
(3) the number of Outstanding APS, if any, subject to
any Sell Order placed by such Existing Holder; and
(D) to the extent such Bidder is a Potential Holder, the
rate per annum specified in such Potential Holder's Bid.
(ii) If any rate per annum specified in any Bid contains more
than three figures to the right of the decimal point, the Auction
Agent shall round such rate up to the next highest one-thousandth
(.001) of 1%.
(iii) If an Order or Orders covering all of the Outstanding APS
held by an Existing Holder are not submitted to the Auction Agent
prior to the Submission Deadline, the Auction Agent shall deem a Hold
Order (in the case of any Auction
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other than an Auction relating to a Special Dividend Period of longer
than 91 days) or a Sell Order (in the case of an Auction relating to a
Special Dividend Period of longer than 91 days) to have been submitted
on behalf of such Existing Holder covering the number of Outstanding
APS held by such Existing Holder and not subject to Orders submitted
to the Auction Agent.
(iv) If one or more Orders on behalf of an Existing Holder
covering in the aggregate more than the number of Outstanding APS held
by such Existing Holder are submitted to the Auction Agent, such Order
shall be considered valid as follows and in the following order of
priority:
(A) any Hold Order submitted on behalf of such Existing
Holder shall be considered valid up to and including the number
of Outstanding APS held by such Existing Holder; provided that if
more than one Hold Order is submitted on behalf of such Existing
Holder and the number of APS subject to such Hold Orders exceeds
the number of Outstanding APS held by such Existing Holder, the
number of APS subject to each of such Hold Orders shall be
reduced pro rata so that such Hold Orders, in the aggregate, will
cover exactly the number of Outstanding APS held by such Existing
Holder;
(B) any Bids submitted on behalf of such Existing Holder
shall be considered valid, in the ascending order of their
respective rates per annum if more than one Bid is submitted on
behalf of such Existing Holder, up to and including the excess of
the number of Outstanding APS held by such Existing Holder over
the number of APS subject to any Hold Order referred to in
Section 11.10(c)(iv)(A) above (and if more than one Bid submitted
on behalf of such Existing Holder specifies the same rate per
annum and together they cover more than the remaining number of
shares that can be the subject of valid Bids after application of
Section 11.10(c)(iv)(A) above and of the foregoing portion of
this Section 11.10(c)(iv)(B) to any Bid or Bids specifying a
lower rate or rates per annum, the number of shares subject to
each of such Bids shall be reduced pro rata so that such Bids, in
the aggregate, cover exactly such remaining number of shares);
and the number of shares, if any, subject to Bids not valid under
this Section 11.10(c)(iv)(B) shall be treated as the subject of a
Bid by a Potential Holder; and
(C) any Sell Order shall be considered valid up to and
including the excess of the number of Outstanding APS held by
such Existing Holder over the number of APS subject to Hold
Orders referred to in Section 11.10(c)(iv)(A) and Bids referred
to in Section 11.10(c)(iv)(B); provided that if more than one
Sell Order is submitted on behalf of any Existing Holder and the
number of APS subject to such Sell Orders is greater than such
excess, the number of APS subject to each of such Sell Orders
shall be reduced pro rata so that such Sell Orders, in the
aggregate, cover exactly the number of APS equal to such excess.
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(v) If more than one Bid is submitted on behalf of any Potential
Holder, each Bid submitted shall be a separate Bid with the rate per
annum and number of APS therein specified.
(vi) Any Order submitted by a Beneficial Owner as a Potential
Beneficial Owner to its Broker-Dealer, or by a Broker-Dealer to the
Auction Agent, prior to the Submission Deadline on any Auction Date
shall be irrevocable.
(vii) The Trust shall not be responsible for a Broker-Dealer's
failure to act in accordance with the instructions of Beneficial
Owners or Potential Beneficial Owners or failure to comply with the
provisions of this Section 11.10.
(d) Determination of Sufficient Clearing Bids, Winning Bid Rate and
Applicable Rate.
(i) Not earlier than the Submission Deadline on each Auction
Date, the Auction Agent shall assemble all Orders submitted or deemed
submitted to it by the Broker-Dealers (each such Order as submitted or
deemed submitted by a Broker-Dealer being hereinafter referred to
individually as a "Submitted Hold Order," a "Submitted Bid" or a
"Submitted Sell Order," as the case may be, or, more generally, as a
"Submitted Order") and shall determine:
(A) the excess of the total number of Outstanding APS over
the number of Outstanding APS that are the subject of Submitted
Hold Orders (such excess being hereinafter referred to as the
"Available APS");
(B) from the Submitted Orders whether the number of
Outstanding APS that are the subject of Submitted Bids by
Potential Holders specifying one or more rates per annum equal to
or lower than the Maximum Applicable Rate exceeds or is equal to
the sum of:
(1) the number of Outstanding APS that are the subject
of Submitted Bids by Existing Holders specifying one or more
rates per annum higher than the Maximum Applicable Rate, and
(2) the number of Outstanding APS that are subject to
Submitted Sell Orders (if such excess or such equality
exists (other than because the number of Outstanding APS in
clause (1) above and this clause (2) are each zero because
all of the Outstanding APS are the subject of Submitted Hold
Orders), such Submitted Bids by Potential Holders being
hereinafter referred to collectively as "Sufficient Clearing
Bids"); and
(C) if Sufficient Clearing Bids exist, the lowest rate per
annum specified in the Submitted Bids (the "Winning Bid Rate")
that if:
(1) each Submitted Bid from Existing Holders specifying
the Winning Bid Rate and all other Submitted Bids from
Existing
A-7
Holders specifying lower rates per annum were rejected, thus
entitling such Existing Holders to continue to hold the APS
that are the subject of such Submitted Bids, and
(2) each Submitted Bid from Potential Holders
specifying the Winning Bid Rate and all other Submitted Bids
from Potential Holders specifying lower rates per annum were
accepted, thus entitling the Potential Holders to purchase
the APS that are the subject of such Submitted Bids, would
result in the number of shares subject to all Submitted Bids
specifying the Winning Bid Rate or a lower rate per annum
being at least equal to the Available APS.
(ii) Promptly after the Auction Agent has made the determinations
pursuant to Section 11.10(d)(i), the Auction Agent shall advise the
Trust of the Maximum Applicable Rate and, based on such
determinations, the Applicable Rate for the next succeeding Dividend
Period as follows:
(A) if Sufficient Clearing Bids exist, that the Applicable
Rate for the next succeeding Dividend Period shall be equal to
the Winning Bid Rate;
(B) if Sufficient Clearing Bids do not exist (other than
because all of the Outstanding APS are the subject of Submitted
Hold Orders), that the Applicable Rate for the next succeeding
Dividend Period shall be equal to the Maximum Applicable Rate; or
(C) if all of the Outstanding APS are the subject of
Submitted Hold Orders, that the Dividend Period next succeeding
the Auction shall automatically be the same length as the
immediately preceding Dividend Period and the Applicable Rate for
the next succeeding Dividend Period shall be equal to 80% of the
Reference Rate on the date of the Auction.
(e) Acceptance and Rejection of Submitted Bids and Submitted Sell
Orders and Allocation of Shares. Existing Holders shall continue to hold
the APS that are subject to Submitted Hold Orders, and, based on the
determinations made pursuant to Section 11.10(d)(i), the Submitted Bids and
Submitted Sell Orders shall be accepted or rejected and the Auction Agent
shall take such other action as set forth below:
(i) If Sufficient Clearing Bids have been made, subject to the
provisions of Section 11.10(e)(iii) and Section 11.10(e)(iv),
Submitted Bids and Submitted Sell Orders shall be accepted or rejected
in the following order of priority and all other Submitted Bids shall
be rejected:
(A) the Submitted Sell Orders of Existing Holders shall be
accepted and the Submitted Bid of each of the Existing Holders
specifying any rate per annum that is higher than the Winning Bid
Rate shall be
A-8
accepted, thus requiring each such Existing Holder to sell the
Outstanding APS that are the subject of such Submitted Sell Order
or Submitted Bid;
(B) the Submitted Bid of each of the Existing Holders
specifying any rate per annum that is lower than the Winning Bid
Rate shall be rejected, thus entitling each such Existing Holder
to continue to hold the Outstanding APS that are the subject of
such Submitted Bid;
(C) the Submitted Bid of each of the Potential Holders
specifying any rate per annum that is lower than the Winning Bid
Rate shall be accepted;
(D) the Submitted Bid of each of the Existing Holders
specifying a rate per annum that is equal to the Winning Bid Rate
shall be rejected, thus entitling each such Existing Holder to
continue to hold the Outstanding APS that are the subject of such
Submitted Bid, unless the number of Outstanding APS subject to
all such Submitted Bids shall be greater than the number of
Outstanding APS ("Remaining Shares") equal to the excess of the
Available APS over the number of Outstanding APS subject to
Submitted Bids described in Section 11.10(e)(i)(B) and Section
11.10(e)(i)(C), in which event the Submitted Bids of each such
Existing Holder shall be accepted, and each such Existing Holder
shall be required to sell Outstanding APS, but only in an amount
equal to the difference between (1) the number of Outstanding APS
then held by such Existing Holder subject to such Submitted Bid
and (2) the number of APS obtained by multiplying (x) the number
of Remaining Shares by (y) a fraction the numerator of which
shall be the number of Outstanding APS held by such Existing
Holder subject to such Submitted Bid and the denominator of which
shall be the sum of the number of Outstanding APS subject to such
Submitted Bids made by all such Existing Holders that specified a
rate per annum equal to the Winning Bid Rate; and
(E) the Submitted Bid of each of the Potential Holders
specifying a rate per annum that is equal to the Winning Bid Rate
shall be accepted but only in an amount equal to the number of
Outstanding APS obtained by multiplying (x) the difference
between the Available APS and the number of Outstanding APS
subject to Submitted Bids described in Section 11.10(e)(i)(B),
Section 11.10(e)(i)(C) and Section 11.10(e)(i)(D) by (y) a
fraction the numerator of which shall be the number of
Outstanding APS subject to such Submitted Bid and the denominator
of which shall be the number of Outstanding APS subject to such
Submitted Bids made by all such Potential Holders that specified
rates per annum equal to the Winning Bid Rate.
(ii) If Sufficient Clearing Bids have not been made (other than
because all of the Outstanding APS are subject to Submitted Hold
Orders), subject to the provisions of Section 11.10(e)(iii), Submitted
Orders shall be accepted or rejected
A-9
as follows in the following order of priority and all other Submitted
Bids shall be rejected:
(A) the Submitted Bid of each Existing Holder specifying any
rate per annum that is equal to or lower than the Maximum
Applicable Rate shall be rejected, thus entitling such Existing
Holder to continue to hold the Outstanding APS that are the
subject of such Submitted Bid;
(B) the Submitted Bid of each Potential Holder specifying
any rate per annum that is equal to or lower than the Maximum
Applicable Rate shall be accepted, thus requiring such Potential
Holder to purchase the Outstanding APS that are the subject of
such Submitted Bid; and
(C) the Submitted Bids of each Existing Holder specifying
any rate per annum that is higher than the Maximum Applicable
Rate shall be accepted and the Submitted Sell Orders of each
Existing Holder shall be accepted, in both cases only in an
amount equal to the difference between (1) the number of
Outstanding APS then held by such Existing Holder subject to such
Submitted Bid or Submitted Sell Order and (2) the number of APS
obtained by multiplying (x) the difference between the Available
APS and the aggregate number of Outstanding APS subject to
Submitted Bids described in Section 11.10(e)(ii)(A) and Section
11.10(e)(ii)(B) by (y) a fraction the numerator of which shall be
the number of Outstanding APS held by such Existing Holder
subject to such Submitted Bid or Submitted Sell Order and the
denominator of which shall be the number of Outstanding APS
subject to all such Submitted Bids and Submitted Sell Orders. If
all of the Outstanding shares of a series of APS are subject to
Submitted Hold Orders, all Submitted Bids for shares of such
series shall be rejected.
(iii) If, as a result of the procedures described in Section
11.10(e), any Existing Holder would be entitled or required to sell,
or any Potential Holder would be entitled or required to purchase, a
fraction of an Auction Preferred Share on any Auction Date, the
Auction Agent shall, in such manner as in its sole discretion it shall
determine, round up or down the number of APS to be purchased or sold
by any Existing Holder or Potential Holder on such Auction Date so
that each Outstanding Auction Preferred Share purchased or sold by
each Existing Holder or Potential Holder on such Auction Date shall be
a whole Auction Preferred Share.
(iv) If, as a result of the procedures described in Section
11.10(e), any Potential Holder would be entitled or required to
purchase less than a whole Auction Preferred Share on any Auction
Date, the Auction Agent shall, in such manner as in its sole
discretion it shall determine, allocate APS for purchase among
Potential Holders so that only whole APS are purchased on such Auction
Date by any Potential Holder, even if such allocation results in one
or more of such Potential Holders not purchasing any APS on such
Auction Date.
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(v) Based on the results of each Auction, the Auction Agent shall
determine, with respect to each Broker-Dealer that submitted Bids or
Sell Orders on behalf of Existing Holders or Potential Holders, the
aggregate number of Outstanding APS to be purchased and the aggregate
number of the Outstanding APS to be sold by such Potential Holders and
Existing Holders and, to the extent that such aggregate number of
Outstanding shares to be purchased and such aggregate number of
Outstanding shares to be sold differ, the Auction Agent shall
determine to which other Broker-Dealer or Broker-Dealers acting for
one or more purchasers such Broker-Dealer shall deliver, or from which
other Broker-Dealer or Broker-Dealers acting for one or more sellers
such Broker-Dealer shall receive, as the case may be, Outstanding APS.
(f) Miscellaneous.
(i) The Trust may in its sole discretion interpret the provisions
of this Section 11.10 to resolve any inconsistency or ambiguity,
remedy any formal defect or make any other change or modification that
does not substantially adversely affect the rights of Beneficial
Owners of APS.
(ii) Unless otherwise permitted by the Trust, a Beneficial Owner
or an Existing Holder (A) may sell, transfer or otherwise dispose of
APS only pursuant to a Bid or Sell Order in accordance with the
procedures described in this Section 11.10 or to or through a
Broker-Dealer or to such other persons as may be permitted by the
Trust, provided that in the case of all transfers other than pursuant
to Auctions such Beneficial Owner or Existing Holder, its
Broker-Dealer, if applicable, or its Agent Member advises the Auction
Agent of such transfer and (B) except as otherwise required by law,
shall have the ownership of the APS held by it maintained in book
entry form by the Securities Depository in the account of its Agent
Member, which in turn will maintain records of such Beneficial Owner's
beneficial ownership. The Trust may not submit an Order in any
Auction.
(iii) All of the Outstanding APS of a series shall be registered
in the name of the nominee of the Securities Depository unless
otherwise required by law or unless there is no Securities Depository.
If there is no Securities Depository, at the Trust's option and upon
its receipt of such documents as it deems appropriate, any APS may be
registered in the Share Register in the name of the Beneficial Owner
thereof and such Beneficial Owner thereupon will be entitled to
receive certificates therefor and required to deliver certificates
therefor upon transfer or exchange thereof.
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APPENDIX B
SETTLEMENT PROCEDURES
The following summary of Settlement Procedures sets forth the procedures
expected to be followed in connection with the settlement of each Auction and
will be incorporated by reference in the Auction Agency Agreement and each
Broker-Dealer Agreement. Nothing contained in this Appendix B constitutes a
representation by the Fund that in each Auction each party referred to herein
actually will perform the procedures described herein to be performed by such
party. Capitalized terms used herein shall have the respective meanings
specified in the Second Amended and Restated Bylaws.
(a) On each Auction Date, the Auction Agent shall notify by telephone or
through the Auction Agent's auction processing system the Broker-Dealers that
participated in the Auction held on such Auction Date and submitted an Order on
behalf of any Beneficial Owner or Potential Beneficial Owner of:
(i) the Applicable Rate fixed for the next succeeding Dividend Period;
(ii) whether Sufficient Clearing Bids existed for the determination of
the Applicable Rate;
(iii) if such Broker-Dealer (a "Seller's Broker-Dealer") submitted a
Bid or a Sell Order on behalf of a Beneficial Owner, the number of
Preferred Shares, if any, to be sold by such Beneficial Owner;
(iv) if such Broker-Dealer (a "Buyer's Broker-Dealer") submitted a Bid
on behalf of a Potential Beneficial Owner, the number of Preferred Shares,
if any, to be purchased by such Potential Beneficial Owner;
(v) if the aggregate number of Preferred Shares to be sold by all
Beneficial Owners on whose behalf such Broker-Dealer submitted a Bid or a
Sell Order exceeds the aggregate number of Preferred Shares to be purchased
by all Potential Beneficial Owners on whose behalf such Broker-Dealer
submitted a Bid, the name or names of one or more Buyer's Broker-Dealers
(and the name of the Agent Member, if any, of each such Buyer's
Broker-Dealer) acting for one or more purchasers of such excess number of
Preferred Shares and the number of such shares to be purchased from one or
more Beneficial Owners on whose behalf such Broker-Dealer acted by one or
more Potential Beneficial Owners on whose behalf each of such Buyer's
Broker-Dealers acted;
(vi) if the aggregate number of Preferred Shares to be purchased by
all Potential Beneficial Owners on whose behalf such Broker-Dealer
submitted a Bid exceeds the aggregate number of Preferred Shares to be sold
by all Beneficial Owners on whose behalf such Broker-Dealer submitted a Bid
or a Sell Order, the name or names of one or more Seller's Broker-Dealers
(and the name of the Agent Member, if any, of each such Seller's
Broker-Dealer) acting for one or more sellers of such excess number of
Preferred
B-1
Shares and the number of such shares to be sold to one or more Potential
Beneficial Owners on whose behalf such Broker-Dealer acted by one or more
Beneficial Owners on whose behalf each of such Seller's Broker-Dealers
acted; and
(vii) the Auction Date of the next succeeding Auction with respect to
the Preferred Shares.
(b) On each Auction Date, each Broker-Dealer that submitted an Order on
behalf of any Beneficial Owner or Potential Beneficial Owner shall:
(i) in the case of a Broker-Dealer that is a Buyer's Broker-Dealer,
instruct each Potential Beneficial Owner on whose behalf such Broker-Dealer
submitted a Bid that was accepted, in whole or in part, to instruct such
Potential Beneficial Owner's Agent Member to pay to such Broker-Dealer (or
its Agent Member) through the Securities Depository the amount necessary to
purchase the number of Preferred Shares to be purchased pursuant to such
Bid against receipt of such shares and advise such Potential Beneficial
Owner of the Applicable Rate for the next succeeding Dividend Period;
(ii) in the case of a Broker-Dealer that is a Seller's Broker-Dealer,
instruct each Beneficial Owner on whose behalf such Broker-Dealer submitted
a Sell Order that was accepted, in whole or in part, or a Bid that was
accepted, in whole or in part, to instruct such Beneficial Owner's Agent
Member to deliver to such Broker-Dealer (or its Agent Member) through the
Securities Depository the number of Preferred Shares to be sold pursuant to
such Order against payment therefor and advise any such Beneficial Owner
that will continue to hold Preferred Shares of the Applicable Rate for the
next succeeding Dividend Period;
(iii) advise each Beneficial Owner on whose behalf such Broker-Dealer
submitted a Hold Order of the Applicable Rate for the next succeeding
Dividend Period;
(iv) advise each Beneficial Owner on whose behalf such Broker-Dealer
submitted an Order of the Auction Date for the next succeeding Auction; and
(v) advise each Potential Beneficial Owner on whose behalf such
Broker-Dealer submitted a Bid that was accepted, in whole or in part, of
the Auction Date for the next succeeding Auction.
(c) On the basis of the information provided to it pursuant to (a) above,
each Broker-Dealer that submitted a Bid or a Sell Order on behalf of a Potential
Beneficial Owner or a Beneficial Owner shall, in such manner and at such time or
times as in its sole discretion it may determine, allocate any funds received by
it pursuant to (b)(i) above and any Preferred Shares received by it pursuant to
(b)(ii) above among the Potential Beneficial Owners, if any, on whose behalf
such Broker-Dealer submitted Bids, the Beneficial Owners, if any, on whose
behalf such Broker-Dealer submitted Bids that were accepted or Sell Orders, and
any Broker-Dealer or Broker-Dealers identified to it by the Auction Agent
pursuant to (a)(v) or (a)(vi) above.
(d) On each Auction Date:
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(i) each Potential Beneficial Owner and Beneficial Owner shall
instruct its Agent Member as provided in (b)(i) or (ii) above, as the case
may be;
(ii) each Seller's Broker-Dealer which is not an Agent Member of the
Securities Depository shall instruct its Agent Member to (A) pay through
the Securities Depository to the Agent Member of the Beneficial Owner
delivering shares to such Broker-Dealer pursuant to (b)(ii) above the
amount necessary to purchase such shares against receipt of such shares,
and (B) deliver such shares through the Securities Depository to a Buyer's
Broker-Dealer (or its Agent Member) identified to such Seller's
Broker-Dealer pursuant to (a)(v) above against payment therefor; and
(iii) each Buyer's Broker-Dealer which is not an Agent Member of the
Securities Depository shall instruct its Agent Member to (A) pay through
the Securities Depository to a Seller's Broker-Dealer (or its Agent Member)
identified pursuant to (a)(vi) above the amount necessary to purchase the
shares to be purchased pursuant to (b)(i) above against receipt of such
shares, and (B) deliver such shares through the Securities Depository to
the Agent Member of the purchaser thereof against payment therefor.
(e) On the day after the Auction Date:
(i) each Bidder's Agent Member referred to in (d)(i) above shall
instruct the Securities Depository to execute the transactions described in
(b)(i) or (ii) above, and the Securities Depository shall execute such
transactions;
(ii) each Seller's Broker-Dealer or its Agent Member shall instruct
the Securities Depository to execute the transactions described in (d)(ii)
above, and the Securities Depository shall execute such transactions; and
(iii) each Buyer's Broker-Dealer or its Agent Member shall instruct
the Securities Depository to execute the transactions described in (d)(iii)
above, and the Securities Depository shall execute such transactions.
(f) If a Beneficial Owner selling Preferred Shares in an Auction fails to
deliver such shares (by authorized book-entry), a Broker-Dealer may deliver to
the Potential Beneficial Owner on behalf of which it submitted a Bid that was
accepted a number of whole Preferred Shares that is less than the number of
shares that otherwise was to be purchased by such Potential Beneficial Owner. In
such event, the number of Preferred Shares to be so delivered shall be
determined solely by such Broker-Dealer. Delivery of such lesser number of
shares shall constitute good delivery. Notwithstanding the foregoing terms of
this paragraph (f), any delivery or non-delivery of shares which shall represent
any departure from the results of an Auction, as determined by the Auction
Agent, shall be of no effect unless and until the Auction Agent shall have been
notified of such delivery or non-delivery in accordance with the provisions of
the Auction Agency Agreement and the Broker-Dealer Agreements.
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APPENDIX C
DESCRIPTION OF SECURITIES RATINGS
The Fund's investments may range in quality from securities rated in the
lowest category to securities rated in the highest category (as rated by Moody's
or S&P or, if unrated, determined by NACM to be of comparable quality). The
percentage of the Fund's assets invested in securities in a particular rating
category will vary. The following terms are generally used to describe the
credit quality of debt securities:
High Quality Debt Securities are those rated in one of the two highest
rating categories (the highest category for commercial paper) or, if unrated,
deemed comparable by NACM.
Investment Grade Debt Securities are those rated in one of the four highest
rating categories or, if unrated, deemed comparable by NACM.
Below Investment Grade, High Yield Securities ("Junk Bonds") are those
rated lower than Baa by Moody's, BBB by S&P and BBB by Fitch and comparable
securities. They are deemed predominately speculative with respect to the
issuer's ability to repay principal and interest.
Following is a description of Moody's, S&P's and Fitch's rating categories
applicable to debt securities.
MOODY'S INVESTORS SERVICE, INC.
CORPORATE AND MUNICIPAL BOND RATINGS
Aaa: Bonds which are rated Aaa are judged to be of 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: Bonds 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 fluctuation of protective
elements may be of greater amplitude or there may be other elements present that
make the long-term risks appear somewhat larger than with Aaa securities.
A: Bonds 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
that suggest a susceptibility to impairment sometime in the future.
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Baa: Bonds 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 bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of a desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca: Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing.
Moody's bond ratings, where specified, are applicable to financial
contracts, senior bank obligations and insurance company senior policyholder and
claims obligations with an original maturity in excess of one year. Obligations
relying upon support mechanisms such as letter-of-credit and bonds of indemnity
are excluded unless explicitly rated. Obligations of a branch of a bank are
considered to be domiciled in the country in which the branch is located.
Unless noted as an exception, Moody's rating on a bank's ability to repay
senior obligations extends only to branches located in countries which carry a
Moody's Sovereign Rating for Bank Deposits. Such branch obligations are rated at
the lower of the bank's rating or Moody's Sovereign Rating for the Bank Deposits
for the country in which the branch is located. When the currency in which an
obligation is denominated is not the same as the currency of the country in
which the obligation is domiciled, Moody's ratings do not incorporate an opinion
as to whether payment of the obligation will be affected by the actions of the
government controlling the currency of denomination. In addition, risk
associated with bilateral conflicts between an investor's home country and
either the issuer's home country or the country where an issuer branch is
located are not incorporated into Moody's ratings.
Moody's makes no representation that rated bank obligations or insurance
company obligations are exempt from registration under the U.S. Securities Act
of 1933 or issued in conformity with any other applicable law or regulation. Nor
does Moody's represent any
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specific bank or insurance company obligation is legally enforceable or a valid
senior obligation of a rated issuer.
Moody's applies numerical modifiers, 1, 2, and 3 in each generic rating
classified from Aa through Caa in its corporate 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.
CORPORATE SHORT-TERM DEBT RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
PRIME-1: Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1 repayment
ability will often be evidenced by many of the following characteristics:
leading market positions in well-established industries; high rates of return on
funds employed; conservative capitalization structure with moderate reliance on
debt and ample asset protection; broad margins in earnings coverage of fixed
financial charges and high internal cash generation; and well-established access
to a range of financial markets and assured sources of alternate liquidity.
PRIME-2: Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
PRIME-3: Issuers rated Prime-3 (or supporting institutions) have an
acceptable ability for repayment of senior short-term obligations. The effect of
industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
NOT PRIME: Issuers rated Not Prime do not fall within any of the Prime
rating categories.
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STANDARD & POOR'S RATINGS SERVICES
ISSUE CREDIT RATING DEFINITIONS
A Standard & Poor's issue credit rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations, or a specific financial program
(including ratings on medium term note programs and commercial paper programs).
It takes into consideration the creditworthiness of guarantors, insurers, or
other forms of credit enhancement on the obligation and takes into account the
currency in which the obligation is denominated. The issue credit rating is not
a recommendation to purchase, sell, or hold a financial obligation, inasmuch as
it does not comment as to market price or suitability for a particular investor.
Issue credit ratings are based on current information furnished by the
obligors or obtained by Standard & Poor's from other sources it considers
reliable. Standard & Poor's does not perform an audit in connection with any
credit rating and may, on occasion, rely on unaudited financial information.
Credit ratings may be changed, suspended, or withdrawn as a result of changes
in, or unavailability of, such information, or based on other circumstances.
Issue credit ratings can be either long-term or short-term. Short-term
ratings are generally assigned to those obligations considered short term in the
relevant market. In the U.S., for example, that means obligations with an
original maturity of no more than 365 days -- including commercial paper.
Short-term ratings are also used to indicate the creditworthiness of an obligor
with respect to put features on long-term obligations. The result is a dual
rating, in which the short-term rating addresses the put feature, in addition to
the usual long-term rating. Medium-term notes are assigned long-term ratings.
Issue credit ratings are based, in varying degrees, on the following
considerations: likelihood of payment -- capacity and willingness of the obligor
to meet its financial commitment on an obligation in accordance with the terms
of the obligation; nature of and provisions of the obligation; protection
afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization, or other arrangement under the laws of bankruptcy
and other laws affecting creditors' rights.
The issue rating definitions are expressed in terms of default risk. As
such, they pertain to senior obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to reflect the lower priority in
bankruptcy, as noted above. (Such differentiation applies when an entity has
both senior and subordinated obligations, secured and unsecured obligations, or
operating company and holding company obligations.) Accordingly, in the case of
junior debt, the rating may not conform exactly with the category definition.
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CORPORATE AND MUNICIPAL BOND RATINGS
Investment Grade
AAA: An obligation rated AAA has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA: An obligation rated AA differs from the highest rated obligations only
in small degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
A: An obligation rated A is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations in
higher rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB: An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
Speculative Grade
Obligations rated BB, B, CCC, CC, and C are regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. BB indicates the least degree of speculation and C
the highest. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major exposures
to adverse conditions.
BB: An obligation rated BB is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B: An obligation rated B is more vulnerable to nonpayment than obligations
rated BB, but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
CCC: An obligation rated CCC is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC: An obligation rated CC is currently highly vulnerable to nonpayment.
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C: A subordinated debt or preferred stock obligation rated C is CURRENTLY
HIGHLY VULNERABLE to nonpayment. The C rating may be used to cover a situation
where a bankruptcy petition has been filed or similar action taken, but payments
on this obligation are being continued. A C also will be assigned to a preferred
stock issue in arrears on dividends or sinking fund payments, but that is
currently paying.
CI: The rating CI is reserved for income bonds on which no interest is
being paid.
D: An obligation rated D is in payment default. The D rating category is
used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poor's believes that
such payments will be made during such grace period. The D rating also will be
used upon the filing of a bankruptcy petition or the taking of a similar action
if payments on an obligation are jeopardized.
Plus (+) or Minus (-): The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Provisional ratings: The letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of the
project being financed by the debt being rated and indicates that payment of
debt service requirements is largely or entirely dependent upon the successful
and timely completion of the project. This rating, however, while addressing
credit quality subsequent to completion of the project, makes no comment on the
likelihood of, or the risk of default upon failure of, such completion. The
investor should exercise his own judgment with respect to such likelihood and
risk.
r: This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk -- such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
The absence of an "r" symbol should not be taken as an indication that an
obligation will exhibit no volatility or variability in total return.
N.R.: This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that Standard & Poor's
does not rate a particular obligation as a matter of policy.
Debt obligations of issuers outside the United States and its territories
are rated on the same basis as domestic corporate and municipal issues. The
ratings measure the creditworthiness of the obligor but do not take into account
currency exchange and related uncertainties.
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COMMERCIAL PAPER RATING DEFINITIONS
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Ratings are graded into several categories, ranging from A for the
highest quality obligations to D for the lowest. These categories are as
follows:
A-1: A short-term obligation rated A-1 is rated in the highest category by
Standard & Poor's. The obligor's capacity to meet its financial commitment on
the obligation is strong. Within this category, certain obligations are
designated with a plus sign (+). This indicates that the obligor's capacity to
meet its financial commitment on these obligations is extremely strong.
A-2: A short-term obligation rated A-2 is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to meet
its financial commitment on the obligation is satisfactory.
A-3: A short-term obligation rated A-3 exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
B: A short-term obligation rated B is regarded as having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet its
financial commitment on the obligation.
C: A short-term obligation rated C is currently vulnerable to nonpayment
and is dependent upon favorable business, financial, and economic conditions for
the obligor to meet its financial commitment on the obligation.
D: A short-term obligation rated D is in payment default. The D rating
category is used when payments on an obligation are not made on the date due
even if the applicable grace period has not expired, unless Standard & Poor's
believes that such payments will be made during such grace period. The D rating
also will be used upon the filing of a bankruptcy petition or the taking of a
similar action if payments on an obligation are jeopardized.
A commercial paper rating is not a recommendation to purchase, sell or hold
a security inasmuch as it does not comment as to market price or suitability for
a particular investor. The ratings are based on current information furnished to
Standard & Poor's by the issuer or obtained from other sources it considers
reliable. Standard & Poor's does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended, or withdrawn as a result of changes in or
unavailability of such information.
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Fitch, Inc.
A brief description of the applicable Fitch, Inc. ("Fitch") ratings symbols
and meanings (as published by Fitch) follows:
LONG-TERM CREDIT RATINGS
Investment Grade
AAA: Highest credit quality. 'AAA' ratings denote the lowest expectation of
credit risk. They are assigned only in case of exceptionally strong capacity for
timely payment of financial commitments. This capacity is highly unlikely to be
adversely affected by foreseeable events.
AA: Very high credit quality. 'AA' ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
A: High credit quality. 'A' ratings denote a low expectation of credit
risk. The capacity for timely payment of financial commitments is considered
strong. This capacity may, nevertheless, be more vulnerable to changes in
circumstances or in economic conditions than is the case for higher ratings.
BBB: Good credit quality. 'BBB' ratings indicate that there is currently a
low expectation of credit risk. The capacity for timely payment of financial
commitments is considered adequate, but adverse changes in circumstances and in
economic conditions are more likely to impair this capacity. This is the lowest
investment-grade category.
Speculative Grade
BB: Speculative. 'BB' ratings indicate that there is a possibility of
credit risk developing, particularly as the result of adverse economic change
over time; however, business or financial alternatives may be available to allow
financial commitments to be met. Securities rated in this category are not
investment grade.
B: Highly speculative. 'B' ratings indicate that significant credit risk is
present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is contingent upon
a sustained, favorable business and economic environment.
CCC, CC, C: High default risk. Default is a real possibility. Capacity for
meeting financial commitments is solely reliant upon sustained, favorable
business or economic developments. A 'CC' rating indicates that default of some
kind appears probable. 'C' ratings signal imminent default.
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DDD, DD, D: Default. The ratings of obligations in this category are based
on their prospects for achieving partial or full recovery in a reorganization or
liquidation of the obligor. While expected recovery values are highly
speculative and cannot be estimated with any precision, the following serve as
general guidelines. 'DDD' obligations have the highest potential for recovery,
around 90%-100% of outstanding amounts and accrued interest. 'DD' indicates
potential recoveries in the range of 50%-90%, and 'D' the lowest recovery
potential, i.e., below 50%. Entities rated in this category have defaulted on
some or all of their obligations. Entities rated 'DDD' have the highest prospect
for resumption of performance or continued operation with or without a formal
reorganization process. Entities rated 'DD' and 'D' are generally undergoing a
formal reorganization or liquidation process; those rated 'DD' are likely to
satisfy a higher portion of their outstanding obligations, while entities rated
'D' have a poor prospect for repaying all obligations.
SHORT-TERM CREDIT RATINGS
A short-term rating has a time horizon of less than 12 months for most
obligations, or up to three years for U.S. public finance securities, and thus
places greater emphasis on the liquidity necessary to meet financial commitments
in a timely manner.
F1: Highest credit quality. Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
F2: Good credit quality. A satisfactory capacity for timely payment of
financial commitments, but the margin of safety is not as great as in the case
of the higher ratings.
F3: Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.
B: Speculative. Minimal capacity for timely payment of financial
commitments, plus vulnerability to near-term adverse changes in financial and
economic conditions.
C: High default risk. Default is a real possibility. Capacity for meeting
financial commitments is solely reliant upon a sustained, favorable business and
economic environment.
D: Default. Denotes actual or imminent payment default.
"+" or "-" may be appended to a rating to denote relative status within
major rating categories. Such suffixes are not added to the 'AAA' long-term
rating category, to categories below 'CCC', or to short-term ratings other than
'F1'.
'NR' indicates that Fitch does not rate the issuer or issue in question.
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'Withdrawn': A rating is withdrawn when Fitch deems the amount of
information available to be inadequate for rating purposes, or when an
obligation matures, is called, or refinanced.
'Rating Watch': Ratings are placed on RatingWatch to notify investors that
there is a reasonable probability of a rating change and the likely direction of
such change. These are designated as "Positive", indicating a potential upgrade,
"Negative", for a potential downgrade, or "Evolving", if ratings may be raised,
lowered or maintained. Rating Watch is typically resolved over a relatively
short period.
A Rating Outlook indicates the direction a rating is likely to move over a
one to two year period. Outlooks may be positive, stable, or negative. A
positive or negative Rating Outlook does not imply a rating change is
inevitable. Similarly, companies whose outlooks are 'stable' could be downgraded
before an outlook moves to positive or negative if circumstances warrant such an
action. Occasionally, Fitch may be unable to identify the fundamental trend. In
these cases, the Rating Outlook may be described as evolving.
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