AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 6, 2003
1933 ACT FILE NO. 333-105859
1940 ACT FILE NO. 811-21333
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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-2
(CHECK APPROPRIATE BOX OR BOXES)
[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. 5
NUVEEN PREFERRED AND CONVERTIBLE INCOME FUND 2
Exact Name of Registrant as Specified in Declaration of Trust
333 WEST WACKER DRIVE, CHICAGO, ILLINOIS 60606
Address of Principal Executive Offices (Number, Street, City, State, Zip Code)
(800) 257-8787
Registrant's Telephone Number, including Area Code
JESSICA R. DROEGER
VICE PRESIDENT AND SECRETARY
333 WEST WACKER DRIVE
CHICAGO, ILLINOIS 60606
Name and Address (Number, Street, City, State, Zip Code) of Agent for Service
COPIES OF COMMUNICATIONS TO:
DAVID A. STURMS ERIC F. FESS SARAH E. COGAN
VEDDER, PRICE, KAUFMAN & CHAPMAN AND CUTLER SIMPSON THACHER & BARTLETT LLP
KAMMHOLZ, P.C. 111 W. MONROE 425 LEXINGTON AVE.
222 N. LASALLE STREET CHICAGO, IL 60603 NEW YORK, NY 10017
CHICAGO, IL 60601
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 are 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)
[ ] when declared effective pursuant to section 8(c)
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CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF SECURITIES AMOUNT BEING OFFERING PRICE PER AGGREGATE OFFERING AMOUNT OF
BEING REGISTERED REGISTERED UNIT PRICE REGISTRATION FEE(1)
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FundPreferred Shares, $0.01
par value.................. 38,600 Shares $25,000 $965,000,000 $78,070*
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* $80.90 has been previously paid.
(1) Transmitted prior to filing.
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.
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THE INFORMATION IN THIS PROSPECTUS 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 PROSPECTUS 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 AUGUST 6, 2003
PROSPECTUS
(NUVEEN INVESTMENTS LOGO) $965,000,000
NUVEEN PREFERRED AND CONVERTIBLE INCOME FUND 2
FUNDPREFERRED(TM) SHARES
3,860 SHARES, SERIES M
3,860 SHARES, SERIES M2
3,860 SHARES, SERIES T
3,860 SHARES, SERIES T2
3,860 SHARES, SERIES W
3,860 SHARES, SERIES W2
3,860 SHARES, SERIES TH
3,860 SHARES, SERIES TH2
3,860 SHARES, SERIES F
3,860 SHARES, SERIES F2
LIQUIDATION PREFERENCE $25,000 PER SHARE
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Nuveen Preferred and Convertible Income Fund 2 (the "Fund") is a recently
organized, diversified, closed-end management investment company. The Fund's
primary investment objective is high current income. The Fund's secondary
objective is total return. Under normal circumstances, the Fund will invest at
least 80% of its Managed Assets (as defined on page 1 of this Prospectus) in
preferred securities, convertible securities and related instruments; and may
invest up to 20% of its Managed Assets in other securities, including debt
instruments and common stocks acquired upon conversion of a convertible security
(such common stocks not normally to exceed 5% of the Fund's Managed Assets).
Initially, Nuveen Institutional Advisory Corp. will allocate approximately
60%, 30% and 10% of the Fund's Managed Assets to preferred securities,
convertible securities and other debt instruments, respectively. Thereafter, the
portion of the Fund's Managed Assets invested in preferred securities,
convertible securities and other debt instruments will vary from time to time
consistent with the Fund's investment objectives, although the Fund will
normally invest at least 50% of its Managed Assets in preferred securities and
at least 20% of its Managed Assets in convertible securities (so long as the
combined total equals at least 80% of the Fund's Managed Assets). In making
allocation decisions, Nuveen Institutional Advisory Corp. will consider factors
such as interest rate levels, conditions and developing trends in the bond and
equity markets, analysis of relative valuations for preferred, convertible and
other debt instruments, and other economic and market factors, including the
overall outlook for the economy and inflation.
Under normal circumstances, the Fund will invest at least 65% of its Managed
Assets in securities that, at the time of investment, are investment grade
quality, which includes securities that are unrated but judged to be of
comparable quality. Split-rated securities (as defined on page 2 of this
Prospectus) are considered to be investment grade quality securities, except
that to the extent the Fund owns split-rated securities that exceed 10% of its
Managed Assets, the excess over 10% will not be considered to be investment
grade quality. The Fund may invest up to 35% of its Managed Assets in securities
that, at the time of investment, are not investment grade quality. The Fund will
only invest in securities that, at the time of investment, are rated B or higher
by at least one nationally recognized statistical rating organization or that
are unrated but judged to be of comparable quality, except, however, the Fund
may invest up to 5% of its Managed Assets in securities with a highest rating of
CCC or that are unrated but judged to be of comparable quality. There can be no
assurance that the Fund will achieve its investment objectives.
The Fund's principal office is located at 333 West Wacker Drive, Chicago,
Illinois 60606, and its telephone number is (312) 917-7700. Investors are
advised to read this Prospectus, which sets forth concisely the information
about the Fund that a prospective investor ought to know before investing, and
retain it for future reference. A Statement of Additional Information dated
, 2003 and as it may be supplemented, containing additional information
regarding the Fund has been filed with the Securities and Exchange Commission
and is hereby incorporated by reference in its entirety into this Prospectus. A
copy of the Statement of Additional Information, the table of contents of which
appears on page 63 of this Prospectus, may be obtained without charge by calling
the Fund at (800) 257-8787. In addition, the SEC maintains a web site
(http://www.sec.gov) that contains the Statement of Additional Information,
material incorporated by reference, and other information filed electronically
with the SEC by the Fund.
---------------------
INVESTING IN FUNDPREFERRED SHARES ("FUNDPREFERRED SHARES") INVOLVES CERTAIN
RISKS. SEE "RISK FACTORS" BEGINNING ON PAGE 31.
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.
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PER
SHARE TOTAL
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Public Offering Price $25,000 $
Sales Load(1) $ $
Proceeds to the Fund(2) (before expenses) $ $
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(1) One half of the sales load from this offering will be paid to certain
underwriters based on their participation in the Funds' offering of common
shares.
(2) Not including offering expenses payable by the Fund estimated to be
$ .
The underwriters are offering the FundPreferred shares subject to various
conditions. The underwriters expect to deliver FundPreferred shares in
book-entry form, through the facilities of the Depository Trust Company to
purchasers on or about , 2003.
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CITIGROUP NUVEEN INVESTMENTS, LLC
A.G. EDWARDS & SONS, INC. WACHOVIA SECURITIES
, 2003
The Fund is offering 3,860, 3,860, 3,860, 3,860, 3,860, 3,860, 3,860,
3,860, 3,860 and 3,860 shares of Series M, Series M2, Series T, Series T2,
Series W, Series W2, Series TH, Series TH2, Series F and Series F2 FundPreferred
shares, respectively. The shares are referred to in this Prospectus as
"FundPreferred shares." The FundPreferred shares have a liquidation preference
of $25,000 per share, plus any accumulated, unpaid dividends. The FundPreferred
shares also have priority over the Fund's Common Shares as to distribution of
assets as described in this Prospectus. The dividend rate for the initial
dividend rate period will be %, %, %, %, %, %, %,
%, % and % for FundPreferred shares Series M, Series M2, Series T,
Series T2, Series W, Series W2, Series TH, Series TH2, Series F and Series F2,
respectively. The initial dividend period is from the date of issuance through
, 2003 for FundPreferred shares Series M, , 2003 for
FundPreferred shares Series M2, , 2003 for FundPreferred shares Series
T, , 2003 for FundPreferred shares Series T2 , 2003 for Fund
Preferred Shares Series W, , 2003 for FundPreferred Shares Series W2,
, 2003 for FundPreferred Shares Series TH, , 2003 for Fund
Preferred Shares Series TH2, , 2003 for FundPreferred Shares Series F
and , 2003 for FundPreferred shares Series F2. For subsequent dividend
periods, FundPreferred shares pay dividends based on a rate set at auction,
usually held every seven (7) days. Prospective purchasers should carefully
review the auction procedures described in the Prospectus and should note: (1) a
buy order (called a "bid order") or sell order is a commitment to buy or sell
FundPreferred shares based on the results of an auction; (2) auctions will be
conducted by telephone; and (3) purchases and sales will be settled on the next
business day after the auction. FundPreferred shares are not listed on an
exchange. You may only buy or sell FundPreferred shares through an order placed
at an auction with or through a broker-dealer that has entered into an agreement
with the auction agent and the Fund, or in a secondary market maintained by
certain broker-dealers. These broker-dealers are not required to maintain this
market, and it may not provide you with liquidity.
The FundPreferred shares do not represent a deposit or obligation of, and
are not guaranteed or endorsed by, any bank or other insured depository
institution, and are not federally insured by the Federal Deposit Insurance
Corporation, the Federal Reserve Board or any other government agency.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR INCORPORATED BY
REFERENCE IN THIS PROSPECTUS. THE FUND HAS NOT AUTHORIZED ANYONE TO PROVIDE YOU
WITH DIFFERENT INFORMATION. THE FUND IS 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.
---------------------
TABLE OF CONTENTS
Prospectus Summary.......................................... 1
Financial Highlights........................................ 11
The Fund.................................................... 12
Use of Proceeds............................................. 12
Capitalization.............................................. 13
Portfolio Composition....................................... 13
The Fund's Investments...................................... 14
Use of Leverage............................................. 24
Hedging Transactions........................................ 24
Risk Factors................................................ 31
Management of the Fund...................................... 38
Description of FundPreferred Shares......................... 41
The Auction................................................. 53
Description of Borrowings................................... 56
Description of Common Shares................................ 56
Certain Provisions in the Declaration of Trust.............. 57
Repurchase of Fund Shares; Conversion to Open-End Fund...... 57
Federal Income Tax Matters.................................. 58
Custodian, Transfer Agent, Auction Agent, Dividend
Disbursing Agent and Redemption Agent..................... 60
Underwriting................................................ 61
Legal Opinions.............................................. 62
Available Information....................................... 62
Table of Contents for the Statement of Additional
Information............................................... 63
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PROSPECTUS SUMMARY
This is only a summary. You should review the more detailed information
contained elsewhere in this Prospectus, Statement of Additional Information and
the Fund's Statement Establishing and Fixing the Rights and Preferences of
FundPreferred shares (the "Statement") attached as Appendix A to the Statement
of Additional Information. Capitalized terms used but not defined in this
Prospectus shall have the meanings given to such terms in the Statement.
The Fund................... Nuveen Preferred and Convertible Income Fund 2 (the
"Fund") is a recently organized, diversified,
closed-end management investment company. See "The
Fund." The Fund's common shares, $.01 par value
("Common Shares"), are traded on the New York Stock
Exchange (the "Exchange") under the symbol "JQC."
See "Description of Common Shares." As of July 30,
2003 the Fund had 141,007,000 Common Shares
outstanding and net assets applicable to Common
Shares of $1,968,872,326.
Investment Objectives and
Policies................. The Fund's primary investment objective is high
current income. The Fund's secondary investment
objective is total return. The Fund's investment
objectives and certain investment policies are
considered fundamental and may not be changed
without shareholder approval. The Fund cannot
assure you that it will attain its investment
objectives. See "The Fund's Investments" and "Risk
Factors."
Under normal circumstances the Fund:
- will invest at least 80% of its Managed Assets in
preferred securities, convertible securities and
related instruments. The Fund intends that most
or all of the preferred securities in which it
invests will generate dividends that are fully
taxable and will not be eligible for the
dividends received deduction or for treatment as
"qualified dividend income;" and
- may invest up to 20% of its Managed Assets in
other securities, including debt instruments and
common stocks acquired upon conversion of a
convertible security (such common stocks not
normally to exceed 5% of the Fund's Managed
Assets).
The Fund's average daily net assets (including
assets attributable to any FundPreferred shares
that may be outstanding and the principal amount of
any Borrowings (as defined below)) is called
"Managed Assets."
The Fund's assets allocated to preferred securities
will be managed by Spectrum Asset Management, Inc.
("Spectrum"). The Fund's assets allocated to
convertible securities will be managed by Froley,
Revy Investment Co., Inc. ("Froley, Revy"). The
Fund's assets allocated to other debt instruments
will be managed by Nuveen Institutional Advisory
Corp. ("NIAC").
NIAC will be responsible for determining the Fund's
overall investment strategy, including allocating
the portion of the Fund's assets to be invested in
preferred securities, convertible securities and
other debt instruments. Initially, NIAC will
allocate approximately 60%, 30% and 10% of the
Fund's Managed Assets to preferred securities,
convertible securities, and other debt instruments,
respectively. Thereafter, the
1
portion of the Fund's Managed Assets invested in
preferred securities, convertible securities and
other debt instruments will vary from time to time
consistent with the Fund's investment objectives,
although the Fund will normally invest at least 50%
of its Managed Assets in preferred securities and
at least 20% of its Managed Assets in convertible
securities (so long as the combined total equals at
least 80% of the Fund's Managed Assets). See "The
Fund's Investments" and "Management of the Fund."
- The Fund will invest at least 65% of its Managed
Assets in securities that, at the time of
investment, are investment grade quality.
Initially, the Fund intends to invest
approximately 75% of its Managed Assets in
investment grade quality securities. Investment
grade quality securities are those securities
that, at the time of investment, are (i) rated by
at least one nationally recognized statistical
rating organization ("NRSRO") within the four
highest grades (Baa or BBB or better by Moody's
Investors Service, Inc. ("Moody's"), Standard &
Poor's Corporation, a division of The McGraw-Hill
Companies ("S&P"), or Fitch Ratings ("Fitch")),
or (ii) unrated but judged to be of comparable
quality.
Securities that, at the time of investment, are
rated below investment grade by Moody's, S&P or
Fitch, so long as at least one NRSRO rates such
securities within the four highest grades (such
securities are called "split-rated securities"),
are considered to be investment grade quality
securities, except that to the extent the Fund
owns split-rated securities that exceed 10% of
its Managed Assets, the excess over 10% will not
be considered to be investment grade quality.
- The Fund may invest up to 35% of its Managed
Assets in securities that, at the time of
investment, are not investment grade quality. The
Fund will only invest in securities that, at the
time of investment, are rated B or higher by at
least one NRSRO or that are unrated but judged to
be of comparable quality, except, however, the
Fund may invest up to 5% of its Managed Assets in
securities with a highest rating of CCC or that
are unrated but judged to be of comparable
quality.
Securities of below investment grade quality are
regarded as having predominately speculative
characteristics with respect to capacity to pay
interest and repay principal, and are commonly
referred to as junk bonds. See "The Fund's
Investments -- Investment Objectives and Policies"
and "Risk Factors -- General Risks of Investing in
the Fund -- High Yield Risk."
In addition, under normal circumstances:
- The Fund intends to invest at least 25% of its
Managed Assets in the securities of companies
principally engaged in financial services. See
"The Fund's Investments -- Portfolio
Composition -- Financial Services Company
Securities."
- The Fund may invest up to 10% of its Managed
Assets in securities that, at the time of
investment, are illiquid (i.e., securities that
are not readily marketable). All securities and
other instruments in
2
which the Fund invests will be subject to this 10% limitation to the extent they
are deemed to be illiquid. Initially, the Fund does not intend to invest more
than 5% of its Managed Assets in illiquid securities.
- The Fund may invest up to 35% of its Managed
Assets in securities of non-U.S. issuers. Subject
to this 35% limitation, up to 10% of the Fund's
Managed Assets may be invested in securities that
are denominated in Japanese yen, Canadian
dollars, British pounds or Euros and which may be
offered, traded or listed in markets other than
U.S. markets. The remainder of the Fund's Managed
Assets that may be invested in securities of
non-U.S. issuers will be invested in U.S. dollar
denominated securities offered, traded or listed
in U.S. markets. Initially, the Fund does not
intend to invest more than 20% of its Managed
Assets in securities of non-U.S. issuers, and
does not currently intend to invest in the
non-U.S. dollar denominated securities described
above.
For a more complete discussion of the Fund's
initial portfolio composition, see "The Fund's
Investments -- Portfolio Composition -- Initial
Portfolio Composition."
The taxable preferred securities in which the Fund
intends to invest generally do not pay dividends
that qualify for reduced rates of federal income
taxation available to noncorporate investors on
"qualified dividend income" under Section 1(h)(11)
of the Internal Revenue Code of 1986, as amended
(the "Code") or the dividends received deduction
(the "Dividends Received Deduction") under Section
243 of the Code. The Jobs and Growth Tax Relief
Reconciliation Act of 2003 reduced to 15% the
maximum tax rate on "qualified dividend income" of
noncorporate investors for taxable years beginning
before January 1, 2009. The Dividends Received
Deduction generally allows corporations to deduct
from their income 70% of qualifying dividends
received. Accordingly, any noncorporate shareholder
who otherwise may be entitled to reduced federal
income tax rates on "qualified dividend income" and
any corporate shareholder who otherwise would
qualify for the Dividends Received Deduction should
not assume that the distributions it receives from
the Fund will qualify for the reduced tax rates or
the Dividends Received Deduction. See "Federal
Income Tax Matters."
Investment Adviser and
Subadvisers.............. NIAC will be the Fund's investment adviser,
responsible for determining the Fund's overall
investment strategy, including allocating the
portion of the Fund's assets to be invested in
preferred securities, convertible securities and
other debt instruments, and also for managing a
portion of the Fund's assets. In making allocation
decisions, NIAC will consider factors such as
interest rate levels, conditions and developing
trends in the bond and equity markets, analysis of
relative valuations for preferred, convertible and
other debt instruments, and other economic and
market factors, including the overall outlook for
the economy and inflation.
The Fund's assets allocated to preferred securities
will be managed by Spectrum. The Fund's assets
allocated to convertible securities will be
3
managed by Froley, Revy. The Fund's assets
allocated to other debt instruments will be managed
by NIAC. Spectrum and Froley, Revy will sometimes
individually be referred to as a "Subadviser" and
collectively be referred to as the "Subadvisers."
NIAC, Spectrum and Froley, Revy will sometimes
individually be referred to as an "Adviser" and
collectively be referred to as the "Advisers."
NIAC, a registered investment adviser, is a wholly
owned subsidiary of Nuveen Investments, Inc.
Founded in 1898, Nuveen Investments, Inc. and its
affiliates had approximately $88 billion of assets
under management as of June 30, 2003. According to
Thomson Wealth Management, Nuveen is the leading
sponsor of closed-end exchange-traded funds as
measured by the number of funds (104) and the
amount of fund assets under management
(approximately $45 billion) as of June 30, 2003.
Spectrum, a registered investment adviser, is an
independently managed wholly owned subsidiary of
Principal Global Investors, LLC. Founded in 1987,
Spectrum had approximately $10.1 billion in assets
under management as of June 30, 2003. Spectrum
specializes in the management of diversified
preferred security portfolios primarily for
institutional clients. Collectively, subsidiaries
and affiliates of Principal Global Investors, LLC
managed over $104.2 billion in combined assets
worldwide as of June 30, 2003.
Froley, Revy, a registered investment adviser, is
an independently managed wholly owned subsidiary of
First Republic Bank. Founded in 1975, Froley, Revy
had approximately $3.2 billion in assets under
management as of June 30, 2003. Froley, Revy
specializes in the management of convertible
securities. Collectively, subsidiaries and
affiliates of First Republic Bank, including
Froley, Revy, managed approximately $9.5 billion in
combined assets as of June 30, 2003.
Use of Leverage............ The Fund intends to use financial leverage,
including issuing FundPreferred shares, for
investment purposes. The Fund currently anticipates
its use of leverage to represent approximately
33 1/3% of its total assets, including the proceeds
of such leverage. In addition to the issuance of
FundPreferred shares, the Fund may make further use
of financial leverage through borrowing, including
the issuance of commercial paper or notes.
Throughout this Prospectus, commercial paper, notes
or other borrowings sometimes may be collectively
referred to as "Borrowings." Any Borrowings will
have seniority over the FundPreferred shares.
Payments to holders of FundPreferred shares in
liquidation or otherwise will be subject to the
prior payment of all outstanding indebtedness,
including Borrowings.
Use of Hedging
Transactions............... The Fund may use derivatives or other transactions
for purposes of hedging the portfolio's exposure to
the risk of increases in interest rates, common
stock risk, high yield credit risk and foreign
currency exchange rate risk. The specific
derivative instruments to be used, or other
transactions to be entered into, each for hedging
purposes may include (i) options and futures
contracts, including options on common stock, stock
indexes, bonds and bond indexes, stock index
futures, bond index futures and related
instruments, (ii) short sales of securities that
the Fund owns or has the right to acquire through
the
4
conversion of securities, (iii) structured notes
and similar instruments, (iv) credit derivative
instruments and (v) currency exchange transactions.
Some, but not all, of the derivative instruments
may be traded and listed on an exchange. The
positions in derivatives will be marked-to-market
daily at the closing price established on the
relevant exchange or at a fair value. See "The
Fund's Investments -- Portfolio
Composition -- Hedging Transactions," "Risk
Factors -- General Risks of Investing in the
Fund -- Hedging Risk" and "Risk Factors -- General
Risks of Investing in the Fund -- Counterparty
Risk." Except for investing in synthetic
convertible securities, the Fund will use
derivatives or other transactions described above
solely for purposes of hedging the Fund's portfolio
risks.
Interest Rate
Transactions............... In connection with the Fund's use of leverage
through the sale of FundPreferred shares or
Borrowings, the Fund, if market conditions are
deemed favorable, likely will enter into interest
rate swap or cap transactions to attempt to protect
itself from increasing dividend or interest
expenses on its FundPreferred shares or Borrowings.
The use of interest rate swaps and caps is a highly
specialized activity that involves investment
techniques and risks different from those
associated with ordinary portfolio security
transactions.
In an interest rate swap, the Fund would agree to
pay to the other party to the interest rate swap
(which is known as the "counterparty") a fixed rate
payment in exchange for the counterparty agreeing
to pay to the Fund a payment at a variable rate
that is expected to approximate the rate on the
Fund's variable rate payment obligation on
FundPreferred shares or any variable rate
Borrowings. The payment obligations would be based
on the notional amount of the swap.
In an interest rate cap, the Fund would pay a
premium to the counterparty to the interest rate
cap and, to the extent that a specified variable
rate index exceeds a predetermined fixed rate,
would receive from the counterparty payments of the
difference based on the notional amount of such
cap. If the counterparty to an interest rate swap
or cap defaults, the Fund would be obligated to
make the payments that it had intended to avoid.
Depending on the general state of short-term
interest rates and the returns on the Fund's
portfolio securities at that point in time, this
default could negatively impact the Fund's ability
to make dividend payments on the FundPreferred
shares or interest payments on Borrowings.
In addition, at the time an interest rate swap or
cap transaction reaches its scheduled termination
date, there is a risk that the Fund would not be
able to obtain a replacement transaction or that
the terms of the replacement would not be as
favorable as on the expiring transaction. If this
occurs, it could have a negative impact on the
Fund's ability to make dividend payments on the
FundPreferred shares or interest payments on
Borrowings. If the Fund fails to meet an asset
coverage ratio required by law or if the Fund does
not meet a rating agency guideline in a timely
manner or if the Fund fails to maintain other
covenants with respect to the FundPreferred shares,
the Fund may be required to redeem some or all of
the FundPreferred shares. See "-- Redemption"
below. Similarly, the Fund could be required to
prepay the principal amount of any Borrowings. Such
redemption or
5
prepayment would likely result in the Fund seeking
to terminate early all or a portion of any swap or
cap transaction. Early termination of a swap could
result in a termination payment by or to the Fund.
Early termination of a cap could result in a
termination payment to the Fund. The Fund intends
to maintain in a segregated account with its
custodian, cash or liquid securities having a value
at least equal to the Fund's net payment
obligations under any swap transaction,
marked-to-market daily. The Fund will not enter
into interest rate swap or cap transactions having
a notional amount that exceeds the outstanding
amount of the Fund's leverage.
See "Use of Leverage" and "Hedging Transactions"
for additional information.
The Offering............... The Fund is offering 3,860 shares of each of Series
M, Series M2, Series T, Series T2, Series W, Series
W2, Series TH, Series TH2, Series F and Series F2,
each at a purchase price of $25,000 per share.
FundPreferred shares are being offered by the
underwriters listed under "Underwriting."
Risk Factors Summary....... Risk is inherent in all investing. Therefore,
before investing you should consider certain risks
carefully when you invest in the Fund. The primary
risks of investing in FundPreferred shares are:
- if an auction fails you may not be able to sell
some or all of your shares;
- because of the nature of the market for
FundPreferred shares, you may receive less than
the price you paid for your shares if you sell
them outside of the auction, especially when
market interest rates are rising;
- a rating agency could downgrade FundPreferred
shares, which could affect liquidity;
- the Fund may be forced to redeem your shares to
meet regulatory or rating agency requirements or
may voluntarily redeem your shares in certain
circumstances;
- in extraordinary circumstances, the Fund may not
earn sufficient income from its investments to
pay dividends;
- the FundPreferred shares will be junior to any
Borrowings;
- any Borrowings may constitute a substantial lien
and burden on the FundPreferred shares by reason
of its prior claim against the income of the Fund
and against the net assets of the Fund in
liquidation; and
- if the Fund leverages through Borrowings, the
Fund may not be permitted to declare dividends or
other distributions with respect to the
FundPreferred shares or purchase FundPreferred
shares unless at the time thereof the Fund meets
certain asset coverage requirements and the
payments of principal and of interest on any such
Borrowings are not in default.
For additional general risks of investing in the
Fund, see "Risk Factors -- General Risks of
Investing in the Fund."
6
Trading Market............. FundPreferred shares are not listed on an exchange.
Instead, you may buy or sell FundPreferred shares
at an auction that is normally held weekly by
submitting orders to a broker-dealer that has
entered into an agreement with the auction agent
and the Fund (a "Broker-Dealer"), or to a
broker-dealer that has entered into a separate
agreement with a Broker-Dealer. In addition to the
auctions, Broker-Dealers and other broker-dealers
may maintain a secondary trading market in
FundPreferred shares outside of auctions, but may
discontinue this activity at any time. There is no
assurance that a secondary market will be created
or, if created, that it will provide shareholders
with liquidity or that the trading price in any
secondary market would be $25,000. You may transfer
shares outside of auctions only to or through a
Broker-Dealer, or a broker-dealer that has entered
into a separate agreement with a Broker-Dealer.
The table below shows the first auction date for
each Series of FundPreferred shares and the day on
which each subsequent auction will normally be held
for each Series of FundPreferred shares. The first
auction date for each Series of FundPreferred
shares will be the business day before the dividend
payment date for the initial dividend period for
each Series of FundPreferred shares.
The start date for subsequent dividend periods
normally will be the business day following the
auction date unless the then-current dividend
period is a special dividend period, or the day
that normally would be the auction date or the
first day of the subsequent dividend period is not
a business day.
FIRST AUCTION SUBSEQUENT
SERIES DATE* AUCTION
------ ------------- ----------
M........................ Monday
M2....................... Monday
T........................ Tuesday
T2....................... Tuesday
W........................ Wednesday
W2....................... Wednesday
TH....................... Thursday
TH2...................... Thursday
F........................ Friday
F2....................... Friday
-----------------------------------------
* All dates are 2003.
Dividends and Dividend
Periods.................. The table below shows the dividend rate for the
initial dividend period of the FundPreferred shares
offered in this Prospectus. For subsequent dividend
periods, FundPreferred shares will pay dividends
based on a rate set at auctions, normally held
every seven (7) days. In most instances dividends
are also paid every seven (7) days, on the day
following the end of the rate period. The
Applicable Rate that results from an Auction will
not be lower than 70% of the applicable AA
Composite Commercial Paper Rate (the "Minimum
Rate") or greater than 150% (the "Maximum Rate") of
the applicable AA Composite Commercial Paper Rate
(for a Dividend Period of fewer than 184 days) or
the applicable Treasury Index Rate (for a Dividend
7
Period of 184 days or more) at the close of
business on the Business Day next preceding such
Auction Date. See "Description of FundPreferred
Shares -- Dividends and Dividend
Periods -- Determination of Dividend Rate" and "The
Auction."
The table below also shows the date from which
dividends on the FundPreferred shares will
accumulate at the initial rate, the dividend
payment date for the initial dividend period and
the day on which dividends will normally be paid.
If dividends are payable on Monday or Tuesday and
that day is not a business day, then your dividends
will normally be paid on the first business day
that falls after that day. If dividends are payable
on a Wednesday, Thursday or Friday and that day is
not a business day, then dividends will normally be
paid on the first business day prior to that day.
Finally, the table below shows the number of days
of the initial dividend period for the
FundPreferred shares. Subsequent dividend periods
generally will be seven (7) days. The dividend
payment date for special dividend periods of other
than seven (7) days will be set out in the notice
designating a special dividend period. See
"Description of FundPreferred Shares -- Dividends
and Dividend Periods -- Notification of Dividend
Period."
DATE OF PAYMENT DATE NUMBER OF
INITIAL ACCUMULATION FOR INITIAL SUBSEQUENT DAYS OF INITIAL
DIVIDEND AT INITIAL DIVIDEND DIVIDEND DIVIDEND
SERIES RATE RATE* PERIOD* PAYMENT DAY PERIOD
------ -------- ------------ ------------ ----------- ---------------
M..... Tuesday
M2.... Tuesday
T..... Wednesday
T2.... Wednesday
W..... Thursday
W2.... Thursday
TH.... Friday
TH2... Friday
F..... Monday
F2.... Monday
----------
* All dates are 2003.
Ratings.................... It is a condition of the underwriters' obligation
to purchase the FundPreferred shares that the
FundPreferred shares receive a rating of "AAA" from
Fitch and "Aaa" from Moody's.
Restrictions on Dividend
Redemption and Other
Payments................. If the Fund issues any Borrowings that constitute
senior securities representing indebtedness (as
defined in the 1940 Act), under the 1940 Act, the
Fund would not be permitted to declare any dividend
on FundPreferred shares unless, after giving effect
to such dividend, asset coverage with respect to
such Borrowings that constitute senior securities
representing indebtedness, if any, is at least
200%. In addition, the Fund would not be permitted
to declare any distribution on or purchase or
redeem FundPreferred shares unless, after giving
effect to such distribution, purchase or
redemption, asset coverage with respect to such
Borrowings that constitute senior securities
representing
8
indebtedness, if any, is at least 300%. Dividends
or other distributions on or redemptions or
purchases of FundPreferred shares would also be
prohibited at any time that an event of default
under any Borrowings has occurred and is
continuing. See "Description of FundPreferred
Shares -- Restrictions on Dividend, Redemption and
Other Payments."
Asset Maintenance.......... The Fund must maintain Eligible Assets having an
aggregated Discounted Value at least equal to the
FundPreferred Shares Basic Maintenance Amount as of
each Valuation Date. The Fund also must maintain
asset coverage for the FundPreferred shares on a
non-discounted basis of at least 200% as of the
last business day of each month. See "Description
of FundPreferred Shares -- Asset Maintenance."
The Discount Factors and guidelines for calculating
the Discounted Value of the Fund's portfolio for
purposes of determining whether the FundPreferred
Shares Basic Maintenance Amount has been satisfied
have been established by Fitch and Moody's in
connection with the Fund's receipt from Fitch and
Moody's of the "AAA" and "Aaa", respectively,
Credit Rating with respect to the FundPreferred
shares on their Date of Original Issue.
The Fund estimates that on the Date of Original
Issue, the 1940 Act FundPreferred Shares Asset
Coverage, based on the composition of its portfolio
as of July 30, 2003, and after giving effect to the
issuance of the FundPreferred shares offered hereby
($965,000,000) and the deduction of sales loads and
estimated offering expenses for such FundPreferred
shares ($19,700,000), will be 302%.
In addition, there may be additional asset coverage
requirements imposed in connection with any
Borrowings.
Redemption................. Although the Fund will not ordinarily redeem
FundPreferred shares, it may be required to redeem
shares if, for example, the Fund does not meet an
asset coverage ratio required by law, correct a
failure to meet a rating agency guideline in a
timely manner or maintain other covenants with
respect to the FundPreferred shares. The Fund
voluntarily may redeem FundPreferred shares in
certain circumstances. See "Description of
FundPreferred Shares -- Redemption."
Liquidation Preference..... The liquidation preference of the shares of each
series of FundPreferred shares will be $25,000 per
share plus accumulated but unpaid dividends, if
any, thereon. See "Description of FundPreferred
Shares -- Liquidation Rights."
Voting Rights.............. Except as otherwise indicated, holders of
FundPreferred shares have one vote per share and
vote together with holders of Common Shares as a
single class.
In connection with the election of the Board of
Trustees, the holders of outstanding preferred
shares of beneficial interest ("Preferred Shares"),
including FundPreferred shares, as a class, shall
be entitled to elect two trustees of the Fund. The
holders of outstanding shares of Common Shares and
Preferred Shares, including FundPreferred shares,
voting together, shall elect the remainder.
However, upon the Fund's failure to pay dividends
on the Preferred Shares in an amount equal to two
full
9
years of dividends, the holders of Preferred Shares
have the right to elect, as a class, the smallest
number of additional Trustees as shall be necessary
to assure that a majority of the Trustees has been
elected by the holders of Preferred Shares. The
terms of the additional Trustees shall end when the
Fund pays or provides for all accumulated and
unpaid dividends. See "Description of FundPreferred
Shares -- Voting Rights."
Federal Income Taxes....... Distributions with respect to the FundPreferred
shares will generally be subject to U.S. federal
income taxation. Because the Fund's portfolio
income will consist principally of (i) income from
taxable preferred and similar securities, (ii)
capital gain, and (iii) interest income, corporate
investors in the FundPreferred shares are not
expected to receive dividends that are eligible for
the Dividends Received Deduction and noncorporate
investors in the FundPreferred shares are not
expected to receive "qualified dividend income"
that is generally subject to reduced rates of
federal income taxation. The Internal Revenue
Service ("IRS") currently requires that a regulated
investment company, which 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 gain) based upon the
percentage of total dividends distributed to each
class for the tax year. Accordingly, the Fund
intends each year to allocate ordinary income
dividends and capital gain dividends between its
Common Shares and FundPreferred shares in
proportion to the total dividends paid to each
class during or with respect to such year. See
"Federal Income Tax Matters."
10
FINANCIAL HIGHLIGHTS
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 June 30, 2003 until July 17, 2003. Since the Fund was recently
organized and commenced operations on June 30, 2003, the table covers less than
three weeks of operations, during which a substantial portion of the Fund's
portfolio was held in temporary investments pending investment in long-term
securities 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.
(JUNE 30, 2003 -
JULY 17, 2003)
-----------------
(UNAUDITED)
PER SHARE OPERATING PERFORMANCE:
Common Share Net Asset Value, Beginning of Period......... $ 14.33
----------
Net Investment Income.................................. .01
Net Realized/Unrealized Gain from Investments.......... (.20)
----------
Total From Investment Operations..................... (.19)
----------
Offering Costs............................................ (.01)
----------
Common Share Net Asset Value, End of Period............... $ 14.13
==========
Per Share Market Value, End of Period..................... $ 15.00
Total Return on Common Share Net Asset Value(a)........... (1.40)%
Total Investment Return on Market Value(a)................ --%
RATIOS/SUPPLEMENTAL DATA:
Net Assets Applicable to Common Shares, End of Period
(In Thousands)......................................... $1,908,011
Ratio of Expenses to Average Net Assets Applicable to
Common Shares Before Reimbursement..................... .96%*
Ratio of Net Investment Income to Average Net Assets
Applicable to Common Shares Before Reimbursement....... 1.17%*
Ratio of Expenses to Average Net Assets Applicable to
Common Shares After Reimbursement...................... .64%*
Ratio of Net Investment Income to Average Net Assets
Applicable to Common Shares After Reimbursement........ 1.49%*
Portfolio Turnover Rate................................... --%
------------
* Annualized.
(a) Total Investment Return on Market Value is the combination of reinvested
dividend income, reinvested capital gains distributions, if any, and changes
in stock price per share. Total Return on Common Share Net Asset Value is
the combination of reinvested dividend income, reinvested capital gains
distributions, if any, and changes in Common Share net asset value per
share. Total returns are not annualized.
11
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 March 17, 2003, pursuant to a Declaration of
Trust (the "Declaration of Trust") governed by the laws of The Commonwealth of
Massachusetts. On June 30, 2003, the Fund issued an aggregate of 135,000,000
Common Shares pursuant to the initial public offering thereof. On July 22, 2003,
the Fund issued an additional 6,000,000 Common Shares in connection with a
partial exercise by the underwriters of the over-allotment option. The Common
Shares are traded on the Exchange under the symbol "JQC." The Fund's principal
office is located at 333 West Wacker Drive, Chicago, Illinois 60606, and its
telephone number is (800) 257-8787.
The following provides information about the Fund's outstanding shares as
of July 30, 2003:
AMOUNT HELD
BY THE FUND OR AMOUNT
TITLE OF CLASS AMOUNT AUTHORIZED FOR ITS ACCOUNT OUTSTANDING
-------------- ----------------- --------------- -----------
Common Shares....................................... Unlimited 0 141,007,000
FundPreferred shares................................ Unlimited 0 0
USE OF PROCEEDS
The net proceeds of the offering will be approximately $945,300,000 after
payment of the sales load and estimated offering costs. The Fund will invest the
net proceeds of the offering in accordance with the Fund's investment objectives
and policies as described under "The Fund's Investments," as soon as
practicable. It is presently anticipated that the Fund will be able to invest
substantially all of the net proceeds in preferred, convertible and other debt
instruments that meet those investment objectives and policies within
approximately 1 to 1 1/2 months after the completion of the offering. Pending
such investment, it is anticipated that the proceeds will be invested in
short-term or long-term securities issued by the U.S. Government or its agencies
or instrumentalities or in high quality, short-term money market instruments.
12
CAPITALIZATION
The following table sets forth the capitalization of the Fund as of July
30, 2003, and as adjusted, to give effect to the issuance of the FundPreferred
shares offered hereby.
ACTUAL AS ADJUSTED
JULY 30, 2003 JULY 30, 2003
------------- -------------
(UNAUDITED) (UNAUDITED)
FundPreferred shares, $25,000 stated value per share, at
liquidation value; unlimited shares authorized (no shares
issued and 38,600 shares issued, as adjusted,
respectively)*............................................ $ -- $ 965,000,000
============== ==============
COMMON SHAREHOLDERS' EQUITY:
Common Shares, $.01 par value per share; unlimited shares
authorized (141,007,000 shares outstanding)*........... $ 1,410,070 $ 1,410,070
Paid-in surplus**......................................... 2,016,576,101 1,996,876,101
Undistributed net investment income....................... 5,431,552 5,431,552
Accumulated net realized gain (loss) from investments..... (400,122) (400,122)
Net unrealized appreciation (depreciation) of
investments............................................ (54,145,275) (54,145,275)
-------------- --------------
Net assets applicable to Common Shares.................... $1,968,872,326 $1,949,172,326
============== ==============
------------
* None of these outstanding shares are held by or for the account of the Fund.
** As adjusted paid-in surplus reflects a reduction for the sales load and
estimated offering costs of the FundPreferred shares issuance ($19,700,000).
PORTFOLIO COMPOSITION
As of July 30, 2003, 87.18% of the market value of the Fund's portfolio was
invested in long-term investments and 12.82% of the market value of the Fund's
portfolio was invested in short-term investments.
13
THE FUND'S INVESTMENTS
INVESTMENT OBJECTIVES AND POLICIES
The Fund's primary investment objective is high current income. The Fund's
secondary objective is total return. There can be no assurance that the Fund's
investment objectives will be achieved.
Under normal circumstances, the Fund:
- will invest at least 80% of its Managed Assets in preferred securities,
convertible securities and related instruments; and
- may invest up to 20% of its Managed Assets in other securities, including
debt instruments and common stocks acquired upon conversion of a
convertible security (such common stocks not normally to exceed 5% of the
Fund's Managed Assets).
NIAC will be responsible for determining the Fund's overall investment
strategy, including allocating the portion of the Fund's assets to be invested
in preferred securities, convertible securities and other debt instruments. See
"Management of the Fund."
The Fund's assets allocated to preferred securities will be managed by
Spectrum. The Fund's assets allocated to convertible securities will be managed
by Froley, Revy. The Fund's assets allocated to other debt instruments will be
managed by NIAC.
Under normal circumstances, portfolio allocations will conform to the
following guidelines:
MINIMUM % OF MAXIMUM % OF
TYPE OF INVESTMENT MANAGED ASSETS MANAGED ASSETS
------------------ -------------- --------------
Preferred Securities........................................ 50 80
Convertible Securities...................................... 20 50
Other Debt Instruments...................................... 0 20
Initially, NIAC will allocate approximately 60%, 30% and 10% of the Fund's
Managed Assets to preferred securities, convertible securities and other debt
instruments, respectively. Thereafter, the portion of the Fund's Managed Assets
invested in preferred securities, convertible securities and other debt
instruments will vary from time to time consistent with the Fund's investment
objectives, although the Fund will normally invest at least 50% of its Managed
Assets in preferred securities and at least 20% of its Managed Assets in
convertible securities (so long as the combined total equals at least 80% of the
Fund's Managed Assets). Convertible preferred securities will be regarded as
convertible securities for purposes of these limits. In making allocation
decisions, NIAC will consider factors such as interest rate levels, conditions
and developing trends in the bond and equity markets, analysis of relative
valuations for preferred, convertible and other debt instruments and other
economic and market factors, including the overall outlook for the economy and
inflation.
The Fund will invest at least 65% of its Managed Assets in securities that,
at the time of investment, are investment grade quality. Investment grade
quality securities are those securities that, at the time of investment, are (i)
rated by at least one of the NRSROs within the four highest grades (Baa or BBB
or better by Moody's, S&P or Fitch) or (ii) unrated but judged to be of
comparable quality by the Adviser responsible for the investment. Split-rated
securities are considered to be investment grade quality securities, except that
to the extent the Fund owns split-rated securities that exceed 10% of its
Managed Assets, the excess over 10% will not be considered to be investment
grade quality. Initially, the Fund intends to invest approximately 75% of its
Managed Assets in investment grade quality securities. The Fund may invest up to
35% of its Managed Assets in securities that, at the time of investment, are not
investment grade quality. The Fund will only invest in securities that, at the
time of investment, are rated B or higher by at least one NRSRO or that are
unrated but judged to be of comparable quality by the Adviser responsible for
the investment, except, however, the Fund may invest up to 5% of its Managed
Assets in securities with a highest rating of CCC or that are unrated but judged
to be of comparable quality by the Adviser responsible for the investment.
Securities of below investment grade quality are
14
commonly referred to as junk bonds and are regarded as having predominately
speculative characteristics with respect to capacity to pay interest and repay
principal. See "Risk Factors -- General Risks of Investing in the Fund -- High
Yield Risk." See Appendix B in the Statement of Additional Information for a
description of security ratings.
The Fund may invest up to 10% of its Managed Assets in securities that, at
the time of investment, are illiquid (i.e., securities that are not readily
marketable). Initially, the Fund does not intend to invest more than 5% of its
Managed Assets in illiquid securities. In addition, the Fund may invest up to
35% of its Managed Assets in securities of non-U.S. issuers. Subject to this 35%
limitation, up to 10% of the Fund's Managed Assets may be invested in securities
that are denominated in Japanese yen, Canadian dollars, British pounds or Euros
and which may be offered, traded or listed in markets other than U.S. markets.
The remainder of the Fund's Managed Assets that may be invested in securities of
non-U.S. issuers will be invested in U.S. dollar denominated securities offered,
traded or listed in U.S. markets. Initially, the Fund does not intend to invest
more than 20% of its Managed Assets in securities of non-U.S. issuers and does
not currently intend to invest in the non-U.S. dollar denominated securities
described above.
For a more complete discussion of the Fund's initial portfolio composition,
see "Portfolio Composition -- Initial Portfolio Composition."
The Fund cannot change its investment objectives without the approval of
the holders of a "majority of the outstanding" Common Shares and FundPreferred
shares voting together as a single class, and of the holders of a "majority of
the outstanding" FundPreferred shares voting as a separate class. When used with
respect to particular shares of the Fund, a "majority of the outstanding" shares
means (i) 67% or more of the shares present at a meeting, if the holders of more
than 50% of the shares are present or represented by proxy, or (ii) more than
50% of the shares, whichever is less. See "Description of FundPreferred
Shares -- Voting Rights" for additional information with respect to the voting
rights of holders of FundPreferred shares.
INVESTMENT PHILOSOPHY AND PROCESS
NUVEEN INSTITUTIONAL ADVISORY CORP. (NIAC)
Asset Allocation Philosophy. NIAC is responsible for the overall strategy
and asset allocation decisions among the three primary asset classes in which
the Fund invests -- preferred securities, convertible securities and other debt
instruments. The goal of the allocation decision is to effectively capture the
diversification benefits provided by the low return-correlation across these
asset classes and provide the potential for high income generation, an
opportunity to participate in rising equity markets and some protection against
risks associated with rising interest rates. NIAC believes that the opportunity
will exist from time to time to potentially enhance the Fund's total return by
over-weighting or under-weighting these asset classes as the relative
attractiveness of the asset classes changes.
Asset Allocation Process. In determining the Fund's asset allocation, NIAC
will periodically consult with the Fund's Subadvisers and other investment
manager affiliates of NIAC. NIAC will consider factors such as interest rate
levels, market conditions and developing trends in the bond and equity markets,
analysis of relative valuations for preferred securities, convertible securities
and other debt instruments, and other economic and market factors, including the
overall outlook for the economy and inflation.
Investment Philosophy. NIAC is responsible for managing the other debt
instruments in which the Fund may invest. NIAC believes that managing risk,
particularly in a volatile asset class such as high yield debt, is of paramount
importance. NIAC believes that a combination of fundamental credit analysis and
valuation information that is available from the equity markets provide a means
of identifying what it believes to be superior investment candidates.
Additionally, NIAC focuses primarily on liquid securities to help ensure that
exit strategies remain available under different market conditions.
Investment Process. NIAC begins with a quantitative screening of other
debt instruments to identify investment candidates with favorable capital
structures, and then factors in valuation and other equity
15
market indicators. NIAC screens this universe of securities for liquidity
constraints and relative value opportunities to determine investment candidates.
Subsequently, the investment team performs rigorous fundamental analysis to
identify investments with sound industry fundamentals, cash flow sufficiency and
asset quality. The final portfolio is constructed using proprietary risk factors
and monitoring systems to ensure proper diversification.
SPECTRUM ASSET MANAGEMENT, INC. (SPECTRUM)
Investment Philosophy. Spectrum's investment philosophy with respect to
preferred securities is centered on several underlying themes:
- High levels of current income are the primary return contributor to the
total return potential of preferred securities.
- Investing in the subordinated preferred securities of stronger,
solidly-rated issuers is potentially more advantageous than owning the
senior debt of weaker, potentially deteriorating issuers.
- Investment grade quality preferred securities, over time, present an
attractive risk/return opportunity.
- Diversifying across a large number of different industries and issuers
helps insulate an overall portfolio of preferred securities from events
that affect any particular company or sector.
- Inefficiencies in the preferred securities market, particularly in the
pricing and trading of securities, can create opportunities to enhance
portfolio value.
Investment Process. Spectrum's investment process begins with
macroeconomic and fundamental credit analysis to identify sectors, industries
and companies that are potential investments. In its fundamental analysis,
Spectrum employs a value-oriented style that considers the relative
attractiveness of the security to other preferred securities and to the same
issuer's senior debt. In addition, Spectrum evaluates the structural features of
each security as well as its liquidity. In its investment decisions, Spectrum
also considers the contribution of sectors and individual securities to the
overall goal of achieving a well-diversified portfolio.
FROLEY, REVY INVESTMENT CO., INC. (FROLEY, REVY)
Investment Philosophy. Froley, Revy's investment philosophy with respect
to convertible securities is centered on the belief that convertible securities
are a total return vehicle that afford the opportunity to earn common stock-like
returns with substantially reduced risk relative to equities, while providing
some current income. The firm believes that focusing on the mid-market sector of
the convertible securities market (i.e., securities that have both common
stock-like and bond-like investment qualities) while investing opportunistically
in the bond-like and equity-like areas of the convertible securities market may
enhance total return potential. In addition, the firm believes that because of
the hybrid nature of convertible securities, research that emphasizes both
fundamental credit analysis and equity valuation analysis can help identify
investment opportunities with the greatest potential for enhancing a portfolio's
overall total return.
Investment Process. Froley, Revy's investment process begins with
screening convertible securities on certain valuation and structural parameters,
including price, yield, premium, calls, equity sensitivity and other factors. On
this pool of potential investments, Froley, Revy then conducts credit (bond)
analysis and valuation (equity) analysis to identify the most attractive
candidates within the universe. Additional inputs into the sector and security
selection decisions are top down, macroeconomic analysis of economic, interest
rate and other trends and the analysis of the structural characteristics of the
individual securities.
Froley, Revy monitors all securities and sectors on an on-going basis to
identify those that fall outside the intended investment range. Positions in
securities that have increased in value and common stock-like qualities may be
reduced to normal position weights or sold entirely based on the fundamental
outlook for
16
the underlying equity. In addition, Froley, Revy considers significant declines
from the purchase prices of securities in determining whether to purchase or
sell a particular security.
PORTFOLIO COMPOSITION
The Fund's portfolio will be composed principally of the following
investments. A more detailed description of the Fund's investment policies and
restrictions and more detailed information about the Fund's portfolio
investments are contained in the Statement of Additional Information.
Preferred Securities. Preferred securities generally pay fixed or
adjustable rate dividends to investors, and have a "preference" over common
stock in the payment of dividends and the liquidation of a company's assets.
This means that a company must pay dividends on preferred stock before paying
any dividends on its common stock. Preferred stockholders usually have no right
to vote for corporate directors or on other matters. The Fund intends that all
of the preferred securities in which it will invest will be investment grade
quality at the time of investment. The average call protection of the Fund's
portfolio allocated to preferred securities is expected to be approximately
three to four years.
The Fund intends to invest at least 25% of its Managed Assets in the
securities of companies principally engaged in financial services, which are
prominent issuers of preferred securities, and is subject to the risks of such
concentration. See "-- Financial Services Company Securities."
Taxable Preferred Securities. The Fund intends that most or all of the
preferred securities in which it invests will be fully taxable and will not pay
dividends that qualify for the Dividends Received Deduction or treatment as
"qualified dividend income." Pursuant to the Dividends Received Deduction,
corporations may generally deduct 70% of the dividend income they receive.
Noncorporate shareholders are generally entitled to reduced federal income tax
rates on "qualified dividend income." Corporate shareholders of a regulated
investment company like the Fund generally are permitted to claim a deduction
with respect to that portion of their distributions attributable to amounts
received by the regulated investment company that qualify for the Dividends
Received Deduction. Similarly, noncorporate shareholders are generally entitled
to treat as "qualified dividend income" a portion of their distributions
attributable to "qualified dividend income" received by the regulated investment
company. Taxable preferred securities that do not pay dividends that are
eligible for the Dividends Received Deduction or treatment as "qualified
dividend income" (often referred to as "hybrid" preferred securities) typically
offer additional yield spread versus other types of preferred securities due to
this lack of special tax treatment.
Taxable preferred securities are a comparatively new asset class. Taxable
preferred securities are typically issued by corporations, generally in the form
of interest-bearing notes or preferred securities, or by an affiliated business
trust of a corporation, generally in the form of beneficial interests in
subordinated debentures or similarly structured securities. The taxable
preferred securities market consists of both fixed and adjustable coupon rate
securities that are either perpetual in nature or have stated maturity dates.
The taxable preferred securities market is divided into the "$25 par" and the
"institutional" segments. The $25 par segment is typified by securities that are
listed on the Exchange, which trade and are quoted "flat", i.e., without accrued
dividend income, and which are typically callable at the issuer's option at par
value five years after their original issuance date. The institutional segment
is typified by $1,000 par value securities that are not exchange-listed, which
trade and are quoted on an "accrued income" basis, and which typically have a
minimum of 10 years of call protection (at premium prices) from the date of
their original issuance.
Taxable preferred securities are typically junior and fully subordinated
liabilities of an issuer or the beneficiary of a guarantee that is junior and
fully subordinated to the other liabilities of the guarantor. In addition,
taxable preferred securities typically permit an issuer to defer the payment of
interest for eighteen months or more without triggering an event of default.
Generally, the deferral period is five years or more. Because of their
subordinated position in the capital structure of an issuer, the ability to
defer payments for extended periods of time without adverse consequence to the
issuer, and certain other features (such as restrictions on common dividend
payments by the issuer or ultimate guarantor when cumulative payments on the
taxable preferred securities have not been made), these taxable preferred
securities are often treated as close substitutes for traditional preferred
securities, both by issuers and investors. Taxable preferred
17
securities have many of the key characteristics of equity due to their
subordinated position in an issuer's capital structure and because their quality
and value are heavily dependent on the profitability of the issuer rather than
on any legal claims to specific assets or cash flows.
Taxable preferred securities include, but are not limited to:((1))
- trust originated preferred securities ("TOPRS(R)");
- monthly income preferred securities ("MIPS(R)");
- quarterly income bond securities ("QUIBS(R)");
- quarterly income debt securities ("QUIDS(R)");
- quarterly income preferred securities ("QUIPS(SM)");
- corporate trust securities ("CORTS(R)");
- public income notes ("PINES(R)"); and
- other trust preferred securities.
Taxable preferred securities are typically issued with a final maturity
date, although some are perpetual in nature. In certain instances, a final
maturity date may be extended and/or the final payment of principal may be
deferred at the issuer's option for a specified time without any adverse
consequence to the issuer. No redemption can typically take place unless all
cumulative payment obligations have been met, although issuers may be able to
engage in open-market repurchases without regard to any cumulative dividends
payable. A portion of the portfolio may include investments in non-cumulative
preferred securities, whereby the issuer does not have an obligation to make up
any arrearages to its shareholders. Should an issuer default on its obligations
under such a security, the amount of dividends the Fund pays may be adversely
affected.
Many taxable preferred securities are issued by trusts or other special
purpose entities established by operating companies and are not a direct
obligation of an operating company. At the time a trust or special purpose
entity sells its preferred securities to investors, the trust or special purpose
entity purchases debt of the operating company (with terms comparable to those
of the trust or special purpose entity securities), which enables the operating
company to deduct for income tax purposes the interest paid on the debt held by
the trust or special purpose entity. The trust or special purpose entity is
generally required to be treated as transparent for federal income tax purposes
such that the holders of the taxable preferred securities are treated as owning
beneficial interests in the underlying debt of the operating company.
Accordingly, payments on the taxable preferred securities are treated as
interest rather than dividends for federal income tax purposes and, as such, are
not eligible for the Dividends Received Deduction or treatment as "qualified
dividend income." The trust or special purpose entity in turn would be a holder
of the operating company's debt and would have priority with respect to the
operating company's earnings and profits over the operating company's common
shareholders, but would typically be subordinated to other classes of the
operating company's debt. Typically a taxable preferred share has a rating that
is slightly below that of its corresponding operating company's senior debt
securities.
Convertible Securities. Convertible securities are bonds, debentures,
notes, preferred securities or other securities that may be converted or
exchanged (by the holder or the issuer) into shares of the underlying common
stock (or cash or securities of equivalent value) at a stated exchange ratio or
predetermined price (the "conversion price"). Convertible securities have
general characteristics similar to both debt securities and common stocks. The
interest paid on convertible securities may be fixed or floating rate. Floating
rate convertible securities may specify an interest rate or rates that are
conditioned upon changes to the market price of the underlying common stock.
Convertible securities also may be
------------
(1) TOPRS is a registered service mark owned by Merrill Lynch & Co., Inc. MIPS
and QUIDS are registered service marks and QUIPS is a service mark owned by
Goldman, Sachs & Co. QUIBS is a registered service mark owned by Morgan
Stanley Dean Witter & Co. CORTS and PINES are registered service marks owned
by Citigroup Global Markets Inc.
18
issued in zero coupon form with an original issue discount. See "Risk
Factors -- General Risks of Investing in the Fund -- Convertible Security Risk."
Although to a lesser extent than with debt securities, the market value of
convertible securities tends to decline as interest rates increase and,
conversely, tends to increase as interest rates decline. In addition, because of
the conversion feature, the market value of convertible securities tends to vary
with fluctuations in the market value of the underlying common stocks and,
therefore, will also react to the variations in the general market for common
stocks. Depending upon the relationship of the conversion price to the market
value of the underlying common stock, a convertible security may trade more like
a common stock than a debt instrument.
Mandatory convertible securities are distinguished as a subset of
convertible securities because they may be called for conversion by the issuer
after a particular date and under certain circumstances (including at a
specified price) established upon its issuance. If a mandatory convertible
security is called for conversion, the Fund will be required to either convert
it into the underlying common stock or sell it to a third party.
Convertible securities are investments that typically provide for a stable
stream of income with generally higher yields than common stocks. There can be
no assurance of current income because the issuers of the convertible securities
may default on their obligations. The convertible securities in which the Fund
may invest may be below investment grade quality. See "-- High Yield Securities"
below.
Convertible securities generally offer lower interest or dividend yields
than non-convertible securities of similar credit quality because of the
potential for capital appreciation. A convertible security, in addition to
providing current income, offers the potential for capital appreciation through
the conversion feature, which enables the holder to benefit from any increases
in the market price of the underlying common stock.
Synthetic Convertible Securities. Although the Fund does not currently
intend to invest in synthetic convertible securities, it may invest up to 10% of
its Managed Assets in such securities. Synthetic convertible securities possess
the two principal characteristics of a true convertible security, i.e., a fixed-
income security ("fixed-income component") and the right to acquire an equity
security ("equity component"). If the Fund invests in synthetic convertible
securities, it is expected that the Fund will invest in such synthetic
convertible securities that are created by third parties, typically investment
banks or other financial institutions. Synthetic convertible securities created
by other parties typically trade as a single security with a unitary value,
similar to a true convertible security. The Fund may also invest in synthetic
convertible securities by acquiring separate securities, one possessing a
fixed-income component and the other possessing an equity component. The
fixed-income component is achieved by investing in non-convertible, fixed-income
securities such as bonds, debentures, notes, preferred stocks and money market
instruments. The equity component is achieved by investing in warrants or
options to buy common stock at a certain exercise price, or options on a common
stock index. The fixed-income and equity components of such a synthetic
convertible security may be issued separately by different issuers and at
different times. Unlike a true convertible security or a synthetic convertible
security created by third parties, each of which is a single security having a
unitary market value, a synthetic convertible security that is comprised of two
or more separate securities will have a "market value" that is the sum of the
values of its fixed-income component and its equity component. For this reason,
the value of such a synthetic convertible security may respond differently to
market fluctuations than would a true convertible security or synthetic
convertible security created by a third party. The Fund's holdings of synthetic
convertible securities, including those created by third parties, are considered
convertible securities for purposes of the Fund's policy to invest at least 80%
of its Managed Assets in preferred securities and convertible securities and the
maximum and minimum allocations to preferred securities and convertible
securities set forth in "-- Investment Objectives and Policies" above.
Warrants and Options on Securities and Indexes. In connection with its
investments in synthetic convertible securities, the Fund may purchase warrants,
call options on common stock and call options on common stock indexes. A warrant
is a certificate that gives the holder of the warrant the right to buy, at a
specified time or specified times, from the issuer of the warrant, the common
stock of the issuer at a
19
specified price. A call option is a contract that gives the holder of the
option, in return for a premium, the right to buy from the writer of the option
the common stock underlying the option (or the cash value of the common stock
index) at a specified exercise price at any time during the term of the option.
Other Debt Instruments. The Fund may invest in other debt instruments
including, but not limited to, corporate bonds, notes and debentures and other
similar types of corporate debt instruments, including corporate loans. The form
of such other debt instruments may include zero coupon bonds, payment-in-kind
securities and structured notes. The debt instruments in which the Fund may
invest may be below investment grade quality. See "-- High Yield Securities."
The Fund may invest up to 20% of its Managed Assets in these types of other debt
securities, as described in more detail below.
Corporate Bonds. Corporate bonds generally are used by corporations as
well as governments and other issuers to borrow money from investors. The issuer
pays the investor a fixed or variable rate of interest and normally must repay
the amount borrowed on or before maturity.
Corporate Loans. The Fund may invest (i) in loans made by banks or other
financial institutions to corporate issuers or (ii) participation interests in
such loans. Corporate loans generally bear interest at rates set at a margin
above a generally recognized base lending rate that may fluctuate on a
day-to-day basis, in the case of the prime rate of a U.S. bank. Consequently,
the value of corporate loans held by the Fund may be expected to fluctuate
significantly less than the value of other fixed rate high yield instruments as
a result of changes in the interest rate environment. On the other hand, the
secondary dealer market for certain corporate loans may not be as well developed
as the secondary dealer market for high yield debt and, therefore, presents
increased market risk relating to liquidity and pricing concerns. By purchasing
a participation interest in a loan, the Fund acquires some or all of the
interest of a bank or other financial institution in a loan to a corporate
borrower. Purchasing a participation in a corporate loan typically will result
in the Fund having a contractual relationship with the lender, not the borrower.
In this instance, the Fund would have the right to receive payments of
principal, interest and any fees to which it is entitled only from the lender
selling the participation and only upon receipt by the lender of the payments
from the borrower. If the Fund only acquires a participation in a loan made by a
third party, the Fund may not be able to control the exercise of any remedies
that the lender would have under the corporate loan.
Zero Coupon Bonds and Payment-In-Kind Securities. A zero coupon bond is a
bond that does not pay interest either for the entire life of the obligation or
for an initial period after the issuance of the obligation. When held to its
maturity, its return comes from the difference between the purchase price and
its maturity value. Payment-in-kind securities ("PIKs") are debt obligations
that pay "interest" or dividends in the form of additional securities of the
issuer, instead of in cash. Each of these instruments is normally issued and
traded at a deep discount from face value. Zero coupon bonds and PIKs allow an
issuer to avoid or delay the need to generate cash to meet current interest
payments and, as a result, may involve greater credit risk than bonds that pay
interest currently or in cash. The Fund would be required to distribute the
income on any of these instruments as it accrues, even though the Fund will not
receive all of the income on a current basis or in cash. Thus, the Fund may have
to sell other investments, including when it may not be advisable to do so, to
make income distributions to its shareholders.
Structured Notes. The Fund may utilize structured notes and similar
instruments for investment purposes and also for hedging purposes. Structured
notes are privately negotiated debt obligations where the principal and/or
interest is determined by reference to the performance of a benchmark asset,
market or interest rate (an "embedded index"), such as selected securities, an
index of securities or specified interest rates, or the differential performance
of two assets or markets. The terms of such structured instruments normally
provide that their principal and/or interest payments are to be adjusted upwards
or downwards (but not ordinarily 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. The rate of return on structured notes may be
determined by applying a multiplier to the performance or
20
differential performance of the referenced index(es) or other asset(s).
Application of a multiplier involves leverage that will serve to magnify the
potential for gain and the risk of loss.
No Floating Rate Securities. The Fund will not invest in inverse floating
rate securities, which are securities that pay interest at rates that vary
inversely with changes in prevailing interest rates and which represent a
leveraged investment in an underlying security.
High Yield Securities. The Fund may invest up to 35% of its Managed Assets
in securities that, at the time of investment, are not investment grade quality.
The Fund will only invest in securities that, at the time of investment, are
rated B or higher by at least one NRSRO or that are unrated but judged to be of
comparable quality by the Adviser responsible for the investment, except,
however, the Fund may invest up to 5% of its Managed Assets in securities with a
highest rating of CCC or that are unrated but judged to be of comparable quality
by the Adviser responsible for the investment. Below investment grade quality
securities are regarded as having predominately speculative characteristics with
respect to capacity to pay interest and repay principal, and are commonly
referred to as junk bonds. Issuers of high yield securities may be highly
leveraged and may not have available to them more traditional methods of
financing. The prices of these lower grade securities typically are more
sensitive to negative developments, such as a decline in the issuer's revenues
or a general economic downturn, than the prices of higher grade securities. The
secondary market for high yield securities may not be as liquid as the secondary
market for more highly rated securities, a factor which may have an adverse
effect on the Fund's ability to dispose of a particular security. There are
fewer dealers in the market for high yield securities than for investment grade
obligations. The prices quoted by different dealers may vary significantly and
the spread between the bid and ask price is generally much larger than for
higher quality instruments. Under adverse market or economic conditions, the
secondary market for high yield securities could contract further, independent
of any specific adverse changes in the condition of a particular issuer, and
these instruments may become illiquid. As a result, the Fund could find it more
difficult to sell these securities or may be able to sell the securities only at
prices lower than if such securities were widely traded. Prices realized upon
the sale of such lower rated or unrated securities, under these circumstances,
may be less than the prices used in calculating the Fund's net asset value.
Non-U.S. Securities. The Fund may invest up to 35% of its Managed Assets
in securities of non-U.S. issuers. Subject to this 35% limitation, up to 10% of
the Fund's Managed Assets may be invested in securities that are denominated in
Japanese yen, Canadian dollars, British pounds or Euros and which may be
offered, traded or listed in markets other than U.S. markets. The remainder of
the Fund's Managed Assets that may be invested in securities of non-U.S. issuers
will be invested in U.S. dollar denominated securities offered, traded or listed
in U.S. markets. Initially, the Fund does not intend to invest more than 20% of
its Managed Assets in securities of non-U.S. issuers and does not currently
intend to invest in the non-U.S. dollar denominated securities described above.
The Fund may invest in any region of the world and invest in companies operating
in developed countries such as Canada, Japan, Australia, New Zealand and most
Western European countries. The Fund does not intend to invest in companies
based in emerging markets such as the Far East, Latin America and Eastern
Europe. The World Bank and other international agencies define emerging markets
based on such factors as trade initiatives, per capita income and level of
industrialization. For purposes of the 35% limitation described above, non-U.S.
securities include securities represented by American Depository Receipts.
Financial Services Company Securities. The Fund intends to invest at least
25% of its Managed Assets in securities issued by companies "principally
engaged" in financial services. A company is "principally engaged" in financial
services if it has financial services-related businesses that generate at least
50% of its revenues. Companies in the financial services sector include
commercial banks, industrial banks, savings institutions, finance companies,
diversified financial services companies, investment banking firms, securities
brokerage houses, investment advisory companies, leasing companies, insurance
companies and companies providing similar services.
Common Stocks. The Fund does not intend to purchase common stock as part
of its investment strategy. The Fund will have exposure to common stock risks by
virtue of the equity component of the
21
convertible securities in which the Fund invests. The Fund may hold common
stocks in its portfolio upon conversion of a convertible security, such holdings
not normally to exceed 5% of its Managed Assets. In addition, in keeping with
the income focus of the Fund, the Fund expects to sell any common stock holdings
as soon as practicable after conversion of a convertible security. Common stock
generally represents an ownership interest in an issuer. Although common stocks
historically have generated higher average returns than fixed-income securities,
common stocks also have experienced significantly more volatility in those
returns. An adverse event, such as an unfavorable earnings report, may depress
the value of a particular common stock held by the Fund. Also, prices of common
stocks are sensitive to general movements in the stock market. A drop in the
stock market may depress the prices of common stocks held by the Fund or to
which it has exposure.
Hedging Transactions. The Fund may use derivatives or other transactions
for the purpose of hedging the portfolio's exposure to the risk of increases in
interest rates, common stock risk, high yield credit risk and foreign currency
exchange rate risk. The specific derivative instruments to be used, or other
transactions to be entered into, each for hedging purposes may include (i)
options and futures contracts, including options on common stock, stock indexes,
bonds and bond indexes, stock index futures, bond index futures and related
instruments, (ii) short sales of securities that the Fund owns or has the right
to acquire through the conversion of securities, (iii) structured notes and
similar instruments, (iv) credit derivative instruments and (v) currency
exchange transactions. Some, but not all, of the derivative instruments may be
traded and listed on an exchange. The positions in derivatives will be
marked-to-market daily at the closing price established on the exchange or at a
fair value. Except for investing in synthetic convertible securities, the Fund
will use derivatives or other transactions described in this paragraph solely
for purposes of hedging the Fund's portfolio risks. See "Risk Factors -- General
Risks of Investing in the Fund -- Hedging Risk," "Risk Factors -- General Risks
of Investing in the Fund -- Counterparty Risk," "-- Synthetic Convertible
Security Risk" and "Other Investment Policies and Techniques" in the Fund's
Statement of Additional Information for further information on hedging
transactions.
Illiquid Securities. The Fund may invest up to 10% of its Managed Assets
in securities that, at the time of investment, are illiquid (i.e., securities
that are not readily marketable), however, initially, the Fund does not intend
to invest more than 5% of its Managed Assets in such securities. All securities
and other instruments in which the Fund invests will be subject to the 10%
limitation referred to above to the extent they are deemed to be illiquid. For
this purpose, illiquid securities may include, but are not limited to,
restricted securities (securities the disposition of which is restricted under
the federal securities laws), securities that may only be resold pursuant to
Rule 144A under the Securities Act of 1933, as amended (the "Securities Act"),
that are deemed to be illiquid, and repurchase agreements with maturities in
excess of seven days. The Board of Trustees or its delegate has the ultimate
authority to determine, to the extent permissible under the federal securities
laws, which securities are liquid or illiquid for purposes of this 10%
limitation. The Board of Trustees has delegated to the Advisers the day-to-day
determination of the illiquidity of any security held by the Fund, although it
has retained oversight and ultimate responsibility for such determinations.
Although no definitive liquidity criteria are used, the Board of Trustees has
directed the Advisers to look for such factors as (i) the nature of the market
for a security (including the institutional private resale market; the frequency
of trades and quotes for the security; the number of dealers willing to purchase
or sell the security; the amount of time normally needed to dispose of the
security; and the method of soliciting offers and the mechanics of transfer),
(ii) the terms of certain securities or other instruments allowing for the
disposition to a third party or the issuer thereof (e.g., certain repurchase
obligations and demand instruments), and (iii) other relevant factors.
Restricted securities may be sold only in privately negotiated transactions
or in a public offering with respect to which a registration statement is in
effect under the Securities Act. Where registration is required, the Fund may be
obligated to pay all or part of the registration expenses and a considerable
period may elapse between the time of the decision to sell and the time the Fund
may be permitted to sell a security under an effective registration statement.
If, during such a period, adverse market conditions were to develop, the Fund
might obtain a less favorable price than that which prevailed when it decided to
22
sell. Illiquid securities will be priced at fair value as determined in good
faith by the Board of Trustees or its delegate. If, through the appreciation of
illiquid securities or the depreciation of liquid securities, the Fund should be
in a position where more than 10% of the value of its Managed Assets is invested
in illiquid securities, including restricted securities that are not readily
marketable, the Fund will take such steps as are deemed advisable, if any, to
protect liquidity.
Short-Term/Long-Term Debt Securities; Defensive Position; Invest-Up
Period. Upon an Adviser's recommendation and during temporary defensive periods
or in order to keep the Fund's cash fully invested, including the period during
which the net proceeds of the offering of Common Shares or FundPreferred shares
are being invested, the Fund may deviate from its investment objectives and
invest all or any portion of its assets in investment grade debt securities. In
such a case, the Fund may not pursue or achieve its investment objectives. In
addition, during the temporary periods when the net proceeds of the offering of
Common Shares or FundPreferred shares are being invested, the Fund may invest
all or a portion of its assets in debt securities of long-term maturities issued
by the U.S. Government or its agencies or instrumentalities.
When-Issued and Delayed Delivery Transactions. The Fund may buy and sell
securities on a when-issued or delayed delivery basis, making payment or taking
delivery at a later date, normally within 15 to 45 days of the trade date. This
type of transaction may involve an element of risk because no interest accrues
on the securities prior to settlement and, because securities are subject to
market fluctuations, the value of the securities at time of delivery may be less
(or more) than cost. A separate account of the Fund will be established with its
custodian consisting of cash equivalents or liquid securities having a market
value at all times at least equal to the amount of the commitment.
Other Investment Companies. The Fund may invest up to 10% of its Managed
Assets in securities of other open- or closed-end investment companies that
invest primarily in securities of the types in which the Fund may invest
directly, or short-term debt securities. The Fund generally expects to invest in
other investment companies either during periods when it has large amounts of
uninvested cash, such as the period shortly after the Fund receives the proceeds
of the offering of its FundPreferred shares, or during periods when there is a
shortage of attractive securities of the types in which the Fund may invest in
directly available in the market. As an investor 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 advisory and administrative fees
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. The Advisers will take expenses into account when
evaluating the investment merits of an investment in the investment company
relative to available securities of the types in which the Fund may invest
directly. In addition, the securities of other investment companies also may be
leveraged and therefore will be subject to the same leverage risks described
herein. As described in the section entitled "Risk Factors," 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.
Initial Portfolio Composition. If current market conditions persist, the
Fund expects that its initial portfolio of preferred securities, convertible
securities and other debt instruments will be comprised of securities with the
following ratings, or in unrated securities judged by the Adviser responsible
for the investment to be of comparable credit quality: 5% in AA or better, 35%
in A, 35% in Baa/BBB, 15% in Ba/BB and 10% in B. Initially, the Fund intends to
invest approximately 75% of its Managed Assets in investment grade quality
securities. Initially, the Fund does not intend to invest more than 5% of its
Managed Assets in illiquid securities or more than 20% of its Managed Assets in
securities of non-U.S. issuers. In addition, the Fund does not currently intend
to invest in the non-U.S. dollar denominated securities described in this
Prospectus. The Fund also intends that all of the preferred securities in which
it will invest will be investment grade quality at the time of investment. The
Fund's intentions may change over time based on market and other conditions
beyond the Fund's control and there can be no assurance that the parameters of
the initial portfolio composition as described above will be achieved.
23
Lending of Portfolio Securities. The Fund may lend its portfolio
securities to broker-dealers and banks. Any such loan must be continuously
secured by collateral in cash or cash equivalents maintained on a current basis
in an amount at least equal to the market value of the securities loaned by the
Fund. The Fund would continue to receive the equivalent of the interest or
dividends paid by the issuer on the securities loaned, and would also receive an
additional return that may be in the form of a fixed fee or a percentage of the
collateral. The Fund may pay reasonable fees to persons unaffiliated with the
Fund for services in arranging these loans. The Fund would have the right to
call the loan and obtain the securities loaned at any time on notice of not more
than five business days. The Fund would not have the right to vote the
securities during the existence of the loan but would call the loan to permit
voting of the securities, if, in an Adviser's judgment, a material event
requiring a shareholder vote would otherwise occur before the loan was repaid.
In the event of bankruptcy or other default of the borrower, the Fund could
experience both delays in liquidating the loan collateral or recovering the
loaned securities and losses, including (a) possible decline in the value of the
collateral or in the value of the securities loaned during the period while the
Fund seeks to enforce its rights thereto, (b) possible subnormal levels of
income and lack of access to income during this period, and (c) expenses of
enforcing its rights.
Portfolio Turnover. The Fund may engage in portfolio trading when
considered appropriate, but short-term trading will not be used as the primary
means of achieving the Fund's investment objectives. Although the Fund cannot
accurately predict its annual portfolio turnover rate, it is not expected to
exceed 75% under normal circumstances. However, there are no limits on the rate
of portfolio turnover, and investments may be sold without regard to length of
time held when, in the opinion of an Adviser, investment considerations warrant
such action. A higher portfolio turnover rate results in correspondingly greater
brokerage commissions and other transactional expenses that are borne by the
Fund. High portfolio turnover may result in the realization of net short-term
capital gains by the Fund which, when distributed to shareholders, will be
taxable as ordinary income. See "Federal Income Tax Matters."
USE OF LEVERAGE
The Fund intends to use leverage through the issuance of FundPreferred
shares, for investment purposes. The Fund currently anticipates its use of
leverage to represent approximately 33 1/3% of its total assets, including the
proceeds of such leverage. In addition to issuing FundPreferred shares, the Fund
may make further use of financial leverage through borrowing, including the
issuance of commercial paper or notes. See "Description of FundPreferred Shares"
and "Description of Borrowings" below. The Fund employs financial leverage for
the purpose of acquiring additional income-producing investments when the
Advisers believe that such use of proceeds will enhance the Fund's net income.
The amount of outstanding financial leverage may vary with prevailing market or
economic conditions. Leverage entails special risks. See "Risk Factors -- Risks
of Investing in FundPreferred Shares -- Leverage Risk." The management fee paid
to the Advisers will be calculated on the basis of the Fund's Managed Assets,
(which includes proceeds of financial leverage), so the fees will be higher when
leverage is used.
HEDGING TRANSACTIONS
The Fund may use derivatives or other transactions for the purpose of
hedging a portion of its portfolio holdings or in connection with the Fund's use
of leverage through its sale of FundPreferred shares or Borrowings.
Portfolio Hedging Transactions. The Fund may use derivatives or other
transactions for purposes of hedging the portfolio's exposure to the risk of
increases in interest rates, common stock risk, high yield credit risk and
foreign currency exchange rate risk. The specific derivative instruments to be
used, or other transactions to be entered into, each for hedging purposes may
include (i) options and futures contracts, including options on common stock,
stock indexes, bonds and bond indexes, stock index futures, bond index futures
and related instruments, (ii) short sales of securities that the Fund owns or
has the right to acquire through the conversion of securities, (iii) structured
notes and similar instruments, (iv) credit derivative instruments and (v)
currency exchange transactions. Some, but not all, of the derivative
24
instruments may be traded and listed on an exchange. The positions in
derivatives will be marked-to-market daily at the closing price established on
the relevant exchange or at a fair value. Except for investing in synthetic
convertible securities, the Fund will use derivatives or other transactions
described in this paragraph solely for purposes of hedging the Fund's portfolio
risks. See "The Fund's Investments -- Portfolio Composition -- Synthetic
Convertible Securities."
There may be an imperfect correlation between changes in the value of the
Fund's portfolio holdings and hedging positions entered into by the Fund, which
may prevent the Fund from achieving the intended hedge or expose the Fund to
risk of loss. In addition, the Fund's success in using hedging instruments is
subject to an Adviser's ability to predict correctly changes in the
relationships of such hedge instruments to the Fund's portfolio holdings or
other factors, and there can be no assurance that an Adviser's judgment in this
respect will be correct. Consequently, the use of hedging transactions might
result in a poorer overall performance for the Fund, whether or not adjusted for
risk, than if the Fund had not hedged its portfolio holdings. In addition, there
can be no assurance that the Fund will enter into hedging or other transactions
at times or under circumstances in which it which it would be advisable to do
so. See "Risk Factors -- General Risks of Investing in the Fund -- Hedging
Risk."
Options on Securities. In order to hedge against adverse market shifts,
the Fund may purchase put and call options on stock, bonds or other securities.
In addition, the Fund may seek to hedge a portion of its portfolio investments
through writing (i.e., selling) covered put and call options. A put option
embodies the right of its purchaser to compel the writer of the option to
purchase from the option holder an underlying security or its equivalent at a
specified price at any time during the option period. In contrast, a call option
gives the purchaser the right to buy the underlying security covered by the
option or its equivalent from the writer of the option at the stated exercise
price at any time during the option period.
As a holder of a put option, the Fund will have the right to sell the
securities underlying the option and as the holder of a call option, the Fund
will have the right to purchase the securities underlying the option, in each
case at their exercise price at any time prior to the option's expiration date.
The Fund may choose to exercise the options it holds, permit them to expire or
terminate them prior to their expiration by entering into closing sale or
purchase transactions. In entering into a closing sale transaction, the Fund
would sell an option of the same series as the one it has purchased. The ability
of the Fund to enter into a closing sale transaction with respect to options
purchased and to enter into a closing purchase transaction with respect to
options sold depends on the existence of a liquid secondary market. There can be
no assurance that a closing purchase or sale transaction can be effected when
the Fund so desires. The Fund's ability to terminate option positions
established in the over-the-counter market may be more limited than in the case
of exchange-traded options and may also involve the risk that securities dealers
participating in such transactions would fail to meet their obligations to the
Fund.
In purchasing a put option, the Fund will seek to benefit from a decline in
the market price of the underlying security, while in purchasing a call option,
the Fund will seek to benefit from an increase in the market price of the
underlying security. If an option purchased is not sold or exercised when it has
remaining value, or 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 equal to
or below the exercise price, in the case of a call, during the life of the
option, the option will expire worthless. For the purchase of an option to be
profitable, the market price of the underlying security must decline
sufficiently below the exercise price, in the case of a put, and must increase
sufficiently above the exercise price, in the case of a call, to cover the
premium and transaction costs. Because option premiums paid by the Fund are
small in relation to the market value of the instruments underlying the options,
buying options can result in additional amounts of leverage to the Fund. The
leverage caused by trading in options could cause the Fund's net asset value to
be subject to more frequent and wider fluctuation than would be the case if the
Fund did not invest in options.
The Fund will receive a premium when it writes put and call options, which
increases the Fund's return on the underlying security in the event the option
expires unexercised or is closed out at a profit. By writing a call, the Fund
will limit its opportunity to profit from an increase in the market value of the
25
underlying security above the exercise price of the option for as long as the
Fund's obligation as the writer of the option continues. Upon the exercise of a
put option written by the Fund, the Fund may suffer an economic loss equal to
the difference between the price at which the Fund is required to purchase the
underlying security and its market value at the time of the option exercise,
less the premium received for writing the option. Upon the exercise of a call
option written by the Fund, the Fund may suffer an economic loss equal to an
amount not less than the excess of the security's market value at the time of
the option exercise over the Fund's acquisition cost of the security, less the
sum of the premium received for writing the option and the difference, if any,
between the call price paid to the Fund and the Fund's acquisition cost of the
security. Thus, in some periods the Fund might receive less total return and in
other periods greater total return from its hedged positions than it would have
received from its underlying securities unhedged.
Options on Stock and Bond Indexes. The Fund may purchase put and call
options on stock and bond indexes to hedge against risks of market-wide price
movements affecting its assets. In addition, the Fund may write covered put and
call options on stock and bond indexes. A stock or bond index measures the
movement of a certain group of stocks or bonds by assigning relative values to
the stocks or bonds included in the index. Options on a stock or bond index are
similar to options on securities. Because no underlying security can be
delivered, however, the option represents the holder's right to obtain from the
writer, in cash, a fixed multiple of the amount by which the exercise price
exceeds (in the case of a put) or is less than (in the case of a call) the
closing value of the underlying index on the exercise date. The advisability of
using stock or bond index options to hedge against the risk of market-wide
movements will depend on the extent of diversification of the Fund's investments
and the sensitivity of its investments to factors influencing the underlying
index. The effectiveness of purchasing or writing stock or bond index options as
a hedging technique will depend upon the extent to which price movements in the
Fund's investments correlate with price movements in the stock or bond index
selected. In addition, successful use by the Fund of options on stock or bond
indexes will be subject to the ability of an Adviser to predict correctly
changes in the relationship of the underlying index to the Fund's portfolio
holdings. No assurance can be given that the Adviser's judgment in this respect
will be correct.
When the Fund writes an option on a stock or bond index, it will establish
a segregated account with its custodian in which the Fund will deposit liquid
securities in an amount equal to the market value of the option, and will
maintain the account while the option is open.
Stock and Bond Index Futures Contracts. The Fund may purchase and sell
stock index futures as a hedge against movements in the equity markets. Stock
and bond index futures contracts are agreements in which one party agrees to
deliver to the other an amount of cash equal to a specific dollar amount times
the difference between the value of a specific stock or bond index at the close
of the last trading day of the contract and the price at which the agreement is
made. No physical delivery of securities is made.
For example, if an Adviser expects general stock or bond market prices to
decline, it might sell a futures contract on a particular stock or bond index.
If that index does in fact decline, the value of some or all of the securities
in the fund's portfolio may also be expected to decline, but that decrease would
be offset in part by the increase in the value of the Fund's position in such
futures contract. If, on the other hand, an Adviser expects general stock or
bond market prices to rise, it might purchase a stock or bond index futures
contract as a hedge against an increase in prices of particular securities it
wants ultimately to buy. If in fact the stock or bond index does rise, the price
of the particular securities intended to be purchased may also increase, but
that increase would be offset in part by the increase in the value of the Fund's
futures contract resulting from the increase in the index.
Under regulations of the Commodity Futures Trading Commission currently in
effect, which may change from time to time, with respect to futures contracts
purchased by the Fund, the Fund will set aside in a segregated account liquid
securities with a value at least equal to the value of instruments underlying
such futures contracts less the amount of initial margin on deposit for such
contracts. The current view of the staff of the Securities and Exchange
Commission is that the Fund's long and short positions in futures
26
contracts must be collateralized with cash or certain liquid assets held in a
segregated account or "covered" in order to counter the impact of any potential
leveraging.
There are several risks associated with the use of futures contracts and
futures options. A purchase or sale of a futures contract may result in losses
in excess of the amount invested in the futures contract. While the Fund may
enter into futures contracts and options on futures contracts for hedging
purposes, the use of futures contracts and options on futures contracts might
result in a poorer overall performance for the Fund than if it had not engaged
in any such transactions. There may be an imperfect correlation between the
Fund's portfolio holdings and futures contracts or options on futures contracts
entered into by the Fund, which may prevent the Fund from achieving the intended
hedge or expose the Fund to risk of loss. The degree of imperfection of
correlation depends on circumstances such as: variations in speculative market
demand for futures, futures options and the related securities, including
technical influences in futures and futures options trading and differences
between the securities markets and the securities underlying the standard
contracts available for trading. Further, the Fund's use of futures contracts
and options on futures contracts to reduce risk involves costs and will be
subject to an Adviser's ability to predict correctly changes in interest rate
relationships or other factors.
Short Sales. The Fund may make short sales of securities if, at all times
when a short position is open, the Fund owns at least an equal amount of such
securities or securities convertible into or exchangeable for, without payment
of any further consideration, securities of the same issuer as, and equal in
amount to, the securities sold short. This technique is called selling short
"against the box."
In a short sale, the Fund will not deliver from its portfolio the
securities sold and will not receive immediately the proceeds from the short
sale. Instead, the Fund will borrow the securities sold short from a
broker-dealer through which the short sale is executed and the broker-dealer
will deliver such securities, on behalf of the Fund, to the purchaser of such
securities. Such broker-dealer will be entitled to retain the proceeds from the
short sale until the Fund delivers to such broker-dealer the securities sold
short. In addition, the Fund will be required to pay the broker-dealer the
amount of any dividends paid on shares sold short. Finally, to secure its
obligation to deliver to such broker-dealer the securities sold short, the Fund
must deposit and continuously maintain in a separate account with its custodian
an equivalent amount of the securities sold short or securities convertible into
or exchangeable for such securities without the payment of additional
consideration. The Fund is said to have a short position in the securities sold
until it delivers to the broker-dealer the securities sold, at which time the
Fund will receive the proceeds of the sale. Because the Fund ordinarily will
want to continue to hold securities in its portfolio that are sold short, the
Fund will normally close out a short position by purchasing on the open market
and delivering to the broker-dealer an equal amount of the securities sold
short, rather than by delivering portfolio securities.
Short sales may protect the Fund against the risk of losses in the value of
its portfolio securities because any unrealized losses with respect to such
portfolio securities should be wholly or partially offset by a corresponding
gain in the short position. However, any potential gain in such portfolio
securities should be wholly or partially offset by a corresponding loss in the
short position. The extent to which such gains or losses are offset will depend
upon the amount of securities sold short relative to the amount the Fund owns,
either directly or indirectly, and, in the case where the Fund owns convertible
securities, changes in the conversion premium. The Fund will incur transaction
costs in connection with short sales.
In addition to enabling the Fund to hedge against market risk, short sales
may afford the Fund an opportunity to earn additional current income to the
extent the Fund is able to enter into arrangements with broker-dealers through
which the short sales are executed to receive income with respect to the
proceeds of the short sales during the period the Fund's short positions remain
open.
The Code imposes constructive sale treatment for federal income tax
purposes on certain hedging strategies with respect to appreciated financial
positions. Under these rules, taxpayers will recognize gain, but not loss, with
respect to securities if they enter into short sales or "offsetting notional
principal contracts" (as defined by the Code) with respect to, or futures or
forward contracts to deliver, the same or substantially identical property, or
if they enter into such transactions and then acquire the same or
27
substantially identical property. The Secretary of the Treasury is authorized to
promulgate regulations that will treat as constructive sales certain
transactions that have substantially the same effect as these transactions.
Structured Notes. The Fund may use structured notes and similar
instruments for hedging purposes. Structured notes are privately negotiated debt
obligations where the principal and/or interest is determined by reference to
the performance of a benchmark asset, market or interest rate (an "embedded
index"), such as selected securities, an index of securities or specified
interest rates or the differential performance of two assets or markets. The
terms of such structured instruments normally provide that their principal
and/or interest payments are to be adjusted upwards or downwards (but not
ordinarily 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. 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 that will serve to magnify the potential for gain and the risk of loss.
Credit Derivative Instruments. The Fund may purchase credit derivative
instruments for the purpose of hedging the Fund's credit risk exposure to
certain issuers of securities that the Fund owns. For example, the Fund may
enter into credit swap default contracts for hedging purposes where the Fund
would be the buyer of such a contract. The Fund would be entitled to receive the
par (or other agreed-upon) value of a referenced debt obligation from the
counterparty to the contract 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 pay to 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 have spent the stream of payments and received no benefit from
the contract.
Currency Exchange Transactions. The Fund may enter into currency exchange
transactions to hedge the Fund's exposure to foreign currency exchange rate risk
in the event the Fund invests in non-U.S. denominated securities of non-U.S.
issuers as described in this Prospectus. The Fund's currency transactions will
be limited to portfolio hedging involving portfolio positions. Portfolio hedging
is the use of a forward contract with respect to a portfolio security position
denominated or quoted in a particular currency. A forward contract is an
agreement to purchase or sell a specified currency at a specified future date
(or within a specified time period) and price set at the time of the contract.
Forward contracts are usually entered into with banks, foreign exchange dealers
or broker-dealers, are not exchange-traded, and are usually for less than one
year, but may be renewed.
At the maturity of a forward contract to deliver a particular currency, the
Fund may either sell the portfolio security related to such contract and make
delivery of the currency, or it may retain the security and either acquire the
currency on the spot market or terminate its contractual obligation to deliver
the currency by purchasing an offsetting contract with the same currency trader
obligating it to purchase on the same maturity date the same amount of the
currency.
It is impossible to forecast with absolute precision the market value of
portfolio securities at the expiration of a forward contract. Accordingly, it
may be necessary for the Fund to purchase additional currency on the spot market
(and bear the expense of such purchase) if the market value of the security is
less than the amount of currency that the Fund is obligated to deliver and if a
decision is made to sell the security and make delivery of the currency.
Conversely, it may be necessary to sell on the spot market some of the currency
received upon the sale of the portfolio security if its market value exceeds the
amount of currency the Fund is obligated to deliver.
If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward contract to sell the
currency. Should forward prices decline during the period between the Fund's
entering into a forward
28
contract for the sale of a currency and the date it enters into an offsetting
contract for the purchase of the currency, the Fund will realize a gain to the
extent the price of the currency it has agreed to sell exceeds the price of the
currency it has agreed to purchase. Should forward prices increase, the Fund
will suffer a loss to the extent the price of the currency it has agreed to
purchase exceeds the price of the currency it has agreed to sell. A default on
the contract would deprive the Fund of unrealized profits or force the Fund to
cover its commitments for purchase or sale of currency, if any, at the current
market price.
Hedging against a decline in the value of a currency does not eliminate
fluctuations in the prices of portfolio securities or prevent losses if the
prices of such securities decline. Such transactions also preclude the
opportunity for gain if the value of the hedged currency should rise. Moreover,
it may not be possible for the Fund to hedge against a devaluation that is so
generally anticipated that the Fund is not able to contract to sell the currency
at a price above the devaluation level it anticipates. The cost to the Fund of
engaging in currency exchange transactions varies with such factors as the
currency involved, the length of the contract period, and prevailing market
conditions. Since currency exchange transactions are usually conducted on a
principal basis, no fees or commissions are involved.
The Fund also may invest in relatively new instruments without a
significant trading history for purposes of hedging the Fund's portfolio risks.
See "Other Investment Policies and Techniques" in the Fund's Statement of
Additional Information for further information on hedging transactions.
Interest Rate Transactions. In connection with the Fund's use of leverage
through its sale of FundPreferred shares or Borrowings, the Fund, if market
conditions are deemed favorable, likely will enter into interest rate swap or
cap transactions to attempt to protect itself from increasing dividend or
interest expenses on its FundPreferred shares or Borrowings. Interest rate swaps
involve the Fund's agreement with the swap counterparty to pay a fixed rate
payment in exchange for the counterparty agreeing to pay the Fund a payment at a
variable rate that is expected to approximate the rate on the Fund's variable
rate payment obligation on FundPreferred shares or any variable rate Borrowings.
The payment obligations would be based on the notional amount of the swap. The
Fund's payment obligations under the swap are general unsecured obligations of
the Fund and are ranked senior to distributions under the Common Shares and
FundPreferred shares.
The Fund may use an interest rate cap, which would require it to pay a
premium to the cap counterparty and would entitle it, 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 of
such cap. The Fund would use interest rate swaps or caps only with the intent to
reduce or eliminate the risk that an increase in short-term interest rates could
have on Common Share net earnings as a result of leverage.
The Fund will usually enter into swaps or caps on a net basis; that is, the
two payment streams will be netted out in a cash settlement on the payment date
or dates specified in the instrument, with the Fund receiving or paying, as the
case may be, only the net amount of the two payments. The Fund intends to
maintain in a segregated account with its custodian cash or liquid securities
having a value at least equal to the Fund's net payment obligations under any
swap transaction, marked-to-market daily. Under certain circumstances, the Fund
may be required to pledge the assets in such segregated account to the counter-
party.
The use of interest rate swaps and caps is a highly specialized activity
that involves investment techniques and risks different from those associated
with ordinary portfolio security transactions. The Fund has no current intention
of selling an interest rate swap or cap. The Fund will not enter into interest
rate swap or cap transactions in an aggregate notional amount that exceeds the
outstanding amount of the Fund's leverage.
Interest rate swaps and caps do not involve the delivery of securities or
other underlying assets or principal. Accordingly, the risk of loss with respect
to interest rate swaps is limited to the net amount of interest payments that
the Fund is contractually obligated to make. If the counterparty defaults, the
Fund would not be able to use the anticipated net receipts under the swap or cap
to offset the dividend
29
payments on FundPreferred shares or interest payments on Borrowings. Depending
on whether the Fund would be entitled to receive net payments from the
counterparty on the swap or cap, which in turn would depend on the general state
of short-term interest rates at that point in time, such a default could
negatively impact the Fund's ability to make dividend payments on the
FundPreferred shares or interest payments on Borrowings.
Although this will not guarantee that the counterparty does not default,
the Fund will not enter into an interest rate swap or cap transaction with any
counterparty that NIAC believes does not have the financial resources to honor
its obligation under the interest rate swap or cap transaction. Further, NIAC
will regularly monitor the financial stability of a counterparty to an interest
rate swap or cap transaction in an effort to proactively protect the Fund's
investments.
In addition, at the time the interest rate swap or cap transaction reaches
its scheduled termination date, there is a risk that the Fund will not be able
to obtain a replacement transaction or that the terms of the replacement will
not be as favorable as on the expiring transaction. If this occurs, it could
have a negative impact the Fund's ability to make dividend payments on the
FundPreferred shares or interest payments on Borrowings.
The Fund may choose or be required to redeem some or all FundPreferred
shares or prepay any Borrowings. This redemption would likely result in the Fund
seeking to terminate early all or a portion of any swap or cap transaction. Such
early termination of a swap could result in a termination payment by or to the
Fund. An early termination of a cap could result in a termination payment to the
Fund.
30
RISK FACTORS
Risk is inherent in all investing. Investing in any investment company
security involves risk, including the risk that you may receive little or no
return on your investment or even that you may lose part or all of your
investment. Therefore, before investing you should consider carefully the
following risks that you assume when you invest in FundPreferred shares.
RISKS OF INVESTING IN FUNDPREFERRED SHARES
Interest Rate Risk. The Fund issues FundPreferred shares, which pay
dividends based on short-term interest rates. The Fund generally will purchase
preferred, convertible and debt securities that pay fixed or adjustable rate
dividends. If short-term interest rates rise, dividend rates on the
FundPreferred shares may rise so that the amount of dividends paid to
stockholders of FundPreferred shares exceeds the income from the Fund's
portfolio securities. Because income from the Fund's entire investment portfolio
(not just the portion of the portfolio purchased with the proceeds of the
FundPreferred shares offering) is available to pay dividends on the
FundPreferred shares, dividend rates on the FundPreferred shares would need to
greatly exceed the Fund's net portfolio income before the Fund's ability to pay
dividends on the FundPreferred shares would be jeopardized. If market 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
FundPreferred shares. The Fund anticipates entering into interest rate swap or
cap transactions with the intent to reduce or eliminate the risk posed by an
increase in market interest rates. There is no guarantee that the Fund will
engage in these transactions or that these transactions will be successful in
reducing or eliminating interest rate risk.
Auction Risk. You may not be able to sell your FundPreferred shares at an
auction if the auction fails; that is, if there are more FundPreferred shares
offered for sale than there are buyers for those shares. Also, if you place hold
orders (orders to retain FundPreferred shares) at an auction only at a specified
rate, and that bid rate exceeds the rate set at the auction, you will not retain
your FundPreferred shares. Finally, if you buy shares or elect to retain shares
without specifying a rate below which you would not wish to 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. See "Description of
FundPreferred Shares" and "The Auction -- Auction Procedures."
Secondary Market Risk. If you try to sell your FundPreferred shares
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. If the Fund has designated a special dividend period (a
rate period other than seven (7) days), changes in interest rates could affect
the price you would receive if you sold your shares in the secondary market.
Broker-dealers that maintain a secondary trading market for FundPreferred shares
are not required to maintain this market, and the Fund is not required to redeem
shares either if an auction or an attempted secondary market sale fails because
of a lack of buyers. FundPreferred shares are not registered on a stock exchange
or the NASDAQ stock market. If you sell your FundPreferred shares 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.
Ratings and Asset Coverage Risk. While Moody's and Fitch assign ratings of
"Aaa" and "AAA," respectively, to FundPreferred shares, the ratings do not
eliminate or necessarily mitigate the risks of investing in FundPreferred
shares. A rating agency could downgrade FundPreferred shares, which may make
your shares less liquid at an auction or in the secondary market, though
probably with higher resulting dividend rates. If a rating agency downgrades
FundPreferred shares, the Fund will alter its portfolio or redeem FundPreferred
shares. The Fund may voluntarily redeem FundPreferred shares under certain
circumstances. See "Description of FundPreferred Shares -- Asset Maintenance"
for a description of the asset maintenance tests the Fund must meet.
31
36
Inflation Risk. Inflation is the reduction in the purchasing power of
money resulting from the increase in the price of goods and services. Inflation
risk is the risk that the inflation adjusted (or "real") value of your
FundPreferred shares investment or the income from that investment will be worth
less in the future. As inflation occurs, the real value of the FundPreferred
shares and distributions declines. In an inflationary period, however, it is
expected that, through the auction process, FundPreferred shares dividend rates
would increase, tending to offset this risk.
Decline in Net Asset Value Risk. A material decline in the Fund's net
asset value may impair the Fund's ability to maintain required levels of asset
coverage. For a description of risks affecting the Fund, please see "-- General
Risks of Investing in the Fund" below.
Payment Restrictions. The Fund is prohibited from declaring, paying or
making any dividends or distributions on FundPreferred shares unless it
satisfies certain conditions. See "Description of FundPreferred
Shares -- Restrictions on Dividend, Redemption and Other Payments." The Fund is
also prohibited from declaring, paying or making any dividends or distributions
on Common Shares unless it satisfies certain conditions. These prohibitions on
the payment of dividends or distributions might impair the Fund's ability to
maintain its qualification as a regulated investment company for federal income
tax purposes. The Fund intends, however, to redeem shares of FundPreferred
shares if necessary to comply with the asset coverage requirements. There can be
no assurance, however, that such redemptions can be effected in time to permit
the Fund to distribute its income as required to maintain its qualification as a
regulated investment company under the Code. See "Federal Income Tax
Matters -- Federal Income Tax Treatment of the Fund."
Leverage Risk. The Fund uses financial leverage for investment purposes in
an amount currently anticipated to represent approximately 33 1/3% of its total
assets (including the proceeds from such financial leverage). In addition to
issuing FundPreferred shares, the Fund may make further use of financial
leverage through borrowing, including the issuance of commercial paper or notes.
In addition, the Fund may also borrow funds (a) in connection with a loan made
by a bank or other party that is privately arranged and not intended to be
publicly distributed or (b) in an amount equal to up to 5% of its total assets
for temporary purposes only.
If the Fund issues any senior securities representing indebtedness (as
defined in the 1940 Act) under the requirements of the 1940 Act, the value of
the Fund's total assets, less all liabilities and indebtedness of the Fund not
represented by such senior securities, must be at least equal, immediately after
any such senior securities representing indebtedness, to 300% of the aggregate
value of such senior securities. Upon the issuance of FundPreferred shares, the
value of the Fund's total assets, less all liabilities and indebtedness of the
Fund not represented by senior securities must be at least equal, immediately
after the issuance of the FundPreferred shares, to 200% of the aggregate value
of any senior securities and the FundPreferred shares.
If the Fund seeks an investment grade rating from one or more nationally
recognized statistical rating organizations for any commercial paper and notes
(which the Fund expects to do if it issues any such commercial paper or notes),
asset coverage or portfolio composition provisions in addition to and more
stringent than those required by the 1940 Act may be imposed in connection with
the issuance of such a rating. In addition, restrictions may be imposed on
certain investment practices in which the Fund may otherwise engage. Any lender
with respect to borrowings by the Fund may require additional asset coverage and
portfolio composition provisions as well as restrictions on the Fund's
investment practices.
The money borrowed pursuant to any Borrowings may constitute a substantial
lien and burden on the FundPreferred shares by reason of their prior claim
against the income of the Fund and against the net assets of the Fund in
liquidation. The Fund may not be permitted to declare dividends or other
distributions, including with respect to FundPreferred shares, or purchase or
redeem shares, including FundPreferred shares unless (i) at the time thereof the
Fund meets certain asset coverage requirements and (ii) there is no event of
default under any Borrowings, that is continuing. See "Description of
FundPreferred Shares -- Restrictions on Dividend, Redemption and Other
Payments." In the event of a default under any Borrowings, the lenders may have
the right to cause a liquidation of the collateral (i.e.,
32
sell portfolio securities) and if any such default is not cured, the lenders may
be able to control the liquidation as well.
The Fund reserves the right at any time, if it believes that market
conditions are appropriate, to increase its level of debt or other senior
securities to maintain or increase the Fund's current level of leverage to the
extent permitted by the 1940 Act and existing agreements between the Fund and
third parties.
Because the fee paid to the Advisers will be calculated on the basis of
Managed Assets, the fee will be higher when leverage is utilized, giving the
Advisers an incentive to utilize leverage.
GENERAL RISKS OF INVESTING IN THE FUND
Limited Operating History. The Fund is a recently organized, diversified,
closed-end management investment company with a limited operating history.
Investment Risk and Interest Rate Risk. Your investment in the
FundPreferred shares represents an indirect investment in the securities owned
by the Fund, most of which are traded on a national securities exchange or in
the over-the-counter markets. The value of these securities, like other market
investments, may move up or down, sometimes rapidly and unpredictably.
Interest rate risk is the risk that fixed-income securities such as
preferred, convertible and other debt securities will decline in value because
of changes in market interest rates. When market interest rates rise, the market
value of such securities generally will fall. The Fund's investment in such
securities means that the net asset value of the Fund will tend to decline if
market interest rates rise. Market interest rates currently are at historically
low levels.
During periods of declining interest rates, the issuer of a security may
exercise its option to prepay principal earlier than scheduled, forcing the Fund
to reinvest in lower yielding securities. This is known as call or prepayment
risk. Preferred and debt securities frequently have call features that allow the
issuer to repurchase the security prior to its stated maturity. An issuer may
redeem an obligation if the issuer can refinance the debt at a lower cost due to
declining interest rates or an improvement in the credit standing of the issuer.
During periods of rising interest rates, the average life of certain types of
securities may be extended because of slower than expected principal payments.
This may lock in a below market interest rate, increase the security's duration
and reduce the value of the security. This is known as extension risk.
Market interest rates for investment grade fixed-income securities have
declined significantly to near historically low average rates for such
securities. This decline may have increased the risk that these rates will rise
in the future (which would cause the value of the Fund's net assets to decline)
and the degree to which asset values may decline in such events; however,
historical interest rate levels are not necessarily predictive of future
interest rate levels.
Credit Risk; Subordination. Credit risk is the risk that a security in the
Fund's portfolio will decline in price or fail to make dividend or interest
payments when due because the issuer of the security experiences a decline in
its financial status. Such credit risk is generally greater for issuers of high
yield securities. The Fund may also invest in split-rated securities.
Split-rated securities are those securities that, at the time of investment, are
rated below investment grade by Moody's, S&P or Fitch, so long as at least one
NRSRO rates such securities within the four highest grades. Split-rated
securities are considered to be investment grade quality securities, except that
to the extent the Fund owns split-rated securities that exceed 10% of its
Managed Assets, the excess over 10% will not be considered to be investment
grade quality. A split-rated security may be regarded by one NRSRO (but by
definition not by all NRSROs) as having predominately speculative
characteristics with respect to the issuer's capacity to pay interest and repay
principal, and accordingly subject to a greater risk of default. The prices of
split-rated securities, in the view of one but not all NRSROs, may be more
sensitive to negative developments, than securities without a split-rating such
as a decline in the issuer's revenues or a general economic downturn.
33
Preferred and convertible securities are typically subordinated to bonds
and other debt instruments in a company's capital structure, in terms of
priority to corporate income, and therefore will be subject to greater credit
risk than those debt instruments.
High Yield Risk. The Fund may invest up to 35% of its Managed Assets in
securities that, at the time of investment, are not investment grade quality.
The Fund will only invest in securities that, at the time of investment, are
rated B or higher by at least one NRSRO or that are unrated but judged to be of
comparable quality by the Adviser responsible for the investment, except,
however, the Fund may invest up to 5% of its Managed Assets in securities with a
highest rating of CCC or that are unrated but judged to be of comparable quality
by the Adviser responsible for the investment. Securities of below investment
grade quality are regarded as having predominately speculative characteristics
with respect to capacity to pay interest and repay principal, and are commonly
referred to as junk bonds. Issuers of high yield securities may be highly
leveraged and may not have available to them more traditional methods of
financing. The prices of these lower grade securities are typically more
sensitive to negative developments, such as a decline in the issuer's revenues
or a general economic downturn, than are the prices of higher grade securities.
The secondary market for high yield securities may not be as liquid as the
secondary market for more highly rated securities, a factor which may have an
adverse effect on the Fund's ability to dispose of a particular security. There
are fewer dealers in the market for high yield securities than for investment
grade obligations. The prices quoted by different dealers may vary significantly
and the spread between the bid and ask price is generally much larger than for
higher quality instruments. Under adverse market or economic conditions, the
secondary market for high yield securities could contract further, independent
of any specific adverse changes in the condition of a particular issuer, and
these instruments may become illiquid. As a result, the Fund could find it more
difficult to sell these securities or may be able to sell the securities only at
prices lower than if such securities were widely traded. Prices realized upon
the sale of such lower rated or unrated securities, under these circumstances,
may be less than the prices used in calculating the Fund's net asset value.
Convertible Security Risk. Convertible securities generally offer lower
interest or dividend yields than non-convertible fixed-income securities of
similar credit quality because of the potential for capital appreciation. The
market values of convertible securities tend to decline as interest rates
increase and, conversely, to increase as interest rates decline. However, a
convertible security's market value also tends to reflect the market price of
the common stock of the issuing company, particularly when the stock price is
greater than the convertible security's conversion price. The conversion price
is defined as the predetermined price or exchange ratio at which the convertible
security can be converted or exchanged for the underlying common stock. As the
market price of the underlying common stock declines below the conversion price,
the price of the convertible security tends to be increasingly influenced more
by the yield of the convertible security than by the market price of the
underlying common stock. Thus, it may not decline in price to the same extent as
the underlying common stock, and convertible securities generally have less
potential for gain or loss than common stocks. However, mandatory convertible
securities (as discussed below) generally do not limit the potential for loss to
the same extent as securities convertible at the option of the holder. In the
event of a liquidation of the issuing company, holders of convertible securities
would be paid before that company's common stockholders. Consequently, an
issuer's convertible securities generally entail less risk than its common
stock. However, convertible securities fall below debt obligations of the same
issuer in order of preference or priority in the event of a liquidation and are
typically unrated or rated lower than such debt obligations. See "-- Credit
Risk; Subordination." In addition, contingent payment convertible securities
allow the issuer to claim deductions based on its nonconvertible cost of debt,
which generally will result in deductions in excess of the actual cash payments
made on the securities (and accordingly, holders will recognize income in
amounts in excess of the cash payments received).
Mandatory convertible securities are distinguished as a subset of
convertible securities because the conversion is not optional and the conversion
price at maturity is based solely upon the market price of the underlying common
stock, which may be significantly less than par or the price (above or below
par) paid. For these reasons, the risks associated with investing in mandatory
convertible securities most closely
34
resemble the risks inherent in common stocks. Mandatory convertible securities
customarily pay a higher coupon yield to compensate for the potential risk of
additional price volatility and loss upon conversion. Because the market price
of a mandatory convertible security increasingly corresponds to the market price
of its underlying common stock as the convertible security approaches its
conversion date, there can be no assurance that the higher coupon will
compensate for the potential loss. See "-- Common Stock Risk" below.
Synthetic Convertible Security Risk. Although the Fund does not currently
intend to invest in synthetic convertible securities, it may invest up to 10% of
its Managed Assets in such securities. The Fund may invest in synthetic
convertible securities created by third parties that, similar to true
convertible securities, typically trade as a single security with a unitary
value. The Fund may also invest in synthetic convertible securities by acquiring
separate securities, one possessing a fixed-income component and the other
possessing an equity component. The value of a synthetic convertible security
that is comprised of separate securities, may respond differently to market
fluctuations than a true convertible security or a synthetic convertible
security traded as a single security because each separate security comprising
such a synthetic convertible security has its own market value. In addition,
because the equity component may be synthetically achieved by investing in
warrants or options to buy common stock at a certain exercise price, or options
on a common stock index, synthetic convertible securities are subject to the
risks associated with warrants and options. In addition, if the value of the
underlying common stock or the level of the index involved in the equity
component falls below the exercise price of the warrant or option, the warrant
or option may lose all value. See "-- Convertible Security Risk."
The Fund will be subject to the risks of warrants and options to the extent
it invests in synthetic convertible securities that use warrants or options on
common stocks or common stock indexes as their equity components. The Fund's
investments in warrants and options involve risks different from, and possibly
greater than, the risks associated with investing directly in convertible
securities. Warrants and options are subject to a number of risks associated
with derivative instruments generally and described elsewhere in this Prospectus
such as illiquidity risks and risks associated with investments in common
stocks. They also involve the risk of mispricing or improper valuation, the risk
of ambiguous documentation, and the risk that changes in the value of a warrant
or option may not correlate perfectly with the underlying common stock or common
stock index.
Concentration Risk. The Fund intends to invest at least 25% of its Managed
Assets in securities of companies principally engaged in financial services.
This policy makes the Fund more susceptible to adverse economic or regulatory
occurrences affecting that sector.
Concentration of investments in the financial services sector includes the
following risks:
- regulatory actions -- financial services companies may suffer a setback
if regulators change the rules under which they operate;
- changes in interest rates -- unstable interest rates can have a
disproportionate effect on the financial services sector;
- concentration of loans -- financial services companies whose securities
the Fund may purchase may themselves have concentrated portfolios, such
as a high level of loans to real estate developers, which makes them
vulnerable to economic conditions that affect that sector; and
- competition -- financial services companies have been affected by
increased competition, which could adversely affect the profitability and
viability of such companies.
Non-U.S. Securities Risk. The Fund may invest up to 35% of its Managed
Assets in securities of non-U.S. issuers. Subject to this 35% limitation, up to
10% of the Fund's Managed Assets may be invested in securities that are
denominated in Japanese yen, Canadian dollars, British pounds or Euros and which
may be offered, traded or listed in markets other than U.S. markets. The
remainder of the Fund's Managed Assets that may be invested in securities of
non-U.S. issuers will be invested in U.S. dollar denominated securities offered,
traded or listed in U.S. markets. Initially, the Fund does not intend to
35
invest more than 20% of its Managed Assets in securities of non-U.S. issuers and
does not currently intend to invest in the non-U.S. dollar denominated
securities described above. Investments in securities of non-U.S. issuers
involve special risks not presented by investments in securities of U.S.
issuers, including the following: (i) less publicly available information about
non-U.S. issuers or markets due to less rigorous disclosure or accounting
standards or regulatory practices; (ii) many non-U.S. markets are smaller, less
liquid and more volatile meaning that in a changing market, an Adviser may not
be able to sell the Fund's portfolio securities at times, in amounts and at
prices it considers reasonable; (iii) potential adverse effects of fluctuations
in currency exchange rates or controls on the value of the Fund's investments;
(iv) the economies of non-U.S. countries may grow at slower rates than expected
or may experience a downturn or recession; (v) the impact of economic,
political, social or diplomatic events; (vi) possible seizure; expropriation or
nationalization of the company or its assets; (vii) certain non-U.S. countries
may impose restrictions on the ability of non-U.S. issuers to make payments of
principal and/or interest to investors located outside the U.S., due to blockage
of foreign currency exchanges or otherwise; and (viii) withholding and other
non-U.S. taxes may decrease the Fund's return. Although an Adviser may hedge the
Fund's exposure to certain of these risks, including the foreign currency
exchange rate risk, there can be no assurance that the Fund will enter into
hedging transactions at any time or at times or under circumstances in which it
might be advisable to do so.
Economies and social and political climates in individual countries may
differ unfavorably from the United States. Non-U.S. economies may have less
favorable rates of growth of gross domestic product, rates of inflation,
currency valuation, capital reinvestment, resource self-sufficiency and balance
of payments positions. Many countries have experienced substantial, and in some
cases extremely high, rates of inflation for many years. Unanticipated political
and social developments may also affect the values of the Fund's investments and
the availability to the Fund of additional investments in such countries.
Common Stock Risk. The Fund will have exposure to common stocks by virtue
of the equity component of the convertible securities in which the Fund invests.
The Fund may hold common stocks in its portfolio upon conversion of a
convertible security, such holdings not normally to exceed 5% of the Fund's
Managed Assets. In addition, in keeping with the income focus of the Fund, the
Fund expects to sell any common stock holdings as soon as practicable after
conversion of a convertible security. Although common stocks historically have
generated higher average returns than fixed-income securities, common stocks
also have experienced significantly more volatility in those returns. An adverse
event, such as an unfavorable earnings report, may depress the value of a
particular common stock held by the Fund. Also, the price of common stock is
sensitive to general movements in the stock market. A drop in the stock market
may depress the price of common stocks held by the Fund or to which it has
exposure.
Hedging Risk. The Fund may use derivatives or other transactions for
purposes of hedging the portfolio's exposure to the risk of increases in
interest rates, common stock risk, high yield credit risk and foreign currency
exchange rate risk that could result in poorer overall performance for the Fund.
There may be an imperfect correlation between the Fund's portfolio holdings and
such derivatives, which may prevent the Fund from achieving the intended
consequences of the applicable transaction or expose the Fund to risk of loss.
Further, the Fund's use of derivatives or other transactions to reduce risk
involves costs and will be subject to an Adviser's ability to predict correctly
changes in the relationships of such hedging instruments to the Fund's portfolio
holdings or other factors. No assurance can be given that such Adviser's
judgment in this respect will be correct. Consequently, the use of hedging
transactions might result in a poorer overall performance for the Fund, whether
or not adjusted for risk, than if the Fund had not hedged its portfolio
holdings. In addition, no assurance can be given that the Fund will enter into
hedging transactions at times or under circumstances in which it would be
advisable to do so. See "Hedging Transactions" and "Other Investment Policies
and Techniques -- Hedging Transactions" in the Fund's Statement of Additional
Information. Except for investing in synthetic convertible securities, the Fund
will use derivatives or other transactions described above solely for purposes
of hedging the Fund's portfolio risks.
Counterparty Risk. The Fund may be subject to credit risk with respect to
the counterparties to certain derivative agreements entered into by the Fund. If
a counterparty becomes bankrupt or otherwise fails to perform its obligations
under a derivative contract due to financial difficulties, the Fund may
36
experience significant delays in obtaining any recovery under the derivative
contract in a bankruptcy or other reorganization proceeding. The Fund may obtain
only a limited recovery or may obtain no recovery in such circumstances.
Interest Rate Transactions Risk. The Fund may enter into an interest rate
swap or cap transaction to attempt to protect itself from increasing dividend or
interest expenses on its FundPreferred shares or Borrowings resulting from
increasing short-term interest rates. A decline in interest rates may result in
a decline in the value of the swap or cap, which may result in a decline in the
net asset value of the Fund. See "Use of Leverage," "Hedging Transactions" and
"Other Investment Policies and Techniques" in the Fund's Statement of Additional
Information.
Certain Risks Related to Preferred Securities.
Limited Voting Rights. Generally, preferred security holders (such as
the Fund) have no voting rights with respect to the issuing company unless
preferred dividends have been in arrears for a specified number of periods,
at which time the preferred security holders may elect a number of
directors to the issuer's board. Generally, once all the arrearages have
been paid, the preferred security holders no longer have voting rights. In
the case of certain taxable preferred securities, holders generally have no
voting rights, except (i) if the issuer fails to pay dividends for a
specified period of time or (ii) if a declaration of default occurs and is
continuing. In such an event, rights of preferred security holders
generally would include the right to appoint and authorize a trustee to
enforce the trust or special purpose entity's rights as a creditor under
the agreement with its operating company.
Special Redemption Rights. In certain varying circumstances, an
issuer of preferred securities may redeem the securities prior to a
specified date. For instance, for certain types of preferred securities, a
redemption may be triggered by a change in federal income tax or securities
laws. As with call provisions, a redemption by the issuer may negatively
impact the return of the security held by the Fund.
New Types of Securities. From time to time, preferred securities and
convertible securities have been, and may in the future be, offered having
features other than those described herein. The Fund reserves the right to
invest in these securities if the Adviser responsible for the investment
believes that doing so would be consistent with the Fund's investment objectives
and policies. Because the market for these instruments would be new, the Fund
may have difficulty disposing of them at a suitable price and time. In addition
to limited liquidity, these instruments may present other risks, such as high
price volatility.
Corporate Loan Risk. The Fund may invest up to 20% of its Managed Assets
in other debt instruments, including corporate loans. Corporate loans in which
the Fund may invest may not be rated by a NRSRO at the time of investment,
generally will not be registered with the Securities and Exchange Commission and
generally will not be listed on a securities exchange. In addition, the amount
of public information available with respect to corporate loans generally will
be less extensive than that available for more widely rated, registered and
exchange-listed securities. Because the interest rates of corporate loans reset
frequently, if market interest rates fall, the loans' interest rates will be
reset to lower levels, potentially reducing the Fund's income. No active trading
market currently exists for many corporate loans in which the Fund may invest
and, thus, they are relatively illiquid. As a result, corporate loans generally
are more difficult to value than more liquid securities for which a trading
market exists.
The Fund also may purchase a participation interest in a corporate loan and
by doing so acquire some or all of the interest of a bank or other lending
institution in a loan to a corporate borrower. A participation typically will
result in the Fund having a contractual relationship only with the lender, not
the borrower. In this instance, the Fund will have the right to receive payments
of principal, interest and any fees to which it is entitled only from the lender
selling the participation and only upon receipt by the lender of the payments
from the borrower. If the Fund only acquires a participation in the loan made by
a third party, the Fund may not be able to control the exercise of any remedies
that the lender would have
37
under the corporate loan. Such third party participation arrangements are
designed to give corporate loan investors preferential treatment over high yield
investors in the event of a deterioration in the credit quality of the issuer.
Even when these arrangements exist, however, there can be no assurance that the
principal and interest owed on the corporate loan will be repaid in full.
Illiquid Securities Risk. The Fund may invest up to 10% of its Managed
Assets in securities that, at the time of investment, are illiquid. Illiquid
securities are securities that are not readily marketable and may include some
restricted securities, which are securities that may not be resold to the public
without an effective registration statement under the Securities Act of 1933 or,
if they are unregistered, may be sold only in a privately negotiated transaction
or pursuant to an exemption from registration. Illiquid securities involve the
risk that the securities will not be able to be sold at the time desired by the
Fund or at prices approximating the value at which the Fund is carrying the
securities on its books.
Market Disruption Risk. Certain events have a disruptive effect on the
securities markets, such as terrorist attacks (including the terrorist attacks
in the U.S. on September 11, 2001), war and other geopolitical events. The Fund
cannot predict the effects of similar events in the future on the U.S. economy.
High yield securities and securities of issuers with smaller market
capitalization tend to be more volatile than higher rated securities and
securities of issuers with larger market capitalization so that these events and
any actions resulting from them may have a greater impact on the prices and
volatility of high yield securities and securities of issuers with smaller
market capitalization than on higher rated securities and securities of issuers
with larger market capitalization.
Certain Affiliations. Certain broker-dealers may be considered to be
affiliated persons of the Fund, NIAC, Spectrum, Froley, Revy and/or Nuveen.
Absent an exemption from the Securities and Exchange Commission or other
regulatory relief, the Fund is generally precluded from effecting certain
principal transactions with affiliated brokers, and its ability to purchase
securities being underwritten by an affiliated broker or a syndicate including
an affiliated broker, or to utilize affiliated brokers for agency transactions,
is subject to restrictions. This could limit the Fund's ability to engage in
securities transactions and take advantage of market opportunities. In addition,
unless and until the underwriting syndicate is broken in connection with the
initial public offering of the FundPreferred shares, the Fund will be precluded
from effecting principal transactions with brokers who are members of the
syndicate.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The Board of Trustees is responsible for the management of the Fund,
including supervision of the duties performed by the Advisers. 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 ADVISER AND SUBADVISERS
NIAC will be responsible for determining the Fund's overall investment
strategy, including portfolio allocations, and the use of leverage, hedging and
interest rate transactions. NIAC also is responsible for the selection of the
Subadvisers and ongoing monitoring of the Subadvisers, managing the Fund's
business affairs and providing certain clerical, bookkeeping and other
administrative services.
NIAC, 333 West Wacker Drive, Chicago, Illinois 60606, is the investment
adviser to the Fund and is responsible for managing the portion of the Fund's
assets allocated to other debt instruments. NIAC and its affiliate Nuveen
Advisory Corp. serve as investment advisers to investment portfolios with
approximately $57.5 billion in assets under management as of June 30, 2003. See
the Statement of Additional Information under "Investment Advisers."
NIAC, a registered investment adviser, is a wholly owned subsidiary of
Nuveen Investments, Inc. Founded in 1898, Nuveen Investments, Inc. and its
affiliates had approximately $88 billion of assets
38
under management as of June 30, 2003. Nuveen Investments, Inc. is a
publicly-traded company and a majority-owned subsidiary of The St. Paul
Companies, Inc., a publicly-traded company that is principally engaged in
providing property-liability insurance through subsidiaries.
Gunther Stein and Lenny Mason are the portfolio managers at NIAC
responsible for investing the portion of the Fund's assets allocated to other
debt instruments. Mr. Stein is a Vice President of NIAC. He also has been lead
portfolio manager for high yield strategies at Symphony Asset Management, LLC
("Symphony"), a wholly-owned subsidiary of Nuveen Investments, Inc., since 1999.
Prior to joining Symphony in 1999, Mr. Stein was a high yield portfolio manager
at Wells Fargo. Mr. Mason is a Vice President of NIAC. He also is a high yield
portfolio manager at Symphony. Prior to joining Symphony in 2001, Mr. Mason was
a Managing Director of FleetBoston's Technology and Communications Group.
Spectrum, 4 High Ridge Park, Stamford, Connecticut 06905, is a Subadviser
to the Fund and is responsible for managing the portion of the Fund's assets
allocated to preferred securities. Spectrum specializes in the management of
diversified preferred security portfolios for institutional investors, including
Fortune 500 companies, pension funds, insurance companies and foundations.
Spectrum, a registered investment adviser, commenced operations in 1987 and had
approximately $10.1 billion in assets under management as of June 30, 2003.
Spectrum is an independently managed wholly owned subsidiary of Principal
Global Investors, LLC, which is part of Principal Financial Group Inc., a
publicly traded, diversified, insurance and financial services company.
Collectively, subsidiaries and affiliates of Principal Global Investors, LLC
managed over $104.2 billion in combined assets worldwide as of June 30, 2003.
A team of Spectrum professionals led by Mark A. Lieb, Bernard M. Sussman
and L. Phillip Jacoby, IV is responsible for investing the portion of the Fund's
assets allocated to preferred securities. Mr. Lieb is an Executive Director and
the Chief Financial Officer of Spectrum. Mr. Sussman is an Executive Director
and the Chief Investment Officer of Spectrum and is Chairman of Spectrum's
Investment Committee. Mr. Jacoby is a Senior Vice President of Spectrum. As a
subsidiary of Principal Global Investors, LLC, Spectrum also can take advantage
of Principal's extensive staff of internal credit analysts. See "The Fund's
Investments -- Investment Philosophy and Process."
Spectrum may act as broker for the Fund in connection with the purchase or
sale of preferred securities by or to the Fund if and to the extent permitted by
procedures adopted from time to time by the Board of Trustees of the Fund. The
Board of Trustees, including a majority of the trustees who are not "interested"
trustees, has determined that portfolio transactions for the Fund may be
executed through Spectrum if, in the judgment of NIAC and Spectrum, the use of
Spectrum is likely to result in prices and execution at least as favorable to
the Fund as would be available from other qualified brokers and if, in such
transactions, Spectrum charges the Fund commission rates at least as favorable
to the Fund as those charged by Spectrum to comparable unaffiliated customers in
similar transactions. The Board of Trustees also has adopted procedures that are
reasonably designed to provide that any commission, fee or other remuneration
paid to Spectrum is consistent with the foregoing standard. The Fund will not
effect principal transactions with Spectrum. In executing transactions through
Spectrum, the Fund will be subject to, and intends to comply with, Section 17(e)
of the 1940 Act and the rules thereunder. See "Portfolio Transactions and
Brokerage" in the Statement of Additional Information.
Froley, Revy, 10900 Wilshire Boulevard, Suite 900, Los Angeles, California
90024, is a Subadviser to the Fund and is responsible for managing the portion
of the Fund's assets allocated to convertible securities. Froley, Revy
specializes in the management of convertible securities. Froley, Revy, a
registered investment adviser, commenced operations in 1975 and had
approximately $3.2 billion in assets under management as of June 30, 2003.
Froley, Revy is an independently managed wholly owned subsidiary of First
Republic Bank, which is a publicly-traded commercial bank and wealth management
firm. Collectively, subsidiaries and affiliates of First Republic Bank,
including Froley, Revy, managed approximately $9.5 billion in combined assets as
of June 30, 2003.
39
Andrea Revy O'Connell and Michael Revy are the portfolio managers at
Froley, Revy responsible for investing the portion of the Fund's assets
allocated to convertible securities. Ms. O'Connell is President and Chief
Executive Officer of Froley, Revy and has been a Managing Director and a
Principal of Froley, Revy since 1994. Mr. Revy is a Senior Vice President,
Senior Portfolio Manager and a Managing Director of Froley, Revy and is
responsible for the development and co-management of Froley, Revy's convertible
arbitrage product. Before joining Froley, Revy in 2002, Mr. Revy was a private
banker at Wechsler & Co., Inc. since 1998, and prior thereto worked for Lehman
Brothers for six years in that firm's convertible bond group.
INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an investment management agreement between NIAC and the Fund,
the Fund has agreed to pay an annual management fee for the services and
facilities provided by NIAC, payable on a monthly basis, according to the
following schedule:
MANAGEMENT
AVERAGE DAILY MANAGED ASSETS FEE
---------------------------- ----------
Up to $500 million.......................................... .9000%
$500 million to $1 billion.................................. .8750
$1 billion to $1.5 billion.................................. .8500
$1.5 billion to $2.0 billion................................ .8250
Over $2.0 billion........................................... .8000
Pursuant to investment sub-advisory agreements between NIAC and each of the
Subadvisers, each Subadviser will receive from NIAC a management fee equal to
40% of the management fee payable by the Fund to NIAC (net of the reimbursements
described below) with respect to that Subadviser's allocation of Managed Assets
up to the first $500 million of the average daily Managed Assets of the Fund
allocated to that Subadviser and 35% thereafter.
In addition to the fee of NIAC, the Fund pays all other costs and expenses
of its operations, including compensation of its trustees (other than those
affiliated with NIAC), custodian, transfer agency and dividend disbursing
expenses, legal fees, expenses of independent auditors, expenses of repurchasing
shares, expenses of preparing, printing and distributing shareholder reports,
notices, proxy statements and reports to governmental agencies, and taxes, if
any.
For the first eight full years of the Fund's operation, the Advisers have
contractually agreed to reimburse the Fund for fees and expenses in the amounts,
and for the time periods, set forth below:
PERCENTAGE
REIMBURSED
YEAR ENDING (AS A PERCENTAGE OF
JUNE 30, MANAGED ASSETS)
----------- -------------------
2003(1)............ .32%
2004............... .32
2005............... .32
2006............... .32
2007............... .32
PERCENTAGE
REIMBURSED
YEAR ENDING (AS A PERCENTAGE OF
JUNE 30, MANAGED ASSETS)
----------- -------------------
2008............... .32%
2009............... .24
2010............... .16
2011............... .08
------------
(1) From the commencement of operations.
The Advisers have not agreed to reimburse the Fund for any portion of its
fees and expenses beyond June 30, 2011.
40
DESCRIPTION OF FUNDPREFERRED SHARES
The following is a brief description of the terms of FundPreferred shares.
This description does not purport to be complete and is subject to and qualified
in its entirety by reference to the more detailed description of FundPreferred
shares in the Fund's Statement Establishing and Fixing the Rights and
Preferences of FundPreferred Shares (the "Statement") a form of which is
attached as Appendix A to the Statement of Additional Information. Capitalized
terms not otherwise defined in the Prospectus shall have the same meaning as
defined in the Statement.
GENERAL
The Fund's Declaration of Trust authorizes the issuance of an unlimited
number of preferred shares, par value $0.01 per share, in one or more classes or
series, with rights as determined by the Board of Trustees without the approval
of Common Shareholders. The Statement currently authorizes the issuance of
FundPreferred shares as follows: 3,860, 3,860, 3,860, 3,860, 3,860, 3,860,
3,860, 3,860, 3,860 and 3,860 FundPreferred shares Series M, Series M2, Series
T, Series T2, Series W, Series W2, Series TH, Series TH2, Series F and Series
F2, respectively. The FundPreferred shares have a liquidation preference of
$25,000 per share, plus all accumulated but unpaid dividends (whether or not
earned or declared) to the date of final distribution. The FundPreferred shares
when issued and sold through this Offering (i) will be fully paid and, subject
to matters discussed in "Certain Provisions in the Declaration of Trust," non-
assessable, (ii) will not be convertible into Common Shares or other capital
stock of the Fund, (iii) will have no preemptive rights, and (iv) will not be
subject to any sinking fund. The FundPreferred shares will be subject to
optional and mandatory redemption as described below under "-- Redemption."
Holders of FundPreferred shares will not receive certificates representing
their ownership interest in such shares. DTC will initially act as Securities
Depository for the Agent Members with respect to the FundPreferred shares.
In addition to serving as the Auction Agent in connection with the Auction
Procedures described below, the Auction Agent will act as the transfer agent,
registrar, and paying agent for the FundPreferred shares. Furthermore, the
Auction Agent will send notices to holders of FundPreferred shares of any
meeting at which holders of FundPreferred shares have the right to vote. See
"-- Voting Rights" below. However, the Auction Agent generally will serve merely
as the agent of the Fund, acting in accordance with the Fund's instructions.
Except in an Auction, the Fund will have the right (to the extent permitted
by applicable law) to purchase or otherwise acquire any share of FundPreferred
shares, so long as the Fund is current in the payment of dividends on the
FundPreferred shares and on any other capital shares of the Fund ranking on a
parity with the FundPreferred shares with respect to the payment of dividends or
upon liquidation.
DIVIDENDS AND DIVIDEND PERIODS
General. Holders of FundPreferred shares will be entitled to receive,
when, as and if declared by the Board of Trustees, out of funds legally
available therefor, cumulative cash dividends on their shares, at the Applicable
Rate determined as set forth below under "-- Determination of Dividend Rate,"
payable on the respective dates set forth below. Dividends so declared and
payable shall be paid to the extent permitted under the Code, and to the extent
available and in preference to and priority over any dividend declared and
payable on the Common Shares.
On the Business Day next preceding each Dividend Payment Date, the Fund is
required to deposit with the Paying Agent sufficient funds for the payment of
dividends. The Fund does not intend to establish any reserves for the payment of
dividends.
All moneys paid to the Paying Agent for the payment of dividends shall be
held in trust for the payment of such dividends to the Holders. Each dividend
will be paid by the Paying Agent to the Holders as their names appear on the
share ledger or share records of the Fund, which Holder is expected to be the
nominee of the Securities Depository. The Securities Depository will credit the
accounts of the Agent
41
Members of the beneficial owners in accordance with the Securities Depository's
normal procedures. The Securities Depository's current procedures provide for it
to distribute dividends in same-day funds to Agent Members who are in turn
expected to distribute such dividends to the persons for whom they are acting as
agents. The Agent Member of a beneficial owner will be responsible for holding
or disbursing such payments on the applicable Dividend Payment Date to such
beneficial owner in accordance with the instructions of such beneficial owner.
Dividends in arrears for any past Dividend Period may be declared and paid
at any time, without reference to any regular Dividend Payment Date, to the
Holders as their names appear on the share ledger or share records of the Fund
on such date, not exceeding 15 days preceding the payment date thereof, as may
be fixed by the Board of Trustees. Any dividend payment shall first be credited
against the earliest accumulated but unpaid dividends. No interest will be
payable in respect of any dividend payment or payments which may be in arrears.
See "-- Default Period" below.
The amount of dividends per share payable (if declared) on each Dividend
Payment Date of each Dividend Period of less than one year (or in respect of
dividends on another date in connection with a redemption during such Dividend
Period) shall be computed by multiplying the Applicable Rate (or the Default
Rate) for such Dividend Period (or a portion thereof) by a fraction, the
numerator of which will be the number of days in such Dividend Period (or
portion thereof) that such share was outstanding and for which the Applicable
Rate or the Default Rate was applicable and the denominator of which will be
365, multiplying the amount so obtained by $25,000, and rounding the amount so
obtained to the nearest cent. During any Dividend Period of one year or more,
the amount of dividends per share payable on any Dividend Payment Date (or in
respect of dividends on another date in connection with a redemption during such
Dividend Period) shall be computed as described in the preceding sentence,
except that it will be determined on the basis of a year consisting of twelve
30-day months.
Determination of Dividend Rate. The dividend rate for the initial Dividend
Period (i.e., the period from and including the Date of Original Issue to and
including the initial Auction Date) and the initial Auction Date are set forth
on the inside cover page of the Prospectus. For each subsequent Dividend Period,
subject to certain exceptions, the dividend rate will be the Applicable Rate
that the Auction Agent advises the Fund has resulted from an Auction.
The initial Dividend Period for the FundPreferred shares shall be , ,
, , , , , , and days for FundPreferred shares Series M, Series
M2, Series T, Series T2, Series W, Series W2, Series TH, Series TH2, Series F
and Series F2, respectively. Dividend Periods after the initial Dividend Period
shall either be Standard Dividend Periods or, subject to certain conditions and
with notice to Holders, Special Dividend Periods.
A Special Dividend Period will not be effective unless Sufficient Clearing
Bids exist at the Auction in respect of such Special Dividend Period (that is,
in general, the number of shares subject to Buy Orders by Potential Holders is
at least equal to the number of shares subject to Sell Orders by Existing
Holders).
Dividends will accumulate at the Applicable Rate from the Date of Original
Issue and shall be payable on each Dividend Payment Date thereafter. For
Dividend Periods of less than 30 days Dividend Payment Dates shall occur on the
first Business Day following such Dividend Period and, if greater than 30 days
then on a monthly basis on the first Business Day of each month within such
Dividend Period and on the Business Day following the last day of such Dividend
Period. Dividends will be paid through the Securities Depository on each
Dividend Payment Date.
Except during a Default Period as described below, the Applicable Rate
resulting from an Auction will not be greater than the Maximum Rate, which is
equal to 150% of the applicable AA Composite Commercial Paper Rate (for a
Dividend Period of fewer than 184 days) or the applicable Treasury Index Rate
(for a Dividend Period of 184 days or more (each, a "Reference Rate")), in each
case subject to upward but not downward adjustment in the discretion of the
Board of Trustees after consultation with the Broker-Dealers, provided that
immediately following any such increase the Fund would be in compliance with the
FundPreferred Shares Basic Maintenance Amount nor, for Standard Dividend Periods
or less
42
only, will the Applicable Rate be less than the Minimum Rate, which is 70% of
the applicable AA Composite Commercial Paper Rate. No minimum rate is specified
for Auctions in respect to Dividend Periods of more than the Standard Dividend
Period.
The Maximum Rate for the FundPreferred shares will apply automatically
following an Auction for such shares in which Sufficient Clearing Bids have not
been made (other than because all shares of FundPreferred shares were subject to
Submitted Hold Orders) or following the failure to hold an Auction for any
reason on the Auction Date scheduled to occur (except for circumstances in which
the Dividend Rate is the Default Rate, as described below).
The All Hold Rate will apply automatically following an Auction in which
all of the outstanding shares are subject to (or are deemed to be subject to)
Submitted Hold Orders. The All Hold Rate is 80% of the applicable AA Composite
Commercial Paper Rate.
Prior to each Auction, Broker-Dealers will notify Holders of the term of
the next succeeding Dividend Period as soon as practicable after the
Broker-Dealers have been so advised by the Fund. After each auction, on the
Auction Date, Broker-Dealers will notify Holders of the Applicable Rate for the
next succeeding Dividend Period and of the Auction Date of the next succeeding
Auction.
Notification of Dividend Period. The Fund will designate the duration of
Dividend Periods of the FundPreferred shares; provided, however, that no such
designation is necessary for a Standard Dividend Period and that any designation
of a Special Dividend Period shall be effective only if (i) notice thereof shall
have been given as provided herein, (ii) any failure to pay in the timely manner
to the Auction Agent the full amount of any dividend on, or the redemption price
of, the FundPreferred shares shall have been cured as set forth under
"-- Default Period," (iii) Sufficient Clearing Bids shall have existed in an
Auction held on the Auction Date immediately preceding the first day of such
proposed Special Dividend Period, (iv) if the Fund shall have mailed a notice of
redemption with respect to any shares, as described under "-- Redemption" below,
the Redemption Price with respect to such shares shall have been deposited with
the Paying Agent, and (v) in the case of the designation of a Special Dividend
Period, the Fund has confirmed that, as of the Auction Date next preceding the
first day of such Special Dividend Period, it has Eligible Assets with an
aggregate Discounted Value at least equal to the FundPreferred Shares Basic
Maintenance Amount (as defined below) and has consulted with the Broker-Dealers
and has provided notice and a FundPreferred Shares Basic Maintenance Certificate
(as defined below) to each Rating Agency which is then rating the FundPreferred
shares and so requires.
If the Fund proposes to designate any Special Dividend Period, not fewer
than seven (7) (or two Business Days in the event the duration of the Dividend
Period prior to such Special Dividend Period is fewer than eight (8) days) nor
more than 30 days prior to the first day of such Special Dividend Period, notice
shall be (i) made by press release and (ii) communicated by the Fund by
telephonic or other means to the Auction Agent and confirmed in writing promptly
thereafter. Each such notice shall state (A) that the Fund proposes to exercise
its option to designate a succeeding Special Dividend Period, specifying the
first and last days thereof and (B) that the Fund will, by 3:00 p.m. New York
City time, on the second Business Day next preceding the first day of such
Special Dividend Period, notify the Auction Agent, who will promptly notify the
Broker-Dealers, of either (x) its determination, subject to certain conditions,
to proceed with such Special Dividend Period, subject to the terms of any
Specific Redemption Provisions, or (y) its determination not to proceed with
such Special Dividend Period in which latter event the succeeding Dividend
Period shall be a Standard Dividend Period.
No later than 3:00 p.m., New York City time, on the second Business Day
next preceding the first day of any proposed Special Dividend Period, the Fund
shall deliver to the Auction Agent, who will promptly deliver to the
Broker-Dealers and Existing Holders, either:
(i) a notice stating (A) that the Fund has determined to designate the
next succeeding Dividend Period as a Special Dividend Period,
specifying the first and last days thereof and (B) the terms of any
Specific Redemption Provisions; or
43
(ii) a notice stating that the Fund has determined not to exercise its
option to designate a Special Dividend Period.
If the Fund fails to deliver either such notice with respect to any
designation of any proposed Special Dividend Period to the Auction Agent or is
unable to make the confirmation described above by 3:00 p.m., New York City
time, on the second Business Day next preceding the first day of such proposed
Special Dividend Period, the Fund shall be deemed to have delivered a notice to
the Auction Agent with respect to such Dividend Period to the effect set forth
in clause (ii) above, thereby resulting in a Standard Dividend Period.
Default Period. Subject to cure provisions, a "Default Period" with
respect to a particular Series will commence on any date the Fund fails to
deposit irrevocably in trust in same-day funds, with the Paying Agent by 12:00
noon, New York City time, (A) the full amount of any declared dividend on that
Series payable on the Dividend Payment Date (a "Dividend Default") or (B) the
full amount of any redemption price (the "Redemption Price") payable on the date
fixed for redemption (the "Redemption Date") (a "Redemption Default") and
together with a Dividend Default, hereinafter referred to as "Default"). Subject
to cure provisions, a Default Period with respect to a Dividend Default or a
Redemption Default shall end on the Business Day on which, by 12:00 noon, New
York City time, all unpaid dividends and any unpaid Redemption Price shall have
been deposited irrevocably in trust in same-day funds with the Paying Agent. In
the case of a Dividend Default, the Applicable Rate for each Dividend Period
commencing during a Default Period will be equal to the Default Rate, and each
subsequent Dividend Period commencing after the beginning of a Default Period
shall be a Standard Dividend Period; provided, however, that the commencement of
a Default Period will not by itself cause the commencement of a new Dividend
Period. No Auction shall be held during a Default Period applicable to that
Series of FundPreferred shares. No Default Period with respect to a Dividend
Default or Redemption Default shall be deemed to commence if the amount of any
dividend or any Redemption Price due (if such default is not solely due to the
willful failure of the Fund) is deposited irrevocably in trust, in same-day
funds with the Paying Agent by 12:00 noon, New York City time within three
Business Days after the applicable Dividend Payment Date or Redemption Date,
together with an amount equal to the Default Rate applied to the amount of such
non-payment based on the actual number of days comprising such period divided by
365 for each Series. The Default Rate shall be equal to the Reference Rate
multiplied by three (3).
Subject to the foregoing, and any requirements of Massachusetts law, to the
extent that the Fund's investment company taxable income for any year exceeds
any current or accumulated dividends on the FundPreferred shares, the Fund
intends to distribute such excess investment company taxable income to the
holders of the Common Shares. The term "investment company taxable income," as
it is defined in the Code, includes interest, dividends, net short-term capital
gains and other income received or accrued less the advisory fee, bank custodian
charges, taxes (except capital gains taxes) and other expenses properly
chargeable against income, but generally does not include net capital gains,
dividends paid in shares of stock, transfer taxes, brokerage or other capital
charges or distributions designated as a return of capital. The Fund also
intends to distribute any realized net capital gains (defined as the excess of
net long-term capital gains over net short-term capital losses) annually to the
holders of the Common Shares (subject to the prior rights of the holders of the
FundPreferred shares) subject to the foregoing and any requirements of
Massachusetts law. The Fund will designate distributions made with respect to
FundPreferred shares as capital gain distributions in proportion to the
FundPreferred shares' share of total dividends paid by the Fund during the year.
See "Federal Income Tax Matters -- Federal Income Tax Treatment of Holders of
FundPreferred Shares."
RESTRICTIONS ON DIVIDEND, REDEMPTION AND OTHER PAYMENTS
Under the 1940 Act, the Fund may not (i) declare any dividend with respect
to the FundPreferred shares if, at the time of such declaration (and after
giving effect thereto), asset coverage with respect to any Borrowings of the
Fund that are senior securities representing indebtedness (as defined in the
1940 Act), would be less than 200% (or such other percentage as may in the
future be specified in or under the 1940 Act as the minimum asset coverage for
senior securities representing indebtedness of a closed-end
44
investment company as a condition of declaring dividends on its preferred
shares) or (ii) declare any other distribution on the FundPreferred shares or
purchase or redeem FundPreferred shares if at the time of the declaration (and
after giving effect thereto), asset coverage with respect to such Borrowings
that are senior securities representing indebtedness would be less than 300% (or
such higher percentage as may in the future be specified in or under the 1940
Act as the minimum asset coverage for senior securities representing
indebtedness of a closed-end investment company as a condition of declaring
distributions, purchases or redemptions of its shares of beneficial interest).
"Senior securities representing indebtedness" generally means any bond,
debenture, note or similar obligation or instrument constituting a security
(other than shares of beneficial interest) and evidencing indebtedness and could
include the Fund's obligations under any Borrowings. For purposes of determining
asset coverage for senior securities representing indebtedness in connection
with the payment of dividends or other distributions on or purchases or
redemptions of stock, the term "senior security" does not include any promissory
note or other evidence of indebtedness issued in consideration of any loan,
extension or renewal thereof, made by a bank or other person and privately
arranged, and not intended to be publicly distributed. The term "senior
security" also does not include any such promissory note or other evidence of
indebtedness in any case where such a loan is for temporary purposes only and in
an amount not exceeding 5% of the value of the total assets of the Fund at the
time when the loan is made; a loan is presumed under the 1940 Act to be for
temporary purposes if it is repaid within 60 days and is not extended or
renewed; otherwise it is presumed not to be for temporary purposes. For purposes
of determining whether the 200% and 300% asset coverage requirements described
above apply in connection with dividends or distributions on or purchases or
redemptions of FundPreferred shares, such asset coverages may be calculated on
the basis of values calculated as of a time within 48 hours (not including
Sundays or holidays) next preceding the time of the applicable determination.
In addition, a declaration of a dividend or other distribution on or
purchase or redemption of FundPreferred shares may be prohibited (i) at any time
that an event of default under any Borrowings has occurred and is continuing; or
(ii) after giving effect to such declaration, the Fund would not have eligible
portfolio holdings with an aggregated Discounted Value at least equal to any
asset coverage requirements associated with such Borrowings; or (iii) the Fund
has not redeemed the full amount of Borrowings, if any, required to be redeemed
by any provision for mandatory redemption.
Upon failure to pay dividends for two years or more, the holders of
FundPreferred shares will acquire certain additional voting rights. See
"-- Voting Rights" below. Such rights shall be the exclusive remedy of the
holders of FundPreferred shares upon any failure to pay dividends on the
FundPreferred shares.
For so long as any FundPreferred shares are outstanding, except in
connection with the liquidation of the Fund, or a refinancing of the
FundPreferred shares as provided in the Statement, the Fund will not declare,
pay or set apart for payment any dividend or other distribution (other than a
dividend or distribution paid in shares of, or options, warrants or rights to
subscribe for or purchase, Common Shares or other shares of beneficial interest,
if any, ranking junior to the FundPreferred shares as to dividends or upon
liquidation) in respect to Common Shares or any other shares of the Fund ranking
junior to or on a parity with the FundPreferred shares as to dividends or upon
liquidation, or call for redemption, redeem, purchase or otherwise acquire for
consideration any Common Shares or any other such junior shares (except by
conversion into or exchange for shares of the Fund ranking junior to the
FundPreferred shares as to dividends and upon liquidation) or any such parity
shares (except by conversion into or exchange for shares of the Fund ranking
junior to or on a parity with the FundPreferred shares as to dividends and upon
liquidation), unless (i) there is no event of default under any Borrowings that
is continuing; (ii) immediately after such transaction, the Fund would have
Eligible Assets with an aggregate Discounted Value at least equal to the
FundPreferred Shares Basic Maintenance Amount (as defined below) and the Fund
would maintain the 1940 Act FundPreferred Shares Asset Coverage (as defined
below) (see "-- Asset Maintenance"); (iii) immediately after such transaction,
the Fund would have eligible portfolio holdings with an aggregated discounted
value at least equal to the asset coverage requirements, if any, under any
Borrowings; (iv) full cumulative dividends on the FundPreferred shares due on or
prior to the date of the transaction have been declared and paid; (v) the Fund
has redeemed the full number of FundPreferred shares required to be redeemed by
any provision for mandatory redemption contained in the
45
Statement (see "-- Redemption"); and (vi) the Fund has redeemed the full amount
of any Borrowings required to be redeemed by any provision for mandatory
redemption.
REDEMPTION
Optional Redemption. To the extent permitted under the 1940 Act and
Massachusetts law, the Fund at its option may redeem FundPreferred shares having
a Dividend Period of one year or less, in whole or in part, out of funds legally
available therefor, on the Dividend Payment Date upon not less than 15 days' and
not more than 40 days' prior notice. The optional redemption price per share
shall be $25,000 per share, plus an amount equal to accumulated but unpaid
dividends thereon (whether or not earned or declared) to the date fixed for
redemption. FundPreferred shares having a Dividend Period of more than one year
are redeemable at the option of the Fund, in whole or in part, out of funds
legally available therefor, prior to the end of the relevant Dividend Period,
subject to any Specific Redemption Provisions, which may include the payment of
redemption premiums to the extent required under any applicable Specific
Redemption Provisions. The Fund shall not effect any optional redemption unless
after giving effect thereto (i) the Fund has available certain 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 FundPreferred shares by
reason of the redemption of FundPreferred shares on such date fixed for the
redemption and (ii) the Fund would have Eligible Assets with an aggregate
Discounted Value at least equal to the FundPreferred Shares Basic Maintenance
Amount.
The Fund also reserves the right to repurchase FundPreferred shares in
market or other transactions from time to time in accordance with applicable law
and at a price that may be more or less than the liquidation preference of the
FundPreferred shares, but is under no obligation to do so.
Mandatory Redemption. If the Fund fails to maintain, as of any Valuation
Date, Eligible Assets with an aggregate Discounted Value at least equal to the
FundPreferred Shares Basic Maintenance Amount or, as of the last Business Day of
any month, the 1940 Act FundPreferred Shares Asset Coverage, and such failure is
not cured within ten Business Days following such Valuation Date in the case of
a failure to maintain the FundPreferred Shares Basic Maintenance Amount or on
the last Business Day of the following month in the case of a failure to
maintain the 1940 Act FundPreferred Shares Asset Coverage as of such last
Business Day (each an "Asset Coverage Cure Date"), the FundPreferred shares will
be subject to mandatory redemption out of funds legally available therefor. See
"-- Asset Maintenance." The number of FundPreferred shares to be redeemed in
such circumstances will be equal to the lesser of (i) the minimum number of
FundPreferred shares the redemption of which, if deemed to have occurred
immediately prior to the opening of business on the relevant Asset Coverage Cure
Date, would result in the Fund having sufficient Eligible Assets to restore the
FundPreferred Shares Basic Maintenance Amount or 1940 Act FundPreferred Shares
Asset Coverage, as the case may be, in either case as of the relevant Asset
Coverage Cure Date (provided that, if there is no such minimum number of shares
the redemption of which would have such result, all FundPreferred shares then
outstanding will be redeemed), and (ii) the maximum number of FundPreferred
shares that can be redeemed out of funds expected to be available therefore on
the Mandatory Redemption Date (as defined below) at the Mandatory Redemption
Price (as defined below).
The Fund shall allocate the number of shares required to be redeemed to
satisfy the FundPreferred Shares Basic Maintenance Amount or the 1940 Act
FundPreferred Shares Asset Coverage, as the case may be, pro rata among the
Holders of FundPreferred shares in proportion to the number of shares they hold,
by lot or by such other method as the Fund shall deem fair and equitable,
subject to mandatory redemption provisions, if any.
The Fund is required to effect such a mandatory redemption not later than
40 days after the Asset Coverage Cure Date, as the case may be (the "Mandatory
Redemption Date"), except that if the Fund does not have funds legally available
for the redemption of, or is not otherwise legally permitted to redeem, all of
the required number of FundPreferred shares which are subject to mandatory
redemption, or the
46
Fund otherwise is unable to effect such redemption on or prior to such Mandatory
Redemption Date, the Fund will redeem those FundPreferred shares on the earliest
practicable date on which the Fund will have such funds available, upon notice
to record owners of shares of FundPreferred shares and the Paying Agent. The
Fund's ability to make a mandatory redemption may be limited by the provisions
of the 1940 Act or Massachusetts law.
The redemption price per share in the event of any mandatory redemption
will be $25,000 per share, plus an amount equal to accumulated but unpaid
dividends (whether or not earned or declared) to the date fixed for redemption,
plus (in the case of a Dividend Period of more than one year) any redemption
premium, if any, determined by the Board of Trustees after consultation with the
Broker-Dealers and set forth in any applicable Specific Redemption Provisions
(the "Mandatory Redemption Price").
Redemption Procedure. Pursuant to Rule 23c-2 under the 1940 Act, the Fund
will file a notice of its intention to redeem with the SEC so as to provide at
least the minimum notice required by such Rule or any successor provision
(notice currently must be filed with the SEC generally at least 30 days prior to
the redemption date). The Fund shall deliver a notice of redemption to the
Auction Agent containing the information described below one Business Day prior
to the giving of notice to Holders in the case of optional redemptions as
described above and on or prior to the 30th day preceding the Mandatory
Redemption Date in the case of a mandatory redemption as described above. The
Auction Agent will use its reasonable efforts to provide notice to each holder
of FundPreferred shares called for redemption by electronic means not later than
the close of business on the Business Day immediately following the Business Day
on which the Auction Agent determines the shares to be redeemed (or, during a
Default Period with respect to such shares, not later than the close of business
on the Business Day immediately following the day on which the Auction Agent
receives notice of redemption from the Fund). Such notice will be confirmed
promptly in writing not later than the close of business on the third Business
Day preceding the redemption date by providing the notice to each holder of
record of shares of FundPreferred shares called for redemption, the Paying Agent
(if different from the Auction Agent) and the Securities Depository ("Notice of
Redemption"). Notice of Redemption will be addressed to the registered owners of
the FundPreferred shares at their addresses appearing on the share records of
the Fund. Such notice will set forth (i) the redemption date, (ii) the number
and identity of FundPreferred shares to be redeemed, (iii) the redemption price
(specifying the amount of accumulated dividends to be included therein), (iv)
that dividends on the shares to be redeemed will cease to accumulate on such
redemption date, and (v) the provision under which redemption shall be made. No
defect in the Notice of Redemption or in the transmittal or mailing thereof will
affect the validity of the redemption proceedings, except as required by
applicable law.
If fewer than all of the shares of a series of FundPreferred shares are
redeemed on any date, the shares to be redeemed on such date will be selected by
the Fund on a pro rata basis in proportion to the number of shares held by such
holders, by lot or by such other method as is determined by the Fund to be fair
and equitable, subject to the terms of any Specific Redemption Provisions.
Shares of FundPreferred shares may be subject to mandatory redemption as
described herein notwithstanding the terms of any Specific Redemption
Provisions. The Auction Agent will give notice to the Securities Depository,
whose nominee will be the record holder of all of the FundPreferred shares, and
the Securities Depository will determine the number of shares to be redeemed
from the account of the Agent Member of each beneficial owner. Each Agent Member
will determine the number of shares to be redeemed from the account of each
beneficial owner for which it acts as agent. An Agent Member may select for
redemption shares from the accounts of some beneficial owners without selecting
for redemption any shares from the accounts of other beneficial owners.
Notwithstanding the foregoing, if neither the Securities Depository nor its
nominee is the record holder of all of the shares, the particular shares to be
redeemed shall be selected by the Fund by lot, on a pro rata basis between each
series or by such other method as the Fund shall deem fair and equitable, as
contemplated above.
If Notice of Redemption has been given, then upon the deposit of funds
sufficient to effect such redemption, dividends on such shares should cease to
accumulate and such shares should be no longer deemed to be Outstanding for any
purpose and all rights of the owners of the shares so called for
47
redemption will cease and terminate, except the right of the owners of such
shares to receive the redemption price, but without any interest or additional
amount. The Fund shall be entitled to receive from the Paying Agent, promptly
after the date fixed for redemption, any cash deposited with the Paying Agent in
excess of (i) the aggregate redemption price of the FundPreferred shares called
for redemption on such date and (ii) such other amounts, if any, to which
holders of FundPreferred shares called for redemption may be entitled. The Fund
will be entitled to receive, from time to time, from the Paying Agent the
interest, if any, earned on such funds deposited with the Paying Agent and the
owners of shares so redeemed will have no claim to any such interest. Any funds
so deposited which are unclaimed two years after such redemption date will be
paid, to the extent permitted by law, by the Paying Agent to the Fund upon its
request. Thereupon, Holders of FundPreferred shares called for redemption may
look only to the Fund for payment.
So long as any FundPreferred shares are held of record by the nominee of
the Securities Depository, the redemption price for such shares will be paid on
the redemption date to the nominee of the Securities Depository. The Securities
Depository's normal procedures provide for it to distribute the amount of the
redemption price to Agent Members who, in turn, are expected to distribute such
funds to the persons for whom they are acting as agent.
Notwithstanding the provisions for redemption described above, no
FundPreferred shares may be redeemed unless all dividends in arrears on the
outstanding FundPreferred shares, and all shares of beneficial interest of the
Fund ranking on a parity with the FundPreferred shares with respect to the
payment of dividends or upon liquidation, have been or are being
contemporaneously paid or set aside for payment, except in connection with the
liquidation of the Fund in which case all FundPreferred shares and all shares
ranking in a parity with the FundPreferred shares must receive proportionate
amounts and that the foregoing shall not prevent the purchase or acquisition of
all the Outstanding FundPreferred shares pursuant to the successful completion
of an otherwise lawful purchase or exchange offer made on the same terms to, and
accepted by, Holders of all Outstanding FundPreferred shares.
Except for the provisions described above, nothing contained in the
Statement limits any legal right of the Fund to purchase or otherwise acquire
any shares of FundPreferred shares outside of an Auction at any price, whether
higher or lower than the price that would be paid in connection with an optional
or mandatory redemption, so long as, at the time of any such purchase, there is
no arrearage in the payment of dividends on or the mandatory or optional
redemption price with respect to, any shares of FundPreferred shares for which
Notice of Redemption has been given and the Fund is in compliance with the 1940
Act FundPreferred Shares Asset Coverage and has Eligible Assets with an
aggregate Discounted Value at least equal to the FundPreferred Shares Basic
Maintenance Amount after giving effect to such purchase or acquisition on the
date thereof. Any shares which are purchased, redeemed or otherwise acquired by
the Fund shall have no voting rights. If fewer than all the outstanding shares
of FundPreferred shares are redeemed or otherwise acquired by the Fund, the Fund
shall give notice of such transaction to the Auction Agent, in accordance with
the procedures agreed upon by the Board of Trustees.
ASSET MAINTENANCE
The Fund is required to satisfy two separate asset maintenance requirements
in respect of the FundPreferred shares: (i) the Fund must maintain assets in its
portfolio that have a value, discounted in accordance with guidelines set forth
by a rating agency, at least equal to the aggregate liquidation preference of
the FundPreferred shares plus specified liabilities, payment obligations and
other amounts; and (ii) the Fund must maintain asset coverage for FundPreferred
shares of at least 200%.
FundPreferred Shares Basic Maintenance Amount. The Fund must maintain, as
of each Valuation Date on which any share of FundPreferred shares is
Outstanding, Eligible Assets having an aggregate Discounted Value at least equal
to the FundPreferred Shares Basic Maintenance Amount, which is calculated
separately for Moody's (if Moody's is then rating the FundPreferred shares),
Fitch (if Fitch is then rating the FundPreferred shares) and any Other Rating
Agency which is then rating the FundPreferred shares and so requires. If the
Fund fails to maintain Eligible Assets having an aggregated
48
Discounted Value at least equal to the FundPreferred Shares Basic Maintenance
Amount as of any Valuation Date and such failure is not cured on or before the
related Asset Coverage Cure Date, the Fund will be required in certain
circumstances to redeem certain of the shares of FundPreferred shares. See
"-- Redemption -- Mandatory Redemption."
The "FundPreferred Shares Basic Maintenance Amount" as of any Valuation
Date is defined as the dollar amount equal to:
(i) (A) the sum of the products resulting from multiplying the number
of Outstanding FundPreferred shares on such date by the liquidation
preference (and redemption premium, if any) per share; (B) the aggregate
amount of dividends that will have accumulated at the Applicable Rate
(whether or not earned or declared) to and including the first Dividend
Payment Date for each Outstanding FundPreferred shares that follows such
Valuation Date (or to the 30th day after such Valuation Date, if such 30th
day occurs before the first following Dividend Payment Date); (C) the
amount of anticipated Fund non-interest expenses for the 90 days subsequent
to such Valuation Date; (D) the amount of the current outstanding balances
of any indebtedness which is senior to the FundPreferred shares plus
interest actually accrued together with 30 days additional interest on the
current outstanding balances calculated at the current rate; and (E) any
current liabilities, payable during the 30 days subsequent to such
Valuation Date, including, without limitation, indebtedness due within one
year and any redemption premium due with respect to Preferred Shares for
which a Notice of Redemption has been given, as of such Valuation Date, to
the extent not reflected in any of (i)(A) through (i)(D): less
(ii) the sum of any cash plus the value of any of the Fund's assets
irrevocably deposited by the Fund for the payment of any (i)(B) through
(i)(F) ("value," for purposes of this clause (ii), means the Discounted
Value of the security, except that if the security matures prior to the
relevant redemption payment date and is either fully guaranteed by the U.S.
Government or is rated at least P-1 by Moody's, it will be valued at its
face value).
The Market Value of the Fund's portfolio securities (used in calculating
the Discounted Value of Eligible Assets) is calculated in the same manner as the
Fund calculates its net asset value. See "Net Asset Value" in the Statement of
Additional Information.
The discount factors, the criteria used to determine whether the assets
held in the Fund's portfolio are Eligible Assets, and guidelines for determining
the Market Value of the Fund's portfolio holdings for purposes of determining
compliance with the FundPreferred Shares Basic Maintenance Amount are based on
criteria established in connection with rating the FundPreferred shares. The
Discount Factor relating to any asset of the Fund, the FundPreferred Shares
Basic Maintenance Amount, the assets eligible for inclusion in the calculation
of the Discounted Value of the Fund's portfolio and certain definitions and
methods of calculation relating thereto may be changed from time to time by the
Fund, without shareholder approval, but only in the event that the Fund receives
written confirmation from each rating agency which is then rating the
FundPreferred shares and which so requires that any such changes would not
impair its rating.
A rating agency's guidelines will apply to FundPreferred shares only so
long as such rating agency is rating such shares. The Fund will pay certain fees
to Moody's and Fitch for rating FundPreferred shares. The ratings assigned to
FundPreferred shares are not recommendations to buy, sell or hold FundPreferred
shares. Such ratings may be subject to revision or withdrawal by the assigning
rating agent at any time. Any rating of FundPreferred shares should be evaluated
independently of any other rating.
1940 Act FundPreferred Shares Asset Coverage. The Fund is also required to
maintain, with respect to FundPreferred shares, as of the last Business Day on
any month in which any FundPreferred shares is outstanding, asset coverage of at
least 200% (or such other percentage as may in the future be specified in or
under the 1940 Act as the minimum asset coverage for senior securities
representing shares of a closed-end investment company as a condition of
declaring dividends on its common shares) ("1940 Act FundPreferred Shares Asset
Coverage"). If the Fund fails to maintain the 1940 Act FundPreferred Shares
49
Asset Coverage as of the last Business Day of any month and such failure is not
cured as of the related Asset Coverage Cure Date, the Fund will be required to
redeem certain shares of FundPreferred shares. See "-- Redemption -- Mandatory
Redemption."
The Fund estimates that based on the composition of its portfolio as of
July 30, 2003, assuming the issuance of all FundPreferred shares offered hereby
and giving effect to the deduction of sales load and estimated offering costs
related thereto estimated at $19,700,000, the 1940 Act FundPreferred Shares
Asset Coverage would be:
Value of Fund assets less liabilities not
representing senior securities $2,914,172,326
------------------------------------------------------------ = -------------- = 302%
Senior securities representing indebtedness plus $965,000,000
aggregate liquidation preference of
FundPreferred shares
Notices. After the Date of Original Issue and in certain other
circumstances, the Fund is required to deliver to any Rating Agency which is
then rating the FundPreferred shares (i) a certificate with respect to the
calculation of the FundPreferred Shares Basic Maintenance Amount; (ii) a
certificate with respect to the calculation of the 1940 Act FundPreferred Shares
Asset Coverage and the value of the portfolio holdings of the Fund; and (iii) a
letter proposed by the Fund's independent accountants regarding the accuracy of
such calculations. See "Description of FundPreferred Shares -- Notices" in the
Statement of Additional Information.
LIQUIDATION RIGHTS
In the event of a liquidation, dissolution or winding up of the affairs of
the Fund, whether voluntary or involuntary, the holders of each Series of
FundPreferred shares then outstanding and any other shares ranking on a parity
with the FundPreferred shares then outstanding, in preference to the holders of
Common Shares, will be entitled to payment out of the assets of the Fund, or the
proceeds thereof, available for distribution to shareholders after satisfaction
of claims of creditors of the Fund, of a liquidation preference in the amount
equal to $25,000 per share of the FundPreferred shares, plus an amount equal to
accumulated dividends (whether or not earned or declared but without interest)
to the date of payment of such preference is made in full or a sum sufficient
for the payment thereof is set apart with the Paying Agent. However, holders of
FundPreferred shares will not be entitled to any premium to which such holder
would be entitled to receive upon redemption of such FundPreferred shares. After
payment of the full amount of such liquidation distribution, the owners of the
FundPreferred shares will not be entitled to any further participation in any
distribution of assets of the Fund.
If, upon any such liquidation, dissolution or winding up of the affairs of
the Fund, whether voluntary or involuntary, the assets of the Fund available for
distribution among the holders of all outstanding Preferred Shares, including
the FundPreferred shares, shall be insufficient to permit the payment in full to
such holders of the amounts to which they are entitled, then such available
assets shall be distributed among the holders of all outstanding Preferred
Shares, including the FundPreferred shares, ratably in any such distribution of
assets according to the respective amounts which would be payable on all such
shares if all amounts thereon were paid in full. Upon the dissolution,
liquidation or winding up of the affairs of the Fund, whether voluntary or
involuntary, until payment in full is made to the holders of FundPreferred
shares of the liquidation distribution to which they are entitled, no dividend
or other distribution shall be made to the holders of shares of Common Shares or
any other class of shares of beneficial interest of the Fund ranking junior to
FundPreferred shares upon dissolution, liquidation or winding up and no
purchase, redemption or other acquisition for any consideration by the Fund
shall be made in respect of the shares of Common Shares or any other class of
shares of beneficial interest of the Fund ranking junior to FundPreferred shares
upon dissolution, liquidation or winding up.
A consolidation, reorganization or merger of the Fund with or into any
other trust or company, or a sale, lease or exchange of all or substantially all
of the assets of the Fund in consideration for the issuance
50
of equity securities of another trust or company, shall not be deemed to be a
liquidation, dissolution or winding up of the Fund.
VOTING RIGHTS
Except as otherwise indicated in the Declaration, Statement or as otherwise
required by applicable law, holders of FundPreferred shares have one vote per
share and vote together with holders of shares of Common Shares as a single
class. Under applicable rules of the Exchange, the Fund is currently required to
hold annual meetings of shareholders.
In connection with the election of the Board of Trustees, the holders of
outstanding Preferred Shares, including each Series of the FundPreferred 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
beneficial interest of the Fund, to elect two Trustees of the Fund. The holders
of outstanding Common Shares and Preferred Shares, including each Series of the
FundPreferred shares, voting together as a single class, shall elect the balance
of the Trustees. Notwithstanding the foregoing, if (a) at the close of business
on any Dividend Payment Date accumulated dividends (whether or not earned or
declared) on the Preferred Shares, including FundPreferred shares, equal to at
least two full years' dividends shall be due and unpaid; or (b) any time holders
of any Preferred Shares are entitled under the 1940 Act to elect a majority of
the Trustees of the Fund, then the number of members constituting the Board
shall automatically be increased by the smallest number that, when added to the
two Trustees elected exclusively by the holders of Preferred Shares, including
the FundPreferred shares, as described above, would constitute a majority of the
Board as so increased by such smallest number; and at a special meeting of
shareholders which will be called and held as soon as practicable, and at all
subsequent meetings at which Trustees are to be elected, the holders of
Preferred Shares, including the FundPreferred shares, voting as a separate
class, will be entitled to elect the smallest number of additional Trustees
that, together with the two Trustees which such holders will be in any event
entitled to elect, constitutes a majority of the total number of Trustees of the
Fund as so increased. The terms of office of the persons who are Trustees at the
time of that election will continue. If the Fund thereafter shall pay, or
declare and set apart for payment, in full all dividends payable on all
outstanding Preferred Shares, including the FundPreferred shares, for all past
Dividend Periods, or the Voting Period is otherwise terminated, the voting
rights stated in the above sentence shall cease, and the terms of office of all
of the additional Trustees elected by the holders of Preferred Shares, including
the FundPreferred shares (but not of the Trustees with respect to whose election
the holders of Common Shares were entitled to vote or the two Trustees the
holders of Preferred Shares, including the FundPreferred shares, have the right
to elect in any event), will terminate automatically. Any shares of
FundPreferred shares issued after the date hereof shall vote with the
FundPreferred shares as a single class on the matters described above, and the
issuance of any other FundPreferred shares by the Fund may reduce the voting
power of the FundPreferred shares.
The affirmative vote of the holders of a majority of the outstanding
Preferred Shares, including each Series of the FundPreferred shares, determined
with reference to a "majority of outstanding voting securities" as the term is
defined in Section 2(a)(42) of the 1940 Act, voting as a separate class, is
required to (i) amend, alter or repeal any of the preferences, rights or powers
of such class so as to affect materially and adversely such preferences, rights
or powers; (ii) increase the authorized number of shares of Preferred Shares;
(iii) create, authorize or issue shares of any class of shares ranking senior to
or on a parity with the Preferred Shares with respect to the payment of
dividends or the distribution of assets, or any securities convertible into, or
warrants, options or similar rights to purchase, acquire or receive, such shares
of beneficial interest ranking senior to or on parity with the Preferred Shares
or reclassify any authorized shares of beneficial interest of the Fund into any
shares ranking senior to or on parity with the Preferred Shares (except that the
Board of Trustees, without the vote or consent of the holders of Preferred
Shares, may from time to time authorize, create and classify, and the Fund may
from time to time issue shares or series of Preferred Shares, including other
series of FundPreferred shares, ranking on a parity with the FundPreferred
shares with respect to the payment of dividends and the distribution of assets
upon dissolution, liquidation or winding up to the affairs of the Fund, and may
authorize, reclassify and/or issue any additional shares of
51
each Series of FundPreferred shares, including shares previously purchased or
redeemed by the Fund, subject to continuing compliance by the Fund with 1940 Act
FundPreferred Shares Asset Coverage and FundPreferred Shares Basic Maintenance
Amount requirements); (iv) institute any proceedings to be adjudicated bankrupt
or insolvent, or consent to the institution of bankruptcy or insolvency
proceedings against it, or file a petition seeking or consenting to
reorganization or relief under any applicable federal or state law relating to
bankruptcy or insolvency, or consent to the appointment of a receiver,
liquidator, assignee, Trustee, sequestrator (or other similar official) of the
Fund or a substantial part of its property, or make any assignment for the
benefit of creditors, or, except as may be required by applicable law, admit in
writing its inability to pay its debts generally as they become due or take any
corporate action in furtherance of any such action; (v) create, incur or suffer
to exist, or agree to create, incur or suffer to exist, or consent to cause or
permit in the future (upon the happening of a contingency or otherwise) the
creation, incurrence or existence of any material lien, mortgage, pledge,
charge, security interest, security agreement, conditional sale or trust receipt
or other material encumbrance of any kind upon any of the Fund's assets as a
whole, except (A) liens the validity of which are being contested in good faith
by appropriate proceedings, (B) liens for taxes that are not then due and
payable or that can be paid thereafter without penalty, (C) liens, pledges,
charges, security interests, security agreements or other encumbrances arising
in connection with any indebtedness senior to the FundPreferred shares, or
arising in connection with any futures contracts or options thereon, interest
rate swap or cap transactions, forward rate transactions, put or call options,
or other similar transactions, (D) liens, pledges, charges, security interests,
security agreements or other encumbrances arising in connection with any
indebtedness permitted under clause (vi) below and (E) liens to secure payment
for services rendered including, without limitation, services rendered by the
Fund's custodian and the Auction Agent; or (vi) create, authorize, issue, incur
or suffer to exist any indebtedness for borrowed money or any direct or indirect
guarantee of such indebtedness for borrowed money or any direct or indirect
guarantee of such indebtedness, except the Fund may borrow as may be permitted
by the Fund's investment restrictions; provided, however, that transfers of
assets by the Fund subject to an obligation to repurchase shall not be deemed to
be indebtedness for purposes of this provision to the extent that after any such
transaction the Fund has Eligible Assets with an aggregate Discounted Value at
least equal to the FundPreferred Shares Basic Maintenance Amount as of the
immediately preceding Valuation Date.
In addition, the affirmative vote of the holders of a majority of the
outstanding Preferred Shares, including any Series of FundPreferred shares,
voting separately from any other series, shall be required with respect to any
matter that materially and adversely affects the rights, preferences, or powers
of such series in a manner different from that of other series of classes of the
Fund's shares of beneficial interest. For purposes of the foregoing, no matter
shall be deemed to adversely affect any right, preference or power unless such
matter (i) alters or abolishes any preferential right of such series; (ii)
creates, alters or abolishes any right in respect of redemption of such series;
or (iii) creates or alters (other than to abolish) any restriction on transfer
applicable to such series.
The foregoing voting provisions will not apply with respect to the
FundPreferred shares 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 shall have been deposited in trust to effect such redemption.
The Board of Trustees, without the vote or consent of any holder of
Preferred Shares, including FundPreferred shares, or any other shareholder of
the Fund, may from time to time adopt, amend, alter or repeal any or all of any
definitions set forth in the Statement or add covenants and other obligations of
the Fund or confirm the applicability of covenants and other obligations set
forth in the Statement in connection with obtaining or maintaining the rating of
Moody's, Fitch or any Other Rating Agency with respect to FundPreferred shares
and any such adoption, amendment, alteration or repeal will not be deemed to
affect the preferences, rights or powers of FundPreferred shares or the holders
thereof, provided the Board of Trustees receives written confirmation from the
relevant rating agency (such confirmation in no event being required to be
obtained from a particular rating agency with respect to definitions or other
provisions relevant only to another rating agency's rating) that any such
amendment, alteration or repeal would not adversely affect the rating then
assigned by such rating agency.
52
Also, subject to compliance with applicable law, the Board of Trustees may
amend the definition of Maximum Rate to increase the percentage amount by which
the Reference Rate is multiplied to determine the Maximum Rate shown therein
without the vote or consent of the holders of the Preferred Shares, including
FundPreferred shares, or any other shareholder of the Fund, and without
receiving any confirmation from any rating agency after consultation with the
Broker-Dealers, provided that immediately following any such increase the Fund
would be in compliance with the FundPreferred Shares Basic Maintenance Amount.
Unless otherwise required by law, holders of FundPreferred shares shall not
have any relative rights or preferences or other special rights other than those
specifically set forth in the Statement. The holders of FundPreferred shares
shall have no rights to cumulative voting. In the event that the Fund fails to
pay any dividends on the FundPreferred shares, the exclusive remedy of the
holders shall be the right to vote for Trustees as discussed above.
THE AUCTION
GENERAL
Auction Agency Agreement. The Fund has entered into an Auction Agency
Agreement (the "Auction Agency Agreement") with the Auction Agent (currently,
The Bank of New York) which provides, among other things, that the Auction Agent
will follow the Auction Procedures for purposes of determining the Applicable
Rate for each series of FundPreferred shares so long as the Applicable Rate for
shares of such series is to be based on the results of an Auction.
The Auction Agent may terminate the Auction Agency Agreement upon notice to
the Fund on a date no earlier than 45 days after such notice. If the Auction
Agent should resign, the Fund will use its best efforts to enter into an
agreement with a successor Auction Agent containing substantially the same terms
and conditions as the Auction Agency Agreement. The Fund may remove the Auction
Agent provided that prior to such removal the Fund shall have entered into such
an agreement with a successor Auction Agent.
Broker-Dealer Agreements. Each Auction requires the participation of one
or more Broker-Dealers. The Auction Agent has entered into agreements
(collectively, the "Broker-Dealer Agreements") with several Broker-Dealers
selected by the Fund, which provide for the participation of those
Broker-Dealers in Auctions for FundPreferred shares.
The Auction Agent after each Auction for FundPreferred shares will pay to
each Broker-Dealer, from funds provided by the Fund, a service charge at the
annual rate of 1/4 of 1% in the case of any Auction immediately preceding a
Dividend Period of less than one year, or a percentage agreed to by the Fund and
the Broker-Dealers in the case of any Auction immediately preceding a Dividend
Period of one year or longer, of the purchase price of FundPreferred shares
placed by such Broker-Dealer at such Auction. For the purposes of the preceding
sentence, FundPreferred shares will be placed by a Broker-Dealer if such shares
were (a) the subject of Hold Orders deemed to have been submitted to the Auction
Agent by the Broker-Dealer and were acquired by such Broker-Dealer for its own
account or were acquired by such Broker-Dealer for its customers who are
Beneficial Owners or (b) the subject of an Order submitted by such Broker-Dealer
that is (i) a Submitted Bid of an Existing Holder that resulted in such Existing
Holder continuing to hold such shares as a result of the Auction or (ii) a
Submitted Bid of a Potential Holder that resulted in such Potential Holder
purchasing such shares as a result of the Auction or (iii) a valid Hold Order.
The Fund may request the Auction Agent to terminate one or more
Broker-Dealer Agreements at any time, provided that at least one Broker-Dealer
Agreement is in effect after such termination.
53
AUCTION PROCEDURES
Prior to the Submission Deadline on each Auction Date for series of
FundPreferred shares, each 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 (a "Beneficial Owner") may submit orders ("Orders")
with respect to shares of such series to that Broker-Dealer as follows:
- Hold Order -- indicating its desire to hold shares of such series without
regard to the Applicable Rate for shares of such series for the next
Dividend Period thereof.
- Bid -- indicating its desire to sell shares of such series at $25,000 per
share if the Applicable Rate for shares of such series for the next
Dividend Period thereof is less than the rate specified in such Bid (also
known as a hold-at-a-rate order).
- Sell Order -- indicating its desire to sell shares of such series at
$25,000 per share without regard to the Applicable Rate for shares of
such series for the next Dividend Period thereof.
A Beneficial Owner may submit different types of Orders to its
Broker-Dealer with respect to shares of a series of FundPreferred shares then
held by such Beneficial Owner. A Beneficial Owner of shares of such series that
submits a Bid with respect to shares of such series to its Broker-Dealer having
a rate higher than the Maximum Rate for shares of such series on the Auction
Date therefore will be treated as having submitted a Sell Order with respect to
such shares to its Broker-Dealer. A Beneficial Owner of shares of such series
that fails to submit an Order with respect to such shares to its Broker-Dealer
will be deemed to have submitted a Hold Order with respect to such shares of
such series to its Broker-Dealer; provided, however, that if a Beneficial Owner
of shares of such series fails to submit an Order with respect to shares of such
series to its Broker-Dealer for an Auction relating to a Dividend Period of more
than 28 Dividend Period Days, such Beneficial Owner will be deemed to have
submitted a Sell Order with respect to such shares to its Broker-Dealer. A Sell
Order shall constitute an irrevocable offer to sell the FundPreferred shares
subject thereto. A Beneficial Owner that offers to become the Beneficial Owner
of additional FundPreferred shares is, for purposes of such offer, a Potential
Beneficial Owner as discussed below.
A customer of a Broker-Dealer that is not a Beneficial Owner of a series of
FundPreferred shares 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 (in each case, a "Potential Beneficial Owner"),
may submit Bids to its Broker-Dealer in which it offers to purchase shares of
such series at $25,000 per share if the Applicable Rate for shares of such
series for the next Dividend Period thereof is not less than the rate specified
in such Bid. A Bid placed by a Potential Beneficial Owner of shares of such
series specifying a rate higher than the Maximum Rate for shares of such series
on the Auction Date therefore will not be accepted.
The Broker-Dealers in turn will submit the Orders of their respective
customers who are Beneficial Owners and Potential Beneficial Owners to the
Auction Agent, designating themselves (unless otherwise permitted by the Fund)
as Existing Holders in respect of shares subject to Orders submitted or deemed
submitted to them by Beneficial Owners and as Potential Holders in respect of
shares subject to Orders submitted to them by Potential Beneficial Owners.
However, neither the Fund nor the Auction Agent will be responsible for a
Broker-Dealer's failure to comply with the foregoing. 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 in the same manner as an Order placed with a
Broker-Dealer by a Beneficial Owner or Potential Beneficial Owner. Similarly,
any failure by a Broker-Dealer to submit to the Auction Agent an Order in
respect of FundPreferred shares held by it or customers who are Beneficial
Owners will be treated in the same manner as a Beneficial Owner's failure to
submit to its Broker-Dealer an Order in respect of FundPreferred shares 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 it is not an
affiliate of the Fund.
If Sufficient Clearing Bids for a series of FundPreferred shares exist
(that is, the number of shares of such series subject to Bids submitted or
deemed submitted to the Auction Agent by Broker-Dealers as or
54
on behalf of Potential Holders with rates equal to or lower than the Maximum
Rate for shares of such series is at least equal to the number of shares of such
series subject to Sell Orders submitted or deemed submitted to the Auction Agent
by Broker-Dealers as or on behalf of Existing Holders), the Applicable Rate for
shares of such series for the next succeeding Dividend Period thereof will be
the lowest rate specified in the Submitted Bids which, 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 Existing Holders and Potential
Holders owning the shares of such series available for purchase in the Auction.
If Sufficient Clearing Bids for a series of FundPreferred shares do not exist,
the Applicable Rate for shares of such series for the next succeeding Dividend
Period thereof will be the Maximum Rate for shares of such series on the Auction
Date therefore. In such event, Beneficial Owners of shares of such series that
have submitted or are deemed to have submitted Sell Orders may not be able to
sell in such Auction all shares of such series subject to such Sell Orders. If
Broker-Dealers submit or are deemed to have submitted to the Auction Agent Hold
Orders with respect to all Existing Holders of a series of FundPreferred shares,
the Applicable Rate for shares of such series for the next succeeding Dividend
Period thereof will be the All Hold Rate.
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 shares of a series of
FundPreferred shares that is fewer than the number of shares of such series
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
(also a Dividend Payment Date) after the Auction Date through the Securities
Depository. Purchasers will make payment through their Agent Members in same-day
funds to the Securities Depository against delivery to their respective Agent
Members. The Securities Depository will make payment to the sellers' Agent
Members in accordance with the Securities Depository's normal procedures, which
now provide for payment against delivery by their Agent Members in same-day
funds.
SECONDARY MARKET TRADING AND TRANSFER OF FUNDPREFERRED SHARES
The Broker-Dealers may maintain a secondary trading market of FundPreferred
shares outside of Auctions, but are not obligated to do so, and may discontinue
such activity at any time. There can be no assurance that such secondary trading
market of FundPreferred shares will provide owners with liquidity of investment.
FundPreferred shares are not registered on any stock exchange or on the Nasdaq
Stock Market. Investors who purchase shares in an Auction for a Special Dividend
Period should note that because the dividend rate on such shares will be fixed
for the length of such Dividend Period, the value of the shares may fluctuate in
response to 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
therefore, depending upon market conditions.
A Beneficial Owner or an Existing Holder may sell, transfer or otherwise
dispose of FundPreferred shares only in whole shares and only (1) pursuant to a
Bid or Sell Order placed with the Auction Agent in accordance with the Auction
Procedures, (2) to a Broker-Dealer or (3) to such other persons as may be
permitted by the Fund; provided, however, that (a) a sale, transfer or other
disposition of FundPreferred 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 the foregoing if such
Broker-Dealer remains the Existing Holder of the shares so sold, transferred or
disposed of immediately after such sale, transfer or disposition and (b) in the
case of all transfers other than pursuant to Auctions, the Broker-Dealer (or
other person, if permitted by the Fund) to whom such transfer is made shall
advise the Auction Agent of such transfer.
55
DESCRIPTION OF BORROWINGS
The Declaration of Trust authorizes the Fund, without prior approval of
holders of Common and Preferred Shares, including FundPreferred shares, to
borrow money. In this connection, the Fund may issue notes or other evidence of
indebtedness (including bank borrowings or commercial paper) and may secure any
such borrowings by mortgaging, pledging or otherwise subjecting as security the
Fund's assets. In connection with such borrowing, the Fund may be required to
maintain minimum average balances with the lender or to pay a commitment or
other fee to maintain a line of credit. Any such requirements will increase the
cost of borrowing over the stated interest rate. Any Borrowings will rank senior
to the FundPreferred shares.
Limitations. Under the requirements of the 1940 Act, the Fund, immediately
after issuing any Borrowings that are senior securities representing
indebtedness (as defined in the 1940 Act), must have an asset coverage of at
least 300%. With respect to any such Borrowings, asset coverage means the ratio
which the value of the total assets of the Fund, less all liabilities and
indebtedness not represented by senior securities, bears to the aggregate amount
of any such Borrowings that are senior securities representing indebtedness,
issued by the Fund. Certain types of Borrowings may also result in the Fund
being subject to covenants in credit agreements relating to asset coverages or
portfolio composition or otherwise. In addition, the Fund may be subject to
certain restrictions imposed by guidelines of one or more rating agencies which
may issue ratings for commercial paper or notes issued by the Fund. Such
restrictions may be more stringent than those imposed by the 1940 Act.
Distribution Preference. The rights of lenders to the Fund to receive
interest on and repayment of principal of any such Borrowings will be senior to
those of the FundPreferred shares shareholders, and the terms of any such
Borrowings may contain provisions which limit certain activities of the Fund,
including the payment of dividends to FundPreferred shares shareholders in
certain circumstances.
Voting Rights. The 1940 Act does (in certain circumstances) grant to the
lenders to the Fund certain voting rights in the event of default in the payment
of interest on or repayment of principal. In the event that such provisions
would impair the Fund's status as a regulated investment company under the Code,
the Fund, subject to its ability to liquidate its portfolio, intends to repay
the Borrowings. Any Borrowing will likely be ranked senior or equal to all other
existing and future borrowings of the Fund.
The discussion above describes the Board of Trustees' present intention
with respect to a possible offering of Borrowings. If the Board of Trustees
determines to authorize any of the foregoing, the terms may be the same as, or
different from, the terms described above, subject to applicable law and the
Fund's Declaration.
DESCRIPTION OF COMMON SHARES
The Declaration of Trust authorizes the issuance of an unlimited number of
Common Shares, par value $0.01 per share. All Common Shares have equal rights to
the payment of dividends and the distribution of assets upon liquidation. Common
Shares will, when issued, be fully paid and, subject to matters discussed in
"Certain Provisions in the Declaration of Trust," non-assessable, and will have
no pre-emptive or conversion rights or rights to cumulative voting. At any time
when FundPreferred shares are outstanding, Common Shareholders will not be
entitled to receive any cash distributions from the Fund unless all accrued
dividends on FundPreferred shares have been paid, and unless asset coverage (as
defined in the 1940 Act) with respect to FundPreferred shares would be at least
200% after giving effect to the distributions.
The Common Shares are listed on the 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.
56
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST
Under Massachusetts law, shareholders could, under certain circumstances,
be held personally liable for the obligations of the Fund. However, the
Declaration of Trust 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.
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. Specifically, the Declaration requires a vote by holders of at
least two-thirds of the Common Shares and FundPreferred shares, voting together
as a single class, except as described below, to authorize (1) a conversion of
the Fund from a closed-end to an open-end investment company, (2) a merger or
consolidation of the Fund, or a series or class of the Fund, with any
corporation, association, trust or other organization or a reorganization of the
Fund, or a series or class of the Fund, (3) a sale, lease or transfer of all or
substantially all of the Fund's assets (other than in the regular course of the
Fund's investment activities), (4) in certain circumstances, a termination of
the Fund, or a series or class of the Fund, or (5) a removal of trustees by
shareholders, and then only for cause, unless, with respect to (1) through (4),
such transaction has already been authorized by the affirmative vote of
two-thirds of the total number of trustees fixed in accordance with the
Declaration or the By-laws, in which case the affirmative vote of the holders of
at least a majority of the Fund's Common Shares and FundPreferred shares
outstanding at the time, voting together as a single class, is required,
provided, however, that where only a particular class or series is affected (or,
in the case of removing a trustee, when the trustee has been elected by only one
class), only the required vote by the applicable class or series will be
required. Approval of shareholders is not required, however, for any
transaction, whether deemed a merger, consolidation, reorganization or otherwise
whereby the Fund issues shares in connection with the acquisition of assets
(including those subject to liabilities) from any other investment company or
similar entity. In the case of the conversion of the Fund to an open-end
investment company, or in the case of any of the foregoing transactions
constituting a plan of reorganization which adversely affects the holders of
FundPreferred shares, the action in question will also require the affirmative
vote of the holders of at least two-thirds of the FundPreferred shares
outstanding at the time, voting as a separate class, or, if such action has been
authorized by the affirmative vote of two-thirds of the total number of trustees
fixed in accordance with the Declaration or the By-laws, the affirmative vote of
the holders of at least a majority of the FundPreferred shares outstanding at
the time, voting as a separate class. None of the foregoing provisions may be
amended except by the vote of at least two-thirds of the Common Shares and
FundPreferred shares, voting together as a single class. The votes required to
approve the conversion of the Fund from a closed-end to an open-end investment
company or to approve transactions constituting a plan of reorganization which
adversely affects the holders of FundPreferred shares are higher than those
required by the 1940 Act. The Board of Trustees believes that the provisions of
the Declaration relating to such higher votes are in the best interest of the
Fund and its shareholders. See the Statement of Additional Information under
"Certain Provisions in the Declaration of Trust."
Reference should be made to the Declaration on file with the Commission for
the full text of these provisions.
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. Instead, the
Common Shares will trade in the open market at a price that will be a function
of several factors, including dividend levels (which are in turn affected by
expenses), net asset value, call protection, dividend stability, portfolio
credit quality, relative demand for
57
and supply of such shares in the market, general market and economic conditions
and other factors. Because shares of closed-end investment companies may
frequently trade at prices lower than net asset value, the Fund's Board of
Trustees has currently determined that, at least annually, it will consider
action that might be taken to reduce or eliminate any material discount from net
asset value in respect of Common Shares, which may include the repurchase of
such shares in the open market or in private transactions, the making of a
tender offer for such shares at net asset value, or the conversion of the Fund
to an open-end investment company. The Fund cannot assure that its Board of
Trustees will decide to take any of these actions, or that share repurchases or
tender offers will actually reduce market discount.
If the Fund converted to an open-end investment company, it would be
required to redeem all FundPreferred shares then outstanding (requiring in turn
that it liquidate a portion of its investment portfolio), and the Common Shares
would no longer be listed on the 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 the 1940 Act or the rules thereunder) at their net asset value,
less any redemption charge that is in effect at the time of redemption. See the
Statement of Additional Information under "Certain Provisions in the Declaration
of Trust" for a discussion of the voting requirements applicable to the
conversion of the Fund to an open-end investment company.
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 shares
should trade at a discount, the Board of Trustees may determine that, in the
interest of the Fund and its shareholders, no action should be taken. See the
Statement of Additional Information under "Repurchase of Fund Shares; Conversion
to Open-End Fund" for a further discussion of possible action to reduce or
eliminate such discount to net asset value.
FEDERAL INCOME TAX MATTERS
The following is intended to be a general summary of certain federal income
tax consequences of investing in FundPreferred shares. It is not intended to be
a complete discussion of all such federal income tax consequences, nor does it
purport to deal with all categories of investors. INVESTORS ARE THEREFORE
ADVISED TO CONSULT WITH THEIR OWN TAX ADVISORS BEFORE MAKING AN INVESTMENT IN
THE FUND.
FEDERAL INCOME TAX TREATMENT OF THE FUND
The Fund intends to qualify for, and to elect to be treated as, a regulated
investment company under Subchapter M of the Code and intends to qualify under
those provisions each year. As a regulated investment company, the Fund
generally will not be subject to federal income tax on its investment company
taxable income and net capital gains (net long-term capital gains in excess of
the sum of net short-term capital losses and capital loss carryovers from prior
years), if any, that it distributes to shareholders. However, the Fund would be
subject to corporate income tax (currently imposed at a maximum effective rate
of 35%) on any undistributed income. The Fund intends to distribute to its
shareholders, at least annually, substantially all of its investment company
taxable income and net capital gains.
Amounts not distributed on a timely basis in accordance with a calendar
year distribution requirement are also subject to a nondeductible 4% federal
excise tax. To prevent imposition of this tax, the Fund must distribute, or be
deemed to have distributed, during each calendar year an amount equal to the sum
of (1) at least 98% of its ordinary income (not taking into account any capital
gains or losses) for the calendar year, (2) at least 98% of its capital gains in
excess of its capital losses (adjusted for certain ordinary losses) for the
twelve month period ending on October 31 of the calendar year, and (3) all such
ordinary income and capital gains for previous years that were not distributed
during such years. A distribution will be treated as having been paid on
December 31 if it is declared by the Fund in October,
58
November or December with a record date in such months and is paid by the Fund
in January of the following year. Accordingly, such distributions will be
taxable to shareholders in the calendar year in which the distributions are
declared. To prevent application of this excise tax, the Fund intends to make
distributions to satisfy the calendar year distribution requirement.
If in any taxable year the Fund fails to qualify as a regulated investment
company under the Code, the Fund would be taxed in the same manner as an
ordinary corporation and distributions to its shareholders would not be
deductible by the Fund in computing its taxable income. In addition, in the
event of a failure to qualify as a regulated investment company, the Fund's
distributions, to the extent derived from the Fund's current or accumulated
earnings and profits, would generally constitute dividends, which would
generally be eligible for the Dividends Received Deduction available to
corporate shareholders. Furthermore, in such event, noncorporate shareholders
generally would be able to treat such distributions as "qualified dividend
income" eligible for reduced rates of federal income taxation in taxable years
beginning on or before December 31, 2008.
The Fund's transactions, if any, in forward contracts, options, futures
contracts and hedge investments will be subject to special provisions of the
Code that, among other things, may affect the character of gain and loss
realized by the Fund (i.e., may affect whether gain or loss is ordinary or
capital), accelerate recognition of income to the Fund, defer Fund losses, and
affect whether capital gain and loss is characterized as long-term or
short-term. These rules could therefore affect the character, amount and timing
of distributions to shareholders. These provisions also may require the Fund to
mark-to-market certain types of the positions in its portfolio (i.e., treat them
as if they were closed out), which may cause the Fund to recognize income
without receiving cash with which to make distributions in amounts necessary to
satisfy the distribution requirements for avoiding income and excise taxes. The
Fund will monitor its transactions, make the appropriate tax elections, and make
the appropriate entries in its books and records when it acquires any option,
futures contract, forward contract, or hedged investment in order to mitigate
the effect of these rules, prevent disqualification of the Fund as a regulated
investment company, and minimize the imposition of income and excise taxes.
FEDERAL INCOME TAX TREATMENT OF HOLDERS OF FUNDPREFERRED SHARES
Under present law, the Fund is of the opinion that FundPreferred shares
will constitute stock of the Fund, and thus distributions with respect to
FundPreferred shares (other than as described below and other than distributions
in redemption of FundPreferred shares subject to Section 302(b) of the Code)
will generally 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 but
generally will not qualify for the Dividends Received Deduction available to
corporations under Section 243 of the Code or the reduced rates of federal
income taxation for "qualified dividend income" currently available to
noncorporate shareholders under Section 1(h)(11) of the Code. Dividends
designated by the Fund as capital gain dividends will be treated as long-term
capital gains in the hands of holders regardless of the length of time such
holders have held their shares. Distributions in excess of the Fund's earnings
and profits, if any, will first reduce a shareholder's adjusted tax basis in his
or her shares and, after the adjusted tax basis is reduced to zero, will
constitute capital gains to a holder who holds such shares as a capital asset.
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). Accordingly, the
Fund intends to designate dividends made with respect to FundPreferred shares as
capital gain dividends in proportion to the FundPreferred shares' share of total
dividends paid by the Fund during the year.
59
SALE OF SHARES
The sale of FundPreferred shares by holders will generally be a taxable
transaction for federal income tax purposes. Holders of FundPreferred shares who
sell such shares will generally recognize gain or loss in an amount equal to the
difference between the net proceeds of the sale and their adjusted tax basis in
the shares sold. If such FundPreferred shares are held as a capital asset at the
time of the sale, the gain or loss will generally be a capital gain or loss.
Similarly, a redemption by the Fund (including a redemption resulting from
liquidation of the Fund), if any, of all the FundPreferred shares actually and
constructively held by a shareholder generally will give rise to capital gain or
loss under Section 302(b) of the Code if the shareholder does not own (and is
not regarded under certain tax law rules of constructive ownership as owning)
any Common Shares in the Fund, and provided that the redemption proceeds do not
represent declared but unpaid dividends. Other redemptions may also give rise to
capital gain or loss, but certain conditions imposed by Section 302(b) of the
Code must be satisfied to achieve such treatment. Any loss realized upon a
taxable disposition of FundPreferred shares held for six months or less will be
treated as a long-term capital loss to the extent of any distributions of net
capital gain received (or deemed received) with respect to such shares.
BACKUP WITHHOLDING
The Fund may be required to withhold, for U.S. federal income tax purposes,
a portion of all taxable distributions (including redemption proceeds) payable
to shareholders who fail to provide the Fund with their correct taxpayer
identification number, who fail to make required certifications or who have been
notified by the IRS that they are subject to backup withholding (or if the Fund
has been so notified). Certain corporate and other shareholders specified in the
Code and the regulations thereunder are exempt from backup withholding. 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.
OTHER TAXATION
Foreign shareholders, including shareholders who are nonresident aliens,
may be subject to U.S. withholding tax on certain distributions at a rate of 30%
or such lower rates as may be prescribed by any applicable treaty.
Investors are advised to consult their own tax advisors with respect to the
application to their own circumstances of the above-described general federal
income taxation rules and with respect to other federal, state, local or foreign
tax consequences to them of an investment in FundPreferred shares.
CUSTODIAN, TRANSFER AGENT, AUCTION AGENT, DIVIDEND
DISBURSING AGENT AND REDEMPTION AGENT
The custodian of the assets of the Fund is State Street Bank and Trust
Company, One Federal Street, Boston, Massachusetts 02110. The custodian performs
custodial, fund accounting and portfolio accounting services. The Fund's
transfer, shareholder services and dividend paying agent is also State Street
Bank and Trust Company, One Federal Street, Boston, Massachusetts 02110. The
Bank of New York is the Auction Agent with respect to the FundPreferred shares
and acts as transfer agent, registrar, dividend disbursing agent and redemption
agent with respect to the FundPreferred shares.
60
UNDERWRITING
Citigroup Global Markets Inc. is acting as representative of the
underwriters named below. Subject to the terms and conditions stated in the
underwriting agreement dated the date hereof, each underwriter named below has
severally agreed to purchase, and the Fund has agreed to sell to such
underwriter, the number of FundPreferred shares set forth opposite the name of
such underwriter.
NUMBER OF SHARES
-------------------------------------------------------------------------------------------
UNDERWRITERS SERIES M SERIES M2 SERIES T SERIES T2 SERIES W SERIES W2 SERIES TH SERIES TH2
------------ -------- --------- -------- --------- -------- --------- --------- ----------
Citigroup Global Markets
Inc. .......................
Nuveen Investments, LLC.......
A.G. Edwards & Sons, Inc. ....
Wachovia Capital Markets,
LLC.........................
----- ----- ----- ----- ----- ----- ----- -----
Total................. 3,860 3,860 3,860 3,860 3,860 3,860 3,860 3,860
NUMBER OF SHARES
--------------------
UNDERWRITERS SERIES F SERIES F2
------------ -------- ---------
Citigroup Global Markets
Inc. .......................
Nuveen Investments, LLC.......
A.G. Edwards & Sons, Inc. ....
Wachovia Capital Markets,
LLC.........................
----- -----
Total................. 3,860 3,860
The underwriting agreement provides that the obligations of the several
underwriters to purchase the shares included in this offering are subject to
approval of certain legal matters by counsel and to certain other conditions.
The underwriters are obligated to purchase all the FundPreferred shares if they
purchase any of the shares.
The underwriters propose to offer some of the shares directly to the public
at the public offering price set forth on the cover page of this Prospectus and
some of the shares 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
$ per share is equal to % of the initial offering price. One half of the
sales load from this offering will be paid to certain underwriters based on
their participation in the offering of the Fund's Common Shares. The
underwriters may allow, and such dealers may reallow, a concession not in excess
of $ per share on sales to certain other dealers. If all of the
FundPreferred shares are not sold at the initial offering price, the
representatives may change the public offering price and other selling terms.
Investors must pay for any FundPreferred shares purchased on or before
, 2003.
The Fund and the Advisers have each agreed that, for a period of 180 days
from the date of this Prospectus, they will not, without the prior written
consent of Citigroup Global Markets Inc. on behalf of the Underwriters, sell,
contract to sell, or otherwise dispose of any senior securities (as defined in
the 1940 Act) of the Fund, or any securities convertible into or exchangeable
for senior securities or grant any options or warrants to purchase senior
securities of the Fund other than FundPreferred shares. Citigroup Global Markets
Inc. on behalf of the underwriters in its sole discretion may release any of the
securities subject to those lock-up agreements at any time without notice.
The Fund anticipates that from time to time certain of the underwriters may
act as brokers or dealers in connection with the execution of the Fund's
portfolio transactions after they have ceased to be underwriters and, subject to
certain restrictions, may act as brokers while they are underwriters.
The Fund anticipates that the underwriters or one of 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.
Nuveen, 333 West Wacker Drive, Chicago, Illinois, 60606, one of the
underwriters, is an affiliate of NIAC.
The Fund, NIAC, Spectrum and Froley, Revy have agreed to indemnify the
underwriters against certain liabilities, including liabilities arising under
the Securities Act of 1933, or to contribute to payments the underwriters may be
required to make because of any of those liabilities. Insofar as indemnification
for liability arising under the Securities Act of 1933 may be permitted to
directors, officers and controlling persons of the registrant pursuant to the
foregoing provisions, or otherwise, the registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is, therefore, 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 a director,
officer or controlling person of the registrant in the successful defense of any
action, suit
61
or proceeding) is asserted by such director, officer or controlling person 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.
The principal business address of Citigroup Global Markets Inc. is 388
Greenwich Street, New York, New York, 10013.
LEGAL OPINIONS
Certain legal matters in connection with the FundPreferred shares offered
hereby will be passed upon for the Fund by Vedder, Price, Kaufman & Kammholz,
P.C., Chicago, Illinois, and for the underwriters by Simpson Thacher & Bartlett
LLP, New York, New York. Vedder, Price, Kaufman & Kammholz, P.C. and Simpson
Thacher & Bartlett LLP may rely as to certain matters of Massachusetts law on
the opinion of Bingham McCutchen LLP, Boston, Massachusetts.
AVAILABLE INFORMATION
The Fund is subject to the informational requirements of the Securities
Exchange Act of 1934 and the 1940 Act and is required to file reports, proxy
statements and other information with the SEC. These documents can be inspected
and copied for a fee at the SEC's public reference room, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Reports, proxy statements, and other information about
the Fund can be inspected at the offices of the Exchange.
This Prospectus does not contain all of the information in the Fund's
registration statement, including amendments, exhibits, and schedules.
Statements in this Prospectus about the contents of any contract or other
document are not necessarily complete and in each instance reference is made to
the copy of the contract or other document filed as an exhibit to the
registration statement, each such statement being qualified in all respects by
this reference.
Additional information about the Fund and FundPreferred shares can be found
in the Fund's Registration Statement (including amendments, exhibits, and
schedules) on Form N-2 filed with the SEC. The SEC maintains a web site
(http://www.sec.gov) that contains each Fund's 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. Additional information may be found on the
Internet at http://www.nuveen.com.
62
TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION
Investment Objectives....................................... S-1
Investment Restrictions..................................... S-1
Investment Policies and Techniques.......................... S-3
Other Investment Policies and Techniques.................... S-12
Management of the Fund...................................... S-28
Investment Advisers......................................... S-33
Portfolio Transactions and Brokerage........................ S-37
Net Asset Value............................................. S-39
Description of FundPreferred Shares......................... S-40
Additional Information Concerning the Auctions for
FundPreferred Shares...................................... S-42
Certain Provisions in the Declaration of Trust.............. S-43
Repurchase of Fund Shares; Conversion to Open-End Fund...... S-44
Federal Income Tax Matters.................................. S-46
Experts..................................................... S-51
Custodian, Transfer Agent, Auction Agent, Dividend
Disbursing Agent and Redemption Agent..................... S-51
Additional Information...................................... S-51
Report of Independent Auditors.............................. F-1
Financial Statements........................................ F-2
Statement Establishing and Fixing the Rights and Preferences
of FundPreferred Shares (Appendix A)...................... A-1
Ratings of Investments (Appendix B)......................... B-1
63
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
$965,000,000
NUVEEN PREFERRED AND CONVERTIBLE
INCOME FUND 2
FUNDPREFERRED(TM) SHARES
3,860 SHARES, SERIES M
3,860 SHARES, SERIES M2
3,860 SHARES, SERIES T
3,860 SHARES, SERIES T2
3,860 SHARES, SERIES W
3,860 SHARES, SERIES W2
3,860 SHARES, SERIES TH
3,860 SHARES, SERIES TH2
3,860 SHARES, SERIES F
3,860 SHARES, SERIES F2
-----------------
PROSPECTUS
, 2003
-----------------
CITIGROUP
NUVEEN INVESTMENTS, LLC
A.G. EDWARDS & SONS, INC.
WACHOVIA SECURITIES
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
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 AUGUST 6, 2003
NUVEEN PREFERRED AND CONVERTIBLE INCOME FUND 2
STATEMENT OF ADDITIONAL INFORMATION
Nuveen Preferred and Convertible Income Fund 2 (the "Fund") is a
recently organized, diversified, closed-end management investment company.
This Statement of Additional Information relating to this offering does
not constitute a Prospectus, but 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 FundPreferred shares in
this offering. Investors should obtain and read the Fund's Prospectus prior to
purchasing such shares. A copy of the Fund's Prospectus may be obtained without
charge by calling (800) 257-8787. You may also obtain a copy of the Fund's
Prospectus on the Securities and Exchange Commission's web site
(http://www.sec.gov). Capitalized terms used but not defined in this Statement
of Additional Information have the meanings ascribed to them in the Prospectus.
TABLE OF CONTENTS
Investment Objectives..........................................................................................S-1
Investment Restrictions........................................................................................S-1
Investment Policies and Techniques.............................................................................S-3
Other Investment Policies and Techniques......................................................................S-12
Management of the Fund........................................................................................S-28
Investment Advisers...........................................................................................S-33
Portfolio Transactions and Brokerage..........................................................................S-37
Net Asset Value...............................................................................................S-39
Description of FundPreferred Shares...........................................................................S-40
Additional Information Concerning the Auctions for FundPreferred Shares.......................................S-42
Certain Provisions in the Declaration of Trust................................................................S-43
Repurchase of Fund Shares; Conversion to Open-End Fund........................................................S-44
Federal Income Tax Matters....................................................................................S-46
Experts .....................................................................................................S-51
Custodian, Transfer Agent, Auction Agent, Dividend Disbursing Agent and Redemption Agent......................S-51
Additional Information........................................................................................S-51
Report of Independent Auditors................................................................................F-1
Financial Statements..........................................................................................F-2
Statement Establishing and Fixing the Rights and Preferences of
FundPreferred Shares (Appendix A).....................................................................A-1
Ratings of Investments (Appendix B)............................................................................B-1
This Statement of Additional Information is dated ______, 2003.
INVESTMENT OBJECTIVES
The Fund's primary objective is high current income. The Fund's
secondary objective is total return. There can be no assurance that the Fund's
investment objectives will be achieved.
The Fund cannot change its investment objectives without the approval
of the holders of a "majority of the outstanding" Common Shares and
FundPreferred shares voting together as a single class, and of the holders of a
"majority of the outstanding" FundPreferred shares voting as a separate class.
When used with respect to particular shares of the Fund, a "majority of the
outstanding" shares means (i) 67% or more of the shares present at a meeting, if
the holders of more than 50% of the shares are present or represented by proxy,
or (ii) more than 50% of the shares, whichever is less. See "Description of
FundPreferred Shares -- Voting Rights" in the Fund's Prospectus and "Description
of FundPreferred Shares -- Voting Rights" in this Statement of Additional
Information for additional information with respect to the voting rights of
holders of FundPreferred shares.
INVESTMENT RESTRICTIONS
Except as described below, the Fund, as a fundamental policy, may not,
without the approval of the holders of a majority of the outstanding Common
Shares and FundPreferred shares voting together as a single class, and of the
holders of a majority of the outstanding FundPreferred shares voting as a
separate class:
(1) Issue senior securities, as defined in the Investment
Company Act of 1940, other than (i) preferred shares which immediately
after issuance will have asset coverage of at least 200%, (ii)
indebtedness which immediately after issuance will have asset coverage
of at least 300%, or (iii) the borrowings permitted by investment
restriction (2) set forth below;
(2) Borrow money, except as permitted by the Investment
Company Act of 1940 and exemptive orders granted under the Investment
Company Act of 1940;
(3) Act as underwriter of another issuer's securities, except
to the extent that the Fund may be deemed to be an underwriter within
the meaning of the Securities Act of 1933 in connection with the
purchase and sale of portfolio securities or acting as an agent or one
of a group of co-agents in originating corporate loans;
(4) Invest more than 25% of its total assets in securities of
issuers in any one industry other than the financial services industry;
provided, however, that such limitation shall not apply to obligations
issued or guaranteed by the United States Government or by its agencies
or instrumentalities, and provided further that for purposes of this
limitation the term "issuer" shall not include a lender selling a
participant to the Fund together with any other person interpositioned
between such lender and Fund with respect to a participation;
(5) Purchase or sell real estate, except pursuant to the
exercise by the Fund of its rights under loan agreements and except to
the extent that interests in corporate loans the Fund may invest in
are considered to be interests in real estate, and this shall not
prevent the Fund from investing in securities of companies that deal
in real estate or are engaged in the real estate business, including
real estate investment trusts, and securities secured by real estate
or interests therein, and the Fund may hold and sell real estate or
mortgages on real estate acquired through default, liquidation, or
other distributions of an interest in real estate as a result of the
Fund's ownership of such securities;
(6) Purchase or sell physical commodities unless acquired as a
result of ownership of securities or other instruments, except
pursuant to the exercise by the Fund of its rights under loan
agreements and except to the extent that interests in corporate loans
the Fund may invest in are considered to be interests in commodities
and this shall not prevent the Fund from
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purchasing or selling options, futures contracts, derivative
instruments or from investing in securities or other instruments backed
by physical commodities);
(7) Make loans, except as permitted by the Investment Company
Act of 1940 and exemptive orders granted under the Investment Company
Act of 1940; and
(8) With respect to 75% of the value of the Fund's total
assets, purchase any securities (other than obligations issued or
guaranteed by the United States Government or by its agencies or
instrumentalities), if as a result more than 5% of the Fund's total
assets would then be invested in securities of a single issuer or if as
a result the Fund would hold more than 10% of the outstanding voting
securities of any single issuer and, provided further that for
purposes of this restriction, the term "issuer" includes both the
borrower under a loan agreement and the lender selling a participation
to the Fund, together with any other persons interpositioned between
such lender and the Fund with respect to a participation.
For purposes of the foregoing and "Description of FundPreferred Shares"
below, "majority of the outstanding," when used with respect to particular
shares of the Fund, means (i) 67% or more of the shares present at a meeting, if
the holders of more than 50% of the shares are present or represented by proxy,
or (ii) more than 50% of the shares, whichever is less.
For the purpose of applying the limitation set forth in subparagraph
(8) above, an issuer shall be deemed the single issuer of a security when its
assets and revenues are separate from other governmental entities and its
securities are backed only by its assets and revenues. Similarly, in the case of
a non-governmental issuer, such as an industrial corporation or a privately
owned or operated hospital, if the security is backed only by the assets and
revenues of the non-governmental issuer, then such non-governmental issuer would
be deemed to be the single issuer. Where a security is also backed by the
enforceable obligation of a superior or unrelated governmental or other entity
(other than a bond insurer), it shall also be included in the computation of
securities owned that are issued by such governmental or other entity. Where a
security is guaranteed by a governmental entity or some other facility, such as
a bank guarantee or letter of credit, such a guarantee or letter of credit would
be considered a separate security and would be treated as an issue of such
government, other entity or bank. When a municipal bond is insured by bond
insurance, it shall not be considered a security that is issued or guaranteed by
the insurer; instead, the issuer of such municipal bond will be determined in
accordance with the principles set forth above.
Under the Investment Company Act of 1940, the Fund may invest only up
to 10% of its Managed Assets in the aggregate in shares of other investment
companies and only up to 5% of its Managed Assets in any one investment company,
provided the investment does not represent more than 3% of the voting stock of
the acquired investment company at the time such shares are purchased. As a
stockholder in any investment company, the Fund will bear its ratable share of
that investment company's expenses, and will remain subject to payment of the
Fund's management, advisory and administrative fees with respect to assets so
invested. Holders of Common Shares would therefore be subject to duplicative
expenses to the extent the Fund invests in other investment companies. 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 Prospectus in the section entitled "Risk Factors," 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.
In addition to the foregoing fundamental investment policies, the Fund
is also subject to the following non-fundamental restrictions and policies,
which may be changed by the Board of Trustees. The Fund may not:
(1) Sell securities short, except that the Fund may make short
sales of securities if, at all times when a short position is open, the
Fund owns at least an equal amount of such securities
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or securities convertible into or exchangeable for, without payment of
any further consideration, securities of the same issuer as, and equal
in amount to, the securities sold short, and provided that transactions
in options, futures contracts, options on futures contracts, or other
derivative instruments are not deemed to constitute selling securities
short.
(2) Purchase securities of open-end or closed-end investment
companies except in compliance with the Investment Company Act of 1940
or any exemptive relief obtained thereunder. The Fund will rely on
representations of borrowers in loan agreements in determining whether
such borrowers are investment companies.
(3) Purchase securities of companies for the purpose of
exercising control, except to the extent that exercise by the Fund of
its rights under loan agreements would be deemed to constitute
exercising control.
The restrictions and other limitations set forth above will apply only
at the time of purchase of securities and will not be considered violated unless
an excess or deficiency occurs or exists immediately after and as a result of an
acquisition of securities.
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the Fund's
investment objectives, policies, and techniques that are described in the Fund's
Prospectus.
The Fund's primary investment objective is high current income. The
Fund's secondary objective is total return. There can be no assurance that the
Fund's investment objectives will be achieved.
Under normal circumstances, the Fund:
o will invest at least 80% of its Managed Assets in preferred
securities, convertible securities and related instruments.
The Fund intends that most or all of the preferred securities
in which it invests will generate dividends that are fully
taxable and will not be eligible for the dividends received
deduction or for treatment as "qualified dividend income;" and
o may invest up to 20% of its Managed Assets in other
securities, including debt instruments and common stocks
acquired upon conversion of a convertible security (such
common stocks not normally to exceed 5% of the Fund's Managed
Assets).
NIAC will be responsible for determining the Fund's overall investment
strategy, including allocating the portion of the Fund's assets to be invested
in preferred securities, convertible securities and other debt instruments. The
Fund's assets allocated to preferred securities will be managed by Spectrum. The
Fund's assets allocated to convertible securities will be managed by Froley,
Revy. The Fund's assets allocated to other debt instruments will be managed by
NIAC. Initially, NIAC will allocate approximately 60%, 30% and 10% of the Fund's
Managed Assets to preferred securities, convertible securities and other debt
instruments, respectively. Thereafter, the portion of the Fund's Managed Assets
invested in preferred securities, convertible securities and other debt
instruments will vary from time to time consistent with the Fund's investment
objectives, although the Fund will normally invest at least 50% of its Managed
Assets in preferred securities and at least 20% of its Managed Assets in
convertible securities (so long as the combined total equals at least 80% of the
Fund's Managed Assets). Convertible preferred securities will be regarded as
convertible securities for purposes of these limits. In making allocation
decisions, NIAC will consider factors such as interest rate levels, conditions
and developing trends in the bond and equity markets, analysis of relative
valuations for preferred, convertible and other
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debt instruments, and other economic and market factors, including the overall
outlook for the economy and inflation.
The Fund will invest at least 65% of its Managed Assets in securities
that, at the time of investment, are investment grade quality. Investment grade
quality securities are those securities that, at the time of investment, are (i)
rated by at least one of the NRSROs within the four highest grades (Baa or BBB
or better by Moody's, S&P or Fitch) or (ii) unrated but judged to be of
comparable quality by the Adviser responsible for the investment. Split-rated
securities are considered to be investment grade quality securities, except that
to the extent the Fund owns split rated securities that exceed 10% of its
Managed Assets, the excess over 10% will not be considered to be investment
grade quality. Initially, the Fund intends to invest approximately 75% of its
Managed Assets in investment grade quality securities. The Fund may invest up to
35% of its Managed Assets in securities that, at the time of investment, are not
investment grade quality. The Fund will only invest in securities that, at the
time of investment, are rated B or higher by at least one NRSRO or that are
unrated but judged to be of comparable quality by the Adviser responsible for
the investment, except, however, the Fund may invest up to 5% of its Managed
Assets in securities with a highest rating of CCC or that are unrated but judged
to be of comparable quality by the Adviser responsible for the investment.
The Fund may invest up to 10% of its Managed Assets in securities that,
at the time of investment, are illiquid (i.e., securities that are not readily
marketable). All securities and other instruments in which the Fund invests will
be subject to this 10% limitation to the extent they are deemed to be illiquid.
Initially, the Fund does not intend to invest more than 5% of its Managed Assets
in illiquid securities. In addition, the Fund may invest up to 35% of its
Managed Assets in securities of non-U.S. issuers. Subject to this 35%
limitation, up to 10% of the Fund's Managed Assets may be invested in securities
that are denominated in Japanese yen, Canadian dollars, British pounds or Euros
and which may be offered, traded or listed in markets other than U.S. markets.
The remainder of the Fund's Managed Assets that may be invested in securities of
non-U.S. issuers will be invested in U.S. dollar denominated securities offered,
traded or listed in U.S. markets. Initially, the Fund does not intend to invest
more than 20% of its Managed Assets in securities of non-U.S. issuers and does
not currently intend to invest in the non-U.S. dollar denominated securities
described above.
INVESTMENT PHILOSOPHY AND PROCESS
NUVEEN INSTITUTIONAL ADVISORY CORP. (NIAC)
Asset Allocation Philosophy. NIAC is responsible for the overall
strategy and asset allocation decisions among the three primary asset classes in
which the Fund invests - preferred securities, convertible securities and other
debt instruments. The goal of the allocation decision is to effectively capture
the diversification benefits provided by the low-correlation across these asset
classes and provide the potential for high income generation, an opportunity to
participate in rising equity markets and some protection against risks
associated with rising interest rates. NIAC believes that the opportunity will
exist from time to time to potentially enhance the Fund's total return by
over-weighting or under-weighting these asset classes as the relative
attractiveness of the asset classes changes.
Asset Allocation Process. In determining the Fund's asset allocation,
NIAC will periodically consult with the Fund's Subadvisers and other investment
manager affiliates of NIAC. NIAC will consider factors such as interest rate
levels, conditions and developing trends in the bond and equity markets,
analysis of relative valuations for preferred, convertible and other debt
instruments, and other economic and market factors, including the overall
outlook for the economy and inflation.
Investment Philosophy. NIAC is responsible for managing the other debt
instruments in which the Fund may invest. NIAC believes that managing risk,
particularly in a volatile asset class such as high
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yield debt, is of paramount importance. NIAC believes that a combination of
fundamental credit analysis and valuation information that is available from the
equity markets provide a means of identifying what it believes to be superior
investment candidates. Additionally, NIAC focuses on liquid securities to ensure
that exit strategies remain viable throughout market cycles.
Investment Process. NIAC begins with a quantitative screening of the
universe to identify investment candidates with favorable capital structures,
factor valuation and other equity market indicators. NIAC screens this universe
of securities for liquidity constraints and relative value opportunities to
determine investment candidates. Subsequently, the investment team performs
rigorous fundamental analysis to ensure sound industry fundamentals, cash flow
sufficiency and asset quality. The final portfolio is constructed using
proprietary risk factor and monitoring systems to ensure proper diversification.
SPECTRUM ASSET MANAGEMENT, INC. (SPECTRUM)
Investment Philosophy. Spectrum's investment philosophy with respect to
preferred securities is centered on several underlying themes:
o High levels of current income are the primary return
contributor to the total return potential of preferred
securities.
o Investing in the subordinated preferred securities of
stronger, highly-rated issuers is potentially more
advantageous than owing the senior debt of weaker, potentially
deteriorating issuers.
o Investment grade quality preferred securities, over time,
present a very attractive risk/return opportunity.
o Diversifying across a large number of different industries and
issuers helps insulate an overall portfolio of preferred
securities from events that affect any particular company or
sector.
o Inefficiencies in the preferred securities market,
particularly in the pricing and trading of securities, can
create opportunities to enhance portfolio value.
Investment Process. Spectrum's investment process begins with
macroeconomic and fundamental credit analysis to identify sectors, industries
and companies that are potential investments. In its fundamental analysis,
Spectrum employs a value-oriented style that considers the relative
attractiveness of the security to other preferred securities and to the same
issuer's senior debt. In addition, Spectrum evaluates the structural features of
each security as well as its liquidity. In its investment decision, Spectrum
also considers the contribution of sectors and individual securities to the
overall goal of achieving a well-diversified portfolio.
FROLEY, REVY INVESTMENT CO., INC. (FROLEY, REVY)
Investment Philosophy. Froley, Revy's investment philosophy with
respect to convertible securities is centered on the belief that convertible
securities are a total return vehicle that afford the opportunity to earn
equity-like returns with substantially reduced risk relative to equities, while
providing some current income. The firm believes that focusing on the mid-market
sector of the convertibles market while investing opportunistically in the
bond-like and equity-like areas of the convertible securities market may enhance
total return potential. In addition, the firm believes that because of the
hybrid nature of the asset class, research that emphasizes both fundamental
credit analysis and equity valuation analysis can help identify investment
opportunities with the greatest potential for enhancing a portfolio's overall
total return.
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Investment Process. Froley, Revy's investment process begins with
screening the universe of convertible securities on certain valuation and
structural parameters, including price, yield, premium, calls, equity
sensitivity and other factors. On this pool of potential investments, Froley,
Revy then conducts credit (bond) analysis and valuation (equity) analysis to
identify what it believes to be the most attractive candidates within the
universe. Additional inputs into the sector and security selection decision are
top down, macroeconomic analysis of economic, interest rate and other trends and
the analysis of the structural characteristics of the individual securities.
Froley, Revy monitors all securities and sectors on an on-going basis
to identify those that fall outside the intended investment range. Positions in
securities that have increased in value and equity sensitivity may be reduced to
normal position weights or sold entirely based on the fundamental outlook for
the underlying equity. In addition, Froley, Revy considers significant declines
from the purchase prices of securities in determining whether to purchase or
sell a particular security.
PORTFOLIO COMPOSITION
Under normal circumstances, the Fund will invest at least 80% of its
Managed Assets in preferred securities, convertible securities and related
instruments. The Fund will notify shareholders at least 60 days prior to any
change in the 80% policy.
Preferred Securities. The Fund intends that most or all of the
preferred securities in which it invests will generate dividends that are fully
taxable and will not generate dividends that qualify for treatment as "qualified
dividend income" or the Dividends Received Deduction. Preferred securities
generally pay fixed or adjustable rate dividends to investors, and have a
"preference" over common stock in the payment of dividends and the liquidation
of a company's assets. This means that a company must pay dividends on preferred
stock before paying any dividends on its common stock. In order to be payable,
distributions on preferred securities must be declared by the issuer's board of
directors. Income payments on typical preferred securities currently outstanding
are cumulative, causing dividends and distributions to accrue even if not
declared by the board of directors or otherwise made payable. There is no
assurance that dividends or distributions on the preferred securities in which
the Fund invests will be declared or otherwise made payable.
Preferred stockholders usually have no right to vote for corporate
directors or on other matters.
Shares of preferred securities have a liquidation value that generally
equals the original purchase price at the date of issuance. The market value of
preferred securities may be affected by favorable and unfavorable changes
impacting companies in the utilities and financial services sectors, which are
prominent issuers of preferred securities, and by actual and anticipated changes
in tax laws, such as changes in federal corporate income tax rates, federal
income tax rates applicable to capital gains and dividend income, and in the
Dividends Received Deduction.
Because the claim on an issuer's earnings represented by preferred
securities may become onerous when interest rates fall below the rate payable on
such securities, the issuer may redeem the securities. Thus, in declining
interest rate environments in particular, the Fund's holdings of higher
rate-paying fixed rate preferred securities may be reduced and the Fund would be
unable to acquire securities paying comparable rates with the redemption
proceeds.
The Fund intends that all of the preferred securities in which it will
invest will be investment grade quality at the time of investment. The average
call protection of the Fund's portfolio allocated to preferred securities is
expected to be approximately three to four years.
Taxable preferred securities are treated in a similar fashion to
traditional preferred securities by several regulatory agencies, including the
Federal Reserve Bank, and by credit rating agencies, for
S-6
various purposes, such as the assignment of minimum capital ratios,
over-collateralization rates and diversification limits.
Additional Information on Taxable Preferred Securities. See "The Fund's
Investments -- Portfolio Composition -- Taxable Preferred Securities" in the
Fund's Prospectus for a general description of taxable preferred securities.
Convertible Securities. Convertible securities are bonds, debentures,
notes, preferred securities or other securities that may be converted or
exchanged (by the holder or the issuer) into shares of the underlying common
stock (or cash or securities of equivalent value) at a stated exchange ratio or
predetermined price (the "conversion price"). Convertible securities have
general characteristics similar to both debt securities and common stocks. The
interest paid on convertible securities may be fixed or floating rate. Floating
rate convertible securities also may be issued in zero coupon form with an
original issue discount. See "Other Investment Policies and Techniques-Zero
Coupon and Payment-In-Kind Securities." Although to a lesser extent than with
debt securities, the market value of convertible securities tends to decline as
interest rates increase and, conversely, tends to increase as interest rates
decline. In addition, because of the conversion feature, the market value of
convertible securities tends to vary with fluctuations in the market value of
the underlying common stocks and, therefore, will also react to the variations
in the general market for common stocks. Depending upon the relationship of the
conversion price to the market value of the underlying common stock, a
convertible security may trade more like a common stock than a debt instrument.
Mandatory convertible securities are distinguished as a subset of
convertible securities because they may be called for conversion by the issuer
after a particular date and under certain circumstances (including at a
specified price) established upon its issuance. If a mandatory convertible
security is called for conversion, the Fund will be required to either convert
it into the underlying common stock or sell it to a third party, which may have
an adverse effect on the Fund's ability to achieve its investment objective.
A convertible security generally entitles the holder to receive
interest paid or accrued until the convertible security matures or is redeemed,
converted or exchanged. Convertible securities rank senior to common stock in a
corporation's capital structure and, therefore, generally entail less risk than
the corporation's common stock, although the extent to which such risk is
reduced depends in large measure upon the degree to which the convertible
security sells above its value as a debt obligation. Before conversion,
convertible securities have characteristics similar to non-convertible debt
obligations and can provide for a stable stream of income with generally higher
yields than common stocks. However, convertible securities fall below debt
obligations of the same issuer in order of preference or priority in the event
of a liquidation, and are typically unrated or rated lower than such debt
obligations. In addition, contingent payment convertible securities allow the
issuer to claim deductions based on its nonconvertible cost of debt which
generally will result in deductions in excess of the actual cash payments made
on the securities (and accordingly, holders will recognize income in amounts in
excess of the cash payments received). There can be no assurance of current
income because the issuers of the convertible securities may default on their
obligations. The convertible securities in which the Fund may invest may be
below investment grade quality. See "-- High Yield Securities" below.
Convertible securities generally offer lower interest or dividend
yields than non-convertible securities of similar credit quality because of the
potential for capital appreciation. A convertible security, in addition to
providing current income, offers the potential for capital appreciation through
the conversion feature, which enables the holder to benefit from any increases
in the market price of the underlying common stock. The common stock underlying
convertible securities may be issued by a different entity than the issuer of
the convertible securities.
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The value of convertible securities is influenced by both the yield of
non-convertible securities of comparable issuers and by the value of the
underlying common stock. The value of a convertible security viewed without
regard to its conversion feature (i.e., strictly on the basis of its yield) is
sometimes referred to as its "investment value." The investment value of the
convertible security typically will fluctuate based on the credit quality of the
issuer and will fluctuate inversely with changes in prevailing interest rates.
However, at the same time, the convertible security will be influenced by its
"conversion value," which is the market value of the underlying common stock
that would be obtained if the convertible security were converted. Conversion
value fluctuates directly with the price of the underlying common stock, and
will therefore be subject to risks relating to the activities of the issuer
and/or general market and economic conditions. Depending upon the relationship
of the conversion price to the market value of the underlying security, a
convertible security may trade more like an equity security than a debt
instrument.
If, because of a low price of the common stock, the conversion value is
substantially below the investment value of the convertible security, the price
of the convertible security is governed principally by its investment value. If
the conversion value of a convertible security increases to a point that
approximates or exceeds its investment value, the value of the security will be
principally influenced by its conversion value. A convertible security will sell
at a premium over its conversion value to the extent investors place value on
the right to acquire the underlying common stock while holding a fixed-income
security.
Mandatory convertible securities are distinguished as a subset of
convertible securities because the conversion is not optional and the conversion
price at maturity (or redemption) is based solely upon the market price of the
underlying common stock, which may be significantly less than par or the price
(above or below par) paid. For these reasons, the risks associated with the
investing in mandatory convertible securities most closely resemble the risks
inherent in common stocks. Mandatory convertible securities customarily pay a
higher coupon yield to compensate for the potential risk of additional price
volatility and loss upon redemption. Since the correlation of common stock risk
increases as the security approaches its redemption date, there can be no
assurance that the higher coupon will compensate for the potential loss.
Synthetic Convertible Securities. Although the Fund does not currently
intend to invest in synthetic convertible securities, the Fund may invest up to
10% of its Managed Assets in such securities. Synthetic convertible securities
possess the two principal characteristics of a true convertible security, i.e.,
a fixed-income security ("fixed-income component") and the right to acquire an
equity security ("convertible component"). If the Fund invests in synthetic
convertible securities, it is expected that the Fund will invest in such
synthetic convertible securities that are created by third parties, typically
investment banks or other financial institutions. Synthetic convertible
securities created by third parties typically trade as a single security with a
unitary value, similar to a true convertible security. The Fund may also invest
in synthetic convertible securities by acquiring separate securities, one
possessing a fixed-income component and the other possessing an equity
component. The fixed-income component is achieved by investing in
non-convertible, fixed-income securities such as bonds, debentures, notes,
preferred stocks and money market instruments. The equity component is achieved
by investing in warrants or options to buy common stock at a certain exercise
price, or options on a common stock index. Unlike a true convertible security or
a synthetic convertible security created by third parties, each of which is a
single security having a unitary market value, a synthetic convertible security
that is comprised of two or more separate securities will have a "market value"
that is the sum of the values of its fixed-income component and its equity
component. For this reason, the value of a synthetic convertible security that
is comprised of separate securities may respond differently to market
fluctuations than would a true convertible security or synthetic convertible
security created by a third party. More flexibility is possible in the assembly
of a synthetic convertible security than in the purchase of a convertible
security.
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Although synthetic convertible securities may be selected where the two
components are issued by a single issuer, thus making the synthetic convertible
security similar to the true convertible security, the character of a synthetic
convertible security allows the combination of components representing distinct
issuers, when an Adviser believes that such a combination would better promote
the Fund's investment objective. A synthetic convertible security also is a more
flexible investment in that its two components may be purchased separately. For
example, the Fund may purchase a warrant for inclusion in a synthetic
convertible security but temporarily hold short-term investments while
postponing the purchase of a corresponding bond pending development of more
favorable market conditions.
A holder of a synthetic convertible security faces the risk of a
decline in the price of the security or the level of the index involved in the
equity component, causing a decline in the value of the call option or warrant
purchased to create the synthetic convertible security. Should the price of the
stock fall below the exercise price and remain there throughout the exercise
period, the entire amount paid for the call option or warrant would be lost.
Because a synthetic convertible security includes the fixed-income component as
well, the holder of a synthetic convertible security also faces the risk that
interest rates will rise, causing a decline in the value of the fixed-income
instrument. Convertible structured notes are fixed-income debentures linked to
equity, which have the attributes of a convertible security; however, the
investment bank that issued the convertible note, rather than the issuer of the
underlying common stock into which the note is convertible, assumes the credit
risk associated with the investment. The Fund's holdings of synthetic
convertible securities, including those created by third parties, are considered
convertible securities for purposes of the Fund's policy to invest at least 80%
of its Managed Assets in preferred securities and convertible securities.
WARRANTS TO PURCHASE SECURITIES
The Fund may invest in warrants to purchase debt securities or equity
securities in connection with its investments in synthetic convertible
securities. A warrant to purchase equity securities is a right to purchase
common stock at a specific price (usually at a premium above the market value of
the underlying common stock at time of issuance) during a specified period of
time. Such a warrant may have a life ranging from less than a year to twenty
years or longer, but the warrant becomes worthless unless it is exercised or
sole before expiration. In addition, if the market price of the common stock
does not exceed an equity security warrant's exercise price during the life of
the warrant, the warrant will expire worthless. Equity security warrants have no
voting rights, pay no dividends and have no rights with respect to the assets of
the corporation issuing them. The percentage increase or decrease in the value
of an equity security warrant may be greater than the percentage increase or
decrease in the value of the underlying common stock.
Debt obligations with warrants attached to purchase equity securities
have many characteristics of convertible securities and their prices may, to
some degree, reflect the performance of the underlying stock. Debt obligations
also may be issued with warrants attached to purchase additional debt securities
at the same coupon rate. A decline in interest rates would permit the Fund to
buy additional bonds at the favorable rate or to sell such warrants at a profit.
If interest rates rise, these warrants would generally expire with no value.
OPTIONS ON SECURITIES AND INDEXES
In connection with its investments in synthetic convertible securities,
the Fund may purchase call options on common stocks and call options on common
stock indexes. The Fund may purchase call options on common stocks or common
stock 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.
S-9
A call 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 the writer
of the option the security underlying the option (or the cash value of the
common stock 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. 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.)
If an option purchased by the Fund expires unexercised, the Fund
realizes a capital loss equal to the premium paid. Prior to the earlier of
exercise or expiration, an exchange-traded option may be closed out by an
offsetting purchase or sale of an option of the same series (type, exchange,
underlying security or index, exercise price, and expiration). There can be no
assurance, however, that a closing purchase or sale transaction can be effected
when the Fund desires.
The Fund may sell 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
call option which is sold. The principal factors affecting the market value of 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 call option purchased by the Fund is an asset of
the Fund. The value of an option purchased 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.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
If a call option purchased by the Fund is not sold when it has
remaining value, and if the market price of the underlying security remains less
than or equal to the exercise price, the Fund will lose its entire investment in
the option.
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 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.
Short-Term/Long-Term Debt Securities; Defensive Position; Invest-Up
Period. Upon an Adviser's recommendation and for temporary defensive purposes or
to keep cash on hand 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 Managed Assets in cash equivalents and investment grade fixed-income
securities. In
S-10
such a case, the Fund may not pursue or achieve its investment objectives. These
investments are defined to include, without limitation, the following:
(1) U.S. government securities, including bills, notes and
bonds differing as to maturity and rates of interest that are either
issued or guaranteed by the U.S. Treasury or by U.S. government
agencies or instrumentalities. U.S. government agency securities
include securities issued by (a) the Federal Housing Administration,
Farmers Home Administration, Export-Import Bank of the United States,
Small Business Administration, and the Government National Mortgage
Association, whose securities are supported by the full faith and
credit of the United States; (b) the Federal Home Loan Banks, Federal
Intermediate Credit Banks, and the Tennessee Valley Authority, whose
securities are supported by the right of the agency to borrow from the
U.S. Treasury; (c) the Federal National Mortgage Association, whose
securities are supported by the discretionary authority of the U.S.
government to purchase certain obligations of the agency or
instrumentality; and (d) the Student Loan Marketing Association, whose
securities are supported only by its credit. While the U.S. government
provides financial support to such U.S. government-sponsored agencies
or instrumentalities, no assurance can be given that it always will do
so since it is not so obligated by law. The U.S. government, its
agencies, and instrumentalities do not guarantee the market value of
their securities. Consequently, the value of such securities may
fluctuate.
(2) Certificates of Deposit issued against funds deposited in
a bank or a savings and loan association. Such certificates are for a
definite period of time, earn a specified rate of return, and are
normally negotiable. The issuer of a certificate of deposit agrees to
pay the amount deposited plus interest to the bearer of the certificate
on the date specified thereon. Under current FDIC regulations, the
maximum insurance payable as to any one certificate of deposit is
$100,000; therefore, certificates of deposit purchased by the Fund may
not be fully insured.
(3) Repurchase agreements, which involve purchases of debt
securities. At the time the Fund purchases securities pursuant to a
repurchase agreement, it simultaneously agrees to resell and redeliver
such securities to the seller, who also simultaneously agrees to buy
back the securities at a fixed price and time. This assures a
predetermined yield for the Fund during its holding period, since the
resale price is always greater than the purchase price and reflects an
agreed-upon market rate. Such actions afford an opportunity for the
Fund to invest temporarily available cash. The Fund may enter into
repurchase agreements only with respect to obligations of the U.S.
government, its agencies or instrumentalities; certificates of deposit;
or bankers' acceptances in which the Fund may invest. Repurchase
agreements may be considered loans to the seller, collateralized by the
underlying securities. The risk to the Fund is limited to the ability
of the seller to pay the agreed-upon sum on the repurchase date; in the
event of default, the repurchase agreement provides that the Fund is
entitled to sell the underlying collateral. If the seller defaults
under a repurchase agreement when the value of the underlying
collateral is less than the repurchase price, the Fund could incur a
loss of both principal and interest. The Fund's investment adviser
monitors the value of the collateral at the time the action is entered
into and at all times during the term of the repurchase agreement. The
investment adviser does so in an effort to determine that the value of
the collateral always equals or exceeds the agreed-upon repurchase
price to be paid to the Fund. If the seller were to be subject to a
federal bankruptcy proceeding, the ability of the Fund to liquidate the
collateral could be delayed or impaired because of certain provisions
of the bankruptcy laws.
(4) Commercial paper, which consists of short-term unsecured
promissory notes, including variable rate master demand notes issued by
corporations to finance their current operations. Master demand notes
are direct lending arrangements between the Fund and a
S-11
corporation. There is no secondary market for such notes. However, they
are redeemable by the Fund at any time. An Adviser will consider the
financial condition of the corporation (e.g., earning power, cash flow,
and other liquidity measures) and will continuously monitor the
corporation's ability to meet all of its financial obligations, because
the Fund's liquidity might be impaired if the corporation were unable
to pay principal and interest on demand. Investments in commercial
paper will be limited to commercial paper rated in the highest
categories by a NRSRO and which mature within one year of the date of
purchase or carry a variable or floating rate of interest.
OTHER INVESTMENT POLICIES AND TECHNIQUES
NON-U.S. SECURITIES
The Fund may invest up to 35% of its Managed Assets in securities of
non-U.S. issuers. Subject to this 35% limitation, up to 10% of the Fund's
Managed Assets may be invested in securities that are denominated in Japanese
yen, Canadian dollars, British pounds or Euros and which may be offered, traded
or listed in markets other than U.S. markets. The remainder of the Fund's
Managed Assets that may be invested in securities of non-U.S. issuers will be
invested in U.S. dollar denominated securities offered, traded or listed in U.S.
markets. Initially, the Fund does not intend to invest more than 20% of its
Managed Assets in securities of non-U.S. issuers, and does not currently intend
to invest in the non-U.S. dollar denominated securities described above. For
this purpose, securities of non-U.S. issuers include American Depository
Receipts (ADRs), Global Depositary Receipts (GDRs) or other securities
representing underlying shares of non-U.S. issuers. Positions in those
securities are not necessarily denominated in the same currency as the common
stocks into which they may be converted. ADRs are receipts typically issued by
an American bank or trust company evidencing ownership of the underlying
securities. GDRs are U.S. dollar-denominated receipts evidencing ownership of
non-U.S. securities. Generally, ADRs, in registered form, are designed for the
U.S. securities markets and GDRs, in bearer form, are designed for use in
non-U.S. securities markets. The Fund may invest in sponsored or unsponsored
ADRs. In the case of an unsponsored ADR, the Fund is likely to bear its
proportionate share of the expenses of the depository and it may have greater
difficulty in receiving shareholder communications than it would have with a
sponsored ADR.
Investors should understand and consider carefully the risks involved
in investing in securities of non-U.S. issuers. Investing in securities of
non-U.S. issuers involves certain considerations comprising both risks and
opportunities not typically associated with investing in securities of U.S.
issuers. These considerations include: (i) less publicly available information
about non-U.S. issuers or markets due to less rigorous disclosure or accounting
standards or regulatory practices; (ii) many non-U.S. markets are smaller, less
liquid and more volatile meaning that in a changing market, an Adviser may not
be able to sell the Fund's portfolio securities at times, in amounts and at
prices it considers reasonable; (iii) potential adverse effects of fluctuations
in currency exchange rates or controls on the value of the Fund's investments;
(iv) the economies of non-U.S. countries may grow at slower rates than expected
or may experience a downturn or recession; (v) the impact of economic,
political, social or diplomatic developments may adversely affect the securities
markets; (vi) withholding and other non-U.S. taxes may decrease the Fund's
return; (vii) certain non-U.S. countries may impose restrictions on the ability
of non-U.S. issuers to make payments of principal and/or interest to investors
located outside the U.S., due to blockage of foreign currency exchanges or
otherwise; and (viii) possible seizure, expropriation or nationalization of the
company or its assets. These risks are more pronounced to the extent that the
Fund invests a significant amount of its investments in issuers located in one
region. Although an Adviser may hedge the Fund's exposure to certain of these
risks, including the foreign currency exchange rate risk,
S-12
there can be no assurance that the Fund will enter into hedging transactions at
any time or at times or under circumstances in which it might be advisable to do
so.
Although the Fund intends to invest in companies and government
securities of countries having stable political environments, there is the
possibility of expropriation or confiscatory taxation, seizure or
nationalization of non-U.S. bank deposits or other assets, establishment of
exchange controls, the adoption of non-U.S. government restrictions, or other
adverse political, social or diplomatic developments that could affect
investment in non-U.S. issuers.
Debt Obligations of Non-U.S. Governments. An investment in debt
obligations of non-U.S. governments and their political subdivisions (sovereign
debt) involves special risks that are not present in corporate debt obligations.
The non-U.S. issuer of the sovereign debt or the non-U.S. governmental
authorities that control the repayment of the debt may be unable or unwilling to
repay principal or interest when due, and the Fund may have limited recourse in
the event of a default. During periods of economic uncertainty, the market
prices of sovereign debt may be more volatile than prices of debt obligations of
U.S. issuers. In the past, certain non-U.S. countries have encountered
difficulties in servicing their debt obligations, withheld payments of principal
and interest and declared moratoria on the payment of principal and interest on
their sovereign debt.
A sovereign debtor's willingness or ability to repay principal and pay
interest in a timely manner may be affected by, among other factors, its cash
flow situation, the extent of its non-U.S. currency reserves, the availability
of sufficient non-U.S. currency, the relative size of the debt service burden,
the sovereign debtor's policy toward its principal international lenders and
local political constraints. Sovereign debtors may also be dependent on expected
disbursements from non-U.S. governments, multilateral agencies and other
entities to reduce principal and interest arrearages on their debt. The failure
of a sovereign debtor to implement economic reforms, achieve specified levels of
economic performance or repay principal or interest when due may result in the
cancellation of third-party commitments to lend funds to the sovereign debtor,
which may further impair such debtor's ability or willingness to service its
debts.
Eurodollar Instruments and Yankee Bonds. The Fund may invest in
Eurodollar instruments and Yankee bonds. Yankee bonds are U.S. dollar
denominated bonds typically issued in the U.S. by non-U.S. governments and their
agencies and non-U.S. banks and corporations. These investments involve risks
that are different from investments in securities issued by U.S. issuers,
including potential unfavorable political and economic developments, non-U.S.
withholding or other taxes, seizure of non-U.S. deposits, currency controls,
interest limitations or other governmental restrictions which might affect
payment of principal or interest.
BONDS
The Fund may invest in a wide variety of bonds and related debt
obligations of varying maturities issued by U.S. and foreign corporations
(including banks) and other business entities, as well as governments and other
issuers to borrow money from investors. Bonds are fixed or variable rate debt
obligations, including bills, notes, debentures, money market instruments and
similar instruments and securities. Bonds generally are used by corporations,
governments and other issuers to borrow money from investors. The issuer pays
the investor a fixed or variable rate of interest and normally must repay the
amount borrowed on or before maturity. Certain bonds are "perpetual" in that
they have no maturity date. The Fund may invest up to 35% of its Managed Assets
in securities of foreign issuers, including corporate debt securities of foreign
issuers in accordance with the Fund's investment objective and policies as
described in the Prospectus. See "Non-U.S. Securities" above.
S-13
The Fund may also invest in corporate bonds that are generally used by
corporations as well as governments and other issuers to borrow money from
investors. The issuer pays the investor a fixed or variable rate of interest and
normally must repay the amount borrowed on or before maturity. The Fund may also
invest in corporate bonds that are below investment grade quality. See "--High
Yield Securities" below.
The Fund's investments in bonds are subject to a number of risks
described in the Prospectus and elaborated upon elsewhere in this section of the
Statement of Additional Information, including interest rate risk, credit risk,
high yield risk, issuer risk, foreign (non-U.S.) investment risk, inflation
risk, liquidity risk, smaller company risk and management risk.
STRUCTURED NOTES
The Fund may use "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, market or interest rate (an "embedded
index"), such as selected securities, an index of securities or specified
interest rates, or the differential performance of two assets or markets.
Structured notes may be issued by corporations, including banks, as well as by
governmental agencies. Structured notes 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 notes 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 notes 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. 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 that will serve to magnify the potential for gain
and the risk of loss.
An Adviser may utilize structured notes 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 notes may offer the
potential for a favorable rate of return from time to time, they also entail
certain risks. Structured notes may be less liquid than other debt securities,
and the price of structured notes may be more volatile. In some cases, depending
on the terms of the embedded index, a structured note may provide that the
principal and/or interest payments may be adjusted below zero. Structured notes
also may involve significant credit risk and risk of default by the
counterparty. Although structured notes are not necessarily illiquid, NIAC
believes that currently most structured notes are illiquid. Like other
sophisticated strategies, the Fund's use of structured notes may not work as
intended. If the value of the embedded index changes in a manner other than that
expected by an Adviser, principal and/or interest payments received on the
structured notes may be substantially less than expected. Also, if an Adviser
uses structured notes 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).
NO INVERSE FLOATING RATE SECURITIES
The Fund will not invest in inverse floating rate securities, which are
securities that pay interest at rates that vary inversely with changes in
prevailing interest rates and which represent a leveraged investment in an
underlying security.
S-14
HIGH YIELD SECURITIES
Non-investment grade quality securities are sometimes referred to as
"high yield" securities or "junk bonds." See also "--Split-Rated Securities."
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. Issuers of high yield securities may be highly leveraged and may not
have available to them more traditional methods of financing. 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 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. Each Adviser 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 for high yield securities may not be as liquid as
the secondary market for more highly rated securities, a factor which may have
an adverse effect on the Fund's ability to dispose of a particular security.
There are fewer dealers in the market for high yield securities than for
investment grade obligations. The prices quoted by different dealers may vary
significantly and the spread between the bid and ask price is generally much
larger than for higher quality instruments. Under adverse market or economic
conditions, the secondary market for high yield securities could contract
further, independent of any specific adverse changes in the condition of a
particular issuer, and these instruments may become illiquid. As a result, the
Fund could find it more difficult to sell these securities or may be able to
sell the securities only at prices lower than if such securities were widely
traded. Prices realized upon the sale of such lower rated or unrated securities,
under these circumstances, may be less than the prices used in calculating the
Fund's net asset value.
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
an Adviser's research and analysis when investing in high yield securities. Each
Adviser seeks to minimize the risks of investing in all securities through
in-depth credit analysis and attention to current developments in interest rates
and market conditions.
A general description of the ratings of securities by Moody's and S&P
is set forth in Appendix B to this Statement of Additional Information. The
ratings of Moody's and S&P represent their opinions as
S-15
to the quality of the securities they rate. It should be emphasized, however,
that ratings are general and are not absolute standards of quality.
Consequently, in the case of debt obligations, certain debt obligations with the
same maturity, coupon and rating may have different yields while debt
obligations with the same maturity and coupon with different ratings may have
the same yield. For these reasons, the use of credit ratings as the sole method
of evaluating high yield securities can involve certain risks. For example,
credit ratings evaluate the safety of principal and interest payments, not the
market value risk of high yield securities. Also, credit rating agencies may
fail to change credit ratings in a timely fashion to reflect events since the
security was last rated. The Advisers do not rely solely on credit ratings when
selecting securities for the Fund, and develop their own independent analysis of
issuer credit quality.
The Fund's credit quality policies apply only at the time a security is
purchased, and the Fund is not required to dispose of a security in the event
that a rating agency or an Adviser downgrades its assessment of the credit
characteristics of a particular issue. In determining whether to retain or sell
such a security, an Adviser may consider such factors as an Adviser's assessment
of the credit quality of the issuer of such security, the price at which such
security could be sold and the rating, if any, assigned to such security by
other rating agencies. However, analysis of the creditworthiness of issuers of
high yield securities may be more complex than for issuers of higher quality
debt securities.
COMMON STOCK
The Fund does not intend to purchase common stock as part of its
investment strategy. The Fund will have exposure to common stock risks by virtue
of the equity component of the convertible securities in which the Fund invests.
The Fund may hold common stocks in its portfolio upon conversion of a
convertible security, such holdings not normally to exceed 5% of the Fund's
Managed Assets. In addition, in keeping with the income focus of the Fund, the
Fund expects to sell any common stock holdings as soon as practicable after
conversion of a convertible security. Common stock generally represents an
ownership interest in an issuer. Although common stocks historically have
generated higher average returns than debt securities, common stocks also have
experienced significantly more volatility in those returns. An adverse event,
such as an unfavorable earnings report, may depress the value of a particular
common stock held by the Fund or to which it has exposure. Also, prices of
common stocks are sensitive to general movements in the stock market. A drop in
the stock market may depress the prices of common stocks held by the Fund or to
which it has exposure.
SPLIT-RATED SECURITIES
Split-rated securities are those securities that, at the time of
investment, are rated below investment grade by Moody's, S&P or Fitch, so long
as at least one NRSRO rates such securities within the four highest grades
(i.e., investment grade quality). This means that a split-rated security may be
regarded by one NRSRO (but by definition not by all NRSROs or by an Adviser) as
having predominately speculative characteristics with respect to the issuer's
capacity to pay interest and repay principal, and accordingly subject to a
greater risk of default. The prices of split-rated securities, in the view of
one but not all NRSROs, may be more sensitive to negative developments, such as
a decline in the issuer's revenues or a general economic downturn, than
securities without a split-rating.
CORPORATE LOANS
The Fund may invest up to 20% of its Managed Assets in other debt
instruments including corporate loans. Corporate loans, as with the other types
of securities in which the Fund may invest, are counted for purposes of various
other limitations described in this Statement of Additional Information,
including the limitation on investing no more than 10% of the Fund's Managed
Assets in illiquid securities, to the extent such corporate loans are deemed to
be illiquid.
S-16
Corporate loans, like most other debt obligations, are subject to the
risk of default. Default in the payment of interest or principal on a corporate
loan results in a reduction in income to the Fund, a reduction in the value of
the corporate loan and a decrease in the Fund's net asset value. This decrease
in the Fund's net asset value would be magnified by the Fund's use of leverage.
The risk of default increases in the event of an economic downturn or a
substantial increase in interest rates. An increased risk of default could
result in a decline in the value of corporate loans and in the Fund's net asset
value.
The Fund may acquire corporate loans of borrowers that are
experiencing, or are more likely to experience, financial difficulty, including
corporate loans of borrowers that have filed for bankruptcy protection.
Borrowers may have corporate loans or other outstanding debt obligations that
are rated below investment grade or that are unrated but of comparable quality
to such securities. Debt securities rated below investment grade are viewed by
the rating agencies as speculative and are commonly known as junk bonds.
Corporate loans may not be rated at the time that the Fund purchases
them. If a corporate loan is rated at the time of purchase, the Adviser
responsible for the investment may consider the rating when evaluating the
corporate loan but the Adviser responsible for the investment may not view
ratings as a determinative factor in investment decisions. As a result, the Fund
is more dependent on an Adviser's credit analysis abilities. Because of the
protective terms of most corporate loans, it is possible that the Fund is more
likely to recover more of its investment in a defaulted corporate loan than
would be the case for most other types of defaulted debt securities. The values
of corporate loans of borrowers that have filed for bankruptcy protection or
that are experiencing payment difficulty will reflect, among other things, the
assessment of the Adviser responsible for the investment of the likelihood that
the Fund ultimately will receive repayment of the principal amount of such
corporate loans, the likely duration, if any, of a lapse in the scheduled
payment of interest and repayment of principal and prevailing interest rates.
In the case of collateralized corporate loans, there is no assurance
that sale of the collateral would raise enough cash to satisfy the borrower's
payment obligation or that the collateral can or will be liquidated. In the
event of bankruptcy, liquidation may not occur and the court may not give
lenders the full benefit of their senior positions. If the terms of a corporate
loan do not require the borrower to pledge additional collateral in the event of
a decline in the value of the original collateral, the Fund will be exposed to
the risk that the value of the collateral will not at all times equal or exceed
the amount of the borrower's obligations under the corporate loan. To the extent
that a corporate loan is collateralized by stock in the borrower or its
subsidiaries, such stock may lose all of its value in the event of bankruptcy of
the borrower. Uncollateralized corporate loans involve a greater risk of loss.
Some corporate loans in which the Fund may invest are subject to the risk that a
court, pursuant to fraudulent conveyance or other similar laws, could
subordinate such corporate loans to presently existing or future indebtedness of
the borrower or take other action detrimental to the holders of corporate loans,
such as the Fund, including, under certain circumstances, invalidating such
corporate loans. Lenders commonly have certain obligations pursuant to the loan
agreement, which may include the obligation to make additional loans or release
collateral in certain circumstances.
Information about most corporate loans is less readily available and
reliable than is the case for many other types of securities. In addition, there
is no minimum rating or other independent evaluation of a borrower or its
securities limiting the Fund's investments. The Adviser responsible for the
investment may rely exclusively or primarily on its own evaluation of borrower
credit quality in selecting corporate loans for purchase. As a result, the Fund
is particularly dependent on the analytical abilities of the Adviser responsible
for the investment.
S-17
No active trading market currently exists for many corporate loans.
Corporate loans are thus relatively illiquid. Liquidity relates to the ability
of the Fund to sell an investment in a timely manner at a price approximately
equal to its value on the Fund's books. The illiquidity of corporate loans may
impair the Fund's ability to realize the full value of its assets in the event
of a voluntary or involuntary liquidation of such assets. Because of the lack of
an active trading market, illiquid securities are also difficult to value and
prices provided by external pricing services may not reflect the true fair value
of the securities. However, many corporate loans are of a large principal amount
and are held by a large number of financial institutions. It is possible that
this should enhance their liquidity. In addition, in recent years the number of
institutional investors purchasing corporate loans has increased. The risks of
illiquidity are particularly important when the Fund's operations require cash,
and may in certain circumstances require that the Fund borrow to meet short-term
cash requirements. To the extent that a secondary market does exist for certain
corporate loans, the market may be subject to irregular trading activity, wide
bid/ask spreads and extended trade settlement periods. The market for corporate
loans could be disrupted in the event of an economic downturn or a substantial
increase or decrease in interest rates. This could result in increased
volatility in the market and in the Fund's net asset value and market price per
share.
If legislation or state or federal regulators impose additional
requirements or restrictions on the ability of financial institutions to make
loans that are considered highly leveraged transactions, the availability of
corporate loans for investment by the Fund may be adversely affected. In
addition, such requirements or restrictions could reduce or eliminate sources of
financing for certain borrowers. This would increase the risk of default. If
legislation or federal or state regulators require financial institutions to
dispose of corporate loans that are considered highly leveraged transactions or
subject such corporate loans to increased regulatory scrutiny, financial
institutions may determine to sell such corporate loans. Such sales could result
in prices that, in the opinion of the Adviser, do not represent fair value. If
the Fund attempts to sell a corporate loan at a time when a financial
institution is engaging in such a sale, the price the Fund could get for the
corporate loan may be adversely affected.
Some corporate loans are subject to the risk that a court, pursuant to
fraudulent conveyance or other similar laws, could subordinate the corporate
loans to presently existing or future indebtedness of the borrower or take other
action detrimental to lenders. Such court action could under certain
circumstances include invalidation of corporate loans. Any lender, which could
include the Fund, is subject to the risk that a court could find the lender
liable for damages in a claim by a borrower arising under the common laws of
tort or contracts or anti-fraud provisions of certain securities laws for
actions taken or omitted to be taken by the lenders under the relevant terms of
a loan agreement or in connection with actions with respect to the collateral
underlying in the corporate loan.
The Fund may purchase participations in corporate loans. By purchasing
a participation interest in a loan, the Fund acquires some or all of the
interest of a bank or other financial institution in a loan to a corporate
borrower. Under a participation, the Fund generally will have rights that are
more limited than the rights of lenders or of persons who acquire a corporate
loan by assignment. In a participation, the Fund typically has a contractual
relationship with the lender selling the participation, but not with the
borrower. As a result, the Fund assumes the credit risk of the lender selling
the participation in addition to the credit risk of the borrower. In the event
of insolvency of the lender selling the participation, the Fund may be treated
as a general creditor of the lender and may not have a senior claim to the
lenders' interest in the corporate loan. A lender selling a participation and
other persons interpositioned between the lender and the Fund with respect to
participations will likely conduct their principal business activities in the
banking, finance and financial services industries.
S-18
WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS
The Fund may buy and sell securities on a when-issued or delayed
delivery basis, making payment or taking delivery at a later date, normally
within 15-45 days of the trade date. On such transactions the payment obligation
and the interest rate are fixed at the time the buyer enters into the
commitment. Beginning on the date the Fund enters into a commitment to purchase
securities on a when-issued or delayed delivery basis, the Fund is required
under rules of the Commission to maintain in a separate account liquid assets,
consisting of cash, cash equivalents or liquid securities having a market value
at all times of at least equal to the amount of the commitment. Income generated
by any such assets which provide taxable income for federal income tax purposes
is includable in the taxable income of the Fund. The Fund may enter into
contracts to purchase securities on a forward basis (i.e., where settlement will
occur more than 60 days from the date of the transaction) only to the extent
that the Fund specifically collateralizes such obligations with a security that
is expected to be called or mature within sixty days before or after the
settlement date of the forward transaction. The commitment to purchase
securities on a when-issued, delayed delivery or forward basis may involve an
element of risk because no interest accrues on the bonds prior to settlement and
at the time of delivery the market value may be less than cost.
REPURCHASE AGREEMENTS
As temporary investments, the Fund may invest in repurchase agreements.
A repurchase agreement is a contractual agreement whereby the seller of
securities (U.S. Government securities or municipal bonds) agrees to repurchase
the same security at a specified price on a future date agreed upon by the
parties. The agreed-upon repurchase price determines the yield during the Fund's
holding period. Repurchase agreements are considered to be loans collateralized
by the underlying security that is the subject of the repurchase contract. The
Fund will only enter into repurchase agreements with registered securities
dealers or domestic banks that, in the opinion of an Adviser, present minimal
credit risk. The risk to the Fund is limited to the ability of the issuer to pay
the agreed-upon repurchase price on the delivery date; however, although the
value of the underlying collateral at the time the transaction is entered into
always equals or exceeds the agreed-upon repurchase price, if the value of the
collateral declines there is a risk of loss of both principal and interest. In
the event of default, the collateral may be sold but the Fund might incur a loss
if the value of the collateral declines, and might incur disposition costs or
experience delays in connection with liquidating the collateral. In addition, if
bankruptcy proceedings are commenced with respect to the seller of the security,
realization upon the collateral by the Fund may be delayed or limited. The
Adviser responsible for the investment will monitor the value of the collateral
at the time the transaction is entered into and at all times subsequent during
the term of the repurchase agreement in an effort to determine that such value
always equals or exceeds the agreed-upon repurchase price. In the event the
value of the collateral declines below the repurchase price, Spectrum will
demand additional collateral from the issuer to increase the value of the
collateral to at least that of the repurchase price, including interest.
ZERO COUPON 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 obligation. When
held to its maturity, its return comes from the difference between the purchase
price and its maturity value. 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
S-19
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 and PIKs generally are
more volatile than the market prices of debt instruments that pay interest
currently and in cash and are likely to respond to changes in interest rates to
a greater degree than do other types of securities having similar maturities and
credit quality. In order to satisfy a requirement for qualification as a
"regulated investment company" under the Internal Revenue Code of 1986, as
amended (the "Code"), an investment company, such as the Fund, must distribute
each year at least 90% of its investment company taxable income, including the
original issue discount accrued on zero coupon bonds and PIKs. Because the Fund
will not on a current basis receive cash payments from the issuer of these
securities in respect of any accrued original issue discount, in some years the
Fund may have to distribute cash obtained from selling other portfolio holdings
of the Fund in order to avoid unfavorable tax consequences. In some
circumstances, such sales might be necessary in order to satisfy cash
distribution requirements even though investment considerations might otherwise
make it undesirable for the Fund to sell securities at such time. Under many
market conditions, investments in zero coupon bonds and PIKs may be illiquid,
making it difficult for the Fund to dispose of them or determine their current
value.
LENDING OF PORTFOLIO SECURITIES
The Fund may lend its portfolio securities to broker-dealers and banks.
Any such loan must be continuously secured by collateral in cash or cash
equivalents maintained on a current basis in an amount at least equal to the
market value of the securities loaned by the Fund. The Fund would continue to
receive the equivalent of the interest or dividends paid by the issuer on the
securities loaned, and would also receive an additional return that may be in
the form of a fixed fee or a percentage of the collateral. The Fund may pay
reasonable fees to persons unaffiliated with the Fund for services in arranging
these loans. The Fund would have the right to call the loan and obtain the
securities loaned at any time on notice of not more than five business days. The
Fund would not have the right to vote the securities during the existence of the
loan but would call the loan to permit voting of the securities, if, in an
Adviser's judgment, a material event requiring a shareholder vote would
otherwise occur before the loan was repaid. In the event of bankruptcy or other
default of the borrower, the Fund could experience both delays in liquidating
the loan collateral or recovering the loaned securities and losses, including
(a) possible decline in the value of the collateral or in the value of the
securities loaned during the period while the Fund seeks to enforce its rights
thereto, (b) possible subnormal levels of income and lack of access to income
during this period, and (c) expenses of enforcing its rights.
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 an
Adviser believes to be a temporary price disparity between the two securities.
Temporary price disparities between two comparable securities may result from
supply and demand imbalances where, for example, a temporary oversupply of
certain securities may cause a temporarily low price for such securities, as
compared with other securities of like quality and characteristics.
The Fund may also engage to a limited extent 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, but
the Fund will not engage in trading solely to recognize a gain. Subject to the
foregoing, the Fund will attempt to achieve its investment objectives by prudent
selection of preferred securities with a view to holding them for investment.
While there can be no assurance thereof, the Fund anticipates that its annual
portfolio turnover rate will generally not exceed 75%. However, the rate of
turnover will not be a limiting factor
S-20
when the Fund deems it desirable to sell or purchase securities. Therefore,
depending upon market conditions, the annual portfolio turnover rate of the Fund
may exceed 75% in particular years. A higher portfolio turnover rate results in
correspondingly greater brokerage commissions and other transactional expenses
that are borne by the Fund. High portfolio turnover may result in the
realization of net short-term capital gains by the Fund which, when distributed
to shareholders, will be taxable as ordinary income.
HEDGING TRANSACTIONS
As a non-fundamental policy that can be changed by the Board of
Trustees, the use of derivatives and other transactions for purposes of hedging
the portfolio will be restricted to reducing the portfolio's exposure to the
risk of increases in interest rates, common stock risk, high yield credit risk
and foreign currency exchange risk. The specific derivative instruments to be
used, or other transactions to be entered into, for hedging purposes may include
(i) options and futures contracts, including options on common stock, stock
indexes, bonds and bond indexes, stock index futures, bond index futures and
related instruments, (ii) short sales of securities that the Fund owns or has
the right to acquire through the conversion of securities, (iii) structured
notes and similar instruments, (iv) credit derivative instruments, and (v)
currency exchange transactions. Some, but not all, of the derivative instruments
may be traded and listed on an exchange. The positions in derivatives will be
marked-to-market daily at the closing price established on the relevant exchange
or at a fair value. Except for investing in synthetic convertible securities,
the Fund will use derivatives or other transactions described in this paragraph
solely for purposes of hedging the Fund's portfolio risks.
There may be an imperfect correlation between changes in the value of
the Fund's portfolio holdings and hedging positions entered into by the Fund,
which may prevent the Fund from achieving the intended hedge or expose the Fund
to risk of loss. In addition, the Fund's success in using hedging instruments is
subject to an Adviser's ability to predict correctly changes in the
relationships of such hedge instruments to the Fund's portfolio holdings or
other factors, and there can be no assurance that an Adviser's judgment in this
respect will be correct. Consequently, the use of hedging transactions might
result in a poorer overall performance for the Fund, whether or not adjusted for
risk, than if the Fund had not hedged its portfolio holdings. In addition, there
can be no assurance that the Fund will enter into hedging or other transactions
at times or under circumstances in which it would be advisable to do so. See
"Risk Factors -- General Risks of Investing in the Fund-- Hedging Risk" in the
Fund's prospectus.
Options on Securities. In order to hedge against adverse market shifts,
the Fund may purchase put and call options on stock, bonds or other securities.
In addition, the Fund may seek to hedge a portion of its portfolio investments
through writing (i.e., selling) covered put and call options. A put option
embodies the right of its purchaser to compel the writer of the option to
purchase from the option holder an underlying security or its equivalent at a
specified price at any time during the option period. In contrast, a call option
gives the purchaser the right to buy the underlying security covered by the
option or its equivalent from the writer of the option at the stated exercise
price at any time during the option period.
As a holder of a put option, the Fund will have the right to sell the
securities underlying the option and as the holder of a call option, the Fund
will have the right to purchase the securities underlying the option, in each
case at their exercise price at any time prior to the option's expiration date.
The Fund may choose to exercise the options it holds, permit them to expire or
terminate them prior to their expiration by entering into closing sale or
purchase transactions. In entering into a closing sale or purchase transaction,
the Fund would sell an option of the same series as the one it has purchased.
The ability of the Fund to enter into a closing sale transaction with respect to
options purchased and to enter into a closing purchase transaction with respect
to options sold depends on the existence of a liquid
S-21
secondary market. There can be no assurance that a closing purchase or sale
transaction can be effected when the Fund so desires. The Fund's ability to
terminate option positions established in the over-the-counter market may be
more limited than in the case of exchange-traded options and may also involve
the risk that securities dealers participating in such transactions would fail
to meet their obligations to the Fund.
In purchasing a put option, the Fund will seek to benefit from a
decline in the market price of the underlying security, while in purchasing a
call option, the Fund will seek to benefit from an increase in the market price
of the underlying security. If an option purchased is not sold or exercised when
it has remaining value, or 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 equal to or below the exercise price, in the case of a call, during the
life of the option, the option will expire worthless. For the purchase of an
option to be profitable, the market price of the underlying security must
decline sufficiently below the exercise price, in the case of a put, and must
increase sufficiently above the exercise price, in the case of a call, to cover
the premium and transaction costs. Because option premiums paid by the Fund are
small in relation to the market value of the instruments underlying the options,
buying options can result in additional amounts of leverage to the Fund. The
leverage caused by trading in options could cause the Fund's net asset value to
be subject to more frequent and wider fluctuation than would be the case if the
Fund did not invest in options.
The Fund will receive a premium when it writes put and call options,
which increases the Fund's return on the underlying security in the event the
option expires unexercised or is closed out at a profit. By writing a call, the
Fund will limit its opportunity to profit from an increase in the market value
of the underlying security above the exercise price of the option for as long as
the Fund's obligation as the writer of the option continues. Upon the exercise
of a put option written by the Fund, the Fund may suffer an economic loss equal
to the difference between the price at which the Fund is required to purchase
the underlying security and its market value at the time of the option exercise,
less the premium received for writing the option. Upon the exercise of a call
option written by the Fund, the Fund may suffer an economic loss equal to an
amount not less than the excess of the security's market value at the time of
the option exercise over the Fund's acquisition cost of the security, less the
sum of the premium received for writing the option and the difference, if any,
between the call price paid to the Fund and the Fund's acquisition cost of the
security. Thus, in some periods the Fund might receive less total return and in
other periods greater total return from its hedged positions than it would have
received from its underlying securities unhedged.
Options on Stock and Bond Indexes. The Fund may purchase put and call
options on stock and bond indexes to hedge against risks of market-wide price
movements affecting its assets. In addition, the Fund may write covered put and
call options on stock and bond indexes. A stock or bond index measures the
movement of a certain group of stocks or bonds by assigning relative values to
the stocks or bonds included in the index. Options on a stock or bond index are
similar to options on securities. Because no underlying security can be
delivered, however, the option represents the holder's right to obtain from the
writer, in cash, a fixed multiple of the amount by which the exercise price
exceeds (in the case of a put) or is less than (in the case of a call) the
closing value of the underlying index on the exercise date. The advisability of
using stock or bond index options to hedge against the risk of market-wide
movements will depend on the extent of diversification of the Fund's investments
and the sensitivity of its investments to factors influencing the underlying
index. The effectiveness of purchasing or writing stock or bond index options as
a hedging technique will depend upon the extent to which price movements in the
Fund's investments correlate with price movements in the stock or bond index
selected. In addition, successful use by the Fund of options on stock or bond
indexes will be subject to the ability of an Adviser to predict correctly
changes in the relationship of the underlying index to the Fund's portfolio
holdings. No assurance can be given that the Adviser's judgment in this respect
will be correct.
S-22
When the Fund writes an option on a stock or bond index, it will
establish a segregated account with its custodian in which the Fund will deposit
liquid securities in an amount equal to the market value of the option, and will
maintain the account while the option is open.
Stock and Bond Index Futures Contracts. The Fund may purchase and sell
stock index futures as a hedge against movements in the equity markets. Stock
and bond index futures contracts are agreements in which one party agrees to
deliver to the other an amount of cash equal to a specific dollar amount times
the difference between the value of a specific stock or bond index at the close
of the last trading day of the contract and the price at which the agreement is
made. No physical delivery of securities is made.
For example, if an Adviser expects general stock or bond market prices
to decline, it might sell a futures contract on a particular stock or bond
index. If that index does in fact decline, the value of some or all of the
securities in the fund's portfolio may also be expected to decline, but that
decrease would be offset in part by the increase in the value of the Fund's
position in such futures contract. If, on the other hand, an Adviser expects
general stock or bond market prices to rise, it might purchase a stock or bond
index futures contract as a hedge against an increase in prices of particular
securities it wants ultimately to buy. If in fact the stock or bond index does
rise, the price of the particular securities intended to be purchased may also
increase, but that increase would be offset in part by the increase in the value
of the Fund's futures contract resulting from the increase in the index. The
Fund may purchase futures contracts on a stock or bond index to enable an
Adviser to gain immediate exposure to the underlying securities market pending
the investment in individual securities of the portion of the Fund's portfolio
allocated to that Adviser.
Under regulations of the Commodity Futures Trading Commission ("CFTC")
currently in effect, which may change from time to time, with respect to futures
contracts purchased by the Fund, the Fund will set aside in a segregated account
liquid securities with a value at least equal to the value of instruments
underlying such futures contracts less the amount of initial margin on deposit
for such contracts. The current view of the staff of the Securities and Exchange
Commission is that the Fund's long and short positions in futures contracts must
be collateralized with cash or certain liquid assets held in a segregated
account or "covered" in order to counter the impact of any potential leveraging.
Parties to a futures contract must make "initial margin" deposits to
secure performance of the contract. There are also requirements to make
"variation margin" deposits from time to time as the value of the futures
contract fluctuates. The Fund is not a commodity pool and, in compliance with
CFTC regulations currently in effect, may enter into any futures contracts and
related options for "bona fide hedging" purposes and, in addition, for other
purposes, provided that aggregate initial margin and premiums required to
establish positions other than those considered by the CFTC to be "bona fide
hedging" will not exceed 0.5% of the Fund's Managed Assets, after taking into
account unrealized profits and unrealized losses on any such contracts. The Fund
reserves the right to engage in transactions involving futures and options
thereon to the extent allowed by CFTC regulations in effect from time to time
and in accordance with the Fund's policies. In addition, certain provisions of
the Code may limit the extent to which the Fund may enter into futures contracts
or engage in options transactions. See "Federal Income Tax Matters."
The potential loss related to the purchase of an option on a futures
contract is limited to the premium paid for the option (plus transaction costs).
With respect to options purchased by the Fund, there are no daily cash
payments made by the Fund to reflect changes in the value of the underlying
contract; however, the value of the option does change daily and that change
would be reflected in the net asset value of the Fund.
S-23
Risks Associated with Futures Contracts and Options on Futures
Contracts. Futures prices are affected by many factors, such as current and
anticipated short-term interest rates, changes in volatility of the underlying
instrument and the time remaining until expiration of the contract. A purchase
or sale of a futures contract may result in losses in excess of the amount
invested in the futures contract. While the Fund may enter into futures
contracts and options on futures contracts for hedging purposes, the use of
futures contracts and options on futures contracts might result in a poorer
overall performance for the Fund than if it had not engaged in any such
transactions. If, for example, the Fund had insufficient cash, it might have to
sell a portion of its underlying portfolio of securities in order to meet daily
variation margin requirements on its futures contracts or options on futures
contracts at a time when it might be disadvantageous to do so. There may be an
imperfect correlation between the Fund's portfolio holdings and futures
contracts or options on futures contracts entered into by the Fund, which may
prevent the Fund from achieving the intended hedge or expose the Fund to risk of
loss. The degree of imperfection of correlation depends on circumstances such
as: variations in speculative market demand for futures, futures options and the
related securities, including technical influences in futures and futures
options trading and differences between the securities markets and the
securities underlying the standard contracts available for trading. Futures
prices are affected by many factors, such as current and anticipated short-term
interest rates, changes in volatility of the underlying instrument and the time
remaining until the expiration of the contract. Further, the Fund's use of
futures contracts and options on futures contracts to reduce risk involves costs
and will be subject to an Adviser's ability to predict correctly changes in
interest rate relationships or other factors. A decision as to whether, when and
how to use futures contracts 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 stock price or interest rate trends. No assurance
can be given that Spectrum's judgment in this respect will be correct.
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. Stock index futures contracts are not normally subject to
such daily price change limitations.
The Fund may invest in other options. An option is an instrument that
gives the holder of the instrument the right, but not the obligation, to buy or
sell a predetermined number of specific securities (i.e. preferred stocks,
common stocks or bonds) at a stated price within the expiration period of the
instrument, which is generally less than 12 months from its issuance. If the
right is not exercised after a specified period but prior to the expiration, the
option expires. Both put and call options may be used by the Fund.
Short Sales. The Fund may make short sales of securities if, at all
times when a short position is open, the Fund owns at least an equal amount of
such securities or securities convertible into or exchangeable for, without
payment of any further consideration, securities of the same issue as, and equal
in amount to, the securities sold short. This technique is called selling short
"against the box."
In a short sale against the box, the Fund will not deliver from its
portfolio the securities sold and will not receive immediately the proceeds from
the short sale. Instead, the Fund will borrow the securities sold short from a
broker-dealer through which the short sale is executed and the broker-dealer
will deliver such securities, on behalf of the Fund, to the purchaser of such
securities. Such broker-dealer
S-24
will be entitled to retain the proceeds from the short sale until the Fund
delivers to such broker-dealer the securities sold short. In addition, the Fund
will be required to pay the broker-dealer the amount of any dividends paid on
shares sold short. Finally, to secure its obligation to deliver to such
broker-dealer the securities sold short, the Fund must deposit and continuously
maintain in a separate account with its custodian an equivalent amount of the
securities sold short or securities convertible into or exchangeable for such
securities without the payment of additional consideration. The Fund is said to
have a short position in the securities sold until it delivers to the
broker-dealer the securities sold, at which time the Fund will receive the
proceeds of the sale. Because the Fund ordinarily will want to continue to hold
securities in its portfolio that are sold short, the Fund will normally close
out a short position by purchasing on the open market and delivering to the
broker-dealer an equal amount of the securities sold short, rather than by
delivering portfolio securities.
Short sales may protect the Fund against the risk of losses in the
value of its portfolio securities because any unrealized losses with respect to
such portfolio securities should be wholly or partially offset by a
corresponding gain in the short position. However, any potential gain in such
portfolio securities should be wholly or partially offset by a corresponding
loss in the short position. The extent to which such gains or losses are offset
will depend upon the amount of securities sold short relative to the amount the
Fund owns, either directly or indirectly, and, in the case where the Fund owns
convertible securities, changes in the conversion premium. The Fund will incur
transaction costs in connection with short sales.
In addition to enabling the Fund to hedge against market risk, short
sales may afford the Fund an opportunity to earn additional current income to
the extent the Fund is able to enter into arrangements with broker-dealers
through which the short sales are executed to receive income with respect to the
proceeds of the short sales during the period the Fund's short positions remain
open.
The Code imposes constructive sale treatment for federal income tax
purposes on certain hedging strategies with respect to appreciated financial
positions. Under these rules, taxpayers will recognize gain, but not loss, with
respect to securities if they enter into short sales or "offsetting notional
principal contracts" (as defined by the Code) with respect to, or futures or
forward contracts to deliver, the same or substantially identical property, or
if they enter into such transactions and then acquire the same or substantially
identical property. The Secretary of the Treasury is authorized to promulgate
regulations that will treat as constructive sales certain transactions that have
substantially the same effect as these transactions. See "Federal Income Tax
Matters."
Structured Notes. The Fund may use structured notes and similar
instruments for hedging purposes. Structured notes are privately negotiated debt
obligations where the principal and/or interest is determined by reference to
the performance of a benchmark asset, market or interest rate (an "embedded
index"), such as selected securities, an index of securities or specified
interest rates or the differential performance of two assets or markets. The
terms of such structured instruments normally provide that their principal
and/or interest payments are to be adjusted upwards or downwards (but not
ordinarily 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. 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 that will serve to magnify the potential for gain and the risk of loss.
Credit Derivative Instruments. The Fund may purchase credit derivative
instruments for purposes of hedging the Fund's credit risk exposure to certain
issuers of securities that the Fund owns. For example, the Fund may enter into
credit default swap contracts for hedging purposes where the Fund
S-25
would be the buyer of such a default contract. The Fund would be entitled to
receive the par (or other agreed-upon) value of a referenced debt obligation
from the counterparty to the contract 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 pay to 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 have spent the stream of payments and received
no benefit from the contract.
Currency Exchange Transactions. The Fund may enter into currency
exchange transactions to hedge the Fund's exposure to foreign currency exchange
rate risk in the event the Fund invests in non-U.S. dollar denominated
securities of non-U.S. issuers as described in this Statement of Additional
Information. The Fund's currency transactions will be limited to portfolio
hedging involving portfolio positions. Portfolio hedging is the use of a forward
contract with respect to a portfolio security position denominated or quoted in
a particular currency. A forward contract is an agreement to purchase or sell a
specified currency at a specified future date (or within a specified time
period) and price set at the time of the contract. Forward contracts are usually
entered into with banks, foreign exchange dealers or broker-dealers, are not
exchange-traded, and are usually for less than one year, but may be renewed.
At the maturity of a forward contract to deliver a particular currency,
the Fund may either sell the portfolio security related to such contract and
make delivery of the currency, or it may retain the security and either acquire
the currency on the spot market or terminate its contractual obligation to
deliver the currency by purchasing an offsetting contract with the same currency
trader obligating it to purchase on the same maturity date the same amount of
the currency.
It is impossible to forecast with absolute precision the market value
of portfolio securities at the expiration of a forward contract. Accordingly, it
may be necessary for the Fund to purchase additional currency on the spot market
(and bear the expense of such purchase) if the market value of the security is
less than the amount of currency that the Fund is obligated to deliver and if a
decision is made to sell the security and make delivery of the currency.
Conversely, it may be necessary to sell on the spot market some of the currency
received upon the sale of the portfolio security if its market value exceeds the
amount of currency the Fund is obligated to deliver.
If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward contract to sell the
currency. Should forward prices decline during the period between the Fund's
entering into a forward contract for the sale of a currency and the date it
enters into an offsetting contract for the purchase of the currency, the Fund
will realize a gain to the extent the price of the currency it has agreed to
sell exceeds the price of the currency it has agreed to purchase. Should forward
prices increase, the Fund will suffer a loss to the extent the price of the
currency it has agreed to purchase exceeds the price of the currency it has
agreed to sell. A default on the contract would deprive the Fund of unrealized
profits or force the Fund to cover its commitments for purchase or sale of
currency, if any, at the current market price.
Hedging against a decline in the value of a currency does not eliminate
fluctuations in the prices of portfolio securities or prevent losses if the
prices of such securities decline. Such transactions also preclude the
opportunity for gain if the value of the hedged currency should rise. Moreover,
it may not be possible for the Fund to hedge against a devaluation that is so
generally anticipated that the Fund is not able to contract to sell the currency
at a price above the devaluation level it anticipates. The cost to the Fund of
engaging in currency exchange transactions varies with such factors as the
currency involved, the length of the contract period, and prevailing market
conditions. Since currency exchange transactions are usually conducted on a
principal basis, no fees or commissions are involved.
S-26
The Fund may invest in relatively new instruments without a significant
trading history for purposes of hedging the Fund's portfolio risks. As a result,
there can be no assurance that an active secondary market will develop or
continue to exist.
INTEREST RATE TRANSACTIONS
In connection with the Fund's likely use of leverage through its sale
of FundPreferred shares or Borrowings, the Fund, if market conditions are deemed
favorable, likely will enter into interest rate swap or cap transactions to
attempt to protect itself from increasing dividend or interest expenses on its
FundPreferred shares or Borrowings. Interest rate swaps involve the Fund's
agreement with the swap counterparty to pay a fixed rate payment in exchange for
the counterparty agreeing to pay the Fund a payment at a variable rate that is
expected to approximate the rate on the Fund's variable rate payment obligation
on FundPreferred shares or any variable rate Borrowings. The payment obligations
would be based on the notional amount of the swap. The Fund may use an interest
rate cap, which would require it to pay a premium to the cap counterparty and
would entitle it, 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 would use interest rate swaps
or caps only with the intent to reduce or eliminate the risk that an increase in
short-term interest rates could have on Common Share net earnings as a result of
leverage.
The Fund will usually enter into swaps or caps on a net basis; that is,
the two payment streams will be netted out in a cash settlement on the payment
date or dates specified in the instrument, with the Fund receiving or paying, as
the case may be, only the net amount of the two payments. The Fund intends to
maintain in a segregated account with its custodian cash or liquid securities
having a value at least equal to the Fund's net payment obligations under any
swap transaction, marked-to-market daily.
The use of interest rate swaps and caps is a highly specialized
activity that involves investment techniques and risks different from those
associated with ordinary portfolio security transactions. Depending on the state
of interest rates in general, the Fund's use of interest rate swaps or caps
could enhance or harm the overall performance on the Common Shares. To the
extent there is a decline in interest rates, the value of the interest rate swap
or cap could decline, and could result in a decline in the net asset value of
the Common Shares. In addition, if short-term interest rates are lower than the
Fund's fixed rate of payment on the interest rate swap, the swap will reduce
Common Share net earnings. If, on the other hand, short-term interest rates are
higher than the fixed rate of payment on the interest rate swap, the swap will
enhance Common Share net earnings. Buying interest rate caps could enhance the
performance of the Common Shares by providing a maximum leverage expense. Buying
interest rate caps could also decrease the net earnings of the Common Shares in
the event that the premium paid by the Fund to the counterparty exceeds the
additional amount the Fund would have been required to pay had it not entered
into the cap agreement. The Fund has no current intention of selling an interest
rate swap or cap. The Fund will not enter into interest rate swap or cap
transactions in an aggregate notional amount that exceeds the outstanding amount
of the Fund's leverage.
Interest rate swaps and caps do not involve the delivery of securities
or other underlying assets or principal. Accordingly, the risk of loss with
respect to interest rate swaps is limited to the net amount of interest payments
that the Fund is contractually obligated to make. If the counterparty defaults,
the Fund would not be able to use the anticipated net receipts under the swap or
cap to offset the dividend payments on the FundPreferred shares or interest
payments on Borrowings. Depending on whether the Fund would be entitled to
receive net payments from the counterparty on the swap or cap, which in turn
would depend on the general state of short-term interest rates at that point in
time, such a default could negatively impact the performance of the Common
Shares.
S-27
Although this will not guarantee that the counterparty does not
default, the Fund will not enter into an interest rate swap or cap transaction
with any counter-party that NIAC believes does not have the financial resources
to honor its obligation under the interest rate swap or cap transaction.
Further, NIAC will continually monitor the financial stability of a counterparty
to an interest rate swap or cap transaction in an effort to proactively protect
the Fund's investments.
In addition, at the time the interest rate swap or cap transaction
reaches its scheduled termination date, there is a risk that the Fund would not
be able to obtain a replacement transaction or that the terms of the replacement
would not be as favorable as on the expiring transaction. If this occurs, it
could have a negative impact on the performance of the Fund's Common Shares.
The Fund may choose or be required to redeem some or all of the
Preferred Shares, including FundPreferred shares, or prepay any Borrowings. This
redemption would likely result in the Fund seeking to terminate early all or a
portion of any swap or cap transaction. Such early termination of a swap could
result in termination payment by or to the Fund. An early termination of a cap
could result in a termination payment to the Fund.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The management of the Fund, including general supervision of the duties
performed for the Fund under the Management Agreement, is the responsibility of
the Board of Trustees of the Fund. The number of trustees of the Fund is
currently set at 12. None of the trustees who are not "interested persons" of
the Fund has ever been a director or employee of, or consultant to, Nuveen,
Spectrum or Froley, Revy or their affiliates. The Trustees serve annual terms
until the next annual shareholder meeting. The names and business addresses of
the trustees and officers of the Fund, their principal occupations and other
affiliations during the past five years, the number of portfolios each oversees
and other directorships they hold are set forth below.
POSITIONS AND PRINCIPAL OCCUPATIONS, NUMBER OF
OFFICES WITH THE INCLUDING PORTFOLIOS
FUND AND YEAR OTHER DIRECTORSHIPS IN FUND COMPLEX
FIRST ELECTED OR HELD, DURING OVERSEEN BY
NAME AND ADDRESS BIRTHDATE APPOINTED PAST FIVE YEARS TRUSTEE
---------------- --------- ---------------------- ----------------------------- ---------------
TRUSTEE WHO IS AN "INTERESTED PERSON" OF THE FUND:
Timothy R. Schwertfeger* 03/28/49 Chairman of the Board Chairman and Director (since 140
333 West Wacker Drive and Trustee, 2003 1996) of Nuveen Investments,
Chicago, IL 60606 Inc., Nuveen Investments,
LLC, Nuveen Advisory Corp.
and Nuveen Institutional
Advisory Corp.; Chairman and
Director (since; 1997) of
Nuveen Asset Management,
Inc.; Director (since 1996)
of Institutional Capital
Corporation; Chairman and
Director (since 1999) of
Rittenhouse Asset Management,
Inc.; Chairman (since 2002)
of Nuveen Investments
Advisers Inc.
----------
* Mr. Schwertfeger is an "interested person" of the Fund, as defined in the
Investment Company Act of 1940, because he is an officer and director of Nuveen
Investments, Inc., Nuveen Investments, LLC and NIAC.
S-28
POSITIONS AND PRINCIPAL OCCUPATIONS, NUMBER OF
OFFICES WITH THE INCLUDING PORTFOLIOS
FUND AND YEAR OTHER DIRECTORSHIPS IN FUND COMPLEX
FIRST ELECTED OR HELD, DURING OVERSEEN BY
NAME AND ADDRESS BIRTHDATE APPOINTED PAST FIVE YEARS TRUSTEE
---------------- --------- ---------------------- ----------------------------- ---------------
TRUSTEES WHO ARE NOT "INTERESTED" PERSONS OF THE FUND:
William E. Bennett 10/16/46 Trustee, 2003 Private Investor; 140
333 West Wacker Drive previously, President and
Chicago, IL 60606 Chief Executive Officer,
Draper & Kramer, Inc., a
private company that handles
mortgage banking, real
estate development, pension
advisory and real estate
management (1995-1998).
Robert P. Bremner 8/22/40 Trustee, 2003 Private Investor and 134
333 West Wacker Drive Management Consultant.
Chicago, IL 60606
Lawrence H. Brown 7/29/34 Trustee, 2003 Retired (since 1989) as 134
333 West Wacker Drive Senior Vice President of
Chicago, IL 60606 The Northern Trust
Company; Director of
the United Way of
Highland Park-
Highwood (since 2002).
Jack B. Evans 10/22/48 Trustee, 2003 President, The Hall-Perrine 70
333 West Wacker Drive Foundation, a private
Chicago, IL 60606 philanthropic corporation
(since 1996); Director,
Alliant Energy; Director and
Vice Chairman, United Fire &
Casualty Company; Director,
Federal Reserve Bank of
Chicago; formerly, President
and Chief Operating Officer,
SCI Financial Group, Inc., a
regional financial services
firm.
Anne E. Impellizzeri 1/26/33 Trustee, 2003 Retired, formerly Executive 134
333 West Wacker Drive Director (1998-2001) of
Chicago, IL 60606 Manitoga (Center for Russel
Wright's Design with Nature);
formerly, President and
Executive Officer of Blanton-
Peale Institutes Chief of
Religion and Health (since
1990); prior thereto, Vice
President, Metropolitan Life
Insurance Co.
William L. Kissick 7/29/32 Trustee, 2003 Professor Emeritus, School 70
333 West Wacker Drive of Medicine and the Wharton
Chicago, IL 60606 School of Management and
former Chairman, Leonard
Davis Institute of Health
Economics, University of
Pennsylvania; Adjunct
Professor, Health Policy and
Management, Yale University.
Thomas E. Leafstrand 11/11/31 Trustee, 2003 Retired; previously, Vice 70
333 West Wacker Drive President in charge of
Chicago, IL 60606 Municipal Underwriting and
Dealer Sales at The Northern
Trust Company.
Peter R. Sawers 4/3/33 Trustee, 2003 Adjunct Professor of Business 134
333 West Wacker Drive and Economics, University of
Chicago, IL 60606 Dubuque, Iowa; formerly
(1991-2000), Adjunct
Professor, Lake Forest
Graduate School of
Management, Lake Forest,
Illinois; prior thereto,
Executive Director, Towers
Perrin Australia, a management
consulting firm; Chartered
Financial Analyst; Director,
Executive Service Corps of
Chicago, a not-for-profit
organization; Certified
Management Consultant.
William J. Schneider 9/24/44 Trustee, 2003 Senior Partner and Chief 134
333 West Wacker Drive Operating Officer, Miller-
Chicago, IL 60606 Valentine Group; Vice
President, Miller-Valentine
Realty, a development and
contract company; Chair,
Miami Valley Hospital; Chair,
Miami Valley Economic
Development Coalition;
formerly, Member, Community
Advisory Board, National City
Bank, Dayton, Ohio and
Business Advisory Council,
Cleveland Federal Reserve
Bank.
Judith M. Stockdale 12/29/47 Trustee, 2003 Executive Director, Gaylord 134
333 West Wacker Drive and Dorothy Donnelly
Chicago, IL 60606 Foundation (since 1994); prior
thereto, Executive Director,
Great Lakes Protection Fund
(from 1990 to 1994).
Sheila W. Wellington 2/24/32 Trustee, 2003 President (since 1993) of 70
333 West Wacker Drive Catalyst (a not-for-profit
Chicago, IL 60606 organization focusing on
women's leadership
development in business and
the professions).
S-29
POSITIONS AND PRINCIPAL OCCUPATIONS, NUMBER OF
OFFICES WITH THE INCLUDING PORTFOLIOS
FUND AND YEAR OTHER DIRECTORSHIPS IN FUND COMPLEX
FIRST ELECTED OR HELD, DURING OVERSEEN BY
NAME AND ADDRESS BIRTHDATE APPOINTED PAST FIVE YEARS OFFICER
---------------- --------- ---------------------- ----------------------------- ---------------
OFFICERS OF THE FUND:
Gifford R. Zimmerman 9/9/56 Chief Administrative Managing Director (since 140
333 West Wacker Drive Officer, 2003 2002), Assistant Secretary
Chicago, IL 60606 and Associate General
Counsel, formerly, Vice
President and Assistant
General Counsel of Nuveen
Investments, LLC; Managing
Director (since 2002),
General Counsel and
Assistant Secretary,
formerly, Vice President of
Nuveen Advisory Corp. and
Nuveen Institutional
Advisory Corp.; Managing
Director (since 2002),
Assistant Secretary and
Associate General Counsel,
formerly, Vice President
(since 2000), of Nuveen
Asset Management, Inc. (since
1994); Assistant Secretary of Nuveen
Investments, Inc. (since 1994);
Assistant Secretary of NWO
investment Management Company,LLC
(since 2002); Vice President and
Assistant Secretary of Nuveen
Investments Advisers Inc. (since 2002);
Managing Director, Associate
General Counsel and Assistant
Secretary of Rittenhouse Asset
Management, Inc. (since May 2003);
Chartered Financial Analyst.
Michael T. Atkinson 2/3/66 Vice President and Vice President (since 140
333 West Wacker Drive Assistant Secretary, 2002), formerly
Chicago, IL 60606 2003 Assistant Vice President
(since 2000), previously,
Associate of Nuveen
Investments, LLC.
Peter H. D'Arrigo 11/28/67 Vice President and Vice President of Nuveen 140
333 West Wacker Drive Treasurer, 2003 Investments, LLC
Chicago, IL 60606 (since 1999), prior thereto,
Assistant Vice President
(from 1997); Vice
President and Treasurer
(since 1999) of Nuveen
Investments, Inc.; Vice
President and Treasurer
(since 1999) of Nuveen
Advisory Corp. and Nuveen
Institutional Advisory
Corp.; Vice President and
Treasurer (since 2002) of
Nuveen Asset Management, Inc.
and of Nuveen Investments
Advisers Inc.; Assistant
Treasurer of NWO Investment
Management Company, LLC
(since 2002); Chartered
Financial Analyst.
Susan M. DeSanto 9/8/54 Vice President, 2003 Vice President of Nuveen 140
333 West Wacker Drive Advisory Corp. (since 2001);
Chicago, IL 60606 previously, Vice President
of Van Kampen Investment
Advisory Corp. (since 1998);
prior thereto, Assistant
Vice President of Van Kampen
Investment Advisory Corp.
(since 1994).
Jessica R. Droeger 9/24/64 Vice President and Vice President (since 140
333 West Wacker Drive Secretary, 2003 2002) and Assistant
Chicago, IL 60606 General Counsel (since
1998); formerly, Assistant
Vice President (since 1998),
of Nuveen Investments, LLC;
Vice President (since
2002) and Assistant
Secretary (since 1998);
formerly Assistant Vice
President of Nuveen Advisory
Corp. and Nuveen
Institutional Advisory Corp.
Lorna C. Ferguson 10/24/45 Vice President, 2003 Vice President of Nuveen 140
333 West Wacker Drive Investments, LLC; Vice
Chicago, IL 60606 President (since 1998) of
Nuveen Advisory Corp. and
Nuveen Institutional
Advisory Corp.
William M. Fitzgerald 3/2/64 Vice President, 2003 Managing Director (since 140
333 West Wacker Drive 2002) of Nuveen Investments,
Chicago, IL 60606 LLC; Managing Director
(since 2001), formerly, Vice
President of Nuveen Advisory
Corp. and Nuveen
Institutional Advisory Corp.
(since 1995); Managing Director
of Nuveen Asset Management, Inc.
(since 2001); Vice President
of Nuveen Investments Advisers Inc.
(since 2002); Chartered
Financial Analyst.
Stephen D. Foy 5/31/54 Vice President and Vice President (since 1993) and 140
333 West Wacker Drive Controller, 2003 Funds Controller (since 1998) of
Chicago, IL 60606 Nuveen Investments, LLC; Vice
President and Funds Controller
(since 1998) of Nuveen Investments,
Inc.; Certified Public Accountant.
S-30
POSITIONS AND PRINCIPAL OCCUPATIONS, NUMBER OF
OFFICES WITH THE INCLUDING PORTFOLIOS
FUND AND YEAR OTHER DIRECTORSHIPS IN FUND COMPLEX
FIRST ELECTED OR HELD, DURING OVERSEEN BY
NAME AND ADDRESS BIRTHDATE APPOINTED PAST FIVE YEARS OFFICER
---------------- --------- ---------------------- ----------------------------- ---------------
David J. Lamb 3/22/63 Vice President, 2003 Vice President (since 2000) 140
333 West Wacker Drive of Nuveen Investments, LLC,
Chicago, IL 60606 previously Assistant Vice
President (since 1999);
prior thereto, Associate of
Nuveen Investments, LLC;
Certified Public Accountant.
Tina M. Lazar 8/27/61 Vice President, 2003 Vice President (since 1999), 140
333 West Wacker Drive previously Assistant Vice
Chicago, IL 60606 President (since 1993) of
Nuveen Investments, LLC.
Larry W. Martin 7/27/51 Vice President and Vice President, Assistant 140
333 West Wacker Drive Assistant Secretary, Secretary and Assistant
Chicago, IL 60606 2003 General Counsel of Nuveen
Investments, LLC; Vice
President and Assistant
Secretary of Nuveen Advisory
Corp. and Nuveen
Institutional Advisory
Corp.; Assistant Secretary
of Nuveen Investments, Inc.
and (since 1997) of Nuveen
Asset Management, Inc.;
Vice President (since 2000),
Assistant Secretary and
Assistant General Counsel
(since 1998) of Rittenhouse
Asset Management, Inc.; Vice
President and Assistant
Secretary of Nuveen
Investments Advisers Inc.
(since 2002); Assistant
Secretary of NWO Investment
Management Company, LLC
(since 2002).
Edward F. Neild, IV 7/7/65 Vice President, 2003 Managing Director (since 140
333 W. Wacker Drive 2002) of Nuveen Investments,
Chicago, IL 60606 LLC; Managing Director
(since 1997), formerly Vice
President (since 1996) of
Nuveen Advisory Corp. and
Nuveen Institutional
Advisory Corp.; Managing
Director of Nuveen Asset
Management, Inc. (since 1999);
Chartered Financial Analyst.
The Board of Trustees has five standing committees: the executive
committee, the audit committee, the nominating and governance committee, the
dividend committee and the valuation and risk committee. Because the Fund is
newly organized, none of the committees have met during the Fund's last fiscal
year. The executive committee met once prior to the commencement of the Fund's
operations.
Robert P. Bremner, Anne E. Impellizzeri and Timothy R. Schwertfeger,
Chair, serve as members of the executive committee of the Board of Trustees of
the Fund. The executive committee, which meets between regular meetings of the
Board of Trustees, is authorized to exercise all of the powers of the Board of
Trustees. The executive committee also serves as the pricing committee with
respect to the FundPreferred Shares.
The audit committee monitors the accounting and reporting policies and
practices of the Funds, the quality and integrity of the financial statements of
the Funds, compliance by the Funds with legal and regulatory requirements and
the independence and performance of the external and internal auditors. The
members of the audit committee are William E. Bennett, Robert P. Bremner,
Lawrence W. Brown, Jack B. Evans, Thomas E. Leafstrand, William J. Schneider,
Chair, and Peter R. Sawers.
The nominating and governance committee is responsible for Board
selection and tenure; selection and review of committees; and Board education
and operations. In addition, the committee monitors performance of legal counsel
and other service providers; periodically reviews and makes recommendations
about any appropriate changes to trustee compensation; and has the resources and
authority to discharge its responsibilities -- including retaining special
counsel and other experts or consultants at the expense of the Fund. In the
event of a vacancy on the Board, the nominating and governance committee
receives suggestions from various sources (including shareholders) as to
suitable candidates. Suggestions should be sent in writing to Lorna Ferguson,
Vice President for Board Relations, Nuveen Investments, LLC, 333 West Wacker
Drive, Chicago, IL 60606. The nominating and governance committee sets
appropriate standards and requirements for nominations for new trustees and
reserves the right to interview all candidates and to make the final selection
of any new trustees. The members of the
S-31
nominating and governance committee are William E. Bennett, Robert P. Bremner,
Chair, Lawrence H. Brown, Jack B. Evans, Anne E. Impellizzeri, William L.
Kissick, Peter R. Sawers, William J. Schneider, Judith M. Stockdale and Sheila
W. Wellington.
The dividend committee is authorized to declare distributions on the
Fund's shares including, but not limited to, regular and special dividends,
capital gains and ordinary income distributions. The members of the dividend
committee are Timothy R. Schwertfeger, Chair, Lawrence H. Brown, Jack B. Evans
and Thomas E. Leafstrand.
The valuation committee oversees the Fund's pricing procedures
including, but not limited to, the review and approval of fair value pricing
determinations made by Nuveen's Valuation Group. The members of the valuation
committee are William E. Bennett, Chair, Lawrence H. Brown, Thomas E.
Leafstrand and Judith M. Stockdale.
Trustees Evans, Kissick, Leafstrand and Wellington are also trustees of
6 Nuveen open-end funds and 12 Nuveen closed-end funds managed by NIAC and 30
open-end funds and 40 closed-end funds managed by Nuveen Advisory Corp. Trustees
Bremner, Brown, Impellizzeri, Sawers, Schneider and Stockdale are also directors
or trustees, as the case may be, of 30 open-end and 92 closed-end funds managed
by Nuveen Advisory Corp. and 6 open-end funds and 6 closed-end funds managed by
NIAC. Trustee Bennett is also trustee of 6 open-end funds and 12 closed-end
funds managed by NIAC and 30 open-end and 92 closed-end funds managed by Nuveen
Advisory Corp. Mr. Schwertfeger is also a director or trustee, as the case may
be, of 36 Nuveen open-end funds and 104 closed-end funds managed by NIAC or
Nuveen Advisory Corp. None of the independent trustees, nor any of their
immediate family members, has ever been a director, officer, or employee of, or
a consultant to, NIAC, Nuveen or their affiliates. In addition, none of the
independent trustees owns beneficially or of record, any security of NIAC,
Nuveen or any person (other than a registered investment company) directly or
indirectly controlling, controlled by or under common control with NIAC or
Nuveen.
Holders of FundPreferred shares, voting as a separate class, will elect
two trustees at the next annual meeting of Common Shareholders and the remaining
trustees shall be elected by Common Shareholders and holders of FundPreferred
shares, voting together as a single class. Holders of FundPreferred shares will
be entitled to elect a majority of the Fund's trustees under certain
circumstances. See "Description of FundPreferred Shares -- Voting Rights." The
following table sets forth the dollar range of equity securities beneficially
owned by each trustee as of December 31, 2002:
AGGREGATE DOLLAR RANGE OF
EQUITY SECURITIES IN ALL
REGISTERED INVESTMENT COMPANIES
DOLLAR RANGE OF EQUITY OVERSEEN BY TRUSTEE IN FAMILY
NAME OF TRUSTEE SECURITIES IN THE FUND OF INVESTMENT COMPANIES
--------------- ---------------------- -------------------------------
Timothy R. Schwertfeger........ $0 Over $100,000
William E. Bennett............. $0 $50,001 - 100,000
Robert P. Bremner.............. $0 $10,001 - $50,000
Lawrence H. Brown.............. $0 $50,001 - $100,000
Jack B. Evans.................. $0 Over $100,000
Anne E. Impellizzeri........... $0 $10,001 - $50,000
William L. Kissick............. $0 $50,001 - $100,000
Thomas E. Leafstrand........... $0 Over $100,000
Peter R. Sawers................ $0 Over $100,000
William S. Schneider........... $0 Over $100,000
Judith M. Stockdale............ $0 $10,001 - $50,000
Sheila W. Wellington........... $0 Over $100,000
No trustee who is not an interested person of the Fund owns
beneficially or of record, any security of NIAC, Nuveen, Spectrum, Froley, Revy,
Citigroup Global Markets Inc. or any person (other than a registered investment
company) directly or indirectly controlling, controlled by or under common
control with NIAC, Nuveen, Spectrum, Froley, Revy or Citigroup Global Markets
Inc.
The trustees and officers of the Fund as a group own less than one
percent of the Fund's outstanding common shares.
The following table sets forth estimated compensation to be paid by the
Fund projected during the Fund's first full fiscal year after commencement of
operation. The Fund does not have a retirement or pension plan. The officers and
trustees affiliated with Nuveen serve without any compensation from the Fund.
The Fund has a deferred compensation plan (the "Plan") that permits any trustee
who is not an
S-32
"interested person" of the Fund to elect to defer receipt of all or a portion of
his or her compensation as a trustee. The deferred compensation of a
participating trustee is credited to a book reserve account of the Fund when the
compensation would otherwise have been paid to the trustee. The value of the
trustee's deferral account at any time is equal to the value that the account
would have had if contributions to the account had been invested and reinvested
in shares of one or more of the eligible Nuveen funds. At the time for
commencing distributions from a trustee's deferral account, the trustee may
elect to receive distributions in a lump sum or over a period of five years. The
Fund will not be liable for any other fund's obligations to make distributions
under the Plan.
ESTIMATED TOTAL
AGGREGATE COMPENSATION AMOUNT OF TOTAL
COMPENSATION FROM FUND AND COMPENSATION THAT
NAME OF TRUSTEE FROM FUND* FUND COMPLEX** HAS BEEN DEFERRED
--------------- ------------ -------------- -----------------
Timothy R. Schwertfeger......... $ 0 $ 0 $ 0
William E. Bennett.............. 4,901 53,050 41,564
Robert P. Bremner............... 4,901 77,500 8,780
Lawrence H. Brown............... 5,109 82,000 0
Jack B. Evans................... 5,109 49,100 19,357
Anne E. Impellizzeri............ 4,851 77,500 58,535
William L. Kissick.............. 4,851 49,000 18,000
Thomas E. Leafstrand............ 5,109 52,300 20,542
Peter R. Sawers................. 4,901 79,250 58,785
William S. Schneider............ 5,057 77,500 58,535
Judith M. Stockdale............. 4,851 77,750 14,690
Sheila W. Wellington............ 4,851 47,600 37,403
----------
* Based on the estimated compensation to be earned by the independent
trustees for the 12-month period ending 7/31/2004, representing the
Fund's first full fiscal year, for services to the Fund.
** Based on the compensation paid to the trustees for the one year period
ending 12/31/02 for services to the Nuveen open-end and closed-end
funds.
The Fund has no employees. Its officers are compensated by Nuveen
Investments, Inc. or its affiliates.
Nuveen Investments, Inc. maintains charitable contributions programs
to encourage the active support and involvement of individuals in the civic
activities of their community. These programs include a matching contributions
program and a direct contributions program. The Independent Board Members of
the funds managed by NIAC are eligible to participate in the charitable
contributions program of Nuveen Investments, Inc. Under the matching program,
Nuveen Investments, Inc. will match the personal contributions of a Board
Member to Section 501(c)(3) organizations up to an aggregate maximum amount of
$10,000 during any calendar year. Under its direct (non-matching) program,
Nuveen Investments, Inc. makes contributions to qualifying Section 501(c)(3)
organizations, as approved by the Corporate Contributions Committee of Nuveen
Investments, Inc. The Independent Board Members are also eligible to submit
proposals to the committee requesting that contributions be made under this
program to Section 501(c)(3) organizations identified by the Board Member, in
an aggregate amount not to exceed $5,000 during any calendar year. Any
contribution made by Nuveen Investments, Inc. under the direct program is made
solely at the discretion of the Corporate Contributions Committee.
INVESTMENT ADVISERS
NIAC, 333 West Wacker Drive, Chicago, Illinois 60606, will be
responsible for determining the Fund's overall investment strategy, including
portfolio allocations, and the use of leverage, hedging and interest rate
transactions. NIAC also is responsible for selection of the Fund's Subadvisers
and ongoing monitoring of the Subadvisers, managing the Fund's business affairs
and providing day-to-day administrative services to the Fund. For additional
information regarding the management services performed by NIAC, see "Management
of the Fund" in the Fund's Prospectus.
NIAC serves as the investment adviser to the Fund and is responsible
for managing the portion of the Fund's assets allocated to other debt
instruments.
NIAC, a registered investment adviser, is a wholly owned subsidiary of
Nuveen Investments, Inc. According to data from Thomson Wealth Management,
Nuveen Investments, Inc. is the leading sponsor of exchange-traded funds as
measured by number of funds (104) and fund assets under management
(approximately $45 billion) as of June 30, 2003. Founded in 1898, Nuveen
Investments, Inc. and its affiliates had approximately $88 billion in assets
under management as of June 30, 2003. Nuveen Investments, Inc. is a
publicly-traded company that is approximately 79% owned by The St. Paul
Companies, Inc. ("St. Paul"). St. Paul is a publicly-traded company located in
St. Paul, Minnesota, and is principally engaged in providing property-liability
insurance through subsidiaries.
Gunther Stein and Lenny Mason are the portfolio managers for NIAC
responsible for investing the Fund's assets allocated to other debt instruments.
S-33
Mr. Stein is a Vice President of NIAC. He also has been lead portfolio manager
for high yield strategies at Symphony Asset Management, LLC ("Symphony"), a
wholly owned subsidiary of Nuveen Investments, Inc. since 1999. Prior to joining
Symphony in 1999, Mr. Stein was a high yield portfolio manager at Wells Fargo.
Mr. Mason is a Vice President of NIAC. He also is a high yield portfolio manager
at Symphony. Prior to joining Symphony in 2001, Mr. Mason was a Managing
Director in FleetBoston's Technology and Communications Group.
Nuveen Investments, Inc. provides investment services to financial
advisors serving high-net-worth clients and institutional clients. Nuveen
Investments today markets its capabilities -- which include tax-free investing,
separately-managed accounts and market neutral alternative investment portfolios
-- under four distinct brands: Nuveen, NWQ, Rittenhouse and Symphony. Nuveen
Investments, Inc. is listed on The New York Stock Exchange and trades under the
symbol "JNC."
Spectrum, 4 High Ridge Park, Stamford, Connecticut 06905, is a
Subadviser to the Fund and is responsible for managing the portion of the Fund's
assets allocated to preferred securities. As one of the leading managers of
preferred securities in the U.S., Spectrum specializes in the management of
diversified preferred security portfolios for institutional investors, including
Fortune 500 companies, pension funds, insurance companies and foundations.
Spectrum also serves as a sub-adviser for a large offshore fund. Spectrum, a
registered investment adviser, commenced operations in 1987 and had
approximately $10.1 billion in assets under management as of June 30, 2003.
Spectrum is an independently managed wholly owned subsidiary of
Principal Global Investors, LLC, which is part of Principal Financial Group
Inc., a publicly traded, diversified, insurance and financial services company.
Collectively, subsidiaries and affiliates of Principal Global Investors, LLC
managed over $104.2 billion in combined assets worldwide as of June 30, 2003. As
a subsidiary of Principal Global Investors, LLC, Spectrum also can take
advantage of Principal's extensive staff of internal credit analysts.
A team of Spectrum professionals led by Mark A. Lieb, Bernard M.
Sussman and L. Phillip Jacoby, IV is responsible for investing the portion of
the Fund's assets allocated to preferred securities.
Mr. Lieb is an Executive Director and the Chief Financial Officer of
Spectrum. Mr. Lieb is responsible for business development of Spectrum. Prior to
founding Spectrum in 1987, Mr. Lieb was a founder, director and partner of DBL
Preferred Management, Inc., a wholly owned corporate cash management subsidiary
of Drexel Burnham Lambert, Inc. Mr. Lieb was instrumental in the formation and
continual development of all aspects of DBL Preferred Management, Inc.,
including the daily management of preferred stock portfolio for institutional
clients, general hedging strategies, and market strategies employed by the firm.
Mr. Lieb's prior employment included the development of the preferred stock
trading desk at Mosley Hallgarten & Estabrook. Mr. Lieb has a B.A. in economics
from Central Connecticut State College and an M.B.A. in finance from the
University of Hartford.
Mr. Sussman is an Executive Director and the Chief Investment Officer
of Spectrum and is Chairman of Spectrum's Investment Committee. Prior to joining
Spectrum in 1995, Mr. Sussman was employed by Goldman Sachs & Co. for nearly 18
years. A general partner and head of the Preferred Stock Department, he was in
charge of sales, trading and underwriting for all preferred products and was
instrumental in the development of the hybrid (MIPS) market. Mr. Sussman was a
limited partner at Goldman Sachs from December 1994 through November 1996. He
has a B.S. in industrial relations and an M.B.A. in finance from Cornell
University.
Mr. Jacoby is a Senior Vice President of Spectrum. He joined Spectrum
in 1995 as a Portfolio Manager. Previously, Mr. Jacoby worked as a senior
investment officer at USL Capital Corporation (a
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subsidiary of Ford Motor Corporation) and was a co-manager of a $600 million
preferred stock portfolio. Mr. Jacoby has a B.S. in finance from Boston
University.
Froley, Revy, 10900 Wilshire Boulevard, Suite 900, Los Angeles,
California 90024, is a Subadviser to the Fund and is responsible for managing
the portion of the Fund's assets allocated to convertible securities. Froley,
Revy specializes in the management of convertible securities. Froley, Revy
commenced operations in 1975 and had approximately $3.2 billion in assets under
management as of June 30, 2003.
Froley, Revy is an independently managed wholly owned subsidiary of
First Republic Bank, which is a publicly-traded commercial bank and wealth
management firm. Collectively, subsidiaries and affiliates of First Republic
Bank, including Froley, Revy, managed approximately $9.5 billion in combined
assets as of June 30, 2003.
Andrea Revy O'Connell and Michael Revy are the portfolio managers at
Froley, Revy responsible for investing the portion of the Fund's assets
allocated to convertible securities. Ms. O'Connell is President and Chief
Executive Officer of Froley, Revy and has been Managing Director and a Principal
of Froley, Revy since 1994. Mr. Revy is a Senior Vice President, Senior
Portfolio Manager and a Managing Director of Froley, Revy and is responsible for
the development and co-management of Froley, Revy's convertible arbitrage
product. Before joining Froley, Revy in 2002, Mr. Revy was a private banker at
Weschler & Co., Inc. since 1998, and prior thereto worked for Lehman Brothers
for six years in that firm's convertible bond group.
Pursuant to an investment management agreement between NIAC and the
Fund, the Fund has agreed to pay an annual management fee for the services and
facilities provided by NIAC, payable on a monthly basis, according to the
following schedule:
AVERAGE DAILY MANAGED ASSETS MANAGEMENT FEE
---------------------------- --------------
Up to $500 million................ .9000%
$500 million to $1 billion........ .8750
$1 billion to $1.5 billion........ .8500
$1.5 billion to $2.0 billion...... .8250
Over $2.0 billion................. .8000
Pursuant to investment subadvisory agreements between NIAC and each of
the Subadvisers, each Subadviser will receive from NIAC a management fee equal
to 40% of the management fee payable by the Fund to NIAC (net of the
reimbursements described below) with respect to the Subadviser's allocation of
Managed Assets up to the first $500 million of the average daily Managed Assets
of the Fund allocated to that Subadviser and 35% thereafter.
In addition to the fee of NIAC, the Fund pays all other costs and
expenses of its operations, including compensation of its trustees (other than
those affiliated with NIAC), custodian, transfer agency and dividend disbursing
expenses, legal fees, expenses of independent auditors, expenses of repurchasing
shares, expenses of issuing any FundPreferred shares, expenses of preparing,
printing and distributing shareholder reports, notices, proxy statements and
reports to governmental agencies, and taxes, if any. All fees and expenses are
accrued daily and deducted before payment of dividends to investors.
For the first eight full years of the Fund's operation, the Advisers
have contractually agreed to reimburse the Fund for fees and expenses in the
amounts, and for the time periods, set forth below:
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PERCENTAGE PERCENTAGE
REIMBURSED REIMBURSED
YEAR ENDING (AS A PERCENTAGE OF YEAR ENDING (AS A PERCENTAGE
JUNE 30 MANAGED ASSETS) JUNE 30 OF MANAGED ASSETS)
----------- ------------------- ----------- ------------------
2003(1) .32% 2008 .32%
2004 .32 2009 .24
2005 .32 2010 .16
2006 .32 2011 .08
2007 .32
----------
(1) From the commencement of operations.
Reducing Fund expenses in this manner will tend to increase the amount
of income available for the Common Shareholders. The Advisers have not agreed to
reimburse the Fund for any portion of its fees and expenses beyond June 30,
2011.
Unless earlier terminated as described below, the Fund's investment
management agreement with NIAC and the Fund's investment sub-advisory agreements
(the "management agreements") will remain in effect until August 1, 2004. The
management agreements continue in effect from year to year so long as such
continuation is approved at least annually by (1) the Board of Trustees or the
vote of a majority of the outstanding voting securities of the Fund, and (2) a
majority of the trustees who are not interested persons of any party to the
investment management agreement, cast in person at a meeting called for the
purpose of voting on such approval. The investment management agreement may be
terminated at any time, without penalty, by either the Fund or NIAC upon 60 days
written notice, and is automatically terminated in the event of its assignment
as defined in the 1940 Act. Each investment sub-advisory agreement may be
terminated at any time, without penalty, by the Fund, NIAC or the Subadviser
party thereto upon 60 days written notice, and is automatically terminated in
the event of its assignment as defined in the 1940 Act.
The management agreements have been approved by a majority of the
independent trustees of the Fund and the sole shareholder of the Fund. The
independent trustees have determined that the terms of the Fund's management
agreements are fair and reasonable and that the agreements are in the Fund's
best interests. The independent trustees believe that the management agreements
will enable the Fund to obtain high quality investment management services at a
cost that they deem appropriate, reasonable, and in the best interests of the
Fund and its shareholders. In making such determination, the independent
trustees met independently from the interested trustee of the Fund and any
officers of NIAC, Spectrum, Froley, Revy and their affiliates. The independent
trustees also relied upon the assistance of counsel to the independent trustees.
In evaluating the investment management agreement between the Fund and
NIAC, the independent trustees reviewed materials furnished by NIAC at the
annual advisory contract renewal meeting held in May, 2003, including
information regarding NIAC, its affiliates and its personnel, operations and
financial condition. In evaluating the investment sub-advisory agreements, the
independent trustees reviewed materials previously furnished by Spectrum in May,
2003, including information regarding Spectrum, its affiliates and its
personnel, operations and financial condition. The independent trustees also
reviewed materials furnished by Froley, Revy, including information regarding
Froley, Revy, its affiliates and its personnel, operations and financial
condition. The independent trustees also reviewed, among other things, the
nature and quality of services to be provided by NIAC, Spectrum and Froley,
Revy, the proposed fees to be charged by NIAC, Spectrum and Froley, Revy for
investment management services, the profitability to NIAC, Spectrum and Froley,
Revy of their relationships with the Fund, fall-out benefits to NIAC, Spectrum
and Froley, Revy from that relationship, economies of
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scale achieved by NIAC, Spectrum and Froley, Revy, the experience of the
investment advisory and other personnel providing services to the Fund, the
historical quality of the services provided by NIAC, Spectrum and Froley, Revy
and comparative fees and expense ratios of investment companies with similar
objectives and strategies managed by other investment advisers, and other
factors that the independent trustees deemed relevant. The independent trustees,
at various times, discussed with representatives of NIAC, Spectrum and Froley,
Revy the Fund's operations and each of NIAC's, Spectrum's and Froley, Revy's
ability to provide advisory and other services to the Fund.
The Fund, NIAC, Nuveen, Spectrum, Froley, Revy, Citigroup Global
Markets Inc. and other related entities have adopted codes of ethics which
essentially prohibit certain of their personnel, including the Fund's portfolio
managers, from engaging in personal investments which compete or interfere with,
or attempt to take advantage of a client's, including the Fund's, anticipated or
actual portfolio transactions, and are designed to assure that the interests of
clients, including Fund shareholders, are placed before the interests of
personnel in connection with personal investment transactions. Text-only
versions of the codes of ethics of the Fund, NIAC, Nuveen, Spectrum, and Froley,
Revy can 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 those 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.
The Fund has delegated proxy voting responsibilities to its subadvisers
and Symphony, subject to the Boards' general oversight. Each subadviser and
Symphony has adopted its own proxy voting policy, that is briefly summarized
below.
SPECTRUM. Spectrum's proxy voting policy seeks to ensure that proxies
for securities held by the Fund are voted solely in the best economic interests
of the Fund and to act without undue influence from individuals or groups who
may have an economic interest in the outcome of a proxy vote.
Spectrum classifies proxy voting into three broad categories: Routine
Administrative Items, Special Interest Issues, and Issues Having the Potential
for Significant Economic Impact. Once it has analyzed and identified each issue
as belonging in a particular category, Spectrum will cast the Fund's vote in
accordance with the guidelines developed for that particular category.
On any occasion when a proxy vote presents a potential conflict of
interest, Spectrum will review the matter before casting such vote in a manner
that is contrary to the pre-determined policy.
FROLEY, REVY. Froley, Revy's proxy voting policy requires that proxies
be voted in the best ultimate long-term economic interests of the Fund. Froley,
Revy's primary consideration in deciding how to vote a proxy is the ultimate
economic impact of a proxy proposal on the value of the company's stock based on
Froley, Revy's independent analysis of the stock's investment considerations.
Froley, Revy utilizes a proxy committee made up of portfolio managers
and research analysts. With respect to each proxy issue, the committee will
analyze the economic impact on the company of voting in favor of or against the
proposal. Where proxy voting involves a potential conflict of interest, the
committee shall disclose its conflict to the Fund and allow the Fund an
opportunity to approve the recommended vote based upon the committee's
communicated rationale.
SYMPHONY. Symphony uses the services of Institutional Shareholder
Services ("ISS"), an independent proxy voting service, which handles all proxy
voting for Symphony's client accounts and the Fund. The proxy voting policies
and procedures of ISS are reviewed and approved each year by the management of
Symphony. Symphony believes that following the proxy voting guidelines
established by ISS allows Symphony to avoid conflicts of interest in voting
proxies on behalf of the Fund.
When required by applicable regulations, information regarding how the
Fund voted proxies relating to portfolio securities will be available without
charge by calling (800) 257-8787 or by accessing the Securities and Exchange
Commission's website at http://www.sec.gov.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the supervision of the Board of Trustees, each Adviser, with
respect to the securities for which it is responsible, is responsible for
decisions to buy and sell securities for the Fund and the negotiation of
brokerage commissions to be paid. Transactions on stock exchanges involve the
payment by the Fund of brokerage commissions. There generally is no stated
commission in the case of securities traded in the over-the-counter market but
the price paid by the Fund usually includes an undisclosed dealer commission or
mark-up. In certain instances, the Fund may make purchases of underwritten
issues at prices which include underwriting fees.
NIAC
NIAC, with respect to the securities for which it is responsible, is
responsible for decisions to buy and sell securities for the Fund and for the
placement of the Fund's securities business, the negotiation of the prices to be
paid for principal trades and the allocation of its transactions among various
dealer firms. Portfolio securities will normally be purchased directly from an
underwriter or in the over-the-counter market from the principal dealers in such
securities, unless it appears that a better price or execution may be obtained
through other means. Portfolio securities will not be purchased from Nuveen or
its affiliates except in compliance with the 1940 Act.
With respect to interests in corporate loans, the Fund generally will
engage in privately negotiated transactions for purchase or sale in which NIAC
will negotiate on behalf of the Fund, although a more developed market may exist
for certain corporate loans. The Fund may be required to pay fees, or forgo a
portion of interest and any fees payable to the Fund, to the lender selling
participations or assignments to the Fund. NIAC will determine the lenders from
whom the Fund will purchase assignments and participations by considering their
professional ability, level of service, relationship with the borrower,
financial condition, credit standards and quality of management. Although the
Fund intends generally to hold interests in corporate loans until maturity or
prepayment of the corporate loan, the illiquidity of many corporate loans may
restrict the ability of NIAC to locate in a timely manner persons willing to
S-37
purchase the Fund's interests in corporate loans at a fair price should the Fund
desire to sell such interests. See "Risk Factors" in the Prospectus.
The Fund expects that substantially all other portfolio transactions
will be effected on a principal (as opposed to an agency) basis and,
accordingly, does not expect to pay any brokerage commissions. Purchases from
underwriters will include a commission or concession paid by the issuer to the
underwriter, and purchases from dealers will include the spread between the bid
and ask price. It is the policy of NIAC to seek the best execution under the
circumstances of each trade. NIAC evaluates price as the primary consideration,
with the financial condition, reputation and responsiveness of the dealer
considered secondary in determining best execution. Given the best execution
obtainable, it will be NIAC's practice to select dealers which, in addition,
furnish research information (primarily credit analyses of issuers and general
economic reports) and statistical and other services to NIAC. It is not possible
to place a dollar value on information and statistical and other services
received from dealers. Since it is only supplementary to NIAC's own research
efforts, the receipt of research information is not expected to reduce
significantly NIAC's expenses. While NIAC will be primarily responsible for the
placement of the business of the Fund, the policies and practices of NIAC in
this regard must be consistent with the foregoing and will, at all times, be
subject to review by the Board of Trustees of the Fund.
NIAC may manage other investment accounts and investment companies for
other clients which have investment objectives similar to those of the Fund.
Subject to applicable laws and regulations, NIAC seeks to allocate portfolio
transactions equitably whenever concurrent decisions are made to purchase or
sell assets or securities by the Fund and another advisory account. In making
such allocations the main factors to be considered will be the respective
investment objectives, the relative size of portfolio holdings of the same or
comparable securities, the availability of cash for investment and the size of
investment commitments generally held. While this procedure could have a
detrimental effect on the price or amount of the securities available to the
Fund from time to time, it is the opinion of the Board of Trustees that the
benefits available from NIAC's organization will outweigh any disadvantage that
may arise from exposure to simultaneous transactions.
SPECTRUM
In selecting a broker to execute each particular transaction for which
it is responsible, Spectrum will take the following into consideration: the best
net price available; the reliability, integrity and financial condition of the
broker; the size and difficulty in executing the order; and the value of the
expected contribution of the broker to the investment performance of a Fund on a
continuing basis.
Spectrum may act as broker for the Fund in connection with the purchase
or sale of securities by or to the Fund if and to the extent permitted by
procedures adopted from time to time by the Board of Trustees of the Fund. The
Board of Trustees, including a majority of the trustees who are not "interested"
trustees, has determined that portfolio transactions for the Fund may be
executed through Spectrum if, in the judgment of NIAC and Spectrum, the use of
Spectrum is likely to result in prices and execution at least as favorable to
the Fund as would be available from other qualified brokers and if, in such
transactions, Spectrum charges the Fund commission rates at least as favorable
to the Fund as those charged by Spectrum to comparable unaffiliated customers in
similar transactions. The Board of Trustees also has adopted procedures that are
reasonably designed to provide that any commission, fee or other remuneration
paid to Spectrum is consistent with the foregoing standard. The Fund will not
effect principal transactions with Spectrum. In executing transactions through
Spectrum, the Fund will be subject to, and intends to comply with, Section 17(e)
of the 1940 Act and the rules thereunder.
The cost of the brokerage commissions to the Fund in any transaction
(other than those effected by Spectrum) may be greater than that available from
other brokers if the difference is reasonably
S-38
justified by other aspects of the portfolio execution services offered. Subject
to such policies and procedures as the trustees may determine, Spectrum shall
not be deemed to have acted unlawfully or to have breached any duty solely by
reason of having caused the Fund to pay a broker (other than Spectrum) that
provides research services an amount of commission for effecting a portfolio
investment transaction in excess of the amount of commission another broker
would have charged for effecting that transaction if Spectrum determines in good
faith that such amount of commission was reasonable in relation to the value of
the research service provided by such broker viewed in terms of either that
particular transaction or Spectrum's ongoing responsibilities with respect to
the Fund. Research and investment information may be provided by these and other
brokers at no cost to Spectrum and is available for the benefit of other
accounts advised by Spectrum and its affiliates, and not all of the information
will be used in connection with the Fund. Although this information may be
useful in varying degrees and may tend to reduce Spectrum's expenses, it is not
possible to estimate its value and in the opinion of Spectrum it does not reduce
expenses in a determinable amount. The extent to which Spectrum makes use of
statistical, research and other services furnished by brokers is considered by
Spectrum in the allocation of brokerage business but there is no formula by
which such business is allocated. Spectrum does so in accordance with its
judgment of the best interests of the Fund and its shareholders. Spectrum may
also take into account payments made by brokers effecting transactions for the
Fund to other persons on behalf of the Fund for services provided to them for
which they would be obligated to pay (such as custodial and professional fees).
In addition, consistent with the Conduct Rules of the National Association of
Securities Dealers, Inc., and subject to seeking best price and execution,
Spectrum may consider sales of shares of the Fund as a fact in the selection of
brokers and dealers to enter into portfolio transactions with the Fund.
Certain other clients of Spectrum may have investment objectives and
policies similar to those of the Fund. Spectrum may, from time to time, make
recommendations that result in the purchase or sale of a particular security by
their other clients simultaneously with the Fund. If transactions on behalf of
more than one client during the same period increase the demand for securities
being sold, there may be an adverse effect on the price of such securities. It
is the policy of Spectrum to allocate advisory recommendations and the placing
of orders in a manner that each deems equitable to the accounts involved,
including the Fund. When two or more of the clients of Spectrum (including the
Fund) are purchasing or selling the same security on a given day through the
same broker-dealer, such transactions may be averaged as to price.
FROLEY, REVY
It is the policy of Froley, Revy to secure the execution of orders on
its portfolio transactions in an effective manner at the most favorable
available price. Pursuant to its agreement with the Fund, Froley, Revy
determines, subject to the general supervision of the Board of Trustees and in
accordance with the Fund's investment objectives, policies and restrictions,
which securities are to be purchased and sold and which brokers are to be
eligible to execute its portfolio transactions. It is not the policy of Froley,
Revy to deal solely with one broker, but it is Froley, Revy's intention to place
portfolio transactions with those brokers which provide the most favorable
combination of price, execution and services to the Fund. Research services are
a factor in selection of brokers, but payment in excess of brokerage commissions
charged by other brokers is made in recognition of research services. The
reasonableness of brokerage commissions is evaluated by comparison to fees
charged by other brokers where the execution and services are comparable.
NET ASSET VALUE
The Fund will determine the net asset value of its Common Shares daily,
as of the close of regular session trading on the New York Stock Exchange
(normally 4:00 p.m. eastern time). Net asset value is
S-39
computed by dividing the value of all assets of the Fund (including accrued
interest and dividends), less all liabilities (including accrued expenses and
dividends declared but unpaid), by the total number of shares outstanding. Any
swap transaction that the Fund enters into may, depending on the applicable
interest rate environment, have a positive or negative value for purposes of
calculating net asset value. Any cap transaction that the Fund enters into may,
depending on the applicable interest rate environment, have no value or a
positive value. In addition, accrued payments to the Fund under such
transactions will be assets of the Fund and accrued payments by the Fund will be
liabilities of the Fund.
For purposes of determining the net asset value of the Fund, readily
marketable portfolio securities listed on the New York Stock Exchange are
valued, except as indicated below, at the last sale price reflected on the
consolidated tape at the close of the New York Stock Exchange on the business
day as of which such value is being determined. If there has been no sale on
such day, the securities are valued at the mean of the closing bid and asked
prices on such day. If no bid or asked prices are quoted on such day, then the
security is valued by such method as the Board of Trustees shall determine in
good faith to reflect its fair market value. Readily marketable securities not
listed on the New York Stock Exchange but listed on other domestic or foreign
securities exchanges or admitted to trading on the National Association of
Securities Dealers Automated Quotations, Inc. ("Nasdaq") National List are
valued in a like manner except that Nasdaq National List securities are valued
using the Nasdaq Official Closing Price for such securities. Portfolio
securities traded on more than one securities exchange are valued at the last
sale price on the business day as of which such value is being determined as
reflected on the tape at the close of the exchange representing the principal
market for such securities.
Readily marketable securities traded in the over-the counter market,
including listed securities whose primary market is believed by the investment
adviser to be over-the-counter, but excluding securities admitted to trading on
the Nasdaq National List, are valued at the mean of the current bid and asked
prices as reported by Nasdaq or, in the case of securities not quoted by Nasdaq,
the National Quotation Bureau or such other comparable source as the Trustees
deem appropriate to reflect their fair market value. However, certain
fixed-income securities may be valued on the basis of prices provided by a
pricing service when such prices are believed by the Board of Trustees to
reflect the fair market value of such securities. The prices provided by a
pricing service take into account institutional size trading in similar groups
of securities and any developments related to specific securities. Where
securities are traded on more than one exchange and also over-the-counter, the
securities will generally be valued using the quotations the Board of Trustees
believes reflect most closely the value of such securities.
DESCRIPTION OF FUNDPREFERRED SHARES
Notices. The Fund shall deliver to the Auction Agent and Moody's (if
Moody's is then rating FundPreferred shares), Fitch (if Fitch is then rating
FundPreferred shares) and any other rating agency which is then rating
FundPreferred shares and which so requires a certificate which sets forth a
determination of certain items (a "FundPreferred Shares Basic Maintenance
Certificate") as of (A) the Date of Original Issue, (B) the last Valuation Date
of each month, (C) any date requested by any rating agency, (D) a Business Day
on or before any Asset Coverage Cure Date relating to the Fund's cure of a
failure to meet the FundPreferred Shares Basic Maintenance Amount Test, (E) any
day that Common Shares or Preferred Shares, including FundPreferred shares, are
redeemed and (F) any day the Eligible Assets have an aggregate discounted value
less than or equal to 115% of the FundPreferred Shares Basic Maintenance Amount.
Such FundPreferred Shares Basic Maintenance Certificate shall be delivered in
the case of clause (i)(A) on or before the seventh Business Day following the
Date of Original Issue and in the case of all other clauses above on or before
the seventh Business Day after the relevant Valuation Date or Asset Coverage
Cure Date.
S-40
The Fund shall deliver to the Auction Agent, Moody's (if Moody's is
then rating FundPreferred shares), Fitch (if Fitch is then rating FundPreferred
shares) and any Other Rating Agency which is then rating FundPreferred shares
and which so requires a certificate with respect to the calculation of the 1940
Act FundPreferred Shares Asset Coverage and the value of the portfolio holdings
of the Fund (a "1940 Act FundPreferred Shares Asset Coverage Certificate") (i)
as of the Date of Original Issue, and (ii) as of (A) the last Valuation Date of
each quarter thereafter, and (B) as of the Business Day on or before the Asset
Coverage Cure Date relating to the failure to satisfy the 1940 Act FundPreferred
Shares Asset Coverage. Such 1940 Act FundPreferred Shares Asset Coverage
Certificate shall be delivered in the case of clause (i) on or before the
seventh Business Day following the Date of original Issue and in the case of
clause (ii) on or before the seventh Business Day after the relevant Valuation
Date or the Asset Coverage Cure Date. The certificates of (d) and (e) of this
Section 12 may be combined into a single certificate.
Within ten Business Days of the Date of Original Issue, the Fund shall
deliver to the Auction Agent, Moody's (if Moody's is then rating FundPreferred
shares), Fitch (if Fitch is then rating FundPreferred shares) and any Other
Rating Agency which is then rating FundPreferred shares and which so requires a
letter prepared by the Fund's independent accountants (an "Accountant's
Certificate") regarding the accuracy of the calculations made by the Fund in the
FundPreferred Shares Basic Maintenance Certificate and the 1940 Act
FundPreferred Shares Asset Coverage Certificate required to be delivered by the
Fund as of the Date of Original Issue. Within ten Business Days after the last
Valuation Date of each fiscal quarter of the Fund on which a FundPreferred
Shares Basic Maintenance Certificate is required to be delivered, the Fund will
deliver to the Auction Agent, Moody's (if Moody's is then rating FundPreferred
shares), Fitch (if Fitch is then rating the FundPreferred shares) and any other
Rating Agency which is then rating FundPreferred shares and which so requires an
Accountant's Certificate regarding the accuracy of the calculations made by the
Fund in such FundPreferred Shares Basic maintenance certificate and in any other
FundPreferred Shares Basic Maintenance Certificate randomly selected by the
Fund's independent accountants during such fiscal quarter. Within ten Business
Days after the last Valuation Date of each fiscal quarter of the Fund on which a
1940 Act FundPreferred Shares Asset Coverage Certificate is required to be
delivered, the Fund will deliver to the Auction Agent, Moody's (if Moody's is
then rating FundPreferred shares), Fitch (if Fitch is then rating the
FundPreferred shares) and any Other Rating Agency which is then rating
FundPreferred shares and which so requires an Accountant's Certificate regarding
the accuracy of the calculations made by the Fund in such 1940 Act FundPreferred
Shares Asset Coverage Certificate. In addition, the Fund will deliver to the
relevant persons specified in the preceding sentence an Accountant's Certificate
regarding the accuracy of the calculations made by the Fund on each
FundPreferred Shares Basic Maintenance Certificate and 1940 Act FundPreferred
Shares Asset Coverage Certificate delivered pursuant to clause (iv) of paragraph
(d) or clause (ii)(B) of paragraph (e) of this Section 13, as the case may be,
within ten days after the relevant Asset Coverage Cure Date.
Asset Coverage Cure Date. If an Accountant's Certificate delivered with
respect to an Asset Coverage Cure Date shows an error was made in the Fund's
report with respect to such Asset Coverage Cure Date, the calculation or
determination made by the Fund's independent accountants will be conclusive and
binding on the Fund with respect to such reports. If any other Accountant's
Certificate shows that an error was made in any such report, the calculation or
determination made by the Fund's independent accountants will be conclusive and
binding on the Fund; provided, however, any errors shown in the Accountant's
Certificate filed on a quarterly basis shall not be deemed to be a failure to
maintain the FundPreferred Shares Basic Maintenance Amount on any prior
Valuation Dates.
S-41
ADDITIONAL INFORMATION CONCERNING
THE AUCTIONS FOR FUNDPREFERRED SHARES
GENERAL
Auction Agency Agreement. The Fund has entered into an Auction Agency
Agreement (the "Auction Agency Agreement") with the Auction Agent (currently,
The Bank of New York) which provides, among other things, that the Auction Agent
will follow the Auction Procedures for purposes of determining the Applicable
Rate for each series of FundPreferred shares so long as the Applicable Rate for
shares of such series is to be based on the results of an Auction.
Broker-Dealer Agreements. Each Auction requires the participation of
one or more Broker-Dealers. The Auction Agent has entered into agreements
(collectively, the "Broker-Dealer Agreements") with several Broker-Dealers
selected by the Fund, which provide for the participation of those
Broker-Dealers in Auctions for FundPreferred shares. See "Broker-Dealers" below.
Securities Depository. The Depository Trust Company ("DTC") will act as
the Securities Depository for the Agent Members with respect to each series of
FundPreferred shares. One certificate for all of the shares of each series of
FundPreferred shares will be registered in the name of Cede & Co., as nominee of
the securities Depository. Such certificate will bear a legend to the effect
that such certificate is issued subject to the provisions restricting transfers
of FundPreferred shares contained in the Statement. The Fund will also issue
stop-transfer instructions to the transfer agent for each series of
FundPreferred shares. Prior to the commencement of the right of holders of
preferred shares to elect a majority of the Fund's trustees, as described under
"Description of FundPreferred shares -- Voting Rights" in the Prospectus, Cede &
Co. will be the holder of record of all shares of each series of FundPreferred
shares 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 (including the Agent Members), 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 FundPreferred shares, whether for its own
account or as a nominee for another person.
CONCERNING THE AUCTION AGENT
The Auction Agent is acting as agent for the Fund in connection with
Auctions. In the absence of bad faith or negligence on its part, the Auction
Agent will not be liable for any action taken, suffered, or omitted or for any
error of judgment made by it in the performance of its duties under the Auction
Agency Agreement and will not be liable for any error of judgment made in good
faith unless the Auction Agent will have been negligent in ascertaining the
pertinent facts.
The Auction Agent may rely upon, as evidence of the identities of the
Existing Holders of shares of FundPreferred shares, 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 -- Secondary Market Trading and Transfer of FundPreferred
shares" 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.
The Auction Agent may terminate the Auction Agency Agreement upon
notice to the Fund on a date no earlier than 45 days after such notice. If the
Auction Agent should resign, the Fund will use its
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best efforts to enter into an agreement with a successor Auction Agent
containing substantially the same terms and conditions as the Auction Agency
Agreement. The Fund may remove the Auction Agent provided that prior to such
removal the Fund shall have entered into such an agreement with a successor
Auction Agent.
BROKER-DEALERS
The Auction Agent after each Auction for shares of FundPreferred shares
will pay to each Broker-Dealer, from funds provided by the Fund, a service
charge at the annual rate of 1/4 of 1% in the case of any Auction immediately
preceding a Rate Period of less than one year, or a percentage agreed to by the
Fund and the Broker-Dealers in the case of any Auction immediately preceding a
Rate Period of one year or longer, of the purchase price of FundPreferred shares
placed by such Broker-Dealer at such Auction. For the purposes of the preceding
sentence, FundPreferred shares will be placed by a Broker-Dealer if such shares
were (a) the subject of Hold Orders deemed to have been submitted to the Auction
Agent by the Broker-Dealer and were acquired by such Broker-Dealer for its own
account or were acquired by such Broker-Dealer for its customers who are
Beneficial owners or (b) the subject of an order submitted by such Broker-Dealer
that is (i) a Submitted Bid of an Existing Holder that resulted in such Existing
Holder continuing to hold such shares as a result of the Auction or (ii) a
Submitted Bid of a Potential Holder that resulted in such Potential Holder
purchasing such shares as a result of the Auction or (iii) a valid Hold Order.
The Fund may request the Auction Agent to terminate one or more
Broker-Dealer Agreements at any time, provided that at least one Broker-Dealer
Agreement is in effect after such termination.
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.
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST
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 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.
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. Specifically, the Declaration requires a vote by holders of
at least two-thirds of the Common Shares and FundPreferred shares, voting
together as a single class, except as described below, to authorize (1) a
conversion of the Fund from a closed-end to an open-end investment company, (2)
a merger or consolidation of the Fund, or a series or class of the Fund, with
any corporation, association, trust or other organization or a reorganization of
the
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Fund, or a series or class of the Fund, (3) a sale, lease or transfer of all or
substantially all of the Fund's assets (other than in the regular course of the
Fund's investment activities), (4) in certain circumstances, a termination of
the Fund, or a series or class of the Fund or (5) removal of trustees by
shareholders, and then only for cause, unless, with respect to (1) through (4),
such transaction has already been authorized by the affirmative vote of
two-thirds of the total number of trustees fixed in accordance with the
Declaration or the By-laws, in which case the affirmative vote of the holders of
at least a majority of the Fund's Common Shares and FundPreferred shares
outstanding at the time, voting together as a single class, is required,
provided, however, that where only a particular class or series is affected (or,
in the case of removing a trustee, when the trustee has been elected by only one
class), the required vote by only the applicable class or series will be
required. Approval of shareholders is not required, however, for any
transaction, whether deemed a merger, consolidation, reorganization or otherwise
whereby the Fund issues shares in connection with the acquisition of assets
(including those subject to liabilities) from any other investment company or
similar entity. None of the foregoing provisions may be amended except by the
vote of at least two-thirds of the Common Shares and FundPreferred shares,
voting together as a single class. In the case of the conversion of the Fund to
an open-end investment company, or in the case of any of the foregoing
transactions constituting a plan of reorganization which adversely affects the
holders of FundPreferred shares, the action in question will also require the
affirmative vote of the holders of at least two-thirds of the Fund's
FundPreferred shares outstanding at the time, voting as a separate class, or, if
such action has been authorized by the affirmative vote of two-thirds of the
total number of trustees fixed in accordance with the Declaration or the Bylaws,
the affirmative vote of the holders of at least a majority of the Fund's
FundPreferred shares outstanding at the time, voting as a separate class. The
votes required to approve the conversion of the Fund from a closed-end to an
open-end investment company or to approve transactions constituting a plan of
reorganization which adversely affects the holders of FundPreferred shares are
higher than those required by the 1940 Act. The Board of Trustees believes that
the provisions of the Declaration relating to such higher votes are in the best
interest of the Fund and its shareholders.
Reference should be made to the Declaration on file with the Commission
for the full text of these provisions.
The Declaration provides that the obligations of the Fund are not
binding upon the trustees of the Fund individually, but only upon the assets and
property of the Fund, and that the trustees shall not be liable for errors of
judgment or mistakes of fact or law. Nothing in the Declaration, however,
protects a trustee against any liability to which he would otherwise be subject
by reason of willful misfeasance, bad faith, gross negligence or reckless
disregard of the duties involved in the conduct of his office.
REPURCHASE OF 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.
Instead, the Fund's Common Shares will trade in the open market at a price that
will be a function of several factors, including dividend levels (which are in
turn affected by expenses), net asset value, call protection, price, dividend
stability, relative demand for and supply of such shares in the market, general
market and economic conditions and other factors. Because shares of a closed-end
investment company may frequently trade at prices lower than net asset value,
the Fund's Board of Trustees has currently determined that, at least annually,
it will consider action that might be taken to reduce or eliminate any material
discount from net asset value in respect of Common Shares, which may include the
repurchase of such shares in the open market or in private transactions, the
making of a tender offer for such shares at net asset value, or the conversion
of the Fund to an open-end investment company. There can be no assurance,
however, that the Board of Trustees will decide to take any of these actions, or
that share repurchases or tender offers, if undertaken, will reduce market
discount.
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Notwithstanding the foregoing, at any time when the Fund's Preferred
shares, including FundPreferred shares, are outstanding, the Fund may not
purchase, redeem or otherwise acquire any of its Common Shares unless (1) all
accrued Preferred Shares, including FundPreferred shares, dividends have been
paid and (2) at the time of such purchase, redemption or acquisition, the net
asset value of the Fund's portfolio (determined after deducting the acquisition
price of the Common Shares) is at least 200% of the liquidation value of the
outstanding FundPreferred shares (expected to equal the original purchase price
per share plus any accrued and unpaid dividends thereon). The staff of the
Commission currently requires that any tender offer made by a closed-end
investment company for its shares must be at a price equal to the net asset
value of such shares on the close of business on the last day of the tender
offer. Any service fees incurred in connection with any tender offer made by the
Fund will be borne by the Fund and will not reduce the stated consideration to
be paid to tendering shareholders.
Subject to its investment limitations, the Fund may borrow to finance
the repurchase of shares or to make a tender offer. Interest on any borrowings
to finance share repurchase transactions or the accumulation of cash by the Fund
in anticipation of share repurchases or tenders will reduce the Fund's net
income. Any share repurchase, tender offer or borrowing that might be approved
by the Board of Trustees would have to comply with the Securities Exchange Act
of 1934, as amended, and the 1940 Act and the rules and regulations thereunder.
Although the decision to take action in response to a discount from net
asset value will be made by the Board of the Fund at the time it considers such
issue, it is the Board's present policy, which may be changed by the Board, not
to authorize repurchases of Common Shares or a tender offer for such shares if
(1) such transactions, if consummated, would (a) result in the delisting of the
Common Shares from the New York Stock Exchange, or (b) impair the Fund's status
as a regulated investment company under the Code (which would make the Fund a
taxable entity, causing the Fund's income to be taxed at the corporate level in
addition to the taxation of shareholders who receive dividends from the Fund) or
as a registered closed-end investment company under the 1940 Act; (2) the Fund
would not be able to liquidate portfolio securities in an orderly manner and
consistent with the Fund's investment objectives and policies in order to
repurchase shares; or (3) there is, in the Board's judgment, any (a) material
legal action or proceeding instituted or threatened challenging such
transactions or otherwise materially adversely affecting the Fund, (b) general
suspension of or limitation on prices for trading securities on the New York
Stock Exchange, (c) declaration of a banking moratorium by Federal or state
authorities or any suspension of payment by United States or state banks in
which the Fund invests, (d) material limitation affecting the Fund or the
issuers of its portfolio securities by Federal or state authorities on the
extension of credit by lending institutions or on the exchange of non-U.S.
currency, (e) commencement of war, armed hostilities or other international or
national calamity directly or indirectly involving the United States, or (f)
other event or condition which would have a material adverse effect (including
any adverse tax effect) on the Fund or its shareholders if shares were
repurchased. The Board of Trustees of the Fund may in the future modify these
conditions in light of experience.
Conversion to an open-end company would require the approval of the
holders of at least two-thirds of the Fund's Common Shares and FundPreferred
shares outstanding at the time, voting together as a single class, and of the
holders of at least two-thirds of the Fund's FundPreferred shares outstanding at
the time, voting as a separate class, provided however, that such separate class
vote shall be a majority vote if the action in question has previously been
approved, adopted or authorized by the affirmative vote of two-thirds of the
total number of trustees fixed in accordance with the Declaration or By-laws.
See the Prospectus under "Certain Provisions in the Declaration of Trust" for a
discussion of voting requirements applicable to conversion of the Fund to an
open-end company. If the Fund converted to an open-end company, it would be
required to redeem all FundPreferred shares then outstanding, and the Fund's
Common Shares 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
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certain circumstances as authorized by or under the 1940 Act) at their net asset
value, less such redemption charge, if any, as might be in effect at the time of
redemption. In order to avoid maintaining large cash positions or liquidating
favorable investments to meet redemptions, open-end companies typically engage
in a continuous offering of their shares. Open-end companies are thus subject to
periodic asset in-flows and out-flows that can complicate portfolio management.
The Board of Trustees of the Fund may at any time propose conversion of the Fund
to an open-end company depending upon their judgment as to the advisability of
such action in light of circumstances then prevailing.
The repurchase by the Fund of its shares at prices below net asset
value will result in an increase in the net asset value of those shares that
remain outstanding. However, there can be no assurance that share repurchases or
tenders at or below net asset value will result in the Fund's shares trading at
a price equal to their net asset value. Nevertheless, the fact that the Fund's
shares may be the subject of repurchase or tender offers at net asset value from
time to time, or that the Fund may be converted to an open-end company, may
reduce any spread between market price and net asset value that might otherwise
exist.
In addition, a purchase by the Fund of its Common Shares will decrease
the Fund's total assets 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 FundPreferred shares are outstanding will increase the leverage applicable
to the outstanding Common Shares then remaining. See the Fund's Prospectus under
"Risk Factors -- Concentration Risk" and "Risk Factors -- Leverage Risk."
Before deciding whether to take any action if the Fund's Common Shares
trade below net asset value, the Board of the Fund would consider all relevant
factors, including the extent and duration of the discount, the liquidity of the
Fund's portfolio, the impact of any action that might be taken on the Fund or
its shareholders and market considerations. Based on these considerations, even
if the Fund's shares should trade at a discount, the Board of Trustees may
determine that, in the interest of the Fund and its shareholders, no action
should be taken.
FEDERAL INCOME TAX MATTERS
The following is intended to be a general summary of certain federal
income tax consequences of investing in FundPreferred shares. It is not intended
to be a complete discussion of all such federal income tax consequences, nor
does it purport to deal with all categories of investors. INVESTORS ARE
THEREFORE ADVISED TO CONSULT WITH THEIR OWN TAX ADVISERS BEFORE MAKING AN
INVESTMENT IN THE FUND.
FEDERAL INCOME TAX TREATMENT OF THE FUND
The Fund intends to qualify for, and to elect to be treated as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code") and intends to qualify under those provisions each
year. To qualify as a regulated investment company, the Fund must, among other
things, (a) derive in each taxable year at least 90% of its gross income from
dividends, interest, payments with respect to securities loans and gains from
the sale or other disposition of stock, securities or foreign currencies, or
other income derived with respect to its business of investing in such stocks,
securities or currencies; and (b) diversify its holdings so that, at the end of
each quarter of its 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, with such other securities of any one issuer limited for the
purposes of this calculation to an amount not greater in value than 5% of the
value of the Fund's total assets and 10% of the outstanding voting securities of
such issuer and (ii) not more than 25% of the value of its total assets is
invested in the securities of any one issuer (other than U.S. Government
securities or securities of other regulated investment companies) or of
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two or more issuers controlled by the Fund and engaged in the same, similar or
related trades or businesses.
As a regulated investment company, in any taxable year with respect to
which the Fund distributes at least 90% of its investment company taxable
income (as that term is defined in the Code, without regard to the deduction for
dividends paid), the Fund (but not its shareholders) generally will be relieved
of U.S. federal income taxes on its investment company taxable income and net
capital gain (i.e., the Fund's net long-term capital gain in excess of the sum
of net short-term capital loss and capital loss carryovers from prior years) if
any, that it distributes to shareholders. However, the Fund will be subject to
federal income tax (currently imposed at a maximum effective rate of 35%) on any
undistributed investment company taxable income and net capital gain. The Fund
intends to distribute to its shareholders, at least annually, substantially all
of its investment company taxable income and net capital gain.
Amounts not distributed on a timely basis in accordance with a calendar
year distribution requirement are also subject to a nondeductible 4% federal
excise tax payable by the Fund. To prevent imposition of this tax, the Fund must
distribute, or be deemed to have distributed, during each calendar year an
amount equal to the sum of (1) at least 98% of its ordinary income (not taking
into account any capital gains or losses) for the calendar year, (2) at least
98% of its capital gains in excess of its capital losses (adjusted for certain
ordinary losses) for the twelve-month period ending on October 31 of the
calendar year, and (3) all such ordinary income and capital gains for previous
years that were not distributed during such years. For this purpose, any income
or gain retained by the Fund that is subject to corporate tax will be considered
to have been distributed by year-end. To prevent application of this excise tax,
the Fund intends to make distributions to satisfy the calendar year distribution
requirement. Compliance with the calendar year distribution requirement may
limit the extent to which the Fund will be able to retain its net capital gain
for investment.
If in any taxable year the Fund fails to qualify as a regulated
investment company under the Code, the Fund will be taxed in the same manner as
an ordinary corporation and distributions to its shareholders will not be
deductible by the Fund in computing its taxable income. In addition, in the
event of failure to qualify as a regulated investment company, the Fund's
distributions, to the extent derived from the Fund's current or accumulated
earnings and profits, will constitute dividends, which will generally be
eligible for the Dividends Received Deduction available to corporate
shareholders. Furthermore, in such event, noncorporate shareholders of the Fund
generally would generally be able to treat such distributions as "qualified
dividend income" eligible for reduced rates of federal income taxation in
taxable years beginning on or before December 31, 2008.
If the Fund does not meet the asset coverage requirements of the 1940
Act, the Fund will be required to suspend distributions to the holders of the
Common Shares and/or the FundPreferred shares until the asset coverage is
restored. See "Description of FundPreferred Shares -- Restrictions on Dividend,
Redemption and Other Payments" in the Prospectus. Such a suspension of
distributions might prevent the Fund from distributing 90% of its investment
company taxable income as is required in order to qualify for special tax
treatment as a regulated investment company or cause the Fund to incur a tax
liability, a non-deductible 4% federal excise tax on its undistributed taxable
income (including gain), or both.
Upon any failure to meet the asset coverage requirements of the 1940
Act, the Fund intends to repurchase or redeem (to the extent permitted under the
1940 Act) FundPreferred shares in order to maintain or restore the requisite
asset coverage and avoid failure to remain qualified as a regulated investment
company. The determination to repurchase or redeem FundPreferred shares and the
amounts to be repurchased or redeemed, if any, will be made in the sole
discretion of the Fund.
Use of the Fund's cash to repurchase or redeem FundPreferred shares may
adversely affect the Fund's ability to distribute annually at least 90% of its
investment company taxable income, which distribution is required to qualify for
taxation as a regulated investment company. The Fund may also recognize income
in connection with funding repurchases or redemptions of FundPreferred shares,
and such income would
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be taken into account in determining whether or not the above-described
distribution requirements have been met. Depending on the size of the Fund's
assets relative to its outstanding senior securities, redemption of
FundPreferred shares might restore asset coverage. Payment of distributions
after restoration of asset coverage could requalify (or avoid a disqualification
of) the Fund as a regulated investment company, depending upon the facts and
circumstances.
Investments of the Fund in securities issued at a discount (or treated
as if issued at a discount) or providing for deferred interest or payment of
interest in kind are subject to special tax rules that will affect the amount,
timing and character of distributions to shareholders. For example, with respect
to certain securities issued, or treated as if issued, at a discount, the Fund
will be required to accrue as income each year a portion of the discount and to
distribute such income each year in order to satisfy the 90% distribution
requirement and the distribution requirements for avoiding income and excise
taxes. In order to generate sufficient cash to make distributions necessary to
satisfy the 90% distribution requirement and to avoid income and excise taxes,
the Fund may have to borrow money or dispose of securities that it would
otherwise have continued to hold.
The Fund's transactions, if any, in forward contracts, options, futures
contracts and hedge investments will be subject to special provisions of the
Code that, among other things, may affect the character of gain and loss
realized by the Fund (i.e., may affect whether gain or loss is ordinary or
capital), accelerate recognition of income to the Fund, defer Fund losses, and
affect whether capital gain and loss is characterized as long-term or
short-term. These rules could therefore affect the character, amount and timing
of distributions to shareholders. These provisions also may require the Fund to
mark-to-market certain types of the positions in its portfolio (i.e., treat them
as if they were closed out), which may cause the Fund to recognize income
without receiving cash with which to make distributions in amounts necessary to
satisfy the distribution requirements for avoiding income and excise taxes. The
Fund will monitor its transactions, make the appropriate tax elections, and make
the appropriate entries in its books and records when it acquires any option,
futures contract, forward contract, or hedged investment in order to mitigate
the effect of these rules, prevent disqualification of the Fund as a regulated
investment company, and minimize the imposition of income and excise taxes.
The Fund may invest in preferred securities, convertible securities or
other securities the federal income tax treatment of which is uncertain or
subject to recharacterization by the Internal Revenue Service. To the extent the
tax treatment of such securities or income differs from the tax treatment
expected by the Fund, it could affect the timing or character of income
recognized by the Fund, requiring the Fund to purchase or sell securities, or
otherwise change its portfolio, in order to comply with the tax rules applicable
to regulated investment companies under the Code.
FEDERAL INCOME TAX TREATMENT OF HOLDERS OF FUNDPREFERRED SHARES
Under present law and based in part on the fact that there is no
express or implied agreement between or among a Broker-Dealer or any other
party, and the Fund or any owners of the FundPreferred shares, that the
Broker-Dealer or any other party will guarantee or otherwise arrange to ensure
that an owner of FundPreferred shares will be able to sell his or her shares,
the Fund is of the opinion that the FundPreferred shares will constitute stock
of the Fund for federal income tax purposes, and thus distributions with respect
to the FundPreferred shares (other than capital gain distributions and
distributions in redemption of the FundPreferred shares subject to Section
302(b) of the Code) will generally constitute dividends to the extent of the
Fund's current or accumulated earnings and profits, as calculated for federal
income tax purposes. The following discussion assumes such treatment will apply.
The Fund's income will consist of investment company taxable income and
may also consist of net capital gain. The character of the Fund's income will
not affect the amount of dividends to which the holders of the FundPreferred
shares are entitled. Holders of the FundPreferred shares are entitled to receive
only the amount of dividends as determined by periodic auctions. For federal
income tax purposes, however, the Internal Revenue Service currently requires
that a regulated investment company that has two or more classes of shares
allocate to each such class proportionate amounts of each type of its income
(such as ordinary income and net capital gain) for each tax year. Accordingly,
the Fund intends to designate dividends made with respect to the Common Shares
and the FundPreferred shares as consisting of particular types of income (i.e.,
net capital gain and ordinary income) in accordance with each class's
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proportionate share of the total dividends paid to both classes for such taxable
year. Thus, if the Fund designates any dividend as a capital gains dividend,
capital gains will be allocated to the FundPreferred shares in proportion to the
FundPreferred shares' proportionate share of the total dividends paid on both
the FundPreferred shares and the Common Shares during the year. Each holder of
the FundPreferred shares during the year will be notified of the allocation of
income within 60 days after the end of the year. The amount of the net capital
gain realized by the Fund may not be significant, and there is no assurance that
any such income will be realized by the Fund in any year. Distributions of the
Fund's investment company taxable income are, except in the case of capital
gains dividends, taxable to shareholders as ordinary income to the extent of the
Fund's current or accumulated earnings and profits, as calculated for federal
income tax purposes. Distributions designated by the Fund as derived from net
capital gain, if any, are taxable to shareholders at rates applicable to
long-term capital gains, regardless of the length of time the FundPreferred
shares have been held by holders. Distributions in excess of the Fund's earnings
and profits, if any, will first reduce a shareholder's adjusted tax basis in his
or her FundPreferred shares and, after the adjusted tax basis is reduced to
zero, will constitute capital gains to a holder of FundPreferred shares who
holds such shares as a capital asset. Earnings and profits are treated, for
federal income tax purposes, as first being used to pay distributions on the
FundPreferred shares, and then to the extent remaining, if any, to pay
distributions on the Common Shares.
Although the Fund is required to distribute annually at least 90% of
its investment company taxable income, the Fund is not required to distribute
net capital gain to the shareholders. The Fund may retain and reinvest such
gains and pay federal income taxes on such gains (the "net undistributed capital
gain"). However, it is unclear whether a portion of the net undistributed
capital gain would have to be allocated to the FundPreferred shares for federal
income tax purposes. Until and unless the Fund receives acceptable guidance from
the Internal Revenue Service as to the allocation of the net undistributed
capital gain between the Common Shares and the FundPreferred shares, the Fund
intends to distribute its net capital gain for any year during which it has
FundPreferred shares outstanding. Such distribution will affect the tax
character, but not the amount, of dividends to which holders of FundPreferred
shares are entitled.
Although dividends generally will be treated as distributed when paid,
dividends declared in October, November or December with a record date in such
months, and paid in January of the following year, will be treated as having
been distributed by the Fund and received by the shareholders on December 31 of
the year in which the dividend was declared. In addition, solely for the purpose
of satisfying the 90% distribution requirement and the distribution requirement
for avoiding income taxes, certain distributions made after the close of a
taxable year of the Fund may be "spilled back" and treated as paid during such
taxable year. In such case, shareholders will be treated as having received such
dividends in the taxable year in which the distribution was actually made. The
Internal Revenue Service has ruled privately that dividends paid following the
close of the taxable year that are treated for tax purposes as derived from
income from the prior year will be treated as dividends "paid" in the prior year
for purposes of determining the proportionate share of a particular type of
income for each class. Accordingly, the Fund intends to treat any such dividends
that are paid following the close of a taxable year as "paid" in the prior year
for purposes of determining a class's proportionate share of a particular type
of income. However, the private ruling is not binding on the Internal Revenue
Service, and there can be no assurance that the Internal Revenue Service will
respect such treatment.
Most of the Fund's net investment income is expected to be derived from
dividends from securities which are not eligible for the Dividends Received
Deduction or the reduced rates of federal income taxation for "qualified
dividend income." Accordingly, dividends paid with respect to the FundPreferred
shares generally will not qualify for the Dividends Received Deduction available
to corporate shareholders or the reduced rates of taxation for "qualified
dividend income" available to noncorporate shareholders. However, from time to
time, a portion of the Fund's net investment income may be attributable to
dividends on equity securities which are eligible for the Dividends Received
Deduction under Section 243 of the Code or which are considered "qualified
dividend income" under Section 1(h)(11) of the Code. In such event, corporate
shareholders who otherwise are eligible to claim the Dividends Received
Deduction under Section 243 of the Code should be able to deduct 70% of the
portion of the FundPreferred shares' dividend representing the shareholder's
portion of the Fund's income eligible for the Dividends Received Deduction. The
Internal Revenue Service has ruled that corporate shareholders
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of a regulated investment company must meet the 45-day holding requirements of
Section 246(c)(1)(A) of the Code with respect to the shares of the regulated
investment company to qualify for the Dividends Received Deduction. If a portion
of the Fund's net investment income is attributable to "qualified dividend
income," as such term is defined in Section 1(h)(11)(B) of the Code, then for
taxable years beginning on or before December 31, 2008, distributions of such
qualified dividend income by the Fund to noncorporate shareholders generally
will be taxed at the federal income tax rates applicable to net capital gain.
For such taxable years, the maximum federal income tax rate applicable to net
capital gain for noncorporate investors has been reduced to 15%.
The Fund will notify holders of FundPreferred shares of the source and
tax status of all distributions shortly after the close of each calendar year.
SALE OF SHARES
A holder's sale of FundPreferred shares will generally be a taxable
transaction for federal income tax purposes. Selling holders of such shares will
generally recognize gain or loss in an amount equal to the difference between
the amount received and their adjusted tax basis in the FundPreferred shares
sold. If such FundPreferred shares are held as a capital asset at the time of
sale, the gain or loss will generally be a capital gain or loss. Similarly, a
redemption (including a redemption by the Fund resulting from liquidation of the
Fund), if any, of all the FundPreferred shares actually and constructively held
by a shareholder generally will give rise to capital gain or loss under Section
302(b) of the Code if the shareholder does not own (and is not regarded under
certain federal income tax law rules of constructive ownership as owning) any
Common Shares in the Fund and provided that the redemption proceeds do not
represent declared but unpaid dividends. Other redemptions may also give rise to
capital gain or loss, if several conditions imposed by Section 302(b) of the
Code are satisfied. Any loss realized on a sale or exchange will be disallowed
to the extent the shares disposed of are reacquired within a period of 61 days
beginning 30 days before and ending 30 days after the disposition of the shares.
In such a case, the basis of the shares acquired will be adjusted to reflect the
disallowed loss. Any loss realized upon a taxable disposition of FundPreferred
shares held for six months or less will be treated as a long-term capital loss
to the extent of any distributions of net capital gain received (or deemed
received) with respect to such shares.
REGULATIONS ON "REPORTABLE TRANSACTIONS"
Under recently promulgated Treasury regulations, if a shareholder
recognizes a loss with respect to FundPreferred shares of $2 million or more in
a single taxable year (or $4 million or more in any combination of taxable
years) for shareholders who are individuals, S corporations or trusts, or $10
million or more in a single taxable year (or $20 million or more in any
combination of taxable years) for a corporate shareholder, the shareholder must
file with the Internal Revenue Service a disclosure statement on Form 8886.
Direct shareholders of portfolio securities are in many cases excepted from this
reporting requirement, but under current guidance, shareholders of a regulated
investment company are not excepted. Future guidance may extend the current
exception from this reporting requirement to shareholders of most or all
regulated investment companies. 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 advisors
to determine the applicability of these regulations in light of their individual
circumstances.
BACKUP WITHHOLDING
The Fund may be required to withhold for U.S. federal income purposes a
portion of all taxable distributions (including redemption proceeds) payable to
shareholders who fail to provide the Fund with their correct taxpayer
identification number or who fail to make required certifications, or if the
Fund or a shareholder has been notified by the Internal Revenue Service that the
shareholder is subject to backup withholding. Certain corporate shareholders and
other shareholders specified in the Code are exempt from such backup
withholding. 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 Internal Revenue
Service.
OTHER TAXATION
Foreign shareholders, including shareholders who are nonresident
aliens, may be subject to U.S. withholding tax on certain distributions at a
rate of 30%, or such lower rates as may be prescribed by any applicable treaty.
Investors are advised to consult their own tax advisors with respect to
the application of the above-described general federal income tax rules to their
own circumstances and with respect to other federal, state, local or foreign tax
consequences to them of an investment in FundPreferred shares.
S-50
EXPERTS
The audited Financial Statements of the Fund as of June 3, 2003,
appearing in this Statement of Additional Information have been audited by Ernst
& Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein, and is included in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing. Ernst &
Young LLP provides accounting and auditing services to the Fund. The principal
business address of Ernst & Young LLP is 233 South Wacker Drive, Chicago,
Illinois 60606.
CUSTODIAN, TRANSFER AGENT, AUCTION AGENT, DIVIDEND DISBURSING AGENT
AND REDEMPTION AGENT
The custodian of the assets of the Fund is State Street Bank and Trust
Company, One Federal Street, Boston, Massachusetts 02110. The custodian performs
custodial, fund accounting and portfolio accounting services. The Fund's
transfer, shareholder services and dividend paying agent is also State Street
Bank and Trust Company, One Federal Street, Boston, Massachusetts 02110. The
Bank of New York is the Auction Agent with respect to the FundPreferred shares
and acts as transfer agent, registrar, dividend disbursing agent and redemption
agent with respect to the FundPreferred shares.
ADDITIONAL INFORMATION
A Registration Statement on Form N-2, including amendments thereto,
relating to the shares of the Fund offered hereby, has been filed by the Fund
with the Commission, 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 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 Commission's
principal office in Washington, D.C., and copies of all or any part thereof may
be obtained from the Commission upon the payment of certain fees prescribed by
the Commission.
S-51
REPORT OF INDEPENDENT AUDITORS
The Board of Trustees and Shareholder of
Nuveen Preferred and Convertible Income Fund 2
We have audited the accompanying statement of assets and liabilities of Nuveen
Preferred and Convertible Income Fund 2 (the "Fund") as of June 3, 2003 and the
related statement of operations for the period from March 17, 2003 (date of
organization) through June 3, 2003. These financial statements are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Fund at June 3, 2003,
and the results of its operations for the period from March 17, 2003 (date of
organization) through June 3, 2003, in conformity with accounting
principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
Chicago, Illinois
June 4, 2003
F-1
NUVEEN PREFERRED AND CONVERTIBLE INCOME FUND 2
FINANCIAL STATEMENTS
Nuveen Preferred and Convertible Income Fund 2
Statement of Assets and Liabilities
June 3, 2003
Assets:
Cash.............................................................. $ 100,275
Offering costs.................................................... 1,330,000
Receivable from Adviser........................................... 11,500
----------
Total assets................................................... 1,441,775
----------
Liabilities:
Accrued offering costs............................................ 1,330,000
Payable for organization costs.................................... 11,500
----------
Total liabilities.............................................. 1,341,500
----------
FundPreferred shares, $25,000 liquidation value; unlimited number of
shares authorized, no shares outstanding.......................... -
----------
Net assets applicable to Common shares............................... $ 100,275
==========
Net asset value per Common share outstanding ($100,275 divided
by 7,000 Common shares outstanding)............................... $ 14.325
==========
Net assets applicable to Common shares represent:
Common shares, $.01 par value; unlimited number of shares
authorized, 7,000 shares outstanding........................... $ 70
Paid-in surplus................................................... 100,205
----------
$ 100,275
==========
F-2
NUVEEN PREFERRED AND CONVERTIBLE INCOME FUND 2
Statement of Operations
Period from March 17, 2003 (date of organization) through June 3, 2003
Investment income.................................................. $ --
--------
Expenses:
Organization costs................................................ $ 11,500
Expense reimbursement............................................. (11,500)
--------
Total expenses.................................................. --
--------
Net investment income.............................................. $ --
========
Note 1: Organization
The Fund was organized as a Massachusetts business trust on March 17, 2003,
and has been inactive since that date except for matters relating to its
organization and registration as a diversified, closed-end management
investment company under the Investment Company Act of 1940, as amended, and the
Securities Act of 1933, as amended, and the sale of 7,000 Common shares to
Nuveen Institutional Advisory Corp., the Fund's investment adviser (the
"Adviser"), a wholly owned subsidiary of Nuveen Investments, Inc.
Nuveen Investments, LLC, also a wholly owned subsidiary of Nuveen Investments,
Inc. has agreed to reimburse all organization expenses (approximately $11,500)
and pay all Common share offering costs (other than the sales load) that exceed
$.03 per Common share.
The Fund's primary investment objective is high current income.
The Fund is authorized by its Declaration of Trust to issue FundPreferred shares
having a liquidation value of $25,000 per share in one or more classes or
series, with dividend, liquidation preference and other rights as determined by
the Fund's Board of Trustees without approval of the Common shareholders.
Note 2: Significant Accounting Policies
The Fund's financial statements are prepared in accordance with accounting
principles generally accepted in the United States which require the use of
management estimates. Actual results may differ from those estimates.
The Fund's share of Common share offering costs will be recorded as a reduction
of the proceeds from the sale of Common shares upon the commencement of Fund
operations. If the Fund offers FundPreferred shares, the offering costs will be
borne by Common shareholders as a direct reduction to paid-in capital.
Note 3: Investment Management Agreement
Pursuant to an investment management agreement between the Adviser and the Fund,
the Fund has agreed to pay a management fee, payable on a monthly basis, at an
annual rate ranging from 0.9000% of the first $500 million of the average daily
net assets (including net assets attributable to FundPreferred shares and the
principal amount of borrowings ("Managed Assets")) to 0.8000% of the average
daily Managed Assets in excess of $2 billion.
In addition to the reimbursement and waiver of organization and Common share
offering costs discussed in Note 1, the Adviser has contractually agreed to
reimburse the Fund for fees and expenses in the amount of .32% of average daily
Managed Assets for the first 5 full years of the Fund's operations, .24% in year
6, .16% in year 7 and .08% in year 8. The Adviser has not agreed to reimburse
the Fund for any portion of its fees and expenses beyond June 30, 2011.
Note 4: Income Taxes
The Fund intends to comply with the requirements of the Internal Revenue Code
applicable to regulated investment companies and to distribute all of its net
investment income, in addition to any realized capital gains from investment
transactions.
F-3
STATEMENT OF ASSETS AND LIABILITIES (UNAUDITED)
July 17, 2003
ASSETS
Investments, at market value (cost $2,096,715,444) $2,070,897,348
Cash 1,356
Receivables:
Dividend 246,013
Interest 7,298,350
Investments sold 2,121,793
--------------
Total assets 2,080,564,860
--------------
LIABILITIES
Payable for investments purchased 170,403,216
Accrued expenses:
Management fees 488,630
Organization and offering costs 1,575,823
Other 85,818
--------------
Total liabilities 172,553,487
--------------
Net assets applicable to Common shares $1,908,011,373
==============
Common shares outstanding 135,007,000
==============
Net asset value per Common share outstanding (net assets
applicable to Common shares, divided by Common shares
outstanding) $ 14.13
==============
NET ASSETS APPLICABLE TO COMMON SHARES CONSIST OF:
Common shares, $.01 par value per share $ 1,350,070
Paid-in surplus 1,931,060,882
Undistributed net investment income 1,417,484
Accumulated net realized gain from investment transactions 1,033
Net unrealized appreciation (depreciation) of investments (25,818,096)
--------------
Net assets $1,908,011,373
==============
Authorized shares:
Common Unlimited
FundPreferred shares Unlimited
==============
See accompanying notes to financial statements.
F-4
STATEMENT OF OPERATIONS (UNAUDITED)
For the Period June 30, 2003 (commencement of operations) through
July 17, 2003
INVESTMENT INCOME
Dividends $ 320,406
Interest 1,700,922
------------
Total investment income 2,021,328
------------
EXPENSES
Management fees 821,891
Shareholders' servicing agent fees and expenses 888
Custodian's fees and expenses 18,838
Trustees fees and expenses 2,959
Professional fees 9,708
Shareholders' reports - printing and mailing expenses 46,565
Investor relations expense 7,443
------------
Total expenses before expense reimbursement 908,292
Expense reimbursement (304,448)
------------
Net expenses 603,844
------------
Net investment income 1,417,484
------------
REALIZED AND UNREALIZED GAIN (LOSS) FROM INVESTMENTS
Net realized gain from investments 1,033
Change in net unrealized appreciation (depreciation)
of investments (25,818,096)
------------
Net gain (loss) from investments (25,817,063)
------------
Net increase (decrease) in net assets applicable to
Common shares from operations $(24,399,579)
============
See accompanying notes to financial statements.
F-5
STATEMENT OF CHANGES IN NET ASSETS (UNAUDITED)
For the Period June 30, 2003 (commencement of operations) through
July 17, 2003
OPERATIONS
Net investment income $ 1,417,484
Net realized gain from investments 1,033
Change in net unrealized appreciation (depreciation)
of investments (25,818,096)
--------------
Net increase (decrease) in net assets applicable to
Common shares from operations (24,399,579)
--------------
CAPITAL SHARE TRANSACTIONS
Net proceeds from sale of Common shares 1,932,310,677
--------------
Net increase in net assets applicable to Common shares 1,907,911,098
Net assets applicable to Common shares at the
beginning of period 100,275
--------------
Net assets applicable to Common shares at the end of period $1,908,011,373
==============
Undistributed net investment income at the end of period $ 1,417,484
==============
See accompanying notes to financial statements.
F-6
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING POLICIES
Nuveen Preferred and Convertible Income Fund 2 (the "Fund") is a diversified,
closed-ended management investment company registered under the Investment
Company Act of 1940, as amended. The Fund's Common shares are listed on the New
York Stock Exchange and trade under the ticker symbol "JQC." The Fund was
organized as a Massachusetts business trust on March 17, 2003.
Prior to the commencement of operations, the Fund had no operations other than
those related to organizational matters, the initial capital contribution of
$100,275 by Nuveen Institutional Advisory Corp. (the "Adviser"), a wholly owned
subsidiary of Nuveen Investments, Inc., and the recording of the organization
expenses ($11,500) and their reimbursement by Nuveen Investments, LLC, also a
wholly owned subsidiary of Nuveen Investments, Inc.
The Fund seeks to provide high current income by investing primarily in a
portfolio of preferred securities, convertible securities, other debt securities
and common stocks acquired upon conversion of a convertible security.
The following is a summary of significant accounting policies followed by the
Fund in the preparation of its financial statements in accordance with
accounting principles generally accepted in the United States.
Securities Valuation
Securities are valued at the last sales price on the securities exchange or
Nasdaq on which such securities are primarily traded. Securities traded on a
securities exchange or Nasdaq for which there are no transactions on a given day
or securities not listed on a securities exchange or Nasdaq are valued at the
mean of the closing bid and asked price. The Fund prices securities traded on
Nasdaq at the Nasdaq Official Closing Price. The prices of fixed-income
securities are provided by a pricing service approved by the Fund's Board of
Trustees and based on the mean between the bid and asked price. When price
quotes are not readily available, the pricing service establishes fair market
value based on prices of comparable securities. If it is determined that market
prices for a security are unavailable or inappropriate, the Board of Trustees of
the Fund, or its designee, may establish a fair value for the security.
Short-term securities are valued at amortized cost, which approximates market
value.
Securities Transactions
Securities transactions are recorded on a trade date basis. Realized gains and
losses from such transactions are determined on the specific identification
method. Securities purchased or sold on a when-issued or delayed delivery basis
may have extended settlement periods. The securities so purchased are subject to
market fluctuation during this period. The Funds have instructed the custodian
to segregate assets with a current value at least equal to the amount of the
when-issued and delayed delivery purchase commitments. At July 17, 2003, the
Fund had outstanding when-issued purchase commitments of $30,119,250.
Investment Income
Dividend income is recorded on the ex-dividend date. Interest income, which
includes the amortization of premiums and accretion of discounts for financial
reporting purposes, is recorded on an accrual basis.
F-7
Income Taxes
The Fund intends to comply with the requirements of the Internal Revenue Code
applicable to regulated investment companies and to distribute substantially
all of its net investment income to its shareholders. Therefore, no federal
income tax provision is required.
Dividends and Distributions to Common Shareholders
Dividends from net investment income are declared monthly. Net realized capital
gains from investment transactions, if any, are distributed to shareholders not
less frequently than annually. Furthermore, capital gains are distributed only
to the extent they exceed available capital loss carryforwards.
Distributions to Common shareholders of net investment income and net realized
capital gains, if any, are recorded on the ex-dividend date. The amount and
timing of distributions are determined in accordance with federal income tax
regulations, which may differ from accounting principles generally accepted in
the United States.
Interest Rate Swap Transactions
The Fund is authorized to enter into hedging transactions, including interest
rate swap transactions. The Fund will use interest rate swaps with the intent to
reduce or eliminate the risk that an increase in short-term interest rates could
have on Common share net earnings as a result of leverage. 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 is intended to approximate the Fund's variable rate payment obligation on
FundPreferred shares or any variable rate borrowing. The payment obligation is
based on the notional amount of the swap. Interest rate swaps do not involve the
delivery of securities or other underlying assets or principal. Accordingly, the
risk of credit loss with respect to interest rate swaps is limited to the net
amount of interest payments that the Fund is to receive. The Fund has instructed
the custodian to segregate assets with a current value at least equal to the
amount of the net payment obligations under any interest rate swap transactions.
Interest rate swap positions are marked to market daily. Although there are
economic advantages of entering into interest rate swap transactions, there are
also additional risks. The Fund helps manage the credit risks associated with
interest rate swap transactions by entering into agreements only with firms the
Adviser believes has the financial resources to honor its obligations, by having
the Adviser continually monitor the financial stability of that swap
counterparty.
For the period June 30, 2003 (commencement of operations) through July
17, 2003, the Fund did not enter into any interest rate swap transactions.
F-8
Repurchase Agreements
In connection with transactions in repurchase agreements, it is the Fund's
policy that its custodian take possession of the underlying collateral
securities, the fair value of which exceeds the principal amount of the
repurchase transaction, including accrued interest, at all times. If the seller
defaults, and the fair value of the collateral declines, realization of the
collateral may be delayed or limited.
Custodian Fee Credit
The Fund has an arrangement with the custodian bank whereby certain custodian
fees and expenses are reduced by credits earned on the Fund's cash on deposit
with the bank. Such deposit arrangements are an alternative to overnight
investments. During the period June 30, 2003 (commencement of operations)
through July 17, 2003, no such credit was recorded.
Organization and Offering Costs
Nuveen Investments, LLC has agreed to reimburse all organization expenses
(approximately $11,500) and pay all Common share offering costs (other than the
sales load) that exceed $.03 per Common share. The Fund's share of offering
costs ($1,564,323) was recorded as a reduction of the proceeds from the sale of
Common shares.
If the Fund offers FundPreferred shares, the offering costs will be borne by
Common shareholders as a direct reduction to paid-in surplus.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of increases and
decreases in net assets applicable to Common shares from operations during the
reporting period. Actual results may differ from those estimates.
2. FUND SHARES
The Fund sold 135,000,000 Common shares during the period June 30, 2003
(commencement of operations) through July 17, 2003.
3. SECURITIES TRANSACTIONS
Purchases and sales of investment securities (excluding short-term investments)
and U.S. Government and agency obligations (excluding short-term investments)
for the period June 30, 2003 (commencement of operations) through July 17, 2003,
were as follows:
----------------------------------------------------------------
Purchases:
Investment securities $1,401,537,653
U.S. Government and agency obligations 214,916,016
Sales:
Investment securities 2,109,654
U.S. Government and agency obligations --
================================================================
4. INCOME TAX INFORMATION
The following information is presented on an income tax basis. Differences
between amounts for financial statement and federal income tax purposes are
primarily due to recognition of premium amortization and timing differences in
recognizing certain gains and losses on security transactions.
--------------------------------------------------------------------------------
Cost of investments $2,096,765,586
================================================================================
--------------------------------------------------------------------------------
Gross unrealized:
Appreciation $ 3,607,440
Depreciation (29,475,678)
--------------------------------------------------------------------------------
Net unrealized appreciation (depreciation) on investments $(25,868,238)
================================================================================
The Fund made no distributions during the period June 30, 2003 (commencement
of operations) through July 17, 2003.
5. MANAGEMENT FEE AND OTHER TRANSACTIONS WITH AFFILIATES
Under the Fund's investment management agreement with the Adviser, the Fund pays
an annual management fee, payable monthly, at the rates set forth below, which
are based upon the average daily managed assets of the Fund. "Managed Assets"
means the average daily net assets of the Fund including assets attributable to
FundPreferred shares and the principal amount of borrowings.
AVERAGE DAILY MANAGED ASSETS MANAGEMENT FEE
-----------------------------------------------------------------------------------------------------
For the first $500 million .9000%
For the next $500 million .8750
For the next $500 million .8500
For the next $500 million .8250
For Managed Assets over $2 billion .8000
======================================================================================================
The management fee compensates the Adviser for overall investment advisory and
administrative services and general office facilities. The Adviser has entered
into Sub-Advisory Agreements with Spectrum Asset Management, Inc. ("Spectrum"),
and Froley, Revy Investment Co., Inc. (Froley, Revy). Spectrum manages the
portion of the Fund's investment portfolio allocated to preferred securities
while Froley, Revy manages the portion of the investment portfolio allocated to
convertible securities. Spectrum and Froley, Revy are compensated for their
services to the Fund from the management fee paid to the Adviser. The Adviser
manages the portion of the investment portfolio allocated to other debt
securities.
F-9
For the first eight years of the Fund's operations, the Advisers have agreed to
reimburse the Fund for fees and expenses in the amounts, and for the time
periods, set forth below:
PERCENTAGE PERCENTAGE
REIMBURSED REIMBURSED
(AS A PERCENTAGE (AS A PERCENTAGE
YEAR ENDING OF AVERAGE DAILY YEAR ENDING OF AVERAGE DAILY
JUNE 30, MANAGED ASSETS) JUNE 30, MANAGED ASSETS)
------------- ----------------- ------------- -----------------
2003*........................ .32% 2008 ................ .32%
2004 ........................ .32 2009 ................ .24
2005 ........................ .32 2010 ................ .16
2006 ........................ .32 2011 ................ .08
2007 ........................ .32
---------------
* From the commencement of operations.
The Advisers have not agreed to reimburse the Fund for any portion of its fees
and expenses beyond June 30, 2011.
The Fund pays no compensation directly to those of its Trustees who are
affiliated with the Advisers or to its officers, all of whom receive
remuneration for their services to the Fund from the Advisers.
6. SUBSEQUENT EVENT
On July 22, 2003, the Fund issued an additional 6,000,000 Common shares in
connection with the exercise by the underwriters of the over-allotment option.
F-10
Portfolio of Investments (Unaudited)
Nuveen Preferred and Convertible Income Fund 2 (JQC)
July 17, 2003
Market
Shares Description (1) Value
---------------------------------------------------------------------------------------------------------------------------
$25 PAR PREFERRED SECURITIES - 22.6% (21.0% OF TOTAL INVESTMENTS)
AUTO - FOREIGN - 0.0%
1,400 Magna International Inc., Series B, 8.875% $ 36,890
BANKING - 7.4%
56,200 Associates Bank Corp. Capital Trust I, 7.625% 1,523,020
306,984 Bank of New York Capital V, 5.950% 7,785,114
61,700 Bank One Capital VI, 7.200% 1,659,730
302,800 BankAmerica Capital Trust II, 7.000% 8,160,460
84,010 BankAmerica Capital Trust I, 7.000% 2,230,466
60,000 BankAmerica Capital Trust IV, 5.875% 1,527,600
61,100 BankAmerica Capital Trust III, 7.000% 1,664,364
800 Chittenden Bank Capital Trust I, 8.000% 21,448
678,600 Citigroup Capital IX, 6.000% 17,229,654
5,000 Citigroup Capital VI, 6.875% 127,750
157,800 Citigroup Capital VIII, 6.950% 4,165,920
128,700 Citigroup Capital VII, 7.125% 3,449,160
25,700 Comerica Corp. Capital, 7.600% 693,900
73,800 Compass Bank Trust III, 7.350% 1,972,674
5,500 First Union Institutional Capital I, 8.200% (CORTS) 158,950
7,000 First Union Capital I, 7.500% (CORTS) 187,670
294,400 Fleet Capital Trust VII, 7.200% 7,801,600
329,600 Fleet Capital Trust VIII, 7.200% 8,790,432
392,700 JP Morgan Chase Capital XI, 5.875% 9,719,325
436,100 JP Morgan Chase Capital X, 7.000% 11,587,177
4,600 JPMorgan Capital Trust I, 7.125% (PCARS) 121,762
15,500 JPMorgan Chase, 7.125% (SATURNS) 407,805
13,900 JPMorgan Chase, 7.200% (CBTCS) 369,879
3,900 Keycorp, 7.750% (CBTCS) 104,442
2,000 Keycorp, Series 2001-3, 8.250% (CORTS) 53,900
144,600 Keycorp Capital V, 5.875% 3,535,470
10,900 National Commerce Capital Trust II, 7.700% 295,717
11,000 Old National Bancorp Capital Trust II, 8.000% 302,720
27,500 Suntrust Capital V, 7.050% 743,875
1,000 Suntrust Capital IV, 7.125% 27,280
245,200 U S Bancorp Capital IV, 7.350% 6,657,180
568,600 U S Bancorp Capital III, 7.750% 15,556,896
202,400 U S Bancorp Capital V, 7.250% 5,424,320
19,600 Valley National Bank Capital Trust I, 7.750% 527,240
8,700 Washington Mutual, 7.650% (CORTS) 233,160
311,550 Wells Fargo Capital VII, 5.850% 7,832,367
56,100 Wells Fargo Capital VI, 6.950% 1,506,285
314,900 Wells Fargo Capital IV, 7.000% 8,533,790
15,200 Zion Capital Trust B, 8.000% 413,440
BANKING - FOREIGN - 3.1%
1,615,170 ABN Amro Capital Funding Trust V, 5.900% 40,104,671
77,000 ABN Amro Capital Funding Trust II, 7.125% 1,967,350
10,000 ANZ Exchangeable Preferred Trust II, 8.080% 253,000
4,400 BBVA Preferred Capital Ltd., 7.750% 123,992
11,000 Banco Totta & Acores Financing, Series A, 8.875% 304,810
1,000 BCH Capital Ltd., Series B, 9.430% 27,500
100 BSCH Finance Ltd., Series H, 7.790% 2,515
3,800 BSCH Finance Ltd., Series G, 8.125% 98,800
6,500 BSCH Finance Ltd., Series F, 8.125% 168,870
26,900 BSCH Finance Ltd., Series Q, 8.625% 735,715
6,000 BSCH Finance Ltd., Series J, 7.350% 151,080
5,000 Espirito Santo Overseas Ltd., Series B, 8.500% 134,900
5,800 NAB Exchangeable Preferred Trust, 8.000% 146,740
5,000 National Westminster Bank plc, 7.875% 127,200
598,700 Royal Bank of Scotland Group plc, 5.750% 14,578,345
BROKERAGE - 2.8%
10,300 Bear Stearns Capital Trust III, 7.800% 285,104
270,600 Bear Stearns Company, Series G, 5.490% (a) 13,611,180
12,000 Goldman Sachs, 6.000% (PPLUS) 309,600
8,000 Goldman Sachs, 6.000% (SATURN) 204,800
198,550 Lehman Brothers Holdings Inc., 5.940% (a) 10,622,425
122,500 Lehman Brothers Holdings Inc., 5.670% (a) 6,308,750
133,100 Merrill Lynch Preferred Capital Trust III, 7.000% 3,588,376
79,300 Merrill Lynch Preferred Capital Trust IV, 7.120% 2,149,030
91,500 Merrill Lynch Preferred Capital Trust V, 7.280% 2,490,630
5,400 Merrill Lynch Preferred Capital Trust I, 7.750% 150,390
48,100 Merrill Lynch Preferred Capital Trust II, 8.000% 1,356,420
12,000 Morgan Stanley Trust 1, 7.050% (PPLUS) 321,000
132,400 Morgan Stanley Capital Trust IV, 6.250% 3,365,608
91,500 Morgan Stanley Capital Trust V, 5.750% 2,260,050
233,200 Morgan Stanley Capital Trust III, 6.250% 5,913,952
14,200 Morgan Stanley Capital Trust II, 7.250% 373,460
COMPUTER - 0.0%
5,600 IBM, Series 2001-1, 7.125% (SATURNS) 150,136
ENERGY - FOREIGN - 0.0%
1,700 Talisman Energy Inc. (TLM B), 8.900% 44,914
FINANCIAL - 0.9%
3,700 CIT Capital Trust I, 7.750% (CORTS) 103,119
18,500 Countrywide Trust II, 8.000% (CORTS) 496,910
5,000 Countrywide Trust I, 8.050% (PPLUS) 134,800
496,700 Countrywide Capital IV, 6.750% 12,665,850
14,000 General Electric Capital Corp., 6.625% 371,000
20,000 Household Finance Corp., 6.875% 528,000
76,700 Household Capital Trust VII, Series V, 7.500% 2,076,269
3,600 Household Capital Trust VI, Series F, 8.250% 100,260
38,000 Philadelphia Authority, Series 99C, 6.550% 967,860
FINANCIAL - FOREIGN - 1.2%
2,900 Credit Suisse First Boston Trust, 7.000% (SATURNS) 77,140
490,975 ING Group NV (IND), 7.050% 12,937,191
232,320 ING Group NV (INZ), 7.200% 6,200,621
105,000 ING Capital Funding Trust I, 7.700% 2,745,750
2,000 Swedish Export Credit Corp., 7.375% 50,800
FOOD - FOREIGN - 0.0%
800 Grand Met. De Ltd. Partnership, 9.420% 22,064
GAS - 0.0%
400 AGL Capital Trust II, 8.000% 11,000
5,000 Dominion CNG, 7.800% 137,750
28,700 MCN Financing, 8.625% 737,590
INDUSTRIAL - 0.0%
7,900 Sherwin Williams Trust III, 7.250% (CORTS) 216,855
INSURANCE - FINANCIAL - 0.3%
5,000 AMBAC Financial Group Inc., 5.875% 126,400
157,100 AMBAC Financial Group Inc., 5.950% 3,990,340
1,000 Financial Security Assurance Holdings Ltd., Series H, 6.875% 26,900
34,000 Nationwide Financial Services Capital Trust II, 7.100% 867,000
53,000 WR Berkley, 8.125% (CBTCS) 574,520
INSURANCE - LIFE - 0.8%
148,700 Aetna Inc., 8.500% 4,074,380
426,867 Delphi Financial Group Inc., 8.000% 11,290,632
1,000 Lincoln National Capital V, series E, 7.650% 27,110
4,800 Protective Life Company Capital Trust IV, 7.250% 129,456
5,100 Protective Life Company Capital Trust III, 7.500% 136,476
4,000 Torchmark Capital Trust I, 7.750% 110,000
INSURANCE - MULTI LINE - 0.1%
2,700 American General Institutional Capital A, Series 2002-11, 6.000% (SATURNS) 69,498
1,100 Hartford Capital I, Series A, 7.200% 27,775
70,700 Hartford Life Capital III, Series C, 7.450% 1,885,569
1,500 Safeco Capital Trust III, 8.072% (CORTS) 39,150
2,700 Safeco Capital Trust II, 8.700% (CORTS) 72,644
1,200 Safeco Capital Trust I, 8.750% (CORTS) 34,800
500 Safeco, Series 2001-7, 8.250% (SATURNS) 13,280
INSURANCE - P&C - 1.6%
291,500 Ace Ltd., 7.800% 7,374,950
17,100 Everest RE Capital Trust, 7.850% 477,945
220,100 Converium Finance SA, 8.250% 5,971,313
4,300 PartnerRe Ltd. Capital Trust I, 7.900% 116,788
467,502 PartnerRe Ltd., 6.750% 11,968,051
77,500 RenaissanceRe Holdings, Series B, 7.300% 2,065,375
23,000 RenaissanceRe Holdings, Series A, 8.100% 629,050
53,300 XL Capital Ltd., Series B, 7.625% 1,471,080
15,500 XL Capital Ltd., Series A, 8.000% 430,900
PAPER - 0.0%
6,800 International Paper Capital Trust III, 7.875% 172,652
PHARMACEUTICALS - FOREIGN - 0.0%
2,400 Rhone-Poulenc Overseas, Series A, 8.125% 60,744
REAL ESTATE INVESTMENT TRUSTS - 4.1%
266,555 AMB Property Corp., Series L, 6.500% 6,577,245
20,200 Avalonbay Communities Inc., Series H, 8.700% 587,820
1,300 BRE Properties Inc., Series B, 8.080% 35,334
1,120,000 Developers Diversified Realty, 7.375% (WI, settling 7/28/03) 27,697,600
6,500 Developers Diversified Realty, 8.000% 169,780
16,000 Equity Office Properties Trust, 7.750% 437,760
200 Equity Residential Properties, Series B, 9.125% 5,628
444,539 Equity Residential Properties, Series N, 6.480% 11,104,584
54,300 Gables Residential Trust, 7.500% 1,387,908
20,100 HRPT Properties Trust, Series A, 9.875% 557,976
5,500 HRPT Properties Trust, Series B, 8.750% 150,700
8,300 New Plan Excel Realty Trust Inc., Series E, 7.625% 224,183
19,000 Public Storage Inc., Series T, 7.625% 511,100
20,200 Public Storage Inc., Series U, 7.625% 546,006
1,000 Public Storage Inc., Series V, 7.500% 27,250
12,700 Public Storage Inc., Series S, 7.875% 342,138
39,400 Public Storage Inc., Series R, 8.000% 1,063,800
9,000 Regency Centers Corp., 7.450% 236,250
960,570 Wachovia Bank Preferred Funding Corp., Series A, 7.250% 26,607,789
TELECOM - 0.2%
30,200 AT&T Wireless, 8.000% (CBTCS) 799,092
10,400 AT&T Wireless Services, Series 2002-8, 9.250% (SATURNS) 291,512
6,900 Bell South Capital Funding, Series 2001-3, 7.125% (SATURNS) 182,988
9,200 Bell South, 7.000% (CBTCS) 246,514
4,300 Bell South Capital I, 7.120% (CORTS) 113,563
5,600 Citizens Communications, Series 2001-2, 8.625% (SATURNS) 151,480
5,700 Citizens Communications, 8.375% (PPLUS) 147,972
5,400 Deutsche Telekom, 7.875% (CBTCS) 140,940
5,000 SBC Communications Inc., 7.000% 133,200
23,000 Telephone & Data Systems Inc., Series A, 7.600% 617,550
200 Telephone & Data Systems Capital II, 8.040% 5,032
5,000 U S Cellular Corp., 8.750% 144,500
2,600 Verizon Global Funding Corp., Series VZ, 7.625% (CORTS) 71,110
1,000 Verizon Global Funding Corp., 7.375% (CORTS) 26,850
23,000 Verizon New England Inc., 7.000% 626,980
UTILITY - 0.1%
16,000 Energy East Capital Trust I, 8.250% 437,920
27,000 Virginia Power Capital Trust II, 7.375% 744,930
13,000 Wisconsin Energy Corp. Capital Trust I, 6.850% 329,940
Total $25 Par Preferred Securities (cost $438,684,082) 433,870,676
CONVERTIBLE PREFERRED SECURITIES - 8.4% (7.7% OF TOTAL INVESTMENTS)
AEROSPACE & DEFENSE - 0.1%
28,000 Northrop Grumman Corp., Convertible Equity Units, 7.250%, 11/16/04 2,821,000
AUTO - 0.2%
103,400 Ford Motor Co. Capital Trust II, Convertible Preferred, 6.500% 4,466,880
BANKING - 0.5%
71,250 Citigroup Global Markets Holdings / Regency Convertible Exchangeable, 2.000% (DECS) 2,493,750
138,200 Washington Mutual Inc., Unit 1 Trust, Convertible Income Equity, 5.375% (PIERS) 7,704,650
BROADCASTING & CABLE TV - 0.4%
204,000 Equity Securities Trust I / Cablevision Systems Corp., 6.500% 4,777,680
60,000 Sinclair Broadcast Group, Convertible Preferred, Series D, 6.000% 2,715,000
COMPUTER - 0.1%
51,800 Pioneer Standard Financial Trust, Convertible Preferred, 6.750% 2,318,050
ENTERTAINMENT - 0.3%
112,000 Emmis Corp., Convertible Preferred, 6.250% 4,865,280
ENVIRONMENTAL SERVICES - 0.1%
18,400 Allied Waste North America Inc., Senior Mandatory Convertible Equity Units, 6.250%,
4/01/06 1,236,112
FINANCIAL - 0.8%
304,000 Gabelli Asset Management, Convertible, 6.950%, 2/17/05 (FELINE PRIDES) 7,654,720
143,225 Prudential Financial Inc., Convertible Equity Units, 6.750%, 11/15/04 8,328,534
GAS - 0.7%
107,500 Dominion Resources Inc., Convertible (II), 8.750% (DECS) 5,611,500
265,000 Sempra Energy, Convertible Equity Units, 8.500% 7,115,250
INDUSTRIAL - 0.6%
180,000 Cendant Corp., Convertible Upper, 7.750%, 8/17/04 (DECS) 8,037,000
98,000 Teekay Shipping Corp., Convertible Equity Units, 7.250% 2,866,500
INSURANCE - LIFE - 0.8%
86,500 Anthem Inc., Convertible Equity Units, 6.000%, 11/15/04 7,914,750
146,500 Reinsurance Group America Inc. Trust I, Convertible Equity Units, 5.750% 8,058,965
INSURANCE - PROPERTY & CASUALTY - 0.3%
104,000 Partnerre Capital Trust I, Convertible, Series T, 8.000% (PEPS) 5,464,160
IT CONSULTING & SERVICES - 0.0%
41,000 Electronic Data Systems, Convertible, 7.625% (PRIDES) 940,950
MEDICAL PRODUCTS - 0.4%
166,000 Baxter International Inc., Convertible Equity Units, 7.000% 7,959,700
REAL ESTATE INVESTMENT TRUSTS - 0.7%
49,800 Equity Office Properties Trust, Convertible Preferred, 5.250%, 2/15/08 2,480,040
229,000 Equity Residential Properties, Convertible Preferred, Series G, 7.250% 5,839,500
119,000 Host Marriott Financial Trust, 6.750% (QUIPS) 4,998,000
RETAIL - 0.6%
170,000 Newell Financial Trust, 5.250% (QUIPS) 8,117,500
100,500 Toys R US Inc., Convertible Equity Units, 6.250%, 8/16/05 3,819,000
STEEL - 0.1%
37,800 TXI Capital Trust I, Convertible Preferred, 5.500% (SPuRS) 1,317,330
TELECOM - 1.0%
162,000 Alltel Corp., Convertible Equity Units, 7.750%, 5/17/05 7,814,880
6,200 Lucent Technologies Capital Trust, Convertible Preferred (II), 7.750% 4,274,900
154,100 Motorola Inc., Convertible Equity Units, 7.000% 4,877,265
UTILITIES - 0.7%
121,000 Cinergy Corp., Convertible, 9.500%, 2/16/05 (FELINE PRIDES) 6,918,780
98,500 FPL Group Inc., Convertible Equity Units (II), 8.000%, 2/16/06 5,363,325
52,500 PPL Capital Fund Trust I, Convertible, 7.750% (PEPS) 1,092,000
Total Convertible Preferred Securities (cost $163,038,213) 160,262,951
CAPITAL PREFERRED - HYBRID SECURITIES - 1.2% (1.1% OF TOTAL INVESTMENTS)
TELECOM - 1.2%
19,545 Centaur Funding Corp., Series B, 9.080% 22,892,081
Total Capital Preferred - Hybrid Securities (cost $23,604,173) 22,892,081
CAPITAL PREFERRED - EURO-MARKET LISTED SECURITIES - 5.9% (5.4% OF TOTAL INVESTMENTS)
BANKING - FOREIGN - 4.6%
6,250 BNP Paribas Capital Trust V, 7.200%, 6/30/07 6,551,531
28,750 CA Preferred Fund Trust, 7.000%, 1/30/09 27,901,789
25,750 HBOS Capital Funding LP, 6.850%, 3/23/09 26,136,250
7,000 Lloyds TSB Bank, 6.900%, 11/22/07 7,293,699
18,750 Royal Bank of Scotland, 6.800%, 3/31/08 18,655,950
FINANCIAL - FOREIGN - 1.3%
24,850,000 Old Mutual Capital Funding, 8.000%, 12/22/08 25,315,938
Total Capital Preferred - Euro-Market Listed Securities (cost $116,122,538) 111,855,157
Principal Market
Amount (000) Description(1) Value
---------------------------------------------------------------------------------------------------------------------------
CONVERTIBLE BONDS - 12.0% (11.0% OF TOTAL INVESTMENTS)
ADVERTISING - 0.3%
$ 5,650 Interpublic Group, Convertible Subordinated Notes, 1.870%, 6/01/06 $ 4,979,063
AIRLINES - 0.4%
2,000 Continental Airlines Inc., Convertible Senior Notes (I), 4.500%, 2/01/07 1,555,000
3,000 Delta Air Lines Inc., Convertible Senior Notes, Series 144A, 8.000%, 6/03/23 2,906,250
2,725 Northwest Airlines, Convertible Senior Notes, Series 144A, 6.625%, 5/15/23 2,752,250
AUTO - 0.9%
696 General Motors Corp., Convertible Senior Debentures C, 1.563%, 7/15/33 17,017,200
1,250 Sonic Automotive Inc., Convertible Senior Notes, 5.250%, 5/07/09 1,215,625
BIOTECHNOLOGY - 0.4%
6,165 Fisher Scientific International, Convertible Senior Notes, Series 144A, 2.500%, 10/01/23 6,380,775
1,000 Sepracor Inc., Convertible Subordinated Notes (II), 5.000%, 2/15/07 906,250
BROADCASTING & CABLE TV - 0.4%
12,400 LIBERTY MEDIA / PCS Exchangeable Notes, 4.000%, 11/15/29 7,517,500
COMPUTER - 1.5%
1,725 Brooks Automation Inc., Convertible Subordinated Notes, 4.750%, 6/01/08 1,584,844
4,200 Computer Associates International Inc., Convertible Senior Notes (I), 5.000%, 3/15/07 5,103,000
4,000 Electronic Data Systems, Convertible Senior Notes, Series 144A, 3.875%, 7/15/23 4,165,000
5,000 Hewlett Packard Co., Convertible, 0.000%, 10/14/17 (LYONS) 2,850,000
5,200 International Rectifier Corp., Convertible Subordinated Notes, 4.250%, 7/15/07 5,096,000
3,815 Maxtor Corp., Convertible Senior Notes, Series 144A (IN REG), 6.800%, 4/30/10 4,606,613
2,000 Mentor Graphics Corp., Convertible Senior Notes, 6.875%, 6/15/07 2,225,000
4,713 Mercury Interactive Corp., Convertible Subordinated Notes, 4.75%, 7/01/07 4,707,109
ELECTRONIC EQUIPMENT & INSTRUMENTS - 0.6%
8,000 Anixter International Inc., Convertible Senior (I), 0.000%, 6/28/20 (LYONS) 2,610,000
12,000 Arrow Electronics Inc., Convertible Senior Debentures, 0.000%, 2/21/21 5,850,000
2,076 General Semiconductor Inc., Convertible Subordinated Notes, 5.750%, 12/15/06 2,065,620
ENERGY - 0.3%
6,000 McMoRan Exploration, Convertible Senior Notes, Series 144A, 6.000%, 7/2/08 6,232,500
ENTERTAINMENT - 0.6%
9,500 Liberty Media Corp., Senior Exchangeable Debentures, 3.500%, 1/15/31 6,661,875
5,000 Liberty Media Corp., Senior Exchangeable Debentures for Viacom Inc., Class B, 3.250%,
3/15/31 5,125,000
FINANCIAL - 0.4%
8,000 Providian Financial Corp., Convertible Senior Notes (I), 3.250%, 8/15/05 7,340,000
HEALTHCARE FACILITIES - 0.3%
5,000 LifePoint Hospitals, Inc., Convertible Subordinated Notes, 4.500%, 6/01/09 5,056,250
500 Province Healthcare, Convertible Subordinated Notes (II), 4.250%, 10/10/08 464,375
INDUSTRIAL - 0.4%
2,850 EDO Corp., Convertible Subordinated Notes, 5.250%, 4/15/07 2,899,875
4,730 Gencorp Inc., Convertible Subordinated Notes, 5.750%, 4/15/07 4,511,238
INDUSTRIAL CONGLOMERATES - 0.4%
7,000 Tyco International Group S.A., Convertible Subordinated Notes, Series B 144A (III),
3.125%, 1/15/23 7,481,250
INSURANCE - P&C - 0.4%
306 Travelers Property Casualty Corp, Convertible Subordinated Notes, 4.500%, 4/15/32 7,374,500
LEISURE FACILITIES - 0.7%
7,175 Carnival Cruise Lines, Convertible Senior Debentures, 2.000%, 4/15/21 7,784,875
12,000 Royal Caribbean Cruises Ltd., Convertible (I), 0.000%, 2/02/21 (LYONS) 5,265,000
NETWORK EQUIPMENT - 0.6%
2,000 Agere Systems, Convertible Subordinated Notes, 6.500%, 12/15/09 2,492,500
10,500 Brocade Communications Systems Inc., Convertible Subordinated Notes, 2.000%, 1/01/07 8,741,250
OFFICE ELECTRONICS - 0.3%
5,500 IOS Corp. / IKON Convertible Subordinated Notes, Series 144A, 5.000%, 5/01/07 5,094,375
PHARMACEUTICALS - 0.7%
4,125 Indevus Pharmaceuticals Inc., Convertible Senior Notes, Series 144A, 6.250%, 7/15/08 4,620,000
1,500 IVAX Corp., Convertible Senior Notes (I), 5.500%, 5/15/07 1,501,875
3,500 IVAX Corp., Convertible Senior Subordinated Notes (II), 4.500%, 5/15/08 3,421,250
6,000 Medarex Inc., Convertible Subordinated Notes, 4.500%, 7/01/06 5,032,500
RETAIL - 0.3%
630 Barnes & Noble Inc., Convertible Subordinated Notes, 5.250%, 3/15/09 644,175
4,625 Best Buy Inc., Convertible Subordinated Notes (II), 2.250%, 1/15/22 4,740,625
RETAIL - SPECIALTY - 0.5%
3,000 Charming Shops Inc., Convertible Notes, 4.750%, 6/01/12 2,820,000
8,000 Lowes Companies, Convertible (I), 0.000%, 2/16/21 (LYONS) 6,330,000
SEMICONDUCTORS - 0.3%
5,500 ASML Holding NV, Convertible Subordinated Notes EURO (III), 5.750%, 10/15/06 5,843,750
STEEL - 0.2%
5,045 Shaw Group Inc., Convertible Senior, 0.000%, 5/01/21 (LYONS) 3,222,494
TELECOM - 0.5%
6,000 Ciena Corp., Convertible Notes, 3.750%, 2/01/08 5,107,500
1,500 Nextel Communications Inc., Convertible Senior Notes (III), 6.000%, 6/01/11 1,623,750
3,000 Nortel Networks Corp., Convertible Senior Notes, 4.250%, 9/01/08 2,527,500
UTILITY - 0.6%
5,000 Calpine Corp., Convertible Senior Notes, 4.000%, 12/26/06 4,656,250
235 CenterPoint Energy / AOL Time Warner Convertible, 2.000%, 9/15/29 (ZENS) 7,520,000
Total Convertible Bonds (cost $228,700,134) 228,229,631
CORPORATE BONDS - 5.6% (5.1% OF TOTAL INVESTMENTS)
AUTO - 1.3%
$ 6,315 Ford Motor Company, 9.980%, 2/15/47 6,871,762
7,570 Ford Motor Company, 7.700%, 5/15/97 6,618,814
10,000 General Motors Corp., 8.375%, 7/15/33 9,773,630
2,000 Tenneco Automotive Inc., Senior Secondary Notes, Series 144A, 10.250%, 7/15/13 2,030,000
ENERGY - 0.1%
2,000 Chesapeake Energy Corp., Senior Notes, 9.000%, 8/15/12 2,200,000
ENTERTAINMENT - 0.6%
2,900 Allbritton Communications Co., Senior Subordinated Notes, 7.750%, 12/15/12 2,972,500
2,000 Allbritton Communications Co., Senior Subordinated Notes, Series 144A, 7.750%, 12/15/12 2,050,000
1,000 CSC Holding Inc., Senior Debentures, Series B, 8.125%, 8/15/09 1,032,500
1,000 Park Place Entertainment Corp., Senior Subordinated Notes, 7.875%, 3/15/10 1,080,000
2,000 Penn National Gaming Inc., Senior Subordinated Notes, 8.875%, 3/15/10 2,150,000
2,000 Pinnacle Entertainment Inc., Senior Subordinated Notes, Series B, 9.250%, 2/15/07 2,030,000
FINANCIAL - 0.3%
2,500 MDP Acquisitions plc, U.S. Senior Notes, 9.625%, 10/01/12 2,737,500
3,000 Universal City Development Partners, Senior Notes, Series 144A, 11.750%, 4/01/10 3,345,000
FOOD - 0.6%
4,500 Del Monte Corp., Senior Subordinated Notes, Series 144A, 8.625%, 12/15/12 4,860,000
5,000 Dole Foods Co., 8.750%, 7/15/13 5,350,000
1,400 Dole Foods Co., Senior Notes, 8.625%, 5/01/09 1,473,500
HEALTHCARE FACILITIES - 0.1%
1,480 Iasis Healthcare Corp., Senior Subordinated Notes, 13.000%, 10/15/09 1,657,600
HOMEBUILDING - 0.2%
3,000 William Lyon Homes, Senior Notes, 10.750%, 4/01/13 3,255,000
INDUSTRIAL - 0.8%
2,000 Jacuzi Brands Inc., Senior Secondary Notes, Series 144A, 9.625%, 7/01/10 2,110,000
3,000 Laidlaw Inc., Senior Notes, Series 144A, 10.750%, 6/15/11 3,202,500
2,000 Owens-Brockway Glass Container Inc., Guaranteed Senior Notes, Series 144A, 8.250%, 5/15/13 2,100,000
3,000 Owens-Illinois Inc., Senior Debentures, 7.500%, 5/15/10 2,985,000
3,000 Terex Corp., Guaranteed Senior Subordinated Notes, 8.875%, 4/01/08 3,135,000
2,100 U.S. Can Corp., Senior Secondary Notes, Series 144A, 10.875%, 7/15/10 (WI, settling
7/22/03) 2,131,500
PAPER - 0.3%
3,000 Georgia-Pacific Corp., Bonds, 8.125%, 5/15/11 3,112,500
2,000 Georgia-Pacific Corp., Debentures, 7.700%, 6/15/15 1,910,000
PUBLISHING & PRINTING - 0.4%
1,500 Mail-Well I Corp., Senior Notes, 9.625%, 3/15/12 1,605,000
1,000 Primedia Inc., Senior Notes, 8.875%, 5/15/11 1,062,500
4,000 Vertis Inc., Senior Notes, Series 144A, 9.750%, 4/01/09 4,180,000
REAL ESTATE INVESTMENT TRUSTS - 0.1%
1,500 LNR Property Corp., Senior Subordinated Notes, 10.500%, 1/15/09 1,627,500
RETAIL - 0.8%
1,500 Williams Scotsman Inc., Senior Notes, 9.875%, 6/01/07 1,477,500
2,000 Saks Inc., 7.500%, 12/01/10 2,075,000
2,000 Saks Inc., Notes, 7.375%, 2/15/19 1,895,000
1,000 Saks Inc., Notes, 9.875%, 10/01/11 1,140,000
4,000 Toys R Us Inc., Notes, 7.875%, 4/15/13 4,127,940
4,000 Warnaco Inc., Senior Notes, Series 144A, 8.875%, 6/15/13 4,180,000
SPECIALTY CHEMICALS - 0.0%
500 United Industries Corp., Senior Subordinated Notes, Series D, 9.875%, 4/01/09 530,000
Total Corporate Bonds (cost $105,953,579) 106,074,746
================================================================================
CAPITAL PREFERRED SECURITIES - 16.4% (15.1% OF TOTAL INVESTMENTS)
AGENCY - 2.2%
$ 20,000 Fannie Mae, 4.625%, 5/01/13 19,860,720
20,000 Freddie Mac, Subordinated Debt, 5.875%, 3/21/11 21,955,280
BANKING - 4.0%
6,075 Bank One Capital III, 8.750%, 9/01/30 7,970,892
2,183 BankAmerica Capital II, 8.000% 12/15/26 2,479,860
5,000 BankAmerica Institutional Capital-A, Series 144A, 8.070%, 12/31/26 5,619,680
2,000 BankBoston Capital Trust I, Series B, 8.250%, 12/15/26 2,271,140
4,000 BT Capital Trust-B, Series B1, 7.900%, 1/15/27 4,374,200
2,350 FBS Capital I, 8.090%, 11/15/26 2,678,441
3,000 JPM Cap Trust II, 7.950%, 2/01/27 3,316,338
15,000 KeyCorp Institutional Capital-A, Series A, 7.826%, 12/01/26 16,327,200
18,060 Mellon Capital I, Series A, 7.720%, 12/01/26 20,040,857
1,002 HSBC USA Capital Trust IV, 7.530%, 12/04/26 1,077,421
9,000 State Street Institutional Capital-B, Series 144A, 8.035% 3/15/27 10,323,909
BANKING - FOREIGN - 4.8%
20,000 Abbey National Capital Trust I, 8.963%, 12/29/49 27,603,200
29,075 Barclays Bank plc, Series 144A, 6.860%, 6/15/32 32,239,494
20,000 HSBC Capital Funding LP, Series 144A, 10.176%, 6/30/30 30,142,600
FINANCIAL - 0.2%
3,725 St. George Funding Co., Series 144A, 8.485%, 6/30/07 4,054,148
FINANCIAL - FOREIGN - 0.6%
10,000 ING Capital Funding Trust III, 8.439%, 12/29/49 12,187,720
INSURANCE - FINANCIAL - 0.7%
10,000 American General Capital II, 8.500%, 7/01/30 13,323,630
612 Berkley Capital Trust, 8.197%, 12/15/45 631,994
INSURANCE - LIFE - 0.3%
5,000 American General Institutional Capital-A, Series 144A, 7.570%, 12/01/45 6,112,510
INSURANCE - MULTI LINE - 1.8%
12,353 SAFECO Capital Trust I, 8.072%, 7/15/37 13,752,842
19,513 Zurich Capital Trust, 8.376%, 6/01/37 20,776,798
INSURANCE - MULTI LINE - FOREIGN - 1.6%
30,000 Mangrove Bay Pass-Through Trust, Series 144A, 6.102%, 7/15/33 29,587,500
SAVINGS & LOANS - THRIFT - 0.2%
3,365 Washington Mutual Inc., 8.206%, 2/01/27 3,734,925
Total Capital Preferred Securities (cost $323,335,955) 312,443,299
U.S. GOVERNMENT and AGENCY OBLIGATIONS - 11.2% (10.3% OF TOTAL INVESTMENTS)
U.S. TREASURY NOTES - 11.2%
$ 70,000 1.125%, 6/30/05 69,584,410
15,000 2.000%, 5/15/06 15,064,455
90,000 2.625%, 5/15/08 89,303,940
40,000 3.625%, 5/15/13 38,946,880
Total U.S. Government and Agency Obligations (cost $214,907,648) 212,899,685
SHORT-TERM INVESTMENTS - 25.2% (23.3% OF TOTAL INVESTMENTS)
$257,384 State Street Repurchase Agreement, 0.950%, dated 7/17/03, due 7/18/03,
repurchase price $257,390,792, collateralized by U.S. Treasury Bonds 257,384,000
25,000 American Express Credit, Commercial Paper, 0.993%, 7/22/03 24,997,277
40,000 American General Financial Services, Commercial Paper, 0.930%, 7/18/03 40,000,000
16,000 Boston Edison, Commercial Paper, 1.010%, 7/21/03 15,998,652
50,000 Citigroup Global, Commercial Paper, 1.020%, 7/23/03 49,992,916
40,000 General Electric Capital, Commercial Paper, 0.970%, 7/18/03 40,000,000
25,000 Household Finance, Commercial Paper, 0.993%, 7/22/03 24,997,277
20,000 Prudential Fund, Commercial Paper, 0.910%, 7/18/03 20,000,000
9,000 Shell Finance UK, Commercial Paper, 1.000%, 7/22/03 8,999,000
Total Short-Term Investments (cost $482,369,122) 482,369,122
Total Investments (cost $2,096,715,444) - 108.5% 2,070,897,348
Other Assets Less Liabilities - (8.5)% (162,885,975)
Net Assets Applicable to Common Shares - 100% $1,908,011,373
(1) All percentages shown in the Portfolio of Investments are based on net assets
applicable to Common Shares unless otherwise noted.
(a) Security is eligible for the Dividends Received Deduction.
(CBTCS) Corporate Backed Trust Certificates.
(CORTS) Corporate Backed Trust Securities.
(DECS) Dividend Enhanced Convertible Stock.
(FELINE
PRIDES) Provisionally Redeemable Income Debt Exchangeable for Stock
consisting of a trust originated preferred shares security
plus a stock purchase contract.
(LYONS) Liquid Yield Option Notes.
(PCARS) Public Credit and Repackaged Securities.
(PEPS) Premium Exchangeable Participating Shares.
(PIERS) Preferred Income Equity Redeemable Stock.
(PPLUS) PreferredPlus Trust.
(QUIPS) Convertible Quarterly Preferred Securities.
(SATURNS) Structured Asset Trust Unit Repackaging.
(SPuRS) Shared Preference Redeemable Securities.
(WI) Security purchased on a when-issued basis.
(ZENS) Zero-Premium Exchangeable Subordinated Notes.
See accompanying notes to financial statements.
APPENDIX A
NUVEEN PREFERRED AND CONVERTIBLE INCOME FUND 2
STATEMENT ESTABLISHING AND FIXING THE RIGHTS AND PREFERENCES OF
FUNDPREFERRED SHARES
Nuveen Preferred and Convertible Income Fund 2 (the "Fund"), a
Massachusetts business trust, certifies that:
FIRST, pursuant to the authority expressly vested in the Board of the
Fund by Articles IV and VI of Fund's Declaration of Trust (which, as hereafter
restated or amended from time to time, are together with this Statement herein
called the "Declaration"), the Board of Trustees has, by resolution, authorized
the issuance of 38,600 Preferred Shares of beneficial interest ("Preferred
Shares"), $.01 par value, classified as FundPreferred shares ("FundPreferred
shares"), and further classified as Series M, Series M2, Series T, Series T2,
Series W, Series W2, Series TH, Series TH2, Series F and Series F2
FundPreferred shares (each series, and together with additional series of
FundPreferred shares that may be authorized and issued, a "Series") each with a
liquidation preference of $25,000 per share;
SECOND, the preferences, rights, voting powers, restrictions,
limitations as to dividends, qualifications and terms and conditions of
redemption of the shares of such series of FundPreferred shares are as follows:
DESIGNATION
Series M: A series of 3,860 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series M FundPreferred shares" ("FundPreferred
shares Series M"). The initial Dividend Period for FundPreferred shares Series M
shall be the period from and including the Date of Original Issue thereof to but
excluding ______, 2003. Each share of FundPreferred shares Series M shall
have an Applicable Rate for its initial Dividend Period equal to ____% per annum
and an initial Dividend Payment Date of ______, 2003, and each share of
FundPreferred shares Series M shall have such other preferences, rights, voting
powers, restrictions, limitations as to dividends, qualifications and terms and
conditions of redemption, in addition to those required by applicable law or set
forth in the Declaration applicable to preferred shares of the Fund, as are set
forth in Part I and Part II of this Statement. The FundPreferred shares Series M
shall constitute a separate series of Preferred Shares of the Fund.
Series M2: A series of 3,860 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series M2 FundPreferred shares"
("FundPreferred shares Series M2"). The initial Dividend Period for
FundPreferred shares Series M2 shall be the period from and including the Date
of Original Issue thereof to but excluding ______, 2003. Each share of
FundPreferred shares Series M2 shall have an Applicable Rate for its initial
Dividend Period equal to ____% per annum and an initial Dividend Payment Date of
______, 2003, and each share of FundPreferred shares Series M2 shall have such
other preferences, rights, voting powers, restrictions, limitations as to
dividends, qualifications and terms and conditions of redemption, in addition to
those required by applicable law or set forth in the Declaration applicable to
preferred shares of the Fund, as are set forth in Part I and Part II of this
Statement. The FundPreferred shares Series M2 shall constitute a separate series
of Preferred Shares of the Fund.
Series T: A series of 3,860 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series T FundPreferred shares"
("FundPreferred shares Series T"). The initial Dividend Period for
FundPreferred shares Series T shall be the period from and including the Date
of Original Issue thereof to but excluding ______, 2003. Each share of
FundPreferred shares Series T shall have an Applicable Rate for its initial
Dividend Period equal to __% per annum and an initial Dividend Payment Date of
______, 2003, and each share of FundPreferred shares Series T shall have such
other preferences, rights, voting powers, restrictions, limitations as to
dividends, qualifications and terms and conditions of redemption, in addition to
those required by applicable law or set forth in the Declaration applicable to
preferred shares of the Fund, as are set forth in Part I and Part II of this
Statement. The FundPreferred shares Series T shall constitute a separate series
of Preferred Shares of the Fund.
Series T2: A series of 3,860 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series T2 FundPreferred shares"
("FundPreferred shares Series T2"). The initial Dividend Period for
FundPreferred shares Series T2 shall be the period from and including the Date
of Original Issue thereof to but excluding ______, 2003. Each share of
FundPreferred shares Series T2 shall have an Applicable Rate for its initial
Dividend Period equal to __% per annum and an initial Dividend Payment Date of
______, 2003, and each share of FundPreferred shares Series T2 shall have such
other preferences, rights, voting powers, restrictions, limitations as to
dividends, qualifications and terms and conditions of redemption, in addition to
those required by applicable law or set forth in the Declaration applicable to
preferred shares of the Fund, as are set forth in Part I and Part II of this
Statement. The FundPreferred shares Series T2 shall constitute a separate series
of Preferred Shares of the Fund.
Series W: A series of 3,860 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series W FundPreferred shares"
("FundPreferred shares Series W"). The initial Dividend Period for
FundPreferred shares Series W shall be the period from and including the Date
of Original Issue thereof to but excluding ______, 2003. Each share of
FundPreferred shares Series W shall have an Applicable Rate for its initial
Dividend Period equal to __% per annum and an initial Dividend Payment Date of
______, 2003, and each share of FundPreferred shares Series W shall have such
other preferences, rights, voting powers, restrictions, limitations as to
dividends, qualifications and terms and conditions of redemption, in addition to
those required by applicable law or set forth in the Declaration applicable to
preferred shares of the Fund, as are set in Part I or Part II of this Statement.
The FundPreferred shares Series W shall constitute a separate series of
Preferred Shares of the Fund.
Series W2: A series of 3,860 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series W2 FundPreferred shares"
("FundPreferred shares Series W2"). The initial Dividend Period for
FundPreferred shares Series W2 shall be the period from and including the Date
of Original Issue thereof to but excluding ______, 2003. Each share of
FundPreferred shares Series W2 shall have an Applicable Rate for its initial
Dividend Period equal to ____% per annum and an initial Dividend Payment Date of
______, 2003, and each share of FundPreferred shares Series W2 shall have such
other preferences, rights, voting powers, restrictions, limitations as to
dividends, qualifications and terms and conditions of redemption, in addition to
those required by applicable law or set forth in the Declaration applicable to
preferred shares of the Fund, as are set forth in Part I and Part II of this
Statement. The FundPreferred shares Series W2 shall constitute a separate series
of Preferred Shares of the Fund.
Series TH: A series of 3,860 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series TH FundPreferred shares"
("FundPreferred shares Series TH"). The initial Dividend Period for
FundPreferred shares Series TH shall be the period from and including the Date
of Original Issue
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thereof to but excluding ______, 2003. Each share of FundPreferred shares
Series TH shall have an Applicable Rate for its initial Dividend Period equal to
____% per annum and an initial Dividend Payment Date of ______, 2003, and
each share of FundPreferred shares Series TH shall have such other preferences,
rights, voting powers, restrictions, limitations as to dividends, qualifications
and terms and conditions of redemption, in addition to those required by
applicable law or set forth in the Declaration applicable to preferred shares of
the Fund, as are set forth in Part I and Part II of this Statement. The
FundPreferred shares Series TH shall constitute a separate series of Preferred
Shares of the Fund.
Series TH2: A series of 3,860 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series TH2 FundPreferred shares"
("FundPreferred shares Series TH2"). The initial Dividend Period for
FundPreferred shares Series TH2 shall be the period from and including the Date
of Original Issue thereof to but excluding ______, 2003. Each share of
FundPreferred shares Series TH2 shall have an Applicable Rate for its initial
Dividend Period equal to ____% per annum and an initial Dividend Payment Date of
______, 2003, and each share of FundPreferred shares Series TH2 shall have such
other preferences, rights, voting powers, restrictions, limitations as to
dividends, qualifications and terms and conditions of redemption, in addition to
those required by applicable law or set forth in the Declaration applicable to
preferred shares of the Fund, as are set forth in Part I and Part II of this
Statement. The FundPreferred shares Series TH2 shall constitute a separate
series of Preferred Shares of the Fund.
Series F: A series of 3,860 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series F FundPreferred shares" ("FundPreferred
shares Series F"). The initial Dividend Period for FundPreferred shares Series F
shall be the period from and including the Date of Original Issue thereof to but
excluding ______, 2003. Each share of FundPreferred shares Series F shall have
an Applicable Rate for its initial Dividend Period equal to ____% per annum and
an initial Dividend Payment Date of ______, 2003, and each share of
FundPreferred shares Series F shall have such other preferences, rights, voting
powers, restrictions, limitations as to dividends, qualifications and terms and
conditions of redemption, in addition to those required by applicable law or set
forth in the Declaration applicable to preferred shares of the Fund, as are set
forth in Part I and Part II of this Statement. The FundPreferred shares Series F
shall constitute a separate series of Preferred Shares of the Fund.
Series F2: A series of 3,860 Preferred Shares, liquidation preference
$25,000 per share, is designated "Series F2 FundPreferred shares"
("FundPreferred shares Series F2"). The initial Dividend Period for
FundPreferred shares Series F2 shall be the period from and including the Date
of Original Issue thereof to but excluding ______, 2003. Each share of
FundPreferred shares Series F2 shall have an Applicable Rate for its initial
Dividend Period equal to ____% per annum and an initial Dividend Payment Date of
______, 2003, and each share of FundPreferred shares Series F2 shall have such
other preferences, rights, voting powers, restrictions, limitations as to
dividends, qualifications and terms and conditions of redemption, in addition to
those required by applicable law or set forth in the Declaration applicable to
preferred shares of the Fund, as are set forth in Part I and Part II of this
Statement. The FundPreferred shares Series F2 shall constitute a separate series
of Preferred Shares of the Fund.
Subject to the provisions of Section 11(b) of Part I hereof, the Board
of Trustees of the Fund may, in the future, authorize the issuance of additional
shares of the Fund's Preferred Shares as FundPreferred shares Series M, M2, T,
T2, W, W2, TH, TH2, F and F2 with the same preferences, rights, voting powers,
restrictions, limitations as to dividends, qualifications and terms and
conditions of redemption and other terms of the respective series herein
described, except that the Applicable Rate for its initial Dividend Period, its
initial Dividend Payment Date and any other changes in the terms herein set
forth shall be as set forth in an amendment to this Statement.
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As used in Part I and Part II of this Statement, capitalized terms
shall have the meanings provided in Section 18 of Part I.
PART I: FUND PREFERRED SHARES TERMS
1. Number of Shares; Ranking.
(a) The initial number of authorized shares constituting each
of FundPreferred shares Series M, Series M2, Series T, Series T2, Series W,
Series W2, Series TH, Series TH2, Series F, and Series F2, is 3,860 shares,
respectively. No fractional shares of FundPreferred shares Series M, Series M2,
Series T, Series T2, Series W, Series W2, Series TH, Series TH2, Series F and
Series F2 shall be issued.
(b) Any shares of each Series of FundPreferred shares which at
any time have been redeemed or purchased by the Fund shall, after such
redemption or purchase, have the status of authorized but unissued shares of
Preferred Shares.
(c) The shares of each Series of FundPreferred shares shall
rank on a parity with shares of any other series of Preferred Shares (including
any other FundPreferred shares) as to the payment of dividends to which such
shares are entitled and the distribution of assets upon dissolution, liquidation
or winding up of the affairs of the Fund.
(d) No holder of shares of any Series of FundPreferred shares
shall have, solely by reason of being such a holder, any preemptive right, or,
unless otherwise determined by the Trustees other right to acquire, purchase or
subscribe for any shares of any Series of FundPreferred shares, shares of Common
Shares of the Fund or other securities of the Fund which it may hereafter issue
or sell.
2. Dividends.
(a) The Holders of shares of any Series of FundPreferred
shares shall be entitled to receive, when, as and if declared by the Board of
Trustees, out of funds legally available therefor, cumulative cash dividends on
their shares at the Applicable Rate, determined as set forth in paragraph (c) of
this Section 2, and no more, payable on the respective dates determined as set
forth in paragraph (b) of this Section 2. Dividends on the Outstanding shares of
any Series of FundPreferred shares issued on the Date of Original Issue shall
accumulate from the Date of Original Issue.
(b) (i) Dividends shall be payable when, as and if declared by
the Board of Trustees following the initial Dividend Payment Date, subject to
subparagraph (b)(ii) of this Section 2, on the shares of each Series of
FundPreferred shares, with respect to any Dividend Period on the first Business
Day following the last day of such Dividend Period; provided, however, if the
Dividend Period is greater than 30 days then on a monthly basis on the first
Business Day of each month within such Dividend Period and on the Business Day
following the last day of such Dividend Period.
(ii) If a day for payment of dividends resulting from the
application of subparagraph (b)(i) above is not a Business Day, (A)
then the Dividend Payment Date shall be the first Business Day
following such day for payment of dividends in the case of a Series of
FundPreferred shares designated as "Series M" or "Series F" or (B)
then the Dividend Payment Date shall be the first Business Day that
falls prior to such day for payment of dividends in the case of a
Series of FundPreferred shares designated as "Series T," "Series W," or
"Series TH."
(iii) The Fund shall pay to the Paying Agent not later
than 3:00 p.m., New York City time, on the Business Day next preceding
each Dividend Payment Date for the shares
A-3
of each Series of FundPreferred shares, an aggregate amount of funds
available on the next Business Day in the City of New York, New York,
equal to the dividends to be paid to all Holders of such shares on such
Dividend Payment Date. The Fund shall not be required to establish any
reserves for the payment of dividends.
(iv) All moneys paid to the Paying Agent for the payment
of dividends shall be held in trust for the payment of such dividends
by the Paying Agent for the benefit of the Holders specified in
subparagraph (b)(v) of this Section 2. Any moneys paid to the Paying
Agent in accordance with the foregoing but not applied by the Paying
Agent to the payment of dividends, including interest earned on such
moneys, will, to the extent permitted by law, be repaid to the Fund at
the end of 90 days from the date on which such moneys were to have been
so applied.
(v) Each dividend on a Series of FundPreferred shares
shall be paid on the Dividend Payment Date therefor to the Holders of
that series as their names appear on the share ledger or share records
of the Fund on the Business Day next preceding such Dividend Payment
Date. Dividends in arrears for any past Dividend Period may be declared
and paid at any time, without reference to any regular Dividend Payment
Date, to the Holders as their names appear on the share ledger or share
records of the Fund on such date, not exceeding 15 days preceding the
payment date thereof, as may be fixed by the Board of Trustees. No
interest will be payable in respect of any dividend payment or payments
which may be in arrears.
(c) (i) The dividend rate on Outstanding shares of each Series
of FundPreferred shares during the period from and after the Date of Original
Issue to and including the last day of the initial Dividend Period therefor
shall be equal to the rate per annum set forth under "Designation" above. For
each subsequent Dividend Period with respect to the FundPreferred shares
Outstanding thereafter, the dividend rate shall be equal to the rate per annum
that results from an Auction; provided, however, that if an Auction for any
subsequent Dividend Period of a Series of FundPreferred shares is not held for
any reason or if Sufficient Clearing Bids have not been made in an Auction
(other than as a result of all shares of a Series of FundPreferred shares being
the subject of Submitted Hold Orders), then the dividend rate on the shares of a
Series of FundPreferred shares for any such Dividend Period shall be the Maximum
Rate (except (i) during a Default Period when the dividend rate shall be the
Default Rate, as set forth in Section 2(c)(ii) below) or (ii) after a Default
Period and prior to the beginning of the next Dividend Period when the dividend
rate shall be the Maximum Rate at the close of business on the last day of such
Default Period). The All Hold Rate will apply automatically following an Auction
in which all of the Outstanding shares of a Series of FundPreferred shares are
subject (or are deemed to be subject) to Hold Orders. The rate per annum at
which dividends are payable on shares of a Series of FundPreferred shares as
determined pursuant to this Section 2(c)(i) shall be the "Applicable Rate."
(ii) Subject to the cure provisions below, a "Default
Period" with respect to a particular Series will commence on any date
the Fund fails to deposit irrevocably in trust in same-day funds, with
the Paying Agent by 12:00 noon, New York City time, (A) the full amount
of any declared dividend on that Series payable on the Dividend Payment
Date (a "Dividend Default") or (B) the full amount of any redemption
price (the "Redemption Price") payable on the date fixed for redemption
(the "Redemption Date") (a "Redemption Default") and together with a
Dividend Default, hereinafter referred to as "Default"). Subject to the
cure provisions of Section 2(c)(iii) below, a Default Period with
respect to a Dividend Default or a Redemption Default shall end on the
Business Day on which, by 12:00 noon, New York City time, all unpaid
dividends and any unpaid Redemption Price shall have been deposited
irrevocably in trust in
A-4
same-day funds with the Paying Agent. In the case of a Dividend
Default, the Applicable Rate for each Dividend Period commencing during
a Default Period will be equal to the Default Rate, and each subsequent
Dividend Period commencing after the beginning of a Default Period
shall be a Standard Dividend Period; provided, however, that the
commencement of a Default Period will not by itself cause the
commencement of a new Dividend Period. No Auction shall be held during
a Default Period applicable to that Series of FundPreferred shares.
(iii) No Default Period with respect to a Dividend Default
or Redemption Default shall be deemed to commence if the amount of any
dividend or any Redemption Price due (if such default is not solely due
to the willful failure of the Fund) is deposited irrevocably in trust,
in same-day funds with the Paying Agent by 12:00 noon, New York City
time within three Business Days after the applicable Dividend Payment
Date or Redemption Date, together with an amount equal to the Default
Rate applied to the amount of such non-payment based on the actual
number of days comprising such period divided by 365 for each Series.
The Default Rate shall be equal to the Reference Rate multiplied by
three (3).
(iv) The amount of dividends per share payable (if
declared) on each Dividend Payment Date of each Dividend Period of less
than one (1) year (or in respect of dividends on another date in
connection with a redemption during such Dividend Period) shall be
computed by multiplying the Applicable Rate (or the Default Rate) for
such Dividend Period (or a portion thereof) by a fraction, the
numerator of which will be the number of days in such Dividend Period
(or portion thereof) that such share was Outstanding and for which the
Applicable Rate or the Default Rate was applicable and the denominator
of which will be 365, multiplying the amount so obtained by $25,000,
and rounding the amount so obtained to the nearest cent. During any
Dividend Period of one (1) year or more, the amount of dividends per
share payable on any Dividend Payment Date (or in respect of dividends
on another date in connection with a redemption during such Dividend
Period) shall be computed as described in the preceding sentence,
except that it will be determined on the basis of a year consisting of
twelve 30-day months.
(d) Any dividend payment made on shares of any Series of
FundPreferred shares shall first be credited against the earliest accumulated
but unpaid dividends due with respect to such Series.
(e) For so long as the FundPreferred shares are Outstanding,
except as contemplated by Part I of this Statement, the Fund will not declare,
pay or set apart for payment any dividend or other distribution (other than a
dividend or distribution paid in shares of, or options, warrants or rights to
subscribe for or purchase, Common Shares or other shares of beneficial interest,
if any, ranking junior to the FundPreferred shares as to dividends or upon
liquidation) in respect to Common Shares or any other shares of the Fund ranking
junior to or on a parity with the FundPreferred shares as to dividends or upon
liquidation, or call for redemption, redeem, purchase or otherwise acquire for
consideration any Common Shares or any other such junior shares (except by
conversion into or exchange for shares of the Fund ranking junior to the
FundPreferred shares as to dividends and upon liquidation) or any such parity
shares (except by conversion into or exchange for shares of the Fund ranking
junior to or on a parity with the FundPreferred shares as to dividends and upon
liquidation), unless (i) immediately after such transaction, the Fund would have
Eligible Assets with an aggregate Discounted Value at least equal to the
FundPreferred Shares Basic Maintenance Amount and the 1940 Act FundPreferred
Shares Asset Coverage would be achieved, (ii) full cumulative dividends on the
FundPreferred shares due on or prior to the date of the transaction have been
declared and paid and (iii) the Fund has redeemed the full number of
FundPreferred shares required to be redeemed by any provision for mandatory
redemption contained in Section 3(a)(ii).
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(f) The Fund will not declare, pay or set apart for payment
any dividend or other distribution in respect to the FundPreferred shares unless
(i) there is not an event of default under indebtedness senior to the
FundPreferred shares, if any, or (ii) immediately after such transaction, the
Fund would have eligible portfolio holdings with an aggregate discounted value
at least equal to the asset coverage requirements under the indebtedness senior
to the FundPreferred shares.
3. Redemption.
(a) (i) After the initial Dividend Period, subject to the
provisions of this Section 3 and to the extent permitted under the 1940 Act and
Massachusetts law, the Fund may, at its option, redeem in whole or in part out
of funds legally available therefor shares of a Series of FundPreferred shares
herein designated as (A) having a Dividend Period of one year or less, on the
Business Day after the last day of such Dividend Period by delivering a notice
of redemption not less than 15 days and not more than 40 days prior to the date
fixed for such redemption, at a redemption price per share equal to $25,000,
plus an amount equal to accumulated but unpaid dividends thereon (whether or
not earned or declared) to the date fixed for redemption ("Redemption Price"),
or (B) having a Dividend Period of more than one year, on any Business Day prior
to the end of the relevant Dividend Period by delivering a notice of redemption
not less than 15 days and not more than 40 days prior to the date fixed for such
redemption, at the Redemption Price, plus a redemption premium, if any,
determined by the Board of Trustees after consultation with the Broker-Dealers
and set forth in any applicable Specific Redemption Provisions at the time of
the designation of such Dividend Period as set forth in Section 4 of this
Statement; provided, however, that during a Dividend Period of more than one
year no shares of a Series of FundPreferred shares will be subject to optional
redemption except in accordance with any Specific Redemption Provisions approved
by the Board of Trustees after consultation with the Broker-Dealers at the time
of the designation of such Dividend Period. Notwithstanding the foregoing, the
Fund shall not give a notice of or effect any redemption pursuant to this
Section 3(a)(i) unless, on the date on which the Fund intends to give such
notice and on the date of redemption (a) the Fund has available certain 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 a Series of FundPreferred
shares by reason of the redemption of such FundPreferred shares on such date
fixed for the redemption and (b) the Fund would have Eligible Assets with an
aggregate Discounted Value at least equal the FundPreferred Shares Basic
Maintenance Amount immediately subsequent to such redemption, if such redemption
were to occur on such date, it being understood that the provisions of paragraph
(d) of this Section 3 shall be applicable in such circumstances in the event the
Fund makes the deposit and takes the other action required thereby.
(ii) If the Fund fails to maintain, as of any Valuation
Date, Eligible Assets with an aggregate Discounted Value at least equal
to the FundPreferred Shares Basic Maintenance Amount or, as of the last
Business Day of any month, the 1940 Act FundPreferred Shares Asset
Coverage, and such failure is not cured within ten Business Days
following such Valuation Date in the case of a failure to maintain the
FundPreferred Shares Basic Maintenance Amount or on the last Business
Day of the following month in the case of a failure to maintain the
1940 Act FundPreferred Shares Asset Coverage as of such last Business
Day (each an "Asset Coverage Cure Date"), the FundPreferred shares will
be subject to mandatory redemption out of funds legally available
therefor. The number of FundPreferred shares to be redeemed in such
circumstances will be equal to the lesser of (A) the minimum number of
FundPreferred shares the redemption of which, if deemed to have
occurred immediately prior to the opening of business on the relevant
Asset Coverage Cure Date, would result in the Fund having Eligible
Assets with an aggregate Discounted Value at least equal to the
FundPreferred Shares Basic Maintenance
A-6
Amount, or sufficient to satisfy 1940 Act FundPreferred Shares Asset
Coverage, as the case may be, in either case as of the relevant Asset
Coverage Cure Date (provided that, if there is no such minimum number
of shares the redemption of which would have such result, all shares of
FundPreferred shares then Outstanding will be redeemed), and (B) the
maximum number of FundPreferred shares that can be redeemed out of
funds expected to be available therefor on the Mandatory Redemption
Date at the Mandatory Redemption Price set forth in subparagraph
(a)(iii) of this Section 3.
(iii) In determining the FundPreferred shares required to
be redeemed in accordance with the foregoing Section 3(a)(ii), the Fund
shall allocate the number of shares required to be redeemed to satisfy
the FundPreferred Shares Basic Maintenance Amount or the 1940 Act
FundPreferred Shares Asset Coverage, as the case may be, pro rata among
the Holders of FundPreferred shares in proportion to the number of
shares they hold and shares of other Preferred Shares subject to
mandatory redemption provisions similar to those contained in this
Section 3, subject to the further provisions of this subparagraph
(iii). The Fund shall effect any required mandatory redemption pursuant
to subparagraph (a)(ii) of this Section 3 no later than 40 days after
the Asset Coverage Cure Date (the "Mandatory Redemption Date"), except
that if the Fund does not have funds legally available for the
redemption of, or is not otherwise legally permitted to redeem, the
number of shares of the FundPreferred shares which would be required to
be redeemed by the Fund under clause (A) of subparagraph (a)(ii) of
this Section 3 if sufficient funds were available, together with shares
of other Preferred Shares which are subject to mandatory redemption
under provisions similar to those contained in this Section 3, or the
Fund otherwise is unable to effect such redemption on or prior to such
Mandatory Redemption Date, the Fund shall redeem those shares of the
FundPreferred shares, and shares of other Preferred Shares which it was
unable to redeem, on the earliest practicable date on which the Fund
will have such funds available, upon notice pursuant to Section 3(b) to
record owners of the FundPreferred shares to be redeemed and the Paying
Agent. The Fund will deposit with the Paying Agent funds sufficient to
redeem the specified number of FundPreferred shares with respect to a
redemption required under subparagraph (a)(ii) of this Section 3, by
1:00 p.m., New York City time, of the Business Day immediately
preceding the Mandatory Redemption Date. If fewer than all of the
Outstanding FundPreferred shares are to be redeemed pursuant to this
Section 3(a)(iii), the number of shares to be redeemed shall be
redeemed pro rata from the Holders of such shares in proportion to the
number of such shares held by such Holders, by lot or by such other
method as the Fund shall deem fair and equitable, subject, however, to
the terms of any applicable Specific Redemption Provisions. "Mandatory
Redemption Price" means the Redemption Price plus (in the case of a
Dividend Period of one year or more only) a redemption premium, if any,
determined by the Board of Trustees after consultation with the
Broker-Dealers and set forth in any applicable Specific Redemption
Provisions.
(b) In the event of a redemption pursuant to Section 3(a), the
Fund will file a notice of its intention to redeem with the Securities and
Exchange Commission so as to provide at least the minimum notice required under
Rule 23c-2 under the 1940 Act or any successor provision. In addition, the Fund
shall deliver a notice of redemption to the Auction Agent (the "Notice of
Redemption") containing the information set forth below (i) in the case of an
optional redemption pursuant to subparagraph (a)(i) above, one Business Day
prior to the giving of notice to the Holders, (ii) in the case of a mandatory
redemption pursuant to subparagraph (a)(ii) above, on or prior to the 30th day
preceding the Mandatory Redemption Date. The Auction Agent will use its
reasonable efforts to provide notice to each Holder of shares of each Series of
FundPreferred shares called for redemption by electronic or other reasonable
means not later than the close of business on the Business Day immediately
following the day on which the Auction Agent determines the shares to be
redeemed (or, during a Default Period with respect to such shares, not later
than the close of business on the Business Day immediately following the
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day on which the Auction Agent receives Notice of Redemption from the Fund). The
Auction Agent shall confirm such notice in writing not later than the close of
business on the third Business Day preceding the date fixed for redemption by
providing the Notice of Redemption to each Holder of shares called for
redemption, the Paying Agent (if different from the Auction Agent) and the
Securities Depository. Notice of Redemption will be addressed to the registered
owners of each Series of FundPreferred shares at their addresses appearing on
the share records of the Fund. Such Notice of Redemption will set forth (i) the
date fixed for redemption, (ii) the number and identity of FundPreferred shares
to be redeemed, (iii) the redemption price (specifying the amount of accumulated
dividends to be included therein), (iv) that dividends on the shares to be
redeemed will cease to accumulate on such date fixed for redemption, and (v) the
provision under which redemption shall be made. No defect in the Notice of
Redemption or in the transmittal or mailing thereof will affect the validity of
the redemption proceedings, except as required by applicable law. If fewer than
all shares held by any Holder are to be redeemed, the Notice of Redemption
mailed to such Holder shall also specify the number of shares to be redeemed
from such Holder.
(c) Notwithstanding the provisions of paragraph (a) of this
Section 3, but subject to Section 7(e), no FundPreferred shares may be redeemed
unless all dividends in arrears on the Outstanding FundPreferred shares and all
shares of beneficial interest of the Fund ranking on a parity with the
FundPreferred shares with respect to payment of dividends or upon liquidation,
have been or are being contemporaneously paid or set aside for payment;
provided, however, that the foregoing shall not prevent the purchase or
acquisition of all Outstanding FundPreferred shares pursuant to the successful
completion of an otherwise lawful purchase or exchange offer made on the same
terms to, and accepted by, Holders of all Outstanding FundPreferred shares.
(d) Upon the deposit of funds sufficient to redeem shares of
any Series of FundPreferred shares with the Paying Agent and the giving of the
Notice of Redemption to the Auction Agent under paragraph (b) of this Section 3,
dividends on such shares shall cease to accumulate and such shares shall no
longer be deemed to be Outstanding for any purpose (including, without
limitation, for purposes of calculating whether the Fund has maintained the
requisite FundPreferred Shares Basic Maintenance Amount or the 1940 Act
FundPreferred Shares Asset Coverage), and all rights of the holder of the shares
so called for redemption shall cease and terminate, except the right of such
holder to receive the redemption price specified herein, but without any
interest or other additional amount. Such redemption price shall be paid by the
Paying Agent to the nominee of the Securities Depository. The Fund shall be
entitled to receive from the Paying Agent, promptly after the date fixed for
redemption, any cash deposited with the Paying Agent in excess of (i) the
aggregate redemption price of the FundPreferred shares called for redemption on
such date and (ii) such other amounts, if any, to which Holders of shares of
each Series of FundPreferred shares called for redemption may be entitled. Any
funds so deposited that are unclaimed at the end of two years from such
redemption date shall, to the extent permitted by law, be paid to the Fund,
after which time the Holders of FundPreferred shares so called for redemption
may look only to the Fund for payment of the redemption price and all other
amounts, if any, to which they may be entitled. The Fund shall be entitled to
receive, from time to time after the date fixed for redemption, any interest
earned on the funds so deposited.
(e) To the extent that any redemption for which Notice of
Redemption has been given is not made by reason of the absence of legally
available funds therefor, or is otherwise prohibited, such redemption shall be
made as soon as practicable to the extent such funds become legally available or
such redemption is no longer otherwise prohibited. Failure to redeem shares of
any Series of FundPreferred shares shall be deemed to exist at any time after
the date specified for redemption in a Notice of Redemption when the Fund shall
have failed, for any reason whatsoever, to deposit in trust with the Paying
Agent the redemption price with respect to any shares for which such Notice of
Redemption has been given. Notwithstanding the fact that the Fund may not have
redeemed shares of any Series of
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FundPreferred shares for which a Notice of Redemption has been given, dividends
may be declared and paid on FundPreferred shares Series and shall include those
FundPreferred shares for which Notice of Redemption has been given but for which
deposit of funds has not been made.
(f) All moneys paid to the Paying Agent for payment of the
redemption price of shares of any Series of FundPreferred shares called for
redemption shall be held in trust by the Paying Agent for the benefit of holders
of shares so to be redeemed.
(g) So long as any shares of any Series of FundPreferred
shares are held of record by the nominee of the Securities Depository, the
redemption price for such shares will be paid on the date fixed for redemption
to the nominee of the Securities Depository for distribution to Agent Members
for distribution to the persons for whom they are acting as agent.
(h) Except for the provisions described above, nothing
contained in this Statement limits any right of the Fund to purchase or
otherwise acquire any shares of each Series of FundPreferred shares outside of
an Auction at any price, whether higher or lower than the price that would be
paid in connection with an optional or mandatory redemption, so long as, at the
time of any such purchase, there is no arrearage in the payment of dividends on,
or the mandatory or optional redemption price with respect to, any shares of any
Series of FundPreferred shares for which Notice of Redemption has been given and
the Fund is in compliance with the 1940 Act FundPreferred Shares Asset Coverage
and has Eligible Assets with an aggregate Discounted Value at least equal to the
FundPreferred Shares Basic Maintenance Amount after giving effect to such
purchase or acquisition on the date thereof. Any shares which are purchased,
redeemed or otherwise acquired by the Fund shall have no voting rights. If fewer
than all the Outstanding shares of any Series of FundPreferred shares are
redeemed or otherwise acquired by the Fund, the Fund shall give notice of such
transaction to the Auction Agent, in accordance with the procedures agreed upon
by the Board of Trustees.
(i) In the case of any redemption pursuant to this Section 3,
only whole shares of FundPreferred shares shall be redeemed, and in the event
that any provision of the Declaration would require redemption of a fractional
share, the Auction Agent shall be authorized to round up so that only whole
shares are redeemed.
(j) Notwithstanding anything herein to the contrary,
including, without limitation, Sections 2(e), 6(f) and 11 of Part I hereof, the
Board of Trustees may authorize, create or issue any class or series of shares
of beneficial interest, including other series of FundPreferred shares, ranking
prior to or on a parity with the FundPreferred shares with respect to the
payment of dividends or the distribution of assets upon dissolution, liquidation
or winding up of the affairs of the Fund, to the extent permitted by the 1940
Act, as amended, if, upon issuance, either (A) the net proceeds from the sale of
such shares of beneficial interest (or such portion thereof needed to redeem or
repurchase the Outstanding FundPreferred shares) are deposited with the Auction
Agent in accordance with Section 3(d) of Part I hereof, Notice of Redemption as
contemplated by Section 3(b) of Part I hereof has been delivered prior thereto
or is sent promptly thereafter, and such proceeds are used to redeem all
Outstanding FundPreferred shares or (B) the Fund would meet the 1940 Act
FundPreferred Shares Asset Coverage, the FundPreferred Shares Basic Maintenance
Amount and the requirements of Section 11 of Part I hereof.
4. Designation of Dividend Period.
(a) The initial Dividend Period for each Series of
FundPreferred shares is as set forth under "Designation" above. The Fund will
designate the duration of subsequent Dividend Periods of each Series of
FundPreferred shares; provided, however, that no such designation is necessary
for a Standard Dividend Period and, provided further, that any designation of a
Special Dividend Period shall be effective only if (i) notice thereof shall have
been given as provided herein, (ii) any failure to pay in a
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timely manner to the Auction Agent the full amount of any dividend on, or the
redemption price of, FundPreferred shares shall have been cured as provided
above, (iii) Sufficient Clearing Bids shall have existed in an Auction held on
the Auction Date immediately preceding the first day of such proposed Special
Dividend Period, (iv) if the Fund shall have mailed a Notice of Redemption with
respect to any shares, the redemption price with respect to such shares shall
have been deposited with the Paying Agent, and (v) in the case of the
designation of a Special Dividend Period, the Fund has confirmed that as of the
Auction Date next preceding the first day of such Special Dividend Period, it
has Eligible Assets with an aggregate Discounted Value at least equal to the
FundPreferred Shares Basic Maintenance Amount, and the Fund has consulted with
the Broker-Dealers and has provided notice of such designation and a
FundPreferred Shares Basic Maintenance Certificate to Moody's (if Moody's is
then rating the FundPreferred shares), Fitch (if Fitch is then rating the
FundPreferred shares) and any Other Rating Agency which is then rating the
FundPreferred shares and so requires.
(b) If the Fund proposes to designate any Special Dividend
Period, not fewer than 7 (or two Business Days in the event the duration of the
Dividend Period prior to such Special Dividend Period is fewer than 8 days) nor
more than 30 Business Days prior to the first day of such Special Dividend
Period, notice shall be (i) made by press release and (ii) communicated by the
Fund by telephonic or other means to the Auction Agent and confirmed in writing
promptly thereafter. Each such notice shall state (A) that the Fund proposes to
exercise its option to designate a succeeding Special Dividend Period,
specifying the first and last days thereof and (B) that the Fund will by 3:00
p.m., New York City time, on the second Business Day next preceding the first
day of such Special Dividend Period, notify the Auction Agent, who will promptly
notify the Broker-Dealers, of either (x) its determination, subject to certain
conditions, to proceed with such Special Dividend Period, subject to the terms
of any Specific Redemption Provisions, or (y) its determination not to proceed
with such Special Dividend Period, in which latter event the succeeding Dividend
Period shall be a Standard Dividend Period.
No later than 3:00 p.m., New York City time, on the second
Business Day next preceding the first day of any proposed Special Dividend
Period, the Fund shall deliver to the Auction Agent, who will promptly deliver
to the Broker-Dealers and Existing Holders, either:
(i) a notice stating (A) that the Fund has determined
to designate the next succeeding Dividend Period as a Special Dividend
Period, specifying the first and last days thereof and (B) the terms of
any Specific Redemption Provisions; or
(ii) a notice stating that the Fund has determined
not to exercise its option to designate a Special Dividend Period.
If the Fund fails to deliver either such notice with respect to any designation
of any proposed Special Dividend Period to the Auction Agent or is unable to
make the confirmation provided in clause (v) of Paragraph (a) of this Section 4
by 3:00 p.m., New York City time, on the second Business Day next preceding the
first day of such proposed Special Dividend Period, the Fund shall be deemed to
have delivered a notice to the Auction Agent with respect to such Dividend
Period to the effect set forth in clause (ii) above, thereby resulting in a
Standard Dividend Period.
5. Restrictions on Transfer. Shares of a Series of FundPreferred shares
may be transferred only (a) pursuant to an order placed in an Auction, (b) to or
through a Broker-Dealer or (c) to the Fund or any Affiliate. Notwithstanding the
foregoing, a transfer other than pursuant to an Auction will not be effective
unless the selling Existing Holder or the Agent Member of such Existing Holder,
in the case of an Existing Holder whose shares are listed in its own name on the
books of the Auction Agent, or the Broker-Dealer or Agent Member of such
Broker-Dealer, in the case of a transfer between persons holding FundPreferred
shares through different Broker-Dealers, advises the Auction Agent of such
transfer. The
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certificates representing the shares of a Series of FundPreferred
shares issued to the Securities Depository will bear legends with respect to the
restrictions described above and stop-transfer instructions will be issued to
the Transfer Agent and/or Registrar.
6. Voting Rights.
(a) Except as otherwise provided in the Declaration or as
otherwise required by applicable law, (i) each Holder of shares of any Series of
FundPreferred shares shall be entitled to one vote for each share of any Series
of FundPreferred shares held on each matter submitted to a vote of shareholders
of the Fund, and (ii) the holders of Outstanding shares of Preferred Shares,
including each Series of FundPreferred shares, and shares of Common Shares shall
vote together as a single class on all matters submitted to shareholders;
provided, however, that, at any meeting of the shareholders of the Fund held for
the election of Trustees, the holders of Outstanding shares of Preferred Shares,
including each Series of FundPreferred 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
Fund, to elect two Trustees of the Fund, each share of Preferred Shares,
including each Series of FundPreferred shares, entitling the holder thereof to
one vote. The identity of the nominees of such Trustees may be fixed by the
Board of Trustees. Subject to paragraph (b) of this Section 6, the holders of
Outstanding shares of Common Shares and Preferred Shares, including each Series
of FundPreferred shares, voting together as a single class, shall elect the
balance of the Trustees.
(b) During any period in which any one or more of the
conditions described below shall exist (such period being referred to herein as
a "Voting Period"), the number of Trustees constituting the Board of Trustees
shall be automatically increased by the smallest number that, when added to the
two Trustees elected exclusively by the holders of shares of Preferred Shares,
including each Series of FundPreferred shares, would constitute a majority of
the Board of Trustees as so increased by such smallest number; and the holders
of shares of Preferred Shares, including each Series of FundPreferred 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 the
Fund), 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:
(i) if at the close of business on any Dividend
Payment Date accumulated dividends (whether or not earned or declared)
on Preferred Shares equal to at least two full years' dividends shall
be due and unpaid; or
(ii) if at any time holders of any Preferred Shares
are entitled under the 1940 Act to elect a majority of the Trustees of
the Fund.
Upon the termination of a Voting Period, the voting rights described in this
paragraph (b) of Section 6 shall cease, subject always, however, to the
revesting of such voting rights in the Holders of shares of Preferred Shares,
including each Series of FundPreferred shares, upon the further occurrence of
any of the events described in this paragraph (b) of Section 6.
(c) As soon as practicable after the accrual of any right of
the Holders of shares of Preferred Shares, including each Series of
FundPreferred shares, to elect additional Trustees as described in paragraph (b)
of this Section 6, the Fund shall notify the Auction Agent, and the Auction
Agent shall call a special meeting of such holders, by mailing a notice of such
special meeting to such holders, such meeting to be held not less than 10 nor
more than 30 days after the date of mailing of such notice. If the Fund fails to
send such notice to the Auction Agent or if the Auction Agent does not call such
a special meeting, 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
A-11
Day preceding the day on which such notice is mailed. At any such special
meeting and at each meeting of holders of shares of Preferred Shares, including
each Series of FundPreferred 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 capital stock of
the Fund), shall be entitled to elect the number of Trustees prescribed in
paragraph (b) of this Section 6 on a one-vote-per-share basis.
(d) The terms of office of all persons who are Trustees of the
Fund at the time of a special meeting of holders of the FundPreferred shares 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 such holders, together with the two incumbent Trustees
elected by such holders and the remaining incumbent Trustees, shall constitute
the duly elected Trustees of the Fund.
(e) Simultaneously with the termination of a Voting Period,
the terms of office of the additional directors elected by the Holders of the
FundPreferred shares and holders of other Preferred Shares pursuant to paragraph
(b) of this Section 6 shall terminate, the remaining Trustees shall constitute
the Trustees of the Fund and the voting rights of such holders to elect
additional Trustees pursuant to paragraph (b) of this Section 6 shall cease,
subject to the provisions of the last sentence of paragraph (b) of this Section
6.
(f) So long as any of the shares of Preferred Shares,
including each Series of FundPreferred shares, are Outstanding, the Fund will
not, without the affirmative vote of the holders of a majority of the
Outstanding shares of Preferred Shares determined with reference to a "majority
of outstanding voting securities" as that term is defined in Section 2(a)(42) of
the 1940 Act, voting as a separate class, (i) amend, alter or repeal any of the
preferences, rights or powers of such class so as to affect materially and
adversely such preferences, rights or powers as defined in Section 6(h) below;
(ii) increase the authorized number of shares of Preferred Shares; (iii) create,
authorize or issue shares of any class of shares of beneficial interest ranking
senior to or on a parity with the Preferred Shares with respect to the payment
of dividends or the distribution of assets, or any securities convertible into,
or warrants, options or similar rights to purchase, acquire or receive, such
shares of beneficial interest ranking senior to or on a parity with the
Preferred Shares or reclassify any authorized shares of beneficial interest of
the Fund into any shares ranking senior to or on a parity with the Preferred
Shares (except that, notwithstanding the foregoing, but subject to the
provisions of either Section 3(j) or 11, as applicable, the Board of Trustees,
without the vote or consent of the holders of the Preferred Shares, may from
time to time authorize, create and classify, and the Fund may from time to time
issue, shares or series of Preferred Shares, including other series of
FundPreferred shares, ranking on a parity with the FundPreferred shares with
respect to the payment of dividends and the distribution of assets upon
dissolution, liquidation or winding up to the affairs of the Fund, and may
authorize, reclassify and/or issue any additional shares of each Series of
FundPreferred shares, including shares previously purchased or redeemed by the
Fund, subject to continuing compliance by the Fund with 1940 Act FundPreferred
Shares Asset Coverage and FundPreferred Shares Basic Maintenance Amount
requirements); (iv) institute any proceedings to be adjudicated bankrupt or
insolvent, or consent to the institution of bankruptcy or insolvency proceedings
against it, or file a petition seeking or consenting to reorganization or relief
under any applicable federal or state law relating to bankruptcy or insolvency,
or consent to the appointment of a receiver, liquidator, assignee, trustee,
sequestrator (or other similar official) of the Fund or a substantial part of
its property, or make any assignment for the benefit of creditors, or, except as
may be required by applicable law, admit in writing its inability to pay its
debts generally as they become due or take any corporate action in furtherance
of any such action; (v) create, incur or suffer to exist, or agree to create,
incur or suffer to exist, or consent to cause or permit in the future (upon the
happening of a contingency or otherwise) the creation, incurrence or existence
of any material lien, mortgage, pledge, charge, security interest, security
agreement, conditional sale or trust receipt or other material encumbrance of
any kind upon any of the
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Fund's assets as a whole, except (A) liens the validity of which are being
contested in good faith by appropriate proceedings, (B) liens for taxes that are
not then due and payable or that can be paid thereafter without penalty, (C)
liens, pledges, charges, security interests, security agreements or other
encumbrances arising in connection with any indebtedness senior to the
FundPreferred shares, or arising in connection with any futures contracts or
options thereon, interest rate swap or cap transactions, forward rate
transactions, put or call options, short sales of securities or other similar
transactions, (D) liens, pledges, charges, security interests, security
agreements or other encumbrances arising in connection with any indebtedness
permitted under clause (vi) below and (E) liens to secure payment for services
rendered including, without limitation, services rendered by the Fund's
custodian and the Auction Agent; or (vi) create, authorize, issue, incur or
suffer to exist any indebtedness for borrowed money or any direct or indirect
guarantee of such indebtedness for borrowed money or any direct or indirect
guarantee of such indebtedness, except the Fund may borrow as may be permitted
by the Fund's investment restrictions; provided, however, that transfers of
assets by the Fund subject to an obligation to repurchase shall not be deemed to
be indebtedness for purposes of this provision to the extent that after any such
transaction the Fund has Eligible Assets with an aggregate Discounted Value at
least equal to the FundPreferred Shares Basic Maintenance Amount as of the
immediately preceding Valuation Date.
(g) The affirmative vote of the holders of a majority of the
Outstanding shares of Preferred Shares, including each Series of FundPreferred
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 or any action requiring a vote of security holders of the Fund under
Section 13(a) of the 1940 Act. In the event a vote of holders of shares of
Preferred Shares is required pursuant to the provisions of Section 13(a) of the
1940 Act, the Fund 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
FundPreferred shares), Fitch (if Fitch is then rating the FundPreferred shares)
and any Other Rating Agency which is then rating FundPreferred shares and which
so requires that such vote is to be taken and the nature of the action with
respect to which such vote is to be taken and shall, not later than ten Business
Days after the date on which such vote is taken, notify Moody's, Fitch and any
such Other Rating Agency, as applicable, of the results of such vote.
(h) The affirmative vote of the holders of a majority of the
Outstanding shares of any series of Preferred Shares, including any Series of
FundPreferred shares, voting separately from any other series, shall be required
with respect to any matter that materially and adversely affects the rights,
preferences, or powers of that series in a manner different from that of other
series of classes of the Fund's shares of beneficial interest. For purposes of
the foregoing, no matter shall be deemed to adversely affect any right,
preference or power unless such matter (i) alters or abolishes any preferential
right of such series; (ii) creates, alters or abolishes any right in respect of
redemption of such series; or (iii) creates or alters (other than to abolish)
any restriction on transfer applicable to such series. The vote of holders of
any shares described in this Section 6(h) will in each case be in addition to a
separate vote of the requisite percentage of Common Shares and/or Preferred
Shares, if any, necessary to authorize the action in question.
(i) The Board of Trustees, without the vote or consent of any
holder of shares of Preferred Shares, including any Series of FundPreferred
shares, or any other shareholder of the Fund, may from time to time adopt,
amend, alter or repeal any or all of the definitions contained herein, add
covenants and other obligations of the Fund, or confirm the applicability of
covenants and other obligations set forth herein, in connection with obtaining
or maintaining the rating of Moody's (if Moody's is then rating the
FundPreferred shares), Fitch (if Fitch is then rating the FundPreferred shares)
or any Other Rating Agency which is then rating the FundPreferred shares, and
any such adoption, amendment, alteration or repeal will not be deemed to affect
the preferences, rights or powers of Preferred Shares, including FundPreferred
shares, or the Holders thereof, provided that the Board of Trustees
A-13
receives written confirmation from Moody's, Fitch or Other Rating Agency, as
applicable (with such confirmation in no event being required to be obtained
from a particular rating agency with respect to definitions or other provisions
relevant only to and adopted in connection with another rating agency's rating
of any Series of FundPreferred shares) that any such amendment, alteration or
repeal would not adversely affect the rating then assigned by such rating
agency.
In addition, subject to compliance with applicable law, the
Board of Trustees may amend the definition of Maximum Rate to increase the
percentage amount by which the Reference Rate is multiplied to determine the
Maximum Rate shown therein without the vote or consent of the holders of the
Preferred Shares, including any Series of FundPreferred shares, or any other
shareholder of the Fund, and without receiving any confirmation from any rating
agency after consultation with the Broker-Dealers, provided that immediately
following any such increase the Fund would be in compliance with the
FundPreferred Shares Basic Maintenance Amount.
(j) Unless otherwise required by law, holders of shares of any
Series of FundPreferred shares shall not have any relative rights or preferences
or other special rights other than those specifically set forth herein. The
holders of shares of any Series of FundPreferred shares shall have
no rights to cumulative voting. In the event that the Fund fails to pay any
dividends on the shares of any Series of FundPreferred shares, the exclusive
remedy of the holders shall be the right to vote for Trustees pursuant to the
provisions of this Section 6.
(k) The foregoing voting provisions will not apply with
respect to any Series of FundPreferred shares 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 shall have been deposited in trust to effect
such redemption.
7. Liquidation Rights.
(a) Upon the dissolution, liquidation or winding up of the
affairs of the Fund, whether voluntary or involuntary, the holders of each
Series of FundPreferred shares then Outstanding, together with holders of shares
of any class of shares ranking on a parity with each Series of FundPreferred
shares upon dissolution, liquidation or winding up, shall be entitled to receive
and to be paid out of the assets of the Fund (or the proceeds thereof) available
for distribution to its shareholders after satisfaction of claims of creditors
of the Fund an amount equal to the liquidation preference with respect to such
shares. The liquidation preference for shares of each Series of FundPreferred
shares shall be $25,000 per share, plus an amount equal to all accumulated
dividends thereon (whether or not earned or declared but without interest) to
the date payment of such distribution is made in full or a sum sufficient for
the payment thereof is set apart with the Paying Agent. No redemption premium
shall be paid upon any liquidation even if such redemption premium would be paid
upon optional or mandatory redemption of the relevant shares.
(b) If, upon any such liquidation, dissolution or winding up
of the affairs of the Fund, whether voluntary or involuntary, the assets of the
Fund available for distribution among the holders of all outstanding Preferred
Shares, including the FundPreferred shares, shall be insufficient to permit the
payment in full to such holders of the amounts to which they are entitled, then
such available assets shall be distributed among the holders of all outstanding
Preferred Shares, including the FundPreferred shares, ratably in any such
distribution of assets according to the respective amounts which would be
payable on all such shares if all amounts thereon were paid in full.
(c) Upon the dissolution, liquidation or winding up of the
affairs of the Fund, whether voluntary or involuntary, until payment in full is
made to the holders of FundPreferred shares of the liquidation distribution to
which they are entitled, no dividend or other distribution shall be made to
A-14
the holders of shares of Common Shares or any other class of shares of
beneficial interest of the Fund ranking junior to FundPreferred shares upon
dissolution, liquidation or winding up and no purchase, redemption or other
acquisition for any consideration by the Fund shall be made in respect of the
shares of Common Shares or any other class of shares of beneficial interest of
the Fund ranking junior to FundPreferred shares upon dissolution, liquidation or
winding up.
(d) A consolidation, reorganization or merger of the Fund with
or into any other trust or company, or a sale, lease or exchange of all or
substantially all of the assets of the Fund in consideration for the issuance of
equity securities of another trust or company shall not be deemed to be a
liquidation, dissolution or winding up, whether voluntary or involuntary, for
the purposes of this Section 7.
(e) After the payment to the Holders of Preferred Shares,
including FundPreferred shares, of the full preferential amounts provided for in
this Section 7, the holders of Preferred Shares, including FundPreferred shares,
as such shall have no right or claim to any of the remaining assets of the Fund.
(f) In the event the assets of the Fund or proceeds thereof
available for distribution to the Holders of FundPreferred shares, upon any
dissolution, liquidation or winding up of the affairs of the Fund, whether
voluntary or involuntary, shall be insufficient to pay in full all amounts to
which such holders are entitled pursuant to paragraph (a) of this Section 7, 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 FundPreferred shares unless
proportionate distributive amounts shall be paid on account of the FundPreferred
shares, ratably, in proportion to the full distributable amounts to which
holders of all such parity shares are entitled upon such dissolution,
liquidation or winding up.
(g) Subject to the rights of the holders of shares of any
Series or class or classes of stock ranking on a parity with FundPreferred
shares with respect to the distribution of assets upon dissolution, liquidation
or winding up of the affairs of the Fund, after payment shall have been made in
full to the holders of the FundPreferred shares as provided in paragraph (a) of
this Section 7, but not prior thereto, any other series or class or classes of
stock ranking junior to FundPreferred shares with respect to the distribution of
assets upon dissolution, liquidation or winding up of the affairs of the Fund
shall, subject to any 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 FundPreferred shares shall not be entitled to share
therein.
8. Auction Agent. For so long as any FundPreferred shares are
Outstanding, the Auction Agent, duly appointed by the Fund to so act, shall be
in each case a commercial bank, trust company or other financial institution
independent of the Fund and its Affiliates (which, however, may engage or have
engaged in business transactions with the Fund or its Affiliates) and at no time
shall the Fund 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 FundPreferred shares are
Outstanding, the Fund shall use its best efforts promptly thereafter to appoint
another qualified commercial bank, trust company or financial institution to act
as the Auction Agent.
9. 1940 Act FundPreferred Shares Asset Coverage. The Fund shall
maintain, as of the last Business Day of each month in which any shares of the
FundPreferred shares are Outstanding, asset coverage with respect to the
FundPreferred shares which is equal to or greater than the 1940 Act
FundPreferred Shares Asset Coverage; provided, however, that Section 3(a)(ii)
shall be the sole remedy in the event the Fund fails to do so.
A-15
10. FundPreferred Shares Basic Maintenance Amount. So long as the
FundPreferred shares are Outstanding and Moody's, Fitch or any Other Rating
Agency which so requires is then rating the shares of the FundPreferred shares,
the Fund shall maintain, as of each Valuation Date, Moody's Eligible Assets (if
Moody's is then rating the FundPreferred shares), Fitch Eligible Assets (if
Fitch is then rating the FundPreferred shares) and (if applicable) Other Rating
Agency Eligible Assets having an aggregate Discounted Value equal to or greater
than the FundPreferred Shares Basic Maintenance Amount; provided, however, that
Section 3(a)(ii) shall be the sole remedy in the event the Fund fails to do so.
11. Certain Other Restrictions. For so long as any shares of
FundPreferred shares are Outstanding and Moody's, Fitch or any Other Rating
Agency which so requires is then rating the shares of FundPreferred shares, the
Fund will not, unless it has received written confirmation from Moody's (if
Moody's is then rating FundPreferred shares), Fitch (if Fitch is then rating the
FundPreferred shares) and (if applicable) such Other Rating Agency that any such
action would not impair the rating then assigned by such rating agency to a
Series of FundPreferred shares, engage in any one or more of the following
transactions:
(a) write unsecured put or uncovered call options on portfolio
securities;
(b) issue additional shares or series of FundPreferred shares
or any class or series of shares ranking prior to or on a parity with
FundPreferred shares with respect to the payment of dividends or the
distribution of assets upon dissolution, liquidation or winding up of the Fund,
or reissue any shares of FundPreferred shares Series M, T, W, TH, F and F2
previously purchased or redeemed by the Fund;
(c) engage in any short sales of securities;
(d) lend portfolio securities; or
(e) merge or consolidate into or with any other corporation.
12. Compliance Procedures for Asset Maintenance Tests. For so long as
any FundPreferred shares are Outstanding and Moody's, Fitch or any Other Rating
Agency which so requires is then rating such shares:
(a) As of each Valuation Date, the Fund shall determine in
accordance with the procedures specified herein (i) the Market Value of each
Eligible Asset owned by the Fund on that date, (ii) the Discounted Value of each
such Eligible Asset using the Discount Factors, (iii) whether the FundPreferred
Shares Basic Maintenance Amount is met as of that date, (iv) the value of the
total assets of the Fund, less all liabilities, and (v) whether the 1940 Act
FundPreferred Shares Asset Coverage is met as of that date.
(b) Upon any failure to maintain the required FundPreferred
Shares Basic Maintenance Amount or 1940 Act FundPreferred Shares Asset Coverage
on any Valuation Date, the Fund may use reasonable commercial efforts
(including, without limitation, altering the composition of its portfolio,
purchasing FundPreferred shares outside of an Auction or in the event of a
failure to file a certificate on a timely basis, submitting the requisite
certificate), subject to the fiduciary obligations of the Board of Trustees, to
reattain (or certify in the case of a failure to file on a timely basis, as the
case may be) the required FundPreferred Shares Basic Maintenance Amount or 1940
Act FundPreferred Shares Asset Coverage on or prior to the Asset Coverage Cure
Date.
A-16
(c) Compliance with the FundPreferred Shares Basic Maintenance
Amount and 1940 Act FundPreferred Shares Asset Coverage tests shall be
determined with reference to those FundPreferred shares which are deemed to be
Outstanding hereunder.
(d) The Fund shall deliver to Moody's (if Moody's is then
rating FundPreferred shares), Fitch (if Fitch is then rating FundPreferred
shares) and any Other Rating Agency which is then rating FundPreferred shares
and when so requires a certificate which sets forth a determination of items
(i)-(iii) of paragraph (a) of this Section 12 (a "FundPreferred Shares Basic
Maintenance Certificate") as of (A) the Date of Original Issue, (B) the last
Valuation Date of each month, (C) any date requested by any rating agency, (D) a
Business Day on or before any Asset Coverage Cure Date relating to the Fund's
cure of a failure to meet the FundPreferred Shares Basic Maintenance Amount
Test, (E) any day that Common Shares or Preferred Shares, including
FundPreferred shares, are redeemed and (F) any day the Eligible Assets have an
aggregate discounted value less than or equal to 115% of the FundPreferred
Shares Basic Maintenance Amount. Such FundPreferred Shares Basic Maintenance
Certificate shall be delivered in the case of clause (i)(A) on or before the
seventh Business Day following the Date of Original Issue and in the case of all
other clauses above on or before the seventh Business Day after the relevant
Valuation Date or Asset Coverage Cure Date.
(e) The Fund shall deliver to Moody's (if Moody's is then
rating FundPreferred shares), Fitch (if Fitch is then rating FundPreferred
shares) and any Other Rating Agency which is then rating FundPreferred shares
and which so requires a certificate with respect to the calculation of the 1940
Act FundPreferred Shares Asset Coverage and the value of the portfolio holdings
of the Fund (a "1940 Act FundPreferred Shares Asset Coverage Certificate") (i)
as of the Date of Original Issue, and (ii) as of (A) the last Valuation Date of
each quarter thereafter, and (B) as of the Business Day on or before the Asset
Coverage Cure Date relating to the failure to satisfy the 1940 Act FundPreferred
Shares Asset Coverage. Such 1940 Act FundPreferred Shares Asset Coverage
Certificate shall be delivered in the case of clause (i) on or before the
seventh Business Day following the Date of Original Issue and in the case of
clause (ii) on or before the seventh Business Day after the relevant Valuation
Date or the Asset Coverage Cure Date. The certificates of (d) and (e) of this
Section 12 may be combined into a single certificate.
(f) Within ten Business Days of the Date of Original Issue,
the Fund shall deliver to the Auction Agent, Moody's (if Moody's is then rating
FundPreferred shares), Fitch (if Fitch is then rating FundPreferred shares) and
any Other Rating Agency which is then rating FundPreferred shares and which so
requires a letter prepared by the Fund's independent accountants (an
"Accountant's Certificate") regarding the accuracy of the calculations made by
the Fund in the FundPreferred Shares Basic Maintenance Certificate and the 1940
Act FundPreferred Shares Asset Coverage Certificate required to be delivered by
the Fund as of the Date of Original Issue. Within ten Business Days after the
last Valuation Date of each fiscal quarter of the Fund on which a FundPreferred
Shares Basic Maintenance Certificate is required to be delivered, the Fund will
deliver to the Auction Agent, Moody's (if Moody's is then rating FundPreferred
shares), Fitch (if Fitch is then rating the FundPreferred shares) and any Other
Rating Agency which is then rating FundPreferred shares and which so requires an
Accountant's Certificate regarding the accuracy of the calculations made by the
Fund in such FundPreferred Shares Basic Maintenance Certificate and in any other
FundPreferred Shares Basic Maintenance Certificate randomly selected by the
Fund's independent accountants during such fiscal quarter. Within ten Business
Days after the last Valuation Date of each fiscal quarter of the Fund on which a
1940 Act FundPreferred Shares Asset Coverage Certificate is required to be
delivered, the Fund will deliver to the Auction Agent, Moody's (if Moody's is
then rating FundPreferred shares), Fitch (if Fitch is then rating the
FundPreferred shares) and any Other Rating Agency which is then rating
FundPreferred shares and which so requires an Accountant's Certificate regarding
the accuracy of the calculations made by the Fund in such 1940 Act FundPreferred
Shares Asset Coverage Certificate. In addition, the Fund will deliver to the
relevant persons specified in the preceding sentence an Accountant's Certificate
regarding the accuracy of the
A-17
calculations made by the Fund on each FundPreferred Shares Basic Maintenance
Certificate and 1940 Act FundPreferred Shares Asset Coverage Certificate
delivered pursuant to clause (iv) of paragraph (d) or clause (ii)(B) of
paragraph (e) of this Section 12, as the case may be, within ten days after the
relevant Asset Coverage Cure Date. If an Accountant's Certificate delivered with
respect to an Asset Coverage Cure Date shows an error was made in the Fund's
report with respect to such Asset Coverage Cure Date, the calculation or
determination made by the Fund's independent accountants will be conclusive and
binding on the Fund with respect to such reports. If any other Accountant's
Certificate shows that an error was made in any such report, the calculation or
determination made by the Fund's independent accountants will be conclusive and
binding on the Fund; provided, however, any errors shown in the Accountant's
Certificate filed on a quarterly basis shall not be deemed to be a failure to
maintain the FundPreferred Shares Basic Maintenance Amount on any prior
Valuation Dates.
(g) The Accountant's Certificates referred to in paragraph (g)
will confirm, based upon the independent accountant's review, (i) the
mathematical accuracy of the calculations reflected in the related FundPreferred
Shares Basic Maintenance Amount and 1940 Act FundPreferred Shares Asset Coverage
Certificates, as the case may be, and (ii) that the Fund determined whether the
Fund had, at such Valuation Date, Eligible Assets with an aggregate Discounted
Value at least equal to the Basic Maintenance Amount in accordance with the
Declaration.
(h) In the event that a FundPreferred Shares Basic Maintenance
Certificate or 1940 Act FundPreferred Shares Asset Coverage Certificate with
respect to an applicable Valuation Date is not delivered within the time periods
specified in this Section 12, the Fund shall be deemed to have failed to
maintain the FundPreferred Shares Basic Maintenance Amount or the 1940 Act
FundPreferred Shares Asset Coverage, as the case may be, on such Valuation Date
for purposes of Section 13(b). In the event that a FundPreferred Shares Basic
Maintenance Certificate or 1940 Act FundPreferred Shares Asset Coverage
Certificate or the applicable Accountant's Certificates with respect to an
applicable Asset Coverage Cure Date are not delivered within the time periods
specified herein, the Fund shall be deemed to have failed to have Eligible
Assets with an aggregate Discounted Value at least equal to the FundPreferred
Shares Basic Maintenance Amount or the 1940 FundPreferred Shares Asset Coverage,
as the case may be, as of the related Valuation Date, and such failure shall be
deemed not to have been cured as of such Asset Coverage Cure Date for purposes
of the mandatory redemption provisions.
13. Notice. All notices or communications hereunder, unless otherwise
specified in this Statement, shall be sufficiently given if in writing and
delivered in person, by telecopier, by electronic means or mailed by first-class
mail, postage prepaid. Notices delivered pursuant to this Section 13 shall be
deemed given on the earlier of the date received or the date five days after
which such notice is mailed.
14. Waiver. Holders of at least two-thirds of the Outstanding
FundPreferred shares, acting collectively, or each Series of FundPreferred
shares acting as a separate series, may waive any provision hereof intended for
their respective benefit in accordance with such procedures as may from time to
time be established by the Board of Trustees.
15. Termination. In the event that no FundPreferred shares are
Outstanding, all rights and preferences of such shares established and
designated hereunder shall cease and terminate, and all obligations of the Fund
under this Statement, shall terminate.
16. Amendment. Subject to the provisions of this Statement, the Board
of Trustees may, by resolution duly adopted, without shareholder approval
(except as otherwise provided by this Statement or required by applicable law),
amend this Statement to (1) reflect any amendments hereto which the Board of
Trustees is entitled to adopt pursuant to the terms of this Statement without
shareholder approval or (2) add additional series of FundPreferred shares or
additional shares of a series of FundPreferred shares (and terms relating
thereto) to the series and shares of FundPreferred shares theretofore described
thereon.
A-18
All such additional shares shall be governed by the terms of this Statement,
except as set forth in such amendment with respect to such additional shares. To
the extent permitted by applicable law, the Board of Trustees may interpret,
amend or adjust the provisions of this Statement to resolve any inconsistency or
ambiguity or to remedy any defect.
17. Definitions. As used in Part I and Part II of this Statement, 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:
(a) "'AA' Composite Commercial Paper Rate" on any date means
(i) the interest equivalent of the 7-day rate, in the case of a Dividend Period
which is a Standard Dividend Period or shorter; for Dividend Periods greater
than 7 days but fewer than or equal to 31 days, the 30-day rate; for Dividend
Periods greater than 31 days but fewer than or equal to 61 days, the 60-day
rate; for Dividend Periods greater than 61 days but fewer than or equal to 91
days, the 90-day rate; for Dividend Periods greater than 91 days but fewer than
or equal to 270 days, the rate described in (ii); for Dividend Periods greater
than 270 days, the Treasury Index Rate; on commercial paper on behalf of issuers
whose corporate bonds are rated "AA" by S&P, or the equivalent of such rating by
another nationally recognized rating agency, as announced by the Federal Reserve
Bank of New York for the close of business on the Business Day immediately
preceding such date; or (ii) if the Federal Reserve Bank of New York does not
make available such a rate, then the arithmetic average of the interest
equivalent of such rates on commercial paper placed on behalf of such issuers,
as quoted on a discount basis or otherwise by the Commercial Paper Dealers to
the Auction Agent for the close of business on the Business Day immediately
preceding such date (rounded to the next highest .001 of 1%). If any Commercial
Paper Dealer does not quote a rate required to determine the "AA" Composite
Commercial Paper Rate, such rate shall be determined on the basis of the
quotations (or quotation) furnished by the remaining Commercial Paper Dealers
(or Dealer), if any, or, if there are no such Commercial Paper Dealers, by the
Auction Agent. For purposes of this definition, (A) "Commercial Paper Dealers"
shall mean (1) Citigroup Global Markets Inc., Lehman Brothers Inc., Merrill
Lynch, Pierce, Fenner & Smith Incorporated and Goldman Sachs & Co.; (2) in lieu
of any thereof, its respective Affiliate or successor; and (3) in the event that
any of the foregoing shall cease to quote rates for commercial paper of issuers
of the sort described above, in substitution therefor, a nationally recognized
dealer in commercial paper of such issuers then making such quotations selected
by the Corporation, and (B) "interest equivalent" of a rate stated on a discount
basis for commercial paper of a given number of days' maturity shall mean a
number equal to the quotient (rounded upward to the next higher one-thousandth
of 1%) of (1) such rate expressed as a decimal, divided by (2) the difference
between (x) 1.00 and (y) a fraction, the numerator of which shall be the product
of such rate expressed as a decimal, multiplied by the number of days in which
such commercial paper shall mature and the denominator of which shall be 360.
(b) "Accountant's Certificate" has the meaning set forth in
Section 12(g) of this Part I.
(c) "Affiliate" means any person controlled by, in control of
or under common control with the Fund; provided that no Broker-Dealer controlled
by, in control of or under common control with the Fund shall be deemed to be an
Affiliate nor shall any corporation or any person controlled by, in control of
or under common control with such corporation one of the trustees, directors or
executive officers of which is also a Trustee of the Fund be deemed to be an
Affiliate solely because such Trustee, director or executive officer is also a
Trustee of the Fund.
(d) "Agent Member" means a member of or participant in the
Securities Depository that will act on behalf of a Bidder.
(e) "All Hold Rate" means 80% of the "AA" Composite Commercial
Paper Rate.
A-19
(f) "Applicable Rate" means, with respect to each Series of
FundPreferred shares for each Dividend Period (i) if Sufficient Clearing Orders
exist for the Auction in respect thereof, the Winning Bid Rate, (ii) if
Sufficient Clearing Orders do not exist for the Auction in respect thereof, the
Maximum Applicable Rate and (iii) in the case where all the shares of
FundPreferred shares are the subject of Hold Orders for the Auction in respect
thereof, the All Hold Rate.
(g) "Approved Foreign Nations" has the meaning set forth in
the definition of "Fitch Eligible Assets."
(h) "Approved Price" means the "fair value" as determined by
the Fund in accordance with the valuation procedures adopted from time to time
by the Board of Trustees of the Fund and for which the Fund receives a
mark-to-market price (which, for the purpose of clarity, shall not mean Market
Value) from an independent source at least semi-annually.
(i) "Asset Coverage Cure Date" has the meaning set forth in
Section 3(a)(ii).
(j) "Auction" means each periodic operation of the procedures
set forth under "Auction Procedures."
(k) "Auction Agent" means The Bank of New York unless and
until another commercial bank, trust company, or other financial institution
appointed by a resolution of the Board of Trustees enters into an agreement with
the Fund to follow the Auction Procedures for the purpose of determining the
Applicable Rate.
(l) "Auction Date" means the first Business Day next preceding
the first day of a Dividend Period for each Series of FundPreferred shares.
(m) "Auction Procedures" means the procedures for conducting
Auctions set forth in Part II hereof.
(n) "Bank Loans" means direct purchases of, assignments of,
participants 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.
(o) "Beneficial Owner," with respect to shares of each Series
of FundPreferred 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.
(p) "Bid" shall have the meaning specified in paragraph (a) of
Section 1 of Part II of this Statement.
(q) "Bidder" shall have the meaning specified in paragraph (a)
of Section 1 of Part II of this Statement; provided, however, that neither the
Fund 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 Fund may be a Bidder
in an Auction, but only if the Orders placed by such Broker-Dealer are not for
its own account.
(r) "Board of Trustees" or "Board" means the Board of Trustees
of the Fund or any duly authorized committee thereof as permitted by applicable
law.
(s) "Broker-Dealer" means any broker-dealer or broker-dealers,
or other entity permitted by law to perform the functions required of a
Broker-Dealer by the Auction Procedures, that has been selected by the Fund and
has entered into a Broker-Dealer Agreement that remains effective.
(t) "Broker-Dealer Agreement" means an agreement among the
Auction Agent and a Broker-Dealer, pursuant to which such Broker-Dealer agrees
to follow the Auction Procedures.
A-20
(u) "Business Day" means a day on which the New York Stock
Exchange is open for trading and which is not a Saturday, Sunday or other day on
which banks in the City of New York, New York are authorized or obligated by law
to close.
(v) "Canadian Bonds" has the meaning set forth in the
definition of "Fitch Eligible Assets."
(w) "Code" means the Internal Revenue Code of 1986, as
amended.
(x) "Commercial Paper Dealers" has the meaning set forth in
the definition of AA Composite Commercial Paper Rate.
(y) "Commission" means the Securities and Exchange Commission.
(z) "Common Share" means the shares of beneficial interest,
par value $.01 per share, of the Fund.
(aa) "Date of Original Issue" means, with respect to Series M,
M2, T, T2, W, W2, TH, TH2, F, and F2 FundPreferred shares, ______, 2003.
(bb) "Debt Securities" has the meaning set forth in paragraph
(iv) of the definition of "Fitch Eligible Assets."
(cc) "Default" has the meaning set forth in Section 2(c)(ii)
of this Part I.
(dd) "Default Period" has the meaning set forth in Section
2(c)(ii) of this Part I.
(ee) "Default Rate" means the Reference Rate multiplied by
three (3).
(ff) "Deposit Securities" means cash and any obligations or
securities, including Short Term Money Market Instruments that are Eligible
Assets, rated at least AAA, A-2 or SP-2 by S&P, except that, for purposes of
section 3(a)(i) of this Part I, such obligations or securities shall be
considered "Deposit Securities" only if they are also rated at least P-2 by
Moody's.
(gg) "Discount Factor" means the Moody's Discount Factor (if
Moody's is then rating the FundPreferred shares), Fitch Discount Factor (if
Fitch is then rating the FundPreferred shares) or the discount factor
established by any Other Rating Agency which is then rating the FundPreferred
shares and which so requires, whichever is applicable.
(hh) "Discounted Value" means the quotient of the Market Value
of an Eligible Asset divided by the applicable Discount Factor, provided that
with respect to an Eligible Asset that is currently callable, Discounted Value
will be equal to the quotient as calculated above or the call price, whichever
is lower, and that with respect to an Eligible Asset that is prepayable,
Discounted Value will be equal to the quotient as calculated above or the par
value, whichever is lower.
(ii) "Dividend Default" has the meaning set forth in Section
2(c)(iii) of this Part I.
(jj) "Dividend Payment Date" with respect to a Series of
FundPreferred shares means any date on which dividends are payable pursuant to
Section 2(b) of this Part I.
(kk) "Dividend Period" means, with respect to a Series of
FundPreferred shares, the period commencing on the Date of Original Issue
thereof and ending on the date specified for such series on the Date of Original
Issue thereof and thereafter, as to such series, the period commencing on the
day
A-21
following each Dividend Period for such series and ending on the day established
for such series by the Fund.
(ll) "Eligible Assets" means Moody's Eligible Assets or
Fitch's Eligible Assets (if Moody's or Fitch are then rating the FundPreferred
shares) and/or Other Rating Agency Eligible Assets if any Other Rating Agency is
then rating the FundPreferred shares, whichever is applicable.
(mm) "Existing Holder," with respect to shares of a series of
FundPreferred shares, shall mean a Broker-Dealer (or any such other Person as
may be permitted by the Fund) that is listed on the records of the Auction Agent
as a holder of shares of such series.
(nn) "Fitch" means Fitch Ratings and its successors at law.
(oo) "Fitch Discount Factor" means for purposes of determining
the Discounted Value of any Fitch Eligible Asset, the percentage determined as
follows, provided however, that for unhedged foreign investments a discount
factor of 105% shall be applied to the Market Value thereof in addition to the
Discount Factor as determined in accordance with the procedures below, provided
further that, if the foreign issuer of such unhedged foreign investment is from
a country whose sovereign debt rating in a non-local currency is not assigned a
rating of AA or better by Fitch, a discount factor of 117% shall be applied to
the Market Value thereof in addition to the Discount Factor as determined in
accordance with the procedures below. 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) Preferred Stock: The percentage determined by
references to the rating of a preferred stock in accordance with the
table set forth below.
PREFERRED STOCK(1) DISCOUNT FACTOR
------------------ ---------------
AAA Taxable Preferred...................................... 130%
AA Taxable Preferred....................................... 133%
A Taxable Preferred........................................ 135%
BBB Taxable Preferred...................................... 139%
BB Taxable Preferred....................................... 154%
Not rated or below BB Taxable Preferred.................... 161%
Investment Grade DRD Preferred............................. 164%
Not rated or below Investment Grade DRD Preferred.......... 200%
----------
(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 Baa,
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 Ba, a Fitch rating of
BB will be used). If a security is not rated by any Rating Agency, the
Fund will use the percentage set forth under "not rated" in this table.
(ii) Corporate Debt Securities: The percentage
determined by reference to the rating of a corporate debt security in
accordance with the table set forth below.
NOT
RATED
OR
BELOW
TERM TO MATURITY OF CORPORATE DEBT SECURITY(1) AAA AA A BBB BB BB
---------------------------------------------------- ------ ------ ------ ------ ------ -------
3 years or less (but longer than 1 year)............ 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
A-22
----------
(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 Baa,
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 Ba, a Fitch rating of
BB will be used). If a security is not rated by any Rating Agency, the
Fund will use the percentage set forth under "not rated" 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 Pricing Service or
an Approved Price. The Fitch Discount Factor noted in the table above
for a Debt Security rated B by Fitch shall apply to any non-Performing
Debt Security with a price equal to or greater than $0.90. The Fitch
Discount Factor noted in the table above for a Debt Security rated CCC
by Fitch shall apply to any non-Performing Debt Security with a price
less than $0.90 but equal to or greater than $0.20. If a Debt Security
does not have a Market Value determined by a Pricing Service or an
Approved Price, a rating two rating categories below the actual rating
on the Debt Security will be used (e.g., where the actual rating is A-,
the rating for Debt Securities rated BB- will be used). The Fitch
Discount Factor for a 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 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.
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.
(iii) 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
premium greater than 100% nor (y) 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 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.
A-23
The Fitch Discount Factor applied to convertible
securities which have a yield to maturity or yield to worse of greater
than 15.00% above the relevant Treasury curve is 370%.
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 Baa, 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 Ba, a Fitch rating of BB will be used). If a security
is not rated by any Rating Agency, the Fund will treat the security as
if it were below investment grade.
(iv) U.S. Government Securities and U.S. Treasury
Strips:
TIME REMAINING TO MATURITY DISCOUNT FACTOR
-------------------------- ---------------
1 year or less.................................... 100%
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%
15 years or less (but longer than 10 years)....... 122%
20 years or less (but longer than 15 years)....... 130%
25 years or less (but longer than 20 years)....... 146%
Greater than 30 years............................. 154%
(v) Short-Term Investments and Cash: The Fitch
Discount Factor applied to short-term portfolio securities, including
without limitation 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 Fitch Exposure Period; (B) 115%, so long as such portfolio
securities mature or have a demand feature at par not exercisable
within the Fitch Exposure Period; and (C) 125%, so long as such
portfolio securities neither mature nor have a demand feature at par
exercisable within the Fitch Exposure Period. A Fitch Discount Factor
of 100% will be applied to cash. Rule 2a-7 money market funds rated by
Fitch or another NRSRO will also have a discount factor of 100%, and
unrated Rule 2a-7 money market funds will have a discount factor of
115%.
(vi) 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.
(vii) Foreign Bonds: The Fitch Discount Factor (A) for
a Foreign Bond the principal of which (if not denominated in U.S.
dollars) is subject to a currency hedging transaction will be the Fitch
Discount Factor that would otherwise apply to such Foreign Bonds in
accordance with this definition and (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 and (2) a bond issued in a currency
other than U.S. dollars 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%.
(viii) Bank Loans: The percentage determined by
reference to the Category in accordance with the table set forth below
Fitch Loan Category Discount Factor
---------------------- -----------------
A................... 126%
B................... 157
C................... 184
D................... 433
(pp) "Fitch Eligible Asset" means
(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 Business Days of the
Valuation Date, (B) A or higher by Fitch or the equivalent by another
A-24
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 within the Fitch 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 settled within five
business days;
(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; in
addition, money market funds subject to Rule 2a-7 under the 1940 Act
are also eligible investments;
(iii) U.S. Government Securities and U.S. Treasury
Strips;
(iv) debt securities if such securities have been
registered under the Securities Act or are restricted as to resale
under U.S. federal securities laws but are eligible for resale pursuant
to Rule 144A under the Securities Act; and 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, or the United Kingdom (the
"Approved Foreign Nations"), (3) the government of any Approved Foreign
Nation or any of its agencies, instrumentalities or political
subdivisions (the debt securities of Approved Foreign Nation issuers
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 Fund 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 Fund 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 Fund 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. 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 Fund's investment manager or
portfolio manager acting pursuant to procedures approved by the Board
of Trustees of the Fund; (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 "Debt
Securities."
(v) preferred stocks;
(vi) Bank Loans;
A-25
(vii) Rule 144A Securities; and
(viii) Interest rate swaps entered into according to
International Swap Dealers Association ("ISDA") standards if (1) the
counterparty to the swap transaction has a short-term rating of not
less than F1 by Fitch or the equivalent by another, NRSRO, or, if the
swap counterparty does not have a short-term rating, the counterparty's
senior unsecured long-term debt rating is AA or higher by Fitch or the
equivalent by another NRSRO and (2) the original aggregate notional
amount of the interest rate swap transaction or transactions is not
greater than the liquidation preference of the FundPreferred originally
issued.
Financial contracts, as such term is defined in
Section 3(c)(2)(B)(ii) of the Investment Company 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 Fund of a writing from Fitch specifying any conditions on
including such financial contract in Fitch Eligible Assets and assuring
the Fund that including such financial contract in the manner so
specified would not affect the credit rating assigned by Fitch to the
FundPreferred.
Where the Fund 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 Fund is
required to pay upon repurchase of such asset will count as a liability
for the purposes of the FundPreferred Basic Maintenance Amount. Where
the Fund purchases an asset and agrees to sell it to a third party in
the future, cash receivable by the Fund thereby will constitute a 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 FundPreferred 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 Fund 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 Fund by
its investment manager or portfolio manager, the Fund's custodian,
transfer agent or registrar or the Auction Agent and (D) Liens arising
by virtue of any repurchase agreement.
(qq) "Fitch Exposure Period" means the period commencing on
(and including) a given Valuation Date and ending 49 days thereafter.
(rr) "Fitch Hedging Transactions" means purchases or sales of
exchange-traded financial futures contracts based on any index approved
by Fitch or Treasury Bonds, and purchases, writings or sales of
exchange-traded put options on such futures contracts, any index
approved by Fitch or Treasury Bonds and purchases, writings or sales of
exchange-traded call options on such financial futures contracts, any
index approved by Fitch or Treasury bonds ("Fitch Hedging
Transactions"), subject to the following limitations:
(i) The Fund may not engage in any Fitch Hedging
Transaction based on any index approved by Fitch (other than
transactions that terminate a futures contract or option held by the
Fund by the Fund's taking the opposite position thereto ("closing
transactions")) that would cause the Fund at the time of such
transaction to own or have sold outstanding financial futures contracts
based on such index exceeding in number 10% of the average number of
daily
A-26
traded financial futures contracts based on such index in the 30 days
preceding the time of effecting such transaction as reported by The
Wall Street Journal.
(ii) The Fund will not engage in any Fitch Hedging
Transaction based on Treasury Bonds (other than closing transactions)
that would cause the Fund at the time of such transaction to own or
have sold:
(A) Outstanding financial futures contracts
based on Treasury Bonds with such contracts having an
aggregate market value exceeding 20% of the aggregate market
value of Fitch Eligible Assets owned by the Fund and rated at
least AA by Fitch (or, if not rated by Fitch Ratings, rated at
least Aa by Moody's; or, if not rated by Moody's, rated at
least AAA by S&P); or
(B) Outstanding financial futures contracts
based on Treasury Bonds with such contracts having an
aggregate market value exceeding 40% of the aggregate market
value of all Fitch Eligible Assets owned by the Fund (other
than Fitch Eligible Assets already subject to a Fitch Hedging
Transaction) and rated at least A or BBB by Fitch (or, if not
rated by Fitch Ratings, rated at least Baa by Moody's; or, if
not rated by Moody's, rated at least A or AA by S&P) (for
purposes of the foregoing clauses (i) and (ii), the Fund shall
be deemed to own futures contracts that underlie any
outstanding options written by the Fund);
(iii) The Fund may engage in closing transactions to
close out any outstanding financial 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 Fund.
(iv) The Fund may not enter into an option or futures
transaction unless, after giving effect thereto, the Fund would
continue to have Fitch Eligible Assets with an aggregate Discounted
Value equal to or greater than the Preferred Shares Basic Maintenance
Amount.
(ss) "Fitch Industry Classifications" means, for the purposes
of determining Fitch Eligible Assets, each of the following industry
classifications:
Aerospace & Defense
Automobiles
Banking, Finance & Real Estate
Broadcasting & Media
Building & Materials
Cable
Chemicals
Computers & Electronics
Consumer Products
Energy
Environmental Services
Farming & Agriculture
Food, Beverage & Tobacco
Gaming, Lodging & Restaurants
Healthcare & Pharmaceuticals
Industrial/Manufacturing
Insurance Leisure & Entertainment
Metals & Mining
Miscellaneous
Paper & Forest Products
Retail
Sovereign
Supermarkets & Drugstores
Telecommunications
Textiles & Furniture
Transportation Utilities
A-27
The Fund shall use its discretion in determining which
industry classification is applicable to a particular investment.
(tt) "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 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.
(iii) "Fitch Loan Category C" -- means (A) Performing
Bank Loans which have a Market Value or an Approved Price 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 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 Ratings. If a security is
not rated by Fitch Ratings but is rated by two other NRSROs, then the
lower of the ratings on the security from the two other NRSROs 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 rating by Fitch Ratings of BBB+
will be used). If a security is not rated by Fitch Ratings but is rated
by only one other NRSRO, then the rating on the security from the other
NRSRO 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 rating by
Fitch Ratings of AAA- will be used, and where the only rating on a
security is a Moody's rating of Ba3, a rating by Fitch Ratings 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 in 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.
(uu) "Foreign Bonds" has the meaning set forth in the
definition of "Fitch Eligible Assets."
(vv) "Forward Commitment" has the meaning set forth in Section
8 of Part I of this Statement.
(ww) "FundPreferred shares" means FundPreferred shares,
liquidation preference $25,000 per share.
(xx) "FundPreferred Shares Basic Maintenance Amount" as of any
Valuation Date means the dollar amount equal to the sum of
(i) (A) the sum of the products resulting from
multiplying the number of Outstanding FundPreferred shares on such date
by the liquidation preference (and redemption premium, if any) per
share; (B) the aggregate amount of dividends that will have accumulated
at the Applicable Rate (whether or not earned or declared) to and
including the first Dividend Payment Date for each Outstanding
FundPreferred shares that follows such Valuation Date (or to the 30th
day after such Valuation Date, if such 30th day occurs before the first
following Dividend Payment Date); (C) the amount of anticipated Fund
non-interest expenses for the 90 days subsequent to such Valuation
Date; (D) the amount of the current outstanding balances of any
indebtedness which is senior to the FundPreferred shares plus interest
actually accrued together with 30 days additional interest on the
current outstanding balances calculated at the current rate; and (E)
any current liabilities, payable during the 30 days subsequent to such
Valuation Date, including, without limitation, indebtedness due within
one year and any redemption premium due with respect to Preferred
Shares for which a Notice of Redemption has been given, as of such
Valuation Date, to the extent not reflected in any of (i)(A) through
(i)(D): less
(ii) the sum of any cash plus the value of any of the
Fund's assets irrevocably deposited by the Fund for the payment of any
(i)(B) through (i)(F) ("value," for purposes of this clause (ii), means
the Discounted Value of the security, except that if the security
matures prior to the relevant redemption payment date and is either
fully guaranteed by the U.S. Government or is rated at least P-1 by
Moody's, it will be valued at its face value).
(yy) "FundPreferred Shares Basic Maintenance Certificate" has
the meaning set forth in Section 13(d) of this Part I.
(zz) "FundPreferred shares Series M, M2, T, T2, W, W2, TH,
TH2, F and F2" means the shares of Series M, M2, T, T2, W, W2, TH, TH2, F and F2
of the FundPreferred shares or any other shares of Preferred Shares hereinafter
designated as shares of Series M, M2, T, T2, W, W2, TH, TH2, F and F2 of the
FundPreferred shares.
A-28
(aaa) "Holder" means, with respect to FundPreferred shares,
the registered holder of shares of each Series of FundPreferred shares as the
same appears on the share ledger or share records of the Fund.
(bbb) "Hold Order" shall have the meaning specified in
paragraph (a) of Section 1 of Part II of this Statement.
(ccc) "Mandatory Redemption Date" has the meaning set forth in
Section 3(a)(iii) of this Part I.
(ddd) "Mandatory Redemption Price" has the meaning set forth
in Section 3(a)(iii) of this Part I.
(eee) "Market Value" means the fair market value of an asset
of the Fund as computed as follows: readily marketable portfolio securities
listed on the New York Stock Exchange are valued, except as indicated below, at
the last sale price reflected on the consolidated tape at the close of the New
York Stock Exchange on the business day as of which such value is being
determined. If there has been no sale on such day, the securities are valued at
the mean of the closing bid and asked prices on such day. If no bid or asked
prices are quoted on such day, then the security is valued by such method as the
Board of Trustees shall determine in good faith to reflect its fair market
value. Readily marketable securities not listed on the New York Stock Exchange
but listed on other domestic or foreign securities exchanges or admitted to
trading on the National Association of Securities Dealers Automated Quotations,
Inc. ("Nasdaq") National List are valued in a like manner. Portfolio securities
traded on more than one securities exchange are valued at the last sale price on
the business day as of which such value is being determined as reflected on the
tape at the close of the exchange representing the principal market for such
securities. Readily marketable securities traded in the over-the-counter market,
including listed securities whose primary market is believed by the investment
adviser to be over-the-counter, but excluding securities admitted to trading on
the Nasdaq National List, are valued at the mean of the current bid and asked
prices as reported by Nasdaq or, in the case of securities not quoted by Nasdaq,
the National Quotation Bureau or such other comparable source as the Trustees
deem appropriate to reflect their fair market value. However, certain
fixed-income securities may be valued on the basis of prices provided by a
pricing service when such prices are believed by the Board of Trustees to
reflect the fair market value of such securities. The prices provided by a
pricing service take into account institutional size trading in similar groups
of securities and any developments related to specific securities. Where
securities are traded on more than one exchange and also over-the-counter, the
securities will generally be valued using the quotations the Board of Trustees
believes reflect most closely the value of such securities.
(fff) "Maximum Rate" means, on any date on which the
Applicable Rate is determined, the rate equal to 150% of the applicable
Reference Rate, subject to upward but not downward adjustment in the discretion
of the Board of Trustees after consultation with the Broker-Dealers, provided
that immediately following any such increase the Fund would be in compliance
with the FundPreferred Shares Basic Maintenance Amount.
(ggg) "Minimum Rate" means, on any Auction Date with respect
to a Dividend Period of 28 days or fewer, 70% of the AA Composite Commercial
Paper Rate at the close of business on the Business Day next preceding such
Auction Date. There shall be no Minimum Rate on any Auction Date with respect to
a Dividend Period of more than the Standard Dividend Period.
(hhh) "Moody's" means Moody's Investors Service, Inc., a
Delaware corporation, and its successors at law.
A-29
(iii) "Moody's Discount Factor" means, for purposes of
determining the Discounted Value of any Moody's Eligible Asset, the percentage
determined as follows. According to Moody's guidelines, in addition to standard
monthly reporting, the Fund must notify Moody's if the portfolio coverage ratio
of the discounted value of Moody's Eligible Assets to liabilities is less than
115%. Computation of rating agency asset coverage ratio requires use of the
Diversification Table prior to applying discount factors noted below and after
identifying Moody's eligible assets for purposes of completing basic maintenance
tests. 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) Preferred Stock: The Moody's Discount Factor
for preferred stock shall be (A) for preferred stocks issued by a
utility, 152%; (B) for preferred stocks of industrial and financial
issuers, 197%; (C) for preferred stocks issued by real estate related
issuers, 154%; and (D) for auction rate preferred stocks, 350%.
(ii) 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(1)
--------------------------------------------------------
TERMS TO MATURITY OF CORPORATE DEBT SECURITY Aaa Aa A Baa Ba B NR(2)
-------------------------------------------------- ----- ----- ----- ------ ----- ----- ------
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) If a security is not rated by Moody's but is rated by two other
nationally ratings organizations ("NRSROs"), then the lower of the
ratings assigned to the security by the two other NRSROs will be used
to determine the Moody's Discount Factor (e.g., where the S&P rating is
A and the Fitch rating is A-, a Moody's rating of A3 will be used). If
a security is not rated by Moody's but is rated by only one other
NRSRO, then the rating on the security from the other NRSRO will be
used to determine the Moody's Discount Factor (e.g., where the only
rating on a security is an S&P rating of A, a Moody's rating of A2 will
be used, and where the only rating on a security is a Fitch rating of
A-, a Moody's rating of a A3 will be used). If a security is not rated
by any NRSRO, the Fund will use the percentage set forth under "NR" in
this table.
(2) Unrated corporate debt securities, which are corporate debt securities
rated by neither Moody's, S&P, nor Fitch, are limited to 10% of
discounted Moody's Eligible Assets.
The Moody's Discount Factors presented in the immediately preceding
table will also apply to corporate debt securities that do not pay interest in
U.S. dollars or euros, provided that the Moody's Discount Factor determined from
the table shall be multiplied by a factor of 120% for purposes of calculating
the Discounted Value of such securities.
A-30
(iii) U.S. Government Securities and U.S. Treasury
Strips:
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
(iv) Short-Term Instruments and Cash: The Moody's
Discount Factor applied to short-term portfolio securities, including
without limitation short-term corporate debt securities, Short Term
Money Market Instruments and short-term municipal debt obligations,
will be (A) 100%, so long as such portfolio securities mature or have a
demand feature at par exercisable within the Moody's Exposure Period;
(B) 115%, so long as such portfolio securities mature or have a demand
feature at par not exercisable within the Moody's Exposure Period; and
(C) 125%, if such securities are not rated by Moody's, so long as such
portfolio securities are rated at least A-1+/AA or SP-1+/AA by S&P and
mature or have a demand feature at par exercisable within the Moody's
Exposure Period. A Moody's Discount Factor of 100% will be applied to
cash. Moody's rated 2a-7 money market funds will also have a discount
factor of 100%.
(v) Rule 144A Securities: The Moody's Discount
Factor applied to Rule 144A Securities for Rule 144A Securities will be
110% of the Moody's Discount Factor which would apply were the
securities registered under the Securities Act.
(vi) Convertible Securities:
(A) Convertible Bonds:
MOODY'S RATING CATEGORY(1)
-----------------------------------------------------------------
INDUSTRY CATEGORY Aaa Aa A Baa Ba B UNRATED(2)
----------------- ----- ---- ----- ----- ---- ----- ----------
Utility 162% 167% 172% 188% 195% 199% 300%
Industrial 256% 261% 266% 282% 290% 293% 300%
Financial 233% 238% 243% 259% 265% 270% 300%
-------------
(1) If a security is not rated by Moody's but is rated by two other NRSROs,
then the lower of the ratings assigned to the security by the two other
NRSROs will be used to determine the Moody's Discount Factor (e.g.,
where the S&P rating is A and the Fitch rating is A-, a Moody's rating
of A3 will be used). If a security is not rated by Moody's but is rated
by only one other NRSRO, then the rating on the security from the other
NRSRO will be used to determine the Moody's Discount Factor (e.g.,
where the only rating on a security is an S&P rating of A, a Moody's
rating of A2 will be used, and where the only rating on a security is a
Fitch rating of A-, a Moody's rating of A3 will be used). If a security
is not rated by any NRSRO, the Fund will use the percentage set forth
under "NR" in this table.
(2) Unrated convertible bonds taken together with other unrated securities,
which are securities rated by neither Moody's, S&P, nor Fitch are
limited to 10% of the discounted Moody's Eligible Assets.
(B) Upon conversion to Common Stock, the
Discount Factor of 350% will be applied to the Common Stock
holdings
(vii) Bank Loans: The Moody's discount Factor applied
to senior Bank Loans ("Senior Loans") shall be the percentage specified
in the table below opposite such Moody's Loan Category:
MOODY'S LOAN CATEGORY DISCOUNT FACTOR
--------------------- ---------------
A................... 118%
B................... 137
C................... 161
D................... 222
E................... 222
(jjj) "Moody's Eligible Assets" means:
(i) cash (including interest and dividends due on
assets rated (A) Baa3 or higher by Moody's if the payment date is
within five Business Days of the Valuation Date, (B) A2 or higher if
the payment date is within thirty days of the Valuation Date, and (C)
A1 or higher if the payment date is within the Moody's Exposure Period)
and receivables for Moody's Eligible Assets sold if the receivable is
due within five Business Days of the Valuation Date, and if the trades
which generated such receivables are (A) settled through clearing house
firms
A-31
with respect to which the Fund 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. In
addition, Moody's rated 2a-7 money market funds are also eligible
investments.
(iii) U.S. Government Securities and U.S. Treasury
Strips;
(iv) Rule 144A Securities;
(v) Senior Loans and other Bank Loans approved by
Moody's;
(vi) Corporate debt securities if (A) such securities
are rated B3 or higher by Moody's or if not rated by Moody's
equivalently rated by another NRSRO (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; (C) for securities, which provide for conversion or
exchange at the option of the issuer into equity capital at some time
over their lives, the issuer must be rated at least B3 by Moody's (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 Fund's investment manager or portfolio manager acting
pursuant to procedures approved by the Board of Trustees, except that
such securities that are not subject to U.S. federal securities laws
shall be considered Moody's Eligible Assets if they are publicly
traded; and (F) such securities are not subject to extended settlement.
In order to merit consideration as Moody's eligible
asset, debt securities are issued by entities which:
- have not filed for bankruptcy within the
past three years
- are current on all principle and interest in
their fixed income obligations
- are current on all preferred stock dividends
- possess a current, unqualified auditor's
report without qualified, explanatory
language
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, and will have assigned a discount factor
of 250%.
(vii) Preferred stocks if (A) dividends on such
preferred stock are cumulative, or if non-cumulative discount factor
should be amplified by a Factor of 1.10 x Moody's listed discount
factor, (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) if such security consists of $1000 par
bonds that tend to trade over the counter, (E) the issuer of such a
preferred stock has a senior debt rating from Moody's of Baal or
higher or a preferred stock rating from Moody's of Baa3 or higher and
(F) such preferred stock has paid consistent cash dividends in U.S.
dollars or Euros over the last three years or has a minimum rating of
A1 (if the issuer of such preferred stock has other preferred issues
outstanding that have been paying dividends consistently for the last
three years, then a preferred stock without such a dividend history
would also be eligible). In addition, the preferred stocks must have
the diversification requirements set forth in the table below and the
preferred stock issue must be greater than $50 million.
A-32
Diversification Table:
The table below establishes maximum limits for inclusion as eligible
assets prior to applying Moody's discount factors to eligible securities:
MAXIMUM SINGLE MAXIMUM SINGLE
MAXIMUM SINGLE INDUSTRY(3)(4) INDUSTRY(3)(4) MINIMUM ISSUE SIZE
RATINGS(1) ISSUER(2)(3) NON-UTILITY UTILITY ($ IN MILLION)(5)
---------- -------------- -------------- -------------- ------------------
Aaa................ 100% 100% 100% $100
Aa................. 20 60 30 100
A.................. 10 40 25 100
Baa................ 6 20 20 100
Ba................. 4 12 12 50(6)
B1-B2.............. 3 8 8 50(6)
B3 or below........ 2 5 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 Fund's total assets.
(viii) Financial contracts, as such term is defined
in Section 3(c)(2)(B)(ii) of the Investment Company Act, not otherwise
provided for in this definition but only upon receipt by the Fund of a
letter from Moody's specifying any conditions on including such
financial contract in Moody's Eligible Assets and assuring the Fund
that including such financial contract in the manner so specified would
not affect the credit rating assigned by Moody's to the FundPreferred.
(ix) Interest rate swaps entered into according to
International Swap Dealers Association ("ISDA") standards if (i) the
counterparty to the swap transaction has a short-term rating of not
less than P-1 or, if the counterparty does not have a short-term
rating, the counterparty's senior unsecured long-term debt rating is A3
or higher and (ii) the original aggregate notional amount of the
interest rate swap transaction or transactions is not to be greater
than the liquidation preference of the Preferred Shares originally
issued. The interest rate swap transaction will be marked-to-market
daily.
Where the Fund sells an asset and agrees to
repurchase such asset in the future, the Discounted Value of such asset
will constitute a Moody's Eligible Asset and the amount the Fund is
required to pay upon repurchase of such asset will count as a liability
for the purposes of the FundPreferred share Basic Maintenance Amount.
Where the Fund purchases an asset and agrees to sell it to a third
party in the future, cash receivable by the Fund thereby will
constitute a Moody's Eligible Asset if the long-term debt of such other
party is rated at least A2 by Moody's and such agreement has a term of
30 days or less; otherwise the Discounted Value of such purchased asset
will constitute a Moody's Eligible Asset. For the purposes of
calculation of Moody's Eligible Assets, portfolio securities which have
been called for redemption by the issuer thereof shall be valued at the
lower of Market Value or the call price of such portfolio securities.
Notwithstanding the foregoing, an asset will not be
considered a Moody's Eligible Asset to the extent that it has been
irrevocably deposited for the payment of (i)(A) through (i)(E) under
the definition of FundPreferred Basic Maintenance Amount or to the
extent
A-33
it is subject to any Liens, including assets segregated under margin
account requirements in connection with fund engagement in hedging
transactions, except for (A) Liens which are being contested in good
faith by appropriate proceedings and which Moody's has indicated to the
Fund will not affect the status of such asset as a Moody's Eligible
Asset, (B) Liens for taxes that are not then due and payable or that
can be paid thereafter without penalty, (C) Liens to secure payment for
services rendered or cash advanced to the Fund by its investment
manager or portfolio manager, the Fund's custodian, transfer agent or
registrar or the Auction Agent and (D) Liens arising by virtue of any
repurchase agreement.
(kkk) "Moody's Exposure Period" means the period commencing
on a given Valuation Date and ending 49 days thereafter.
(lll) "Moody's Hedging Transactions" means purchases or sales
of exchange-traded financial futures contracts based on any index approved by
Moody's or Treasury Bonds, and purchases, writings or sales of exchange-traded
put options on such financial futures contracts, any index approved by Moody's
or Treasury Bonds, and purchases, writings or sales of exchange-traded call
options on such financial futures contracts, any index approved by Moody's or
Treasury Bonds, subject to the following limitations:
(i) the Fund will not engage in any Moody's Hedging
Transaction based on any index approved by Moody's (other than Closing
Transactions) that would cause the Fund at the time of such transaction
to own or have sold:
(A) Outstanding financial futures contracts
based on such index exceeding in number 10% of the average
number of daily traded financial futures contracts based on
such index in the 30 days preceding the time of effecting such
transaction as reported by The Wall Street Journal; or
(B) 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 Fund constituting Moody's Eligible Assets owned by the
Fund;
(ii) The Fund will not engage in any Moody's Hedging
Transaction based on Treasury Bonds (other than Closing Transactions)
that would cause the Fund at the time of such transaction to own or
have sold:
(A) Outstanding financial futures contracts
based on Treasury Bonds with such contracts having an
aggregate Market Value exceeding 20% of the aggregate Market
Value of Moody's Eligible Assets owned by the Fund and rated
Aa by Moody's (or, if not rated by Moody's but rated by S&P,
rated AAA by S&P); or
(B) Outstanding financial futures contracts
based on Treasury Bonds with such contracts having an
aggregate Market Value exceeding 50% of the aggregate Market
Value of all portfolio securities of the Fund constituting
Moody's Eligible Assets owned by the Fund (other than Moody's
Eligible Assets already subject to a Moody's Hedging
Transaction) and rated Baa or A by Moody's (or, if not rated
by Moody's but rated by S&P, rated A or AA by S&P);
(iii) The Fund will engage in Closing Transactions to
close out any outstanding financial 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 Fund;
A-34
(iv) The Fund will engage in a Closing Transaction to
close out any outstanding financial futures contract by no later than
the fifth Business Day of the month in which such contract expires and
will engage in a Closing Transaction to close out any outstanding
option on a financial futures contract by no later than the first
Business Day of the month in which such option expires;
(v) The Fund will engage in Moody's Hedging
Transactions only with respect to financial futures contracts or
options thereon having the next settlement date or the settlement date
immediately thereafter;
(vi) The Fund (A) will not engage in options and
futures transactions for leveraging or speculative purposes, except
that an option or futures transaction shall not for these purposes be
considered a leveraged position or speculative and (B) will not write
any call options or sell any financial futures contracts for the
purpose of hedging the anticipated purchase of an asset prior to
completion of such purchase; and
(vii) The Fund will not enter into an option or
futures transaction unless, after giving effect thereto, the Fund would
continue to have Moody's Eligible Assets with an aggregate Discounted
Value equal to or greater than the FundPreferred shares Basic
Maintenance Amount.
(mmm) "Moody's Industry Classifications" 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 FundPreferred shares).
(i) Aerospace and Defense: Major Contractor,
Subsystems, Research, Aircraft Manufacturing, Arms, Ammunition.
(ii) Automobile: Automobile Equipment,
Auto-Manufacturing, Auto Parts Manufacturing, Personal Use Trailers,
Motor Homes, Dealers.
(iii) Banking: Bank Holding, Savings and Loans,
Consumer Credit, Small Loan, Agency, Factoring, Receivables.
(iv) 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,
Distributors, Candy, Gum, Seafood, Frozen Food, Cigarettes, Cigars,
Leaf/Snuff, Vegetable Oil.
(v) 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.
(vi) Chemicals, Plastics and Rubber: Chemicals
(non-agricultural), Industrial Gases, Sulphur, Plastics, Plastic
Products, Abrasives, Coatings, Paints, Varnish, Fabricating Containers.
(vii) Packaging and Glass: Glass, Fiberglass,
Containers made of: Glass, Metal, Paper, Plastic, Wood or Fiberglass.
(viii) Personal and Non-Durable Consumer Products
(Manufacturing Only): Soaps, Perfumes, Cosmetics, Toiletries, Cleaning
Supplies, School Supplies.
A-35
(ix) Diversified/Conglomerate Manufacturing.
(x) Diversified/Conglomerate Service.
(xi) Diversified Natural Resources, Precious Metals
and Minerals: Fabricating, Distribution.
(xii) Ecological: Pollution Control, Waste Removal,
Waste Treatment and Waste Disposal.
(xiii) Electronics: Computer Hardware, Electric
Equipment, Components, Controllers, Motors, Household Appliances,
Information Service Communication Systems, Radios, TVs, Tape Machines,
Speakers, Printers, Drivers, Technology.
(xiv) Finance: Investment Brokerage, Leasing,
Syndication, Securities.
(xv) Farming and Agriculture: Livestock, Grains,
Produce, Agriculture Chemicals, Agricultural Equipment, Fertilizers.
(xvi) Grocery: Grocery Stores, Convenience Food
Stores.
(xvii) Healthcare, Education and Childcare: Ethical
Drugs, Proprietary Drugs, Research, Health Care Centers, Nursing Homes,
HMOs, Hospitals, Hospital Supplies, Medical Equipment.
(xviii) Home and Office Furnishings, Housewares, and
Durable Consumer Products: Carpets, Floor Coverings, Furniture,
Cooking, Ranges.
(xix) Hotels, Motels, Inns and Gaming.
(xx) Insurance: Life, Property and Casualty, Broker,
Agent, Surety.
(xxi) 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.
(xxii) Machinery (Non-Agricultural, Non-Construction,
Non-Electronic): Industrial, Machine Tools, Steam Generators.
(xxiii) 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.
(xxiv) Oil and Gas: Crude Producer, Retailer, Well
Supply, Service and Drilling.
(xxv) Printing, Publishing, and Broadcasting: Graphic
Arts, Paper, Paper Products, Business Forms, Magazines, Books,
Periodicals, Newspapers, Textbooks, Radio, T.V., Cable Broadcasting
Equipment.
A-36
(xxvi) Cargo Transport: Rail, Shipping, Railroads,
Rail-car Builders, Ship Builders, Containers, Container Builders,
Parts, Overnight Mail, Trucking, Truck Manufacturing, Trailer
Manufacturing, Air Cargo, Transport.
(xxvii) Retail Stores: Apparel, Toy, Variety, Drugs,
Department, Mail Order Catalog, Showroom.
(xxviii) Telecommunications: Local, Long Distance,
Independent, Telephone, Telegraph, Satellite, Equipment, Research,
Cellular.
(xxix) Textiles and Leather: Producer, Synthetic
Fiber, Apparel Manufacturer, Leather Shoes.
(xxx) Personal Transportation: Air, Bus, Rail, Car
Rental.
(xxxi) Utilities: Electric, Water, Hydro Power, Gas.
(xxxii) Diversified Sovereigns: Semi-sovereigns,
Canadian Provinces, Supra-national Agencies.
The Fund will use SIC codes in determining which
industry classification is applicable to a particular investment in
consultation with the Independent Accountant and Moody's, to the extent
the Fund considers necessary.
(nnn) "Moody's Loan Category" means the following five categories (and
for purposes of this categorization, the Market Value of a Moody's Eligible
Asset trading at par is equal to $1.00):
(i) "Moody's Loan Category A" means Performing Senior
Loans which have a Market Value or an Approved Price greater than or
equal to $0.90.
(ii) "Moody's Loan Category B" means: (A) Performing
Senior Loans which have a Market Value or an Approved Price greater
than or equal to $0.80 but less than $0.90; and (B) non-Performing
Senior Loans which have a Market Value or an Approved Price greater
than or equal to $0.85.
(iii) "Moody's Loan Category C" means: (A) Performing
Senior Loans which have a Market Value or an Approved Price greater
than or equal to $0.70 but less than $0.80; and (B) non-Performing
Senior Loans which have a Market Value or an Approved Price greater
than or equal to $0.75 but less than 0.85.
(iv) "Moody's Loan Category D" means Senior Loans
which have a Market Value or an Approved Price less than $0.75.
(v) "Moody's Loan Category E" means non-Senior Loans
which have a Market Value or an Approved Price.
Notwithstanding any other provision contained above,
for purposes of determining whether a Moody's Eligible Asset falls
within a specific Moody's Loan Category, to the extent that any Moody's
Eligible Asset would fall in more than one of the Moody's Loan
Categories, such Moody's Eligible Asset shall be deemed to fall into
the Moody's Loan Category with the lowest applicable Moody's Discount
Factor.
(ooo) "1940 Act" means the Investment Company Act of 1940, as
amended from time to time.
(ppp) "1940 Act FundPreferred Shares Asset Coverage" means
asset coverage, as determined in accordance with Section 18(h) of the 1940 Act,
of at least 200% with respect to all outstanding senior securities of the Fund
which are stock, including all Outstanding FundPreferred 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 stock of a closed-end
investment company as a condition of declaring dividends on its common shares),
determined on the basis of values calculated as of a time within 48 hours next
preceding the time of such determination.
(qqq) "1940 Act FundPreferred Shares Asset Coverage
Certificate" means the certificate required to be delivered by the Fund pursuant
to Section 12(e) of this Part I.
(rrr) "Notice of Redemption" means any notice with respect to
the redemption of shares of FundPreferred shares pursuant to Section 3.
(sss) "Order" shall have the meaning specified in paragraph
(a) of Section 1 of Part II of this Statement.
(ttt) "Other Rating Agency" means any rating agency other than
Moody's or Fitch then providing a rating for the FundPreferred shares pursuant
to the request of the Fund.
(uuu) "Other Rating Agency Eligible Assets" means assets of
the Fund designated by any Other Rating Agency as eligible for inclusion in
calculating the discounted value of the Fund's assets in connection with such
Other Rating Agency's rating of FundPreferred shares.
(vvv) "Outstanding" or "outstanding" means, as of any date,
FundPreferred shares theretofore issued by the Fund except, without duplication,
(i) any shares of FundPreferred shares
A-37
theretofore canceled, redeemed or repurchased by the Fund, or delivered to the
Auction Agent for cancellation or with respect to which the Fund has given
notice of redemption and irrevocably deposited with the Paying Agent sufficient
funds to redeem such FundPreferred shares and (ii) any FundPreferred shares
represented by any certificate in lieu of which a new certificate has been
executed and delivered by the Fund. Notwithstanding the foregoing, (A) for
purposes of voting rights (including the determination of the number of shares
required to constitute a quorum), any of the FundPreferred shares to which the
Fund or any Affiliate of the Fund shall be the Existing Holder shall be
disregarded and not deemed Outstanding; (B) in connection with any Auction, any
Series of FundPreferred shares as to which the Fund or any person known to the
Auction Agent to be an Affiliate of the Fund shall be the Existing Holder
thereof shall be disregarded and deemed not to be Outstanding; and (C) for
purposes of determining the FundPreferred Shares Basic Maintenance Amount,
FundPreferred shares held by the Fund shall be disregarded and not deemed
Outstanding but shares held by any Affiliate of the Fund shall be deemed
Outstanding.
(www) "Paying Agent" means The Bank of New York unless and
until another entity appointed by a resolution of the Board of Trustees enters
into an agreement with the Fund to serve as paying agent, which paying agent may
be the same as the Auction Agent.
(xxx) "Performing" means with respect to any asset, the issuer
of such investment is not in default of any payment obligations in respect
thereof.
(yyy) "Person" or "person" means and includes an individual, a
partnership, a trust, a Fund, an unincorporated association, a joint venture or
other entity or a government or any agency or political subdivision thereof.
(zzz) "Potential Beneficial Owner," with respect to shares of
a series of FundPreferred 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.
(aaaa) "Preferred Share" means the preferred shares of
beneficial interest, par value $.01 per share, including the FundPreferred
shares, of the Fund from time to time.
(bbbb) "Pricing Service" means any pricing service designated
by the Board of Trustees of the Fund and approved by Fitch or Moody's, as
applicable, for purposes of determining whether the Fund has Eligible Assets
with an aggregate Discounted Value that equals or exceeds the FundPreferred
Shares Basic Maintenance Amount.
(cccc) "Redemption Default" has the meaning set forth in
Section 2(c)(ii) of this Part I.
(dddd) "Redemption Price" has the meaning set forth in Section
3(a)(i) of this Part I.
(eeee) "Reference Rate" means, with respect to the
determination of the Maximum Rate and Default Rate, the applicable AA Composite
Commercial Paper Rate (for a Dividend Period of fewer than 184 days) or the
applicable Treasury Index Rate (for a Dividend Period of 184 days or more).
(ffff) "Reorganization Bonds" has the meaning set forth under
the definition of "Fitch Eligible Assets."
(gggg) "Rule 144A Securities" means securities which are
restricted as to resale under federal securities laws but are eligible for
resale pursuant to Rule 144A under the Securities Act as
A-38
determined by the Fund's investment manager or portfolio manager acting pursuant
to procedures approved by the Board of Trustees of the Fund.
(hhhh) "S&P" means Standard & Poor's Ratings Services, a
division of The McGraw-Hill Companies, Inc., or its successors.
(iiii) "Securities Act" means the Securities Act of 1933, as
amended from time to time.
(jjjj) "Securities Depository" means The Depository Trust
Company and its successors and assigns or any successor securities depository
selected by the Fund that agrees to follow the procedures required to be
followed by such securities depository in connection with the shares of
FundPreferred shares Series M, M2, T, T2, W, W2, TH, TH2, F and F2.
(kkkk) "Sell Order" shall have the meaning specified in
paragraph (a) of Section 1 of Part II of this Statement.
(llll) "Senior Loans" has the meaning set forth under the
definition of "Moody's Discount Factor."
(mmmm) "Short-Term Money Market Instrument" means the
following types of instruments if, on the date of purchase or other acquisition
thereof by the Fund, the remaining term to maturity thereof is not in excess of
180 days:
(i) commercial paper rated A-1 if such commercial
paper matures in 30 days or A-1+ if such commercial paper matures in
over 30 days;
(ii) demand or time deposits in, and banker's
acceptances and certificates of deposit of (A) a depository institution
or trust company incorporated under the laws of the United States of
America or any state thereof or the District of Columbia or (B) a
United States branch office or agency of a foreign depository
institution (provided that such branch office or agency is subject to
banking regulation under the laws of the United States, any state
thereof or the District of Columbia);
(iii) overnight funds;
(iv) U.S. Government Securities; and
(v) Eurodollar demand or time deposits in, or
certificates of deposit of, the head office or the London branch office
of a depository institution or trust company if the certificates of
deposit, if any, and the long-term unsecured debt obligations (other
than such obligations the ratings of which are based on the credit of a
person or entity other than such depository institution or trust
company) of such depository institution or Fund company that have (1)
credit ratings on such 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 Fund, all of the foregoing requirements shall be
applicable except that the required long-term unsecured debt credit
rating of such depository institution or trust company from Moody's,
Fitch and S&P shall be at least A2, A 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 Fund
company are not rated on any
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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 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 Fund); and provided further, that the interest receivable by the
Fund shall not be subject to any withholding or similar taxes.
(nnnn) "Special Dividend Period" means a Dividend Period that
is not a Standard Dividend Period.
(oooo) "Specific Redemption Provisions" means, with respect to
any Special Dividend Period of more than one year, either, or any combination of
(i) a period (a "Non-Call Period") determined by the Board of Trustees after
consultation with the Broker-Dealers, during which the shares subject to such
Special Dividend Period are not subject to redemption at the option of the Fund
pursuant to Section 3(a)(ii) and (ii) a period (a "Premium Call Period"),
consisting of a number of whole years as determined by the Board of Trustees
after consultation with the Broker-Dealers, during each year of which the shares
subject to such Special Dividend Period shall be redeemable at the Fund's option
pursuant to Section 3(a)(i) and/or in connection with any mandatory redemption
pursuant to Section 3(a)(ii) at a price per share equal to $25,000 plus
accumulated but unpaid dividends plus a premium expressed as a percentage or
percentages of $25,000 or expressed as a formula using specified variables as
determined by the Board of Trustees after consultation with the Broker-Dealers.
(pppp) "Standard Dividend Period" means a Dividend Period of 7
days.
(qqqq) "Submission Deadline" means 1:00 P.M., Eastern Standard
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.
(rrrr) "Submitted Bid" shall have the meaning specified in
paragraph (a) of Section 3 of Part II of this Statement.
(ssss) "Submitted Hold Order" shall have the meaning specified
in paragraph (a) of Section 3 of Part II of this Statement.
(tttt) "Submitted Order" shall have the meaning specified in
paragraph (a) of Section 3 of Part II of this Statement.
(uuuu) "Submitted Sell Order" shall have the meaning specified
in paragraph (a) of Section 3 of Part II of this Statement.
(vvvv) "Sufficient Clearing Bids" shall have the meaning
specified in paragraph (a) of Section 3 of Part II of this Statement.
(wwww) "Treasury Index Rate" means the average yield to
maturity for actively traded marketable U.S. Treasury fixed interest rate
securities having the same number of 30-day periods to maturity as the length of
the applicable Dividend Period, determined, to the extent necessary, by linear
interpolation based upon the yield for such securities having the next shorter
and next longer number of 30-day periods to maturity treating all Dividend
Periods with a length greater than the longest maturity for such securities as
having a length equal to such longest maturity, in all cases based upon data set
forth in the most recent weekly statistical release published by the Board of
Governors of the Federal Reserve System (currently in H.15(519)); provided,
however, if the most recent such statistical release shall not have been
published during the 15 days preceding the date of computation, the foregoing
computations
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shall be based upon the average of comparable data as quoted to the Fund by at
least three recognized dealers in U.S. Government securities selected by the
Fund.
(xxxx) "U.S. Government Securities" mean securities that are
direct obligations of, and obligations the timely payment of principal and
interest on which is fully guaranteed by, the United States of America or any
agency or instrumentality of the United States of America, the obligations of
which are backed by the full faith and credit of the United States of America
and in the form of conventional bills, bonds and notes.
(yyyy) "U.S. Treasury Securities" means direct obligations of
the United States Treasury that are entitled to the full faith and credit of the
United States.
(zzzz) "U.S. Treasury Strips" means securities based on U.S.
Treasury Securities created through the Separate Trading of Registered Interest
and Principal of Securities program.
(aaaaa) "Valuation Date" means every Friday, or, if such day
is not a Business Day, the next preceding Business Day; provided, however, that
the first Valuation Date may occur on any other date established by the Fund;
provided, further, however, that such date shall be not more than one week from
the date on which FundPreferred shares Series M, M2, T, T2, W, W2, TH, TH2, F
and F2 initially is issued.
(bbbbb) "Winning Bid Rate" has the meaning set forth in
Section 3(a)(iii) of Part II of this Statement.
18. Interpretation. References to sections, subsections, clauses,
sub-clauses, paragraphs and subparagraphs are to such sections, subsections,
clauses, sub-clauses, paragraphs and subparagraphs contained in this Part I or
Part II hereof, as the case may be, unless specifically identified otherwise.
PART II: AUCTION PROCEDURES
1. Orders.
(a) Prior to the Submission Deadline on each Auction Date for
shares of a series of FundPreferred 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 Dividend 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 Dividend Period
of shares of such series shall be less than the rate per annum
specified by such Beneficial Owner; and/or
(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 Dividend Period of shares of such series;
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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 Dividend 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 (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 FundPreferred 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 (a) of Section 4 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 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 (b) of Section 4 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 FundPreferred 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 (b) of Section 4 of this Part II if Sufficient
Clearing Bids for shares of such series do not exist;
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PROVIDED, HOWEVER, that a Broker-Dealer that is an Existing Holder with respect
to shares of a series of FundPreferred 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 (c) of Section 2 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 Fund) with the provisions of Section 7 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 FundPreferred 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 (a) of Section 4 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 FundPreferred 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
FundPreferred shares of a series subject to an Auction on such Auction Date
obtained by such Broker-Dealer, designating itself (unless otherwise permitted
by the Fund) 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 Fund);
(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
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(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
shares of FundPreferred 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 Dividend Period consisting of more than 28 Dividend 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.
(d) If one or more Orders of an Existing Holder is submitted
to the Auction Agent covering in the aggregate more than the number of
Outstanding FundPreferred 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
A-44
(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
Fund 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.
(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 FundPreferred 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 FundPreferred 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 between the Minimum Rate (for
Standard Dividend Periods or less, only) and the Maximum Rate
(for all Dividend Periods) 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 between the Minimum Rate (for
Standard Dividend Periods or less, only) and the Maximum Rate
(for all Dividend Periods) 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:
A-45
(A) (I) each such Submitted Bid of Existing
Holders specifying such lowest 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 such lowest 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 FundPreferred shares
of such series.
(b) Promptly after the Auction Agent has made the
determinations pursuant to paragraph (a) of this Section 3, the Auction Agent
shall advise the Fund of the Minimum Rate and Maximum Rate for shares of the
series of FundPreferred 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 Dividend 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 Dividend 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
Dividend 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 Applicable Rate for all
shares of such series for the next succeeding Dividend Period thereof
shall be All Hold Rate.
4. Acceptance and Rejection of Submitted Bids and Submitted Sell Orders
and Allocation of Shares. Existing Holders shall continue to hold the
FundPreferred shares that are subject to Submitted Hold Orders, and, based on
the determinations made pursuant to paragraph (a) of Section 3 of this Part II,
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
FundPreferred 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 (d) and (e) of this Section 4, 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 FundPreferred shares subject to such
Submitted Bids;
A-46
(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 FundPreferred 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 FundPreferred shares subject to
such Submitted Bid, unless the number of Outstanding FundPreferred
shares subject to all such Submitted Bids shall be greater than the
number of FundPreferred shares ("remaining shares") in the excess of
the Available FundPreferred shares of such series over the number of
FundPreferred shares subject to Submitted Bids described in clauses
(ii) and (iii) of this paragraph (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 FundPreferred shares
subject to such Submitted Bid, but only in an amount equal to the
number of FundPreferred 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 FundPreferred shares held by such
Existing Holder subject to such Submitted Bid and the denominator of
which shall be the aggregate number of Outstanding FundPreferred 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 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 FundPreferred shares of
such series over the number of FundPreferred shares subject to
Submitted Bids described in clauses (ii) through (iv) of this paragraph
(a) by a fraction, the numerator of which shall be the number of
Outstanding FundPreferred shares subject to such Submitted Bid and the
denominator of which shall be the aggregate number of Outstanding
FundPreferred 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
FundPreferred 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 (d) of this Section 4, 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 FundPreferred
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
A-47
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
FundPreferred 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 (a) or clause (iii) of paragraph (b) of this Section 4, any
Existing Holder would be entitled or required to sell, or any Potential Holder
would be entitled or required to purchase, a fraction of a share of a series of
FundPreferred 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 FundPreferred 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 shares of FundPreferred
shares.
(e) If, as a result of the procedures described in clause (v)
of paragraph (a) of this Section 4, any Potential Holder would be entitled or
required to purchase less than a whole share of a series of FundPreferred shares
on any Auction Date, the Auction Agent shall, in such manner as it shall
determine in its sole discretion, allocate FundPreferred shares of such series
or purchase among Potential Holders so that only whole shares of FundPreferred
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 FundPreferred shares of such series on
such Auction Date.
(f) Based on the results of each Auction for shares of a
series of FundPreferred 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, FundPreferred
shares of such series. Notwithstanding any provision of the Auction Procedures
or the Settlement Procedures to the contrary, in the event an Existing Holder or
Beneficial Owner of shares of a series of FundPreferred 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 shares of FundPreferred 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 Fund 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 FundPreferred shares
of any series or to pay for FundPreferred shares of any series sold or purchased
pursuant to the Auction Procedures or otherwise.
[Signature Page Follows]
A-48
IN WITNESS WHEREOF, NUVEEN PREFERRED AND CONVERTIBLE INCOME FUND 2 has
caused these presents to be signed on ______, 2003 in its name and on its
behalf by its Vice-President, and its corporate seal to be hereunto affixed and
attested by its Assistant Secretary. The Fund's Declaration of Trust is on file
with the Secretary of State of the Commonwealth of Massachusetts, and the said
officers of the Fund have executed this Statement as officers and not
individually, and the obligations and rights set forth in this Statement are not
binding upon any such officers, or the Trustees or shareholders of the Fund,
individually, but are binding only upon the assets and property of the Fund.
NUVEEN PREFERRED AND CONVERTIBLE INCOME FUND 2
By:
------------------------------------------
Jessica R. Droeger, Vice President
ATTEST:
-----------------------------------------
Virginia L. O'Neal, Assistant Secretary
A-49
APPENDIX B
RATINGS OF INVESTMENTS
Standard & Poor's Corporation -- A brief description of the applicable
Standard & Poor's Corporation, a division of The McGraw-Hill Companies
("Standard & Poor's" or "S&P"), rating symbols and their meanings (as published
by S&P) follows:
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. 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 ratings address the put feature, in
addition to the usual long-term rating. Medium-term notes are assigned long-term
ratings.
LONG-TERM ISSUE CREDIT RATINGS
Issue credit ratings are based in varying degrees, on the following
considerations:
1. 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;
2. Nature of and provisions of the obligation; and
3. 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 ratings 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.
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.
B-1
A An obligation rated 'A' is somewhat more susceptible
to the adverse effects of changes in circumstances
and economic conditions than obligations in
higher-rated categories. However, the obligor's
capacity to meet its financial commitment on the
obligation is still strong.
BBB An obligation rated 'BBB' exhibits adequate
protection parameters. However, adverse economic
conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet
its financial commitment on the obligation.
BB, B, CCC, Obligations rated 'BB', 'B', 'CCC', 'CC', and 'C' are
CC, And C regarded as having significant speculative
characteristics. 'BB' indicates the least degree of
speculation and 'C' the highest. While such
obligations will likely have some quality and
protective characteristics, these may be 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 The 'C' rating may be used to cover a situation where
a bankruptcy petition has been filed or similar
action has been taken, but payments on this
obligation are being continued.
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.
B-2
C The 'c' subscript is used to provide additional
information to investors that the bank may terminate
its obligation to purchase tendered bonds if the
long-term credit rating of the issuer is below an
investment-grade level and/or the issuer's bonds are
deemed taxable.
p The letter 'p' indicates that the rating is
provisional. A provisional rating assumes the
successful completion of the project financed by the
debt being rated and indicates that payment of debt
service requirements is largely or entirely dependent
upon the successful, 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.
Continuance of the ratings is contingent upon
Standard & Poor's receipt of an executed copy of the
escrow agreement or closing documentation confirming
investments and cash flows.
r The 'r' highlights derivative, hybrid, and certain
other obligations that Standard & Poor's believes may
experience high volatility or high variability in
expected returns as a result of noncredit risks.
Examples of such obligations are securities with
principal or interest return indexed to equities,
commodities, or currencies; certain swaps and
options; and interest-only and principal-only
mortgage securities. 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. Not rated.
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.
BOND INVESTMENT QUALITY STANDARDS
Under present commercial bank regulations issued by the Comptroller of
the Currency, bonds rated in the top four categories ('AAA', 'AA', 'A', 'BBB',
commonly known as investment-grade ratings) generally are regarded as eligible
for bank investment. Also, the laws of various states governing legal
investments impose certain rating or other standards for obligations eligible
for investment by savings banks, trust companies, insurance companies, and
fiduciaries in general.
SHORT-TERM ISSUE CREDIT RATINGS
NOTES
A Standard & Poor's note ratings reflects the liquidity factors and
market access risks unique to notes. Notes due in three years or less will
likely receive a note rating. Notes maturing beyond three years will most likely
receive a long-term debt rating. The following criteria will be used in making
that assessment:
- Amortization schedule -- the larger the final maturity relative
to other maturities, the more likely it will be treated as a
note; and
B-3
- Source of payment -- the more dependent the issue is on the
market for its refinancing, the more likely it will be treated
as a note.
Note rating symbols are as follows:
SP-1 Strong capacity to pay principal and interest. An
issue determined to possess a very strong capacity to
pay debt service is given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest,
with some vulnerability to adverse financial and
economic changes over the term of the notes.
SP-3 Speculative capacity to pay principal and interest.
A note 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
S&P by the issuer or obtained by S&P from other sources it considers reliable.
S&P 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 or based on other circumstances.
COMMERCIAL PAPER
An S&P 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-1' for the
highest quality obligations to 'D' for the lowest. These categories are as
follows:
A-1 A short-term obligation rated 'A-1' is rated in the
highest category by Standard & Poor's. The obligor's
capacity to meet its financial commitment on the
obligation is strong. Within this category, certain
obligations are designated with a plus sign (+). This
indicates that the obligor's capacity to meet its
financial commitment on these obligations is
extremely strong.
A-2 A short-term obligation rated 'A-2' is somewhat more
susceptible to the adverse effects of changes in
circumstances and economic conditions than
obligations in higher rating categories. However, the
obligor's capacity to meet its financial commitment
on the obligation is satisfactory.
A-3 A short-term obligation rated 'A-3' exhibits adequate
protection parameters. However, adverse economic
conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet
its financial commitment on the obligation.
B A short-term obligation rated 'B' is regarded as
having significant speculative characteristics. The
obligor currently has the capacity to meet its
financial commitment on the obligation; however, it
faces major ongoing uncertainties which could lead to
the obligor's inadequate capacity to meet its
financial commitment on the obligation.
B-4
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 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 S&P by the issuer or
obtained by S&P from other sources it considers
reliable. S&P 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 or
based on other circumstances.
Moody's Investors Service, Inc. -- A brief
description of the applicable Moody's Investors
Service, Inc. ("Moody's") rating symbols and their
meanings (as published by Moody's) follows:
MUNICIPAL BONDS
Aaa Bonds which are rated 'Aaa' are judged to be of the
best quality. They carry the smallest degree of
investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or
by an exceptionally stable margin and principal is
secure. While the various protective elements are
likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong
position of such issues.
Aa Bonds which are rated 'Aa' are judged to be of high
quality by all standards. Together with the 'Aaa'
group they comprise what are generally known as high
grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as
in 'Aaa' securities or fluctuation of protective
elements may be of greater amplitude or there may be
other elements present which make the long-term risks
appear somewhat larger than in 'Aaa' securities.
A Bonds which are rated 'A' possess many favorable
investment attributes and are to be considered as
upper medium grade obligations. Factors giving
security to principal and interest are considered
adequate, but elements may be present which suggest a
susceptibility to impairment sometime in the future.
B-5
Baa Bonds which are rated 'Baa' are considered as medium
grade obligations, i.e., they are neither highly
protected nor poorly secured. Interest payments and
principal security appear adequate for the present but
certain protective elements may be lacking or may be
characteristically unreliable over any great length of
time. Such bonds lack outstanding investment
characteristics and in fact have speculative
characteristics as well.
Ba Bonds which are rated 'Ba' are judged to have
speculative elements; their future cannot be
considered as well assured. Often the protection of
interest and principal payments may be very moderate
and thereby not well safeguarded during both good and
bad times over the future. Uncertainty of position
characterizes bonds in this class.
B Bonds which are rated 'B' generally lack
characteristics of the desirable investment. Assurance
of interest and principal payments or of maintenance
of other terms of the contract over any long period of
time may be small.
Caa Bonds which are rated 'Caa' are of poor standing. Such
issues may be in default or there may be present
elements of danger with respect to principal or
interest.
Ca Bonds which are rated 'Ca' represent obligations which
are speculative in a high degree. Such issues are
often in default or have other marked shortcomings.
C Bonds which are rated 'C' are the lowest rated class
of bonds, and issues so rated can be regarded as
having extremely poor prospects of ever attaining any
real investment standing.
#(hatchmark): Represents issues that are secured by escrowed funds held
in cash, held in trust, invested and reinvested in direct, non-callable,
non-prepayable United States government obligations or non-callable,
non-prepayable obligations unconditionally guaranteed by the U.S. Government,
Resolution Funding Corporation debt obligations.
Con. (...): Bonds for which the security depends upon the completion of
some act or the fulfillment of some condition are rated conditionally. These are
bonds secured by (a) earnings of projects under construction, (b) earnings of
projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. The parenthetical rating denotes probable credit stature upon
completion of construction or elimination of the basis of the condition.
(P): When applied to forward delivery bonds, indicates the rating is
provisional pending delivery of the bonds. The rating may be revised prior to
delivery if changes occur in the legal documents or the underlying credit
quality of the bonds.
Note: Moody's applies numerical modifiers 1, 2 and 3 in each generic
rating classification from Aa through Caa. The modifier 1 indicates that the
issue ranks in the higher end of its generic rating category; the modifier 2
indicates a mid-range ranking; and the modifier 3 indicates that the issue ranks
in the lower end of its generic rating category.
B-6
SHORT-TERM LOANS
MIG 1/VMIG 1 This designation denotes superior credit
quality. Excellent protection is afforded by
established cash flows, highly reliable
liquidity support, or demonstrated
broad-based access to the market for
refinancing.
MIG 2/VMIG 2 This designation denotes strong credit
quality. Margins of protection are ample,
although not as large as in the preceding
group.
MIG 3/VMIG 3 This designation denotes acceptable credit
quality. Liquidity and cash-flow protection
may be narrow, and market access for
refinancing is likely to be less
well-established.
SG This designation denotes speculative-grade
credit quality. Debt instruments in this
category may lack sufficient margins of
protection.
COMMERCIAL PAPER
Issuers (or supporting institutions) rated Prime-1 have a superior
ability for repayment of senior short-term debt obligations. Prime-1 repayment
ability will normally be evidenced by the following characteristics:
-- Leading market positions in well-established industries.
-- High rates of return on funds employed.
-- Conservative capitalization structures with moderate reliance
on debt and ample asset protection.
-- Broad margins in earnings coverage of fixed financial charges
and high internal cash generation.
-- Well-established access to a range of financial markets and
assured sources of alternate liquidity.
Issuers (or supporting institutions) rated Prime-2 have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation than is the case for Prime-2 securities. Capitalization
characteristics, while still appropriate, may be more affected by external
conditions. Ample alternate liquidity is maintained.
Issuers (or supporting institutions) rated Prime-3 have an acceptable
ability for repayment of senior short-term debt obligations. The effect of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and the requirement for relatively high financial
leverage. Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
Fitch Ratings -- A brief description of the applicable Fitch Ratings
("Fitch") ratings symbols and meanings (as published by Fitch) follows:
B-7
LONG-TERM CREDIT RATINGS
INVESTMENT GRADE
AAA Highest credit quality. 'AAA' ratings denote the
lowest expectation of credit risk. They are assigned
only in case of exceptionally strong capacity for
timely payment of financial commitments. This
capacity is highly unlikely to be adversely affected
by foreseeable events.
AA Very high credit quality. 'AA' ratings denote a very
low expectation of credit risk. They indicate very
strong capacity for timely payment of financial
commitments. This capacity is not significantly
vulnerable to foreseeable events.
A High credit quality. 'A' ratings denote a low
expectation of credit risk. The capacity for timely
payment of financial commitments is considered
strong. This capacity may, nevertheless, be more
vulnerable to changes in circumstances or in economic
conditions than is the case for higher ratings.
BBB Good credit quality. 'BBB' ratings indicate that
there is currently a low expectation of credit risk.
The capacity for timely payment of financial
commitments is considered adequate, but adverse
changes in circumstances and in economic conditions
are more likely to impair this capacity. This is the
lowest investment-grade category.
SPECULATIVE GRADE
BB Speculative. 'BB' ratings indicate that there is a
possibility of credit risk developing, particularly
as the result of adverse economic change over time;
however, business or financial alternatives may be
available to allow financial commitments to be met.
Securities rated in this category are not investment
grade.
B Highly speculative. 'B' ratings indicate that
significant credit risk is present, but a limited
margin of safety remains. Financial commitments are
currently being met; however, capacity for continued
payment is contingent upon a sustained, favorable
business and economic environment.
CCC, CC, C High default risk. Default is a real possibility.
Capacity for meeting financial commitments is solely
reliant upon sustained, favorable business or
economic developments. A 'CC' rating indicates that
default of some kind appears probable. 'C' ratings
signal imminent default.
B-8
DDD, DD, and The ratings of obligations in this category are based
D Default on their prospects for achieving partial or full
recovery in a reorganization or liquidation of the
obligor. While expected recovery values are highly
speculative and cannot be estimated with any
precision, the following serve as general guidelines.
'DDD' obligations have the highest potential for
recovery, around 90%-100% of outstanding amounts and
accrued interest. 'DD' indicates potential recoveries
in the range of 50%-90%, and 'D' the lowest recovery
potential, i.e., below 50%. Entities rated in this
category have defaulted on some or all of their
obligations. Entities rated 'DDD' have the highest
prospect for resumption of performance or continued
operation with or without a formal reorganization
process. Entities rated 'DD' and 'D' are generally
undergoing a formal reorganization or liquidation
process; those rated 'DD' are likely to satisfy a
higher portion of their outstanding obligations,
while entities rated 'D' have a poor prospect for
repaying all obligations.
SHORT-TERM CREDIT RATINGS
A short-term rating has a time horizon of less than 12 months for most
obligations, or up to three years for U.S. public finance securities, and thus
places greater emphasis on the liquidity necessary to meet financial commitments
in a timely manner.
F1 Highest credit quality. Indicates the strongest
capacity for timely payment of financial commitments;
may have an added "+" to denote any exceptionally
strong credit feature.
F2 Good credit quality. A satisfactory capacity for
timely payment of financial commitments, but the
margin of safety is not as great as in the case of
the higher ratings.
F3 Fair credit quality. The capacity for timely payment
of financial commitments is adequate; however,
near-term adverse changes could result in a reduction
to non-investment grade. B Speculative. Minimal
capacity for timely payment of financial commitments,
plus vulnerability to near-term adverse changes in
financial and economic conditions.
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.
Notes to Long-term and Short-term ratings:
"+" 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 Ratings does not rate the issuer or issue in
question.
B-9
'Withdrawn': A rating is withdrawn when Fitch Ratings 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, ratings for which outlooks are `stable' could be
downgraded before an outlook moves to positive or negative if circumstances
warrant such an action. Occasionally, Fitch Ratings may be unable to identify
the fundamental trend. In these cases, the Rating Outlook may be described as
evolving.
B-10
Nuveen Preferred and Convertible Income Fund 2
------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
------------------------------------------
______, 2003
PART C - OTHER INFORMATION
ITEM 24: FINANCIAL STATEMENTS AND EXHIBITS
1. FINANCIAL STATEMENTS:
Statement of Assets and Liabilities, June 3, 2003 (audited)
Statement of Operations from March 17, 2003 (date of
organization) through June 3, 2003 (audited)
Statement of Assets and Liabilities, July 17, 2003
(unaudited)
Statement of Operations from June 30, 2003 (commencement of
operations) through July 17, 2003 (unaudited)
Statement of Changes in Net Assets from June 30, 2003
(commencement of operations) through July 17, 2003 (unaudited)
Portfolio of Investments July 17, 2003 (unaudited)
2. EXHIBITS:
a.1 Declaration of Trust dated March 17, 2003. Filed on
April 17, 2003 as Exhibit a to the Registrant's
Registration Statement on Form N-2 (File No.
333-104599) and incorporated herein by reference.*
a.2 Form of Statement Establishing and Fixing the Rights
and Preferences of FundPreferred shares. Filed
herewith as Appendix A to the Statement of
Additional Information contained herein.
b. By-laws of Registrant. Filed on April 17, 2003 as
Exhibit b to the Registrant's Registration Statement
on Form N-2 (File No. 333-104599) and incorporated
herein by reference.*
c. None.
d. Form of Share Certificate.**
e. Terms and Conditions of the Dividend Reinvestment
Plan. Filed on May 21, 2003 as Exhibit e to
Pre-Effective Amendment No. 1 to the Registrant's
Registration Statement on Form N-2 (File No.
333-104599) and incorporated herein by reference.*
f. None.
g.1 Investment Management Agreement between Registrant
and Nuveen Institutional Advisory Corp. dated
May 15, 2003. Filed on May 21, 2003 as Exhibit
g.1 to Pre-Effective Amendment No. 1 to the
Registrant's Registration Statement on Form N-2 (File
No. 333- 104599) and incorporated herein by
reference.*
g.2 Investment Sub-Advisory Agreement between Nuveen
Institutional Advisory Corp. and Spectrum Asset
Management, Inc. dated May 15, 2003. Filed on
June 24, 2003 as Exhibit g.2 to Pre-Effective
Amendment No. 2 to the Registrant's Registration
Statement on Form N-2 (File No. 333-104599) and
incorporated herein by reference*
g.3 Investment Sub-Advisory Agreement between Nuveen
Institutional Advisory Corp. and Froley, Revy
Investment Co., Inc. dated May 15, 2003. Filed on
June 24, 2003 as Exhibit g.3 to Pre-Effective
Amendment No. 2 to the Registrant's Registration
Statement on Form N-2 (File No. 333-104599) and
incorporated herein by reference.*
h.1 Form of Underwriting Agreement.**
h.2 Form of Salomon Smith Barney Inc. Master Selected
Dealer Agreement.**
h.3 Form of Salomon Smith Barney Inc. Master Agreement
Among Underwriters.**
i. Nuveen Open-End and Closed-End Funds Deferred
Compensation Plan for Independent Directors and
Trustees. Filed on May 21, 2003 as Exhibit i to
Pre-Effective Amendment No. 1 to the Registrant's
Registration Statement on Form N-2 (File No.
333-104599) and incorporated herein by reference.*
j. Master Custodian Agreement between Registrant and
State Street Bank & Trust Company dated August 19,
2002. Filed on June 24, 2003 as Exhibit j to
Pre-Effective Amendment No. 2 to the Registrant's
Registration Statement in Form N-2 (File No.
333-104599) and incorporated herein by reference.*
k.1 Shareholder Transfer Agency and Service Agreement
between Registrant and State Street Bank & Trust
Company dated October 7, 2002. Filed on June 24,
2003 as Exhibit K.1 to Pre-Effective Amendment No. 2
to the Registrant's Registration Statement on Form
N-2 (File No. 333-104599) and incorporated herein by
reference.*
k.2 Expense Reimbursement Agreement between Registrant
and Nuveen Institutional Advisory Corp. dated
May 15, 2003. Filed on May 21, 2003 as Exhibit
k.2 to Pre-Effective Amendment No. 1 to the
Registrant's Registration Statement on Form N-2 (File
No. 333-104599) and incorporated herein by
reference.*
k.3 Form of Auction Agency Agreement.**
k.4 Form of Broker-Dealer Agreement.**
k.5 Form of DTC Representations Letter.**
l.1 Opinion and consent of Vedder, Price, Kaufman &
Kammholz, P.C.**
l.2 Opinion and consent of Bingham McCutchen LLP.**
Part C-1
m. None.
n. Consent of Ernst & Young LLP.**
o. None.
p. Subscription Agreement of Nuveen Institutional
Advisory Corp. dated June 3, 2003. Filed on June 24,
2003 as Exhibit p to Pre-Effective Amendment No. 2 to
the Registrant's Registration Statement on Form N-2
(File No. 333-104599) and incorporated herein by
reference.*
q. None.
r.1 Code of Ethics of Nuveen Institutional Advisory Corp.
Filed on May 21, 2003 as Exhibit r.1 to
Pre-Effective Amendment No. 1 to the Registrant's
Registration Statement on Form N-2 (File No.
333-104599) and incorporated herein by reference.*
r.2 Code of Ethics of Spectrum Asset Management, Inc.
Filed on May 21, 2003 as Exhibit r.2 to
Pre-Effective Amendment No. 1 to the Registrant's
Registration Statement on Form N-2 (File No.
333-104599) and incorporated herein by reference.*
r.3 Code of Ethics of Froley, Revy Investment Co., Inc.
Filed on May 21, 2003 as Exhibit r.3 to
Pre-Effective Amendment No. 1 to the Registrant's
Registration Statement on Form N-2 (File No.
333-104599) and incorporated herein by reference.*
s. Powers of Attorney filed on May 21, 2003 as Exhibit
s to Post-Effective Amendment No. 1 to the
Registrant's Registration Statement on Form N-2 (File
No. 333-104599) and incorporated herein by
reference.*
----------
* Previously filed.
** Filed herewith.
ITEM 25: MARKETING ARRANGEMENTS
Sections 2, 3 and 5(n) of the Form of Underwriting Agreement to be
filed as Exhibit h.1 to this Registration Statement.
See the Introductory Paragraph and Sections 2 and 3(d) of the Form of
Salomon Smith Barney Inc. Master Selected Dealer Agreement to be filed as
Exhibit h.2 to this Registration Statement.
See Introductory Paragraph and Sections 1.2, 3.1, 3.2, 3.4-3.8, 4.1,
4.2, 5.1-5.4, 6.1, 10.9 and 10.10 of the Form of Master Agreement Among
Underwriters to be filed as Exhibit h.3 to this Registration Statement.
ITEM 26: OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
Securities and Exchange Commission fees................. $ 78,165
Printing and engraving expenses......................... 60,000
Legal fees.............................................. 80,000
Accounting expenses..................................... 6,500
Rating Agency fees...................................... 165,000
Miscellaneous expenses.................................. 10,335
----------
Total................................................... $ 400,000
==========
ITEM 27: PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
Not applicable.
ITEM 28: NUMBER OF HOLDERS OF SECURITIES
At June 24, 2003.
TITLE OF CLASS NUMBER OF RECORD HOLDERS
------------------------------------------ ------------------------
COMMON SHARES, $0.01 par value........... 1
Part C-2
ITEM 29: INDEMNIFICATION
Section 4 of Article XII of the Registrant's Declaration of Trust
provides as follows:
Subject to the exceptions and limitations contained in this Section 4,
every person who is, or has been, a Trustee, officer, employee or agent of the
Trust, including persons who serve at the request of the Trust as directors,
trustees, officers, employees or agents of another organization in which the
Trust has an interest as a shareholder, creditor or otherwise (hereinafter
referred to as a "Covered Person"), shall be indemnified by the Trust to the
fullest extent permitted by law against liability and against all expenses
reasonably incurred or paid by him in connection with any claim, action, suit or
proceeding in which he becomes involved as a party or otherwise by virtue of his
being or having been such a Trustee, director, officer, employee or agent and
against amounts paid or incurred by him in settlement thereof.
No indemnification shall be provided hereunder to a Covered Person:
(a) against any liability to the Trust or its Shareholders by
reason of a final adjudication by the court or other body before which
the proceeding was brought that he engaged in willful misfeasance, bad
faith, gross negligence or reckless disregard of the duties involved in
the conduct of his office;
(b) with respect to any matter as to which he shall have been
finally adjudicated not to have acted in good faith in the reasonable
belief that his action was in the best interests of the Trust; or
(c) in the event of a settlement or other disposition not
involving a final adjudication (as provided in paragraph (a) or (b))
and resulting in a payment by a Covered Person, unless there has been
either a determination that such Covered Person did not engage in
willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of his office by the court or
other body approving the settlement or other disposition or a
reasonable determination, based on a review of readily available facts
(as opposed to a full trial-type inquiry), that he did not engage in
such conduct:
(i) by a vote of a majority of the Disinterested
Trustees acting on the matter (provided that a majority of the
Disinterested Trustees then in office act on the matter); or
(ii) by written opinion of independent legal counsel.
The rights of indemnification herein provided may be insured against by
policies maintained by the Trust, shall be severable, shall not affect any other
rights to which any Covered Person may now or hereafter be entitled, shall
continue as to a person who has ceased to be such a Covered Person and shall
inure to the benefit of the heirs, executors and administrators of such a
person. Nothing contained herein shall affect any rights to indemnification to
which Trust personnel other than Covered Persons may be entitled by contract or
otherwise under law.
Expenses of preparation and presentation of a defense to any claim,
action, suit or proceeding subject to a claim for indemnification under this
Section 4 shall be advanced by the Trust prior to final disposition thereof upon
receipt of an undertaking by or on behalf of the recipient to repay such amount
if it is ultimately determined that he is not entitled to indemnification under
this Section 4, provided that either:
(a) such undertaking is secured by a surety bond or some other
appropriate security or the Trust shall be insured against losses
arising out of any such advances; or
Part C-3
(b) a majority of the Disinterested Trustees acting on the
matter (provided that a majority of the Disinterested Trustees then in
office act on the matter) or independent legal counsel in a written
opinion shall determine, based upon a review of the readily available
facts (as opposed to a full trial-type inquiry), that there is reason
to believe that the recipient ultimately will be found entitled to
indemnification.
As used in this Section 4, a "Disinterested Trustee" is one (x) who is
not an Interested Person of the Trust (including anyone, as such Disinterested
Trustee, who has been exempted from being an Interested Person by any rule,
regulation or order of the Commission), and (y) against whom none of such
actions, suits or other proceedings or another action, suit or other proceeding
on the same or similar grounds is then or has been pending.
As used in this Section 4, the words "claim," "action," "suit" or
"proceeding" shall apply to all claims, actions, suits, proceedings (civil,
criminal, administrative or other, including appeals), actual or threatened; and
the words "liability" and "expenses" shall include without limitation,
attorneys' fees, costs, judgments, amounts paid in settlement, fines, penalties
and other liabilities.
The trustees and officers of the Registrant are covered by Investment
Trust Directors and Officers and Errors and Omission policies in the aggregate
amount of $50,000,000 against liability and expenses of claims of wrongful acts
arising out of their position with the Registrant, except for matters which
involve willful acts, bad faith, gross negligence and willful disregard of duty
(i.e., where the insured did not act in good faith for a purpose he or she
reasonably believed to be in the best interest of Registrant or where he or she
had reasonable cause to believe this conduct was unlawful). The policy has a
$500,000 deductible, which does not apply to individual trustees or officers.
Section 8 of the Form of Underwriting Agreement filed as Exhibit h.1 to
this Registration Statement provides for each of the parties thereto, including
the Registrant and the Underwriters, to indemnify the others, their trustees,
directors, certain of their officers, trustees, directors and persons who
control them against certain liabilities in connection with the offering
described herein, including liabilities under the federal securities laws.
Insofar as indemnification for liability arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the Registrant pursuant to the foregoing provisions, or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act of 1933 and is, therefore, 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 a director, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
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
Securities Act of 1933 and will be governed by the final adjudication of such
issue.
ITEM 30: BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
Nuveen Institutional Advisory Corp. ("NIAC") serves as investment
adviser to the following open-end and closed-end management type investment
companies: Nuveen Investment Trust, Nuveen Investment Trust II, Nuveen
Investment Trust III, Nuveen Senior Income Fund, Nuveen Select Tax-Free Income
Portfolio, Nuveen Select Tax-Free Income Portfolio 2, Nuveen California Select
Tax-Free Income, Nuveen New York Select Tax-Free Income Portfolio, Nuveen Select
Tax-Free Income Portfolio 3, Nuveen Quality Preferred Income Fund, Nuveen
Part C-4
Quality Preferred Income Fund 2, Nuveen Quality Preferred Income Fund 3 and
Nuveen Preferred and Convertible Income Fund.
NIAC has no other clients or business at the present time. For a
description of other business, profession, vocation or employment of a
substantial nature in which any director or officer of the investment adviser
who serve as officers or Trustees of the Registrant has engaged during the last
two years for his or her account or in the capacity of director, officer,
employee, partner or trustee, see the descriptions under "Management of the
Fund" in Part B of this Registration Statement. Such information for the
remaining senior officers of NIAC appears below:
OTHER BUSINESS PROFESSION, VOCATION OR EMPLOYMENT
NAME AND POSITION WITH NIAC DURING PAST TWO YEARS
-------------------------------------------------------- -------------------------------------------------------
John P. Amboian, President.............................. President, formerly Executive Vice President of Nuveen
Investments, Inc., Nuveen Investments, LLC, Nuveen
Advisory Corp., Nuveen Asset Management, Inc. and
Nuveen Senior Loan Asset Management, Inc. and Executive
Vice President and Director of Rittenhouse Asset Management,
Inc.
Alan G. Berkshire, Senior Vice President Senior Vice President and General Counsel (since 1997)
and Secretary........................................... and Secretary (since 1998) of Nuveen Investments, Inc.,
Nuveen Investments, LLC, and Nuveen Asset Management, Inc.;
Senior Vice President (since 1997) and Secretary (since
1998) of Nuveen Advisory Corp.; Senior Vice President,
Secretary and General Counsel of Rittenhouse Asset
Management, Inc. (since 2001).
Margaret E. Wilson, Senior Vice President, Senior Vice President, Finance of Nuveen Investments,
Finance................................................. Inc., Nuveen Investments, LLC and Nuveen Advisory Corp.;
formerly CFO of Sara Lee Corp., Bakery Division.
Gunther Stein, Vice President........................... Lead portfolio manager for high yield strategies at
Symphony since 1999. Prior to joining Symphony, Mr.
Stein was a High Yield Portfolio Manager at Wells Fargo.
Lenny Mason, Vice President............................. High yield portfolio manager at Symphony. Prior to
joining Symphony, Mr. Mason was a Managing Director in
FleetBoston's Technology & Communications Group.
The address of Symphony Asset Management, LLC is 555 California Street,
Suite 2975, San Francisco, CA 94104.
Spectrum Asset Management, Inc. ("Spectrum") serves as an investment
adviser to a non-U.S. fund and offers separate account management for certain
institutions and high net worth individuals. Spectrum also is a registered
broker-dealer. See "Management of the Fund" in Part B of the Registration
Statement.
Part C-5
Set forth below is a list of each director and officer of Spectrum,
indicating each business profession, vocation or employment of a substantial
nature in which such person has been, at any time during the past two fiscal
years, engaged for his or her own account or in the capacity of director,
officer, partner or trustee.
OTHER BUSINESS PROFESSION, VOCATION OR EMPLOYMENT
NAME AND POSITION WITH SPECTRUM DURING PAST TWO FISCAL YEARS
-------------------------------------------------------- -------------------------------------------------------
Fernando Diaz, Vice President........................... --
Nancy K. Dray, Legal and Compliance Officer............. --
Ralph C. Eucher, Director............................... President of Princor Financial Services Corporation
since May 1999. Senior Vice President of Principal Life
Insurance Company since August 2002.
Richard W. Hibbs, Director.............................. Executive Vice President Marketing for Principal Global
Investors since September 1998. Vice President of Principal
Life Insurance Company since September 1998.
Timothy Howald, Director................................ Chief Financial Officer of Principal Global Investors
since November 1998. Vice President of Principal Life
Insurance Company since November 1998.
Patrick G. Hurley, Senior Vice President
and Chief Information Officer........................... --
L. Philip Jacoby, IV, Senior Vice
President and Portfolio Manager......................... --
Mark A. Lieb, Executive Director and
Chief Financial Officer................................. --
Jim McCaughan, Director................................. Global Head of Asset Management for Principal Global
Investors since April 2002. Executive Vice President
of Principal Life Insurance Company since April 2002.
Senior Vice President of Principal Financial Group,
Inc. since April 2002. Previously Chief Executive
Officer of Credit Suisse Asset Management Americas.
Jean M. Orlando, Vice President and
Controller.............................................. --
Gloria Reeg, Director................................... Global Head of Fixed Income for Principal Global
Investors since February 2002. Vice President of
Principal Life Insurance Company since February 2002.
Previously the Managing Director of Global Consulting
for Frank Russell Company.
Bernard M. Sussman, Executive Director
and Chief Investment Officer............................ --
Albano Tunnera, Assistant Vice President
and Operations Manager.................................. --
Joseph J. Urciuoli, Vice President and
Director of Research.................................... --
Froley, Revy Investment Co., Inc. ("Froley, Revy") serves as a
subadviser to two other funds and offers separate account management services to
institutions and high net worth individuals. See "Management of the Fund" in
Part B of the Registration Statement.
Part C-6
================================================================================
Set forth below is a list of each director and officer of Froley, Revy,
indicating each business profession, vocation or employment of a substantial
nature in which such person has been, at any time during the past two fiscal
years, engaged for his or her own account or in the capacity of director,
officer, partner or trustee.
OTHER BUSINESS PROFESSION, VOCATION OR EMPLOYMENT
NAME AND POSITION WITH FROLEY, REVY DURING PAST TWO FISCAL YEARS
----------------------------------------------------------- -------------------------------------------------------
George A. Froley, III, Director, Chairman and
Managing Director.......................................... --
Jim Herbert, Director...................................... President, Chief Executive Officer and Director of
First Republic Bank
Katherine Auguste-DeWilde, Director........................ Chief Operating Officer, Executive Vice President and
Director of First Republic Bank
Ed Dobranski, Director..................................... Senior Vice President, General Counsel and Secretary of
First Republic Bank
Melinda Gordon, Director and Managing Director............. --
K. Andrea O'Connell, Director, President, Chief
Executive Officer, Managing Director and
Assistant Secretary........................................ --
Michael Revy, Managing Director and Senior Vice President.. Director, Staub Holding AG, Emil-Staub Strasse 2,
CH-8708 Mannedorf, Switzerland. Private banker with
Wechsler & Co., Inc. until 2002.
James Barry, Managing Director and Senior
Vice President............................................. --
Ravi Malik, Managing Director and Senior Vice President.... --
Warren Chun, First Vice President.......................... --
Mike Opre, Vice President.................................. --
Monica Erickson, Vice President............................ --
Steve Wachtel, Vice President.............................. --
David Epstein, Vice President.............................. --
Kim Nicholas, Vice President,
Assistant Secretary and Chief Financial Officer/
Controller................................................. --
Melissa Shanahan, Vice President........................... --
John Padden, Vice President................................ --
Ed Hackney, Vice President................................. --
Lily Yu, First Vice President.............................. --
Ted Heigel, Vice President................................. --
Ann Houlihan, Secretary.................................... --
ITEM 31: LOCATION OF ACCOUNTS AND RECORDS
Nuveen Institutional Advisory Corp., 333 West Wacker Drive, Chicago,
Illinois 60606, maintains the Declaration of Trust, By-Laws, minutes of trustees
and shareholders meetings and contracts of the Registrant and all advisory
material of the investment adviser.
Spectrum Asset Management, Inc., 4 High Ridge Park, Stamford, CT 06905,
maintains certain advisory material of the subadviser.
Part C-7
Froley, Revy Investment Co., Inc., 10900 Wilshire Boulevard,
Suite 900, Los Angeles, CA 90024, maintains certain of its advisory material.
State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, maintains all general and subsidiary ledgers, journals,
trial balances, records of all portfolio purchases and sales, and all other
required records not maintained by Nuveen Institutional Advisory Corp.
ITEM 32: MANAGEMENT SERVICES
Not applicable.
ITEM 33: UNDERTAKINGS
1. Registrant undertakes to suspend the offering of its shares until it
amends its Prospectus 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 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 a 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 the Registration Statement as of the time it was
declared effective.
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.
Part C-8
SIGNATURES
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 this City of Chicago, and State of Illinois, on the 6th day of
August, 2003.
NUVEEN PREFERRED AND CONVERTIBLE INCOME FUND 2
/s/ JESSICA R. DROEGER
------------------------------------------------
Jessica R. Droeger, Vice President and Secretary
Pursuant to the requirements of the Securities Act of 1933, this Registration
Statement has been signed below by the following persons in the capacities and
on the date indicated.
SIGNATURE TITLE DATE
---------------------------------------- ------------------------------------------- --------------
/s/ STEPHEN D. FOY Vice President and ,Controller August 6, 2003
---------------------------------------- (Principal Financial and Accounting Officer)
Stephen D. Foy
/s/ GIFFORD R. ZIMMERMAN Chief Administrative Officer August 6, 2003
---------------------------------------- (Principal Executive Officer)
Gifford R. Zimmerman
Timothy R. Schwertfeger* Chairman of the Board and Trustee
William E. Bennett* Trustee
Robert P. Bremner* Trustee
Lawrence H. Brown* Trustee
Jack B. Evans* Trustee
Anne E. Impellizzeri* Trustee
William L. Kissick* Trustee
Thomas E. Leafstrand* Trustee
Peter R. Sawers* Trustee
William J. Schneider* Trustee
Judith M. Stockdale* Trustee
Sheila W. Wellington* Trustee
By: /s/ JESSICA R. DROEGER
----------------------------------------
Jessica R. Droeger
Attorney-In-Fact
August 6, 2003
----------
* Original powers of attorney authorizing Jessica R. Droeger and Gifford R.
Zimmerman, among others, to execute this Registration Statement, and
Amendments thereto, for each of the trustees of the Registrant on whose
behalf this Registration Statement is filed, have been executed and filed
on June 24, 2003 as Exhibits to Pre-Effective Amendment No. 2 to
Registrant's Registration Statement on Form N-2 (File No. 333-104599) and
are incorporated herein by reference.
INDEX TO EXHIBITS
a.1 Declaration of Trust dated March 17, 2003. Filed on
April 17, 2003 as Exhibit a to the Registrant's
Registration Statement on Form N-2 (File No.
333-104599) and incorporated herein by reference.*
a.2 Form of Statement Establishing and Fixing the Rights
and Preferences of FundPreferred shares. Filed
herewith as Appendix A to the Statement of
Additional Information contained herein.
b. By-laws of Registrant. Filed on April 17, 2003 as
Exhibit b to the Registrant's Registration Statement
on Form N-2 (File No. 333-104599) and incorporated
herein by reference.*
c. None.
d. Form of Share Certificate.**
e. Terms and Conditions of the Dividend Reinvestment
Plan. Filed on May 21, 2003 as Exhibit e to
Pre-Effective Amendment No. 1 to the Registrant's
Registration Statement on Form N-2 (File No.
333-104599) and incorporated herein by reference.*
f. None.
g.1 Investment Management Agreement between Registrant
and Nuveen Institutional Advisory Corp. dated
May 15, 2003. Filed on May 21, 2003 as Exhibit
g.1 to Pre-Effective Amendment No. 1 to the
Registrant's Registration Statement on Form N-2 (File
No. 333-104599) and incorporated herein by
reference.*
g.2 Investment Sub-Advisory Agreement between Nuveen
Institutional Advisory Corp. and Spectrum Asset
Management, Inc. dated May 15, 2003. Filed on
June 24, 2003 as Exhibit g.2 to Pre-Effective
Amendment No. 2 to the Registrant's Registration
Statement on Form N-2 (File No. 333-104599) and
incorporated herein by reference*
g.3 Investment Sub-Advisory Agreement between Nuveen
Institutional Advisory Corp. and Froley, Revy
Investment Co., Inc. dated May 15, 2003. Filed on
June 24, 2003 as Exhibit g.3 to Pre-Effective
Amendment No. 2 to the Registrant's Registration
Statement on Form N-2 (File No. 333-104599) and
incorporated herein by reference.*
h.1 Form of Underwriting Agreement.**
h.2 Form of Salomon Smith Barney Inc. Master Selected
Dealer Agreement.**
h.3 Form of Salomon Smith Barney Inc. Master Agreement
Among Underwriters.**
i. Nuveen Open-End and Closed-End Funds Deferred
Compensation Plan for Independent Directors and
Trustees. Filed on May 21, 2003 as Exhibit i to
Pre-Effective Amendment No. 1 to the Registrant's
Registration Statement on Form N-2 (File No.
333-104599) and incorporated herein by reference.*
j. Master Custodian Agreement between Registrant and
State Street Bank & Trust Company dated August 19,
2002. Filed on June 24, 2003 as Exhibit j to
Pre-Effective Amendment No. 2 to the Registrant's
Registration Statement in Form N-2 (File No.
333-104599) and incorporated herein by reference.*
k.1 Shareholder Transfer Agency and Service Agreement
between Registrant and State Street Bank & Trust
Company dated October 7, 2002. Filed on June 24,
2003 as Exhibit K.1 to Pre-Effective Amendment No. 2
to the Registrant's Registration Statement on Form
N-2 (File No. 333-104599) and incorporated herein by
reference.*
k.2 Expense Reimbursement Agreement between Registrant
and Nuveen Institutional Advisory Corp. dated
May 15, 2003. Filed on May 21, 2003 as Exhibit
k.2 to Pre-Effective Amendment No. 1 to the
Registrant's Registration Statement on Form N-2 (File
No. 333-104599) and incorporated herein by
reference.*
k.3 Form of Auction Agency Agreement.**
k.4 Form of Broker-Dealer Agreement.**
k.5 Form of DTC Representations Letter.**
l.1 Opinion and consent of Vedder, Price, Kaufman &
Kammholz, P.C.**
l.2 Opinion and consent of Bingham McCutchen LLP.**
m. None.
n. Consent of Ernst & Young LLP.**
o. None.
p. Subscription Agreement of Nuveen Institutional
Advisory Corp. dated June 3, 2003. Filed on June 24,
2003 as Exhibit p to Pre-Effective Amendment No. 2 to
the Registrant's Registration Statement on Form N-2
(File No. 333-104599) and incorporated herein by
reference.*
q. None.
r.1 Code of Ethics of Nuveen Institutional Advisory Corp.
Filed on May 21, 2003 as Exhibit r.1 to
Pre-Effective Amendment No. 1 to the Registrant's
Registration Statement on Form N-2 (File No.
333-104599) and incorporated herein by reference.*
r.2 Code of Ethics of Spectrum Asset Management, Inc.
Filed on May 21, 2003 as Exhibit r.2 to
Pre-Effective Amendment No. 1 to the Registrant's
Registration Statement on Form N-2 (File No.
333-104599) and incorporated herein by reference.*
r.3 Code of Ethics of Froley, Revy Investment Co., Inc.
Filed on May 21, 2003 as Exhibit r.3 to
Pre-Effective Amendment No. 1 to the Registrant's
Registration Statement on Form N-2 (File No.
333-104599) and incorporated herein by reference.*
s. Powers of Attorney filed on May 21, 2003 as Exhibit
s to Post-Effective Amendment No. 1 to the
Registrant's Registration Statement on Form N-2 (File
No. 333-104599) and incorporated herein by
reference.*
----------
* Previously filed.
** Filed herewith.