As filed with the Securities and Exchange Commission on December 11, 2003
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1933 Act File No. 333-109707
1940 Act File No. 811-21403
U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-2
/X/ REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
/X/ Pre-Effective Amendment No. 1
/ / Post-Effective Amendment No. _____________________
and
/X/ REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
/X/ Amendment No. 4
Western Asset/Claymore U.S. Treasury Inflation Protected
Securities Fund
(Exact Name of Registrant as Specified in Declaration of Trust)
117 East Colorado Boulevard
Pasadena, California 91105
(Address of Principal Executive Offices)
(Number, Street, City, State, Zip Code)
(626) 844-9400
(Registrant's Telephone Number, including Area Code)
Gregory B. McShea
c/o Western Asset Management Company
117 East Colorado Boulevard
Pasadena, California 91105
(Name and Address (Number, Street, City, State, Zip Code) of Agent for Service)
Copies of Communications to:
Bryan Chegwidden, Esq. Leonard B. Mackey, Jr., Esq.
Ropes & Gray LLP Clifford Chance US LLP
45 Rockefeller Plaza 200 Park Avenue
New York, NY 10111-0087 New York, NY 10166
Approximate Date of Proposed Public Offering:
As soon as practicable after the effective date of this Registration Statement
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If any of the securities being registered on this form will be offered on a
delayed or continuous basis in reliance on Rule 415 under the Securities Act of
1933, other than securities offered in connection with a dividend reinvestment
plan, check the following box. / /
It is proposed that this filing will become effective (check appropriate
box)
/X/ when declared effective pursuant to Section 8(c)
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CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
AMOUNT BEING OFFERING PRICE PER AGGREGATE OFFERING REGISTRATION
TITLE OF SECURITIES BEING REGISTERED REGISTERED UNIT PRICE(1) FEE(2)
------------------------------------ ----------------- ------------------ ------------------ ------------
Taxable Auction Market Preferred Shares, Series M 2 Shares $25,000.00 $50,000 $4.04
Taxable Auction Market Preferred Shares, Series T 2 Shares $25,000.00 $50,000 $4.04
Taxable Auction Market Preferred Shares, Series W 2 Shares $25,000.00 $50,000 $4.04
Taxable Auction Market Preferred Shares, Series TH 2 Shares $25,000.00 $50,000 $4.04
Taxable Auction Market Preferred Shares, Series F 2 Shares $25,000.00 $50,000 $4.04
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(1) Estimated solely for the purpose of calculating the registration fee.
(2) Previously paid.
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states this Registration Statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the Registration Statement shall become
effective on such dates as the Commission, acting pursuant to said Section 8(a),
may determine.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. THE FUND
MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES
IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED DECEMBER 11, 2003
PROSPECTUS
[WESTERN ASSET LOGO] [CLAYMORE LOGO]
$205,000,000
WESTERN ASSET/CLAYMORE U.S. TREASURY INFLATION PROTECTED SECURITIES FUND
TAXABLE AUCTION MARKET PREFERRED SHARES ("AMPS")
1,640 SHARES, SERIES M
1,640 SHARES, SERIES T
1,640 SHARES, SERIES W
1,640 SHARES, SERIES TH
1,640 SHARES, SERIES F
LIQUIDATION PREFERENCE $25,000 PER SHARE
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Western Asset/Claymore U.S. Treasury Inflation Protected Securities Fund (the
"Fund") is a recently organized, diversified, closed-end management investment
company. The Fund's primary investment objective is to provide current income.
Capital appreciation, when consistent with current income, is a secondary
investment objective.
THE OFFERING. The Fund is simultaneously offering 1,640 Series M Taxable
Auction Market Preferred Shares ("Series M AMPS"), 1,640 Series T Taxable
Auction Market Preferred Shares ("Series T AMPS"), 1,640 Series W Taxable
Auction Market Preferred Shares ("Series W AMPS"),
(CONTINUED ON NEXT PAGE)
INVESTING IN THE AMPS INVOLVES RISKS THAT ARE DESCRIBED IN THE "RISKS"
SECTION BEGINNING ON PAGE 27 OF THIS PROSPECTUS. THE MINIMUM PURCHASE AMOUNT OF
THE AMPS IS $25,000.
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PER SHARE TOTAL
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Public offering price.................................. $25,000 $205,000,000
Sales load............................................. $250 $2,050,000
Proceeds, before expenses, to the Fund(1).............. $24,750 $202,950,000
(1) Not including offering expenses payable by the Fund estimated to be
$304,585.
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.
The Underwriters are offering the AMPS subject to various conditions. The
Underwriters expect to deliver the AMPS, in book-entry form, through the
facilities of The Depository Trust Company on or about , 2003.
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MERRILL LYNCH & CO.
LEGG MASON WOOD WALKER INCORPORATED
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The date of this prospectus is , 2003.
(CONTINUED FROM PREVIOUS PAGE)
1,640 Series TH Taxable Auction Market Preferred Shares ("Series TH AMPS") and
1,640 Series F Taxable Auction Market Preferred Shares ("Series F AMPS"). These
shares are referred to together in this prospectus as "AMPS." The AMPS will not
be listed on any exchange. Generally, investors may only buy and sell the AMPS
through an order placed at an auction with or through a broker-dealer that has
entered into an agreement with the auction agent, or in a secondary market that
certain broker-dealers may maintain. These broker-dealers are not required to
maintain a market in the AMPS, and a secondary market, if one develops, may not
provide investors with liquidity.
PORTFOLIO CONTENTS. Under normal market conditions, the Fund will invest at
least 80% of its total managed assets in U.S. Treasury Inflation Protected
Securities ("U.S. TIPS"). U.S. TIPS are fixed income securities issued by the
U.S. Department of the Treasury, the principal amounts of which are adjusted
daily based upon changes in the rate of inflation (currently represented by the
non-seasonally adjusted Consumer Price Index for All Urban Consumers (the
"CPI-U")). The Fund may also invest up to 20% of its total managed assets in
corporate bonds or other securities and instruments. The Fund intends to limit
its investments to U.S. dollar-denominated securities and instruments, and will
not invest in bonds that are below investment grade quality at the time of
purchase. Investment grade quality bonds are bonds rated within a rating
agency's four highest grades (Baa or BBB or higher by Moody's Investors Service,
Inc. ("Moody's"), Standard & Poor's Rating Group ("S&P") or Fitch Ratings
("Fitch") or a similar rating of another nationally recognized rating agency) or
bonds that are unrated but judged to be of comparable quality by the Fund's
investment advisor. The Fund may enter into short sales, use reverse repurchase
agreements and dollar rolls, and engage in other types of transactions,
including derivative transactions (such as options, futures contracts and
swaps), for risk management purposes or as part of its investment strategies.
The Fund currently expects that the average effective duration of its portfolio
will range between zero and 15 years, although this target duration may change
from time to time. "Total managed assets" means the total assets of the Fund
(including any assets attributable to leverage) minus accrued liabilities (other
than liabilities representing leverage). There can be no assurance that the Fund
will achieve its investment objectives.
INVESTMENT ADVISOR. Western Asset Management Company will act as investment
advisor to the Fund. See "Management of the Fund."
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 , 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 60 of this prospectus. You may request a free copy of the Statement of
Additional Information by calling 1-800-345-7999 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 AMPS 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.
Investors in AMPS will be entitled to receive cash dividends at an annual
rate that may vary for the successive dividend periods for the AMPS. The
dividend rate for the initial dividend period will be % for Series M AMPS, %
for Series T AMPS, % for Series W AMPS, % for Series TH AMPS and % for
Series F AMPS. The initial dividend period for the AMPS is from the date of
issuance through , for Series M AMPS, , for Series T AMPS,
, for Series W AMPS, , for Series TH AMPS, and ,
for Series F AMPS. For subsequent dividend periods, the AMPS will pay dividends
based on a rate generally set at auctions held every seven days for each series
of the AMPS.* Generally, investors may only buy or sell AMPS
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* Although auctions to establish the dividend rate for each series of AMPS will
normally be held weekly in the absence of a special rate period, the Fund
anticipates that the initial auctions for each series of AMPS will not be held
until on or about the week of January 12-16, 2004.
through an order placed at an auction with or through a broker-dealer in
accordance with the procedures specified in this prospectus. Prospective
purchasers should carefully review the auction procedures described in this
prospectus, and should note:
- a buy order (called a "bid") or sell order is a commitment to buy or sell
AMPS based on the results of an auction; and
- purchases and sales will be settled on the next business day after the
auction.
The AMPS have a liquidation preference of $25,000 per share, plus any
accumulated, unpaid dividends. The AMPS also have priority over the Fund's
common shares of beneficial interest, no par value ("common shares"), as to
distribution of assets as described in this prospectus. See "Description of
AMPS." The Fund may redeem AMPS as described under "Description of
AMPS--Redemption."
The AMPS will not be listed on an exchange. You may only buy or sell AMPS
through an order placed at an auction with or through a broker-dealer that has
entered into an agreement with the auction agent or in a secondary market
maintained by certain broker-dealers. These broker-dealers are not required to
maintain this market, and there can be no assurance that a secondary market for
the AMPS 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 AMPS, and an investor that sells AMPS between auctions may
receive a price per share of less than $25,000.
The AMPS will be senior to the Fund's outstanding common shares. The Fund's
common shares are traded on the New York Stock Exchange under the symbol "WIA."
It is a condition of closing this offering that the AMPS be offered with a
rating of "Aaa" from Moody's and of "AAA" from Fitch.
TABLE OF CONTENTS
PAGE
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Prospectus Summary.................................................... 5
Financial Highlights.................................................. 18
The Fund.............................................................. 19
Use of Proceeds....................................................... 19
Capitalization........................................................ 20
Portfolio Composition................................................. 20
The Fund's Objectives, Strategies and Investments..................... 21
Risks................................................................. 27
How the Fund Manages Risk............................................. 34
Management of the Fund................................................ 36
Description of AMPS................................................... 38
The Auction........................................................... 46
Net Asset Value....................................................... 50
Description of Capital Structure...................................... 51
Anti-Takeover and Other Provisions in the Declaration of Trust........ 52
Repurchase of Fund Shares; Conversion to Open-End Fund................ 54
Tax Matters........................................................... 54
Underwriting.......................................................... 58
Custodian and Transfer Agent; Auction Agent........................... 59
Legal Matters......................................................... 59
Available Information................................................. 59
Table of Contents for the Statement of Additional Information......... 60
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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 these securities
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.
The Fund will amend or supplement this Prospectus to reflect material changes to
the information contained in this Prospectus to the extent required by
applicable law.
4
PROSPECTUS SUMMARY
This is only a summary. This summary may not contain all of the information
that you should consider before investing in the AMPS. You should review the
more detailed information contained in this Prospectus and in the Statement of
Additional Information.
THE FUND................ Western Asset/Claymore U.S. Treasury Inflation
Protected Securities Fund is a recently organized,
diversified, closed-end management investment company.
Throughout this prospectus, Western Asset/ Claymore
U.S. Treasury Inflation Protected Securities Fund is
referred to simply as the "Fund." The Fund commenced
investment operations on September 30, 2003, upon the
closing of an initial public offering of 25,250,000
common shares. As of November 20, 2003, the Fund had
28,831,981 common shares outstanding and total managed
assets of $616,800,106. The Fund's common shares are
traded on the New York Stock Exchange under the symbol
"WIA." See "The Fund." The Fund's principal office is
located at 117 East Colorado Boulevard, Pasadena,
California 91105, and its telephone number is (626)
844-9400.
THE OFFERING............ The Fund is offering 1,640 Series M AMPS, no par
value, 1,640 Series T AMPS, no par value, 1,640 Series
W AMPS, no par value, 1,640 Series TH AMPS, no par
value, and 1,640 Series F AMPS, no par value, each at
a purchase price of $25,000 per share plus dividends,
if any, that have accumulated from the date the Fund
first issues the AMPS. The AMPS are offered through
Merrill Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch") and Legg Mason Wood Walker,
Incorporated (together, the "Underwriters").
The AMPS entitle their holders to receive cash
dividends at an annual rate that may vary for the
successive dividend periods of the AMPS. In general,
except as described under "--Dividends on AMPS" below
and "Description of AMPS--Dividends and Rate Periods,"
the dividend period for each series of the AMPS will
be seven days. The auction agent will determine the
dividend rate for a particular rate period by an
auction conducted on the business day immediately
prior to the start of that rate period. See "The
Auction."
The AMPS are not listed on an exchange. Instead,
investors will generally buy or sell AMPS in an
auction by submitting orders to broker-dealers that
have entered into an agreement with the auction agent.
Generally, investors in AMPS will not receive
certificates representing ownership of their shares.
The securities depository (The Depository Trust
Company or any successor) or its nominee for the
account of the investor's broker-dealer will maintain
record ownership of AMPS in book-entry form. An
investor's broker-dealer, in turn, will maintain
records of that investor's beneficial ownership of
AMPS.
5
INVESTMENT ADVISOR...... Western Asset Management Company, a wholly owned
subsidiary of Legg Mason, Inc., serves as the
investment advisor to the Fund. Subject to supervision
by the Board of Trustees of the Fund (the "Board of
Trustees"), Western Asset Management Company is
responsible for managing the investment activities of
the Fund and certain of the Fund's business affairs
and other administrative matters. The Fund will pay
Western Asset Management Company an annual fee,
payable monthly, in an amount equal to .40% of the
Fund's average weekly assets. See "Management of the
Fund--Investment Advisor" for more information about
Western Asset Management Company and how this fee is
calculated. Western Asset Management Company is
referred to as "Western Asset" in this prospectus.
INVESTMENT OBJECTIVES... The Fund's primary investment objective is to provide
current income. Capital appreciation, when consistent
with current income, is a secondary investment
objective. No assurance can be given that the Fund
will achieve its investment objectives.
INVESTMENT POLICIES..... Under normal market conditions, the Fund will invest
at least 80% of its total managed assets in U.S. TIPS.
U.S. TIPS are fixed income securities issued by the
U.S. Department of the Treasury, the principal amounts
of which are adjusted daily based upon changes in the
rate of inflation (currently represented by the non-
seasonally adjusted CPI-U). The Fund may also invest
up to 20% of its total managed assets in corporate
bonds or other securities and instruments. The Fund
intends to limit its investments to U.S.
dollar-denominated securities and instruments, and
will not invest in bonds that are below investment
grade quality at the time of purchase. Investment
grade quality bonds are bonds rated within a rating
agency's four highest grades (Baa or BBB or higher by
Moody's, S&P or Fitch or a similar rating of another
nationally recognized rating agency) or bonds that are
unrated but judged to be of comparable quality by
Western Asset. The Fund may enter into short sales,
use reverse repurchase agreements and dollar rolls,
and engage in other types of transactions, including
derivative transactions (such as options, futures
contracts and swaps), for risk management purposes or
as part of its investment strategies. The Fund
currently expects that the average effective duration
of its portfolio will range between zero and 15 years,
although this target duration may change from time to
time. See "The Fund's Objectives, Strategies and
Investments."
LEVERAGE................ The Fund anticipates that, immediately after
completion of the offering of AMPS, the AMPS will
represent approximately 33% of the Fund's total
managed assets. The Fund entered into reverse
repurchase agreements and/or dollar roll transactions
for leveraging purposes as a substitute for all or a
portion of the AMPS offered hereunder during the
period prior to their issuance and will continue to
enter into such transactions following the issuance of
the AMPS to the extent determined by Western Asset.
The precise amount of leverage used by the Fund may
vary from time to time,
6
but the AMPS, together with other forms of leverage
(including reverse repurchase agreements and dollar
roll transactions), will not exceed 38% of its total
managed assets. "Total managed assets" means the total
assets of the Fund (including any assets attributable
to leverage) minus accrued liabilities (other than
liabilities representing leverage). For purposes of
calculating "total managed assets," the liquidation
preference of any preferred shares outstanding is not
considered a liability.
Although the Fund may in the future offer other
preferred shares, the Fund does not currently intend
to offer preferred shares other than the AMPS offered
in this prospectus. In addition to the forms of
leverage described above, the Fund currently expects
to use short sales, futures contracts, options, credit
default swaps, and/or other transactions that may in
certain circumstances be considered leverage. To the
extent that the Fund covers its obligations under such
transactions by the segregation of liquid assets, by
entering into offsetting transactions, or by owning
positions covering its obligations, such transactions
will not be considered leverage for purposes of the
Fund's policy on the amount of leverage it may incur.
However, these transactions, even if covered,
represent a form of economic leverage (although they
will not be considered "leverage" for purposes of
calculating total managed assets) and will involve
special risks. Although the Fund does not currently
intend to borrow from banks or other financial
institutions or issue commercial paper in order to
leverage its portfolio, it may do so in the future.
Bank borrowings and outstanding commercial paper will
be included when calculating the amount of the Fund's
outstanding leverage.
The Fund generally will not utilize leverage if it
anticipates that it would result in a lower return to
holders of the Fund's common shares ("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 dividends on the common
shares and of the net asset value and market price of
the common shares), and there can be no assurance that
the Fund's use of leverage will be successful. Because
the fees received by Western Asset are based on the
average weekly assets of the Fund (including assets
represented by the AMPS and other leverage), Western
Asset has a financial incentive for the Fund to issue
the AMPS and incur other leverage. See "Risks--General
Risks of Investing in the Fund--Leverage Risk."
SPECIAL RISK
CONSIDERATIONS........ RISKS OF INVESTING IN THE AMPS. Before investing in
the AMPS, you should consider certain risks carefully.
The primary risks of investing in AMPS are:
- the Fund will generally not be permitted to declare
dividends or other distributions with respect to
your AMPS or redeem your AMPS unless the Fund meets
certain asset coverage
7
requirements, as discussed in "Description of
AMPS--Rating Agency Guidelines and Asset Coverage";
- if an auction fails, you may not be able to sell
some or all of your AMPS;
- because of the nature of the market for the AMPS,
you may receive less than the price you paid for
your AMPS if you sell them outside of the auction,
especially when market interest rates are rising;
- a rating agency could downgrade the rating assigned
to the AMPS, which could affect the liquidity of
your investment;
- the Fund may be forced to redeem your AMPS to meet
regulatory or rating agency requirements, and may
voluntarily redeem your shares in certain
circumstances;
- in certain circumstances the Fund may not earn
sufficient income from its investments to pay
dividends on AMPS;
- if interest rates rise, the value of the Fund's
investment portfolio may decline, reducing the
asset coverage for the AMPS; and
- if an issuer of a bond in which the Fund invests
experiences financial difficulties or defaults, or
if an issuer in which the Fund invests is affected
by other adverse market factors, there may be a
negative impact on the income and/or asset value of
the Fund's investment portfolio, which will make it
more difficult for the Fund to pay dividends on the
AMPS and will reduce asset coverage for the AMPS.
In addition to the risks described above, certain
general risks relating to an investment in the Fund
may under certain circumstances reduce the Fund's
ability to pay dividends and meet its asset coverage
requirements on the AMPS. These risks include:
LIMITED OPERATING HISTORY. The Fund is a recently
organized, diversified, closed-end management
investment company that has been operational for fewer
than three months.
INTEREST RATE RISK. Interest rate risk is the risk
that the bonds in the Fund's portfolio (including U.S.
TIPS) will decline in value because of increases in
market interest rates. The prices of longer-term bonds
generally fluctuate more than prices of shorter-term
bonds as interest rates change. Because the Fund will
invest primarily in intermediate- to longer-term
bonds, the Fund's net asset value will fluctuate more
in response to changes in market interest rates than
if the Fund invested primarily in shorter-term bonds.
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, as described below, will
increase interest rate risk. See "Risks--General Risks
of Investing in the Fund--Leverage Risk."
8
RISKS RELATING TO U.S. TIPS. The value of
inflation-protected securities such as U.S. TIPS
generally fluctuates in response to changes in real
interest rates, which are in turn tied to the
relationship between nominal interest rates and the
rate of inflation. Therefore, if inflation were to
rise at a faster rate than nominal interest rates,
real interest rates might decline, leading to an
increase in value of U.S. TIPS. In contrast, if
nominal interest rates increased at a faster rate than
inflation, real interest rates might rise, leading to
a decrease in value of U.S. TIPS. Although the
principal value of U.S. TIPS declines in periods of
deflation, holders at maturity receive no less than
the par value of the bond. However, if the Fund
purchases U.S. TIPS in the secondary market whose
principal values have been adjusted upward due to
inflation since issuance, the Fund may experience a
loss if there is a subsequent period of deflation. If
inflation is lower than expected during the period the
Fund holds U.S. TIPS, the Fund may earn less on the
securities than on conventional bonds. Any increase in
principal value of U.S. TIPS caused by an increase in
the CPI-U is taxable in the year the increase occurs,
even though the Fund will not receive cash
representing the increase at that time. As a result,
the Fund could be required at times to liquidate other
investments, including when it is not advantageous to
do so, in order to satisfy its distribution
requirements as a regulated investment company under
the Internal Revenue Code of 1986, as amended (the
"Code"). See "Tax Matters."
If real interest rates rise (i.e., if interest rates
rise due to reasons other than inflation), the value
of the U.S. TIPS in the Fund's portfolio will decline.
In addition, because the principal amount of U.S. TIPS
would be adjusted downward during a period of
deflation, the Fund will be subject to deflation risk
with respect to its investments in these securities.
The daily adjustment of the principal value of U.S.
TIPS is currently tied to the non-seasonally adjusted
CPI-U, which is calculated monthly by the U.S. Bureau
of Labor Statistics. The CPI-U is a measurement of
changes in the cost of living, made up of components
such as housing, food, transportation and energy. Its
calculation includes a three-month lag. There can be
no assurance that such index will accurately measure
the real rate of inflation in the prices of goods and
services.
The U.S. Treasury only began issuing
inflation-protected securities in 1997, and the market
for such securities may be less developed or liquid,
and more volatile, than certain other securities
markets as a result. The U.S. Treasury currently
issues U.S. TIPS in only ten-year maturities, although
U.S. TIPS with different maturities have been issued
in the past and may be issued in the future.
CREDIT RISK. Credit risk is the risk that one or more
bonds in the Fund's portfolio will decline in price,
or fail to pay interest or principal when due, because
the issuer of the bond experiences a decline in its
financial status.
9
LOWER GRADE AND UNRATED SECURITIES RISK. Although the
Fund will not invest in securities that are below
investment grade quality at the time of purchase, the
Fund is not required to dispose of a security if a
rating agency or Western Asset downgrades its
assessment of the credit characteristics of a
particular issue. As a result the Fund may, from time
to time, hold bonds of below investment grade quality.
Lower grade securities, or equivalent unrated
securities, which are commonly known as "junk bonds,"
typically entail greater potential price volatility
and may be less liquid than higher-rated securities.
Lower grade securities are regarded as having
predominately speculative characteristics with respect
to the issuer's capacity to pay interest and repay
principal. These securities may also be more
susceptible to real or perceived adverse economic and
competitive industry conditions than higher-rated
securities. Unrated securities may be less liquid than
comparable rated securities and involve the risk that
Western Asset may not accurately evaluate the
security's comparative credit rating. Analysis of the
creditworthiness of issuers of lower grade securities
may be more complex than for issuers of higher-quality
debt obligations. To the extent that the Fund holds
lower grade and/or unrated securities, the Fund's
success in achieving its investment objectives may
depend more heavily on Western Asset's credit analysis
than if the Fund held exclusively higher-quality and
rated securities.
LEVERAGE RISK. The Fund is offering the AMPS in order
to purchase additional assets for investment purposes.
This practice is known as "leverage." Leverage risk
includes the risk associated with the issuance of AMPS
to leverage the Fund's common shares. The Fund intends
to use other instruments that may be considered
leverage under certain circumstances, including
reverse repurchase agreements, credit default swaps,
dollar rolls and other investment techniques, each of
which (to the extent that it is considered leverage)
will amplify the effects of leverage on the Fund's
portfolio. Counterparties on these instruments may
have a claim to the Fund's assets that is prior to the
claim of the holders of AMPS.
If the dividend rate on the AMPS and interest rates on
other forms of leverage, as reset periodically, exceed
the net rate of return on the Fund's portfolio, the
use of 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 AMPS would be reduced.
ISSUER RISK. The value of a corporate debt instrument
may decline for a number of reasons that directly
relate to the issuer, such as management performance,
financial leverage and reduced demand for the issuer's
goods and services.
SMALLER COMPANY RISK. The general risks associated
with corporate debt obligations are particularly
pronounced for securities issued by companies with
smaller market capitalizations. These companies may
have limited product lines, markets or financial
resources, or
10
may depend on a few key employees. As a result, they
may be subject to greater levels of credit, interest
rate and issuer risk. Securities of smaller companies
may trade less frequently and in less 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.
COUNTRY RISK. Investments in securities of non-U.S.
issuers (including those denominated in U.S. dollars)
involve certain risks not typically associated with
investments in domestic issuers. For example, the
value of those investments may decline in response to
unfavorable political and legal developments,
unreliable or untimely information, or economic and
financial instability. Settlement procedures outside
the U.S. may also involve additional risks. The risks
described in this paragraph will be greater to the
extent the Fund invests in securities of issuers based
in developing or "emerging market" countries.
PREPAYMENT RISK. Many fixed income securities,
especially those issued at high interest rates,
provide that the issuer may repay them early. Issuers
often exercise this right when interest rates decline.
Accordingly, holders of securities that may be called
or prepaid may not benefit fully from the increase in
value that other fixed income securities experience
when rates decline. Furthermore, the Fund reinvests
the proceeds of the payoff at current yields, which
are lower than those paid by the security that was
paid off.
REINVESTMENT RISK. Reinvestment risk is the risk that
income from the Fund's portfolio will decline if and
when the Fund reinvests the proceeds from matured,
traded or called bonds at market interest rates that
are below the portfolio's current earnings rate.
DERIVATIVES RISK. The Fund may invest in a variety of
derivative instruments for investment or risk
management purposes, such as options, futures
contracts and swaps. Derivatives are subject to a
number of risks described elsewhere in this
prospectus, such as interest rate risk, leverage risk
and management risk. The Fund will be subject to
credit risk with respect to the counterparties to the
derivatives contracts purchased by the Fund. If a
counterparty becomes bankrupt or otherwise fails to
perform its obligations under a derivatives contract,
the Fund may obtain only a limited recovery or may
obtain no recovery in such circumstances. Derivative
transactions also involve the risk of mispricing or
improper valuation, the risk of ambiguous
documentation and the risk that changes in the value
of a 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 to reduce
exposure to other risks when that would be beneficial
or that these transactions will be successful.
11
INFLATION/DEFLATION RISK. Inflation risk is the risk
that the Fund's assets or income from the Fund's
investments may be worth less in the future as
inflation decreases the value of money. As inflation
increases, the real value of the AMPS and
distributions could decline. Inflation risk is
expected to be greater with respect to the Fund's
investments in securities or instruments other than
U.S. TIPS. Deflation risk is the risk that prices
throughout the economy may decline over time--the
opposite of inflation. Deflation may have an adverse
effect 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. Because
the principal amounts of U.S. TIPS would be adjusted
downward during a period of deflation, the Fund will
be subject to deflation risk with respect to its
investments in such securities.
TURNOVER RISK. The length of time the Fund has held a
particular security is not generally a consideration
in investment decisions. A change in the securities
held by the Fund is known as "portfolio turnover." As
a result of the Fund's investment policies, under
certain market conditions the Fund's turnover rate may
be higher than that of other investment companies.
Portfolio turnover generally involves some expense to
the Fund, including brokerage commissions or dealer
mark-ups and other transaction costs on the sale of
securities and reinvestment in other securities. These
transactions may result in realization of taxable
capital gains. Higher portfolio turnover rates, such
as those above 100%, are likely to result in higher
brokerage commissions or other transaction costs and
could give rise to a greater amount of taxable capital
gains.
MANAGEMENT RISK. The Fund is subject to management
risk because it is an actively managed investment
portfolio. Western Asset 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 Agreement and
Declaration of Trust (as amended and restated, the
"Declaration") includes 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 change the composition of the Board of
Trustees.
MARKET DISRUPTION AND GEOPOLITICAL RISKS. The war with
Iraq, its aftermath and the continuing occupation of
the country by coalition forces are likely to have a
substantial impact on the U.S. and world economies and
securities markets. The duration and nature of the war
and occupation and the potential costs of rebuilding
the Iraqi infrastructure and political systems 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 the
occurrence of similar events cannot be
12
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 securities markets, interest rates,
auctions, secondary trading, ratings, credit risk,
inflation, deflation and other factors relating to the
AMPS.
CERTAIN AFFILIATIONS. Certain broker-dealers may be
considered to be affiliated persons of the Fund and/or
Western Asset. 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 regulatory and other
restrictions. This could limit the Fund's ability to
engage in securities transactions and take advantage
of market opportunities.
TRADING MARKET.......... The AMPS will not be listed on a stock exchange.
Instead, you may buy or sell AMPS at a periodic
auction by submitting orders to a broker-dealer that
has entered into a separate agreement with the auction
agent (a "Broker-Dealer") or to a broker-dealer that
has entered into an agreement with a Broker-Dealer. In
addition to the auctions, Broker-Dealers and other
broker-dealers may maintain a separate secondary
trading market in AMPS, but may discontinue this
activity at any time. You may transfer shares outside
of auctions only to or through a Broker-Dealer, a
broker-dealer that has entered into a separate
agreement with a Broker-Dealer, or other persons as
the Fund permits. There can be no assurance that a
secondary trading market for the AMPS will develop, or
if it does develop, that it will provide holders of
AMPS with liquidity of investment. See "The Auction."
RATINGS................. The Fund will issue the AMPS only if the AMPS have
received a credit quality rating of "Aaa" from Moody's
and of "AAA" from Fitch.
DIVIDENDS ON AMPS....... The table below shows the dividend rates, the dates of
accumulation at such rates, the dividend payment dates
and the number of days for the initial rate periods on
each series of AMPS offered in this prospectus, as
well as the subsequent dividend payment date for each
series. For subsequent dividend periods, AMPS will pay
dividends based on a rate set at auctions normally
held every seven days. In most instances, dividends
are payable on the first business day following the
end of the rate period. The rate set at auction will
not exceed the maximum applicable rate. See
"Description of AMPS--Dividends and Rate Periods."
13
Dividends on AMPS will be cumulative from the date the
shares are first issued and will be paid out of
legally available funds.
DIVIDEND NUMBER
DATE OF PAYMENT SUBSEQUENT OF DAYS
INITIAL ACCUMULATION DATE FOR DIVIDEND OF INITIAL
DIVIDEND AT INITIAL INITIAL RATE PAYMENT RATE
AMPS RATE RATE PERIOD DAY PERIOD
---- -------- ------------ -------------- ----------------- ----------
Series M...................... % Every Tuesday
Series T...................... % Every Wednesday
Series W...................... % Every Thursday
Series TH..................... % Every Friday
Series F...................... % Every Monday
Notwithstanding the schedule above, the Fund may,
subject to certain conditions, designate special rate
periods of more than seven days. The Fund may not
designate a special rate period unless sufficient
clearing bids were made in the most recent auction. In
addition, full cumulative dividends and any amounts
due with respect to mandatory redemptions or optional
redemptions must be paid in full or deposited with the
auction agent. The Fund also must have received
confirmation from Moody's and Fitch or any substitute
rating agency that the proposed special rate period
will not adversely affect such agency's then-current
rating on the AMPS. The Fund may establish one or more
dividend payment dates in respect of a special rate
period. The dividend payment date or dates for a
special rate period will be set out in the notice
designating the special rate period.
The Fund currently expects to declare a special rate
period under circumstances in which it has the
opportunity to secure an advantageous dividend rate on
the AMPS, although it may choose not to do so. These
circumstances could include, among others, (i) if
Western Asset believes that interest rates will rise
more than market expectations over a particular period
or (ii) if long-term interest and dividend rates are
lower than short-term interest and dividend rates for
a particular period. Depending on market conditions,
the Fund intends to declare a special rate period with
respect to Series M AMPS, Series W AMPS and Series F
AMPS shortly after the issuance of the AMPS.
DETERMINATION OF MAXIMUM
APPLICABLE RATE....... The applicable dividend rate for any rate period for a
series of AMPS will not exceed the maximum applicable
rate (calculated as described below) attributable to
such shares. The maximum applicable rate for each
series of AMPS will depend on the credit rating
assigned to such shares and on the duration of the
rate period. The maximum applicable rate will be the
higher of the applicable percentage of the reference
rate or the applicable spread plus the reference rate.
The reference rate is the applicable LIBOR Rate (for a
rate period of fewer than 365 days) or the applicable
Treasury Rate Index (for a rate period of 365 days or
more). The applicable percentage or applicable spread
as so determined is
14
further subject to upward but not downward adjustment
in the discretion of the Board of Trustees after
consultation with the Broker-Dealers, provided that
any such adjustment does not impair the rating of the
AMPS and that immediately following any such
adjustment the Fund could meet the Preferred Shares
Basic Maintenance Amount test (as described in
"Description of AMPS--Rating Agency Guidelines and
Asset Coverage"). The applicable percentage and spread
is as follows:
FITCH'S APPLICABLE
MOODY'S CREDIT RATING CREDIT RATING PERCENTAGE APPLICABLE SPREAD
--------------------- ------------- ---------- -----------------
Aaa AAA 125% 125 bps
Aa3 to Aa1 AA- to AA+ 150% 150 bps
A3 to A1 A- to A+ 200% 200 bps
Baa3 to Baa1 BBB- to BBB+ 250% 250 bps
Below Baa3 Below BBB- 300% 300 bps
There is no minimum applicable rate in respect of any
rate period. See "Description of AMPS--Dividends and
Rate Periods."
LIQUIDATION
PREFERENCE............ The liquidation preference (that is, the amount the
Fund must pay to holders of AMPS if the Fund is
liquidated) for AMPS will be $25,000 per share plus
accumulated but unpaid dividends, if any, whether or
not earned or declared.
ASSET MAINTENANCE....... Under revised Article Twelve set forth in the Fund's
Second Amended and Restated Bylaws (the "Second
Amended and Restated Bylaws"), attached as Appendix C
to the Statement of Additional Information, which
establishes and fixes the rights and preferences of
each series of AMPS, the Fund must maintain:
- asset coverage on the AMPS as required by the
rating agency or agencies rating the AMPS; and
- asset coverage of at least 200% with respect to
senior securities that are stock, including the
AMPS, as discussed in "Description of AMPS--Rating
Agency Guidelines and Asset Coverage."
In the event that the Fund does not maintain (or cure
a failure to maintain) these coverage tests, some or
all of the AMPS will be subject to mandatory
redemption. See "Description of AMPS--Redemption."
Based on the composition of the Fund's portfolio as of
November 20, 2003, the Fund estimates that the asset
coverage of the AMPS, as measured pursuant to the
Investment Company Act of 1940 and the rules and
regulations thereunder, as amended (the "1940 Act"),
would be approximately 300.51% if the Fund were to
issue all of the AMPS offered in this prospectus,
representing approximately 33% of the Fund's total
managed assets. This asset coverage will change from
time to time.
MANDATORY REDEMPTION.... If the Preferred Shares Basic Maintenance Amount or
the 1940 Act Preferred Shares Asset Coverage (each as
defined in the Second Amended and Restated Bylaws and
discussed in "Description of
15
AMPS--Rating Agency Guidelines and Asset Coverage") is
not maintained or restored in a timely manner, the
AMPS will be subject to mandatory redemption, out of
funds legally available, at the redemption price of
$25,000 per share plus an amount equal to dividends
thereon (whether or not earned or declared)
accumulated but unpaid to (but not including) the date
fixed for redemption. Any such redemption will be
limited to the minimum number of AMPS necessary to
restore the Preferred Shares Basic Maintenance Amount
or the 1940 Act Preferred Shares 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
AMPS--Redemption."
OPTIONAL REDEMPTION..... The AMPS are redeemable at the option of the Fund, in
whole or in part, on any dividend payment date at the
redemption price of $25,000 per share, plus an amount
equal to the accumulated but unpaid dividends (whether
or not earned or declared) to (but not including) the
date fixed for redemption. See "Description of
AMPS--Redemption."
Although the AMPS are subject to redemption under
certain circumstances as described above and under
"Description of AMPS--Redemption," the AMPS may not be
redeemed at a shareholder's option at net asset value,
unlike the shares of an open-end mutual fund.
VOTING RIGHTS........... The 1940 Act requires that the holders of any
outstanding series of AMPS and any other outstanding
preferred shares, voting together as a single class
separate from the Common Shareholders, have the right
to elect at least two Trustees of the Fund at all
times and to elect a majority of the Trustees if two
years' dividends on any outstanding series of the AMPS
or any other preferred shares are unpaid until all
unpaid dividends on all series of the AMPS and any
other preferred shares are paid (or otherwise provided
for). The holders of AMPS and any other outstanding
preferred shares will vote as a separate class (and,
in certain circumstances, the holders of each series
of AMPS will vote as a separate class) on certain
other matters as required under the Declaration, the
Fund's Bylaws, as amended (the "Bylaws"), or the 1940
Act. See "Description of AMPS--Voting Rights." Each
common share, each of the AMPS, and each share of any
other series of preferred shares of the Fund is
entitled to one vote per share.
FEDERAL INCOME
TAXATION.............. The distributions with respect to any series of AMPS
(other than distributions in redemption of AMPS
subject to Section 302(b) of 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. For
taxable years beginning on or before December 31,
2008, provided holding period and other requirements
are met, the Fund may designate distributions of
investment income derived from dividends of U.S.
corporations and some foreign corporations as
"qualified dividend income." Qualified
16
dividend income will be taxed in the hands of
individuals at the rates applicable to long-term
capital gain, provided these same holding period and
other requirements are met by the shareholder. The
Fund does not expect a significant portion of Fund
distributions to be derived from qualified dividend
income. 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
AMPS 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 will similarly be
allocated between and among classes. See "Tax
Matters."
CUSTODIAN, AUCTION
AGENT, TRANSFER AGENT,
REGISTRAR, DIVIDEND
PAYING AGENT AND
REDEMPTION AGENT...... State Street Bank & Trust Company serves as the Fund's
custodian. Deutsche Bank Trust Company Americas serves
as auction agent, transfer agent, registrar, dividend
paying agent and redemption agent for the AMPS.
17
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 September 30, 2003
through November 20, 2003. Because the Fund is recently organized and commenced
investment operations on September 30, 2003, the table covers fewer than eight
weeks of operations, during which a substantial portion of the Fund's portfolio
was held in temporary investments pending investment in bonds and other
investments that meet the Fund's investment objectives and policies.
Accordingly, the information presented may not provide a meaningful picture of
the Fund's operating performance.
FOR THE PERIOD FROM
SEPTEMBER 30, 2003*
THROUGH NOVEMBER 20, 2003
-------------------------
(UNAUDITED)
PER COMMON SHARE OPERATING PERFORMANCE
Net Asset Value, Beginning of Period.............. $ 14.33(1)
--------
Less Offering Costs Charged to Additional Paid in
Capital......................................... $ (0.03)
Income From Investment Operations:
Net Investment Income........................... $ 0.13
Net Realized and Unrealized Gain/(Loss) on
Investments................................... $ 0.08
--------
Total from Investment Operations.............. $ 0.21
Less Dividends and Distributions to Shareholders
from:
Net Investment Income........................... $ 0.00
Net Realized Gain on Investments................ $ 0.00
Return of Capital............................... $ 0.00
Total Dividends and Distributions to
Shareholders................................ $ 0.00
Net Increase/(Decrease) in Net Assets............. $ 0.21
Net Asset Value, End of Period(2)................. $ 14.51
========
Per Share Market Value, End of Period(2).......... $ 15.35
========
Total Return on NAV Excluding Offering Costs...... 1.26%(3)
Total Investment Return on Market Value........... 2.33%(4)
RATIOS/SUPPLEMENTAL DATA:
Net Assets, End of Period (in thousands).......... $418,361
Ratio of Expenses to Average Weekly Net Assets
(including interest expense)(5)................. 1.34%(6)
Ratio of Net Investment Income to Average Daily
Net Assets...................................... 6.73%(6)
Portfolio Turnover Rate........................... 98.00%(6)
-------------------
* Date of commencement of operations
(1) Net sales load of $0.68 on initial shares issued.
(2) Net asset value and market value are published in THE WALL STREET JOURNAL
each Monday.
(3) Not annualized. Total return on NAV including offerings costs is 1.47%.
(4) Total investment return is calculated assuming a purchase of common stock
on the opening of the first day and a sale on the closing of the last day
of period. Total investment return is not annualized. Brokerage commissions
are not reflected.
(5) As a percentage of weekly net assets, which includes any liabilities or
senior securities constituting indebtedness in connection with financial
leverage.
(6) Annualized.
18
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 July 14, 2003, pursuant to the Declaration,
which is governed by the laws of The Commonwealth of Massachusetts. The Fund's
principal office is located at 117 East Colorado Boulevard, Pasadena, California
91105, and its telephone number is (626) 844-9400.
The Fund commenced operations on September 30, 2003, upon the closing of an
initial public offering of 25,250,000 of its common shares. The proceeds of such
offering were approximately $360,948,750 after the payment of organizational and
offering expenses. In connection with the initial public offering of the Fund's
common shares, the underwriters for the common shares were granted an option to
purchase up to an additional 3,787,500 common shares to cover over-allotments.
On October 27, 2003, and November 12, 2003, such underwriters purchased, in each
case at a price of $14.325 per common share, an additional 1,750,000 and
1,825,000 common shares of the Fund, respectively, pursuant to the
over-allotment option. The Fund's common shares are traded on the New York Stock
Exchange under the symbol "WIA."
USE OF PROCEEDS
The net proceeds of the offering of AMPS will be approximately $202,645,415
after payment of the sales load and estimated offering costs (not expected to
exceed $304,585). The Fund will invest the net proceeds of the offering in
accordance with the Fund's investment objectives and policies as stated below.
It is presently anticipated that the Fund will use the net proceeds of the
offering to purchase U.S. TIPS and other investments that meet its investment
objectives and policies and/or to repay certain currently outstanding reverse
repurchase agreements or other leverage. Pending such use, it is anticipated
that the proceeds will be invested in short-term investment grade securities.
19
CAPITALIZATION
The following table sets forth the unaudited capitalization of the Fund as
of November 20, 2003, and as adjusted to give effect to the issuance of the AMPS
offered hereby (including estimated offering expenses and sales load of
$2,354,585).
ACTUAL AS ADJUSTED
------------ ------------
Series M AMPS, no par value (no shares
issued; 1,640 shares issued, as
adjusted, at $25,000 per share
liquidation preference)............... $ 0 $ 41,000,000
Series T AMPS, no par value (no shares
issued; 1,640 shares issued, as
adjusted, at $25,000 per share
liquidation preference)............... $ 0 $ 41,000,000
Series W AMPS, no par value (no shares
issued; 1,640 shares issued, as
adjusted, at $25,000 per share
liquidation preference)............... $ 0 $ 41,000,000
Series TH AMPS, no par value (no shares
issued; 1,640 shares issued, as
adjusted, at $25,000 per share
liquidation preference)............... $ 0 $ 41,000,000
Series F AMPS, no par value (no shares
issued; 1,640 shares issued, as
adjusted, at $25,000 per share
liquidation preference)............... $ 0 $ 41,000,000
------------ ------------
Total AMPS.............................. $ 0 $205,000,000
============ ============
Common shares, no par value, unlimited
shares authorized, 28,831,981 shares
issued and outstanding................ $412,257,166 $409,902,581
Undistributed net investment income..... $ 3,621,198 $ 3,621,198
Accumulated net realized gain/(loss)
on investment transactions.......... $ 771,593 $ 771,593
Net unrealized
appreciation/(depreciation) on
investments......................... $ 1,711,325 $ 1,711,325
------------ ------------
Net assets applicable to Common
Shares.............................. $418,361,282 $416,006,697
============ ============
PORTFOLIO COMPOSITION
The following table sets forth certain information with respect to the
composition of the Fund's investment portfolio as of November 20, 2003, based on
the highest rating assigned each investment.
CREDIT RATING VALUE PERCENT
------------- ------------ -------
Aaa/AAA................................. $527,307,141 85.49%
Aa/AA................................... 15,875,284 2.57
A/A..................................... 0 0
Baa/BBB................................. 73,617,681 11.94
Ba/BB................................... 0 0
B/B..................................... 0 0
Caa/CCC................................. 0 0
Unrated+................................ 0 0
------------ ------
Total................................. $616,800,106 100.0%
============ ======
-------------------
+ Refers to securities that have not been rated by Moody's, S&P, Fitch or
another nationally recognized rating agency. See "The Fund's Objectives,
Strategies and Investments--Portfolio Contents and Management Strategies."
U.S. TIPS are unrated, but are backed by the full faith and credit of the
United States and are therefore considered by Western Asset to be
comparable to bonds rated Aaa/AAA.
20
THE FUND'S OBJECTIVES, STRATEGIES AND INVESTMENTS
INVESTMENT OBJECTIVES
The Fund's primary investment objective is to provide current income.
Capital appreciation, when consistent with current income, is a secondary
investment objective. No assurance can be given that the Fund will achieve its
investment objectives.
PORTFOLIO CONTENTS AND MANAGEMENT STRATEGIES
GENERAL. Under normal market conditions, the Fund will invest at least 80%
of its total managed assets in U.S. TIPS. U.S. TIPS are fixed income securities
issued by the U.S. Department of the Treasury, the principal amounts of which
are adjusted daily based upon changes in the rate of inflation (currently
represented by the non-seasonally adjusted CPI-U, calculated with a three-month
lag). The Fund may invest up to 20% of its total managed assets in corporate
bonds or other securities and instruments. The Fund will invest primarily in
bonds that, in the opinion of Western Asset, provide current income and, when
consistent with current income, may have the potential for capital appreciation.
When consistent with the Fund's investment objectives, Western Asset may, but is
not required to, use a variety of derivative instruments for risk management
purposes or as part of its investment strategies. See
"--Investments--Derivatives" below.
The Fund anticipates that, immediately after completion of the offering of
AMPS, the AMPS will represent approximately 33% of the Fund's total managed
assets. The Fund entered into reverse repurchase agreements and/or dollar roll
transactions for leveraging purposes as a substitute for all or a portion of the
AMPS offered hereunder during the period prior to their issuance and will
continue to enter into such transactions following the issuance of the AMPS to
the extent determined by Western Asset. The precise amount of leverage used by
the Fund may vary from time to time, but the AMPS, together with other forms of
leverage (including reverse repurchase agreements and dollar roll transactions),
will not exceed 38% of its total managed assets. The Fund also currently expects
to use short sales, futures contracts, options, credit default swaps and other
investment techniques that may in certain circumstances be considered leverage.
The Fund may (but is not required to) cover its commitments under these
transactions by the segregation of liquid assets or by entering into offsetting
transactions or owning positions covering its obligations. To the extent these
transactions are so covered, investment in these transactions will not be
considered leverage for purposes of the Fund's policy on the amount of leverage
it may incur. However, such transactions, even if so covered, represent a form
of economic leverage (although they will not be considered "leverage" for
purposes of calculating total managed assets), and thus entail special risks.
See "Risks--General Risks of Investing in the Fund--Leverage Risk." While the
Fund does not currently anticipate borrowing funds from banks or other financial
institutions in order to leverage its portfolio, it may do so in the future.
Upon Western Asset's recommendation, during temporary defensive periods
(including the period during which the net proceeds of this offering are being
invested) and in order to keep the Fund's cash fully invested, the Fund may
invest up to 100% of its total managed assets in short-term investments,
including, but not limited to, U.S. government securities, certificates of
deposit, bankers' acceptances, commercial paper and repurchase agreements. Such
periods will not be considered "normal market conditions" for purposes of the
80% test described above. The Fund may not achieve its investment objectives
under these circumstances.
The Fund may borrow money in an amount up to 5% of its total assets as a
temporary measure for extraordinary or emergency purposes, including the payment
of dividends and the settlement of
21
securities transactions that otherwise might require untimely dispositions of
Fund securities. Such borrowings are not considered leverage for purposes of the
Fund's policy on the amount of leverage it may incur.
The Fund cannot change its investment objectives without the approval of the
holders of a "majority of the outstanding" common shares and preferred shares
(including the AMPS), voting together as a single class. In addition, the
holders of a "majority of the outstanding" preferred shares (including the AMPS)
voting separately as a class would have to approve any change in the Fund's
investment objectives. Under the 1940 Act, a "majority of the outstanding"
shares (whether voting together as a single class or voting as a separate class)
means (1) 67% or more of the outstanding shares present at a meeting, if the
holders of more than 50% of the shares are present or represented by proxy, or
(2) more than 50% of the outstanding shares, whichever is less. See "Description
of AMPS--Voting Rights" for additional information with respect to the voting
rights of holders of AMPS.
So long as and to the extent it is required by applicable law, the Fund will
not change its policy to invest, under normal market conditions, at least 80% of
its total managed assets in U.S. TIPS unless it provides shareholders with at
least 60 days' written notice of such change.
CREDIT QUALITY. The Fund will not invest in bonds that are below investment
grade quality at the time of purchase. Investment grade quality bonds are bonds
rated within a rating agency's four highest grades (Baa or BBB or higher by
Moody's, S&P or Fitch or a similar rating of another nationally recognized
rating agency) or bonds that are unrated but judged to be of comparable quality
by Western Asset. If a bond is rated differently by two or more nationally
recognized rating agencies, Western Asset may rely on the higher rating if it
believes that rating to be more accurate. The Fund expects that the initial
dollar-weighted credit quality of its bond portfolio will be AA, and that, under
normal market conditions, substantially all of the Fund's assets will be of
investment grade quality. However, the portfolio's credit quality will vary from
time to time. Changes in economic conditions or other circumstances are more
likely to lead to a weakened capacity for bonds that are graded Baa or BBB (or
that are of comparable quality) to make principal and interest payments than is
the case for higher quality bonds. Although the Fund will not invest in bonds
that are below investment grade quality at the time of purchase, the Fund is not
required to dispose of a security if a rating agency or Western Asset downgrades
its assessment of the credit characteristics of a particular issue. As a result,
the Fund may from time to time hold bonds of below investment grade quality. As
described under "Risks--General Risks of Investing in the Fund--Lower Grade and
Unrated Securities Risk," bonds of below investment grade quality are regarded
as having predominately speculative characteristics with respect to the issuer's
capacity to pay interest and repay principal and are commonly referred to as
"junk bonds." The Fund may purchase unrated securities (which are not rated by a
rating agency) if Western Asset determines that the securities are of a quality
comparable to rated securities that the Fund may purchase.
The Fund's credit quality policies depend in part on credit ratings
developed by rating agencies such as Moody's, S&P and Fitch. Rating agencies are
private services that provide ratings of the credit quality of debt obligations,
including convertible securities. 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
ratings of a debt security may change over time. Rating agencies monitor and
evaluate the ratings assigned to securities on an ongoing basis. As a result,
rated debt 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. See "Risks--
General Risks of Investing in the Fund--Lower Grade and Unrated Securities
Risk."
22
The credit quality policies described in this prospectus and the Statement
of Additional Information apply only at the time a security is purchased, and,
as noted above, the Fund is not required to dispose of a security if a rating
agency or Western Asset downgrades its assessment of the credit characteristics
of a particular issue. In determining whether to retain or sell such a security,
Western Asset may consider such factors as its assessment of the credit quality
of the issuer of the security, the price at which the security could be sold,
and the rating, if any, assigned to the security by other rating agencies. For
purposes of the Fund's credit quality policies, the Fund will consider a bond
that has been assigned any rating by a rating agency within the category Baa/BBB
to be rated Baa/BBB grade by such rating agency (e.g., a bond rated BBB- will be
considered to be a bond graded BBB). Appendix A to the Statement of Additional
Information contains a general description of Moody's, S&P's and Fitch's ratings
of debt securities.
DURATION. As part of the management of the Fund, Western Asset will manage
the effective duration of the Fund's portfolio. The Fund currently expects that
the average effective duration of its portfolio will range between zero and 15
years, although this target duration may change from time to time. Effective
duration measures the expected sensitivity of market price to changes in
interest rates, taking into account the effects of structural complexities. Each
year of duration represents an expected 1% change in the price of a bond for
every 1% change in interest rates. For example, if a bond has a duration of four
years, its price will fall about 4% when interest rates rise by 1%. Conversely,
the bond's price will rise about 4% when interest rates fall by 1%.
INVESTMENTS
U.S. TIPS. Under normal market conditions, the Fund will invest at least 80%
of its total managed assets in U.S. TIPS. U.S. TIPS are fixed income securities
issued by the U.S. Department of the Treasury, the principal amounts of which
are adjusted daily based upon changes in the rate of inflation (currently
represented by the non-seasonally adjusted CPI-U, calculated with a three-month
lag).
The U.S. Treasury currently issues U.S. TIPS in only ten-year maturities,
although it is possible that U.S. TIPS with other maturities will be issued in
the future. U.S. TIPS have previously been issued with maturities of five, ten
or thirty years. U.S. TIPS pay interest on a semi-annual basis, equal to a fixed
percentage of the inflation-adjusted principal amount. The interest rate on
these bonds is fixed at issuance, but over the life of the bond, this interest
may be paid on an increasing or decreasing principal value that has been
adjusted for inflation. Repayment of the original bond principal upon maturity
(as adjusted for inflation) is guaranteed even during a period of deflation.
However, because the principal amount of U.S. TIPS would be adjusted downward
during a period of deflation, the Fund will be subject to deflation risk with
respect to its investments in these securities. In addition, the current market
value of the bonds is not guaranteed, and will fluctuate. If the Fund purchases
U.S. TIPS in the secondary market whose principal values have been adjusted
upward due to inflation since issuance, the Fund may experience a loss if there
is a subsequent period of deflation. If inflation is lower than expected during
the period the Fund holds a U.S. TIPS, the Fund may earn less on the security
than on a conventional bond.
Investing in U.S. TIPS involves certain risks. See "Risks--General Risks of
Investing in the Fund--Risks Relating to U.S. TIPS." The Fund may invest in
inflation-protected securities with other structures or characteristics as such
securities become available in the market. It is currently expected that other
types of inflation-protected securities would have characteristics similar to
those described above.
U.S. GOVERNMENT SECURITIES. The Fund intends to invest primarily in U.S.
TIPS, which are a type of U.S. government security, and may also invest in other
types of U.S. government securities. U.S.
23
government securities 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. U.S. government securities are subject to interest rate
risk, and, in some cases, may be subject to credit risk.
CORPORATE BONDS. The Fund may invest in corporate bonds. The investment
return of corporate bonds reflects interest on the security and changes in the
market value of the security. The market value of a corporate bond generally may
be expected to rise and fall inversely with interest rates, and may also be
affected by the credit rating of the corporation, the corporation's performance,
perceptions of the corporation in the marketplace and general market liquidity.
The value of the intermediate- and longer-term corporate bonds in which the Fund
generally will invest normally fluctuates more in response to changes in
interest rates than does the value of shorter-term corporate bonds. There is a
risk that the issuers of corporate bonds may not be able to meet their
obligations on interest or principal payments at the time called for by a bond.
REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLL TRANSACTIONS. A reverse
repurchase agreement is a portfolio management technique in which the Fund
temporarily transfers possession of a portfolio instrument to another person,
such as a financial institution or broker-dealer, in return for cash, which the
Fund then uses to purchase additional investments. At the same time, the Fund
agrees to repurchase the instrument at an agreed upon time (normally within
seven days) and price, including an interest payment. While engaging in reverse
repurchase agreements, the Fund may maintain cash or securities in a segregated
account or may otherwise enter into positions that would cover such obligations.
To the extent assets are segregated or the Fund's obligation is otherwise
"covered," these instruments will not be considered leverage for purposes of the
1940 Act, and thus will not be subject to the 300% asset coverage test described
under "Description of Capital Structure." However, the Fund considers such
instruments to be leverage for purposes of its policy on the amount of leverage
it may incur. The Fund has engaged in reverse repurchase agreements and dollar
roll transactions during the period prior to the issuance of the AMPS, as a
substitute form of leverage for all or a portion of the AMPS, and intends to
continue to do so following the issuance of AMPS to the extent described
under "--Portfolio Contents and Management Strategies--General" above. Reverse
repurchase agreements may expose the Fund to greater fluctuations in the value
of its assets and render the segregated assets unavailable for sale or other
disposition.
The Fund may also enter into dollar roll transactions in which the Fund
sells a fixed income security for delivery in the current month and
simultaneously contracts to purchase substantially similar (same type, coupon
and maturity) securities at an agreed upon future time. By engaging in a dollar
roll transaction the Fund forgoes principal and interest paid on the security
that is sold, but receives the difference between the current sales price and
the forward price for the future purchase. The Fund would also be able to earn
interest on the income that is received from the initial sale.
The obligation to purchase securities on a specified future date involves
the risk that the market value of the securities that the Fund is obligated to
purchase may decline below the purchase price. In addition, in the event the
other party to the transaction files for bankruptcy, becomes insolvent or
defaults on its obligation, the Fund may be adversely affected. In addition, the
interest costs associated with reverse repurchase agreements and dollar roll
transactions will reduce the Fund's net asset value and could, in some
circumstances, leave the Fund worse off than if it had not used such
instruments. For purposes of calculating the Fund's total managed assets, any
liability associated with reverse repurchase agreements or dollar roll
transactions will not be taken into account.
24
SHORT SALES. A short sale is a transaction in which the Fund sells an
instrument that it does not own in anticipation that the market price will
decline. The Fund may use short sales for investment and risk management
purposes. When the Fund engages in a short sale, it must borrow the security
sold short and deliver it to the counterparty. The Fund may have to pay a fee to
borrow particular securities and would often be obligated to pay over any
payments received on such borrowed securities. The Fund's obligation to replace
the borrowed security will be secured by collateral deposited with the lender,
which is usually a broker-dealer, and/or with the Fund's custodian. The Fund may
not receive any payments (including interest) on its collateral. Short sales
expose the Fund to the risk that it will be required to cover its short position
at a time when the securities have appreciated in value, thus resulting in a
loss to the Fund. Although it does not currently expect to do so under normal
market conditions, the Fund may engage in so-called "naked" short sales where it
does not own or have the immediate right to acquire the security sold short at
no additional cost, in which case the Fund's losses could be unlimited.
CREDIT DEFAULT SWAPS. The Fund may enter into credit default swap contracts
for investment purposes and to leverage its portfolio. As the seller in a credit
default swap contract, the Fund would be required to pay the par (or other
agreed-upon) value of a referenced debt obligation to the counterparty in the
event of a default by a third party, such as a corporate issuer, on the debt
obligation. In return, the Fund would receive from the counterparty a periodic
stream of payments over the term of the contract provided that no event of
default had occurred. These payments are based on the difference between an
interest rate applicable to the relevant issuer and a benchmark interest rate
for a given maturity. If no default occurred, the Fund would keep the stream of
payments and would have no payment obligations. As the seller, the Fund would
effectively add leverage to its portfolio because, in addition to its total
managed assets, the Fund would be subject to investment exposure on the notional
amount of the swap.
For hedging purposes, the Fund may also purchase credit default swaps, in
which case it would make periodic payments to the counterparty in exchange for
the right to receive the notional value of the underlying debt obligation in the
event of a default. The Fund may (but is not required to) cover any accrued but
unpaid net amounts owed to a swap counterparty through the segregation of liquid
assets. To the extent assets are segregated, these transactions will not be
considered leverage for purposes of the Fund's policy on the amount of leverage
it may incur.
LOANS OF PORTFOLIO SECURITIES. The Fund may lend its portfolio securities in
order to earn income. The Fund will receive collateral in cash or high quality
securities at least equal to the current value of the loaned securities. The
Fund earns interest on the securities it lends and income when it invests the
collateral for the loaned securities. These loans will be limited to 33 1/3% of
the value of the Fund's total assets.
DERIVATIVES. The Fund may, but is not required to, use a variety of
derivative instruments for risk management purposes or as part of its investment
strategies. Generally, derivatives are financial contracts whose value depends
upon, or is derived from, the value of an underlying asset, reference rate or
index, and often may relate to individual debt instruments, interest rates,
commodities and related indexes. Examples of derivative instruments that the
Fund may use include options contracts, futures contracts, options on futures
contracts, warrants and swaps. 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--General Risks of Investing in the Fund--Derivatives Risk."
WHEN-ISSUED, DELAYED DELIVERY AND FORWARD COMMITMENT TRANSACTIONS. The Fund
may buy and sell bonds on a when-issued, delayed delivery or forward commitment
basis, with settlement occurring at a later date, normally within 45 days of the
trade date. These transactions involve risk because no interest
25
accrues on the bonds prior to settlement and because the value of the bonds at
time of delivery may be less (or more, in the case of a sale by the Fund) than
cost (or the agreed upon price). When such transactions are outstanding, the
Fund may segregate until the settlement date assets determined to be liquid by
Western Asset in an amount sufficient to meet its obligations. To the extent
assets are segregated, these transactions will not be considered leverage for
purposes of the Fund's policy on the amount of leverage it may incur.
PREFERRED STOCK. The Fund may invest in preferred stock. Preferred stock
pays dividends at a specified rate and has preference over common stock in the
payment of dividends and the liquidation of an issuer's assets but is junior to
the debt securities of the issuer in those same respects. The market prices of
preferred stocks are subject to changes in interest rates and are more sensitive
to changes in an issuer's creditworthiness than are the prices of debt
securities. Holders of preferred stock may also suffer a loss of value if
dividends are not paid. Under ordinary circumstances, preferred stock does not
carry voting rights.
STRUCTURED NOTES AND RELATED INSTRUMENTS. The Fund may invest in
"structured" notes and other related instruments, which are privately negotiated
debt obligations the principal and/or interest of which 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. Structured instruments may be issued by corporations and banks as well as
by governmental agencies. Structured instruments frequently are assembled in the
form of medium-term notes, but a variety of forms are available and may be used
in particular circumstances. The terms of such structured instruments normally
provide that their principal and/or interest payments are to be adjusted upwards
or downwards (but ordinarily not below zero) to reflect changes in the embedded
index while the structured instruments are outstanding. As a result, the
interest and/or principal payments that may be made on a structured product may
vary widely, depending on a variety of factors, including the volatility of the
embedded index and the effect of changes in the embedded index on principal
and/or interest payments. Western Asset may utilize structured instruments for
investment purposes and also for risk management purposes, such as to reduce the
duration and interest rate sensitivity of the Fund's portfolio.
While structured instruments may offer the potential for a favorable rate of
return from time to time, they also entail certain risks. Structured instruments
may be less liquid than other debt securities, and the price of structured
instruments may be more volatile. In some cases, depending on the terms of the
embedded index, a structured instrument may provide that the principal and/or
interest payments may be adjusted below zero. Structured investments may also
involve significant credit risk and risk of default by the counterparty.
Although structured instruments are not necessarily illiquid, Western Asset
believes that most structured instruments are illiquid. Like other sophisticated
strategies, the Fund's use of structured instruments may not work as intended.
If the value of the embedded index changes in a manner other than that expected
by Western Asset, principal and/or interest payments received on the structured
instrument may be substantially less than expected. In addition, if Western
Asset uses structured instruments to reduce the duration of the Fund's
portfolio, this may limit the Fund's return when having a longer duration would
be beneficial (for instance, when interest rates decline).
OTHER INVESTMENT COMPANIES. The Fund may invest in securities of other
closed-end or open-end investment companies that invest primarily in bonds or
other securities and instruments of the types in which the Fund may invest
directly. The Fund may invest in other investment companies 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 the AMPS, during periods when
there is a shortage of attractive bonds available in the market, or when Western
Asset believes share prices of other investment companies offer attractive
values. The Fund may invest in investment companies that are advised by Western
Asset or its affiliates to the extent permitted by applicable law and/or
pursuant to exemptive relief from the
26
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. Western Asset will take expenses into account when
evaluating the investment merits of an investment in an investment company
relative to available bond investments. In addition, the securities of other
investment companies may also be leveraged and will therefore be subject to the
same leverage risks described herein. As described in the section entitled
"Risks--General Risks of Investing in the Fund--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. Other investment companies may have investment policies that
differ from those of the Fund. In addition, to the extent the Fund invests in
other investment companies, the Fund will be dependent upon the investment and
research abilities of persons other than Western Asset. For purposes of the
Fund's investment policies, an investment in such investment companies will be
(1) treated as an investment in U.S. TIPS (to the extent the underlying
investment company invests under normal market conditions at least 80% of its
total assets in U.S. TIPS) and (2) assigned a credit rating deemed appropriate
by Western Asset.
NEW SECURITIES AND OTHER INVESTMENT TECHNIQUES. New types of securities and
other investment and hedging practices are developed from time to time. Western
Asset expects, consistent with the Fund's investment objectives and policies, to
invest in such new types of securities and to engage in such new types of
investment practices if Western Asset believes that these investments and
investment techniques may assist the Fund in achieving its investment
objectives. In addition, Western Asset may use investment techniques and
instruments that are not specifically described herein.
RISKS
RISKS OF INVESTING IN THE AMPS
INTEREST RATE RISK. The AMPS pay dividends based on shorter-term interest
rates. The Fund invests assets attributable to the AMPS principally in
intermediate- and longer-term bonds, the interest rates on which are typically,
although not always, higher than shorter-term interest rates. Both shorter-term
and intermediate- to longer-term interest rates may fluctuate. If shorter-term
interest rates rise, dividend rates on the AMPS may rise so that the amount of
dividends to be paid to holders of AMPS exceeds the income from the
intermediate-and longer-term bonds and other investments purchased by the Fund
with assets attributable to the AMPS. Because income from the Fund's entire
investment portfolio (not just the portion of the portfolio purchased with
assets attributable to the AMPS) is available to pay dividends on the AMPS,
however, dividend rates on the AMPS would need to exceed the Fund's net
portfolio income by a wide margin before the Fund's ability to pay dividends on
the AMPS would be jeopardized. If intermediate- to longer-term interest rates
rise, this could negatively impact the value of the Fund's investment portfolio,
reducing the amount of assets serving as asset coverage for the AMPS.
AUCTION RISK. You may not be able to sell your AMPS at an auction if the
auction fails, i.e., if there are more AMPS offered for sale than there are
buyers for those shares. Also, if you place a bid order (an order to retain
AMPS) at an auction only at a specified rate, and that rate exceeds the rate set
at the auction, your order will be deemed an irrevocable offer to sell your
AMPS, and you will not retain your AMPS. Additionally, if you buy shares or
elect to retain AMPS without specifying a rate below which you would not wish to
buy or continue to hold those shares, and the auction sets a below-market rate,
you may receive a lower rate of return on your shares than the market rate for
similar investments. Finally, the dividend period and rate period for the AMPS
may be changed by the Fund, subject to certain conditions and with notice to the
holders of the AMPS, which could also affect the liquidity of your investment.
See "Description of AMPS" and "The Auction."
27
SECONDARY MARKET RISK. If you try to sell your AMPS between auctions, you
may not be able to sell any or all of your shares, or you may not be able to
sell them for $25,000 per share or $25,000 per share plus accumulated dividends.
Changes in interest rates could affect the price you would receive if you sold
your shares in the secondary market, particularly if the Fund has designated a
special rate period (a rate period of more than seven days). Broker-dealers that
maintain a secondary trading market (if any) for the AMPS are not required to
maintain this market, and the Fund is not required to redeem shares if either an
auction or an attempted secondary market sale fails because of a lack of buyers.
The AMPS are not registered on a stock exchange or the National Association of
Securities Dealers Automated Quotations, Inc. ("NASDAQ") stock market. If you
sell your AMPS to a broker-dealer between auctions, you may receive less than
the price you paid for them, especially when market interest rates have risen
since the last auction or during a special rate period.
RATINGS AND ASSET COVERAGE RISK. While it is a condition to the closing of
the offering that Moody's assigns a rating of "Aaa" and Fitch assigns a rating
of "AAA" to the AMPS, these ratings do not eliminate or necessarily mitigate the
risks of investing in AMPS. In addition, Moody's, Fitch or another rating agency
then rating the AMPS could downgrade the AMPS, which may make your shares less
liquid at an auction or in the secondary market. If a rating agency downgrades
the AMPS, the Fund may (but is not required to) alter its portfolio in an effort
to improve the rating, although there is no assurance that it will be able to do
so to the extent necessary to restore the prior rating. See "--General Risks of
Investing in the Fund--Turnover Risk." In addition, the Fund may be forced to
redeem your AMPS to meet regulatory or rating agency requirements. The Fund may
also voluntarily redeem AMPS under certain circumstances. See "Description of
AMPS--Redemption." The asset coverage requirements imposed by a rating agency
may limit the Fund's ability to invest in certain securities or utilize certain
investment techniques that Western Asset might otherwise consider desirable. See
"Description of AMPS--Rating Agency Guidelines and Asset Coverage" for a
description of the rating agency guidelines with which the Fund must currently
comply.
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS. Restrictions imposed on
the declaration and payment of dividends or other distributions to the holders
of the Fund's common shares and AMPS, both by the 1940 Act and by requirements
imposed by rating agencies, might impair the Fund's ability to maintain its
qualification as a regulated investment company for federal income tax purposes.
While the Fund intends to redeem AMPS to enable the Fund to distribute its
income as required to maintain its qualification as a regulated investment
company under the Code, there can be no assurance that such redemptions can be
effected in time to meet the requirements of the Code. See "Tax Matters."
GENERAL RISKS OF INVESTING IN THE FUND
LIMITED OPERATING HISTORY. The Fund is a recently organized, diversified,
closed-end management investment company that has been in operation for less
than three months.
INVESTMENT RISK. An investment in the Fund is subject to investment risk,
including the possible loss of the entire amount that you invest.
INTEREST RATE RISK. Interest rate risk is the risk that bonds (and the
Fund's total managed assets) will change in value because of changes in interest
rates. This is true of all bonds, including U.S. TIPS. Generally, bonds will
decrease in value when interest rates rise and increase in value when interest
rates decline. This means that the net asset value of the Fund will fluctuate
with interest rate changes and the corresponding changes in the value of the
Fund's bond 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 value of the intermediate- and longer-term bonds in
which the Fund generally will invest normally fluctuates more in response to
changes in interest rates than does the value of shorter-term bonds. Because the
Fund will invest primarily in intermediate-to-longer-term bonds, the Fund's
28
net asset value will fluctuate more in response to changes in market interest
rates than if the Fund invested primarily in shorter-term bonds. The Fund's use
of leverage will increase interest rate risk. See "--Leverage Risk."
The Fund may utilize certain strategies, including swaps, futures contracts,
options on futures and options based on U.S. Treasury securities, for the
purpose of reducing the interest rate sensitivity of the portfolio, although
there is no assurance that it will do so or that such strategies will be
successful. See "How the Fund Manages Risk--Hedging and Related Strategies."
RISKS RELATING TO U.S. TIPS. The value of inflation-protected securities
such as U.S. TIPS generally fluctuates in response to changes in real interest
rates, which are in turn tied to the relationship between nominal interest rates
and the rate of inflation. Therefore, if inflation were to rise at a faster rate
than nominal interest rates, real interest rates might decline, leading to an
increase in value of U.S. TIPS. In contrast, if nominal interest rates increased
at a faster rate than inflation, real interest rates might rise, leading to a
decrease in value of U.S. TIPS. Although the principal value of U.S. TIPS
declines in periods of deflation, holders at maturity receive no less than the
par value of the bond. However, if the Fund purchases U.S. TIPS in the secondary
market whose principal values have been adjusted upward due to inflation since
issuance, the Fund may experience a loss if there is a subsequent period of
deflation. If inflation is lower than expected during the period the Fund holds
a U.S. TIPS, the Fund may earn less on the security than on a conventional bond.
Any increase in principal value caused by an increase in the CPI-U
(described below) is taxable in the year the increase occurs, even though the
Fund will not receive cash representing the increase at that time. As a result,
the Fund could be required at times to liquidate other investments, including
when it is not advantageous to do so, in order to satisfy its distribution
requirements as a regulated investment company under the Code. See "Tax
Matters."
If real interest rates rise (i.e., if interest rates rise for reasons other
than inflation, for example, due to changes in currency exchange rates), the
value of the U.S. TIPS in the Fund's portfolio will decline. Moreover, because
the principal amount of U.S. TIPS would be adjusted downward during a period of
deflation, the Fund will be subject to deflation risk with respect to its
investments in these securities.
The daily adjustment of the principal value of U.S. TIPS is currently tied
to the non-seasonally adjusted CPI-U, which the U.S. Bureau of Labor Statistics
calculates monthly. The CPI-U is a measurement of changes in the cost of living,
made up of components such as housing, food, transportation and energy. There
can be no assurance that such index will accurately measure the real rate of
inflation in the prices of goods and services. In addition, calculation of the
CPI-U includes a three-month lag for purposes of determining the principal value
of U.S. TIPS which, consequently, could have a negative impact on the value of
U.S. TIPS under certain market conditions.
The U.S. Treasury only began issuing inflation-protected securities in 1997,
and, as a result, the market for such securities may be less developed or
liquid, and more volatile, than certain other securities markets. The U.S.
Treasury currently issues U.S. TIPS in only ten-year maturities, although U.S.
TIPS with different maturities have been issued in the past and may be issued in
the future.
CREDIT RISK. Credit risk is the risk that the Fund could lose money if the
issuer of a debt obligation, or the counterparty to a derivatives contract,
reverse repurchase agreement, loan of portfolio securities or similar
transaction, is unable or unwilling to make timely principal and/or interest
payments, or otherwise to honor its obligations. In addition, a bond held by the
Fund could decline in price because the issuer of the bond experiences or is
perceived to experience a decline in its financial status.
29
Not all U.S. government securities are backed by the full faith and credit
of the United States. Some securities, such as securities issued by Freddie Mac,
are backed only by the credit of the issuing agency or instrumentality.
Accordingly, credit risk exists with respect to these securities. U.S. TIPS are
backed by the full faith and credit of the United States.
LOWER GRADE AND UNRATED SECURITIES RISK. Although the Fund will not invest
in bonds that are below investment grade quality at the time of purchase, the
Fund is not required to dispose of a security if a rating agency or Western
Asset downgrades its assessment of the credit characteristics of a particular
issue. As a result, the Fund may from time to time hold bonds of below
investment grade quality. Holding lower grade securities involves special risks
in addition to the risks associated with investments in investment grade debt
obligations. While offering a greater potential opportunity for capital
appreciation and higher yields, lower grade securities typically entail greater
potential price volatility and may be less liquid than higher-rated securities.
Lower grade securities are regarded as having predominately speculative
characteristics with respect to the issuer's capacity to pay interest and repay
principal and are commonly referred to as "junk bonds." These securities may
also be more susceptible to real or perceived adverse economic and competitive
industry conditions than higher-rated securities. Debt securities in the lowest
investment grade category may also be considered to possess some speculative
characteristics.
The market values of lower grade 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. Certain emerging market governments that issue lower grade
securities are among the largest debtors to commercial banks, governments and
supra-national organizations such as the World Bank, and may not be able or
willing to make principal and/or interest payments as they come due.
Unrated securities may be less liquid than comparable rated securities and
involve the risk that Western Asset may not accurately evaluate the security's
comparative credit rating. Analysis of the creditworthiness of issuers of lower
grade securities may be more complex than for issuers of higher-quality debt
obligations. To the extent that the Fund holds lower grade and/or unrated
securities, the Fund's success in achieving its investment objectives may depend
more heavily on Western Asset's credit analysis than if the Fund held
exclusively higher-quality and rated securities.
LEVERAGE RISK. The Fund utilizes leverage on an ongoing basis for investment
purposes. Leverage risk includes the risk associated with the issuance of the
AMPS. The Fund intends to use other instruments that may be considered leverage
under certain circumstances, including reverse repurchase agreements, credit
default swaps, dollar rolls and other investment techniques, each of which (to
the extent that it is considered leverage) will amplify the effects of leverage
on the Fund's portfolio. Counterparties to these instruments may have a claim to
the Fund's assets that is prior to the claim of the holders of the AMPS. The
Fund may (but is not required to) cover its commitments under these instruments
by the segregation of liquid assets, equal in value to the amount of the Fund's
commitments, or by entering into offsetting transactions or owning positions
covering its obligations. To the extent these instruments are so covered,
(1) they will not be considered "senior securities" under the 1940 Act and
therefore will not be subject to the 300% asset coverage requirement otherwise
applicable to borrowings by the Fund (see "Description of Capital Structure")
and (2) investment in these instruments (other than reverse repurchase
agreements and dollar roll transactions) will not be considered "leverage" by
the Fund for purposes of the Fund's policy on the amount of leverage it may
incur. Although the Fund does not currently intend to borrow from banks or other
financial institutions or issue commercial paper in order to leverage its
portfolio, it may do so in the future. Bank borrowings and outstanding
commercial paper, to the extent used, would add additional leverage to the
Fund's portfolio.
30
If the dividend rates on the AMPS and the interest rates on other forms of
leverage exceed the net rate of return on the Fund's portfolio, the use of
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 AMPS will be reduced. Because the intermediate- to
longer-term bonds included in the Fund's portfolio will typically pay fixed
rates of interest while the dividend rate on the AMPS and interest rates on
other forms of leverage 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" and "AAA" ratings on the AMPS. In an extreme case, the Fund's
current investment income might not be sufficient to meet the dividend
requirements on the AMPS. 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 AMPS. 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 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 common share price
if the prediction were to turn out to be correct, and determine not to reduce
leverage as described above.
The Fund may invest in the securities of other investment companies. Such
securities may also be leveraged and will therefore be subject to the leverage
risks described above. Such additional leverage may in certain market conditions
serve to reduce the net asset value of the Fund or reduce asset coverage on the
AMPS.
The Fund may also invest in derivative instruments, which may amplify the
effects of leverage and may adversely affect the Fund's net asset value per
share and reduce asset coverage on the AMPS. See "--Derivatives Risk" and the
Statement of Additional Information under "Investment Objectives and
Policies--Derivative Instruments."
Because the fees received by Western Asset are based on the average weekly
assets of the Fund (including assets represented by AMPS and other leverage),
Western Asset has a financial incentive for the Fund to issue AMPS and incur
other leverage.
ISSUER RISK. The value of a corporate debt instrument may decline for a
number of reasons that directly relate to the issuer, such as management
performance, financial leverage and reduced demand for the issuer's goods and
services.
SMALLER COMPANY RISK. The general risks associated with corporate debt
obligations are particularly pronounced for securities issued by companies with
smaller market capitalizations. These companies may have limited product lines,
markets or financial resources or may depend on a few key employees. As a
result, they may be subject to greater levels of credit, interest rate and
issuer risk. Securities of smaller companies may trade less frequently and in
less volume than more widely held securities, and their values may fluctuate
more sharply than the values of other securities. Companies with medium-sized
market capitalizations may have risks similar to those of smaller companies.
31
COUNTRY RISK. Investments in securities of non-U.S. issuers (including those
denominated in U.S. dollars) involve certain risks not typically associated with
investments in domestic issuers. The values of these securities are subject to
economic and political developments in the countries and regions where the
companies operate or are domiciled, or where the securities are traded, such as
changes in economic or monetary policies, and to changes in exchange rates.
Values may also be affected by restrictions on receiving the investment proceeds
from a country other than the United States.
In general, less information is publicly available about these companies
than about U.S. companies. These companies are generally not subject to the same
accounting, auditing and financial reporting standards as are U.S. companies.
Some securities issued by non-U.S. governments or their subdivisions,
agencies and instrumentalities may not be backed by the full faith and credit of
the issuing government. Even where a security is backed by the full faith and
credit of a government, it may be difficult for the Fund to pursue its rights
against such government in that country's courts. Some countries and governments
have defaulted on principal and interest payments.
In addition, the Fund's investments in non-U.S. securities may be subject to
the risk of nationalization or expropriation of assets, confiscatory taxation,
political or financial instability and adverse diplomatic developments.
Dividends or interest on, or proceeds from the sale of, these securities may be
subject to withholding taxes, and special U.S. tax considerations may apply.
In addition to brokerage commissions, custodial services and other costs
relating to investment in non-U.S. countries are generally more expensive than
in the United States. Such markets have at times been unable to keep pace with
the volume of securities transactions, making it difficult to conduct such
transactions. The inability of the Fund to make intended securities purchases
due to settlement problems could cause the Fund to miss attractive investment
opportunities. An inability to dispose of a security due to settlement problems
could result in losses to the Fund due to subsequent declines in the value of
the security.
Investment in securities of issuers based in developing or "emerging market"
countries entails all of the risks of investing in securities of non-U.S.
issuers outlined above, but to a heightened degree. Emerging market countries
typically have economic and political systems that are less fully developed, and
can be expected to be less stable than those of more advanced countries. For
example, the economies of such countries can be subject to rapid and
unpredictable rates of inflation or deflation. Low trading volumes may result in
a lack of liquidity and in price volatility. Emerging market countries may have
policies that restrict investment by foreigners, or that prevent foreign
investors from withdrawing their money at will.
PREPAYMENT RISK. Many fixed income securities, especially those issued at
high interest rates, provide that the issuer may repay them early. Issuers often
exercise this right when interest rates decline. Accordingly, holders of
securities that may be called or prepaid may not benefit fully from the increase
in value that other fixed income securities experience when rates decline.
Furthermore, the Fund reinvests the proceeds of the payoff at current yields,
which are lower than those paid by the security that was paid off. Prepayments
may cause losses on securities purchased at a premium, and unscheduled
prepayments, which will be made at par, will cause the Fund to experience a loss
equal to any unamortized premium.
REINVESTMENT RISK. Reinvestment risk is the risk that income from the Fund's
portfolio will decline if and when the Fund reinvests the proceeds from matured,
traded or called bonds 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 AMPS.
32
DERIVATIVES RISK. The Fund may engage in a variety of transactions using
"derivatives," such as futures, options, warrants and swaps. Derivatives are
financial instruments whose value depends upon, or is derived from, the value of
something else, such as one or more underlying investments or indexes.
Derivatives may be traded on organized exchanges, or in individually negotiated
transactions with other parties (these are known as "over-the-counter"). The
Fund may use derivatives both for hedging and non-hedging purposes, including
for purposes of enhancing returns. Although Western Asset has the flexibility to
make use of derivatives, it may choose not to for a variety of reasons, even
under very volatile market conditions.
Derivatives involve special risks and costs and may result in losses to the
Fund. The successful use of derivatives transactions requires sophisticated
management, and the Fund will depend on Western Asset's ability to analyze and
manage derivatives transactions. Derivatives transactions also involve the risk
of mispricing or improper valuation, the risk of ambiguous documentation and the
risk that changes in the value of a derivative may not correlate perfectly with
an underlying asset, interest rate or index. The prices of derivatives may move
in unexpected ways, especially in abnormal market conditions. Some derivatives
are "leveraged" and therefore may magnify or otherwise increase investment
losses to the Fund. See "-- Leverage Risk." The Fund's use of derivatives may
also increase the amount of taxes payable by shareholders. As a result, the
Fund's use of derivatives (whether used for hedging purposes or otherwise) may
result in a lower return than if it had not used derivatives.
Other risks arise from the potential inability to terminate or sell
derivatives positions. A liquid secondary market may not always exist for the
Fund's derivatives positions. In fact, many over-the-counter instruments will
not be liquid. Derivatives instruments may be subject to wide fluctuations in
market value, and the Fund may be subject to significant delays in disposing of
them. Accordingly, the Fund may be forced to close derivatives positions at less
than fair market value or may not be able to close them when Western Asset
believes it is desirable to do so.
The Fund will be subject to credit risk with respect to the counterparties
to the derivative contracts purchased by the Fund. If a counterparty becomes
bankrupt or otherwise fails to perform its obligations under a derivatives
contract, the Fund may experience significant delays in obtaining any recovery
under the derivatives contract in bankruptcy or other reorganization
proceedings. The Fund may obtain only a limited recovery or may obtain no
recovery in such circumstances.
INFLATION/DEFLATION RISK. Inflation risk is the risk that the Fund's assets
or income from the Fund's investments may be worth less in the future as
inflation decreases the purchasing power and, consequently, the value of money.
As inflation increases, the real value of the AMPS and distributions can
decline. However, during periods of rising inflation, dividend rates on the AMPS
would likely increase, which would tend to offset this risk. Inflation risk is
expected to be greater with respect to the Fund's investments in securities or
instruments other than U.S. TIPS. Deflation risk is the risk that prices
throughout the economy may decline over time--the opposite of inflation.
Deflation may have an adverse effect 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. Because the principal amounts of U.S. TIPS would be
adjusted downward during a period of deflation, the Fund will be subject to
deflation risk with respect to its investment in such securities.
33
TURNOVER RISK. The length of time the Fund has held a particular security is
not generally a consideration in investment decisions. A change in the
securities held by the Fund is known as "portfolio turnover." As a result of the
Fund's investment policies, under certain market conditions the Fund's turnover
rate may be higher than that of other investment companies. Portfolio turnover
generally involves some expense to the Fund, including brokerage commissions or
dealer mark-ups and other transaction costs on the sale of securities and
reinvestment in other securities. These transactions may result in realization
of taxable capital gains. Higher portfolio turnover rates, such as those above
100%, are likely to result in higher brokerage commissions or other transaction
costs and could give rise to a greater amount of taxable capital gains.
MANAGEMENT RISK. The Fund is subject to management risk because it is an
actively managed investment portfolio. Western Asset 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.
MARKET DISRUPTION AND GEOPOLITICAL RISKS. The war with Iraq, its aftermath
and the continuing occupation of the country by coalition forces are likely to
have a substantial impact on the U.S. and world economies and securities
markets. The duration and nature of the war and occupation and the potential
costs of rebuilding the Iraqi infrastructure and political systems 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 the occurrence of 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, deflation and other factors relating to the AMPS.
CERTAIN AFFILIATIONS. Certain broker-dealers may be considered to be
affiliated persons of the Fund and/or Western Asset. 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 regulatory and other
restrictions. This could limit the Fund's ability to engage in securities
transactions and take advantage of market opportunities.
HOW THE FUND MANAGES RISK
INVESTMENT LIMITATIONS
The Fund has adopted certain investment limitations designed to limit
investment risk and maintain portfolio diversification. Certain of these
limitations (two of which are listed below) are fundamental and may not be
changed without the approval of the holders of a majority (as defined in the
1940 Act) of the outstanding common shares and any preferred shares (including
the AMPS) voting together as a single class, and the approval of the holders of
a majority (as defined in the 1940 Act) of the outstanding preferred shares
(including the AMPS) voting as a separate class. Only those limitations
expressly designated as such are fundamental investment limitations. All other
polices or restrictions may be changed without shareholder approval.
The Fund may not invest 25% or more of its total assets, except as noted
below, in a particular industry or group of industries.
34
As a diversified investment company under the 1940 Act, the Fund currently
may not, 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.
As described in the Statement of Additional Information, the Fund's industry
concentration policy described above does not preclude it from investing 25% or
more of its total assets in issuers in a group of industries (such as different
types of technology issuers) under certain circumstances. Securities issued or
guaranteed by the U.S. government or its agencies or instrumentalities will not
be considered to represent an industry. In addition, as described in the
Statement of Additional Information, the Fund may invest 25% or more of its
total assets in certificates of deposit or bankers' acceptances issued by
domestic branches of U.S. or foreign banks under certain circumstances.
The Fund is subject to guidelines which are more limiting than the
investment restrictions set forth above or in the Statement of Additional
Information in order to obtain and maintain a rating on the AMPS of "Aaa" from
Moody's and "AAA" from Fitch and may become subject to additional guidelines in
the future. See "Description of AMPS--Rating Agency Guidelines and Asset
Coverage." The Fund does not anticipate that such guidelines will have a
material adverse effect on the Fund's ability to achieve its investment
objectives. See "Investment Objectives and Policies" and "Investment
Restrictions" in the Statement of Additional Information.
QUALITY OF INVESTMENTS
The Fund will not invest in bonds that are below investment grade quality at
the time of purchase. Investment grade quality means that such bonds are rated
by a nationally recognized rating agency within the rating agency's four highest
grades (Baa or BBB or higher by Moody's, S&P or Fitch or a similar rating of
another nationally recognized rating agency) or are unrated but judged to be of
comparable quality by Western Asset.
MANAGEMENT OF INVESTMENT PORTFOLIO AND CAPITAL STRUCTURE TO LIMIT LEVERAGE RISK
The Fund may take certain actions if market conditions change (or the Fund
anticipates such a change) and the Fund's leverage begins (or is expected) to
affect Common Shareholders adversely. In order to attempt to offset such a
negative impact of leverage on Common Shareholders, the Fund may shorten the
average maturity or duration of its investment portfolio (by investing in
shorter-term, high quality securities) or may reduce its indebtedness or extend
the maturity of outstanding preferred shares (for example, by declaring a
special rate period with respect to one or more series of AMPS). The Fund may
also attempt to reduce leverage by redeeming or otherwise purchasing AMPS
(subject to the restrictions discussed under "Description of AMPS--Redemption")
or reducing any holdings in reverse repurchase agreements, credit default swaps,
futures, short sales, options, dollar rolls or other instruments that create
leverage. As explained above under "Risks--General Risks of Investing in the
Fund--Leverage Risk," the success of any such attempt to limit leverage risk
depends on Western Asset's ability to predict interest rate or other market
changes accurately. Because of the difficulty of making such predictions, the
Fund may not be successful in managing its interest rate exposure in the manner
described in this paragraph.
If market conditions suggest that additional leverage would be beneficial,
the Fund may sell previously unissued preferred shares or preferred shares that
the Fund previously issued but later repurchased or may utilize reverse
repurchase agreements, credit default swaps, dollar roll transactions or other
forms of leverage, including bank borrowings.
35
HEDGING AND RELATED STRATEGIES
The Fund may use various investment strategies designed to limit risk and to
preserve capital. These hedging strategies may include, among others, the use of
swaps, futures contracts, short sales, options on futures or options based on
U.S. Treasury securities, an index of longer-term securities or other
instruments. Under current market conditions, the Fund initially intends to
hedge 100% of the value of its portfolio by purchasing put options that should
increase in value if interest rates were to rise significantly. Income earned by
the Fund from many hedging activities will be treated as capital gain and, if
not offset by net realized capital loss, will be distributed to shareholders in
taxable distributions. If effectively used, hedging strategies can offset some
or all of the loss incurred on the Fund's investments due to adverse changes in
interest rates or inflation rates or other factors. There is no assurance that
these hedging strategies (including the purchase of put options described above)
will be available at any time, that Western Asset will use them for the Fund if
available or that they will be successful if used. Hedging transactions involve
costs and may result in losses to the Fund. Under some circumstances (e.g., if
interest rates decline, or if interest rates rise, but not to a significant
extent), the Fund might have been better off not attempting to hedge its
portfolio or a portion of its portfolio, because the hedging strategies would
not have been successful (and thus the Fund's net asset value would have
declined) and the Fund would have incurred costs (e.g., the price paid to
purchase the put options) to establish such hedging positions. In addition, in
accordance with the rating agency guidelines described in this Prospectus, the
Fund's ability to use hedging transactions may be limited in order to obtain and
maintain ratings on the AMPS. For more information about these restrictions, see
"Description of AMPS--Rating Agency Guidelines and Asset Coverage" and Article
Twelve of the Second Amended and Restated Bylaws, which is attached as Appendix
C to the Statement of Additional Information.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
There are currently five Trustees of the Fund, two of whom are "interested
persons" (as defined in the 1940 Act) and three of whom are not "interested
persons." 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 ADVISOR
Subject to the supervision of the Board of Trustees, Western Asset is
responsible for managing the investment activities of the Fund and certain of
the Fund's business affairs and other administrative matters. Western Asset,
established in 1971 and since 1986 a wholly-owned subsidiary of Legg Mason,
Inc., acts as investment advisor to institutional accounts, such as corporate
pension plans, mutual funds and endowment funds. Western Asset is located at 117
East Colorado Boulevard, Pasadena, California 91105. Total assets under
management by Western Asset and its London-based affiliate, Western Asset
Management Company Limited, were approximately $138 billion as of September 30,
2003.
PORTFOLIO MANAGERS
Western Asset does not employ individual portfolio managers to determine the
investments of the Fund. Instead, the Fund's investments will be the
responsibility of Western Asset's Investment Strategy Group, which is currently
chaired by Western Asset's Chief Investment Officer and which also currently
includes Western Asset's Deputy Chief Investment Officer, its Senior Economist
and the head of each sector group.
36
INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an investment management agreement between Western Asset and the
Fund (the "Investment Management Agreement"), the Fund has agreed to pay Western
Asset an annual management fee payable on a monthly basis at the annual rate of
..40% of the Fund's average weekly assets for the services it provides. "Average
weekly assets" means the average weekly value of the total assets of the Fund
(including any assets attributable to leverage) minus accrued liabilities (other
than liabilities representing leverage). For purposes of calculating "average
weekly assets," neither the liquidation preference of any preferred shares
outstanding (including the AMPS) nor any liabilities associated with any
instruments or transactions used by Western Asset to leverage the Fund's
portfolio (whether or not such instruments or transactions are "covered" as
described in this prospectus) is considered a liability. With respect to reverse
repurchase or dollar roll transactions, "average weekly assets" includes any
proceeds from the sale of an asset of the Fund to a counterparty in such a
transaction, in addition to the value of the underlying asset as of the relevant
measuring date. Because the fees received by Western Asset are based on the
average weekly assets of the Fund (including assets represented by the AMPS and
other leverage), Western Asset has a financial incentive for the Fund to issue
the AMPS and incur other leverage, which may create a conflict of interest. The
Investment Management Agreement automatically terminates on assignment (as
defined in the 1940 Act). The Investment Management Agreement may also be
terminated on not more than 60 days' written notice by Western Asset to the Fund
or by the Fund to Western Asset.
EXPENSES
In addition to the fees of Western Asset, the Fund pays all other costs and
expenses of its operations, including compensation of its Trustees (other than
those who are "interested persons" of the Fund within the meaning of the 1940
Act), fees of the servicing agent and administrator, custodial expenses,
transfer agency and dividend disbursing expenses, listing expenses, legal fees,
expenses of independent auditors, expenses of repurchasing shares, expenses of
issuing the AMPS, expenses of preparing, printing and distributing prospectuses,
shareholder reports, notices, proxy statements and reports to governmental
agencies, and taxes, if any.
ADMINISTRATOR
Under an Administrative Services Agreement with the Fund, Legg Mason Fund
Adviser, Inc. (the "Administrator"), an affiliate of Western Asset, provides
certain administrative and accounting functions for the Fund, including, among
others, coordination of the services provided by the Fund's service providers
(including the custodian, transfer agent, counsel and independent accountants),
preparation, review and filing of various required reports and SEC forms, and
the provision of certain office space and personnel necessary to the Fund's
operations. Additionally, the Administrator has entered into a contract with
State Street Bank and Trust Company pursuant to which State Street Bank and
Trust Company will perform certain asset coverage test calculations required by
the rating agencies rating the AMPS. In consideration of the services provided
by the Administrator, the Fund will pay the Administrator a fee, paid monthly,
at an annual rate of $100,000.
ADDITIONAL COMPENSATION AGREEMENT
In connection with the offering of the Fund's common shares, Western Asset
has agreed to pay from its own assets additional compensation to Merrill Lynch.
This additional compensation will be payable quarterly at the annual rate of
..15% of the Fund's average weekly assets (including assets attributable to any
AMPS that may be outstanding) during the continuance of the Investment
Management Agreement or other advisory agreement between Western Asset and the
Fund. The total amount of these additional payments will not exceed 2.185% of
the total price to the public of the common shares sold in the Fund's offering
of common shares. Merrill Lynch has agreed to provide certain after-
37
market support services to Western Asset designed to maintain the visibility of
the Fund on an ongoing basis and to provide relevant information, studies or
reports regarding the Fund and the closed-end investment company industry.
DESCRIPTION OF AMPS
The following is a brief description of the terms of the AMPS. For a more
complete description of the AMPS, please refer to the detailed description of
the AMPS in Article Twelve of the Second Amended and Restated Bylaws, which is
attached as Appendix C to the Statement of Additional Information. Certain of
the capitalized terms used herein are defined in the Second Amended and Restated
Bylaws.
GENERAL
Under the Declaration, the Fund is authorized to issue preferred shares
having such par value and such preferences, voting powers, terms of redemption,
if any, and special or relative rights or privileges (including conversion
rights, if any) as determined by the Board of Trustees, without the approval of
Common Shareholders. The AMPS are preferred shares of beneficial interest with
no par value. Each series of AMPS 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). The AMPS of each series will rank on a parity with
shares of any other series of preferred shares of the Fund as to the payment of
dividends and the distribution of assets upon liquidation. The AMPS carry one
vote per share on all matters on which such shares are entitled to vote. The
AMPS, when issued by the Fund and paid for pursuant to the terms of this
prospectus, will be fully paid and, subject to matters discussed in "Anti-
Takeover and Other Provisions in the Declaration of Trust," non-assessable and
will have no preemptive, exchange or conversion rights. Any AMPS repurchased or
redeemed by the Fund will be classified as authorized and unissued preferred
shares without designation as to series. The AMPS will not be subject to any
sinking fund, but will be subject to mandatory redemption and optional
redemption under certain circumstances described below.
DIVIDENDS AND RATE PERIODS
GENERAL. The following is a general description of dividends and rate
periods for the AMPS. The initial rate period for the Series M AMPS will be
days, and the dividend rate for this period will be %. The initial rate
period for the Series T AMPS will be days, and the dividend rate for this
period will be %. The initial rate period for the Series W AMPS will be
days, and the dividend rate for this period will be %. The initial rate
period for the Series TH AMPS will be days, and the dividend rate for this
period will be %. The initial rate period for the Series F AMPS will be
days, and the dividend rate for this period will be %. Subsequent rate
periods generally will be seven days, and the dividend rates for those periods
will generally be determined by auction. Further description of the auction
procedures can be found below under "The Auction" and in Article Twelve of the
Second Amended and Restated Bylaws, which is attached as Appendix C to the
Statement of Additional Information. The Fund, subject to certain conditions,
may change the length of subsequent rate periods by designating them as special
rate periods. See "--Designation of Special Rate Periods" below.
DIVIDEND PAYMENT DATES. Dividends on AMPS will be payable when, as and if
declared by the Board, out of legally available funds in accordance with the
Declaration, the Bylaws and applicable law. Dividend periods generally will
begin on the first business day after an auction. If dividends are payable on a
day that is not a business day, then dividends will generally be payable on the
next business day, or as otherwise specified in the Second Amended and Restated
Bylaws. The Fund, at its discretion, may establish dividend payment dates in
respect of any special rate period of AMPS consisting of more than seven days,
provided that such dates shall be set forth in the notice of special rate period
relating to such special rate period and certain other conditions are met.
38
Dividends will be paid through the Depository Trust Company ("DTC") on each
dividend payment date. The dividend payment date will normally be the first
business day after the dividend period ends. DTC, in accordance with its current
procedures, is expected to distribute dividends received from the auction agent
in same-day funds on each dividend payment date to members of DTC that will act
on behalf of existing or potential holders of AMPS ("Agent Members"). These
Agent Members are in turn expected to distribute such dividends to the persons
for whom they are acting as agents. However, each of the current Broker-Dealers
has indicated to the Fund that dividend payments will be available in same-day
funds on each dividend payment date to customers that use a Broker-Dealer or a
Broker-Dealer's designee as Agent Member.
CALCULATION OF DIVIDEND PAYMENT. The Fund computes the dividend per share of
each series of AMPS by multiplying the applicable rate for such series of shares
in effect by a fraction. The numerator of this fraction will normally be seven
(i.e., the number of days in the rate period) and the denominator will normally
be 360. If the Fund has designated a special rate period, then the numerator
will be the number of days in the special rate period, and the denominator will
normally be 360. In either case, this rate is then multiplied by $25,000 to
arrive at the dividend per share.
Dividends on the AMPS will accumulate from the date of their original issue.
For each dividend period after the initial rate period, the dividend rate will
be the dividend rate determined at auction, except as provided in the Second
Amended and Restated Bylaws. The dividend rate that results from an auction will
not be greater than the maximum applicable rate described below.
The maximum applicable rate for any regular rate period will be the higher
of the applicable percentage of the reference rate, or the applicable spread
plus the reference rate. The reference rate for a regular rate period will be
the applicable LIBOR Rate (as defined below). The applicable percentage and
applicable spread for any regular rate period will generally be determined based
on the higher of the credit rating or ratings assigned to the AMPS by Moody's
and Fitch on the auction date for such period (as set forth in the table below).
If Moody's and/or Fitch shall not make such rating available, the rate shall be
determined by reference to equivalent ratings issued by a substitute rating
agency. In the case of a special rate period, (1) the maximum applicable rate
will be specified by the Fund in the notice of special rate period for such rate
period, (2) the applicable percentage and applicable spread will be determined
on the date two business days before the first day of such special rate period,
and (3) the reference rate will be the applicable LIBOR Rate (for a rate period
of fewer than 365 days) or the Treasury Index Rate (as defined below) (for a
rate period of 365 days or more).
MOODY'S FITCH'S
CREDIT RATING CREDIT RATING APPLICABLE PERCENTAGE APPLICABLE SPREAD
-------------------------------- ------------- --------------------- -----------------
Aaa AAA 125% 125 bps
Aa3 to Aa1 AA- to AA+ 150% 150 bps
A3 to A1 A- to A+ 200% 200 bps
Baa3 to Baa1 BBB- to BBB+ 250% 250 bps
Below Baa3 Below BBB- 300% 300 bps
The Fund will take all reasonable action necessary to enable Moody's and
Fitch to provide ratings for each series of AMPS. If such ratings are not made
available by Moody's or Fitch, the Fund, after consultation with the
Underwriters or their affiliates and successors, will select one or more other
rating agencies to act as substitute rating agencies.
The "LIBOR Rate" is the applicable London Inter-Bank Offered Rate for
deposits in U.S. dollars for the period most closely approximating the
applicable rate period for a series of AMPS. For a more detailed description,
please see Article Twelve of the Second Amended and Restated Bylaws.
39
The "Treasury Index Rate" is the average yield to maturity for certain U.S.
Treasury securities having substantially the same length to maturity as the
applicable rate period for a series of AMPS. For a more detailed description,
please see Article Twelve of the Second Amended and Restated Bylaws.
Assuming the Fund maintains an Aaa/AAA rating on the AMPS, the practical
effect of the different methods used to calculate the maximum applicable rate is
shown in the table below:
MAXIMUM APPLICABLE RATE MAXIMUM APPLICABLE RATE METHOD USED TO DETERMINE
USING THE APPLICABLE USING THE APPLICABLE THE MAXIMUM APPLICABLE
REFERENCE RATE PERCENTAGE SPREAD RATE
-------------- ----------------------- ----------------------- ------------------------
1% 1.25% 2.25% Spread
2% 2.50% 3.25% Spread
3% 3.75% 4.25% Spread
4% 5.00% 5.25% Spread
5% 6.25% 6.25% Either
6% 7.50% 7.25% Percentage
No later than 12:00 noon, New York City time, on each dividend payment date,
the Fund is required to deposit with the auction agent sufficient funds for the
payment of declared dividends. As specified in the Second Amended and Restated
Bylaws, auctions will generally not be held if the Fund fails to make such
deposit. In such a situation, dividends for the next dividend period would
normally be paid at the maximum applicable rate. The Fund does not intend to
establish any reserves for the payment of dividends.
The Board of Trustees, after consultation with the Broker-Dealers, may
adjust upward but not downward the applicable percentage or the applicable
spread, which may have the effect of increasing the maximum applicable rate,
without the vote or consent of the holders of AMPS, including each series, or
any other shareholder of the Fund, but only with confirmation from each rating
agency then rating the AMPS that such action will not impair such agency's
then-current rating of the AMPS, provided that immediately following any such
increase the Fund could meet the Preferred Shares Basic Maintenance Amount test
discussed below under "--Rating Agency Guidelines and Asset Coverage."
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS. While the AMPS are
outstanding, the Fund generally may not declare, pay or set apart for payment,
any dividend or other distribution in respect of its common shares or any other
shares (other than the AMPS) of the Fund ranking junior to or on a parity with
the AMPS (other than in additional common shares or rights to purchase common
shares). In addition, the Fund generally may not call for redemption or redeem
any of its common shares (except by conversion into or exchange for shares of
the Fund ranking junior to the AMPS as to the payment of dividends and the
distribution of assets on liquidation) or any other shares (other than the AMPS)
of the Fund ranking junior to or on a parity with the AMPS. However, the Fund is
not confined by the above restrictions if:
- immediately after such transaction, (i) the discounted value of the
Fund's portfolio (i.e., the aggregate value of the Fund's portfolio
according to criteria set forth by each rating agency then rating the
AMPS) would be equal to or greater than the Preferred Shares Basic
Maintenance Amount, and (ii) the 1940 Act Preferred Shares Asset
Coverage would be satisfied (see "--Rating Agency Guidelines and
Asset Coverage" below);
- full cumulative dividends on each series of AMPS due on or prior to
the Fund's most recently ended dividend period have been paid or have
been declared and sufficient funds for the payment thereof have been
deposited with the auction agent; and
- the Fund has redeemed the full number of AMPS required to be redeemed
by any provision for mandatory redemption.
40
The Fund generally will not declare, pay or set apart for payment any
dividend on any class or series of shares of the Fund ranking, as to the payment
of dividends, on a parity with the AMPS unless the Fund has declared and paid in
full cumulative or the same proportionate share of dividends on the AMPS through
the most recent dividend payment date. When the Fund has not paid dividends in
full upon a series of the AMPS through the most recent dividend payment date or
upon any class or series of shares of the Fund ranking, as to the payment of
dividends, on a parity with such series of AMPS through their most recent
respective dividend payment dates, the amount of dividends declared per share on
such series of AMPS and such other class or series of shares will in all cases
bear to each other the same ratio that accumulated dividends per share on such
series of AMPS and such other class or series of shares bear to each other.
DESIGNATION OF SPECIAL RATE PERIODS. The Fund may, in certain situations,
declare a special rate period on the AMPS. To declare a special rate period, the
Fund will give notice (a "notice of special rate period") to the auction agent
and to each Broker-Dealer. The notice will request that the next succeeding rate
period for the AMPS be a number of days evenly divisible by seven and not to
exceed five years as specified in such notice. The Fund may not request a
special rate period unless sufficient clearing bids for the AMPS were made in
the most recent auction. In addition, full cumulative dividends and any amounts
due with respect to mandatory redemptions or optional redemptions must be paid
in full or deposited with the auction agent. The Fund also must have received
confirmation from Moody's and Fitch or any substitute rating agency that the
proposed special rate period will not impair such agency's then-current rating
of the AMPS. The Fund may provide that, in order to redeem AMPS at the Fund's
option during a special rate period, the Fund must pay to holders of the AMPS a
"redemption premium" in addition to the redemption price per share of $25,000,
plus an amount equal to the accumulated but unpaid dividends. A notice of
special rate period will specify whether the shares of a particular series of
AMPS will be subject to optional redemption during such special rate period and,
if so, the redemption premium, if any, required to be paid by the Fund in
connection with such optional redemption. Depending on market conditions, the
Fund intends to declare a special rate period with respect to Series M AMPS,
Series W AMPS and Series F AMPS shortly after the issuance of the AMPS. The
length of such special rate period will be determined based on factors including
but not limited to interest rate levels at such time.
The Fund's declaration of a special rate period may affect the liquidity of
your investment. A special rate period would be longer than a regular rate
period, and you would be unable to sell AMPS in an auction for a corresponding
longer period of time. If you sell your AMPS between auctions, you may receive
less than the price you paid for them, especially when market interest rates
have risen. The risks described in this paragraph will become greater as the
length of the special rate period increases.
VOTING RIGHTS
Except as otherwise described in this prospectus and in the Statement of
Additional Information or as otherwise set forth in the Declaration or the
Bylaws or required by law, holders of AMPS will have equal voting rights with
Common Shareholders and holders of any other preferred shares of the Fund (each
class having one vote per share) and will vote together with Common Shareholders
and any other preferred shares as a single class.
Holders of outstanding preferred shares of the Fund, including AMPS, voting
as a separate class, are entitled to elect two of the Fund's Trustees. The
remaining Trustees are elected by Common Shareholders and holders of preferred
shares, including AMPS, 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 AMPS, are due and unpaid in an amount
equal to 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, the sole remedy of holders of the outstanding preferred shares
of the Fund is that the number of Trustees constituting the Trustees will be
automatically increased by the
41
smallest number that, when added to the two Trustees elected exclusively by the
holders of preferred shares as described above, would constitute a majority of
the Trustees. The holders of preferred shares of the Fund will be entitled to
elect such Trustees at a special meeting of holders of preferred shares held as
soon as practicable and at all subsequent meetings at which Trustees are to be
elected. The terms of office of the persons who are Trustees at the time of that
election will continue. If the Fund thereafter pays in full (or otherwise
provides for) all dividends payable on all outstanding preferred shares of the
Fund, the special voting rights stated above will cease and the terms of office
of the additional Trustees elected by the holders of the preferred shares will
automatically terminate.
Unless a higher percentage is provided for under the Declaration or the
Bylaws or applicable law, the Fund will not, without the affirmative vote or
consent of the holders of at least a majority (as defined in the 1940 Act) of
the AMPS outstanding at the time (voting together as a separate class), except
as noted below:
(a) authorize, create or issue any class or series of shares ranking prior
to or on a parity with the AMPS with respect to payment of dividends or the
distribution of assets on liquidation, or authorize, create or issue additional
shares of AMPS, unless, in each case, the Fund obtains written confirmation from
Moody's (if Moody's is then rating AMPS) or Fitch (if Fitch is then rating AMPS)
that such authorization, creation or issuance would not impair the rating then
assigned by such rating agency to the AMPS, in which case the vote or consent of
the holders of the AMPS is not required;
(b) amend, alter or repeal the provisions of Section 12.1 of the Second
Amended and Restated Bylaws if such amendment, alteration or repeal would affect
adversely the preferences, rights or powers expressly set forth in the
Declaration or the Bylaws of holders of a series of AMPS; or
(c) authorize the Fund's conversion from a closed-end to an open-end
investment company.
For purposes of the foregoing, no matter shall be deemed adversely to affect
any preference, right or power of a holder of AMPS unless such matter (i)
adversely alters or abolishes any preferential right of the AMPS; (ii) creates,
adversely alters or abolishes any right in respect of redemption of such shares;
or (iii) creates or adversely alters (other than to abolish) any restriction on
transfer applicable to such shares. To the extent not prohibited by the
Declaration, the Bylaws or applicable law, if any action with respect to which
holders of AMPS are granted voting rights under the Second Amended and Restated
Bylaws would adversely affect the rights of one or more series of AMPS in a
manner different from any other series of AMPS, the Fund will not approve any
such action without the affirmative vote or consent of the holders of at least a
majority (as defined in the 1940 Act) of the outstanding shares of each such
affected series (each such affected series voting separately as a class). The
vote of holders of any series described in this paragraph will in each case be
in addition to a separate vote of the requisite percentage, if any, of common
shares and/or preferred shares necessary to authorize the action in question.
Unless a higher percentage is provided for under the Declaration or the
Bylaws or applicable law, the affirmative vote of the holders of a majority (as
defined in the 1940 Act) of the outstanding AMPS, voting together 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 Fund's investment restrictions designated as
fundamental under "Investment Restrictions" in the Statement of Additional
Information and changes in the Fund's subclassification as a closed-end
investment company. However, to the extent permitted by applicable law, no vote
of Common Shareholders, either separately or together with holders of preferred
shares as a single class, is necessary to take the actions contemplated by (a)
and (b) above.
42
The foregoing voting provisions will not apply with respect to AMPS 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.
If a series of preferred shares other than the AMPS is issued in the future,
it is anticipated that such series would have voting rights comparable to those
described above.
RATING AGENCY GUIDELINES AND ASSET COVERAGE
In connection with the Fund's receipt of a rating of "Aaa" from Moody's and
a rating of "AAA" from Fitch with respect to the AMPS, the Fund is required to
maintain assets having in the aggregate a discounted value at least equal to the
Preferred Shares Basic Maintenance Amount. The Preferred Shares Basic
Maintenance Amount includes the sum of (a) the aggregate liquidation preference
of the preferred shares then outstanding (including the AMPS) and (b) certain
accrued and projected payment obligations of the Fund, including without
limitation any accrued and projected dividends on the preferred shares then
outstanding (including the AMPS).
Moody's and Fitch have each established separate guidelines for calculating
discounted value. These guidelines specify discount factors that the Fund must
apply to various types of securities in its portfolio for purposes of
calculating whether the discounted value of the Fund's assets equals the
Preferred Shares Basic Maintenance Amount (with the level of discount generally
becoming greater as the credit quality of a security becomes lower). In
addition, under the guidelines, certain types of securities (including
securities in which the Fund may otherwise invest) are not eligible for
inclusion in the calculation of the discounted value of the Fund's portfolio.
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 set forth herein, it is currently anticipated that they will not
constitute a significant portion of the Fund's portfolio under normal
circumstances. The rating agency guidelines for calculating discounted value do
not impose any limitations on the percentage of the Fund's assets that may be
invested in ineligible assets, and the amount of ineligible assets included in
the Fund's portfolio at any time may vary depending upon the rating,
diversification and other characteristics of the eligible assets included in the
portfolio.
In addition, the Fund is required by the 1940 Act, as well as by the rating
agency guidelines, to maintain asset coverage of at least 200% with respect to
senior securities that are equity securities, including the AMPS ("1940 Act
Preferred Shares Asset Coverage"). The Fund's 1940 Act Preferred Shares Asset
Coverage is tested as of the last business day of each month in which any senior
equity securities are outstanding. The minimum required 1940 Act Preferred
Shares Asset Coverage amount of 200% may be increased or decreased if the 1940
Act is amended. Based on the composition of the portfolio of the Fund and market
conditions as of November 20, 2003, the 1940 Act Preferred Shares Asset Coverage
with respect to all of the Fund's preferred shares, assuming the issuance on
that date of all AMPS offered hereby and giving effect to the deduction of the
related offering costs and sales load estimated at $2,354,585, would have been
computed as follows:
Value of Fund assets less liabilities
not constituting senior securities $ 616,045,913
= = 300.51%
--------------------------------------- -----------
Senior securities representing indebtedness $ 205,000,000
plus liquidation value of the preferred shares
43
In the event the Fund does not timely cure a failure to maintain (a) a
discounted value of its portfolio equal to the Preferred Shares Basic
Maintenance Amount or (b) the 1940 Act Preferred Shares Asset Coverage, in each
case in accordance with the requirements of the rating agency or agencies then
rating the AMPS, the Fund will be required to redeem AMPS as described under
"--Redemption--Mandatory Redemption" below.
In addition to the requirements described above, the rating agency
guidelines impose restrictions on the Fund's use of certain financial
instruments or investment techniques that the Fund might otherwise utilize. For
example, the guidelines limit the use of certain hedging transactions such as
futures contracts and options. The guidelines also limit the use of certain
other investment techniques, including borrowing of money, short sales, loans of
portfolio securities, and reverse repurchase agreements. For a complete
description of such restrictions, see Article Twelve of the Second Amended and
Restated Bylaws, which is attached as Appendix C to the Fund's Statement of
Additional Information.
The Fund may, but is not required to, adopt any modifications to the
guidelines that may be established by Moody's or Fitch. 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 AMPS may, at any time, change or withdraw any such
rating. The Trustees may, without shareholder approval, amend, alter or repeal
any or all of the definitions and related provisions that have been adopted by
the Fund pursuant to the rating agency guidelines in the event the Fund receives
written confirmation from Moody's or Fitch, as the case may be, that any such
amendment, alteration or repeal would not impair the rating then assigned to the
AMPS.
As recently described by Moody's and Fitch, a preferred stock rating is an
assessment of the capacity and willingness of an issuer to pay preferred stock
obligations. The rating on the AMPS is not a recommendation to purchase, hold or
sell those shares, inasmuch as the rating does 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 AMPS will be able to
sell such shares in an auction or otherwise. The ratings are based on current
information furnished to Moody's and Fitch by the Fund and Western Asset 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 Fund's common shares have not been rated by a nationally
recognized statistical rating organization.
A rating agency's guidelines will apply to the AMPS only so long as the
rating agency is rating the shares. The Fund will pay certain fees to Moody's
and Fitch for rating the AMPS. A more detailed description of how Moody's and
Fitch calculate discounted value and the other limitations imposed by the rating
agencies is contained in Article Twelve of the Second Amended and Restated
Bylaws, which is attached as Appendix C to the Fund's Statement of Additional
Information.
LIQUIDATION
Subject to the rights of holders of any series or class or classes of shares
ranking on a parity with AMPS with respect to the distribution of assets upon
liquidation of the Fund, upon a liquidation of the Fund (whether voluntary or
involuntary), the holders of AMPS then outstanding will be entitled to receive
and to be paid, out of the assets of the Fund available for distribution to its
shareholders, before any payment or distribution will be made on the common
shares or any other class of shares of the Fund ranking junior to the AMPS, an
amount equal to the liquidation preference with respect to such AMPS ($25,000
per share), plus an amount equal to all dividends thereon (whether or not earned
or declared by the Fund, but excluding the interest thereon) accumulated but
unpaid to (but not including) the date of final distribution in same-day funds
in connection with the liquidation of the Fund. If such assets of the Fund are
insufficient to make the full liquidation payment on the outstanding AMPS, no
distribution shall be made on any shares of any other class or series of
preferred shares
44
ranking on a parity with the AMPS with respect to the distribution of assets
upon such liquidation unless proportionate distributive amounts shall be paid on
the AMPS, ratably, in proportion to the full distributable amounts for which
holders of all such parity shares are respectively entitled upon such
liquidation. After the payment to the holders of AMPS of the full preferential
amounts provided for as described herein, the holders of AMPS as such will have
no right or claim to any of the remaining assets of the Fund.
For purposes of the foregoing paragraph, a liquidation of the Fund does not
include:
- the sale of all or any portion of the property or business of the
Fund;
- the merger or consolidation of the Fund into or with any business
trust or other entity; or
- the merger or consolidation of any business trust or other entity
into or with the Fund.
REDEMPTION
MANDATORY REDEMPTION. The Fund is required to maintain (a) a discounted
value of eligible portfolio securities equal to the Preferred Shares Basic
Maintenance Amount and (b) the 1940 Act Preferred Shares Asset Coverage.
Eligible portfolio securities for the purposes of (a) above will be determined
from time to time by the rating agencies then rating the AMPS. If the Fund fails
to maintain such asset coverage amounts and does not timely cure such failure in
accordance with the requirements of the rating agencies that rate the AMPS, the
Fund must redeem all or a portion of the AMPS. This mandatory redemption will
take place on a date that the Trustees specify out of legally available funds in
accordance with the Declaration, the Bylaws and applicable law, at the
redemption price of $25,000 per share, plus accumulated but unpaid dividends
(whether or not earned or declared) to (but not including) the date fixed for
redemption. In determining the number of AMPS required to be redeemed in
accordance with the foregoing, the Fund will allocate the number of shares
required to be redeemed to satisfy the Preferred Shares Basic Maintenance Amount
or the 1940 Act Preferred Shares Asset Coverage, as the case may be, pro rata
among the AMPS and any other preferred shares of the Fund subject to redemption
or retirement. The mandatory redemption will be limited to the number of AMPS
and any other preferred shares necessary to restore the required discounted
value or the 1940 Act Preferred Shares Asset Coverage, as the case may be.
OPTIONAL REDEMPTION. The Fund, at its option, may redeem the AMPS, in whole
or in part, out of legally available funds. Any optional redemption will occur
on a dividend payment date at the optional redemption price per share of
$25,000, plus an amount equal to accumulated but unpaid dividends (whether or
not earned or declared) to (but not including) the date fixed for redemption,
plus the premium, if any, specified in a special redemption provision. No AMPS
may be redeemed if the redemption would cause the Fund to violate the 1940 Act.
The Fund has the authority to redeem the AMPS for any reason and may redeem all
or part of the outstanding AMPS if it anticipates that the Fund's leveraged
capital structure will result in a lower rate of return to Common Shareholders
for any significant period of time than that obtainable if the common shares
were unleveraged. The Fund may exercise such redemption option as to any series
of AMPS and as to some or all of the shares of each series, subject to certain
limitations. The optional redemption of shares of a series will, if less than
all the shares of a series are redeemed, be made on a pro rata basis.
The Fund will not make any optional redemption unless (i) the Fund has
available certain deposit securities with maturities or tender dates not later
than the day preceding the applicable redemption date and having a value not
less than the amount (including any applicable premium) due to holders of the
AMPS by reason of the redemption of the AMPS on such date fixed for the
redemption and (ii) the Fund has eligible assets with an aggregate discounted
value at least equal to the Preferred Shares Basic Maintenance Amount (both
before and after giving effect to such redemption).
45
Notwithstanding the foregoing, if unpaid dividends exist with respect to
shares of a series of AMPS (whether or not earned or declared), no shares of
such series shall be redeemed (by either mandatory redemption or optional
redemption) unless all outstanding shares of such series are simultaneously
redeemed; provided, however, that this limitation will not apply to an otherwise
lawful purchase or exchange offer made on the same terms to the holders of all
outstanding shares of such series.
Although the AMPS are subject to redemption under certain circumstances as
described above and under "--Mandatory Redemption," the AMPS may not be redeemed
at a shareholder's option at net asset value, unlike the shares of an open-end
mutual fund.
THE AUCTION
GENERAL
Under the Second Amended and Restated Bylaws, the applicable rate for the
AMPS for each rate period after the initial rate period will generally be the
rate that results from an auction conducted as set forth in the Second Amended
and Restated Bylaws and summarized below. In such an auction, persons determine
to hold or offer to sell AMPS regardless of the rate set by the auction or offer
to purchase or sell AMPS based on specific dividend rates bid by them. See
Article Twelve of the Second Amended and Restated Bylaws for a more complete
description of the auction process.
AUCTION AGENCY AGREEMENT. The Fund will enter into an auction agency
agreement with the auction agent (currently, Deutsche Bank Trust Company
Americas) which provides, among other things, that the auction agent will follow
the auction procedures set forth in the Second Amended and Restated Bylaws to
determine the applicable rate for AMPS so long as the applicable rate for AMPS
is to be based on the results of an auction.
The auction agent may terminate the auction agency agreement upon notice to
the Fund no earlier than 60 days after such notice (30 days after such notice,
if the auction agent has not been paid). If the auction agent should resign, the
Fund will attempt to appoint another qualified institution to act as auction
agent. The Fund may remove the auction agent provided that prior to such removal
the Fund has entered into an agreement with a successor auction agent to perform
substantially similar services.
BROKER-DEALER AGREEMENTS. Each auction requires the participation of one or
more Broker-Dealers. The auction agent will enter into agreements with one or
more Broker-Dealers selected by the Fund that provide for the participation of
those Broker-Dealers in auctions for AMPS ("Broker-Dealer Agreements").
The auction agent will pay to each Broker-Dealer after each auction, from
funds provided by the Fund, a service charge that will generally be at the
annual rate of 1/4 of 1% of the stated value ($25,000 per share) of the AMPS
held by a Broker-Dealer's customers upon settlement in an auction.
The Fund may request the auction agent to terminate one or more
Broker-Dealer Agreements at any time upon five days' notice, provided that at
least one Broker-Dealer Agreement is in effect after such termination.
AUCTION PROCEDURES
Prior to the submission deadline on each auction date for the AMPS, each
customer of a Broker-Dealer who is listed on the records of that Broker-Dealer
(or, if applicable, the auction agent) as a
46
beneficial owner of AMPS may submit the following types of orders with respect
to AMPS to that Broker-Dealer:
1. Hold Order--indicating its desire to hold AMPS without regard to the
applicable rate for shares of such series for the next rate period.
2. Bid--indicating its desire to purchase or hold the indicated number
of AMPS at $25,000 per share if the applicable rate for shares of
such series for the next rate period is not less than the rate
specified in the bid. A bid order by an existing holder will be
deemed an irrevocable offer to sell AMPS at $25,000 per share if the
applicable rate for shares of such series for the next rate period
is less than the rate specified in the bid.
3. Sell Order--indicating its desire to sell AMPS at $25,000 per share
without regard to the applicable rate for shares of such series for
the next rate period.
A beneficial owner of AMPS may submit different types of orders to its
Broker-Dealer with respect to different AMPS then held by the beneficial owner.
A beneficial owner that submits a bid to its Broker-Dealer having a rate higher
than the maximum applicable rate on the auction date will be treated as having
submitted a sell order to its Broker-Dealer. A beneficial owner that fails to
submit an order to its Broker-Dealer will ordinarily be deemed to have submitted
a hold order to its Broker-Dealer. However, if a beneficial owner fails to
submit an order for some or all of its shares to its Broker-Dealer for an
auction relating to a rate period of more than 91 days, such beneficial owner
will be deemed to have submitted a sell order for such shares to its
Broker-Dealer. A sell order constitutes an irrevocable offer to sell the AMPS
subject to the sell order. A beneficial owner that offers to become the
beneficial owner of additional AMPS is, for the purposes of such offer, a
potential holder as discussed below.
A potential holder is either a customer of a Broker-Dealer that is not a
beneficial owner of AMPS but that wishes to purchase AMPS or a beneficial owner
that wishes to purchase additional AMPS. A potential holder may submit bids to
its Broker-Dealer in which it offers to purchase AMPS at $25,000 per share if
the applicable rate for the next rate period is not less than the rate specified
in such bid. A bid placed by a potential holder specifying a rate higher than
the maximum applicable rate on the auction date will not be accepted.
The Broker-Dealers in turn will submit the orders of their respective
customers who are beneficial owners and potential holders to the auction agent.
Unless otherwise permitted by the Fund, the Broker-Dealers will designate
themselves as existing holders of shares subject to orders submitted or deemed
submitted to them by beneficial owners. They will also designate themselves as
potential holders of shares subject to orders submitted to them by potential
holders. However, neither the Fund nor the auction agent will be responsible for
a Broker-Dealer's failure to comply with these procedures. Any order placed with
the auction agent by a Broker-Dealer as or on behalf of an existing holder or a
potential holder will be treated the same way as an order placed with a
Broker-Dealer by a beneficial owner or potential holder. Similarly, any failure
by a Broker-Dealer to submit to the auction agent an order for any AMPS held by
it or customers who are beneficial owners will be treated as a beneficial
owner's failure to submit to its Broker-Dealer an order in respect of AMPS held
by it. A Broker-Dealer may also submit orders to the auction agent for its own
account as an existing holder or potential holder, provided that it is not an
affiliate of the Fund.
There are sufficient clearing bids in an auction if the number of shares of
a series of AMPS subject to bids submitted or deemed submitted to the auction
agent by Broker-Dealers for potential holders with rates equal to or lower than
the maximum applicable rate for shares of such series is at least equal to the
sum of the number of applicable AMPS subject to sell orders submitted or deemed
submitted to the auction agent by Broker-Dealers for existing holders and the
number of applicable
47
AMPS subject to bids specifying rates higher than the maximum applicable rate
for shares of such series submitted or deemed submitted to the auction agent by
Broker-Dealers for existing holders. If there are sufficient clearing bids, the
applicable rate for the relevant AMPS for the next succeeding rate period
thereof will be the lowest rate specified in the submitted bids that, taking
into account such rate and all lower rates bid by Broker-Dealers as or on behalf
of existing holders and potential holders, would result in such existing holders
and potential holders owning the relevant AMPS available for purchase in the
auction.
If there are not sufficient clearing bids, the applicable rate for the next
rate period will be the maximum applicable rate on the auction date. If there
are not sufficient clearing bids, beneficial owners of AMPS that have submitted
or are deemed to have submitted sell orders may not be able to sell in the
auction all shares subject to such sell orders. If all of the applicable
outstanding AMPS are the subject of submitted hold orders, then the rate period
following the auction will automatically be the same length as the preceding
rate period and the applicable rate for the next rate period will be 90% of the
reference rate (i.e., 90% of the applicable LIBOR Rate (for a rate period of
fewer than 365 days) or Treasury Index Rate (for a rate period of 365 days or
more)) for the AMPS.
The auction procedures include a pro rata allocation of shares for purchase
and sale, which may result in an existing holder continuing to hold or selling,
or a potential holder purchasing, a number of AMPS that is different from the
number of shares specified in its order. To the extent the allocation procedures
have that result, Broker-Dealers that have designated themselves as existing
holders or potential holders in respect of customer orders will be required to
make appropriate pro rata allocations among their respective customers.
Settlement of purchases and sales will be made on the next business day
(which is also a dividend payment date) after the auction date through DTC.
Purchasers will make payment through their Agent Members in same-day funds to
DTC against delivery to their respective Agent Members. DTC will make payment to
the sellers' Agent Members in accordance with DTC's normal procedures, which
currently provide for payment against delivery by their Agent Members in
same-day funds.
The auctions for AMPS will normally be held every seven days, and each
subsequent rate period will normally begin on the following business day.*
The first auction for the Series M AMPS will be held on , the
business day preceding the dividend payment date for the initial dividend
period. Thereafter, except during special rate periods, auctions for the Series
M AMPS normally will be held every seven days thereafter, and each subsequent
dividend period for the Series M AMPS normally will begin on the following
business day.
The first auction for the Series T AMPS will be held on , the
business day preceding the dividend payment date for the initial dividend
period. Thereafter, except during special rate periods, auctions for the Series
T AMPS normally will be held every seven days thereafter, and each subsequent
dividend period for the Series T AMPS normally will begin on the following
business day.
The first auction for the Series W AMPS will be held on , the
business day preceding the dividend payment date for the initial dividend
period. Thereafter, except during special rate periods, auctions for the Series
W AMPS normally will be held every seven days thereafter, and each subsequent
dividend period for the Series W AMPS normally will begin on the following
business day.
-------------------
* Although auctions to establish the dividend rate for each series of AMPS will
normally be held weekly in the absence of a special rate period, the Fund
anticipates that the initial auctions for each series of AMPS will not be held
until on or about the week of January 12-16, 2004.
48
The first auction for the Series TH AMPS will be held on , the
business day preceding the dividend payment date for the initial dividend
period. Thereafter, except during special rate periods, auctions for the Series
TH AMPS normally will be held every seven days thereafter, and each subsequent
dividend period for the Series TH AMPS normally will begin on the following
business day.
The first auction for the Series F AMPS will be held on , the
business day preceding the dividend payment date for the initial dividend
period. Thereafter, except during special rate periods, auctions for the Series
F AMPS normally will be held every seven days thereafter, and each subsequent
dividend period for the Series F AMPS normally will begin on the following
business day.
If an auction date is not a business day because the New York Stock Exchange
is closed for business due to an act of God, natural disaster, act of war, civil
or military disturbance, act of terrorism, sabotage, riots or a loss or
malfunction of utilities or communications services, or if the auction agent is
not able to conduct an auction in accordance with the auction procedures for any
such reason, then the dividend rate for the next dividend period will be the
dividend rate determined on the previous auction date.
If a dividend payment date is not a business day because the New York Stock
Exchange is closed for business due to an act of God, natural disaster, act of
war, civil or military disturbance, act of terrorism, sabotage, riots or a loss
or malfunction of utilities or communications services, or the dividend payable
on such date can not be paid for any such reason, then:
- the dividend payment date for the affected dividend period will be
the next business day on which the Fund and its paying agent, if any,
are able to cause the dividend to be paid using their reasonable best
efforts;
- the affected dividend period will end on the day it would have ended
had such event not occurred and the dividend payment date had
remained the scheduled date; and
- the next dividend period will begin and end on the dates it would
have begun and ended had such event not occurred and the dividend
payment date had remained the scheduled date.
The following is a simplified example of how a typical auction works. Assume
that the Fund has 1,000 outstanding AMPS of a series and three current holders.
The three current holders and three potential holders submit orders through
broker-dealers at the auction:
Current Holder A........................ Owns 500 shares, wants to sell all 500 Bid order of 2.1% rate for all 500
shares if auction rate is less than 2.1% shares
Current Holder B........................ Owns 300 shares, wants to hold Hold order--will take the auction rate
Current Holder C........................ Owns 200 shares, wants to sell all 200 Bid order of 1.9% rate for all 200
shares if auction rate is less than 1.9% shares
Potential Holder D...................... Wants to buy 200 shares Places order to buy 200 shares at or
above 2.0%
Potential Holder E...................... Wants to buy 300 shares Places order to buy 300 shares at or
above 1.9%
Potential Holder F...................... Wants to buy 200 shares Places order to buy 200 shares at or
above 2.1%
49
The lowest dividend rate that will result in all 1,000 AMPS continuing to be
held is 2.0% (the offer by D). Therefore, the dividend rate will be 2.0%.
Current holders B and C will continue to own their shares. Current holder A will
sell its shares because A's dividend rate bid was higher than the dividend rate.
Potential holder D will buy 200 shares and potential holder E will buy 300
shares because their bid rates were at or below the dividend rate. Potential
holder F will not buy any shares because its bid rate was above the dividend
rate.
The dividend rates used in the example above are hypothetical, and are not
necessarily indicative of the rates that may be payable on the AMPS at any given
time.
For further description of the auction procedures, please see Article Twelve
of the Second Amended and Restated Bylaws, which is attached as Appendix C to
the Statement of Additional Information.
SECONDARY MARKET TRADING AND TRANSFER OF AMPS
The Underwriters are not required to make a market in the AMPS. The
Broker-Dealers (including the Underwriters) may maintain a secondary trading
market for the AMPS outside of auctions, but they are not required to do so.
There can be no assurance that a secondary trading market for AMPS will develop
or, if it does develop, that it will provide holders of AMPS with liquidity of
investment. AMPS will not be registered on any stock exchange or on the NASDAQ
market. Investors who purchase AMPS in an auction (particularly if the Fund has
declared a special rate period) should note that, because the dividend rate on
such shares will be fixed for the length of that rate period, the value of such
shares may fluctuate in response to the changes in interest rates, and may be
more or less than their original cost if sold on the open market in advance of
the next auction thereof, depending on market conditions.
You may sell, transfer, or otherwise dispose of AMPS only in whole shares
and only:
- pursuant to a bid or sell order placed with the auction agent in
accordance with the auction procedures;
- to a Broker-Dealer; or
- to such other persons as may be permitted by the Fund; provided,
however, that (x) if you hold your AMPS in the name of a
Broker-Dealer, a sale or transfer of your AMPS to that Broker-Dealer,
or to another customer of that Broker-Dealer, will not be considered
a sale or transfer for purposes of the foregoing limitation if that
Broker-Dealer remains the existing holder of the AMPS immediately
after the transaction; and (y) in the case of all transfers, other
than through an auction, the Broker-Dealer (or other person, if the
Fund permits) receiving the transfer will advise the auction agent of
the transfer.
NET ASSET VALUE
Net asset value per common share will be determined for the Fund as of the
close of regular trading on the New York Stock Exchange on each day the New York
Stock Exchange is open. In the event that it is not practicable to calculate the
Fund's net asset value on any business day for which a calculation is required,
the Fund's net asset value for that day may be calculated subsequently. The New
York Stock Exchange is normally closed on all national holidays and Good Friday.
To calculate the Fund's net asset value per common share, the Fund's assets are
valued and totaled, liabilities are subtracted, and the resulting net assets are
divided by the number of common shares outstanding.
Portfolio securities and other assets for which market quotations are
readily available are valued at current market value as determined by pricing
services, broker-dealer quotations or other approved
50
methods. Securities with remaining maturities of 60 days or less are generally
valued at amortized cost. Unless certain unusual circumstances occur (including
those described in the following paragraph), fixed income securities for which
daily market quotations are not readily available will, to the extent
appropriate under the circumstances, be valued with reference to fixed income
securities whose prices are more readily available and whose durations are
comparable to those of the securities being valued.
Other assets and securities for which no quotations are readily available
are valued at fair value as determined in good faith by the Trustees or persons
acting at their direction. Because of time zone differences, non-U.S. exchanges
and securities markets will usually be closed prior to the time of the closing
of the New York Stock Exchange. The principal markets for fixed income
securities also generally close prior to the close of the New York Stock
Exchange. Consequently, values of non-U.S. investments and fixed income
securities will be determined as of the earlier closing of such exchanges and
markets. However, events affecting the values of such non-U.S. investments and
fixed income securities may occasionally occur between the earlier closings of
such exchanges and markets and the closing of the New York Stock Exchange that
will not be reflected in the computation of the net asset value. If an event
that is likely materially to affect the value of such investments occurs during
such period, then such investments will be valued at fair value as determined in
good faith by the Trustees or persons acting at their direction.
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 Declaration authorizes an unlimited number of common
shares of beneficial interest, and the Trustees have authorized 8,200 preferred
shares of beneficial interest. Preferred shares (such as the AMPS) 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 AMPS, see "Description of
AMPS." The following table shows the number of (i) shares authorized and (ii)
shares outstanding, for each class of authorized securities of the Fund as of
November 20, 2003.
NUMBER HELD BY OR FOR
TITLE OF CLASS NUMBER AUTHORIZED THE ACCOUNT OF THE FUND NUMBER OUTSTANDING
-------------- ----------------- ----------------------- ------------------
Common Shares...................... Unlimited 0 28,831,981
Preferred Shares
Series M AMPS.................... 1,640 0 0
Series T AMPS.................... 1,640 0 0
Series W AMPS.................... 1,640 0 0
Series TH AMPS................... 1,640 0 0
Series F AMPS.................... 1,640 0 0
Common Shareholders are entitled to share equally in dividends declared by
the Board of Trustees payable to Common Shareholders and in the net assets of
the Fund available for distribution to Common Shareholders after payment of the
preferential amounts payable to holders of any outstanding preferred shares of
beneficial interest. Neither Common Shareholders nor holders of preferred shares
have conversion rights or 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 Common Shareholders.
51
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 Equiserve Trust Company, N.A. as agent for the Common
Shareholders, unless the Common Shareholder elects to receive cash. The Fund and
Equiserve Trust Company, N.A. reserve the right to amend or terminate the
Dividend Reinvestment Plan.
Common Shareholders will vote with the holders of any outstanding AMPS or
other preferred shares on each matter submitted to a vote of Common
Shareholders, except as described under "Description of AMPS--Voting Rights" and
except as otherwise required by the Declaration, the Bylaws or applicable law.
Shareholders of each class or series are entitled to one vote for each share
held. Except as provided under "Description of AMPS--Voting Rights" and except
as otherwise required by the Declaration, the Bylaws or applicable law, holders
of preferred shares, including AMPS (voting as a separate class) are entitled to
elect two Trustees, and the remaining Trustees will be elected by holders of
common shares and preferred shares, voting as a single class.
So long as any AMPS or any other preferred shares are outstanding, Common
Shareholders will not be entitled to receive any dividends or other
distributions from the Fund, unless at the time of such declaration (1) all
accrued dividends on AMPS have 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" (as defined in the 1940 Act), is at least 300% of the
aggregate amount of senior securities representing indebtedness (to the extent
any such senior securities are outstanding) and at least 200% of the aggregate
amount of any 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 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 AMPS from rating agencies. These requirements
include an asset coverage test more stringent than under the 1940 Act. See
"Description of AMPS--Dividends and Rate Periods--Restrictions on Dividends and
Other Distributions."
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 New York Stock Exchange
on September 26, 2003. On November 20, 2003, the net asset value per common
share was $14.45, and the closing price per common share on the New York Stock
Exchange was $15.35.
OTHER ISSUES RELATING TO THE AMPS
Under the 1940 Act, the Fund is permitted to have outstanding more than one
series of preferred shares of beneficial interest 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 Common Shareholders nor holders of preferred
shares have pre-emptive rights to purchase any AMPS or any other preferred
shares that the Fund may issue.
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
52
into three classes. 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, subject to any voting powers of Common Shareholders or
holders of preferred shares, the Declaration provides that a Trustee may be
removed only for cause and only (1) 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, at a meeting called for the purpose, or
(2) 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 (1) has been a member of the
Board for a period of at least thirty-six months (or since immediately after the
initial registered public offering of the Fund's common shares, if less than
thirty-six months); (2) was nominated to serve as a member of the Board of
Trustees by a majority of the Continuing Trustees then members of the Board; or
(3) prior to the sale of the common shares pursuant to an initial public
offering only, serves as a Trustee.
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 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
shareholder authorization would not be required by the Declaration, but might 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). 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 Trustees and seventy-five percent (75%) of the Continuing
Trustees. The Declaration also requires the approval of both a majority of the
Trustees and seventy-five percent (75%) of the Continuing Trustees for certain
extraordinary distributions from the Fund to shareholders. 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 Bylaws.
The overall effect of these provisions is to render more difficult the
accomplishment of a merger 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 objectives 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 has considered the
foregoing anti-takeover provisions and concluded that they are in the best
interests of the Fund.
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 are on file with the Securities and Exchange Commission.
53
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 FUND 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. Common shares
of a closed-end investment company frequently trade at prices lower than net
asset value. The Fund's Board of Trustees will regularly monitor the
relationship between the market price and net asset value of the common shares.
If the Fund converted to an open-end company, it would be required to redeem
all preferred shares (including the AMPS) then outstanding (requiring in turn
that it liquidate a portion of its investment portfolio), and the common shares
would likely 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. The Fund
expects that it would pay all such redemption requests in cash, but reserves the
right to pay redemption requests in securities or through a combination of cash
and securities. If such full or partial payment in securities were made,
investors may incur brokerage costs in converting such securities to cash. The
Fund reserves the right to impose a sales load on its shares if it converts into
an open-end investment company. If the Fund converted into an open-end company,
the differences in risks and operational requirements between closed-end and
open-end investment companies could affect the Fund's ability to achieve its
investment objectives. Conversion to an open-end investment company would also
require a shareholder vote under certain circumstances. See "Anti-Takeover and
Other Provisions in the Declaration of Trust."
Before deciding whether to take any action if the common shares trade below
net asset value, 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 common
shares should trade at a substantial discount for an extended period of time,
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.
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
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
54
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 AMPS to be
eligible to be treated as capital gain dividends, the AMPS 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 AMPS at any time in the future, it is the
opinion of Ropes & Gray LLP that the AMPS 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 AMPS 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 AMPS should be treated as debt for federal income tax
purposes, distributions on AMPS (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 AMPS should be treated as debt for federal
income tax purposes, the IRS would be unlikely to prevail.
To satisfy the distribution requirement applicable to regulated investment
companies, amounts paid as dividends by the Fund to its shareholders, including
holders of its preferred shares, 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 its common shares and any series of outstanding
preferred shares of beneficial interest (including AMPS) 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 preferred shares constitute preferential
dividends under Section 562(c) of the Code, and thus do not qualify for the
dividends-paid deduction. The Fund believes this position, if asserted, would be
unlikely to prevail.
If at any time when preferred shares 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 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 or purchase preferred shares
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 redemptions, which may
result in transaction expenses and gain at the Fund level and in further
distributions.
The Fund's investments in certain debt obligations (including U.S. TIPS) 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, including when it is not advantageous to do so, in order to satisfy
its distribution requirements.
The Fund may at times buy investments at a discount from the price at which
they were originally issued, especially during periods of rising interest rates.
For federal income tax purposes, some or all of
55
this market discount will be included in the Fund's ordinary income and will be
taxable to shareholders as such when it is distributed.
For federal income tax purposes, distributions of investment income are
generally 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 of net gains from the
sale of investments that the Fund owned for more than one year and that are
properly designated by the Fund as capital gain dividends will be taxable as
long-term 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. For
taxable years beginning on or before December 31, 2008, distributions of
investment income designated by the Fund as derived from "qualified dividend
income" will be taxed in the hands of individuals at the rates applicable to
long-term capital gain, provided holding period and other requirements are met
at both the shareholder and Fund levels. The Fund does not expect a significant
portion of Fund distributions to be derived from qualified dividend income. Any
gain resulting from the sale or exchange of Fund shares generally will be
taxable as capital gains.
Long-term capital gain rates applicable to individuals have been temporarily
reduced--in general, to 15% with lower rates applying to taxpayers in the 10%
and 15% rate brackets--for taxable years beginning on or before December 31,
2008.
The Fund's transactions in options, futures contracts, hedging transactions,
forward contracts, swap agreements, straddles and foreign currencies 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.
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
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 28% for amounts paid through
2010. The backup withholding rate will be 31% for amounts paid after December
31, 2010. In order for a foreign investor to qualify for exemption from the
back-up withholding tax rates and for reduced 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. Please see "Tax Matters" in the Statement of Additional
Information for additional information about backup withholding tax rates.
If, in connection with the designation of a special rate period, (i) the
Fund provides in a notice of special rate period that the Fund may redeem all or
part of a series of AMPS and that upon such redemption the holders of that
series of AMPS 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 rate period, (ii) based on all the facts and circumstances at the time
of the designation of the special rate period the Fund is more likely than not
to redeem such series of AMPS during the special rate period, and (iii) the
premium to be paid upon redemption during such special rate 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).
56
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 adviser 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.
57
UNDERWRITING
Subject to the terms and conditions stated in a purchase agreement dated
, 2003, each Underwriter has agreed to purchase, and the Fund has
agreed to sell to such Underwriter, the number of AMPS set forth opposite the
name of such Underwriter.
NUMBER OF AMPS
-------------------------------------------------
UNDERWRITER SERIES M SERIES T SERIES W SERIES TH SERIES F
----------- -------- -------- -------- --------- --------
Merrill Lynch, Pierce, Fenner & Smith
Incorporated......................................
Legg Mason Wood Walker, Incorporated........................
----- ----- ----- ----- -----
Total.............................................
===== ===== ===== ===== =====
The purchase agreement provides that the obligations of the Underwriters to
purchase the shares included in this offering are subject to the approval of
certain legal matters by counsel and to other conditions, including without
limitation the receipt by the Underwriters of customary closing certificates,
opinions and other documents and the receipt by the Fund of "Aaa" and "AAA"
ratings on the AMPS by Moody's and Fitch, respectively, as of the time of the
offering. The Underwriters are obligated to purchase all the AMPS if they
purchase any of the AMPS. In the purchase agreement, the Fund and Western Asset
have agreed to indemnify the Underwriters against certain liabilities, including
liabilities arising under the Securities Act of 1933, as amended, or to
contribute payments the Underwriters may be required to make for any of those
liabilities.
The Underwriters propose to initially offer some of the AMPS directly to the
public at the public offering price set forth on the cover page of this
prospectus and some of the AMPS to certain dealers at the public offering price
less a concession not in excess of $ per share. The sales load the Fund will
pay of $250 per share is equal to 1% of the initial offering price of the AMPS.
After the initial public offering, the Underwriters may change the public
offering price and the concession. Investors must pay for any AMPS purchased on
or before , 2003.
The Fund anticipates that the Underwriters may from time to time act as
brokers or dealers in executing the Fund's portfolio transactions after they
have ceased to be Underwriters. The Underwriters are active underwriters of, and
dealers in, securities and act as market makers in a number of such securities,
and therefore can be expected to engage in portfolio transactions with, and
perform services for, the Fund.
The Fund anticipates that the Underwriters or their respective affiliates
may, from time to time, act in auctions as broker-dealers and receive fees as
set forth under "The Auction" and in the Statement of Additional Information.
The principal business address of Merrill Lynch is 4 World Financial Center,
New York, New York 10080. The principal business address of Legg Mason Wood
Walker, Incorporated is 100 Light Street, Baltimore, Maryland 21202.
The settlement date for the purchase of the AMPS will be ,
2003, as agreed upon by the Underwriters, the Fund and Western Asset pursuant to
Rule 15c6-1 under the Securities Exchange Act of 1934.
58
CUSTODIAN AND TRANSFER AGENT; AUCTION AGENT
The custodian of the assets of the Fund is State Street Bank & Trust
Company, 150 Newport Avenue AFB/4N, North Quincy, Massachusetts 02171. The
custodian performs custodial and certain fund accounting services.
Deutsche Bank Trust Company Americas serves as the auction agent, transfer
agent, registrar, divided paying agent and redemption agent for the AMPS.
EquiServe, 150 Royall Street, Canton, Massachusetts 02021, serves as the
Fund's transfer agent, registrar, and dividend disbursing agent for the Fund's
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 AMPS offered hereby will be
passed upon for the Fund by Ropes & Gray LLP, New York, New York, and for the
Underwriters by Clifford Chance US LLP, New York, New York. Clifford Chance US
LLP may rely as to certain matters of Massachusetts law on the opinion of Ropes
& Gray LLP.
AVAILABLE INFORMATION
The Fund is subject to certain informational requirements under the federal
securities laws and in accordance therewith is required to file reports, proxy
statements and other information with the United States Securities and Exchange
Commission (the "SEC"). Any such reports, proxy statements and other information
can be inspected and copied at the public reference facilities of the SEC,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. Reports, proxy
statements and other information concerning the Fund can also be inspected at
the offices of the New York Stock Exchange, 20 Broad Street, New York, New York
10005.
Additional information regarding the Fund and the AMPS is contained in the
Registration Statement on Form N-2, including amendments, exhibits and schedules
thereto, relating to such shares filed by the Fund with the SEC. This prospectus
does not contain all of the information set forth in the Registration Statement,
including any amendments, exhibits and schedules thereto. For further
information with respect to the Fund and the shares offered hereby, reference is
made to the Registration Statement. Statements contained in this prospectus 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.
A copy 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. The SEC maintains a web site (http://www.sec.gov) that contains the
Registration Statement, other documents incorporated by reference, and other
information the Fund has filed electronically with the SEC, including proxy
statements and reports filed under the Securities Exchange Act of 1934.
59
TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION
PAGE
----
Use of Proceeds....................................................... 1
Investment Objectives and Policies.................................... 1
Investment Restrictions............................................... 33
Management of the Fund................................................ 36
Investment Advisor and Administrator.................................. 44
Portfolio Transactions................................................ 46
Distributions......................................................... 47
Description of Shares................................................. 48
Additional Information Concerning the Auctions for AMPS............... 49
Anti-Takeover and Other Provisions in the Declaration of Trust........ 50
Repurchase of Common Shares; Conversion to Open-End Fund.............. 52
Tax Matters........................................................... 54
Performance-Related, Comparative and Other Information................ 60
Proxy Voting Policies and Procedures.................................. 62
Custodian, Transfer Agent and Dividend Paying Agent................... 62
Independent Accountants............................................... 62
Counsel............................................................... 62
Registration Statement................................................ 62
Financial Statements.................................................. 62
Appendix A--Description of Securities Ratings......................... A-1
Appendix B--Proxy Voting Policies and Procedures...................... B-1
Appendix C--Article 12 of the Second Amended and Restated Bylaws...... C-1
60
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
[WESTERN ASSET LOGO] [CLAYMORE LOGO]
$205,000,000
WESTERN ASSET/CLAYMORE U.S. TREASURY INFLATION
PROTECTED SECURITIES FUND
TAXABLE AUCTION MARKET PREFERRED SHARES ("AMPS")
1,640 SHARES, SERIES M
1,640 SHARES, SERIES T
1,640 SHARES, SERIES W
1,640 SHARES, SERIES TH
1,640 SHARES, SERIES F
LIQUIDATION PREFERENCE $25,000 PER SHARE
-----------------
PROSPECTUS
-----------------
MERRILL LYNCH & CO.
LEGG MASON WOOD WALKER INCORPORATED
, 2003
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
The information in this Statement of Additional Information is not
complete and may be changed. We may not sell these securities until the
registration statement filed with the Securities and Exchange Commission is
effective. This Statement of Additional Information is not an offer to sell
these securities and it is not soliciting an offer to buy these securities in
any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION -- DATED DECEMBER 11, 2003
WESTERN ASSET/CLAYMORE U.S. TREASURY INFLATION PROTECTED
SECURITIES FUND
STATEMENT OF ADDITIONAL INFORMATION
[ ], 2003
Western Asset/Claymore U.S. Treasury Inflation Protected Securities Fund
(the "Fund") is a recently organized, diversified, closed-end management
investment company.
This Statement of Additional Information relating to the Series M
Taxable Auction Market Preferred Shares, Series T Taxable Auction Market
Preferred Shares, Series W Taxable Auction Market Preferred Shares, Series TH
Taxable Auction Market Preferred Shares and Series F Taxable Auction Market
Preferred Shares of the Fund (collectively, the "AMPS") is not a prospectus,
and should be read in conjunction with the Fund's prospectus relating thereto
dated [ ], 2003 (the "Prospectus"). This Statement of Additional
Information does not include all information that a prospective investor
should consider before purchasing AMPS, 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 1-800-345-7999. You may also obtain a
copy of the Prospectus on the web site (http://www.sec.gov) of the Securities
and Exchange Commission (the "SEC"). Capitalized terms used but not defined
in this Statement of Additional Information have the meanings ascribed to
them in the Prospectus.
TABLE OF CONTENTS
PAGE
USE OF PROCEEDS 1
INVESTMENT OBJECTIVES AND POLICIES 1
INVESTMENT RESTRICTIONS 33
MANAGEMENT OF THE FUND 36
INVESTMENT ADVISOR AND ADMINISTRATOR 44
PORTFOLIO TRANSACTIONS 46
DISTRIBUTIONS 47
DESCRIPTION OF SHARES 48
ADDITIONAL INFORMATION CONCERNING THE AUCTIONS FOR AMPS 49
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST 50
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND 52
TAX MATTERS 54
PERFORMANCE-RELATED, COMPARATIVE AND OTHER INFORMATION 60
PROXY VOTING POLICIES AND PROCEDURES 62
CUSTODIAN, TRANSFER AGENT AND DIVIDEND PAYING AGENT 62
INDEPENDENT ACCOUNTANTS 62
COUNSEL 62
REGISTRATION STATEMENT 62
FINANCIAL STATEMENTS 62
APPENDIX A - DESCRIPTION OF SECURITIES RATINGS A-1
APPENDIX B - PROXY VOTING POLICIES AND PROCEDURES B-1
APPENDIX C - ARTICLE 12 OF THE SECOND AMENDED AND RESTATED BYLAWS C-1
This Statement of Additional Information is dated __________, 2003.
i
USE OF PROCEEDS
The net proceeds of the offering of AMPS of the Fund will be
approximately $202,645,415 after payment of the offering costs and sales load.
The Fund will invest the net proceeds of the offering in accordance with
the Fund's investment objectives and policies as stated below and in the
Prospectus. It is presently anticipated that the Fund will use the net proceeds
of the offering to purchase U.S. Treasury Inflation Protected Securities ("U.S.
TIPS") and other investments that meet the Fund's investment objectives and
policies and/or to repay certain currently outstanding reverse repurchase
agreements or other leverage. Pending such use, it is anticipated that the net
proceeds of the offering will be invested in short-term investment grade
securities.
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives 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.
INFLATION-INDEXED BONDS
Under normal market conditions, the Fund will invest at least 80% of its
total managed assets in U.S. TIPS. U.S. TIPS are fixed income securities issued
by the U.S. Department of Treasury, the principal amounts of which are adjusted
daily based upon changes in the rate of inflation (currently represented by the
non-seasonally adjusted Consumer Price Index for All Urban Consumers, calculated
with a three-month lag). The Consumer Price Index for All Urban Consumers
("CPI-U") calculated by the U.S. Department of Treasury for the first day of
each calendar month is the CPI-U for the third preceding calendar month. For
example, the CPI-U used for April 1 in any year is the CPI-U for January of that
year, which is reported in February. The factor used to calculate the principal
amount of a U.S. TIPS each day is determined by a linear interpolation between
the CPI-U for the first day of the month and the CPI-U on the first day of the
next month.
The U.S. Treasury currently issues U.S. TIPS in only ten-year maturities,
although it is possible that U.S. TIPS with other maturities will be issued in
the future. U.S. TIPS have previously been issued with maturities of five, ten
and thirty years. U.S. TIPS pay interest on a semi-annual basis, equal to a
fixed percentage of the inflation-adjusted principal amount.
The interest rate on these bonds is fixed at issuance, but over the life of
the bond, this interest may be paid on an increasing or decreasing principal
value that has been adjusted for inflation. Repayment of the original bond
principal upon maturity (as adjusted for inflation) is guaranteed even during a
period of deflation. However, because the principal amount of U.S. TIPS would be
adjusted downward during a period of deflation, the Fund will be subject to
deflation risk with respect to its investments in these securities. In addition,
the current market value of the bonds is not guaranteed, and will fluctuate. If
the Fund purchases U.S. TIPS in the secondary market whose principal values have
been adjusted upward due to inflation since issuance, the Fund may experience a
loss if there is a subsequent period of deflation. If inflation is lower than
expected during the period the Fund holds a U.S. TIPS, the Fund may earn less on
the security than on a conventional bond. For more information about certain
risks relating to investments in U.S. TIPS, see "Risks -- General Risks of
Investing in the Fund -- Risks Relating to U.S. TIPS" in the Fund's Prospectus.
The Fund may invest in inflation-indexed securities with other structures
or characteristics as such securities become available in the market. Most other
issuers, including non-U.S. governments, their agencies or instrumentalities,
and corporations, currently pay out the Consumer Price Index accruals as part of
a semi-annual coupon. It is currently expected that other types of
inflation-indexed securities would have characteristics similar to those
described above.
1
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 U.S. inflation-indexed bonds. For federal income tax purposes, any
increase in the principal amount of an inflation-indexed bond will be original
issue discount which is taxable as ordinary income in the year accrued, even
though investors do not receive their principal, including any increases
thereto, until maturity. See "Tax Matters--Original Issue Discount and
Payment-in-Kind Securities" below. Because the Fund will not, on a current
basis, receive cash payments from the issuer of these securities in respect of
accrued original issue discount, in some years the 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 U.S. inflation-indexed bonds may be illiquid,
making it difficult for the Fund to dispose of them or determine their current
value.
CORPORATE BONDS
The Fund may invest in a wide variety of U.S. dollar-denominated 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 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. Although the
Fund will not invest in bonds of below investment grade quality (as defined in
the Prospectus) at the time of purchase, due to fluctuations in the credit
characteristics of a particular issue, the Fund may from time to time hold
corporate bonds of less than investment grade quality. See "-Lower Grade
Securities ("Junk Bonds")" below.
The Fund's investments in corporate bonds are subject to a number of risks
described in the Prospectus and elaborated upon elsewhere in this Statement of
Additional Information and the Prospectus, including interest rate risk, credit
risk, lower grade and unrated securities risk, issuer risk, smaller company
risk, foreign risk, currency risk, inflation 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 objectives and policies, including unrated
commercial paper for which Western Asset Management Company ("Western Asset" or
the "Advisor"), the Fund's investment advisor, has made a credit quality
assessment. See Appendix A to this Statement of Additional Information for a
description of the ratings assigned by Moody's Investor Services, Inc.
("Moody's"), Standard & Poor's Rating Services ("S&P") and Fitch Ratings
("Fitch") to 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.
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. 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
2
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
stockholders are generally paid dividends and liquidation proceeds 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. The Fund
may also invest in fixed rate preferred stocks other than perpetual preferred
stocks and sinking fund 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 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 usually for mandatory redemption prior to expiration of the
credit arrangement. In addition, no redemption can usually 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.
EQUITY SECURITIES
The Fund may directly or indirectly invest its assets in equity securities.
Among other risks, prices of equity securities generally fluctuate more than
those of other securities. The Fund may experience a substantial or complete
loss on an individual stock. These risks may affect a single issuer, industry or
section of the economy or may affect the market as a whole.
CONVERTIBLE SECURITIES AND SYNTHETIC CONVERTIBLE SECURITIES
The Fund may invest in convertible securities, which are bonds, debentures,
notes or other securities that entitle the holder to acquire common stock or
other equity securities of the same or a different issuer.
3
Convertible securities have general characteristics similar to both debt and
equity securities. The Advisor will generally evaluate these instruments based
on their debt characteristics.
A convertible security generally entitles the holder to receive interest
paid or accrued until the convertible security matures or is redeemed, converted
or exchanged. Before conversion, convertible securities have characteristics
similar to non-convertible debt obligations. 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.
Because of the conversion feature, the price of the convertible security
will normally fluctuate in some proportion to changes in the price of the
underlying asset, and will therefore be subject to risks relating to the
activities of the issuer and/or general market and economic conditions. The
income component of convertible securities may tend to cushion the securities
against declines in the price of the underlying asset. However, the income
component of convertible securities will typically cause fluctuations in the
value of such securities based upon changes in interest rates and the credit
quality of the issuer. In addition, convertible securities are often lower-rated
securities. See "-Lower Grade Securities ("Junk Bonds")" below.
A convertible security may be subject to redemption at the option of the
issuer at a predetermined price. If a convertible security held by the Fund is
called for redemption, the Fund would be required to permit the issuer to redeem
the security and convert it to underlying common stock, or would sell the
convertible security to a third party, which may have an adverse effect on the
Fund's ability to achieve its investment objectives.
The Fund may invest in so-called "synthetic convertible securities," which
are composed of two or more different securities whose investment
characteristics, taken together, resemble those of convertible securities. For
example, the Fund may purchase a non-convertible debt security and a warrant or
option. The synthetic convertible security differs from the true convertible
security in several respects. Unlike a true convertible security, which is a
single security having a unitary market value, a synthetic convertible security
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 convertible component. For this reason,
the values of a synthetic convertible security and a true convertible security
may respond differently to market fluctuations.
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.
4
Subject to the Fund's limitation on concentration in the securities of
issuers in a particular industry or group of industries, the Fund may invest
without limit 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" below,
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.
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
unsecured loans 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
5
pay only a small fraction of the amount owed. Consequently, to the extent the
Fund holds 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 or group of industries (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
currently 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
financial intermediary, or a group of intermediaries engaged in the same
industry, even if the underlying borrowers represent many different companies
and industries. The Fund reserves the right to treat the corporate borrower as
the issuer of such participations to the extent permitted by applicable law,
regulations, or SEC staff interpretations or orders in the future.
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 the Advisor 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 the Advisor'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 and perceived credit quality of the issuer to a greater degree than are
other types of securities having similar maturities and credit
6
quality. As discussed above in connection with inflation-indexed bonds, the
distribution requirements applicable to regulated investment companies require
that the Fund distribute 90% of its net investment income, including the
original issue discount accrued on zero-coupon bonds, step-ups and PIKs. As a
result, in some years the Fund may have to distribute cash obtained from selling
other portfolio holdings of the Fund, 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.
LOWER GRADE SECURITIES ("JUNK BONDS")
Although the Fund will not invest in bonds that are below investment grade
quality (as defined in the Prospectus) at the time of purchase, the Fund is not
required to dispose of a security if a rating agency or the Advisor downgrades
its assessment of the credit characteristics of a particular issue. As a result,
the Fund may from time to time hold bonds of below investment grade quality.
Such investments may include debt securities not rated Baa by Moody's or BBB by
S&P or Fitch or higher, or securities that are unrated but judged to be of
comparable quality by the Advisor. 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. Debt 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 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. In the case
of high yield securities structured as zero-coupon, step-up or payment-in-kind
securities, their market prices will normally be affected to a greater extent by
interest rate changes, and therefore tend to be more volatile than securities
which pay interest currently and in cash. The Advisor 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 daily 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
the Advisor's research and analysis when investing in high yield securities.
7
A general description of Moody's, S&P's, and Fitch's ratings of securities
is set forth in Appendix A to this Statement of Additional Information. The
ratings of Moody's, S&P and Fitch 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, debt
obligations with the same maturity, coupon and rating may have different yields
while 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. The Advisor does not rely solely on credit ratings
when selecting securities for the Fund and develops its own independent analysis
of issuer credit quality. Because of this, the Fund's performance may depend
more on the Advisor's own credit analysis than in the case of a fund investing
in higher-rated securities.
As noted above, the Fund is not required to dispose of a security in the
event that a rating agency or the Advisor downgrades its assessment of the
credit characteristics of a particular issue. In determining whether to retain
or sell such a security, the Advisor may consider such factors as the Advisor'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.
FOREIGN (NON-U.S.) SECURITIES
The Fund may invest in U.S. dollar-denominated debt obligations of foreign
issuers, including foreign corporate issuers, foreign banks (see "-Bank
Obligations" above), foreign governments and their respective sub-divisions,
agencies and instrumentalities, government-sponsored enterprises, international
agencies and supra-national government entities. The Fund does not currently
anticipate holding non-U.S. dollar-denominated investments but reserves the
flexibility to invest, from time to time, in debt instruments denominated in
foreign currencies (of both developed and "emerging market" countries) upon the
recommendation of the Advisor.
The U.S. dollar-denominated foreign securities in which the Fund may invest
include, among others, 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
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 may also invest in American Depository Receipts ("ADRs") or Global
Depository Receipts ("GDRs"). 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.
8
The Fund also may invest in U.S. dollar denominated 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 and are actively
traded in the over-the-counter secondary market. Brady Bonds are not considered
to be U.S. 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.
To the extent the Fund invests in non-U.S. instruments, the following
guidelines will apply in determining the Fund's net asset value. The values of
such securities and investments are translated into U.S. dollars at current
exchange rates or at such other rates as the Trustees or persons acting at their
discretion may determine in computing net asset value. Because of time zone
differences, non-U.S. exchanges and securities markets and non-U.S. currency
markets will usually be closed prior to the time of closing of the New York
Stock Exchange. Consequently, the values of non-U.S. securities and investments
will be determined as of the
9
earlier closing of such exchanges and markets. Events affecting the values of
such non-U.S. securities and investments may occasionally occur between the
earlier closings of such exchanges and markets and the closing of the New York
Stock Exchange that will not be reflected in the computation of the net asset
value. If an event that is likely materially to affect the value of such
securities or investments occurs during such period, then such securities or
investments will be valued at fair value as determined in good faith by the
Trustees or persons acting at their discretion.
EMERGING MARKET SECURITIES. The risks of investing in foreign securities
are particularly high when securities of issuers based in or denominated in
currencies of developing (or "emerging market") countries are involved.
Investing in emerging market countries involves certain risks not typically
associated with investing in U.S. securities, and imposes risks greater than, or
in addition to, risks of investing in foreign, developed countries. These risks
include: greater risks of nationalization or expropriation of assets or
confiscatory taxation; greater social, economic and political uncertainty and
instability (including the risk of war); more substantial government involvement
in the economy; less government supervision and regulation of the securities
markets and participants in those markets; controls on foreign investment and
limitations on repatriation of invested capital; the fact that companies in
emerging market countries may be smaller, less seasoned and newly organized
companies; the difference in, or lack of, auditing and financial reporting
standards, which may result in unavailability of material information about
issuers; the risk that it may be more difficult to obtain and/or enforce a
judgment in a court outside the United States; and greater price volatility,
substantially less liquidity and significantly smaller market capitalization of
securities markets. In addition, a number of emerging market countries restrict,
to various degrees, foreign investment in securities, and high rates of
inflation and rapid fluctuations in inflation rates have had, and may continue
to have, negative effects on the economies and securities markets of certain
emerging market countries. Also, any change in the leadership or politics of
emerging market countries, or the countries that exercise a significant
influence over those countries, may halt the expansion of or reverse the
liberalization of foreign investment policies now occurring and adversely affect
existing investment opportunities.
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 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.
FOREIGN CURRENCY EXCHANGE-RELATED SECURITIES
PRINCIPAL EXCHANGE RATE LINKED SECURITIES. Principal exchange rate linked
securities ("PERLs"(SM)) are debt obligations the principal on which is payable
at maturity in an amount that may vary based on the
10
exchange rate between the U.S. dollar and a particular foreign currency at or
about that time. The return on "standard" principal exchange rate linked
securities is enhanced if the foreign currency to which the security is linked
appreciates against the U.S. dollar, and is adversely affected by increases in
the foreign exchange value of the U.S. dollar; "reverse" principal exchange rate
linked securities are like "standard" securities, except that their return is
enhanced by increases in the value of the U.S. dollar and adversely impacted by
increases in the value of foreign currency. Interest payments on the securities
are generally made in U.S. dollars at rates that reflect the degree of foreign
currency risk assumed or given up by the purchaser of the notes (i.e., at
relatively higher interest rates if the purchaser has assumed some of the
foreign exchange risk, or relatively lower interest rates if the issuer has
assumed some of the foreign exchange risk, based on the expectations of the
current market). Principal exchange rate linked securities may in limited cases
be subject to acceleration of maturity (generally, not without the consent of
the holders of the securities), which may have an adverse impact on the value of
the principal payment to be made at maturity.
PERFORMANCE INDEXED PAPER. Performance indexed paper ("PIPs"(SM)) is U.S.
dollar-denominated commercial paper the yield of which is linked to certain
foreign exchange rate movements. The yield to the investor on performance
indexed paper is established at maturity as a function of spot exchange rates
between the U.S. dollar and a designated currency as of or about that time
(generally, the index maturity two days prior to maturity). The yield to the
investor will be within a range stipulated at the time of purchase of the
obligation, generally with a guaranteed minimum rate of return that is below,
and a potential maximum rate of return that is above, market yields on U.S.
dollar-denominated commercial paper, with both the minimum and maximum rates of
return on the investment corresponding to the minimum and maximum values of the
spot exchange rate two business days prior to maturity.
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 utilize
these instruments successfully may depend in part upon the ability of the
Advisor 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.
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 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
11
securities guaranteed by the Government National Mortgage Association (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
includes state and federally chartered savings and loan associations, mutual
savings banks, commercial banks, 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 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.
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
12
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.
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
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.
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. The issuer of a CMO may elect to be treated as a
real estate mortgage investment conduit (a "REMIC"), a pass-through vehicle
created to issue multi-class mortgage-backed securities. The characteristics of
and risks relating to REMICs are substantially similar to those of CMOs.
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.
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
13
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.
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
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.
14
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.
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, 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.
OTHER ASSET-BACKED SECURITIES. Similarly, the Advisor 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
Certificates for Automobile Receivables(SM) ("CARS(SM)"). 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 Fund 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. Consistent with the Fund's
investment objectives and policies, the Advisor also may invest in other types
of asset-backed securities.
Non-mortgage asset-backed securities involve risks that are not presented
by mortgage-related securities. Primarily, these securities do not have the
benefit of the same security interest in the underlying collateral. Credit card
receivables are generally unsecured, and the debtors are entitled to the
protection of a number of state and Federal consumer credit laws which give
debtors the right to set off certain amounts owed on the credit cards, thereby
reducing the balance due. Most issuers of automobile
15
receivables permit the servicers to retain possession of the underlying
obligations. If the servicer were to sell these obligations to another party,
there is a risk that the purchaser would acquire an interest superior to that of
the holders of the related automobile receivables. In addition, because of the
large number of vehicles involved in a typical issuance and technical
requirements under state laws, the trustee for the holders of the automobile
receivables may not have an effective security interest in all of the
obligations backing such receivables. Therefore, there is a possibility that
recoveries on repossessed collateral may not, in some cases, be able to support
payments on these securities.
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 which is tied to another interest rate, 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.
A floater may be considered to be leveraged in an economic sense to the
extent that its interest rate varies by a magnitude that exceeds the magnitude
of the change in the index rate of interest. However, the Fund does not
currently consider floaters to be "leverage" for purposes of its policy on the
amount of leverage it may incur or for purposes of calculating total managed
assets. The higher degree of leverage inherent in some floaters is associated
with greater volatility in their market values. With respect to purchasable
variable and floating rate instruments, the Advisor will consider the earning
power, cash flows and liquidity ratios of the issuers and guarantors of such
instruments and, if the instruments are subject to a demand feature, will
monitor their financial status to meet payment on demand. Such instruments may
include variable amount master demand notes that permit the indebtedness
thereunder to vary in addition to providing for periodic adjustments in the
interest rate. The absence of an active secondary market with respect to
particular variable and floating rate instruments could make it difficult for
the Fund to dispose of a variable or floating rate note if the issuer defaulted
on its payment obligation or during periods that the Fund is not entitled to
exercise its demand rights, and the Fund could, for these or other reasons,
suffer a loss with respect to such instruments. In determining average-weighted
portfolio maturity, an instrument will be deemed to have a maturity equal to
either the period remaining until the next interest rate adjustment or the time
the Fund involved can recover payment of principal as specified in the
instrument, depending on the type of instrument involved.
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
16
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 indices 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.
REAL ESTATE INVESTMENT TRUSTS
Real estate investment trusts ("REITs") pool investors' funds for
investment primarily in income producing real estate or real estate related
loans or interests. Under the Code, a REIT is not taxed on income it distributes
to its shareholders if it complies with several requirements relating to its
organization, ownership, assets, and income and a requirement that it generally
distribute to its shareholders at least 95% of its taxable income (other than
net capital gains) for each taxable year. REITs can generally be classified as
Equity REITs, Mortgage REITs, and Hybrid REITs. Equity REITs, which invest the
majority of their assets directly in real property, derive their income
primarily from rents. Equity REITs can also realize capital gains by selling
properties that have appreciated in value. Mortgage REITs, which invest the
majority of their assets in real estate mortgages, derive their income primarily
from interest payments. Hybrid REITs combine the characteristics of both Equity
REITs and Mortgage REITs.
While the Fund will not generally invest in real estate directly, to the
extent it invests in REITs, it may be subject to risks similar to those
associated with the direct ownership of real estate. These risks include
declines in the value of real estate, risks related to general and local
economic conditions, dependency on management skill, heavy cash flow dependency,
possible lack of availability of mortgage funds, overbuilding, extended
vacancies of properties, increased competition, increases in property taxes and
operating expenses, changes in zoning laws, losses due to costs resulting from
the clean-up of environmental problems, liability to third parties for damages
resulting from environmental problems, casualty or condemnation losses,
limitations on rents, changes in neighborhood values and in the appeal of
properties to tenants and changes in interest rates.
In addition to these risks, REITs may be affected by changes in the value
of the underlying property owned by the trusts, or by the quality of any credit
they extend. Further, REITs are dependent upon management skills and generally
may not be diversified. REITs are also subject to heavy cash flow dependency,
defaults by borrowers and self-liquidation. In addition, REITs could possibly
fail to qualify for tax-free pass-through of income under the Code or to
maintain their exemptions from registration under the Investment Company Act of
1940, and the rules and regulations thereunder, each as amended from time to
time (the "1940 Act"). The above factors may also adversely affect a borrower's
or a lessee's ability to meet its obligations to the REIT. In the event of a
default by a borrower or lessee, the REIT may experience delays in enforcing its
rights as a mortgagee or lessor and may incur substantial costs associated with
protecting its investments. The Fund may invest in certain "special purpose"
REITs that invest their assets in specific real estate sectors, such
17
as hotel REITs, nursing home REITs or warehouse REITs, and are therefore
subject, in addition to the foregoing risks, to the risks associated with
adverse developments in any such sectors.
The Fund's investment in a REIT may require the Fund to accrue and
distribute income not yet received or may result in the Fund making
distributions which constitute a return of capital to shareholders for federal
income tax purposes. In addition, distributions by the Fund from REITs will not
qualify for the corporate dividends-received deduction.
DELAYED FUNDING LOANS AND REVOLVING CREDIT FACILITIES
The Fund may also enter into, or acquire participations in, delayed funding
loans and revolving credit facilities. Delayed funding loans and revolving
credit facilities are borrowing arrangements in which the lender agrees to make
loans up to a maximum amount upon demand by the borrower during a specified
term. A revolving credit facility differs from a delayed funding loan in that as
the borrower repays the loan, an amount equal to the repayment may be borrowed
again during the term of the revolving credit facility. Delayed funding loans
and revolving credit facilities usually provide for floating or variable rates
of interest. These commitments may have the effect of requiring the Fund to
increase its investment in a company at a time when it might not otherwise be
desirable to do so (including a time when the company's financial condition
makes it unlikely that such amounts will be repaid). To the extent that the Fund
is committed to advance additional funds, it will at all times segregate liquid
assets as required by the 1940 Act and SEC staff orders and interpretations
thereunder.
The Fund may invest in delayed funding loans and revolving credit
facilities with credit quality comparable to that of issuers of its securities
investments. Delayed funding loans and revolving credit facilities may be
subject to restrictions on transfer, and only limited opportunities may exist to
resell such instruments. As a result, the Fund may be unable to sell such
investments at an opportune time or may have to resell them at less than fair
market value. The Fund currently intends to treat delayed funding loans and
revolving credit facilities for which there is no readily available market as
illiquid. For a further discussion of the risks involved in investing in loan
participations and other forms of direct indebtedness, see "-Loan Participations
and Assignments." Participation interests in revolving credit facilities will be
subject to the limitations discussed in "-Loan Participations and Assignments."
Delayed funding loans and revolving credit facilities are considered to be debt
obligations for the purposes of the Fund's investment restriction relating to
the lending of funds or assets by the Fund.
DERIVATIVE INSTRUMENTS
In pursuing its investment objectives, 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 and index futures contracts and
purchase and sell options on such futures contracts ("futures options") to add
leverage to the portfolio, for hedging purposes, for duration management or as
part of its overall investment strategy. For example, the Fund may use
derivatives in an attempt to protect against possible changes in the market
value of the Fund's portfolio resulting from trends in the bond markets and
changes in interest rates, to protect the Fund's unrealized gains in the value
of its portfolio securities, to facilitate the sale of such securities for
investment purposes, to establish a position in the securities markets as a
temporary substitute for purchasing particular securities and to enhance income
or gain. The Fund also may enter into swap agreements with respect to interest
rates, securities indexes and other assets and measures of risk or return. The
Fund may also use other types of instruments that are currently available or
that may be introduced in the future, including other types of options, futures
contracts or futures options, provided that their use is consistent with the
Fund's investment objectives.
18
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 utilize these
instruments successfully may depend in part upon the ability of the Advisor to
forecast interest rates and other economic factors correctly. If the Advisor
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 the Advisor
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 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 due to 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.
OPTIONS ON SECURITIES, SWAP AGREEMENTS AND INDEXES. The Fund may purchase
and sell both put and call options on securities, swap agreements 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.
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 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 generally 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,
segregates cash or other liquid assets in the amount of the security's value 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 liquid assets in such amount are segregated on the Fund's records) 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
liquid assets, 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 liquid assets. A put option on a security or an index is
"covered" if the Fund segregates liquid assets 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
19
written, or (ii) less than the exercise price of the put written, provided the
difference is maintained by the Fund in segregated liquid assets. The Fund may
also cover options that it writes using other permitted methods.
If an option written by the Fund expires unexercised, the Fund realizes a
capital gain equal to the premium received 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. Transaction costs must also be included
in these calculations. 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.
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."
For more information regarding options on swap agreements, see "-Swap
Agreements" below.
OVER-THE-COUNTER ("OTC") OPTIONS. Unlike exchange-traded options, which are
standardized with respect to the underlying instrument, expiration date,
contract size and strike price, the terms of OTC options (options not traded on
exchanges) generally are established through negotiation with the other party to
the option contract. While this type of arrangement allows the Fund great
flexibility to tailor the option to its needs, OTC options generally involve
greater risk than exchange-traded options, which are guaranteed by the clearing
organization of the exchanges where they are traded. Thus, when the Fund
purchases an OTC option, it relies on the counterparty from whom it purchased
the option to make or take delivery of the underlying investment upon exercise
of the option. Failure by the counterparty to do so would result in the loss of
any premium paid by the Fund as well as the loss of any expected benefit of the
transaction.
Closing transactions can be made for OTC options only by negotiating
directly with the counterparty, or by a transaction in the secondary market if
any such market exists. There can be no assurance that the Fund will in fact be
able to close out an OTC option position at a favorable price prior to
expiration. In the event of
20
insolvency of the counterparty, the Fund might be unable to close out an OTC
option position at any time prior to its expiration, if at all. In addition, OTC
options are considered illiquid by the SEC.
RISKS ASSOCIATED WITH OPTIONS ON SECURITIES, SWAP AGREEMENTS AND INDEXES.
There are several risks associated with transactions in options on securities,
swap agreements and 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 objective. 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 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 corporate debt obligations
(to the extent they are available), U.S. Government securities and other market
measures, as well as purchase put and call options on such futures contracts.
A futures contract on an index or interest rate or other market measure 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 or
interest rate or other market measure at the close of the last trading day of
the contract and the price at which the index or interest rate contract was
originally written. Although the value of an index might be a function of the
value of certain specified securities, no physical delivery of these securities
is made. A public market exists in futures contracts covering a number of
indexes as well as financial instruments, including, among others: U.S. Treasury
bonds; U.S. Treasury notes; GNMA Certificates; three-month U.S. Treasury bills;
90-day commercial paper; bank certificates of deposit; Eurodollar certificates
of deposit; the
21
Australian dollar; the Canadian dollar; the British pound; the Japanese yen; the
Mexican peso; and certain multinational currencies, such as the euro. 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 futures 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.
Futures contracts and futures options generally are standardized and traded
on a U.S. or other exchange, board of trade or similar entity, or quoted on an
automated quotation system.
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 liquid assets ("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 which 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. The Fund may cover a straddle in
several ways including the following. 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."
The Fund is operated by a person who has claimed an exclusion from the
definition of the term "commodity pool operator" under the Commodity Exchange
Act (the "CEA"), and, therefore, such person is not subject to registration or
regulation as a pool operator under the CEA.
22
LIMITATIONS ON USE OF FUTURES AND FUTURES OPTIONS. When purchasing a
futures contract, the Fund will maintain with its custodian (and mark-to-market
on a daily basis) liquid assets, 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 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) liquid assets 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) liquid assets 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) liquid assets 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.
Segregation of assets to cover the Fund's obligations under futures
contracts and related options 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."
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, 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, when and how 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.
23
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.
SWAP AGREEMENTS. The Fund may enter into swap agreements with respect to
interest rates, currencies, indexes of securities and other assets or measures
of risk or return. The Fund may also enter into options on swap agreements
("swap options"). 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 to a substantial degree in connection
with its leveraging strategies. See "-Certain Interest Rate Swap Transactions"
below. A swap option 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 swap
options.
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
24
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 liquid assets. 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 or
borrowings.
Whether the Fund's use of swap agreements or swap options will be
successful in furthering its investment objectives will depend on the Advisor'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. Swap agreements of the type the Fund will enter into are
generally exempt from most provisions of the CEA and, therefore, are not
regulated as futures or commodity option transactions under the CEA. 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 swap option than it
will incur when it purchases a swap option. When the Fund purchases a swap
option, 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
swap option, upon exercise of the option the Fund will become obligated
according to the terms of the underlying agreement.
CERTAIN INTEREST RATE SWAP 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 AMPS or any variable rate borrowing or other form of leverage
with a variable cost. 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 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 beneficial interest 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 or investment purposes. Such transactions involve costs,
however, and may not be successful.
CREDIT DEFAULT SWAPS
The Fund may enter into credit default swap contracts for investment
purposes and to add leverage to the portfolio. As the seller in a credit default
swap contract, the Fund would be required to pay the par (or other agreed-upon)
value of a referenced debt obligation to the counterparty in the event of a
default by a third party, such as a U.S. or foreign corporate issuer, on the
debt obligation. In return, the Fund would receive from the counterparty a
periodic stream of payments over the term of the contract provided that no event
of default has occurred. If no default occurs, the Fund would keep the stream of
payments and would have no payment obligations. As the seller, the Fund would
effectively add leverage to its portfolio because, in addition to its total
managed assets, the Fund would be subject to investment exposure on the notional
amount of the swap.
The Fund may also purchase credit default swap contracts in order to hedge
against the risk of default of debt securities held in its portfolio, in which
case the Fund would function as the counterparty referenced in the
25
preceding paragraph. This would involve the risk that the investment may expire
worthless and would only generate income in the event of an actual default by
the issuer of the underlying obligation (as opposed to a credit downgrade or
other indication of financial instability). It would also involve credit risk -
that the seller may fail to satisfy its payment obligations to the Fund in the
event of a default.
STRUCTURED NOTES AND OTHER HYBRID INSTRUMENTS
The Fund may invest in "structured" notes, which are privately negotiated
debt obligations where the principal and/or interest is determined by reference
to the performance of a benchmark asset or market, such as selected securities
or an index of securities, or the differential performance of two assets or
markets, such as indices reflecting taxable and tax-exempt bonds. Depending on
the terms of the note, the Fund may forgo all or part of the interest and
principal that would be payable on a comparable conventional note. The rate of
return on structured notes may be determined by applying a multiplier to the
performance or differential performance of the referenced index(es) or other
asset(s). Application of a multiplier involves leverage which will serve to
magnify the potential for gain and the risk of loss. The Fund may use structured
notes to add leverage to the portfolio and for investment as well as risk
management purposes, such as to reduce the interest rate sensitivity of the
Fund's portfolio (and thereby decrease the Fund's exposure to interest rate
risk). Like other sophisticated strategies, the Fund's use of structured notes
may not work as intended; for example, by reducing the duration of the Fund's
portfolio, structured notes may limit the Fund's return when having a longer
duration would be beneficial (for instance, when interest rates decline).
Because structured notes of the type in which the Fund anticipates it will
invest typically involve no credit enhancement, their credit risk generally will
be equivalent to that of the underlying investments.
The Fund may invest in other types of "hybrid" instruments which combine
the characteristics of securities, futures, and options. For example, the
principal amount or interest rate of a hybrid could be tied (positively or
negatively) to the price of some commodity, currency or securities index or
another interest rate (each a "benchmark"). The interest rate or (unlike most
debt obligations) the principal amount payable at maturity of a hybrid security
may be increased or decreased, depending on changes in the value of the
benchmark. Hybrids can be used as an efficient means of pursuing a variety of
investment goals, including duration management and increased total return.
Hybrids may not bear interest or pay dividends. The value of a hybrid or its
interest rate may be a multiple of a benchmark and, as a result, may be
leveraged and move (up or down) more steeply and rapidly than the benchmark.
These benchmarks may be sensitive to economic and political events that cannot
be readily foreseen by the purchaser of a hybrid. Under certain conditions, the
redemption value of a hybrid could be zero. Thus, an investment in a hybrid may
entail significant market risks that are not associated with a similar
investment in a traditional, U.S. dollar-denominated bond that has a fixed
principal amount and pays a fixed rate or floating rate of interest. The
purchase of hybrids also exposes the Fund to the credit risk of the issuer of
the hybrids. These risks may cause significant fluctuations in the net asset
value of the Fund.
Certain issuers of structured products such as hybrid instruments may be
deemed to be investment companies as defined in the 1940 Act. As a result, the
Fund's investments in these products may be subject to limits applicable to
investments in investment companies and may be subject to restrictions contained
in the 1940 Act. Structured products are typically sold in private placement
transactions, and there currently is no active trading market for structured
products.
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 or market price of the Fund's shares. Some U.S.
Government securities, such as U.S. TIPS and 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
26
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. No
assurance can be given that the U.S. Government will provide financial support
to U.S. Government-sponsored instrumentalities if it is not obligated to do so
by law. U.S. Government securities include securities that have no coupons, or
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." 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.
MUNICIPAL BONDS
The Fund may invest in municipal bonds which pay interest that, in the
opinion of bond counsel to the issuer (or on the basis of other authority
believed by the Advisor to be reliable), is exempt from federal income taxes
("municipal bonds"), although dividends that the Fund pays that are attributable
to such interest will not be tax-exempt to shareholders of the Fund.
Municipal bonds share the attributes of debt obligations in general, but
are generally issued by states, municipalities and other political subdivisions,
agencies, authorities and instrumentalities of states and multi-state agencies
or authorities. The municipal bonds that the Fund may purchase include general
obligation bonds and limited obligation bonds (or revenue bonds), including
industrial development bonds issued pursuant to former federal tax law. General
obligation bonds are obligations involving the credit of an issuer possessing
taxing power and are payable from such issuer's general revenues and not from
any particular source. Limited obligation bonds are payable only from the
revenues derived from a particular facility or class of facilities or, in some
cases, from the proceeds of a special excise or other specific revenue source.
Tax-exempt private activity bonds and industrial development bonds generally are
also revenue bonds and thus are not payable from the issuer's general revenues.
The credit and quality of private activity bonds and industrial development
bonds are usually related to the credit of the corporate user of the facilities.
Payment of interest on and repayment of principal of such bonds is the
responsibility of the corporate user (and/or any guarantor).
Municipal bonds are subject to credit and market risk. Generally, prices of
higher quality issues tend to fluctuate less with changes in market interest
rates than prices of lower quality issues and prices of longer maturity issues
tend to fluctuate more than prices of shorter maturity issues. Prices and yields
on municipal bonds are dependent on a variety of factors, including general
money-market conditions, the financial condition of the issuer, general
conditions of the municipal bond market, the size of a particular offering, the
maturity of the obligation and the rating of the issue. A number of these
factors, including the ratings of particular issues, are subject to change from
time to time. Information about the financial condition of an issuer of
municipal bonds may not be as extensive as that which is made available by
corporations whose securities are publicly traded. Obligations of issuers of
municipal bonds are subject to the provisions of bankruptcy, insolvency and
other laws, such as the Federal Bankruptcy Reform Act of 1978, affecting the
rights and remedies of creditors. Congress or state legislatures may seek to
extend the time for payment of principal or interest, or both, or to impose
other constraints upon enforcement of such obligations. There is also the
possibility that as a result of litigation or other conditions, the power or
ability of issuers to meet their obligations for the payment of interest and
principal on their municipal bonds may be materially affected or their
obligations may be found to be invalid or unenforceable.
27
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 liquid assets 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. When-issued, delayed delivery or forward
commitment transactions may be considered securities in themselves, and involve
a risk of loss if the value of the security to be purchased declines prior to
the settlement date, which risk is in addition to the risk of decline in the
value of the Fund's other assets. Where such purchases are made through dealers,
the Fund relies on the dealer to consummate the sale. The dealer's failure to do
so may result in the loss to the Fund of an advantageous yield or price. 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.
REPURCHASE AGREEMENTS
For the purposes of maintaining liquidity and achieving income or
otherwise, the Fund may enter into repurchase agreements with domestic
commercial banks or registered broker/dealers. A repurchase agreement is a
contract under which the Fund would acquire a security for a relatively short
period (usually not more than one week) subject to the obligation of the seller
to repurchase and the Fund to resell such security at a fixed time and price
(representing the Fund's cost plus interest). In the case of repurchase
agreements with broker-dealers, the value of the underlying securities (or
collateral) will be at least equal at all times to the total amount of the
repurchase obligation, including the interest factor. The Fund bears a risk of
loss in the event that the other party to a repurchase agreement defaults on its
obligations and the Fund is delayed or prevented from exercising its rights to
dispose of the collateral securities. This risk includes the risk of procedural
costs or delays in addition to a loss on the securities if their value should
fall below their repurchase price. The Advisor will monitor the creditworthiness
of the counterparties.
BORROWING
The Fund may borrow money 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 money to
add leverage to the portfolio. The Fund may also borrow money for temporary
administrative purposes.
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 and other senior
28
securities) is at least 300% of the principal amount of such borrowing. In
addition, the Fund is not permitted to declare any cash dividend or other
distribution on the Common Shares unless, at the time of such declaration,
such asset coverage test is satisfied. 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 holders of AMPS (the "AMPS
Holders"), and other holders of preferred shares of the Fund, if any, to
elect a majority of the Trustees of the Fund.
As described elsewhere in this section and in the Prospectus, the Fund also
may enter into certain transactions, including reverse repurchase agreements,
credit default swap contracts and other derivative instruments that can
constitute a form of borrowing or financing transaction by the Fund. The Fund
may enter into these transactions in order to add leverage to the portfolio. See
"The Fund's Objectives, Strategies and Investments" in the Prospectus. The Fund
may (but is not required to) cover its commitment under these instruments by the
segregation of liquid assets or by entering into offsetting transactions or
owning positions covering its obligations. To the extent these instruments are
so covered, (1) they will not be considered "senior securities" under the 1940
Act and therefore will not be subject to the 300% asset coverage requirement
otherwise applicable to borrowings by the Fund and (2) investments in these
instruments (other than reverse repurchase agreements and dollar roll
transactions) will not be considered leverage for purposes of the Fund's policy
on the amount of leverage it may incur or considered "leverage" for purposes of
calculating the Fund's total managed assets. Although this Statement of
Additional Information describes certain permitted methods of segregating assets
or otherwise "covering" such transactions for these purposes, such descriptions
are not complete. The Fund may cover such transactions using other methods
currently or in the future permitted under the 1940 Act or orders issued by the
SEC thereunder. For these purposes, interpretations and guidance provided by the
SEC staff may be taken into account when deemed appropriate by the Fund.
Borrowing 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 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 enter into reverse repurchase agreements and economically
similar transactions in order to add leverage to the portfolio or for hedging or
cash management purposes. A reverse repurchase agreement involves the sale of a
portfolio-eligible security by the Fund, coupled with its agreement to
repurchase the instrument at a specified time and price. Under a reverse
repurchase agreement, the Fund continues to receive any principal and interest
payments on the underlying security during the term of the agreement. Reverse
repurchase agreements involve leverage risk and the risk that the market value
of securities retained by the Fund may decline below the repurchase price of the
securities sold by the Fund which it is obligated to repurchase. The Fund may
(but is not required to) segregate liquid assets, 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 less
liabilities (other than the borrowings and other senior securities). Also,
reverse repurchase agreements involve the risk that the market value of the
securities retained in lieu of sale by the Fund in connection with the reverse
repurchase agreement may decline in price. If the buyer of securities under a
reverse repurchase agreement files for bankruptcy or becomes insolvent, such
buyer or its trustee or receiver may receive an extension of time to determine
whether to enforce the Fund's obligation to repurchase the securities, and the
Fund's use of the proceeds of the reverse repurchase agreement may effectively
be restricted pending such decision. Also, the Fund would bear the risk of loss
to the extent that the proceeds of the reverse repurchase agreement are less
than the value of the securities subject to such agreement.
29
The Fund also may effect simultaneous purchase and sale transactions that
are known as "sale-buybacks." A sale-buyback is similar to a reverse repurchase
agreement, except that in a sale-buyback, the counterparty who purchases the
security is entitled to receive any principal or interest payments made on the
underlying security pending settlement of the Fund's repurchase of the
underlying security.
DOLLAR ROLLS
A "dollar roll" is similar to a reverse repurchase agreement in certain
respects. In a "dollar roll" transaction the Fund sells a security to a dealer
and simultaneously agrees to repurchase a similar security (but not the same
security) in the future at a pre-determined price. During the period between the
sale and repurchase, the Fund will not be entitled to receive interest and
principal payments on the securities sold. A "dollar roll" can be viewed, like a
reverse repurchase agreement, as a collateralized borrowing in which the Fund
pledges a security to a dealer to obtain cash. However, unlike reverse
repurchase agreements, the dealer or other party with which the Fund enters into
a dollar roll transaction is not obligated to return the same securities as
those originally sold by the Fund, but only securities which are "substantially
identical." To be considered "substantially identical," the securities returned
to the Fund generally must: (1) if applicable, be collateralized by the same
types of underlying mortgages and be issued by the same agency and be part of
the same program; (2) have a similar original stated maturity; (3) have
identical net coupon rates; (4) have similar market yields (and therefore
price); and (5) satisfy "good delivery" requirements, meaning that the aggregate
principal amounts of the securities delivered and received back must be within
2.5% of the initial amount delivered.
As with reverse repurchase agreements, to the extent that positions in
dollar roll agreements are not covered by segregated liquid assets, such
transactions would be subject to the Fund's restrictions on borrowings.
Proceeds of the sale will be invested in additional instruments for the
Fund, and the income from these investments will generate income for the Fund.
If such income does not exceed the income, capital appreciation and gain or loss
that would have been realized on the securities sold as part of the dollar roll,
the use of this technique will diminish the investment performance of the Fund
compared with what the performance would have been without the use of dollar
rolls. Dollar roll transactions involve the risk that the market value of the
securities the Fund is required to purchase may decline below the agreed upon
repurchase price of those securities. The Fund's right to purchase or repurchase
securities may be restricted. Successful use of mortgage dollar rolls may depend
upon the Advisor's ability to predict interest rates and prepayments correctly.
There is no assurance that dollar rolls can be successfully employed.
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
30
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.
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 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 term "illiquid securities" means 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, repurchase agreements
with maturities in excess of seven days, 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).
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. In
addition, restricted securities may sell at a price lower than similar
securities that are not subject to restrictions on resale.
PORTFOLIO TRADING AND TURNOVER RATE
Portfolio trading may be undertaken to accomplish the investment objectives
of the Fund in relation to actual and anticipated movements in interest rates.
In addition, a security may be sold and another of comparable quality purchased
at approximately the same time to take advantage of what the Advisor 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 bonds may cause
a temporarily low price for such bonds, as compared with other bonds of like
quality and characteristics. The Fund may also engage in short-term trading
consistent with its investment objectives. 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." The Advisor 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. 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. 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. The higher the rate of portfolio turnover of
the Fund, the higher these 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.
31
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.
WARRANTS TO PURCHASE SECURITIES
The Fund may invest in warrants to purchase debt or equity securities. Debt
obligations with warrants attached to purchase equity securities have many
characteristics of convertible bonds 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 the warrants at a profit. If interest
rates rise, the warrants would generally expire. Warrants do not carry with them
the right to dividends or voting rights with respect to the securities that they
entitle their holder to purchase, and they do not represent any rights in the
assets of the issuer. As a result, warrants may be considered more speculative
than certain other types of investments. In addition, the value of a warrant
does not necessarily change with the value of the underlying securities and a
warrant ceases to have value if it is not exercised prior to its expiration
date.
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
(including such loans). 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 the
Advisor 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. The Fund may lend its
portfolio securities so long as the terms and the structure of such loans are
not inconsistent with all regulatory requirements, including the requirements of
the 1940 Act and the New York Stock Exchange. The Fund may pay fees in
connection with loaned securities, so long as such fees are set forth in a
written contract and approved by the Fund's Board of Trustees.
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 the Fund's ability to
trade in or acquire additional positions in
32
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
the Advisor 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.
COLLATERALIZED BOND OBLIGATIONS
The Fund may invest in collateralized bond obligations ("CBOs"), which are
structured products backed by a diversified pool of high yield public or private
fixed income securities. The pool of high yield securities is typically
separated into tranches representing different degrees of credit quality. The
top tranche of CBOs, which represents the highest credit quality in the pool,
has the greatest collateralization and pays the lowest interest rate. Lower CBO
tranches represent lower degrees of credit quality and pay higher interest rates
to compensate for the attendant risks. The bottom tranche specifically receives
the residual interest payments (i.e., money that is left over after the higher
tiers have been paid) rather than a fixed interest rate. The return on the
bottom tranche of CBOs is especially sensitive to the rate of defaults in the
collateral pool.
MEZZANINE INVESTMENTS
The Fund may invest in certain high yield securities known as mezzanine
investments, which are subordinated debt securities which are generally issued
in private placements in connection with an equity security (e.g., with attached
warrants). Such mezzanine investments may be issued with or without registration
rights. Maturities of mezzanine investments are typically seven to ten years,
but the expected average life is significantly shorter at three to five years.
Mezzanine investments are usually unsecured and subordinate to other obligations
of the issuer.
PROJECT LOANS
The Fund may invest in project loans, which are fixed income securities of
issuers whose revenues are primarily derived from mortgage loans to
multi-family, nursing home and other real estate development projects. The
principal payments on these mortgage loans will be insured by agencies and
authorities of the U.S. Government.
SHORT-TERM INVESTMENTS / TEMPORARY DEFENSIVE STRATEGIES
Upon the Advisor'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 total managed assets in high-quality, short-term debt instruments.
Such investments may prevent the Fund from achieving its investment objectives.
INVESTMENT RESTRICTIONS
FUNDAMENTAL INVESTMENT RESTRICTIONS
The Fund may (except as noted below):
(1) Borrow money, make loans or issue senior securities to the fullest
extent permitted by the 1940 Act, the rules or regulations thereunder or
applicable orders of the SEC, as such statute, rules, regulations or orders may
be amended from time to time.
33
(2) Not invest 25% or more of its total assets in a particular industry or
group of industries. Securities issued or guaranteed by the U.S. Government or
its agencies or instrumentalities will not be considered to represent an
industry.
(3) Underwrite securities to the fullest extent permitted by the 1940 Act,
the rules or regulations thereunder or applicable orders of the SEC, as such
statute, rules, regulations or orders may be amended from time to time.
(4) Purchase or sell commodities, commodities contracts, futures contracts
and related options, options, forward contracts or real estate to the fullest
extent permitted by the 1940 Act, the rules or regulations thereunder or
applicable orders of the SEC, as such statute, rules, regulations or orders may
be amended from time to time.
The fundamental investment limitations set forth above restrict the Fund's
ability to engage in certain practices and purchase securities and other
instruments other than as permitted by, or consistent with, the 1940 Act.
Relevant limitations of the 1940 Act are described below. These limitations are
based either on the 1940 Act itself, the rules or regulations thereunder or
applicable orders of the SEC. In addition, interpretations and guidance provided
by the SEC staff may be taken into account, where deemed appropriate by the
Fund, to determine if a certain practice or the purchase of securities or other
instruments is permitted by the 1940 Act, the rules or regulations thereunder or
applicable orders of the SEC. As such, these limitations of the 1940 Act are not
"fundamental;" that is, the limitations will change as the statute, rules,
regulations or orders (or, if applicable, interpretations) change, and no
shareholder vote will be required or sought.
Fundamental Investment Restriction (1). Under the 1940 Act, the Fund may
only borrow up to one-third of the value of its total assets less liabilities
(other than liabilities representing senior securities). For more information on
leverage and the risks relating thereto, see "The Fund's Objectives, Strategies
and Investments" and "Risks - General Risks of Investing in the Fund - Leverage
Risk" in the Prospectus.
The 1940 Act also restricts the ability of any closed-end fund to lend.
Under the 1940 Act, the Fund may only make loans if expressly permitted to do so
by the Fund's investment policies, and the Fund may not make loans to persons
who control or are under common control with the Fund. Thus, the 1940 Act
effectively prohibits the Fund from making loans to certain persons when
conflicts of interest or undue influence are most likely present. The Fund may,
however, make other loans which if made would expose shareholders to additional
risks, such as the failure of the other party to repay the loan. The Fund
retains the flexibility to make loans to the extent permitted by its investment
policies, other than loans of securities, which will be limited to 33 1/3% of
the Fund's total assets.
The ability of a closed-end fund to issue senior securities is severely
circumscribed by complex regulatory constraints under the 1940 Act that
restrict, for instance, the amount, timing, and form of senior securities that
may be issued. Certain portfolio management techniques, such as reverse
repurchase agreements, credit default swaps, futures contracts, dollar rolls,
the purchase of securities on margin, short sales, or the writing of puts on
portfolio securities, may be considered senior securities unless appropriate
steps are taken to segregate the Fund's assets or otherwise cover its
obligations. To the extent the Fund covers its commitment under these
transactions, including by the segregation of liquid assets, such instrument
will not be considered a "senior security" by the Fund and therefore will not be
subject to the 300% asset coverage requirement otherwise applicable to
borrowings by the Fund (or, as the case may be, the 200% asset coverage
requirement applicable to preferred shares).
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 5% of the value
34
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 AMPS are a senior security. See the Prospectus under the heading
"Description of Capital Structure" for more information.
Fundamental Investment Restriction (2). If the Fund were to invest 25% or
more of its total assets in a particular industry or group of industries,
investors would be exposed to greater risks because the Fund's performance would
be largely dependent on the performance of that industry or industries. For
purposes of this limitation, the Fund may invest 25% or more of its total assets
in certificates of deposit or banker's acceptances issued by domestic branches
of U.S. or foreign banks for temporary defensive purposes or in order to keep
the Fund fully invested, including the period during which the net proceeds of
the offering are being invested. The Fund's industry concentration policy does
not preclude it from investing 25% or more of its total assets in issuers in a
group of industries (such as different types of technology issuers) for
temporary defensive purposes or in order to keep the Fund fully invested,
including during the period during which the net proceeds of the offering are
being invested.
Fundamental Investment Restriction (3). The 1940 Act prohibits a
diversified closed-end fund from underwriting securities in excess of 25% of its
total assets.
Fundamental Investment Restriction (4). This restriction would permit
investment in commodities, commodities contracts (e.g., futures contracts or
related options), options, forward contracts or real estate to the extent
permitted under the 1940 Act. However, it is unlikely that the Fund would make
such investments, other than the use of futures contracts and related options,
options, forward contracts and certain real estate-related instruments as
explained in the Prospectus and this Statement of Additional Information. The
Fund, however, would like the ability to consider using these investment
techniques in the future. Commodities, as opposed to commodity futures,
represent the actual underlying bulk goods, such as grains, metals and
foodstuffs. Real estate-related instruments include real estate investment
trusts, commercial and residential mortgage-backed securities, and real estate
financings, and such instruments are generally sensitive to factors such as
changes in real estate values and property taxes, interest rates, cash flow of
underlying real estate assets, overbuilding, and the management skill and
creditworthiness of the issuer.
The restrictions listed above are fundamental policies of the Fund.
Except as described herein, the Fund, as a fundamental policy, may not alter
these policies without the approval of the holders of a majority of the
outstanding Common Shares and any preferred shares (including AMPS) voting
together as a single class, and of the holders of a majority of the
outstanding preferred shares (including AMPS) voting as a separate class. 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 and the Prospectus) 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 the Advisor to be of comparable quality), or
change in the percentage of the Fund's 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. In
the event that rating agencies assign different ratings to the same security,
the Advisor 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.
35
Under normal market conditions, the Fund will invest at least 80% of its
total managed assets in U.S. TIPS (as defined in the Prospectus). So long as and
to the extent it is required by applicable law, the Fund will not change the
policy described in the foregoing sentence unless it provides shareholders with
at least 60 days' written notice of such change. For purposes of such 80% test,
the Fund will consider instruments, including synthetic instruments, U.S. TIPS
if, in the judgment of the Advisor, they have economic characteristics similar
to U.S. TIPS.
It is a condition of the issuance of the AMPS that they be issued with
a credit quality rating of "Aaa" from Moody's and "AAA" from S&P and Fitch.
In order to obtain and maintain the required ratings, the Fund will be
required to comply with investment quality, diversification and other
guidelines established by Moody's and Fitch. 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
holders of Common Shares ("Common Shareholders") or its ability to achieve
its investment objectives. Moody's and Fitch receive fees in connection with
their ratings issuances.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The business of the Fund is managed under the general 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 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, and a description of
their principal occupations during the past five years are listed below. 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 or officer may have held different positions
with such employer(s). Unless otherwise indicated, the business address of the
persons listed below is c/o Western Asset Management Company, 117 East Colorado
Blvd., Pasadena, CA 91105.
NUMBER OF
PORTFOLIOS IN
PRINCIPAL FUND
TERM OF OFFICE OCCUPATION(S) COMPLEX OTHER
POSITION(S) AND LENGTH OF DURING THE PAST FIVE OVERSEEN BY DIRECTORSHIPS
NAME AND AGE(1) WITH THE FUND TIME SERVED YEARS TRUSTEE HELD BY TRUSTEE
--------------- ------------- ----------------- ----------------------- -------------- ---------------
INDEPENDENT TRUSTEES
Peter Erichsen Trustee and Term expires in Vice President, General 1 None
Age: 47 Chairman of the 2005; served Counsel and Secretary of
Trustees since August 2003 the J. Paul Getty Trust
(2) (3) (2001-present); Governor
of the Philadelphia
Stock Exchange
(1999-present); Chairman
of the Philadelphia
Stock Exchange's Audit
Committee (1999-present).
Formerly: Vice President
and General
36
NUMBER OF
PORTFOLIOS IN
PRINCIPAL FUND
TERM OF OFFICE OCCUPATION(S) COMPLEX OTHER
POSITION(S) AND LENGTH OF DURING THE PAST FIVE OVERSEEN BY DIRECTORSHIPS
NAME AND AGE(1) WITH THE FUND TIME SERVED YEARS TRUSTEE HELD BY TRUSTEE
--------------- ------------- ----------------- ----------------------- -------------- ---------------
Counsel of the University
of Pennsylvania (1997-
2001).
Ronald Nyberg Trustee Term expires in Founding partner of 1 Trustee of MBIA
Age: 50 (2) (3) 2005; served Nyberg & Gustafson, a Capital/Claymore
since August 2003 law firm specializing in Municipal Funds
corporate law, estate (3 Funds) (2003-
planning and business present); Trustee
transactions (2000- of Advent Claymore
present). Formerly: Convertible
Executive Vice President, Securities &
General Counsel and Income Fund (2003
Corporate Secretary of - present).
Van Kampen Investments,
an investment advisory
firm (1982-1999);
Associate at Querrey &
Harrow, a law firm
(1978-1982).
Ronald E. Toupin, Jr. Trustee Term expires in Formerly: Vice President, 1 Trustee of MBIA
Age: 45 (2) (3) 2006; served Manager and Portfolio Capital/Claymore
since August 2003 Manager of Nuveen Asset Municipal Funds (3
Management, an investment Funds) (2003 -
advisory firm (1998- present); Trustee
1999), Vice President and of Advent Claymore
Portfolio Manager of Convertible
Nuveen Investment Securities &
Advisory Corporation, an Income Fund (2003
investment advisory firm - present).
(1992-1999), Vice
President and Manager of
Nuveen Unit Investment
Trusts (1991-1998) and
Assistant Vice President
and Portfolio Manager of
Nuveen Unit Trusts
(1988-1990), each of John
Nuveen & Company,
Inc. (1982-
37
NUMBER OF
PORTFOLIOS IN
PRINCIPAL FUND
TERM OF OFFICE OCCUPATION(S) COMPLEX OTHER
POSITION(S) AND LENGTH OF DURING THE PAST FIVE OVERSEEN BY DIRECTORSHIPS
NAME AND AGE(1) WITH THE FUND TIME SERVED YEARS TRUSTEE HELD BY TRUSTEE
--------------- ------------- ----------------- ----------------------- -------------- -------------------
1999).
INTERESTED TRUSTEES
Nicholas Dalmaso Trustee Term expires in Senior Managing Director 1 Trustee of
Age: 38 2004; served and General Counsel of MBIA/Claymore
(4) since August Claymore Securities, Managed Duration
2003 Inc. (2001-present) and Investment Grade
Claymore Advisors, LLC Municipal Fund
(2003 - present); Vice (2003 - present);
President and Assistant Director of
Secretary of F&C/Claymore
F&C/Claymore Preferred Preferred
Securities Income Fund, Securities Income
Inc. (2002 - present) Fund, Inc. (2002
and Flaherty & - present);
Crumrine/Claymore Total Trustee of Advent
Return Fund, Inc. (2003 Claymore Convertible
- present); Manager of Securities & Income
Claymore Fund Management Fund (2003 -
Company LLC (2002 - present); Trustee
present); Vice President of Dreman/Claymore
of Boyar Value Fund Dividend & Income
(2003 - present). Fund (2003 -
Formerly: Assistant present).
General Counsel of John
Nuveen and Company, Inc.
(1999-2001); Vice
President and Associate
General Counsel of Van
Kampen Investments
(1992-1999); Associate
at Cantwell and
Cantwell, a law firm
(1991-1992).
Randolph L. Kohn Trustee and Term expires in Formerly: Director, 1 None
Age: 56 President 2006; served Global Client Services
(5) since August and Marketing, Western
38
NUMBER OF
PORTFOLIOS IN
PRINCIPAL FUND
TERM OF OFFICE OCCUPATION(S) COMPLEX OTHER
POSITION(S) AND LENGTH OF DURING THE PAST FIVE OVERSEEN BY DIRECTORSHIPS
NAME AND AGE(1) WITH THE FUND TIME SERVED YEARS TRUSTEE HELD BY TRUSTEE
--------------- ------------- ----------------- ----------------------- -------------- ---------------
2003 (6) Asset Management Company
(1984-2002); Director
(1996-2001) and Chairman
(2000-2001), Arroyo
Seco, Inc.; Director of
Marketing, American
Express Asset Management
(1982-1984); Director
of Marketing, First
Asset Management (1979-
1982); Marketing
Executive, Kemper
Financial Services
(1975-1979).
OFFICERS
Gregory B. McShea Vice President Served since Head of Compliance, N/A N/A
Age: 37 August 2003 Western Asset Management
(6) Company (2003-present).
Formerly: Associate
General Counsel and
Compliance Director,
Private Client Group,
Legg Mason Wood Walker,
Incorporated, a
brokerage firm ("LMWW")
(1997-2003); Associate,
Weinberg & Green LLC, a
law firm (1992-1997).
Marie K. Karpinski Treasurer Served since Vice President, LMWW N/A N/A
Age: 54 August 2003 (1992-present); Vice
(6) President and Treasurer
100 Light Street of all Legg Mason retail
Baltimore, MD 21202 funds, open-end
investment companies
(1986-present); Vice
President and Treasurer
of Legg Mason Charles
Street Trust, Inc., an
39
NUMBER OF
PORTFOLIOS IN
PRINCIPAL FUND
TERM OF OFFICE OCCUPATION(S) COMPLEX OTHER
POSITION(S) AND LENGTH OF DURING THE PAST FIVE OVERSEEN BY DIRECTORSHIPS
NAME AND AGE(1) WITH THE FUND TIME SERVED YEARS TRUSTEE HELD BY TRUSTEE
--------------- ------------- ----------------- ----------------------- -------------- ---------------
open-end investment
company (1998-present);
Treasurer and Principal
Financial and Accounting
Officer of Pacific
American Income Shares,
Inc. (closed-end
investment company),
Western Asset Funds, Inc.
and Western Asset Premier
Bond Fund (2001-present).
Formerly: Assistant
Treasurer of Pacific
American Income Shares,
Inc. (1988-2001).
Erin K. Morris Assistant Served since Assistant Vice President N/A N/A
Age: 36 Treasurer August 2003 of LMWW (2002-present);
(6) Assistant Treasurer of
100 Light Street Legg Mason Income Trust,
Baltimore, MD 21202 Inc., Legg Mason Cash
Reserve Trust, Legg
Mason Tax Exempt Trust,
Inc. (open-end
investment companies),
Legg Mason Tax-Free
Income Fund, Pacific
American Income Shares,
Inc., Western Asset
Funds, Inc. and Western
Asset Premier Bond Fund
(2001-present); Manager,
Fund Accounting, LMWW
(2000-present).
Formerly: Assistant
Manager, Fund
Accounting, LMWW
(1993-2000).
40
NUMBER OF
PORTFOLIOS IN
PRINCIPAL FUND
TERM OF OFFICE OCCUPATION(S) COMPLEX OTHER
POSITION(S) AND LENGTH OF DURING THE PAST FIVE OVERSEEN BY DIRECTORSHIPS
NAME AND AGE(1) WITH THE FUND TIME SERVED YEARS TRUSTEE HELD BY TRUSTEE
--------------- ------------- ----------------- ----------------------- -------------- ---------------
Anne S. Kochevar Secretary Served since Vice President, N/A N/A
Age: 40 August 2003 Compliance, Claymore
(6) Securities, Inc.
210 N. Hale Street (2002-present);
Wheaton, IL 60187 Advertising Principal,
Allstate Financial
Services (2001-2002);
Compliance Coordinator,
John Nuveen & Company,
Inc. (2000-2001); Vice
President & Compliance
Director of: Van Kampen
Management Inc., an
investment advisory firm
(1999-2000); Van Kampen
Investments (1992-2000);
Van Kampen Investment
Advisory Corp.
(1999-2000); Van Kampen
Funds Inc. (1999-2000);
Van Kampen Asset
Management Inc.
(1999-2000); Van Kampen
Advisors Inc. (1999-
2000).
----------
(1) It is expected that upon completion of the offering of the AMPS,
Michael Larson will be elected by the current Trustees to serve as
a Trustee. Mr. Larson serves as Chief Investment Officer for William H.
Gates III (1994 - present). In addition, Mr. Larson is a director of Pan
American Silver Corp., a silver mining, development and exploration company
(1999 - present) and is also a director of Extend America, Inc., a
telecommunications company (2002 - present).
(2) Member of the Audit Committee of the Board of Trustees.
(3) Member of the Governance and Nominating Committee of the Board of
Trustees.
(4) Mr. Dalmaso may be deemed an "interested person" (as defined in
section 2(a)(19) of the 1940 Act) of the Fund on the basis of his position
as an officer of Claymore Securities, Inc., the Fund's shareholder
servicing agent and an underwriter of the Fund's offering of Common Shares,
and his ownership of an interest therein.
(5) Mr. Kohn is an "interested person" (as defined above) of the Fund on
the basis of his former employment with Western Asset and certain of its
affiliated entities (as disclosed above), as well as his ownership of
certain shares of common stock of Legg Mason, Inc., Western Asset's parent
company.
41
(6) Each officer shall hold office until his or her respective successor is
chosen and qualified, or in each case until he or she sooner dies, resigns,
is removed with or without cause or becomes disqualified.
As of December 31, 2002, no Trustee beneficially owned securities of the
Fund or securities of any registered investment companies overseen or to be
overseen by the Trustee in the same "family of investment companies" as the
Fund.
As of December 31, 2002, Ronald A. Nyberg was the indirect beneficial
owner of a $114,266 bond issued by Merrill Lynch & Co., Inc., the parent
company of Merrill Lynch, Pierce, Fenner & Smith Incorporated, the principal
underwriter of the Fund with respect to the offering of the AMPS. As of
August 15, 2003, Mr. Nyberg no longer held any security issued by Merrill
Lynch.
Except as described in the immediately preceding paragraph, as of
December 31, 2002, no Trustee who is not an "interested person" (as defined in
Section 2(a)(19) of the 1940 Act) of the Fund, and none of his or her family
members, had beneficial or record ownership in securities of an investment
adviser or principal underwriter of the Fund, or an entity (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.
The Fund's Board of Trustees has established an Audit Committee and a
Governance and Nominating Committee, each currently comprised of Messrs.
Erichsen, Nyberg and Toupin. Mr. Nyberg currently chairs the Governance and
Nominating Committee. Mr. Toupin currently chairs the Audit Committee. The Audit
Committee provides oversight with respect to the accounting and financial
reporting policies and practices of the Fund and, among other things, considers
the selection of independent public accountants for the Fund and the scope of
the audit and approves all significant services proposed to be performed by
those accountants on behalf of the Fund. The Governance and Nominating Committee
meets to select nominees for election as Trustees of the Fund and consider other
matters of Board policy. It is not the policy of the Governance and Nominating
Committee to consider nominees recommended by shareholders. Because the Fund has
only recently been organized, neither the Board of Trustees nor any Committees
held meetings in 2002.
As of November 20, 2003, the Fund's officers and Trustees as a group owned
less than 1% of the outstanding Common Shares.
Except as noted below, none of the independent Trustees has ever been a
director, officer, or employee of, or a consultant to, the Advisor, any one or
more of the Underwriters or any one or more affiliates of any of the foregoing.
As indicated in the table above, each officer of the Fund, except Ms. Kochevar,
is affiliated with the Advisor.
In accordance with the Fund's staggered board (see "Anti-Takeover and
Other Provisions in the Declaration of Trust"), the Common Shareholders and
the AMPS Holders, if any, of the Fund will elect Trustees to fill the
vacancies of Trustees whose terms expire at each annual meeting of
shareholders. If any AMPS are outstanding, AMPS Holders, voting as a separate
class, will elect two Trustees and the remaining Trustees shall be elected by
Common Shareholders and AMPS Holders, voting together as a single class.
AMPS Holders will be entitled to elect a majority of the Fund's Trustees under
certain circumstances.
Officers and Trustees of the Fund who are affiliated persons of the Fund,
the Advisor, Claymore Securities, Inc. ("Claymore") or one or more of the
Underwriters (including Claymore) receive no salary or fees from the Fund. Each
other Trustee of the Fund receives a fee of $8,000 annually for serving as a
Trustee of the Fund, and a fee of $1,000 and related expenses for each meeting
of the Board of Trustees attended. The Chairman of the Trustees receives an
additional $1,500 per year for serving in that capacity. Audit Committee
42
members receive $500 for each meeting, and the Audit Committee Chairman receives
an additional $1,500 annually. Other committee members receive $500 per meeting.
It is estimated that the Trustees will receive the amounts set forth in the
following table for the fiscal year ending December 31, 2003. For the calendar
year ended December 31, 2002, no Trustee served as a trustee of other funds in
the same "Fund Complex" as the Fund.
TOTAL COMPENSATION
PENSION OR FROM THE FUND
ESTIMATED COMPENSATION RETIREMENT ESTIMATED COMPLEX PAID TO THE
FROM THE FUND FOR THE BENEFITS ACCRUED ANNUAL BENEFITS TRUSTEES FOR THE
FISCAL YEAR ENDING AS PART OF FUND UPON CALENDAR YEAR ENDING
NAME OF TRUSTEE DECEMBER 31, 2003* EXPENSES RETIREMENT DECEMBER 31, 2002**
--------------- ---------------------- --------------------- ---------------- ----------------------
INDEPENDENT TRUSTEES
Peter Erichsen $ 6,458 N/A N/A N/A
Ronald Nyberg $ 5,833 N/A N/A N/A
Ronald E. Toupin, Jr. $ 6,458 N/A N/A N/A
INTERESTED TRUSTEES
Nicholas Dalmaso $ 0 N/A N/A N/A
Randolph L. Kohn $ 0 N/A N/A N/A
----------
* 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.
** The Fund is the only investment company in the fund complex on which
the Trustees serve as trustees.
The Fund has no employees. Its officers are compensated by Western Asset
or, in the case of Ms. Kochevar, Claymore.
SHAREHOLDERS
As of November 20, 2003, the following persons owned of record the number
of Common Shares noted below, representing the indicated percentage of the
Fund's outstanding shares as of such date and, except as noted below, no other
person owned of record or, to the knowledge of the Fund, owned beneficially 5%
or more of any class of shares of the Fund.
NUMBER OF PERCENTAGE OF THE FUND'S
COMMON OUTSTANDING SHARES
SHAREHOLDER SHARES AS OF NOVEMBER 20, 2003
----------- ----------- -------------------------
Merrill Lynch, Pierce, Fenner & Smith 14,721,081 51.06%
Safekeeping
4 Corporate Place
Piscataway, NJ 08854
Legg Mason Wood Walker, Inc. 4,998,337 17.34%
100 Light Street
Baltimore, MD 21202
RBC Dain Rauscher Inc. 1,874,752 6.50%
510 Marquette Avenue South
Minneapolis, MN 55402
It may not be possible for matters subject to a vote of a majority of the
outstanding voting securities of the Fund to be approved without the affirmative
vote of a "controlling" shareholder, and it may be possible for
43
such matters to be approved by a controlling shareholder without the affirmative
vote of any other shareholders.
INVESTMENT ADVISOR AND ADMINISTRATOR
Western Asset serves as investment advisor to the Fund pursuant to an
investment management agreement (the "Investment Management Agreement") between
it and the Fund. Western Asset is a wholly-owned subsidiary of Legg Mason, Inc.,
a publicly traded financial services holding company.
Western Asset, subject to the supervision of the Board of Trustees, is
responsible for managing, either directly or through others selected by Western
Asset, the investments of the Fund. Western Asset also furnishes to the Board of
Trustees periodic reports on the investment performance of the Fund.
Under the terms of the Investment Management Agreement, subject to such
policies as the Trustees of the Fund may determine, Western Asset, 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 objectives, policies and restrictions.
Subject to the control of the Trustees, Western Asset also manages,
supervises and conducts certain other business affairs of the Fund, provides
bookkeeping and certain clerical services (or subcontracts for such services)
and pays all salaries, fees and expenses of officers and Trustees of the Fund
who are affiliated with Western Asset. As indicated under "Portfolio
Transactions -- Brokerage and Research Services," the Fund's portfolio
transactions may be placed with broker-dealers which furnish the Advisor,
without cost, certain research, statistical and quotation services of value to
the Advisor or its affiliates in advising the Fund or its 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
Western Asset an annual management fee, payable on a monthly basis, at the
annual rate of .40% of the Fund's average weekly assets for the services it
provides. "Average weekly assets" means the average weekly value of the total
assets of the Fund (including any assets attributable to leverage) minus accrued
liabilities (other than liabilities representing leverage). For purposes of
calculating "average weekly assets," neither the liquidation preference of any
AMPS outstanding nor any liabilities associated with any instruments
or transactions used by Western Asset to leverage the Fund's portfolio (whether
or not such instruments or transactions are "covered" as described in this
prospectus) is considered a liability. With respect to reverse repurchase or
dollar roll transactions, "average weekly assets" includes any proceeds from the
sale of an asset of the Fund to a counterparty in such a transaction, in
addition to the value of the underlying asset as of the relevant measuring date.
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
Western Asset, including, without limitation, fees and expenses of Trustees who
are not "interested persons" of the Fund, interest charges, taxes, brokerage
commissions, listing fees, 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, servicing
agents and administrators, 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.
44
CERTAIN TERMS OF THE INVESTMENT MANAGEMENT AGREEMENT. The Investment
Management Agreement was approved by the Trustees of the Fund (including all of
the Trustees who are not "interested persons" of the Advisor). The Investment
Management Agreement will continue in force with respect to the Fund for two
years from its date, and from year to year thereafter, but only so long as its
continuance is approved at least annually by (i) the vote, cast in person at a
meeting called for that purpose, of a majority of those Trustees who are not
"interested persons" of the Advisor or the Fund, and by (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. The Investment Management
Agreement automatically terminates on assignment. The Investment Management
Agreement may be terminated on not more than 60 days' written notice by Western
Asset to the Fund or by the Fund to Western Asset.
The Investment Management Agreement provides that Western Asset 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.
TRUSTEE APPROVAL OF THE INVESTMENT MANAGEMENT AGREEMENT. The Board of
Trustees, including a majority of the independent Trustees, considered and
approved the Investment Management Agreement at an in-person meeting held on
August 21, 2003.
In arriving at their decision to approve the Investment Management
Agreement, the Trustees met with representatives of the Advisor and reviewed
information prepared by the Advisor and materials provided by fund counsel. As
part of their review, the Trustees examined the Advisor's ability to provide
high quality investment management services to the Fund. The Trustees were
provided with information on the investment philosophy and research and
decision-making processes of the Advisor; the investment management fees charged
by certain other Funds investing primarily in U.S. TIPS and certain other
products available from Western Asset for investments in U.S. TIPS; the Fund's
hedging strategies and its use of leverage; and the level of skill required to
manage the Fund. Based on the foregoing, the Trustees concluded that the
Advisor's investment process, research capabilities and philosophy were well
suited to the Fund given the Fund's investment objectives and policies.
In addition, the Trustees reviewed, with respect to all of the Advisor's
responsibilities under the Investment Management Agreement, information
regarding the nature, cost, scope and anticipated quality of the services
provided to the Fund and its shareholders under the Investment Management
Agreement. The Trustees were also provided with information regarding other fees
to be paid by the Fund or other parties in connection with the offering of the
Fund's Common Shares, including certain fees payable to Claymore (as described
in the Prospectus) and certain fees to be paid to Merrill Lynch by Western Asset
for ongoing after-market services (as described in the Prospectus).
The Trustees further evaluated potential benefits of the advisory
relationship to the Advisor, including the direct and indirect benefits that
the Advisor may receive from its relationship with the Fund. In this regard,
the Trustees took into account services provided by affiliates of the Advisor
to the Fund, including services provided by Legg Mason Wood Walker,
Incorporated as a principal underwriter with respect to the initial public
offering of the Common Shares and the engagement of Legg Mason Fund Adviser,
Inc. (the "Administrator") as the Fund's administrator. The Trustees noted
the fact that, because the advisory fees paid to Western Asset by the Fund
are based on the Fund's average weekly assets, including assets represented
by the AMPS and other leverage, Western Asset has a financial incentive for
the Fund to issue the AMPS and incur other leverage, which may create a
conflict of interest between Western Asset and the Fund's shareholders.
In arriving at a decision to approve the Investment Management Agreement,
the Trustees, including the independent Trustees, did not identify any single
matter as all-important or controlling, and the foregoing summary does not
detail all the matters considered. The Trustees judged the terms and conditions
of the
45
Investment Management Agreement, including the investment advisory fees, in
light of all of the surrounding circumstances. Based upon their review, the
Trustees, including all of the independent Trustees, determined, in the exercise
of their business judgment, that approval of the Investment Management Agreement
was in the best interest of the Fund and its shareholders.
ADMINISTRATIVE SERVICES
Pursuant to an Administrative Services Agreement between the Fund and the
Administrator, an affiliate of Western Asset, the Administrator performs or
arranges for the performance of certain administrative and accounting functions
for the Fund, including: (i) oversight of the maintenance of the Fund's books
and records which are maintained by the Fund's custodian and the Fund's transfer
agent; (ii) calculation and publication of the Fund's net asset value daily;
(iii) preparation of financial information for the Fund's reports to
shareholders; (iv) preparation of all tax returns to be filed by the Fund; (v)
oversight, or preparation, of performance calculations, expense budgets and
expense ratios and the Fund's periodic dividends and distributions; (vi)
preparation of reports required by any stock exchange on which the Fund's shares
are listed; (vii) preparation and filing of Forms N-SAR and N-CSR; (viii)
preparation, or review, of ratings agencies' asset coverage tests with respect
to the issuance of preferred securities (as needed); and (ix) oversight of any
stock purchase or dividend reinvestment program authorized by the Fund. In
consideration of the services provided by the Administrator, the Fund will pay
the Administrator a fee, paid monthly, at an annual rate of $100,000.
CODES OF ETHICS
The Fund and Western Asset have adopted codes of ethics under Rule 17j-1 of
the 1940 Act. These codes permit personnel subject to the codes to invest in
securities, including securities that may be purchased or held by the Fund.
Text-only versions of the codes of ethics may be viewed online or downloaded
from the EDGAR Database on the SEC's internet web site at 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 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.
PORTFOLIO TRANSACTIONS
INVESTMENT DECISIONS AND PORTFOLIO TRANSACTIONS
Investment decisions for the Fund and for the other investment advisory
clients of the Advisor 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 Advisor, including accounts of
employees and affiliates. 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
Advisor 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 Advisor. The Advisor 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. There may be circumstances
when purchases or sales of portfolio securities for one or more clients will
have an adverse effect on other clients.
46
BROKERAGE AND RESEARCH SERVICES
There is generally no stated commission in the case of fixed income
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.
The Advisor 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 and other instruments for the
Fund through a substantial number of brokers and dealers. In so doing, the
Advisor 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, the Advisor, 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.
It has for many years been a common practice in the investment advisory
business for advisors of investment companies and other institutional investors
to receive research services from broker-dealers which execute portfolio
transactions for the clients of such advisors. Consistent with this practice,
the Advisor may receive research services from many broker-dealers with which
the Advisor places the Fund's portfolio transactions. The Advisor 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
the Advisor 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. The management fee paid by the Fund to the Advisor is not reduced because
the Advisor and its affiliates receive such services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, an
Advisor may cause the Fund to pay a broker-dealer which provides "brokerage and
research services" (as defined in such Act) to the Advisor 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 and/or the Advisor.
DISTRIBUTIONS
See "Description of AMPS - Dividends and Rate Periods" and "Description
of Capital Structure" in the Prospectus for information related to
distributions made to AMPS Holders.
For tax purposes, the Fund is currently required to allocate net capital
gain and other taxable income, if any, among the Common Shares, the Series M
AMPS, the Series T AMPS, the Series W AMPS, the Series TH AMPS and the Series
F AMPS in proportion to total dividends paid to each class for the year in
which such capital gain or other taxable income is realized.
47
While any AMPS 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 accrued dividends on AMPS have been paid, (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" (as defined in the 1940
Act), is at least 300% of the aggregate amount of senior securities
representing indebtedness (to the extent any such senior securities are
outstanding) and at least 200% of the aggregate amount of any 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 any accrued and
unpaid dividends thereon, whether or not earned or declared and on a
cumulative basis), (3) the Fund has redeemed the full number of AMPS and any
other preferred shares outstanding required to be redeemed by any provision
for mandatory redemption, and (4) other requirements imposed by any rating
agencies rating any AMPS issued by the Fund have been met.
These latter limitations 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 Fund has paid dividends, in the amount of $0.065625 per Common
Share, on November 28, 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
without par value. 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 AMPS are outstanding, Common Shareholders will not
be entitled to receive any distributions from the Fund unless all accrued
dividends on AMPS have been paid, asset coverage (as defined in the 1940 Act)
with respect to AMPS and senior securities representing indebtedness (to the
extent any such senior securities are outstanding) would be at least 200% and
300%, respectively, after giving effect to such distributions, and other
requirements imposed by any rating agencies rating any AMPS issued by the
Fund have been met. See "-AMPS" below. See "Description of AMPS - Dividends
and Rate Periods - Restrictions on Dividends and Other Distributions,"
"Description of AMPS - Rating Agency Guidelines and Asset Coverage" and
"Description of Capital Structure" in the Prospectus.
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 like the
Fund that invest in debt obligations 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 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. See
"Repurchase of Common Shares; Conversion to Open-End Fund" below and the Fund's
Prospectus under "Repurchase of Fund Shares; Conversion to Open-End Fund."
48
AMPS
See "Description of AMPS" and "Description of Capital Structure" in the
Prospectus for information relating to the AMPS. Revised Article 12 set forth in
the Fund's Second Amended and Restated Bylaws (the "Second Amended and Restated
Bylaws"), which establishes many of the terms of the AMPS, is set forth in its
entirety in Appendix C to this Statement of Additional Information.
ADDITIONAL INFORMATION CONCERNING
THE AUCTIONS FOR AMPS
GENERAL
AUCTION AGENCY AGREEMENT. The Fund will enter into an auction agency
agreement with the auction agent (currently, Deutsche Bank Trust Company
Americas) which provides, among other things, that the auction agent will
follow the auction procedures set forth in the Second Amended and Restated
Bylaws for purposes of determining the applicable rate for AMPS so long as
the applicable rate for such shares is to be based on the results of an
auction.
BROKER-DEALER AGREEMENTS. Each auction requires the participation of one or
more broker-dealers that have entered into a separate agreement with the auction
agent (each, a "Broker-Dealer"). The auction agent will enter into broker-dealer
agreements with one or more Broker-Dealers selected by the Fund that provide for
the participation of those Broker-Dealers in auctions for AMPS.
SECURITIES DEPOSITORY. The Depository Trust Company ("DTC") will act as
securities depository for the agent members with respect to each series of
AMPS. One certificate for each series of the AMPS will be registered in the
name of Cede & Co., as nominee of DTC. Such certificates will bear a legend
to the effect that such certificate is issued subject to the provisions
restricting transfers of AMPS contained in the Bylaws. Prior to the
commencement of the right of AMPS Holders to elect a majority of the Fund's
Trustees, as described under "Description of AMPS - Voting Rights" in the
Prospectus, Cede & Co. will be the holder of record of all AMPS, and owners
of such shares will not be entitled to receive certificates representing
their ownership interest in such shares.
DTC, a New York-chartered limited purpose trust company, performs
services for its participants, some of whom (and/or their representatives)
own DTC. DTC maintains lists of its participants and will maintain the
positions (ownership interests) held by each such participant (the "agent
member") in AMPS, whether for its own account or as a nominee for another
person. Additional information concerning DTC and the DTC depository system
is included as an Exhibit to the Registration Statement of which this
Statement of Additional Information forms a part.
AUCTION AGENT
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.
The auction agent may rely, as evidence of the identities of the
existing AMPS Holders, upon the auction agent's registry of existing holders,
the results of auctions and notices from any Broker-Dealer (or other person,
if permitted by the Fund) with respect to transfers described under "The
Auction" in the Prospectus, and notices from the Fund. The auction agent is
not required to accept any such notice for an auction unless it is received
by the auction agent by 3:00 p.m., New York City time, on the business day
preceding such auction.
49
The auction agent may terminate the auction agency agreement upon notice to
the Fund on a date no earlier than 60 days after such notice (30 days after such
notice, if the auction agent has not been paid). If the auction agent should
resign, the Fund will attempt to appoint a successor auction agent. The Fund may
remove the auction agent provided that prior to such removal the Fund shall have
entered into an agreement with a successor auction agent to perform
substantially similar services.
BROKER-DEALERS
After each auction for shares of each series of AMPS, the auction agent
will pay to each Broker-Dealer, from funds provided by the Fund, a service
charge that will generally be at the annual rate of 1/4 of 1% of the stated
value ($25,000) of the AMPS held by such Broker-Dealer's customers upon
settlement in such auction.
The Broker-Dealer agreement provides that a Broker-Dealer (other than an
affiliate of the Fund) may submit orders in auctions for its own account, unless
the Fund notifies all Broker-Dealers that they may no longer do so, in which
case Broker-Dealers may continue to submit hold orders and sell orders for their
own accounts. Any Broker-Dealer that is an affiliate of the Fund may submit
orders in auctions, but only if such orders are not for its own account. If a
Broker-Dealer submits an order for its own account in any auction, it might have
an advantage over other bidders because it would have knowledge of all orders
submitted by it in that auction; such Broker-Dealer, however, would not have
knowledge of orders submitted by other Broker-Dealers in that auction.
The Fund may request the auction agent to terminate one or more
Broker-Dealer agreements at any time upon five days' notice, provided that at
least one Broker-Dealer agreement is in effect after such termination.
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.
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, subject to any voting powers of Common
Shareholders or AMPS Holders, 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
50
such Trustee, at a meeting called for such purpose, 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 is 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 of any securities issued by the Fund or such series or
class to any other person or entity for cash, securities or other property (or
combination thereof), excluding sales of securities of the Fund or such series
or class in connection with a public offering and issuances of securities of the
Fund or such series or class pursuant to a dividend reinvestment plan adopted 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 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). A vote of both a majority of the Board of Trustees and seventy-five
percent (75%) of the Continuing Trustees (as defined below) is required for
distributions to the Fund's shareholders (in one or a series of distributions)
during any twelve-month period of any property (in cash, shares or otherwise)
with an aggregate fair market value in excess of 110% of the income and gains
(accrued or realized) of the Fund during such twelve-month period.
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 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.
The Trustees may from time to time grant other voting rights to
shareholders with respect to these and other matters in the Fund's Bylaws.
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 objectives and management policies. The
Board of Trustees has determined that the voting
51
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 (i) has been a member of the Board for a period
of at least thirty-six months (or since immediately after the initial registered
public offering of the Fund's Common Shares, if less than thirty-six months),
(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 or (iii) prior to the first
sale of shares pursuant to an initial public offering, serves as a Trustee.
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 or her office.
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its shareholders do
not have the right to cause the Fund to redeem their shares. Instead, the Fund's
Common Shares trade in the open market at a price that will be a function of
several factors, including the Fund's use of leverage, dividend levels (which
are in turn affected by expenses and other factors), net asset value, call
protection, dividend stability, portfolio credit quality and liquidity, 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.
Notwithstanding the foregoing, at any time when the Fund's AMPS are
outstanding, the Fund may not purchase, redeem or otherwise acquire any of
its Common Shares unless (1) full cumulative dividends on each series of AMPS
and any other preferred shares outstanding due on or prior to the date of the
transaction have been declared and paid or have been declared and sufficient
funds for the payment thereof have been deposited with the auction agent, (2)
the value of the Fund's total assets (determined after deducting the
acquisition price of the Common Shares), less all liabilities and
indebtedness of the Fund not represented by "senior securities" (as defined
in the 1940 Act), is at least 300% of the aggregate amount of senior
securities representing indebtedness (to the extent any such senior
securities are outstanding) and at least 200% of the aggregate amount of any
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 any accrued
and unpaid dividends thereon, whether or not earned or declared and on a
cumulative basis), (3) the Fund has redeemed the full number of AMPS and any
other preferred shares outstanding required to be redeemed by any provision
for mandatory redemption, and (4) other requirements imposed by any rating
agencies rating any AMPS issued by the Fund have been met.
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
52
with the Securities Exchange Act of 1934, as amended, and the 1940 Act and the
rules and regulations thereunder.
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 AMPS voting together as a single class, and the holders of
a "majority of the outstanding" AMPS 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 AMPS 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. 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. The Fund expects that it would pay
all such redemption requests in cash, but reserves the right to pay redemption
requests in securities or through a combination of cash and securities. If
payment in securities were made, investors may incur brokerage costs in
converting such securities to cash. The Fund reserves the right to impose a
sales load on its shares if it converts into an open-end company. 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. If the Fund converted to
an open-end company, the differences in risks and operational requirements
between closed-end and open-end investment companies could affect the Fund's
ability to achieve its investment objectives.
To the extent the Fund repurchases its shares at prices below net asset
value, such repurchases 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 which 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 AMPS are outstanding will increase the leverage applicable to the
outstanding Common Shares then remaining. See the Fund's Prospectus under
"Risks -- General Risks of Investing in the Fund - 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 substantial discount for an extended
period of time, the Board of Trustees may determine that, in the interest of the
Fund and its shareholders, no action should be taken.
53
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 for each taxable year from
dividends, interest, payments with respect to certain securities loans, and
gains from the sale or other disposition 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; and
(b) 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 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 and distributes with respect to each taxable year at least 90% of
the sum of its investment company taxable income (as that term is defined in the
Code without regard to the deduction for dividends paid--generally taxable
ordinary income and the excess, if any, of net short-term capital gains over net
long-term capital losses) and its net tax-exempt interest income, for such year,
the Fund will not be subject to federal income tax on such 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, generally would be taxable to shareholders as ordinary income.
Portions of such distributions generally would be eligible (i) to be treated as
qualified dividend income in the case of shareholders taxed as individuals, and
(ii) 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 (computed without
regard to deductions for dividends paid) and any net tax-exempt interest, 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.
54
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 nondeductible
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
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. Except as discussed above, the Fund intends
generally to make distributions sufficient to avoid imposition of the 4% excise
tax.
FUND DISTRIBUTIONS. Distributions from the Fund generally will be taxable
to shareholders as ordinary income. 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. Distributions from capital gains
are generally made after applying any available capital loss carryovers.
Distributions of gains from the sale of investments that the Fund owned for one
year or less will be taxable as ordinary income. Long-term capital gain rates
applicable to individuals have been temporarily reduced--in general, to 15% with
lower rates applying to taxpayers in the 10% and 15% rate brackets--for taxable
years beginning on or before December 31, 2008.
For taxable years beginning on or before December 31, 2008, provided
holding period and other requirements are met by both the Fund and the holder,
the Fund may designate distributions of investment income derived from dividends
of U.S. corporations and some foreign corporations as "qualified dividend
income." Qualified dividend income will be taxed in the hands of individuals at
the rates applicable to long-term capital gain, provided the shareholder meets
these same holding period and other requirements. The Fund does not expect a
significant portion of Fund distributions to be derived from qualified dividend
income.
Dividends (including Capital Gain Dividends) will be taxable as described
above whether received in cash or in shares. A shareholder whose distributions
are reinvested in shares will be treated as having received a dividend equal to
either (i) the fair market value of the new shares issued to the shareholder, or
(ii) if the shares are trading below net asset value, the amount of cash
allocated to the shareholder for the purchase of shares on its behalf in the
open market.
Dividends of net investment income received by corporate shareholders of
the Fund may 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. However,
in light of the Fund's investment policies, the Fund does not expect to receive
a significant amount of qualifying dividends.
The Internal Revenue Service ("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 any series of outstanding preferred shares of beneficial interest
(including AMPS) in proportion to the total dividends paid to each class with
respect to such tax year. Dividends qualifying and not qualifying for (a)
treatment as qualified dividend income and (b) the dividends received
deduction, if any, will similarly be allocated between and among any such
classes.
55
Existing authorities do not specifically address whether dividends that are
paid following the close of a taxable year, but that are treated for tax
purposes as derived from the income of such prior taxable year, are treated as
dividends paid during such prior taxable year for purposes of determining each
class's proportionate share of a particular type of income. The Fund currently
intends to treat such dividends as having been paid in the prior taxable year
for purposes of determining each class's proportionate share of a particular
type of income with respect to such prior taxable year. Existing authorities
also do not specifically address the allocation of taxable income among the
dividends paid to holders of a class of shares during or with respect to a
taxable year. It is possible that the IRS could disagree with the Fund's
position concerning the treatment of dividends paid after the close of a taxable
year or with the Fund's method of allocation, in which case the IRS could
attempt to recharacterize a portion of the dividends paid to the holders of
preferred shares. If the IRS were to prevail with respect to any such attempted
recharacterization, holders of preferred shares could be subject to additional
tax on amounts so recharacterized and the Fund could be subject to federal
income and excise tax.
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 (including earnings and profits arising from
tax-exempt income, if any), the excess distribution will be treated as a
return of capital to the extent of the shareholder's tax basis in his or her
shares, and thereafter as capital gain. A return of capital is not taxable,
but it reduces the shareholder's tax basis in his or her shares, thus
reducing any loss or increasing any gain on a subsequent taxable disposition
by the shareholder of his or her 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 in the Fund (including
the AMPS), and only thereafter to distributions made to Common Shareholders.
As a result, the holders of any outstanding preferred shares of beneficial
interest in the Fund (including the AMPS) 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 shareholder).
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 one year. 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. In
addition, the ability to deduct capital losses may be subject to other
limitations.
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 AMPS
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 AMPS 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
56
shareholder tenders fewer than all of its Common Shares, or retains a
substantial portion of its AMPS, 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
redeems some but not all of the AMPS held by an AMPS Holder and such
shareholder is treated as having received a taxable dividend upon such
redemption, there is a remote risk that Common Shareholders and non-redeeming
AMPS Holders 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.
Debt obligations with a fixed maturity date of more than one year from the
date of issuance acquired by the Fund may be (and all zero-coupon debt
obligations acquired by the Fund will 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 taxable income
(and is required to be distributed) 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. Increases in the principal amount of U.S. TIPS and
other inflation-indexed debt instruments will be treated as OID. A portion of
the OID includable in income with respect to certain high-yield corporate debt
obligations (including certain payment-in-kind securities) may be treated as a
dividend for certain U.S. federal income tax purposes.
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.
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
57
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 be
deductible to the issuer. This may affect the issuer's cash flow. 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.
Interest paid on debt obligations owned by the Fund, 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, possibly affecting the cash
flow of the issuer.
OPTIONS, FUTURES, FORWARD CONTRACTS AND SWAP AGREEMENTS. The Fund's
transactions in options, futures contracts, hedging transactions, forward
contracts, swap agreements, straddles and foreign currencies 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 (including its transactions, if
any, in foreign currencies or foreign currency-denominated instruments) 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 described above under "--Return of
Capital Distributions." 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.
REMICs and REITs. The Fund may invest in REMICs and certain REITs holding
interests in REMICs. Income generated by a residual interest in a REMIC may be
passed through to the holders of the Fund. Such income (i) cannot be offset by
net operating losses, (ii) will constitute unrelated business taxable income and
(iii) in the case of foreign shareholders will not qualify for a reduction in
U.S. withholding taxes. In addition, if a holder of the Fund is a "disqualified
organization" under the U.S. tax law the Fund itself will be subject to tax on
the income from the residual interest allocable to that organization.
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.
SHARES PURCHASED THROUGH TAX-QUALIFIED PLANS. Special tax rules apply to
investments through defined contribution plans and other tax-qualified plans.
Shareholders should consult their tax advisors 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.
58
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 within the meaning of the Code (i.e., a "foreign person") 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 generally 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 of the
Fund or on Capital Gain Dividends unless (i) such gain or Capital Gain Dividend
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 or Capital Gain
Dividend 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 distributions and redemption
proceeds 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 28% for amounts paid through 2010. The backup withholding tax rate will
be 31% for amounts paid after December 31, 2010.
In order for a foreign investor to qualify for exemption from the backup
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 advisors in this regard. Backup withholding is
not an additional tax. Any amounts withheld may be credited against the
shareholder's U.S. federal income tax liability, provided the appropriate
information is furnished to the IRS.
RECENT TAX SHELTER REPORTING REGULATIONS. Under recently promulgated
Treasury regulations, if a shareholder recognizes a loss with respect to Fund
shares of $2 million or more for an individual shareholder or $10 million or
more for a corporate shareholder, the shareholder must file with the IRS 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. The fact that a
loss is reportable under these regulations does not affect the legal
determination of whether the taxpayer's treatment of the loss is proper.
Shareholders should consult their tax advisers to determine the applicability of
these regulations in light of their individual circumstances.
GENERAL. The federal income tax discussion set forth above is for general
information only. Prospective investors should consult their tax advisors
regarding the specific federal tax consequences of purchasing,
59
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, COMPARATIVE AND OTHER INFORMATION
The Fund may be a suitable investment for a shareholder who is thinking of
adding bond investments to his portfolio to balance the appreciated stocks that
the shareholder is holding.
PERFORMANCE-RELATED 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.
COMPARATIVE INFORMATION. From time to time, the Fund's advertisements or
information furnished to present or prospective shareholders may refer to the
returns and yields offered by various types of investments, as well as the yield
spreads on such investments.
The Fund and/or the Advisor may report to shareholders or to the public in
advertisements concerning the performance of the Advisor as advisor to clients
other than the Fund, or on the comparative performance or standing of the
Advisor in relation to other money managers. The Advisor also may provide to
current or prospective private account clients, in connection with standardized
performance information for the Fund, performance information for the Fund gross
of fees and expenses for the purpose of assisting such clients in evaluating
similar performance information provided by other investment managers or
institutions. Comparative information may be compiled or provided by independent
ratings services or by news organization.
Performance information for the Fund or for other investment companies or
accounts managed by the Advisor may also be compared to various unmanaged
indexes or to other benchmarks, some of which may not be available for direct
investment. Any performance information, whether related to the Fund or the
Advisor, should be considered in light of the Fund's investment objectives and
policies, the characteristics and quality of the Fund, and the market conditions
during the time period indicated, and should not be considered to be
representative of what may be achieved in the future.
Past performance is not indicative of future results. At the time Common
Shareholders sell their shares, they may be worth more or less than their
original investment. At any time in the future, yields and total return may be
higher or lower than past yields and total return, and there can be no assurance
that any historical results will continue.
INFLATION. The Fund's advertising or related materials may from time to
time discuss the effects of inflation. One of the primary drawbacks to a
fixed-rate investment is the negative impact that inflation can have on an
investment's real future return. Inflation is generally defined as an increase
in the level of consumer prices or as a decline in the purchasing power of
money. For investors in long-term fixed-rate investments, exposure to inflation
can theoretically put them in a position whereby their investment is now worth
less purchasing power than when they made the initial investment, despite what
may have been an attractive stated return at the time. Such materials may assert
that it is this erosion of purchasing power that has historically disappointed
investors seeking the relative quality of traditional fixed-rate investments.
U.S. TIPS. Advertising or related materials may discuss the structure and
characteristics of U.S. TIPS. U.S. TIPS may provide an attractive alternative to
other government-backed or fixed-rate investments. U.S. TIPS are the only
yield-bearing securities directly linked to inflation that are backed by the
full faith and credit
60
of the U.S. government. Unlike a direct investment in U.S. TIPS, however, an
investment in the Fund is not guaranteed and may at any time be worth more or
less than the price originally paid for it.
U.S. TIPS, also referred to as inflation-indexed securities, were designed
to protect investors and the future value of these fixed-income investments from
the adverse effects of inflation. As of 10/31/03, the total market value of
U.S. TIPS was approximately $200 billion and the average daily trading volume
was over $4.5 billion in market value.
Fund advertisements may also discuss the expected tax characteristics of
investing in U.S. TIPS and the Fund. By investing in the Fund, individual
investors alter one of the tax aspects of investing directly in U.S. TIPS. When
individual investors invest directly in U.S. TIPS, they are subject to income
tax each year on any net inflation adjustments to the principal value of the
U.S. TIPS, even though they do not receive the full benefit of those adjustments
until the U.S. TIPS mature. Thus, individual investors investing directly in
U.S. TIPS may have to pay income taxes on adjustments to the principal value of
U.S. TIPS even though they do not receive any current income in respect of those
adjustments. Because the Fund must distribute an amount to its shareholders each
year equal to substantially all its income, including amounts attributable to
the net inflation adjustments, a shareholder receiving cash dividends will
always receive cash sufficient to pay the tax attributable to such adjustments.
However, since the Fund may not have sufficient income to make the required
distributions, it may have to sell securities at times it would not otherwise
have done so in order to obtain such income. Under current tax regulations, the
portion of the Fund's dividends directly attributable to U.S. TIPS coupon income
and adjustments to principal is expected to be exempt from state and local
income tax in certain states. Investors should consult with their tax advisors
with respect to the effects of their investments on their particular tax
situations.
ADVISOR. From time to time, the Advisor or the Fund may use, in
advertisements or information furnished to present or prospective shareholders,
information regarding the Advisor including, without limitation, information
regarding the Advisor's investment style, countries of operation, organization,
professional staff, clients (including other registered investment companies),
assets under management and performance record. These materials may refer to
opinions or rankings of the Advisor's overall investment management performance
contained in third-party reports or publications. The Advisor was founded in
1971 and is one of the world's premier fixed-income managers, with offices in
Pasadena, London and Singapore. Exclusively focused on fixed-income, the Advisor
managed, as of 9/30/03, over $138 billion in assets for over 341 institutional
clients in 22 countries. The Advisor's client base includes several of the
largest companies in the world as well as numerous public entities, healthcare
organizations, foundations and public pension plans. For the Fund, the Advisor
intends to employ proprietary risk management techniques that were developed
specifically to enhance other leveraged funds.
THE FUND. The Fund's listing of the Common Shares on the New York Stock
Exchange is expected to provide liquidity, convenience and daily price
visibility through electronic services and in newspaper stock tables.
The offering period for the Common Shares began on August 27, 2003 and
ended on September 25, 2003. The first trade date for the Common Shares was
September 26, 2003, with a settlement date of September 30, 2003. The initial
offering of the Common Shares carried a commission to brokers of $0.675 per
share (4.50% of the offering price).
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.
For the period from September 30, 2003 (commencement of the Fund's
operations) through November 20, 2003, the Fund's net increase in net assets
resulting from investment operations was $6,104,000.
61
PROXY VOTING POLICIES AND PROCEDURES
The Trustees of the Fund have adopted the proxy voting policy of Western
Asset (the "Policy") as the Proxy Voting Policies and Procedures of the Fund.
The Policy governs in determining how proxies relating to the Fund's portfolio
securities are voted. A copy of the Policy is attached as Appendix B to this
Statement of Additional Information.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND PAYING AGENT
State Street Bank & Trust Company, 150 Newport Avenue AFB/4N, North Quincy,
Massachusetts 02171, serves as custodian for the assets of the Fund. The
custodian performs custodial and fund accounting services.
Deutsche Bank Trust Company Americas, 60 Wall Street, New York, New York
10005, serves as auction agent, transfer agent, registrar, dividend paying
agent and redemption agent for the AMPS.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 250 W. Pratt Street, Baltimore, Maryland 21201,
serves as independent accountants for the Fund. PricewaterhouseCoopers LLP
provides audit services, tax return preparation and assistance and consultation
in connection with the review of SEC filings to the Fund.
COUNSEL
Ropes & Gray LLP, 45 Rockefeller Plaza, New York, New York 10111-0087,
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 Fund's 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 Fund's 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.
FINANCIAL STATEMENTS
The Statement of Assets and Liabilities of the Fund dated as of September
9, 2003, and the Statement of Operations for the one-day period ended September
9, 2003, including the Notes thereto, and the report of PricewaterhouseCoopers
LLP thereon dated September 24, 2003, included in the Fund's Statement of
Additional Information dated September 25, 2003, relating to the Common Shares,
is hereby incorporated by reference into this Statement of Additional
Information, which means that such Statement of Assets and Liabilities 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 September 29, 2003 (Accession No.
000104047469-03-31991).
62
WESTERN ASSET/CLAYMORE U.S. TREASURY INFLATION PROTECTED SECURITIES FUND
STATEMENT OF ASSETS AND LIABILITIES
NOVEMBER 20, 2003
(amounts in thousands) (unaudited)
Assets
Investments, at value (cost $606,577) $ 611,083
Options purchased (cost $3,420) 1,219
Cash 117
Interest receivable 5,999
------------
Total assets 618,418
------------
Liabilities
Reverse repurchase agreement and interest payable 197,685
Options written (proceeds $883) 1,477
Offering expense payable 631
Investment management fee payable 127
Servicing agent fee payable 47
Administrative fee payable 14
Accrued expenses and other liabilities 76
------------
Total liabilities 200,057
------------
Net Assets $ 418,361
------------
Capital
Common shares, no par value, unlimited number of shares authorized,
28,832 shares issued and outstanding $ 412,257
Undistributed net investment income 3,621
Accumulated net realized gain/(loss) on investments and options 772
Net unrealized appreciation/(depreciation) on
investments and options 1,711
------------
Net Assets $ 418,361
------------
Net asset value per share of common share:
($418,361 divided by 28,832 shares of common stock issued and
outstanding) $ 14.51
------------
See Notes to Financial Statements
WESTERN ASSET/CLAYMORE U.S. TREASURY INFLATION PROTECTED SECURITIES FUND
STATEMENT OF OPERATIONS
For the period September 30, 2003* through November 20, 2003
(amounts in thousands) (unaudited)
Investment Income:
Interest $ 4,341
------------
Total Income 4,341
------------
Expenses:
Advisory and administration fees 300
Servicing agent fees 107
Audit and legal fees 27
Trustees' fees 18
Custodian fees 14
Reports to shareholders 7
Registration fees 5
Transfer agent and shareholder servicing fee 8
Other expenses 5
------------
Total operating expenses 491
Interest expense 229
------------
Total expenses 720
------------
Net Investment Income 3,621
------------
Net Realized and Unrealized Gain (Loss) on Investments and Options:
Realized gain/(loss) on:
Investments 41
Options 731
------------
Total realized gain/(loss) on investments and options 772
Unrealized appreciation/(depreciation) on investments and options 1,711
------------
Net realized and unrealized gain/(loss) on investments and options 2,483
------------
Change in Net Assets resulting from Operations $ 6,104
------------
*Commencement of operations
See Notes to Financial Statements
WESTERN ASSET/CLAYMORE U.S. TREASURY INFLATION PROTECTED SECURITIES FUND
STATEMENT OF CHANGES IN NET ASSETS
For the period September 30, 2003* through November 20, 2003
(amounts in thousands) (unaudited)
Change in Net Assets Applicable to Common Shareholders
Net investment income $ 3,621
Net realized gain/(loss) on investments, options and futures 772
Unrealized appreciation/(depreciation) on investments, options and futures 1,711
------------
Change in Net Assets Resulting from Operations 6,104
------------
Capital Transactions
Proceeds from initial offering 412,788
Offering costs (631)
------------
Change in net assets 418,261
------------
Net Assets
Beginning of period 100
End of period $ 418,361
------------
Undistributed net investment income $ 3,621
------------
*Commencement of operations
See Notes to Financial Statements
WESTERN ASSET/CLAYMORE U.S. TREASURY INFLATION PROTECTED SECURITIES FUND
STATEMENT OF CASH FLOWS
For the period September 30, 2003* through November 20, 2003
(amounts in thousands) (unaudited)
Increase/(Decrease) in Cash
Cash flows provided from/(used for) operating activities:
Interest received** $ (3,541)
Expenses paid (227)
Interest expense paid (212)
Purchase of long-term portfolio investments (591,528)
Proceeds from sale of long-term investments 14,779
Net purchases in excess of proceeds from sales of short-term portfolio
transactions (30,593)
Net premiums received from written options transactions 883
------------
Net cash provided from/(used for) operating activities (610,439)
------------
Cash flows provided from/(used for) financing activities:
Net cash provided from initial public offering 412,788
Net cash provided from reverse repurchase agreements 197,668
------------
Net cash provided from financing activities 610,456
------------
Net increase in cash
Cash at beginning of period $ 100
------------
Cash at end of period 117
------------
Reconciliation of Net Decrease in Net Assets Resulting from Operations
to Net Cash Used for Operating Activities
Net increase in net assets resulting from operations $ 6,104
------------
Increase in investments (608,973)
Net realized gain on investment transactions (772)
Net change in unrealized appreciation/(depreciation) on investments (1,711)
Increase in interest receivable (5,999)
Increase in interest expense payable 17
Increase in accrued expenses and other liabilities 895
------------
Total adjustments (616,543)
------------
Net cash provided by/(used for) operating activities $ (610,439)
------------
*Commencement of operations
**Amount is negative due to purchased interest that is in interest receivable
but not considered income.
See Notes to Financial Statements
WESTERN ASSET/CLAYMORE U.S. TREASURY INFLATION PROTECTED SECURITIES FUND
SCHEDULE OF INVESTMENTS
November 20, 2003
(amounts in thousands) (unaudited)
% OF
NET MATURITY
ASSETS RATE DATE PAR VALUE
-----------------------------------------------------------
Long-Term Securities 138.8%
Corporate Bonds and Notes 19.2%
Aerospace/Defense 0.3%
The Boeing Company 6.125% 2/15/33 $ 1,150 $ 1,166
----------
Automotive 2.2%
Ford Motor Company 7.450% 7/16/31 2,435 2,305
Ford Motor Company 8.900% 1/15/32 2,175 2,291
General Motors Corporation 8.375% 7/15/33 4,355 4,744
----------
9,340
Cable 0.9%
Comcast Corporation 6.500% 1/15/15 3,455 3,758
----------
Chemicals 0.7%
The Dow Chemical Company 7.375% 11/1/29 2,435 2,733
----------
Commercial Services and Supplies 0.2%
Cendant 7.375% 1/15/13 770 894
----------
Corporation
Computer Services and Systems 1.0%
Electronic Data Systems Corporation 7.450% 10/15/29 4,225 4,149
----------
Diversified Financial Services 0.8%
General Electric Capital Corporation 6.750% 3/15/32 2,815 3,163
----------
Drug and Grocery Store Chains 0.2%
Safeway Inc. 7.250% 2/1/31 770 857
----------
Electric 2.2%
CenterPoint Energy, Inc. 6.850% 6/1/15 510 533(A)
Dominion Resources, Inc. 6.250% 6/30/12 1,665 1,820
Duke Energy Corporation 6.450% 10/15/32 1,150 1,193
FirstEnergy Corp. 7.375% 11/15/31 5,375 5,724
----------
9,270
Environmental Services 1.4%
Waste Management, Inc. 7.750% 5/15/32 4,995 5,948
----------
% OF
NET MATURITY
ASSETS RATE DATE PAR VALUE
-----------------------------------------------------------
Corporate Bonds and Notes (CONTINUED)
Food, Beverage and Tobacco 2.0%
Altria Group, Inc. 7.750% 1/15/27 $ 3,455 $ 3,657
Kraft Foods Inc. 6.500% 11/1/31 2,175 2,273
Sara Lee Corporation 6.125% 11/1/32 1,280 1,331
Tyson Foods, Inc. 7.000% 1/15/28 1,280 1,299
----------
8,560
Media 2.2%
AOL Time Warner Inc. 7.700% 5/1/32 4,480 5,173
News America Holdings 7.750% 12/1/45 1,535 1,828
News America Incorporated 7.625% 11/30/28 1,790 2,099
----------
9,100
Oil and Gas 0.4%
Amerada Hess Corporation 7.125% 3/15/33 895 920
Conoco Inc. 6.950% 4/15/29 770 879
----------
1,799
Photo Equipment and Supplies 0.3%
Eastman Kodak Company 7.250% 11/15/13 1,200 1,255
----------
Services 0.3%
Fuji Co., Ltd. 9.870% 12/31/49 1,025 1,139(A)
----------
Special Purpose 3.0%
DiamlerChrysler NA Holding Corp. 8.500% 1/18/31 3,840 4,447
H.J. Heinz Finance Company 6.750% 3/15/32 770 865
Sprint Capital Corporation 8.750% 3/15/32 4,610 5,312
Verizon Global Funding Corp. 7.750% 6/15/32 1,665 1,958
----------
12,582
Telecommunications 0.7%
AT&T Corp. 8.750% 11/15/31 2,305 2,704
----------
Telecommunications (Cellular/Wireless) 0.4%
AT&T Wireless 8.750% 3/1/31 1,410 1,687
Services, Inc.
----------
Total Corporate Bonds and Notes
(Identified Cost - $79,676) 80,104
----------
% OF
NET MATURITY
ASSETS RATE DATE PAR VALUE
-----------------------------------------------------------
U.S. Government and Agency Obligations 116.9%
Indexed Securities 116.9%
United States Treasury
Inflation-Protected Security 3.375% 1/15/07 $ 8,173 $ 8,875
United States Treasury
Inflation-Protected Security 3.500% 1/15/11 105,114 118,397
United States Treasury
Inflation-Protected Security 3.375% 1/15/12 105,739 118,824
United States Treasury
Inflation-Protected Security 3.000% 7/15/12 108,848 119,274
United States Treasury
Inflation-Protected Security 1.875% 7/15/13 123,981 123,826
----------
Total U.S. Government and Agency
Obligations (Identified Cost -
$485,200) 489,196
----------
Yankee Bonds 2.7%
Manufacturing (Diversified) 1.8%
Tyco International Group SA 6.375% 10/15/11 3,455 3,636
Tyco International Group SA 6.875% 1/15/29 3,715 3,697
----------
7,333
Special Purpose 0.9%
Deutsche Telekom International
Finance BV 8.750% 6/15/30 2,175 2,770
UFJ Finance Aruba A E C 6.750% 7/15/13 1,025 1,086
----------
3,856
Total Yankee Bonds (Identified
Cost - $11,108) 11,189
----------
Total Long-Term Securities (Identified
Cost - $575,984) 580,489
-----------------------------------------------------------------------------------------------------------
Short-Term Securities 7.6%
U.S. Government Agency Mortgage-
Backed Securities 0.4%
Fixed Rate Securities 0.4%
Fannie Mae 0.000% 3/24/04 1,900 1,893(B)
----------
Options Purchased (C) 0.3%
U.S. Treasury Note Futures Put,
December 2003, Strike Price 108 1,000(D) 16
U.S. Treasury Note Futures Put,
March 2004, Strike Price $108 1,750(D) 1,203
----------
1,219
% OF
NET MATURITY
ASSETS RATE DATE PAR VALUE
-----------------------------------------------------------
Repurchase Agreements 6.9%
Lehman Brothers, Inc.
1.01% dated 11/20/03, to be
repurchased at $28,701 on 11/21/03
(Collateral: $30,000 Freddie Mac
bonds, 5.45%, due 6/5/13,
value $28,458; $955 Resolution
Funding Corp. principal-only
security, due 7/15/08, value $816) 1.010% 11/21/03 $ 28,700 $ 28,700
----------
Total Short-Term Securities
(Identified Cost - $34,013) 31,812
Total Investments
(Identified Cost - $609,997) 146.4% 612,301
Other Assets Less Liabilities (46.4)% (193,940)
----------
Net Assets 100.0% $ 418,361
----------
ACTUAL APPRECIATION/
EXPIRATION CONTRACTS DEPRECIATION
Options Written (C)
U.S. Treasury Note Futures Put, March,
Strike Price $115.00 2004 1,500 (593)
----------
$ (593)
----------
(A) Rule 144A Security - A security purchased pursuant to Rule 144A under the
Securities Act of 1933 which may not be resold subject to that rule except to
qualified institutional buyers. These securities represent 0.4% of net assets.
(B) Zero coupon bond - A bond with no periodic interest payments which is sold
at such a discount as to produce a current yield to maturity.
(C) Options and futures are described in more detail in the notes to financial
statements.
(D) Represents actual number of contracts.
See Notes to Financial Statements
WESTERN ASSET/CLAYMORE U.S. TREASURY INFLATION PROTECTED SECURITIES FUND
FINANCIAL HIGHLIGHTS
FOR THE PERIOD SEPTEMBER 30, 2003* THROUGH NOVEMBER 20, 2003
(UNAUDITED)
Per Common Share Operating Performance
Net Asset Value, Beginning of Period $ 14.33(1)
----------
Less Offering Costs Charged to Additional Paid in Capital $ (0.03)
Income From Investment Operations:
Net Investment Income $ 0.13
Net Realized and Unrealized Gain/(Loss) on Investments $ 0.08
----------
Total from Investment Operations $ 0.21
Less Dividends and Distributions to Shareholders from:
Net Investment Income $ 0.00
Net Realized Gain on Investments $ 0.00
Return of Capital $ 0.00
Total Dividends and Distributions to Shareholders $ 0.00
Net Increase/(Decrease) in Net Assets $ 0.21
Net Asset Value, End of Period (2) $ 14.51
----------
Per Share Market Value, End of Period (2). $ 15.35
----------
Total Return on NAV Excluding Offering Costs. 1.26%(3)
Total Investment Return on Market Value 2.33%(4)
Ratios/Supplemental Data:
Net Assets, End of Period (in thousands) $ 418,361
Ratio of Expenses to Average Weekly Net Assets (including interest expense) (5) 1.34%(6)
Ratio of Net Investment Income to Average Daily Net Assets 6.73%(6)
Portfolio Turnover Rate 98.00%(6)
*Commencement of operations
(1) Net sales load of $0.68 on initial shares issued.
(2) Net asset value and market value are published in The Wall Street Journal
each Monday.
(3) Not annualized. Total return on NAV including offering costs is 1.47%.
(4) Total investment return is calculated assuming a purchase of common stock
on the opening of the first day and a sale on the closing of the last day of
period. Total investment return is not annualized. Brokerage commissions are
not reflected.
(5)As a percentage of weekly net assets, which includes any liabilities or
senior securities constituting indebtedness in connection with financial
leverage.
(6) Annualized.
See Notes to Financial Statements
WESTERN ASSET/CLAYMORE U.S. TREASURY INFLATION PROTECTED SECURITIES FUND
NOTES TO FINANCIAL STATEMENTS
NOVEMBER 20, 2003
(AMOUNTS IN THOUSANDS) (UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES:
Western Asset/Claymore U.S. Treasury Inflation Protected Securities Fund (the
"Fund") is registered under the Investment Company Act of 1940 as a diversified,
closed-end management investment company. The Fund commenced operations on
September 30, 2003.
The Fund's primary investment objective is to provide current income. Capital
appreciation, when consistent with current income, is a secondary investment
objective. The Fund currently seeks to achieve its investment objective by
investing at least 80% of its total managed assets in U.S. Treasury Inflation
Protected Securities. The Fund may also invest up to 20% of its total managed
assets in corporate bonds or other securities and instruments.
The following is a summary of significant accounting policies followed by the
Fund in the preparation of its financial statements:
SECURITY VALUATION
Portfolio securities and other assets for which market quotations are readily
available are valued at current market value as determined by pricing services,
broker-dealer quotations or other approved methods. Securities with remaining
maturities of 60 days or less are generally valued at amortized cost. Unless
certain unusual circumstances occur (including those described in the following
paragraph), fixed income securities for which daily market quotations are not
readily available will, to the extent appropriate under the circumstances, be
valued with reference to fixed income securities whose prices are more readily
available and whose durations are comparable to those of the securities being
valued.
Other assets and securities for which no quotations are readily available are
valued at fair value as determined in good faith by the Trustees or persons
acting at their direction. Because of time zone differences, non-U.S. exchanges
and securities markets will usually be closed prior to the time of the closing
of the New York Stock Exchange. The principal markets for fixed income
securities also generally close prior to the close of the New York Stock
Exchange. Consequently, values of non-U.S. investments and fixed income
securities will be determined as of the earlier closing of such exchanges and
markets. However, events affecting the values of such non-U.S. investments and
fixed income securities may occasionally occur between the earlier closings of
such exchanges and markets and the closing of the New York Stock Exchange that
will not be reflected in the computation of the net asset value. If an event
that is likely materially to affect the value of such investments occurs during
such period, then such investments will be valued at fair value as determined in
good faith by the Trustees or persons acting at their direction.
FOREIGN CURRENCY TRANSACTIONS
Assets and liabilities initially expressed in non-U.S. currencies are translated
into U.S. dollars at the closing daily rate of exchange. Purchases and sales of
securities and income and expenses are translated into U.S. dollars at the
prevailing market rates on the dates of such transactions. The effects of
changes in non-U.S. currency exchange rates on investments securities and other
assets and liabilities are included with the net realized and unrealized gain or
loss on investment securities.
REVERSE REPURCHASE AGREEMENTS
The Fund may enter into reverse repurchase agreements. Under the terms of a
reverse repurchase agreement, the Fund sells a security subject to an obligation
to repurchase the security from the buyer at an agreed-upon time and price,
thereby determining the yield during the buyer's holding period. A reverse
repurchase agreement involves the risk that the market value of the collateral
retained by the Fund may decline below the price of the securities the Fund has
sold but is obligated to repurchase under the agreement. In the event the buyer
of securities under a 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 party, or its trustee or receiver, whether to
enforce the Fund's obligation to repurchase the securities. In entering into
reverse repurchase agreements, the Fund may maintain cash, U.S. government
securities or other liquid high grade debt obligations at least equal in value
to its obligations with respect to reverse repurchase agreements. Under normal
circumstances, the Fund will not enter into reverse repurchase agreements if
entering into such agreements would cause more than one-third of the value of
their respective total assets to be subject to such agreements at the time of
entering into such agreements.
OPTIONS, FUTURES AND SWAP AGREEMENTS
The current market value of an exchange traded option is the last sale price or,
in the absence of a sale, the price obtained by reference to broker-dealer
quotations. Futures contracts are valued daily at the settlement price
established by the board of trade or exchange on which they are traded. Futures
contracts are marked-to-market on a daily basis. As the contract's value
fluctuates, payments known as variation margin are made to or received from the
futures commission merchant. Swap agreements are priced daily based upon
quotations from brokers and the change, if any, is recorded as unrealized
appreciation or depreciation.
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.
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 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.
DISTRIBUTIONS TO SHAREHOLDERS
Net investment income for dividend purposes is recorded on the accrual basis and
consists of interest and dividends less expenses. All premiums and discounts are
amortized for financial reporting and tax purposes using the effective interest
method over the period to maturity of the security, and serve to reduce or
increase interest income. Dividend income is recorded on the ex-dividend date.
Dividends from net investment income are paid monthly. Distributions are
determined in accordance with income tax regulations, which may differ from
accounting principles generally accepted in the United States of America;
accordingly, periodic reclassifications are made within the Fund's capital
accounts to reflect income and gains available for distribution under tax
regulations.
SECURITY TRANSACTIONS
Security transactions are recorded on the trade date. Realized gains and losses
from security transactions are reported on an identified cost basis for both
financial reporting and federal income tax purposes.
USE OF ESTIMATES
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.
FEDERAL INCOME TAXES
No provision for federal income or excise taxes is required since the Fund
intends to continue to qualify as a regulated investment company and distribute
substantially all of its taxable income to its shareholders.
2. FINANCIAL INSTRUMENTS:
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund may use various instruments, including forward foreign currency
exchange contracts, to help manage its currency exposure. Forward foreign
currency exchange contracts are marked-to-market daily using forward foreign
currency exchange rates supplied by an independent pricing service. The change
in the contract's market value is recorded by the Fund as an unrealized gain or
loss. When a contract is closed or delivery is taken, the Fund records a
realized gain or loss equal to the difference between the value of the contract
at the time it was opened and the value at the time it was closed.
The use of forward foreign currency exchange contracts does not eliminate
fluctuations in the underlying prices of the Fund's securities, but it does
establish a rate of exchange that can be achieved in the future. These contracts
involve market risk in excess of amounts reflected in the financial statements.
Although contracts used for hedging purposes limit the risk of loss due to the
decline in the value of the hedged currency, they also limit any potential gain
that might result should the value of the currency increase. In addition, the
Fund could be exposed to risks if the counterparties to the contracts are unable
to meet the terms of their contracts. The Fund had no outstanding contracts as
of November 20, 2003.
OPTIONS TRANSACTIONS
A call option gives the option holder the right to purchase the underlying
security at a specified price until a specified date. A put option gives the
option holder the right to sell the underlying security at a specified price
until a specified date. The risk in writing a covered call option is that the
Fund may forgo the opportunity for profit if the market price of the underlying
security increases and the option is exercised. The risk in writing a put option
is that the Fund may incur a loss if the market price of the underlying security
decreases and the option is exercised. In addition, there is a risk that the
Fund may not be able to enter into a closing transaction because of an illiquid
secondary market or, for over-the-counter options, because of the counterparty's
inability to perform. Activity in written call and put options during the period
was as follows:
CALLS PUTS
-------------------- --------------------
CONTRACTS PREMIUMS CONTRACTS PREMIUMS
--------- -------- --------- --------
Options outstanding at September 30, 2003 -- $ -- -- $ --
Options written -- -- 1,500 883
Options closed -- -- -- --
Options expired -- -- -- --
Options exercised -- -- -- --
--------- -------- --------- --------
Options outstanding at November 20, 2003 -- $ -- 1,500 $ 883
========= ======== ========= ========
SWAP AGREEMENTS
The use of swaps involves risks that are different from those associated with
ordinary portfolio securities transactions. Swap agreements may be considered to
be illiquid. Although the Fund will not enter into any swap agreement unless the
Adviser believes that the other party to the transaction is creditworthy, the
Fund does bear the risk of loss of the amount expected to be received under the
swap agreement in the event of the default or bankruptcy of the agreement
counterparty. The Fund had no open swap agreements at November 20, 2003.
FUTURES
Upon entering into a futures contract, the Fund is required to deposit with the
broker an amount of cash or cash equivalents equal to a percentage of the
contract amount. This is known as the "initial margin." Subsequent payments
("variation margin") are made or received by the Fund each day, depending on the
daily fluctuation in the value of the contract. The daily changes in contract
value are recorded as unrealized gains or losses and the Fund recognizes a gain
or loss when the contract is closed.
The Fund may enter into futures contracts in connection with its interest rate
management strategy or for other purposes. Risks arise from, among other
sources, the possible illiquidity of the futures market and from the possibility
that a change in the value of a contract may not correlate with changes in
interest rates. The Fund had no open futures positions at November 20, 2003.
REVERSE REPURCHASE AGREEMENTS
Under a reverse repurchase agreement, the Fund sells securities and agrees to
repurchase them at a mutually agreed-upon date and price. At the time the Fund
enters into a reverse repurchase agreement, the Fund may maintain cash, U.S.
government securities or other liquid high grade debt obligations at least equal
in value to its obligations with respect to reverse repurchase agreements. For
the period ended November 20, 2003, the average amount of reverse repurchase
agreements outstanding was approximately $56,718 and the daily weighted average
interest rate was 0.82%.
3. PORTFOLIO TRANSACTIONS:
Purchases and sales of investment securities (excluding short-term investments,
U.S. government securities and U.S. government agencies) aggregated $90,803 and
$0, respectively, for the period
ended November 20, 2003. There were purchases of $495,907 and sales of $12,609
of U.S. government and government agency obligations for the period ended
November 20, 2003.
At November 20, 2003, the cost of securities of the Fund for federal income tax
purposes was substantially the same as the cost for financial reporting
purposes. Accordingly, gross unrealized appreciation of investments was $4,891
and gross unrealized depreciation of investments was $2,587, resulting in net
unrealized depreciation of $2,304.
4. CAPITAL:
Of the 28,831,981 shares of common stock outstanding at November 20, 2003,
Western Asset Management Company owned 6,981 shares (share amounts are not in
thousands).
5. SECURITIES LOANED:
The Fund may lend its portfolio securities in order to earn income. The Fund
will receive collateral in cash or high quality securities at least equal to the
current value of the loaned securities. The Fund earns interest on the
securities it lends and income when it invests the collateral for the loaned
securities. As of November 20, 2003, there were no securities on loan.
6. TRANSACTIONS WITH AFFILIATES AND CERTAIN OTHER PARTIES:
The Fund has entered into an Investment Advisory Agreement with Western Asset
Management Company (the "Investment Adviser"), which provides for payment of a
monthly fee computed at the annual rate of 0.40% of the Fund's average weekly
assets. "Average weekly assets" means the average weekly value of the total
assets of the Fund (including any assets attributable to leverage) minus accrued
liabilities (other than liabilities representing leverage). For purposes of
calculating "average weekly assets", neither the liquidation preference of any
preferred shares outstanding nor any liabilities associated with any instrument
or transactions used by the Investment Adviser to leverage the Fund's portfolio
(whether or not such instruments or transactions are "covered" as described in
the prospectus) is considered a liability.
Claymore Securities, Inc. (the "Servicing Agent") will act as servicing agent
for the Fund. For its services, the Servicing Agent will receive an annual fee
from the Fund, payable monthly in arrears, which will be based on the Fund's
average weekly assets in an amount equal to 0.15% of the Fund's average weekly
assets.
Under the Administrative Services Agreement with the Fund, Legg Mason Fund
Adviser, Inc. (the "Administrator"), an affiliate of Western Asset, provides
certain administrative and accounting functions for the Fund. In consideration
of these services, the Fund will pay the Administrator a fee, paid monthly, at
an annual rate of $100,000.
7. TRUSTEE COMPENSATION (DOLLAR AMOUNTS ARE NOT IN THOUSANDS):
Each Trustee currently receives a fee of $8,000 annually for serving as a
Trustee of the Fund, and a fee of $1,000 and related expenses for each meeting
of the Board of Trustees attended. The Chairman of the Board receives an
additional $1,500 per year for serving in that capacity. Audit Committee members
receive $500 for each meeting, and the Audit Committee Chairman receives an
additional $1,500 annually. Other committee members receive $500 per meeting.
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, S&P or Fitch or, if unrated, determined by the Advisor 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 the Advisor.
INVESTMENT GRADE DEBT SECURITIES are those rated in one of the four highest
rating categories or, if unrated, deemed comparable by the Advisor.
BELOW INVESTMENT GRADE, HIGH YIELD SECURITIES ("JUNK BONDS") are those
rated lower than Baa by Moody's or BBB by S&P or 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
Moody's long-term obligation ratings are opinions of the relative credit
risk of fixed-income obligations with an original maturity of one year or more.
They address the possibility that a financial obligation will not be honored as
promised. Such ratings reflect both the likelihood of default and any financial
loss suffered in the event of default.
Aaa. Obligations rated Aaa are judged to be of the highest quality, with
minimal credit risk.
Aa. Obligations rated Aa are judged to be of high quality and are subject
to very low credit risk.
A. Obligations rated A are considered upper-medium grade and are subject to
low credit risk.
A-1
Baa. Obligations rated Baa are subject to moderate credit risk. They are
considered medium-grade and as such may possess certain speculative
characteristics
Ba. Obligations rated Ba are judged to have speculative elements and are
subject to substantial credit risk.
B. Obligations rated B are considered speculative and are subject to high
credit risk.
Caa. Obligations rated Caa are judged to be of poor standing and are
subject to very high credit risk.
Ca. Obligations rated Ca are highly speculative and are likely in, or very
near, default, with some prospect of recovery of principal and interest.
C. Obligations rated C are the lowest rated class of bonds and are
typically in default, with little prospect for recovery of principal and
interest.
Note: Moody's appends numerical modifiers 1, 2, and 3 to each generic
rating classification from Aa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category; the modifier
2 indicates a mid-range; and the modifier 3 indicates a ranking in the lower end
of that generic rating category.
A-2
CORPORATE SHORT-TERM DEBT RATINGS
Moody's short-term ratings are opinions of the ability of issuers to honor
short-term financial obligations. Ratings may be assigned to issuers, short-term
programs or to individual short-term debt instruments. Such obligations
generally have an original maturity not exceeding thirteen months, unless
explicitly noted.
P-1 Issuers (or supporting institutions) rated Prime-1 have a superior
ability to repay short-term debt obligations.
P-2 Issuers (or supporting institutions) rated Prime-2 have a strong
ability to repay short-term debt obligations.
P-3 Issuers (or supporting institutions) rated Prime-3 have an acceptable
ability to repay short-term obligations.
NP Issuers (or supporting institutions) rated Not Prime do not fall within
any of the Prime rating categories.
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
A-3
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.
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.
A-4
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
predominately 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.
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.
A-5
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.
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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.
FITCH RATINGS
A brief description of the applicable Fitch Ratings ("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
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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.
DDD, DD, and 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.
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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.
'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 Rating Watch 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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APPENDIX B
PROXY VOTING POLICIES AND PROCEDURES
BACKGROUND
Western Asset Management Company ("WA") and Western Asset Management Company
Limited ("WAML") (together "Western Asset") have adopted and implemented
policies and procedures that we believe are reasonably designed to ensure that
proxies are voted in the best interest of clients, in accordance with our
fiduciary duties and SEC Rule 206(4)-6 under the Investment Advisers Act of 1940
("Advisers Act"). Our authority to vote the proxies of our clients is
established through investment management agreements or comparable documents,
and our proxy voting guidelines have been tailored to reflect these specific
contractual obligations. In addition to SEC requirements governing advisers, our
proxy voting policies reflect the long-standing fiduciary standards and
responsibilities for ERISA accounts. Unless a manager of ERISA assets has been
expressly precluded from voting proxies, the Department of Labor has determined
that the responsibility for these votes lies with the Investment Manager.
In exercising its voting authority, Western Asset will not consult or enter into
agreements with officers, directors or employees of Legg Mason Inc. or any of
its affiliates (except that WA and WAML may so consult and agree with each
other) regarding the voting of any securities owned by its clients.
POLICY
Western Asset's proxy voting procedures are designed and implemented in a way
that is reasonably expected to ensure that proxy matters are handled in the best
interest of our clients. While the guidelines included in the procedures are
intended to provide a benchmark for voting standards, each vote is ultimately
cast on a case-by-case basis, taking into consideration Western Asset's
contractual obligations to our clients and all other relevant facts and
circumstances at the time of the vote (such that these guidelines may be
overridden to the extent Western Asset deems appropriate).
PROCEDURES
RESPONSIBILITY AND OVERSIGHT
The Western Asset Compliance Department ("Compliance Department") is responsible
for administering and overseeing the proxy voting process. The gathering of
proxies is coordinated through the Corporate Actions area of Investment Support
("Corporate Actions"). Research analysts and portfolio managers are responsible
for determining appropriate voting positions on each proxy utilizing any
applicable guidelines contained in these procedures.
CLIENT AUTHORITY
Prior to August 1, 2003, all existing client investment management agreements
("IMAs") will be reviewed to determine whether Western Asset has authority to
vote client proxies. At account start-up, or upon amendment of an IMA, the
applicable client IMA are similarly reviewed. If an
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agreement is silent on proxy voting, but contains an overall delegation of
discretionary authority or if the account represents assets of an ERISA plan,
Western Asset will assume responsibility for proxy voting. The Client Account
Transition Team maintains a matrix of proxy voting authority.
PROXY GATHERING
Registered owners of record, client custodians, client banks and trustees
("Proxy Recipients") that receive proxy materials on behalf of clients should
forward them to Corporate Actions. Prior to August 1, 2003, Proxy Recipients of
existing clients will be reminded of the appropriate routing to Corporate
Actions for proxy materials received and reminded of their responsibility to
forward all proxy materials on a timely basis. Proxy Recipients for new clients
(or, if Western Asset becomes aware that the applicable Proxy Recipient for an
existing client has changed, the Proxy Recipient for the existing client) are
notified at start-up of appropriate routing to Corporate Actions of proxy
materials received and reminded of their responsibility to forward all proxy
materials on a timely basis. If Western Asset personnel other than Corporate
Actions receive proxy materials, they should promptly forward the materials to
Corporate Actions.
PROXY VOTING
Once proxy materials are received by Corporate Actions, they are forwarded to
the Compliance Department for coordination and the following actions:
a. Proxies are reviewed to determine accounts impacted.
b. Impacted accounts are checked to confirm Western Asset voting
authority.
c. Compliance Department staff reviews proxy issues to determine any
material conflicts of interest. (See conflicts of interest section of
these procedures for further information on determining material
conflicts of interest.)
d. If a material conflict of interest exists, (i) to the extent
reasonably practicable and permitted by applicable law, the client is
promptly notified, the conflict is disclosed and Western Asset obtains
the client's proxy voting instructions, and (ii) to the extent that it
is not reasonably practicable or permitted by applicable law to notify
the client and obtain such instructions (e.g., the client is a mutual
fund or other commingled vehicle or is an ERISA plan client), Western
Asset seeks voting instructions from an independent third party.
e. Compliance Department staff provides proxy material to the appropriate
research analyst or portfolio manager to obtain their recommended
vote. Research analysts and portfolio managers determine votes on a
case-by-case basis taking into account the voting guidelines contained
in these procedures. For avoidance of doubt, depending on the best
interest of each individual client, Western Asset may vote the same
proxy differently for different clients. The analyst's or portfolio
manager's basis for their decision is documented and maintained by the
Compliance Department.
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f. Compliance Department staff votes the proxy pursuant to the
instructions received in (d) or (e) and returns the voted proxy as
indicated in the proxy materials.
TIMING
Western Asset personnel act in such a manner to ensure that, absent special
circumstances, the proxy gathering and proxy voting steps noted above can be
completed before the applicable deadline for returning proxy votes.
RECORDKEEPING
Western Asset maintains records of proxies voted pursuant to Section 204-2 of
the Advisers Act and ERISA DOL Bulletin 94-2. These records include:
a. A copy of Western Asset's policies and procedures.
b. Copies of proxy statements received regarding client securities.
c. A copy of any document created by Western Asset that was material to
making a decision how to vote proxies.
d. Each written client request for proxy voting records and Western
Asset's written response to both verbal and written client requests.
e. A proxy log including:
1. Issuer name;
2. Exchange ticker symbol of the issuer's shares to be voted;
3. Council on Uniform Securities Identification Procedures ("CUSIP")
number for the shares to be voted;
4. A brief identification of the matter voted on;
5. Whether the matter was proposed by the issuer or by a shareholder
of the issuer;
6. Whether a vote was cast on the matter;
7. A record of how the vote was cast; and
8. Whether the vote was cast for or against the recommendation of
the issuer's management team.
Records are maintained in an easily accessible place for five years, the first
two in Western Asset's offices.
DISCLOSURE
Part II of both the WA Form ADV and the WAML Form ADV contain a description of
Western Asset's proxy policies. Prior to August 1, 2003, Western Asset will
deliver Part II of its revised Form ADV to all existing clients, along with a
letter identifying the new disclosure. Clients will be provided a copy of these
policies and procedures upon request. In addition, upon request, clients may
receive reports on how their proxies have been voted.
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CONFLICTS OF INTEREST
All proxies are reviewed by the Compliance Department for material conflicts of
interest. Issues to be reviewed include, but are not limited to:
1. Whether Western Asset (or, to the extent required to be
considered by applicable law, its affiliates) manages assets
for the company or an employee group of the company or
otherwise has an interest in the company;
2. Whether Western Asset or an officer or director of Western
Asset or the applicable portfolio manager or analyst
responsible for recommending the proxy vote (together,
"Voting Persons") is a close relative of or has a personal
or business relationship with an executive, director or
person who is a candidate for director of the company or is
a participant in a proxy contest; and
3. Whether there is any other business or personal relationship
where a Voting Person has a personal interest in the outcome
of the matter before shareholders.
VOTING GUIDELINES
Western Asset's substantive voting decisions turn on the particular facts and
circumstances of each proxy vote and are evaluated by the designated research
analyst or portfolio manager. The examples outlined below are meant as
guidelines to aid in the decision making process.
Guidelines are grouped according to the types of proposals generally presented
to shareholders. Part I deals with proposals which have been approved and are
recommended by a company's board of directors; Part II deals with proposals
submitted by shareholders for inclusion in proxy statements; Part III addresses
issues relating to voting shares of investment companies; and Part IV addresses
unique considerations pertaining to foreign issuers.
I. Board Approved Proposals
The vast majority of matters presented to shareholders for a vote involve
proposals made by a company itself that have been approved and recommended by
its board of directors. In view of the enhanced corporate governance practices
currently being implemented in public companies, Western Asset generally votes
in support of decisions reached by independent boards of directors. More
specific guidelines related to certain board-approved proposals are as follows:
1. Matters relating to the Board of Directors
Western Asset votes proxies for the election of the company's nominees
for directors and for board-approved proposals on other matters
relating to the board of directors with the following exceptions:
a. Votes are withheld for the entire board of directors if the board
does not have a majority of independent directors or the board
does not have nominating,
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audit and compensation committees composed solely of independent
directors.
b. Votes are withheld for any nominee for director who is considered
an independent director by the company and who has received
compensation from the company other than for service as a
director.
c. Votes are withheld for any nominee for director who attends less
than 75% of board and committee meetings without valid reasons
for absences.
d. Votes are cast on a case-by-case basis in contested elections of
directors.
2. Matters relating to Executive Compensation
Western Asset generally favors compensation programs that relate
executive compensation to a company's long-term performance. Votes are
cast on a case-by-case basis on board-approved proposals relating to
executive compensation, except as follows:
a. Except where the firm is otherwise withholding votes for the
entire board of directors, Western Asset votes for stock option
plans that will result in a minimal annual dilution.
b. Western Asset votes against stock option plans or proposals that
permit replacing or repricing of underwater options.
c. Western Asset votes against stock option plans that permit
issuance of options with an exercise price below the stock's
current market price.
d. Except where the firm is otherwise withholding votes for the
entire board of directors, Western Asset votes for employee stock
purchase plans that limit the discount for shares purchased under
the plan to no more than 15% of their market value, have an
offering period of 27 months or less and result in dilution of
10% or less.
3. Matters relating to Capitalization
The management of a company's capital structure involves a number of
important issues, including cash flows, financing needs and market
conditions that are unique to the circumstances of each company. As a
result, Western Asset votes on a case-by-case basis on board-approved
proposals involving changes to a company's capitalization except where
Western Asset is otherwise withholding votes for the entire board of
directors.
a. Western Asset votes for proposals relating to the authorization
of additional common stock.
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b. Western Asset votes for proposals to effect stock splits
(excluding reverse stock splits).
c. Western Asset votes for proposals authorizing share repurchase
programs.
4. Matters relating to Acquisitions, Mergers, Reorganizations and Other
Transactions
Western Asset votes these issues on a case-by-case basis on
board-approved transactions.
5. Matters relating to Anti-Takeover Measures
Western Asset votes against board-approved proposals to adopt
anti-takeover measures except as follows:
a. Western Asset votes on a case-by-case basis on proposals to
ratify or approve shareholder rights plans.
b. Western Asset votes on a case-by-case basis on proposals to adopt
fair price provisions.
6. Other Business Matters
Western Asset votes for board-approved proposals approving such
routine business matters such as changing the company's name,
ratifying the appointment of auditors and procedural matters relating
to the shareholder meeting.
a. Western Asset votes on a case-by-case basis on proposals to amend
a company's charter or bylaws.
b. Western Asset votes against authorization to transact other
unidentified, substantive business at the meeting.
II. Shareholder Proposals
SEC regulations permit shareholders to submit proposals for inclusion in a
company's proxy statement. These proposals generally seek to change some aspect
of a company's corporate governance structure or to change some aspect of its
business operations. Western Asset votes in accordance with the recommendation
of the company's board of directors on all shareholder proposals, except as
follows:
1. Western Asset votes for shareholder proposals to require shareholder
approval of shareholder rights plans.
2. Western Asset votes for shareholder proposals that are consistent with
Western Asset's proxy voting guidelines for board-approved proposals.
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3. Western Asset votes on a case-by-case basis on other shareholder
proposals where the firm is otherwise withholding votes for the entire
board of directors.
III. Voting Shares of Investment Companies
Western Asset may utilize shares of open or closed-end investment companies to
implement its investment strategies. Shareholder votes for investment companies
that fall within the categories listed in Parts I and II above are voted in
accordance with those guidelines.
1. Western Asset votes on a case-by-case basis on proposals relating to
changes in the investment objectives of an investment company taking
into account the original intent of the fund and the role the fund
plays in the clients' portfolios.
2. Western Asset votes on a case-by-case basis all proposals that would
result in increases in expenses (e.g., proposals to adopt 12b-1 plans,
alter investment advisory arrangements or approve fund mergers) taking
into account comparable expenses for similar funds and the services to
be provided.
IV. Voting Shares of Foreign Issuers
In the event Western Asset is required to vote on securities held in foreign
issuers - i.e. issuers that are incorporated under the laws of a foreign
jurisdiction and that are not listed on a U.S. securities exchange or the NASDAQ
stock market, the following guidelines are used, which are premised on the
existence of a sound corporate governance and disclosure framework. These
guidelines, however, may not be appropriate under some circumstances for foreign
issuers and therefore apply only where applicable.
1. Western Asset votes for shareholder proposals calling for a majority
of the directors to be independent of management.
2. Western Asset votes for shareholder proposals seeking to increase the
independence of board nominating, audit and compensation committees.
3. Western Asset votes for shareholder proposals that implement corporate
governance standards similar to those established under U.S. federal
law and the listing requirements of U.S. stock exchanges, and that do
not otherwise violate the laws of the jurisdiction under which the
company is incorporated.
4. Western Asset votes on a case-by-case basis on proposals relating to
(1) the issuance of common stock in excess of 20% of a company's
outstanding common stock where shareholders do not have preemptive
rights, or (2) the issuance of common stock in excess of 100% of a
company's outstanding common stock where shareholders have preemptive
rights.
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APPENDIX C
WESTERN ASSET/CLAYMORE U.S. TREASURY INFLATION PROTECTED
SECURITIES FUND
ARTICLE 12 OF THE SECOND AMENDED AND RESTATED BYLAWS
ARTICLE 12
Shares of Beneficial Interest
12. The Trust has an unlimited number of Common Shares, without par value,
which may be issued from time to time by the Trustees.
12.1 Statement Creating Five Series of Taxable Preferred Shares.
DESIGNATION
SERIES M: A series of 1,640 shares of preferred shares of beneficial
interest, without par value, liquidation preference $25,000 per share plus
accumulated but unpaid dividends, if any, thereon (whether or not earned or
declared), is hereby designated "Series M Taxable Auction Market Preferred
Shares" and is referred to below as "Series M." Each of the 1,640 shares of
Series M issued on December __, 2003 shall, for purposes hereof, be deemed to
have a Date of Original Issue of December __, 2003; have an Applicable Rate
for its Initial Rate Period equal to ____% per annum; have an initial
Dividend Payment Date of _______, ____; and have such other preferences,
voting powers, terms of redemption and special or relative rights or
privileges, in addition to those required by applicable law or set forth in
the Declaration of Trust, as amended and restated, applicable to Series M, as
set forth in Part I and Part II of this Article 12. Any shares of Series M
issued thereafter shall be issued on the first day of a Rate Period of the
then outstanding shares of Series M; shall have, for such Rate Period, an
Applicable Rate equal to the Applicable Rate for shares of such series
established in the first Auction for shares of such series preceding the date
of such issuance; and shall have such other preferences, voting powers, terms
of redemption and special or relative rights or privileges, in addition to
those required by applicable law or set forth in the Declaration of Trust
applicable to Series M, as set forth in Part I and Part II of this Article
12. The Series M shall constitute a separate series of preferred shares of
beneficial interest of the Trust, and each share of Series M shall be
identical except as provided in this Section 12.1.
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SERIES T: A series of 1,640 shares of preferred shares of beneficial
interest, without par value, liquidation preference $25,000 per share plus
accumulated but unpaid dividends, if any, thereon (whether or not earned or
declared), is hereby designated "Series T Taxable Auction Market Preferred
Shares" and is referred to below as "Series T." Each of the 1,640 shares of
Series T issued on December __, 2003 shall, for purposes hereof, be deemed to
have a Date of Original Issue of December __, 2003; have an Applicable Rate
for its Initial Rate Period equal to ____% per annum; have an initial
Dividend Payment Date of _______, ____; and have such other preferences,
voting powers, terms of redemption and special or relative rights or
privileges, in addition to those required by applicable law or set forth in
the Declaration of Trust, as amended and restated, applicable to Series T, as
set forth in Part I and Part II of this Article 12. Any shares of Series T
issued thereafter shall be issued on the first day of a Rate Period of the
then outstanding shares of Series T; shall have, for such Rate Period, an
Applicable Rate equal to the Applicable Rate for shares of such series
established in the first Auction for shares of such series preceding the date
of such issuance; and shall have such other preferences, voting powers, terms
of redemption and special or relative rights or privileges, in addition to
those required by applicable law or set forth in the Declaration of Trust
applicable to Series T, as set forth in Part I and Part II of this Article
12. The Series T shall constitute a separate series of preferred shares of
beneficial interest of the Trust, and each share of Series T shall be
identical except as provided in this Section 12.1.
SERIES W: A series of 1,640 shares of preferred shares of beneficial
interest, without par value, liquidation preference $25,000 per share plus
accumulated but unpaid dividends, if any, thereon (whether or not earned or
declared), is hereby designated "Series W Taxable Auction Market Preferred
Shares" and is referred to below as "Series W." Each of the 1,640 shares of
Series W issued on December __, 2003 shall, for purposes hereof, be deemed to
have a Date of Original Issue of December __, 2003; have an Applicable Rate
for its Initial Rate Period equal to ____% per annum; have an initial
Dividend Payment Date of _______, ____; and have such other preferences,
voting powers, terms of redemption and special or relative rights or
privileges, in addition to those required by applicable law or set forth in
the Declaration of Trust, as amended and restated, applicable to Series W, as
set forth in Part I and Part II of this Article 12. Any shares of Series W
issued thereafter shall be issued on the first day of a Rate Period of the
then outstanding shares of Series W; shall have, for such Rate Period, an
Applicable Rate equal to the Applicable Rate for shares of such series
established in the first Auction for shares of such series preceding the date
of such issuance; and shall have such other preferences, voting powers, terms
of redemption and special or relative rights or privileges, in addition to
those required by applicable law or set forth in the Declaration of Trust
applicable to Series W, as set forth in Part I and Part II of this Article
12. The Series W shall constitute a separate series of preferred shares of
beneficial interest of the Trust, and each share of Series W shall be
identical except as provided in this Section 12.1.
SERIES TH: A series of 1,640 shares of preferred shares of beneficial
interest, without par value, liquidation preference $25,000 per share plus
accumulated but unpaid dividends, if any, thereon (whether or not earned or
declared), is hereby designated "Series TH Taxable Auction Market Preferred
Shares" and is referred to below as "Series TH." Each of the 1,640 shares of
Series TH issued on December __, 2003 shall, for purposes hereof, be deemed to
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have a Date of Original Issue of December __, 2003; have an Applicable Rate for
its Initial Rate Period equal to ____% per annum; have an initial Dividend
Payment Date of _______, ____; and have such other preferences, voting powers,
terms of redemption and special or relative rights or privileges, in addition to
those required by applicable law or set forth in the Declaration of Trust, as
amended and restated, applicable to Series TH, as set forth in Part I and Part
II of this Article 12. Any shares of Series TH issued thereafter shall be issued
on the first day of a Rate Period of the then outstanding shares of Series TH;
shall have, for such Rate Period, an Applicable Rate equal to the Applicable
Rate for shares of such series established in the first Auction for shares of
such series preceding the date of such issuance; and shall have such other
preferences, voting powers, terms of redemption and special or relative rights
or privileges, in addition to those required by applicable law or set forth in
the Declaration of Trust applicable to Series TH, as set forth in Part I and
Part II of this Article 12. The Series TH shall constitute a separate series of
preferred shares of beneficial interest of the Trust, and each share of Series
TH shall be identical except as provided in this Section 12.1.
SERIES F: A series of 1,640 shares of preferred shares of beneficial
interest, without par value, liquidation preference $25,000 per share plus
accumulated but unpaid dividends, if any, thereon (whether or not earned or
declared), is hereby designated "Series F Taxable Auction Market Preferred
Shares" and is referred to below as "Series F," and, together with Series M,
Series T, Series W and Series TH, the "Preferred Shares." Each of the 1,640
shares of Series F issued on December __, 2003 shall, for purposes hereof, be
deemed to have a Date of Original Issue of December __, 2003; have an Applicable
Rate for its Initial Rate Period equal to _______% per annum; have an initial
Dividend Payment Date of _______, ____; and have such other preferences, voting
powers, terms of redemption and special or relative rights or privileges, in
addition to those required by applicable law or set forth in the Declaration of
Trust, as amended and restated, applicable to Series F, as set forth in Part I
and Part II of this Article 12. Any shares of Series F issued thereafter shall
be issued on the first day of a Rate Period of the then outstanding shares of
Series F; shall have, for such Rate Period, an Applicable Rate equal to the
Applicable Rate for shares of such series established in the first Auction for
shares of such series preceding the date of such issuance; and shall have such
other preferences, voting powers, terms of redemption and special or relative
rights or privileges, in addition to those required by applicable law or set
forth in the Declaration of Trust applicable to Series F, as set forth in Part I
and Part II of this Article 12. The Series F shall constitute a separate series
of preferred shares of beneficial interest of the Trust, and each share of
Series F shall be identical except as provided in this Section 12.1.
DEFINITIONS
As used in Parts I and II of this Section 12.1, the following terms shall
have the following meanings (with terms defined in the singular having
comparable meanings when used in the plural and vice versa), unless the context
otherwise requires:
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(a) "Affected Series" shall have the meaning specified in paragraph
4(c)(i) of Part I of this Section 12.1.
(b) "Affiliate" shall mean, for purposes of the definition of
"Outstanding," any Person known to the Auction Agent to be controlled by, in
control of or under common control with the Trust; provided, however, that no
Broker-Dealer controlled by, in control of or under common control with the
Trust shall be deemed to be an Affiliate, nor shall any corporation, one of
the trustees, directors or executive officers of which is a Trustee or any
Person controlled by, in control of or under common control with such
corporation, be deemed to be an Affiliate solely because such trustee,
director or executive officer is also a Trustee.
(c) "Agent Member" shall mean a member of or participant in the
Securities Depository that will act on behalf of a Bidder.
(d) "Annual Valuation Date" shall mean the last Business Day of each
March of each year.
(e) "Applicable Percentage" means the percentage determined based on
the prevailing credit rating assigned to the series of Preferred Shares on
such date by Moody's (if Moody's is then rating the Preferred Shares) or
Fitch (if Fitch is then rating the Preferred Shares) as follows:
Credit Ratings
--------------------------------- Applicable
Moody's Fitch Percentage
------------ ------------ ----------
Aaa AAA 125%
Aa3 to Aa1 AA- to AA+ 150%
A3 to A1 A- to A+ 200%
Baa3 to Baa1 BBB- to BBB+ 250%
Below Baa3 Below BBB- 300%
For purposes of this definition, the "prevailing credit rating" of
shares of a series of Preferred Shares shall be (i) AAA if such shares have
a rating of Aaa by Moody's or AAA by Fitch or the equivalent of such
ratings by a Substitute Rating Agency; (ii) if not AAA, then AA- if such
shares have a rating of Aa3 or better by Moody's or AA- or better by Fitch
or the equivalent of such ratings by a Substitute Rating Agency, (iii) if
not AA- or higher, then A- if such shares have a rating of A3 or better by
Moody's or A- or better by Fitch or the equivalent of such ratings by a
Substitute Rating Agency, (iv) if not A- or higher, then BBB- if such
shares have a rating of Baa3 or better by Moody's or BBB- or better by
Fitch or the equivalent of such ratings by a Substitute Rating Agency, and
(v) if not BBB- or higher, then below BBB-.
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 and
subject to paragraph 4(d) of Part I of this
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Section 12.1, provided that immediately following any such increase the
Trust would be in compliance with the Preferred Shares Basic Maintenance
Amount. The Trust shall take all reasonable action necessary to enable
Moody's and Fitch to provide a rating for each series of Preferred Shares.
If Moody's or Fitch shall not make such a rating available, the Trust,
after consultation with the Lead Broker-Dealer or its affiliates and
successors, shall select another Rating Agency to act as a Substitute
Rating Agency. Notwithstanding the foregoing, the Trust shall not be
required to have more than one Rating Agency provide a rating for any
series of the Preferred Shares.
(f) "Applicable Rate" shall have the meaning specified in paragraph
2(e)(i) of Part I of this Section 12.1.
(g) "Applicable Spread" means the spread determined based on the
prevailing credit rating assigned to the series of Preferred Shares on such
date by Moody's (if Moody's is then rating the Preferred Shares) or Fitch (if
Fitch is then rating the Preferred Shares) as follows:
Credit Ratings
--------------------------------- Applicable
Moody's Fitch Spread
------------ ------------ ----------
Aaa AAA 125 bps
Aa3 to Aa1 AA- to AA+ 150 bps
A3 to A1 A- to A+ 200 bps
Baa3 to Baa1 BBB- to BBB+ 250 bps
Below Baa3 Below BBB- 300 bps
For purposes of this definition only, the "prevailing credit
rating" of shares of a series of Preferred Shares shall be (i) AAA if such
shares have a rating of Aaa by Moody's or AAA by Fitch or the equivalent of
such ratings by a Substitute Rating Agency; (ii) if not AAA, then AA- if
such shares have a rating of Aa3 or better by Moody's or AA- or better by
Fitch or the equivalent of such ratings by a Substitute Rating Agency,
(iii) if not AA- or higher, then A- if such shares have a rating of A3 or
better by Moody's or A- or better by Fitch or the equivalent of such
ratings by a Substitute Rating Agency, (iv) if not A- or higher, then BBB-
if such shares have a rating of Baa3 or better by Moody's or BBB- or better
by Fitch or the equivalent of such ratings by a Substitute Rating Agency,
and (v) if not BBB- or higher, then below BBB-.
The Applicable Spread as so determined shall be further subject to
upward but not downward adjustment in the discretion of the Board of
Trustees after consultation with the Broker-Dealers and subject to
paragraph 4(d) of Part I of this Section 12.1, provided that immediately
following any such increase the Trust would be in compliance with the
Preferred Shares Basic Maintenance Amount. The Trust shall take all
reasonable action necessary to enable Moody's and Fitch to provide a rating
for each series of Preferred Shares. If Moody's or Fitch shall not make
such a rating available, the Trust, after consultation with the Lead
Broker-Dealer or its affiliates and successors, shall select another Rating
Agency to act as a Substitute Rating Agency. Notwithstanding the
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foregoing, the Trust shall not be required to have more than one Rating
Agency provide a rating for any series of the Preferred Shares.
(h) "Approved Foreign Nations" shall have the meaning set forth in
paragraph (iv) of the definition of "Fitch Eligible Assets."
(i) "Approved Price" means the "fair value" as determined by the Trust
in accordance with the valuation procedures adopted from time to time by the
Trustees and for which the Trust receives a mark-to-market price (which, for
the purpose of clarity, shall not mean Market Value) from an independent
source at least semi-annually.
(j) "ARMs" shall have the meaning set forth in paragraph (vii)(G) of
the definition of "Moody's Eligible Assets."
(k) "Auction" shall mean each periodic implementation of the Auction
Procedures.
(l) "Auction Agent" shall mean the entity appointed as such by a
resolution of the Trustees in accordance with paragraph 6 of Part II of this
Section 12.1.
(m) "Auction Date," with respect to any Rate Period, shall mean the
Business Day next preceding the first day of such Rate Period.
(n) "Auction Procedures" shall mean the procedures for conducting
Auctions set forth in Part II of this Section 12.1.
(o) "Auditor's Confirmation" shall have the meaning specified in
paragraph 6(c) of Part I of this Section 12.1.
(p) "Available Preferred Shares" shall have the meaning specified in
paragraph 3(a) of Part II of this Section 12.1.
(q) "Bank Loans" shall mean 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.
(r) "Beneficial Owner," with respect to shares of a series of
Preferred Shares, 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 shares of such series.
(s) "Bid" and "Bids" shall have the respective meanings specified in
paragraph 1(a) of Part II of this Section 12.1.
(t) "Bidder" and "Bidders" shall have the respective meanings
specified in paragraph 1(a) of Part II of this Section 12.1; provided,
however, that neither the Trust nor any affiliate thereof shall be permitted
to be a Bidder in an Auction, except that any Broker-Dealer that is an
affiliate of the Trust may be a Bidder in an Auction, but only if the Orders
placed by such Broker-Dealer are not for its own account.
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(u) "Brady Bonds" shall mean securities created through the exchange
of existing commercial bank loans to sovereign entities for new obligations
in connection with a debt restructuring under a plan introduced by former
U.S. Secretary of the Treasury Nicholas F. Brady.
(v) "Broker-Dealer" shall mean any broker-dealer, commercial bank or
other entity permitted by law to perform the functions required of a
Broker-Dealer in Part II of this Section 12.1, that is a member of, or a
participant in, the Securities Depository or is an affiliate of such member
or participant, has been selected by the Trust and has entered into a
Broker-Dealer Agreement that remains effective.
(w) "Broker-Dealer Agreement" shall mean an agreement between the
Auction Agent on behalf of the Trust and a Broker-Dealer pursuant to which
such Broker-Dealer agrees to follow the procedures specified in Part II of
this Section 12.1.
(x) "Business Day" shall mean a day on which the New York Stock
Exchange is open for trading and which is neither a Saturday nor a Sunday nor
any other day on which banks in The City of New York, New York, are
authorized by law to close.
(y) "Canadian Bonds" shall have the meaning set forth in paragraph
(iv) of the definition of "Fitch Eligible Assets."
(z) "Closing Transactions" shall have the meaning specified in
paragraph 10(a)(i)(A) of Part I of this Section 12.1.
(aa) "CMOs" shall have the meaning set forth in paragraph (vii) of
the definition of "Moody's Eligible Assets" below.
(bb) "Common Shares" shall mean the common shares of beneficial
interest of the Trust.
(cc) "Corporate Debt Securities" shall have the meaning set forth in
paragraph (iv) of the definition of "Fitch Eligible Assets."
(dd) "Cure Date" shall mean the Preferred Shares Basic Maintenance
Cure Date or the 1940 Act Cure Date, as the case may be.
(ee) "Date of Original Issue," with respect to shares of a series of
Preferred Shares, shall mean the date on which the Trust initially issued
such shares.
(ff) "Declaration of Trust" shall mean the Trust's Agreement and
Declaration of Trust in effect from time to time.
(gg) "Deposit Securities" shall mean 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), A1 or F-1 by Fitch.
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(hh) "Discounted Value," as of any Valuation Date, shall mean (i) with
respect to a Fitch Eligible Asset or Moody's Eligible Asset that is not
currently callable as of such Valuation Date at the option of the issuer
thereof, the quotient of the lesser of the Market Value thereof and the par
value thereof divided by the Fitch Discount Factor for a Fitch Eligible Asset
or the Moody's Discount Factor for a Moody's Eligible Asset; or (ii) with
respect to a Fitch Eligible Asset or Moody's Eligible Asset that is currently
callable as of such Valuation Date at the option of the issuer thereof, the
quotient of (1) the lesser of the Market Value and call price thereof divided
by (2) the Fitch Discount Factor for Fitch Eligible Assets or the Moody's
Discount Factor for Moody's Eligible Assets.
(ii) "Dividend Payment Date," with respect to shares of a series of
Preferred Shares, shall mean any date on which dividends are payable on
shares of such series pursuant to the provisions of paragraph 2(d) of Part I
of this Section 12.1.
(jj) "Dividend Period," with respect to shares of a series of
Preferred Shares, shall mean the period from and including the Date of
Original Issue of shares of such series to but excluding the initial Dividend
Payment Date for shares of such series and any period thereafter from and
including one Dividend Payment Date for shares of such series to but
excluding the next succeeding Dividend Payment Date for shares of such
series.
(kk) "DRDs" shall mean preferred shares the dividends on which qualify
for the inter-corporate dividends received deduction.
(ll) "Existing Holder," with respect to shares of a series of
Preferred Shares, shall mean a Broker-Dealer (or any such other Person as may
be permitted by the Trust) that is listed on the records of the Auction Agent
as a holder of shares of such series.
(mm) "Exposure Period" shall mean the period commencing on a given
Valuation Date and ending 49 days thereafter.
(nn) "Failure to Deposit," with respect to shares of a series of
Preferred Shares, shall mean a failure by the Trust to pay to the Auction
Agent, not later than 12:00 Noon, New York City time, (A) on any Dividend
Payment Date for shares of such series, in funds available on such Dividend
Payment Date in The City of New York, New York, the full amount of any
dividend (whether or not earned or declared) to be paid on such Dividend
Payment Date on any share of such series or (B) on any redemption date in
funds available on such redemption date for shares of such series in The City
of New York, New York, the Redemption Price to be paid on such redemption
date for any share of such series after Notice of Redemption is mailed
pursuant to paragraph 8(c) of Part I of this Section 12.1; provided, however,
that the foregoing clause (B) shall not apply to the Trust's failure to pay
the Redemption Price in respect of Preferred Shares when the related Notice
of Redemption provides that redemption of such shares is subject to one or
more conditions precedent and any such condition precedent shall not have
been satisfied at the time or times and in the manner specified in such
Notice of Redemption; and provided, further, that no Failure to Deposit shall
exist on a day that would have been a Dividend Payment Date but for the
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occurrence of one or more of the events described in paragraph 5(b) of Part
II of this Section 12.1.
(oo) "FFCB," "FHLB," "FHLMC" and "FNMA" shall have the respective
meanings set forth in paragraph (vii) of the definition of "Moody's Eligible
Assets" below.
(pp) "FHLB, FNMA and FFCB Debentures" shall have the meaning set forth
in paragraph (vii) of the definition of "Moody's Eligible Assets" below.
(qq) "Fitch" shall mean Fitch Ratings and its successors.
(rr) "Fitch Discount Factor" shall mean, for purposes of determining
the Discounted Value of any Fitch Eligible Asset, the percentage determined
as follows. The Fitch Discount Factor for any Fitch Eligible Asset other than
the securities set forth below will be the percentage provided in writing by
Fitch.
(i) Corporate Debt Securities: The percentage determined by
reference to the rating of the Corporate Debt Security in accordance with
the table set forth below.
Term to Maturity of Not Rated
Corporate Debt or Below
Security(1) AAA AA A BBB BB BB
------------------------------------------ ------- ------- ------- ------- ------- ---------
3 years or less 106.38% 108.11% 109.89% 111.73% 129.87% 151.52%
5 years or less (but longer than 3 years) 111.11% 112.99% 114.94% 116.96% 134.24% 151.52%
7 years or less (but longer than 5 years) 113.64% 115.61% 117.65% 119.76% 135.66% 151.52%
10 years or less (but longer than 7 years) 115.61% 117.65% 119.76% 121.95% 136.74% 151.52%
15 years or less (but longer than 10 years) 119.76% 121.95% 124.22% 126.58% 139.05% 151.52%
More than 15 years 124.22% 126.58% 129.03% 131.58% 144.55% 151.52%
----------
(1) If a security is not rated by Fitch but is rated by two other
Rating Agencies, then the lower of the ratings on the security from the two
other Rating Agencies will be used to determine the Fitch Discount Factor
(E.G., where the S&P rating is A- and the Moody's rating is Baa1, a Fitch
rating of BBB+ will be used). If a security is not rated by Fitch but is
rated by only one other Rating Agency, then the rating on the security from
the other Rating Agency will be used to determine the Fitch Discount Factor
(e.g., where the only rating on a security is an S&P rating of AAA, a Fitch
rating of AAA will be used, and where the only rating on a security is a
Moody's rating of Ba3, a Fitch rating of BB- will be used). If a security
is not rated by any Rating Agency, the Trust will use the percentage set
forth under "Not Rated or Below BB" in this table.
The Fitch Discount Factors presented in the immediately preceding table
apply to Corporate Debt Securities that are Performing and have a Market
Value determined by a
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Pricing Service or an Approved Price. The Fitch Discount Factor noted in
the table above for a Corporate Debt Security not rated or rated below BB
by Fitch shall apply to any non-Performing Corporate Debt Security with a
price equal to or greater than $0.20. If a Corporate Debt Security does not
have a Market Value determined by a Pricing Source or an Approved Price, a
rating two rating categories below the actual rating on the Corporate Debt
Security will be used (e.g., where the actual rating is A-, the rating for
Corporate Debt Securities rated BB- will be used). The Fitch Discount
Factor for a Corporate Debt Security issued by a limited partnership that
is not a Rule 144A Security shall be the Discount Factor determined in
accordance with the table set forth above multiplied by 105%.
The Fitch Discount Factors presented in the immediately preceding table
will also apply to (i) interest rate swaps and caps, whereby the rating of
the counterparty to the swap or cap will be the rating used to determine
the Fitch Discount Factor in the table; and (ii) Tradable Credit Baskets,
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 Tradable Credit Baskets.
The Fitch Discount Factors presented in the immediately preceding table
will also apply to corporate obligations backed by a guaranty, a letter of
credit or insurance issued by a third party. If the third-party credit
rating is the basis for the rating on the obligation, then the rating on
the third party will be used to determine the Fitch Discount Factor in the
table. The Fitch Discount Factors presented in the immediately preceding
table will also apply to preferred trust certificates, the rating on which
will by determined by the underlying debt instruments in the trust, unless
such preferred trust certificates are determined by Fitch to qualify for a
traditional equity discount factor, in which case the Fitch Discount Factor
shall be 370%.
(ii) Short-term instruments: The Fitch Discount Factor applied to
short-term portfolio securities, including without limitation Corporate
Debt Securities, Short Term Money Market Instruments and municipal debt
obligations, will be (A) 100%, so long as such portfolio securities mature
within, or have a demand feature at par exercisable within, the Exposure
Period; and (B) 125%, so long as such portfolio securities neither mature
within nor have a demand feature at par exercisable within the Exposure
Period. A Fitch Discount factor of 100% will be applied to cash.
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(iii) U.S. Government Securities and U.S. Treasury Strips:
Time Remaining to Maturity Discount Factor
-------------------------- ---------------
1 year or less 102%
2 years or less (but longer than 1 year) 103%
3 years or less (but longer than 2 years) 105%
4 years or less (but longer than 3 years) 107%
5 years or less (but longer than 4 years) 109%
7 years or less (but longer than 5 years) 112%
10 years or less (but longer than 7 years) 114%
Greater than 10 years 122%
(iv) Rule 144A Securities: The Fitch Discount Factor applied to Rule
144A Securities will be 110% of the Fitch Discount Factor which would apply
were the securities registered under the Securities Act.
(v) Asset-backed and mortgage-backed securities: The percentage
determined by reference to the asset type in accordance with the table set
forth below.
Asset Type (with time remaining to maturity, if applicable) Discount Factor
---------- ---------------
U.S. Treasury/agency securities (10 years or less) 118%
U.S. Treasury/agency securities (greater than 10 years) 127%
U.S. agency sequentials (10 years or less) 128%
U.S. agency sequentials (greater than 10 years) 142%
U.S. agency principal only securities 236%
U.S. agency interest only securities
(with Market Value greater than $0.40) 498%
U.S. agency interest only securities
(with Market Value less than or equal to $0.40) 214%
AAA LockOut securities, interest only 236%
U.S. agency planned amortization class bonds (10 years or less) 115%
U.S. agency planned amortization class bonds (greater than 10 years) 136%
AAA sequentials (10 years or less) 118%
AAA sequentials (greater than 10 years) 135%
AAA planned amortization class bonds (10 years or less) 115%
AAA planned amortization class bonds (greater than 10 years) 140%
Jumbo mortgages rated AAA(1) 123%
Jumbo mortgages rated AA(1) 130%
Jumbo mortgages rated A(1) 136%
Jumbo mortgages rated BBB(1) 159%
Commercial mortgage-backed securities rated AAA 131%
Commercial mortgage-backed securities rated AA 139%
Commercial mortgage-backed securities rated A 148%
Commercial mortgage-backed securities rated BBB 177%
Commercial mortgage-backed securities rated BB 283%
Commercial mortgage-backed securities rated B 379%
Commercial mortgage-backed securities rated CCC or not rated 950%
----------
(1) Applies to jumbo mortgages, credit cards, auto loans, home equity
loans, manufactured housing and prime mortgage-backed securities not
issued by a U.S. agency or instrumentality.
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(vi) Bank Loans: The percentage determined by reference to the Fitch
Loan Category in accordance with the table set forth below.
Fitch Loan Category Discount Factor
------------------- ---------------
A 126%
B 157%
C 184%
D 433%
(vii) Municipal debt obligations: The Fitch Discount Factor applied to
municipal debt obligations will be the percentage determined by reference
to the table set forth below:
Fitch Rating Category
exposure period AAA(1) AA(1) A(1) BBB(1) F1(2) UNRATED(3)
--------------- ----- ---- ---- ------ ----- ----------
7 weeks 151% 159% 166% 173% 136% 225%
8 weeks or less but greater than 7 weeks 154% 161% 168% 176% 137% 231%
9 weeks or less but greater than 8 weeks 158% 163% 170% 177% 138% 240%
----------
(1) Fitch rating.
(2) Municipal debt obligations rated by Fitch which do not mature, but have
a demand feature at par exercisable in 30 days and which do not have a
long-term rating.
(3) If a security is not rated by Fitch but is rated by two other Rating
Agencies, then the lower of the ratings on the security from the two other
Rating Agencies will be used to determine the Fitch Discount Factor (e.g.,
where the S&P rating is A- and the Moody's rating is Baa1, a Fitch rating
of BBB+ will be used). If a security is not rated by Fitch but is rated by
only one other Rating Agency, then the rating on the security from the
other Rating Agency will be used to determine the Fitch Discount Factor
(e.g., where the only rating on a security is an S&P rating of AAA, a Fitch
rating of AAA will be used, and where the only rating on a security is a
Moody's rating of Ba3, a Fitch rating of BB- will be used). If a security
is not rated by any Rating Agency, the Trust will use the percentage set
forth under "Unrated" in this table.
(viii) Foreign Bonds: The Fitch Discount Factor (A) for (1) a Foreign
Bond the principal of which (if not denominated in U.S. dollars) is subject
to a currency hedging transaction or (2) a Foreign Bond the principal of
which is denominated in U.S. dollars, will be the Fitch Discount Factor
that would otherwise apply to such Foreign Bonds in accordance with
paragraph (i) of this definition of "Fitch Discount Factor," or (B) for (1)
a Foreign Bond the principal of which (if not denominated in U.S. dollars)
is not subject to a currency hedging transaction or (2) a bond issued by a
corporation, limited liability company or limited partnership domiciled in,
or the government or any agency, instrumentality or political subdivision
of, a nation other than an Approved Foreign Nation, will be 370%.
(ix) Structured Notes: The Fitch Discount Factor applied to Structured
Notes will be (A) in the case of a corporate issuer, the Fitch Discount
Factor determined in accordance
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with paragraph (i) 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 Fitch Discount Factor in the table in paragraph
(i); and (B) in the case of an issuer that is the U.S. government or an
agency or instrumentality thereof, the Fitch Discount Factor determined in
accordance with paragraph (iii) under this definition.
(x) Convertible securities: The Fitch Discount Factor applied to
convertible securities is (A) 200% for investment grade convertibles and
(B) 222% for below investment grade convertibles so long as such
convertible securities have neither (x) conversion premiums greater than
100% nor (y) a yield to maturity or yield to worst of greater than 15.00%
above the relevant Treasury curve.
The Fitch Discount Factor applied to convertible securities which have
conversion premiums of greater than 100% is (A) 152% for investment grade
convertibles, and (B) 179% for below investment grade convertibles so long
as such convertible securities do not have a yield to maturity or yield to
worst of greater than 15.00% above the relevant Treasury curve.
The Fitch Discount Factor applied to convertible securities which have a
yield to maturity or yield to worst of greater than 15.00% above the
relevant Treasury curve is 370%.
(xi) Preferred securities: The percentage determined by reference to the
rating of a preferred security in accordance with the table set forth
below.
Fitch Rating Category
Not Rated or
Preferred Security(1) AAA AA A BBB BB Below BB
--------------------- --- -- - --- -- ------------
Taxable Preferred 130.58% 133.19% 135.91% 138.73% 153.23% 161.08%
Dividend Received Deduction (DRD) Preferred 163.40% 163.40% 163.40% 163.40% 201.21% 201.21%
----------
(1) If a security is not rated by Fitch but is rated by two other Rating
Agencies, then the lower of the ratings on the security from the two other
Rating Agencies will be used to determine the Fitch Discount Factor (e.g.,
where the S&P rating is A- and the Moody's rating is Baa1, a Fitch rating
of BBB+ will be used). If a security is not rated by Fitch but is rated by
only one other Rating Agency, then the rating on the security from the
other Rating Agency will be used to determine the Fitch Discount Factor
(e.g., where the only rating on a security is an S&P rating of AAA, a Fitch
rating of AAA will be used, and where the only rating on a security is a
Moody's rating of Ba3, a Fitch rating of BB- will be used). If a security
is not rated by any Rating Agency, the Trust will use the percentage set
forth under "Not Rated or Below BB" in this table.
(ss) "Fitch Eligible Asset" shall mean
(i) cash (including interest and dividends due on assets rated (A) BBB
or higher by Fitch or the equivalent by another Rating Agency if the
payment date is within five
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Business Days of the Valuation Date, (B) A or higher by Fitch or the
equivalent by another Rating Agency if the payment date is within thirty
days of the Valuation Date, and (C) A+ or higher by Fitch or the equivalent
by another Rating Agency if the payment date is otherwise within the
Exposure Period) and receivables for Fitch 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) with counterparties
having a long-term debt rating of at least BBB- from Fitch or the
equivalent from another Rating Agency or (B) with counterparties having a
Short Term Money Market Instrument rating of at least F1+ by Fitch or the
equivalent by another Rating Agency;
(ii) Short Term Money Market Instruments so long as (A) such securities
are rated at least F1+ by Fitch or the equivalent by another Rating Agency,
(B) in the case of demand deposits, time deposits and overnight funds, the
supporting entity is rated at least A by Fitch or the equivalent by another
Rating Agency, or (C) in all other cases, the supporting entity (1) is
rated at least A by Fitch or the equivalent by another Rating Agency and
the security matures within three months or (2) is rated at least AA by
Fitch or the equivalent by another Rating Agency and the security matures
within six months;
(iii) U.S. Government Securities and U.S. Treasury Strips;
(iv) debt securities if (A) such securities have been registered under
the Securities Act or are restricted as to resale under federal securities
laws but are eligible for resale pursuant to Rule 144A under the Securities
Act as determined by the Trust's investment manager or portfolio manager;
and (B) such securities are issued by (1) a U.S. corporation, limited
liability company or limited partnership, (2) a corporation, limited
liability company or limited partnership domiciled in Argentina, Australia,
Brazil, Chile, France, Germany, Italy, Japan, Korea, Mexico, Spain, the
United Kingdom, or any country represented in the JP Morgan Emerging
Markets Bond Index Plus (the "Approved Foreign Nations"), (3) the
government of any Approved Foreign Nation or any of its agencies,
instrumentalities or political subdivisions, including Brady Bonds (the
debt securities described in clauses (2) and (3) being referred to
collectively as "Foreign Bonds"), (4) a corporation, limited liability
company or limited partnership domiciled in Canada or (5) the Canadian
government or any of its agencies, instrumentalities or political
subdivisions (the debt securities of Canadian issuers being referred to
collectively as "Canadian Bonds"). Foreign Bonds held by the Trust will
qualify as Fitch Eligible Assets only up to a maximum of 20% of the
aggregate Market Value of all assets constituting Fitch Eligible Assets.
Similarly, Canadian Bonds held by the Trust will qualify as Fitch Eligible
Assets only up to a maximum of 20% of the aggregate Market Value of all
assets constituting Fitch Eligible Assets. Notwithstanding the limitations
in the two preceding sentences, Foreign Bonds and Canadian Bonds held by
the Trust will qualify as Fitch Eligible Assets only up to a maximum of 30%
of the aggregate Market Value of all assets constituting Fitch Eligible
Assets. In addition, bonds which are issued in connection with a
reorganization under U.S. federal bankruptcy law ("Reorganization Bonds")
will be considered debt securities constituting Fitch Eligible Assets if
(a) they provide for periodic payment of interest in cash in U.S.
C-14
dollars or euros; (b) they do not provide for conversion or exchange into
equity capital at any time over their lives; (c) they have been registered
under the Securities Act or are restricted as to resale under federal
securities laws but are eligible for trading under Rule 144A promulgated
pursuant to the Securities Act as determined by the Trust's investment
manager or portfolio manager; (d) they were issued by a U.S. corporation,
limited liability company or limited partnership; and (e) at the time of
purchase at least one year had elapsed since the issuer's reorganization.
Reorganization Bonds may also be considered debt securities constituting
Fitch Eligible Assets if they have been approved by Fitch, which approval
shall not be unreasonably withheld. All debt securities satisfying the
foregoing requirements and restrictions of this paragraph (iv) are herein
referred to as "Corporate Debt Securities";
(v) 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, (D) the issuer of such a preferred stock has a senior debt rating
or preferred stock rating from Fitch of BBB- or higher or the equivalent
rating by another Rating Agency. In addition, the preferred stocks' issue
must be at least $50 million;
(vi) asset-backed and mortgage-backed securities;
(vii) Rule 144A Securities;
(viii) Bank Loans;
(ix) municipal debt obligations that (A) pay interest in cash and (B)
are part of an issue of municipal debt obligations of at least $5 million,
except for municipal debt obligations rated below A by Fitch or the
equivalent rating by another Rating Agency, in which case the minimum issue
size is $10 million;
(x) Tradable Credit Baskets (e.g., Traded Custody Receipts or TRACERs
and Targeted Return Index Securities Trust or TRAINS);
(xi) convertible debt and convertible preferred stocks; and
(xii) any other security or instrument approved by Fitch.
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 may be included in
Fitch Eligible Assets, but, with respect to any financial contract, only upon
receipt by the Trust of a writing from Fitch specifying any conditions on
including such financial contract in Fitch Eligible Assets and assuring the
Trust that including such financial contract in the manner so specified would
not affect the credit rating assigned by Fitch to the Preferred Shares.
C-15
Where the Trust sells an asset and agrees to repurchase such asset in the
future, the Discounted Value of such asset will constitute a Fitch Eligible
Asset and the amount the Trust is required to pay upon repurchase of such asset
will count as a liability for the purposes of the Preferred Shares Basic
Maintenance Amount. Where the Trust purchases an asset and agrees to sell it to
a third party in the future, cash receivable by the Trust thereby will
constitute a Fitch Eligible Asset if the long-term debt of such other party is
rated at least A- by Fitch or the equivalent by another Rating Agency and such
agreement has a term of 30 days or less; otherwise the Discounted Value of such
purchased asset will constitute a Fitch Eligible Asset.
Notwithstanding the foregoing, an asset will not be considered a Fitch
Eligible Asset to the extent that it has been irrevocably deposited for the
payment of (i)(A) through (i)(E) under the definition of Preferred Shares 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 Fitch has indicated to the Trust will not affect the status of such asset
as a Fitch 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 Trust by its investment manager or
portfolio manager, the Trust's custodian, transfer agent or registrar or the
Auction Agent and (D) Liens arising by virtue of any repurchase agreement.
Portfolio holdings as described above must be within the following
diversification and issue size requirements in order to be included in Fitch
Eligible Assets:
Security Rated Maximum Single Maximum Single Minimum Issue Size
At Least Issuer(1) Industry(1),(2) ($ in millions)(3)
AAA 100% 100% $ 100
AA- 20% 75% 100
A- 10% 50% 100
BBB- 6% 25% 100
BB- 4% 16% 50
B- 3% 12% 50
CCC or Below 2% 8% 50
(1) Percentages represent a portion of the aggregate market value of
Corporate Debt Securities.
(2) Industries are determined according to Fitch Industry Classifications, as
defined herein.
(3) Preferred stock has a minimum issue size of $50 million.
(tt) "Fitch Hedging Transaction" shall have the meaning specified in
paragraph 10(b)(i) of Part I of this Section 12.1.
(uu) "Fitch Industry Classification" means, for the purposes of
determining Fitch Eligible Assets, each of the following industry
classifications:
C-16
1. Aerospace & Defense
2. Automobiles
3. Banking, Finance & Real Estate
4. Broadcasting & Media
5. Building & Materials
6. Cable
7. Chemicals
8. Computers & Electronics
9. Consumer Products
10. Energy
11. Environmental Services
12. Farming & Agriculture
13. Food, Beverage & Tobacco
14. Gaming, Lodging & Restaurants
15. Healthcare & Pharmaceuticals
16. Industrial/Manufacturing
17. Insurance
18. Leisure & Entertainment
19. Metals & Mining
20. Miscellaneous
21. Paper & Forest Products
22. Retail
23. Sovereign
24. Supermarkets & Drugstores
25. Telecommunications
26. Textiles & Furniture
27. Transportation
28. Utilities
The Trust shall use its discretion in determining which industry
classification is applicable to a particular investment.
(vv) "Fitch Loan Category" means the following four categories (and,
for purposes of this categorization, the Market Value of a Fitch Eligible
Asset trading at par is equal to $1.00):
(i) "Fitch Loan Category A" means Performing Bank Loans which have a
Market Value or an Approved Price greater than or equal to $0.90.
(ii) "Fitch Loan Category B" means: (A) Performing Bank 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 Bank Loans which have a Market
Value or an Approved Price greater than or equal to $0.85.
C-17
(iii) "Fitch Loan Category C" means: (A) Performing Bank Loans which
have a Market Value or an Approved Price of greater than or equal to $0.70
but less than $0.80; (B) non-Performing Bank Loans which have a Market
Value or an Approved Price of greater than or equal to $0.75 but less than
$0.85; and (C) Performing Bank Loans without an Approved Price rated BB- or
higher by Fitch. If a security is not rated by Fitch but is rated by two
other Rating Agencies, then the lower of the ratings on the security from
the two other Rating Agencies will be used to determine the Fitch Discount
Factor (e.g., where the S&P rating is A- and the Moody's rating is Baa1, a
Fitch rating of BBB+ will be used). If a security is not rated by Fitch but
is rated by only one other Rating Agency, then the rating on the security
from the other Rating Agency will be used to determine the Fitch Discount
Factor (e.g., where the only rating on a security is an S&P rating of AAA,
a Fitch rating of AAA will be used, and where the only rating on a security
is a Moody's rating of Ba3, a Fitch rating of BB- will be used).
(iv) "Fitch Loan Category D" means Bank Loans not described in any of
the foregoing categories.
Notwithstanding any other provision contained above, for purposes of
determining whether a Fitch Eligible Asset falls within a specific Fitch Loan
Category, to the extent that any Fitch Eligible Asset would fall within more
than one of the Fitch Loan Categories, such Fitch Eligible Asset shall be deemed
to fall into the Fitch Loan Category with the lowest applicable Fitch Discount
Factor.
(ww) "Foreign Bonds" shall have the meaning set forth in paragraph
(iv) of the definition of "Fitch Eligible Assets."
(xx) "Forward Commitments" shall have the meaning specified in
paragraph 10(a)(iv) of Part I of this Section 12.1.
(yy) "GNMA" shall have the meaning set forth in paragraph (vii) of
the definition of "Moody's Eligible Assets" below.
(zz) "Holder," with respect to shares of a series of Preferred Shares,
shall mean the registered holder of such shares as the same appears on the
record books of the Trust.
(aaa) "Hold Order" and "Hold Orders" shall have the respective
meanings specified in paragraph 1(a) of Part II of this Section 12.1.
(bbb) "Independent Accountant" shall mean a nationally recognized
accountant, or firm of accountants, retained by the Trust that is with
respect to the Trust an independent public accountant or firm of independent
public accountants under the Securities Act.
(ccc) "Initial Rate Period," with respect to Series M, shall be the
period from and including the Date of Original Issue thereof to but excluding
_________, ____; with respect to Series T, shall be the period from and
including the Date of Original Issue thereof to but excluding _________,
____; with respect to Series W, shall be the period from and
C-18
including the Date of Original Issue thereof to but excluding _________,
____; with respect to Series TH, shall be the period from and including the
Date of Original Issue thereof to but excluding _________, ____; and with
respect to Series F, shall be the period from and including the Date of
Original Issue thereof to but excluding _________, ____.
(ddd) "Late Charge" shall have the meaning specified in paragraph
2(e)(i)(B) of Part I of this Section 12.1.
(eee) "Lead Broker-Dealer" shall mean a Broker-Dealer designated as
the "lead" Broker-Dealer by the Trust from time to time in its discretion.
Initially, the Lead Broker-Dealer shall be Merrill Lynch, Pierce, Fenner &
Smith Incorporated.
(fff) "LIBOR Dealers" means Merrill Lynch, Pierce, Fenner & Smith
Incorporated and such other dealer or dealers as the Trust may from time to
time appoint, or, in lieu of any thereof, their respective affiliates or
successors.
(ggg) "LIBOR Determination Date" shall have the meaning set forth in
the definition of "LIBOR Rate."
(hhh) "LIBOR Rate" on any Auction Date, means (i) the rate for
deposits in U.S. dollars for the designated Rate Period (as described
below), which appears on display page 3750 of Moneyline's Telerate Service
("Telerate Page 3750") (or such other page as may replace the page on that
service, or such other service as may be selected by the LIBOR Dealer or its
successors that are LIBOR Dealers) as of 11:00 a.m., London time, on the day
that is the London Business Day preceding the Auction Date (the "LIBOR
Determination Date"), or (ii) if such rate does not appear on Telerate Page
3750 or such other page as may replace such Telerate Page 3750, (A) the LIBOR
Dealer shall determine the arithmetic mean of the offered quotations of the
Reference Banks to leading banks in the London interbank market for deposits
in U.S. dollars for the designated Rate Period (as described below) in an
amount determined by such LIBOR Dealer by reference to requests for
quotations as of approximately 11:00 a.m. (London time) on such date made by
such LIBOR Dealer to the Reference Banks, (B) if at least two of the
Reference Banks provide such quotations, LIBOR Rate shall equal such
arithmetic mean of such quotations, and (C) if only one or none of the
Reference Banks provides such quotations, LIBOR Rate shall be deemed to be
the arithmetic mean of the offered quotations that leading banks in The City
of New York selected by the LIBOR Dealer (after obtaining the Trust's
approval) are quoting on the relevant LIBOR Determination Date for deposits
in U.S. dollars for the designated Rate Period (as described below) in an
amount determined by the LIBOR Dealer (after obtaining the Trust's approval)
that is representative of a single transaction in such market at such time by
reference to the principal London offices of leading banks in the London
interbank market; provided, however, that if one of the LIBOR Dealers does
not quote a rate required to determine the LIBOR Rate, the LIBOR Rate will be
determined on the basis of the quotation or quotations furnished by any
Substitute LIBOR Dealer or Substitute LIBOR Dealers selected by the Trust to
provide such rate or rates not being supplied by the LIBOR Dealer; provided,
further, that if the LIBOR and Substitute LIBOR Dealers are required but
C-19
unable to determine a rate in accordance with at least one of the procedures
provided above, LIBOR Rate shall be LIBOR Rate as determined on the previous
Auction Date. If the number of Rate Period days shall be (i) 7 or more
but fewer than 21 days, such rate shall be the seven-day LIBOR rate; (ii)
more than 21 but fewer than 49 days, such rate shall be the one-month LIBOR
rate; (iii) 49 or more but fewer than 77 days, such rate shall be the
two-month LIBOR rate; (iv) 77 or more but fewer than 112 days, such rate
shall be the three-month LIBOR rate; (v) 112 or more but fewer than 140 days,
such rate shall be the four-month LIBOR rate; (vi) 140 or more but fewer than
168 days, such rate shall be the five-month LIBOR rate; (vii) 168 or more but
fewer than 189 days, such rate shall be the six-month LIBOR rate; (viii) 189
or more but fewer than 217 days, such rate shall be the seven-month LIBOR
rate; (ix) 217 or more but fewer than 252 days, such rate shall be the
eight-month LIBOR rate; (x) 252 or more but fewer than 287 days, such rate
shall be the nine-month LIBOR rate; (xi) 287 or more but fewer than 315 days,
such rate shall be the ten-month LIBOR rate; (xii) 315 or more but fewer than
343 days, such rate shall be the eleven-month LIBOR rate; and (xiii) 343 or
more but fewer than 365 days, such rate shall be the twelve-month LIBOR rate.
(iii) "Lien" shall mean any material lien, mortgage, pledge, security
interest or security agreement of any kind, but shall not include assets
segregated on the Trust's books for regulatory or other reasons.
(jjj) "Liquidation Preference," with respect to a given number of
Preferred Shares, means $25,000 times that number.
(kkk) "London Business Day" means any day on which commercial banks
are generally open for business in London.
(lll) "Market Value" of any asset of the Trust shall be the market
value thereof determined by any pricing service designated by the Trust and
approved by Moody's and Fitch, if Moody's and Fitch are then rating the
Preferred Shares, and from any Substitute Rating Agency then rating the
Preferred Shares (the "Pricing Service"). Market Value of any asset shall
include any interest accrued thereon. The Pricing Service shall value
portfolio property at the lower of the quoted bid price and the mean between
the quoted bid and ask price or the yield equivalent when quotations are
readily available. Securities and other property for which quotations are not
readily available shall be valued at fair value as determined by the 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. The
Pricing Service may employ electronic data processing techniques and/or a
matrix system to determine valuations. If the Pricing Service fails to
provide the Market Value of any securities, such securities shall be valued
at the lower of two bid quotations (at least one of which shall be in
writing) obtained by the Trust from two dealers who are members of the
National Association of Securities Dealers, Inc. and are making a market in
such securities. If two bid quotations are not readily available for any
securities, such securities shall be valued at fair value on a consistent
basis using methods determined in good faith by the Trustees.
C-20
Futures contracts and options are valued at 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 as determined by the Pricing Service or, if the Pricing Service is not
able to value such instruments, shall be valued at fair value on a consistent
basis using methods determined in good faith 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.
(mmm) "Maximum Rate" means, on any date on which the Applicable Rate
is determined, the greater of the Applicable Percentage of the Reference Rate
on such date or the Applicable Spread plus the Reference Rate on such date.
(nnn) "Minimum Rate Period" shall mean any Rate Period consisting of 7
Rate Period Days.
(ooo) "Moody's" shall mean Moody's Investors Service, Inc., a Delaware
corporation, and its successors.
(ppp) "Moody's Discount Factor" shall mean, for purposes of
determining the Discounted Value of any Moody's Eligible Asset, the
percentage determined as follows. The Moody's Discount Factor for any Moody's
Eligible Asset other than the securities set forth below will be the
percentage provided in writing by Moody's.
(i) Corporate debt securities: 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(2) 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 the Trust's assets can be
derived from other sources, securities rated below B by Moody's and unrated
securities, which are securities rated by neither Moody's, S&P nor Fitch,
are limited to 10% of Moody's Eligible Assets. If a corporate debt security
is unrated by Moody's, S&P or Fitch, the Trust will use the percentage set
forth under "Unrated" in this table. Ratings assigned by S&P or Fitch are
generally accepted by Moody's at face value. However, adjustments to face
value may be made to
C-21
particular categories of credits for which the S&P and/or Fitch rating does
not seem to approximate a Moody's rating equivalent. Split rated securities
assigned by S&P and Fitch will be accepted at the lower of the two ratings.
(2) The Moody's Discount Factors for corporate debt securities shall also
be applied to any interest rate swap or cap, in which case the rating of
the counterparty shall determine the appropriate rating category.
For corporate debt securities that do not pay interest in U.S. dollars,
the Trust will contact Moody's to obtain the applicable currency conversion
rates.
The Moody's Discount Factors presented in the immediately preceding
table will also apply to Moody's rated credit baskets (e.g., 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.
(ii) Preferred stock(1): The Moody's Discount Factor for
taxable preferred stock shall be:
Aaa 150%
Aa 155%
A 160%
Baa 165%
Ba 196%
B 216%
Less than B or Not Rated 250%
(1) Rule 144A securities' Moody's Discount Factor will be increased by an
additional 20%.
Because of the size of the DRD market, DRDs will be assigned a different
Moody's Discount Factor to reflect their liquidity. Investment grade DRDs
will be assigned a 165% Moody's Discount Factor and non-investment grade DRDs
will be assigned a 216% Moody's Discount Factor.
(iii) Convertible securities (including convertible
preferreds): The Moody's Discount Factor for convertible securities
(including convertible preferreds) shall be:
Moody's Discount Factors(1)
-------------------------------------------------------------
Ratings(2) 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%
NR 300% 300% 300% 300%
(1) Discount factors are for 7-week exposure period.
C-22
(2) Unless conclusions regarding liquidity risk as well as estimates of
both the probability and severity of default for the corporation's assets
can be derived from other sources, securities rated below B by Moody's and
unrated securities, which are securities rated by neither Moody's, S&P nor
Fitch, are limited to 10% of Moody's Eligible Assets. If a convertible
corporate debt security is unrated by Moody's, S&P or Fitch, the Trust will
use the percentage set forth under "NR" in this table. Ratings assigned by
S&P or Fitch are generally accepted by Moody's 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. Split rated securities assigned by S&P and Fitch
will be accepted at the lower of the two ratings.
(iv) Short-term instruments: The Moody's Discount Factor applied
to short-term portfolio securities, including without limitation corporate
debt securities, Short Term Money Market Instruments and municipal debt
obligations, will be (A) 100%, so long as such portfolio securities mature
or have a demand feature at par exercisable within the Exposure Period; (B)
115%, so long as such portfolio securities mature or have a demand feature
at par not exercisable within the 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 an equivalent rating by
Fitch and mature or have a demand feature at par exercisable within the
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
Moody's Discount Factor for U.S. Government securities and U.S. Treasury
strips shall be:
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 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.
(vii) Bank Loans: The Moody's Discount Factor applied to senior
Bank Loans ("Senior Loans") shall be the percentage specified in
accordance with the table set forth below (or such lower percentage as
Moody's may approve in writing from time to time):
:
C-23
Moody's Rating Category
-----------------------
Baa and Caa and below (including
Type of Loan Aaa-A Ba(1) B(1) distressed and unrated) (1)
------------ ----- ----- ---- ---------------------------
Senior Loans greater 118% 136% 149% 250%
than $250 MM
non-Senior Loans greater 128% 146% 159% 250%
than $250 MM
loans less than $250MM 138% 156% 169% 270%
(1) If a Senior Loan is not rated by any of Moody's, S&P or Fitch Ratings,
the Fund will use the applicable percentage set forth under the column entitled
"Caa and below (including distressed and unrated)" in the table above. Ratings
assigned by S&P and/or Fitch are generally accepted by Moody's at face value.
However, adjustments to face value may be made to particular categories of
securities for which the ratings by S&P and/or Fitch do not seem to approximate
a Moody's rating equivalent. Split-rated securities assigned by S&P and Fitch
(i.e. these rating agencies assign different rating categories to the security)
will be accepted at the lower of the two ratings, provided however, that, in a
situation where a security is rated "B" (or equivalent) by a given rating agency
and rated "CCC" (or equivalent) by another rating agency, the Fund will use the
applicable percentage set forth under the column entitled "B" in the table
above.
(viii) Asset-backed securities: The Moody's Discount Factor applied
to asset-backed securities shall be 131%.
(ix) Mortgage-backed securities: 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 in accordance with
the table set forth below.
Remaining Term to Maturity Discount Factors
-------------------------- ----------------
3 years or less 133%
7 years or less (but longer than 3 years) 142%
10 years or less (but longer than 7 years) 158%
20 years or less (but longer than 10 years) 174%
Greater than 20 years 205%
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 in accordance
with the table set forth below.
Coupon Discount Factors
------ ----------------
5% 166%
6% 162%
7% 158%
8% 154%
9% 151%
10% 148%
11% 144%
12% 142%
13% 139%
Adjustable 165%
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.
The Moody's Discount Factor applied to whole loans shall be determined
by reference to the coupon paid by such security in accordance with the
table set forth below.
C-24
Coupon Discount Factors
------ ----------------
5% 172%
6% 167%
7% 163%
8% 159%
9% 155%
10% 151%
11% 148%
12% 145%
13% 142%
Adjustable 170%
(x) 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
Exposure Period, in accordance with the table set forth below:
Exposure Period Aaa Aa A Baa MIG-1(1) MIG-1(2) Unrated(3)
--------------- --- -- - --- -------- -------- ----------
7 weeks 151% 159% 160% 173% 135% 148% 225%
8 weeks or less but 154 161 168 176 137 149 231
greater than seven
weeks
9 weeks or less but 158 163 170 177 138 150 240
greater than eight
weeks
(1) Municipal debt obligations not rated by Moody's but rated equivalent to
MIG-1, VMIG-1 or P-1 by S&P and Fitch that have a maturity less than or
equal to 49 days.
(2) Municipal debt obligations not rated by Moody's but rated equivalent to
MIG-1, VMIG-1 or P-1 by S&P and Fitch that have a maturity greater than 49
days.
(3) Unless conclusions regarding liquidity risk as well as estimates of
both the probability and severity of default for the municipal issuer's
assets can be derived from other sources, securities rated below Baa by
Moody's and unrated securities, which are securities rated by neither
Moody's, S&P nor Fitch, are limited to 10% of Moody's Eligible Assets. If a
municipal debt security is unrated by Moody's, S&P or Fitch, the Trust will
use the percentage set forth under "Unrated" in the Municipal Debt Table.
Ratings assigned by S&P or Fitch are generally accepted by Moody's 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. Split rated securities assigned
by S&P and Fitch will be accepted at the lower of the two ratings.
(xi) 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 (i) 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 (i); and
C-25
(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.
(qqq) "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 otherwise within the 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 with respect to which the Trust
has received prior written authorization from Moody's 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 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 need not meet any otherwise applicable Moody's rating
criteria;
(iii) U.S. Government Securities and U.S. Treasury Strips;
(iv) Rule 144A Securities;
(v) Performing 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 or 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 Moody's 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 or are restricted
as to resale under federal securities laws but are eligible for resale
pursuant to Rule 144A under the Securities Act as determined by the Trust's
investment manager or portfolio
C-26
manager, 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 Trust) 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 neither Moody's nor S&P nor 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.
Preferred stocks if (A) dividends on such preferred stocks 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 issuers of such preferred stocks have common stock
listed on either the New York Stock Exchange or the American Stock
Exchange, (D) the issuers of such preferred stocks have 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 stocks have paid
consistent cash dividends in U.S. dollars or euros over the last three
years or have a minimum rating of A1 (if the issuer of such a 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). 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 Trust 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;
(vii) 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
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by the Trust 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
Trust (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 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
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servicing agreements creating such certificates, and (4) pools have been
rated Aa or better by Moody's;
(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) neither are currently delinquent (30 days
or more) nor were 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
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;
(viii) 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
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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 $10,000,000;
(ix) Structured Notes and Moody's rated credit baskets (e.g.,
TRACERs);
(x) Financial contracts, as such term is defined in Section
3(c)(2)(B)(ii) of the 1940 Act, not otherwise provided for in this
definition but only upon receipt by the Trust of a letter from Moody's
specifying any conditions on including such financial contract in Moody's
Eligible Assets and assuring the Trust that including such financial
contract in the manner so specified would not affect the credit rating
assigned by Moody's to the Preferred Shares; and
(xi) Any other security or instrument approved by Moody's.
In addition, portfolio holdings as described above must be within the
following diversification and issue size requirements in order to be included in
Moody's Eligible Assets:
Maximum Single Maximum Single Minimum Issue Size
Ratings(1) Issuer (2),(3) Industry (3),(4) ($ in millions) (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.
(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 Trust's total assets.
Where the Trust 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 Trust is required to pay upon repurchase of such asset
will count as a liability for the purposes of the Preferred Shares Basic
Maintenance Amount. Where the Trust purchases an asset and agrees to sell it to
a third party in the future, cash receivable by the Trust 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 and the call price of such
portfolio securities.
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Notwithstanding the foregoing, an asset will not be considered a Moody's
Eligible Asset to the extent that it has been irrevocably deposited for the
payment of (i)(A) through (i)(E) under the definition of Preferred Shares 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 Trust 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 Trust by its investment
manager or portfolio manager, the Trust's custodian, transfer agent or registrar
or the Auction Agent, (D) Liens arising by virtue of any repurchase agreement
and (E) Liens created by virtue of the Trust's investment activity.
(rrr) "Moody's Hedging Transaction" shall have the meaning specified
in paragraph 10(a)(i) of Part I of this Section 12.1.
(sss) "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 Preferred Shares):
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
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
C-31
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
C-32
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
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 Trust will use its discretion in determining which industry classification
is applicable to a particular investment in consultation with the Independent
Accountant and Moody's, to the extent the Trust considers necessary.
(ttt) "1940 Act" shall mean the Investment Company Act of 1940, as
amended from time to time.
(uuu) "1940 Act Cure Date," with respect to the failure by the Trust
to maintain the 1940 Act Preferred Shares Asset Coverage (as required by
paragraph 5 of Part I of this Section 12.1) as of the last Business Day of
each month, shall mean the last Business Day of the following month.
(vvv) "1940 Act Preferred Shares Asset Coverage" shall mean asset
coverage, as defined in Section 18(h) of the 1940 Act, of at least 200% with
respect to all outstanding senior securities of the Trust which are shares of
beneficial interest, including all
C-33
outstanding Preferred Shares (or such other asset coverage as may in the
future be specified in or under the 1940 Act as the minimum asset coverage
for senior securities which are shares or stock of a closed-end investment
company as a condition of declaring dividends on its common shares or stock).
(www) "Notice of Redemption" shall mean any notice with respect to the
redemption of Preferred Shares pursuant to paragraph 8(c) of Part I of this
Section 12.1.
(xxx) "Notice of Special Rate Period" shall mean any notice with
respect to a Special Rate Period of Preferred Shares pursuant to paragraph
3(d)(i) of Part I of this Section 12.1.
(yyy) "Order" and "Orders" shall have the respective meanings
specified in paragraph 1(a) of Part II of this Section 12.1.
(zzz) "Outstanding" shall mean, as of any Auction Date with respect to
shares of a series of Preferred Shares, the number of shares of such series
theretofore issued by the Trust except, without duplication, (i) any shares
of such series theretofore cancelled or delivered to the Auction Agent for
cancellation or redeemed by the Trust as provided in paragraph 8(f) of Part I
of this Section 12.1, (ii) any shares of such series as to which the Trust or
any Affiliate thereof shall be an Existing Holder and (iii) any shares of
such series represented by any certificate in lieu of which a new certificate
has been executed and delivered by the Trust.
(aaaa) "PACs" shall have the meaning set forth in paragraph (vii) of
the definition of "Moody's Eligible Assets" above.
(bbbb) "Performing" shall mean, 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.
(cccc) "Person" shall mean and include an individual, a partnership, a
corporation, a trust, an unincorporated association, a joint venture or other
entity or a government or any agency or political subdivision thereof.
(dddd) "Potential Beneficial Owner," with respect to shares of a
series of Preferred Shares, shall mean a customer of a Broker-Dealer that is
not a Beneficial Owner of shares of such series but that wishes to purchase
shares of such series, or that is a Beneficial Owner of shares of such series
that wishes to purchase additional shares of such series.
(eeee) "Potential Holder," with respect to shares of a series of
Preferred Shares, shall mean a Broker-Dealer (or any such other person as may
be permitted by the Trust) that is not an Existing Holder of shares of such
series or that is an Existing Holder of shares of such series that wishes to
become the Existing Holder of additional shares of such series.
C-34
(ffff) "Preferred Shares" shall have the meaning set forth under
"DESIGNATION" above.
(gggg) "Preferred Shares Basic Maintenance Amount," as of any
Valuation Date, shall mean the dollar amount equal to the sum of: (i)(A) the
product of the number of Preferred Shares outstanding on such date multiplied
by $25,000 (plus the product of the number of shares of any other series of
preferred shares outstanding on such date multiplied by the liquidation
preference of such shares), plus any redemption premium applicable to the
Preferred Shares (or other preferred shares) 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 the Preferred
Shares 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 Preferred Shares outstanding from such
first respective Dividend Payment Date therefor through the 49th day after
such Valuation Date, at the Maximum 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 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 pursuant to clause (B) that
are also included in the period described in clause (C), the dividend for
purposes of calculation would accumulate at the Applicable Rate in effect for
purposes of clause (B) in respect of those days); (D) the amount of
anticipated expenses of the Trust for the 90 days subsequent to such
Valuation Date; (E) the amount of any indebtedness or obligations of the
Trust senior in right of payment to the Preferred Shares; and (F) any current
liabilities as of such Valuation Date to the extent not reflected in any of
(i)(A) through (i)(E) (including, without limitation, any payables for
portfolio securities of the Trust purchased as of such Valuation Date and any
liabilities incurred for the purpose of clearing securities transactions);
less (ii) the value (i.e., for purposes of current Fitch and Moody's
guidelines, the face value of cash, short-term securities rated, in the case
of Fitch, F1 by Fitch or the equivalent by another Rating Agency, or, in the
case of Moody's, MIG-1, VMIG-1 or P-1 by Moody's, 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)(F) become payable, otherwise the Discounted Value) of any of the
Trust's assets irrevocably deposited by the Trust for the payment of any of
(i)(A) through (i)(F).
(hhhh) "Preferred Shares Basic Maintenance Cure Date," with respect to
the failure by the Trust to satisfy the Preferred Shares Basic Maintenance
Amount (as required by paragraph 6(a) of Part I of this Section 12.1) as of a
given Valuation Date, shall mean the seventh Business Day following such
Valuation Date.
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(iiii) "Preferred Shares Basic Maintenance Report" shall mean a report
signed by the President, Treasurer or any Senior Vice President or Vice
President of the Trust which sets forth, as of the related Valuation Date,
the assets of the Trust, the Market Value and the Discounted Value thereof
(seriatim and in aggregate), and the Preferred Shares Basic Maintenance
Amount.
(jjjj) "Pricing Service" shall have the meaning specified in the
definition of "Market Value" above.
(kkkk) "Quarterly Valuation Date" shall mean the last Friday of the
last month of each fiscal quarter of the Trust in each fiscal year of the
Trust, commencing on December 26, 2003, provided that if such day is not a
Business Day, then the immediately preceding Business Day.
(llll) "Rate Period," with respect to shares of a series of Preferred
Shares, shall mean each of the Initial Rate Period of shares of such series
and any Subsequent Rate Period, including any Special Rate Period, of shares
of such series.
(mmmm) "Rate Period Days," for any Rate Period or Dividend Period,
means the number of days that would constitute such Rate Period or Dividend
Period but for the application of paragraph 2(d) of Part I of this Section
12.1.
(nnnn) "Rating Agency" means a nationally recognized statistical
rating organization.
(oooo) "Redemption Price" shall mean the applicable redemption price
specified in paragraph 8(a) or paragraph 8(b), as the case may be, of Part I
of this Section 12.1.
(pppp) "Reference Banks" means four major banks in the London
interbank market selected by Merrill Lynch, Pierce, Fenner & Smith
Incorporated or its affiliates or successors or such other party as the Trust
may from time to time appoint.
(qqqq) "Reference Rate" means the applicable LIBOR Rate (for a
Rate Period of fewer than 365 days) or the applicable Treasury Index Rate
(for a Rate Period of 365 days or more).
(rrrr) "Reorganization Bonds" shall have the meaning set forth under
paragraph (iv) of the definition of "Fitch Eligible Assets."
(ssss) "Rule 144A Securities" shall mean securities which are
restricted as to resale under federal securities laws but are eligible for
resale pursuant to Rule 144A under the Securities Act as determined by the
Trust's investment manager or portfolio manager.
(tttt) "S&P" shall mean Standard & Poor's Rating Group and its
successors.
C-36
(uuuu) "Securities Act" shall mean the Securities Act of 1933, as
amended from time to time.
(vvvv) "Securities Depository" shall mean The Depository Trust Company
and its successors and assigns or any other securities depository selected by
the Trust which agrees to follow the procedures required to be followed by
such securities depository in connection with the Preferred Shares.
(wwww) "Sell Order" and "Sell Orders" shall have the respective
meanings specified in paragraph 1(a) of Part II of this Section 12.1.
(xxxx) "Senior Loans" shall have the meaning set forth in paragraph
(vi) of the definitions of "Moody's Discount Factor."
(yyyy) "Series F" shall mean the Series F Taxable Auction Market
Preferred Shares.
(zzzz) "Series M" shall mean the Series M Taxable Auction Market
Preferred Shares.
(aaaaa) "Series T" shall mean the Series T Taxable Auction Market
Preferred Shares.
(bbbbb) "Series TH" shall mean the Series TH Taxable Auction Market
Preferred Shares.
(ccccc) "Series W" shall mean the Series W Taxable Auction Market
Preferred Shares.
(ddddd) "Short Term Money Market Instruments" shall mean the following
types of instruments if, on the date of purchase or other acquisition thereof
by the Trust, 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 F1 by Fitch or A-1 by S&P if such
commercial paper matures in 30 days or P-1 by Moody's and either F1+ 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;
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(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 have (1) credit ratings on each Valuation Date of at least
P-1 from Moody's and either F1+ 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 Trust, 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 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, F1+ by Fitch or A-1+ by S&P and
there is no long-term rating, and (3) the holding company of such
depository institution or trust company shall meet all of the foregoing
credit rating requirements (including the preceding proviso in the case of
investments that mature in no more than one Business Day from the date of
purchase or other acquisition by the Trust); and provided further that the
interest receivable by the Trust shall not be subject to any withholding or
similar taxes.
(eeeee) "Special Rate Period," with respect to shares of a series of
Preferred Shares, shall have the meaning specified in paragraph 3(a) of Part
I of this Section 12.1.
(fffff) "Special Redemption Provisions" shall have the meaning
specified in paragraph 8(a)(i) of Part I of this Section 12.1.
(ggggg) "Structured Notes" shall mean 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.
(hhhhh) "Submission Deadline" shall mean 1:30 P.M., New York City
time, on any Auction Date or such other time on any Auction Date by which
Broker-Dealers are required to submit Orders to the Auction Agent as
specified by the Auction Agent from time to time.
(iiiii) "Submitted Bid" and "Submitted Bids" shall have the respective
meanings specified in paragraph 3(a) of Part II of this Section 12.1.
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(jjjjj) "Submitted Hold Order" and "Submitted Hold Orders" shall have
the respective meanings specified in paragraph 3(a) of Part II of this
Section 12.1.
(kkkkk) "Submitted Order" and "Submitted Orders" shall have the
respective meanings specified in paragraph 3(a) of Part II of this Section
12.1.
(lllll) "Submitted Sell Order" and "Submitted Sell Orders" shall have
the respective meanings specified in paragraph 3(a) of Part II of this
Section 12.1.
(mmmmm) "Subsequent Rate Period," with respect to shares of a series
of Preferred Shares, shall mean the period from and including the first day
following the Initial Rate Period of shares of such series to but excluding
the next Dividend Payment Date for shares of such series and any period
thereafter from and including one Dividend Payment Date for shares of such
series to but excluding the next succeeding Dividend Payment Date for shares
of such series; provided, however, that if any Subsequent Rate Period is also
a Special Rate Period, such term shall mean the period commencing on the
first day of such Special Rate Period and ending on the last day of the last
Dividend Period thereof.
(nnnnn) "Substitute LIBOR Dealers" means LIBOR Dealers appointed by
the Trust from time to time to act as substitute LIBOR Dealers.
(ooooo) "Substitute Rating Agency" means a Rating Agency selected by
the Trust to act as the substitute Rating Agency to determine the credit
ratings of the Preferred Shares.
(ppppp) "Sufficient Clearing Bids" shall have the meaning specified in
paragraph 3(a) of Part II of this Section 12.1.
(qqqqq) "TACs" shall have the meaning set forth in paragraph (vii) of
the definition of "Moody's Eligible Assets."
(rrrrr) "Telerate Page 3750" shall have the meanings set forth in the
definition of "LIBOR Rate."
(sssss) "Total Managed Assets" shall have the meaning specified in
paragraph 10(c) of Part I of this Section 12.1.
(ttttt) "Tradable Credit Baskets" shall mean Traded Custody Receipts
(TRACERs), which are traded custody receipts representing direct ownership in
a portfolio of underlying securities, and Targeted Return Index Securities
Trusts (TRAINS).
(uuuuu) "Treasury Bill" shall mean a direct obligation of the U.S.
Government having a maturity at the time of issuance of 364 days or less.
(vvvvv) "Treasury Bonds" shall mean United States Treasury Bonds or
Notes.
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(wwwww) "Treasury Futures" shall mean futures and related options on
Treasury Bills, Treasury Bonds and/or Treasury Notes.
(xxxxx) "Treasury Index Rate" shall mean 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 applicable
Rate 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 Rate 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, then the
foregoing computations shall be based upon the average of comparable data as
quoted to the Trust by at least three U.S. Government Securities Dealers.
(yyyyy) "Treasury Note" shall mean a direct obligation of the U.S.
Government having a maturity at the time of issuance of five years or less
but more than 364 days.
(zzzzz) "Trust" shall mean Western Asset/Claymore U.S. Treasury
Inflation Protected Securities Fund.
(aaaaaa) "Trustees" shall mean the trustees of the Trust.
(bbbbbb) "U.S. Government Securities" shall mean 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, and which for the
avoidance of doubt shall include U.S. Treasury Inflation Protected
Securities.
(cccccc) "U.S. Government Securities Dealer" shall mean Lehman
Government Securities Incorporated, Goldman, Sachs & Co., Salomon Brothers
Inc., Morgan Guaranty Trust Company of New York and any other recognized
dealer in U.S. Government Securities selected by the Trust as to which
Moody's (if Moody's is then rating the Preferred Shares) or Fitch (if Fitch
is then rating the Preferred Shares) shall not have objected, and in each
case their respective affiliates or successors, if such entity is a
recognized dealer in U.S. Government Securities.
(dddddd) "U.S. Treasury Securities" shall mean direct obligations of
the United States Treasury that are entitled to the full faith and credit of
the United States.
(eeeeee) "U.S. Treasury Strips" shall mean securities based on U.S.
Treasury Securities created through the Separate Trading of Registered
Interest and Principal of Securities program of the U.S. Treasury.
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(ffffff) "Valuation Date" shall mean, for purposes of determining
whether the Trust is maintaining the Preferred Shares Basic Maintenance
Amount, the last Business Day of each week.
(gggggg) "Volatility Factor" shall mean 1.6.
(hhhhhh) "Voting Period" shall have the meaning specified in paragraph
4(b)(i) of Part I of this Section 12.1.
(iiiiii) "Winning Bid Rate" shall have the meaning specified in
paragraph 3(a) of Part II of this Section 12.1.
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PART I.
1. Number of Authorized Shares.
The number of authorized shares constituting Series M shall be 1,640
shares, the number of authorized shares constituting Series T shall be 1,640
shares, the number of authorized shares constituting Series W shall be 1,640
shares, the number of authorized shares constituting Series TH shall be 1,640
shares, and the number of authorized shares constituting Series F shall be 1,640
shares.
2. Dividends.
(a) Ranking. The shares of a series of the Preferred Shares shall
rank on a parity with each other, with shares of any other series of the
Preferred Shares and with shares of any other series of preferred shares as
to the payment of dividends by the Trust and the distribution of assets
upon liquidation of the Trust.
(b) Cumulative Cash Dividends. The Holders of shares of any series
of Preferred Shares shall be entitled to receive, when, as and if declared
by the Trustees, out of funds legally available therefor in accordance with
the Declaration of Trust and applicable law, cumulative cash dividends at
the Applicable Rate for shares of such series, determined as set forth in
paragraph 2(e) of this Part I, and no more, payable on the Dividend Payment
Dates with respect to shares of such series determined pursuant to
paragraph 2(d) of this Part I. Holders of Preferred Shares shall not be
entitled to any dividend, whether payable in cash, property or shares, in
excess of full cumulative dividends, as herein provided, on Preferred
Shares. No interest, or sum of money in lieu of interest, shall be payable
in respect of any dividend payment or payments on Preferred Shares which
may be in arrears, and, except to the extent set forth in paragraph 2(e)(i)
of this Part I, no additional sum of money shall be payable in respect of
any such arrearage.
(c) Dividends Cumulative from Date of Original Issue. Dividends on
shares of any series of Preferred Shares shall accumulate at the Applicable
Rate for shares of such series from the Date of Original Issue thereof.
(d) Dividend Payment Dates and Adjustment Thereof. Dividends shall
be payable on shares of Series M for the Initial Rate Period on _________,
____, and on each 7th day thereafter, on shares of Series T for the Initial
Rate Period on ________, ____, and on each 7th day thereafter, on shares of
Series W for the Initial Rate Period on __________, ____, and on each 7th
day thereafter, on shares of Series TH for the Initial Rate Period on
________, ____, and on each 7th day thereafter, and on shares of Series F
for the Initial Rate Period on _________, ____, and on each 7th day
thereafter (each date being a "Dividend Payment Date"); provided, however,
that:
(i) if the day on which dividends would otherwise be payable
on shares of such series is not a Business Day, then such dividends
shall be payable on such shares on the first Business Day that falls
after such day; and
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(ii) notwithstanding this paragraph 2(d), the Trust in its
discretion may establish the Dividend Payment Dates in respect of any
Special Rate Period of shares of a series of Preferred Shares
consisting of more than 7 Rate Period Days; provided, however, that
such dates shall be set forth in the Notice of Special Rate Period
relating to such Special Rate Period, as delivered to the Auction
Agent, which Notice of Special Rate Period shall be filed with the
Secretary of the Trust; and further provided that (1) any such
Dividend Payment Date shall be a Business Day when determined (and if
not a Business Day at the time of payment, the provisions of clause
(i) above will apply) and (2) the last Dividend Payment Date in
respect of such Special Rate Period shall be the Business Day
immediately following the last day thereof; and
(iii) notwithstanding the above, if for any reason a Dividend
Period for a series of Preferred Shares is scheduled to begin on the
same day and end on the same day as a Dividend Period for another
series of Preferred Shares, then the last day of such Dividend Period
for the series of Preferred Shares designated by the Trust shall be
the second Business Day next succeeding such scheduled day unless the
Trust obtains the opinion of tax counsel referred to in this
paragraph. Subject to the limitation in the next sentence, if for any
reason a Dividend Payment Date cannot be fixed as described above,
then the Trustees shall otherwise fix the Dividend Payment Date. In no
event, however, may the Dividend Period of any series of Preferred
Shares be co-extensive with any Dividend Period of any other series of
Preferred Shares unless the Trust 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 Preferred Shares.
(e) Dividend Rates and Calculation of Dividends.
(i) Dividend Rates. The dividend rate on Preferred Shares of
any series during the period from and after the Date of Original Issue
of shares of such series to and including the last day of the Initial
Rate Period of shares of such series shall be equal to the rate per
annum set forth with respect to shares of such series under
"DESIGNATION" above. For each Subsequent Rate Period of shares of such
series thereafter, the dividend rate on shares of such series shall be
equal to the rate per annum that results from an Auction for shares of
such series on the Auction Date next preceding such Subsequent Rate
Period; provided, however, that if:
(A) an Auction for any such Subsequent Rate Period is
not held for any reason other than as described below in
paragraphs 2(e)(i)(B)-(D) or as provided for in paragraph 5 of
Part II of this Section 12.1, the dividend rate on shares of
such series for such Subsequent Rate Period will be the Maximum
Rate for shares of such series on the Auction Date therefor;
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(B) any Failure to Deposit shall have occurred with
respect to shares of such series during any Rate Period thereof
(other than any Special Rate Period consisting of more than 364
Rate Period Days or any Rate Period succeeding any Special Rate
Period consisting of more than 364 Rate Period Days during which
a Failure to Deposit occurred that has not been cured), but,
prior to 12:00 Noon, New York City time, on the third Business
Day next succeeding the date on which such Failure to Deposit
occurred, such Failure to Deposit shall have been cured in
accordance with paragraph 2(f) of this Part I and the Trust
shall have paid to the Auction Agent a late charge ("Late
Charge") equal to the sum of (1) if such Failure to Deposit
consisted of the failure timely to pay to the Auction Agent the
full amount of dividends with respect to any Dividend Period of
the shares of such series, an amount computed by multiplying
(x) 300% of the Reference Rate for the Rate Period during which
such Failure to Deposit occurs on the Dividend Payment Date for
such Dividend Period by (y) a fraction, the numerator of which
shall be the number of days for which such Failure to Deposit
has not been cured in accordance with paragraph 2(f) of this
Part I (including the day such Failure to Deposit occurs and
excluding the day such Failure to Deposit is cured) and the
denominator of which shall be 360, and multiplying the rate
obtained by the aggregate Liquidation Preference of the
outstanding shares of such series and (2) if such Failure to
Deposit consisted of the failure timely to pay to the Auction
Agent the Redemption Price of the shares, if any, of such series
for which Notice of Redemption has been mailed by the Trust
pursuant to paragraph 8(c) of this Part I of this Section 12.1,
an amount computed by multiplying (x) 300% of the Reference Rate
for the Rate Period during which such Failure to Deposit occurs
on the redemption date by (y) a fraction, the numerator of which
shall be the number of days for which such Failure to Deposit is
not cured in accordance with paragraph 2(f) of this Part I
(including the day such Failure to Deposit occurs and excluding
the day such Failure to Deposit is cured) and the denominator of
which shall be 360, and multiplying the rate obtained by the
aggregate Liquidation Preference of the outstanding shares of
such series to be redeemed, no Auction will be held in respect
of shares of such series for the first Subsequent Rate Period
thereof thereafter and the dividend rate for shares of such
series for such Subsequent Rate Period will be the Maximum Rate
for shares of such series on the Auction Date for such
Subsequent Rate Period;
(C) any Failure to Deposit shall have occurred with
respect to shares of such series during any Rate Period thereof
(other than any Special Rate Period consisting of more than 364
Rate Period Days or any Rate Period succeeding any Special Rate
Period consisting of more than 364 Rate Period Days during which
a Failure to Deposit occurred that has not been cured), and,
prior to 12:00 Noon, New York City time, on the
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third Business Day next succeeding the date on which such
Failure to Deposit occurred, such Failure to Deposit shall not
have been cured in accordance with paragraph 2(f) of this Part I
or the Trust shall not have paid the applicable Late Charge to
the Auction Agent, no Auction will be held in respect of shares
of such series for the first Subsequent Rate Period thereof
thereafter (or for any Rate Period thereof thereafter to and
including the Rate Period during which (1) such Failure to
Deposit is cured in accordance with paragraph 2(f) of this Part
I and (2) the Trust pays the applicable Late Charge to the
Auction Agent (the condition set forth in this clause (2) to
apply only in the event Moody's or Fitch is rating such shares
at the time the Trust cures such Failure to Deposit), in each
case no later than 12:00 Noon, New York City time, on the fourth
Business Day prior to the end of such Rate Period), and the
dividend rate for shares of such series for each such Subsequent
Rate Period shall be a rate per annum equal to the Maximum Rate
for shares of such series on the Auction Date for such
Subsequent Rate Period (but with the credit rating for shares of
such series, for purposes of determining such Maximum Rate,
being deemed to be below Baa3 (if Moody's is rating the
Preferred Shares) and below BBB- (if Fitch is rating the
Preferred Shares); or
(D) any Failure to Deposit shall have occurred with
respect to shares of such series during a Special Rate Period
thereof consisting of more than 364 Rate Period Days, or during
any Rate Period thereof succeeding any Special Rate Period
consisting of more than 364 Rate Period Days during which a
Failure to Deposit occurred that has not been cured, and, prior
to 12:00 Noon, New York City time, on the fourth Business Day
preceding the Auction Date for the Rate Period subsequent to
such Rate Period, such Failure to Deposit shall not have been
cured in accordance with paragraph 2(f) of this Part I or, in
the event Moody's or Fitch is then rating such shares, the Trust
shall not have paid the applicable Late Charge to the Auction
Agent (such Late Charge, for purposes of this subparagraph (D),
to be calculated by using, as the Reference Rate, the Reference
Rate applicable to a Rate Period (x) consisting of more than 364
Rate Period Days and (y) commencing on the date on which the
Rate Period during which such Failure to Deposit occurs
commenced), no Auction will be held in respect of shares of such
series for such Subsequent Rate Period (or for any Rate Period
thereof thereafter to and including the Rate Period during which
(1) such Failure to Deposit is cured in accordance with
paragraph 2(f) of this Part I and (2) the Trust pays the
applicable Late Charge to the Auction Agent (the condition set
forth in this clause (2) to apply only in the event Moody's or
Fitch is rating such shares at the time the Trust cures such
Failure to Deposit), in each case no later than 12:00 Noon, New
York City time, on the fourth Business Day prior to the end of
such Rate Period), and the dividend rate for shares of such
series for each such Subsequent Rate Period shall be a
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rate per annum equal to the Maximum Rate for shares of such
series on the Auction Date for such Subsequent Rate Period (but
with the credit rating for shares of such series, for purposes
of determining such Maximum Rate, being deemed to be below Baa3
(if Moody's is rating the Preferred Shares) and below BBB- (if
Fitch is rating the Preferred Shares)) (the rate per annum at
which dividends are payable on shares of a series of Preferred
Shares for any Rate Period thereof in accordance with this
Section 12.1 being herein referred to as the "Applicable Rate"
for shares of such series).
(ii) Calculation of Dividends. The amount of dividends per
share payable on shares of a series of Preferred Shares on any date on
which dividends shall be payable on shares of such series shall be
computed by multiplying the Applicable Rate for shares of such series
in effect for such Dividend Period or Dividend Periods or part thereof
for which dividends have not been paid by a fraction, the numerator of
which shall be the number of days in such Dividend Period or Dividend
Periods or part thereof and the denominator of which shall be 360; and
multiplying the rate obtained by $25,000.
(f) Curing a Failure to Deposit. A Failure to Deposit with respect
to shares of a series of Preferred Shares shall have been cured with
respect to any Rate Period of shares of such series if, within the
respective time periods described in paragraph 2(e)(i) above, the Trust
shall have paid to the Auction Agent (A) all accumulated and unpaid
dividends on shares of such series and (B) without duplication, the
Redemption Price for shares, if any, of such series for which Notice of
Redemption has been mailed by the Trust pursuant to paragraph 8(c) of this
Part I of this Section 12.1; provided, however, that the foregoing clause
(B) shall not apply to the Trust's failure to pay the Redemption Price in
respect of Preferred Shares when the related Notice of Redemption provides
that redemption of such shares is subject to one or more conditions
precedent and any such condition precedent shall not have been satisfied at
the time or times and in the manner specified in such Notice of Redemption.
(g) Dividend Payments by Trust to Auction Agent. The Trust shall pay
to the Auction Agent, not later than 12:00 Noon, New York City time, on
each Dividend Payment Date for shares of a series of Preferred Shares, an
aggregate amount of funds available on such Dividend Payment Date in The
City of New York, New York, equal to the dividends to be paid to all
Holders of shares of such series on such Dividend Payment Date.
(h) Auction Agent as Trustee of Dividend Payments by Trust. All
moneys paid to the Auction Agent for the payment of dividends (or for the
payment of any Late Charge) or the Redemption Price shall be held in trust
for the payment of such dividends (and any such Late Charge) or Redemption
Price by the Auction Agent for the benefit of the Holders specified in
paragraph 2(i) of this Part I of this Section 12.1. Any moneys paid to the
Auction Agent in accordance with the foregoing but not applied by the
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Auction Agent to the payment of dividends (and any such Late Charge) will,
to the extent permitted by law, be repaid to the Trust at the end of 90
days from the date on which such moneys were so to have been applied.
(i) Dividends Paid to Holders. Each dividend on Preferred Shares
shall be paid on the Dividend Payment Date therefor to the Holders thereof
as their names appear on the record books of the Trust on the Business Day
next preceding such Dividend Payment Date.
(j) Dividends Credited Against Earliest Accumulated But Unpaid
Dividends. Any dividend payment made on Preferred Shares shall first be
credited against the earliest accumulated but unpaid dividends due with
respect to such shares. Dividends in arrears for any past Dividend Period
may be declared and paid on any date as may be fixed by the Trustees,
without reference to any regular Dividend Payment Date, to the Holders as
their names appear on the record books of the Trust on the record date
fixed by the Trustees, not exceeding 15 days preceding the payment date
thereof.
3. Designation of Special Rate Periods.
(a) Length of and Preconditions for Special Rate Period. The Trust
may designate any succeeding Subsequent Rate Period of shares of a series
of Preferred Shares as a "Special Rate Period" consisting of a specified
number of Rate Period Days evenly divisible by 7 and not more than 1,820. A
designation of a Special Rate Period with respect to any series of
Preferred Shares shall be effective only if (A) notice thereof shall have
been given in accordance with paragraph 3(c) and paragraph 3(d)(i) of this
Part I, (B) an Auction for shares of such series shall have been held on
the Auction Date immediately preceding the first day of such proposed
Special Rate Period and Sufficient Clearing Bids for shares of such series
shall have existed in such Auction, (C) if any Notice of Redemption shall
have been mailed by the Trust pursuant to paragraph 8(c) of this Part I
with respect to any shares of such series, the Redemption Price with
respect to such shares shall have been deposited with the Auction Agent,
(D) if such redemption is subject to one or more conditions precedent, each
such condition shall have been satisfied at the time or times and in the
manner specified in such Notice of Redemption, (E) full cumulative
dividends and any amounts due with respect to mandatory redemptions and
optional redemptions shall have been paid in full or deposited with the
Auction Agent, and (F) the Trust shall have obtained written confirmation
from Moody's and Fitch, if Moody's and Fitch are then rating the Preferred
Shares, and from any Substitute Rating Agency then rating the Preferred
Shares that such proposed Special Rate Period will not impair the rating
then assigned by Moody's, Fitch or such Substitute Rating Agency to the
Preferred Shares.
(b) RESERVED.
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(c) Notice of Proposed Special Rate Period. If the Trust proposes to
designate any succeeding Subsequent Rate Period of shares of a series of
Preferred Shares as a Special Rate Period pursuant to paragraph 3(a) of
this Part I, not less than 20 (or such lesser number of days as may be
agreed to from time to time by the Auction Agent) nor more than 30 days
prior to the date the Trust proposes to designate as the first day of such
Special Rate Period (which shall be such day that would otherwise be the
first day of a Minimum Rate Period), notice shall be (i) published or
caused to be published by the Trust in a newspaper of general circulation
to the financial community in The City of New York, New York, which carries
financial news, and (ii) mailed by the Trust by first-class mail, postage
prepaid, to the Holders of shares of such series. Each such notice shall
state (A) that the Trust may exercise its option to designate a succeeding
Subsequent Rate Period of shares of such series as a Special Rate Period,
specifying the first day thereof and the Maximum Rate applicable to such
Special Rate Period (as though the day of notice were the second Business
Day next preceding the first day of such Special Rate Period), and (B) that
the Trust will, by 11:00 A.M., New York City time, on the second Business
Day next preceding such date (or by such later time or date, or both, as
may be agreed to by the Auction Agent) notify the Auction Agent and each
Broker-Dealer of either (x) its determination, subject to certain
conditions, to exercise such option, in which case the Trust shall specify
the Special Rate Period designated, or (y) its determination not to
exercise such option.
(d) Notice of Special Rate Period. No later than 11:00 A.M., New
York City time, on the second Business Day next preceding the first day of
any proposed Special Rate Period of shares of a series of Preferred Shares
as to which notice has been given as set forth in paragraph 3(c) of this
Part I (or such later time or date, or both, as may be agreed to by the
Auction Agent and each Broker-Dealer), the Trust shall deliver to the
Auction Agent and each Broker-Dealer either:
(i) a notice ("Notice of Special Rate Period") stating (A)
that the Trust has determined to designate the next succeeding Rate
Period of shares of such series as a Special Rate Period, specifying
the same and the first day thereof, (B) the Maximum Rate for such
Special Rate Period (which shall be determined on the second Business
Day next preceding the first day of such Special Rate Period), (C) the
Auction Date immediately prior to the first day of such Special Rate
Period, (D) that such Special Rate Period shall not commence if (1) an
Auction for shares of such series shall not be held on such Auction
Date for any reason or (2) an Auction for shares of such series shall
be held on such Auction Date but Sufficient Clearing Bids for shares
of such series shall not exist in such Auction, and (E) whether the
shares of a particular series of Preferred Shares will be subject to
optional redemption during such Special Rate Period and, if so, the
redemption premium, if any, required to be paid by the Trust in
connection with such optional redemption, such notice to be
accompanied by a Preferred Shares Basic Maintenance Report showing
that, as of the third Business Day next preceding such proposed
Special Rate Period (which shall for these purposes be treated as a
Valuation Date), Moody's Eligible Assets and Fitch Eligible Assets
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(if Moody's and Fitch are then rating the series in question) each
have an aggregate Discounted Value at least equal to the Preferred
Shares Basic Maintenance Amount as of such Business Day; or
(ii) a notice stating that the Trust has determined not to
exercise its option to designate a Special Rate Period of shares of
such series and that the next succeeding Rate Period of shares of such
series shall be a Minimum Rate Period.
(e) Failure to Deliver Notice of Special Rate Period. If the Trust
fails to deliver either of the notices described in paragraphs 3(d)(i) and
3(d)(ii) of this Part I (and, in the case of the notice described in
paragraph 3(d)(i) of this Part I, a Preferred Shares Basic Maintenance
Report to the effect set forth in such paragraph (if either Moody's or
Fitch is then rating the series in question)) with respect to any
designation of any proposed Special Rate Period to the Auction Agent by
11:00 A.M., New York City time, on the second Business Day next preceding
the first day of such proposed Special Rate Period (or by such later time
or date, or both, as may be agreed to by the Auction Agent), the Trust
shall be deemed to have delivered a notice to the Auction Agent with
respect to such Special Rate Period to the effect set forth in paragraph
3(d)(ii) of this Part I. In the event the Trust delivers to the Auction
Agent a notice described in paragraph 3(d)(i) of this Part I, it shall file
a copy of such notice with the Secretary of the Trust, and the contents of
such notice shall be binding on the Trust. In the event the Trust delivers
to the Auction Agent a notice described in paragraph 3(d)(ii) of this Part
I, the Trust will provide Moody's (if Moody's is then rating the series in
question) and Fitch (if Fitch is then rating the series in question) with a
copy of such notice.
4. Voting Rights.
(a) One Vote Per Share of Preferred Shares. Except as otherwise
provided herein or in the Declaration of Trust or as otherwise required by
law, (i) each Holder of Preferred Shares shall be entitled to one vote for
each share of Preferred Shares held by such Holder on each matter submitted
to a vote of shareholders of the Trust, and (ii) the holders of outstanding
preferred shares, including each share of the Preferred Shares, and of
Common Shares shall vote together as a single class; provided, however,
that, at any meeting of the shareholders of the Trust held for the election
of Trustees, the holders of outstanding preferred shares, including the
Preferred Shares, represented in person or by proxy at said meeting shall
be entitled, as a class, to the exclusion of the holders of all other
securities and classes of shares of beneficial interest of the Trust, to
elect two Trustees of the Trust, each Preferred Share entitling the holder
thereof to one vote. Subject to paragraph 4(b) of this Part I, the holders
of outstanding Common Shares and preferred shares, voting together as a
single class, shall elect the balance of the Trustees.
(b) Voting for Additional Trustees.
(i) Voting Period. Except as otherwise provided in the
Declaration of Trust or as otherwise required by law, during any
period in which any one or
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more of the conditions described in subparagraphs (A) or (B) of this
subparagraph (b)(i) shall exist (such period being referred to herein
as a "Voting Period"), the number of trustees constituting the
Trustees shall be automatically increased by the smallest number that,
when added to the two Trustees elected exclusively by the holders of
preferred shares, including the Preferred Shares, would constitute a
majority of the Trustees as so increased by such smallest number, and
the holders of preferred shares, including the Preferred Shares, shall
be entitled, voting as a class on a one-vote-per-share basis (to the
exclusion of the holders of all other securities and classes of shares
of beneficial interest of the Trust), to elect such smallest number of
additional Trustees, together with the two Trustees that such holders
are in any event entitled to elect. A Voting Period shall commence:
(A) if at the close of business on any Dividend Payment
Date accumulated dividends (whether or not earned or declared)
on any outstanding preferred shares, including the Preferred
Shares, equal to at least two full years' dividends shall be due
and unpaid and sufficient cash or specified securities shall not
have been deposited with the Auction Agent for the payment of
such accumulated dividends; or
(B) if at any time holders of preferred shares,
including the Preferred Shares, are entitled under the 1940 Act
to elect a majority of the Trustees of the Trust.
Upon the termination of a Voting Period, the voting rights described
in this subparagraph (b)(i) shall cease, subject always, however, to
the revesting of such voting rights in the holders of preferred shares
upon the further occurrence of any of the events described in this
subparagraph (b)(i).
(ii) Notice of Special Meeting. As soon as practicable after
the accrual of any right of the holders of preferred shares, including
the Preferred Shares, to elect additional Trustees as described in
paragraph 4(b)(i) of this Part I, the Trust shall so notify the
Auction Agent and a special meeting of such holders shall be called by
mailing a notice of such special meeting to such holders, such meeting
to be held not less than 10 nor more than 20 days after the date of
mailing of such notice. If the Trust fails to send such notice to the
Auction Agent or if such special meeting is not called, it may be
called by any such holder on like notice. The record date for
determining the holders entitled to notice of and to vote at such
special meeting shall be the close of business on the fifth Business
Day preceding the day on which such notice is mailed. At any such
special meeting and at each meeting of holders of preferred shares,
including the Preferred Shares, held during a Voting Period at which
Trustees are to be elected, such holders, voting together as a class
(to the exclusion of the holders of all other securities and classes
of shares of beneficial interest of the Trust), shall be entitled to
elect the number of Trustees prescribed in paragraph 4(b)(i) of this
Part I on a one-vote-per-share basis.
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(iii) Terms of Office of Existing Trustees. The terms of office
of all persons who are Trustees of the Trust at the time of a special
meeting of Holders and holders of other preferred shares to elect
Trustees shall continue, notwithstanding the election at such meeting
by the Holders and such other holders of the number of Trustees that
they are entitled to elect, and the persons so elected by the Holders
and such other holders, together with the two incumbent Trustees
elected by the Holders and such other holders of preferred shares and
the remaining incumbent Trustees elected by the holders of the Common
Shares and preferred shares, shall constitute the duly elected
Trustees.
(iv) Terms of Office of Certain Trustees to Terminate upon
Termination of Voting Period. Simultaneously with the termination of a
Voting Period, the terms of office of the additional Trustees elected
by the Holders and holders of other Preferred Shares pursuant to
paragraph 4(b)(i) of this Part I shall automatically terminate, the
remaining Trustees shall constitute the Trustees of the Trust and the
voting rights of the Holders and such other holders to elect
additional Trustees pursuant to paragraph 4(b)(i) of this Part I shall
cease, subject to the provisions of the last sentence of paragraph
4(b)(i) of this Part I.
(c) Holders of Preferred Shares to Vote on Certain Other Matters.
(i) Increase in Capitalization; Voluntary Petition for
Bankruptcy. So long as any Preferred Shares are outstanding, the Trust
shall not, without the affirmative vote or consent of the Holders of
at least a "majority of the outstanding Preferred Shares" (unless a
higher percentage is provided for herein or in the Declaration of
Trust or by applicable law), in person or by proxy, either in writing
or at a meeting, voting as a separate class, authorize, create or
issue any class or series of shares ranking prior to or on a parity
with the Preferred Shares with respect to the payment of dividends or
the distribution of assets upon dissolution, liquidation or winding up
of the affairs of the Trust, or authorize, create or issue additional
shares of any series of Preferred Shares (except that, notwithstanding
the foregoing, but subject to the provisions of paragraph 10(c)(ii) of
this Part I, the Trustees, without the vote or consent of the Holders
of Preferred Shares, may from time to time authorize and create, and
the Trust may from time to time issue, additional shares of any series
of Preferred Shares or classes or series of other preferred shares
ranking on a parity with Preferred Shares with respect to the payment
of dividends and the distribution of assets upon dissolution,
liquidation or winding up of the affairs of the Trust if the Trust
receives written confirmation from Moody's (if Moody's is then rating
the Preferred Shares) and Fitch (if Fitch is then rating the Preferred
Shares) that such authorization, creation or issuance would not impair
the rating then assigned by such Rating Agency to the Preferred
Shares). To the extent any shareholder vote is required under the
previous sentence of this paragraph 4(c)(i) of Part I, holders of
Common Shares will have no rights with respect to such vote unless
required by law. So long as any Preferred Shares are outstanding, the
Trust shall not,
C-51
without the affirmative vote or consent of the Holders of at least a
"majority of the outstanding Preferred Shares" (unless a higher
percentage is provided for herein or in the Declaration of Trust or by
applicable law), in person or by proxy, either in writing or at a
meeting, voting as a separate class, file a voluntary application for
relief under Federal bankruptcy law or any similar application under
state law for so long as the Trust is solvent and does not foresee
becoming insolvent.
For purposes of paragraph 4 of this Part I, "majority of the
outstanding Preferred Shares" (or a series thereof) 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.
To the extent not prohibited by these Bylaws, the Declaration of Trust
or applicable law, if any action with respect to which Holders of
Preferred Shares are granted voting rights under paragraph 4 of this
Part I (including without limitation paragraphs 4(c) and 4(d)) would
adversely affect the rights of one or more series (the "Affected
Series") of Preferred Shares in a manner different from any other
series of Preferred Shares, the Trust will not approve any such action
without the affirmative vote or consent of the Holders of at least a
"majority of outstanding shares" of each such Affected Series
outstanding at the time, in person or by proxy, either in writing or
at a meeting (each such Affected Series voting as a separate class).
(ii) 1940 Act Matters. Unless a higher percentage is provided
for herein or in the Declaration of Trust or by applicable law, (A)
the affirmative vote of the Holders of at least a "majority of the
outstanding Preferred Shares," voting as a separate class, shall be
required to approve any conversion of the Trust from a closed-end to
an open-end investment company and (B) the affirmative vote of the
Holders of a "majority of the outstanding Preferred Shares," voting as
a separate class, shall be required to approve any plan of
reorganization (as such term is used in the 1940 Act) adversely
affecting such shares. The affirmative vote of the Holders of at least
a "majority of the outstanding Preferred Shares," voting as a separate
class, shall be required to approve any action not described in the
first sentence of this paragraph 4(c)(ii) requiring a vote of security
holders of the Trust under section 13(a) of the 1940 Act. In the event
a vote of Holders of Preferred Shares is required pursuant to the
provisions of section 13(a) of the 1940 Act, the Trust shall, not
later than ten Business Days prior to the date on which such vote is
to be taken, notify Moody's (if Moody's is then rating the Preferred
Shares) and Fitch (if Fitch is then rating the Preferred Shares) that
such vote is to be taken and the nature of the action with respect to
which such vote is to be taken. The Trust shall, not later than ten
Business Days after the date on which such vote is taken, notify
Moody's (if Moody's is then rating the Preferred Shares) and Fitch (if
Fitch is then rating the Preferred Shares) of the results of such
vote.
C-52
(d) Board May Take Certain Actions Without Shareholder Approval. The
Trustees, without the vote or consent of the shareholders of the Trust, may
from time to time amend, alter or repeal any provision of this Section 12.1
if such amendment, alteration or repeal would not adversely affect the
preferences, rights or powers of the Holders of Preferred Shares expressly
set forth in the Declaration of Trust or Bylaws; provided, however, that
the Trustees receive written confirmation from Moody's (such confirmation
being required to be obtained only in the event Moody's is then rating the
Preferred Shares) or Fitch (such confirmation being required to be obtained
only in the event that Fitch is then rating the Preferred Shares) that any
such amendment, alteration or repeal would not impair the ratings then
assigned by Moody's (if Moody's is then rating the Preferred Shares) or
Fitch (if Fitch is then rating the Preferred Shares) to Preferred Shares.
To the extent any shareholder vote is required under paragraph 4(d) of this
Part I, (i) the affirmative vote of the Holders of at least a "majority of
outstanding Preferred Shares" shall be required (unless a higher percentage
is provided for herein or in the Declaration of Trust or by applicable law)
and (ii) holders of Common Shares will have no rights unless required by
law.
For purposes of the foregoing and paragraph 4(c) above, no matter shall be
deemed adversely to affect any preference, right or power of a Holder of
Preferred Shares unless such matter (a) adversely alters or abolishes any
preferential right of the Preferred Shares; (b) creates, adversely alters or
abolishes any right in respect of redemption of such shares; or (c) creates or
adversely alters (other than to abolish) any restriction on transfer applicable
to such shares.
Notwithstanding the foregoing, the Trustees may, without the vote or
consent of the Holders of the Preferred Shares, from time to time amend, alter
or repeal any or all of the provisions of paragraph 10 of this Part I, as well
as any or all of the definitions of the terms listed below (and any terms
defined within, or related to, such definitions), and any such amendment,
alteration or repeal will be deemed not to affect the preferences, rights or
powers of the Preferred Shares or the Holders thereof, provided the Trustees
receive written confirmation from Moody's (if Moody's is then rating the
Preferred Shares) and Fitch (if Fitch is then rating the Preferred Shares) that
any such amendment, alteration or repeal would not impair the ratings then
assigned to the Preferred Shares by Moody's (if Moody's is then rating the
Preferred Shares) or Fitch (if Fitch is then rating the Preferred Shares):
C-53
Annual Valuation Date Moody's Discount Factor
Applicable Percentage Moody's Eligible Assets
Applicable Spread Moody's Hedging Transactions
Approved Foreign Nations Moody's Industry Classifications
Auditor's Confirmation Moody's Loan Category
Bank Loans
Brady Bonds 1940 Act Cure Date
Canadian Bonds 1940 Act Preferred Shares Asset Coverage
Closing Transactions PACs
CMOs Performing
Corporate Debt Securities Preferred Shares Basic Maintenance Amount
Deposit Securities Preferred Shares Basic Maintenance Cure Date
Discounted Value Preferred Shares Basic Maintenance Report
Exposure Period Pricing Service
FFCB Reorganization Bonds
FHLB Senior Loans
FHLB, FNMA and FFCB Debentures Short Term Money Market Instruments
FHLMC Structured Notes
Fitch Discount Factor TACs
Fitch Eligible Assets TRACERs
Fitch Hedging Transactions Tradable Credit Baskets
Fitch Industry Classifications Treasury Bill
Fitch Loan Category Treasury Bonds
FNMA Treasury Futures
Foreign Bonds Treasury Note
Forward Commitments U.S. Government Securities
GNMA U.S. Treasury Securities
Independent Accountant U.S. Treasury Strips
Market Value Valuation Date
Maximum Rate Volatility Factor
(e) Voting Rights Set Forth Herein Are Sole Voting Rights. Unless
otherwise required by law, the Holders of Preferred Shares shall not have
any relative rights or preferences or other special rights other than those
specifically set forth herein.
(f) No Preemptive Rights or Cumulative Voting. The Holders of
Preferred Shares shall have no preemptive rights or rights to cumulative
voting.
(g) Voting for Trustees Sole Remedy for Trust's Failure to Pay
Dividends. In the event that the Trust fails to pay any dividends on the
Preferred Shares, the exclusive remedy of the Holders shall be the right to
vote for Trustees pursuant to the provisions of this paragraph 4.
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(h) Holders Entitled to Vote. For purposes of determining any rights
of the Holders to vote on any matter, whether such right is created by this
Section 12.1, by provisions of the Declaration of Trust, by statute or
otherwise, no Holder shall be entitled to vote any Preferred Share and no
Preferred Share shall be deemed to be "outstanding" for the purpose of
voting or determining the number of shares required to constitute a quorum
if, prior to or concurrently with the time of determination of shares
entitled to vote or shares deemed outstanding for quorum purposes, as the
case may be, the requisite Notice of Redemption with respect to such shares
shall have been mailed as provided in paragraph 8(c) of this Part I and the
Redemption Price for the redemption of such shares shall have been
deposited in trust with the Auction Agent for that purpose. No Preferred
Share held by the Trust or any Affiliate of the Trust (except for shares
held by a Broker-Dealer that is an Affiliate of the Trust for the account
of its customers) shall have any voting rights or be deemed to be
outstanding for voting or other purposes.
5. 1940 Act Preferred Shares Asset Coverage.
The Trust shall maintain, as of the last Business Day of each month in
which any Preferred Shares are outstanding, the 1940 Act Preferred Shares Asset
Coverage.
6. Preferred Shares Basic Maintenance Amount.
(a) So long as Preferred Shares are outstanding, the Trust shall
maintain, on each Valuation Date, and shall verify to its satisfaction that
it is maintaining on such Valuation Date, Fitch Eligible Assets having an
aggregate Discounted Value equal to or greater than the Preferred Shares
Basic Maintenance Amount (if Fitch is then rating the Preferred Shares) and
Moody's Eligible Assets having an aggregate Discounted Value equal to or
greater than the Preferred Shares Basic Maintenance Amount (if Moody's is
then rating the Preferred Shares).
(b) (i) On or before 5:00 P.M., New York City time, on the third
Business Day after a Valuation Date on which the Trust fails to satisfy the
Preferred Shares Basic Maintenance Amount, and on the third Business Day
after the Preferred Shares Basic Maintenance Cure Date with respect to such
Valuation Date, the Trust shall complete and deliver to Moody's (if Moody's
is then rating the Preferred Shares) and Fitch (if Fitch is then rating the
Preferred Shares) and the Auction Agent (if either Moody's or Fitch is then
rating the Preferred Shares) a Preferred Shares Basic Maintenance Report as
of the date of such failure or such Preferred Shares Basic Maintenance Cure
Date, as the case may be, which will be deemed to have been delivered to
the Auction Agent if the Auction Agent receives a copy or telecopy, telex
or other electronic transcription thereof and on the same day the Trust
mails to the Auction Agent for delivery on the next Business Day the full
Preferred Shares Basic Maintenance Report.
(ii) The Trust shall also deliver a Preferred Shares Basic
Maintenance Report to:
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(A) the Auction Agent (if either Moody's or Fitch is then rating the
Preferred Shares) as of the last Friday of each calendar month (or, if such
day is not a Business Date, the immediately preceding Business Day), and
(B) Moody's (if Moody's is then rating the Preferred Shares) and Fitch
(if Fitch is then rating the Preferred Shares) as of any Quarterly
Valuation Date, in each case on or before the third Business Day after such
day.
A failure by the Trust to deliver a Preferred Shares Basic Maintenance
Report pursuant to the preceding sentence shall be deemed to be delivery of a
Preferred Shares Basic Maintenance Report indicating the Discounted Value for
all assets of the Trust is less than the Preferred Shares Basic Maintenance
Amount, as of the relevant Valuation Date.
(c) Within ten Business Days after the date of delivery of a
Preferred Shares Basic Maintenance Report in accordance with paragraph 6(b)
of this Part I relating to a Quarterly Valuation Date that is also an
Annual Valuation Date, the Trust shall cause the Independent Accountant to
confirm in writing to Moody's (if Moody's is then rating the Preferred
Shares), Fitch (if Fitch is then rating the Preferred Shares) and the
Auction Agent (if either Moody's or Fitch is then rating the Preferred
Shares):
(i) the mathematical accuracy of the calculations reflected
in such Preferred Shares Basic Maintenance Report (and in any other
Preferred Shares Basic Maintenance Report, randomly selected by the
Independent Accountant, that was prepared by the Trust during the
quarter ending on such Annual Valuation Date),
(ii) that, in such Preferred Shares Basic Maintenance Report
(and in such randomly selected Preferred Shares Basic Maintenance
Report), the Trust determined in accordance with this Section 12.1
whether the Trust had, at such Annual Valuation Date (and at the
Valuation Date addressed in such randomly selected Preferred Shares
Basic Maintenance Report), Moody's Eligible Assets (if Moody's is then
rating the Preferred Shares) of an aggregate Discounted Value at least
equal to the Preferred Shares Basic Maintenance Amount,
(iii) that, in such Preferred Shares Basic Maintenance Report
(and in such randomly selected Preferred Shares Basic Maintenance
Report), the Trust determined in accordance with this Section 12.1
whether the Trust had, at such Annual Valuation Date (and at the
Valuation Date addressed in such randomly selected Preferred Shares
Basic Maintenance Report), Fitch Eligible Assets (if Fitch is then
rating the Preferred Shares) of an aggregate Discounted Value at least
equal to the Preferred Shares Basic Maintenance Amount,
(iv) that, in such Preferred Shares Basic Maintenance Report
(and in such randomly selected Preferred Shares Basic Maintenance
Report), the Trust determined whether the Trust had, at such Annual
Valuation Date (and at the
C-56
Valuation Date addressed in such randomly selected Preferred Shares
Basic Maintenance Report), met the Preferred Shares Basic Maintenance
Amount in accordance with this Section 12.1,
(v) with respect to the Fitch ratings on portfolio securities
of the Trust (if Fitch is then rating the Preferred Shares), the
issuer name, issue size and coupon rate, if any, listed in such
Preferred Shares Basic Maintenance Report verified by the Independent
Accountant by reference to Bloomberg Financial Services or another
independent source approved in writing by Fitch (if Fitch is then
rating the Preferred Shares), and the Independent Accountant shall
provide a listing in its letter of any differences,
(vi) with respect to the Moody's ratings on portfolio
securities of the Trust (if Moody's is then rating the Preferred
Shares), the issuer name, issue size and coupon rate, if any, listed
in such Preferred Shares Basic Maintenance Report verified by the
Independent Accountant by reference to Bloomberg Financial Services or
another independent source approved in writing by Moody's (if Moody's
is then rating the Preferred Shares), and the Independent Accountant
shall provide a listing in its letter of any differences,
(vii) with respect to the bid or mean price (or such
alternative permissible factor used in calculating the Market Value)
used for purposes of valuing securities in the Trust's portfolio, that
the Independent Accountant has traced the price from the accounting
records of the Trust to the price listed in such Preferred Shares
Basic Maintenance Report and verified that such information agrees (in
the event such information does not agree, the Independent Accountant
will provide a listing in its letter of such differences), and
(viii) with respect to such confirmation to Moody's (if Moody's
is then rating the Preferred Shares) and Fitch (if Fitch is then
rating the Preferred Shares), that the Trust has satisfied the
requirements of paragraph 10 of this Part I of Section 12.1
(such information is herein called the "Auditor's Confirmation").
(d) Within ten Business Days after the date of delivery of a
Preferred Shares Basic Maintenance Report in accordance with paragraph
6(b)(1) of this Part I relating to any Valuation Date on which the Trust
failed to satisfy the Preferred Shares Basic Maintenance Amount, and
relating to the Preferred Shares Basic Maintenance Cure Date with respect
to such failure to satisfy the Preferred Shares Basic Maintenance Amount,
the Trust shall cause the Independent Accountant to provide to Moody's (if
Moody's is then rating the Preferred Shares), Fitch (if Fitch is then
rating the Preferred Shares) and the Auction Agent (if either Moody's or
Fitch is then rating the Preferred Shares) an Auditor's Confirmation as
to such Preferred Shares Basic Maintenance Report.
C-57
(e) If any Auditor's Confirmation delivered pursuant to paragraph
6(c) or 6(d) of this Part I shows that an error was made in the Preferred
Shares Basic Maintenance Report for a particular Valuation Date for which
such Auditor's Confirmation was required to be delivered, or shows that
a lower aggregate Discounted Value for the aggregate of all Moody's
Eligible Assets (if Moody's is then rating the Preferred Shares) or Fitch
Eligible Assets (if Fitch is then rating the Preferred Shares), as the case
may be, of the Trust was determined by the Independent Accountant, the
calculation or determination made by such Independent Accountant shall be
final and conclusive and shall be binding on the Trust, and the Trust shall
accordingly amend and deliver the Preferred Shares Basic Maintenance Report
to Moody's (if Moody's is then rating the Preferred Share), Fitch (if Fitch
is then rating the Preferred Shares) and the Auction Agent (if either
Moody's or Fitch is then rating the Preferred Shares) promptly following
receipt by the Trust of such Auditor's Confirmation.
(f) On or before 5:00 P.M., New York City time, on the first
Business Day after the Date of Original Issue of any Preferred Shares, the
Trust shall complete and deliver to Moody's (if Moody's is then rating the
Preferred Shares) and Fitch (if Fitch is then rating the Preferred Shares)
a Preferred Shares Basic Maintenance Report as of the close of business on
such Date of Original Issue. Within ten Business Days of such Date of
Original Issue, the Trust shall cause the Independent Accountant to deliver
in writing to the Auction Agent (if either Moody's or Fitch is then rating
the Preferred Shares), Moody's (if Moody's is then rating the Preferred
Shares) and Fitch (if Fitch is then rating the Preferred Shares) an
Auditor's Confirmation as to such Preferred Shares Basic Maintenance
Report.
(g) On or before 5:00 P.M., New York City time, on the third
Business Day after:
(i) the Trust shall have redeemed Common Shares, or
(ii) whenever requested by Moody's (if Moody's is then rating
the Preferred Shares) or Fitch (if Fitch is then rating the Preferred
Shares),
the Trust shall complete and deliver to Moody's (if Moody's is then rating the
Preferred Shares) or Fitch (if Fitch is then rating the Preferred Shares), as
the case may be, a Preferred Shares Basic Maintenance Report as of the date of
such event.
7. Restrictions on Dividends and Other Distributions.
(a) Dividends on Shares Other Than the Preferred Shares. Except as
set forth in the next sentence, no dividends shall be declared or paid or
set apart for payment on the shares of any class or series of shares of
beneficial interest of the Trust ranking, as to the payment of dividends,
on a parity with the Preferred Shares for any period unless full cumulative
dividends have been or contemporaneously are declared and paid on the
shares of each series of the Preferred Shares through its most recent
Dividend Payment
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Date. When dividends are not paid in full upon the shares of each series of
the Preferred Shares through its most recent Dividend Payment Date or upon
the shares of any other class or series of shares of beneficial interest of
the Trust ranking on a parity as to the payment of dividends with the
Preferred Shares through their most recent respective dividend payment
dates, all dividends declared upon a series of the Preferred Shares and any
other such class or series of shares of beneficial interest ranking on a
parity as to the payment of dividends with such series of the Preferred
Shares shall be declared pro rata so that the amount of dividends declared
per share on such series of the Preferred Shares and such other class or
series of shares of beneficial interest shall in all cases bear to each
other the same ratio that accumulated dividends per share on such series of
the Preferred Shares and such other class or series of shares of beneficial
interest bear to each other (for purposes of this sentence, the amount of
dividends declared per share on a series of the Preferred Shares shall be
based on the Applicable Rate for such share for the Dividend Periods during
which dividends were not paid in full).
(b) Dividends and Other Distributions with Respect to Common Shares
Under the 1940 Act. The Trustees shall not declare any dividend (except a
dividend payable in Common Shares or rights to purchase Common Shares), or
declare any other distribution, upon the Common Shares, or purchase Common
Shares (except in connection with the conversion of such Common Shares into
or exchange of such Common Shares for shares of the Trust ranking junior to
the Preferred Shares as to the payment of dividends and the distribution of
assets on liquidation), unless in every such case the Trust maintains, at
the time of any such declaration or purchase, the 1940 Act Preferred Shares
Asset Coverage after deducting the amount of such dividend, distribution or
purchase price, as the case may be.
(c) Other Restrictions on Dividends and Other Distributions. For so
long as any Preferred Shares are outstanding, and except as set forth in
paragraph 7(a) and paragraph 9(c) of this Part I, (A) the Trust shall not
declare, pay or set apart for payment any dividend or other distribution
(other than a dividend or distribution paid in shares of, or in options,
warrants or rights to subscribe for or purchase, Common Shares or other
shares, if any, ranking junior to the Preferred Shares as to the payment of
dividends and the distribution of assets upon dissolution, liquidation or
winding up) in respect of the Common Shares or any other shares (other than
the Preferred Shares) of the Trust ranking junior to or on a parity with
the Preferred Shares as to the payment of dividends or the distribution of
assets upon dissolution, liquidation or winding up, 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 the Trust ranking junior to the Preferred Shares as to the
payment of dividends and the distribution of assets upon dissolution,
liquidation or winding up), or any such parity shares (except by conversion
into or exchange for shares of the Trust ranking junior to or on a parity
with Preferred Shares as to the payment of dividends and the distribution
of assets upon dissolution, liquidation or winding up), unless (i) full
cumulative dividends on shares of each series of Preferred Shares through
its most recently ended Dividend Period shall have been paid or shall have
been declared and sufficient funds for the payment thereof
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deposited with the Auction Agent and (ii) the Trust has redeemed the full
number of Preferred Shares required to be redeemed by any provision for
mandatory redemption pertaining thereto, and (B) the Trust shall not
declare, pay or set apart for payment any dividend or other distribution
(other than a dividend or distribution paid in shares of, or in options,
warrants or rights to subscribe for or purchase, Common Shares or other
shares, if any, ranking junior to Preferred Shares as to the payment of
dividends and the distribution of assets upon dissolution, liquidation or
winding up) in respect of Common Shares or any other shares of the Trust
ranking junior to Preferred Shares as to the payment of dividends or the
distribution of assets upon dissolution, liquidation or winding up, 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 the Trust ranking junior to Preferred Shares as to
the payment of dividends and the distribution of assets upon dissolution,
liquidation or winding up), unless immediately after such transaction the
Discounted Value of Moody's Eligible Assets (if Moody's is then rating the
Preferred Shares) and Fitch Eligible Assets (if Fitch is then rating the
Preferred Shares) would each at least equal the Preferred Shares Basic
Maintenance Amount.
8. Redemption.
(a) Optional Redemption.
(i) Subject to the provisions of subparagraph (v) of this
paragraph 8(a), Preferred Shares of any series may be redeemed from
time to time, at the option of the Trust, in whole or in part, on any
Dividend Payment Date for shares of such series, out of funds legally
available therefor, at a redemption price per share equal to the sum
of $25,000 plus an amount equal to accumulated but unpaid dividends
thereon (whether or not earned or declared) to (but not including) the
date fixed for redemption; provided, however, that (1) shares of a
series of Preferred Shares may not be redeemed in part if after such
partial redemption fewer than 300 shares of such series would remain
outstanding; (2) unless otherwise provided, shares of a series of
Preferred Shares are redeemable by the Trust during the Initial Rate
Period thereof only on the last Dividend Payment Date for such Initial
Rate Period; and (3) subject to subparagraph (ii) of this paragraph
8(a), the Notice of Special Rate Period relating to a Special Rate
Period of shares of a series of Preferred Shares, as delivered to the
Auction Agent and filed with the Secretary of the Trust, may provide
that shares of such series shall not be redeemable during the whole or
any part of such Special Rate Period (except as provided in
subparagraph (iv) of this paragraph 8(a)) or shall be redeemable
during the whole or any part of such Special Rate Period only upon
payment of such redemption premium or premiums as shall be specified
therein (the provisions set forth in clauses (1) through (3) being
referred to herein as the "Special Redemption Provisions").
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(ii) A Notice of Special Rate Period relating to shares of a
series of Preferred Shares for a Special Rate Period thereof may
contain Special Redemption Provisions only if the Trustees, after
consultation with the Broker-Dealer or Broker-Dealers for such Special
Rate Period of shares of such series, determine that such Special
Redemption Provisions are in the best interest of the Trust.
(iii) If fewer than all of the outstanding shares of a series
of Preferred Shares are to be redeemed pursuant to subparagraph (i) of
this paragraph 8(a), the number of shares of such series to be
redeemed shall be determined by the Trustees, and such shares shall be
redeemed pro rata from the Holders of shares of such series in
proportion to the number of shares of such series held by such
Holders.
(iv) Subject to the provisions of subparagraph (v) of this
paragraph 8(a), shares of any series of Preferred Shares may be
redeemed, at the option of the Trust, in whole but not in part, out of
funds legally available therefor, on the first day following any
Dividend Period thereof included in a Rate Period consisting of more
than 364 Rate Period Days if, on the date of determination of the
Applicable Rate for shares of such series for such Rate Period, such
Applicable Rate equaled or exceeded on such date of determination the
Treasury Index Rate for such Rate Period, at a redemption price per
share equal to the sum of $25,000 plus an amount equal to accumulated
but unpaid dividends thereon (whether or not earned or declared) to
(but not including) the date fixed for redemption.
(v) The Trust may not on any date mail a Notice of Redemption
pursuant to paragraph 8(c) of this Part I in respect of a redemption
contemplated to be effected pursuant to this paragraph (a) unless on
such date (1) the Trust has available Deposit Securities with maturity
or tender dates not later than the day preceding the applicable
redemption date and having a value not less than the amount (including
any applicable premium) due to Holders of Preferred Shares by reason
of the redemption of such shares on such redemption date and (2) the
Discounted Value of Moody's Eligible Assets (if Moody's is then rating
the Preferred Shares) and Fitch Eligible Assets (if Fitch is then
rating the Preferred Shares) each at least equals the Preferred Shares
Basic Maintenance Amount, and each would at least equal the Preferred
Shares Basic Maintenance Amount immediately subsequent to such
redemption if such redemption were to occur on such date. The Trust
shall not be required to have available Deposit Securities as
described in clause (1) of this subparagraph (v) in respect of a
redemption of any series of Preferred Shares, in whole or in part,
contemplated to be effected pursuant to paragraph 8(a) where such
redemption is subject to the issuance of shares of any other series of
preferred shares of beneficial interest of the Trust.
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(b) Mandatory Redemption. The Trust shall redeem, at a redemption
price equal to $25,000 per share plus accumulated but unpaid dividends
thereon (whether or not earned or declared) to (but not including) the date
fixed by the Trustees for redemption, certain of the Preferred Shares, if
the Trust fails to have either Moody's Eligible Assets (if Moody's is then
rating the Preferred Shares) or Fitch Eligible Assets (if Fitch is then
rating the Preferred Shares) with a Discounted Value greater than or equal
to the Preferred Shares Basic Maintenance Amount or fails to maintain the
1940 Act Preferred Shares Asset Coverage, in accordance with the
requirements of the Rating Agency or Agencies then rating the Preferred
Shares, and such failure is not cured on or before the Preferred Shares
Basic Maintenance Cure Date or the 1940 Act Cure Date, as the case may be.
The number of Preferred Shares to be redeemed shall be equal to the lesser
of:
(i) the minimum number of Preferred Shares, together with all
other preferred shares subject to redemption or retirement, the
redemption of which, if deemed to have occurred immediately prior to
the opening of business on the Cure Date, would have resulted in the
Trust's having Moody's Eligible Assets (if Moody's is then rating the
Preferred Shares) and Fitch Eligible Assets (if Fitch is then rating
the Preferred Shares) with a Discounted Value greater than or equal to
the Preferred Shares Basic Maintenance Amount or maintaining the 1940
Act Preferred Shares Asset Coverage, as the case may be, on such Cure
Date (provided, however, that if there is no such minimum number of
Preferred Shares and other preferred shares the redemption or
retirement of which would have had such result, all Preferred Shares
and other preferred shares then outstanding shall be redeemed), and
(ii) the maximum number of Preferred Shares, together with all
other preferred shares subject to redemption or retirement, that can
be redeemed out of funds expected to be legally available therefor in
accordance with the Declaration of Trust and applicable law.
In determining the Preferred Shares required to be redeemed in accordance
with the foregoing, the Trust shall allocate the number required to be
redeemed to satisfy the Preferred Shares Basic Maintenance Amount or the
1940 Act Preferred Shares Asset Coverage, as the case may be, pro rata
among Preferred Shares and other preferred shares (and, then, pro rata
among each series of Preferred Shares) subject to redemption or retirement.
The Trust shall effect such redemption on the date fixed by the Trust therefor,
which date shall not be earlier than 20 days nor later than 40 days after such
Cure Date, except that if the Trust does not have funds legally available for
the redemption of all of the required number of the Preferred Shares and other
preferred shares which are subject to redemption or retirement or the Trust
otherwise is unable to effect such redemption on or prior to 40 days after such
Cure Date, the Trust shall redeem those Preferred Shares and other preferred
shares which it was unable to redeem on the earliest practicable date on which
it is able to effect such redemption. If fewer
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than all of the outstanding shares of a series of Preferred Shares are to be
redeemed pursuant to this paragraph 8(b), the number of shares of such series to
be redeemed shall be redeemed pro rata from the Holders of shares of such series
in proportion to the number of shares of such series held by such Holders.
(c) Notice of Redemption. If the Trust shall determine or be
required to redeem shares of a series of Preferred Shares pursuant to
paragraph 8(a) or 8(b) of this Part I, it shall mail a notice ("Notice of
Redemption") with respect to such redemption by first-class mail, postage
prepaid, to each Holder of the shares of such series to be redeemed, at
such Holder's address as the same appears on the record books of the Trust
on the record date established by the Trustees. Such Notice of Redemption
shall be so mailed not less than 20 nor more than 45 days prior to the date
fixed for redemption. Each such Notice of Redemption shall state:
(i) the redemption date;
(ii) the number of Preferred Shares to be redeemed and the
series thereof;
(iii) the CUSIP number for shares of such series;
(iv) the Redemption Price;
(v) the place or places where the certificate(s) for such
shares (properly endorsed or assigned for transfer, if the Trustees
shall so require and the Notice of Redemption shall so state) are to
be surrendered for payment of the Redemption Price;
(vi) that dividends on the shares to be redeemed will cease to
accumulate on such redemption date;
(vii) the Securities Depository publication date, which shall
be reasonably acceptable to the Auction Agent; and
(viii) the provisions of this paragraph 8 under which such
redemption is made.
If fewer than all shares of a series of Preferred Shares held by any Holder are
to be redeemed, the Notice of Redemption mailed to such Holder shall also
specify the number of shares of such series to be redeemed from such Holder. The
Trust may provide in any Notice of Redemption relating to a redemption
contemplated to be effected pursuant to paragraph 8(a) of this Part I that such
redemption is subject to one or more conditions precedent and that the Trust
shall not be required to effect such redemption unless each such condition shall
have been satisfied at the time or times and in the manner specified in such
Notice of Redemption.
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(d) No Redemption Under Certain Circumstances. Notwithstanding the
provisions of paragraphs 8(a) or 8(b) of this Part I, if any dividends on
shares of a series of Preferred Shares (whether or not earned or declared)
are in arrears, no shares of such series shall be redeemed unless all
outstanding shares of such series are simultaneously redeemed, and the
Trust shall not purchase or otherwise acquire any shares of such series;
provided, however, that the foregoing shall not prevent the purchase or
acquisition of outstanding shares of such series pursuant to the successful
completion of an otherwise lawful purchase or exchange offer made on the
same terms to Holders of all outstanding shares of such series. To the
extent that any redemption for which Notice of Redemption has been mailed
is not made by reason of the absence of legally available funds therefor in
accordance with the Declaration of Trust and applicable law, such
redemption shall be made as soon as practicable to the extent such funds
become available. Failure to redeem Preferred Shares shall be deemed to
exist at any time there is a Failure to Deposit with respect to a
redemption specified in a Notice of Redemption.
Notwithstanding the fact that the Trust may not have redeemed
Preferred Shares for which a Notice of Redemption has been mailed, dividends
may be declared and paid on Preferred Shares and shall include those
Preferred Shares for which a Notice of Redemption has been mailed.
(e) Auction Agent as Trustee of Redemption Payments by Trust. All
moneys paid to the Auction Agent for payment of the Redemption Price of
Preferred Shares called for redemption shall be held in trust by the
Auction Agent for the benefit of Holders of shares so to be redeemed.
(f) Shares for Which Notice of Redemption Has Been Given Are No
Longer Outstanding. Provided a Notice of Redemption has been mailed
pursuant to paragraph 8(c) of this Part I, upon the deposit with the
Auction Agent (not later than 12:00 noon, New York City time, on the date
fixed for redemption thereby, in funds available on such date in The City
of New York, New York) of funds sufficient to redeem the Preferred Shares
that are the subject of such notice, dividends on such shares shall cease
to accumulate and such shares shall no longer be deemed to be outstanding
for any purpose, and all rights of the Holders of the shares so called for
redemption shall cease and terminate (including without limitation voting
rights), except the right of such Holders to receive the Redemption Price,
but without any interest or other additional amount, except as provided in
subparagraph 2(e)(i) of this Part I. Upon surrender in accordance with the
Notice of Redemption of the certificates for any shares so redeemed
(properly endorsed or assigned for transfer, if the Trustees shall so
require and the Notice of Redemption shall so state), the Redemption Price
shall be paid by the Auction Agent to the Holders of Preferred Shares
subject to redemption. In the case that fewer than all of the shares
represented by any such certificate are redeemed, a new certificate shall
be issued, representing the unredeemed shares, without cost to the Holder
thereof. The Trust shall be entitled to receive from the Auction Agent,
promptly after the date fixed for redemption, any cash deposited with the
Auction Agent in excess of:
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(i) the aggregate Redemption Price of the Preferred Shares
called for redemption on such date, and
(ii) all other amounts to which Holders of Preferred Shares
called for redemption may be entitled.
Any funds so deposited that are unclaimed at the end of 90 days from such
redemption date shall, to the extent permitted by law, be repaid to the Trust,
after which time the Holders of Preferred Shares so called for redemption may
look only to the Trust for payment of the Redemption Price and all other amounts
to which they may be entitled. The Trust shall be entitled to receive, from time
to time after the date fixed for redemption, any interest on the funds so
deposited.
(g) Compliance with Applicable Law. In effecting any redemption
pursuant to this paragraph 8, the Trust shall use its best efforts to
comply with all applicable conditions precedent to effecting such
redemption under the 1940 Act and any applicable Massachusetts law, and
shall effect no redemption except in accordance with the 1940 Act and any
applicable Massachusetts law.
(h) Only Whole Preferred Shares May Be Redeemed. In the case of any
redemption pursuant to this paragraph 8, only whole Preferred Shares shall
be redeemed, and in the event that any provision of the Declaration of
Trust would require redemption of a fractional share, the Auction Agent
shall be authorized to round up so that only whole shares are redeemed.
9. Liquidation Rights.
(a) Ranking. The shares of a series of Preferred Shares shall rank
on a parity with each other, with shares of any other series of preferred
shares and with shares of any other series of Preferred Shares as to the
distribution of assets upon dissolution, liquidation or winding up of the
affairs of the Trust.
(b) Distributions upon Liquidation. Upon the dissolution,
liquidation or winding up of the affairs of the Trust, whether voluntary or
involuntary, the Holders of Preferred Shares then outstanding shall be
entitled to receive and to be paid out of the assets of the Trust available
for distribution to its shareholders, before any payment or distribution
shall be made on the Common Shares or on any other class of shares of the
Trust ranking junior to the Preferred Shares upon dissolution, liquidation
or winding up, an amount equal to the Liquidation Preference with respect
to such shares plus an amount equal to all dividends thereon (whether or
not earned or declared but excluding the interest thereon) accumulated but
unpaid to (but not including) the date of final distribution in same-day
funds. After the payment to the Holders of the Preferred Shares of the full
preferential amounts provided for in this paragraph 9(b), the Holders of
Preferred Shares as such shall have no right or claim to any of the
remaining assets of the Trust.
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(c) Pro Rata Distributions. In the event the assets of the Trust
available for distribution to the Holders of Preferred Shares upon any
dissolution, liquidation, or winding up of the affairs of the Trust,
whether voluntary or involuntary, shall be insufficient to pay in full all
amounts to which such Holders are entitled pursuant to paragraph 9(b) of
this Part I, no such distribution shall be made on account of any shares of
any other class or series of preferred shares ranking on a parity with the
Preferred Shares with respect to the distribution of assets upon such
dissolution, liquidation or winding up unless proportionate distributive
amounts shall be paid on account of the Preferred Shares, ratably, in
proportion to the full distributable amounts for which holders of all such
parity shares are respectively entitled upon such dissolution, liquidation
or winding up.
(d) Rights of Junior Shares. Subject to the rights of the holders of
shares of any series or class or classes of shares ranking on a parity with
the Preferred Shares with respect to the distribution of assets upon
dissolution, liquidation or winding up of the affairs of the Trust, after
payment shall have been made in full to the Holders of the Preferred Shares
as provided in paragraph 9(b) of this Part I, but not prior thereto, any
other series or class or classes of shares ranking junior to the Preferred
Shares with respect to the distribution of assets upon dissolution,
liquidation or winding up of the affairs of the Trust shall, subject to the
respective terms and provisions (if any) applying thereto, be entitled to
receive any and all assets remaining to be paid or distributed, and the
Holders of the Preferred Shares shall not be entitled to share therein.
(e) Certain Events Not Constituting Liquidation. Neither the sale of
all or substantially all, or any portion of, the property or business of
the Trust, nor the merger or consolidation of the Trust into or with any
business trust or other entity nor the merger or consolidation of any
business trust or other entity into or with the Trust shall be a
dissolution, liquidation or winding up, whether voluntary or involuntary,
for the purposes of this paragraph 9.
10. Futures and Options Transactions; Forward Commitments.
(a) If Moody's is rating any Preferred Shares, then:
(i) For so long as any Preferred Shares are rated by Moody's,
the Trust will not buy or sell futures contracts, write, purchase or
sell call options on futures contracts or purchase put options on
futures contracts or write call options (except covered call options)
on portfolio securities unless it receives written confirmation from
Moody's that engaging in such transactions would not impair the
ratings then assigned to such Preferred Shares by Moody's, except that
the Trust may purchase or sell exchange-traded futures contracts based
on any index approved by Moody's or Treasury Futures, and purchase,
write or sell exchange-traded put options on such futures contracts
and purchase, write or sell exchange-traded call options on such
futures contracts (collectively, "Moody's Hedging Transactions"),
subject to the following limitations:
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(A) the Trust will not engage in any Moody's Hedging
Transaction based on any index approved by Moody's (other than
transactions which terminate a futures contract or option held
by the Trust by the Trust's taking an opposite position thereto
("Closing Transactions")) which would cause the Trust at the
time of such transaction to own or have sold:
(I) outstanding futures contracts based on such
index or indices exceeding in number 10% of the average
number of daily traded futures contracts based on such
index or indices in the 30 days preceding the time of
effecting such transaction as reported by The Wall Street
Journal; or
(II) outstanding financial futures contracts based
on any index approved by Moody's having a Market Value
exceeding 50% of the Market Value of all portfolio
securities of the Trust constituting Moody's Eligible
Assets owned by the Trust (other than Moody's Eligible
Assets already subject to a Moody's Hedging Transaction);
(B) the Trust will not engage in any Moody's Hedging
Transaction based on Treasury Futures (other than Closing
Transactions) which would cause the Trust at the time of such
transaction to own or have sold outstanding futures contracts
based on Treasury Futures having an aggregate Market Value
exceeding 80% of the aggregate Market Value of all portfolio
securities of the Trust constituting Moody's Eligible Assets
owned by the Trust (other than Moody's Eligible Assets already
subject to a Moody's Hedging Transaction) and rated Baa or above
by Moody's (or, if not rated by Moody's, rated A or above by S&P
or an equivalent rating by Fitch) (for purposes of the
foregoing, the Trust shall be deemed to own futures contracts
that underlie any outstanding options written by the Trust);
(C) the Trust will engage in Closing Transactions to
close out any outstanding futures contract based on any index
approved by Moody's if the amount of open interest in such index
as reported by The Wall Street Journal is less than an amount to
be mutually determined by Moody's and the Trust; and
(D) the Trust will not enter into an option or futures
transaction unless, after giving effect thereto, the Trust would
continue to have Moody's Eligible Assets with an aggregate
Discounted Value equal to or greater than the Preferred Shares
Basic Maintenance Amount.
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(ii) For purposes of determining whether the Trust has Moody's
Eligible Assets with an aggregate Discounted Value that equals or
exceeds the Preferred Shares Basic Maintenance Amount, the Discounted
Value of Moody's Eligible Assets which the Trust is obligated to
deliver or receive pursuant to an outstanding futures contract or
option shall be valued as follows:
(A) assets subject to call options written by the Trust
which are either exchange-traded and "readily reversible" or
expire within 49 days after the date as of which such valuation
is made shall be valued at the lesser of:
(I) Discounted Value and
(II) the exercise price of the call option written
by the Trust;
(B) assets subject to call options written by the Trust
not meeting the requirements of clause (A) of this sentence
shall have no value;
(C) assets subject to put options written by the Trust
shall be valued at the lesser of:
(I) the exercise price and
(II) the Discounted Value of the subject security;
(D) 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 Trust is the seller the contract may be
valued at the settlement price and where the Trust is the buyer
the contract may be valued at the Discounted Value of the assets
subject to the futures contract; and
(E) where delivery may be made to the Trust with any
security of a class of securities, the Trust shall assume that
it will take delivery of the security with the lowest Discounted
Value.
(iii) For purposes of determining whether the Trust has Moody's
Eligible Assets with an aggregate Discounted Value that equals or
exceeds the Preferred Shares Basic Maintenance Amount, the following
amounts shall be subtracted from the aggregate Discounted Value of the
Moody's Eligible Assets held by the Trust:
(A) 10% of the exercise price of a written call option;
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(B) the exercise price of any written put option;
(C) where the Trust is the seller under a futures
contract, 10% of the settlement price of the futures contract;
(D) where the Trust is the purchaser under a futures
contract, the settlement price of assets purchased under such
futures contract;
(E) the settlement price of the underlying futures
contract if the Trust writes put options on a futures contract;
and
(F) 105% of the Market Value of the underlying futures
contracts if the Trust writes call options on a futures contract
and does not own the underlying contract.
(iv) For so long as any Preferred Shares are rated by Moody's,
the Trust will not enter into any contract to purchase securities for
a fixed price at a future date beyond customary settlement time (other
than such contracts that constitute Moody's Hedging Transactions that
are permitted under paragraph 10(a)(i) of this Part I), except that
the Trust may enter into such contracts to purchase newly issued
securities on the date such securities are issued ("Forward
Commitments"), subject to the following limitations:
(A) the Trust will maintain in a segregated account
cash, cash equivalents or short-term, fixed-income securities
rated P-1, MTG-1 or MIG-1 by Moody's and maturing prior to the
date of the Forward Commitment with a Market Value that equals
or exceeds the amount of the Trust's obligations under any
Forward Commitment to which it is from time to time a party or
long-term fixed income securities with a Discounted Value that
equals or exceeds the amount of the Trust's obligations under
any Forward Commitment to which it is from time to time a party;
and
(B) the Trust will not enter into a Forward Commitment
unless, after giving effect thereto, the Trust would continue to
have Moody's Eligible Assets with an aggregate Discounted Value
equal to or greater than the Preferred Shares Maintenance
Amount.
For purposes of determining whether the Trust has Moody's Eligible Assets
with an aggregate Discounted Value that equals or exceeds the Preferred
Shares Basic Maintenance Amount, the Discounted Value of all Forward
Commitments to which the Trust is a party and of all securities deliverable
to the Trust pursuant to such Forward Commitments shall be zero.
(b) If Fitch is rating any Preferred Shares, then:
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(i) For so long as any Preferred Shares are rated by Fitch,
the Trust will not buy or sell futures contracts, write, purchase or
sell call options on futures contracts or purchase put options on
futures contracts or write call options (except covered call options)
on portfolio securities unless it receives written confirmation from
Fitch that engaging in such transactions would not impair the ratings
then assigned to such Preferred Shares by Fitch, except that the Trust
may purchase or sell exchange-traded futures contracts based on any
index approved by Fitch or Treasury Futures, and purchase, write or
sell exchange-traded put options on such futures contracts and
purchase, write or sell exchange-traded call options on such futures
contracts (collectively, "Fitch Hedging Transactions"), subject to the
following limitations:
(A) the Trust will not engage in any Fitch Hedging
Transaction based on any index approved by Fitch (other than
Closing Transactions) which would cause the Trust at the time of
such transaction to own or have sold outstanding futures
contracts based on such index exceeding in number 10% of the
average number of daily traded futures contracts based on such
index in the 30 days preceding the time of effecting such
transaction as reported by The Wall Street Journal;
(B) the Trust will not engage in any Fitch Hedging
Transaction based on Treasury Futures (other than Closing
Transactions) which would cause the Trust at the time of such
transaction to own or have sold outstanding futures contracts
based on Treasury Futures having an aggregate Market Value
exceeding 80% of the aggregate Market Value of all Fitch
Eligible Assets owned by the Trust (other than Fitch Eligible
Assets already subject to a Fitch Hedging Transaction) and rated
BBB or above by Fitch (or, if not rated by Fitch, rated Baa or
above by Moody's; or, if not rated by Moody's, rated A or above
by S&P) (for purposes of the foregoing, the Trust shall be
deemed to own futures contracts that underlie any outstanding
options written by the Trust);
(C) the Trust will engage in Closing Transactions to
close out any outstanding futures contract based on any index
approved by Fitch if the amount of open interest in such index
as reported by The Wall Street Journal is less than an amount to
be mutually determined by Fitch and the Trust; and
(D) the Trust will not enter into an option or futures
transaction unless, after giving effect thereto, the Trust would
continue to have Fitch Eligible Assets with an aggregate
Discounted Value equal to or greater than the Preferred Shares
Basic Maintenance Amount.
(ii) For purposes of determining whether the Trust has Fitch
Eligible Assets with an aggregate Discounted Value that equals or
exceeds the Preferred
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Shares Basic Maintenance Amount, the Discounted Value of Fitch
Eligible Assets which the Trust is obligated to deliver or receive
pursuant to an outstanding futures contract or option shall be valued
as follows:
(A) assets subject to call options written by the Trust
which are either exchange-traded and "readily reversible" or
expire within 49 days after the date as of which such valuation
is made shall be valued at the lesser of:
(I) Discounted Value and
(II) the exercise price of the call option written
by the Trust;
(B) assets subject to call options written by the Trust
not meeting the requirements of clause (A) of this sentence
shall have no value;
(C) assets subject to put options written by the Trust
shall be valued at the lesser of:
(I) the exercise price and
(II) the Discounted Value of the subject security;
(D) 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 Trust is the seller the contract may be
valued at the settlement price and where the Trust is the buyer
the contract may be valued at the Discounted Value of the assets
subject to the futures contract; and
(E) where delivery may be made to the Trust with any
security of a class of securities, the Trust shall assume that
it will take delivery of the security with the lowest Discounted
Value.
(iii) For purposes of determining whether the Trust has Fitch
Eligible Assets with an aggregate Discounted Value that equals or
exceeds the Preferred Shares Basic Maintenance Amount, the following
amounts shall be subtracted from the aggregate Discounted Value of the
Fitch Eligible Assets held by the Trust:
(A) 10% of the exercise price of a written call option;
(B) the exercise price of any written put option;
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(C) where the Trust is the seller under a futures
contract, 10% of the settlement price of the futures contract;
(D) where the Trust is the purchaser under a futures
contract, the settlement price of assets purchased under such
futures contract;
(E) the settlement price of the underlying futures
contract if the Trust writes put options on a futures contract;
and
(F) 105% of the Market Value of the underlying futures
contracts if the Trust writes call options on a futures contract
and does not own the underlying contract.
(iv) For so long as any Preferred Shares are rated by Fitch,
the Trust will not enter into any contract to purchase securities for
a fixed price at a future date beyond customary settlement time (other
than such contracts that constitute Fitch Hedging Transactions that
are permitted under paragraph 10(b)(i) of this Part I), except that
the Trust may enter into Forward Commitments, subject to the following
limitations:
(A) the Trust will maintain in a segregated account
cash, cash equivalents or short-term, fixed-income securities
rated F-1 by Fitch (or, if not rated by Fitch, rated P-1, MTG-1
or MIG-1 by Moody's) and maturing prior to the date of the
Forward Commitment with a Market Value that equals or exceeds
the amount of the Trust's obligations under any Forward
Commitment to which it is from time to time a party or
long-term fixed income securities with a Discounted Value that
equals or exceeds the amount of the Trust's obligations under
any Forward Commitment to which it is from time to time a party;
and
(B) the Trust will not enter into a Forward Commitment
unless, after giving effect thereto, the Trust would continue to
have Fitch Eligible Assets with an aggregate Discounted Value
equal to or greater than the Preferred Shares Maintenance
Amount.
For purposes of determining whether the Trust has Fitch Eligible Assets
with an aggregate Discounted Value that equals or exceeds the Preferred
Shares Basic Maintenance Amount, the Discounted Value of all Forward
Commitments to which the Trust is a party and of all securities deliverable
to the Trust pursuant to such Forward Commitments shall be zero.
(c) For so long as any Preferred Shares are outstanding and Moody's
or Fitch is, or both are, rating such shares, the Trust will not, unless it
has received written confirmation from Moody's or Fitch or both, as
applicable, that any such action would not impair the rating then assigned
by such Rating Agency to such shares, engage in any one or more of the
following transactions:
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(i) borrow money, except that the Trust may, without
obtaining the written confirmation described above, borrow money for
the purpose of clearing securities transactions if:
(A) the Preferred Shares Basic Maintenance Amount would
continue to be satisfied after giving effect to such borrowing,
and
(B) such borrowing:
(I) is privately arranged with a bank or other
person and is evidenced by a promissory note or other
evidence of indebtedness that is not intended to be
publicly distributed; or
(II) is for "temporary purposes," is evidenced by a
promissory note or other evidence of indebtedness and is
in an amount not exceeding 5% of the value of the total
assets of the Trust at the time of the borrowing (for
purposes of the foregoing, "temporary purposes" means
that the borrowing is to be repaid within sixty days and
is not to be extended or renewed);
(ii) except as provided in paragraph 4 of this Part I, issue
additional shares of any series of Preferred Shares or any class or
series of shares ranking prior to or on a parity with Preferred Shares
with respect to the payment of dividends or the distribution of assets
upon dissolutions, liquidation or winding up of the Trust, or reissue
any Preferred Shares previously purchased or redeemed by the Trust;
(iii) engage in any short sales of securities;
(iv) lend securities;
(v) merge or consolidate into or with any other corporation
or entity; or
(vi) change the Pricing Service.
11. Miscellaneous.
(a) Amendment of This Section to Add Additional Series. Subject to
the provisions of paragraph 10(c)(ii) of this Part I, the Trustees may, by
resolution duly adopted, without shareholder approval (except as otherwise
provided by this Section 12.1 or required by applicable law), amend this
Section 12.1 to (1) reflect any amendments hereto which the Trustees are
entitled to adopt pursuant to the terms of this Section 12.1 without
shareholder approval or (2) add additional series of Preferred Shares or
additional shares of a series of Preferred Shares (and terms relating
thereto) to the series and
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Preferred Shares theretofore described thereon. Each such additional series
and all such additional shares shall be governed by the terms of this
Section 12.1.
(b) No Fractional Shares. No fractional shares of Preferred Shares
shall be issued.
(c) Status of Preferred Shares Redeemed, Exchanged or Otherwise
Acquired by the Trust. Preferred Shares which are redeemed, exchanged or
otherwise acquired by the Trust shall return to the status of authorized
and unissued preferred shares without designation as to series.
(d) Board May Resolve Ambiguities. To the extent permitted by
applicable law, the Trustees may interpret or adjust the provisions of this
Section 12.1 to resolve any inconsistency or ambiguity or to remedy any
formal defect, and may amend this Section 12.1 with respect to any series
of Preferred Shares prior to the issuance of shares of such series.
(e) Heading Not Determinative. The headings contained in this
Section 12.1 are for convenience of reference only and shall not affect the
meaning or interpretation of this Section 12.1.
(f) Notices. All notices or communications, unless otherwise
specified in the Bylaws of the Trust or this Section 12.1, shall be
sufficiently given if in writing and delivered in person or mailed by
first-class mail, postage prepaid.
PART II.
1. Orders.
(a) Prior to the Submission Deadline on each Auction Date for shares
of a series of Preferred Shares:
(i) each Beneficial Owner of shares of such series may submit
to its Broker-Dealer by telephone or otherwise information as to:
(A) the number of Outstanding shares, if any, of such
series held by such Beneficial Owner which such Beneficial Owner
desires to continue to hold without regard to the Applicable
Rate for shares of such series for the next succeeding Rate
Period of such shares;
(B) the number of Outstanding shares, if any, of such
series held by such Beneficial Owner which such Beneficial Owner
offers to sell if the Applicable Rate for shares of such series
for the next succeeding Rate Period of shares of such series
shall be less than the rate per annum specified by such
Beneficial Owner; and/or
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(C) the number of Outstanding shares, if any, of such
series held by such Beneficial Owner which such Beneficial Owner
offers to sell without regard to the Applicable Rate for shares
of such series for the next succeeding Rate Period of shares of
such series;
and
(ii) one or more Broker-Dealers, using lists of Potential
Beneficial Owners, shall in good faith, for the purpose of conducting
a competitive Auction in a commercially reasonable manner, contact
Potential Beneficial Owners (by telephone or otherwise), including
Persons that are not Beneficial Owners, on such lists to determine the
number of shares, if any, of such series which each such Potential
Beneficial Owner offers to purchase if the Applicable Rate for shares
of such series for the next succeeding Rate Period of shares of such
series 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 by a Broker-Dealer to the
Auction Agent, of information referred to in clause (i)(A), (i)(B), (i)(C) or
(ii) of this paragraph 1(a) is hereinafter referred to as an "Order" and
collectively as "Orders," and each Beneficial Owner and each Potential
Beneficial Owner placing an Order with a Broker-Dealer, and such Broker-Dealer
placing an order with the Auction Agent, is hereinafter referred to as a
"Bidder" and collectively as "Bidders"; an Order containing the information
referred to in clause (i)(A) of this paragraph (a) is hereinafter referred to as
a "Hold Order" and collectively as "Hold Orders"; an Order containing the
information referred to in clause (i)(B) or (ii) of this paragraph (a) is
hereinafter referred to as a "Bid" and collectively as "Bids"; and an Order
containing the information referred to in clause (i)(C) of this paragraph (a) is
hereinafter referred to as a "Sell Order" and collectively as "Sell Orders."
(b) (i) A Bid by a Beneficial Owner or an Existing Holder of
shares of a series of Preferred Shares subject to an Auction on any Auction
Date shall constitute an irrevocable offer to sell:
(A) the number of Outstanding shares of such series
specified in such Bid if the Applicable Rate for shares of such
series determined on such Auction Date shall be less than the
rate specified therein;
(B) such number or a lesser number of Outstanding shares
of such series to be determined as set forth in clause (iv) of
paragraph 4(a) of this Part II if the Applicable Rate for shares
of such series determined on such Auction Date shall be equal to
the rate specified therein; or
(C) the number of Outstanding shares of such series
specified in such Bid if the rate specified therein shall be
higher than the Maximum
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Rate for shares of such series, or such number or a lesser
number of Outstanding shares of such series to be determined as
set forth in clause (iii) of paragraph 4(b) of this Part II if
the rate specified therein shall be higher than the Maximum Rate
for shares of such series and Sufficient Clearing Bids for
shares of such series do not exist.
(ii) A Sell Order by a Beneficial Owner or an Existing Holder of
shares of a series of Preferred Shares subject to an Auction on any Auction
Date shall constitute an irrevocable offer to sell:
(A) the number of Outstanding shares of such series specified
in such Sell Order; or
(B) such number or a lesser number of Outstanding shares of
such series as set forth in clause (iii) of paragraph 4(b) of this
Part II if Sufficient Clearing Bids for shares of such series do not
exist; provided, however, that a Broker-Dealer that is an Existing
Holder with respect to shares of a series of Preferred Shares shall
not be liable to any Person for failing to sell such shares pursuant
to a Sell Order described in the proviso to paragraph 2(c) of this
Part II if (1) such shares were transferred by the Beneficial Owner
thereof without compliance by such Beneficial Owner or its transferee
Broker-Dealer (or other transferee person, if permitted by the Trust)
with the provisions of paragraph 6 of this Part II or (2) such
Broker-Dealer has informed the Auction Agent pursuant to the terms of
its Broker-Dealer Agreement that, according to such Broker-Dealer's
records, such Broker-Dealer believes it is not the Existing Holder of
such shares.
(iii) A Bid by a Potential Beneficial Holder or a Potential Holder of
shares of a series of Preferred Shares subject to an Auction on any Auction
Date shall constitute an irrevocable offer to purchase:
(A) the number of outstanding shares of such series specified
in such Bid if the Applicable Rate for shares of such series
determined on such Auction Date shall be higher than the rate
specified therein; or
(B) such number or a lesser number of Outstanding shares of
such series as set forth in clause (v) of paragraph 4(a) of this Part
II if the Applicable Rate for shares of such series determined on such
Auction Date shall be equal to the rate specified therein.
(c) No Order for any number of Preferred Shares other than whole
shares shall be valid.
2. Submission of Orders by Broker-Dealers to Auction Agent.
(a) Each Broker-Dealer shall submit in writing to the Auction Agent
prior to the Submission Deadline on each Auction Date all Orders for
Preferred Shares of a series
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subject to an Auction on such Auction Date 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 shall
specify with respect to each Order for such shares:
(i) the name of the Bidder placing such Order (which shall be
the Broker-Dealer unless otherwise permitted by the Trust);
(ii) the aggregate number of shares of such series that are
the subject of such Order;
(iii) to the extent that such Bidder is an Existing Holder of
shares of such series:
(A) the number of shares, if any, of such series subject
to any Hold Order of such Existing Holder;
(B) the number of shares, if any, of such series subject
to any Bid of such Existing Holder and the rate specified in
such Bid; and
(C) the number of shares, if any, of such series subject
to any Sell Order of such Existing Holder; and
(iv) to the extent such Bidder is a Potential Holder of shares
of such series, the rate and number of shares of such series specified
in such Potential Holder's Bid.
(b) If any rate 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%.
(c) If an Order or Orders covering all of the outstanding Preferred
Shares of a series held by any Existing Holder is not submitted to the
Auction Agent prior to the Submission Deadline, the Auction Agent shall
deem a Hold Order to have been submitted by or on behalf of such Existing
Holder covering the number of Outstanding shares of such series held by
such Existing Holder and not subject to Orders submitted to the Auction
Agent; provided, however, that if an Order or Orders covering all of the
Outstanding shares of such series held by any Existing Holder is not
submitted to the Auction Agent prior to the Submission Deadline for an
Auction relating to a Special Rate Period consisting of more than 91 Rate
Period Days, the Auction Agent shall deem a Sell Order to have been
submitted by or on behalf of such Existing Holder covering the number of
Outstanding shares of such series held by such Existing Holder and not
subject to Orders submitted to the Auction Agent.
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(d) If one or more Orders of an Existing Holder are submitted to the
Auction Agent covering in the aggregate more than the number of Outstanding
Preferred Shares of a series subject to an Auction held by such Existing
Holder, such Orders shall be considered valid in the following order of
priority:
(i) all Hold Orders for shares of such series shall be
considered valid, but only up to and including in the aggregate the
number of Outstanding shares of such series held by such Existing
Holder, and if the number of shares of such series subject to such
Hold Orders exceeds the number of Outstanding shares of such series
held by such Existing Holder, the number of shares subject to each
such Hold Order shall be reduced pro rata to cover the number of
Outstanding shares of such series held by such Existing Holder;
(ii) (A) any Bid for shares of such series shall be
considered valid up to and including the excess of the number of
Outstanding shares of such series held by such Existing Holder over
the number of shares of such series subject to any Hold Orders
referred to in clause (i) above;
(B) subject to subclause (A), if more than one Bid of an
Existing Holder for shares of such series is submitted to the Auction
Agent with the same rate and the number of Outstanding shares of such
series subject to such Bids is greater than such excess, such Bids
shall be considered valid up to and including the amount of such
excess, and the number of shares of such series subject to each Bid
with the same rate shall be reduced pro rata to cover the number of
shares of such series equal to such excess;
(C) subject to subclauses (A) and (B), if more than one
Bid of an Existing Holder for shares of such series is submitted to
the Auction Agent with different rates, such Bids shall be considered
valid in the ascending order of their respective rates up to and
including the amount of such excess; and
(D) in any such event, the number, if any, of such
Outstanding shares of such series subject to any portion of Bids
considered not valid in whole or in part under this clause (ii) shall
be treated as the subject of a Bid for shares of such series by or on
behalf of a Potential Holder at the rate therein specified; and
(iii) all Sell Orders for shares of such series shall be
considered valid up to and including the excess of the number of
Outstanding shares of such series held by such Existing Holder over
the sum of shares of such series subject to valid Hold Orders referred
to in clause (i) above and valid Bids referred to in clause (ii)
above.
(e) If more than one Bid for one or more shares of a series of
Preferred Shares is submitted to the Auction Agent by or on behalf of any
Potential Holder, each such Bid submitted shall be a separate Bid, with the
rate and number of shares therein specified.
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(f) 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.
3. Determination of Sufficient Clearing Bids, Winning Bid Rate and Applicable
Rate.
(a) Not earlier than the Submission Deadline on each Auction Date
for shares of a series of Preferred Shares, the Auction Agent shall
assemble all valid Orders submitted or deemed submitted to it by the
Broker-Dealers in respect of shares of such series (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 as a "Submitted Order" and
collectively as "Submitted Hold Orders," "Submitted Bids" or "Submitted
Sell Orders," as the case may be, or as "Submitted Orders") and shall
determine for such series:
(i) the excess of the number of Outstanding shares of such
series over the number of Outstanding shares of such series subject to
Submitted Hold Orders (such excess being hereinafter referred to as
the "Available Preferred Shares" of such series);
(ii) from the Submitted Orders for shares of such series
whether:
(A) the number of Outstanding shares of such series
subject to Submitted Bids of Potential Holders specifying one or
more rates equal to or lower than the Maximum Rate for shares of
such series;
exceeds or is equal to the sum of:
(B) the number of Outstanding shares of such series
subject to Submitted Bids of Existing Holders specifying one or
more rates higher than the Maximum Rate for shares of such
series; and
(C) the number of Outstanding shares of such series
subject to Submitted Sell Orders
(in the event such excess or such equality exists (other than because
the number of shares of such series in subclauses (B) and (C) above is
zero because all of the Outstanding shares of such series are subject
to Submitted Hold Orders), such Submitted Bids in subclause (A) above
being hereinafter referred to collectively as "Sufficient Clearing
Bids" for shares of such series); and
(iii) if Sufficient Clearing Bids for shares of such series
exist, the lowest rate specified in such Submitted Bids (the "Winning
Bid Rate" for shares of such series) which if:
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(A) (I) each such Submitted Bid of Existing Holders
specifying the Winning Bid Rate and (II) all other such
Submitted Bids of Existing Holders specifying lower rates were
rejected, thus entitling such Existing Holders to continue to
hold the shares of such series that are subject to such
Submitted Bids; and
(B) (I) each such Submitted Bid of Potential Holders
specifying the Winning Bid Rate and (II) all other such
Submitted Bids of Potential Holders specifying lower rates were
accepted;
would result in such Existing Holders described in subclause (A) above
continuing to hold an aggregate number of Outstanding shares of such
series which, when added to the number of Outstanding shares of such
series to be purchased by such Potential Holders described in
subclause (B) above, would equal not less than the Available Preferred
Shares of such series.
(b) Promptly after the Auction Agent has made the determinations
pursuant to paragraph 3(a) of this Part II, the Auction Agent shall advise
the Trust of the Maximum Rate for shares of the series of Preferred Shares
for which an Auction is being held on the Auction Date and, based on such
determination, the Applicable Rate for shares of such series for the next
succeeding Rate Period thereof as follows:
(i) if Sufficient Clearing Bids for shares of such series
exist, that the Applicable Rate for all shares of such series for the
next succeeding Rate Period thereof shall be equal to the Winning Bid
Rate for shares of such series so determined;
(ii) if Sufficient Clearing Bids for shares of such series do
not exist (other than because all of the Outstanding shares of such
series are subject to Submitted Hold Orders), that the Applicable Rate
for all shares of such series for the next succeeding Rate Period
thereof shall be equal to the Maximum Rate for shares of such series;
or
(iii) if all of the Outstanding shares of such series are
subject to Submitted Hold Orders, that the Rate Period next
succeeding the Auction shall automatically be the same length as the
immediately preceding Rate Period and the Applicable Rate for all
shares of such series for the next succeeding Rate Period thereof
shall be 90% of the applicable Reference Rate.
4. Acceptance and Rejection of Submitted Bids and Submitted Sell Orders and
Allocation of Shares.
Existing Holders shall continue to hold the Preferred Shares that are
subject to Submitted Hold Orders, and, based on the determinations made pursuant
to paragraph 3(a) of this Part II,
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the Submitted Bids and Submitted Sell Orders shall be accepted or rejected by
the Auction Agent and the Auction Agent shall take such other action as set
forth below:
(a) If Sufficient Clearing Bids for shares of a series of Preferred
Shares have been made, all Submitted Sell Orders with respect to shares of
such series shall be accepted and, subject to the provisions of paragraphs
4(d) and 4(e) of this Part II, Submitted Bids with respect to shares of
such series shall be accepted or rejected as follows in the following order
of priority and all other Submitted Bids with respect to shares of such
series shall be rejected:
(i) Existing Holders' Submitted Bids for shares of such
series specifying any rate that is higher than the Winning Bid Rate
for shares of such series shall be accepted, thus requiring each such
Existing Holder to sell the Preferred Shares subject to such Submitted
Bids;
(ii) Existing Holders' Submitted Bids for shares of such
series specifying any rate that is lower than the Winning Bid Rate for
shares of such series shall be rejected, thus entitling each such
Existing Holder to continue to hold the Preferred Shares subject to
such Submitted Bids;
(iii) Potential Holders' Submitted Bids for shares of such
series specifying any rate that is lower than the Winning Bid Rate for
shares of such series shall be accepted;
(iv) each Existing Holder's Submitted Bid for shares of such
series specifying a rate that is equal to the Winning Bid Rate for
shares of such series shall be rejected, thus entitling such Existing
Holder to continue to hold the Preferred Shares subject to such
Submitted Bid, unless the number of Outstanding Preferred Shares
subject to all such Submitted Bids shall be greater than the number of
Preferred Shares ("remaining shares") equal to the excess of the
Available Preferred Shares of such series over the number of Preferred
Shares subject to Submitted Bids described in clauses (ii) and (iii)
of this paragraph 4(a), in which event such Submitted Bid of such
Existing Holder shall be rejected in part, and such Existing Holder
shall be entitled to continue to hold Preferred Shares subject to such
Submitted Bid, but only in an amount equal to the number of Preferred
Shares of such series obtained by multiplying the number of remaining
shares by a fraction, the numerator of which shall be the number of
Outstanding Preferred Shares held by such Existing Holder subject to
such Submitted Bid and the denominator of which shall be the aggregate
number of Outstanding Preferred Shares subject to such Submitted Bids
made by all such Existing Holders that specified a rate equal to the
Winning Bid Rate for shares of such series; and
(v) each Potential Holder's Submitted Bid for shares of such
series specifying a rate that is equal to the Winning Bid Rate for
shares of such series
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shall be accepted but only in an amount equal to the number of shares
of such series obtained by multiplying the number of shares in the
excess of the Available Preferred Shares of such series over the
number of Preferred Shares subject to Submitted Bids described in
clauses (ii) through (iv) of this paragraph 4(a) by a fraction, the
numerator of which shall be the number of Outstanding Preferred Shares
subject to such Submitted Bid and the denominator of which shall be
the aggregate number of Outstanding Preferred Shares subject to such
Submitted Bids made by all such Potential Holders that specified a
rate equal to the Winning Bid Rate for shares of such series.
(b) If Sufficient Clearing Bids for shares of a series of Preferred
Shares have not been made (other than because all of the Outstanding shares
of such series are subject to Submitted Hold Orders), subject to the
provisions of paragraph 4(d) of this Part II, Submitted Orders for shares
of such series shall be accepted or rejected as follows in the following
order of priority and all other Submitted Bids for shares of such series
shall be rejected:
(i) Existing Holders' Submitted Bids for shares of such
series specifying any rate that is equal to or lower than the Maximum
Rate for shares of such series shall be rejected, thus entitling such
Existing Holders to continue to hold the Preferred Shares subject to
such Submitted Bids;
(ii) Potential Holders' Submitted Bids for shares of such
series specifying any rate that is equal to or lower than the Maximum
Rate for shares of such series shall be accepted; and
(iii) Each Existing Holder's Submitted Bid for shares of such
series specifying any rate that is higher than the Maximum Rate for
shares of such series and the Submitted Sell Orders for shares of such
series of each Existing Holder shall be accepted, thus entitling each
Existing Holder that submitted or on whose behalf was submitted any
such Submitted Bid or Submitted Sell Order to sell the shares of such
series subject to such Submitted Bid or Submitted Sell Order, but in
both cases only in an amount equal to the number of shares of such
series obtained by multiplying the number of shares of such series
subject to Submitted Bids described in clause (ii) of this paragraph
(b) by a fraction, the numerator of which shall be the number of
Outstanding shares of such series held by such Existing Holder subject
to such Submitted Bid or Submitted Sell Order and the denominator of
which shall be the aggregate number of Outstanding shares of such
series subject to all such Submitted Bids and Submitted Sell Orders.
(c) If all of the Outstanding shares of a series of Preferred Shares
are subject to Submitted Hold Orders, all Submitted Bids for shares of such
series shall be rejected.
(d) If, as a result of the procedures described in clause (iv) or
(v) of paragraph 4(a) or clause (iii) of paragraph 4(b) of this Part II,
any Existing Holder would be entitled
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or required to sell, or any Potential Holder would be entitled or required
to purchase, a fraction of a share of a series of Preferred Shares on any
Auction Date, the Auction Agent shall, in such manner as it shall determine
in its sole discretion, round up or down the number of Preferred Shares of
such series to be purchased or sold by any Existing Holder or Potential
Holder on such Auction Date as a result of such procedures so that the
number of shares so purchased or sold by each Existing Holder or Potential
Holder on such Auction Date shall be whole Preferred Shares.
(e) If, as a result of the procedures described in clause (v) of
paragraph 4(a) of this Part II, any Potential Holder would be entitled or
required to purchase less than a whole share of a series of Preferred
Shares on any Auction Date, the Auction Agent shall, in such manner as it
shall determine in its sole discretion, allocate Preferred Shares of such
series for purchase among Potential Holders so that only whole shares of
Preferred Shares of such series are purchased on such Auction Date as a
result of such procedures by any Potential Holder, even if such allocation
results in one or more Potential Holders not purchasing Preferred Shares of
such series on such Auction Date.
(f) Based on the results of each Auction for shares of a series of
Preferred Shares, the Auction Agent shall determine the aggregate number of
shares of such series to be purchased and the aggregate number of shares of
such series to be sold by Potential Holders and Existing Holders and, with
respect to each Potential Holder and Existing Holder, to the extent that
such aggregate number of shares to be purchased and such aggregate number
of shares to be sold differ, determine to which other Potential Holder(s)
or Existing Holder(s) they shall deliver, or from which other Potential
Holder(s) or Existing Holder(s) they shall receive, as the case may be,
Preferred Shares of such series. Notwithstanding any provision of the
Auction Procedures to the contrary, in the event an Existing Holder or
Beneficial Owner of a series of Preferred Shares with respect to whom a
Broker-Dealer submitted a Bid to the Auction Agent for such shares that was
accepted in whole or in part, or submitted or is deemed to have submitted a
Sell Order for such shares that was accepted in whole or in part, fails to
instruct its Agent Member to deliver such shares against payment therefor,
partial deliveries of Preferred Shares that have been made in respect of
Potential Holders' or Potential Beneficial Owners' submitted Bids for
shares of such series that have been accepted in whole or in part shall
constitute good delivery to such Potential Holders and Potential Beneficial
Owners.
(g) Neither the Trust nor the Auction Agent nor any affiliate of
either shall have any responsibility or liability with respect to the
failure of an Existing Holder, a Potential Holder, a Beneficial Owner, a
Potential Beneficial Owner or its respective Agent Member to deliver
Preferred Shares of any series or to pay for Preferred Shares of any series
sold or purchased pursuant to the Auction Procedures or otherwise.
5. Force Majeure.
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(a) Notwithstanding anything else set forth herein, if an Auction
Date is not a Business Day because the New York Stock Exchange is closed
for business due to an act of God, natural disaster, act of war, civil or
military disturbance, act of terrorism, sabotage, riots or a loss or
malfunction of utilities or communications services, or if the Auction
Agent is not able to conduct an Auction in accordance with the Auction
Procedures for any such reason, then the Applicable Rate for the next
Rate Period shall be the Applicable Rate determined on the previous
Auction Date.
(b) Notwithstanding anything else set forth herein, if a Dividend
Payment Date is not a Business Day because the New York Stock Exchange is
closed for business due to an act of God, natural disaster, act of war,
civil or military disturbance, act of terrorism, sabotage, riots or a loss
or malfunction of utilities or communications services, or if the dividend
payable on such date cannot be paid for any such reason, then:
(i) The Dividend Payment Date for the affected Dividend
Period shall be the next Business Day on which the Trust and the
Auction Agent are able to cause the dividend to be paid using
commercially reasonable best efforts;
(ii) The affected Dividend Period shall end on the day it
would have ended had such event not occurred and the Dividend Payment
Date had remained the scheduled date; and
(iii) The next Dividend Period will begin and end on the dates
on which it would have begun and ended had such event not occurred and
the Dividend Payment Date remained the scheduled date.
6. Auction Agent.
For so long as any Preferred Shares are outstanding, the Auction Agent,
duly appointed by the Trust to so act, shall be in each case a commercial bank,
trust company or other institution independent of the Trust and its affiliates
(which, however, may engage or have engaged in business transactions with the
Trust or its affiliates), and at no time shall the Trust or any of its
affiliates act as the Auction Agent in connection with the Auction Procedures.
If the Auction Agent resigns or for any reason its appointment is terminated
during any period that any Preferred Shares are outstanding, the Trustees shall
attempt to appoint another qualified commercial bank, trust company or
institution to act as the Auction Agent. The Auction Agent's registry of
Existing Holders of a series of Preferred Shares shall be conclusive and binding
on the Broker-Dealers. A Broker-Dealer may inquire of the Auction Agent between
3:00 p.m. on the Business Day preceding an Auction for a series of Preferred
Shares and 9:30 a.m. on the Auction Date for such Auction to ascertain the
number of shares of such series in respect of which the Auction Agent has
determined such Broker-Dealer to be an Existing Holder. If such Broker-Dealer
believes it is the Existing Holder of fewer shares of such series than specified
by the Auction Agent in response to such Broker-Dealer's inquiry, such
Broker-Dealer may so inform the Auction Agent of that belief. Such Broker-Dealer
shall not, in its capacity as Existing Holder of shares of such series, submit
Orders in such Auction in respect of shares of such series
C-84
covering in the aggregate more than the number of shares of such series
specified by the Auction Agent in response to such Broker-Dealer's inquiry.
7. Transfer of Preferred Shares.
Unless otherwise permitted by the Trust, a Beneficial Owner or an Existing
Holder may sell, transfer or otherwise dispose of Preferred Shares only in whole
shares and only pursuant to a Bid or Sell Order placed with the Auction Agent in
accordance with the procedures described in this Part II or to a Broker-Dealer;
provided, however, that (a) a sale, transfer or other disposition of Preferred
Shares 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 this paragraph 6 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 the case of all
transfers other than pursuant to Auctions, the Broker-Dealer (or other Person,
if permitted by the Trust) to whom such transfer is made shall advise the
Auction Agent of such transfer.
8. Global Certificate.
Prior to the commencement of a Voting Period, (i) all of the shares of a
series of Preferred Shares outstanding from time to time shall be represented by
one global certificate registered in the name of the Securities Depository or
its nominee and (ii) no registration of transfer of shares of a series of
Preferred Shares shall be made on the books of the Trust to any Person other
than the Securities Depository or its nominee.
C-85
PART C - OTHER INFORMATION
Item 24: Financial Statements and Exhibits
1. Financial Statements:
Included in Part A: Not applicable.
Included in Part B: Financial Statements.
Unaudited Statement of Assets and Liabilities as of November 20, 2003.
Unaudited Statement of Operations for the Period September 30, 2003
through November 20, 2003.
Unaudited Statement of Changes in Net Asset for the Period
September 30, 2003 through November 20, 2003.
Unaudited Statement of Cash Flows for the Period September 30, 2003
through November 20, 2003.
Unaudited Schedule of Investments as of November 20, 2003.
Unaudited Financial Highlights for the Period September 30, 2003
through November 20, 2003.
Unaudited Notes to Financial Statements as of November 20, 2003.
The Registrant's audited Statement of Assets and Liabilities dated as
of September 9, 2003 and Statement of Operations for the one-day
period ending September 9, 2003, including notes thereto and the
report of PricewaterhouseCoopers LLP thereon, are incorporated by
reference into Part B from the Statement of Additional Information
dated September 25, 2003 for the offering of the Registrant's common
shares, which was filed with the SEC on September 29, 2003 (File No.
333-107150).
2. Exhibits:
a.1 Agreement and Declaration of Trust dated July 14, 2003. (1)
a.2 Amended and Restated Agreement and Declaration of Trust dated August 21,
2003. (2)
b.1 Amended and Restated Bylaws of Registrant dated August 21, 2003. (2)
b.2 Second Amended and Restated Bylaws of Registrant, to be filed by
amendment.
c. None.
d.1 Article III (Shares) and Article V (Shareholders' Voting Powers and
Meetings) of the Amended and Restated Agreement and Declaration of
Trust. (2)
d.2 Article 10 (Shareholders' Voting Powers and Meetings) of the Amended
and Restated Bylaws of Registrant. (2)
d.3 Specimen Certificate representing Registrant's Taxable Auction Market
Preferred Shares of beneficial interest ("AMPS"), filed herewith.
e. Terms and Conditions of Dividend Reinvestment Plan. (3)
f. None.
g. Form of Investment Management Agreement between Registrant and Western
Asset Management Company ("Western Asset"). (3)
h. Form of Underwriting Agreement for the AMPS, to be filed by amendment.
i. None.
j. Form of Custodian Agreement between Registrant and State Street Bank and
Trust Company. (3)
1
k.1 Form of Transfer Agency and Service Agreement among Registrant, EquiServe
Trust Company, N.A. and EquiServe, Inc. (3)
k.2 Form of Servicing Agreement between Registrant and Claymore Securities,
Inc. ("Claymore"). (3)
k.3 Form of Administrative Services Agreement between Registrant and Legg
Mason Fund Adviser, Inc. (3)
k.4 Auction Agency Agreement between the Registrant and the Auction Agent
as to the Registrant's AMPS, to be filed by amendment.
k.5 Broker-Dealer Agreement as to the Registrant's AMPS, to be filed by
amendment.
k.6 Depository Trust Company Representations Letter as to the Registrant's
AMPS, filed herewith.
l. Opinion and consent of Ropes & Gray LLP as to the Registrant's AMPS, to
be filed by amendment.
m. None.
n. Consent of PricewaterhouseCoopers LLP, filed herewith.
o. None.
p. Subscription Agreement of Western Asset. (3)
q. None.
r.1 Code of Ethics of Registrant and Western Asset. (2)
r.2 Code of Ethics of Legg Mason Wood Walker, Incorporated. (2)
r.3 Code of Ethics of Claymore. (3)
s.1 Power of Attorney for each of Messrs. Dalmaso, Nyberg, Toupin, McShea
and Mses. Karpinski and Kochevar, dated August 21, 2003.(4)
s.2 Power of Attorney for Mr. Erichsen, dated September 4, 2003.(4)
s.3 Power of Attorney for Mr. Kohn and Ms. Morris, dated October 3, 2003.(4)
----------
(1) Incorporated by reference from the Registrant's initial Registration
Statement on Form N-2, File No. 333-107150, filed on July 18, 2003.
(2) Incorporated by reference to Pre-Effective Amendment No. 1 to the
Registrant's initial Registration Statement on Form N-2, File No.
333-107150, filed on August 27, 2003.
(3) Incorporated by reference to Pre-Effective Amendment No. 2 to the
Registrant's initial Registration Statement on Form N-2, File No.
333-107150, filed on September 25, 2003.
(4) Incorporated by reference to Pre-Effective Amendment No.3 to the
Registrant's initial Registration Statement on Form N-2, File No.
333-109707, filed on October 15, 2003.
Item 25: Marketing Arrangements
See Exhibit h of this Registration Statement, including Sections 2,
3(a)(xi), 3(b), 6, 7 and 10.
Item 26: Other Expenses of Issuance and Distribution
Securities and Exchange Commission fees $16,585
2
Printing and engraving expenses $ 35,000
Legal fees $100,000
Moody's Registration Fee $ 61,500
Fitch Rating's Registration Fee $ 61,500
Accounting expenses $ 30,000
---------
Total $304,585
* Estimated expenses to be completed by amendment.
Item 27: Persons Controlled by or under Common Control with Registrant
Not applicable.
Item 28: Number of Holders of Securities
At November 20, 2003
TITLE OF CLASS NUMBER OF RECORD HOLDERS
------------------------------ ------------------------
AMPS, no par value 0
Common Shares, no par value 59
Item 29: Indemnification
Reference is made to Article VIII, Sections 1 through 4, of the
Registrant's Amended and Restated Agreement and Declaration of Trust, which
is incorporated by reference herein.
Insofar as indemnification for liabilities arising under the
Securities Act of 1933, as amended (the "Act"), may be permitted to trustees,
officers and controlling persons of the Registrant by the Registrant pursuant
to the Registrant's Amended and Restated Agreement and Declaration of Trust,
its Second Amended and Restated Bylaws or otherwise, the Registrant is aware
that in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Act and,
therefore, is unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of
expenses incurred or paid by trustees, officers or controlling persons of the
Registrant in the successful defense of any action, suit or proceeding) is
asserted by such trustees, officers or controlling persons in connection with
the securities being registered, the Registrant will, unless in the opinion
of its counsel the matter has been settled by controlling precedent, submit
to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
3
Item 30: Business and Other Connections of Investment Adviser
Western Asset is an investment adviser registered with the Securities and
Exchange Commission under the Investment Advisers Act of 1940. The following is
a list of other substantial business activities in which directors, officers or
partners of Western Asset have been engaged as director, officer, employee,
partner or trustee.
Bruce D. Alberts Chief Financial Officer, Western Asset
Peter L. Bain Director, Western Asset
Director, Barrett
Director, Bartlett
Director, Berkshire
Manager, Brandywine
Director, LMFC
Executive Vice President, LMI
Director, LML
Director, LMP
Director, LMRES
Director, LMT
Director, PCM
Manager, President and CEO, PCMH
Manager, Royce
James W. Hirschmann III President, CEO and Director, Western Asset
Managing Director and Director, WAML
Gavin L. James Director of Global Client Services, Western Asset
S. Kenneth Leech Chief Investment Officer, Western Asset
Director, WAML
Gregory B. McShea Secretary and Head of Compliance, Western Asset
Edward A. Taber III Director, Western Asset
Executive Vice President, LMI
Manager, Brandywine
Director, Batterymarch
Director, LMCM
Director, WAML
Director, LMREI
Director, LMFA
Director, LMAM
Director, Perigee
Stephen A. Walsh Deputy Chief Investment Officer, Western Asset
4
Addresses for Item 30:
Barrett Associates, Inc. ("Barrett")
565 5th Avenue
New York, NY 10017
Bartlett & Co. ("Bartlett")
36 East Fourth Street
Cincinnati, OH 45202
Batterymarch Financial Management, Inc. ("Batterymarch")
200 Clarendon Street
Boston, MA 02116
Berkshire Asset Management, Inc. ("Berkshire")
46 Public Square, Suite 700
Wilkes-Barre, PA 18701
Brandywine Asset Management, LLC ("Brandywine")
Three Christina Centre, Suite 1200
201 North Walnut Street
Wilmington, DE 19801
Legg Mason Asset Management (Asia) Pte. Ltd ("LMAM")
Three Temasek Avenue, # 10-02, Centennial Tower
Singapore 039190
Legg Mason Capital Management, Inc. ("LMCM")
100 Light Street
Baltimore, MD 21202
Legg Mason Focus Capital, Inc. ("LMFC")
Two Town Center, Suite 200
Bryn Mawr, PA 19010
Legg Mason Fund Adviser, Inc. ("LMFA")
100 Light Street
Baltimore, MD 21202
Legg Mason, Inc. ("LMI")
100 Light Street
Baltimore, MD 21202
Legg Mason Limited ("LML")
155 Bishopsgate
London EC2M 3XG
England
Legg Mason Properties, Inc. ("LMP")
100 Light Street
Baltimore, Maryland 21202
Legg Mason Real Estate Investors, Inc. ("LMREI")
100 Light Street
Baltimore, MD 21202
Legg Mason Real Estate Services, Inc. ("LMRES")
Mellon Bank Center, 12th Floor
1735 Market Street
Philadelphia, PA 19103
Legg Mason Trust, fsb ("LMT")
100 Light Street
Baltimore, MD 21202
5
PCM Holdings, Inc. ("PCM")
8889 Pelican Bay Boulevard, Suite 500
Naples, FL 34108-7512
PCM Holdings II, LLC ("PCMH")
8889 Pelican Bay Boulevard, Suite 500
Naples, FL 34108-7512
Perigee Investment Counsel Inc. ("Perigee")
Box 9, Suite 1400
320 Bay Street
Toronto, Ontario M5H 4A6
Royce & Associates, LLC ("Royce")
1414 Avenue of the Americas
New York, NY 10019
Western Asset Management Company ("Western Asset")
117 East Colorado Boulevard
Pasadena, CA 91105
Western Asset Management Company Limited ("WAML")
155 Bishopsgate
London EC2M 3XG England
Item 31: Location of Accounts and Records
The account books and other documents required to be maintained by the
Registrant pursuant to Section 31(a) of the Investment Company Act of 1940 and
the Rules thereunder will be maintained at the offices of State Street Bank &
Trust Company, 150 Newport Avenue AFB/4N, North Quincy, Massachusetts 02171,
Legg Mason Fund Adviser, Inc., 100 Light Street, Baltimore, Maryland 21202
and/or EquiServe Trust Company, N.A., 150 Royall Street, Canton, MA 02021.
Item 32: Management Services
Not applicable.
Item 33: Undertakings
1. Registrant undertakes to suspend the offering of its AMPS until it
amends the prospectus filed herewith if (1) subsequent to the effective date
of its registration statement, the net asset value declines more than 10
percent from its net asset value as of the effective date
6
of the registration statement or (2) the net asset value increases to an amount
greater than its net proceeds as stated in the prospectus.
2. Not applicable.
3. Not applicable.
4. Not applicable.
5. The Registrant undertakes that:
a. For purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed as
part of this registration statement in reliance upon Rule 430A and
contained in the form of prospectus filed by the Registrant under Rule
497(h) under the Securities Act of 1933 shall be deemed to be part of
this registration statement as of the time it was declared effective; and
b. For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of the securities at
that time shall be deemed to be the initial bona fide offering thereof.
6. The Registrant undertakes to send by first class mail or other means
designed to ensure equally prompt delivery, within two business days of receipt
of a written or oral request, any Statement of Additional Information.
7
Notice
A copy of the Agreement and Declaration of Trust of Western
Asset/Claymore U.S. Treasury Inflation Protected Securities Fund (the
"Trust"), together with all amendments thereto, is on file with the
Secretary of the Commonwealth of Massachusetts, and notice is hereby given
that this instrument is executed on behalf of the Trust by any officer or
trustee of the Trust as an officer or trustee and not individually and that
the obligations of or arising out of this instrument are not binding upon any
of the Trustees of the Trust or shareholders of the Trust individually, but
are binding only upon the assets and property of the Trust.
8
SIGNATURE PAGE
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Pasadena, and State of California on the 11th day of
December, 2003.
WESTERN ASSET/CLAYMORE U.S. TREASURY
INFLATION PROTECTED SECURITIES FUND
By: /s/ Randolph L. Kohn*
-----------------------
Randolph L. Kohn
President
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
NAME CAPACITY DATE
---- -------- -----
/s/ Randolph L. Kohn* President and Trustee December 11, 2003
-----------------------------------
Randolph L. Kohn
/s/ Peter Erichsen* Trustee December 11, 2003
-----------------------------------
Peter Erichsen
/s/ Ronald Nyberg* Trustee December 11, 2003
-----------------------------------
Ronald Nyberg
/s/ Ronald E. Toupin* Trustee December 11, 2003
-----------------------------------
Ronald E. Toupin
/s/ Nicholas Dalmaso* Trustee December 11, 2003
-----------------------------------
Nicholas Dalmaso
/s/ Marie K. Karpinski* Treasurer and Principal Financial December 11, 2003
----------------------------------- and Accounting Officer
Marie K. Karpinski
*By: /s/ Gregory B. McShea
---------------------------
Gregory B. McShea
Attorney-In-Fact
Date: December 11, 2003
INDEX TO EXHIBITS
EXHIBIT EXHIBIT NAME
------- ------------
d.3 Specimen Certificate representing Registrant's Taxable Auction
Market Preferred Shares of beneficial interest ("AMPS").
k.6 Depository Trust Company Representations Letter as to the
Registrant's AMPS.
n. Consent of PricewaterhouseCoopers LLP.