As filed with the Securities and Exchange Commission on October 3, 2003
1933 Act Registration No. 333-_____
1940 Act Registration No. 811-7528
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Pre-Effective Amendment No. __
Post-Effective Amendment No. __
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
Amendment No. 10
INSURED MUNICIPAL INCOME FUND INC.
(Exact name of Registrant as specified in charter)
51 West 52nd Street
New York, New York 10019-6114
(Address of principal executive offices)
Registrant's telephone number, including area code: (212) 882-5000
AMY R. DOBERMAN, ESQ.
UBS Global Asset Management (US) Inc.
51 West 52nd Street
New York, New York 10019-6114
(Name and address of agent for service)
Copies to:
JACK W. MURPHY, ESQ.
Dechert LLP
1775 I Street, N.W.
Washington, D.C. 20006-2401
Telephone: (202) 261-3300
Approximate date of proposed public offering: as soon as practicable after this
Registration Statement becomes effective.
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF SECURITIES AMOUNT OFFERING AGGREGATE AMOUNT OF
BEING REGISTERED BEING REGISTERED PRICE PER UNIT OFFERING PRICE REGISTRATION FEE
-----------------------------------------------------------------------------------------------------
Auction Preferred
Shares,
Series E and F 20 $ 50,000 $ 1,000,000(1) $ 80.90
----------
(1) Estimated solely for the purpose of calculating the registration fee.
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 that 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 date as the Commission, acting pursuant to said Section 8(a),
may determine.
INSURED MUNICIPAL INCOME FUND INC.
CROSS-REFERENCE SHEET
Part A--Prospectus [VERIFY]
Items in Part A of Form N-2 Location in Prospectus
Item 1. Outside Front Cover Front Cover Page
Item 2. Cover Pages; Other Offering Information Inside Front and Outside Back Cover Page
Item 3. Fee Table and Synopsis N/A
Item 4. Financial Highlights Capitalization; Portfolio Composition
Item 5. Plan of Distribution Underwriting
Item 6. Selling Shareholders N/A
Item 7. Use of Proceeds Use of Proceeds
Item 8. General Description of the Registrant The Fund; Investment Objective and Policies;
Rating Agency Guidelines and Asset Maintenance
Item 9. Management Management of the Fund
Item 10. Capital Stock, Long-term Debt, and Other Description of APS; The Auction; Rating Agency
Securities Guidelines and Asset Maintenance; Taxation;
Description of Common Stock
Item 11. Defaults and Arrears on Senior Securities N/A
Item 12. Legal Proceedings N/A
Item 13. Table of Contents of the Statement of Additional Table of Contents of the Statement of Additional
Information Information
Part B--Statement of Additional Information Location in Statement of Additional Information
Item 14. Cover Page Cover Page of SAI
Item 15. Table of Contents Cover Page of SAI
Item 16. General Information and History N/A
Item 17. Investment Objective and Policies Investment Objectives and Policies; Rating
Agency Guidelines and Asset Maintenance;
Investment Limitations; Taxation; Valuation of
Common Stock; Description of APS; The Auction;
Appendices
Item 18. Management Directors and Officers
Item 19. Control Persons and Principal Holders of Directors and Officers
Securities
Item 20. Investment Advisory and Other Services Management of the Fund
Item 21. Brokerage Allocation and Other Practices Portfolio Transactions
Item 22. Tax Status Taxation
Item 23. Financial Statements Financial Statements
Part C--Other Information
Items 24-33 Part C
2
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD, NOR MAY
OFFERS TO BUY BE ACCEPTED, PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. NEITHER THE UNDERWRITER NOR THE FUND IS MAKING AN OFFERING OF THESE
SECURITIES OR A SOLICITATION OF AN OFFER TO BUY THESE SECURITIES IN ANY STATE
WHERE SUCH OFFER OR SOLICITATION IS NOT PERMITTED, AND THIS PROSPECTUS DOES NOT
CONSTITUTE SUCH AN OFFER OR SOLICITATION.
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED OCTOBER ___, 2003
$________
INSURED MUNICIPAL INCOME FUND INC.
__ AUCTION PREFERRED SHARES SERIES E
__ AUCTION PREFERRED SHARES SERIES F
LIQUIDATION PREFERENCE $50,000 PER SHARE
Insured Municipal Income Fund Inc. (the "Fund") is offering __ Auction Preferred
Shares, Series E ("APS Series E") and __ Auction Preferred Shares, Series F
("APS Series F"). APS Series E and APS Series F have a liquidation preference of
$50,000 per share, plus any accumulated, unpaid dividends. APS Series E and APS
Series F also have priority over the Fund's Common Stock as to distribution of
assets as described in this prospectus. It is a condition of closing this
offering that APS Series E and APS Series F each be offered with a rating of
"Aaa" from Moody's and "AAA" from S&P. The Fund currently has outstanding 800
shares of each of APS Series A, B, C, and 600 shares of APS Series D.
The Fund is a diversified, closed-end management investment company. The Fund's
investment objective is to achieve a high level of current income that is exempt
from federal income tax, consistent with the preservation of capital. To achieve
this objective, the Fund normally invests substantially all of its assets in a
diversified portfolio of Municipal Obligations. Under normal circumstances, the
Fund invests at least 80% of its net assets in insured Municipal Obligations,
the income from which is exempt from regular federal income tax. "Insured
Municipal Obligations" are Municipal Obligations that are insured as to the
timely payment of both principal and interest by an entity that, at the time of
investment, has a claims-paying ability rated Aaa by Moody's Investors Services,
Inc. ("Moody's"), AAA by Standard & Poor's Corporation ("S&P"), or an equivalent
rating from another nationally recognized statistical rating organization
("NRSRO" or "rating agency"). The Fund may invest up to 20% of its net assets in
Municipal Obligations that are not insured but that are, at the time of
investment, (1) backed by an escrow or trust account containing sufficient US
government or US government agency securities to ensure the timely payment of
principal and interest; (2) guaranteed as to timely payment of principal and
interest by an entity which has a credit rating of Aaa by Moody's, AAA by S&P or
an equivalent rating by another NRSRO; or (3) not insured, guaranteed or backed
by escrows but rated Aaa by Moody's, AAA by S&P or an equivalent rating by
another NRSRO. All the Municipal-Obligations described above will have, at the
time of investment, ratings of Aaa from Moody's, AAA from S&P or equivalent
ratings from another NRSRO or (with respect to the Municipal Obligations
described in (1) above), if unrated, will have been determined by the investment
advisor to be of comparable quality to Municipal Obligations that have received
such ratings. There is no guarantee that the Fund will achieve its investment
objective.
UBS Global Asset Management (US) Inc. ("UBS Global AM") serves as investment
advisor and administrator to the Fund. The address of the Fund is 51 West 52nd
Street, New York, New York 10019-6114, and its telephone number is 212-882 5000.
Insurance does not protect the market value of Municipal Obligations or the net
asset value of the Fund.
Investing in APS involves certain risks. See "Investment Risks." The minimum
purchase amount of the APS is $50,000.
As with all investment companies, neither the Securities and Exchange
Commission ("SEC") nor any state securities commission has approved or
disapproved the fund's shares or determined whether this prospectus is
complete or accurate. To state otherwise is a crime.
PRICE TO PUBLIC SALES LOAD(1) PROCEEDS TO FUND (2)
--------------------------------------------------------------------------
Per Share $__ $__ $__
Total $__ $__ $__
(1) The Fund and UBS Global AM have agreed to indemnify the underwriters
against certain liabilities, including liabilities under the
Securities Act of 1933. See "Underwriting."
(2) Before deducting estimated offering expenses of $___ payable by the
Fund.
UBS INVESTMENT
BANK
This Prospectus concisely sets forth certain information an investor should know
before investing and should be retained for future reference. A Statement of
Additional Information, dated October __, 2003, containing additional
information about the Fund has been filed with the Securities and Exchange
Commission ("SEC") and is incorporated by reference into this Prospectus. A copy
of the SAI can be obtained without charge by writing to the Fund or by calling
toll-free 1-800-647 1568 or from the SEC's website at http://www.sec.gov.
The APS do not represent a deposit or obligation of, and are not guaranteed or
endorsed by, any bank or other insured depository institution, and are not
federally insured by the Federal Deposit Insurance Corporation, the Federal
Reserve board or any other government agency.
Dividends on shares of each series of APS, to the extent payable from tax-exempt
income earned on the Fund's investments, will be exempt from federal income tax
in the hands of APS shareholders, subject to the possible application of the
federal alternative minimum tax. The Fund is required to allocate net capital
gains and other taxable income, if any, proportionately between shares of common
stock and the APS. The Fund may give notice of the amount of any dividend income
with respect to each series of the APS that is taxable for federal income tax
purposes in advance of the related Auction, as described in more detail below.
The amount of taxable income allocable to the APS will depend on the amount of
any such income realized by the Fund. See "Taxation."
The PER ANNUM dividend rate for the initial dividend period will be (i) ___ %
PER ANNUM for APS Series E and (ii) ___ % PER ANNUM for APS Series F. For each
Subsequent Dividend Period, the dividend rate on shares of APS Series E and APS
Series F APS Series will be based on a rate set at Auction, except as provided
in this Prospectus. See "Description of APS--Dividends and Dividend Periods."
Prospective purchasers should carefully review the Auction procedures described
in this Prospectus and should note that (i) a bid or sell order constitutes a
commitment to purchase or sell APS based upon the results of an Auction, (ii)
Auctions will be conducted through telephone [or other electronic]
communications and (iii) settlement for purchases and sales will be on the next
business day following an Auction.
Dividends on shares of each series of APS shall accumulate at the applicable
rate PER ANNUM from the date of original issue and, except as provided below,
shall be payable in the case of APS Series E on [day of week] and each [day of
week] thereafter, and in the case of APS Series F on [day of week] and each [day
of week] thereafter. The first Auction Dates for APS Series E and APS Series F
are scheduled for __________, 2003 and _____________, 2003, respectively.
Subsequent Dividend Periods shall generally be seven days for each of APS Series
E and APS Series F. However, the Fund, subject to certain conditions, may
designate any dividend period of any APS series as a special dividend period,
which shall be such number of consecutive days, whole months or whole years as
the Fund's board of directors ("Board") shall specify, subject to certain
conditions. The shares of each series of APS are redeemable by the Fund as
described herein. See "Description of APS--Redemption."
Prior to this offering, there has been no market for shares of APS Series E and
APS Series F APS Series. You may buy or sell APS only through an order placed at
an Auction or to or through a broker-dealer or to a person that has delivered a
signed Master Purchaser's Letter to the Auction Agent. APS Series A, B, and C
have been outstanding since 1993.
The APS offered hereby are offered by UBS Securities LLC, subject to its receipt
and acceptance of and right to reject any order in whole or in part. It is
expected that one certificate for each series of APS will be delivered to or
through the facilities of Depository Trust Company on or about __________, 2003.
You should rely only on the information contained or incorporated by reference
in this Prospectus. Neither the Fund nor UBS Global AM has authorized anyone to
provide you with different information.
2
You should not assume that the information contained in this prospectus is
accurate as of any date other that the date on the front of this prospectus.
NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.
THE DATE OF THIS PROSPECTUS IS OCTOBER ___, 2003.
3
TABLE OF CONTENTS
PROSPECTUS SUMMARY 5
FINANCIAL HIGHLIGHTS 9
THE FUND 11
USE OF PROCEEDS 11
CAPITALIZATION 11
PORTFOLIO COMPOSITION 12
INVESTMENT OBJECTIVE AND POLICIES 12
INVESTMENT RISKS 19
DESCRIPTION OF APS 23
THE AUCTION 31
TAXATION 34
MANAGEMENT OF THE FUND 35
DESCRIPTION OF COMMON STOCK 35
UNDERWRITING 37
CUSTODIAN, TRANSFER AND DIVIDEND DISBURSING AGENT,
REGISTRAR AND AUCTION AGENT 38
LEGAL MATTERS 38
AUDITORS 38
AVAILABLE INFORMATION 38
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION 39
TYPES OF MUNICIPAL OBLIGATIONS A-1
MASTER PURCHASER'S LETTER Inside Back Cover
PRIVACY PRINCIPLES OF THE FUND
The Fund is committed to protecting the personal information it collects
about individuals who are prospective, current or former investors. The
following information is provided to help you understand how the Fund
protects personal information, and why, in certain cases, the Fund may
share information with certain other parties.
The Fund may collect personal information to process requests and
transactions and to provide customer service. The Fund limits access to
personal information to those individuals who need to know that information
in order to process transactions and service accounts. Such individuals are
required to maintain and protect the confidentiality of personal
information. The Fund does not disclose any personal information it
receives to anyone, except for business purposes, such as to facilitate the
servicing of accounts, or otherwise as permitted or required by law. The
Fund maintains physical, electronic and procedural safeguards to protect
personal information [, and requests the same from other companies,
affiliated and unaffiliated, that provide services to the Fund and its
shareholders].
THE FUND IS NOT A COMPLETE OR BALANCED INVESTMENT PROGRAM.
4
PROSPECTUS SUMMARY
This is only a summary. This summary may not contain all of the information
that you should consider before investing in APS Series E or APS Series F. You
should read the more detailed information contained in this Prospectus and the
Statement of Additional Information.
The Fund Insured Municipal Income Fund Inc. is a diversified,
closed-end management investment company. Insured
Municipal Income Fund Inc. is referred to simply as "the
Fund" throughout the prospectus. The Fund's Common Stock
trades on the New York Stock Exchange under the symbol
"PIF." See "Description of Common Stock." As of
September 31, 2003, the Fund had outstanding 20,628,363
shares of Common Stock, 800 shares of Auction Preferred
Shares (APS) Series A, B, C, and 600 shares of APS
Series D. As of September 30, 2003, the Fund's total
assets were $473,084,088.
Investment Objective The Fund's investment objective is to achieve a high
and Policies level of current income that is exempt from federal
income tax, consistent with the preservation of capital.
There is no assurance that the Fund will achieve its
investment objective.
The Fund normally invests substantially all of its
assets in a diversified portfolio of Municipal
Obligations. Under normal circumstances, the Fund
invests at least 80% of its net assets in insured
Municipal Obligations, the income from which is exempt
from regular federal income tax. The Fund normally
invests in intermediate to longer-term Municipal
Obligations. However, in order to invest cash reserves
or when, in the opinion of the investment advisor, no
suitable intermediate to longer-term Municipal
Obligations are available, the Fund may invest up to 20%
of its net assets in high quality short-term Municipal
Obligations that are rated, at the time of investment,
no lower than MIG-2 by Moody's, SP-2 by S&P or the
equivalent by another NRSRO or, if unrated, that are
determined by the investment advisor to be of comparable
quality to Municipal Obligations that are rated at least
MIG-2 or SP-2. These short-term Municipal Obligations
may include variable or floating rate demand notes and
similar instruments that trade as short-term
obligations. For temporary defensive purposes, the Fund
may invest without limit in such short-term Municipal
Obligations. In addition, if in the opinion of the
investment advisor no suitable short-term Municipal
Obligations are available, the Fund temporarily may hold
cash and, with respect to up to 20% of its net assets,
invest in taxable money market instruments. See
"Investment Objective and Policies," "Investment Risks,"
"Taxation" and Appendix A.
Insured Municipal Insured municipal obligations held by the Fund will be
Obligations insured as to their scheduled payment of principal and
interest under (i) an insurance policy obtained by the
issuer or underwriter of the municipal obligation at the
time of its original issuance ("original issue
insurance"), (ii) an insurance policy obtained by the
Fund or a third party subsequent to the municipal bond's
original issuance ("secondary market insurance") or
(iii) another municipal insurance policy purchased by
the Fund ("portfolio insurance"). This insurance does
not protect the market value of the municipal
obligations it covers or the net asset value of the
Fund.
Investment Advisor UBS Global AM, an indirect, wholly owned subsidiary of
and Administrator UBS AG, is the Fund's investment advisor and
administrator. UBS Global AM provides investment
advisory and portfolio management services to investment
companies, pension funds and other institutional,
corporate and individual clients. As investment advisor
and administrator, UBS Global AM is entitled to receive
from the Fund a fee, computed weekly and paid monthly,
in an amount equal to an annual rate of 0.90% of the
Fund's average weekly net assets. UBS Global AM has
agreed to waive a portion of
5
its fee in the amount of 0.20% of average weekly net
assets, effectively reducing the annual fee paid to UBS
Global AM by the Fund to 0.70% of average weekly net
assets. This waiver will continue indefinitely unless
the Fund's Board of Directors agrees to any change. See
"Management of the Fund."
The Offering The Fund is offering its preferred stock, designated as
APS Series E and APS Series F, at a purchase price of
$50,000 per share. Shares of APS Series E and APS Series
F are being made available by UBS Securities LLC.
Auction Preferred The Fund has outstanding 800 shares of each of APS
Shares Series A, B, and C, and 600 shares of APS Series D,
having an aggregate liquidation value of $150,000,000.
Shares of APS Series E and APS Series F are very similar
to APS Series A, B, C and D. The issuance of APS Series
E and APS Series F will increase the total assets of the
Fund. The APS pay dividends at rates that are adjusted
over relatively short periods of time and that reflect
prevailing short-term, tax-exempt interest rates. The
proceeds of APS offerings are invested in longer-term
Municipal Obligations, which typically bear interest at
rates that are higher than short-term, tax-exempt
interest rates. The APS offered hereby are expected to
receive ratings of Aaa from Moody's and AAA from S&P.
See "Description of APS."
Risk Factors Summary Risk is inherent in all investing. Therefore, before
investing in the APS, you should consider certain risks
carefully. The primary risks of investing in the APS
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 APS, 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 suspend, withdraw or
downgrade the rating assigned to the APS, 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;
- if interest rates rise, the value of the Fund's
investment portfolio will decline, reducing the
asset coverage for the APS;
- if an issuer of a Municipal Obligation in which the
Fund invests experiences financial difficulty or
defaults, there may be a negative impact on the
income and assets of the Fund's portfolio; and
- the Fund may invest up to 20% of its net assets in
Municipal Obligations that are not insured but that
are of higher quality at the time of purchase as
noted above.
For additional risks of investing in the Fund, see
"Investment Objectives and Policies" and "Investment
Risks."
Trading Market APS are not listed on an exchange. Instead, you may buy
or sell APS through an Auction that normally is held
weekly, by submitting orders to or through a
Broker-Dealer or other person that has delivered a
signed Master Purchaser's Letter to the Auction Agent.
The Broker-Dealers may maintain a secondary trading
market in the APS outside of Auctions. They have no
obligation to do so, however, and there can be no
assurance that a secondary market for the APS will
develop or, if it does develop, that it will provide
holders with liquidity. APS Series E and APS Series F
will not be registered on any stock exchange or on The
Nasdaq Stock Market.
The first Auction Dates for APS Series E and APS Series
F are ___________, 2003
6
and ___________, 2003, respectively, and each subsequent
Auction will normally be held on each [day of week] and
[day of week] thereafter, resepectively, provided that
the Fund, subject to certain conditions, may designate
any Subsequent Dividend Period as a Special Dividend
Period, which shall be such number of consecutive days,
whole months or whole years as the Board of Directors
shall specify, subject to certain conditions. The start
date for subsequent dividend periods will normally be
the business day following the Auction Dates, unless the
then-current dividend period is a special dividend
period.
Dividends and The table below shows the dividend rate for the initial
Dividend Periods dividend periods on APS Series E and APS Series F. For
subsequent dividend periods, APS will pay dividends
based on a rate set at Auction, normally held weekly. In
most instances, dividends are paid [weekly], on the day
following the end of the dividend period. The rate set
at Auction will not exceed the Maximum Rate. See
"Description of APS--Dividends and Dividend Periods."
In addition, the table below also shows the date from
which dividends on the APS 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 the day on which dividends
otherwise would be paid is a Sunday, Monday or Tuesday
that is not a Business Day, then your dividends will be
paid on the first Business Day that falls after that
day. If the day on which dividends would otherwise be
paid is a Wednesday, Thursday, Friday, or Saturday that
is not a Business Day, then your dividends will be paid
on the first Business Day that falls prior to such day.
Finally, the table below shows the number of days of the
initial dividend period for the APS. Subsequent dividend
periods generally will be [seven days]. The Dividend
Payment Date for special dividend periods of more than
[seven days] will be set out in the notice designating a
special dividend period. See "Description of
APS--Dividends and Dividend Periods."
DIVIDEND
DATE OF PAYMENT DATE SUBSEQUENT NUMBER OF
INITIAL DIVIDEND ACCUMULATION FOR INITIAL DIVIDEND DAYS OF INITIAL
RATE AT INITIAL RATE DIVIDEND PERIOD PAYMENT DAY DIVIDEND PERIOD
---------------------------------------------------------------------------------------------------
SERIES E
SERIES F
Special Tax Because under normal circumstances the Fund will invest
Considerations substantially all of its assets in municipal bonds, the
income you receive will ordinarily be exempt from
federal income tax. Taxable income or gain earned by the
Fund will be allocated proportionately to holders of APS
and Common Stock, based on the percentage of total
dividends paid to each class for that year. Accordingly,
certain specified APS dividends may be taxable to
holders of APS. Under certain circumstances, the Fund
will be required to pay additional amounts to holders of
APS in order to offset the federal income tax effect of
the taxable income so allocated. See "Taxation" and
"Description of APS--Dividends and Dividend Periods."
Ratings APS Series E and APS Series F are expected to be issued
with a rating of "Aaa" from Moody's and "AAA" from S&P.
In order to maintain these ratings, the Fund must own
portfolio securities of a sufficient value and with
adequate credit quality to meet the rating agencies'
guidelines. See "Description of APS--Rating Agency
Guidelines and Asset Maintenance."
7
Redemption The Fund may be required to redeem APS if, for example,
the Fund does not meet an asset coverage ratio required
by law or fails to correct a failure to meet a rating
agency guideline in a timely manner. The Fund
voluntarily may redeem APS under certain conditions. See
"Description of APS--Redemption" and "Description of
APS--Rating Agency Guidelines and Asset Maintenance."
Liquidation The liquidation preference for shares of APS Series E
Preference and APS Series F will be $50,000 per share plus
accumulated but unpaid dividends. See "Description of
APS--Liquidation Preference."
Voting Rights The holders of all outstanding series of APS, voting as
a separate class, have the right to elect at least two
directors of the Fund at all times. Such holders also
have the right to elect a majority of the directors in
the event that two years' dividends on the preferred
shares are unpaid. In each case, the remaining directors
will be elected by holders of Common Stock and all
outstanding series of APS, voting together as a single
class. The holders of all outstanding series of APS will
vote as a separate class or classes on certain other
matters as required under the Fund's Articles of
Incorporation, the Investment Company Act of 1940, as
amended, and Maryland law. See "Description of
APS--Voting Rights," and "Description of Common
Stock--Certain Anti-Takeover Provisions of the Articles
of Incorporation."
8
FINANCIAL HIGHLIGHTS
The following financial highlights tables are intended to help you understand
the Fund's financial performance for the past 5 years, with respect to its
common stock and with respect to its currently outstanding APS. Certain
information reflects financial results for a single share of common stock, or
single share of APS, respectively. In the first table, 'total investment return'
represents the rate that an investor would have earned on an investment in the
Fund's common stock.
The information in the financial highlights (for the three most recently
completed fiscal years), except for the six-month period ended March 31, 2003,
has been audited by Ernst & Young LLP, independent auditors, whose report
appears in the Fund's Annual Report to Shareholders. The Fund's financial
statements are included in the Fund's Annual and Semi-Annual Reports to
Shareholders. You may obtain the Fund's Annual and Semi-Annual Reports to
Shareholders without charge by calling 1-800-762 1000. The information in the
financial highlights prior to the three most recently completed fiscal years was
audited by the Fund's previous independent auditor.
[WE WILL NEED TO ADD UNAUDITED STUB FINANCIALS FOR THE 6 MONTHS ENDED
SEPTEMBER 30, 2003]
FOR THE YEARS ENDED MARCH 31,
--------------------------------------------------------------------------------
2003 2002 2001 2000 1999
--------------------------------------------------------------------------------
NET ASSET VALUE,
BEGINNING OF PERIOD $ 15.15 $ 15.30 $ 14.54 $ 15.58 $ 15.40
--------------------------------------------------------------------------------------------------------------------------------
Net investment income 0.97 1.01 1.04 1.04 1.02
--------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gains
(loss) from investment activities 0.58 (0.26) 0.79 (1.05) 0.18
--------------------------------------------------------------------------------------------------------------------------------
Common share equivalent of dividends
paid to auction preferred
shareholders from net investment income (0.10) (0.17) (0.31) (0.26) (0.25)
--------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) from
operations applicable to common
shareholders 1.45 0.58 1.52 (0.27) 0.95
--------------------------------------------------------------------------------------------------------------------------------
Dividends paid to common shareholders
from net investment income (0.84) (0.73) (0.76) (0.77) (0.77)
--------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 15.76 $ 15.15 $ 15.30 $ 14.54 $ 15.58
--------------------------------------------------------------------------------------------------------------------------------
MARKET VALUE, END OF PERIOD $ 13.98 $ 13.42 $ 13.11 $ 12.00 $ 14.25
--------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN(1) 10.61% 8.04% 16.02% (10.49)% 10.96%
--------------------------------------------------------------------------------------------------------------------------------
RATIO TO AVERAGE NET ASSETS
ATTRIBUTABLE TO COMMON SHARES:
Total expenses, net of waivers from advisor 1.41% 1.42% 1.44% 1.44% 1.46%
--------------------------------------------------------------------------------------------------------------------------------
Total expenses, before waivers from
advisor 1.60% 1.61% 1.63% 1.63% 1.65%
--------------------------------------------------------------------------------------------------------------------------------
Net investment income before auction
preferred shares dividends 6.23% 6.57% 7.00% 7.05% 6.58%
--------------------------------------------------------------------------------------------------------------------------------
Auction preferred shares dividends
from net investment income 0.61% 1.11% 2.10% 1.75% 1.60%
--------------------------------------------------------------------------------------------------------------------------------
Net investment income available to
common shareholders, net of waivers
from advisor 5.62% 5.46% 4.90% 5.30% 4.98%
--------------------------------------------------------------------------------------------------------------------------------
Net investment income available to
common shareholders, before waivers
from advisor 5.43% 5.27% 4.71% 5.11% 4.79%
--------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets applicable to common
shareholders, end of year, 1000's $ 325,060 $ 312,552 $ 315,568 $ 299,876 $ 321,361
--------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover 24% 14% 2% 8% 5%
--------------------------------------------------------------------------------------------------------------------------------
Asset coverage per share of auction
preferred shares, end of period $ 158,353 $ 154,184 $ 155,189 $ 149,959 $ 157,120
--------------------------------------------------------------------------------------------------------------------------------
(1) Total investment return is calculated assuming a $10,000 purchase of common
stock at the current market price on the first day of each period reported and a
sale at the current market price on the last day of each period reported, and
assuming reinvestment of dividends and other distributions to common
shareholders as prices obtained under the Fund's Dividend Reinvestment Plan.
Total investment return does not reflect brokerage commissions or taxes that a
shareholder would pay on Fund distributions.
9
FOR THE YEARS ENDED MARCH 31,
--------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------------------------------------------------------------------------
NET ASSET VALUE,
BEGINNING OF PERIOD $ 14.10 $ 14.11 $ 13.42 $ 13.42 $ 15.00
--------------------------------------------------------------------------------------------------------------------------------
Net investment income 1.03 1.05 1.06 1.02** 0.73
--------------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gains
(loss) from investment activities 1.30 (0.03) 0.67 0.04** 1.44
--------------------------------------------------------------------------------------------------------------------------------
Common share equivalent of dividends
paid to auction preferred
shareholders from net investment income (0.26) (0.26) (0.28) (0.25) (0.13)
--------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) from
operations applicable to common
shareholders 2.33 1.02 1.73 1.06 (0.71)
--------------------------------------------------------------------------------------------------------------------------------
Dividends paid to common shareholders
from net investment income (0.77) (0.77) (0.76) (0.79) (0.60)
--------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 15.40 $ 14.10 $ 14.11 $ 13.42 $ 13.42
--------------------------------------------------------------------------------------------------------------------------------
MARKET VALUE, END OF PERIOD $ 13.56 $ 12.00 $ 12.13 $ 11.13 $ 13.00
--------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN(1) 19.70% 5.45% 16.13% (8.17)% 9.74%
--------------------------------------------------------------------------------------------------------------------------------
RATIO TO AVERAGE NET ASSETS
ATTRIBUTABLE TO COMMON SHARES:
Total expenses, net of waivers from advisor 1.49% 1.38% 1.33% 1.74% 1.57%*
--------------------------------------------------------------------------------------------------------------------------------
Total expenses, before waivers from advisor 1.74% 1.76% 1.65% 1.74% 1.57%*
--------------------------------------------------------------------------------------------------------------------------------
Net investment income before auction
preferred shares dividends 6.84% 7.37% 7.45% 7.94% 5.92%*
--------------------------------------------------------------------------------------------------------------------------------
Auction preferred shares dividends
from net investment income 1.75% 1.81% 1.97% 2.02% 0.98%*
--------------------------------------------------------------------------------------------------------------------------------
Net investment income available to common
shareholders, net of waivers from advisor 5.09% 5.56% 5.48% 5.30% 4.98%
--------------------------------------------------------------------------------------------------------------------------------
Net investment income available to common
shareholders, before waivers from advisor
--------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets applicable to common
shareholders, end of year, 1000's $ 467,761 $ 440,758 $ 441.040 $ 426,795 $ 333,825
--------------------------------------------------------------------------------------------------------------------------------
Portfolio turnover 6% 0% 4% 4% 8%
--------------------------------------------------------------------------------------------------------------------------------
Asset coverage per share of auction
preferred shares, end of period $ 155,920 $ 146,919 $ 147,013 $ 142,265 $ 139,094
--------------------------------------------------------------------------------------------------------------------------------
(1) Total investment return is calculated assuming a $10,000 purchase of common
stock at the current market price on the first day of each period reported and
a sale at the current market price on the last day of each period reported,
and assuming reinvestment of dividends and other distributions to common
shareholders as prices obtained under the Fund's Dividend Reinvestment Plan.
Total investment return does not reflect brokerage commissions or taxes that a
shareholder would pay on Fund distributions.
*Annualized
**Calculated using the average share method.
The following information relates to the APS outstanding as of the end of the
periods indicated.
INVOLUNTARY
TOTAL AMOUNT ASSET COVERAGE PER LIQUIDATING AVERAGE MARKET
YEAR SENIOR SECURITIES OUTSTANDING* UNIT** PREFERENCE PER UNIT VALUE PER UNIT***
--------------------------------------------------------------------------------------------------------------------
2003 APS Series A, B, C, D $ 150,000,000 $ 50,000
2002 APS Series A, B, C, D $ 150,000,000 $ 50,000
2001 APS Series A, B, C, D $ 150,000,000 $ 50,000
2000 APS Series A, B, C, D $ 150,000,000 $ 50,000
1999 APS Series A, B, C, D $ 150,000,000 $ 50,000
1998 APS Series A, B, C, D $ 150,000,000 $ 50,000
1997 APS Series A, B, C, D $ 150,000,000 $ 146,919 $ 50,000
1996 APS Series A, B, C, D $ 150,000,000 $ 147,013 $ 50,000
1995+ APS Series A, B, C, D $ 150,000,000 $ 142,265 $ 50,000
1994++ APS Series A, B, C $ 120,000,000 $ 139,094 $ 50,000
10
* Based on liquidation value. Number of APS shares outstanding did not change
after the January 21, 1993 issue date.
** Asset Coverage Per Unit is the same for each APS Series.
*** Average Market Value Per Unit is the same for each APS Series and is
calculated by multiplying $50,000 by the result obtained by dividing (a)
the average monthly market value of the Common Stock during the fiscal
year; by (b) the average of the amount of APS outstanding at the end of
such month.
+ Reflects the full fiscal year for APS Series A,B, and C and the period
from November 28, 1994 (date of issuance) to March 31, 1995 for APS Series
D.
++ Reflects the period from August 12, 1993 (date of issuance of APS Series
A, B and C) to March 31, 1994.
THE FUND
Insured Municipal Income Fund Inc. (the "Fund") is a diversified, closed-end
management investment company registered under the Investment Company Act of
1940 ("1940 Act"). The Fund was incorporated in the State of Maryland on
February 18, 1993. The Fund commenced operations on June 7, 1993, after an
initial public offering of its Common Stock. The Fund issued APS Series A, B,
and C in 1993, and APS Series D in 1994. As of March 31, 2003, the Fund had
20,628,363 shares of Common Stock issued and outstanding. As of September 30,
2003, the Fund's total net assets were $473,084,088, of which $120,000,000 was
due to APS Series A, B, and C ($40,000,000 per series) and $30,000,000 was due
to APS Series D.
The Fund's Common Stock is traded on the New York Stock Exchange, Inc. ("NYSE")
under the symbol "PIF." The Common Stock and the APS are collectively referred
to herein as "Shares," and the holders thereof as "Shareholders." The Fund's
principal office is located at 51 West 52nd Street, New York, New York
10019-6114, and its telephone number is 212-882 5000.
USE OF PROCEEDS
The net proceeds of this offering are estimated to be approximately $__________
after payment of underwriting discounts and offering expenses. Expenses related
to the issuance of APS Series E and APS Series F will be borne by the Fund and
will reduce the net asset value of the Common Stock. The Fund expects to invest
the proceeds in accordance with the Fund's investment objective and policies as
soon as practicable, but in no event later than three months from the closing of
this offering. Pending such investment, the Fund may invest the proceeds in high
quality, short-term, tax-exempt or taxable (if necessary) money market
securities, or in high quality Municipal Obligations with relatively low
volatility (such as pre-refunded securities).
CAPITALIZATION
(UNAUDITED)
The following table sets forth the unaudited capitalization of the Fund as of
September 30, 2003 and as adjusted to give effect to the issuance of the shares
of each APS series offered hereby.
COMPOSITION OF NET ASSETS: ACTUAL AS ADJUSTED
-------------------------------------------------------------------------------------------------------------------
Shareholders Equity:
Preferred Stock, $.001 par value per share (3,000 shares of APS
authorized, issued and outstanding, actual, at $50,000 per share
liquidation preference, and ___ shares of APS authorized, issued and
outstanding as adjusted for issuance of APS Series E and APS Series
F, at $50,000 per share liquidation preference) $ 150,000,000 $ ___
11
Common Stock, $.001 par value; total 199,997,000 shares authorized, actual,
and total ____ shares authorized, as adjusted; 20,628,363 shares issued
and outstanding 20,631
Paid-in surplus 302,679,047 *
Undistributed net investment income 3,342,323
Accumulated net realized losses from investment
transactions (5,580,792)
Net unrealized appreciation of investments 24,598,909 ____
-------------- --------------
Net Assets $ 475,060,118 $ ___
Net Assets Available to holders of Common Stock $ 325,060,118 $ ___
----------
* Net of underwriting discounts and offering expenses relating to the APS Series
E and APS Series F aggregating $___
PORTFOLIO COMPOSITION
As of September 30, 2003, approximately 87.98% of the Fund's total assets was
invested in long- and intermediate-term Municipal Obligations and approximately
12.02% was invested in short-term securities and cash. The following table sets
forth certain information with respect to the composition of the Fund's
investment portfolio as of September 30, 2003. This information is derived from
the Fund's unaudited financial information as of September 30, 2003 included in
the Statement of Additional Information ("SAI"), and should be read in
connection therewith.
[ADJUST TABLE AS NECESSARY TO INCLUDE ONLY RATINGS OF SECURITIES CURRENTLY IN
THE PORTFOLIO]
CREDIT RATING* NUMBER OF ISSUES MARKET VALUE PERCENT
--------------------------------------------------------------------------------------
AAA/Aaa+ [ ] $ [ ] [ ]%
AA/Aa
A/A
BBB/Baa
Unrated+
Short-Term Securities [ ] $ [ ] [ ]%
------------ ------
Total [ ] $ [ ] 100.00%
------------ ------
----------
* Ratings--using the higher of the rating from Moody's Investors Service Inc.
("Moody's") or from Standard & Poor's Corporation ("S&P"). See Appendix A
to the SAI. The ratings shown reflect the rating attributable directly to
the Municipal Obligations or short-terms securities or, in the case of any
Municipal Obligations that are covered by a Secondary Market Insurance
Policy, or by a Portfolio Insurance Policy that provides the Fund with the
option to obtain a comparable permanent insurance policy, the rating
attributable to the claims-paying ability of the bond insurer.
+ Includes securities that are backed by an escrow or trust containing
sufficient US Government Securities to ensure the timely payment of
principal and interest.
+ Refers to securities that have not been rated by Moody's, S&P, or another
NRSRO, but that have been assessed by UBS Global AM as being of comparable
credit quality to rated securities in which the Fund may invest.
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to achieve a high level of current income
that is exempt from federal income tax, consistent with the preservation of
capital.
To achieve this objective, the Fund normally invests substantially all of its
assets in a diversified portfolio of Municipal Obligations. Under normal
circumstances, the Fund invests at least 80% of its net assets in insured
Municipal Obligations, the income from which is exempt from regular federal
income tax. "Insured Municipal Obligations" are Municipal Obligations that are
insured as to the timely payment of both principal and interest by an entity
that, at the time of investment, has a claims-paying ability rated Aaa by
Moody's, AAA by S&P or an equivalent rating by another NRSRO. The Fund may
invest up to 20% of its net assets in Municipal Obligations that are not insured
but that are, at the time of investment,
12
(1) backed by an escrow or trust account containing sufficient US government or
US government agency securities to ensure the timely payment of principal and
interest; (2) guaranteed as to timely payment of principal and interest by an
entity which has a credit rating of Aaa by Moody's, AAA by S&P or an equivalent
rating by another NRSRO; or (3) not insured, guaranteed or backed by escrows but
rated Aaa by Moody's, AAA by S&P or an equivalent rating by another NRSRO. All
the Municipal Obligations described above will have, at the time of investment,
ratings of Aaa from Moody's, AAA from S&P or equivalent ratings from another
NRSRO or (with respect to the Municipal Obligations described in (1) above), if
unrated, will have been determined by the investment advisor to be of comparable
quality to Municipal Obligations that have received such ratings. The Fund
normally invests substantially all of its assets in intermediate to longer-term
Municipal Obligations. However, in order to invest cash reserves or when, in the
opinion of the investment advisor, no suitable intermediate to longer-term
Municipal Obligations are available, the Fund may invest up to 20% of its net
assets in high quality short-term Municipal Obligations that are rated, at the
time of investment, no lower than MIG-2 by Moody's, SP-2 by S&P or the
equivalent by another NRSRO or, if unrated, that are determined by the
investment advisor to be of comparable quality to Municipal Obligations that are
rated at least MIG-2 or SP-2. These short-term Municipal Obligations may include
variable or floating rate demand notes and similar instruments that trade as
short-term obligations. For temporary defensive purposes, the Fund may invest
without limit in such short-term Municipal Obligations. In addition, if in the
opinion of the investment advisor no suitable short-term Municipal Obligations
are available, the Fund temporarily may hold cash and, with respect to up to 20%
of its net assets, invest in taxable money market instruments.
Municipal Obligations are issued by or on behalf of states, the District of
Columbia, territories or possessions of the United States or their respective
political subdivisions, agencies or instrumentalities, or by multistate agencies
or authorities, the interest on which is, in the opinion of bond counsel, exempt
from federal income tax.
Municipal Obligations are issued for various public purposes, including
construction of public facilities, such as airports, bridges, hospitals,
housing, mass transportation, schools, streets and water and sewer works. Other
public purposes for which Municipal Obligations may be issued include
refinancing outstanding obligations and obtaining funds for general operating
expenses and for loans to other public institutions and facilities.
Municipal Obligations include (i) "public purpose" obligations, which generate
interest that is exempt from regular federal income tax and is not a an item of
tax preference for purposes of the federal alternative minimum tax ("Tax
Preference Item"), and (ii) qualified "private activity" obligations (which
generate interest that is exempt from federal income tax but that, if the
obligations were issued after August 7, 1986, is a Tax Preference Item. More
information on the types of Municipal Obligations in which the Fund may invest
is contained in Appendix A to this Prospectus and the SAI.
The Fund may invest more than 25% of its total assets in a particular segment of
the Municipal Obligations market, such as hospital, housing or airport revenue
bonds, or in securities, the interest on which is paid from revenues on similar
types of projects, if UBS Global AM determines that the yields available from
obligations in that market segment justify the potential increase in risk
resulting from a large investment in that market segment. Although such
obligations might be supported by the credit of governmental entities or by
non-governmental entities from a number of different industries, an economic,
business, political or other change affecting one such obligation might also
affect other obligations in the same market segment.
The Fund may use options (both exchange-traded and OTC) to attempt to enhance
income (which would be taxable income) and also may attempt to "hedge" or manage
the overall risk of its investments by
13
using options, futures contracts and interest rate protection transactions. The
Fund is not required to use derivatives or other portfolio strategies to seek to
enhance return or to seek to hedge its portfolio, and UBS Global AM may elect
not to do so. The Fund may use derivatives as a substitute for taking a position
in an underlying security or other asset and/or as part of a strategy designed
to reduce exposure to other risks, such as interest rate risk. The Fund also may
use derivatives to add leverage to the portfolio and/or to hedge against
increases in the Fund's costs associated with the dividend payments on the
preferred stock, including the APS. The Fund's use of derivative instruments
involves risks different from, and possibly greater than, the risks associated
with investing directly in securities and other traditional investments.
Derivatives are subject to a number of risks such as liquidity risk, interest
rate risk, credit risk, leverage risk, the risk of ambiguous documentation and
management risk. They also involve the risk of mispricing or improper valuation
and the risk that changes in the value of the derivative may not correlate
perfectly with the underlying asset, rate or index. If UBS Global AM incorrectly
forecasts market values, interest rates or other applicable factors, the Fund's
performance could suffer. If the Fund invests in a derivative instrument it
could lose more than the principal amount invested. There can be no assurance
that the Fund's portfolio strategies will be effective. Some of the derivative
strategies that the Fund may use to seek to enhance its return are riskier than
its hedging transactions and have speculative characteristics. Such strategies
do not attempt to limit the Fund's risk of loss. The use of derivatives also may
increase the amount of taxes payable by stockholders; however, the fund will
attempt to mitigate any taxable dividends resulting from the Fund's use of
derivatives. Also, suitable derivative transactions may not be available in all
circumstances, and there can be no assurance that the Fund will engage in these
transactions to reduce exposure to other risks when that would be beneficial.
The Fund may invest all or a portion of its assets in Municipal Obligations, the
interest on which is subject to the AMT for individual taxpayers. Accordingly,
shareholders who are individuals may be required to include a portion of the
Fund's dividends in calculating their AMT liability. Corporate Shareholders must
include the entire amount of any exempt-interest dividends in calculating their
adjusted current earnings for purposes of the AMT. The Fund may not be an
appropriate investment for investors who are subject to AMT liability or who
would become subject to AMT liability by reason of an investment in the Fund.
All or a portion of the Fund's dividends also may be subject to state and local
taxation. See "Taxation."
Generally, Municipal Obligations which are covered by insurance or a guarantee
would not be rated Aaa or AAA, and might not be considered to be of investment
grade credit quality in the absence of insurance or a guarantee. Although
insurance or guarantees on, or escrows of US government securities with respect
to, Municipal Obligations reduce financial or credit risk with respect to those
Municipal Obligations (I.E., the possibility that owners of the insured
Municipal Obligations will not receive timely scheduled payments of principal or
interest), insured, guaranteed and escrow-backed Municipal Obligations remain
subject to market risk (I.E., fluctuations in market value as a result of
changes in prevailing interest rates). Accordingly, insurance or guarantees on,
or escrow backing with respect to, Municipal Obligations does not ensure the
market value of the Fund's assets or the net asset value or the market price of
its Common Stock or APS.
The Fund's investment objective and certain investment limitations described in
the SAI are fundamental policies that may not be changed without shareholder
approval. In addition, the Fund's policy of normally investing at least 80% of
its net assets in insured Municipal Obligations, the income from which is exempt
from regular federal income tax, may not be deviated from without shareholder
approval. The Fund will interpret its 80% policy (and a related 20% policy with
respect to investments in taxable
14
investments as described below) as if the following phrase appeared immediately
after the words "net assets": "(plus the amount of any borrowing for investment
purposes)." If subsequent to an investment, the Fund's 80% policy is no longer
met (E.G., bonds are called resulting in a large influx of cash), then under
normal circumstances, the Fund's future investments would be made in a manner
that would bring the Fund's investments back in line with the 80% threshold. All
other investment policies may be changed by the Fund's Board without shareholder
approval.
Each insured Municipal Obligation in which the Fund invests will be covered by
original issue insurance, secondary market insurance, or portfolio insurance.
Original issue insurance is purchased with respect to a particular issue of
Municipal Obligations by the issuer thereof or a third party in conjunction with
the original issuance of a municipal obligation. Under original issue insurance,
the insurer unconditionally guarantees to the holder of the municipal bond the
timely payment of principal and interest on such obligations when and as these
payments become due but not paid by the issuer, except that in the event of the
acceleration of the due date of the principal by reason of mandatory or optional
redemption (other than acceleration by reason of a mandatory sinking fund
payment), default or otherwise, the payments guaranteed may be made in the
amounts and at the times as payment of principal would have been due had there
not been any acceleration. Secondary market insurance is purchased by the Fund
or a third party subsequent to the time of original issuance of a Municipal
Obligation. Secondary market insurance generally provides the same type of
coverage as original issue insurance. Both original issue insurance and
secondary market insurance remain in effect as long as the Municipal Obligations
covered thereby remain outstanding and the insurer remains in business,
regardless of whether the fund ultimately disposes of such Municipal
Obligations. Portfolio insurance may be purchased by the Fund with respect to
Municipal Obligations which the Fund intends to purchase or already owns and
would generally terminate when the municipal obligation is sold by the Fund or
redeemed. Portfolio Insurance guarantees the payment of principal and interest
on specified eligible municipal bonds purchased and presently held by the Fund.
The Fund currently intends to emphasize investments in Municipal Obligations
with original issue insurance or secondary market insurance. There is no
limitation on the percentage of the Fund's assets that may be invested in
Municipal Obligations insured by any given insurer.
Original issue insurance, secondary market insurance and portfolio insurance
generally do not insure payment on an accelerated basis, the payment of any
redemption premium (except with respect to certain premium payments in the case
of certain small issue industrial development and pollution control Municipal
Obligations), the value of the Common Stock or the market value of Municipal
Obligations, or payments of any tender purchase price upon the tender of the
Municipal Obligations. Such insurance also does not insure against nonpayment of
principal of or interest on Municipal Obligations resulting from the insolvency,
negligence or any other act or omission of the trustee or other paying agent for
such obligations.
Moody's, S&P and the other nationally recognized statistical rating
organizations are private services that provide ratings of the credit quality of
debt obligations, including Municipal Obligations. It should be emphasized that
ratings are general and are not absolute standards of quality. Consequently,
Municipal Obligations with the same maturity, interest rate and rating may have
different market prices. Also, rating agencies may fail to make timely changes
in credit ratings in response to subsequent events, so that an issuer's
financial condition may be better or worse than is indicated by its rating.
The Fund's policy of investing in Municipal Obligations insured by insurers
whose claims-paying ability is rated Aaa by Moody's, AAA by S&P or the
equivalent by another NRSRO applies only at the time of the Fund's investment in
a particular Municipal Obligation. A subsequent downgrade of an insurer's
claims-paying ability rating by Moody's, S&P or another NRSRO would result in a
downgrade of the rating assigned to the Municipal Obligations insured by such
insurer, although the Municipal Obligations
15
may have an independent rating that is higher than the new rating assigned to
the insurer's claims-paying ability. The securities could experience a decrease
in market price as a result of such a downgrade. In the event the ratings
assigned to such Municipal Obligations decline to below investment grade, such
Municipal Obligations would probably become less liquid or even illiquid. UBS
Global AM will consider a downgrade by Moody's, S&P or another NRSRO with
respect to the claims-paying ability of an insurer or the credit characteristics
of a particular issuer in determining whether the Fund should continue to hold
the relevant municipal obligation. In making such a determination, UBS Global AM
will also consider such factors as the rating assigned to the municipal
obligation independent of the insurance, its assessment of the credit quality of
the issuer of the municipal obligation and the price at which the municipal
obligation could be sold. UBS Global AM will engage in an orderly disposition of
downgraded Municipal Obligations to the extent necessary to ensure that the
Fund's holdings of Municipal Obligations rated below Baa by Moody's, BBB by S&P
or an equivalent rating by another NRSRO do not exceed 5% of the Fund's net
assets. Municipal Obligations rated Baa by Moody's are investment grade but
Moody's considers them to have speculative characteristics. Changes in economic
conditions or other circumstances are more likely to affect the ability of
Municipal Obligations that are rated Baa or BBB (or equivalent) to make
principal and interest payments than that of higher grade Municipal Obligations.
Although UBS Global AM periodically reviews the financial condition of each
insurer of a municipal obligation in the Fund's portfolio, there can be no
assurance that the insurers will be able to honor their obligations in all
circumstances. In the event of a default by an issuer on its obligations with
respect to any Municipal Obligations in the Fund's portfolio, the Fund could
look to the insurer or guarantor of the relevant Municipal Obligations for
payments of principal and interest. Such insurer or guarantor may not be rated
Aaa, AAA or the equivalent. Accordingly, the Fund could be exposed to greater
risk of non-payment in such circumstances which could in turn adversely affect
the Fund's net asset value, the market price per share of the Common Stock and
the price of the APS. Alternatively, the Fund could elect to dispose of these
Municipal Obligations; however, the market prices for such Municipal Obligations
may be lower than the Fund's purchase price for them, and the Fund could sustain
a capital loss as a result.
OTHER INVESTMENT PRACTICES
Certain of the other investment practices in which the Fund may engage and that
are described below may give rise to federal income tax. Under normal
circumstances, the Fund does not intend to engage in those practices to a
significant extent. The Fund's ability to engage in certain of these investment
practices is limited by the rating agency guidelines applicable to the APS,
which are described further below.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. The Fund may purchase Municipal
Obligations on a when-issued basis, or may purchase or sell Municipal
Obligations for delayed delivery. In when-issued or delayed delivery
transactions, delivery of the securities occurs beyond normal settlement
periods, but no payment or delivery will be made by the Fund prior to the actual
delivery or payment by the other party to the transaction. The Fund does not
accrue income with respect to a when-issued or delayed delivery security prior
to its stated delivery date. When the Fund purchases securities on a when-issued
or delayed-delivery basis, however, it immediately assumes the risks of
ownership, including the risk of price fluctuation. Depending on market
conditions, the Fund's when-issued and delayed delivery purchase commitments
could cause its net asset value per share (and thus its market value per share)
to be more volatile, because such securities may increase the amount by which
the Fund's total assets, including the value of when-issued and delayed delivery
securities held by the Fund, exceed its net assets. Failure to deliver a
security purchased on a when-issued or delayed delivery basis may result in a
loss or missed opportunity to make an alternative investment.
16
SHORT-TERM TAX-EXEMPT AND TAXABLE INVESTMENTS. The Fund normally invests
substantially all of its assets in intermediate to longer-term Municipal
Obligations. However, in order to invest cash reserves, or when, in the opinion
of UBS Global AM, no suitable longer-term Municipal Obligations are available,
the Fund may invest up to 20% of its net assets in high quality short-term
Municipal Obligations that are rated, at the time of investment, no lower than
MIG-2 by Moody's, SP-2 by S&P or the equivalent by another NRSRO; or, if
unrated, that are determined by UBS Global AM to be of comparable quality to
Municipal Obligations that are rated at least MIG-2 or SP-2. These Municipal
Obligations may include variable or floating rate demand notes and similar
instruments that trade as short-term obligations. The Fund may invest without
limit in such high quality short-term Municipal Obligations for temporary
defensive purposes.
In addition, if in the opinion of UBS Global AM no suitable short-term Municipal
Obligations are available, the Fund temporarily may hold cash and, with respect
to up to 20% of its net assets, invest in taxable money market instruments,
including: (1) US government securities; (2) high quality commercial paper that
is rated, at the time of purchase, no lower than Prime-2 by Moody's or A-2 by
S&P or, if unrated, that is determined by UBS Global AM to be of comparable
quality to commercial paper that is rated at least Prime-2 or A-2; (3) bank
obligations (including certificates of deposit, time deposits and bankers'
acceptances of domestic banks); and (4) repurchase agreements with respect to
any of the foregoing. Interest earned from such taxable investments will be
taxable to shareholders as ordinary income when distributed. If the Fund were to
hold cash, the cash would not earn interest, and the Fund's yield would be lower
than if the cash had been invested.
REPURCHASE AGREEMENTS. The Fund is authorized to enter into repurchase
agreements with respect to any obligation issued or guaranteed by the U.S.
government, its agencies or instrumentalities and also with respect to
commercial paper, bank certificates of deposit and bankers' acceptances.
Repurchase agreements are transactions in which the Fund would purchase
securities from a bank or recognized securities dealer (or its affiliate) and
simultaneously commit to resell those securities to the counterparty at an
agreed-upon date or upon demand and at a price reflecting a market rate of
interest unrelated to the coupon rate or maturity of the purchased securities.
The Fund would maintain custody of the underlying securities prior to their
repurchase, either through its regular custodian or through a special
"tri-party" custodian or sub-custodian that maintains separate accounts for both
the Fund and its counterparty; thus, the obligation of the counterparty to pay
the repurchase price on the date agreed to or upon demand would, in effect, be
secured by such securities. If the value of such securities were less than the
repurchase price, plus any agreed-upon additional amount, the other party to the
agreement would be required to provide additional collateral so that at all
times the collateral is at least equal to the repurchase price, plus any
agreed-upon additional amount. The difference between the total amount to be
received upon repurchase of the securities and the price which was paid by the
Fund upon acquisition would be accrued as interest and included in the Fund's
net investment income.
Repurchase agreements carry certain risks not associated with direct investments
in securities, including possible declines in the market value of the underlying
securities and delays and costs to the Fund if the other party to the repurchase
agreement becomes insolvent. The Fund intends to enter into repurchase
agreements only with banks and dealers in transactions believed by UBS Global AM
to present minimal credit risks in accordance with guidelines established by the
Fund's board of directors. UBS Global AM will review and monitor the
creditworthiness of such institutions under the board's general supervision.
REVERSE REPURCHASE AGREEMENTS. The Fund may enter into reverse repurchase
agreements with the same parties with whom it may enter into repurchase
agreements. Under a reverse repurchase agreement, the Fund would sell securities
and agree to repurchase (and the buyer would be required to resell) them at a
17
mutually agreed date or upon demand and at a price reflecting a market rate of
interest. At the time the Fund enters into a reverse repurchase agreement, it
will establish and maintain a segregated account with an approved custodian
containing cash or liquid securities, marked to market daily, having a value not
less than the repurchase price (including accrued interest). The market value of
securities sold under reverse repurchase agreements typically is greater than
the proceeds of the sale, and accordingly, the market value of the securities
sold is likely to be greater than the value of the securities in which the Fund
invests those proceeds. Thus, reverse repurchase agreements involve the risk
that the Fund might be unable to reacquire the securities that it has sold. In
the event the buyer of securities under a reverse repurchase agreement files for
bankruptcy or becomes insolvent, such buyer or its trustee or receiver may
receive an extension of time to determine whether to enforce the Fund's
obligation to repurchase the securities, and the Fund's use of the proceeds of
the reverse repurchase agreement may effectively be restricted pending such
decision. Reverse repurchase agreements will be treated as borrowings for
purposes of calculating the Fund's borrowing limitation discussed below.
LENDING OF PORTFOLIO SECURITIES. To attempt to enhance income (which would be
taxable income) the Fund is authorized to lend up to 33 1/3% of the total value
of its portfolio securities to broker-dealers or institutional investors that
UBS Global AM deems qualified, but only if doing so would not adversely affect
the rating of the APS by S&P and only when the borrower maintains acceptable
collateral with the Fund's custodian in an amount, marked to market daily, at
least equal to the market value of the securities loaned, plus accrued interest
and dividends. Acceptable collateral is limited to cash, U.S. government
securities and irrevocable letters of credit that meet certain guidelines
established by UBS Global AM. In determining whether to lend securities to a
particular broker-dealer or institutional investor, UBS Global AM will consider,
and during the period of the loan will monitor, all relevant facts and
circumstances, including the creditworthiness of the borrower. The Fund will
retain authority to terminate any loans at any time. The Fund may pay reasonable
administrative and custodial fees in connection with a loan and may pay a
negotiated portion of the interest earned on the cash held as collateral to the
borrower or placing broker. The Fund will receive reasonable interest on the
loan or a flat fee from the borrower, and amounts equivalent to any dividends,
interest or other distributions on the securities loaned. The Fund will regain
ownership of loaned securities to exercise beneficial rights, such as voting and
subscription rights, when regaining such rights is considered to be in the
Fund's interest.
OTHER PRACTICES. The Fund may invest up to 20% of its net assets in illiquid
securities. Illiquid securities are those that cannot be disposed of within
seven days in the ordinary course of business at approximately the amount at
which the Fund has valued the securities. Illiquid securities include, among
others, securities subject to contractual restrictions on resale, repurchase
agreements maturing in more than seven days and municipal lease obligations
(including certificates of participation) other than those that UBS Global AM
has determined are liquid pursuant to guidelines established by the Board. To
the extent that the Fund invests in illiquid securities, the Fund may not be
able to readily liquidate such investments, and would have to sell other
investments if necessary to raise cash to meet its obligations. The lack of a
liquid secondary market for illiquid securities may make it more difficult for
the Fund to assign a value to those securities for purposes of valuing the
Fund's portfolio and calculating its net asset value. The Fund also may invest
in stand-by commitments with respect to Municipal Obligations it purchases or
holds. The Fund may engage in short sales "against the box."
18
INVESTMENT RISKS
RISK IS INHERENT IN ALL INVESTING. INVESTING IN ANY INVESTMENT COMPANY
SECURITY INVOLVES RISK, INCLUDING THE RISK THAT YOU MAY RECEIVE LITTLE OR NO
RETURN ON YOUR INVESTMENT OR EVEN THAT YOU MAY LOSE PART OR ALL OF YOUR
INVESTMENT. THEREFORE, BEFORE PURCHASING THE FUND'S APS, YOU SHOULD CONSIDER
CAREFULLY THE FOLLOWING RISKS THAT YOU ASSUME WHEN YOU INVEST IN THE FUND. AN
INVESTMENT IN THE FUND'S APS SHOULD NOT CONSTITUTE A COMPLETE INVESTMENT
PROGRAM.
RISKS OF INVESTING IN APS
AUCTION RISK. An attempt to sell APS at an auction may fail if the auction
fails; that is, if there are more APS offered for sale than there are buyers for
those shares. If sufficient clearing bids do not exist in an auction, the
applicable rate will be the maximum applicable rate, and in such event, owners
of APS wishing to sell will not be able to sell all, and may not be able to sell
any, of such shares in the auction. As a result, an investment in APS may be
illiquid. Neither the broker-dealers nor the Fund is obligated to purchase APS
in an auction or otherwise, nor is the Fund required to redeem APS in the event
of a failed auction. Also, if an investor places bid orders (orders to retain
APS) at an auction only at a specified rate, and that bid rate exceeds the
applicable rate set at the auction, the investor will not retain its APS.
Finally, if an investor elects to retain APS without specifying a rate below
which it would not wish to continue to hold its APS, and the auction sets a
below-market rate, it may receive a lower rate of return on its APS than the
market rate. See "The Auction."
RATINGS AND ASSET COVERAGE RISK. While Moody's is expected to assign a rating of
"Aaa" to the APS and S&P is expected to assign a rating of "AAA" to the APS, the
ratings will not eliminate or necessarily mitigate the risks of investing in the
APS. A rating agency could withdraw, suspend or downgrade the rating assigned to
the APS, which may make shares of APS less liquid at an auction or in the
secondary market. In addition, the Fund may be forced to redeem APS to meet
regulatory or rating agency requirements. The Fund may also voluntarily redeem
APS under certain circumstances. See "Description of APS--Redemption." The Fund
may not redeem APS if such a redemption would cause the Fund to fail to meet
regulatory or rating agency asset coverage requirements, and the Fund may not
declare, pay or set apart for payment any dividend or other distribution if
immediately thereafter the Fund would fail to meet regulatory asset coverage
requirements. A material decline in the Fund's net asset value may impair the
Fund's ability to maintain its required levels of asset coverage on the APS, or,
in an extreme case, to pay dividends on APS. In addition, as a condition to its
receipt of "Aaa" and "AAA" ratings on the APS, the Fund has agreed to certain
investment limitations, which may restrict the Fund from making investments that
UBS Global AM believes would benefit the Fund. See "Rating Agency Guidelines"
for descriptions of the significance and limitations of the ratings on the APS
and of the asset maintenance and other tests the Fund must meet.
SECONDARY MARKET RISK. The broker-dealers may maintain a secondary trading
market in the APS outside of auctions; however, they have no obligation to do
so, and there can be no assurance that a secondary market for the APS will
develop or, if it does develop, that it will provide holders with a liquid
trading market (i.e., trading will depend on the presence of willing buyers and
sellers, and the trading price is subject to variables to be determined at the
time of the trade by the broker-dealers). The APS will not be registered on any
stock exchange or on any automated quotation system. Investors may not be able
to sell any or all of their APS between auctions, or may receive a purchase
price of less than $50,000 per share,
19
plus unpaid dividends. An increase in the level of interest rates likely will
have an adverse effect on the secondary market price of the APS.
INTEREST RATE RISK AND APS. The Fund issues shares of APS, which generally pay
dividends based on short-term interest rates. The Fund generally will purchase
Municipal Obligations that pay interest at fixed or adjustable rates. If
short-term interest rates rise, dividend rates on the shares of APS may rise so
that the amount of dividends paid to the holders of shares of APS 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 APS offering) is available to pay dividends on the
shares of APS, dividend rates on the shares of APS would need to greatly exceed
the Fund's net portfolio income before the Fund's ability to pay dividends on
the shares of APS 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 APS.
LEVERAGE RISK. The Fund uses financial leverage for investment purposes by
issuing APS. It is currently anticipated that, taking into account the APS being
offered in this Prospectus and the outstanding Series A APS, Series B APS,
Series C APS, and Series D APS, the amount of leverage will represent
approximately [__%] of the Fund's Managed Assets. The Fund's leveraged capital
structure creates special risks not associated with unleveraged funds having
similar investment objectives and policies. These include the possibility of
higher volatility of the net asset value of the Fund and the APS' asset
coverage.
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS. Restrictions imposed on the
declaration and payment of dividends or other distributions to holders of the
Fund's common shares and APS, both by the Investment Company Act of 1940 and by
requirements imposed by rating agencies, might impair the Fund's ability to
maintain its qualification as a regulated investment company for federal income
tax purposes. While the Fund intends to redeem APS to enable the Fund to
distribute its income as required to maintain its qualification as a regulated
investment company under the Internal Revenue Code ("Code"), there can be no
assurance that such actions can be effected in time to meet the Code
requirements. See "Taxation."
GENERAL RISKS OF INVESTING IN THE FUND
MARKET RISK AND SELECTION RISK. Market risk is the risk that the bond market
will go down in value, including the possibility that the market will go down
sharply and unpredictably. Selection risk is the risk that the securities that
UBS Global AM selects will underperform the bond market, the relevant market
indices, or other funds with similar investment objectives and investment
strategies.
MUNICIPAL OBLIGATION MARKET RISK. The amount of public information available
about the Municipal Obligations in the Fund's portfolio is generally less than
that for corporate equities or bonds, and the investment performance of the Fund
may therefore be more dependent on the analytical abilities of UBS Global AM
than that of an equity fund or a taxable bond fund. The secondary market for
Municipal Obligations also tends to be less well-developed or liquid than many
other securities markets, which may adversely affect the Fund's ability to sell
its bonds at attractive prices or at prices approximating those at which the
Fund currently values them. The Fund may invest up to 20% of its assets in
illiquid securities. See "Investment Objective and Policies - Other Investment
Practices." The ability of municipal issuers to make timely payments of interest
and principal may be diminished during general economic downturns and as
governmental cost burdens are reallocated among federal, state and local
governments. In
20
addition, laws enacted in the future by Congress or state legislatures or
referenda could extend the time for payment of principal and/or interest, or
impose other constraints on enforcement of such obligations, or on the ability
of municipalities to levy taxes. Issuers of Municipal Obligations might seek
protection under the bankruptcy laws. In the event of bankruptcy of such an
issuer, the Fund could experience delays in collecting principal and interest
and the Fund may not, in all circumstances, be able to collect all principal and
interest to which it is entitled. To enforce its rights in the event of a
default in the payment of interest or repayment of principal, or both, the Fund
may take possession of and manage the assets securing the issuer's obligations
on such securities, which may increase the Fund's operating expenses. Any income
derived from the Fund's ownership or operation of such assets may not be
tax-exempt.
INTEREST RATE AND CREDIT RISK. The Fund invests in Municipal Obligations, which
are subject to interest rate and credit risk. Interest rate risk is the risk
that prices of Municipal Obligations generally increase when interest rates
decline and decrease when interest rates increase. Prices of longer term
securities generally change more in response to interest rate changes than
prices of shorter term securities. The common share net asset value and market
price per share of the bonds in which the Fund will invest will fluctuate more
in response to changes in market interest rates than if the Fund invested
primarily in shorter-term bonds. The Fund's use of leverage by the issuance of
APS and its investments in certain other obligations, as described above, may
increase interest rate risk. Market interest rates for investment grade
Municipal Obligations in which the Fund will primarily invest have recently
declined significantly below the recent historical average rates for such bonds
and market interest rates are now near historical lows. These levels increase
the risk that these rates will rise in the future (which would cause the value
of the Fund's net assets to decline). Credit risk is the risk that the issuer
will be unable to pay the interest or principal when due. The degree of credit
risk depends on both the financial condition of the issuer and the terms of the
obligation. The Fund intends to invest in Municipal Obligations that are rated
investment grade by S&P, or another NRSRO. It may also invest up to 20% of its
net assets in unrated Municipal Obligations that UBS Global AM believes are of
comparable quality. Obligations rated in the lowest investment grade category
may have certain speculative characteristics.
CALL AND REDEMPTION RISK. A Municipal Bond's issuer may call the bond for
redemption before it matures. If this happens to a Municipal Bond the Fund
holds, the Fund may lose income and may have to invest the proceeds in Municipal
Obligations with lower yields.
PRIVATE ACTIVITY BONDS. The Fund may invest in certain tax exempt securities
classified as "private activity bonds." These bonds may subject certain
investors in the Fund to the AMT. The Fund is not restricted with respect to
investing in private activity bonds that are not subject to the AMT. See
"Taxation."
INFLATION RISK. Inflation risk is the risk that the value of assets or income
from an investment will be worth less in the future as inflation decreases the
value of money. As inflation increases, the real value of the APS can decline.
PORTFOLIO STRATEGIES. The Fund may engage in various portfolio strategies both
to seek to hedge its portfolio against adverse effects from movements in
interest rates and in the securities markets generally and to seek to increase
the return of the Fund. These strategies include the use of derivatives, such as
exchange-traded financial futures and option contracts, options on futures
contracts or over-the-counter dealer transactions in caps, swap agreements or
swaptions. Such strategies subject the Fund to the risk that, if UBS Global AM
incorrectly forecasts market values, interest rates or other applicable factors,
the Fund's performance could suffer. The Fund is not required to use derivatives
or other portfolio strategies
21
and may not do so. Income earned by the Fund from many hedging activities will
be treated as capital gain and, if not offset by net realized capital loss, will
be distributed to shareholders in taxable distributions. There can be no
assurance that the Fund's portfolio strategies will be effective.
DERIVATIVES RISK. The Fund may use options (both exchange-traded and OTC) to
attempt to enhance income (which would be taxable income) and also may attempt
to "hedge" or manage the overall risk of its investments by using options,
futures contracts and interest rate protection transactions. The Fund is not
required to use derivatives or other portfolio strategies to seek to enhance
return or to seek to hedge its portfolio, and UBS Global AM may elect not to do
so. The Fund may use derivatives as a substitute for taking a position in an
underlying security or other asset and/or as part of a strategy designed to
reduce exposure to other risks, such as interest rate risk. The Fund also may
use derivatives to add leverage to the portfolio and/or to hedge against
increases in the Fund's costs associated with the dividend payments on the
preferred stock, including the APS. The Fund's use of derivative instruments
involves risks different from, and possibly greater than, the risks associated
with investing directly in securities and other traditional investments.
Derivatives are subject to a number of risks such as liquidity risk, interest
rate risk, credit risk, leverage risk, the risk of ambiguous documentation and
management risk. They also involve the risk of mispricing or improper valuation
and the risk that changes in the value of the derivative may not correlate
perfectly with the underlying asset, rate or index. If UBS Global AM incorrectly
forecasts market values, interest rates or other applicable factors, the Fund's
performance could suffer. If the Fund invests in a derivative instrument it
could lose more than the principal amount invested. There can be no assurance
that the Fund's portfolio strategies will be effective. Some of the derivative
strategies that the Fund may use to seek to enhance its return are riskier than
its hedging transactions and have speculative characteristics. Such strategies
do not attempt to limit the Fund's risk of loss. The use of derivatives also may
increase the amount of taxes payable by stockholders. Also, suitable derivative
transactions may not be available in all circumstances, and there can be no
assurance that the Fund will engage in these transactions to reduce exposure to
other risks when that would be beneficial.
ANTI-TAKEOVER PROVISIONS. The Fund's Articles of Incorporation include
provisions that could limit the ability of other entities or persons to acquire
control of the Fund or to change the composition of its Board of Directors. Such
provisions could limit the ability of shareholders to sell their shares at a
premium over prevailing market prices by discouraging a third party from seeking
to obtain control of the Fund. See "Description of Capital Stock --Anti-Takeover
Provisions of the Articles of Incorporation"
MARKET DISRUPTION. The war with Iraq, its aftermath and the continuing
occupation of Iraq are likely to have a substantial impact on the U.S. and world
economies and securities markets. The nature, scope and duration of the war and
occupation cannot be predicted with any certainty. Terrorist attacks on the
World Trade Center and the Pentagon on September 11, 2001 closed some of the
U.S. securities markets for a four-day period, and similar events cannot be
ruled out. The war and occupation, terrorism and related geopolitical risks have
led, and may in the future lead, to increased short-term market volatility and
may have adverse long-term effects on U.S. and world economies and markets
generally. Those events could also have an acute effect on individual issuers or
related groups of issuers. These risks could also adversely affect individual
issuers and securities markets, interest rates, auctions, secondary trading,
ratings, credit risk and other factors relating to the APS.
PORTFOLIO MANAGEMENT AND OTHER CONSIDERATIONS. If short term or medium term
rates increase or other changes in market conditions occur to the point where
the Fund's leverage could adversely affect holders of common shares (or in
anticipation of such changes), the Fund may attempt to shorten the average
22
maturity or duration of its investment portfolio in order to offset the negative
impact of leverage. The Fund also may attempt to reduce the degree to which it
is leveraged by redeeming preferred shares or otherwise by purchasing preferred
shares, including the APS. Purchases and redemptions of preferred shares,
including the APS, whether on the open market or in negotiated transactions, are
subject to limitations under the 1940 Act. In determining whether or not it is
in the best interest of the Fund and its shareholders to redeem or repurchase
outstanding preferred shares, the Board of Trustees will take into account a
variety of factors, including the following:
- market conditions,
- the ratio of preferred shares to common shares, and
- the expenses associated with such redemption or repurchase.
If market conditions subsequently change, the Fund may sell previously unissued
preferred shares or preferred shares that the Fund had issued but later
repurchased or redeemed.
DESCRIPTION OF APS
GENERAL
The Articles of Incorporation authorize the issuance of 200,000,000 shares of
capital stock, currently designated ___________ shares of Common Stock, 800
shares of each of APS Series A, B, and C, and 600 shares of APS Series D. The
Board is authorized to classify and reclassify any unissued shares of capital
stock from time to time by setting or changing the preferences, conversion or
other rights, voting powers, restrictions, limitations as to dividends,
qualifications or terms and conditions of redemption of such shares of stock
and, therefore, to reclassify some or all of the Fund's unissued capital stock
as Preferred Stock. In connection with the issuance of APS Series E and APS
Series F contemplated in this prospectus, the Board has reclassifies and issued
________ shares of its capital stock as APS Series E and _______ shares of its
capital stock as APS Series F.
DEFINED TERMS
As used herein with respect to any APS series, (i) "Applicable Rate" means the
rate PER ANNUM at which dividends are payable on APS series shares for any
Dividend Period thereof, (ii) "Business Day" means a day on which the NYSE is
open for trading and which is not a Saturday, Sunday or other day on which banks
in New York City are authorized by law to close, (iii) "Date of Original Issue"
means the date on which the Fund initially issued shares of such series of APS,
(iv) "Dividend Payment Date" means any date on which dividends on shares of such
series of APS are payable as provided under "Description of APS--Dividends and
Dividend Periods," (v) "Dividend Period" means the period from and including the
Date of Original Issue of such series to but excluding the initial Dividend
Payment Date for such series and any period thereafter from and including one
Dividend Payment Date for such series to but excluding the next succeeding
Dividend Payment Date for such series, (vi) "Initial Dividend Period" means the
period from and including the Date of Original Issue of such series to but
excluding the first Dividend Payment Date which occurs in a month which contains
the first scheduled Auction Date with respect to shares of such series of APS,
(vii) "Rate Period" means the Initial Dividend Period of such series and any
Subsequent Dividend Period of such series, (viii) "Subsequent Dividend Period"
means any period from and including the first day following the Initial Dividend
Period for such series to but excluding the next
23
Dividend Payment Date for such series which follows a scheduled Auction for such
series to but excluding the next succeeding Dividend Payment Date which follows
a scheduled Auction for such series, provided, however, that if any Subsequent
Dividend Period is also a Special Dividend Period, such term shall mean the
period commencing on the first day of such Special Dividend Period and ending on
the last day of the last Dividend Period thereof, (ix) "Minimum Dividend Period"
means any Rate Period consisting of 28 days with respect to each series of APS,
subject to certain exceptions, (x) "Valuation Date" means each Business Day and
(xi) "Special Dividend Period" means any Subsequent Dividend Period commencing
on the date designated by the Fund, as set forth under "Description of APS
- Dividends and Dividend Periods," and ending on the last day of the last
Dividend Period thereof.
Terms used herein and not otherwise defined have the meanings ascribed to them
in the Glossary contained in the SAI.
DIVIDENDS AND DIVIDEND PERIODS
Dividends on shares of APS Series will accumulate at the Applicable Rate PER
ANNUM from the Date of Original Issue and will be payable, when, as and if
declared by the Board out of legally available funds on the dividend dates set
forth below:
SUBSEQUENT DIVIDEND DATES ON
SERIES INITIAL DIVIDEND DATE EACH
APS Series E _____________, 2003 [DAY OF WEEK]
APS Series F _____________, 2003 [DAY OF WEEK]
* However, in any calendar month in which an Auction is scheduled to
occur, dividends are payable on the first business day following
the scheduled Auction Date.
Subsequent Dividend Periods shall be [seven days] for each of APS Series E and
APS Series F, provided that the Fund, subject to certain conditions, may
designate any Subsequent Dividend Period as a Special Dividend Period, which
shall be such number of consecutive days or whole years as the Board shall
specify, subject to certain exceptions.
If the day on which dividends otherwise would be paid is a Sunday, Monday or
Tuesday that is not a Business Day, then your dividends will be paid on the
first Business Day that falls after that Sunday, Monday or Tuesday. If the day
on which dividends would otherwise be paid is a Wednesday, Thursday, Friday or
Saturday that is not a Business Day, then your dividends will be paid on the
first Business Day that falls prior to such Wednesday, Thursday, Friday or
Saturday.
Dividends on APS Series E and APS Series F will be paid through the Securities
Depository (Depository Trust Company or any successor) on each Dividend Payment
Date. The Securities Depository, in accordance with its normal procedures, is
expected to distribute dividends received on APS Series E and APS Series F in
next-day funds to Agent Members, who are in turn expected to distribute such
dividend payments to the persons for whom they are acting as agents. Each of the
initial broker-dealers, however, has indicated to the Fund that it or one of its
affiliates will make such dividend payments available in same-day funds on each
Dividend Payment Date to customers that use such broker-dealer or such affiliate
as Agent Member.
The dividend rate for the respective Initial Dividend Periods for each of APS
Series E and APS Series F will be (i) ___% PER ANNUM for the APS Series E and
(ii) ___% PER ANNUM for APS Series F. For each Subsequent Dividend Period, the
dividend rate for shares of each series of APS will be the Applicable Rate PER
ANNUM that the Auction Agent (Deutsche Bank Trust Company Americas or any
successor)
24
advises the Fund results from an Auction, except as provided below. The dividend
rate that results from an Auction for a series of APS will not be greater than
the Maximum Rate.
The Maximum Rate will generally be the Applicable Percentage (set forth in the
Applicable Percentage Table, below) of the Reference Rate set forth below.
However, where APS Series E or F has or had a Special Dividend period (other
than a Special Dividend Period of 28 days or less) and an Auction at which
sufficient clearing bids existed has not yet occurred for a Minimum Dividend
Period for such series (28 days for each series of APS) after such Special
Dividend Period, the Maximum Rate shall be the Reference Rate multiplied by the
greater of
(A) the dividend rate on shares of such APS series for the then-ending Rate
Period, or
(B) the product of (x) the Applicable Percentage on such Auction Date, and (y)
the higher of (1) the "AA" Composite Commercial Paper Rate on such Auction Date
for the then-ending Rate Period of such series, if such Rate Period is less than
one year, or the Treasury Rate on such Auction Date for such Rate Period, if
such Rate Period is one year or greater, or (2) the "AA" Composite Commercial
Paper Rate on such Auction Date for such Special Dividend Period of such series,
if the Special Dividend Period is less than one year, or the Treasury Rate on
such Auction Date for the Special Dividend Period, if the Special Dividend
Period is one year or greater.
Where an Auction Date immediately precedes the first day of any proposed Special
Dividend Period of more than 28 days, the Maximum Rate shall be the Applicable
Percentage (set forth in the Applicable Percentage Table, below) multiplied by
the highest of (1) the Reference Rate on such Auction Date for the then-ending
Rate Period of such series, if such Rate Period is less than one year, or the
Treasury Rate on such Auction Date for such Rate Period, if such Rate Period is
one year or greater; (2) the Reference Rate on such Auction Date for the Special
Dividend Period of such series for which the Auction is being held, if such
Special Dividend Period is less than one year, or the Treasury Rate on such
Auction Date for the Special Dividend Period for which the Auction is being
held, if such Special Dividend Period is one year or greater; or (3) the
Reference Rate on such Auction Date for a Minimum Dividend Period.
REFERENCE RATES; TREASURY RATES. The applicable Reference Rates and Treasury
Rates will be the rates announced on such Auction Date for the Business Day
immediately prior to such Auction Date.
The Reference Rate is, with respect to any Rate Period of less than one year,
the higher of (i) the "AA" Composite Commercial Paper Rate and (ii) the Taxable
Equivalent of the Short-Term Municipal Bond Rate. The applicable "AA" Composite
Commercial Paper Rates and Treasury Rates will be the rates announced on such
Auction Date for the Business Day immediately prior to such Auction Date.
"AA Composite Commercial Paper Rate," on any date for any Rate Period, means:
(i) (A) in the case of any Minimum Dividend Period or any Rate Period of between
7 and 35 days, the interest equivalent of the 30-day rate; provided, however, in
the case of any Minimum Dividend Period of 7 days or any Rate Period with 7
days, and if the "AA" Composite Commercial Paper Rate is being used to determine
the Applicable Rate when all of the outstanding APS are subject to submitted
hold orders, then the interest equivalent of the 7-day rate, and (B) in the case
of any Rate Period with more than 35 days, the interest equivalent of the
180-day rate, on commercial paper placed on behalf of issuers whose corporate
bonds are rated "AA"' by S&P or the equivalent of such rating by S&P or another
rating agency, as made available on a discount basis or otherwise by the Federal
Reserve Bank of New York for the Business Day immediately preceding such date;
or (ii) in the event that the Federal Reserve Bank of New York does not make
available any such rate, then the arithmetic average of such rates, 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 next preceding such date.
25
"Taxable Equivalent of the Short-Term Municipal Bond Rate" on any date means 90%
of the quotient of (a) the PER ANNUM rate expressed on an Interest Equivalent
basis equal to the Kenny S&P 30-day High Grade Index or any successor index (the
"Kenny Index"), made available for the Business Day immediately preceding such
date but in any event not later than 8:30 A.M., Eastern time, on such date by
Kenny Information Systems Inc. or any successor thereto, (provided that the use
of such successor will not result in a reduction or withdrawal of the rating of
the APS by Moody's, if Moody's is then rating the APS, or by S&P, if S&P is then
rating the APS) based on 30-day yield evaluations at par of bonds, the interest
on which is excludable for regular federal income tax purposes, of "high grade"
component issuers selected by Kenny Information Systems Inc or any such
successor from time to time in its discretion, which component issuers shall
include, without limitation, issuers of general obligation bonds but shall
exclude any bonds the interest on which constitutes an item of tax preference
under section 57(a)(5) of the Internal Revenue Code or successor provisions, for
purposes of the AMT, divided by (b) 1.00 minus the Marginal Tax Rate (expressed
as a decimal); provided, however, that if the Kenny Index is not made so
available by 8:30 A.M., Eastern time, on such date by Kenny Information Systems
Inc. or any successor, the Taxable Equivalent of the Short-Term Municipal Bond
Rate shall mean the quotient of (i) the PER ANNUM rate expressed on an Interest
Equivalent basis equal to the most recent Kenny Index so made available for any
preceding Business Day, divided by (ii) 1.00 minus the Marginal Tax Rate
(expressed as a decimal).
For the purposes of the foregoing, "Treasury Rate," on any date for any Rate
Period, means: (i) the yield on the most recently auctioned non-callable direct
obligations of the US Government (excluding " flower" bonds) with a remaining
maturity within three months of the duration of such Rate Period, as quoted in
THE WALL STREET JOURNAL on such date for the Business Day next preceding such
date; or (ii) in the event that any such rate is not published by THE WALL
STREET JOURNAL, then the arithmetic average of the yields (expressed as an
interest equivalent in the case of a Rate Period which is one year or less and
expressed as a bond equivalent in the case of any longer Rate Period) on the
most recently auctioned non-callable direct obligations of the US Government
(excluding "flower" bonds) with a remaining maturity within three months of the
duration of such Rate Period as quoted on a discount basis or otherwise by the
US Government Securities Dealers to the Auction Agent for the close of business
on the Business Day immediately preceding such date.
The "Applicable Percentage" will be a percentage, determined as set forth below,
based on the prevailing rating of the APS in effect at the close of business on
the Business Day next preceding such Auction Date:
APPLICABLE
PREVAILING RATING PERCENTAGE
----------------- ----------
"aa3"/AA- or higher ___%
"a3"/A- ___%
"baa3"/BBB- ___%
"ba3"/BB- ___%
Below "ba3"/BB- ___%
However, if the Fund has notified the Auction Agent of its intent to allocate
income that is taxable for federal income tax purposes to the APS prior to any
Auction, for purposes of determining the Maximum Rate with respect to such
Auction, the Applicable Percentage in the foregoing table shall be divided by
the quantity (1 minus the Marginal Tax Rate), only to the extent of the portion
of the dividend on the APS
26
for such Rate Period that represents the allocation of taxable income to APS. If
the APS are rated by only one rating agency, such rating will be the prevailing
rating. If the ratings for the APS are split between two of the foregoing
categories, the lower rating will determine the prevailing rating.
If an Auction for any series of APS is not held when scheduled for any reason,
or if the Fund fails to deposit in a timely manner with the Auction Agent the
full amount of any dividend on, or redemption price of, shares of any series of
APS, and such failure has not been cured as set forth below prior to any
succeeding Subsequent Dividend Period, the dividend rate on the shares of such
series for any such Subsequent Dividend Period will be the maximum rate on date
on which the Auction was scheduled to be held.
If the Fund fails to deposit in a timely manner with the Auction Agent the full
amount of any dividend on, or redemption price of, any shares of any APS series
during any Rate Period for that series, and, does not cure its failure to do so
or pay a late charge, if applicable, prior to 12:00 Noon Eastern time on the
third Business Day next following the failure, Auctions for such series will be
suspended until the failure is cured. The dividend rate for such shares of APS
for each dividend period commencing after that failure (including the dividend
period, if any, during which the failure is cured) shall be a rate PER ANNUM
equal to the Maximum Rate on the Auction Date for each such dividend period (but
with the prevailing rating for such shares, for purposes of determining such
Maximum Rate, being deemed to be "Below "ba3"/BB-").
ADDITIONAL DIVIDENDS. If the Fund allocates any net capital gain or other income
taxable for federal income tax purposes to a dividend paid on APS without having
provided advance notice thereof to the Auction Agent (a "Taxable Allocation"),
whether or not such allocation is made retroactively as a result of the
redemption of all or a portion of the APS or the liquidation of the Fund, the
Fund shall pay an additional dividend.
Simultaneously with such allocation, if practicable, but in no event later than
270 days after the end of the Fund's taxable year for which a Taxable Allocation
is made, provide notice thereof to the Auction Agent and to each APS shareholder
during such taxable year at such shareholder's address as it last appears on the
stock books of the Fund. The Fund will, within 30 days of notifying the Auction
Agent, pay to the Auction Agent (who will then distribute to such holders of
shares of APS), out of legally available funds, an amount equal to the aggregate
Additional Dividends (as defined below) with respect to all Taxable Allocations
made to such holders for the taxable year in question. See "Taxation."
The additional dividend will be in an amount approximately equal to the amount
of taxes paid by a holder of APS on the Taxable Allocation and the additional
dividend, provided that the additional dividend will be calculated (i) without
consideration being given to the time value of money; (ii) assuming that no
holder of APS is subject to the AMT with respect to dividends received from the
Fund; and (iii) assuming that each Taxable Allocation would be taxable in the
hands of APS shareholder at the maximum marginal regular federal individual
income tax rate applicable to ordinary income or net capital gain, as
applicable, or the maximum marginal regular federal corporate income tax rate,
whichever is greater, in effect during the taxable year in question.
RATING AGENCY GUIDELINES AND ASSET MAINTENANCE
The Fund is required under Moody's and S&P guidelines to maintain assets having
in the aggregate a Discounted Value at least equal to the APS Basic Maintenance
Amount. Moody's and S&P have each established separate guidelines for
determining Discounted Value. To the extent any particular portfolio holding
does not satisfy the applicable rating agency's guidelines, all or a portion of
such holding's value will not be included in the calculation of Discounted Value
(as defined by such rating agency). The Moody's and S&P guidelines do not impose
any limitations on the percentage of the Fund's assets that
27
may be invested in holdings not eligible for inclusion in the calculation of the
Discounted Value of the Fund's portfolio. The amount of such assets included in
the portfolio at any time may vary depending upon the rating, diversification
and other characteristics of the eligible assets included in the portfolio,
although it is not anticipated that in the normal course of business the value
of such assets would exceed 20% of the Fund's total assets. The APS Basic
Maintenance Amount includes the sum of (a) the aggregate liquidation preference
of shares of APS then outstanding and (b) certain accrued and projected payment
obligations of the Fund.
The Fund is also required under the 1940 Act and rating agency guidelines to
maintain, with respect to shares of APS, as of the last Business Day of each
month in which any such shares are outstanding, asset coverage of at least 200%
with respect to all outstanding senior securities which represent the Fund's
equity securities, including APS (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 represent equity securities of a closed-end investment
company as a condition of declaring dividends on its Common Stock) ("1940 Act
APS Asset Coverage").
Based on the composition of the Fund's portfolio [and market conditions] as of
________, 2003, the 1940 Act APS Asset Coverage with respect to the APS,
assuming the issuance of APS Series E and APS Series F and after giving effect
to the deduction of underwriting discounts and offering expenses relating to all
APS series, estimated at $__________would be computed as follows:
Value of Fund assets less liabilities $___
not constituting senior securities
_________________________ = ______________ = __%
Senior securities representing $___
indebtedness plus liquidation value of
the APS
In the event the Fund does not timely cure a failure to maintain (a) a
Discounted Value of its portfolio equal to the APS Basic Maintenance Amount or
(b) the 1940 Act APS Asset Coverage, in each case in accordance with the
requirements of the rating agency or agencies then rating the shares of APS, the
Fund will be required to redeem shares of APS as described under
"Redemption--Mandatory Redemption" below.
The Fund may, but is not required to, adopt any modifications to the guidelines
that may hereafter be established by Moody's or S&P. Failure to adopt any such
modifications, however, may result in a change in the ratings described above or
a withdrawal of ratings altogether. In addition, any rating agency providing a
rating for the shares of APS may, at any time, change or withdraw any such
rating. The Board may, without shareholder approval, amend, alter or repeal any
or all of the definitions and related provisions which have been adopted by the
Fund pursuant to the rating agency guidelines in the event the Fund receives
written confirmation from Moody's or S&P, or both, as appropriate, that any such
amendment, alteration or repeal would not impair the ratings then assigned by
Moody's and S&P to shares of APS.
As recently described by Moody's and S&P, a preferred stock rating is an
assessment of the capacity and willingness of an issuer to pay preferred stock
obligations. The ratings on the shares of APS are not recommendations to
purchase, hold or sell those shares, inasmuch as the ratings do not comment as
to market price or suitability for a particular investor. The rating agency
guidelines described above also do not address the likelihood that an owner of
shares of APS will be able to sell such shares in an Auction or otherwise. The
ratings are based on current information furnished to Moody's and S&P by the
Fund and
28
the Advisor and information obtained from other sources. The ratings may be
changed, suspended or withdrawn as a result of changes in, or the unavailability
of, such information. The Fund's Common Stock has not been rated by an NRSRO.
A rating agency's guidelines will apply to shares of APS only so long as such
rating agency is rating such shares. The Fund pays certain fees to Moody's or
S&P, or both, for rating shares of APS.
REDEMPTION
MANDATORY REDEMPTION. The Fund will be required to redeem, at the Mandatory
Redemption Price ($50,000 per share of APS plus an amount equal to accumulated
but unpaid dividends thereon to the date fixed for redemption (whether or not
earned or declared)), certain of the APS to the extent permitted under the 1940
Act and Maryland law, if the Fund fails to maintain a Discounted Value of
Moody's Eligible Assets or S&P Eligible Assets in an amount greater than or
equal to the APS Basic Maintenance Amount or fails to maintain the 1940 Act APS
Asset Coverage and such failure is not cured or before the APS Basic Maintenance
Cure Date or the 1940 Act Cure Date (herein respectively referred to as a "Cure
Date"). Any such redemption will be limited to the number of APS necessary to
restore the APS Basic Maintenance Amount or the 1940 Act APS Asset Coverage, as
the case may be.
OPTIONAL REDEMPTION. The Fund, at its option, may redeem shares of any APS
series, in whole or in part, out of legally available funds. Any optional
redemption will occur on the second Business Day next preceding any Dividend
Payment Date applicable to shares of such APS series called for redemption, at
the optional redemption price of $50,000 per APS share plus, in the case of a
Special Dividend Period of 365 days or more, an amount equal to accumulated but
unpaid dividends thereon to the date fixed for redemption and a premium, if any,
determined by the Board (unless the Board has determined that no share of such
series of APS will be subject to optional redemption).
LIQUIDATION PREFERENCE
Upon a liquidation of the Fund, whether voluntary or involuntary, the holders of
any APS series then outstanding will be entitled to receive and to be paid out
of the Fund's assets available for distribution to its Shareholders, before any
payment or distribution shall be made on Common Stock or any class of stock of
the Fund ranking junior to the APS upon liquidation, an amount equal to the
liquidation preference with respect to that APS series. The liquidation
preference for the APS is $50,000 per share, plus an amount equal to all
dividends thereon (whether or not earned or declared) accumulated but unpaid to
the date of final distribution in same-day funds, together with any applicable
Additional Dividends (as defined under "Description of the APS") in connection
with the liquidation of the Fund. After the payment to the holders of the APS of
the full preferential amounts provided for as described herein, the holders of
APS as such shall have no right or claim to any of the remaining assets of the
Fund.
Neither the sale of all or substantially all of the property or business of the
Fund, nor the merger or consolidation of the Fund into or with any other
corporation, nor the merger or consolidation of any other corporation into or
with the Fund, shall be a liquidation, whether voluntary or involuntary, for the
purposes of this paragraph.
VOTING RIGHTS
Holders of the APS generally will have equal voting rights with holders of
Common Stock (one vote per share) and generally will vote together with holders
of Common Stock as a single class. However, in connection with the election of
the Fund's directors, holders of outstanding shares of preferred stock,
including any APS, voting as a separate class, are entitled to elect two of the
Fund's directors; the remaining directors are elected by Common Stockholders and
preferred stockholders, including any APS, voting as a single class. In
addition, if at any time dividends (whether or not earned or declared) on any
29
outstanding preferred stock, including the APS, shall be due and unpaid in an
amount equal to two full years' dividends thereon, then the holders of the
preferred stock, including any outstanding APS, voting as a separate class, will
be entitled to elect a majority of the total number of directors of the Fund so
long as such dividends remain unpaid.
So long as any of the APS are outstanding, the Fund will not, without the
affirmative vote of a majority of the outstanding APS, 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 separately as one class): (a)
authorize, create or issue any class or series of stock ranking prior to or on a
parity with the APS with respect to the payment of dividends or the distribution
of assets upon liquidation or increase the authorized amount of APS (except that
the Fund may, without the vote of the holders of APS, authorize, create or issue
classes or series of preferred stock ranking on a parity with the APS with
respect to the payment of dividends and the distribution of assets upon
liquidation subject to continuing compliance by the Fund with the asset coverage
requirement of the 1940 Act and APS basic maintenance amount requirements
established by Moody's or S&P; provided that the Fund obtains written
confirmation from Moody's (if Moody's is then rating the APS) and S&P (if S&P is
then rating the APS) that the issuance of any such additional class or series of
preferred stock would not impair the rating then assigned by such rating agency
to the APS); (b) amend, alter or repeal the Fund's Articles of Incorporation
insofar as they relate to the APS ("APS Provisions"), whether by merger,
consolidation or otherwise, so as to affect any preference, right or power of
such APS or the holders thereof, provided that (i) none of the actions permitted
by the exception to (a) above will be deemed to affect such preferences, rights
or powers and (ii) the authorization, creation and issuance of classes or series
of stock ranking junior to the APS with respect to payment of dividends and the
distribution of assets upon liquidation will be deemed to affect such
preferences, rights or powers only if Moody's or S&P is then rating the Fund and
such issuance would, at the time thereof, cause the Fund not to satisfy the
assets coverage or APS basic maintenance amounts referred to above; or (c) file
a voluntary application for relief under federal bankruptcy law or any similar
application under state law for so long as the Fund is solvent and does not
foresee becoming insolvent.
The Fund's Board may, however, without approval of the holders of APS, amend,
alter or repeal any or all of the definitions required to be contained in the
APS Provisions by the rating agencies in the event the Fund receives written
confirmation from the appropriate rating agency that any such amendment,
alteration or repeal would not impair the ratings then assigned to the APS by
such rating agency. Unless a higher percentage is provided for under
"Description of Capital Stock--Certain Anti-Takeover Provisions of the Articles
of Incorporation," the affirmative vote of the holders of a majority of the
outstanding APS, voting as a separate class, will be required to approve any
plan of reorganization (as such term is defined under the 1940 Act) adversely
affecting such shares or any action requiring a vote of security holders under
Section 13(a) of the 1940 Act including, among other things, changes in the
Fund's investment objective or changes in the investment restrictions described
as fundamental policies under "Investment Limitations" in the SAI. The class
vote of holders of APS described above will in each case be in addition to a
separate vote of the requisite percentage of shares of Common Stock necessary to
authorize the action in question. To the extent permitted by the 1940 Act, each
series of APS may vote as a separate series in certain circumstances.
The foregoing voting provisions will not apply with respect to APS if, at or
prior to the time when a vote is required, such APS shall have been (i) redeemed
or (ii) called for redemption and sufficient funds shall have been deposited in
trust to effect such redemption. See "Description of APS-Voting Rights" in the
SAI.
30
THE AUCTION
The APS Provisions provide that the Applicable Rate PER ANNUM for each dividend
period after the initial dividend period with respect to each APS series shall
be the rate PER ANNUM that the Auction Agent advises has resulted from an
Auction conducted in accordance with the Auction procedures ("Auction
Procedures") set forth in the APS Provisions and summarized below. In such an
Auction, persons determine to hold or offer to sell or, based on dividend rates
bid by them, offer to purchase or sell shares of such series of APS.
AUCTION AGENCY AGREEMENT. The Fund will enter into an Auction Agency Agreement
with the Auction Agent (currently, Deutsche Bank Trust Company Americas), which
provides, among other things, that the Auction Agent will follow the Auction
procedures to determine the applicable rate for shares of each series of APS, so
long as the applicable rate for shares of such APS series is to be based on the
results of an Auction.
The Auction Agent may terminate the Auction Agency Agreement upon __ days notice
to the Fund. 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 removal, the Fund has
entered into a replacement agreement with a successor Auction Agent.
BROKER-DEALER AGREEMENTS. Each Auction requires the participation of one or more
Broker-Dealers. The Auction Agent will enter into agreements with several
Broker-Dealers selected by the Fund, which provide for the participation of
those Broker-Dealers in Auctions for APS Shares.
The Auction Agent will pay to each Broker-Dealer after each Auction, from funds
provided by the Fund, a service charge at the annual rate of __% in the case of
any Auction before a dividend period of 364 days or less, or a percentage agreed
to by the Fund and the Broker-Dealers, in the case of any Auction before a
dividend period of 365 days or longer, of the purchase price of APS Shares
placed by a Broker-Dealer at the Auction.
The Fund may request the Auction Agent to terminate one or more Broker-Dealer
Agreements at any time [upon __ days' notice], provided that at least one
Broker-Dealer Agreement is in effect after termination of the agreements.
AUCTION PROCEDURES
On each Auction Date (the Business Day prior to the beginning of each Rate
Period after the Initial Dividend Period) for each APS series, each existing
shareholder may submit orders through a Broker-Dealer to the Auction Agent as
follows:
HOLD ORDER-indicating its desire to hold without regard to the applicable
rate for the next Rate Period.
BID-indicating its desire to sell if the applicable rate for the next Rate
Period is less than the rate specified in such Bid.
SELL ORDER-indicating its desire to sell without regard to the applicable
rate for the next Rate Period.
31
An "existing shareholder" of APS series shares is a person who has signed, or on
whose behalf a Broker-Dealer has signed, a Master Purchaser's Letter and is
listed as the beneficial owner of such APS shares in the records of the Auction
Agent. An existing shareholder may submit different types of orders in an
Auction with respect to that shareholder's shares of APS then held. An existing
shareholder that offers to purchase additional shares of APS is, for purposes of
such offer, treated as a "potential shareholder" as described below. Bids of
existing shareholders with rates higher than the Maximum Rate on the Auction
Date will be treated as sell orders. With respect to an Auction preceding a Rate
Period of less than 90 days, a hold order will be deemed to have been submitted
on behalf of an existing shareholder if an order is not submitted on behalf of
such existing shareholder for any reason, including the failure of a
Broker-Dealer to submit such existing shareholder's order to the Auction Agent.
With respect to an Auction preceding a Rate Period of 90 days or greater, a sell
order will be deemed to have been submitted on behalf of an existing shareholder
if an order is not submitted on behalf of such existing shareholder for any
reason, including the failure of a Broker-Dealer to submit such existing
shareholder's order to the Auction Agent.
"Potential shareholders" of shares of any series of APS may submit bids in which
they will offer to purchase shares of such series of APS if the applicable rate
for the next Rate Period is not less than the rate specified in such bid. A bid
by a potential shareholder specifying a rate higher than the Maximum Rate will
not be accepted.
If sufficient clearing bids exist (that is, if the number of shares of a
particular series of APS subject to bids by potential shareholders with rates
equal to or lower than the Maximum Rate is at least equal to the number of
shares of such series of APS subject to sell orders by existing shareholders),
the applicable rate for such series will be the lowest rate specified in the
submitted bids which, taking into account such rate and all lower rates bid by
existing shareholders and potential shareholders, would result in existing
shareholders and potential shareholders owning all the shares of such series of
APS available for purchase in the Auction. If sufficient clearing bids do not
exist, the applicable rate will be the Maximum Rate on the Auction Date, and, in
such event, existing shareholders that have submitted sell orders may not be
able to sell in such Auction all shares of such series of APS subject to such
sell orders. If all existing shareholders of such series of APS submit or are
deemed to have submitted hold orders, the applicable rate will be the product of
(i) (a) the Reference Rate on such Auction Date for the Rate Period for which
the Auction is held, if such Rate Period is less than one year, or (b) the
Treasury Rate on such Auction Date for such Rate Period, if such Rate Period is
one year or longer; and (ii) (1 minus the Marginal Tax Rate); provided, however,
that if the Fund has notified the Auction Agent of its intent to allocate to the
APS in such Rate Period any net capital gains or other income that is taxable
for federal income tax purposes, the Applicable Rate with respect to that
portion of the dividend on the APS for such Rate Period that represents the
allocation of net capital gains or other income taxable for federal income tax
purposes will be the rate described in the preceding clause (i) (a) or (i)(b),
as applicable, without being multiplied by the factor set forth in clause (ii).
The Auction Procedures include a PRO RATA allocation of shares for purchase and
sale, which may result in an existing shareholder continuing to hold or selling,
or a potential holder purchasing, a number of shares of APS that is fewer than
the number of shares of APS specified in its order.
A Bid placed by an existing shareholder specifying a rate greater than the
applicable rate determined in the Auction or a sell order shall constitute an
irrevocable offer to sell the shares of such series of APS subject thereto, in
each case at a price per share equal to $50,000. A bid placed by a potential
shareholder shall constitute an irrevocable offer to purchase the shares of such
series of APS subject thereto at a price per share equal to $50,000 if the rate
specified in such bid is less than or equal to the applicable rate determined in
the Auction. Settlement of purchases and sales will be made on the next Business
Day
32
(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
currently provide for payment against delivery by their Agent Members in
same-day funds.
MASTER PURCHASER'S LETTER
Each prospective purchaser of shares of any series of APS or its Broker-Dealer
will be required to sign and deliver a Master Purchaser's Letter to the Auction
Agent in which such prospective purchaser or its Broker-Dealer will agree, among
other things, that
(i) dispositions of shares of such series of APS may be made only pursuant
to a bid or a sell order placed in an Auction, or to or through a
Broker-Dealer or to a person that has delivered a signed Master Purchaser's
Letter to the Auction Agent; provided that in the case of all transfers
other than those pursuant to Auctions, the existing shareholders of the
shares so transferred, its Agent Member or its Broker-Dealer advises the
Auction Agent of such transfer; and
(ii) ownership of shares of a series of APS will be maintained in book
entry form by the Securities Depository for the account of such prospective
purchaser's Agent Member, which, in turn, will maintain records of the
prospective purchaser's beneficial ownership.
Each prospective purchaser should consult its Broker-Dealer to determine whether
to sign a Master Purchaser's Letter. If the Broker-Dealer submits orders for
prospective purchasers listing the Broker-Dealer as the existing shareholder or
the potential shareholder, a Master Purchaser's Letter signed by the prospective
purchaser may not be required.
An execution copy of the Master Purchaser's Letter is included inside the back
cover of this Prospectus. Execution by a prospective purchaser or its
Broker-Dealer of a Master Purchaser's Letter is not a commitment to purchase
shares of APS in the offering being made by this Prospectus or in any Auction,
but is a condition precedent to a purchaser's purchasing shares of APS. In
addition, acceptance of a Master Purchaser's Letter is not a guarantee that
shares of APS will be available for purchase.
SECONDARY MARKET TRADING
A Broker-Dealer may maintain a secondary trading market in the APS outside of
Auctions. No Broker-Dealer has any obligation to do so, however, and there can
be no assurance that a secondary market for the APS will develop or, if it does
develop, that it will provide holders with liquidity of investment. The APS will
not be registered on any stock exchange or on The Nasdaq Stock Market.
TAXATION
The following is a description of certain US federal income tax consequences to
an investor of acquiring, holding and disposing of APS shares of the Fund. The
discussion reflects applicable tax laws of the US as of the date of this
prospectus, which tax laws may be changed or subject to new interpretations by
the courts or the Internal Revenue Service ("IRS") retroactively or
prospectively. Investors are urged to consult their own tax advisors to
determine the tax consequences to them of investing in the Fund.
The Fund intends to continue to qualify for treatment as a regulated investment
company ("RIC") under Subchapter M of the Code. For each taxable year that the
Fund so qualifies, it will be relieved of federal income tax on that part of its
investment company taxable income (consisting generally of taxable net
33
investment income, net short-term capital gain and net realized gains from
certain hedging transactions) and net capital gain that is distributed to its
stockholders.
In general, dividends on the APS will be exempt from regular federal income tax
in the hands of holders of the APS, subject to the possible application of the
AMT. However, the Fund is required to allocate net capital gains and other
income that is taxable for federal income tax purposes, if any, proportionately
between the Common Stock and the APS. The Fund may notify the Auction Agent of
the amount of any net capital gains or other income that is taxable for federal
income tax purposes that is to be included in any dividend on the APS prior to
the Auction establishing the Applicable Rate for such dividend. The Auction
Agent will in turn notify each Broker-Dealer whenever it receives any such
notice from the Fund, and each Broker-Dealer will notify its Existing Holders
and Potential Holders, as provided in its Broker-Dealer Agreement. The amount of
taxable income allocable to the APS will depend upon the amount of such income
realized by the Fund, but is not generally expected to be significant.
If the Fund retroactively allocates any net capital gains or other income
taxable for federal income tax purposes to the APS without having given advance
notice thereof as described above by reason of the fact that such allocation is
made as a result of (i) the realization of net capital gains or other income
taxable for federal income tax purposes, (ii) the redemption of all or a portion
of the outstanding APS, or (iii) the liquidation of the Fund, the Fund will make
certain payments to holders of APS to which such allocation was made to
substantially offset the tax effect thereof. See "Description of APS-Dividends
and Dividend Periods." In no other instance, including any holder of APS being
subject to the AMT, will the Fund be required to make payments to holders of APS
to offset the tax effect of any reallocation of net capital gains or other
taxable income.
Because the Fund may from time to time invest in Municipal Obligations bearing
income that is taxable under the AMT, the Fund may not be an appropriate
investment for investors who are subject to the AMT or who would become subject
to the AMT by reason of an investment in the Fund.
For a further discussion of tax considerations affecting the Fund and the
Shareholders, see "Taxation" in the SAI.
MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS. The overall management of the business and affairs of
the Fund is vested in its Board. The Board approves all significant agreements
between the Fund and persons or companies furnishing services to it, including
the Fund's agreements with its investment advisor and administrator, custodian
and transfer and dividend disbursing agent and registrar. The day-to-day
operations of the Fund are delegated to its officers and to UBS Global AM,
subject to the Fund's investment objective and policies and to general
supervision by the Board.
INVESTMENT ADVISOR. Subject to the supervision of the Board, investment advisory
and administration services are provided to the Fund by UBS Global AM pursuant
to an Investment Advisory and Administration Contract dated May 26, 1993
("Advisory and Administration Contract"). UBS Global AM's principal business
address is 51 West 52nd Street, New York, New York 10019-6114. UBS Global AM is
an indirect, wholly owned subsidiary of UBS AG ("UBS"). As of September 30,
2003, UBS Global AM had approximately $__ billion in assets under management.
UBS Global AM is a member of the UBS Global Asset Management Division, which had
approximately $__ billion in assets under management as of September 30, 2003.
UBS is an internationally diversified organization headquartered in Zurich,
Switzerland, with operations in many areas of the financial services industry.
34
Pursuant to the Advisory and Administration Contract, UBS Global AM provides a
continuous investment program for the Fund and makes investment decisions and
places orders to buy, sell or hold particular securities. UBS Global AM also
supervises all matters relating to the operation of the Fund and obtains for it
corporate officers, clerical staff, office space, equipment and services. As
compensation for its services, UBS Global AM is entitled to receive a fee,
computed weekly and paid monthly, in an amount equal to the annual rate of 0.90%
of the Fund's average weekly net assets. UBS Global AM has agreed to waive 0.20%
of this management fee, so that the effective management fee for the Fund is
0.70%. This waiver will continue indefinitely unless the Board agrees to any
change.
Effective May 20, 2002, William Veronda assumed primary responsibility for the
day-to-day management of the Fund. Mr. Veronda is an Executive Director and
portfolio manager of UBS Global AM. Mr. Veronda joined UBS Global AM in
September 1995 and has led its municipal research group since that date. Mr.
Veronda previously served as the portfolio manager for PaineWebber Municipal
High Income Fund from September 1995 until March 2001. Mr. Veronda has portfolio
management responsibility for over $___ billion in municipal assets at UBS
Global AM, including municipal bond funds and private accounts. Other members of
UBS Global AM's tax-exempt investments group provide input on market outlook,
interest rate forecasts, and other considerations pertaining to tax-exempt
investments.
UBS Global AM investment personnel may engage in securities transactions for
their own accounts pursuant to a Code of Ethics that establishes procedures for
personal investing and restricts certain transactions.
DESCRIPTION OF COMMON STOCK
The Fund is authorized to issue 200,000,000 shares of capital stock, $.001 par
value, which, as of September 30, 2003, is classified as 800 shares of each of
APS Series A, B, and C, 600 shares of APS Series D, and 199,997,000 shares of
Common Stock. It is anticipated that, in connection with this offering, ____
shares of the Fund's capital stock will be reclassified and issued as APS Series
E and APS Series F. See "Description of APS--General." The description of Common
Stock and the description under "Description of Common Stock--Certain
Anti-Takeover Provisions of the Articles of Incorporation" are subject to the
provisions contained in the Fund's Articles of Incorporation and By-Laws.
Shares of Common Stock have no preemptive, conversion, exchange or redemption
rights. Each such share has equal voting, dividend, distribution and liquidation
rights. The outstanding shares of Common Stock are fully paid and nonassessable.
holders of Common Stock are entitled to one vote per share. The rights of the
holders of the Common Stock to elect directors and to vote on other matters are
subject to the voting rights of any of the APS, as discussed above under
"Description of APS--Voting Rights."
The Fund has established a dividend reinvestment plan under which all holders of
Common Stock whose shares of Common Stock are registered in their own names, or
in the name of UBS Financial Services Inc. or its nominees, have all dividends
and other distributions on their shares of Common Stock automatically reinvested
in additional shares of Common Stock, unless such holders of Common Stock
affirmatively elect to receive cash. Holders of Common Stock may make such an
election, may terminate their participation, and may obtain additional
information regarding the plan, by writing to the transfer agent for the Common
Stock. Holders of Common Stock who hold their shares of Common Stock in the name
of a broker or nominee other than UBS Financial Services Inc. or its nominee
must contact such broker or nominee to determine whether, or how, they may
participate in the plan. Under the plan, shares of Common Stock are purchased in
the open market for participants' accounts; the Fund does not issue any new
shares of Common Stock in connection with the plan. The number of shares for
participants with
35
each dividend is determined on the basis of the average price per share
(including applicable brokerage commissions) obtained in the open market.
Experience under the dividend reinvestment plan may indicate that changes are
desirable; therefore, the Fund reserves the rights to amend or terminate the
plan upon notice to holders of Common Stock.
Under the rules of the NYSE applicable to listed companies, the Fund is normally
required to hold an annual meeting of shareholders in each year. If the Fund is
converted to an open-end investment company or if for any other reason the
Fund's shares are no longer listed on the NYSE (or any other national securities
exchange the rules of which require annual meetings of shareholders), the Fund
may decide not to hold annual meetings of Shareholders. See "Common Stock
Repurchase and Tender Offers; Conversion to Open-End Fund" in the SAI.
CERTAIN ANTI-TAKEOVER PROVISIONS OF THE ARTICLES OF INCORPORATION
The Fund currently has provisions in its Articles of Incorporation that have the
effect of limiting: (1) the ability of other entities or persons to acquire
control of the Fund; (2) the Fund's freedom to engage in certain transactions;
or (3) the ability of the Fund's directors or Shareholders to amend the Articles
of Incorporation. These provisions of the Articles of Incorporation may be
regarded as "anti-takeover" provisions. Under Maryland law and the Articles of
Incorporation, the affirmative vote of the holders of at least a majority of the
votes entitled to be cast is required for the consolidation of the Fund with
another corporation, a merger of the Fund with or into another corporation
(except for certain mergers in which the Fund is the successor), a statutory
share exchange in which the Fund is not the successor, a sale or transfer of all
or substantially all of the Fund's assets, the dissolution of the Fund, and any
amendment to the Articles of Incorporation. In addition, the affirmative vote of
the holders of at least 66 2/3% (which is a greater percentage than that
required under Maryland law or the 1940 Act) of the outstanding shares of the
Fund's capital stock is required generally to authorize any of the following
transactions or to amend the provisions of the Articles of Incorporation
relating to such transactions:
(1) merger, consolidation or statutory share exchange of the Fund with or into
any other corporation;
(2) issuance of any securities of the Fund to any person or entity for cash;
(3) sale, lease or exchange of all or any substantial part of the assets of the
Fund to any entity or person (except assets having an aggregate market value of
less than $1,000,000); or
(4) sale, lease or exchange to the Fund, in exchange for securities of the Fund,
of any assets of any entity or person (except assets having an aggregate fair
market value of less than $1,000,000)
if such corporation, entity or person is directly, or indirectly through
affiliates, the beneficial owner of more than 5% of the outstanding shares of
the Fund (a "Principal Shareholder"). The affirmative vote of at least 66 2/3%
of Shareholders would also be required for any amendment of the Articles of
Incorporation that would convert the Fund to an open-end investment company (by
making any class of the Fund's capital stock a "redeemable security," as that
term is defined in the 1940 Act). Such vote would not be required with respect
to any of the foregoing transactions, however, when, under certain conditions,
the Board approves the transaction, although a majority vote of the outstanding
shares of the Fund's capital stock may nevertheless be required in some cases.
The full text of these provisions is contained in the Articles of Incorporation
of the Fund, which are on file with the SEC. These voting rights are in addition
to the rights Holders of any outstanding Preferred Stock to vote as a single
class on certain matters. See "Description of APS--Voting Rights."
The provisions of the Articles of Incorporation described above and the Fund's
right to repurchase or make a tender offer for its shares could have the effect
of depriving the holders of Common Stock of opportunities to sell their shares
at a premium over prevailing market prices by discouraging a third party
36
from seeking to obtain control of the Fund in a tender offer or similar
transaction. See "Common Stock Repurchases and Tender Offers; Conversion to
Open-End Fund" in the SAI. These provisions effectively render the
accomplishment of a merger or the assumption of control by a Principal
Shareholder more difficult. They provide the advantages of potentially (i)
requiring persons seeking control of the Fund to negotiate with its management
regarding the price to be paid, and (ii) facilitating the continuity of the
Fund's management, investment objective and policies. The Board has considered
the foregoing anti-takeover provisions and concluded that they are in the best
interests of the Fund and its Shareholders.
UNDERWRITING
UBS Securities LLC (the "Underwriter"), 299 Park Avenue, New York, New York, has
agreed, subject to the terms and conditions of the Underwriting Agreement with
the Fund and the Adviser, to purchase from the Fund the number of APS set forth
opposite its name. The Underwriter is committed to purchase and pay for all of
such APS if any are purchased.
UNDERWRITER NUMBER OF APS
UBS Securities LLC
The Underwriter has advised the Fund that it proposes initially to offer the APS
directly to the public at the public offering price set forth on the cover page
of this Prospectus, and to certain dealers at such price less a concession not
in excess of $ per share. The Underwriters may allow, and such dealers may
reallow, a concession not in excess of $ per share to other dealers. After the
initial public offering, the public offering price, concession and discount may
be changed. Investors must pay for any APS purchased in the initial public
offering on or before , 2003.
The Underwriter will act in Auctions as a Broker-Dealer and receive fees as set
forth under "The Auction" and in the Statement of Additional Information. The
Underwriter also may provide information to be used in determining the Reference
Rate.
In connection with this offering, the Underwriter or certain selected dealers
may distribute prospectuses electronically.
The Fund and the Adviser have agreed to indemnify the Underwriter against
certain liabilities including liabilities under the Securities Act.
CUSTODIAN, TRANSFER AND DIVIDEND DISBURSING AGENT, REGISTRAR AND AUCTION AGENT
State Street Bank and Trust Company, One Heritage Drive, North Quincy,
Massachusetts 02171, serves as custodian of the Fund's assets. PFPC Inc., 760
Moore Road, King of Prussia, PA 19406, serves as the Fund's transfer and
dividend disbursing agent and registrar with respect to the Fund's common stock.
Deutsche Bank Trust Company Americas, [address], serves as the Auction Agent
with respect to the APS and acts as transfer agent, registrar, dividend
disbursing agent and agent for certain notifications for the Fund in connection
with the APS.
LEGAL MATTERS
The validity of the shares offered hereby will be passed on for the Fund by the
law firm of Dechert LLP, 1775 I Street, N.W., Washington, D.C. 20006, and for
the Underwriters by Clifford Chance US LLP, 200 Park Avenue, New York, New York,
10166. Dechert LLP also acts as counsel to UBS Global AM in
37
connection with other matters. Clifford Chance US LLP may rely on Dechert LLP
with respect to matters of Maryland law.
AUDITORS
The financial statements of the Fund as of March 31, 2003 are incorporated by
reference in the SAI in reliance on the report of Ernst & Young, independent
auditors, given on the authority of that firm as experts in auditing and
accounting.
AVAILABLE INFORMATION
The Fund is subject to the informational requirements of the Securities Exchange
Act of 1934, as amended and the 1940 Act, and in accordance therewith is
required to file reports, proxy statements and other information with the SEC.
These documents can be inspected and copied at the SEC's public reference
facilities, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the SEC's New
York Regional Office, 233 Broadway, New York, New York, 10279 and Chicago
Regional Office, 175 West Jackson Boulevard, Chicago, Illinois 60604. Reports,
proxy statements and other information concerning the Fund can also be inspected
at the offices of the NYSE, 20 Broad Street, New York, New York 10005.
Additional information regarding the Fund and each series of APS shares is
contained in the Registration Statement on Form N-2, including amendments,
exhibits and schedules thereto relating to such series, filed by the Fund with
the SEC. This Prospectus does not contain all of the information set forth in
the Registration Statement, including any amendments, exhibits and schedules
thereto. Statements contained in this Prospectus as to the contents of any
contract or other document referred to are not necessarily complete, and in each
instance reference is made to the copy of such contract or other document filed
as an exhibit to the Registration Statement, each such statement being qualified
in all respects by this reference.
38
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
PAGE
----
Investment Policies and Restrictions 3
Investment Limitations 15
Hedging and Related Income Strategies 17
Organization of the Fund; Directors and Officers; Principal Holders and Management
Ownership of Shares 24
Investment Advisory and Administration Arrangements 33
Portfolio Transactions 35
Valuation of Common Stock 36
Taxation 37
Description of the APS 41
The Auction 56
Additional Information 67
Financial Information 69
Ratings (Appendix A) A-1
Rating Agency Guidelines (Appendix B) B-1
Auction Procedures (Appendix C) C-1
Settlement Procedures (Appendix D) D-1
Hedging and Related Income Strategies (Appendix E) E-1
39
Appendix A
TYPES OF MUNICIPAL OBLIGATIONS
[Portfolio Manager--verify; should others be included?]
The Fund may invest in the following types of Municipal Obligations and in such
other types of Municipal Obligations as are described in the SAI or as become
available on the market from time to time.
MUNICIPAL BONDS. Municipal bonds are debt obligations issued to obtain funds for
various public purposes. The two principal classifications of municipal bonds
are "general obligation" and "revenue" bonds. General obligation bonds are
secured by the issuer's pledge of its full faith, credit and taxing power for
the payment of principal and interest. Revenue bonds are payable only from the
revenues derived from a particular facility or class of facilities or, in some
cases, from the proceeds of a special excise tax or from another specific
source, such as the user of the facility being financed. Certain municipal bonds
are "moral obligation" issues, which normally are issued by special purpose
public authorities. In the case of such issues, an express or implied "moral
obligation" of a related government unit is pledged to the payment of the debt
service but is usually subject to annual budget appropriations.
INDUSTRIAL DEVELOPMENT BONDS AND PRIVATE ACTIVITY BONDS. Industrial development
bonds ("IDBs") and PABs are municipal bonds issued by or on behalf of public
authorities to finance various privately operated facilities, such as airports
or pollution control facilities. IDBs and PABs are generally revenue bonds and
thus are not payable from the unrestricted revenue of the issuer. The credit
quality of IDBs and PABs is usually directly related to the credit standing of
the user of the facilities being financed. The Fund may invest more than 25% of
its assets in IDBs and PABs. IDBs issued after August 15, 1986 generally are
considered PABs, and to the extent the Fund invests in such PABs, stockholders
generally will be required to include a portion of their exempt-interest
dividends in calculating their liability for the AMT. See "Taxes."
MUNICIPAL LEASE OBLIGATIONS. Municipal lease obligations are Municipal
Obligations that may take the form of leases, installment purchase contracts or
conditional sales contracts, or certificates of participation with respect to
such contracts or leases. Municipal lease obligations are issued by state and
local governments and authorities to purchase land or various types of equipment
and facilities. Although municipal lease obligations do not constitute general
obligations of the municipality for which the municipality's taxing power is
pledged, they ordinarily are backed by the municipality's covenant to budget
for, appropriate and make the payments due under the lease obligation. The
leases underlying certain Municipal Obligations, however, provide that lease
payments are subject to partial or full abatement if, because of material damage
or destruction of the leased property, there is substantial interference with
the lessee's use or occupancy of such property. This "abatement risk" may be
reduced by the existence of insurance covering the leased property, the
maintenance by the lessee of reserve funds or the provision of credit
enhancements such as letters of credit.
The liquidity of municipal lease obligations varies. See "Other Investment
Practices." Certain municipal lease obligations contain "non-appropriation"
clauses which provide that the municipality has no obligation to make lease or
installment purchase payments in future years unless money is appropriated for
such purpose on a yearly basis. In the case of a "non-appropriation" lease, the
Fund's ability to recover under the lease in the event of non-appropriation or
default will be limited solely to the
A-1
repossession of the leased property, without recourse to the general credit of
the lessee, and disposition of the property in the event of foreclosure might
prove difficult. The Fund does not intend to invest a significant portion of its
assets in such "non-appropriation" municipal lease obligations. There is no
limitation on the Fund's ability to invest in other municipal lease obligations.
ZERO COUPON OBLIGATIONS. The Fund may invest up to 10% of its total assets in
zero coupon Municipal Obligations. Such obligations include "pure zero"
obligations, which pay no interest for their entire life (either because they
bear no stated rate of interest or because their stated rate of interest is not
payable until maturity), and "zero/fixed" obligations, which pay no interest for
an initial period and thereafter pay interest currently. Zero coupon obligations
also include securities representing the principal-only components of Municipal
Obligations from which the interest components have been stripped and sold
separately by the holders of the underlying Municipal Obligations. Zero coupon
securities usually trade at a deep discount from their face or par value and
will be subject to greater fluctuations in market value in response to changing
interest rates than obligations of comparable maturities that make current
distributions of interest. While zero coupon Municipal Obligations will not
contribute to the cash available to the Fund for purposes of paying dividends to
stockholders, UBS Global AM believes that limited investments in such securities
may facilitate the Fund's ability to preserve capital while generating income
through the accrual of original issue discount. Zero coupon Municipal
Obligations generally are liquid, although such liquidity may be reduced from
time to time due to interest rate volatility and other factors.
Federal tax law requires the Fund to distribute at least 90% of its tax- exempt
income, plus its investment company taxable income, including non-cash income,
each year in order to qualify for pass-through federal income tax treatment as a
regulated investment company. Accordingly, although the Fund will receive no
payments on its zero coupon Municipal Obligations prior to their maturity or
disposition, it will have income attributable to such securities, and it might
be required, in order to maintain its desired tax treatment, to include in its
dividends the income attributable to its zero coupon securities. The Fund might
be required to liquidate portfolio securities at a time that it otherwise would
not have done so in order to make such dividends. The Fund will not be able to
purchase additional income- producing securities with cash used to make such
distributions, and as a result, its current income ultimately may be reduced.
See "Taxes" and "Investment Objectives and Policies--Other Investment Practices"
in this Prospectus and "Taxes" in the SAI.
FLOATING AND VARIABLE RATE OBLIGATIONS. The Fund also may purchase floating and
variable rate municipal notes and bonds, which frequently permit the holder to
demand payment of principal at any time, or at specified intervals, and permit
the issuer to prepay principal, plus accrued interest, at its discretion after a
specified notice period. The issuer's obligations under the demand feature of
such notes and bonds generally are secured by bank letters of credit or other
credit support arrangements. There may be no secondary market for variable and
floating rate obligations held by the Fund, although the Fund may be able to
obtain payment of principal at face value by exercising the demand feature of
the obligation.
PARTICIPATION INTERESTS. The Fund may invest in participation interests in
municipal bonds, including IDBs, PABs and floating and variable rate
securities. A participation interest gives the Fund an undivided interest in a
municipal bond owned by a bank. The Fund has the right to sell the instrument
back to the bank. Such right is generally backed by the bank's irrevocable
letter of credit or guarantee and permits the Fund to draw on the letter of
credit on demand, after specified notice, for all or any part of the
principal amount of the Fund's participation interest plus accrued interest.
Generally, the Fund intends to exercise the demand under the letters of
credit or other guarantees only upon a default under the terms of the
A-2
underlying bond, or to maintain the Fund's portfolio in accordance with its
investment objective and policies. The ability of a bank to fulfill its
obligations under a letter of credit or guarantee might be affected by possible
financial difficulties of its borrowers, adverse interest rate or economic
conditions, regulatory limitations or other factors. UBS Global AM monitors the
pricing, quality and liquidity jof the participation interests held by the Fund,
and the credit standing of banks issuing letters of credit or guarantees
supporting such participation interests on the bases of published financial
information reports of rating services and bank analytical services.
CUSTODIAL RECEIPTS. The Fund may acquire custodial receipts or certificates
underwritten by securities dealers or banks that evidence ownership of future
interest payments, principal payments or both on certain Municipal Obligations.
The underwriter of these certificates or receipts typically purchases Municipal
Obligations and deposits the obligations in an irrevocable trust or custodial
account with a custodian bank, which then issues receipts or certificates that
evidence ownership of the periodic unmatured coupon payments and the final
principal payment on the obligations. Custodial receipts evidencing specific
coupon or principal payments have the same economic attributes as zero coupon
Municipal Obligations described herein. Although under the terms of a custodial
receipt the Fund would be typically authorized to assert its rights directly
against the issuer of the underlying obligation, the Fund could be required to
assert through the custodian bank those rights that may exist against the
underlying issues. Thus, in the event the underlying issuer fails to pay
principal or interest when due, the Fund may be subject to delays, expenses and
risks that are greater than those that would have been involved if the Fund had
purchased a direct obligation of the issuer. In addition, in the event that the
trust or custodial account in which the underlying security has been deposited
is determined to be an association taxable as a corporation, instead of a
non-taxable entity, the yield on the underlying security would be reduced in
recognition of any taxes paid.
INVERSE FLOATERS. The Fund may invest in Municipal Obligation on which the rate
of interest varies inversely with interest rates on other Municipal Obligations
or an index. Such obligations include components of securities on which interest
is paid in two separate parts -- an auction component, which pays interest at a
rate that is set periodically through an auction process or other method, and a
residual component, which pays interest at a rate equal to the difference
between the rate that the issuer would have paid on a fixed-rate obligation at
the time of issuance and the rate paid on the auction component. The market
value of an inverse floater will be more volatile than that of a fixed-rate
obligation and, like most debt obligations, will vary inversely with changes in
market interest rates.
Because the interest rate paid to holders of residual components is generally
determined by subtracting the interest paid to the holders of auction components
from a fixed amount, the interest rate paid to residual component holders will
decrease as the auction component's rate increases and as the auction
component's rate decreases. Moreover, the extent of the increases and decreases
in market value of residual components may be larger than comparable changes in
the market value of an equal principal amount of a fixed rate Municipal
Obligation having similar credit quality, redemption provisions and maturity.
PUT BONDS. Put bonds are municipal bonds which give the holder an unconditional
right to sell the bond back to the issuer or a remarketing agent at a specified
price and exercise date, which is typically well in advance of the bond's
maturity date. If the put is a "one time only" put, the Fund ordinarily will
sell the bond or put the bond, depending on the more favorable price. If the
bond has a series of puts after the first put, the bond will be held as long as,
in UBS Global AM's opinion, it is in the best interests of the Fund to do so.
The obligation to purchase the bond on the exercise date of the put may be
supported by a
A-3
letter of credit standing of which affects the credit standing of the
obligations. There is no assurance that an issuer or remarketing agent for a put
bond will be able to repurchase the bond on the put exercise date if the Fund
chooses to exercise its right to put the bond back to the issuer or remarketing
agent.
TENDER OPTION BONDS. Tender option bonds are long-term municipal securities sold
by a bank subject to a "tender option" that gives the purchaser the right to
tender them to the bank at par plus accrued interest at designated times (the
"tender option"). The tender option may be exercisable at intervals ranging from
bi-weekly to semi-annually, and the interest rate on the bonds is typically
reset at the end of the applicable interval in order to cause the bonds to have
a market value that approximates their par value. The tender option generally
would not be exercisable in the event of a default on, or significant
downgrading of, the underlying municipal securities. Therefore, a Fund's ability
to exercise the tender option will be affected by the credit standing of both
the bank involved and the issuer of the underlying securities.
MUNICIPAL DERIVATIVES. The Fund may invest in derivative securities that are
Municipal Obligations, or components thereof, that have been specially
structured to reflect investment characteristics ordinarily associated with
other securities or to have other special rights desired by investors.
Generally, such securities are designed to allow investors to take advantage of
expected interest rate trends or to hedge interest rate or other risks.
Detachable call options are sold by issuers of Municipal Obligations separately
from the Municipal Obligations to which the call options relate and permit the
purchasers of the call options to acquire the Municipal Obligations at the call
price(s) and call date(s). In the event that interest rates drop, the purchaser
could exercise the call option to acquire Municipal Obligations that yield
above-market rates. Municipal Obligations with embedded caps provide for
additional tax-free payments for a stated period (generally a period that is
shorter than the bond's maturity) above the fixed rate of interest payable on
the Municipal Obligations to the extent that the average level of a particular
index exceeds a specified base level. The Fund would use Municipal Obligations
with embedded caps in order to attempt to offset the risk of increases in
short-term interest rates while continuing to earn tax-exempt income.
Investments in municipal derivatives may be subject to the same risks as
floating rate Municipal Obligations, risks of adverse tax determinations or, in
the case of municipal derivatives used for hedging purposes, risks similar to
those for other hedging strategies. See "Hedging and Related Income Strategies"
in the SAI. The Fund will only invest in those municipal derivatives that UBS
Global AM believes will facilitate the Fund's ability to achieve its investment
objective.
A-4
MASTER PURCHASER'S LETTER
Relating to Securities Involving Rate
Settings Through Auctions or Remarketings
THE COMPANY
A REMARKETING AGENT
THE TRUST COMPANY
OR AUCTION AGENT
A BROKER-DEALER
AGENT MEMBER
OTHER PERSONS
Dear Sirs:
1. This letter is designed to apply to publicly or privately offered debt
or equity securities ("Securities") of any issuer ("Company"), which are
described in any final prospectus or other offering materials relating to such
Securities, as the same may be amended or supplemented (collectively, with
respect to the particular Securities concerned, the "Prospectus") and which
involve periodic rate settings through auctions ("Auctions") or remarketing
procedures ("Remarketings"). This letter shall be for the benefit of any Company
and of any trust company, auction agent, paying agent (collectively, "trust
company"), remarketing agent, broker-dealer, agent member, securities depository
or other interested person in connection with any Securities and related
Auctions or Remarketings (it being understood that such persons may be required
to execute specified agreements and nothing herein shall alter such
requirements). The terminology used herein is intended to be general in its
application and not to exclude any Securities in respect of which (in the
Prospectus or otherwise) alternative terminology is used.
2. We may from time to time offer to purchase, purchase, offer to
sell and/or sell Securities of any company as described in the Prospectus
relating thereto. We agree that this letter shall apply to all such purchases,
sales and offers and to Securities owned by us. We understand that the
dividend/interest rate on Securities may be based from time to time on the
results of Auctions or Remarketings as set forth in the Prospectus.
3. We agree that any bid or sell order placed by us in an Auction shall
constitute an irrevocable offer (except as otherwise described in the
Prospectus) by us to purchase or sell the Securities subject to such bid or sell
order, or such lesser amount of Securities as we shall be required to sell or
purchase as a result of such Auction or Remarketing, at the applicable price,
all as set forth in the Prospectus, and that if we fail to place a bid or sell
order with respect to Securities owned by us with a broker-dealer on any Auction
or Remarketing date, or a broker-dealer to which we communicate a bid or sell
order fails to submit such bid or sell order to the trust company or remarketing
agent concerned, we shall be deemed to have placed a hold order with respect to
such Securities as described in the Prospectus, except as may otherwise be
described therein. We authorize any broker-dealer that submits a bid or sell
order as our agent in Actions or Remarketings to execute contracts for the sale
of Securities covered by such bid or sell order. We recognize that the payment
by such broker-dealer for Securities purchased on our behalf shall not relieve
us of any liability to such broker-dealer for payment for such Securities.
4. We understand that in a Remarketing, the dividend or interest rate or
rates on the Securities and the allocation of Securities tendered for sale among
dividend or interest periods of different
A-5
lengths will be based from time to time on the determinations of one or more
remarketing agents, and we agree to be conclusively bound by such
determinations. We further agree to the payment of different dividend or
interest rates to different holders of Securities depending on the length of the
dividend or interest period elected by such holders. We agree that any notice
given by us to a remarketing agent (or to a broker-dealer for transmission to a
marketing agent) of our desire to tender Securities in a Remarketing shall
constitute an irrevocable (except to the limited extent set forth in the
Prospectus) offer by us to sell the Securities specified in such notice, or such
lesser number of Securities as we shall be required to sell as a result of such
Remarketing, in accordance with the terms set forth in the Prospectus, and we
authorize the remarketing agent to sell, transfer or otherwise dispose of such
Securities as set forth in the Prospectus.
5. We agree that, during the applicable period as described in the
Prospectus, dispositions of Securities can be made only in the denominations set
forth in the Prospectus, and we will sell, transfer or otherwise dispose of any
Securities held by us from time to time only pursuant to a bid or sell order
placed in an Auction, in a Remarketing, to or through a broker-dealer or, when
permitted in the Prospectus, to a person that has signed and delivered to the
applicable trust company, auction agent or remarketing agent a letter
substantially in the form of this letter (or other applicable purchaser's
letter), provided that in the case of all transfers other than pursuant to
Auctions or Remarketings we or our broker-dealer or our agent member shall
advise such trust company, auction agent or remarketing agent of such transfer.
We understand that a restrictive legend will be placed on certificates
representing the Securities and stop-transfer instructions will be issued to the
transfer agent and/or registrar, all as set forth in the Prospectus.
6. We agree that, during the applicable period as described in the
Prospectus, ownership of Securities shall be represented by one or more global
certificates registered in the name of the applicable securities depository or
its nominee, that we will not be entitled to receive any certificate
representing the Securities, and that our ownership of any Securities will be
maintained in book entry form by the securities depository for the account of
our agent member, which in turn will maintain records of our beneficial
ownership. We authorize and instruct our agent member to disclose to the
applicable trust company, auction agent or remarketing agent such information
concerning our beneficial ownership of Securities as such trust company or
remarketing agent shall request.
7. We acknowledge that partial deliveries of Securities purchased in
Auctions or Remarketings may be made to us and such deliveries shall constitute
good delivery as set forth in the Prospectus.
8. This letter is not a commitment by us to purchase any Securities.
9. This letter supersedes any prior-dated version of this master
purchaser's letter, and supplements any prior- or post-dated purchaser's letter
specific to particular Securities, and this letter may only be revoked by a
signed writing delivered to the original recipients thereof.
10. The descriptions of Auction or Remarketing procedures set forth in
each applicable Prospectus are incorporated by reference herein and in case of
any conflict between this letter, any purchaser's letter specific to particular
Securities and any such description, such description shall control.
11. Any xerographic or other copy of this letter shall be deemed of equal
effect as a signed original.
A-6
12. Our agent member of The Depository Trust Company currently is .
13. Our personnel authorized to place orders with broker-dealers for the
purpose set forth in the Prospectus in Auctions and Remarketings currently
is/are , telephone number ( ).
14. Our taxpayer identification number is .
15. In the case of each purchase, offer to purchase, offer to sell or sale
by us of Securities not registered under the Securities Act of 1933, as amended
(the "Act"), we represent and agree as follows:
A. We understand and expressly acknowledge that the Securities have
not been and will not be registered under the Act and, accordingly, that
the Securities may not be reoffered, resold or otherwise pledged,
hypothecated or transferred unless an applicable exemption from the
registration requirements of the Act is available.
B. We hereby confirm that any purchase of Securities made by us will
be for our own account or for the account of one or more parties for which
we are acting as trustee or agent with complete investment discretion and
with authority to bind such parties, and not with a view to any public
resale or distribution thereof. We and each other party for which we are
acting which will acquire Securities will be "accredited investors" within
the meaning of Regulation D under the Act with respect to the Securities to
be purchased by us or such party, as the case may be, will have previously
invested in similar types of instruments and will be able and prepared to
bear the economic risk of investing in and holding such Securities.
C. We acknowledge that prior to purchasing any Securities we shall
have received a Prospectus (or private placement memorandum) with respect
thereto and acknowledge that we will have had access to such financial and
other information, and have been afforded the opportunity to ask such
questions of representatives of the Company and receive answers thereto, as
we deem necessary in connection with our decision to purchase Securities.
D. We recognize that the Company and broker-dealers will rely upon
the truth and accuracy of the foregoing investment representations and
agreements and we agree that each of our purchases of Securities now or in
the future shall be deemed to constitute our concurrence in all of the
foregoing which shall be binding on us and each party for which we are
acting as set forth in Subparagraph B above.
Dated
-------------------------------- -------------------------------------
(Name of Purchaser)
Mailing Address of Purchaser
By
------------------------------------- -----------------------------------
Printed Name:
------------------------------------- ------------------------
Title:
------------------------------------- -------------------------------
A-7
[Back Cover]
Until _________, all dealers that effect transactions in these securities,
whether or not participating in this offering, may be required to deliver a
prospectus. This is in addition to the dealers' obligation to deliver a
prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
A-8
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD, NOR MAY
OFFERS TO BUY BE ACCEPTED, PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. NEITHER THE UNDERWRITER NOR THE FUND IS MAKING AN OFFERING OF THESE
SECURITIES OR A SOLICITATION OF AN OFFER TO BUY THESE SECURITIES IN ANY STATE
WHERE SUCH OFFER OR SOLICITATION IS NOT PERMITTED, AND THIS PROSPECTUS DOES NOT
CONSTITUTE SUCH AN OFFER OR SOLICITATION.
SUBJECT TO COMPLETION
PRELIMINARY STATEMENT OF ADDITIONAL INFORMATION
DATED OCTOBER __, 2003
INSURED MUNICIPAL INCOME FUND INC.
51 West 52nd Street
New York, New York 10019-6114
Insured Municipal Income Fund Inc. ("the Fund") is a diversified closed-end
management investment company. The Fund's investment objective is to achieve a
high level of current income that is exempt from federal income tax, consistent
with the preservation of capital. There is no guarantee that the Fund will
achieve its investment objective.
This Statement of Additional Information ("SAI") is not a prospectus and should
be read only in conjunction with the prospectus for the Fund, dated October ___,
2003 ("Prospectus"). Capitalized terms not otherwise defined herein have the
same meanings as in the Prospectus. A copy of the Prospectus may be obtained
without charge by writing to the Fund or calling 1-800-762-1000. The Prospectus
is also available on the website of the Securities and Exchange Commission
("SEC") (http://www.sec.gov). The Prospectus also contains more complete
information about the Fund. You should read it carefully before investing.
Portions of the Fund's Annual Report and Semi-Annual Report to Shareholders are
incorporated by reference into this SAI. The Annual Report accompanies this SAI.
You may obtain an additional copy of the Annual Report or the Semi-Annual Report
to Shareholders without charge by calling toll-free [1-800-762 1000.]
The Prospectus and this SAI omit certain of the information contained in the
registration statement relating to these securities filed with the SEC. These
items may be inspected and copied at the SEC's public reference room and are
available on the SEC's website.
TABLE OF CONTENTS
PAGE
----
Investment Policies and Restrictions 3
Investment Limitations 15
Hedging and Related Income Strategies 17
Organization of the Fund; Directors and Officers; Principal Holders and Management
Ownership of Shares 24
Investment Advisory and Administration Arrangements 33
Portfolio Transactions 35
Valuation of Common Stock 36
Taxation 37
Description of APS 41
The Auction 56
Additional Information 67
Financial Information 69
Ratings (Appendix A) A-1
Rating Agency Guidelines (Appendix B) B-1
Auction Procedures (Appendix C) C-1
Settlement Procedures (Appendix D) D-1
Hedging and Related Income Strategies (Appendix E) E-1
THIS SAI IS DATED OCTOBER ____, 2003.
INVESTMENT POLICIES AND RESTRICTIONS
The following supplements the information contained in the Prospectus
concerning the Fund's investment policies and limitations.
APS RATING AGENCY GUIDELINES
The Fund intends that, so long as the APS are outstanding, the composition
of its portfolio will reflect guidelines established by Moody's Investors
Service, Inc. ("Moody's") and Standard & Poor's, a division of The McGraw-Hill
Companies, Inc. ("S&P"), in connection with their respective ratings of the APS.
See Appendix B.
RATINGS AS INVESTMENT CRITERIA
Moody's and S&P and the other nationally recognized statistical rating
organizations ("NRSROs" or "rating agencies") are private services that provide
ratings of the credit quality of debt preferred stock and various other
securities, including Municipal Obligations. It should be emphasized that
ratings are general and are not absolute standards of quality. Consequently,
Municipal Obligations with the same maturity, interest rate and rating may have
different market prices. Also, rating agencies may fail to make timely changes
in credit ratings in response to subsequent events, so that an issuer's
financial condition may be better or worse than is indicated by its rating. A
description of Moody's and S&P's ratings is included in Appendix A to this SAI.
MUNICIPAL OBLIGATIONS
Municipal Obligations are issued for various public purposes, including
construction of public facilities, such as airports, bridges, hospitals,
housing, mass transportation, schools, streets and water and sewer works. Other
public purposes for which Municipal Obligations may be issued include
refinancing outstanding obligations and obtaining funds for general operating
expenses and for loans to other public institutions and facilities.
Municipal Obligations, like other debt obligations, are subject to the risk
of non-payment. The ability of issuers of Municipal Obligations to make timely
payments of interest and principal may be adversely affected in general economic
downturns and as relative governmental cost burdens are allocated and
reallocated among federal, state and local governmental units. Such non-payment
would result in a reduction of income to the Fund, and could result in a
reduction in the value of the Municipal Obligation experiencing non-payment, and
a potential decrease in the net asset value of the Fund. Issuers of Municipal
Obligations might seek protection under the bankruptcy laws. In the event of
bankruptcy of such an issuer, the Fund could experience delays and limitations
with respect to the collection of principal and interest on such Municipal
Obligations and the Fund may not, in all circumstances, be able to collect all
principal and interest to which it is entitled. To enforce its rights in the
event of a default in the payment of interest or repayment of principal, or
both, the Fund may take possession of and manage the assets securing the
issuer's obligations on such securities, which may increase the Fund's operating
expenses and adversely affect the net asset value of the Fund. However, any
decline in the value of the Fund's assets will initially be borne entirely by
the Fund's holders of common stock.
The Fund may invest up to 20% of its net assets in Municipal Obligations
that are not insured but are backed by an escrow or trust account which contains
securities issued or guaranteed by the US government or US government agencies
sufficient in amount to ensure the payment of interest and principal on the
original interest payment and maturity dates ("collateralized obligations").
Such collateralized obligations may not have received a rating from Moody's, S&P
or another NRSRO. Such
2
collateralized obligations include, but are not limited to, Municipal
Obligations that have been (i) advance refunded where the proceeds of the
refunding have been used to purchase US government or US government agency
securities that are placed in escrow and whose interest or maturing principal
payments, or both, are sufficient to cover the remaining scheduled debt service
on the Municipal Obligations, or (ii) issued under state and local housing
finance programs which use the issuance proceeds to fund mortgages that are then
exchanged for US government or US Government agency securities and deposited
with a trustee as security for the Municipal Obligations. Such collateralized
obligations are normally regarded by market participants as having the credit
characteristics of the underlying US government or US government agency
securities.
Under normal circumstances, the Fund will not invest 25% or more of its
total assets in any one industry. Governmental issuers of Municipal Obligations
are not considered part of any industry and, therefore, are not subject to this
limitation. Municipal Obligations backed only by the assets and revenues of
non-governmental entities, however, are considered to be issued by such
non-governmental entities and would be subject to this limitation. The Fund
reserves the right to invest more than 25% of its assets in issuers located in
the same state. If the Fund were to invest more than 25% of its total assets in
issuers located in the same state, it would be more susceptible to adverse
economic, business or regulatory conditions in that state.
The yield on a Municipal Obligation depends on a variety of factors,
including general municipal and fixed-income security market conditions, the
financial condition of the issuer, the size of the particular offering, the
maturity, credit quality and rating of the issue and expectations regarding
changes in income tax rates. Generally, the longer the maturity of a Municipal
Obligation, the higher the yield and the greater the volatility. The market
value of Municipal Obligations, and accordingly the net asset value of the
Fund's Common Stock, normally varies inversely with changes in interest rates.
Such changes in the values of Municipal Obligations held by the Fund will not
affect the interest income derived from them, but may affect the Fund's ability
to meet the APS Basic Maintenance Amount and the 1940 Act APS Coverage.
Certain Municipal Obligations held by the Fund may permit the issuer to
call or redeem the obligations, in whole or in part, at its option. If an issuer
were to redeem Municipal Obligations held by the Fund during a time of declining
interest rates, the Fund might realize capital gains or losses at a time that it
would not otherwise do so, and the Fund might not be able to reinvest the
proceeds of the redemption in Municipal Obligations providing as high a level of
income as the obligations that were redeemed.
Opinions relating to the validity of Municipal Obligations and their
exemption from regular federal income tax (and also, when applicable, from the
federal alternative minimum tax ("AMT")) are rendered by bond counsel to the
issuer at the time of issuance. Further, federal, state and local laws may be
enacted that adversely affect the tax-exempt status of interest on Municipal
Obligations or of the exempt-interest dividends received by the Fund's
shareholders, or that impose other constraints upon enforcement of such
obligations. It is also possible that, as a result of litigation or other
conditions, the power or ability of issuers to meet their obligations for the
payment of principal of and interest on their Municipal Obligations may be
materially and adversely affected.
In addition to the more common varieties of Municipal Obligations, the Fund
also is authorized to invest in the following types of Municipal Obligations:
ASSET-BACKED SECURITIES. The Fund may invest in municipal securities that
are comprised of Municipal Obligations that have been securitized through the
use of trusts or special purpose corporations or other entities. Payments or
distributions of principal and interest may be guaranteed up to a certain
3
amount and for a certain time period by a letter of credit or pool insurance
policy issued by a financial institution unaffiliated with the issuer, or other
credit enhancements may be present.
INDUSTRIAL DEVELOPMENT BONDS AND PRIVATE ACTIVITY BONDS. Industrial
development bonds ("IDBs") and private activity bonds ("PABs") are municipal
bonds issued by or on behalf of public authorities to finance various privately
operated facilities, such as airports or pollution control facilities. IDBs and
PABs are generally revenue bonds, and thus are not payable from the unrestricted
revenue of the issuer. The credit quality of IDBs and PABs is usually directly
related to the credit standing of the user of the facilities being financed. The
Fund may invest more than 25% of its assets in IDBs and PABs.
IDBs issued after August 15, 1986 generally are considered PABs, and to the
extent that the Fund invests in such PABs, shareholders generally will be
required to include a portion of their exempt-interest dividends in calculating
their liability for the AMT. See "Taxation."
MUNICIPAL LEASE OBLIGATIONS. Municipal bonds include municipal lease
obligations, such as leases, installment purchase contracts and conditional
sales contracts, and certificates of participation therein. Municipal lease
obligations are issued by state and local governments and authorities to
purchase land or various types of equipment or facilities and may be subject to
annual budget appropriations. The Fund generally invest in municipal lease
obligations through certificates of participation.
Although municipal lease obligations do not constitute general obligations
of the municipality for which the municipality's taxing power is pledged, they
ordinarily are backed by the municipality's covenant to budget for, appropriate
and make the payments due under the lease obligation. The leases underlying
certain municipal lease obligations, however, provide that lease payments are
subject to partial or full abatement if, because of material damage or
destruction of the leased property, there is substantial interference with the
lessee's use or occupancy of such property. This 'abatement risk' may be reduced
by the existence of insurance covering the leased property, the maintenance by
the lessee of reserve funds or the provision of credit enhancements such as
letters of credit.
Certain municipal lease obligations contain 'non-appropriation' clauses
which provide that the municipality has no obligation to make lease or
installment purchase payments in future years unless money is appropriated for
such purpose on a yearly basis. Some municipal lease obligations of this type
are insured as to timely payment of principal and interest, even in the event of
a failure by the municipality to appropriate sufficient funds to make payments
under the lease. However, in the case of an uninsured municipal lease
obligation, a municipal money market fund's ability to recover under the lease
in the event of a non-appropriation or default will be limited solely to the
repossession of leased property without recourse to the general credit of the
lessee, and disposition of the property in the event of foreclosure might prove
difficult.
ZERO COUPON OBLIGATIONS. The Fund may invest up to 10% of its total assets
in zero coupon Municipal Obligations. Such obligations include "pure zero"
obligations, which pay no interest for their entire life (either because they
bear no stated rate of interest or because their stated rate of interest is not
payable until maturity), and "zero/fixed" obligations, which pay no interest for
an initial period and thereafter pay interest currently. Zero coupon obligations
also include securities representing the principal-only components of Municipal
Obligations from which the interest components have been stripped and sold
separately by the holders of the underlying Municipal Obligations. Zero coupon
securities usually trade at a deep discount from their face or par value and
will be subject to greater fluctuations in market value in response to changing
interest rates than obligations of comparable maturities that make current
distributions of interest. While zero coupon Municipal Obligations will not
contribute to the cash available to the Fund for purposes of paying dividends to
shareholders, UBS Global AM believes that limited investments in such securities
may facilitate the Fund's ability to preserve capital while generating tax-free
income through the accrual of original issue discount.
4
Zero coupon Municipal Obligations generally are liquid, although such
liquidity may be reduced from time to time due to interest rate volatility
and other factors. See "Taxation" herein and "Investment Objective and
Policies --Other Investment Practices" in the Prospectus.
FLOATING AND VARIABLE RATE OBLIGATIONS. The Fund also may purchase floating
and variable rate municipal notes and bonds, which frequently permit the holder
to demand payment of principal at any time, or at specified intervals, and
permit the issuer to prepay principal, plus accrued interest, at its discretion
after a specified notice period. The issuer's obligations under the demand
feature of such notes and bonds are generally secured by bank letters of credit
or other credit support arrangements. There frequently will be no secondary
market for variable and floating rate obligations held by the Fund, although the
Fund may be able to obtain payment of principal at face value by exercising the
demand feature of the obligation.
MORTGAGE SUBSIDY BONDS. The Fund also may purchase mortgage subsidy bonds
that are issued to subsidize mortgages on single family homes and "moral
obligation" bonds that are normally issued by special purpose public
authorities. In some cases the repayment of these bonds depends upon annual
legislative appropriations; in other cases repayment is a legal obligation of
the issuer, and if the issuer is unable to meet its obligations, repayment
becomes a moral commitment of a related government unit (subject, however, to
such appropriations).
PARTICIPATION INTERESTS. The Fund may invest in participation interests in
municipal bonds, including industrial development bonds ("IDBs"), private
activity bonds ("PABs") and floating and variable rate securities obligations
that are , that are owned by financial institutions. These interests carry a
demand feature permitting the holder to tender them back to the financial
institution, which demand feature generally is backed by an irrevocable letter
of credit or guarantee of the financial institution. The credit standing of such
financial institution affects the credit quality of the participation interests.
A participation interest gives the Fund an undivided interest in a
municipal bond owned by a financial institution. The Fund has the right to sell
the instruments back to the financial institution. To the extent that payment of
an obligation is backed by a letter of credit, guarantee or liquidity support
arrangement from a financial institution, that payment may be subject to the
financial institution's ability to satisfy that commitment. UBS Global AM will
monitor the pricing, quality and liquidity of the participation interests held
by the Fund, and the credit standing of financial institutions issuing letters
of credit or guarantees supporting those participation interests on the basis of
published financial information reports of rating services and/or financial
institution analytical services.
CUSTODIAL RECEIPTS. The Fund may acquire custodial receipts or certificates
underwritten by securities dealers or banks that evidence ownership of future
interest payments, principal payments or both on certain Municipal Obligations.
The underwriter of these certificates or receipts typically purchases Municipal
Obligations and deposits the obligations in an irrevocable trust or custodial
account with a custodial bank, which then issues receipts or certificates that
evidence ownership of the periodic unmatured coupon payments and the final
principal payment on the obligations. Custodial receipts evidencing specific
coupon or principal payments have the same economic attributes as zero coupon
Municipal Obligations described herein. Although under the terms of a custodial
receipt, the Fund would be typically authorized to assert its rights directly
against the issuer of the underlying obligation, the Fund could be required to
assert through the custodian bank those rights that may exist against the
underlying issuer. Thus, in the event the underlying issuer fails to pay
principal or interest when due, the Fund may be subject to delays, expenses and
risks that are greater than those that would have been involved if the Fund had
purchased a direct obligation of the issuer. In addition, in the event that the
trust or custodial account in which the underlying security has been deposited
is determined to be an association taxable as
5
a corporation instead of a non-taxable entity, the yield on the underlying
security would be reduced in recognition of any taxes paid.
INVERSE FLOATERS. The Fund may invest in Municipal Obligations on which the
rate of interest varies inversely with interest rates on other Municipal
Obligations or an index. Such obligations include components of securities on
which interest is paid in two separate parts--an auction component, which pays
interest at a rate that is set periodically through an auction process or other
method, and a residual component, which pays interest at a rate equal to the
difference between the rate that the issuer would have paid on a fixed-rate
obligation at the time of issuance and the rate paid on the auction component.
The market value of an inverse floater will be more volatile than that of a
fixed-rate obligation and, like most debt obligations, will vary inversely with
changes in market interest rates.
Because the interest rate paid to holders of residual components is
generally determined by subtracting the interest rate paid to the holders of
auction components from a fixed amount, the interest rate paid to residual
component holders will decrease as the auction component's rate increases and
increase as the auction component's rate decreases. Moreover, the extent of the
increases and decreases in market value of residual components may be larger
than comparable changes in the market value of an equal principal amount of a
fixed rate Municipal Obligation having similar credit quality, redemption
provisions and maturity.
PUT BONDS. A put bond is a Municipal Obligation that gives the holder an
unconditional right to sell the bond back to the issuer or a third party at a
specified price and exercise date, which is typically well in advance of the
bond's maturity date. The obligation to purchase the bond on the exercise date
may be supported by a letter of credit or other credit support arrangement from
a bank, insurance company or other financial institution, the credit standing of
which affects the credit quality of the obligation.
If the Fund holds the bond subject to a "one time only" put, the Fund
ordinarily will either sell the bond or put the bond, depending on the more
favorable price. If a bond has a series of puts after the first put, it will be
held as long as, in the judgment of UBS Global AM, it is in the Fund's best
interests to do so. There is no assurance that an issuer of a put bond acquired
by the Fund will be able to repurchase the bond on the exercise date if the Fund
chooses to exercise its right to put the bond back to the issuer or to a third
party.
TENDER OPTION BONDS. Tender option bonds are Municipal Obligations sold by
a bank subject to a "tender option" that gives the purchaser the right to tender
them to the bank at par plus accrued interest at designated times (the "tender
option"). The tender option may be exercisable at intervals ranging from
bi-weekly to semi-annually, and the interest rate on the bonds is typically
reset at the end of the applicable interval in order to cause the bonds to have
a market value that approximates their par value. The tender option generally
would not be exercisable in the event of a default on, or significant
downgrading of, the underlying municipal securities. Therefore, a Fund's ability
to exercise the tender option will be affected by the credit standing of both
the bank involved and the issuer of the underlying securities.
MUNICIPAL DERIVATIVES. The Fund may invest in derivative securities that
are Municipal Obligations, or components thereof, that have been specially
structured to reflect investment characteristics ordinarily associated with
other securities or to have other special rights desired by investors.
Generally, such securities are designed to allow investors to take advantage of
expected interest rate trends or to hedge interest rate or other risks.
Detachable call options relate
6
and permit the purchasers of the call options to acquire the Municipal
Obligations at the call price(s) and call date(s). In the event that interest
rates drop, the purchaser could exercise the call option to acquire Municipal
Obligations that yield above-market rates. Municipal Obligations with
embedded caps provide for additional tax-free payments for a stated period
(generally a period that is shorter than the bond's maturity) above the
fixed-rated interest payable on the Municipal Obligation, to the extent that the
average level of a particular index exceeds a specified base level. In the event
the fund issues preferred stock as presently contemplated, the Fund would use
Municipal Obligations with embedded caps to offset the risk of increases in
short-term interest rates wile continuing to earn tax-exempt income. Investments
in municipal derivatives may be subject to the same risks as floating rate
Municipal Obligations, risks of adverse tax determinations or, in the case of
municipal derivatives used for hedging purposes, risks similar to those for
other hedging strategies. See "Investment Policies and Restrictions--Hedging and
Related Income Strategies." The Fund invests only in those municipal derivatives
that UBS Global AM believes will facilitate the Fund's ability to achieve its
investment objective.
INSURANCE FOR MUNICIPAL OBLIGATIONS
EFFECT OF INSURANCE ON MUNICIPAL OBLIGATIONS. Municipal Obligations covered
by original issue insurance or secondary market insurance are themselves
assigned a rating of Aaa by Moody's, AAA by S&P or an equivalent rating from
another NRSRO, as the case may be, by virtue of such Aaa, AAA or equivalent
claims-paying ability of the Issuer without regard to the insurance feature. In
the event Moody's, S&P or another NRSRO should downgrade its assessment of the
claims-paying ability of a particular insurer, it could also be expected to
downgrade the ratings assigned to Municipal Obligations insured under original
issue insurance or secondary market insurance issued by such insurer.
The rating, if any, assigned to Municipal Obligations insured under
portfolio insurance will be based primarily upon the credit characteristics of
the issuer without regard to the insurance feature, and will generally carry a
rating that is below Aaa or AAA. While in the portfolio of the Fund, however, a
Municipal Obligation back by portfolio insurance will effectively be of the same
quality as a Municipal Obligation issued by an issuer of comparable credit
characteristics that is backed by original issue insurance or secondary market
insurance. In the event Moody's, S&P or another NRSRO should downgrade the
rating of the issuer of the portfolio insurance, the Municipal Obligations
insured under portfolio insurance issued by such insurer would also be of
reduced quality in the portfolio of the Fund.
Moody's, S&P and other NRSROs continually assess the claims-paying ability
of insurers and the credit characteristics of insurers and issuers, and there
can be no assurance that they will not downgrade their assessments subsequent to
the time the Fund purchases securities. A description of Moody's and S&P's
ratings of insurance companies' claims-paying ability is included in Appendix A
to this SAI.
ORIGINAL ISSUE INSURANCE. Original issue insurance typically is purchased
from insurance companies, through payment of a single premium, with respect to a
particular issue of Municipal Obligations by the issuer thereof or a third party
(such as the underwriter) in conjunction with the original issuance of such
Municipal Obligations. Under such insurance, the insurer unconditionally insures
to the holder of the insured Municipal Obligation the timely payment of
principal and interest on such obligation, when and as such payments shall
become due but shall not be paid by the issuer. However, where the due date of
the principal is accelerated by reason of mandatory or optional redemption
(other than acceleration by reason of a mandatory sinking fund payment), default
or otherwise, the payments insured may be made in such amounts and at such times
as payments of principal would have been due
7
had there not been such acceleration. The issuer is responsible for such
payments less any amounts received by the holder from any trustee for the
Municipal Obligation issuers or from any other source.
In the event that interest on or principal of Municipal Obligation covered
by insurance is due for payment but is unpaid by reason of nonpayment by the
issuer thereof, the applicable insurer will make payments to its fiscal agent
("Fiscal Agent") equal to such unpaid amounts of principal and interest not
later than one business day after the insurer has been notified hat such
nonpayment has occurred (but not earlier than the date such payment is due). The
Fiscal Agent will disburse to the Fund the amount of principal and interest
which is then due for payment but is unpaid upon receipt by the Fiscal Agent of
(i) evidence of the Fund's right to receive payment of such principal and
interest, and (ii) evidence, including any appropriate instruments of
assignment, that all of the rights of payment of such principal or interest then
due for payment shall thereupon vest in the insurer. Upon payment by the insurer
of any principal or interest payments with respect to any Municipal Obligations,
the insurer will succeed to the rights of the Fund with respect to such payment.
Original issue insurance remains in effect as long as the Municipal
Obligations covered thereby remain outstanding and the insurer remains in
business, regardless of whether the Fund ultimately disposes of such Municipal
Obligations. Consequently, original issue insurance may be considered to
represent an element of market value with respect to the Municipal Obligations
so insured, but the exact effect, if any, of this insurance on such market value
cannot be estimated.
SECONDARY MARKET INSURANCE. Subsequent to the time of original issuance of
a Municipal Obligation, the Fund or a third party may, upon the payment of a
single premium, purchase insurance on such Municipal Obligation. Secondary
market insurance generally provides the same type of coverage as is provided by
original issue insurance and, as is the case with original issue insurance,
secondary market insurance remains in effect as long as the Municipal
Obligations covered thereby remain outstanding and the insurer remains in
business, regardless of whether the Fund ultimately disposes thereof. All
premiums respecting Municipal Obligations covered by original issue insurance or
secondary market insurance are paid in advance by the issuer or other party
obtaining the insurance.
One of the purposes of acquiring secondary market insurance with respect to
a particular Municipal Obligation would be to enable the Fund to enhance the
value of that Municipal Obligation. The fund, for example, might seek to
purchase a particular Municipal Obligation and obtain secondary market insurance
with respect thereto if, in the opinion of UBS Global AM , the market value of
such municipal security, as insured, would exceed the current value of the
Municipal Obligation without insurance plus the cost of the secondary market
insurance. Similarly, if the Fund owns but wishes to sell a Municipal Obligation
that is then covered by portfolio insurance, the fund might seek to obtain
secondary market insurance with respect thereto if, in the opinion of UBS Global
AM , the net proceeds of a sale by the Fund of such obligation, as insured,
would exceed the current value of the obligation plus the cost of the secondary
market insurance.
PORTFOLIO INSURANCE. The Fund currently intends to emphasize investments in
Municipal Obligations that have original issue insurance or secondary market
insurance. However, the Fund may purchase one or more policies of portfolio
insurance, each of which would insure the payment of principal and interest on
specified eligible Municipal Obligations purchased by the Fund. Except as
described below, portfolio insurance generally provides the same type of
coverage as is provided by original issue insurance or secondary market
insurance. Municipal Obligations insured under one portfolio insurance policy
generally would not be insured under any other policy purchased by the Fund,
unless the Fund intended to purchase secondary market insurance to facilitate
sale of particular Municipal Obligations. A Municipal Obligation is eligible for
coverage under a policy if it meets certain requirements of the insurer.
Portfolio
8
insurance is intended to reduce financial risk, but the cost thereof and
compliance with investment restrictions imposed under the policy will reduce the
yield to common shareholders of the Fund.
Portfolio insurance policies are effective only as to Municipal Obligations
owned and held by the Fund, and do not cover Municipal Obligations for which the
contract for purchase of such Municipal Obligation fails. A "when-issued"
Municipal Obligation will be covered under a portfolio insurance policy upon the
settlement date of the issue of such "when-issued" Municipal Obligation.
In determining whether to insure Municipal Obligations held by the Fund, an
insurer will apply its own standards, which would be expected to correspond
generally to the standards it has established for determining the insurability
of new issues of Municipal Obligations. See "Original Issue Insurance" above.
Any portfolio insurance policy purchased by the Fund will be
non-cancellable and will remain in effect so long as the Fund is in existence,
the Municipal Obligations covered by the policy continue to be held by the Fund,
and the Fund pays the premiums for the policy. Each insurer generally will
reserve the right at any time upon 90 days' written notice to the Fund to refuse
to insure any additional securities purchased by the Fund after the effective
date of such notice. The board of directors of the Fund ("Board") generally will
reserve the right to terminate each policy upon seven days' written notice to an
insurer if it determines that the cost of such policy is not reasonable in
relation to the value of the insurance to the Fund.
Each portfolio insurance policy will terminate as to any Municipal
Obligation that has been redeemed from or sold by the Fund on the date of such
redemption or the settlement date of such sale, and an insurer will not have any
liability thereafter under a policy as to any such Municipal Obligation, except
that if the date of such redemption or the settlement date of such sale occurs
after a record date and before the related payment date with respect to any such
Municipal Obligation, the policy will terminate as to such Municipal Obligation
on the business day immediately following such payment date. Each policy will
terminate as to all Municipal Obligations covered thereby on the date on which
the last of the covered Municipal Obligations mature, are redeemed or are sold
by the Fund.
One or more policies of portfolio insurance may provide the Fund, pursuant
to an irrevocable commitment of the insurer with the option to exercise the
right to obtain permanent insurance ("Permanent Insurance") (which would be
secondary market insurance) with respect to a Municipal Obligation that is to be
sold by the Fund. The Fund would exercise the right to obtain Permanent
Insurance upon payment of a single, predetermined insurance premium payable from
the proceeds of the sale of such Municipal Obligation. It is expected that the
Fund would exercise the right to obtain Permanent Insurance for a Municipal
Obligation only if, in the opinion of UBS Global AM, such exercise would cause
the net proceeds from the sale by the Fund of such obligation, as insured, to
exceed the proceeds from the sale of such obligation without insurance. The
Permanent Insurance premium with respect to each such obligation is determined
based upon the insurability of each such obligation as of the date of purchase
by the Fund, and will not be increased or decreased for any change in the
9
creditworthiness of that obligation unless the obligation is in default as to
payment of principal or interest, or both. In such event, the Permanent
Insurance premium shall be subject to an increase predetermined at the date of
purchase by the Fund.
Because each portfolio insurance policy will terminate as to Municipal
Obligations sold by the Fund on the date of sale, in which event the insurer
will be liable only for those payments of principal and interest that are then
due and owing (unless permanent insurance is obtained by the Fund), the
provision for this insurance will not enhance the marketability of securities
held by the Fund. The Fund generally intends to retain any insured securities
covered by portfolio insurance that are in default or in significant risk of
default. To the extent that the Fund holds such defaulted securities, it may be
limited in its ability to manage its investment portfolio and to purchase other
Municipal Obligations. On the other hand, because original issue insurance and
secondary market insurance will remain in effect as long as Municipal
Obligations covered thereby are outstanding, such insurance may enhance the
marketability of such securities even when such securities are in default or in
significant risk of default, but the exact effect, if any, on the marketability
cannot be estimated. Accordingly, the Fund may determine to retain or,
alternatively, to sell Municipal Obligations covered by original issue insurance
or secondary market insurance that are in default or in significant risk of
default.
It is anticipated that certain Municipal Obligations to be purchased by the
Fund will be insured under policies obtained by persons other than the Fund. In
instances in which the Fund purchases Municipal Obligations insured under
policies obtained by persons other than the Fund, the Fund does not pay the
premiums for such policies; rather, the cost of such policies may be reflected
in a higher purchase price for such Municipal Obligations. Accordingly, the
yield on such Municipal Obligations may be lower than that on similar uninsured
Municipal Obligations. Premiums for a portfolio insurance policy generally would
be paid by the Fund monthly, and adjusted for purchases and sales of Municipal
Obligations covered by the policy during the month. The yield on the Fund's
portfolio is reduced to the extent of the insurance premiums paid by the Fund
which, in turn, will depend upon the characteristics of the covered Municipal
Obligations held by the Fund. In the event the Fund were to purchase secondary
market insurance with respect to any Municipal Obligations then covered by a
portfolio insurance policy, the coverage and the obligation of the Fund to pay
monthly premiums under such policy would cease with such purchase.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES
As stated in the Prospectus, the Fund may purchase securities on a
"when-issued" basis or may purchase or sell securities for delayed delivery,
I.E., for issuance or delivery to or by the Fund later than the normal
settlement date at a stated price and yield. The Fund generally would not pay
for such securities or start earning interest on them until they are received.
However, when the Fund undertakes a when-issued or delayed delivery obligation,
it immediately assumes the risks of ownership, including the risks of price
fluctuation. Failure of the issuer to deliver a security purchased by a fund on
a when-issued or delayed delivery basis may result in a fund's incurring a loss
or missing an opportunity to make an alternative investment.
A security purchased on a when-issued or delayed delivery basis is recorded
as an asset on the commitment date and is subject to changes in market value,
generally based upon changes in the level of interest rates. Thus, fluctuations
in the value of the security from the time of the commitment date will affect
the Fund's net asset value. A fund's when-issued and delayed delivery purchase
commitments could cause its net asset value per share to be more volatile. The
Fund may sell the right to acquire the security prior to delivery if UBS Global
AM deems it advantageous to do so, which may result in a gain or loss to the
fund. When the Fund commits to purchase securities on a when-issued or delayed
delivery basis, its custodian will set aside in a segregated account cash or
other liquid securities, marked to market
10
daily, with a market value equal to the amount of the commitment. If necessary,
additional assets will be placed in the account daily so that the value of the
account will equal or exceed the amount of the Fund's purchase commitment.
STAND-BY COMMITMENTS
The Fund may acquire stand-by commitments under unusual market conditions
to facilitate portfolio liquidity. Pursuant to a stand-by commitment, a
municipal bond dealer agrees to purchase the securities that are the subject of
the commitment at an amount equal to (1) the acquisition cost (excluding any
accrued interest paid on acquisition), less any amortized market premium and
plus any accrued market or original issue discount, plus (2) all interest
accrued on the securities since the last interest payment date or the date the
securities were purchased, whichever is later.
The Fund will enter into stand-by commitments only with those banks or
other dealers that, in the opinion of UBS Global AM, present minimal credit
risk. The Fund's right to exercise stand-by commitments will be unconditional
and unqualified. Stand-by commitments will not be transferable by the Fund,
although the Fund may sell the underlying securities to a third party at any
time. The Fund may pay for stand-by commitments either separately in cash or by
paying a higher price for the securities that are acquired subject to such a
commitment (thus reducing the yield to maturity otherwise available for the same
securities). The acquisition of a stand-by commitment will not ordinarily affect
the valuation or maturity of the underlying municipal securities. Stand-by
commitments acquired by the Fund will be valued at zero in determining net asset
value. Whether the Fund paid directly or indirectly for a stand-by commitment,
its cost will be treated as unrealized depreciation and will be amortized over
the period the Fund holds the commitment.
LENDING OF PORTFOLIO SECURITIES
The Fund is authorized to lend its portfolio securities with a value of up to
33 1/3% of its total assets to broker-dealers or institutional investors that
UBS Global AM deems qualified. Lending securities enables the Fund to earn
additional income, but could result in a loss or delay in recovering these
securities. The borrower of the Fund's portfolio securities must maintain
acceptable collateral with the Fund's custodian in an amount, marked to market
daily, at least equal to the market value of the securities loaned, plus accrued
interest and dividends. Acceptable collateral is limited to cash, US government
securities and irrevocable letters of credit that meet certain guidelines
established by UBS Global AM. The Fund may reinvest any cash collateral in money
market investments or other short-term liquid investments, including other
investment companies. The Fund also may reinvest cash collateral in private
investment vehicles similar to money market funds, including one managed by UBS
Global AM. In determining whether to lend securities to a particular
broker-dealer or institutional investor, UBS Global AM will consider, and during
the period of the loan will monitor, all relevant facts and circumstances,
including the creditworthiness of the borrower. The Fund will retain authority
to terminate any of its loans at any time. The Fund may pay fees in connection
with a loan and may pay the borrower or placing broker a negotiated portion of
the interest earned on the reinvestment of cash held as collateral. The Fund
will receive amounts equivalent to any interest, dividends or other
distributions on the securities loaned. The Fund will regain record ownership of
loaned securities to exercise beneficial rights, such as voting and subscription
rights, when regaining such rights is considered to be in the Fund's interest.
Pursuant to procedures adopted by the Board governing the Fund's securities
lending program, UBS Securities LLC ("UBS Securities"), another wholly owned
indirect subsidiary of UBS AG, has been retained to serve as lending agent for
the Fund. The Board also has authorized the payment of fees (including fees
calculated as a percentage of invested cash collateral) to UBS Securities for
these services. The Board periodically reviews all portfolio securities loan
transactions for which UBS Securities acted as lending agent. UBS
11
Securities and other affiliated broker-dealers have also been approved as
borrowers under the Fund's securities lending program.
REPURCHASE AGREEMENTS
The Fund is authorized to enter into repurchase agreements with respect to
any obligation issued or guaranteed by the US government, its agencies or
instrumentalities, and also with respect to commercial paper, bank certificates
of deposit and bankers' acceptances. Repurchase agreements are transactions in
which the Fund purchases securities from a bank or recognized securities dealer
(or its affiliate) and simultaneously commit to resell those securities to the
counterparty at an agreed-upon date or upon demand and at a price reflecting a
market rate of interest unrelated to the coupon rate or maturity of the
purchased securities. Securities or other obligations subject to repurchase
agreements may have maturities in excess of 13 months. The Fund maintains
custody of the underlying securities prior to their repurchase, either through
its regular custodian or through a special "tri-party" custodian or
sub-custodian that maintains a separate account for both the Fund and its
counterparty. Thus, the obligation of the counterparty to pay the repurchase
price on the date agreed to is, in effect, secured by such securities. If the
value of such securities were less than the repurchase price, plus any
agreed-upon additional amount, the other party to the agreement would be
required to provide additional collateral so that at all times the collateral is
at least equal to the repurchase price, plus any securities, and the price which
was paid by the Fund upon acquisition would be accrued as interest and included
in the Fund's net investment income.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including possible decline in the market value of the
underlying securities and delays and costs to the Fund if the other party to the
repurchase agreement becomes bankrupt. If their value becomes less than the
repurchase price, plus any agreed-upon additional amount, the counterparty must
provide additional collateral so that at all times the collateral is at least
equal to the repurchase price plus any agreed-upon additional amount. The
difference between the total amount to be received upon repurchase of the
obligations and the price that was paid by the Fund upon acquisition is accrued
as interest and included in its net investment income. Repurchase agreements
involving obligations other than US government securities (such as commercial
paper, corporate bonds and mortgage loans) may be subject to special risks and
may not have the benefit of certain protections in the event of the
counterparty's insolvency. If the seller or guarantor becomes insolvent, the
Fund may suffer delays, costs and possible losses in connection with the
disposition of collateral. The Fund intends to enter into repurchase agreements
only with counterparties in transactions believed by UBS Global AM to present
minimal credit risks.
REVERSE REPURCHASE AGREEMENTS
Reverse repurchase agreements involve the sale of securities held by the
Fund subject to its agreement to repurchase the securities at an agreed-upon
date or upon demand and at a price reflecting a market rate of interest. Reverse
repurchase agreements are subject to the Fund's limitation on borrowings and may
be entered into only with banks or securities dealers or their affiliates. While
a reverse repurchase agreement is outstanding, the Fund will designate cash or
liquid securities on the books of its custodian, marked to market daily, in an
amount at least equal to its obligations under the reverse repurchase agreement.
Reverse repurchase agreements involve the risk that the buyer of the
securities sold by the Fund might be unable to deliver them when the Fund seeks
to repurchase. If the buyer of securities under a reverse repurchase agreement
files for bankruptcy or becomes insolvent, the buyer or trustee or receiver may
receive an extension of time to determine whether to enforce the Fund's
obligation to repurchase the
12
securities, and the Fund's use of the proceeds of the reverse repurchase
agreement may effectively be restricted pending such decision.
Reverse repurchase agreements will be treated as borrowings for purposes of
calculating the Fund's borrowing limitation. See "Investment Limitations."
COUNTERPARTIES
The Fund may be exposed to the risk of financial failure or insolvency
of another party. To help lessen those risks, UBS Global AM, subject to the
supervision of the Board, monitors and evaluates the creditworthiness of the
parties with which the Fund does business.
ILLIQUID SECURITIES
As noted in the Prospectus, the Fund may invest up to 20% of its net assets
in illiquid securities. The term "illiquid securities" means securities that
cannot be disposed of within seven days in the ordinary course of business at
approximately the amount at which the Fund has valued the securities and
includes, among other things, repurchase agreements maturing in more than seven
days and restricted securities other than those UBS Global AM has determined are
liquid pursuant to guidelines established by the Board. The Fund may not be able
to readily liquidate its investments in illiquid securities and may have to sell
other investments if necessary to raise cash to meet its obligations. The lack
of a liquid secondary market for illiquid securities may make it more difficult
for the Fund to assign a value to those securities for purposes of valuing its
portfolio and calculating its net asset value.
Restricted securities are not registered under the Securities Act of 1933,
as amended ("Securities Act"), and may be sold only in privately negotiated or
other exempted transactions or after a registration statement under the
Securities Act has become effective. 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 prevailed when it
decided to sell.
Not all restricted securities are illiquid. A large institutional market
has developed for many US and foreign securities that are not registered under
the Securities Act. Institutional investors generally will not seek to sell
these instruments to the general public but instead will often depend either on
an efficient institutional market in which such unregistered securities can be
readily resold or on an issuer's ability to honor a demand for repayment.
Therefore, the fact that there are contractual or legal restrictions on resale
to the general public or certain institutions is not dispositive of the
liquidity of such investments.
Institutional markets for restricted securities also have developed as a
result of Rule 144A under the Securities Act, which establishes a "safe harbor"
from the registration requirements of that Act for resales of certain securities
to qualified institutional buyers. These markets include automated systems for
the trading, clearance and settlement of unregistered securities of domestic and
foreign issuers, such as the PORTAL System sponsored by the National Association
of Securities Dealers, Inc. An insufficient number of qualified institutional
buyers interested in purchasing Rule 144A-eligible restricted securities held by
the Fund, however, could affect adversely the marketability of such portfolio
securities, and the Fund might be unable to dispose of them promptly or at
favorable prices.
The Board has delegated the function of making day-to-day determinations of
liquidity to UBS Global AM, pursuant to guidelines approved by the Board. UBS
Global AM takes into account a number of factors in reaching liquidity
decisions, which may include (1) the frequency of trades for the security, (2)
the number of dealers that make quotes for the security, (3) the nature of the
security and how trading is effected (E.G., the time needed to sell the
security, how bids are solicited and the mechanics of transfer)
13
and (4) the existence of demand features or similar liquidity enhancements. UBS
Global AM monitors the liquidity of restricted securities in the Fund's
portfolio and reports periodically on such decisions to the Board. UBS Global AM
also monitors the Fund's overall holdings of illiquid securities. If the Fund's
holdings of illiquid securities exceed its limitation on investments in illiquid
securities for any reason (such as a particular security becoming illiquid, or
changes in the relative market values of liquid and illiquid portfolio
securities), UBS Global AM will consider what action would be in the best
interests of the Fund and its shareholders. Such action may include engaging in
an orderly disposition of securities to reduce the Fund's holdings of illiquid
securities. However, the Fund is not required to dispose of illiquid securities
under these circumstances.
In making determinations as to the liquidity of municipal lease
obligations, UBS Global AM will distinguish between direct investments in
municipal lease obligations (or participations therein) and investments in
securities that may be supported by municipal lease obligations or certificates
of participation therein. Since these municipal-lease-obligation-backed
securities are based on a well-established means of securitization, UBS Global
AM does not believe that investing in such securities presents the same
liquidity issues as direct investments in municipal lease obligations. The
assets used as cover for any over-the-counter ("OTC") options written by the
Fund would be considered illiquid unless the OTC options are sold to qualified
dealers who agree that the Fund may repurchase any OTC option it writes at a
maximum price to be calculated by a formula set forth in the option agreement
The cover for an OTC option written subject to this procedure will be considered
illiquid only to the extent that the maximum repurchase price under the formula
exceeds the intrinsic value of the option.
SHORT SALES "AGAINST THE BOX"
The Fund may engage in short sales of securities it owns or has the right
to acquire at no added cost, through conversion or exchange of other securities
it owns (short sales "against the box"). A short sale is effected by selling a
security and having the executing broker borrow the securities being sold on
behalf of the Fund. The Fund is obligated to replace the borrowed securities at
a date in the future.
INVESTMENT LIMITATIONS
The following fundamental investment limitations cannot be changed without
the affirmative vote of the lesser of (a) more than 50% of the outstanding
shares of the Fund or (b) 67% or more of such shares present at a shareholders'
meeting if more than 50% of the outstanding shares are represented at the
meeting in person or by proxy. If a percentage restriction is adhered to at the
time of an investment or transaction, a later increase or decrease in percentage
resulting from a change in values of portfolio securities or the amount of total
assets will not be considered a violation of any of the following limitations or
of any of the Fund's investment policies. The Fund may not:
(1) issue senior securities (including borrowing money from banks and
other entities and thorough reverse repurchase agreements), except (a) the Fund
may borrow in an amount not in excess of 33 1/3 % of total assets (including the
amount of senior securities issued, but reduced by any liabilities and
indebtedness not constituting senior securities), (b) the Fund may issue
preferred stock having a liquidation preference in an amount which, combined
with the amount of any liabilities or indebtedness constituting senior
securities, is not in excess of 50% of its total assets (computed as provided in
clause (a) above) and (c) the Fund may borrow up to an additional 5% of its
total assets (not including the amount borrowed) for temporary or emergency
purposes;
The following interpretation applies to, but is not a part of, fundamental
limitation (1):
Each state (including the District of Columbia and Puerto Rico),
territory and possession of the United States, each political subdivision,
agency, instrumentality and authority thereof, and each multi-state agency
of which a state is a member is a separate 'issuer.' When the assets and
revenues of an agency authority, instrumentality or other political
subdivision are separate from the government creating the subdivision and
the security is backed only by the assets and revenues of the subdivision,
such subdivision would be deemed to be the sole issuer. Similarly, in the
case of an Industrial Development Bond or Private Activity Bond, if that
bond is backed only by the assets and revenues of the non-governmental
user, then that non-governmental user would be deemed to be the sole
issuer. However, if the creating government or another entity guarantees
a security, then to the extent that the value of all securities issued
or guaranteed by that government or entity and owned by the Fund exceeds
10% of the Fund's total assets, the guarantee would be considered a
separate security and would be treated as issued by that government or
entity. This restriction does not limit the percentage of the Fund's
assets that may be invested in Municipal Obligations insured by any
given insurer.
14
(2) purchase any security if, as a result of that purchase, 25 or more
of the Fund's total assets would be invested in securities of issuers having
their principal business activities in the same industry, except that this
limitation does not apply to securities issued or guaranteed by the U.S.
government, its agencies or instrumentalities or to municipal securities.
(3) issue senior securities (including borrowing money from banks and
other entities and through reverse repurchase agreements), except (a) the
Fund may borrow in an amount not in excess of 33 1/3% of total assets
(including the amount of senior securities issued, but reduced by any
liabilities and indebtedness not constituting senior securities), (b) the
Fund may issue preferred stock having a liquidation preference in an amount
which, combined with the amount of any liabilities or indebtedness
constituting senior securities, is not in excess of 50% of its total assets
(computed as provided in clause (a) above) and (c) the Fund may borrow up to
an additional 5% of its total assets (not including the amount borrowed) for
temporary or emergency purposes.
(4) make loans, except through loans of portfolio securities or through
repurchase agreements, provided that for purposes of this restriction, the
acquisition of bonds, debentures, other debt securities or instruments, or
participations or other interests therein and investment in government
obligations, commercial paper, certificates of deposit, bankers' acceptances
or similar instruments will not be considered the making of a loan.
(5) engage in the business of underwriting securities of other issuers,
except to the extent that the Fund might be considered an underwriter under
the federal securities laws in connection with itsdisposition of portfolio
securities.
(6) purchase or sell real estate, except that investments in securities
of issuers that invest in real estate and investments in mortgage-backed
securities, mortgage participations or other instruments supported by
interests in real estate are not subject to this limitation, and except that
the Fund may exercise rights under agreements relating to such securities,
including the right to enforce security interests and to hold real estate
acquired by reason of such enforcement until that real estate can be
liquidated in an orderly manner.
(7) purchase or sell physical commodities unless acquired as a result
of owning securities or other instruments, but the Fund may purchase, sell or
enter into financial options and futures, forward and spot currency
contracts, swap transactions and other financial contracts or derivative
instruments.
15
The Fund has no intention to file a voluntary application for relief under
federal bankruptcy law or any similar application under state law for so long as
the Fund is solvent and does not foresee becoming insolvent.
HEDGING AND RELATED INCOME STRATEGIES
As discussed in the Prospectus, UBS Global AM may use a variety of
financial instruments ("Hedging Instruments"), including certain options,
futures contracts (sometimes referred to as "futures"), options on futures
contracts and interest rate protection transactions, to attempt to hedge the
Fund's portfolio, and may use options to attempt to enhance the Fund's income.
Because the Fund intends to use these instruments for hedging purposes, the Fund
may enter into (1) options and futures transactions that approximate (but do not
exceed) the full value of its portfolio and (2) interest rate protection
transactions (i.e., interest rate swaps and interest rate caps, collars and
floors) with notional amounts that approximate (but do not exceed) the
liquidation preference amount of preferred shares outstanding. Any income
realized from the use of options and futures would be taxable to shareholders.
Hedging strategies can be broadly categorized as "short hedges" and "long
hedges." A short hedge is a purchase or sale of a Hedging Instrument intended to
partially or fully offset potential declines in the value of one or more
investments held in the Fund's portfolio. Thus, in a short hedge, the Fund takes
a position in a Hedging Instrument the price of which is expected to move in the
opposite direction of the price of the investment being hedged. For example, the
Fund might purchase a put option on a security to hedge against a potential
decline in the value of that security. If the price of the security declined
below the exercise price of the put, the Fund could exercise the put and thus
limit its loss below the exercise price to the premium paid plus transaction
costs. In the alternative, because the value of the put option can be expected
to increase as the value of the underlying security declines, the Fund might be
able to close out the put option and realize a gain to offset the decline in the
value of the security.
Conversely, a long hedge is a purchase or sale of a Hedging Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that the Fund intends to acquire. Thus, in a
long hedge the Fund takes a position in a Hedging Instrument the price of which
is expected to move in the same direction as the price of the prospective
investment being hedged. For example, the Fund might purchase a call option on a
security it intends to purchase in order to hedge against an increase in the
cost of the security. If the price of the security increased above the exercise
price of the call, the Fund could exercise the call and thus limit its
acquisition cost to the exercise price plus the premium paid and transaction
costs. Alternatively, the Fund might be able to offset the price increase by
closing out an appreciated call option and realizing a gain.
Hedging Instruments on securities generally are used to hedge against price
movements in one or more particular securities positions that the Fund owns or
intends to acquire. Hedging Instruments on debt securities may be used to hedge
either individual securities or broad fixed income market sectors.
The use of Hedging Instruments is subject to applicable regulations of the
SEC, the several options and futures exchanges upon which they are traded and
the Commodity Futures Trading Commission ("CFTC"). In addition, the Fund's
ability to use Hedging Instruments will be limited by tax considerations. See
"Taxation."
In addition to the products, strategies and risks described below, UBS
Global AM expects additional opportunities to develop in connection with
options, futures contracts and other hedging techniques. These new opportunities
may become available as UBS Global AM develops new techniques, as regulatory
authorities broaden the range of permitted transactions and as new options,
futures contracts or other techniques are developed. UBS Global AM may utilize
these opportunities to the extent that they are consistent with the Fund's
investment objective and permitted by the Fund's investment limitations and
applicable regulatory authorities.
16
SPECIAL RISKS OF HEDGING STRATEGIES
The use of Hedging Instruments involves special considerations and risks,
as described below. Risks pertaining to particular Hedging Instruments are
described in the sections that follow.
(1) Successful use of most Hedging Instruments depends upon UBS Global
AM's ability to predict movements of the overall securities and interest rate
markets, which requires different skills than predicting changes in the prices
of individual securities. While UBS Global AM is experienced in the use of
Hedging Instruments, there can be no assurance that any particular hedging
strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Hedging Instrument and price movements of the investments
being hedged. For example, if the value of a Hedging Instrument used in a short
hedge increased by less than the decline in value of the hedged investment, the
hedge would not be fully successful. Such a lack of correlation might occur due
to factors unrelated to the value of the investments being hedged, such as
speculative or other pressures on the markets in which Hedging Instruments are
traded. The effectiveness of hedges using Hedging Instruments on indexes will
depend on the degree of correlation between price movements in the index and
price movements in the securities being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly
or partially offsetting the negative effect of unfavorable price movements in
the investments being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if the Fund entered into a
short hedge because UBS Global AM projected a decline in the price of a security
in the Fund's portfolio, and the price of that security increased instead, the
gain from that increase might be wholly or partially offset by a decline in the
price of the Hedging Instrument. Moreover, if the price of the Hedging
Instrument declined by more than the increase in the price of the security, the
Fund could suffer a loss. In either such case, the Fund would have been in a
better position had it not hedged at all.
(4) As described below, the Fund might be required to maintain assets as
"cover," maintain segregated accounts or make margin payments when it takes
positions in Hedging Instruments involving obligations to third parties (I.E.,
Hedging Instruments other than purchased options). If the Fund were unable to
close out its positions in such Hedging Instruments, it might be required to
continue to maintain such assets or accounts or make such payments until the
position expired or matured. These requirements might impair the Fund's ability
to sell a portfolio security or make an investment at a time when it would
otherwise be favorable to do so, or require that the Fund sell a portfolio
security at a disadvantageous time. The Fund's ability to close out a position
in a Hedging Instrument prior to expiration or maturity depends on the existence
of a liquid secondary market or, in the absence of such a market, the ability
and willingness of a contra party to enter into a transaction closing out the
position. Therefore, there is no assurance that any hedging position can be
closed out at a time and price that is favorable to the Fund.
COVER FOR HEDGING STRATEGIES
Transactions using Hedging Instruments, other than purchased options,
expose the Fund to an obligation to another party. The Fund will not enter into
any such transactions unless it owns either (1) an offsetting ("covered")
position in securities or other options or futures contracts or (2) cash or
liquid securities, with a value sufficient at all times to cover its potential
obligations to the extent not covered as provided in (1) above. The Fund will
comply with SEC guidelines regarding cover for hedging transactions and will, if
the guidelines so require, set aside cash or liquid securities, marked to market
daily, in a segregated account with its custodian in the prescribed amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Hedging Instrument is open, unless they are
replaced with similar assets. As a result, the
17
commitment of a large portion of the Fund's assets to cover or segregated
accounts could impede portfolio management or the Fund's ability to meet
redemptions of APS or other obligations.
OPTIONS
The Fund may purchase put and call options, and write (sell) covered call
options and covered put options, on debt securities. The purchase of call
options serves as a long hedge, and the purchase of put options serves as a
short hedge. Writing covered put or call options can enable the Fund to enhance
income by reason of the premiums paid by the purchasers of such options.
However, if the market price of the security underlying a covered put option
declines to less than the exercise price on the option, minus the premium
received, the Fund would expect to suffer a loss. Writing covered call options
serves as a limited short hedge, because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing the
option. However, if the security appreciates to a price higher than the exercise
price of the call option, it can be expected that the option will be exercised
and the Fund will be obligated to sell the security at less than its market
value. If the covered call option is an OTC option, the securities or other
assets used as cover would be considered illiquid to the extent described under
"Investment Policies and Restrictions--Illiquid Securities."
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Options normally have expiration dates
of up to nine months. Options that expire unexercised have no value.
The Fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the Fund may terminate its
obligation under a call option that it had written by purchasing an identical
call option; this is known as a closing purchase transaction. Conversely, the
Fund may terminate a position in a put or call option it had purchased by
writing an identical put or call option; this is known as a closing sale
transaction. Closing transactions permit the Fund to realize profits or limit
losses on an option position prior to its exercise or expiration.
The Fund may purchase or write both exchange-traded and OTC options.
However, exchange-traded or liquid OTC options on Municipal Obligations are not
currently available. Exchange-traded options in the United States are issued by
a clearing organization affiliated with the exchange on which the option is
listed which, in effect, guarantees completion of every exchange-traded option
transaction. In contrast, OTC options are contracts between the Fund and its
contra party (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when the Fund purchases or writes an OTC option,
it relies on the contra party to make or take delivery of the underlying
investment upon exercise of the option. Failure by the contra party to do so
would result in the loss of any premium paid by the Fund as well as the loss of
any expected benefit of the transaction.
Generally, OTC options on debt securities are European style options. This
means that the option is only exercisable immediately prior to its expiration.
This is in contrast to American-style options, which are exercisable at any time
prior to the expiration date of the option.
The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the contra party, or by a
transaction in the secondary market if any such market exists. Although the Fund
will enter into OTC options only with contra parties that are expected to be
capable of entering into closing transactions with the Fund, there is no
assurance that the Fund will in fact be able to close out an OTC option position
at a favorable price prior to expiration. In the event of
18
insolvency of the contra party, the Fund might be unable to close out an OTC
option position at any time prior to its expiration.
If the Fund were unable to effect a closing transaction for an option it
had purchased, it would have to exercise the option to realize any profit. The
inability to enter into a closing purchase transaction for a covered call option
written by the Fund could cause material losses because the Fund would be unable
to sell the investment used as cover for the written option until the option
expires or is exercised.
In the event that options on indexes of municipal and non-municipal debt
securities become available, the Fund may purchase and write put and call
options on such indexes in much the same manner as the more traditional options
discussed above, except that index options may serve as a hedge against overall
fluctuations in the debt securities market (or market sectors) rather than
anticipated increases or decreases in the value of a particular security.
FUTURES
The Fund may purchase and sell municipal bond index futures, other interest
rate futures and options thereon. The purchase of futures or call options
thereon can serve as a long hedge, and the sale of futures or the purchase of
put options thereon can serve as a short hedge. Writing covered call options on
futures contracts can serve as a limited short hedge, using a strategy similar
to that used for writing covered call options on securities or indexes.
Similarly, writing covered put options on futures contracts can serve as a
limited long hedge.
Futures strategies also can be used to manage the average duration of the
Fund's portfolio. If UBS Global AM wishes to shorten the average duration of the
Fund's portfolio, the Fund may sell a futures contract or a call option thereon,
or purchase a put option on that futures contract. If UBS Global AM wishes to
lengthen the average duration of the Fund's portfolio, the Fund may buy a
futures contract or a call option thereon, or sell a put option thereon.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract the Fund is required to deposit in a segregated
account with its custodian, in the name of the futures broker through whom the
transaction was effected, "initial margin" consisting of cash, obligations of
the United States or obligations that are fully guaranteed as to principal and
interest by the United States, in an amount generally equal to 10% or less of
the contract value. Margin must also be deposited when writing a call option on
a futures contract, in accordance with applicable exchange rules. Unlike margin
in securities transactions, initial margin on futures contracts does not
represent a borrowing, but rather is in the nature of a performance bond or
good-faith deposit that is returned to the Fund at the termination of the
transaction if all contractual obligations have been satisfied. Under certain
circumstances, such as periods of high volatility, the Fund may be required by
an exchange to increase the level of its initial margin payment, and initial
margin requirements might be increased generally in the future by regulatory
action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Fund's obligations with respect to an open
futures position. When the Fund purchases an option on a future, the premium
paid plus transaction costs is all that is at risk. In contrast, when the Fund
purchases or sells a futures contract or writes a call option thereon, it is
subject to daily variation margin calls that could be substantial in the event
of adverse price movements. If the Fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to the
instrument held or written. Positions in futures and options on futures may be
closed only on an exchange or board of trade that provides a secondary market.
The Fund intends to enter
19
into futures transactions only on exchanges or boards of trade where there
appears to be a liquid secondary market. However, there can be no assurance that
such a market will exist for a particular contract at a particular time.
Secondary markets for options on futures are currently in the development stage,
and the Fund will not trade options on futures on any exchange or board of trade
unless, in UBS Global AM's opinion, the markets for such options have developed
sufficiently that the liquidity risks for such options are not greater than the
corresponding risks for futures.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
If the Fund were unable to liquidate a futures or related options position
due to the absence of a liquid secondary market or the imposition of price
limits, it could incur substantial losses. The Fund would continue to be subject
to market risk with respect to the position. In addition, except in the case of
purchased options, the Fund would continue to be required to make daily
variation margin payments and might be required to maintain the position being
hedged by the future or option or to maintain cash or liquid securities in a
segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options markets
are subject to daily variation margin calls and might be compelled to liquidate
futures or related options positions whose prices are moving unfavorably to
avoid being subject to further calls. These liquidations could increase price
volatility of the instruments and distort the normal price relationship between
the futures or options and the investments being hedged. Also, because initial
margin deposit requirements in the futures market are less onerous than margin
requirements in the securities markets, there might be increased participation
by speculators in the futures markets. This participation also might cause
temporary price distortions. In addition, activities of large traders in both
the futures and securities markets involving arbitrage, "program trading" and
other investment strategies might result in temporary price distortions.
GUIDELINE FOR FUTURES AND RELATED OPTIONS
To the extent that the Fund enters into futures contracts and options on
futures positions that are not for BONA FIDE hedging purposes (as defined by the
CFTC), the aggregate initial margin and premiums on these positions (excluding
the amount by which options are "in-the-money") may not exceed 5% of the Fund's
net assets. [please verify that there have been no changes to this guideline]
This guideline may be modified by the Board without a stockholder vote. Adoption
of this guideline cannot be guaranteed to limit the percentage of the Fund's
assets at risk to 5%.
The Fund may use the following Hedging Instruments:
OPTIONS ON DEBT SECURITIES. A call option is a contract pursuant to which
the purchaser of the option, in return for a premium, has the right to buy the
security underlying the option at a specified price at any time during the term,
or upon the expiration, of the option. The writer of the call option, who
receives the premium, has the obligation, upon exercise of the option, to
deliver the underlying security against payment of the exercise price. A put
option is a similar contract which gives its purchaser, in return for a premium,
the right to sell the underlying security at a specified price during the option
term or upon expiration. The writer of the put option, who receives the premium,
has the obligation, upon exercise, to buy the underlying security at the
exercise price. Options on debt securities are traded primarily in the OTC
market rather than on any of the several options exchanges.
20
OPTIONS ON INDEXES OF DEBT SECURITIES. An index assigns relative values to
the securities included in the index and fluctuates with changes in the market
values of such securities. Index options operate in the same way as more
traditional options except that exercises of index options are effected with
cash payments and do not involve delivery of securities. Thus, upon exercise of
an index option, the purchaser will realize and the writer will pay, an amount
based on the difference between the exercise price and the closing price of the
index.
MUNICIPAL BOND INDEX FUTURES CONTRACTS. A municipal bond index futures
contract is a bilateral agreement pursuant to which one party agrees to accept
and the other party agrees to make delivery of an amount of cash equal to a
specified dollar amount times the difference between the index value at the
close of trading of the contract and the price at which the futures contract is
originally struck. No physical delivery of the bonds comprising the index is
made; generally contracts are closed out prior to the expiration date of the
contract.
MUNICIPAL DEBT FUTURES CONTRACTS. A municipal debt futures contract is a
bilateral agreement pursuant to which one party agrees to accept and the other
party agrees to make delivery of the specific type of municipal debt security
called for in the contract at a specified future time and at a specified price.
OPTIONS ON FUTURES CONTRACTS. Options on futures contracts are similar to
options on securities except that an option on a futures contract gives the
purchaser the right, in return for the premium, to assume a position in a
futures contract (a long position if the option is a call and a short position
if the option is a put), rather than to purchase or sell a security, at a
specified price at any time during the option term. Upon exercise of the option,
the delivery of the futures position to the holder of the option will be
accompanied by delivery of the accumulated balance, which represents the amount
by which the market price of the futures contract exceeds, in the case of a
call, or is less than, in the case of a put, the exercise price of the option on
the future. The writer of an option, upon exercise, will assume a short position
in the case of a call, and a long position in the case of put.
INTEREST RATE PROTECTION TRANSACTIONS. The Fund may enter into interest
rate protection transactions, including interest rate swaps and interest rate
caps, collars and floors. Interest rate swap transactions involve an agreement
between two parties to exchange payments that are based, for example, on
variable and fixed rates of interest and that are calculated on the basis of a
specified amount of principal (the "notional principal amount") for a specified
period of time. Interest rate cap and floor transactions involve an agreement
between two parties in which the first party agrees to make payments to the
counterparty when a designated market interest rate goes above (in the case of a
cap) or below (in the case of a floor) a designated level on predetermined dates
or during a specified time period. Interest rate collar transactions involve an
agreement between two parties in which payments are made when a designated
market interest rate either goes above a designated level or goes below a
designated floor level on predetermined dates or during a specified time period.
The Fund would enter into interest rate protection transactions to preserve
a return or spread on a particular investment or portion of its portfolio, to
protect against any increase in the price of securities the Fund anticipates
purchasing at a later date or to effectively fix the rate of interest that it
pays on one or more borrowings or series of borrowings. The Fund would use these
transactions as a hedge and not as a speculative investment. Interest rate
protection transactions are subject to risks comparable to those described above
with respect to other hedging strategies.
The Fund may enter into interest rate swaps, caps, collars and floors on
either an asset-based or liability-based basis, depending on whether it is
hedging its assets or its liabilities, and will usually enter into interest rate
swaps on a net basis, I.E., the two payment streams are netted out, with the
Fund receiving or paying, as the case may be, only the net amount of the two
payments. Inasmuch as these interest rate protection transactions are entered
into for good faith hedging purposes, and inasmuch as segregated accounts will
be established with respect to such transactions, UBS Global AM and the Fund
believe such obligations do not constitute senior securities and, accordingly,
will not treat them as being
21
subject to its borrowing restrictions. The net amount of the excess, if any, of
the Fund's obligations over its entitlements with respect to each interest rate
swap will be accrued on a daily basis and an amount of cash or liquid
securities, marked to market daily, having an aggregate net asset value at least
equal to the accrued excess will be maintained in a segregated account by a
custodian that satisfies the requirements of the Investment Company Act of 1940
("1940 Act"). The Fund also will establish and maintain such segregated accounts
with respect to its total obligations under any interest rate swaps that are not
entered into on a net basis and with respect to any interest rate caps, collars
and floors that are written by the Fund.
The Fund will enter into interest rate protection transactions only with
banks and recognized securities dealers or their affiliates believed by UBS
Global AM to present minimal credit risks in accordance with guidelines
established by the Board. If there is a default by the other party to such a
transaction, the Fund will have to rely on its contractual remedies (which may
be limited by bankruptcy, insolvency or similar laws) pursuant to the agreements
related to the transaction.
The swap market has grown substantially in recent years with a large number
of banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. Caps, collars and floors are more
recent innovations for which documentation is less standardized, and
accordingly, they are less liquid than swaps.
For as long as shares of any series of APS are rated by Moody's, the Fund
may engage in transactions in options on securities, futures contracts based on
the Municipal Index or Treasury Bonds and options on such futures contracts
(collectively "Moody's Hedging Transactions") only when consistent with the
provisions set forth in Appendix E, unless it receives written confirmation from
Moody's that engaging in such transactions will not impair the ratings then
assigned to the APS by Moody's. For as long as shares of any series of APS are
rated by S&P, the Fund will not buy or sell futures contracts or options thereon
or write put options or call options on portfolio securities or enter into
interest rate caps, collars or floors unless it receives written confirmation
from S&P that engaging in such transactions will not impair the ratings then
assigned to the APS by S&P, except that the Fund may buy and sell futures
contracts based on the Municipal Index or Treasury Bonds, may purchase put and
call options on such contracts, and may write covered call options and secured
put options on portfolio securities (collectively "S&P Hedging Transactions")
subject to the limitations described in Appendix B.
ORGANIZATION OF THE FUND; DIRECTORS AND OFFICERS; PRINCIPAL HOLDERS
AND MANAGEMENT OWNERSHIP OF SECURITIES
The Fund was incorporated under the laws of the state of Maryland on
February 18, 1993. The overall management of the business and affairs of the
Fund is vested in the Board. The Board approves all significant agreements
between the Fund and persons or companies furnishing services to it, including
the Fund's agreements with its investment advisor and administrator, custodian
and transfer and dividend disbursing agent and registrar. The day-to-day
operations of the Fund are delegated to the Fund's officers and to UBS Global
AM, subject to the investment objective and policies of the Fund and to general
supervision by the Board.
Each of the Fund's directors serves an indefinite term of office. Each
director who has attained the age of seventy-two (72) years will be subject to
retirement on the last day of the month in which he or she attains such age. The
tables below show, for each director and executive officer, his or her name,
address and age, the position held with the Fund, the length of time served as a
director or officer of the Fund, the director's or officer's principal
occupations during the last five years, the number of portfolios in the UBS fund
complex overseen by the director or for which such person served as an officer,
and other directorships held by such director.
INTERESTED DIRECTORS
22
TERM OF OTHER
POSITION(S) OFFICE+ AND NUMBER OF PORTFOLIOS IN DIRECTORSHIPS
NAME, ADDRESS, HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) FUND COMPLEX OVERSEEN HELD BY
AND AGE FUND TIME SERVED DURING PAST 5 YEARS BY DIRECTOR DIRECTOR
--------------- ----------- ----------- ---------------------- ----------------------- ----------------
Margo N. Director Since 1996 Mrs. Alexander is Mrs. Alexander is a None
Alexander*++; 56 retired. She was an director or trustee of
executive vice president 19 investment companies
of UBS Financial (consisting of 40
Services Inc. (March portfolios) for which
1984 to December 2002). UBS Global AM or one of
She was chief executive its affiliates serves
officer (from January as investment advisor,
1995 to October 2000), a sub-advisor or manager.
director (from January
1995 to September 2001)
and chairman (from March
1999 to September 2001)
of UBS Global AM.
Brian M. Director Since 2003 Mr. Storms is chief Mr. Storms is a None
Storms*++; 49 and executive officer of UBS director or trustee of
Chairman of Global Asset Management 23 investment companies
the Board -- Americas region (since (consisting of 83
of Directors July 2002). Mr. Storms portfolios) for which
was chief executive UBS Global AM or one of
officer, president its affiliates serves
and/or chief operating as investment advisor,
officer of UBS Global AM sub-advisor or
and certain affiliated manager.
asset management
companies from 1999 to
July 2002. He was
president of Prudential
Investments
(1996-1999).
INDEPENDENT DIRECTORS
Richard Q. Director Since 1995 Mr. Armstrong is Mr. Armstrong is a None.
Armstrong; 68 chairman and principal director or trustee of
R.Q.A. of R.Q.A. Enterprises 19 investment
Enterprises (management consulting companies (consisting
One Old Church firm) (since April 1991 of 40 portfolios) for
Road - Unit # 6 and principal occupation which UBS Global AM or
Greenwich, since March 1995). one of its affiliates
CT 06830 serves as investment
advisor, sub-advisor
or manager.
23
TERM OF OTHER
POSITION(S) OFFICE+ AND NUMBER OF PORTFOLIOS IN DIRECTORSHIPS
NAME, ADDRESS, HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) FUND COMPLEX OVERSEEN HELD BY
AND AGE FUND TIME SERVED DURING PAST 5 YEARS BY DIRECTOR DIRECTOR
--------------- ----------- ----------- ---------------------- ----------------------- ----------------
David J. Director Since 2001 Mr. Beaubien is chairman Mr. Beaubien is a Mr. Beaubien is
Beaubien; 69 of Yankee Environmental director or trustee of also a director
101 Industrial Systems, Inc., a 19 investment companies of IEC Electronics,
Road manufacturer of (consisting of 40 Inc., a manufacturer of
Turners Falls, meteorological measuring portfolios) for which electronic assemblies.
MA 01376 systems (since 1991). UBS Global AM or one of
its affiliates serves
as investment advisor,
sub-advisor or manager.
Richard R. Burt; Director Since 1995 Mr. Burt is chairman of Mr. Burt is a director Mr. Burt is also a director
56 Diligence LLC or trustee of 19 of Hollinger International
1275 (international investment companies Inc. (publishing), HCL
Pennsylvania information and security (consisting of 40 Technologies, Ltd., The
Ave., N.W. firm) and IEP Advisors portfolios) for which Central European Fund, Inc.,
Washington, (international UBS Global AM or one The Germany Fund, Inc.,
D.C. 20004 investments and of its affiliates IGT, Inc. (provides
consulting firm). serves as investment technology to gaming and
advisor, sub-advisor wagering industry) and
or manager. chairman of Weirton Steel
Corp. (makes and finishes
steel products). He is also a
director or trustee of
funds in the Scudder Mutual
Funds Family (consisting of
47 portfolios).
24
TERM OF OTHER
POSITION(S) OFFICE+ AND NUMBER OF PORTFOLIOS IN DIRECTORSHIPS
NAME, ADDRESS, HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) FUND COMPLEX OVERSEEN HELD BY
AND AGE FUND TIME SERVED DURING PAST 5 YEARS BY DIRECTOR DIRECTOR
--------------- ----------- ----------- ---------------------- ----------------------- ----------------
Meyer Feldberg; Director Since 1993 Mr. Feldberg is Dean and Dean Feldberg is a Dean Feldberg is also a
61 Professor of Management director or trustee of director of Primedia Inc.
Columbia of the Graduate School 33 investment companies (publishing), Federated
University of Business, Columbia (consisting of 54 Department Stores, Inc.
101 Uris Hall University (since 1989). portfolios) for which (operator of department
New York, UBS Global AM or one of stores), Revlon, Inc.
New York 10027 its affiliates serves (cosmetics), Select
as investment advisor, Medical Inc. (healthcare
sub-advisor or manager. services) and SAPPI, Ltd.
(producer of paper).
Frederic V. Director Since 1996 Mr. Malek is chairman of Mr. Malek is a Mr. Malek is also a
Malek; 66 Thayer Capital Partners director or trustee of director of Aegis
1455 (merchant bank) and 19 investment Communications, Inc.
Pennsylvania chairman of Thayer Hotel companies (consisting (tele-services), American
Avenue, N.W. Investors III, Thayer of 40 portfolios) for Management Systems, Inc.
Suite 350 Hotel Investors II and which UBS Global AM or (management consulting
Washington, Lodging Opportunities one of its affiliates and computer related
D.C. 20004 Fund (hotel investment serves as investment services), Automatic Data
partnerships) (since advisor, sub-advisor Processing, Inc.
1992). or manager. (computing services), CB
Richard Ellis, Inc. (real
estate services), Federal
National Mortgage
Association, FPL Group,
Inc. (electric services),
Manor Care,
25
TERM OF OTHER
POSITION(S) OFFICE+ AND NUMBER OF PORTFOLIOS IN DIRECTORSHIPS
NAME, ADDRESS, HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) FUND COMPLEX OVERSEEN HELD BY
AND AGE FUND TIME SERVED DURING PAST 5 YEARS BY DIRECTOR DIRECTOR
--------------- ----------- ----------- ---------------------- ----------------------- ----------------
Inc. (health care), and
Northwest Airlines Inc
Carl W. Schafer; 67 Director Since 1996 Mr. Schafer is president Mr. Schafer is a Mr. Schafer is also a
66 Witherspoon of the Atlantic director or trustee of director of Labor Ready,
Street Foundation (charitable 19 investment companies Inc. (temporary
#1100 foundation) (since (consisting of 40 employment), Roadway
Princeton, NJ 1993). portfolios) for which Corp. (trucking),
08542 UBS Global AM or one of Guardian Life Insurance
its affiliates serves Company Mutual Funds
as investment advisor, (consisting of 19
sub-advisor or manager. portfolios), the Harding,
Loevner Funds (consisting
of three portfolios),
E.I.I. Realty Securities
Trust (investment
company) and Frontier Oil
Corporation.
William D. Director Since 2001 Mr. White is retired Mr. White is a None
White; 69 (since 1994). director or trustee of
P.O. Box 199 19 investment
Upper Black companies (consisting
Eddy, PA 18972 of 40 portfolios) for
which UBS Global AM
or one of its affiliates
serves as investment
advisor, sub-advisor
or manager.
----------
* This person's business address is UBS Global Asset Management (US) Inc., 51
West 52nd Street, New York, New York 10019-6114.
+ Each Director holds office for an indefinite term.
++ Mrs. Alexander and Mr. Storms are "interested persons" of the Fund as
defined in the 1940 Act by virtue of their current or former positions with
UBS Global AM and/or its affiliates.
OFFICERS
26
POSITIONS TERM OF OFFICE+ AND PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS; NUMBER OF
NAME, ADDRESS, HELD WITH LENGTH OF TIME PORTFOLIOS IN FUND COMPLEX FOR WHICH PERSON SERVES AS
AND AGE FUND SERVED OFFICER
------------------------------------------------------------------------------------------------------------------------
W. Douglas Beck*; 36 Vice Since 2003 Mr. Beck is an executive director and head of mutual
President fund product management of UBS Global AM (since 2002).
From March 1998 to November 2002, he held various
positions at Merrill Lynch, the most recent being
first vice president and co-manager of the managed
solutions group. Mr. Beck is vice president of 22
investment companies (consisting of 81 portfolios)
for which UBS Global AM or one of its affiliates
serves as investment advisor, sub-advisor or
manager.
Thomas Disbrow*; 37 Vice Since 2000 Mr. Disbrow is a director and a senior manager of the
President and mutual fund finance department of UBS Global AM. Prior
Assistant to November 1999, he was a vice president of
Treasurer Zweig/Glaser Advisers. Mr. Disbrow is a vice president
and assistant treasurer of 19 investment companies
(consisting of 40 portfolios) for which UBS Global
AM or one of its affiliates serves as investment
advisor, sub-advisor or manager.
Amy R. Doberman*; 41 Vice Since 2000 Ms. Doberman is a managing director and general counsel
President and of UBS Global AM. From December 1997 through July 2000,
Secretary she was general counsel of Aeltus Investment Management,
Inc. Ms. Doberman is vice president and assistant
secretary of five investment companies (consisting of 44
portfolios) and vice president and secretary of 19
investment companies (consisting of 40 portfolios) for
which UBS Global AM or one of its affiliates serves as
investment advisor, sub-advisor or manager.
Elbridge T. Gerry Vice President Since 1996 Mr. Gerry is a managing director -- fixed income of UBS
III*; 46 Global AM. Mr. Gerry is a vice president of six
investment companies (consisting of 11 portfolios)
for which UBS Global AM or one of its affiliates
serves as investment advisor, sub-advisor or
manager.
David M. Vice Since 2002 Mr. Goldenberg is an executive director and deputy
Goldenberg*; 37 President and general counsel of UBS Global AM. From 2000 to 2002 he
Assistant was director, legal affairs at Lazard Asset Management.
Secretary Mr. Goldenberg served in various capacities, including
most recently as global director of compliance at
SSB Citi Asset Management Group from 1996 to 2000.
Mr. Goldenberg is a vice president and secretary
of five investment companies (consisting of 44
portfolios) and a vice president and assistant
secretary of 19 investment companies (consisting
of 40 portfolios) for which UBS Global AM or one
of its affiliates serves as investment advisor,
sub-advisor or manager.
27
POSITIONS TERM OF OFFICE+ AND PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS; NUMBER OF
NAME, ADDRESS, HELD WITH LENGTH OF TIME PORTFOLIOS IN FUND COMPLEX FOR WHICH PERSON SERVES AS
AND AGE FUND SERVED OFFICER
------------------------------------------------------------------------------------------------------------------------
Kevin J. Mahoney*; 37 Vice Since 1999 Mr. Mahoney is a director and a senior manager of the
President and mutual fund finance department of UBS Global AM. Prior
Assistant to April 1999, he was the manager of the mutual fund
Treasurer internal control group of Salomon Smith Barney.
Mr. Mahoney is a vice president and assistant
treasurer of 19 investment companies (consisting
of 40 portfolios) for which UBS Global AM or one
of its affiliates serves as investment advisor,
sub-advisor or manager.
Paul H. Schubert*; 40 Vice Since 1994 Mr. Schubert is an executive director and head of the
President and mutual fund finance department of UBS Global AM.
Treasurer Mr. Schubert is treasurer and principal accounting officer
of three investment companies (consisting of 41
portfolios), a vice president and treasurer of 20
investment companies (consisting of 41
portfolios), and treasurer and chief financial
officer of one investment company (consisting of
two portfolios) for which UBS Global AM or one of
its affiliates serves as investment advisor,
sub-advisor or manager.
Joseph A. Varnas*; 35 President Since 2003 Mr. Varnas is a managing director (since March 2003),
chief technology officer (since March 2001) and head of
product, technology and operations of UBS Global AM
(since November 2002). From 2000 to 2001, he was
manager of product development in Investment Consulting
Services at UBS Financial Services Inc. Mr. Varnas was
a senior analyst in the Global Securities Research and
Economics Group at Merrill Lynch from 1995 to 1999.
Mr. Varnas is president of 22 investment companies
(consisting of 81 portfolios) for which UBS Global AM or
one of its affiliates serves as investment advisor,
sub-advisor or manager.
Keith A. Weller*; 42 Vice Since 1995 Mr. Weller is a director and senior associate general
President and counsel of UBS Global AM. Mr. Weller is a vice
Assistant president and assistant secretary of 19 investment
Secretary companies (consisting of 40 portfolios) for which UBS
Global AM or one of its affiliates serves as
investment advisor, sub-advisor or manager.
----------
* This person's business address is UBS Global Asset Management (US) Inc., 51
West 52nd Street, New York, New York 10019-6114.
+ Officers of the Fund are appointed by the Directors and serve at the
pleasure of the Board.
28
INFORMATION ABOUT DIRECTOR OWNERSHIP OF FUND SHARES
AGGREGATE DOLLAR RANGE OF EQUITY
SECURITIES IN ALL REGISTERED INVESTMENT
COMPANIES OVERSEEN BY
DIRECTOR FOR WHICH UBS
FINANCIAL SERVICES INC., UBS GLOBAL AM
OR AN AFFILIATE SERVES AS DIRECTOR
DOLLAR RANGE OF EQUITY SECURITIES IN INVESTMENT ADVISOR, SUB-ADVISOR OR
DIRECTOR FUND+ MANAGER+
-------- ------------------------------------ ---------------------------------------
INTERESTED DIRECTORS
Margo N. Alexander None Over $100,000
Brian M. Storms None $1-$10,000
INDEPENDENT DIRECTORS
Richard Q. Armstrong None Over $100,000
David J. Beaubien None Over $100,000
Richard R. Burt None $10,001-$50,000
Meyer Feldberg None Over $100,000
Frederic V. Malek None $50,001-$100,000
Carl W. Schafer None Over $100,000
William D. White None $10,001-$50,000
----------
+ Information regarding ownership of shares is as of December 31, 2002.
COMMITTEES
The Fund has an Audit and Contract Review Committee and a Nominating
Committee. The members of the Audit and Contract Review Committee are the
Independent Directors (as defined herein). Richard Q. Armstrong is chairperson.
The following Independent Directors are members of the Nominating Committee:
Meyer Feldberg (chairperson), Carl W. Schafer and William D. White.
The Audit and Contract Review Committee is responsible for, among other
things: (i) overseeing the scope of the Fund's audit, the quality and
objectivity of the Fund's financial statements, the Fund's accounting and
financial reporting policies and practices and its internal controls and, as
appropriate, the internal controls of certain service providers; (ii) approving,
and recommending to the board for ratification, the selection, appointment,
retention or termination of the Fund's independent auditors; (iii) determining
the compensation of the Fund's independent auditors; and (iv) pre-approving all
audit and non-audit services provided to the Fund and permissible non-audit
services to be provided to the Fund's affiliates to the extent that such
approval is required under applicable regulations of the SEC.
In furtherance of its duties, the Audit and Contract Review Committee also
is responsible for, among other things: obtaining assurance from the Fund's
independent auditors of its independence and discussing any disclosed
relationships or services that may diminish the objectivity and independence of
the independent auditors; inquiring as to the Fund's qualification under
Subchapter M of the Internal Revenue Code and the amounts distributed and
reported to shareholders; reviewing with the independent auditors any problems
or difficulties with the audit, reviewing certain matters relating to internal
controls and disclosure controls and procedures at the Fund and the Fund's
service providers; and reporting to the full board and making recommendations as
it deems necessary or appropriate. Although the Audit and Contract Review
Committee has the responsibilities described above, it is not responsible for
planning or conducting the Fund's audit or determining whether the Fund's
financial statements are complete and accurate and are in accordance with
accounting principles generally accepted in the United States. Absent
29
actual knowledge to the contrary, Audit and Contract Review Committee members
are entitled to rely on the accuracy of the information they receive from
persons within and outside the Fund. The Audit and Contract Review Committee
also reviews the performance by certain service providers of their contracts and
arrangements with the Fund and recommends to the board concerning the initial
approval and/or continuation of each of the proposed contracts and arrangements
and the reasonableness and appropriateness of the compensation paid by the Fund.
The Audit and Contract Review Committee currently normally meets in conjunction
with regular board meetings, or more frequently as called by its chairperson.
During the Fund's fiscal year ended March 31, 2003, the Audit and Contract
Review Committee held 5 meetings.
The Nominating Committee is responsible for, among other things: selecting,
evaluating and recommending to the board candidates to be nominated as
additional Independent Directors of the Fund and reviewing the compensation
arrangements for each of the directors. [The Nominating Committee did not meet
during the fiscal year ended March 31, 2003.] The Nominating Committee will
consider nominees recommended by shareholders if a vacancy occurs among the
Independent Directors. In order to recommend a nominee, a shareholder should
send a letter to the chairperson of the Nominating Committee, Mr. Meyer
Feldberg, care of the Secretary of the Fund at 51 West 52nd Street, New York,
New York 10019-6114 and indicate on the envelope "Nominating Committee." The
shareholder's letter should state the nominee's name and should include the
nominee's RESUME or CURRICULUM VITAE.
INFORMATION ABOUT INDEPENDENT DIRECTOR OWNERSHIP OF SECURITIES ISSUED BY
UBS GLOBAL AM OR ANY COMPANY CONTROLLING, CONTROLLED BY OR UNDER COMMON CONTROL
WITH UBS GLOBAL AM
As of December 31, 2002, the Independent Directors did not own any
securities issued by UBS Global AM or any company controlling, controlled by or
under common control with UBS Global AM.
COMPENSATION
Each Independent Director receives, in the aggregate from UBS Global AM
funds, an annual retainer of $50,000, and a $10,000 fee for each regular Board
meeting (and each in-person special Board meeting) actually attended. Each such
director is also entitled to a $2,000 fee for each special telephone meeting
attended. The chairperson of the Audit and Contract Review Committee receives
annually $12,500. The chairperson of the Nominating Committee receives annually
$5,000. The foregoing fees will be allocated among all such funds (or each
relevant fund in the case of a special meeting) PRO RATA based on the fund's
relative net assets at the end of the calendar quarter preceding the date of
payment. No officer, director or employee of UBS Global AM or one of its
affiliates currently receives any compensation from the funds for acting as a
director or officer. All directors are reimbursed for expenses incurred in
attending meetings.
The table below includes certain information relating to the compensation
of the current directors and the compensation of those directors from all funds
for which UBS Global AM or an affiliate served as an investment advisor,
sub-advisor or manager during the periods indicated.
COMPENSATION TABLE+
AGGREGATE TOTAL COMPENSATION FROM THE
COMPENSATION FUND AND THE FUND
NAME OF PERSON, POSITION FROM FUND* COMPLEX**
-----------------------------------------------------------------------------------------------------
Richard Q. Armstrong, Director $ 600 $ 111,125
David J. Beaubien, Director 555 108,000
Richard R. Burt, Director 555 108,000
Meyer Feldberg, Director 577 210,500
Frederic V. Malek, Director 532 108,000
30
Carl W. Schafer, Director 555 108,000
William D. White, Director 555 108,000
----------
+ Only Independent Directors are compensated by the Funds for which UBS
Global AM or an affiliate serves as investment advisor, sub-advisor or
manager; directors who are "interested persons," as defined by the
Investment Company Act, do not receive compensation from the Funds.
* Represents total fees paid by the Fund to each director indicated for
the fiscal year ended March 31, 2003.
** Represents fees paid during the calendar year ended December 31, 2002 to
each director by: (a) 22 investment companies in the case of Messrs.
Armstrong, Beaubien, Burt, Malek, Schafer and White; and (b) 36
investment companies in the case of Mr. Feldberg, for which UBS Global
AM or one of its affiliates served as investment advisor, sub-advisor or
manager. No Fund within the UBS Fund complex has a bonus, pension,
profit sharing or retirement plan.
PRINCIPAL HOLDERS AND MANAGEMENT OWNERSHIP OF SECURITIES
As of September 30, 2003, the directors and officers of the Fund
beneficially owned in the aggregate less than 1% of the outstanding shares of
each of the Fund's common stock, APS Series A, and APS Series B.
As of September 30, 2003, ___________ (the nominee for ________) owned of
record ___% of the outstanding shares of the Fund's common stock, ___% of the
outstanding shares of APS Series A, and ___% of the outstanding shares of APS
Series B. As of September 30, 2003, none of the persons on whose behalf those
shares were held was known by the Fund to own 5% or more of the Fund's common
stock, APS Series A, or APS Series B.
INVESTMENT ADVISORY AND ADMINISTRATION ARRANGEMENTS
UBS Global AM is the Fund's investment adviser and administrator pursuant
to a contract dated May 26, 1993 with the Fund ("Advisory and Administration
Contract"). Pursuant to the Advisory and Administration Contract, UBS Global AM
provides a continuous investment program for the Fund and makes investment
decisions and places orders to buy, sell or hold particular securities. As
administrator, UBS Global AM supervises all matters relating to the operation of
the Fund and obtains for it corporate, administrative and clerical personnel,
office space, equipment and services, including arranging for the periodic
preparation, updating, filing and dissemination of proxy materials, tax returns
and reports to the Fund's Board, shareholders and regulatory authorities. Under
the Advisory and Administration Contract, the Fund pays UBS Global AM a fee,
computed weekly and paid monthly, at the annual rate of 0.90% of the Fund's
average weekly net assets. UBS Global AM has agreed to waive 0.20%, of the
advisory fee, so that the Fund's effective advisory fee is 0.70% of average
weekly net assets. This waiver will continue indefinitely unless the Board
agrees to any change. During the fiscal years indicated, the Fund paid (or
accrued) the following investment advisory and administration fees:
FISCAL YEARS ENDED MARCH 31,
--------------------------------------------------------------------------
2003 2002 2001
--------------------------------------------------------------------------
$4,251,755 $4,198,972 $4,098,097
(of which $590,524 was (of which $583,198 was (of which $569,178 was
waived) waived) waived)
In addition to the payments to UBS Global AM under the Advisory and
Administration Contract described above, the Fund pays certain other costs
including: (1) the costs (including any brokerage commissions) of securities
purchased or sold by the Fund and any losses incurred in connection therewith;
(2) expenses incurred on behalf of the Fund by UBS Global AM; (3) organizational
expenses of the Fund, whether or not advanced by UBS Global AM; (4) filing fees
and expenses relating to the registration and qualification of the common stock
under federal and state securities laws; (5) fees and salaries payable to
directors who are not interested persons of the Fund or UBS Global AM; (6) all
expenses incurred in connection with the directors' services, including travel
expenses; (7) taxes (including any income or franchise taxes) and governmental
fees; (8) costs of any liability, uncollectible
31
items of deposit and any other insurance or fidelity bonds; (9) any costs,
expenses or losses arising out of a liability of or claims for damages or other
relief asserted against the Fund for violation of any law; (10) legal,
accounting and auditing expenses, including legal fees of special counsel for
the independent directors; (11) charges of custodians, transfer agents and other
agents; (12) costs of preparing share certificates; (13) expenses of printing
and distributing reports to shareholders; (14) any extraordinary expenses
(including fees and disbursements of counsel) incurred by the Fund; (15) fees,
voluntary assessments and other expenses incurred in connection with membership
in investment company organizations; (16) costs of mailing and tabulating
proxies and costs of meetings of shareholders, the board and any committees
thereof; (17) the costs of investment company literature and other publications
provided to directors and officers; (18) costs of mailing, stationery and
communications equipment; (19) interest charges on borrowings; (20) fees and
expenses of listing and maintaining any listing of the Fund's shares on the New
York Stock Exchange, Inc. ("NYSE") or any other national securities exchange;
and (21) costs and expenses (including rating agency fees) associated with the
issuance of any Preferred Stock.
At the Fund's board meeting on July 23, 2003, the directors considered and
approved the continuance of the Fund's Advisory and Administration Contract with
UBS Global AM. Prior to that meeting, the Board's Audit and Contract Review
Committee (comprised of the Independent Directors) also had met to review and
discuss the investment advisory and administration services provided to the Fund
over the course of the year by UBS Global AM. In considering the continuance of
the Advisory and Administration Contract, the Audit and Contract Review
Committee analyzed the nature, quality and scope of such services, the revenues
received and expenses incurred (actual and projected) by UBS Global AM in
performing the services required under the Advisory and Administration Contract,
and the cost-allocation methods used in calculating such expenses. The Audit and
Contract Review Committee also reviewed UBS Global AM's profitability in
managing the Fund; the current fees paid by the Fund in light of fees paid to
other advisors by comparable funds; fees paid to UBS Global AM by other funds it
advises; and the ability of UBS Global AM to continue to perform the services
contemplated under the Advisory and Administration Contract.
The Audit and Contract Review Committee also evaluated the performance of
the Fund in comparison to funds with similar objectives and policies, the
relevant investment advisory personnel, compliance with its investment
restrictions, tax and reporting requirements and procedures of UBS Global AM
with respect to possible conflicts of interest, including UBS Global AM's code
of ethics; UBS Global AM's trade allocation procedures for its various
investment advisory clients and UBS Global AM's best execution procedures. Based
on all of the above, as well as other factors and considerations, the Audit and
Contract Review Committee recommended to the full Board that the Board approve
the continuance of the Advisory and Administration Contract.
The full Board reviewed the factors considered by the Audit and Contract
Review Committee and also gave substantial consideration to the fees payable
under the contract. In this regard, the Board evaluated UBS Global AM's planned
waiver of 0.20% of the advisory fee and UBS Global AM's profitability with
respect to the Fund, including consideration of both the actual dollar amount of
fees paid by the Fund directly to UBS Global AM and so-called "fallout benefits"
to UBS Global AM or its affiliates, such as, for example, benefits derived from
serving as investment advisor to the Fund and the research services available to
UBS Global AM by reason of portfolio transactions executed for the Fund.
Based on these considerations and the overall high-quality of the
personnel, operations, financial condition, investment advisory capabilities,
methodologies, and performance of UBS Global AM, the Board concluded the fees to
be paid to UBS Global AM under the Advisory and Administration Contract were
fair and reasonable, and the scope and quality of UBS Global AM's services to
the Fund was consistent with the Fund's operational requirements and sufficient
to approve the continuance of the Fund's Advisory and Administration Contract
with UBS Global AM.
32
Under the Advisory and Administration Contract, UBS Global AM will not be
liable for any error of judgment or mistake of law or for any loss suffered by
the Fund in connection with the Advisory and Administration Contract, except a
loss resulting from willful misfeasance, bad faith or gross negligence on the
part of UBS Global AM in the performance of its duties or from reckless
disregard of its duties and obligations under the Advisory and Administration
Contract. The Advisory and Administration Contract is terminable by vote of the
Board or by the holders of a majority of the outstanding voting securities of
the Fund, at any time without penalty, on 60 days' written notice to UBS Global
AM. The Advisory and Administration Contract may also be terminated by UBS
Global AM on 60 days' written notice to the Fund. The Advisory and
Administration Contract terminates automatically upon its assignment.
PORTFOLIO TRANSACTIONS
The Fund purchases portfolio securities from dealers and underwriters as
well as from issuers. Subject to policies established by the board of directors,
UBS Global AM is responsible for the execution of the Fund's portfolio
transactions and the allocation of brokerage transactions. Securities are
usually traded on a net basis with dealers acting as principal for their own
accounts without a stated commission. Prices paid to dealers in principal
transactions generally include a 'spread,' which is the difference between the
prices at which the dealer is willing to purchase and sell a specific security
at the time. When securities are purchased directly from an issuer, no
commissions or discounts are paid. When securities are purchased in underwritten
offerings, they include a fixed amount of compensation to the underwriter.
For purchases or sales with broker-dealer firms that act as principal, UBS
Global AM seeks best execution. Although UBS Global AM may receive certain
research or execution services in connection with these transactions, it will
not purchase securities at a higher price or sell securities at a lower price
than would otherwise be paid if no weight was attributed to the services
provided by the executing dealer. UBS Global AM may consider the sale of shares
of the Fund and of other funds it advises as a factor in the selection of
brokers or dealers to effect transactions for the Fund, subject to UBS Global
AM's duty to seek best execution. UBS Global AM may engage in agency
transactions in over-the-counter securities in return for research and execution
services. These transactions are entered into only pursuant to procedures that
are designed to ensure that the transaction (including commissions) is at least
as favorable as it would have been if effected directly with a market-maker that
did not provide research or execution services.
Research services and information received from brokers or dealers are
supplemental to UBS Global AM's own research efforts and, when utilized, are
subject to internal analysis before being incorporated into its investment
processes. Information and research services furnished by brokers or dealers
through which or with which the Fund effects securities transactions may be used
by UBS Global AM in advising other funds or accounts and, conversely, research
services furnished to UBS Global AM by brokers or dealers in connection with
other funds or accounts that it advises may be used in advising the Fund.
The Fund will not purchase securities that are offered in underwritings in
which UBS Financial Services Inc., UBS Global AM or any of their affiliates is a
member of the underwriting or selling group, except pursuant to procedures
adopted by the board of directors pursuant to Rule 10f-3 under the 1940 Act.
Among other things, these procedures require that the commission or spread paid
in connection with such a purchase be reasonable and fair, that the purchase be
at not more than the public offering price prior to the end of the first
business day after the date of the public offering and that UBS Financial
Services, Inc., UBS Global AM and their affiliates not participate in or
benefit from the sale to the Fund.
During the fiscal years ended March 31, 2003, 2002 and 2001, the Fund paid
no brokerage commissions. Therefore, the Fund has not allocated any brokerage
transactions for research, analysis,
33
advice and similar services. Investment decisions for the Fund and for other
investment accounts managed by UBS Global AM are made independently of one
another in light of differing considerations for the various accounts. However,
the same investment decision may occasionally be made for the Fund and one or
more accounts. In those cases, simultaneous transactions are inevitable.
Purchases or sales are then averaged as to price and allocated between the Fund
and the other account(s) as to amount in a manner deemed equitable to the Fund
and the other account(s). While in some cases this practice could have a
detrimental effect upon the price or value of the security as far as the Fund is
concerned, or upon its ability to complete its entire order, in other cases it
is believed that simultaneous transactions and the ability to participate in
volume transactions will benefit the Fund.
PORTFOLIO TURNOVER
The Fund anticipates that its annual portfolio turnover rate will not
exceed 100%; however, portfolio turnover may vary from year to year and will not
be a limiting factor when UBS Global AM deems portfolio changes appropriate. The
portfolio turnover rate will be calculated by dividing the lesser of the Fund's
annual sales or purchases of portfolio securities (exclusive of purchases or
sales of securities whose maturities at the time of acquisition were one year or
less) by the monthly average value of the long-term securities in the portfolio
during the year.
VALUATION OF COMMON STOCK
The net asset value of the common stock is determined weekly, as determined
by or under the direction of the Board, and also is determined monthly as of the
close of regular trading on the NYSE on the last day of the month on which the
NYSE is open for trading. The net asset value per share of common stock is
computed by dividing the value of the securities held by the Fund plus any cash
or other assets (including interest and dividends accrued but not yet received
and earned discount) minus all liabilities (including accrued expenses) and the
liquidation preference of any outstanding Preferred Stock by the total number of
shares of Common Stock outstanding at such time.
When market quotations are readily available, the Fund's debt securities
are valued based upon those quotations. When market quotations for options and
futures positions held by the Fund are readily available, those positions are
valued based upon such quotations. Market quotations generally are not available
for options traded in the OTC market. When market quotations for options and
futures positions or any other securities and assets of the Fund are not readily
available, they are valued at fair value as determined in good faith by or under
the direction of the Board of Directors. When market quotations are not readily
available for any of the Fund's debt securities, such securities are valued
based upon appraisals received from a pricing service using a computerized
matrix system, or based upon appraisals received from a pricing service using a
computerized matrix system, or based upon appraisals derived from information
concerning the security or similar securities received from recognized dealers
in those securities. Notwithstanding the above, debt securities with maturities
of 60 days or less generally are valued at amortized cost if their original term
to maturity was 60 days or less, or by amortizing the difference between their
fair value as of the 61st day prior to maturity and their maturity value if
their original term to maturity exceed 60 days, unless in either case the Board
of Directors or its delegate determines that this does not represent fair value.
The Fund calculates its net asset value based on the current market value,
where available, for its portfolio securities. The Fund normally obtains market
values for its securities from independent pricing sources and broker-dealers.
Independent pricing sources may use reported last sale prices, current market
quotations, or valuations from computerized "matrix" systems that derive values
based on comparable securities. If a market value is not available from an
independent pricing source for a particular security, that security is valued at
fair value as determined in good faith by or under the direction of the Fund's
Board. The amortized cost method of valuation, which approximates market value,
generally is used to
34
value short-term debt instruments with sixty days or less remaining to maturity,
unless the Board determines that this does not represent fair value.
TAXATION
The following is a summary of the material federal tax considerations
affecting the Fund and its Shareholders. In addition to the considerations
described below, which are applicable to any investment in the Fund, there may
be other federal, state, local or foreign tax considerations applicable to
particular investors. Prospective Shareholders are therefore urged to consult
their tax advisers with respect to the tax consequences to them of an investment
in the Fund.
TAXATION OF THE FUND
GENERAL. The Fund intends to continue to qualify each taxable year for treatment
as, a regulated investment company ("RIC") under Subchapter M of the Internal
Revenue Code. In each taxable year that the Fund so qualifies, the Fund will be
relieved of federal income tax on that part of its investment company taxable
income (consisting generally of taxable net investment income, net short-term
capital gain and net realized gains from certain hedging transactions) and net
capital gain (the excess of net long-term capital gain over net short-term
capital loss) that is distributed to its Shareholders.
In order to qualify for treatment as a RIC, the Fund must distribute
annually to its Shareholders at least 90% of the sum of its net interest income
excludable from gross income under Section 103(a) of the Internal Revenue Code
("tax-exempt income") plus its investment company taxable income ("Distribution
Requirement") and must meet several additional requirements. Among these
requirements are the following: (1) the Fund must derive at least 90% of its
gross income each taxable year from dividends, interest, payments with respect
to securities loans and gains from the sale or other disposition of securities,
or other income (including gains from options or futures contracts) derived with
respect to its business of investing in securities ("Income Requirement"); (2)
at the close of each quarter of the Fund's taxable year, at least 50% of the
value of its total assets must be represented by cash and cash items, US
government securities, securities of other RICs and other securities, with those
other securities limited, in respect of any one issuer, to an amount that does
not exceed 5% of the value of the Fund's total assets; and (3) at the close of
each quarter of the Fund's taxable year, not more than 25% of the value of its
total assets may be invested in securities (other than US government securities
or the securities of other RICs) of any one issuer. If the Fund fails to qualify
for treatment as a RIC for any taxable year, it would be taxed as an ordinary
corporation on its taxable income for that year (even if that income was
distributed to its Shareholders) and all distributions out of its earnings and
profits would be taxable to its Shareholders as dividends (that is, ordinary
income). Such distributors generally would be eligible for (i) the dividends
received deduction in the case of corporate shareholders, and (ii) treatment as
"qualified dividends" in the case of individual shareholders.
The Fund will be subject to a nondeductible 4% excise tax ("Excise Tax") to
the extent that it fails to distribute by the end of any calendar year at least
98% of the sum of its ordinary income (not including tax-exempt income) for that
year and its capital gain net income for the one-year period ending
35
on October 31 of that year, plus certain other amounts. For these purposes, any
such taxable income retained by the Fund, and on which it pays federal income
tax, will be treated as having been distributed.
Dividends on the shares of each series of APS will be treated as
distributions by the Fund for purposes of determining whether the Fund has
satisfied the Distribution Requirement (and thus will qualify for the deduction
for dividends paid) and for the purposes of the Excise Tax. While shares of the
APS are outstanding, the Fund may not declare any cash dividend or other
distribution on its Common Stock unless, at the time of the declaration, the
Fund satisfies certain dividend payment and asset coverage requirements. See
"Description of APS - Dividends-Restrictions on Dividends and Other Payments."
Any such suspension of distributions on the Common Stock could prevent the Fund
from satisfying the Distribution Requirement and avoiding imposition of the
Excise Tax. Upon any failure by the Fund to meet any of such dividend payment or
asset coverage requirements, however, the Fund currently intends to redeem a
sufficient number of shares of the APS to maintain or restore compliance with
such requirements and thus allow the Fund to make distributions necessary to
satisfy the Distribution Requirement and avoid imposition of the Excise Tax.
The Fund may acquire zero coupon Municipal Obligations issued with original
issue discount. As the holder of such a security, the Fund would have to include
in gross income the original issue discount that accrues on the security for the
taxable year, even if the Fund receives no payment on the security during the
year. Because the Fund annually must distribute at least 90% of its tax-exempt
income, including any accrued original issue discount, to satisfy the
Distribution Requirement, the Fund may be required in a particular year to
distribute as a dividend an amount that is greater than the total amount of cash
it actually receives. Those distributions will be made for the Fund's cash
assets, or from the proceeds of sales of portfolio securities or from
borrowings, if necessary. The Fund may realize taxable capital gains or losses
from those sales, which will increase or decrease the Fund's investment company
taxable income or net capital gain.
HEDGING STRATEGIES. The use of hedging strategies, such as writing and
purchasing options and futures, involves complex rules that will determine for
income tax purposes the character and timing of recognition of certain gains and
losses that the Fund realizes in connection therewith by the Fund. These rules
also may require the Fund to "mark to market" (that is, treat as sold for their
fair market value) at the end of each taxable year certain positions in its
portfolio, which may cause the Fund to recognize income without receiving cash
with which to make distributions necessary to satisfy the Distribution
Requirement and to avoid imposition of the Excise Tax. In that event, the Fund
might have to liquidate securities to enable it to make the required
distributions, which would cause the Fund to recognize gains or losses.
Income from transactions in options and futures derived by the Fund with
respect to its business of investing in securities will qualify as permissible
income under the Income Requirement.
The Fund will monitor its hedging transactions and may make certain tax
elections to mitigate the adverse effects of the foregoing rules.
TAXATION OF SHAREHOLDERS
DIVIDENDS AND OTHER DISTRIBUTIONS. The APS will constitute stock of the Fund,
and thus distributions with respect to the APS (other than distributions in
redemption of APS treated as exchanges of stock under Section 302 of the
Internal Revenue Code) will constitute dividends to the extent of the Fund's
current or accumulated earnings and profits, as calculated for federal income
tax purposes. It is possible that the Internal Revenue Service ("Service") might
take a contrary position, however, asserting, for example, that the APS
constitute debt of the Fund. If this position were upheld, the discussion of the
treatment of distributions below would not apply to holders of the APS. Instead,
distributions by the
36
Fund to those holders would constitute interest, would be included in full in
the recipient's income and would be taxed as ordinary interest income. Counsel
to the Fund believes that such a position, if asserted by the Service, would be
unlikely to prevail.
Distributions that the Fund designates as "exempt-interest dividends"
generally may be excluded from gross income by Shareholders for federal income
tax purposes; those distributions may, however, be taxable for state and local
tax purposes. In addition, exempt-interest dividends are included for purposes
of determining the portion, if any, of a person's social security and railroad
retirement benefits that are includable in gross income. In order to pay
exempt-interest dividends, the Fund must (and intends to) satisfy the
requirement that, at the close of each quarter of its taxable year, at least 50%
of the value of its total assets consists of obligations the interest on which
is tax-exempt.
Interest on indebtedness incurred by a Shareholder to purchase or carry
Fund Shares is not deductible to the extent that interest relates to
exempt-interest dividends received from the Fund. If the Fund invests in certain
PABs, the portion of the Fund's exempt-interest dividends that is attributable
to the interest it earns thereon and that is specified in an annual notice from
the Fund must be included by its Shareholders as an item of tax preference in
calculating their liability for the AMT. Corporate Shareholders, however, must
include all of their exempt-interest dividends in calculating their adjusted
current earnings for purposes of the AMT. Accordingly, an investment in the Fund
may cause Shareholders to be subject to (or result in Shareholders' increased
liability under) the AMT. Because the Fund may from time to time invest as much
as 20% of its net assets in Municipal Obligations bearing income that is taxable
under the AMT, the Fund may not be an appropriate investment for investors who
are subject to the AMT or who would become subject to the AMT by reason of an
investment in the Fund.
Entities or persons who are "substantial users" (or persons related to
"substantial users") of facilities financed by IDBs or PABs should consult their
tax advisers before purchasing Fund Shares because, for users of certain of
these facilities, the interest on such bonds is not exempt from federal income
tax. For these purposes, the term "substantial user" is defined generally to
include a "non-exempt person" who regularly uses in trade or business a part of
a facility financed from the proceeds of IDBs or PABs.
If the Fund invests in instruments that generate taxable interest income,
the portion of any Fund dividend attributable to that interest will be taxable
to its Shareholders as ordinary income to the extent of its earnings and
profits. Distributions of the Fund's net capital gain, if any, will be taxable
to its Shareholders as long-term capital gains, regardless of the length of time
they have held their Fund Shares. For taxable years beginning on or before
December 31, 2008, provided holding period and other requirements are met by
both the Fund and the shareholder, dividends qualifying as "qualified dividend
income" will be taxed in the hands of individuals at the rates applicable to
long-term capital gain. The Fund does not expect a significant portion of Fund
distributions to be derived from qualified dividend income. If, and for so long
as, the Fund has outstanding any series of APS, it will be required to allocate
each particular type of its income for the taxable year (such as tax-exempt
income, net realized capital gains, and other taxable income) between the
classes of shares, Common Stock and APS, in proportion to the total
distributions paid to each such class for that year. The Fund may notify the
Auction Agent of the amount of any net capital gains and other taxable income to
be included in any dividend on the APS prior to the Auction establishing the
Applicable Rate for such dividend; except for any such amount of which the Fund
so notifies the Auction Agent, the Fund anticipates that the dividends paid on
the APS will constitute exempt-interest dividends. It is not expected that any
portion of the Fund's distributions will be eligible for the dividends-received
deduction available for corporations.
37
Although the matter is not free from doubt due to the absence of direct
regulatory or judicial authority, in the opinion of counsel to the Fund the
designation of distributions on the Common Stock and on the APS, in the
proportionate manner described above, as consisting of exempt-interest
dividends, net capital gains and other taxable income will be respected for
federal income tax purposes. Counsel has advised the Fund that, in its opinion,
if the Service were to challenge in court the Fund's designations of income and
gains, and the issue were properly litigated, the Service should not prevail.
The Fund will consider any guidance provided by the Service or the courts as to
the manner in which distributions on the Common Stock and on the APS may be so
designated. In the event of a reallocation, some of the dividends identified by
the Fund as exempt-interest dividends to holders of the APS may be
recharacterized as capital gains or other taxable income. In the event of such
recharacterization, the Fund would not be required to make payments to such
holders to offset the tax effect of such reallocation.
If the Fund makes a Retroactive Taxable Allocation, it will pay Additional
Dividends to holders of any series of APS who are subject to the Retroactive
Taxable Allocation. See "Description of APS - Dividends - Additional Dividends."
The federal income tax consequences of Additional Dividends are uncertain. The
Fund intends to treat a holder as receiving a dividend distribution in the
amount of any Additional Dividend only as and when such Additional Dividend is
paid. An Additional Dividend generally will be designated by the Fund as an
exempt-interest dividend if such designation is allowable under applicable law.
However, the Service may assert that all or part of an Additional Dividend is a
taxable dividend.
Dividends and other distributions declared by the Fund in October, November
or December of any year and payable to Shareholders of record on a date in any
of those months will be deemed to have been paid by the Fund and received by the
Shareholders on December 31 of that year if the distributions are paid by the
Fund during the following January. Accordingly, those distributions will be
taxed to Shareholders for the year in which that December 31 falls.
The Fund will notify its Shareholders following the end of each calendar
year of the amounts of exempt-interest dividends, qualified dividend income (if
any), and taxable dividends and capital gain distributions paid (or deemed paid)
that year and of any portion thereof that is an item of tax preference for
purposes of the AMT.
SALES OF SHARES. Upon a sale, exchange, or other taxable disposition of Shares,
a Shareholder will realize a taxable gain or loss equal to the difference
between his adjusted basis for the Shares and the amount realized. Any such gain
or loss will be treated as a capital gain or loss if the Shares are capital
assets in the Shareholder's hands and will be a long-term capital gain or loss
if the Shares have been held for more than one year. Long-term capital gain
rates applicable to individuals have been temporarily reduced, in general, to
15% (or 5% for individuals in the 10% or 15% rate brackets) for taxable years
beginning on or before December 31, 2008. Any loss realized on a sale or
exchange of Shares that were held for six months or less will be disallowed to
the extent of any exempt-interest dividends received on those Shares and will be
treated as a long-term, rather than as a short-term, capital loss to the extent
of any capital gain distributions received thereon. A loss realized on a sale or
exchange of shares of the APS also will be disallowed to the extent that those
shares are replaced by other shares of a series of APS within a period of 61
days beginning 30 days before and ending 30 days after the date of disposition
of the shares. In that event, the basis of the replacement shares will be
adjusted to reflect the disallowed loss.
BACKUP WITHHOLDING. The Fund is required to withhold 31% of all taxable
dividends, capital gain distributions and repurchase proceeds payable to any
individuals and certain other noncorporate Shareholders who do not provide the
Fund with a correct taxpayer identification number. Withholding at that rate
from taxable dividends and capital gain distributions also is required for
Shareholders who otherwise are subject to backup withholding.
38
RECENT TAX SHELTER REPORTING REGULATIONS. Under recently promulgated Treasury
regulations, if a shareholder recognizes a loss on disposition of the Fund's
shares of $2 million or more for an individual shareholder or $10 million or
more for a corporate shareholder, the shareholder must file with the IRS a
disclosure statement on Form 8886. Direct shareholders of portfolio securities
are in many cases excepted from this reporting requirement, but under current
guidance, shareholders of a RIC are not excepted. Future guidance may extend the
current exception from this reporting requirement to shareholders of most or all
regulated investment companies. The fact that a loss is reportable under these
regulations does not affect the legal determination of whether the taxpayer's
treatment of the loss is proper. Shareholders should consult their tax advisers
to determine the applicability of these regulations in light of their individual
circumstances.
DESCRIPTION OF APS
The following is a brief description of the terms of the shares of each
series of the APS. This description does not purport to be complete and is
subject to and qualified in its entirety by reference to the APS Provisions.
Copies of the APS Provisions are filed as exhibits to the Registration Statement
of which this Prospectus is a part and may be inspected, and copies thereof may
be obtained, as described under "Available Information" in the Prospectus. Terms
used herein and not otherwise defined shall have the meanings ascribed to them
in the Glossary immediately preceding the Appendices hereto.
GENERAL
All shares of each series of APS will have a liquidation preference of
$50,000 per share plus an amount equal to accumulated but unpaid dividends
(whether or not earned or declared). The shares of each series of APS will rank
on a parity with shares of any other series of Preferred Stock (including any
other series of APS) as to the payment of dividends and the distribution of
assets upon liquidation. So long as either Moody's or S&P is rating the shares
of any series of APS, the Fund may, without the vote of the holders of APS,
issue additional series of Preferred Stock, including APS, subject to applicable
provisions of the 1940 Act and to continuing compliance with the 1940 Act APS
Asset Coverage and the APS Basic Maintenance Amount, provided that (1) any such
additional series ranks on a parity with the then outstanding APS as to the
payment of dividends and the distribution of assets upon liquidation and (2) the
Fund obtains written confirmation from Moody's or S&P, or both, as the case may
be, that the issuance of any such additional series would not impair the rating
then assigned by such rating agency to the APS.
The Auction Agent will be the transfer agent, registrar, dividend
disbursing agent and redemption agent for the APS. The share of each series of
APS, when issued and sold through this offering, will be fully paid and
nonassessable, will not be convertible into Common Stock or other stock of the
Fund and will have no preemptive rights. The APS will not be subject to any
sinking fund but will be redeemable in the circumstances described under
"Redemption."
DIVIDENDS
GENERAL. The holders of APS will be entitled to receive, when, as and if
declared by the Board of the Fund, out of funds legally available therefor,
cumulative cash dividends at the Applicable Rate per annum thereof, determined
as set forth below under "Determination of Dividend Rate," and no more (except
as otherwise provided below under "Additional Dividends"), payable on the
respective dates determined as set forth below.
39
Dividends on shares of each series of APS shall accumulate at the
Applicable Rate per annum from the Date of Original Issue and, except as
provided below, shall be payable as described in the Prospectus. After the
Initial Dividend Period, the Fund, subject to certain conditions, may designate
any Subsequent Dividend Period of any series of APS as a Special Dividend Period
which shall be such number of consecutive days or whole years as the Board of
Directors shall specify, subject to certain conditions. Shares of the APS are
redeemable by the Fund as described herein.
If the Fund designates any Subsequent Dividend Period as a Special Dividend
Period, dividends will be payable: (i) with respect to a Special Dividend Period
of less than 35 days, the day after the last day thereof and (ii) with respect
to a Special Dividend Period of 35 days or more, the first Business Day of each
calendar month thereafter, provided that in any calendar month in which an
Auction Date is scheduled to occur, dividends shall be payable on the first
Business Day next succeeding such Auction Date.
After any Special Dividend Period, dividends on shares of each series of
APS shall be payable, except as described below, as provided in the second
preceding paragraph above, subject to the option of the Fund to further
designate from time to time any Subsequent Dividend Period of a series as a
Special Dividend Period.
In the case of dividends that otherwise would be payable as set forth
above, if (i) the Sunday, Monday or Tuesday that would otherwise be the Dividend
Payment Date is not a Business Day, then dividends shall be payable on the first
Business Day that falls after such Sunday, Monday or Tuesday, or (ii) the
Wednesday, Thursday, Friday or Saturday that would otherwise be the Dividend
Payment Date is not a Business Day, then dividends shall be payable on the first
Business Day that falls prior to such Wednesday, Thursday, Friday or Saturday.
Each dividend on the APS will be paid on the Dividend Payment Date therefor
to the Securities Depository to pay to the holders of record as their names
appear on the registry of Existing Holders of the Securities Depository 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 books of the Fund on such date, not exceeding 15 days preceding the
payment date thereof, as may be fixed by the Board of the Fund.
The Securities Depository, in accordance with its current procedures, is
expected to credit on each Dividend Payment Date dividends received from the
Fund to the accounts of the respective Agent Members in next-day funds. Each of
the initial Broker-Dealers, however, has represented to the Fund that such
Broker-Dealer (or if such Broker-Dealer does not act as Agent Member, one of its
affiliates) will make such dividend payments available in same-day funds on each
Dividend Payment Date to customers that use such Broker-Dealer or affiliate as
Agent Member. A holder of APS that does not use one of the initial
Broker-Dealers or an affiliate thereof as its Agent Member should contact the
Agent Member used by such holder to determine whether such Agent Member will
make dividend payments available to such holder in next-day or same-day funds.
If any Agent Member does not make such dividends available in same-day funds to
a holder, such holder who uses such Agent Member would not have same-day funds
available to it until the next Business Day, which, in the case of dividends
payable on a Friday, would be the following Monday if it is a Business Day.
DETERMINATION OF DIVIDEND RATE. The dividend rate on shares of any series
of APS during the period from and after the Date of Original Issue thereof to
and including the last day of the Initial Dividend Period therefor will be equal
to the rate per annum set forth with respect to such series on the inside cover
page of the Prospectus. For each Subsequent Dividend Period of any series of APS
40
outstanding thereafter, the dividend rate on shares of such series will be equal
to the rate per annum, except as provided below, that results from an Auction on
the Auction Date next preceding such Subsequent Dividend Period.
If an Auction for any Subsequent Dividend Period of any series of APS is
not held for any reason or if the Fund fails to pay in a timely manner to the
Auction Agent the full amount of any dividend on, or Redemption Price of, shares
of any series of APS and such failure has not been cured as set forth below
prior to any succeeding Subsequent Dividend Period thereof, then, subject to the
next succeeding paragraph, the dividend rate on the shares of such series for
any such Subsequent Dividend Period will be the Maximum Rate for such series of
APS on the Auction Date for such Subsequent Dividend Period.
If the Fund fails to pay in a timely manner to the Auction Agent the full
amount of any dividend on, or the Redemption Price of, any shares of any series
of APS during any Rate Period thereof, and, prior to 12:00 Noon on the third
Business Day next succeeding the date on which such failure occurred, such
failure shall not have been cured in accordance with the next succeeding
paragraph or the Fund shall not have paid to the Auction Agent a late charge
equal to the sum of: (1) if such failure consisted of the failure timely to pay
the Auction Agent the full amount of dividends with respect to any Dividend
Period on the shares of such series, an amount computed by multiplying (x) 200%
of the Reference Rate (or Treasury Rate, if applicable) for the Rate Period
during which such failure occurs on the Dividend Payment Date for such Dividend
Period by (y) a fraction, the numerator of which shall be the number of days for
which such failure has not been cured in accordance with the next succeeding
paragraph (including the day such failure occurs and excluding the day such
failure is cured) and the denominator of which shall be 365, and applying the
rate obtained against the aggregate liquidation preference of the outstanding
shares of such series of APS; and (2) if such failure consisted of the failure
timely to pay to the Auction Agent the Redemption Price of the shares of such
series of APS, if any, for which notice of redemption has been given by the
Fund, an amount computed by multiplying (x) 200% of the Reference Rate (or
Treasury Rate, if applicable) for the Rate Period during which such failure
occurs on the redemption date by (y) a fraction, the numerator of which shall be
the number of days for which such failure is not cured in accordance with the
next succeeding paragraph (including the day such failure occurs and excluding
the day such failure is cured) and the denominator of which shall be 365, and
applying the rate obtained against the aggregate liquidation preference of the
outstanding shares of such series of APS to be redeemed, then Auctions for such
series will be suspended until such failure is so cured and the dividend rate
for shares of such series of APS for each Subsequent Dividend Period thereof
commencing after such failure to and including the Subsequent Dividend Period,
if any, during which such failure is so cured shall be a rate PER ANNUM equal to
the Maximum Rate on the Auction Date for such Subsequent Dividend Period (but
with the prevailing rating for such shares, for purposes of determining such
Maximum Rate, being deemed to be "Below "ba3"/BB-").
Any such failure with respect to shares of any series of APS shall have
been cured (if such failure is not solely due to the willful failure of the Fund
to make the required payment to the Auction Agent) with respect to any Rate
Period if, not later than 12:00 Noon Eastern time on the fourth Business Day
preceding the Auction Date for the Rate Period subsequent to such Rate Period,
the Fund shall have paid to the Auction Agent (i) all accumulated and unpaid
dividends on the shares of such series of APS and (ii) without duplication, the
Redemption Price for the shares of such series of APS, if any, for which notice
of redemption has been given by the Fund.
For the purposes of the foregoing, "'AA' Composite Commercial Paper Rate,"
on any date for any Rate Period, means:
(i) (A) in the case of any Minimum Dividend Period or any Rate Period
of between 7 and 35 days, the interest equivalent of the 30-day rate;
provided, however, in the case of any
41
Minimum Dividend Period of 7 days or any Rate Period with 7 days, and if
the "A" Composite Commercial Paper Rate is being used to determine the
Applicable Rate when all of the outstanding APS of a series are subject to
Submitted Hold Orders, then the interest equivalent of the 7-day rate, and
(B) in the case of any Rate Period with more than 35 days, the interest
equivalent of the 180-day rate, on commercial paper placed on behalf of
issuers whose corporate bonds are rated "AA" by S&P or the equivalent of
such rating by S&P or another rating agency, as made available on a
discount basis or otherwise by the Federal Reserve Bank of New York for the
Business Day immediately preceding such date; or
(ii) in the event that the Federal Reserve Bank of New York does not
make available any such rate, then the arithmetic average of such rates, 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 next
preceding such date.
If any Commercial Paper Dealer does not quote a rate required to determine the
"AA" Composite Commercial Paper Rate, the "AA" Composite Commercial Paper Rate
shall be determined on the basis of the quotation or quotations furnished by the
remaining Commercial Paper Dealer or Commercial Paper Dealers and any Substitute
Commercial Paper Dealer or Substitute Commercial Paper Dealers selected by the
Fund to provide such rate or rates not being supplied by any Commercial Paper
Dealer or Commercial Paper Dealers, as the case may be, or, if the Fund does not
select any such Substitute Commercial Paper Dealer or Substitute Commercial
Paper Dealers, by the remaining Commercial Paper Dealer or Commercial Paper
Dealers. For purposes of this definition, the "interest equivalent" of a rate
stated on a discount basis (a "discount rate") for commercial paper of a given
days' maturity shall be equal to the quotient (rounded upwards to the next
higher one-thousandth (.001) of 1%) of (A) the discount rate divided by (B) the
difference between (x) 1.00 and (y) a fraction the numerator of which shall be
the product of the discount rate times the number of days in which such
commercial paper matures and the denominator of which shall be 360. As used
herein, "Commercial Paper Dealers" means Goldman Sachs Money Markets, L.P.,
Lehman Commercial Paper Incorporated, Merrill Lynch, Pierce Fenner & Smith
Incorporated and Smith Barney or, in lieu of any thereof, their respective
affiliates or successors, if such entity is a commercial paper dealer. As used
herein, "Substitute Commercial Paper Dealer" means Credit Suisse First Boston
LLC, Morgan Stanley & Co. Incorporated or their respective affiliates or
successors, if such entity is a commercial paper dealer, provided that none of
such entities shall be a Commercial Paper Dealer.
"Taxable Equivalent of the Short-Term Municipal Bond Rate" on any date
means 90% of the quotient of (a) the per annum rate expressed on an Interest
Equivalent basis equal to the Kenny S&P 30-day High Grade Index or any successor
index (the "Kenny Index"), made available for the Business Day immediately
preceding such date but in any event not later than 8:30 a.m., Eastern time, on
such date by Kenny Information Systems Inc. or any successor thereto, (provided
that the use of such successor will not result in a reduction or withdrawal of
the rating of the APS by Moody's, if Moody's is then rating the APS, or by S&P,
if the S&P is then rating the APS) based on 30-day yield evaluations at par of
bonds, the interest on which is excludable for regular federal income tax
purposes, of "high grade" component issuers selected by Kenny Information
Systems Inc. or any such successor from time to time in its discretion, which
component issuers shall include, without limitation, issuers of general
obligation bonds but shall exclude any bonds the interest on which constitutes
an item of tax preference under section 57(a)(5) of the Internal Revenue Code or
successor provisions, for purposes of the AMT, divided by (b) 1.00 minus the
Marginal Tax Rate (expressed as a decimal); provided, however, that if the Kenny
Index is not made so available by 8:30 a.m., Eastern time, on such date by Kenny
Information Systems Inc. or any successor the Taxable Equivalent of the
Short-Term Municipal Bond Rate shall mean the quotient of (i) the per annum rate
expressed on an Interest Equivalent basis equal to the most recent Kenny Index
so made available for any preceding Business Day, divided by (ii) 1.00 minus the
Marginal Tax Rate (expressed as a decimal).
42
For the purposes of the foregoing, "Treasury Rate," on any date for any
Rate Period, means:
(i) the yield on the most recently auctioned non-callable direct
obligations of the US Government (excluding "flower" bonds) with a remaining
maturity within three months of the duration of such Rate Period, as quoted in
THE WALL STREET JOURNAL on such date for the Business Day next preceding such
date; or
(ii) in the event that any such rate is not published by THE WALL STREET
JOURNAL, then the arithmetic average of the yields (expressed as an interest
equivalent in the case of a Rate Period which is one year or less and expressed
as a bond equivalent in the case of any longer Rate Period) on the most recently
auctioned non-callable direct obligations of the US Government (excluding
"flower" bonds) with a remaining maturity within three months of the duration of
such Rate Period as quoted on a discount basis or otherwise by the US Government
Securities Dealers to the Auction Agent for the close of business on the
Business Day immediately preceding such date.
If any US Government Securities Dealer does not quote a rate required to
determine the Treasury Rate, the Treasury Rate shall be determined on the basis
of the quotation or quotations furnished by the remaining US Government
Securities Dealer or US Government Securities Dealers and any Substitute US
Government Securities Dealers selected by the Fund to provide such rate or rates
not being supplied by any US Government Securities Dealer or US Government
Securities Dealers, as the case may be, or, if the Fund does not select any such
Substitute US Government Securities Dealer or Substitute US Government
Securities Dealers, by the remaining US Government Securities Dealer or US
Government Securities Dealers. As used herein, "US Government Securities Dealer"
means Goldman, Sachs & Co., Smith Barney, and Morgan Guaranty Trust Company of
New York or their respective affiliates or successors, if such entity is a US
Government securities Dealer. As used herein, "Substitute US Government
Securities Dealer" shall mean Credit Suisse First Boston LLC and Merrill Lynch,
Pierce, Fenner & Smith Incorporated or their respective affiliates or
successors, if such entity is a US Government securities dealer, provided that
none of such entities shall be a US Government Securities Dealer.
Except as set forth in the next sentence, no dividends shall be declared or
paid or set apart for payment on the shares of any class or series of shares of
the Fund" capital stock ranking, as to the payment of dividends, on a parity
with the APS for any period unless full cumulative dividends have been or
contemporaneously are declared and paid on the shares of each series of APS
through its most recent Dividend Payment Date. When dividends are not paid in
full upon the APS through the most recent respective Dividend Payment Dates or
upon the shares of any other class or series of shares of the Fund's capital
stock ranking on a parity as to the payment of dividends with the APS through
the most recent respective Dividend Payment Dates, all dividends declared upon
the APS and any other such class or series of stock ranking on a parity as to
the payment of dividends with the APS shall be declared PRO RATA so that the
amount of dividends declared per share on the APS and such other class or series
of shares shall in all cases bear to each other the same ratio that accumulated
dividends per share on the APS and such other class or series of stock bear to
each other (for purposes of this sentence, the amount of dividends declared per
share shall be based on the Applicable Rate for such shares for the Dividend
Periods during which dividends were not paid in full). Holders of the APS shall
not be entitled to any dividend, whether payable in cash, property or capital
shares, in excess of full cumulative dividends, as provided in the APS
Provisions, on the APS. No interest, or sum of money in lieu of interest, will
be payable in respect of any dividend payment or payments on the APS which may
be in arrears, and, except as otherwise provided herein, no additional sum of
money will be payable in respect of any such arrearage.
43
The amount of dividends per share payable on shares of any series of APS on
any date on which dividends shall be payable on such shares shall be computed by
multiplying the respective Applicable Rate for such series in effect for such
Dividend Period or Dividend Periods or parts thereof for which dividends have
not been paid by a fraction, the numerator of which shall be the number of days
in such Dividend Period or Dividend Periods or parts thereof and the denominator
of which shall be 365 if such Dividend Period is a Rate Period of less than 1
year and 360 for all other Rate Periods, and applying the rate obtained against
$50,000. Any dividend payment made on the APS shall first be credited against
the earliest accumulated but unpaid dividends due with respect to such APS.
DESIGNATION OF SPECIAL DIVIDEND PERIODS. The Fund, at its option, may designate
any succeeding Subsequent Dividend Period of any series of APS as a Special
Dividend Period which shall consist of such number of days or whole years as the
Board of Directors shall specify; provided, however, that such designation shall
be effective only if (i) notice thereof shall have been given as provided
herein, ,(ii) any failure to pay in a timely manner to the Auction Agent the
full amount of any dividend on, or the Redemption Price of, Series E and Series
F shares of the APS shall have been cured as set forth above under "Dividends --
Determination of Dividend Rate," (iii) Sufficient Clearing Bids for such series
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 of such series, as
described under "Redemption -- Notice of Redemption" below, the Redemption Price
with respect to such shares shall have been deposited with the Auction Agent,
and (v) in the event the Fund wishes to designate any succeeding Subsequent
Dividend Period for such series as a Special Dividend Period consisting of more
than 28 days, the Fund has received written confirmation from S&P (if S&P is
then rating the APS) and Moody's (if Moody's is then rating the APS) that such
designation would not affect the rating then assigned by S&P and Moody's,
respectively, to such series.
If the Fund proposes to designate any succeeding Subsequent Dividend Period
of any series of APS as a Special Dividend Period of more than 28 days, not less
than 20 nor more than 30 days prior to the date the Fund proposes to designate
as the first day of such Special Dividend Period (which shall be such day that
would otherwise be the first day of a Minimum Dividend Period), notice shall be
(i) published or caused to be published by the Fund in a newspaper of general
circulation to the financial community in the City of New York, New York, which
carries financial news, 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 may exercise its option to designate a
succeeding Subsequent Dividend Period of such series of APS as a Special
Dividend Period, specifying the first day thereof and (B) that the Fund will by
11:00 A.M., Eastern time, on the second Business Day next preceding such date
notify the Auction Agent, who will promptly notify the Broker-Dealers, of either
(x) its determination, subject to certain conditions, to exercise such option,
in which case the Fund shall specify the Special Dividend Period designated and
the terms of the Specific Redemption Provisions, if any, or (y) its
determination not to exercise such option.
No later than 11:00 A.M., Eastern 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,
either:
(i) a notice stating (A) that the Fund has determined to designate the
next succeeding Rate Period of such series as a Special Dividend Period,
specifying the same and the first day thereof, (B) the Auction Date immediately
prior to the first day of such Special Dividend Period, (C) the terms of the
Specific Redemption Provisions, if any, (D) that such Special Dividend Period
shall not commence if (1) on such Auction Date Sufficient Clearing Bids for such
series shall not exist (in which case the succeeding Rate Period shall be a
Minimum Dividend Period) or (2) the Fund shall have failed to pay in a timely
manner to the Auction Agent the full amount of any dividend on, or the
Redemption Price of,
44
shares of APS Series E and F, as set forth above under "Dividends --
Determination of Dividend Rate," prior to the first day of such Special Dividend
Period with respect to shares of such series of APS and (E) the scheduled
Dividend Payment Dates for such series of APS during such Special Dividend
Period; provided, that, if the proposed Special Dividend Period consists of more
than 28 days, such notice will be accompanied by an APS Basic Maintenance Report
showing, as of the third Business Day next preceding such proposed Special
Dividend Period, (1) a Discounted Value of Moody's Eligible Assets, assuming for
purposes of calculating such Discounted Value in connection with an APS Basic
Maintenance Report required to be prepared pursuant to the APS Provisions, a
Moody's Exposure Period of "eight weeks or less but greater than seven weeks"
(if Moody's is then rating such series) and (2) a Discounted Value of S&P
Eligible Assets (if S&P is then rating such series), each at least equal to APS
Basic Maintenance Amount as of such Business Day (assuming for purposes of the
foregoing calculation that the Maximum Rate is the Maximum Rate on such Business
Day as if such Business Day were the Auction Date for the proposed Special
Dividend Period); or
(ii) a notice stating that the Fund has determined not to exercise its
option to designate a Special Dividend Period for such series that the next
succeeding Rate Period of such series shall be a Minimum 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 by 11:00 A.M.,
Eastern 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 Special Dividend Period to the
effect set forth in clause (ii) above.
RESTRICTIONS ON DIVIDENDS AND OTHER PAYMENTS. Under the 1940 Act, ,the Fund may
not declare dividends (other than dividends payable in Common Stock) or other
distributions with respect to Common Stock or purchase any such shares if, at
the time of the declaration or purchase, as applicable (and after giving effect
thereto), asset coverage (as defined in and determined pursuant to the 1940 Act)
with respect to the outstanding Preferred Stock, including the APS, would be
less than 200% (or such other percentage as may in the future be required by
law).
In addition, for so long as any of the APS are outstanding, except as
otherwise set forth herein, (A) the Fund may not declare, pay or set apart for
payment any dividend or other distribution (other than a dividend or other
distribution paid in shares of, or options, warrants or rights to subscribe for
or purchase, Common Stock or other capital stock of the Fund, if any, ranking
junior to the APS as to the payment of dividends and the distribution of assets
upon liquidation) in respect of Common Stock or any other stock of the Fund
ranking junior to or on a parity with the APS as to the payment of dividends or
the distribution of assets upon liquidation, or call for redemption, redeem,
purchase or otherwise acquire for consideration any Common Stock or any other
such junior stock (except by conversion into or exchange for stock of the Fund
ranking junior to or on a parity with the APS as to the payment of dividends and
the distribution of assets upon liquidation), or any such parity stock (except
by conversion into or exchange for capital shares of the Fund ranking junior to
or on a parity with the APS as to the payment of dividends and the distribution
of assets upon liquidation), unless (1) full cumulative dividends on shares of
each series of APS through its most recently ended Dividend Period shall have
been paid or shall have been declared and sufficient funds for the payment
thereof deposited with the Auction Agent and (2) the Fund has redeemed the full
number of shares of each series of APS required to be redeemed by any provision
for mandatory redemption contained in the APS Provisions, and (B) if either
Moody's or S&P is rating the APS, the Fund may 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 Stock or other shares, if any, ranking junior to the APS as
to the payment of dividends and the distribution of assets upon liquidation) in
respect of Common Stock or any other shares of the Fund
45
ranking junior to the APS as to the payment of dividends or the distribution of
assets upon liquidation, or call for redemption, redeem, purchase or otherwise
acquire for consideration any shares of Common Stock or any other such junior
stock (except by conversion into or exchange for stock of the Fund ranking
junior to the APS as to the payment of dividends or the distribution of assets
upon liquidation), unless immediately after such transaction the Discounted
Values of the Moody's Eligible Assets and of the S&P Eligible Assets would each
at least equal the APS Basic Maintenance Amount. See "Investment Objective and
Policies--Rating Agency Guidelines." "Assets Maintenance" and "Redemption."
Under the Internal Revenue Code, the Fund must, among other things,
distribute at least 90% of the sum of its investment company taxable income and
its net tax-exempt income each year in order to maintain its qualification for
tax treatment as a RIC. The foregoing limitations on dividends, other
distributions and purchases may in certain circumstances impair the Fund's
ability to maintain such qualification. The Fund currently intends, however, to
exercise its optional redemption rights to redeem a portion of the APS when
necessary to preserve such qualification. See "Taxation."
ADDITIONAL DIVIDENDS. If the Fund retroactively allocates any net capital gains
or other income taxable for federal income tax purposes to the APS by reason of
the fact that such allocation is made as a result of (i) the realization of net
capital gains or other income taxable for federal income tax purposes, (ii) the
redemption of all or a portion of the outstanding APS or (iii) the liquidation
of the Fund (such allocation is referred to herein as a "Retroactive Taxable
Allocation"), the Fund will simultaneously, if practicable, with such allocation
but in no event later than 270 days after the end of the Fund's taxable year for
which a Retroactive Taxable Allocation is made, provide notice thereof to the
Auction Agent and to each holder of APS (initially ___________, as nominee of
________) during such taxable year at such holder's address as the same appears
or last appeared on the stock books of the Fund. The Fund will, within 30 days
after such notice is given to the Auction Agent, pay to the Auction Agent (who
will then distribute to such holders of shares APS), out of funds legally
available therefor, an amount equal to the aggregate Additional Dividends (as
defined below) with respect to all Retroactive Taxable Allocations made to such
holders for the taxable year in question. See "Taxation."
"Additional Dividends" means the payment to a holder of APS of an amount
which, when taken together with the aggregate amount of Retroactive Taxable
Allocations made to such holder with respect to the taxable year in question,
would cause such holder's dividends in dollars (after federal income tax
consequences as described below) from the aggregate of both the Retroactive
Taxable Allocations and the Additional Dividends to be equal to the dollar
amount of the dividends which would have been received by such holder if the
amount of the aggregate Retroactive Taxable Allocations would have been
excludable from the gross income of such holder. State taxes imposed on the
Additional Dividends, however, may reduce the amount of after tax cash a holder
would have had if there were no Retroactive Taxable Allocation. Such Additional
Dividends shall be calculated (i) without consideration being given to the time
value of money; (ii) assuming that no holder of APS is subject to the AMT with
respect to dividends received from the Fund; and (iii) assuming that each
Retroactive Taxable Allocation would be taxable in the hands of each holder of
APS at the maximum marginal regular federal individual income tax rate
applicable to ordinary income or net capital gain, as applicable, or the maximum
marginal regular federal corporate income tax rate, whichever if greater, in
effect during the taxable year in question.
ASSET MAINTENANCE
1940 ACT APS ASSET COVERAGE. The Fund will be required under the APS
Provisions to maintain, with respect to the APS, as of the last Business Day of
each month in which any APS are outstanding, asset coverage of at least 200%
with respect to senior securities which are stock, including APS (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
46
declaring dividends on its common stock). If the Fund fails to maintain such
asset coverage in accordance with the requirements of the rating agency or
agencies then rating the APS ("1940 Act APS Asset Coverage") and such failure is
not cured as of the last Business Day of the following month ("1940 Act Cure
Date"), the Fund will be required in certain circumstances to redeem certain of
the shares of APS. See "Redemption" below.
APS BASIC MAINTENANCE AMOUNT. So long as any APS are outstanding, the Fund
will be required under the APS Provisions to maintain as of each Business Day (a
"Valuation Date") assets having in the aggregate a Discounted Value at least
equal to the APS Basic Maintenance Amount established by the rating agency or
agencies then rating the APS. If the Fund fails to meet such requirement on any
Valuation Date and such failure is not cured on or before the third Business Day
after such Valuation Date ("APS Basic Maintenance Cure Date"), the Fund will be
required in certain circumstances to redeem certain of the shares of APS. See
"Redemption" below.
The "APS Basic Maintenance Amount" as of any Valuation Date is defined as
the dollar amount equal to the sum of:
A. (i) the product of the number of APS outstanding on such date
multiplied by $50,000;
(ii) the aggregate amount of dividends that will have accumulated at
the Applicable Rate (whether or not earned or declared) to (but not
including) the respective first Dividend Payment Dates for each of the APS
outstanding that follow such Valuation Date (or to the 47th day after such
Valuation Date, if such 47th day is earlier than the first following
Dividend Payment Date);
(iii) the amount equal to the Projected Dividend Amount (based on the
number of APS outstanding on such date);
(iv) the amount of anticipated Fund expenses for the 90 days
subsequent to such Valuation Date;
(v) the amount of the Fund's Maximum Potential Additional Dividends
Liability as of such Valuation Date;
(vi) the amount of any premium payable pursuant to a Premium Call
Period; and
(vii) any current liabilities as of such Valuation Date to the extent
not reflected in any of (A)(i) through (A)(vi) (including, without
limitation, any amounts described below as required to be treated as
liabilities in connection with the Fund's transactions in futures and
options and including any payables for Municipal Obligations purchased as
of such Valuation Date) less
B. either (i) the face value of any Fund assets irrevocably deposited by
the Fund for the payment of any (A)(i) through (A)(vii) if such assets mature
prior to or on the date of payment of the liability for which such assets are
deposited and are either securities issued or guaranteed by the United States
Government or have a rating assigned by Moody's of P-1, VMIG-1 or MIG-1 (or,
with respect to S&P, SP-1 + or A-1 +) or (ii) the Discounted Value of such
assets.
For purposes of the foregoing, "Maximum Potential Additional Dividends
Liability," as of any Valuation Date, means the aggregate amount of Additional
Dividends that would be due if the Fund were to make Retroactive Taxable
Allocations, with respect to any taxable year, estimated based upon dividends
paid
47
and the amount of undistributed realized net capital gains and other taxable
income earned by the Fund, as of the end of the calendar month immediately
preceding such Valuation Date, ,and assuming such Additional Dividends are fully
taxable.
For purposes of the APS Basic Maintenance Amount in connection with S&P's
ratings of the APS, with respect to any transactions by the Fund in futures
contracts, the Fund shall include as liabilities (i) 30% of the aggregate
settlement value, as marked to market, of any outstanding futures contracts
based on the Municipal Index which are owned by the Fund plus (ii) 25% of the
aggregate settlement value, as marked to market, of any outstanding futures
contracts based on Treasury Bonds which contracts are owned by the Fund. For
purposes of the APS Basic Maintenance Amount in connection with Moody's rating
of the APS, with respect to any transactions by the Fund in securities
operations, the Fund shall include as liabilities (i) 10% of the exercise price
of a call option written by the Fund and (ii) the exercise price of any written
put option.
The Discount Factors and guidelines for determining the market value of the
Fund's portfolio holdings, described above under the heading "Investment
Objective and Policies -- Rating Agency Guidelines," have been based on criteria
established in connection with rating each series of APS. These factors include,
but are not limited to, the sensitivity of the market value of the relevant
assets to changes in interest rates, the liquidity and depth of the market for
the relevant asset, the credit quality of the relevant asset (for example, the
lower the rating of a debt obligation, the higher the related discount factor)
and the frequency with which the relevant asset is marked to market. In no event
shall the Discounted Value of any asset of the Fund exceed its unpaid principal
balance or face amount as of the date of calculation. The Discount Factors
relating to any asset of the Fund and the APS Basic Maintenance Amount, the
assets eligible for inclusion in the calculation of the Discounted Value of the
Fund's portfolio and certain definitions and methods of calculation relating
thereto may be changed from time to time by the Fund without approval of the
holders of the APS, but only in the event the Fund receives written confirmation
from the appropriate rating agency that any such change would not impair the
rating then assigned to the APS by such rating agency. A rating agency's
Discount Factors and guidelines will apply to the APS so long as such rating
agency is rating the APS.
On or before 5:00 P.M., Eastern time, on the third Business Day after a
Valuation Date on which the Fund fails to maintain a Discounted Value of Moody's
Eligible Assets or S&P Eligible Assets in an amount greater than or equal to the
APS Basic Maintenance Amount, and on the third Business Day after the APS Basic
Maintenance Cure Date with respect to such Valuation Date, the Fund is required
to deliver to the Auction Agent (so long as either Moody's or S&P is rating the
APS) a report with respect to the calculation of the APS Basic Maintenance
Amount and the value of its portfolio holdings as of the date of such failure or
such cure date, as the case may be ("APS Basic Maintenance Report"). The Fund
will also deliver an APS Basic Maintenance Report to S&P (if S&P is then rating
the APS) and Moody's (if Moody's is then rating the APS) on a monthly basis
[check] and: (i) on any Valuation Date on which the Discounted Value of Moody's
Eligible Assets or S&P Eligible Assets, as the case may be, is greater than the
APS Basic Maintenance Amount by 5% or less or (ii) on any date on which the Fund
redeems Common Stock. Within ten Business Days after delivery of such report
relating to the last Business day of each [month], the Fund will deliver a
letter prepared by the Fund's independent accountants regarding the accuracy of
the calculations made by the Fund in its most recent APS Basic Maintenance
Report. If any such letter prepared by the Fund's independent accountants shows
that an error was made in the most recent APS Basic Maintenance Report, the
calculation or determination made by the Fund's independent accountants will be
conclusive and binding on the Fund.
48
MINIMUM LIQUIDITY LEVEL
Pursuant to S&P guidelines, so long as S&P is rating the APS, the Fund will
be required under the APS Provisions to have, as of each Valuation Date, Deposit
Securities with maturity or tender dates not later than the days preceding the
first respective Dividend Payment Dates (collectively "Dividend Coverage
Assets") for each share of each series of APS outstanding that follow such
Valuation Date and having a value not less than the Dividend Coverage Amount
(the "Minimum Liquidity Level"). So long as S&P is rating the APS, if, as of
each Valuation Date, the Fund does not have the required Dividend Coverage
Assets, ,the Fund will, as soon as practicable, adjust its portfolio in order to
meet the Minimum Liquidity Level. The "Dividend Coverage Amount," as of any
Valuation Date, means (A) the aggregate amount of dividends that will accumulate
on each share of APS to (but not including) the first Dividend Payment Date for
each share of APS outstanding that follows such Valuation Date plus any
liabilities that will become payable prior to or on such payment date; less (B)
the combined value of Deposit Securities irrevocably deposited for the payment
of dividends on the APS and Receivables for Municipal Obligations Sold which
become due prior to the Dividend Payment Date and interest with respect to
Municipal Obligations which is payable to the Fund prior to the Dividend Payment
Date. "Deposit Securities" generally means cash and Municipal Obligations rated
at least A-1+ or SP-1+ by S&P. The definitions of "Deposit Securities,"
"Dividend Coverage Assets" and "Dividend Coverage Amount" may be changed from
time to time by the Fund without approval of the holders of the APS, but only in
the event the Fund receives written confirmation from S&P that any such change
would not impair the rating then assigned by S&P to the APS.
REDEMPTION
OPTIONAL REDEMPTION. After the Initial Dividend Period, and upon giving a
notice of redemption, as provided below, the Fund at its option may redeem
shares of APS Series E and F, in whole or in part, on the second Business Day
next preceding any Dividend Payment Date applicable to those shares of APS
called for redemption, out of funds legally available therefor, at the Optional
Redemption Price; provided that, during a Special Dividend Period of 365 days or
more, none of the APS will be subject to optional redemption during any Non-Call
Period. Also, shares of any series of APS may not be redeemed in part if after
such partial redemption fewer than 250 shares of such series remain outstanding.
If fewer than all of the outstanding shares of any series of APS are to be
redeemed as set forth above, the number of shares of such series to be redeemed
shall be determined by the Board, and such shares shall be redeemed PRO RATA
from the holders of record of such series (initially _________ , with respect to
APS Series E and F, as nominee of the Securities Depository) in proportion to
the number of such shares held by such holders. Since the nominee of the
Securities Depository is the only record holder of shares of a series of APS,
the Securities Depository will determine the number of shares to be redeemed
from the account of the Agent Member of each beneficial owner. An Agent Member
may determine to redeem shares from some beneficial owners (which may include an
Agent Member holding shares for its own account) without redeeming shares from
the accounts of other beneficial owners.
The Fund may not give a notice of redemption relating to an optional
redemption as described above unless, on the date on which the Fund intends to
give such notice, (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 APS by reason of the redemption of such
APS on such redemption date and (b) the Fund would have assets with an aggregate
Discounted Value at least equal to the APS Basic Maintenance Amount immediately
subsequent to such redemption, if such redemption were to occur on such date,
and on the date of redemption.
49
MANDATORY REDEMPTION. The Fund will be required to redeem, at the Mandatory
Redemption Price, certain of the APS to the extent permitted under the 1940 Act
and Maryland law, if the Fund fails to maintain a Discounted Value of Moody's
Eligible Assets or S&P Eligible Assets in an amount greater than or equal to the
APS Basic Maintenance Amount or fails to maintain the 1940 Act APS Asset
Coverage and such failure is not cured on or before the APS Basic Maintenance
Cure Date or the 1940 Act Cure Date (herein respectively referred to as a "Cure
Date"), as the case may be. The number of APS to be redeemed will be equal to
the lesser of (a) the minimum number of APS the redemption of which, if deemed
to have occurred immediately prior to the opening of business on the Cure Date,
together with all other Preferred Stock subject to redemption or retirement,
would result in the satisfaction of the APS Basic Maintenance Amount or the 1940
Act APS Asset Coverage, as the case may be, on such Cure Date (provided that, if
there is no such minimum number of APS and other Preferred Stock the redemption
of which would have such result, all of the APS and Preferred Stock then
outstanding will be redeemed), and (b) the maximum number of APS, together with
all other Preferred Stock subject to redemption or retirement, that can be
redeemed out of funds expected to be legally available therefor. In determining
the APS required to be redeemed in accordance with the foregoing, the Fund will
allocate the number required to be redeemed to satisfy the APS Basic Maintenance
Amount or the 1940 Act APS Asset Coverage, as the case may be, PRO RATA among
each series of APS and other Preferred Stock subject to redemption provisions
similar to those contained in this paragraph.
The Fund is required to effect such a mandatory redemption not earlier than
20 days and not later than 40 days after such Cure Date, except that if the Fund
does not have funds legally available for the redemption of all of the required
number of APS and other Preferred Stock which are subject to mandatory
redemption or the Fund otherwise is unable to effect such redemption on or prior
to 40 days after such Cure Date, the Fund will redeem those shares of APS and
other Preferred Stock which it was unable to redeem on the earliest practicable
date on which it is able to effect such redemption. If fewer than all of the
outstanding shares of any series of APS are to be redeemed pursuant to a
mandatory redemption, the number of shares of such series 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, in the same manner as described in above in
respect of optional redemptions of fewer than all outstanding shares of any
series of APS.
NOTICE OF REDEMPTION. The Fund is required to give 30 days' Notice of
Redemption. In the event the Fund obtains appropriate exemptive or no-action
relief from the SEC, which is not assured, the number of days' notice required
for a mandatory redemption may be reduced by the Board of the Fund to as few as
two Business Days if Moody's and S&P each has agreed in writing that the revised
notice provision would not adversely affect its then-current ratings of the APS.
The Auction Agent will use its reasonable efforts to provide telephonic notice
to each holder of APS called for redemption not later than the close of business
on the Business Day on which the Auction Agent determines the shares to be
redeemed (as described above) (or, during the occurrence of a Failure to Deposit
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 telephonic notice will be confirmed
promptly in writing not later than the close of business on the third Business
Day preceding the redemption date by notice sent by the Auction Agent to each
holder of record of APS called for redemption, the Broker-Dealers and the
Securities Depository. Every Notice of Redemption and other redemption notice
with respect to APS will state: (1) the redemption date, (2) the number of
shares of each series of APS to be redeemed, (3) the redemption price, (4) that
dividends on the APS to be redeemed will cease to accumulate as of such
redemption date and (5) the provision of the APS Provisions pursuant to which
such shares are being redeemed. No defect in the Notice of Redemption or other
redemption notice or in the transmittal or the mailing thereof will affect the
validity of the redemption proceedings, except as required by applicable law. If
fewer than all shares of any series held
50
by any holder are to be redeemed, the Notice of Redemption mailed to such holder
shall also specify the number of shares of such series to be redeemed from such
holder.
OTHER REDEMPTION PROCEDURES. 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, such redemption will be made as soon as
practicable to the extent such funds become available. Failure to redeem APS
will 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 with the Auction Agent the Optional Redemption Price or Mandatory
Redemption Price, as the case may be, with respect to any shares for which such
notice of redemption has been given. Notwithstanding the fact that the Fund may
not have redeemed the APS for which a notice of redemption has been given,
dividends may be declared and paid on APS and will include those APS for which
notice of redemption has been given.
Upon the deposit of funds sufficient to redeem APS with the Auction Agent
and the giving of notice of redemption, dividends on such APS shares will cease
to accumulate and such shares will no longer be deemed outstanding for any
purpose, and all rights of the holders of the APS so called for redemption will
cease and terminate, except the right of the holders thereof to receive the
Optional Redemption Price or Mandatory Redemption Price, as the case may be, but
without any interest or other additional amount, except as otherwise provided
above under "Dividends -- Additional Dividends." Upon surrender in accordance
with the notice of redemption of the certificates for any APS so redeemed
(properly endorsed or assigned for transfer, if the Board shall so require and
the notice shall so state), the Optional Redemption Price or Mandatory
Redemption Price, as the case may be, shall be paid by the Auction Agent to the
holders of APS subject to redemption. In the case that fewer than all of the APS
represented by any such certificate are redeemed, a new certificate shall be
issued, representing the unredeemed shares, without cost to the holder thereof.
The Fund will be entitled to receive from the Auction Agent, promptly after the
date fixed for redemption, any cash deposited with the Auction Agent in excess
of (i) the aggregate Optional Redemption Price or Mandatory Redemption Price, as
the case may be, of the APS called for redemption on such date and (ii) all
other amounts to which holders of APS called for redemption may be entitled. Any
funds so deposited that are unclaimed at the end of 90 days from such redemption
date will, to the extent permitted by law, be repaid to the Fund, after which
time the holders of APS so called for redemption may look only to the Fund for
payment of the Optional Redemption Price or Mandatory Redemption Price, as the
case may be, and all other amounts to which they may be entitled. The Fund will
be entitled to receive, from time to time after the date fixed for redemption,
any interest on the funds so deposited.
Notwithstanding the foregoing, if any dividends on shares of any series of
APS are in arrears, no shares of such series of APS shall be redeemed unless all
outstanding shares of such series of APS are simultaneously redeemed, and the
Fund shall not purchase or otherwise acquire any shares of such series of APS;
provided, however, that the foregoing shall not prevent the purchase or
acquisition of all outstanding shares of such series of APS 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 shares of such
series of APS.
Except as described above with respect to redemptions and under "The
Auction -- Orders by Existing Holders and Potential Holders," the APS Provisions
do not prohibit the Fund or any affiliate of the Fund from purchasing or
otherwise acquiring any APS.
The Fund has the right to arrange for others to purchase from the holders
thereof APS which are to be redeemed as described above.
LIQUIDATION
51
Upon a liquidation of the Fund, whether voluntary or involuntary, the
holders of APS then outstanding will be entitled to receive and to be paid out
of the assets of the Fund available for distribution to its Shareholders, before
any payment or distribution shall be made on the Common Stock or on any other
class of stock of the Fund ranking junior to the APS upon liquidation, an amount
equal to the liquidation preference with respect to the APS. The liquidation
preference for the APS shall be $50,000 per share, plus an amount equal to all
dividends thereon (whether or not earned or declared) accumulated but unpaid to
the date of final distribution in same-day funds, together with any applicable
Additional Dividends in connection with the liquidation of the Fund. After the
payment to the holders of the APS of the full preferential amounts provided for
as described herein, the holders of APS as such shall have no right or claim to
any of the remaining assets of the Fund. In the event the assets of the Fund
available for distribution to the holders of the APS upon any liquidation of the
Fund, whether voluntary or involuntary, shall be insufficient to pay in full all
amounts to which such holders are entitled, no such distribution shall be made
on account of any shares of any other class or series of Preferred Stock ranking
on a parity with the APS upon such liquidation unless proportionate distributive
amounts shall be paid on account of the APS, ratably, in proportion to the full
distributable amounts for which holders of all such parity shares are
respectively entitled upon such liquidation. Subject to the rights of the
holders of shares of any series or class or classes of stock ranking on a parity
with the APS with respect to the distribution of assets upon liquidation of the
Fund, after payment shall have been made in full to the holders of the APS as
described herein, but not prior thereto, any other series or class or classes of
the Fund's capital stock ranking junior to the APS with respect to the
distribution of assets upon liquidation shall, subject to the respective terms
and provisions (if any) applying thereto, be entitled to receive any and all
assets remaining to be paid or distributed, and the holders of the APS shall not
be entitled to share therein.
Neither the sale of all or substantially all the property or business of
the Fund, nor the merger or consolidation of the Fund into or with any other
corporation nor the merger or consolidation of any other corporation into or
with the Fund shall be a liquidation, whether voluntary or involuntary, for the
purposes of the foregoing paragraph.
VOTING RIGHTS
Except as otherwise indicated in this Prospectus or as otherwise required
by applicable law, holders of the APS will have equal voting rights with holders
of Common Stock (one vote per share) and will vote together with holders of
Common Stock as a single class.
In connection with the election of the Fund's directors, holders of
outstanding shares of Preferred Stock, including any APS, voting as a separate
class, shall be entitled to elect two of the Fund's directors, and the remaining
directors will be elected by holders of Common Stock and Preferred Stock,
including any APS, voting as a single class. In addition, if at any time
dividends (whether or not earned or declared) on Preferred Stock, including any
outstanding APS, shall be due and unpaid in an amount equal to two full years'
dividends thereon, and sufficient cash or specified securities shall not have
been deposited with the Auction Agent for the payment of such dividends, then,
as the sole remedy of holders of Preferred Stock, including any outstanding APS,
the number of directors constituting the Board of Directors shall be
automatically increased by the smallest number that, when added to the two
directors elected exclusively by the holders of Preferred Stock, including any
APS, as described above, would constitute a majority of the Board of Directors
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 directors are to be elected, the holders of
Preferred Stock, including any APS, voting as a separate class, will be entitled
to elect the smallest number of additional directors that, together with the two
directors which such holders will be in any event entitled to elect, constitutes
a majority of the total number of directors of the Fund as so increased. The
terms of office of the persons who are directors at
52
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 shares of Preferred Stock, including any APS for all past Dividend
Periods, the voting rights stated in the preceding sentence shall cease, and the
terms of office of all of the additional directors elected by the holders of
shares of Preferred Stock, including any APS (but not of the directors with
respect to whose election the holders of Common Stock were entitled to vote or
the two directors the holders of shares of APS have the right to elect in any
event), will terminate automatically.
So long as any of the APS outstanding, the Fund will not, without the
affirmative vote of a majority of the outstanding APS, 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 separately as one class): (a)
authorize, create or issue any class or series of stock ranking prior to or on a
parity with the APS with respect to the payment of dividends or the distribution
of assets upon liquidation or increase the authorized amount of APS (except that
the Fund may, without the vote of the holders of APS, authorize, create or issue
classes or series of Preferred Stock ranking on a parity with the APS with
respect to the payment of dividends and the distribution of assets upon
liquidation subject to continuing compliance by the Fund with 1940 Act APS Asset
Coverage and APS Basic Maintenance Amount requirements; provided that the Fund
obtains written confirmation from Moody's (if Moody's is then rating the APS)
and S&P (if S&P is then rating the APS) that the issuance of any such additional
class or series of Preferred Stock would not impair the rating then assigned by
such rating agency to the APS), (b) amend, alter or repeal the APS Provisions,
whether by merger, consolidation or otherwise, so as to affect any preference,
right or power of such APS or the holders thereof; provided that (i) none of the
actions permitted by the exception to (a) above will be deemed to affect such
preferences, rights or powers and (ii) the authorization, creation and issuance
of classes or series of stock ranking junior to the APS with respect to the
payment of dividends and the distribution of assets upon liquidation will be
deemed to affect such preferences, rights or powers only if Moody's or S&P is
then rating the Fund and such issuance would, at the time thereof, cause the
Fund not to satisfy the 1940 Act APS Asset Coverage or the APS Basic Maintenance
Amount, or (c) file a voluntary application for relief under federal bankruptcy
law or any similar application under state law for so long as the Fund is
solvent and does not foresee becoming insolvent.
The Board may, however, without approval of the holders of APS, amend,
alter or repeal any or all of the definitions required to be contained in the
APS Provisions by the rating agencies in the event the Fund receives written
confirmation from the appropriate rating agency that any such amendment,
alteration or repeal would not impair the ratings then assigned to the APS by
such rating agency. Unless a higher percentage is provided for under
"Description of Common Stock -- Certain Anti-Takeover Provisions of the Articles
of Incorporation" in the Prospectus, the affirmative vote of the holders of a
majority of the outstanding APS, voting as a separate class, will be required to
approve any plan of reorganization (as such term is defined under the 1940 Act)
adversely affecting such shares or any action requiring a vote of security
holders under Section 13(a) of the 1940 Act including, among other things,
changes in the Fund's investment objective or changes in the investment
restrictions described as fundamental policies under "Investment Limitations."
The class vote of holders of APS described above will in each case be in
addition to a separate vote of the requisite percentage of shares of Common
Stock necessary to authorize the action in question. To the extent permitted by
the 1940 Act, each series of APS may vote as a separate series in certain
circumstances.
The foregoing voting provisions will not apply with respect to APS if, at
or prior to the time when a vote is required, such APS shall have been (i)
redeemed or (ii) called for redemption for sufficient funds shall have been
deposited in trust to effect such redemption as provided under "Description of
APS -- Redemption."
53
THE AUCTION
GENERAL
The APS Provisions provide that the Applicable Rate per annum for each
Subsequent Dividend Period after the Initial Dividend Period with respect to
each series of APS shall be equal to the rate per annum that the Auction Agent
advises has resulted on the Business Day preceding the first day of such
Subsequent Dividend Period from implementation of the auction procedures
("Auction Procedures") set forth in the APS Provisions, in which persons
determine to hold or offer to sell or, based on dividend rates bid by them,
offer to purchase or sell shares of such series of APS. Each periodic
implementation of the Auction Procedures, which are attached as Appendix C to
this Prospectus, is referred to herein as an "Auction."
The summary is qualified by reference to the Auction Procedures set forth
in Appendix C hereto. The settlement procedures to be used with respect to
Auctions for shares of each series of APS are set forth in Appendix D hereto.
AUCTION AGENCY AGREEMENT. The Fund will enter into an amendment to its
existing agreement ("Auction Agency Agreement") with respect to its APS Series
A, B, C and D shares to make it applicable to its APS Series E and F shares. The
Auction Agency Agreement is between the Fund and Deutsche Bank Trust Company
Americas (together with any successor bank or trust company or other entity
entering into a similar agreement with the Fund, "Auction Agent"), and provides,
among other things, that the Auction Agent will follow the Auction Procedures
for purposes of determining the Applicable Rate for each series of APS so long
as the Applicable Rate for such series 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 will enter into agreements (or amendments
to existing agreements) with UBS Financial Services Inc. and may enter into
similar agreements (or amendments) (collectively, the "Broker-Dealer
Agreements") with one or more additional broker-dealers (collectively the
"Broker-Dealers") selected by the Fund, which provide for the participation of
Broker-Dealers in Auctions for APS Series E and F shares. See "Broker-Dealers"
below.
MASTER PURCHASER'S LETTER. Each prospective purchaser of shares of any
series of APS or its Broker-Dealer will be required to sign and deliver to the
Auction Agent, as a condition to such purchaser's purchasing shares of such
series of APS in any Auction or otherwise, a letter, the form of which is
attached to the Prospectus (the "Master Purchaser's Letter"), in which such
prospective purchaser or its Broker-Dealer will agree, among other things.
(a) to participate in Auctions for shares of such series of APS on the
terms set forth in Appendix C hereto;
(b) to sell, transfer or otherwise dispose of shares of such series of APS
only in whole share and only pursuant to a Bid or a Sell Order (as defined under
"Orders by Existing Holders and Potential Holders" below) in an Auction, or to
or through a Broker-Dealer or to a person that has delivered a signed Master
Purchaser's Letter to the Auction Agent, provided that in the case of any
transfer other than those pursuant to Auctions, the Existing Holder (as defined
below) of the shares so transferred, its Agent Member (as defined below) or its
Broker-Dealer advises the Auction Agent of such transfer; and
(c) to have the ownership of the shares of such series of APS as to
which such purchaser or its Broker-Dealer is the Existing Holder maintained in
book entry form by ______ (together
54
with any successor securities depository selected by the Fund, the "Securities
Depository") for the account of its agent member (the "Agent Member") of such
Securities Depository, which in turn will maintain records of such purchaser's
beneficial ownership, and to authorize such Agent Member to disclose to the
Auction Agent such information with respect to such purchaser's beneficial
ownership as the Auction Agent may request.
Each prospective purchaser should ask its Broker-Dealer whether such
prospective purchaser should sign a Master Purchaser's Letter. If the
Broker-Dealer submits Orders for such prospective purchaser listing the
Broker-Dealer as the Existing Holder or the Potential Holder, a Master
Purchaser's Letter signed by such prospective purchaser may not be required.
An execution copy of the Master Purchaser's Letter is included inside the
back cover of the Prospectus. Execution by a prospective purchaser or its
Broker-Dealer of a Master Purchaser's Letter is not a commitment to purchase
shares of any series of APS in the offering being made by the Prospectus or in
any Auction, but is a condition precedent to such purchaser's purchasing shares
of any series of APS. In addition, acceptance of a Master Purchaser's Letter is
not a guarantee that shares of any series of APS will be available for purchase.
As used herein, "Existing Holder" of shares of a series of APS means a
person who has signed, or on whose behalf a Broker-Dealer has signed, a Master
Purchaser's Letter and is listed as the beneficial owner of such shares of APS
in the records of the Auction Agent. The Auction Agent may rely upon, as
evidence of the identities of the Existing Holders of a series of APS, a list of
the initial owners of the shares of such series of APS provided by the Fund, the
results of Auctions and notices from any Existing Holder, the Agent Member of
such Existing Holder or the Broker-Dealer of such Existing Holder with respect
to transfers described in the next sentence. The Auction Agent will be required
to register a transfer of shares of any series of APS from an Existing Holder to
another person only if such transfer is made to a person that has delivered a
signed Master Purchaser's Letter to the Auction Agent and if: (i) such transfer
is pursuant to an Auction; or (ii) the Auction Agent has been notified in
writing (A) by such Existing Holder, the Agent Member of such Existing Holder or
the Broker-Dealer of such Existing Holder of such transfer or (B) by the
Broker-Dealer of any person that purchased or sold shares of such series of APS
in an Auction of the failure of such APS to be transferred as a result of such
Auction. 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 time,
on the Business Day preceding such Auction.
The Auction Agent is not required to accept the Master Purchaser's Letter
of any Potential Holder who wishes to submit a Bid for the first time in an
Auction or of any Potential Holder or Existing Holder who wishes to amend its
Master Purchaser's Letter unless such Letter or amendment is received by the
Auction Agent by 3:00 P.M., Eastern time, on the Business Day preceding such
Auction.
SECURITIES DEPOSITORY. Depository Trust Company ("DTC") will act as the
Securities Depository for the Agent Members with respect to Shares of APS. One
certificate for all of the shares of each series of APS offered hereby will be
registered in the name of ____________, 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 APS contained in the
APS Provisions and the Master Purchaser's Letters. The Fund will also issue
stop-transfer instructions to the transfer agent for each series of APS.
[Nominee] will be the holder of record of all shares of such series of APS and
beneficial owners of shares of such series of APS will not 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
55
lists of its participants and will maintain the positions (ownership interests)
held by each Agent Member in APS, whether for its own account or as a nominee
for another person.
AUCTION DATES; ADVANCE NOTICE OF ALLOCATION OF TAXABLE INCOME
An Auction to determine the Applicable Rate with respect to each series of
APS for each Rate Period after the Initial Dividend Period thereof will be held
on the first Business Day preceding the first day of such Rate Period (the date
of each Auction being referred to herein as an "Auction Date"). The Auction Date
and the first day of the related Rate Period (also a Dividend Payment Date) must
be Business Days but need not be consecutive days. See "Description of APS -
Dividends" for information concerning the circumstances under which the first
day of a Rate Period or the Auction Date, or both, may be moved to a date other
than such specified days.
In normal circumstances, whenever the Fund intends to include any net
capital gains or other income that is taxable for federal income tax purposes in
any dividend on shares of any series of APS, the Fund may notify the Auction
Agent of the amount to be so included 15 days prior to the Auction Date on which
the Applicable Rate for such dividend is to be established. Whenever the Auction
Agent receives such notice from the Fund, it will in turn notify each
Broker-Dealer, who, on or prior to such Auction Date, in accordance with its
Broker-Dealer Agreement, will notify its Existing Holders and Potential Holders
believed by it to be interested in submitting an Order in the Auction to be held
on such Auction Date.
ORDERS BY EXISTING HOLDERS AND POTENTIAL HOLDERS
Prior to the Submission Deadline (as defined under "Submission of Orders by
Broker-Dealers to Auction Agent" below) on each Auction Date with respect to a
series of APS:
(a) each Existing Holder of shares of such series of APS may submit to
a Broker-Dealer by telephone or otherwise a:
(i) "Hold Order" - indicating the number of outstanding shares,
if any, of such series of APS that such Existing Holder desires to
continue to hold without regard to the Applicable Rate for such series
for the next Rate Period;
(ii) "Bid" - indicating the number of outstanding shares, if any,
of such series of APS that such Existing Holder desires to sell if the
Applicable Rates for such series for the next Rate Period shall be
less than the rate per annum then specified by such Existing Holder;
and/or
(iii) "Sell Order" - indicating the number of outstanding shares,
if any, of such series of APS that such Existing Holder offers to sell
without regard to the Applicable Rate for such series for the next
Rate Period;
and
(b) Broker-Dealers shall contact prospective purchasers of shares of
such series of APS (each such prospective purchaser is herein referred to
as a "Potential Holder," and the term Potential Holder includes an Existing
Holder with respect to an offer by such Existing Holder to purchase
additional shares of such series) by telephone or otherwise to determine
whether such Potential Holders desire to submit Bids, in which Potential
Holders will indicate the number of
56
shares of such series of APS that they offer to purchase if the Applicable
Rate for such series for the next Rate Period is not less than the rite per
annum specified in such Bids.
The communication to a Broker-Dealer of the foregoing information is herein
referred to as an "Order." An Existing Holder or a Potential Holder placing an
Order is herein referred to a "Bidder" and collectively as "Bidders."
An Existing Holder may submit different types of Orders in an Auction with
respect to shares of a series of APS then held by such Existing Holder. An
Existing Holder that offers to purchase additional shares of a series of APS is,
for purposes of such offer, treated as a Potential Holder. For information
concerning the priority given to different types of Orders placed by Existing
Holders, see "Submission of Orders by Broker-Dealers to Auction Agent" below.
Any Bid specifying a rate higher than the Maximum Rate (as defined below)
will (i) be treated as a Sell Order if submitted by an Existing Holder and (ii)
not be accepted if submitted by a Potential Holder. Accordingly, the Auction
Procedures establish the Maximum Rate as a maximum rate per annum that can
result from an Auction. See "Determination of Sufficient Clearing Bids, Winning
Bid Rate and Applicable Rate" and "Acceptance and Rejection of Submitted Bids
and Submitted Sell Orders and Allocation of Shares" below.
As used herein, "Maximum Rate," when used with respect to shares of a
series of APS on an Auction Date, means:
(i) in the case of any Auction Date which is not the Auction Date
immediately prior to the first day of any proposed Special Dividend
Period of more than 28 days, the product of (1) the Reference Rate on
such Auction Date for the next Rate Period of such series and (2) the
Applicable Percentage on such Auction Date, unless such series has or
had a Special Dividend Period (other than a Special Dividend Period of
28 days or less) and an Auction at which Sufficient Clearing Bids
existed has not yet occurred for a Minimum Dividend Period of such
series after such Special Dividend Period, in which case the higher
of:
(A) the dividend rate on shares of such series for the
then-ending Rate Period, and
(B) the product of (x) the higher of (I) the "AA" Composite
Commercial Paper Rate on such Auction Date for the then-ending
Rate Period of such series, if such Rate Period is less than one
year, or the Treasury Rate on such Auction Date for such Rate
Period, if such Rate Period is one year or greater, and (II) the
"AA" Composite Commercial Paper Rate on such Auction Date for
such Special Dividend Period of such series, if such Special
Dividend Period is less than one year, or the Treasury Rate on
such Auction Date for such Special Dividend Period, if such
Special Dividend Period is one year or greater and (y) the
Applicable Percentage on such Auction Date; or
(ii) in the case of any Auction Date which is the Auction Date
immediately prior to the first day of any proposed Special Dividend
Period of more than 28 days, the product of (1) the highest of (x) the
Reference Rate on such Auction Date for the then-ending Rate Period of
such series, if such Rate Period is less than one year, or the
Treasury Rate on such Auction Date for such Rate Period, if such Rate
Period is one year or greater, (y) the Reference Rate on such Auction
Date for the Special Dividend Period
57
for which the Auction is being held, if such Special Dividend Period
is less than one year, or the Treasury Rate on such Auction Date for
the Special Dividend Period for which the Auction is being held, if
such Special Dividend Period is one year or greater, and (z) the
Reference Rate on such Auction Date for the Minimum Dividend Period of
such series and (2) the Applicable Percentage on such Auction Date.
The Reference Rate is, with respect to any Rate Period of less than one
year, the higher of (i) the "AA" 'Composite Commercial Paper Rate and (ii) the
Taxable Equivalent of the Short-Term Municipal Bond Rate. The applicable "AA"
Composite Commercial Paper Rates and Treasury Rates will be the rates announced
on such Auction Date for the Business Day immediately prior to such Auction
Date.
The "Applicable Percentage," for any series of APS on any Auction Date,
will be a percentage, determined as set forth below, based on the prevailing
rating of shares of such series of APS in effect at the close of business on the
Business Day next preceding such Auction Date:
PREVAILING RATING APPLICABLE PERCENTAGE
----------------- ---------------------
"aa3"/AA- or higher 110%
"a3"/A- 125%
"baa3"/BBB 150%
ba3"/BB- 200%
Below "ba3"/BB- 250%
provided, however, that in the event the Fund has notified the Auction Agent of
its intent to allocate income taxable for federal income tax purposes to the APS
prior to the Auction establishing the Applicable Rate for such shares, the
Applicable Percentage in the foregoing table shall be divided by the quantity (1
minus the Marginal Tax Rate); provided that the Applicable Percentage shall be
divided in the foregoing manner only to the extent of the portion of the
dividend on the APS for such Rate Period that represents the allocation of
taxable income to such APS. If the APS are rated by only one rating agency, such
rating will be the prevailing rating.
For purposes of this determination, the "prevailing rating" of shares of a
series of APS shall be (i) "aa3"/AA- or higher if shares of such series of APS
have a rating of "aa3" or better by Moody's and AA-or better by S&P or the
equivalent of such ratings by such agencies or a substitute rating agency or
substitute rating agencies selected as provided below, (ii) if not "aa3"/AA- or
higher, then "a3"/A- if the shares of such series of APS have a rating of "a3"
or better by Moody's and A- or better by S&P or the equivalent of such ratings
by such agencies or a substitute rating agency or substitute rating agencies
selected as provided below, (iii) if not "aa3"/AA- or higher or "a3"/A-, then
"baa3"/BBB- if the shares of such series of APS we a rating of "baa3" or better
by Moody's and BBB- or better by S&P or the equivalent of such ratings by such
agencies or a substitute rating agency or substitute rating agencies selected as
provided below, (iv) if not "aa3"/AA- or higher, "a3"/A- or "baa3 "/BBB-, then
"ba3"/BB- if the shares of such series of APS have a rating of "ba3" or better
by Moody's and BB- or better by S&P or the equivalent of such ratings by such
agencies or substitute rating agency or substitute rating agencies selected as
provided below, and (v) if not "aa3"/AA- or higher, "a3"/A-, "baa3"/BBB-, or
"ba3"/BB-, then Below "ba3"/BB-: provided, however, that if the APS are rated by
only one rating agency, the prevailing rating shall be determined without
reference to the rating of any other rating agency. The Fund will take all
reasonable action necessary to enable either S&P or Moody's to provide a rating
for each series of APS. If neither S&P nor Moody's shall make such a rating
available, [UBS Financial Services Inc.] or its successors as Broker-Dealers
shall select at least one nationally recognized statistical rating organization
(as that term is used in the rules and regulations of the SEC under the
Securities Exchange Act of 1934, as amended ("1934 Act")) to act as a substitute
rating agency in respect of the APS, and the Fund shall take all reasonable
action to enable such rating agency to provide a rating for shares of such
series.
58
The Master Purchaser's Letter to be signed by each Existing Holder and each
Potential Holder or its Broker-Dealer provides that (i) a Sell Order placed by
an Existing Holder shall constitute an irrevocable offer to sell the shares of
the series of APS subject thereto, (ii) a Bid placed by an Existing Holder shall
constitute as irrevocable offer to sell the shares of the series of APS subject
thereto if the rate determined in the Auction is less than the rate specified in
such Bid, and (iii) a Bid placed by a Potential Holder shall constitute as
irrevocable offer to purchase the number of shares of the series of APS
specified in such Bid if the rate determined in the Auction is equal to or
greater than the rate specified in the Bid. The number of shares purchased or
sold may be subject to proration procedures. See "Acceptance and Rejection of
Submitted Bids and Submitted Sell Orders and Allocation of Shares" below. Each
purchase or sale shall be made for settlement on the Business Day next
succeeding the Auction Date at a price per share equal to $50,000. See "The
Auction - Notification of Results; Settlement" below. The Auction Agent is
entitled to rely upon the terms of any Order submitted to it by a Broker-Dealer.
With respect to an Auction preceding a Rate Period of less than 90 days, if
a Sell Order or Sell Orders covering all of the outstanding shares of any series
of APS held by any Existing Holder are not submitted to the Auction Agent prior
to the Submission Deadline, either because a Broker-Dealer failed to contact
such Existing Holder or otherwise, the Auction Agent shall deem a Hold Order or
Sell Order to have been submitted on behalf of such Existing Holder coveting the
number of outstanding shares of such series of APS held by such Existing Holder
and not subject to Orders submitted to the Auction Agent. With respect to an
Auction preceding a Rate Period of 90 days or greater, a Sell Order will be
deemed to have been submitted on behalf of an Existing Holder with respect to
any shares held by such Existing Holder for which an Order is not submitted on
behalf of such Existing Holder for any reason, including the failure of a
Broker-Dealer to submit such Existing Holder's Order to the Auction Agent.
Neither the Fund nor any affiliate thereof may submit an Order in any
Auction, except that any Broker-Dealer that is an affiliate of the Fund may
submit Orders in an Auction, but only if such Orders are not for its own
account.
SUBMISSION OF ORDERS BY BROKER-DEALERS TO AUCTION AGENT
Prior to 1:30 P.M., Eastern time, on each Auction Date, or such other time
on the Auction Date specified by the Auction Agent (the "Submission Deadline"),
each Broker-Dealer will submit to the Auction Agent in writing all Orders
obtained by it for the Auction to be conducted on such Auction Date. Any Order
submitted by a Broker-Dealer to the Auction Agent prior to the Submission
Deadline on any Auction Date shall be irrevocable.
If any rate specified in any Bid contains more than three figures to the
right of the decimal point, the Auction Agent will round such rate to the next
highest one-thousandth (.001) of 1%.
If any Existing Holder submits through a Broker-Dealer to the Auction Agent
one or more Orders covering in the aggregate more than the number of outstanding
shares of the series of APS subject to such Auction held by such Existing
Holder, such Orders will be considered valid in the following order of priority:
(a) all Hold Orders will be considered valid, but only up to and
including in the aggregate the number of shares of such series of APS held
by such Existing Holder;
(b) (i) any Bid will be considered valid up to and including the
excess of the number of outstanding shares of such series of APS held by
such Existing Holder over the number of shares of such series of APS
subject to any Hold Orders referred to in clause (a) above;
59
(ii) subject to sub-clause (i), if more than one Bid with the
same rate is submitted on behalf of such Existing Holder and the
number of shares of such series of APS subject to such Bids is greater
than such excess, such Bids will be considered valid up to and
including the amount of such excess, and the number of shares of such
series of APS subject to each Bid with the same rate will be reduced
PRO RATA to cover the number of shares of such series of APS equal to
such excess;
(iii) subject to sub-clauses (i) and (ii), if more than one Bid
with different rates is submitted on behalf of such Existing Holder,
such Bids shall be considered valid in the ascending order of their
respective rates up to and including the amount of such excess; and
(iv) in any such event, the number, if any, of such shares
subject to Bids not valid under this clause (b) will be treated as the
subject of a Bid by a Potential Holder at the rate specified therein;
and
(c) all Sell Orders will be considered valid up to and including the
excess of the number of outstanding shares of such series of APS held by
such Existing Holder over the sum of shares of such series of APS subject
to valid Hold orders referred to in clause (a) above and valid Bids by such
Existing Holder referred to in clause (b) above.
If more than one Bid is submitted on behalf of any Potential Holder, each
Bid submitted will be a separate Bid with the rate and number of shares therein
specified.
DETERMINATION OF SUFFICIENT CLEARING BIDS, WINNING BID RATE AND APPLICABLE RATE
Not earlier than the Submission Deadline on each Auction Date, the Auction
Agent will assemble all valid Orders submitted or deemed submitted to it by the
Broker-Dealers (each such Hold Order, Bid or Sell Order as submitted or deemed
submitted by a Broker-Dealer being herein referred to as a "Submitted Hold
Order," a "Submitted Bid" or a "Submitted Sell Order," as the case may be, or as
a "Submitted Order") and will determine the excess of the number of outstanding
shares of such series of APS over the number of outstanding shares of such
series of APS subject to Submitted Hold Orders (such excess being herein
referred to as the "Available APS") and whether Sufficient Clearing Bids have
been made in the Auction. "Sufficient Clearing Bids" will have been made if the
number of outstanding shares of such series of APS that are the subject of
Submitted Bids by Potential Holders specifying rates not higher than the Maximum
Rate equals or exceeds the number of outstanding shares that are the subject of
Submitted Sell Orders (including the number of shares of such series subject to
Bids by Existing Holders specifying rates higher than the Maximum Rate).
If Sufficient Clearing Bids have been made, the Auction Agent will
determine the lowest rate specified in the Submitted Bids (the "Winning Bid
Rate") which, taking into account the rites in the Submitted Bids of Existing
Holders, would result in Existing Holders continuing to hold an aggregate number
of outstanding shares of such series of APS which, when added to the number of
outstanding shares of such series of APS to be purchased by Potential Holders,
based on the rates in their Submitted Bids, would equal not less than the
Available APS. In such event, the Winning Bid Rate will be the Applicable Rate
for the next Rate Period for all shares of such series of APS.
If Sufficient Clearing Bids have not been made (other than because all of
the outstanding shares of such series of APS are subject to Submitted Hold
Orders), the Applicable Rate for the next Rate Period, which shall be a Minimum
Dividend Period, for all shares of such series of APS will be equal to the
Maximum Rate. If Sufficient Clearing Bids have not been made, Existing Holders
that have submitted
60
Sell Orders may not be able to sell in the Auction all shares of such series of
APS subject to such Submitted Sell Orders but will continue to own shares of
such series of APS for the next Rate Period, dividends for which may include
taxable income. See "The Auction - Auction Dates; Advance Notice of Allocation
of Taxable Income" above and "The Auction - Acceptance and Rejection of
Submitted Bids and Submitted Sell Orders and Allocation of Shares' below.
If all of the outstanding shares of such series of APS are subject to
Submitted Hold Orders, the Applicable Rate for the next Rate Period for all
shares of such series of APS will be the product of (i) (1) the Reference Rate
on such Auction Date for such Rate Period, if such Rate Period is less than one
year or (2) the Treasury Rate on such Auction Date for such Rate Period, if such
Rate Period is one year or greater and (ii) 1 minus the Marginal Tax Rate;
provided, however, that if the Fund has notified the Auction Agent of its intent
to allocate to shares of such series of APS in such Rate Period any net capital
gains or other income that is taxable for federal income tax purposes, the
Applicable Rate in respect of that portion of the dividend on shares of such
series of APS for such Rate Period that represents the allocation of net capital
gains or other income that is taxable for federal income tax purposes will be
the rate described in the preceding clause (i) (1) or (2), as applicable,
without being multiplied by the factor set forth in the preceding clause (ii).
In calculating the Reference Rate and the Treasury Rate for such purpose, the
rates used will be the rates or yields specified in the applicable definitions
of Reference Rate and "Treasury Rate" set forth under 'Description of APS -
Dividends - Determination of Dividend Rate.'
ACCEPTANCE AND REJECTION OF SUBMITTED BIDS AND SUBMITTED SELL ORDERS AND
ALLOCATION OF SHARES
Based on the determinations made under "Determination of Sufficient
Clearing Bids, Winning Bid Rate and Applicable Rate" above and, subject to the
discretion of the Auction Agent to round and allocate certain shares as
described below, Submitted Bids and Submitted Sell Orders will be accepted or
rejected in the order of priority set forth in the Auction Procedures, with the
result that Existing Holders and Potential Holders of each series of APS of such
series will sell, continue to hold and/or purchase shares of such series of APS
as set forth below. Existing Holders that submitted or were deemed to have
submitted Hold Orders will continue to hold the APS subject to such Hold Orders.
If Sufficient Clearing Bids have been made:
(a) Each Existing Holder that placed a Submitted Sell Order or Submitted
Bid specifying any rate higher than the Winning Bid Rate will sell the
outstanding shares of a series of APS subject to such Submitted Sell Order or
Submitted Bid;
(b) Each Existing Holder that placed a Submitted Bid specifying a rate
lower than the Winning Bid Rate will continue to hold the outstanding shares of
a series of APS subject to such Submitted Bid;
(c) Each Potential Holder that placed a Submitted Bid specifying a rate
lower than the Winning Bid Rate will purchase the number of outstanding shares
of a series of APS subject to such Submitted Bid;
(d) Each Existing Holder that placed a Submitted Bid specifying a rate
equal to the Winning Bid Rate will continue to hold the shares of a series of
APS subject to such Submitted Bid, unless the number of outstanding share of a
series of APS subject to all such Submitted Bids is greater than the number of
shares of such series of APS in excess of the Available APS of such series over
the number of shares of such series of APS accounted for in clauses (b) and (c)
above, in which event each Existing Holder with such a Submitted Bid will
continre to hold a number of outstanding shares of such series of APS subject to
such Submitted Bid determined on a PRO RATA basis based on the number of
outstanding shares of such series of APS subject to all such Submitted Bids by
such Existing Holders; and
61
(e) Each Potential Holder that placed a Submitted Bid specifying a rate
equal to the Winning Bid Rate will purchase any share of such series of
Available APS not accounted for in clauses (b) through (d) above on a PRO RATA
basis based on the outstanding shares of such series of APS subject to all such
Submitted Bids.
If Sufficient Clearing Bids have not been made (unless this results because
all outstanding shares of such series of APS are subject to Submitted Hold
Orders):
(a) Each Existing Holder that placed a Submitted Bid specifying a rate
equal to or lower than the Maximum Rate will continue to hold the outstanding
shares of such series of APS subject to such Submitted Bid;
(b) Each Potential Holder that placed a Submitted Bid specifying a rate
equal to or lower than the Maximum Rate will purchase the number of outstanding
share of such series of APS subject to such Submitted Bid; and
(c) Each Existing Holder that placed a Submitted Bid specifying a rate
higher than the Maximum Rate or a Submitted Sell Order will sell a number of
shares of such series of APS determined on a PRO RATA basis based on the number
of outstanding shares of APS subject to all such Submitted Bids and Submitted
Sell Orders.
If, as a result of the PRO RATA allocation described in clause (d) or (e)
of the second preceding paragraph or clause (c) of the next preceding paragraph,
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 APS,
the Auction Agent will, in such manner as, in its sole discretion. it will
determine, round up or down to the nearest whole share the number of APS being
sold or purchased on such Auction Date so that the number of shares sold or
purchased by each Existing Holder or Potential Holder will be whole shares of
APS. If as a result of the PRO RATA allocation described in clause (e) of the
second preceding paragraph, any Potential Holder would be entitled or required
to purchase less than a whole share of APS, the Auction Agent will, in such
manner as, in its sole discretion, it will determine, allocate APS for purchase
among Potential Holders so that only whole shares of APS are purchased by any
such Potential Holder, even if such allocation results in one or more of such
Potential Holders not purchasing APS.
NOTIFICATION OF RESULTS; SETTLEMENT
The Auction Agent will advise each Broker-Dealer that submitted an Order of
the Applicable Rate for the next Rate Period and, if the Order was a Bid or Sell
Order, whether such Bid or Sell Order was accepted or rejected, in whole or in
part, by telephone by approximately 3:00 P.M., Eastern time, on each Auction
Date. Each Broker-Dealer that submitted an Order on behalf of a Bidder will then
advise such Bidder of the Applicable Rate for the next Rate Period and, if such
Order was a Bid or a Sell Order, whether such Bid or Sell Order was accepted or
rejected, in whole or in part, will confirm purchases and sales with each Bidder
purchasing or selling APS as a result of the Auction and will advise each Bidder
purchasing or selling APS as a result of the Auction to give instructions to its
Agent Member of the Securities Depository to pay the purchase price against
delivery of such shares or to deliver such shares against payment therefor, as
appropriate. The Auction Agent will record each transfer of APS on the registry
of Existing Holders to be maintained by the Auction Agent. See "The Auction -
General" above.
In accordance with the Securities Depository's normal procedures, on the
Business Day after the Auction Date, the transactions described above will be
executed through the Securities Depository and the accounts of the respective
Agent Members at the Securities Depository will be debited and credited and
62
shard delivered to necessary to effect the purchases and sales of APS as
determined in the Auction. Purchasers will make payment through their Agent
Members in same-day funds to the Securities Depository against delivery through
their Agent Members; the Securities Depository will make payment in accordance
with its normal procedures, which now provide for payment against delivery by
their Agent Members in same-day funds.
If any Existing Holder selling APS in an Auction fails to deliver such
shares, the Broker-Dealer of any person that was to have purchased APS in such
Auction may deliver to such person a number of whole shares of APS that is less
than the number of shares that otherwise was to be purchased by such person. In
such event, the number of APS to be so delivered shall be determined by such
Broker-Dealer. Delivery of such lesser number of shares shall constitute good
delivery.
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 terminate the Auction Agency Agreement upon notice to
the Fund on a date no earlier than 100 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-DEALERS
The Auction Agent after each Auction for APS will pay to each
Broker-Dealer, from funds provided by the Fund, a service charge at the annual
rate of 0.25 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 APS placed by such Broker-Dealer at
such Auction. For the purposes of the preceding sentence, APS will be placed by
a Broker-Dealer if such shares were (i) the subject of Hold Orders deemed to
have been made by Existing Holders and were acquired by such Existing Holders
through such Broker-Dealer or (ii)-the subject of an Order submitted by such
Broker-Dealer that is (A) 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 (B) a Submitted Bid of a Potential Holder that resulted in such Potential
Holder purchasing such shares as a result of the Auction or (C) 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 Agreements provide 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
63
of Orders placed through it in that Auction; such Broker-Dealer, however, would
not have knowledge of Orders submitted by other Broker-Dealers in that Auction.
The Broker-Dealers may maintain a secondary trading market in the APS
outside of Auctions. They have no obligation to do so, however, and there can be
no assurance that a secondary market for the APS will develop or, if it does
develop, that it will provide holders with liquidity of investment. The APS will
not be registered on any stock exchange or on the National Association of
Securities Dealers Automated Quotations system.
ADDITIONAL INFORMATION
COMMON STOCK REPURCHASES AND TENDER OFFERS
In recognition of the possibility that the Common Stock might trade at a
discount to net asset value and that any such discount may not be in the
interest of common shareholders, the Board of Directors has determined that it
will consider taking action to attempt to reduce or eliminate any discount. To
that end, the Board may, in consultation with UBS Global AM , from time to time
consider action either to repurchase shares of the Common Stock in the open
market or to make a tender offer for shares of the Common Stock at their net
asset value. The Board currently intends at least annually to consider making
such open market repurchases or tender offers and at such time may consider such
factors as the market price of the Common Stock, the net asset value of the
Common Stock, the liquidity of the assets of the Fund, whether such transactions
would impair the Fund's status as a regulated investment company or result in a
failure to comply with applicable asset coverage requirements, general economic
conditions and such other events or conditions that may have a material effect
on the Fund's ability to consummate such transactions. The Board may at any
time, however, decide that the Fund should not repurchase shares or make a
tender offer. Common Stock will not be repurchased unless after such repurchase
the Fund would continue to satisfy the 1940 Act APS Asset Coverage and the APS
Basic Maintenance Amount.
Subject to the Fund's investment restrictions with respect to borrowings
and subject to the Fund's compliance with the 1940 Act, the Fund may incur debt
to finance Common Stock repurchases or tender offers or (although the Fund has
no current intention of borrowing for such purpose) for investment purposes. See
"Investment Limitations." Should the Fund borrow for these or any other
purposes, it would be required to pay when due the interest obligation on any
debt incurred by it before it would be able to pay dividends on shares of any
series of APS, and it is likely that the Fund would be required to pay the
principal amount of any such debt prior to meeting the liquidation preference of
each series of APS. Because the interest expense on borrowings by the Fund will
reduce the Fund's net investment income available to pay dividends on shares of
any series of APS, borrowing may impair the Fund's ability to pay such
dividends. This risk is heightened in the event the Fund incurs variable rate
debt, the interest rate on which may increase with increases in prevailing
market rates.
There is no assurance that repurchases or tender offers will result in the
Common Stock trading at a price that is equal or close to its net asset value
per share. The market price of shares of the Common Stock will be determined by,
among other things, the relative demand for and supply of such shares in the
market, the Fund's investment performance, the Fund's dividends and yield and
investor perception of the Fund's overall attractiveness as an investment as
compared with other investment alternatives. Nevertheless, the fact that the
Common Stock may be the subject of tender offers at net asset value from time to
time may reduce the spread that might otherwise exist between the market price
of the Common Stock and net asset value per share. In the opinion of UBS Global
AM, sellers may be less inclined to accept a significant discount if they have a
reasonable expectation of being able to recover net asset value in conjunction
with a possible tender offer.
64
Although the Board of Directors believes that Common Stock repurchases and
tender offers generally would have a favorable effect on the market price of the
Common Stock, it should be recognized that the Fund's acquisition of shares of
the Common Stock would decrease the Fund's total assets and therefore have the
effect of increasing the Fund's expense ratio and decreasing the asset coverage
with respect to any outstanding Preferred Stock. Because of the nature of the
Fund's investment objective, policies and portfolio, under current market
conditions UBS Global AM anticipates that repurchases and tender offers
generally should not have a material, adverse effect on the Fund's investment
performance and that UBS Global AM generally should not have any material
difficulty in disposing of portfolio securities in order to consummate Common
Stock repurchases, and tender offers; however, this may not always be the case.
Even if such a tender offer has been made, it will be the Board's announced
policy, which may be changed by the Board, not to accept tenders or effect
repurchases (or, if a tender offer has not been made, not to initiate a tender
offer) if: (1) such transactions, if consummated, would (a) result in the
delisting of the Common Stock from the NYSE (the NYSE having advised the Fund
that it would consider delisting if the aggregate market value of the
outstanding shares is less than $5,000,000, the number of publicly held shares
falls below 600,000 or the number of round-lot holders falls below 1,200), (b)
impair the Fund's status as a regulated investment company under the Internal
Revenue Code (which would eliminate the Fund's eligibility to deduct dividends
paid to Shareholders, thus causing the Fund's taxable income to be fully taxed
at the corporate level in addition to the taxation of Shareholders upon
dividends received from the Fund), or (c) result in a failure to comply with the
1940 Act APS Asset Coverage or the APS Basic Maintenance Amount or both (so long
as the same are applicable); (2) the Fund would not be able to liquidate
portfolio securities in an orderly manner and consistent with the Fund's
investment objective and policies in order to repurchase its 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) suspension of trading or limitation on prices
of securities generally on the NYSE or any other exchange on which portfolio
securities of the Fund are traded, (c) declaration of a trading moratorium by
federal or state authorities or any suspension of payment by banks in the United
States, New York State or any state in which the Fund invests, (d) limitation
affecting the Fund or the issuers of its portfolio securities imposed by federal
or state authorities on the extension of credit by lending institutions, (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 that would have a material adverse effect on the Fund or its
Shareholders if shares were repurchased. The Board may modify these conditions
in light of experience.
Any tender offer made by the Fund for shares of the Common Stock generally
would be at a price equal to the net asset value of the shares of Common Stock
on a date subsequent to the Fund's receipt of all tenders. Each offer would be
made, and the common shareholders would be notified, in accordance with the
requirements of the 1934 Act and the 1940 Act, either by publication or mailing
or both. Each offering document would contain such information as is prescribed
by such laws and the rules and regulations promulgated thereunder. Each person
tendering share of Common Stock would pay to the Fund's transfer agent a service
charge to help defray certain costs, including the processing of tender forms,
effecting payment, postage and handling. Any such service charge would be paid
directly by the tendering shareholder and would not be deducted from the
proceeds of the purchase. The Fund's transfer agent would receive the fee as an
offset to these costs. The Fund expects that the costs of effecting a tender
offer would exceed the aggregate of all service charges received from those who
tender their shares of Common Stock. Costs associated with the tender offer
would be charged against capital.
Tendered shares of Common Stock that have been accepted and purchased by
the Fund will be held in the Fund's treasury until retired by the Board. If
treasury shares are retired, Common Stock issued and outstanding and capital in
excess of par will be reduced. If tendered shares are not retired, the Fund
65
may hold, sell or otherwise dispose of the shares for any lawful corporate
purpose as determined by the Board of Directors.
CONVERSION TO OPEN-END INVESTMENT COMPANY
The Board will consider from time to time whether it would be in the best
interests of the Fund and its common shareholders to convert the Fund to an
open-end investment company. If the Board of Directors determines that such a
conversion would be in the best interests of the Fund and its common
shareholders and is consistent with the 1940 Act, the Board will submit to the
Fund's Shareholders, at the next succeeding annual or special meeting, a
proposal to amend the Fund's Articles of Incorporation to so convert the Fund.
Such amendment would provide that, upon its adoption by the holders of at least
a majority of the Fund's outstanding Shares entitled to vote thereon, the Fund
will convert from a closed-end to an open-end investment company. If the Fund
converted to an open-end investment company, it would be able to continuously
issue and offer for sale shares of the Common Stock, and each such share could
be presented to the Fund at the option of the holder thereof for redemption at a
price based on the then current net asset value per share. In such event, the
Fund could be required to liquidate portfolio securities to meet requests for
redemption, the Common Stock would no longer be listed on the NYSE and certain
investment policies of the Fund would require amendment. In addition, conversion
to an open-end investment company would require that the Fund redeem any
outstanding shares of Preferred Stock, including the APS. The Fund might have to
liquidate portfolio securities to finance such redemptions.
In the absence of approval by a majority of the Board, including a majority
of the directors who are not "interested persons" of the Fund within the meaning
of the 1940 Act, any amendment to the Fund's Articles of Incorporation to
convert the Fund to an open-end investment company would require the vote of the
holders of 66 2/3% of the outstanding shares of the Fund's capital stock. See
"Description of Common Stock -Certain Anti-Takeover Provisions of the Articles
of Incorporation" in the Prospectus.
COUNSEL. The law firm of Dechert LLP, 1775 I Street, N.W., Washington, D.C.
20006, counsel to the Fund, has passed upon the legality of the shares of APS
Series C offered by the Fund's Prospectus. Dechert LLP also acts as counsel to
UBS Global AM in connection with other matters. Willkie Farr & Gallagher, 787
Seventh Avenue, New York, New York 10019, serves as independent counsel to the
Independent Directors.
AUDITORS. Ernst & Young LLP, Five Times Square, New York, New York 10036, serves
as independent auditors for the funds.
FINANCIAL INFORMATION
The Fund's audited financial statements and the independent auditors' report
thereon, appearing in the Fund's Annual Report to Shareholders for the period
ending March 31, 2003 are incorporated by reference in this Statement of
Additional Information. The Fund's Annual Report to Shareholders is available
upon request and free of charge by calling the Fund at 1-800-762 1000.
66
GLOSSARY
"AA Composite Commercial Paper Rate" has the meaning set forth on page [ ] of
this SAI.
"Additional Dividends" has the meaning set forth on page [ ] of the Prospectus.
"Advisory Contract" means the Investment Advisory and Administration Contract
between the Adviser and the Fund pursuant to which the Adviser acts as
investment adviser and administrator to the Fund.
"Affiliate" means any Person known to the Auction Agent to be 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 directors or executive officers of which is also a
director of the Fund, be deemed to be an Affiliate solely because such
director or executive officer is also a director of the Fund.
"Agent Member" means a member of or participant in the Securities Depository
that will act on behalf of a Bidder and is identified as such in such
Bidder's Master Purchaser's Letter.
"Anticipation Notes" means the following Municipal Obligations: bond
anticipation notes that are rated by S&P, tax anticipation notes, revenue
anticipation notes and tax and revenue anticipation notes.
"Applicable Percentage" has the meaning set forth on page [ ] of this SAI.
"Applicable Rate" has the meaning set forth on page [ ] of the Prospectus.
"APS" means Auction Preferred Shares, par value $.001 per share, liquidation
preference $50,000 per share, of the Fund.
"APS Basic Maintenance Amount" has the meaning set forth on page [ ] of this
SAI.
"APS Basic Maintenance Cure Date" has the meaning set forth on page [ ] of this
SAI.
"APS Basic Maintenance Report" has the meaning set forth on page [ ] of this
SAI.
"APS Provisions" has the meaning set forth on page [ ] of the Prospectus.
"Articles of Incorporation" means the Articles of Incorporation, as amended, of
the Fund, including the Articles Supplementary establishing and fixing the
rights and preferences of the APS, on file with the Department of
Assessments and Taxation of the State of Maryland.
"Articles Supplementary" means the Articles Supplementary filed with the
Department of Assessments and Taxation of the State of Maryland and adopted
by the Board of Directors, establishing the rights, preferences, redemption
provisions and other terms of the APS.
"Auction" means each periodic implementation of the Auction Procedures.
"Auction Agency Agreement" has the meaning set forth on page [ ] of this SAI.
"Auction Agent" has the meaning set forth on page [ ] of this SAI.
"Auction Date," with respect to any Rate Period, means the Business Day next
preceding the first day of such Rate Period.
"Auction Procedures" means the procedures for conducting Auctions as described
in the Prospectus.
"Available APS" has the meaning set forth on page [ ] of this SAI.
"Bid" has the meaning set forth on page [ ] of this SAI.
"Bidder" and "Bidders" have the respective meanings set forth on page [ ] of
this SAI.
"Board of Directors" or "Board" means the Board of Directors of the Fund or any
duly authorized committee thereof.
"Broker-Dealer" means any broker-dealer, commercial bank or other entity
permitted by law to perform the functions required of a Broker-Dealer that:
(i) is a member of, or a participant in, the Securities Depository or is an
affiliate of such member or participant; (ii) has been selected by the
Fund; and (iii) has entered into a Broker-Dealer Agreement that remains
effective.
"Broker-Dealer Agreement" means an agreement between the Auction Agent and a
Broker-Dealer pursuant to which such Broker-Dealer agrees to follow the
procedures specified in this SAI.
"Business Day" has the meaning set forth on page [ ] of the Prospectus.
"Closing Transaction" means the termination of a futures contract or option
position by taking an equal position opposite thereto in the same delivery
month as such initial position being terminated.
"Commercial Paper Dealers" has the meaning set forth on page [ ] of this SAI.
"Common Stock" means the common stock, par value $.001 per share, of the Fund.
"Cure Date" means the APS Basic Maintenance Cure Date or the 1940 Act Cure Date,
as the case may be.
"Date of Original Issue" has the meaning set forth on page [ ] of the
Prospectus.
"Deposit Securities" has the meaning set forth on page [ ] this SAI.
"Discount Factor" means a Moody's Discount Factor or an S&P Discount Factor, as
the case may be.
"Discounted Value" of any asset of the Fund means the market value thereof, as
determined by the Fund in accordance with the pricing services to be
provided by the Pricing Service or such other pricing service designated by
the Board of Directors from time to time, discounted by the applicable
Moody's Discount Factor or S&P Discount Factor, as the case may be, in
connection with the Fund's receipt of a rating on the APS from Moody's of
at least "Aaa" and from S&P of at least AAA, provided that, with respect to
a Moody's Eligible Asset, Discounted Value shall not exceed the par value
of such asset at any time.
"Dividend Coverage Amount" has the meaning set forth on page [ ] this SAI.
2
"Dividend Coverage Assets" has the meaning set forth on page [ ] this SAI.
"Dividend Payment Date" has the meaning set forth on page [ ] of the Prospectus.
"Dividend Period" has the meaning set forth on page [ ] of the Prospectus.
"DTC" has the meaning set forth on page [ ] of this SAI.
"Eligible Assets" means Moody's Eligible Assets or S&P Eligible Assets, as the
case may be.
"Existing Holder" has the meaning set forth on page [ ] of this SAI.
"Failure to Deposit," with respect to any series of APS, means a failure by the
Fund to pay to the Auction Agent, not later than 12:00 noon, New York City
time, (A) on the Business Day next preceding any Dividend Payment Date for
such series, in funds available on such Dividend Payment Date in The City
of New York, New York, the full amount of any dividend (whether or not
earned or declared) to be paid on such Dividend Payment Date on any share
of such series or (B) on the Business Day next preceding any redemption
date in funds available on such redemption date for such series in The City
of New York, New York, the Redemption Price to be paid on such redemption
date for any share of such series after Notice of Redemption is given as
set forth in this SAI.
"Fund" means Investment Grade Municipal Income Fund Inc., a Maryland
corporation, which is the issuer of the APS.
"Hold Order" has the meaning set forth on page [ ] of this SAI.
"Holder," or "holder" with respect to any series of APS, means the registered
holder of shares of such series of APS as the same appears on the share
books of the Fund.
"Initial Dividend Period" has the meaning set forth on page [ ] of the
Prospectus.
"Initial Margin" means the amount of cash or securities deposited with a
custodian for the benefit of a futures commission merchant as a good-faith
deposit at the time of the initiation of a purchase or sale position with
respect to a futures contract or a sale position with respect to an option
position thereon.
"Interest Equivalent" means a yield on a 360-day basis of a discount basis
security which is equal to the yield on an equivalent interest-bearing
security.
"Internal Revenue Code" means the Internal Revenue Code of 1986, as amended.
"Kenny Index" has the meaning set forth on page [ ] of this SAI.
"Liens" has the meaning set forth on page [ ] of this SAI.
"Mandatory Redemption Price" means $50,000 per share of APS plus an amount equal
to accumulated but unpaid dividends thereon to the date fixed for
redemption (whether or not earned or declared).
"Marginal Tax Rate" means the maximum marginal regular federal individual income
tax rate applicable to ordinary income or the maximum marginal regular
federal corporate income tax rate, whichever is greater.
3
"Master Purchaser's Letter" means a letter, addressed to the Fund, the Auction
Agent, a Broker-Dealer and an Agent Member, in which a Person agrees, among
other things, to offer to purchase, to purchase, to offer to sell and/or to
sell APS as set forth in the Prospectus.
"Maximum Potential Additional Dividend Liability" has the meaning set forth on
page [ ] of this SAI.
"Maximum Rate" has the meaning set forth on page [ ] of this SAI.
"Minimum Dividend Period" means with respect to each series of APS any Rate
Period with 28 days.
"Minimum Liquidity Level" has the meaning set forth on page [ ] of this SAI.
"Moody's" means Moody's Investors Service, Inc.
"Moody's Discount Factors" has the meaning set forth on page [ ] of this SAI.
"Moody's Eligible Assets" has the meaning set forth on page [ ] of this SAI.
"Moody's Exposure Period" has the meaning set forth on page [ ] of this SAI.
"Moody's Hedging Transactions" has the meaning set forth on page [ ] of this
SAI.
"Moody's Volatility Factor" means 272% (or 302% where notice of a Special
Dividend Period of greater than 28 days but less than 50 days has been
given but not yet exercised), as long as there has been no increase enacted
to the Marginal Tax Rate. If such an increase is enacted but not yet
implemented, the Moody's Volatility Factor shall be as follows:
MOODY'S MOODY'S
VOLATILITY VOLATILITY
% CHANGE IN MARGINAL TAX RATE FACTOR FACTOR*
----------------------------- ---------- ----------
Less than or equal to 5% 292% 323%
Greater than 5% but less than 10% 313 347
Greater than 10% but less than 15% 338 373
Greater than 15% but less than 20% 364 402
Greater than 20% but less than 25% 396 436
Greater than 25% but less than 30% 432 474
Greater than 30% but less than 35% 472 518
Greater than 35% but less than 40% 520 570
* Applicable where a notice of Special Dividend Period of greater than 28
days but less than 50 days has been given but not yet exercised.
"Municipal Index" means The Bond Buyer Municipal Bond Index.
"Municipal Obligation" has the meaning set forth on page [ ] of this SAI.
"1940 Act" means the Investment Company Act of 1940, as amended.
"1940 Act APS Asset Coverage" has the meaning set forth on page [ ] of this SAI.
4
"1940 Act Cure Date" has the meaning set forth on page [ ] of this SAI.
"1933 Act" means the Securities Act of 1933, as amended.
"Non-Call Period" has the meaning described under "Specific Redemption
Provisions" below.
"Notice of Redemption" has the meaning set forth on page [ ] of this SAI.
"NYSE" means the New York Stock Exchange, Inc.
"Optional Redemption Price" means (i) $50,000 per share of APS in the case of a
Rate Period of less than one year, including any Special Dividend Period of
less than 365 days, or (ii) with respect to a Special Dividend Period of
365 days or more, the Optional Redemption Price set forth in the Specific
Redemption Provisions in connection therewith; in each case plus an amount
equal to accumulated but unpaid dividends thereon to the date of redemption
(whether or not earned or declared).
"Order" and "Orders" have the respective meanings set forth on page [ ] of this
SAI.
"Original Issue Insurance" has the meaning set forth on page [ ] of this SAI.
"Outstanding" means, as of any Auction Date with respect to shares of any series
of APS, the number of shares of such series theretofore issued by the Fund
except, without duplication: (i) any shares of such series of APS
theretofore cancelled or delivered to the Auction Agent for cancellation,
or redeemed by the Fund, or as to which (A) a Notice of Redemption shall
have been given by the Fund and (B) the Fund shall have deposited the
Redemption Price with the Auction Agent: (ii) any shares of such series of
APS as to which the Fund or any Affiliate thereof shall be an Existing
Holder: and (iii) any shares of such series of APS represented by any
certificate in lieu of which a new certificate has been executed and
delivered by the Fund.
"Permanent Insurance" has the meaning set forth on page [ ] of this SAI.
"Person" means and includes an individual, a partnership, a corporation, a
trust, an unincorporated association, a joint venture or other entity or a
government or any agency or political subdivision thereof.
"Portfolio Insurance" has the meaning set forth on page [ ] of this SAI.
"Potential Holder" has the meaning set forth on page [ ] of this SAI.
"Preferred Stock" means any of the Fund's capital stock that from time to time
is classified and issued by the Fund as preferred stock, including the APS.
"Preferred Stockholders" means any Holder of APS and any registered holder of
any other Preferred Stock.
"Premium Call Period" has the meaning set forth below under "Specific Redemption
Provisions."
"Pricing Service" means Kenny Information Systems Inc. and any successor pricing
service approved in writing by Moody's (if Moody's is then rating the APS)
and S&P (if S&P is then rating the APS).
5
"Projected Dividend Amount" means, with respect to the shares of any series of
APS, on any Valuation Date, an amount equal to (i) the number of days, if
any, greater than zero from and after the last day of the then current Rate
Period, until 48 calendar days from such Valuation Date, multiplied by (ii)
a rate equal to the Maximum Rate for a Minimum Dividend Period multiplied
by the larger of (A) the applicable Moody's Volatility Factor for a Minimum
Dividend Period or (B) the applicable S&P Volatility Factor.
"Rate Period" has the meaning set forth on page [ ] of the Prospectus.
"Receivables for Municipal Obligations Sold," for purposes of calculating
Moody's Eligible Assets or S&P Eligible Assets, as the case may be, has the
meaning set forth on pages [ ] and [ ] of this SAI. respectively.
"Redemption Price" means the Optional Redemption Price or the Mandatory
Redemption Price, as applicable.
"Reference Rate" has the meaning set forth on page [ ] of this SAI.
"Retroactive Taxable Allocation" has the meaning set forth on page [ ] of the
Prospectus.
"SEC" means the US Securities and Exchange Commission.
"S&P" means Standard & Poor's Corporation.
"S&P Discount Factors" has the meaning set forth on page [ ] of this SAI.
"S&P Eligible Assets" has the meaning set forth on page [ ] of this SAI.
"S&P Exposure Period" has the meaning set forth on page [ ] of this SAI.
"S&P Hedging Transactions" has the meaning set forth on page [ ] of this SAI.
"S&P Volatility Factor" shall mean, for each series of APS: (i) during the
Initial Dividend Period, 277% for APS Series A and APS Series B and 217%
for APS Series C; and (ii) thereafter, depending on the applicable
Reference Rate or Treasury Rate, the following percentages:
RATE PERCENTAGE
---- ----------
Taxable Equivalent of the Short-Term Municipal Bond Rate 277%
30 day 'AA' Composite Commercial Paper Rate 228%
60 day 'AA' Composite Commercial Paper Rate 228%
90 day 'AA' Composite Commercial Paper Rate 222%
180 day 'AA' Composite Commercial Paper Rate 217%
1 year U.S. Treasury Bill Rate 198%
2 year U.S. Treasury Note Rate 185%
3 year U.S. Treasury Note Rate 178%
4 year U.S. Treasury Note Rate 171%
5 year U.S. Treasury Note Rate 169%
6
Notwithstanding the foregoing, the S&P Volatility Factor may mean such other
potential dividend rate increase factor as S&P advises the Fund in writing is
applicable.
"Secondary Market Insurance" has the meaning set forth on page [ ] of this SAI.
"Securities Depository" means The Depository Trust Company and its successors
and assigns or any other securities depository selected by the Fund which
agrees to follow the procedures required to be followed by such securities
depository in connection with the APS.
"Selected Dealers" has the meaning set forth on page [ ] of the Prospectus.
"Sell Order" has the meaning set forth on page [ ] of this SAI.
"Service" means the Internal Revenue Service.
"Shares" has the meaning set forth on page [ ] of the Prospectus.
"Special Dividend Period" has the meaning set forth on page [ ] of the
Prospectus.
"Specific Redemption Provisions" means, with respect to any Special Dividend
Period of 365 or more days, either, or any combination of, (i) a period (a
"Non-Call Period") determined by the Board of Directors, 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 and
(ii) a period (a "Premium Call Period"), consisting of a number of whole
years and determined by the Board of Directors, 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 at a price
per share equal to $50,000 plus accumulated but unpaid dividends plus a
premium expressed as a percentage of $50,000 as determined by the Board of
Directors after consultation with the Broker-Dealers; provided, that during
any Special Dividend Period of 365 or more days if on the date of
determination of the Applicable Rate for such series, such Applicable Rate
equaled or exceeded the Treasury Rate, the Fund may redeem APS without
regard to any Non-Call Period or Premium Call Period at the Mandatory
Redemption Price.
"Submission Deadline" means 1:30 PM., Eastern 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.
"Submitted Bid" has the meaning set forth on page [ ] of this SAI.
"Submitted Hold Order" has the meaning set forth on page [ ] of this SAI.
"Submitted Order" has the meaning set forth on page [ ] of this SAI.
"Submitted Sell Order" has the meaning set forth on page [ ] of this SAI.
"Subsequent Dividend Period" has the meaning set forth on page [ ] of the
Prospectus.
"Substitute Commercial Paper Dealer" has the meaning set forth on page [ ] of
this SAI.
7
"Substitute US Government Securities Dealer" has the meaning set forth on page
[ ] of this SAI.
"Sufficient Clearing Bids" has the meaning set forth on page [ ] of this SAI.
"Taxable Equivalent of the Short-Term Municipal Bond Rate" has the meaning set
forth on page [ ] of this SAI.
"Treasury Bonds" means United States Treasury Bonds backed by the full faith and
credit of the United States government with remaining maturities of ten
years or more.
"Treasury Rate" has the meaning set forth on page [ ] of this SAI.
"UBS Global AM" means UBS Global Asset Management (US) Inc.
"US Government Securities Dealer" has the meaning set forth on page [ ] of this
SAI.
"Valuation Date" has the meaning set forth on page [ ] of this SAI.
"Variation Margin" means, in connection with outstanding purchase or SAI
positions in futures contracts and outstanding SAI positions with respect
to options thereon, the amount of cash and securities paid to and received
from a futures commission merchant (subsequent to the Initial Margin
deposit) from time to time as the value of such position fluctuates.
"Winning Bid Rate" has the meaning set forth on page [ ] of this SAI.
8
APPENDIX A
RATINGS
Municipal bonds are rated by Moody's and S&P. Moody's also publishes
separate ratings for municipal notes. Descriptions of these ratings, together
with the ratings assigned by Moody's and S&P to commercial paper, are set forth
below.
DESCRIPTION OF MOODY'S FOUR HIGHEST MUNICIPAL BOND RATINGS
Aaa. Bonds which are rated Aaa are judged to be of the best quality and
carry the smallest degree of investment risk. 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. They are rated lower than the Aaa 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 considered to be upper medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa. Bonds which are rated Baa are considered to be 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.
NOTE: Those bonds in the Aa, A and Baa groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
A1 and Baa1.
DESCRIPTION OF S&P'S FOUR HIGHEST MUNICIPAL BOND RATINGS
AAA. Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA. Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A. Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB. Debt rated BBB is regarded as having adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
NOTE: Plus (+) or Minus (-): The ratings from "AA" to "BBB" may be modified
by the addition of a plus or minus sign to show relative standing within the
major categories.
DESCRIPTION OF MOODY'S HIGHEST RATINGS OF STATE AND MUNICIPAL NOTES AND
OTHER SHORT-TERM LOANS
Moody's ratings for state and municipal notes and other short-term loans
are designated "Moody's Investment Grade" ("MIG" or, for variable or floating
rate obligations, "VMIG"). Such ratings recognize the differences between short-
term credit risk and long-term risk. Factors affecting the liquidity of the
borrower and short-term cyclical elements are critical in short-term ratings.
Symbols used will be as follows:
MIG-1/VMIG-1. This designation denotes best quality. There is present
strong protection by established cash flows, superior liquidity support or
demonstrated broad based access to the market for refinancing or both.
MIG-2/VMIG-2. This designation denotes high quality. Margins of protection
are ample although not so large as in the preceding group.
DESCRIPTION OF S&P'S RATINGS OF STATE AND MUNICIPAL NOTES AND OTHER
SHORT-TERM LOANS
S&P's tax exempt note ratings are generally given to such notes that mature
in three years or less. The two higher rating categories are as follows:
SP-1. Very strong or strong capacity to pay principal and interest. Those
issues determined to possess overwhelming safety characteristics will be given a
plus (+) designation.
SP-2. Satisfactory capacity to pay principal and interest.
DESCRIPTION OF COMMERCIAL PAPER RATINGS
Issuers assigned Prime-1 by Moody's have a superior capacity for repayment
of short-term promissory obligations. Prime-1 repayment capacity will often 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 earning 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 assigned Prime-2
have a strong capacity for repayment of senior short-term promissory
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, will be more subject to variation. Capitalization characteristics, while
still appropriate, may be more affected by external conditions. Ample alternate
liquidity is maintained.
Issues assigned A by S&P, the highest rating category, are regarded as
having the greatest capacity for timely repayment. Issues in this category are
delineated with the numbers 1, 2 and 3 to indicate the relative degree of
safety. The A-1 designation indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus sign (+) designation. The A-2
designation indicates that the capacity for timely payment is satisfactory.
However, the relative degree of safety is not as high as for issues designated
A-1.
A-2
APPENDIX B
RATING AGENCY GUIDELINES
GENERAL
The guidelines described below have been developed by Moody's and S&P in
connection with other issuances of asset-backed and similar securities,
including debt obligations and adjustable rate preferred stock, generally on a
case-by-case basis through discussions with the issuers of these securities. The
guidelines are designed to ensure that assets underlying outstanding debt or
preferred stock will be sufficiently varied and will be of sufficient quality
and amount to justify investment grade ratings. The guidelines do not have the
force of law, but they have been adopted by the Fund in order to satisfy current
requirements necessary for Moody's and S&P to issue the above- described ratings
for shares of each series of APS, which ratings are generally relied upon by
institutional investors in purchasing such securities. In the context of a
closed-end investment company such as the Fund, therefore, the guidelines
provide a set of tests for portfolio composition and asset coverage that
supplement (and in some cases are more restrictive than) the applicable
requirements under the 1940 Act. A rating agency's guidelines will apply to
shares of any series of APS only so long as such rating agency is rating such
shares.
The Fund intends to maintain a Discounted Value for its portfolio at least
equal to the APS Basic Maintenance Amount and, in addition, so long as S&P is
rating the shares of any series of APS, the Fund intends to maintain a Minimum
Liquidity Level. Moody's and S&P have each established separate guidelines for
determining Discounted Value. To the extent any particular portfolio holding
does not satisfy the applicable rating agency's guidelines, all or a portion of
such holding's value will not be included in the calculation of Discounted Value
(as defined by such rating agency). The Moody's and S&P guidelines do not impose
any limitations on the percentage of Fund assets that may be invested in
holdings not eligible for inclusion in the calculation of the Discounted Value
of the Fund's portfolio. The amount of such assets included in the portfolio at
any time may vary depending upon the rating, diversification and other
characteristics of the Eligible Assets included in the portfolio, although it is
not anticipated that in the normal course of business the value of such assets
would exceed 20% of the Fund's total assets.
In managing the Fund's portfolio, UBS Global AM will not alter the
composition of the Fund's portfolio if, in the reasonable belief of UBS Global
AM, the effect of any such alteration would be to cause the Fund to have
Eligible Assets with an aggregate Discounted Value, as of the immediately
preceding Valuation Date, less than the APS Basic Maintenance Amount of such
Valuation Date; provided, however, that in the event that, as of the immediately
preceding Valuation Date, the aggregate Discounted Value of the Fund's Eligible
Assets exceeded the APS Basic Maintenance Amount by five percent or less, UBS
Global AM will not alter the composition of the Fund's portfolio in a manner
reasonably expected to reduce the aggregate Discounted Value of the Fund's
Eligible Assets unless the Fund shall have confirmed that, after giving effect
to such alteration, the aggregate Discounted Value of the Fund's Eligible Assets
would exceed the APS Basic Maintenance Amount.
Upon any failure to maintain the required Discounted Value, the Fund will
seek to alter the composition of its portfolio to reattain the APS Basic
Maintenance Amount on or prior to the APS Basic Maintenance Cure Date, thereby
incurring additional transaction costs and possible losses and/or gains on
dispositions of portfolio securities. To the extent any such failure is not
cured in a timely manner, shares of each series of APS will be subject to
redemption if either Moody's or S&P is rating such shares. The APS Basic
Maintenance Amount includes the sum of (i) the aggregate liquidation value of
each series of APS then Outstanding and (ii) certain accrued and projected
payment obligations of the Fund. See "Asset Maintenance."
The Fund may, but is not required to, adopt any modifications to these
guidelines that may hereafter be established by Moody's and S&P. Failure to
adopt any such modifications, however, may result in a change in the ratings
described above or a withdrawal of ratings altogether. In addition, any rating
agency providing a rating for the shares of any series of APS may, at any time,
change or withdraw any such rating. As set forth in the APS Provisions, the
Board of Directors may, without Stockholder approval, modify certain definitions
or policies which have been adopted by the Fund pursuant to the rating agency
guidelines, provided the Board of Directors has obtained written confirmation
from Moody's and S&P, as appropriate, that any such change would not impair the
ratings then assigned by Moody's and S&P to any series of APS.
As described by Moody's and S&P, a preferred stock rating is an assessment
of the capacity and willingness of an issuer to pay preferred stock obligations.
The ratings on any series of the APS are not recommendations to purchase, hold
or sell shares of such series of APS, inasmuch as the ratings do not comment as
to market price or suitability for a particular investor nor do the rating
agency guidelines described above address the likelihood that a holder of shares
of any series of APS will be able to sell such shares in an Auction. The ratings
are based on current information furnished to Moody's and S&P by the Fund and
UBS Global AM , and information obtained from other sources. The ratings may be
changed, suspended or withdrawn as a result of changes in, or the unavailability
of, such information. The Fund's Common Stock has not been rated by a nationally
recognized statistical rating organization.
S&P AAA RATING GUIDELINES. For purposes of calculating the Discounted Value
of the Fund's portfolio under current S&P guidelines, the fair market value of
Municipal Obligations eligible for consideration under such guidelines ("S&P
Eligible Assets") must be discounted by certain discount factors set forth in
the table below ("S&P Discount Factors"). The Discounted Value of a Municipal
Obligation under S&P guidelines is the fair market value thereof divided by the
S&P Discount Factor. The S&P Discount Factor used to discount a particular
Municipal Obligation will be determined by reference to the "S&P Exposure
Period" as determined by S&P (currently, 3 Business Days) and the S&P rating on
such Municipal Obligation. S&P Discount Factors for a range of exposure periods
are set forth below:
S&P DISCOUNT S&P DISCOUNT FACTORS
EXPOSURE PERIOD RATING CATEGORY
AAA AA A BBB
--- --- --- ---
40 Business Days 190% 195% 210% 250%
22 Business Days 170 175 190 230
10 Business Days 155 160 175 215
7 Business Days 150 155 170 210
3 Business Days 130 135 150 190
Since the S&P Exposure Period currently applicable to the Fund is 3
Business Days, the S&P Discount Factors currently applicable to S&P Eligible
Assets will be determined by reference to the factors set forth opposite the
line entitled "3 Business Days." Notwithstanding the foregoing:
(i) the S&P Discount Factor for short-term Municipal Obligations will be
115%, so long as such Municipal Obligations are rated A-1+ or SP-1+ by S&P and
mature or have a demand feature exercisable within 30 days or less, or 125%, if
such Municipal Obligations are not rated by S&P but are rated VMIG-1, MIG-1 or
Prime-1 by Moody's; provided, however, that any such Moody's-rated short-term
Municipal Obligations which have demand features exercisable within 30 days or
less must be backed by a letter of credit, liquidity facility or guarantee from
a bank or other financial institution with a short-term rating of at least A-1+
from S&P; and further provided that such Moody's-rated short-term Municipal
B-2
Obligations may comprise no more than 50% of short-term Municipal Obligations
that qualify as S&P Eligible Assets; and
(ii) no S&P Discount Factor will be applied to cash or to Receivables for
Municipal Obligations Sold.
For purposes of the foregoing, Anticipation Notes rated SP-1+ or, if not
rated by S&P, rated MIG-1 or VMIG-1 by Moody's, which do not mature or have a
demand feature at par exercisable in 30 days and which do not have a long-term
rating, will be considered to be short-term Municipal Obligations. "Receivables
for Municipal Obligations Sold," for purposes of calculating S&P Eligible Assets
as of any Valuation Date, means the book value of receivables for Municipal
Obligations sold as of or prior to such Valuation Date if such receivables are
due within five business days of such Valuation Date.
The S&P guidelines impose certain minimum issue size, issuer, geographical
diversification and other requirements for purposes of determining S&P Eligible
Assets:
(1) In order to be considered S&P Eligible Assets, Municipal Obligations
owned by the Fund must:
(a) be interest bearing and pay interest at least semi-annually;
(b) be payable with respect to principal and interest in US dollars;
(c) be publicly rated BBB or higher by S&P or if not rated by S&P but
rated by Moody's, be rated at least A by Moody's; provided that such
Moody's-rated Municipal Obligations will be included in S&P Eligible
Assets only to the extent that the fair market value of such Municipal
Obligations does not exceed 50% of the aggregate fair market value of
S&P Eligible Assets. For purposes of determining the S&P Discount
Factors applicable to such Moody's-rated Municipal Obligations, any
such municipal obligation will be deemed to have an S&P rating which
is one full rating category lower than its Moody's rating;
(d) not be private placements; and
(e) be part of an issue with an original issue size of at least $20
million or, if of an issue with an original issue size below $20
million (but in no event lower than $10 million), be issued by an
issuer with a total of at least $50 million of securities outstanding.
(2) Municipal Obligations of any one issuer or guarantor (excluding bond
insurers) will be considered S&P Eligible Assets only to the extent that the
fair market value of such Municipal Obligations does not exceed 10% of the
aggregate fair market value of S&P Eligible Assets, provided that 2% is added to
the applicable S&P Discount Factor for every 1% by which the fair market value
of such Municipal Obligations exceeds 5% of the aggregate fair market value of
S&P Eligible Assets.
(3) Municipal Obligations guaranteed or insured by any one bond insurer
will be considered S&P Eligible Assets only to the extent that the fair market
value of such Municipal Obligations does not exceed 25% of the aggregate fair
market value of S&P Eligible Assets.
(4) Municipal Obligations issued by issuers in any one state (including
the District of Columbia), territory or possession of the United States will be
considered S&P Eligible Assets only to the extent that the fair market value of
such Municipal Obligations does not exceed 20% of the aggregate fair market
value of S&P Eligible Assets.
B-3
For so long as shares of the APS are outstanding and S&P is rating such
APS, the Fund will not, unless the Fund has received written confirmation from
S&P that any such action would not impair the rating then assigned by S&P to the
APS, engage in any one or more of the following transactions: engage in reverse
repurchase agreement transactions; borrow money, except that the Fund may,
without obtaining the written confirmation described above, borrow money for the
purposes of clearing securities transactions if the APS Basic Maintenance Amount
would continue to be satisfied after giving effect to such borrowing; issue any
class or series of shares ranking prior to or on a parity with the APS with
respect to the payment of dividends or the distribution of assets upon
dissolution, liquidation or winding up of the Fund, or reissue any APS
previously purchased or redeemed by the Fund; lend portfolio securities; merge
or consolidate with any corporation; engage in repurchase agreement transactions
in which the term of such repurchase obligation is longer than 90 days, in which
the underlying security is a security other than United States Treasury
securities (not inclusive of zero-coupon securities), demand deposits,
certificates of deposit, or bankers acceptances in which the counter-party or
its affiliates have securities rated A-1+ by S&P with respect to such underlying
security; or engage in short sale transactions. In addition, as long as shares
of APS are so rated or unless such confirmation has been received, the Fund will
not enter into interest rate caps, collars or floors, purchase or sell futures
contracts or options thereon or write uncovered put or uncovered call options on
portfolio securities except that (i) the Fund may engage in any S&P Hedging
Transactions based on the Municipal Index, provided that the Fund shall not
engage in any S&P Hedging Transaction based on the Municipal Index (other than
Closing Transactions) which would cause the Fund at the time of such transaction
to own or have sold the least of (1) more than 1,000 outstanding futures
contracts based on the Municipal index, (2) outstanding futures contracts based
on the Municipal Index and on the Treasury Bonds exceeding in number 25% of the
quotient of the fair market value of the Fund's total assets divided by 100,000
or (3) outstanding futures contracts based on the Municipal Index exceeding in
number 10% of the average number of daily traded futures contacts based on the
Municipal Index in the month prior to the time of effecting such transaction as
reported by THE WALL STREET JOURNAL, and (ii) the Fund may engage in S&P Hedging
Transactions based on Treasury Bonds, provided that the Fund shall not engage in
any S&P Hedging Transaction based on Treasury Bonds (other then Closing
Transactions) which would cause the Fund at the time of such transaction to own
or have sold the lesser of (1) outstanding futures contracts based on Treasury
Bonds and on the Municipal Index exceeding in number 25% of the quotient of the
fair market value of the Fiend's total assets divided by 100,000 or (2)
outstanding futures contracts based on Treasury Bonds exceeding in number 10% of
the average number of daily traded futures contacts based on Treasury Bonds in
the month prior to the time of effecting such transaction as reported by THE
WALL STREET JOURNAL.
For so long as shares of the APS are rated by S&P, the Fund will engage in
Closing Transactions to close out any outstanding futures contract which the
Fund owns or has sold or any outstanding option thereon owned by the Fund in the
event (i) the Fund does not have S&P Eligible Assets with an aggregate
Discounted Value equal to or greater than the APS Basic Maintenance Amount on
two consecutive Valuation Dates and (ii) the Fund is required to pay Variation
Margin on the second such Valuation Date. For so long as shares of the APS are
rated by S&P, the Fund will engage in a Closing Transaction to close out any
outstanding futures contract or option thereon in the month prior to the
delivery month under the terms of such futures contract or option thereon unless
the Fund holds securities deliverable under such terms. For purposes of
determining S&P Eligible Assets to determine compliance with the APS Basic
Maintenance Amount, no amounts on deposit with the Fund's custodian or broker
representing Initial Margin or Variation Margin shall constitute S&P Eligible
Assets. For so long as shares of the APS are rated by S&P, when the Fund writes
a futures contract or option thereon, it will maintain an amount of cash, cash
equivalents or short-term, money market securities in a segregated account with
the Fund's custodian, so that the amount so segregated plus the amount of
Initial Margin and Variation Margin held
B-4
in the account of the Fund's broker equals the fair market value of the futures
contract, except that in the event the Fund writes a futures contract or option
thereon which requires delivery of an underlying security, the Fund shall hold
such underlying security.
MOODY'S "Aaa" RATING GUIDELINES. For purposes of calculating the Discounted
Value of the Fund's portfolio under current Moody's guidelines, the fair market
value of Municipal Obligations eligible for consideration under such guidelines
("Moody's Eligible Assets") must be discounted by certain discount factors set
forth in the table below ("Moody's Discount Factors"). The Discounted Value of a
municipal obligation under Moody's guidelines is the fair market value thereof
divided by the Moody's Discount Factor. The Moody's Discount Factor used to
discount a particular municipal obligation will be determined by reference to
the "Moody's Exposure Period" currently, the 47-day period commencing on a given
Valuation Date). Moody's Discount Factors for a range of exposure periods are
set forth below:
MOODY'S DISCOUNT FACTORS
RATING CATEGORY
-----------------------------------------------------------------------
MOODY'S EXPOSURE PERIOD VMIG-1 SP-1+
Aaa(1) Aa(1) A(1) Baa(1) OTHER(2) (1)(3)(4) (3)(4)
------ ----- ---- ------ -------- --------- ------
7 weeks or less 151% 159% 168% 202% 229% 136% 148%
8 weeks or less but greater 154 164 173 205 235 137 149
than 7 weeks
9 weeks or less but greater 158 169 179 209 242 138 150
than 8 weeks
----------
(1) Moody's rating.
(2) Municipal Obligations not rated by Moody's but rated BBB-, BBB or BBB +by
S&P
(3) Municipal Obligations rated MIG-1, VMIG-1 or Prime-1 or, if not rated by
Moody's, rated SP-1+ by S&P which do not mature or have a demand feature at
par exercisable within the Moody's Exposure Period and which do not have a
long-term rating.
(4) For the purposes of the definition of Moody's Eligible Assets, these
securities will have an assumed rating of "A" by Moody's.
Since the Moody's Exposure Period currently applicable to the Fund is 47
days, the Moody's Discount Factors currently applicable to Moody's Eligible
Assets will be determined by reference to the factors set forth opposite the
line entitled "7 weeks or less."
Notwithstanding the foregoing, (i) no Moody's Discount Factor will be
applied to short-term Municipal Obligations so long as such Municipal
Obligations are rated at least MIG-1, VMIG-1 or Prime-1 by Moody's and mature or
have a demand feature at par exercisable within the Moody's Exposure Period, and
the Moody's Discount Factor far such Municipal Obligations will be 125% as long
as such Municipal Obligations are rated 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 and
(ii) no Moody's Discount Factor will be applied to cash or to Receivables for
Municipal Obligations Sold. "Receivables for Municipal Obligations Sold," for
purposes of calculating Moody's Eligible Assets as of any Valuation Date, means
no more than the aggregate of the following: (i) the book value of receivables
for Municipal Obligations sold as of or prior to such Valuation Date if such
receivables are due within five business days of such Valuation Date, and if the
trades which generated such receivables are (x) settled through clearinghouse
firms with respect to which the Fund has received prior written authorization
from Moody's or (y) with counterparties having a Moody's long-term debt rating
of at least Baa3; and (ii) the Moody's Discounted Value of Municipal Obligations
sold as of or prior to such Valuation Date which generated receivables, if such
receivables are due within the Moody's Exposure Period but do not comply with
either of conditions (x) or (y).
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The Moody's guidelines impose certain minimum issue size, issuer,
geographical diversification and other requirements for purposes of determining
Moody's Eligible Assets, as set forth in the table below:
MINIMUM ISSUE MAXIMUM UNDERLYING MAXIMUM STATE OR
RATING SIZE (MILLIONS) OBLIGOR** TERRITORY CONCENTRATION**
------ --------------- ------------------ -------------------------
Aaa $ 10 100% 100%
Aa 10 20 60
A 10 10 40
Baa 10 6 20
Other* 10 4 12
----------
* Municipal Obligations not rated by Moody's but rated at least BBB- by S&P
** The referenced percentages represent maximum cumulative totals for the
related rating category and each lower rating category.
Current Moody's guidelines also require that Municipal Obligations
constituting Moody's Eligible Assets pay interest in cash, be publicly rated Baa
or higher by Moody's or, if not rated by Moody's but rated by S&P, that they be
rated at least BBB by S&P, and that they not have suspended ratings. For
purposes of determining the Moody's Discount Factors applicable to such
S&P-rated Municipal Obligations, any such Municipal Obligations (excluding
short-term Municipal Obligations) will be deemed to have a Moody's rating which
is one full rating category lower than its S&P rating. For purposes of
calculation of Minimum Issue Size, Maximum Underlying Obligor and Maximum State
or Territory Concentration, Moody's Eligible Assets shall be calculated without
including cash and Municipal Obligations rated MIG-1, VMIG-1 or Prime-1 or, if
not rated by Moody's, rated SP-1+ by S&P, which either mature or have a demand
feature at par exercisable within the Moody's Exposure Period. Where the Fund
sells an asset and agrees to repurchase such asset in the future, the Discounted
Value of such asset will constitute a Moody's Eligible Asset and the amount the
Fund is required to pay upon repurchase of such asset will count as a liability
for the purposes of the APS Basic Maintenance Amount. Where the Fund purchases
an asset and agrees to sell it to a third party in the future, cash receivable
by the Fund thereby will constitute a Moody's Eligible Asset if the long-term
debt of such other party is rated at least A2 by Moody's and such agreement has
a term of 30 days or less; otherwise the Discounted Value of such asset will
constitute a Moody's Eligible Asset.
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 (A)(i) through (A)(vii) under the definition of APS Basic Maintenance
Amount or it is subject to any material lien, mortgage, pledge, security
interest or security agreement of any kind (collectively, "Liens"), except for
(a) Liens which are being contested in good faith by appropriate proceedings and
which Moody's has indicated to the Fund will not affect the status of such asset
as a Moody's Eligible Asset, (b) Liens for taxes that are not then due and
payable or that can be paid thereafter without penalty, (c) Liens to secure
payment for services rendered or cash advanced to the Fund by UBS Global AM,
State Street Bank and Must Company or the Auction Agent and (d) Liens by virtue
of any repurchase agreement.
For so long as shares of the APS are outstanding and the APS are rated by
Moody's, the Fund will not, unless it has received written confirmation from
Moody's that any such action would not impair the ratings then assigned by
Moody's to the APS engage in any one or more of the following transactions: (1)
incur any indebtedness, except that the Fund may, without obtaining the prior
written approval described above, incur indebtedness for the purpose of clearing
securities transactions if the Discounted Value of Moody's Eligible Assets would
equal or exceed the APS Basic Maintenance Amount after giving effect to such
indebtedness; (2) issue any class or series of shares ranking prior to or on a
parity with the APS with respect to the payment of dividends or the distribution
of assets upon dissolution,
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liquidation or winding up of the Fund, or reissue any APS previously purchased
or redeemed by the Fund; (3) engage in short sale transactions; or (4) except as
necessary to effect Closing Transactions, engage in transactions in options on
securities, futures contracts or options on futures contracts, except that in
connection with Moody's Hedging Transactions: (A) the Fund may buy call or put
options on securities; (B) the Fund may write covered call options on
securities; (C) the Fund may write put options on securities (D) the Fund may
enter into positions in futures contracts based on the Municipal Index provided
that the Fund shall not engage in any such transaction which would cause the
Fund at the time of such transaction to own or have sold (1) outstanding futures
contracts based on the Municipal Index exceeding in number 10% of the rolling
average number of daily traded futures contracts based on the Municipal Index in
the 30 calendar days prior to the time of effecting such transaction as reported
by THE WALL STREET JOURNAL or (2) outstanding futures contracts based on the
Municipal Index and options on such futures contracts having an aggregate fair
market value (taking into account the fair market value of futures contracts
based on Treasury Bonds) exceeding the fair market value of Moody's Eligible
Assets owned by the Fund; (E) the Fund may enter into futures contracts on
Treasury Bonds provided that the Fund shall not engage in any such transaction
which would cause the Fund at the time of such transaction to own or have sold
(1) outstanding futures contracts based on Treasury Bonds and options on such
futures contracts having an aggregate fair market value (taking into account the
fair market value of futures contracts based on the Municipal Index) exceeding
40% of the aggregate fair 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 (2) outstanding futures contracts based on Treasury Bonds
and options on such futures contracts having an aggregate fair market value
(taking into account the fair market value of futures contracts based on the
Municipal Index) exceeding 80% of the aggregate fair market value of Moody's
Eligible Assets owned by the Fund 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); and (F) the Fund may
buy call or put options on futures contracts on the Municipal Index or Treasury
Bonds, may write put options on such futures contracts (provided, that if the
contract would require delivery of a security, that security must be held by the
Fund) and may write call options on such futures if it owns the futures contract
subject to the option. For purposes of the foregoing clauses (D) and (E), the
Fund shall be deemed to own the number of futures contracts that underlie any
outstanding option written by the Fund.
For so long as shares of the APS are rated by Moody's, the Fund will engage
in Closing Transactions to close out any outstanding futures contract based on
the Municipal Index if the open interest with respect to such futures contracts
based on the Municipal Index as reported by THE WALL STREET JOURNAL is less than
5,000. For so long as shares of APS are rated by Moody's, the Fund will engage
in a Closing Transaction to close out any outstanding 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 futures contract by no later than the first Business Day of the month in which
such option expires. For so long as shares of APS are rated by Moody's, the Fund
will engage in transactions with respect to futures contracts or options thereon
having only the next settlement date or the settlement date immediately
thereafter.
For purposes of valuation of Moody's Eligible Assets (i) if the Fund writes
a call option, the underlying asset will be valued as follows: (A) if the option
is exchange-traded and may be offset readily or if the option expires before the
earliest possible redemption of the APS, at the lower of the Discounted Value of
the underlying security of the option and the exercise price of the option or
(B) otherwise, it has no value; (ii) if the Fund writes a put option, the
underlying asset will be valued as follows: the lesser of (A) exercise price and
(B) the Discounted Value of the underlying security; (iii) if the Fund is a
seller under a futures contract, the underlying security will be valued at the
lower of (A) settlement price and (B) Discounted Value of the underlying
security; provided that, if a contract matures within the Moody's
B-7
Exposure Period, the security may be valued at the settlement price; (iv) if the
Fund is the buyer under a futures contract, the underlying security will be
valued at the lower of (A) the settlement price and (B) the Discounted Value of
the underlying security; provided that, if the contract matures within the
Moody's Exposure Period, the security may be valued at Discounted Value of the
underlying security; and (v) call or put option contracts which the Fund buys
have no value. For so long as shares of the APS are rated by Moody's: (1) the
Fund will not engage in options and futures transactions for leveraging or
speculative purposes; (2) the Fund will not write any anticipatory call options
or sell any anticipatory contracts pursuant to which the Fund hedges the
anticipated purchase of an asset prior to completion of such purchase; (3) 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 APS Basic Maintenance
Amount; (4) for purposes of the APS Basic Maintenance Amount (i) assets in
margin accounts are not Moody's Eligible Assets, (ii) 10% of the settlement
price of assets sold under a futures contract, the settlement price of assets
purchased under a futures contract and the settlement price of an underlying
futures contract if the Fund writes put options on futures contracts will
constitute liabilities of the Fund and (iii) if the Fund writes call options on
futures contracts and does not own the underlying futures contract, 105% of the
fair market value of the underlying futures contract will constitute a liability
of the Fund; (5) the Fund shall enter into only exchange-traded futures and
shall write only exchange-traded options on exchanges approved by Moody's; (6)
where delivery may be made to the Fund with any of a class of securities, the
Fund shall assume for purposes of the APS Basic Maintenance Amount that it takes
delivery of that security which yields it the least value; (7) the Fund will not
engage in forward contracts; (8) the Fund will enter into futures contracts as
seller only if it owns the underlying security; and (9) there shall be a
quarterly audit made of the Fund's futures and options transactions by the
Fund's independent accountants to confirm that the Fund is in compliance with
these standards.
B-8
APPENDIX C
AUCTION PROCEDURES
THE FOLLOWING PROCEDURES WILL BE SET FORTH IN THE ARTICLES SUPPLEMENTARY.
THE TERMS NOT DEFINED BELOW ARE DEFINED IN THE GLOSSARY OR ELSEWHERE IN THE
PROSPECTUS OR THIS STATEMENT OF ADDITIONAL INFORMATION.
2. ORDERS BY EXISTING HOLDERS AND POTENTIAL HOLDERS. (a) Prior to the
Submission Deadline on each Auction Date:
(i) each Existing Holder of shares of APS subject to an Auction
on such Auction Date may submit to a Broker-Dealer by telephone or
otherwise information as to:
(A) the number of Outstanding shares, if any, of the
APS held by such Existing Holder which such Existing Holder desires to
continue to hold without regard to the Applicable Rate for the next
succeeding Rate Period;
(B) the number of Outstanding shares, if any, of the
APS which such Existing Holder offers to sell if the Applicable Rate
for the next succeeding Rate Period shall be less than the rate per
annum specified by such Existing Holder; and/or
(C) the number of Outstanding shares, if any, of APS
held by such Existing Holder which such Existing Holder offers to sell
without regard to the Applicable Rate for the next succeeding Rate
Period;
and
(ii) one or more Broker-Dealers, using lists of Potential
Holders, shall in good faith for the purpose of conducting a competitive
Auction in a commercially reasonable manner, contact Potential Holders (by
telephone or otherwise), including Persons that are not Existing Holders,
on such lists to determine the number of shares, if any, of such APS which
each such Potential Holder offers to purchase if the Applicable Rate for
the next succeeding Rate Period shall not be less than the rate per annum
specified by such Potential Holder.
For the purposes hereof, the communication to a Broker-Dealer 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 Existing Holder and each Potential Holder placing an Order 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 an Existing Holder of shares of the APS subject to
an Auction on any Auction Date shall constitute an irrevocable offer to sell:
(A) the number of Outstanding shares of the APS
specified in such Bid if the Applicable Rate determined on such
Auction Date shall be less than the rate specified therein;
(B) such number or a lesser number of outstanding
shares of the APS to be determined as set forth in clause (iv) of
paragraph (a) of Section 5 of this Part II if the Applicable Rate
determined on such Auction Date shall be equal to the rate specified
therein; or
(C) the number of Outstanding shares of the APS
specified in such Bid if the rate specified therein shall be higher
than the Maximum Rate, or such number or a lesser number of
Outstanding shares of the APS to be determined as set forth in clause
(iii) of paragraph (b) of Section 5 of this Part II if the rate
specified therein shall be higher than the Maximum Rate and Sufficient
Clearing Bids for such series do not exist.
(ii) A Sell Order by an Existing Holder on any Auction Date shall
constitute an irrevocable offer to sell:
(A) the number of Outstanding shares of the APS specified
in such Sell Order; or
(B) such number or a lesser number of Outstanding
shares of the APS as set forth in clause (iii) of paragraph (b) of
Section 5 of this Part II if Sufficient Clearing Bids for the APS do
not exist.
(iii) A Bid by a Potential Holder on any Auction Date shall
constitute an irrevocable offer to purchase:
(A) the number of Outstanding shares of the APS
specified in such Bid if the Applicable Rate 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 the APS as set forth in clause (v) of paragraph (a) of
Section 5 of this Part II if the Applicable Rate determined on such
Auction Date shall be equal to the rate specified therein.
(c) No Order for any number of shares of the APS other than whole shares
shall be valid.
3. 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 shares of the APS
subject to an Auction on such Auction Date obtained by such Broker-Dealer and
shall specify with respect to each Order for such shares:
(i) the name of the Bidder placing such Order;
(ii) the aggregate number of shares of the APS that are the
subject of such order;
C-2
(iii) to the extent that such Bidder is an Existing Holder:
(A) the number of shares, if any, of the APS subject to any
Hold Order placed by such Existing Holder;
(B) the number of shares, if any, of the APS subject to any
Bid placed by such Existing Holder and the rate specified in such Bid;
and
(C) the number of shares, if any, of the APS subject to any
Sell Order placed by such Existing Holder; and
(iv) to the extent such Bidder is a Potential Holder, the rate
and number of shares of the APS 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) With respect to an Auction preceding a Rate Period of less than 90
days, if an Order or Orders covering all of the Outstanding shares of the APS
held by any Existing Holder is/are not submitted to the Auction Agent prior to
the Submission Deadline, the Auction Agent shall deem a Hold Order to have been
submitted on behalf of such Existing Holder covering the number of Outstanding
shares of the APS held by such Existing Holder and not subject to Orders
submitted to the Auction Agent. With respect to an Auction preceding a Rate
Period of 90 days or greater, if an Order or Orders covering all of the
Outstanding shares of the APS held by any Existing Holder is/are not submitted
to the Auction Agent prior to the Submission Deadline, the Auction Agent shall
deem a Sell Order to have been submitted on behalf of such Existing Holder
covering the number of Outstanding shares of the APS held by such Existing
Holder and not subject to Orders submitted to the Auction Agent.
(d) If any Existing Holder submits through a Broker-Dealer to the Auction
Agent one or more Orders covering in the aggregate more than the number of
Outstanding shares of the APS 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 the APS shall be considered
valid, but only up to and including in the aggregate the number of
Outstanding shares of the APS held by such Existing Holder, and if the
number of shares of the APS subject to such Hold Orders exceeds the number
of Outstanding shares of the APS 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 the APS held by such Existing
Holder;
(ii) (A) any Bid for shares of the APS shall be considered valid
up to and including the excess of the number of Outstanding shares of the
APS held by such Existing Holder over the number of shares of the APS
subject to any Hold Orders referred to in clause (i) above;
(B) subject to sub-clause (A), if more than one Bid for
shares of the APS with the same rate is submitted on behalf of such
Existing Holder and the number of
C-3
Outstanding shares of the APS 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 the APS subject
to each Bid with the same rate shall be reduced PRO RATA to cover the
number of shares of the APS equal to such excess;
(C) subject to sub-clauses (A) and (B), if more than one
Bid for shares of the APS with different rates is submitted on behalf
of such Existing Holder, 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 the APS 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 the APS by a
Potential Holder at the rate therein specified; and
(iii) all Sell Orders for shares of the APS shall be considered
valid up to and including the excess of the number of Outstanding shares of
the APS held by such Existing Holder over the sum of the APS subject to
valid Hold Orders referred to in clause (i) above and valid Bids by such
Existing Holder referred to in clause (ii) above.
(e) If more than one Bid for one or more shares of the APS is submitted 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 Broker-Dealer to the Auction Agent prior to
the Submission Deadline on any Auction Date shall be irrevocable.
4. DETERMINATION OF SUFFICIENT CLEARING BIDS, WINNING BID RATE AND
APPLICABLE RATE. (a) Not earlier than the Submission Deadline on each Auction
Date, the Auction Agent shall assemble all valid Orders submitted or deemed
submitted to it by the Broker-Dealers (each such Order as submitted or deemed
submitted by a Broker-Dealer being hereinafter referred to individually as a
"Submitted Hold Order," a "Submitted Bid" or a "Submitted Sell Order," as the
case may be, or 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:
(i) the excess of the number of Outstanding shares of the APS
over the number of Outstanding shares of the APS subject to Submitted Hold
Orders (such excess being hereinafter referred to as the "Available APS");
(ii) from the Submitted Orders whether:
(A) the number of Outstanding shares of the APS subject to
Submitted Bids by Potential Holders specifying one or more rates equal
to or lower than the Maximum Rate for the APS exceeds or is equal to
the sum of
(B) the number of Outstanding shares of the APS subject to
Submitted Bids by Existing Holders specifying one or more rates higher
than the Maximum Rate and
C-4
(C) the number of Outstanding shares of the APS subject to
Submitted Sell Orders (in the event such excess or such equality
exists (other than because the number of shares of the APS in
subclauses (B) and (C) above is zero because all of the Outstanding
shares of the APS are subject to Submitted Hold Orders) (such
Submitted Bids in subclause (A) above being hereinafter referred to
collectively as "Sufficient Clearing Bids"); and
(iii) if Sufficient Clearing Bids, the lowest rate specified in
such Submitted Bids (the "Winning Bid Rate") which if:
(A)(I) each such Submitted Bid from Existing Holders
specifying such lowest rate and (II) all other such Submitted Bids
from Existing Holders specifying lower rates were rejected, thus
entitling such Existing Holders to continue to hold the shares of the
APS that are subject to such Submitted Bids; and
(B)(I) each such Submitted Bid from Potential Holders
specifying such lowest rate and (II) all other such Submitted Bids
from 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 the
APS which, when added to the number of Outstanding shares of the APS
to be purchased by such Potential Holders described in subclause (B)
above, would equal not less than the Available APS.
(b) Promptly after the Auction Agent has made the determinations pursuant
to paragraph (a) of this Section 4, the Auction Agent shall advise the Fund of
the Maximum Rate and, based on such determination, the Applicable Rate for the
next succeeding Rate Period as follows:
(i) if Sufficient Clearing Bids exist, that the Applicable Rate
for the next succeeding Rate Period thereof shall be equal to the Winning
Bid Rate so determined;
(ii) if Sufficient Clearing Bids do not exist (other than because
all of the Outstanding shares of the APS are subject to Submitted Hold
Orders), that the Applicable Rate for the next succeeding Rate Period,
which shall be a Minimum Dividend Period, shall be equal to the Maximum
Rate; or
(iii) if all of the Outstanding shares of the APS are subject to
Submitted Hold Orders, that the Applicable Rate for the next succeeding
Rate Period thereof shall be equal to the product of (A)(I) the Reference
Rate on such Auction Date for such Rate Period, if such Rate Period is less
than one year or (II) the Treasury Rate on such Auction Date for such Rate
Period, if such Rate Period is one year or greater, and (B)1 minus the
maximum marginal regular federal individual income tax rate applicable to
ordinary income or the maximum marginal regular federal corporate income
tax rate, whichever is greater; provided, however, that if the Fund has
notified the Auction Agent of its intent to allocate to the APS in such
Rate Period any net capital gains or other income taxable for Federal
income tax purposes, the Applicable Rate in respect of that portion of the
dividend on the APS for such Rate Period that represents the allocation of
net capital gains or other income taxable for federal income tax purposes
will be the rate described in
C-5
the preceding clause (A)(I) or (II), as applicable, without being
multiplied by the factor set forth in the preceding clause (B).
5. ACCEPTANCE AND REJECTION OF SUBMITTED BIDS AND SUBMITTED SELL ORDERS
AND ALLOCATION OF SHARES. Existing Holders shall continue to hold the APS that
are subject to Submitted Hold Orders, and, based on the determinations made
pursuant to paragraph (a) of Section 4 of this Part II, the Submitted Bids and
Submitted Sell Orders shall be accepted or rejected and the Auction Agent shall
take such other action as set forth below:
(a) If Sufficient Clearing Bids have been made, all Submitted Sell Orders
shall be accepted and, subject to the provisions of paragraphs (d) and (e) of
this Section 5, Submitted Bids shall be accepted or rejected as follows in the
following order of priority, and all other Submitted Bids for the APS shall be
rejected:
(i) Existing Holders' Submitted Bids specifying any rate that is
higher than the Winning Bid Rate shall be accepted, thus requiring each
such Existing Holder to sell the APS subject to such Submitted Bids;
(ii) Existing Holders' Submitted Bids specifying any rate that is
lower than the Winning Bid Rate shall be rejected, thus entitling each such
Existing Holder to continue to hold the APS subject to such Submitted Bids;
(iii) Potential Holders' Submitted Bids specifying any rate that
is lower than the Winning Bid Rate shall be accepted;
(iv) each Existing Holder's Submitted Bid for shares of the APS
specifying a rate that is equal to the Winning Bid Rate shall be rejected,
thus entitling such Existing Holder to continue to hold shares of the APS
subject to such Submitted Bid, unless the number of Outstanding shares of
the APS subject to all such Submitted Bids shall be greater than the number
of shares of the APS ("remaining shares") in the excess of the Available
APS over the number of APS 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 the APS subject to such Submitted
Bid, but only in an amount equal to the number of shares of the APS
obtained by multiplying the number of remaining shares by a fraction, the
numerator of which shall be the number of Outstanding shares of the APS
held by such Existing Holder subject to such Submitted Bid and the
denominator of which shall be the aggregate number of Outstanding shares of
the APS subject to such Submitted Bids made by all such Existing Holders
that specified a rate equal to the Winning Bid Rate; and
(v) each Potential Holder's Submitted Bid for shares of the APS
specifying a rate that is equal to the Winning Bid Rate shall be accepted
but only in an amount equal to the number of shares of the APS obtained by
multiplying the number of shares in the excess of the Available APS over
the number of APS 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 shares of the APS subject to such
Submitted Bids and the denominator of which shall be the aggregate number
of Outstanding shares of the APS subject to such Submitted Bids made by all
such Potential Holders that specified a rate equal to the Winning Bid Rate;
and
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(b) If Sufficient Clearing Bids have not been made (other than because all
of the Outstanding shares of the APS are subject to Submitted Hold Orders),
subject to the provisions of paragraph (d) of this Section 5, Submitted Orders
for the APS shall be accepted or rejected as follows in the following order of
priority and all other Submitted Bids for the APS shall be rejected:
(i) Existing Holders' Submitted Bids for shares of the APS
specifying any rate that is equal to or lower than the Maximum Rate shall
be rejected, thus entitling such Existing Holders to continue to hold the
APS subject to such Submitted Bids;
(ii) Potential Holders' Submitted Bids for shares of the APS
specifying any rate that is equal to or lower than the Maximum Rate for the
APS shall be accepted; and
(iii) Each Existing Holder's Submitted Bid for shares of the APS
specifying any rate that is higher than the Maximum Rate and the Submitted
Sell Orders of each Existing Holder shall be accepted, thus entitling each
Existing Holder that submitted any such Submitted Bid or Submitted Sell
Order to sell the shares of the APS subject to such Submitted Bid or
Submitted Sell Order, but in both cases only in an amount equal to the
number of shares of the APS obtained by multiplying the number of shares of
the APS 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 the APS 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 the APS subject to all such
Submitted Bids and Submitted Sell Orders.
(c) If all of the Outstanding shares of the APS are subject to Submitted
Hold Orders, all Submitted Bids for the APS 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 5, 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 the APS 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 shares of the APS 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 of the APS so
purchased or sold by each Existing Holder or Potential Holder on such Auction
Date shall be a whole number of shares of APS.
(e) If as a result of the procedures described in clause (v) of paragraph
(a) of this Section 5, any Potential Holder would be entitled or required to
purchase less than a whole share of the APS on any Auction Date, the Auction
Agent shall, in such manner as it shall determine in its sole discretion,
allocate shares of the APS for purchase among Potential Holders so that only
whole shares of the APS 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 APS on such Auction Date.
(f) Based on the results of each Auction for shares of the APS, the
Auction Agent shall determine the aggregate number of shares of the APS to be
purchased and the aggregate number of shares of the APS to be sold by Potential
Holders and Existing Holders on whose behalf each Broker-Dealer submitted Bids
or Sell Orders and, with respect to each Broker-Dealer, 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 Broker-Dealer or Broker-Dealers
acting for one or more purchasers of shares of the APS such
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Broker-Dealer shall deliver, or from which other Broker-Dealer or Broker-Dealers
acting for one or more sellers of shares of the APS such Broker-Dealer shall
receive, as the case may be, shares of the APS.
6. NOTIFICATION OF ALLOCATIONS. In normal circumstances, whenever the
Fund intends to include any net capital gains or other income taxable for
Federal income tax purposes in any dividend on the APS, the Fund may notify the
Auction Agent of the amount to be so included 15 days prior to the Auction Date
on which the Applicable Rate for such dividend is to be established. Whenever
the Auction Agent receives such notice from the Fund, it will in turn notify
each Broker-Dealer, who, on or prior to such Auction Date, in accordance with
its Broker-Dealer Agreement, will notify its Existing Holders and Potential
Holders believed by it to be interested in submitting an Order in the Auction to
be held on such Auction Date.
7. MISCELLANEOUS. (a) To the extent permitted by applicable law, the
Board of Directors may interpret or adjust the provisions of the Articles
Supplementary to resolve any inconsistency or ambiguity or to remedy any formal
defect, and may amend the Articles Supplementary with respect to the APS prior
to the issuance thereof.
(b) An Existing Holder may sell, transfer or otherwise dispose of APS only
in whole shares and only pursuant to a Bid or Sell Order in accordance with the
procedures described in this Part II or to or through a Broker-Dealer or to a
Person that has delivered a signed copy of a Master Purchaser's Letter to the
Auction Agent; provided that in the case of all transfers other than pursuant to
Auctions, such Existing Holder, its Broker-Dealer or its Agent Member advises
the Auction Agent of such transfer.
(c) All of the shares of APS Outstanding from time to time shall be
represented by one global certificate registered in the name of the Securities
Depository or its nominee.
(d) either the Fund nor any affiliate thereof may submit an Order in any
Auction, except that any Broker-Dealer that is an affiliate of the Fund may
submit Orders in an Auction, but only if such Orders are not for its own
account.
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APPENDIX D
SETTLEMENT PROCEDURES
Capitalized terms used herein have the respective meanings specified in the
Prospectus or this Statement of Additional Information.
(a) On each Auction Date, the Auction Agent shall notify by telephone the
Broker-Dealers that participated in the Auction for the APS held on such Auction
Date and submitted an Order on behalf of an Existing Holder or Potential Holder
of:
(i) the Applicable Rate fixed for the next succeeding Rate
Period;
(ii) whether Sufficient Clearing Bids existed for the
determination of the Applicable Rate;
(iii) if such Broker-Dealer submitted a Bid or a Sell Order on
behalf of an Existing Holder, whether such Bid or Sell Order was accepted
or rejected, in whole or in part, and the number of shares, if any, of the
APS then Outstanding to be sold by such Existing Holder;
(iv) if such Broker-Dealer submitted a Bid on behalf of a
Potential Holder, whether such Bid was accepted or rejected, in whole or in
part, and the number of shares, if any, of the APS to be purchased by such
Potential Holder;
(v) if the aggregate number of shares of the APS to be sold by
all Existing Holders on whose behalf such Broker-Dealer submitted Bids or
Sell Orders is different than the aggregate number of shares of the APS to
be purchased by all Potential Holders on whose behalf such Broker-Dealer
submitted a Bid, the name or names of one or more other Broker-Dealers (and
the Agent Member, if any, of each such other Broker-Dealer) and the number
of shares of the APS to be (x) purchased from one or more Existing Holders
on whose behalf such other Broker-Dealers submitted Bids or Sell Orders, or
(y) sold to one or more Potential Holders on whose behalf such other
Broker-Dealers submitted Bids; and
(v) the scheduled Auction Date of the next succeeding Auction
for the APS.
(b) On each Auction Date, each Broker-Dealer that submitted an Order on behalf
of any Existing Holder or Potential Holder shall:
(i) advise each Existing Holder and Potential Holder on whose
behalf such Broker-Dealer submitted a Bid or Sell Order whether such Bid or
Sell Order was accepted or rejected, in whole or in part;
(ii) instruct each Potential Holder on whose behalf such
Broker-Dealer submitted a Bid that was accepted, in whole or in part, to
instruct such Bidder's Agent Member to pay to such Broker-Dealer (or its
Agent Member) through the Securities Depository the amount necessary to
purchase the number of shares of the APS to be purchased pursuant to such
Bid against receipt of such shares;
(iii) instruct each Existing Holder on whose behalf such
Broker-Dealer submitted a Bid that was accepted, in whole or in part, or a
Sell Order that was accepted, in whole or in part, to instruct such
Bidder's Agent Member to deliver to such Broker-Dealer (or its Agent
Member) through the Securities Depository the number of shares of the APS
to be sold pursuant to such Bid or Sell Order against payment therefor;
(iv) advise each Existing Holder on whose behalf such
Broker-Dealer submitted an Order and each Potential Holder on whose behalf
such Broker-Dealer submitted a Bid of the Applicable Rate for the next
succeeding Rate Period;
(v) advise each Existing Holder on whose behalf such
Broker-Dealer submitted an Order of the Auction Date of the next succeeding
Auction; and
(vi) advise each Potential Holder on whose behalf such
Broker-Dealer submitted a Bid that was accepted, in whole or in part, of
the Auction Date of the next succeeding Auction.
(c) On the basis of the information provided to it pursuant to paragraph (a)
above, each Broker-Dealer that submitted a Bid or Sell Order shall allocate any
funds received by it in respect of such series pursuant to paragraph (b)(ii)
above, and any shares of the APS received by it pursuant to paragraph (b)(iii)
above, among the Potential Holders, if any, on whose behalf such Broker-Dealer
submitted Bids, the Existing Holders, if any, on whose behalf such Broker-Dealer
submitted Bids or Sell Orders, and any Broker-Dealers identified to it by the
Auction Agent pursuant to paragraph (a)(v) above.
(d) On the Business Day after the Auction Date, the Securities Depository shall
execute the transactions described above, debiting and crediting the accounts of
the respective Agent Members as necessary to effect the purchases and sale of
shares of the APS as determined in the Auction.
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APPENDIX E
HEDGING AND RELATED INCOME STRATEGIES
Hedging strategies can be broadly categorized as "short hedges" and "long
hedges." A short hedge is a purchase or sale of a Hedging Instrument intended to
partially or fully offset potential declines in the value of one or more
investments held in the Fund's portfolio. Thus, in a short hedge the Fund takes
a position in a Hedging Instrument the price of which is expected to move in the
opposite direction of the price of the investment being hedged. For example, the
Fund might purchase a put option on a security to hedge against a potential
decline in the value of that security. If the price of the security declined
below the exercise price of the put, the Fund could exercise the put and thus
limit its loss below the exercise price to the premium paid plus transaction
costs. In the alternative, because the value of the put option can be expected
to increase as the value of the underlying security declines, the Fund might be
able to close out the put option and realize a gain to offset the decline in the
value of the security.
Conversely, a long hedge is a purchase or sale of a Hedging Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that the Fund intends to acquire. Thus, in a
long hedge the Fund takes a position in a Hedging Instrument the price of which
is expected to move in the same direction as the price of the prospective
investment being hedged. For example, the Fund might purchase a call option on a
security it intends to purchase in order to hedge against an increase in the
cost of the security. If the price of the security increased above the exercise
price of the call, the Fund could exercise the call and thus limit its
acquisition cost to the exercise price plus the premium paid and transaction
costs. Alternatively, the Fund might be able to offset the price increase by
closing out an appreciated call option and realizing a gain.
Hedging Instruments on securities generally are used to hedge against price
movements in one or more particular securities positions that the Fund owns or
intends to acquire. Hedging Instruments on debt securities may be used to hedge
either individual securities or broad fixed income market sectors.
The use of Hedging Instruments is subject to applicable regulations of the
SEC, the several options and futures exchanges upon which they are traded and
the Commodity Futures Trading Commission ("CFTC"), and may become subject to
regulation by various state regulatory authorities. In addition, the Fund's
ability to use Hedging Instruments will be limited by tax considerations. See
"Taxation."
In addition to the products, strategies and risks described below, UBS
Global AM expects additional opportunities to develop in connection with
options, futures contracts and other hedging techniques. These new opportunities
may become available as UBS Global AM develops new techniques, as regulatory
authorities broaden the range of permitted transactions, and as new options,
futures contracts or other techniques are developed. UBS Global AM may utilize
these opportunities to the extent that they are consistent with the Fund's
investment objective and permitted by the Fund's investment limitations and
applicable regulatory authorities.
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SPECIAL RISKS OF HEDGING STRATEGIES
The use of Hedging Instruments involves special considerations and risks,
as described below. Risks pertaining to particular Hedging Instruments are
described in the sections that follow.
(1) Successful use of most Hedging Instruments depends upon UBS Global
AM's ability to predict movements of the overall securities and interest rate
markets, which requires different skills than predicting changes in the prices
of individual securities. While UBS Global AM is experienced in the use of
Hedging Instruments, there can be no assurance that any particular hedging
strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Hedging Instrument and price movements of the investments
being hedged. For example, if the value of a Hedging Instrument used in a short
hedge increased by less than the decline in value of the hedged investment, the
hedge would not be fully successful. Such a lack of correlation might occur due
to factors unrelated to the value of the investments being hedged, such as
speculative or other pressures on the markets in which Hedging Instruments are
traded. The effectiveness of hedges using Hedging Instruments on indexes will
depend on the degree of correlation between price movements in the index and
price movements in the securities being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly
or partially offsetting the negative effect of unfavorable price movements in
the investments being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if the Fund entered into a
short hedge because UBS Global AM projected a decline in the price of a security
in the Fund's portfolio, and the price of that security increased instead, the
gain from that increase might be wholly or partially offset by a decline in the
price of the Hedging Instrument. Moreover, if the price of the Hedging
Instrument declined by more than the increase in the price of the security, the
Fund could suffer a loss. In either such case, the Fund would have been in a
better position had it not hedged at all.
(4) As described below, the Fund might be required to maintain assets as
"cover," maintain segregated accounts or make margin payments when it takes
positions in Hedging Instruments involving obligations to third parties (I.E.,
Hedging Instruments other than purchased options). If the Fund were unable to
close out its positions in such Hedging Instruments, it might be required to
continue to maintain such assets or accounts or make such payments until the
position expired or matured. These requirements might impair the Fund's ability
to sell a portfolio security or make an investment at a time when it would
otherwise be favorable to do so, or require that the Fund sell a portfolio
security at a disadvantageous time. The Fund's ability to close out a position
in a Hedging Instrument prior to expiration or maturity depends on the existence
of a liquid secondary market or, in the absence of such a market, the ability
and willingness of a counterparty to enter into a transaction closing out the
position. Therefore, there is no assurance that any hedging position can be
closed out at a time and price that is favorable to the Fund.
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COVER FOR HEDGING STRATEGIES
Transactions using Hedging Instruments, other than purchased options,
expose the Fund to an obligation to another party. The Fund will not enter into
any such transactions unless it owns either (1) an offsetting ("covered")
position in securities or other options or futures contracts or (2) cash and
short-term debt securities, with a value sufficient at all times to cover its
potential obligations to the extent not covered as provided in (1) above. The
Fund will comply with SEC guidelines regarding cover for hedging transactions
and will, if the guidelines so require, set aside cash, US government securities
or other liquid, high-grade debt securities in a segregated account with its
custodian in the prescribed amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Hedging Instrument is open, unless they are
replaced with similar assets. As a result, the commitment of a large portion of
the Fund's assets to cover or segregated accounts could impede portfolio
management or the Fund's ability to meet redemption requests or other current
obligations.
OPTIONS
The Fund may purchase put and call options, and write (sell) covered call
options and covered put options, on debt securities. The purchase of call
options serves as a long hedge, and the purchase of put options serves as a
short hedge. Writing covered put or call options can enable the Fund to enhance
income by reason of the premiums paid by the purchasers of such options.
However, if the market price of the security underlying a covered put option
declines to less than the exercise price on the option, minus the premium
received, the Fund would expect to suffer a loss. Writing covered call options
serves as a limited short hedge, because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing the
option. However, if the security appreciates to a price higher than the exercise
price of the call option, it can be expected that the option will be exercised
and the Fund will be obligated to sell the security at less than its market
value. If the covered call option is an OTC option, the securities or other
assets used as cover would be considered illiquid to the extent described under
"Investment Policies and Restrictions - Illiquid Securities."
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Options normally have expiration dates
of up to nine months. Options that expire unexercised have no value.
The Fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the Fund may terminate its
obligation under a call option that it had written by purchasing an identical
call option; this is known as a closing purchase transaction. Conversely, the
Fund may terminate a position in a put or call option it had purchased by
writing an identical put or call option; this is known as a closing sale
transaction. Closing transactions permit the Fund to realize profits or limit
losses on an option position prior to its exercise or expiration.
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The Fund may purchase or write both exchange-traded and OTC options.
However, exchange-traded or liquid OTC options on Municipal Obligations are not
currently available. Exchange-traded options in the United States are issued by
a clearing organization affiliated with the exchange on which the option is
listed which, in effect, guarantees completion of every exchange-traded option
transaction. In contrast, OTC options are contracts between the Fund and its
counterparty (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when the Fund purchases or writes an OTC option,
it relies on the party from whom it purchased the option or to whom it has
written the option (the "counterparty") to make or take delivery of the
underlying investment upon exercise of the option. Failure by the counterparty
to do so would result in the loss of any premium paid by the Fund as well as the
loss of any expected benefit of the transaction.
Generally, OTC options on debt securities are European style options. This
means that the option is only exercisable immediately prior to its expiration.
This is in contrast to American-style options, which are exercisable at any time
prior to the expiration date of the option.
The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the counterparty, or by a
transaction in the secondary market if any such market exists. Although the Fund
will enter into OTC options only with contra parties that are expected to be
capable of entering into closing transactions with the Fund, there is no
assurance that the Fund will in fact be able to close out an OTC option position
at a favorable price prior to expiration. In the event of insolvency of the
counterparty, the Fund might be unable to close out an OTC option position at
any time prior to its expiration.
If the Fund were unable to effect a closing transaction for an option it
had purchased, it would have to exercise the option to realize any profit. The
inability to enter into a closing purchase transaction for a covered call option
written by the Fund could cause material losses because the Fund would be unable
to sell the investment used as cover for the written option until the option
expires or is exercised.
In the event that options on indexes of municipal and non-municipal debt
securities become available, the Fund may purchase and write put and call
options on such indexes in much the same manner as the more traditional options
discussed above, except that index options may serve as a hedge against overall
fluctuations in the debt securities market (or market sectors) rather than
anticipated increases or decreases in the value of a particular security.
FUTURES
The Fund may purchase and sell municipal bond index futures, other interest
rate futures and options thereon. The purchase of futures or call options
thereon can serve as a long hedge, and the sale of futures or the purchase of
put options thereon can serve as a short hedge. Writing covered call options on
futures contracts can serve as a limited short hedge, using a strategy
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similar to that used for writing covered call options on securities or indexes.
Similarly, writing covered put options on futures contracts can serve as a
limited long hedge.
Futures strategies also can be used to manage the average duration of the
Fund's portfolio. If UBS Global AM wishes to shorten the average duration of the
Fund, the Fund may sell a futures contract or a call option thereon, or purchase
a put option on that futures contract. If UBS Global AM wishes to lengthen the
average duration of the Fund, the Fund may buy a futures contract or a call
option thereon, or sell a put option thereon.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract the Fund is required to deposit in a segregated
account with its custodian, in the name of the futures broker through whom the
transaction was effected, "initial margin" consisting of cash, US government
securities or other liquid, high-grade debt securities, in an amount generally
equal to 10% or less of the contract value. Margin must also be deposited when
writing a call option on a futures contract, in accordance with applicable
exchange rules. Unlike margin in securities transactions, initial margin on
futures contracts does not represent a borrowing, but rather is in the nature of
a performance bond or good-faith deposit that is returned to the Fund at the
termination of the transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as periods of high volatility, the
Fund may be required by an exchange to increase the level of its initial margin
payment, and initial margin requirements might be increased generally in the
future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Fund's obligations with respect to an open
futures position. When the Fund purchases an option on a future, the premium
paid plus transaction costs is all that is at risk. In contrast, when the Fund
purchases or sells a futures contract or writes a call option thereon, it is
subject to daily variation margin calls that could be substantial in the event
of adverse price movements. If the Fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to the
instrument held or written. Positions in futures and options on futures may be
closed only on an exchange or board of trade that provides a secondary market.
The Fund intends to enter into futures transactions only on exchanges or boards
of trade where there appears to be a liquid secondary market. However, there can
be no assurance that such a market will exist for a particular contract at a
particular time. Secondary markets for options on futures are currently in the
development stage, and the Fund will not trade options on futures on any
exchange or board of trade unless, in UBS Global AM's opinion, the markets for
such options have developed sufficiently that the liquidity risks for such
options are not greater than the corresponding risks for futures.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
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consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
If the Fund were unable to liquidate a futures or related options position
due to the absence of a liquid secondary market or the imposition of price
limits, it could incur substantial losses. The Fund would continue to be subject
to market risk with respect to the position. In addition, except in the case of
purchased options, the Fund would continue to be required to make daily
variation margin payments and might be required to maintain the position being
hedged by the future or option or to maintain cash or securities in a segregated
account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options markets
are subject to daily variation margin calls and might be compelled to liquidate
futures or related options positions whose prices are moving unfavorably to
avoid being subject to further calls. These liquidations could increase price
volatility of the instruments and distort the normal price relationship between
the futures or options and the investments being hedged. Also, because initial
margin deposit requirements in the futures market are less onerous than margin
requirements in the securities markets, there might be increased participation
by speculators in the futures markets. This participation also might cause
temporary price distortions. In addition, activities of large traders in both
the futures and securities markets involving arbitrage, "program trading" and
other investment strategies might result in temporary price distortions.
GUIDELINE FOR FUTURES AND RELATED OPTIONS
To the extent that the Fund enters into futures contracts and options on
futures positions that are not for bona fide hedging purposes (as defined by the
CFTC), the aggregate initial margin and premiums on these positions (excluding
the amount by which options are "in-the-money") may not exceed 5% of the Fund's
net assets.
The Fund may use the following hedging instruments:
OPTIONS ON DEBT SECURITIES - A call option is a contract pursuant to which
the purchaser of the option, in return for a premium, has the right to buy the
security underlying the option at a specified price at any time during the term,
or upon the expiration, of the option. The writer of the call option, who
receives the premium, has the obligation, upon exercise of the option, to
deliver the underlying security against payment of the exercise price. A put
option is a similar contract which gives its purchaser, in return for a premium,
the right to sell the underlying security at a specified price during the option
term or upon expiration. The writer of the put option, who receives the premium,
has the obligation, upon exercise, to buy the underlying security at the
exercise price. Options on debt securities are traded primarily in the OTC
market rather than on any of the several options exchanges. At present, only
options on US Treasury securities are listed for trading on any recognized
exchange.
OPTIONS ON INDEXES OF DEBT SECURITIES - An index assigns relative values to
the securities included in the index and fluctuates with changes in the market
values of such securities. Index options operate in the same way as more
traditional options except that exercises
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of index options are effected with cash payments and do not involve delivery of
securities. Thus, upon exercise of an index option, the purchaser will realize,
and the writer will pay, an amount based on the difference between the exercise
price and the closing price of the index. Currently, options on indexes of debt
securities do not exist.
MUNICIPAL BOND INDEX FUTURES CONTRACTS - A municipal bond index futures
contract is a bilateral agreement pursuant to which one party agrees to accept
and the other party agrees to make delivery of an amount of cash equal to a
specified dollar amount times the difference between the index value at the
close of trading of the contract and the price at which the futures contract is
originally struck. No physical delivery of the bonds comprising the index is
made; generally contracts are closed out prior to the expiration date of the
contract.
MUNICIPAL DEBT FUTURES CONTRACTS - A municipal debt futures contract is a
bilateral agreement pursuant to which one party agrees to accept and the other
party agrees to make delivery of the specific type of municipal debt security
called for in the contract at a specified future time and at a specified price.
Currently, municipal debt futures contracts do not exist.
OPTIONS ON FUTURES CONTRACTS - Options on futures contracts are similar to
options on securities except that an option on a futures contract gives the
purchaser the right, in return for the premium, to assume a position in a
futures contract (a long position if the option is a call and a short position
if the option is a put), rather than to purchase or sell a security, at a
specified price at any time during the option term. Upon exercise of the option,
the delivery of the futures position to the holder of the option will be
accompanied by delivery of the accumulated balance, which represents the amount
by which the market price of the futures contract exceeds, in the case of a
call, or is less than, in the case of a put, the exercise price of the option on
the future. The writer of an option, upon exercise, will assume a short position
in the case of a call, and a long position in the case of put.
INTEREST RATE PROTECTION TRANSACTIONS - The Fund may enter into interest
rate protection transactions, including interest rate swaps and interest rate
caps, collars and floors. Interest rate swap transactions involve an agreement
between two parties to exchange payments that are based, for example, on
variable and fixed rates of interest and that are calculated on the basis of a
specified amount of principal (the "notional principal amount") for a specified
period of time. Interest rate cap and floor transactions involve an agreement
between two parties in which the first party agrees to make payments to the
counterparty when a designated market interest rate goes above (in the case of a
cap) or below (in the case of a floor) a designated level on predetermined dates
or during a specified time period. Interest rate collar transactions involve an
agreement between two parties in which payments are made when a designated
market interest rate either goes above a designated level or goes below a
designated floor level on predetermined dates or during a specified time period.
The Fund would enter into interest rate protection transactions to preserve
a return or spread on a particular investment or portion of its portfolio, to
protect against any increase in the price of securities the Fund anticipates
purchasing at a later date or to effectively fix the rate of interest that it
pays on one or more borrowings or series of borrowings. The Fund would use these
transactions as a hedge and not as a speculative investment. Interest rate
protection transactions are subject to risks comparable to those described above
with respect to other hedging strategies.
D-9
The Fund may enter into interest rate swaps, caps, collars and floors on
either an asset-based or liability-based basis, depending on whether it is
hedging its assets or its liabilities, and will usually enter into interest rate
swaps on a net basis (I.E., the two payment streams are netted out, with the
Fund receiving or paying, as the case may be, only the net amount of the two
payments). Inasmuch as these interest rate protection transactions are entered
into for good faith hedging purposes, and inasmuch as segregated accounts will
be established with respect to such transactions, UBS Global AM and the Fund
believe such obligations do not constitute senior securities and, accordingly,
will not treat them as being subject to its borrowing restrictions. The net
amount of the excess, if any, of the Fund's obligations over its entitlements
with respect to each interest rate swap will be accrued on a daily basis and an
amount of cash, US government securities or other liquid high grade debt
obligations having an aggregate net asset value at least equal to the accrued
excess will be maintained in a segregated account by a custodian that satisfies
the requirements of the 1940 Act. The Fund also will establish and maintain such
segregated accounts with respect to its total obligations under any interest
rate swaps that are not entered into on a net basis and with respect to any
interest rate caps, collars and floors that are written by the Fund.
The Fund will enter into interest rate protection transactions only with
banks and recognized securities dealers determined by UBS Global AM to present
minimal credit risks in accordance with guidelines established by the Board. If
there is a default by the other party to such a transaction, the Fund will have
to rely on its contractual remedies (which may be limited by bankruptcy,
insolvency or similar laws) pursuant to the agreements related to the
transaction.
The swap market has grown substantially in recent years with a large number
of banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. Caps, collars and floors are more
recent innovations for which documentation is less standardized, and
accordingly, they are less liquid than swaps.
D-10
PART C
OTHER INFORMATION
Item 24. FINANCIAL STATEMENTS AND EXHIBITS
(1) (a) Included in Part A:
(i) Financial Highlights
(b) Included in Part B
(i) Report of Ernst & Young LLP, Independent Auditors 1/
(ii) Portfolio of Investments at March 31, 2003 1/
(iii) Statement of Assets and Liabilities at March 31, 2003 1/
(iv) Statement of Operations for the year ended March 31, 2003
1/
(v) Statement of Changes in Net Assets applicable to
common shareholders for the year ended March 31, 2003 1/
(vi) Notes to Financial Statements 1/
(2) (a) (i) Articles of Incorporation 2/
(ii) Articles Supplementary dated August 5, 1993 2/
(iii) Articles Supplementary dated November 28, 1994 2/
(iv) Articles Supplementary dated April 12, 1996 3/
(v) Articles Supplementary (to be filed)
(b) Bylaws 4/
(c) None
(d) Not Applicable
(e) Dividend Reinvestment Plan 5/
(f) None
(g) Investment Advisory and Administration Contract 6/
(h) (i) Form of Underwriting Agreement (filed herewith)
(ii) Form of Agreement Among Underwriters (to be filed)
(iii) Form of Master Selected Dealer Agreement (to be filed)
(i) None
(j) (i) Custodian Agreement 6/
(ii) Form of Letter Agreement between the Fund and the
Depository Trust Company (to be filed)
(k) (i) Transfer Agency Agreement (to be filed)
(ii) Form of Broker-Dealer Agreement (to be filed)
(iii) Form of Auction Agent Agreement (to be filed)
(iv) Fee Waiver Agreement (filed herewith)
(l) Opinion and Consent of Counsel (to be filed)
(m) None
(n) Consent of Independent Auditors (to be filed)
(o) None
(p) Not Applicable
(q) None
(r) (i) Code of Ethics of Registrant 7/
(ii) Code of Ethics of UBS Global Asset Management (US) Inc. 7/
(iii) Code of Ethics of UBS Securities LLC (to be filed)
(s) Powers of Attorney (to be filed)
----------
1/ Incorporated by reference from the Registrant's Annual Report to
Shareholders for the period ending September 30, 2002, filed on Form
N-CSR on June 6, 2003.
2/ Incorporated by reference from Post-Effective Amendment No. 2 to the
Registrant's registration statement, SEC File No. 33-58532, filed June
15, 1995.
3/ Incorporated by reference from Post-Effective Amendment No. 3 to the
Registrant's registration statement, SEC File No. 58532, filed May 31,
1996.
4/ Incorporated by reference from Registrant's registration statement on
Form N-2, SEC File No. 33-58532, filed February 19, 1993.
5/ Incorporated by reference from Pre-Effective Amendment No. 2 to the
Registrant's registration statement, SEC File No. 33- 58532, filed May
27, 1993.
6/ Incorporated by reference from Post-Effective Amendment No. 1 to the
Registrant's registration statement, SEC File No. 33- 58532, filed
July 25, 1994.
7/ Incorporated by reference from Post-Effective Amendment No. 47 to the
registration statement of UBS Master Series Inc., SEC File No.
33-2524, filed June 30. 2003.
Item 25. MARKETING ARRANGEMENTS
Registration is made to the Form of Underwriting Agreement filed as an exhibit
to this registration statement.
Item 26. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the expenses to be incurred in
connection with the offering described in this Registration Statement:
Securities and Exchange Commission Fees $ 80.90
Rating Agency Fees *
Printing and Engraving Expenses *
Legal Fees *
Accounting Expenses *
Blue Sky Filing Fees and Expenses *
Miscellaneous Expenses *
Total $ *
=======
----------
* To be completed by amendment.
Item 27. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL
None.
Item 28. NUMBER OF HOLDERS OF SECURITIES
NUMBER OF RECORD
STOCKHOLDERS AS OF
TITLE OF CLASS SEPTEMBER 30, 2003
-------------- ------------------
Common Stock, par value
$0.001 per share *
Preferred Stock, par value
$0.001 per share *
* To be completed by amendment
Item 29. INDEMNIFICATION
Incorporated by reference from Item 29 of Part C to Pre-Effective
Amendment No. 2 to the Registrant's registration statement, SEC File No.
33-58532, filed May 27, 1993.
Item 30. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
See "Management of the Fund" in the Prospectus.
UBS Global AM, a Delaware corporation, is a registered investment
advisor and is an indirect wholly owned subsidiary of UBS AG. UBS Global AM is
primarily engaged providing investment management, administration and
distribution services. Information as to the officers and directors of UBS
Global AM is included in its Form ADV, as filed with the Securities and Exchange
Commission (registration number 801-13219) and is incorporated herein by
reference.
Item 31. LOCATION OF ACCOUNTS AND RECORDS
The books and other documents required by: (i) paragraphs (b)(4), (c)
and (d) of Rule 31a-1; and (ii) paragraphs (a)(3), (a)(4), (a)(5), (c) and (e)
of Rule 31a-2 under the Investment Company Act of 1940 are maintained in the
physical possession of UBS Global AM at 51 West 52nd Street, New York, New York
10019-6114. All other accounts, books and documents required by Rule 31a-1 are
maintained in the physical possession of Registrant's transfer agent and
custodian.
Item 32. MANAGEMENT SERVICES
None.
Item 33. UNDERTAKINGS
The Registrant hereby undertakes:
(1) To suspend the offering of shares until the prospectus is
amended if (i) subsequent to the effective date of its registration
statement, the net asset value declines more than ten percent from its
net asset value as of the effective date of the registration statement
or (ii) 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) (a) That for the purpose of determining any liability under
the Securities Act of 1933, the information omitted from the form of
prospectus filed as part of this registration statement in reliance
upon Rule 430A and contained in a
form of prospectus filed by the Registrant under Rule 497(h) under the
Securities Act of 1933 shall be deemed to be part of this registration
statement as of the time it was declared effective.]
(b) That 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 such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(6) 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.
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 the City of New York, and the State of New York, on the 3rd day
of October, 2003.
INSURED MUNICIPAL INCOME FUND, INC.
By: /s/ David M. Goldenberg
-------------------------------------
David M. Goldenberg
Vice President and Assistant Secretary
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment has been signed below by the following persons in the
capacities and on the dates indicated:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Margo N. Alexander Director October 3, 2003
---------------------------
Margo N. Alexander
/s/ Richard Q. Armstrong Director October 3, 2003
---------------------------
Richard Q. Armstrong
/s/ David J. Beaubien Director October 3, 2003
------------------------------------
David J. Beaubien
/s/ Richard R. Burt Director October 3, 2003
------------------------------------
Richard R. Burt
/s/ Meyer Feldberg Director October 3, 2003
------------------------------------
Meyer Feldberg
/s/ Frederic V. Malek Director October 3, 2003
------------------------------------
Frederic V. Malek
/s/ Carl W. Schafer Director October 3, 2003
------------------------------------
Carl W. Schafer
/s/ Paul H. Schubert Vice President and Treasurer October 3, 2003
--------------------
Paul H. Schubert
/s/ Brian M. Storms Director and Chairman of the October 3, 2003
------------------------------------ Board of Directors
Brian M. Storms
/s/ Joseph A. Varnas President October 3, 2003
------------------------------------
Joseph A. Varnas
/s/ William D. White Director October 3, 2003
------------------------------------
William D. White
INSURED MUNICIPAL INCOME FUND, INC.
EXHIBIT INDEX
EXHIBIT
NUMBER
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(h) (i) Form of Underwriting Agreement
(k) (iv) Fee Waiver Agreement