PROSPECTUS July 25, 2003
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$950,000,000
EATON VANCE LIMITED
DURATION INCOME FUND
7,600 SHARES, SERIES A
7,600 SHARES, SERIES B
7,600 SHARES, SERIES C
7,600 SHARES, SERIES D
7,600 SHARES, SERIES E
[EATON VANCE LOGO]
AUCTION PREFERRED SHARES
LIQUIDATION PREFERENCE $25,000 PER SHARE
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INVESTMENT OBJECTIVES. Eaton Vance Limited Duration Income Fund (the "Fund") is
a newly organized, diversified, closed-end management investment company. The
Fund's investment objective is to provide a high level of current income. The
Fund may, as a secondary objective, also seek capital appreciation to the extent
consistent with its primary goal of high current income.
PORTFOLIO CONTENTS. The Fund pursues its objectives by investing its assets
primarily in three distinct investment categories: 1) mortgage-backed securities
that are issued, backed or otherwise guaranteed by the U.S. Government or its
agencies or instrumentalities or that are issued by private issuers ("MBS"); 2)
senior, secured floating rate loans made to corporate and other business
entities ("Senior Loans"); and 3) corporate bonds that are of below "investment
grade" quality ("Non-Investment Grade Bonds"). Non-Investment Grade Bonds,
commonly referred to as "junk bonds," are bonds that are rated below investment
grade by each of the national rating agencies who cover the security, or, if
unrated, are determined to be of comparable quality by the Adviser. Standard &
Poor's Ratings Group ("S&P") and Fitch Ratings ("Fitch") consider securities
rated below BBB- to be below investment grade and Moody's Investors Service,
Inc. ("Moody's") considers securities rated below Baa3 to be below investment
grade. Senior Loans in which the Fund invests are also typically of below
investment grade quality. There is no limitation on the percentage of the Fund's
assets that may be allocated to each of these investment categories; provided
that, under normal market conditions, the Fund will invest at least 25% of its
total assets in each category.
INVESTMENT ADVISER. The Fund's investment adviser is Eaton Vance Management
("Eaton Vance" or the "Adviser"). As of June 30, 2003, Eaton Vance and its
subsidiaries managed approximately $62.7 billion on behalf of funds,
institutional clients and individuals. (continued on inside cover page)
INVESTING IN APS INVOLVES CERTAIN RISKS, INCLUDING THAT THE FUND MAY INVEST
SUBSTANTIAL PORTIONS OF ITS ASSETS IN BELOW INVESTMENT GRADE QUALITY SECURITIES
WITH SPECULATIVE CHARACTERISTICS. SEE "INVESTMENT OBJECTIVES, POLICIES AND
RISKS--RISK CONSIDERATIONS."
NEITHER THE SECURITIES AND EXCHANGE COMMISSION ("SEC") NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
PRICE TO PUBLIC SALES LOAD PROCEEDS TO FUND(1)
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Per Share $ 25,000 $ 250 $ 24,750
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Total $ 950,000,000 $9,500,000 $940,500,000
----------------------------------------------------------------------------------------------------------------
(1) Plus accumulated dividends, if any, from the date the Auction Preferred
Shares are issued, but before offering expenses payable by the Fund
estimated to be $581,855. The Fund and Adviser have agreed to indemnify the
Underwriters against certain liabilities under the Securities Act of 1933,
as amended. See "Underwriting."
The Underwriters are offering the Auction Preferred Shares subject to various
conditions. The Underwriters expect to deliver the APS in book-entry form,
through the facilities of The Depository Trust Company to purchasers on or about
July 30, 2003.
UBS INVESTMENT BANK CITIGROUP MERRILL LYNCH & CO.
A.G. EDWARDS & SONS, INC. WACHOVIA SECURITIES
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(continued from the previous page)
Capitalized terms not otherwise defined are defined in the Glossary that appears
at the end of this Prospectus. The APS are offered at a price per share of
$25,000 subject to a sales load of $250 per share.
Dividends on the APS of the Fund offered hereby will be cumulative from the Date
of Original Issue and payable commencing on the dates specified below (an
"Initial Dividend Payment Date") and, generally, on a weekly basis thereafter on
the days specified below, subject to certain exceptions. The cash dividend rate
(the "Applicable Rate") on the APS for the Initial Dividend Period on such dates
will be the per annum rate specified below:
INITIAL DIVIDEND NORMAL WEEKLY INITIAL
PAYMENT DATE PAYMENT DAY APPLICABLE RATE
---------------- ------------- ---------------
Series A..................................... August 12, 2003 Tuesday 1.07%
Series B..................................... August 13, 2003 Wednesday 1.07%
Series C..................................... August 14, 2003 Thursday 1.07%
Series D..................................... August 15, 2003 Friday 1.07%
Series E..................................... August 18, 2003 Monday 1.07%
The APS will not be registered on any stock exchange or on any automated
quotation system. APS may only be bought or sold through an order at an auction
with or through a broker-dealer that has entered into an agreement with the
auction agent of the Fund, or in a secondary market that may be maintained by
certain broker-dealers. These broker-dealers are not required to maintain this
market and it may not provide you with liquidity. An increase in the level of
interest rates, particularly during any Special Dividend Period that is a Long
Term Dividend Period as discussed in "Description of APS--Dividends and dividend
periods--General," likely will have an adverse effect on the secondary market
price of the APS, and a selling shareholder may sell APS between Auctions at a
price per share of less than $25,000.
Each prospective purchaser should review carefully the detailed information
regarding the Auction Procedures which appears in this Prospectus and the Fund's
Statement of Additional Information and should note that (i) an Order
constitutes an irrevocable commitment to hold, purchase or sell APS based upon
the results of the related Auction, (ii) the Auctions will be conducted through
telephone communications, (iii) settlement for purchases and sales will be on
the Business Day following the Auction and (iv) ownership of APS will be
maintained in book-entry form by or through the Securities Depository. In
certain circumstances, holders of APS may be unable to sell their APS in an
Auction and thus may lack liquidity of investment. The APS may only be
transferred pursuant to a Bid or a Sell Order placed in an Auction through a
Broker-Dealer to the Auction Agent or in the secondary market, if any.
This Prospectus sets forth concisely information you should know before
investing in the APS. Please read and retain this Prospectus for future
reference. A Statement of Additional Information for the Fund dated July 25,
2003 has been filed with the SEC and can be obtained without charge by calling
1-800-225-6265 or by writing to the Fund. The table of contents to the Statement
of Additional Information is located at page 50 of this Prospectus. This
Prospectus incorporates by reference the entire Statement of Additional
Information of the Fund. The Statement of Additional Information is available
along with other Fund-related materials at the SEC's internet web site
(http://www.sec.gov). The Fund's address is The Eaton Vance Building, 255 State
Street, Boston, Massachusetts 02109 and its telephone number is 1-800-225-6265.
The APS do not represent a deposit or obligation of, and are not guaranteed or
endorsed by, any bank or other insured depository institution, and are not
federally insured by the Federal Deposit Insurance Corporation, the Federal
Reserve Board or any other government agency.
You should rely only on the information contained or incorporated by reference
in this Prospectus. The Fund has not authorized any other person to provide you
with different information. The Fund is not making an offer of these securities
in any state where the offer is not permitted. You should not assume that the
information appearing in this Prospectus is accurate as of any date other than
the date on the front of this Prospectus.
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TABLE OF CONTENTS
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Prospectus summary.................... 1
Financial highlights.................. 6
The Fund.............................. 7
Use of proceeds....................... 7
Capitalization........................ 8
Portfolio composition................. 8
Investment objectives, policies and
risks............................... 9
Management of the Fund................ 22
Description of APS.................... 24
The Auctions.......................... 33
Taxes................................. 40
Description of capital structure...... 43
Certain provisions of the Declaration
of Trust............................ 45
Underwriting.......................... 47
Shareholder Servicing Agent, custodian
and transfer agent.................. 47
Legal opinions........................ 48
Independent auditors.................. 48
Additional information................ 49
Table of contents for the Statement of
Additional Information.............. 50
The Fund's privacy policy............. 50
Glossary.............................. 51
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Prospectus summary
This is only a summary. You should review the more detailed information
contained in this Prospectus and in the Fund's Statement of Additional
Information.
THE FUND
Eaton Vance Limited Duration Income Fund (the "Fund") is a recently organized,
diversified, closed-end management investment company. The Fund was organized as
a Massachusetts business trust on March 12, 2003. The Fund has registered under
the Investment Company Act of 1940, as amended (the "1940 Act"). The Fund's
principal office is located at The Eaton Vance Building, 255 State Street,
Boston, Massachusetts 02109, and its telephone number is 1-800-225-6265. The
Fund commenced operations on May 30, 2003 upon the closing of an initial public
offering of its common shares of beneficial interest, par value $0.01 per share
("Common Shares"). The Common Shares of the Fund are traded on the American
Stock Exchange ("AMEX") under the symbol "EVV." In connection with the initial
public offering of the Fund's Common Shares, the underwriters were granted an
option to purchase additional shares to cover over-allotments.
Certain of the capitalized terms used in this Prospectus are defined in the
Glossary that appears at the end of this Prospectus.
THE OFFERING
The Fund is offering, pursuant to this Prospectus, preferred shares of
beneficial interest, par value $0.01 per share, which have been designated
Auction Preferred Shares, Series A, Series B, Series C, Series D and Series E
(collectively, the "APS"). Issuance of the APS represents the leveraging
financing contemplated in connection with the offering of the Common Shares of
the Fund.
The Fund is offering 7,600 Auction Preferred Shares, Series A, 7,600 Auction
Preferred Shares, Series B, 7,600 Auction Preferred Shares, Series C, 7,600
Auction Preferred Shares, Series D and 7,600 Auction Preferred Shares, Series E,
at a purchase price of $25,000 per share plus accumulated dividends, if any,
from the Date of Original Issue. The APS are being offered through a group of
underwriters (collectively, the "Underwriters") led by UBS Securities LLC,
Citigroup Global Markets Inc. and Merrill Lynch, Pierce, Fenner & Smith
Incorporated. See "Underwriting".
INVESTMENT OBJECTIVES AND POLICIES
The Fund's investment objective is to provide a high level of current income.
The Fund may, as a secondary objective, also seek capital appreciation to the
extent consistent with its investment objective of high current income. The Fund
pursues its objectives by investing its assets primarily in three distinct
investment categories: 1) mortgage-backed securities that are issued, backed or
otherwise guaranteed by the U.S. Government or its agencies or instrumentalities
or that are issued by private issuers ("MBS"); 2) senior, secured floating rate
loans made to corporate and other business entities ("Senior Loans"); and 3)
corporate bonds of below "investment grade" quality ("Non-Investment Grade
Bonds"). Non-Investment Grade Bonds, commonly referred to as "junk bonds," are
bonds that are rated below investment grade by each of the national rating
agencies who cover the security, or, if unrated, are determined to be of
comparable quality by the Adviser. Standard & Poor's Ratings Group ("S&P") and
Fitch Ratings ("Fitch") consider securities rated below BBB-- to be below
investment grade and Moody's Investors Service, Inc. ("Moody's") considers
securities rated below Baa3 to be below investment grade. Senior Loans in which
the Fund invests are also typically of below investment grade quality. The
Adviser has broad discretion to allocate the Fund's assets among the three
principal asset classes; provided that, under normal market conditions, the Fund
will invest at least 25% of its assets in each principal investment category.
1
Under normal market conditions, the Adviser expects to maintain a duration of
between two and four years (including the effect of anticipated leverage).
Initially, the Fund is expected to have a duration of approximately three years
(including the effect of anticipated leverage). This duration policy may only be
changed following provision of 60 days' prior notice to shareholders. In
comparison to maturity (which is the date on which a debt instrument ceases and
the issuer is obligated to repay the principal amount), duration is a measure of
the price volatility of a debt instrument as a result of changes in market rates
of interest, based on the weighted average timing of the instrument's expected
principal and interest payments. Duration differs from maturity in that it
considers a security's yield, coupon payments, principal payments and call
features in addition to the amount of time until the security finally matures.
As the value of a security changes over time, so will its duration. Prices of
securities with longer durations tend to be more sensitive to interest rate
changes than securities with shorter durations. In general, a portfolio of
securities with a longer duration can be expected to be more sensitive to
interest rate changes than a portfolio with a shorter duration.
A team of Eaton Vance investment professionals is responsible for the overall
management of the Fund's investments as well as allocations among the Fund's
three principal investment categories. Individual members of this team with
specialized experience are responsible for the day-to-day portfolio management
within each of the Fund's three main asset classes. The Fund's investments are
actively managed, and securities may be bought or sold on a daily basis. The
Adviser attempts to manage yield through timely trading.
The Adviser's staff monitors the credit quality and price of securities held by
the Fund, as well as other securities that are available to the Fund. Under
normal market conditions, the Fund expects to maintain a weighted average
portfolio credit quality of investment grade (which is at least BBB- as
determined by S&P or Fitch, Baa3 as determined by Moody's or, if unrated,
determined to be of comparable quality by the Adviser). For this purpose, when a
security is rated by more than one of these rating agencies, the Adviser
generally will use the highest rating. Within this general guideline, the Fund
may invest in individual securities of any credit quality. Although the Adviser
considers ratings when making investment decisions, it performs its own credit
and investment analysis and does not rely primarily on the ratings assigned by
the rating services. In evaluating the quality of a particular security, whether
rated or unrated, the Adviser will normally take into consideration, among other
things, the issuer's financial resources and operating history, its sensitivity
to economic conditions and trends, the ability of its management, its debt
maturity schedules and borrowing requirements, and relative values based on
anticipated cash flow, interest and asset coverage, and earnings prospects. The
Adviser will attempt to reduce the risks of investing in lower rated or unrated
debt instruments through active portfolio management, credit analysis and
attention to current developments and trends in the economy and the financial
markets. When purchasing and selling MBS, the Adviser focuses on the expected
principal payments on an MBS as well as current and anticipated market
conditions.
The Fund will only invest in U.S. dollar denominated securities. The Fund may
invest up to 5% of its assets in U.S. dollar denominated securities of
non-United States issuers. The Fund's investments may have significant exposure
to certain sectors of the economy and thus may react differently to political or
economic developments than the market as a whole.
The Fund may purchase or sell derivative instruments (which derive their value
from another instrument, security or index) only for risk management purposes,
such as hedging against fluctuations in securities prices or interest rates;
diversification purposes; or changing the duration of the Fund. Transactions in
derivative instruments may include the purchase or sale of futures contracts on
securities, indices and other financial instruments, credit-linked notes,
tranches of collateralized loan obligations, options on futures contracts, and
exchange-traded and over-the-counter options on securities or indices, and
interest rate, total return and credit default swaps. Guidelines of any rating
organization that rates any Preferred Shares issued by the Fund may limit the
Fund's ability to engage in such transactions.
2
INVESTMENT ADVISER AND ADMINISTRATOR
Eaton Vance, an indirect wholly-owned subsidiary of Eaton Vance Corp., is the
Fund's investment adviser and administrator. See "Management of the Fund." As of
June 30, 2003, Eaton Vance and its subsidiaries managed approximately $62.7
billion on behalf of funds, institutional clients and individuals.
RISK FACTORS SUMMARY
Risk is inherent in all investing. Therefore, before investing in the Fund you
should consider certain risks carefully. The primary risks of investing in APS
are:
+ If an auction fails you may not be able to sell some or all of your APS;
+ 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 downgrade APS, which could affect liquidity;
+ The Fund may be forced to redeem your APS to meet regulatory or rating agency
requirements or may elect to redeem your APS in certain circumstances;
+ In extraordinary circumstances, the Fund may not earn sufficient income from
its investments to pay dividends;
+ If long-term interest rates rise, the value of the Fund's investment portfolio
will decline, reducing the asset coverage for its APS;
+ If an issuer of an obligation in which the Fund invests is downgraded or
defaults, there may be a negative impact on the income and/or asset value of
the Fund's portfolio; and
+ The Fund's investments in Non-Investment Grade Bonds are predominantly
speculative because of the credit risk of their issuers. While offering a
greater potential opportunity for capital appreciation and higher yields,
Non-Investment Grade Bonds typically entail greater potential price volatility
and may be less liquid than higher-rated securities. Issuers of Non-Investment
Grade Bonds are more likely to default on their payments of interest and
principal owed to the Fund, and such defaults will reduce the Fund's net asset
value and income distributions. The prices of these lower rated obligations
are more sensitive to negative developments than higher rated securities.
Adverse business conditions, such as a decline in the issuer's revenues or an
economic downturn, generally lead to a higher non-payment rate. In addition, a
security may lose significant value before a default occurs as the market
adjusts to expected higher non-payment rates.
For additional general risks of investing in APS of the Funds, see "Investment
objectives, policies and risks--Risk considerations."
TRADING MARKET
APS are not listed on an exchange. Instead, you may buy or sell APS at an
auction that normally is held weekly by submitting orders to a broker-dealer
that has entered into an agreement with the auction agent and the Fund (a
"Broker-Dealer"), or to a broker-dealer that has entered into a separate
agreement with a Broker-Dealer. In addition to the auctions, Broker-Dealers and
other broker-dealers may maintain a secondary trading market in APS outside of
auctions, but may discontinue this activity at any time. There is no assurance
that a secondary market will develop, or if it does develop, that it will
provide shareholders with liquidity. You may transfer APS outside of auctions
only to or through a Broker-Dealer, or a broker-dealer that has entered into a
separate agreement with a Broker-Dealer.
The table below shows the first auction date for each series of APS of the Fund
and the day on which each subsequent auction will normally be held for each such
series. The first auction date for each series of APS of the Fund will be the
Business Day before the dividend payment date for the initial
3
dividend period for each such series. The start date for subsequent dividend
periods normally will be the Business Day following the auction date unless the
then-current dividend period is a Special Dividend Period, or the day that
normally would be the auction date or the first day of the subsequent dividend
period is not a Business Day.
FIRST AUCTION SUBSEQUENT
DATE* AUCTION*
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Series A.................................................... August 11 August 18
Series B.................................................... August 12 August 19
Series C.................................................... August 13 August 20
Series D.................................................... August 14 August 21
Series E.................................................... August 15 August 22
---------------
* All dates are 2003.
DIVIDENDS AND DIVIDEND PERIODS
The table below shows the dividend rate for the initial dividend period of the
APS offered in this Prospectus. For subsequent dividend periods, APS shares will
pay dividends based on a rate set at auctions, normally held weekly. In most
instances dividends are also paid weekly, on the day following the end of the
dividend period. The rate set at auction will not exceed the Maximum Rate. See
"The Auction--Auction procedures."
Finally the table below shows the numbers of days of the initial dividend period
for the APS. Subsequent dividend periods generally will be 7 days. The dividend
payment date for Special Dividend Periods of more than 28 days will be set out
in the notice designating a Special Dividend Period. See "Description of
APS--Dividends and dividend periods."
DIVIDEND
PAYMENT NUMBER OF
DATE OF DATE FOR SUBSEQUENT DAYS OF
INITIAL ACCUMULATION INITIAL DIVIDEND INITIAL
DIVIDEND OF INITIAL DIVIDEND PAYMENT DIVIDEND
RATE RATE* PERIOD* DATE* PERIOD
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Series A....................... 1.07% July 30 August 12 August 19 13
Series B....................... 1.07% July 30 August 13 August 20 14
Series C....................... 1.07% July 30 August 14 August 21 15
Series D....................... 1.07% July 30 August 15 August 22 16
Series E....................... 1.07% July 30 August 18 August 25 19
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* All dates are 2003.
TAXATION
Dividends paid with respect to APS should constitute dividends for federal
income tax purposes to the extent attributable to the Fund's current or
accumulated earnings and profits. For a further discussion of the tax treatment
of dividends paid by the Fund see "Taxes--General." Corporate holders of the APS
generally will not be entitled to the dividends received deduction for these
dividends. Distributions of net capital gain, to the extent so designated, will
be treated as long-term capital gains.
REDEMPTION
Although the Fund will not ordinarily redeem APS, it may be required to redeem
APS if, for example, the Fund does not meet an asset coverage ratio required by
law or in order to correct a failure to meet a rating agency guideline in a
timely manner. See "Description of APS--Redemption--Mandatory redemption." The
Fund voluntarily may redeem APS in certain circumstances. See "Description of
APS--Redemption--Optional redemption."
4
LIQUIDATION PREFERENCE
The liquidation preference of the APS of each series is $25,000 per share, plus
an amount equal to accumulated but unpaid dividends (whether or not earned or
declared). See "Description of APS--Liquidation rights."
RATING
Shares of APS of the Fund will be issued with a credit quality rating of AAA
from both Moody's and Fitch. The Fund may at some future time look to have its
APS rated by additional or substitute rating agencies. Because the Fund is
required to maintain at least two ratings, it must own portfolio securities of
sufficient value with adequate credit quality to meet the rating agency's
guidelines. See "Description of APS--Rating agency guidelines and asset
coverage."
VOTING RIGHTS
The 1940 Act requires that the holders of APS and any other Preferred Shares of
the Fund, voting as a separate class, have the right to elect at least two
Trustees of the Fund at all times and to elect a majority of the Trustees at any
time when two years' dividends on the APS or any other Preferred Shares are
unpaid. The holders of APS and any other Preferred Shares of the Fund will vote
as a separate class on certain other matters as required under the Fund's
Agreement and Declaration of Trust ("Declaration of Trust") and the 1940 Act.
See "Description of APS--Voting rights" and "Certain provisions of the
Declaration of Trust."
5
Financial highlights
Information contained in the tables below under the headings "Income (loss) from
operations" and "Ratios/Supplemental data" shows the unaudited operating
performance of the Fund from the commencement of the Fund's investment
operations on May 30, 2003 until June 30, 2003. Since the Fund commenced
operations on May 30, 2003, the tables cover approximately five weeks of
operations, during which a substantial portion of the Fund's assets were
invested in high-quality, short-term debt securities. Accordingly, the
information presented may not provide a meaningful picture of the Fund's
operating performance.
FINANCIAL STATEMENTS (UNAUDITED)
FINANCIAL HIGHLIGHTS
AS OF JUNE 30, 2003
PERIOD ENDED
JUNE 30, 2003(1)(2)
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Net asset value--Beginning of period(3)..................... $ 19.100
INCOME (LOSS) FROM OPERATIONS
Net investment income....................................... $ 0.058
Net realized and unrealized gain............................ $ 0.104
----------
Total income from operations................................ $ 0.162
----------
Common share offering costs................................. $ (0.012)
----------
Net asset value--End of period.............................. $ 19.250
----------
Market value--End of period................................. $ 20.000
----------
Total Investment Return on Net Asset Value(4)............... 0.78%
Total Investment Return on Market Value(4).................. 4.71%
RATIOS/SUPPLEMENTAL DATA+
Net assets, end of period (000's omitted)................... $2,040,677
Ratios (As a percentage of average daily net assets):.......
Net expenses.............................................. 0.61%(5)
Net investment income..................................... 3.44%(5)
Portfolio Turnover.......................................... 43%
------------
+ The operating expenses of the Fund reflect a reduction of the investment
adviser fee and a reimbursement of expenses by the Adviser. Had such action
not been taken, the ratios and net investment income per share would have
been as follows:
Ratios (As a percentage of average daily net assets):
Expenses................................................. 0.81%(5)
Net investment income.................................... 3.24%(5)
Net investment income per share............................. $ 0.055
(1) For the period from the start of business, May 30, 2003, to June 30, 2003.
(2) Computed using average common shares outstanding.
(3) Net asset value at beginning of period reflects the deduction of the sales
load of $0.90 per share paid by the shareholder from the $20.00 offering
price.
(4) Total investment return on net asset value is calculated assuming a
purchase at the offering price of $20.00 less the sales load of $0.90 per
share paid by the shareholder on the first day and a sale at the net asset
value on the last day of the period reported. Total investment return on
market value is calculated assuming a purchase at the offering price of
$20.00 less the sales load of $0.90 per share paid by the shareholder on
the first day and a sale at the current market price on the last day of the
period reported. Total investment return on net asset value and total
investment return on market value are not computed on an annualized basis.
(5) Annualized.
6
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The Fund
Eaton Vance Limited Duration Income Fund (the "Fund") is a diversified,
closed-end management investment company. The Fund was organized as a
Massachusetts business trust on March 12, 2003. The Fund has registered under
the Investment Company Act of 1940, as amended (the "1940 Act"). The Fund's
principal office is The Eaton Vance Building, 255 State Street, Boston,
Massachusetts 02109, and its telephone number is 1-800-225-6265.
The Fund commenced operations on May 30, 2003 upon the closing of an initial
public offering of shares of its common shares of beneficial interest, $0.01 par
value (the "Common Shares"). The proceeds of such offering were $1,927,900,000
after the payment of offering expenses. In connection with the initial public
offering of the Fund's Common Shares, the underwriters were granted an option to
purchase, at a price of $20.00 per Common Share, 13,000,000 additional Common
Shares to cover over-allotments. On June 27, 2003, the underwriters partially
exercised the over-allotment option and purchased 5,000,000 Common Shares.
Additionally, on July 11, 2003, the underwriters again partially exercised the
over-allotment option and purchased an additional 5,000,000 Common Shares.
Certain of the capitalized terms used in this Prospectus are defined in the
Glossary that appears at the end of this Prospectus.
Use of proceeds
The net proceeds of this offering will be approximately $939,918,145 after the
payment of the sales load and expected offering costs. See "Underwriting." The
Fund will invest the net proceeds of the offering in accordance with its
investment objective and policies stated below. It is presently anticipated that
the Fund will be able to invest substantially all of the net proceeds in
obligations that meet those investment objectives and policies during a period
estimated not to exceed three months from the completion of the offering of the
APS depending on market conditions and the availability of appropriate
securities. Pending such investment, the proceeds may be invested in high
quality, short-term debt securities.
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7
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Capitalization
The following table sets forth the unaudited capitalization of the Fund as of
June 30, 2003 as if the Common Shares of the Fund purchased by the Underwriters
pursuant to their overallotment option on June 27, 2003 ("Overallotment Common
Shares") had been issued on that date and as adjusted to give effect to the
issuance of the APS offered hereby.
ACTUAL AS ADJUSTED
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(unaudited) (unaudited)
Preferred shares, par value, $0.01 per share (no shares
issued; 38,000, as adjusted, at $25,000 per share
liquidation preference).................................. $ -- $ 950,000,000
============== ==============
SHAREHOLDERS' EQUITY:
Common Shares, par value, $0.01 per share (106,005,000
shares issued and outstanding)........................... $ 1,060,050 $ 1,060,050
Capital in excess of par value attributable to Common
Shares................................................... 2,022,431,860 2,012,350,005
Net undistributed investment income........................ 5,862,920 5,862,920
Net accumulated realized gain (loss)....................... 709,571 709,571
Net unrealized appreciation on investments................. 10,612,950 10,612,950
-------------- --------------
Net Assets................................................. $2,040,677,351 $2,030,595,496
============== ==============
Portfolio composition
As of June 30, 2003, the following table indicates the approximate percentage of
the Fund's portfolio invested in long-term and short-term obligations. Also
included in these tables is other information with respect to the composition of
the Fund's investment portfolio as of the same date.
(91.5% long-term; 8.1% short-term)
NUMBER OF
S&P(1) MOODY'S(1) FITCH(1) ISSUES VALUE PERCENT
---------------------------------------------------------------------
AAA Aaa AAA 163 $ 857,621,575 40%
BBB Baa BBB 5 11,834,565 1%
BB Ba BB 91 381,669,490 18%
B B B 145 631,621,604 29%
CCC Caa CCC 17 44,072,938 2%
Unrated 9 43,199,823 2%
Cash and cash equivalents... -- 184,149,903 8%
-------------- ---
Total....................... 430 $2,154,169,898 100%
============== ===
------------
(1) Ratings: Using the higher of S&P's, Moody's or Fitch's ratings on the
Fund's investments. S&P and Fitch rating categories may be modified further
by a plus (+) or minus (-) in AA, A, BBB, BB, B, and CCC ratings. Moody's
rating categories may be modified further by a 1, 2 or 3 in Aa, A, Baa, Ba,
B, and Caa ratings.
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8
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Investment objectives, policies and risks
INVESTMENT OBJECTIVES
The Fund's investment objective is to provide a high level of current income.
The Fund may, as a secondary objective, also seek capital appreciation to the
extent consistent with its investment objective of high current income. The Fund
pursues its objectives by investing its assets primarily in three distinct
investment categories: 1) mortgage backed securities that are issued, backed or
otherwise guaranteed by the U.S. Government or its agencies or instrumentalities
or that are issued by private issuers ("MBS"); 2) senior, secured floating rate
loans made to corporate and other business entities ("Senior Loans"); and 3)
corporate bonds of below "investment grade" quality ("Non-Investment Grade
Bonds"). Non-Investment Grade Bonds, commonly referred to as "junk bonds," are
bonds that are rated below investment grade by each of the national rating
agencies who cover the security, or, if unrated, are determined to be of
comparable quality by the Adviser. Standard & Poor's Ratings Group ("S&P") and
Fitch Ratings ("Fitch") consider securities rated below BBB- to be below
investment grade and Moody's Investors Service, Inc. ("Moody's") considers
securities rated below Baa3 to be below investment grade. Senior Loans in which
the Fund invests are also typically of below investment grade quality. The
Adviser has broad discretion to allocate the Fund's assets among the three
principal asset classes; provided that, under normal market conditions, the Fund
will invest at least 25% of its assets in each principal investment category.
PRIMARY INVESTMENT POLICIES
GENERAL COMPOSITION OF THE FUND
A team of Eaton Vance investment professionals is responsible for the overall
management of the Fund's investments as well as allocations among the Fund's
three principal investment categories. Individual members of this team with
specialized expertise are responsible for the day-to-day portfolio management
within each of the Fund's three main asset classes. The Fund's investments are
actively managed, and securities may be bought or sold on a daily basis. The
Adviser attempts to manage yield through timely trading.
Under normal market conditions, the Adviser expects to maintain a duration of
between two and four years (including the effect of anticipated leverage).
Initially, the Fund is expected to have a duration of approximately three years
(including the effect of anticipated leverage). This duration policy may only be
changed following provision of 60 days' prior notice to shareholders. In
comparison to maturity (which is the date on which a debt instrument ceases and
the issuer is obligated to repay the principal amount), duration is a measure of
the price volatility of a debt instrument as a result in changes in market rates
of interest, based on the weighted average timing of the instrument's expected
principal and interest payments. Duration differs from maturity in that it
considers a security's yield, coupon payments, principal payments and call
features in addition to the amount of time until the security finally matures.
As the value of a security changes over time, so will its duration. Prices of
securities with longer durations tend to be more sensitive to interest rate
changes than securities with shorter durations. In general, a portfolio of
securities with a longer duration can be expected to be more sensitive to
interest rate changes than a portfolio with a shorter duration.
The Adviser's staff monitors the credit quality and the price of securities held
by the Fund, as well as other securities that are available to the Fund. Under
normal market conditions, the Fund will invest at least 25% of its portfolio in
MBS that are expected to be of the highest quality (generally AAA as determined
by S&P or Fitch, Aaa as determined by Moody's, or, if unrated determined to be
of comparable quality by the Adviser) and at least 25% of its portfolio in each
of Non-Investment Grade Bonds and Senior Loans (many of which are of below
investment grade quality). Under normal market conditions, the Fund will
structure and seek to maintain its portfolio of high quality MBS and lower
--------------------------------------------------------------------------------
9
INVESTMENT OBJECTIVES, POLICIES AND RISKS
--------------------------------------------------------------------------------
quality Non-Investment Grade Bond and Senior Loans in such a manner so that the
Fund has an average dollar weighted portfolio quality of investment grade (which
is BBB- as determined by S&P or Fitch, Baa as determined by Moody's, or, if
unrated determined to be of comparable quality by the Adviser). Within this
general guideline, the Fund may invest in securities of any credit quality. In
order to maintain compliance with this policy, the Fund's holdings of
Non-Investment Grade Bonds and Senior Loans of below investment grade quality
generally will be offset by investments in MBS of the highest quality. The
extremely high credit quality of the MBS will substantially raise the average
portfolio credit quality on a dollar-weighted basis. In addition, to the extent
necessary to maintain compliance with this weighted average portfolio credit
policy, the Fund will focus its investments in Non-Investment Grade Bonds and
Senior Loans on such issues that are rated in the higher tiers of the
non-investment grade range (including in the category just below investment
grade, which is in the BB range as determined by S&P or Fitch, Ba as determined
by Moody's, or if unrated determined to be of comparable quality by the
Adviser). Finally, although the Fund may invest in securities of any quality, to
the extent necessary to comply with its weighted average portfolio credit
policy, the Fund will avoid investing significant portions of its assets in the
lower tiers of the non-investment grade category. For purposes of the Fund's
policy on credit quality, when a security is rated by more than one of these
rating agencies, the Adviser generally will use the highest rating. The Fund
will monitor and adjust its portfolio on an ongoing basis in order to remain in
compliance with this credit quality policy.
A "barbell" portfolio such as the Fund that achieves a weighted average
investment grade credit quality by investing substantially in below investment
grade securities and very high quality securities involves certain risk
characteristics that differ from fixed income securities with credit ratings
equivalent to the portfolio average or from a portfolio of similar average
quality consisting mostly of securities of a quality near this average. Most
notably, the Fund's portfolio will contain a higher percentage of assets of
lower quality that each individually involve a higher degree of credit risk and
may be considered to be speculative in nature. For a description of these risk
characteristics, see "Investment objectives, policies and risks--Primary
investment policies--Non-Investment Grade Bonds."
Although the Adviser considers ratings when making investment decisions, it
performs its own credit and investment analysis and does not rely primarily on
the ratings assigned by the rating services. In evaluating the quality of a
particular security, whether rated or unrated, the Adviser will normally take
into consideration, among other things, the issuer's financial resources and
operating history, its sensitivity to economic conditions and trends, the
ability of its management, its debt maturity schedules and borrowing
requirements, and relative values based on anticipated cash flow, interest and
asset coverage, and earnings prospects. The Adviser will attempt to reduce the
risks of investing in lower rated or unrated debt instruments through active
portfolio management, credit analysis and attention to current developments and
trends in the economy and the financial markets. When purchasing and selling
MBS, the Adviser focuses on the expected principal payments on an MBS as well as
current and anticipated market conditions.
Subject to its obligation on a portfolio wide basis to remain in ongoing
compliance with the weighted average portfolio credit policy discussed above,
the Fund is not required to dispose of a security in the event that a rating
agency downgrades its assessment of the credit characteristics of a particular
issue or withdraws its assessment. In determining whether to retain or sell such
a security, Eaton Vance may consider such factors as Eaton Vance's assessment of
the credit quality of the issuers of such security, the price at which such
security could be sold and the rating, if any, assigned to such security by
other Rating Agencies.
The Fund will only invest in U.S. dollar denominated securities. The Fund may
invest up to 5% of its assets in U.S. dollar denominated securities of
non-United States issuers. The Fund's investments may
--------------------------------------------------------------------------------
10
INVESTMENT OBJECTIVES, POLICIES AND RISKS
--------------------------------------------------------------------------------
have significant exposure to certain sectors of the economy and thus may react
differently to political or economic developments than the market as a whole.
MORTGAGE-BACKED SECURITIES
The Fund invests only in MBS that are backed by a guarantee of the U.S.
Government (or one of its agencies or instrumentalities), although certain of
these instruments may be privately issued. MBS represent participation interests
in pools of fixed-rate and adjustable-rate mortgage loans. Unlike conventional
debt obligations, MBS provide monthly payments derived from the monthly interest
and principal payments (including any prepayments) made by the individual
borrowers on the pooled mortgage loans. The Adviser currently expects to invest
primarily in MBS that include mortgage loans that have had a history of
refinancing opportunities (so called "seasoned MBS"). The Adviser typically
considers MBS with mortgages which have been outstanding for ten years or more
to be seasoned MBS. Seasoned MBS tend to have a higher collateral to debt ratio
than other MBS because a greater percentage of the underlying debt has been
repaid and the collateral property may have appreciated in value. The Adviser
may discontinue the practice of focusing on seasoned MBS at any time. The
Adviser expects that under current market conditions many of the MBS held by the
Fund will be premium bonds acquired at prices that exceed their par or principal
value.
The mortgage loans underlying MBS are generally subject to a greater rate of
principal prepayments in a declining interest rate environment and to a lesser
rate of principal prepayments in an increasing interest rate environment,
although the Fund's investment in seasoned MBS mitigates this risk. Under
certain interest and prepayment rate scenarios, the Fund may fail to recover the
full amount of its investment in MBS, notwithstanding any direct or indirect
governmental or agency guarantee. Because faster than expected prepayments must
usually be invested in lower yielding securities, MBS are less effective than
conventional bonds in "locking in" a specified interest rate. Additionally, the
value of Fund assets may be adversely affected by fluctuations in interest rates
underlying the MBS held by the Fund. In a rising interest rate environment, a
declining prepayment rate will extend the average life of many MBS, which in
turn would lengthen the duration of the Fund's portfolio. This possibility is
often referred to as extension risk. Extending the average life of a
mortgage-backed security increases the risk of depreciation due to future
increases in market interest rates, although investing in seasoned MBS helps
mitigate this extension risk. MBS that are purchased at a premium generate
current income that exceeds market rates for comparable investments but tend to
decrease in value as they mature, which may cause a resulting decrease in the
Fund's net asset value.
The Fund may also invest in classes of collateralized mortgage obligations
("CMOs") and various other MBS. In choosing among CMO classes, the Adviser will
evaluate the total income potential of each class and other factors. See
"Additional investment practices--Securitized interests."
Certain government agencies or instrumentalities, such as GNMA, FNMA and FHLMC
provide a guarantee as to timely payment of principal and interest for MBS each
entity issues but may or may not be backed by the full faith and credit of the
U.S. Government.
SENIOR LOANS
Senior Loans hold the most senior position in the capital structure of a
business entity (the "Borrower"), are typically secured with specific collateral
and have a claim on the assets and/or stock of the Borrower that is senior to
that held by subordinated debt holders and stockholders of the Borrower. The
proceeds of Senior Loans primarily are used to finance leveraged buyouts,
recapitalizations, mergers, acquisitions, stock repurchases, refinancings and to
finance internal growth and for other corporate purposes. Senior Loans typically
have rates of interest which are redetermined either daily, monthly, quarterly
or semi-annually by reference to a base lending rate, plus a premium or credit
spread. These base lending rates are primarily the London-Interbank Offered Rate
--------------------------------------------------------------------------------
11
INVESTMENT OBJECTIVES, POLICIES AND RISKS
--------------------------------------------------------------------------------
("LIBOR"), and secondarily the prime rate offered by one or more major United
States banks (the "Prime Rate") and the certificate of deposit ("CD") rate or
other base lending rates used by commercial lenders. The Senior Loans held by
the Fund will have a dollar-weighted average period until the next interest rate
adjustment of approximately 90 days or less. In the experience of the Adviser
over the last decade, because of prepayments the average life of Senior Loans
has been two to four years.
The Fund may also purchase unsecured loans, other floating rate debt securities
such as notes, bonds and asset-backed securities (such as special purpose trusts
investing in bank loans), credit-linked notes, tranches of collateralized loan
obligations, investment grade fixed income debt obligations and money market
instruments, such as commercial paper.
Senior Loans and other floating-rate debt instruments are subject to the risk of
non-payment of scheduled interest or principal. Such non-payment would result in
a reduction of income to the Fund, a reduction in the value of the investment
and a potential decrease in the net asset value of the Fund. There can be no
assurance that the liquidation of any collateral securing a loan would satisfy
the Borrower's obligation in the event of non-payment of scheduled interest or
principal payments, or that such collateral could be readily liquidated. In the
event of bankruptcy of a Borrower, the Fund could experience delays or
limitations with respect to its ability to realize the benefits of the
collateral securing a Senior Loan. The collateral securing a Senior Loan may
lose all or substantially all of its value in the event of bankruptcy of a
Borrower. Some Senior Loans are subject to the risk that a court, pursuant to
fraudulent conveyance or other similar laws, could subordinate such Senior Loans
to presently existing or future indebtedness of the Borrower or take other
action detrimental to the holders of Senior Loans including, in certain
circumstances, invalidating such Senior Loans or causing interest previously
paid to be refunded to the Borrower. If interest were required to be refunded,
it could negatively affect the Fund's performance.
Many Senior Loans in which the Fund will invest may not be rated by a rating
agency, will not be registered with the Securities and Exchange Commission or
any state securities commission and will not be listed on any national
securities exchange. The amount of public information available with respect to
Senior Loans will generally be less extensive than that available for registered
or exchange listed securities. In evaluating the creditworthiness of Borrowers,
the Adviser will consider, and may rely in part, on analyses performed by
others. Borrowers may have outstanding debt obligations that are rated below
investment grade by a rating agency. Many of the Senior Loans in the Fund have
been assigned ratings below investment grade by independent rating agencies. In
the event Senior Loans are not rated, they are likely to be the equivalent of
below investment grade quality. Because of the protective features of Senior
Loans, the Adviser believes that Senior Loans tend to have more favorable loss
recovery rates as compared to more junior types of below investment grade debt
obligations. The Adviser does not view ratings as the determinative factor in
its investment decisions and relies more upon its credit analysis abilities than
upon ratings.
No active trading market may exist for some loans and some loans may be subject
to restrictions on resale. A secondary market may be subject to irregular
trading activity, wide bid/ask spreads and extended trade settlement periods,
which may impair the ability to realize full value and thus cause a material
decline in the Fund's net asset value. During periods of limited supply and
liquidity of Senior Loans, the Fund's yield may be lower.
When interest rates decline, the value of the Fund invested in fixed-rate
obligations can be expected to rise. Conversely, when interest rates rise, the
value of the Fund invested in fixed-rate obligations can be expected to decline.
Although changes in prevailing interest rates can be expected to cause some
fluctuations in the value of Senior Loans (due to the fact that floating rates
on Senior Loans only reset periodically), the value of Senior Loans is
substantially less sensitive to changes in market interest rates
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12
INVESTMENT OBJECTIVES, POLICIES AND RISKS
--------------------------------------------------------------------------------
than fixed-rate instruments. As a result, the Adviser expects the Fund's policy
of investing a portion of its assets in floating-rate Senior Loans will make the
Fund less volatile and less sensitive to changes in market interest rates than
if the Fund invested exclusively in fixed-rate obligations. Similarly, a sudden
and significant increase in market interest rates may cause a decline in the
value of these investments and in the Fund's net asset value. Other factors
(including, but not limited to, rating downgrades, credit deterioration, a large
downward movement in stock prices, a disparity in supply and demand of certain
securities or market conditions that reduce liquidity) can reduce the value of
Senior Loans and other debt obligations, impairing the Fund's net asset value.
The Fund may purchase and retain in its portfolio a Senior Loan where the
Borrower has experienced, or may be perceived to be likely to experience, credit
problems, including involvement in or recent emergence from bankruptcy
reorganization proceedings or other forms of debt restructuring. Such
investments may provide opportunities for enhanced income as well as capital
appreciation. At times, in connection with the restructuring of a Senior Loan
either outside of bankruptcy court or in the context of bankruptcy court
proceedings, the Fund may determine or be required to accept equity securities
or junior debt securities in exchange for all or a portion of a Senior Loan.
Senior Loan assignments and participations. The Fund expects to primarily
purchase Senior Loans by assignment from a participant in the original syndicate
of lenders or from subsequent assignees of such interests. The Fund may also
purchase participations in the original syndicate making Senior Loans. Such
indebtedness may be secured or unsecured. Loan participations typically
represent direct participations in a loan to a corporate borrower, and generally
are offered by banks or other financial institutions or lending syndicates. The
Fund may participate in such syndications, or can buy part of a loan, becoming a
part lender. When purchasing loan participations, the Fund assumes the credit
risk associated with the corporate borrower and may assume the credit risk
associated with an interposed bank or other financial intermediary. The
participation interests in which the Fund intends to invest may not be rated by
any nationally recognized rating service. Given the current structure of the
markets for loan participations and assignments, the Fund expects to treat these
securities as illiquid.
Senior Loan valuation. The Adviser uses an independent pricing service to value
most loans and other debt securities at their market value. The Adviser may use
the fair value method to value loans or other securities if market quotations
for them are not readily available or are deemed unreliable, or if events
occurring after the close of a securities market and before the Fund values its
assets would materially affect net asset value.
NON-INVESTMENT GRADE BONDS
As indicated above, Non-Investment Grade Bonds are those rated lower than
investment grade (i.e., bonds rated lower than Baa3 by Moody's and lower than
BBB- by S&P and Fitch) or are unrated and of comparable quality as determined by
the Adviser. Non-Investment Grade Bonds rated BB and Ba have speculative
characteristics, while lower rated Non-Investment Grade Bonds are predominantly
speculative.
The Fund may hold securities that are unrated or in the lowest rating categories
(rated C by Moody's or D by S&P or Fitch). Bonds rated C by Moody's are regarded
as having extremely poor prospects of ever attaining any real investment
standing. Bonds rated D by S&P or Fitch are in payment default or a bankruptcy
petition has been filed and debt service payments are jeopardized. In order to
enforce its rights with defaulted securities, the Fund may be required to retain
legal counsel and/or a financial adviser. This may increase the Fund's operating
expenses and adversely affect net asset value.
The credit quality of most securities held by the Fund reflects a greater than
average possibility that adverse changes in the financial condition of an
issuer, or in general economic conditions, or both,
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13
INVESTMENT OBJECTIVES, POLICIES AND RISKS
--------------------------------------------------------------------------------
may impair the ability of the issuer to make payments of interest and principal.
The inability (or perceived inability) of issuers to make timely payment of
interest and principal would likely make the values of securities held by the
Fund more volatile and could limit the Fund's ability to sell its securities at
favorable prices. In the absence of a liquid trading market for securities held
by it, the Fund may have difficulties determining the fair market value of such
securities.
Although the Adviser considers security ratings when making investment
decisions, it performs its own credit and investment analysis and does not rely
primarily on the ratings assigned by the rating services. In evaluating the
quality of a particular security, whether rated or unrated, the Adviser will
normally take into consideration, among other things, the issuer's financial
resources and operating history, its sensitivity to economic conditions and
trends, the ability of its management, its debt maturity schedules and borrowing
requirements, and relative values based on anticipated cash flow, interest and
asset coverage, and earnings prospects. Because of the greater number of
investment considerations involved in investing in high yield, high risk bonds,
the achievement of the Fund's objectives depends more on the Adviser's judgment
and analytical abilities than would be the case if the Fund invested primarily
in securities in the higher rating categories. While the Adviser will attempt to
reduce the risks of investing in lower rated or unrated securities through
active Fund management, diversification, credit analysis and attention to
current developments and trends in the economy and the financial markets, there
can be no assurance that a broadly diversified Fund of such securities would
substantially lessen the risks of defaults brought about by an economic downturn
or recession. In recent years, issuances of Non-Investment Grade Bonds by
companies in various sectors has increased. Accordingly, the Fund's investments
may have significant exposure to certain sectors of the economy and thus may
react differently to political or economic developments than the market as a
whole.
The Fund's high yield securities may have fixed or variable principal payments
and all types of interest rate and dividend payment and reset terms, including
fixed rate, adjustable rate, zero coupon, contingent, deferred, and payment in
kind features.
ADDITIONAL INVESTMENT PRACTICES
OTHER GOVERNMENT SECURITIES
U.S. Government securities include (1) U.S. Treasury obligations, which differ
in their interest rates, maturities and times of issuance: U.S. Treasury bills
(maturities of one year or less), U.S. Treasury notes (maturities of one year to
ten years) and U.S. Treasury bonds (generally maturities of greater than ten
years) and (2) obligations issued or guaranteed by U.S. Government agencies and
instrumentalities which are supported by any of the following: (a) the full
faith and credit of the U.S. Treasury, (b) the right of the issuer to borrow an
amount limited to a specific line of credit from the U.S. Treasury, (c)
discretionary authority of the U.S. Government to purchase certain obligations
of the U.S. Government agency or instrumentality or (d) the credit of the agency
or instrumentality. The Fund may also invest in any other security or agreement
collateralized or otherwise secured by U.S. Government securities. Agencies and
instrumentalities of the U.S. Government include but are not limited to: Federal
Land Banks, Federal Financing Banks, Banks for Cooperatives, Federal
Intermediate Credit Banks, Farm Credit Banks, Federal Home Loan Banks, FHLMC,
FNMA, GNMA, Student Loan Marketing Association, United States Postal Service,
Small Business Administration, Tennessee Valley Authority and any other
enterprise established or sponsored by the U.S. Government. Because the U.S.
Government generally is not obligated to provide support to its
instrumentalities, the Fund will invest in obligations issued by these
instrumentalities only if the Adviser determines that the credit risk with
respect to such obligations is minimal.
The principal of and/or interest on certain U.S. Government securities which may
be purchased by the Fund could be increased or diminished as a result of changes
in the value of the U.S. dollar relative to
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14
INVESTMENT OBJECTIVES, POLICIES AND RISKS
--------------------------------------------------------------------------------
the value of foreign currencies. The value of such portfolio securities may be
affected favorably by changes in the exchange rate between foreign currencies
and the U.S. dollar.
SECURITIZED INTERESTS
The Fund may invest in certain asset-backed securities as discussed below.
Asset-backed securities are payment claims that are securitized in the form of
negotiable paper that is issued by a financing company (generically called a
Special Purpose Vehicle or "SPV"). These securitized payment claims are, as a
rule, corporate financial assets brought into a pool according to specific
diversification rules. The SPV is a company founded solely for the purpose of
securitizing these claims and its only asset is the risk arising out of this
diversified asset pool. On this basis, marketable securities are issued which,
due to the diversification of the underlying risk, generally represent a lower
level of risk than the original assets. The redemption of the securities issued
by the SPV takes place at maturity out of the cash flow generated by the
collected claims. Asset-backed securities may be issued by the U.S. government,
its agencies or instrumentalities, or by non-governmental issuers.
CMOs. The CMO classes in which the Fund may invest include sequential and
parallel pay CMOs, including planned amortization class and target amortization
class securities. CMOs are debt securities issued by either the U.S. government
(or one of its agencies or instrumentalities) or private issuers. The key
feature of the CMO structure is the prioritization of the cash flows from a pool
of mortgages among the several classes of CMO holders, thereby creating a series
of obligations with varying rates and maturities appealing to a wide range of
investors. CMOs generally are secured by an assignment to a trustee under the
indenture pursuant to which the bonds are issued of collateral consisting of a
pool of mortgages. Payments with respect to the underlying mortgages generally
are made to the trustee under the indenture. CMOs are issued in two or more
classes or series with varying maturities and stated rates of interest
determined by the issuer. Senior CMO classes will typically have priority over
residual CMO classes as to the receipt of principal and/or interest payments on
the underlying mortgages. Because the interest and principal payments on the
underlying mortgages are not passed through to holders of CMOs, CMOs of varying
maturities may be secured by the same pool of mortgages, the payments on which
are used to pay interest to each class and to retire successive maturities in
sequence. CMOs are designed to be retired as the underlying mortgages are
repaid. In the event of sufficient early prepayments on such mortgages, the
class or series of CMO first to mature generally will be retired prior to
maturity. Therefore, although in most cases the issuer of CMOs will not supply
additional collateral in the event of such prepayments, there will be sufficient
collateral to secure CMOs that remain outstanding. Currently, the Adviser will
consider privately issued CMOs or other mortgage-backed securities as possible
investments for the Fund only when the mortgage collateral is insured,
guaranteed or otherwise backed by the U.S. Government or one or more of its
agencies or instrumentalities (e.g., insured by the Federal Housing
Administration or Farmers Home Administration or guaranteed by the Administrator
of Veterans Affairs or consisting in whole or in part of U.S. Government
securities).
Collateralized debt obligations ("CDOs"). The Fund may invest in CDOs. A CDO is
a structured credit security issued by a special purpose entity that was created
to reapportion the risk and return characteristics of a pool of assets. The
assets, typically non-investment grade bonds, leveraged loans, and other
asset-backed obligations, are used as collateral supporting the various debt and
equity tranches issued by the special purpose entity. CDOs operate similarly to
CMOs and CLOs and are subject to the same inherent risks.
Collateralized loan obligations ("CLOs"). A CLO is a type of CDO that invests
primarily in leveraged loans as collateral underlying the obligations of the
special purpose entity. CLOs operate similarly to CMOs and are subject to the
same inherent risks.
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15
INVESTMENT OBJECTIVES, POLICIES AND RISKS
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MORTGAGE ROLLS
The Fund may enter into mortgage "dollar rolls" in which the Fund sells
mortgage-backed securities for delivery in the current month and simultaneously
contracts to repurchase substantially similar (same type, coupon and maturity)
securities on a specified future date. During the roll period, the Fund forgoes
principal and interest paid on the mortgage-backed securities. The Fund is
compensated by the difference between the current sales price and the lower
forward price for the future purchase (often referred to as the "drop") as well
as by the interest earned on the cash proceeds of the initial sales. A "covered
roll" is a specific type of dollar roll for which there is an offsetting cash
position or a cash equivalent security position which matures on or before the
forward settlement date of the dollar roll transaction. The Fund will only enter
into covered rolls. Covered rolls are not treated as a borrowing or other senior
security and will be excluded from the calculation of the Fund's borrowings and
other senior securities.
CREDIT-LINKED NOTES
The Fund may invest in credit-linked notes ("CLN"). A CLN is a derivative
instrument. It is a synthetic obligation between two or more parties where the
payment of principal and/or interest is based on the performance of some
obligation (a reference obligation). In addition to credit risk of the reference
obligation and interest rate risk, the buyer/seller of the CLN is subject to
counterparty risk.
COMMERCIAL PAPER
Commercial paper represents short-term unsecured promissory notes issued in
bearer form by corporations such as banks or bank holding companies and finance
companies. The rate of return on commercial paper may be linked or indexed to
the level of exchange rates between the U.S. dollar and a foreign currency or
currencies.
WHEN-ISSUED SECURITIES AND FORWARD COMMITMENTS
Securities may be purchased on a "forward commitment" or "when-issued" basis
(meaning securities are purchased or sold with payment and delivery taking place
in the future) in order to secure what is considered to be an advantageous price
and yield at the time of entering into the transaction. However, the yield on a
comparable security when the transaction is consummated may vary from the yield
on the security at the time that the forward commitment or when-issued
transaction was made. From the time of entering into the transaction until
delivery and payment is made at a later date, the securities that are the
subject of the transaction are subject to market fluctuations. In forward
commitment or when-issued transactions, if the seller or buyer, as the case may
be, fails to consummate the transaction the counterparty may miss the
opportunity of obtaining a price or yield considered to be advantageous. Forward
commitment or when-issued transactions may be expected to occur a month or more
before delivery is due. However, no payment or delivery is made until payment is
received or delivery is made from the other party to the transaction. Forward
commitment or when-issued transactions are not entered into for the purpose of
investment leverage.
ILLIQUID SECURITIES
The Fund may invest in securities for which there is no readily available
trading market or are otherwise illiquid. Illiquid securities include securities
legally restricted as to resale, such as commercial paper issued pursuant to
Section 4(2) of the Securities Act of 1933, as amended, and securities eligible
for resale pursuant to Rule 144A thereunder. Section 4(2) and Rule 144A
securities may, however, be treated as liquid by the Adviser pursuant to
procedures adopted by the Board, which require consideration of factors such as
trading activity, availability of market quotations and number of dealers
willing to purchase the security. If the Fund invests in Rule 144A securities,
the level of portfolio illiquidity may be increased to the extent that eligible
buyers become uninterested in purchasing such securities.
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INVESTMENT OBJECTIVES, POLICIES AND RISKS
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It may be difficult to sell such securities at a price representing the fair
value until such time as such securities may be sold publicly. Where
registration is required, a considerable period may elapse between a decision to
sell the securities and the time when it would be permitted to sell. Thus, the
Fund may not be able to obtain as favorable a price as that prevailing at the
time of the decision to sell. The Fund may also acquire securities through
private placements under which it may agree to contractual restrictions on the
resale of such securities. Such restrictions might prevent their sale at a time
when such sale would otherwise be desirable.
SWAPS
Swap contracts may be purchased or sold to hedge against fluctuations in
securities prices, interest rates or market conditions, to change the duration
of the overall portfolio, or to mitigate default risk. In a standard "swap"
transaction, two parties agree to exchange the returns (or differentials in
rates of return) to be exchanged or "swapped" between the parties, which returns
are calculated with respect to a "notional amount," i.e., the return on or
increase in value of a particular dollar amount invested at a particular
interest rate or in a "basket" of securities representing a particular index.
Interest Rate Swaps. The Fund will enter into interest rate and total return
swaps only 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. Interest rate swaps involve the exchange by the Fund with another
party of their respective commitments to pay or receive interest (e.g., an
exchange of fixed rate payments for floating rate payments). The Fund will only
enter into interest rate swaps on a net basis. If the other party to an interest
rate swap defaults, the Fund's risk of loss consists of the net amount of
payments that the Fund is contractually entitled to receive. The net amount of
the excess, if any, of the Fund's obligations over its entitlements will be
maintained in a segregated account by the Fund's custodian. The Fund will not
enter into any interest rate swap unless the claims-paying ability of the other
party thereto is considered to be investment grade by the Adviser. If there is a
default by the other party to such a transaction, the Fund will have contractual
remedies pursuant to the agreements related to the transaction. These
instruments are traded in the over-the-counter market.
The Fund may use interest rate swaps for risk management purposes only and not
as a speculative investment and would typically use interest rate swaps to
shorten the average interest rate reset time of the Fund's holdings. Interest
rate swaps involve the exchange by the Fund with another party of their
respective commitments to pay or receive interests (e.g., an exchange of fixed
rate payments for floating rate payments). The use of interest rate swaps is a
highly specialized activity which involves investment techniques and risks
different from those associated with ordinary portfolio securities transactions.
If the Adviser is incorrect in its forecasts of market values, interest rates
and other applicable factors, the investment performance of the Fund would be
unfavorably affected.
Total Return Swaps. As stated above, the Fund will enter into total return
swaps only on a net basis. Total return swaps are contracts in which one party
agrees to make payments of the total return from the underlying asset(s) which
may include securities, baskets of securities, or securities indices during the
specified period, in return for payments equal to a fixed or floating rate of
interest or the total return from other underlying asset(s).
Credit Default Swaps. The Fund may enter into credit default swap contracts for
risk management purposes, including diversification. When the Fund is the buyer
of a credit default swap contract, the Fund is entitled to receive the par (or
other agreed-upon) value of a referenced debt obligation from the counterparty
to the contract in the event of a default by a third party, such as a U.S. or
foreign corporate issuer, on the debt obligation. In return, the Fund would pay
the counterparty a periodic stream of payments over the term of the contract
provided that no event of default has occurred. If no default occurs, the Fund
would have spent the stream of payments and received no benefit from the
contract. When the Fund is the seller of a credit default swap contract, it
receives the stream of
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17
INVESTMENT OBJECTIVES, POLICIES AND RISKS
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payments but is obligated to pay upon default of the referenced debt obligation.
As the seller, the Fund would effectively add leverage to its portfolio because,
in addition to its total net assets, the Fund would be subject to investment
exposure on the notional amount of the swap. The Fund will segregate assets in
the form of cash and cash equivalents in an amount equal to the aggregate market
value of the credit default swaps of which it is the seller, marked to market on
a daily basis. These transactions involve certain risks, including the risk that
the seller may be unable to fulfill the transaction.
FUTURES AND OPTIONS ON FUTURES
The Fund may purchase and sell various kinds of financial futures contracts and
options thereon to seek to hedge against changes in interest rates or for other
risk management purposes. Futures contracts may be based on various debt
securities and securities indices. Such transactions involve a risk of loss or
depreciation due to unanticipated adverse changes in securities prices, which
may exceed the Fund's initial investment in these contracts. The Fund will only
purchase or sell futures contracts or related options in compliance with the
rules of the Commodity Futures Trading Commission. These transactions involve
transaction costs. There can be no assurance that Eaton Vance's use of futures
will be advantageous to the Fund. Rating agency guidelines on any Preferred
Shares issued by the Fund may limit use of these transactions.
SECURITIES LENDING
The Fund may seek to earn income by lending portfolio securities to
broker-dealers or other institutional borrowers. As with other extensions of
credit, there are risks of delay in recovery or even loss of rights in the
securities loaned if the borrower of the securities fails financially. In the
judgment of the Adviser, the loans will be made only to organizations whose
credit quality or claims paying ability is considered to be at least investment
grade and when the expected returns, net of administrative expenses and any
finders' fees, justifies the attendant risk. Securities loans currently are
required to be secured continuously by collateral in cash, cash equivalents
(such as money market instruments) or other liquid securities held by the
custodian and maintained in an amount at least equal to the market value of the
securities loaned. The financial condition of the borrower will be monitored by
the Adviser on an ongoing basis.
BORROWINGS
The Fund may borrow money to the extent permitted under the 1940 Act as
interpreted, modified or otherwise permitted by regulatory authority having
jurisdiction, from time to time. The Fund may from time to time borrow money to
add leverage to the portfolio. The Fund may also borrow money for temporary
administrative purposes.
REVERSE REPURCHASE AGREEMENTS
The Fund may enter into reverse repurchase agreements. Under a reverse
repurchase agreement, the Fund temporarily transfers possession of a portfolio
instrument to another party, such as a bank or broker-dealer, in return for
cash. At the same time, the Fund agrees to repurchase the instrument at an
agreed upon time (normally within seven days) and price, which reflects an
interest payment. The Fund may enter into such agreements when it is able to
invest the cash acquired at a rate higher than the cost of the agreement, which
would increase earned income.
When the Fund enters into a reverse repurchase agreement, any fluctuations in
the market value of either the securities transferred to another party or the
securities in which the proceeds may be invested would affect the market value
of the Fund's assets. As a result, such transactions may increase fluctuations
in the market value of the Fund's assets. While there is a risk that large
fluctuations in the market value of the Fund's assets could affect net asset
value, this risk is not significantly increased by entering into reverse
repurchase agreements, in the opinion of the Adviser. Because reverse repurchase
agreements may be considered to be the practical equivalent of borrowing funds,
they constitute a
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18
INVESTMENT OBJECTIVES, POLICIES AND RISKS
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form of leverage. Such agreements will be treated as subject to investment
restrictions regarding "borrowings." If the Fund reinvests the proceeds of a
reverse repurchase agreement at a rate lower than the cost of the agreement,
entering into the agreement will lower the Fund's yield.
PORTFOLIO TURNOVER
The Fund cannot accurately predict its portfolio turnover rate, but the annual
turnover rate may exceed 100% (excluding turnover of securities having a
maturity of one year or less). A high turnover rate (100% or more) necessarily
involves greater expenses to the Fund and may result in a realization of net
short-term capital gains. The Fund may engage in active short-term trading to
benefit from yield disparities among different issues of securities or among the
markets for fixed income securities of different countries, to seek short-term
profits during periods of fluctuating interest rates, or for other reasons. Such
trading will increase the Fund's rate of turnover and may increase the incidence
of net short-term capital gains which, upon distribution by the Fund, are
taxable to Fund Shareholders as ordinary income.
RISK CONSIDERATIONS
Risk is inherent in all investing. Investing in any investment company security
involves risk, including the risk that you may receive little or no return on
your investment or even that you may lose part or all of your investment.
Therefore, before investing you should consider carefully the following risks
that you assume when you invest in APS.
INTEREST RATE RISK
The Fund issues APS, which pay dividends based on short-term interest rates, and
uses the proceeds to buy obligations, which pay interest based on longer-term
yields. Longer-term bond obligation yields are typically, although not always,
higher than short-term interest rates. Both long-term and short-term interest
rates may fluctuate. If short-term interest rates rise, APS rates may rise such
that the amount of dividends paid to APS holders exceeds the income from the
portfolio securities purchased with the proceeds from the sale of APS. Because
income from the Fund's entire investment portfolio (not just the portion
purchased with the proceeds of the APS offering) is available to pay APS
dividends, however, APS dividend rates would need to greatly exceed the Fund's
net portfolio income before the Fund's ability to pay APS dividends would be
jeopardized. If long-term rates rise, the value of the Fund's investment
portfolio will decline, reducing the amount of assets serving as asset coverage
for the APS.
AUCTION RISK
Holders of APS may not be able to sell APS at an Auction if the auction fails;
that is, if there are more APS offered for sale than there are buyers for those
APS. Also, if a hold order is placed at an auction (an order to retain APS) only
at a specified rate, and that bid rate exceeds the rate set at the Auction, the
APS will not be retained. Finally, if you elect to buy or retain APS without
specifying a rate below which you would not wish to continue to hold those APS,
and the auction sets a below market rate, you may receive a lower rate of return
on your APS then the market rate. See "Description of APS" and "The
Auction--Auction procedures."
SECONDARY MARKET RISK
It may not be possible to sell APS between auctions or it may only be possible
to sell them for a price of less than $25,000 per share plus any accumulated
dividends. If the Fund has designated a Special Dividend Period (a dividend
period of more than 7 days), changes in interest rates could affect the price of
APS sold in the secondary market. 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
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19
INVESTMENT OBJECTIVES, POLICIES AND RISKS
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with a liquid trading market (i.e., trading will depend on the presence of
willing buyers and sellers and the trading price is subject to variables to be
determined at the time of the trade by the broker-dealers). The APS will not be
registered on any stock exchange or on any automated quotation system. An
increase in the level of interest rates, particularly during any Long Term
Dividend Period, likely will have an adverse effect on the secondary market
price of the APS, and a selling Shareholder may sell APS between Auctions at a
price per share of less than $25,000. Accrued APS dividends, however, should at
least partially compensate for the increased market interest rate.
RATINGS AND ASSET COVERAGE RISK
While Moody's and Fitch assign a rating of "AAA" to the APS, the ratings do not
eliminate or necessarily mitigate the risks of investing in APS. A rating agency
could downgrade APS, which may make APS less liquid at an Auction or in the
secondary market, although the downgrade would probably result in higher
dividend rates. If a rating agency downgrades APS of the Fund, the Fund will
alter its portfolio or redeem APS. The Fund may voluntarily redeem APS under
certain circumstances. A preferred stock rating is an assessment of the capacity
and willingness of an issuer to pay preferred stock obligations. The ratings on
the Preferred Shares 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 the Preferred Shares will be able to
sell such shares in an auction or otherwise. See "Description of APS--Rating
agency guidelines and asset coverage" for a description of the asset maintenance
tests the Fund must meet.
INCOME RISK
The income investors receive from the Fund is based primarily on the interest it
earns from its investments, which can vary widely over the short- and long-term.
If long-term interest rates drop, the Fund's income available over time to make
dividend payments with respect to APS could drop as well if the Fund purchases
securities with lower interest coupons.
CALL AND OTHER REINVESTMENT RISKS
If interest rates fall, it is possible that issuers of callable bonds with high
interest coupons will "call" (or prepay) their bonds before their maturity date.
If a call were exercised by the issuer during a period of declining interest
rates, the Fund is likely to replace such called security with a lower yielding
security. Similar risks exist when the Fund invests the proceeds from matured or
traded obligations at market interest rates that are below the Fund's current
earnings rate.
CREDIT RISK
Credit risk is the risk that one or more investments in the Fund's portfolio
will decline in price, or fail to pay interest or principal when due, because
the issuer of the obligation experiences a decline in its financial status. In
general, lower rated bonds carry a greater degree of risk that the issuer will
lose its ability to make interest and principal payments, which could have a
negative impact on the Fund's net asset value or dividends. Securities rated in
the fourth highest category are considered investment grade but they also may
have some speculative characteristics.
Changes in the credit quality of the issuers of obligations held by the Fund
will affect the principal value of (and possibly the income earned on) such
obligations. In addition, the value of such securities are affected by changes
in general economic conditions and business conditions affecting the relevant
economic sectors. Changes by Rating Agencies in their ratings of a security and
in the ability of the issuer to make payments of principal and interest may also
affect the value of the Fund's investments. The amount of information about the
financial condition of an issuer of obligations may not be as extensive as that
made available by corporations whose securities are publicly traded.
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20
INVESTMENT OBJECTIVES, POLICIES AND RISKS
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If rating agencies lower their ratings of investments in the Fund's portfolio,
the value of those investments could decline, which could jeopardize the rating
agencies' ratings of the APS. Because the primary source of income for the Fund
is the interest and principal payments on the obligations in which it invests,
any default by an issuer of an obligation could have a negative impact on the
Fund's ability to pay dividends on the APS and could result in the redemption of
some or all of the APS.
LIQUIDITY RISK
At times, a portion of the Fund's assets may be invested in securities as to
which the Fund, by itself or together with other accounts managed by Eaton Vance
and its affiliates, holds a major portion of all of such securities. The
secondary market for some such obligations is less liquid than that for more
widely traded obligations. No established resale market exists for certain of
the obligations in which the Fund may invest. The Fund has no limitation on the
amount of its assets that may be invested in securities which are not readily
marketable or are subject to restrictions on resale. In certain situations, the
Fund could find it more difficult to sell such securities at desirable times
and/or prices.
INFLATION RISK
Inflation risk is the risk that the value of assets or income from investment
will be worth less in the future as inflation decreases the value of money. As
inflation increases, the real value of the APS and distributions thereon can
decline. In an inflationary period, however, it is expected that, through the
Auction process, APS dividend rates would increase, tending to offset the risk.
MARKET DISRUPTION
The terrorist attacks in the United States on September 11, 2001 had a
disruptive effect on the securities markets. The Fund cannot predict the effects
of similar events in the future on the U.S. economy. These terrorist attacks and
related events, including the war in Iraq, have led to increased short-term
market volatility and may have long-term effects on U.S. and world economies and
markets. A similar disruption of the financial markets could impact interest
rates, auctions, secondary trading, ratings, credit risk, inflation and other
factors relating to the Preferred Shares. In particular, Non-Investment Grade
Bonds and Senior Loans tend to be more volatile than higher rated fixed income
securities so that these events and any actions resulting from them may have a
greater impact on the prices and volatility on Non-Investment Grade Bonds and
Senior Loans than on higher rated fixed income securities.
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21
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Management of the Fund
BOARD OF TRUSTEES
The management of the Fund, including general supervision of the duties
performed by the Adviser under the Advisory Agreement (as defined below), is the
responsibility of the Fund's Board under the laws of The Commonwealth of
Massachusetts and the 1940 Act.
THE ADVISER
Eaton Vance acts as the Fund's investment adviser under an Investment Advisory
Agreement (the "Advisory Agreement"). The Adviser's principal office is located
at The Eaton Vance Building, 255 State Street, Boston, MA 02109. Eaton Vance,
its affiliates and predecessor companies have been managing assets of
individuals and institutions since 1924 and of investment companies since 1931.
Eaton Vance (or its affiliates) currently serves as the investment adviser to
investment companies and various individual and institutional clients with
combined assets under management of approximately $62.7 billion as of June 30,
2003. Eaton Vance is an indirect, wholly-owned subsidiary of Eaton Vance Corp.,
a publicly-held holding company, which through its subsidiaries and affiliates
engages primarily in investment management, administration and marketing
activities.
Under the general supervision of the Fund's Board, the Adviser will carry out
the investment and reinvestment of the assets of the Fund, will furnish
continuously an investment program with respect to the Fund, will determine
which securities should be purchased, sold or exchanged, and will implement such
determinations. The Adviser will furnish to the Fund investment advice and
office facilities, equipment and personnel for servicing the investments of the
Fund. The Adviser will compensate all Trustees and officers of the Fund who are
members of the Adviser's organization and who render investment services to the
Fund, and will also compensate all other Adviser personnel who provide research
and investment services to the Fund. In return for these services, facilities
and payments, the Fund has agreed to pay the Adviser as compensation under the
Advisory Agreement a fee in the amount of 0.75% of the average weekly gross
assets of the Fund. Gross assets of the Fund shall be calculated by deducting
accrued liabilities of the Fund not including the amount of any Preferred Shares
outstanding or the principal amount of any indebtedness for money borrowed.
During periods in which the Fund is using leverage, the fees paid to Eaton Vance
for investment advisory services will be higher than if the Fund did not use
leverage because the fees paid will be calculated on the basis of the Fund's
gross assets, including proceeds from any borrowings and from the issuance of
Preferred Shares.
Thomas E. Faust Jr. (Executive Vice President and Chief Investment Officer of
Eaton Vance), Susan Schiff, Scott H. Page, Payson F. Swaffield, Michael
Weilheimer and other Eaton Vance investment professionals comprise the
investment team responsible for the overall management of the Fund's investments
as well as allocations among the Fund's three principal investment categories.
The following individual members of this team are responsible for the day-to-day
management with each of the Fund's three main asset classes:
MBS. Ms. Schiff is responsible for the day-to-day management of the Fund's MBS
strategy. Ms. Schiff, has been an Eaton Vance portfolio manager since 1991, and
is a Vice President of Eaton Vance. Among other portfolios, she currently
manages Eaton Vance Government Obligations Fund, a registered open-end fund,
which employs an investment strategy primarily focused on MBS. As of June 30,
2003, this fund had assets of approximately $1.94 billion.
Senior Loans. Mr. Page and Mr. Swaffield are responsible for the day-to-day
management of the Fund's Senior Loan strategy. Among other portfolios, Mr. Page
and Mr. Swaffield have each been
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22
MANAGEMENT OF THE FUND
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Eaton Vance portfolio managers since 1996, and are Vice Presidents of Eaton
Vance. They currently co-manage Eaton Vance Prime Rate Reserves, a registered
closed-end interval fund, Eaton Vance Classic Senior Floating-Rate Fund, a
registered closed-end interval fund, Eaton Vance Floating-Rate Fund, a
registered open-end fund, Eaton Vance Floating-Rate High Income Fund, a
registered open-end fund, and Eaton Vance Senior Income Trust, a registered
closed-end fund listed on the New York Stock Exchange, all of which employ
investment strategies primarily focused on Senior Loans. As of June 30, 2003,
these funds had combined assets of approximately $5.5 billion. See "Additional
investment information and restrictions--Litigation involving Eaton Vance" in
the SAI for further information.
Non-Investment Grade Bonds. Mr. Weilheimer is responsible for the day-to-day
management of the Fund's Non-Investment Grade Bond strategy. Mr. Weilheimer has
been an Eaton Vance portfolio manager since 1996, and is a Vice President of
Eaton Vance. Among other portfolios, he currently co-manages Eaton Vance High
Income Fund, a registered open-end fund, and Eaton Vance Income Fund of Boston,
a registered open-end fund, both of which employ investment strategies primarily
focused on Non-Investment Grade Bonds. As of June 30, 2003, these funds had
combined assets of approximately $2.26 billion.
The Fund and the Adviser have adopted a Code of Ethics relating to personal
securities transactions. The Code permits Adviser personnel to invest in
securities (including securities that may be purchased or held by the Fund) for
their own accounts, subject to certain pre-clearance, reporting and other
restrictions and procedures contained in such Code.
Eaton Vance serves as administrator of the Fund but currently receives no
compensation for providing administrative services to the Fund. Under an
Administration Agreement with the Fund ("Administration Agreement"), Eaton Vance
is responsible for managing the business affairs of the Fund, subject to the
supervision of the Fund's Board. Eaton Vance will furnish to the Fund all office
facilities, equipment and personnel for administering the affairs of the Fund.
Eaton Vance's administrative services include recordkeeping, preparation and
filing of documents required to comply with federal and state securities laws,
supervising the activities of the Fund's custodian and transfer agent, providing
assistance in connection with the Trustees' and shareholders' meetings,
providing service in connection with any repurchase offers and other
administrative services necessary to conduct the Fund's business.
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23
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Description of APS
The following is a brief description of the terms of the APS. This description
does not purport to be complete and is subject to and qualified in its entirety
by reference to the Fund's Declaration of Trust and Amended By-Laws, including
the provisions thereof establishing the APS. The Fund's Declaration of Trust and
the form of Amended By-Laws establishing the terms of the APS have been filed as
exhibits to or incorporated by reference in the Registration Statement of which
this Prospectus is a part. The Amended By-Laws for the Fund may be found in
Appendix B to the Fund's Statement of Additional Information.
GENERAL
The Declaration of Trust authorizes the issuance of an unlimited number of
shares of beneficial interest with preference rights, including Preferred
Shares, having a par value of $0.01 per share, in one or more series, with
rights as determined by the Board of Trustees, by action of the Board of
Trustees without the approval of the Shareholders. The Fund's Amended By-Laws
currently authorize the number of shares of APS of each series set forth below
in "Description of Capital Structure." The APS will have a liquidation
preference of $25,000 per share plus an amount equal to accumulated but unpaid
dividends (whether or not earned or declared). See "Description of
APS--Liquidation rights."
The APS of each series will rank on parity with shares of any other series of
APS and with shares of other series of Preferred Shares of the Fund, as to the
payment of dividends and the distribution of assets upon liquidation. All shares
of APS carry one vote per share on all matters on which such shares are entitled
to be voted. APS, when issued, will be fully paid and, subject to matters
discussed in "Certain provisions of the Declaration of Trust," non-assessable
and have no preemptive, conversion or cumulative voting rights. The APS will not
be convertible into Common Shares or other capital stock of the Fund, and the
holders thereof will have no preemptive, or cumulative voting rights.
DIVIDENDS AND DIVIDEND PERIODS
GENERAL
After the Initial Dividend Period, each Subsequent Dividend period for the APS
will generally consist of seven days (a "7-Day Dividend Period"); provided,
however, that prior to any Auction, the Fund may elect, subject to certain
limitations described herein, upon giving notice to holders thereof, a Special
Dividend Period as discussed below. The holders of the APS of the Fund will be
entitled to receive, when, as and if declared by that Fund's Board of Trustees,
out of funds legally available therefor, cumulative cash dividends on their APS,
at the Applicable Rate determined as set forth below under "Determination of
Dividend Rate," payable on the dates set forth below. Dividends on the APS of
the Fund so declared and payable shall be paid in preference to and in priority
over any dividends declared and payable on the Fund's Common Shares.
Dividends on the APS will accumulate from the date on which the Fund originally
issues the APS (the "Date of Original Issue") and will be payable on the APS on
the dates described below. Dividends on the APS with respect to the Initial
Dividend Period shall be payable on the Initial Dividend Payment Date. Following
the Initial Dividend Payment Date, dividends on the APS will be payable, at the
option of the Fund, either (i) with respect to any 7-Day Dividend Period and any
Short Term Dividend Period of 28 or fewer days, on the day next succeeding the
last day thereof or (ii) with respect to any Short Term Dividend Period of more
than 28 days and with respect to any Long Term Dividend Period, monthly on the
first Business Day of each calendar month during such Short Term Dividend Period
or Long Term Dividend Period and on the day next succeeding the last day thereof
(each such date referred to in clause (i) or (ii) being referred to herein as a
"Normal Dividend Payment Date"),
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24
DESCRIPTION OF APS
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except that if such Normal Dividend Payment Date is not a Business Day, the
Dividend Payment Date shall be the first Business Day next succeeding such
Normal Dividend Payment Date. Although any particular Dividend Payment Date may
not occur on the originally scheduled date because of the exceptions discussed
above, the next succeeding Dividend Payment Date, subject to such exceptions,
will occur on the next following originally scheduled date. If for any reason a
Dividend Payment Date cannot be fixed as described above, then the Board of
Trustees shall fix the Dividend Payment Date. The Board of Trustees by
resolution prior to authorization of a dividend by the Board of Trustees may
change a Dividend Payment Date if such change does not adversely affect the
contract rights of the holders of APS set forth in the Amended By-Laws. The
Initial Dividend Period, 7-Day Dividend Periods and Special Dividend Periods are
hereinafter sometimes referred to as "Dividend Periods." Each dividend payment
date determined as provided above is hereinafter referred to as a "Dividend
Payment Date."
Prior to each Dividend Payment Date, the Fund is required to deposit with the
Auction Agent sufficient funds for the payment of declared dividends. The Fund
does not intend to establish any reserves for the payment of dividends.
Each dividend will be paid to the record holder of the APS, which holder is
expected to be the nominee of the Securities Depository. See "The
Auctions--General--Securities Depository." The Securities Depository will credit
the accounts of the Agent Members of the Existing Holders in accordance with the
Securities Depository's normal procedures which provide for payment in same-day
funds. The Agent Member of an Existing Holder will be responsible for holding or
disbursing such payments on the applicable Dividend Payment Date to such
Existing Holder in accordance with the instructions of such Existing Holder.
Dividends in arrears for any past Dividend Period may be declared and paid at
any time, without reference to any regular Dividend Payment Date, to the nominee
of the Securities Depository. Any dividend payment made on the APS first shall
be credited against the earliest declared but unpaid dividends accumulated with
respect to such shares.
Holders of the APS will not be entitled to any dividends, whether payable in
cash, property or stock, in excess of full cumulative dividends except as
described under "Non-payment period; late charge" below. No interest will be
payable in respect of any dividend payment or payments on the APS which may be
in arrears.
The amount of cash dividends per share of APS payable (if declared) on the
Initial Dividend Payment Date, each Dividend Payment Date of a 7-Day Dividend
Period and each Dividend Payment Date of each Short Term Dividend Period shall
be computed by multiplying the Applicable Rate for such Dividend Period by a
fraction, the numerator of which will be the number of days in such Dividend
Period or part thereof that such share was outstanding and for which dividends
are payable on such Dividend Payment Date and the denominator of which will be
360, multiplying the amount so obtained by $25,000, and rounding the amount so
obtained to the nearest cent. During any Long Term Dividend Period, the amount
of cash dividends per share of APS payable (if declared) on any Dividend Payment
Date shall be computed by multiplying the Applicable Rate for such Dividend
Period by a fraction, the numerator of which will be such number of days in such
part of such Dividend Period that such share was outstanding and for which
dividends are payable on such Dividend Payment Date and the denominator of which
will be 360, multiplying the amount so obtained by $25,000, and rounding the
amount so obtained to the nearest cent.
NOTIFICATION OF DIVIDEND PERIOD
With respect to each Dividend Period that is a Special Dividend Period, the
Fund, at its sole option and to the extent permitted by law, by telephonic and
written notice (a "Request for Special Dividend Period") to the Auction Agent
and to each Broker-Dealer, may request that the next succeeding Dividend Period
for the APS will be a number of days (other than seven), evenly divisible by
seven,
--------------------------------------------------------------------------------
25
DESCRIPTION OF APS
--------------------------------------------------------------------------------
and not fewer than seven nor more than 364 in the case of a Short Term Dividend
Period or one whole year or more but not greater than five years in the case of
a Long Term Dividend Period, specified in such notice, provided that the Fund
may not give a Request for Special Dividend Period of greater than 28 days (and
any such request shall be null and void) unless, for any Auction occurring after
the initial Auction, Sufficient Clearing Bids were made in the last occurring
Auction and unless full cumulative dividends and any amounts due with respect to
redemptions prior to such date have been paid in full. Such Request for Special
Dividend Period, in the case of a Short Term Dividend Period, shall be given on
or prior to the second Business Day but not more than seven Business Days prior
to an Auction Date for the APS and, in the case of a Long Term Dividend Period,
shall be given on or prior to the second Business Day but not more than 28 days
prior to an Auction Date for the APS. Upon receiving such Request for Special
Dividend Period, the Broker-Dealers jointly shall determine whether, given the
factors set forth below, it is advisable that the Fund issue a Notice of Special
Dividend Period as contemplated by such Request for Special Dividend Period and
the Optional Redemption Price of the APS during such Special Dividend Period and
the Specific Redemption Provisions and shall give the Fund and the Auction Agent
written notice (a "Response") of such determination by no later than the second
Business Day prior to such Auction Date. In making such determination, the
Broker-Dealers will consider (i) existing short-term and long-term market rates
and indices of such short-term and long-term rates, (ii) existing market supply
and demand for short-term and long-term securities, (iii) existing yield curves
for short-term and long-term securities comparable to the APS, (iv) industry and
financial conditions which may affect the APS, (v) the investment objective of
the Fund and (vi) the Dividend Periods and dividend rates at which current and
potential beneficial holders of the APS would remain or become beneficial
holders.
If the Broker-Dealers shall not give the Fund and the Auction Agent a Response
by such second Business Day or if the Response states that given the factors set
forth above it is not advisable that the Fund give a Notice of Special Dividend
Period for the APS, the Fund may not give a Notice of Special Dividend Period in
respect of such Request for Special Dividend Period. In the event the Response
indicates that it is advisable that the Fund give a Notice of Special Dividend
Period for the APS, the Fund, by no later than the second Business Day prior to
such Auction Date, may give a notice (a "Notice of Special Dividend Period") to
the Auction Agent, the Securities Depository and each Broker-Dealer, which
notice will specify (i) the duration of the Special Dividend Period, (ii) the
Optional Redemption Price as specified in the related Response and (iii) the
Specific Redemption Provisions, if any, as specified in the related Response.
The Fund also shall provide a copy of such Notice of Special Dividend Period to
Moody's and Fitch. The Fund shall not give a Notice of Special Dividend Period,
and, if such Notice of Special Dividend Period shall have been given already,
shall give telephonic and written notice of its revocation (a "Notice of
Revocation") to the Auction Agent, each Broker-Dealer, and the Securities
Depository on or prior to the Business Day prior to the relevant Auction Date if
(x) either the 1940 Act APS Asset Coverage is not satisfied or the Fund shall
fail to maintain Moody's Eligible Assets or Fitch Eligible Assets with an
aggregate Discounted Value at least equal to the APS Basic Maintenance Amount,
on each of the two Valuation Dates immediately preceding the Business Day prior
to the relevant Auction Date on an actual basis and on a pro forma basis giving
effect to the proposed Special Dividend Period (using as a pro forma dividend
rate with respect to such Special Dividend Period the dividend rate which the
Broker-Dealers shall advise the Fund is an approximately equal rate for
securities similar to the APS with an equal dividend period), (y) sufficient
funds for the payment of dividends payable on the immediately succeeding
Dividend Payment Date have not been irrevocably deposited with the Auction Agent
by the close of business on the third Business Day preceding the related Auction
Date or (z) the Broker-Dealers jointly advise the Fund that, after consideration
of the factors listed above, they have concluded that it is advisable to give a
Notice of Revocation. The Fund also shall provide a copy of such Notice of
Revocation to Moody's and Fitch. If the Fund is prohibited from giving a Notice
of Special Dividend Period as a result of the factors
--------------------------------------------------------------------------------
26
DESCRIPTION OF APS
--------------------------------------------------------------------------------
enumerated in clause (x), (y) or (z) above or if the Fund gives a Notice of
Revocation with respect to a Notice of Special Dividend Period, the next
succeeding Dividend Period for that series will be a 7-Day Dividend Period. In
addition, in the event Sufficient Clearing Bids are not made in any Auction or
an Auction is not held for any reason, the next succeeding Dividend Period will
be a 7-Day Dividend Period, and the Fund may not again give a Notice of Special
Dividend Period (and any such attempted notice shall be null and void) until
Sufficient Clearing Bids have been made in an Auction with respect to a 7-Day
Dividend Period.
DETERMINATION OF DIVIDEND RATE
The dividend rate on the APS during the period from and including the Date of
Original Issue for the APS to but excluding the Initial Dividend Payment Date
for the APS (the "Initial Dividend Period") will be the rate per annum set forth
on the inside cover page hereof. Commencing on the Initial Dividend Payment Date
for the APS, the Applicable Rate on the APS for each Subsequent Dividend Period,
which Subsequent Dividend Period shall be a period commencing on and including a
Dividend Payment Date and ending on and including the calendar day prior to the
next Dividend Payment Date (or last Dividend Payment Date in a Dividend Period
if there is more than one Dividend Payment Date), shall be equal to the rate per
annum that results from the Auction with respect to such Subsequent Dividend
Period. The Initial Dividend Period and Subsequent Dividend Period for the APS
is referred to herein as a "Dividend Period." Cash dividends shall be calculated
as set forth above under "Dividends--General."
NON-PAYMENT PERIOD; LATE CHARGE
A Non-Payment Period will commence if the Fund fails to (i) declare, prior to
the close of business on the second Business Day preceding any Dividend Payment
Date, for payment on or (to the extent permitted as described below) within
three Business Days after such Dividend Payment Date to the persons who held
such shares as of 12:00 noon, New York City time, on the Business Day preceding
such Dividend Payment Date, the full amount of any dividend on the APS payable
on such Dividend Payment Date or (ii) deposit, irrevocably in trust, in same-day
funds, with the Auction Agent by 12:00 noon, New York City time, (A) on such
Dividend Payment Date the full amount of any cash dividend on such shares (if
declared) payable on such Dividend Payment Date or (B) on any redemption date
for the APS called for redemption, the Mandatory Redemption Price per share of
such APS or, in the case of an optional redemption, the Optional Redemption
Price per share. Such Non-Payment Period will consist of the period commencing
on and including the aforementioned Dividend Payment Date or redemption date, as
the case may be, and ending on and including the Business Day on which, by 12:00
noon, New York City time, all unpaid cash dividends and unpaid redemption prices
shall have been so deposited or otherwise shall have been made available to the
applicable holders in same-day funds, provided that a Non-Payment Period for the
APS will not end unless the Fund shall have given at least five days' but no
more than 30 days' written notice of such deposit or availability to the Auction
Agent, the Securities Depository and all holders of the APS of such series.
Notwithstanding the foregoing, the failure by the Fund to deposit funds as
provided for by clauses (ii) (A) or (ii) (B) above within three Business Days
after any Dividend Payment Date or redemption date, as the case may be, in each
case to the extent contemplated below, shall not constitute a "Non-Payment
Period." The Applicable Rate for each Dividend Period for the APS of any series,
commencing during a Non-Payment Period, will be equal to the Non-Payment Period
Rate; and each Dividend Period commencing after the first day of, and during, a
Non-Payment Period shall be a 7-Day Dividend Period. Any dividend on the APS due
on any Dividend Payment Date for such shares (if, prior to the close of business
on the second Business Day preceding such Dividend Payment Date, the Fund has
declared such dividend payable on such Dividend Payment Date to the persons who
held such shares as of 12:00 noon, New York City time, on the Business Day
preceding such Dividend Payment Date) or redemption price with respect to such
shares not paid to such persons when due may be paid to
--------------------------------------------------------------------------------
27
DESCRIPTION OF APS
--------------------------------------------------------------------------------
such persons in the same form of funds by 12:00 noon, New York City time, on any
of the first three Business Days after such Dividend Payment Date or due date,
as the case may be, provided that such amount is accompanied by a late charge
calculated for such period of non-payment at the Non-Payment Period Rate applied
to the amount of such non-payment based on the actual number of days comprising
such period divided by 360. In the case of a willful failure of the Fund to pay
a dividend on a Dividend Payment Date or to redeem any APS on the date set for
such redemption, the preceding sentence shall not apply and the Applicable Rate
for the Dividend Period commencing during the Non-Payment Period resulting from
such failure shall be the Non-Payment Period Rate. For the purposes of the
foregoing, payment to a person in same-day funds on any Business Day at any time
will be considered equivalent to payment to that person in New York Clearing
House (next-day) funds at the same time on the preceding Business Day, and any
payment made after 12:00 noon, New York City time, on any Business Day shall be
considered to have been made instead in the same form of funds and to the same
person before 12:00 noon, New York City time, on the next Business Day.
The Non-Payment Period Rate initially will be 275% of the applicable Reference
Rate, provided that the Board of Trustees of the Fund shall have the authority
to adjust, modify, alter or change from time to time the initial Non-Payment
Period Rate if the Board of Trustees of the Fund determines and Moody's and
Fitch (or any Substitute Rating Agency in lieu of Moody's and Fitch in the event
such party shall not rate the APS) advises the Fund in writing that such
adjustment, modification, alteration or change will not adversely affect its
then-current rating on the APS.
RESTRICTIONS ON DIVIDENDS AND OTHER PAYMENTS
Under the 1940 Act, the Fund may not declare dividends or make other
distributions on Common Shares or purchase any such shares if, at the time of
the declaration, distribution or purchase, as applicable (and after giving
effect thereto), asset coverage (as defined in the 1940 Act) with respect to the
outstanding APS would be less than 200% (or such other percentage as in the
future may be required by law). Under the Code, the Fund must, among other
things, distribute each year at least 90% of the sum of its investment company
taxable income and certain other income in order to maintain its qualification
for tax treatment as a regulated investment company. The foregoing limitations
on dividends, other distributions and purchases in certain circumstances may
impair the Fund's ability to maintain such qualification. See "Taxes."
Upon any failure to pay dividends on the APS for two years or more, the holders
of the APS will acquire certain additional voting rights. See "Voting rights"
below.
For so long as any APS are outstanding, the Fund will not declare, pay or set
apart for payment any dividend or other distribution (other than a dividend or
distribution paid in shares of, or options, warrants or rights to subscribe for
or purchase, Common Shares or other stock, if any, ranking junior to the APS as
to dividends or upon liquidation) in respect of Common Shares or any other stock
of the Fund ranking junior to or on a parity with the APS as to dividends or
upon liquidation, or call for redemption, redeem, purchase or otherwise acquire
for consideration any Common Shares or shares of any other such junior stock
(except by conversion into or exchange for stock of the Fund ranking junior to
APS as to dividends and upon liquidation) or any such parity stock (except by
conversion into or exchange for stock of the Fund ranking junior to or on a
parity with APS as to dividends and upon liquidation), unless (A) immediately
after such transaction, the Fund would have Moody's Eligible Assets and Fitch
Eligible Assets with an aggregate Discounted Value equal to or greater than the
APS Basic Maintenance Amount, and the 1940 Act APS Asset Coverage (see "Rating
agency guidelines and asset coverage" and "Redemption" below) would be
satisfied, (B) full cumulative dividends on the APS due on or prior to the date
of the transaction have been declared and paid or shall have been declared and
sufficient funds for the payment thereof deposited with the Auction
--------------------------------------------------------------------------------
28
DESCRIPTION OF APS
--------------------------------------------------------------------------------
Agent, and (C) the Fund has redeemed the full number of APS required to be
redeemed by any provision for mandatory redemption contained in the Amended
By-Laws.
REDEMPTION
MANDATORY REDEMPTION
The Fund will be required to redeem, out of funds legally available therefor, at
the Mandatory Redemption Price per share, the APS to the extent permitted under
the 1940 Act and Massachusetts law, on a date fixed by the Board of Trustees, if
the Fund fails to maintain Moody's Eligible Assets or Fitch Eligible Assets with
an aggregate Discounted Value equal to or greater than the APS Basic Maintenance
Amount or to satisfy the 1940 Act APS Asset Coverage and such failure is not
cured on or before the APS Basic Maintenance Cure Date or the 1940 Act Cure Date
(herein collectively referred to as a "Cure Date"), as the case may be.
"Mandatory Redemption Price" of APS means $25,000 per share plus an amount equal
to accumulated but unpaid dividends (whether or not earned or declared) to the
date fixed for redemption. Any such redemption will be limited to the lesser
number of APS necessary to restore the Discounted Value or the 1940 Act APS
Asset Coverage, as the case may be, or the maximum number that can be redeemed
with funds legally available under the Declaration of Trust and applicable law.
OPTIONAL REDEMPTION
To the extent permitted under the 1940 Act and under Massachusetts law, upon
giving a Notice of Redemption, as provided below, the Fund, at its option, may
redeem the APS, in whole or in part, out of funds legally available therefor, at
the Optional Redemption Price per share on any Dividend Payment Date; provided
that no APS may be redeemed at the option of the Fund during (a) the Initial
Dividend Period with respect to the APS or (b) a Non-Call Period to which such
share is subject. "Optional Redemption Price" means $25,000 per share of APS
plus an amount equal to accumulated but unpaid dividends (whether or not earned
or declared) to the date fixed for redemption plus any applicable redemption
premium, if any, attributable to the designation of a Premium Call Period. The
Fund has the authority to redeem the APS for any reason and may redeem all or
part of the outstanding APS if it anticipates that the Fund's leveraged capital
structure will result in a lower rate of return to holders of Common Shares for
any significant period of time than that obtainable if the Common Shares were
unleveraged.
Notwithstanding the provisions for redemption described above, no APS shall be
subject to optional redemption (i) unless all dividends in arrears on all
remaining outstanding APS, and all capital shares of the Fund ranking on a
parity with the APS with respect to the payment of dividends or upon
liquidation, have been or are being contemporaneously paid or declared and set
aside for payment and (ii) if redemption thereof would result in the Fund's
failure to maintain Moody's Eligible Assets and Fitch Eligible Assets with an
aggregate Discounted Value equal to or greater than the APS Basic Maintenance
Amount; provided, however, that the foregoing shall not prevent the purchase or
acquisition of all outstanding APS of such series pursuant to a successful
completion of an otherwise lawful purchase or exchange offer made on the same
terms to, and accepted by, holders of all outstanding APS of such series.
LIQUIDATION RIGHTS
Upon any liquidation, dissolution or winding up of the Fund, whether voluntary
or involuntary, the holders of APS will be entitled to receive, out of the
assets of the Fund available for distribution to shareholders, before any
distribution or payment is made upon any Common Shares or any other shares of
beneficial interest of the Fund ranking junior in right of payment upon
liquidation of APS, $25,000 per share together with the amount of any dividends
accumulated but unpaid (whether or not earned or declared) thereon to the date
of distribution, and after such payment the holders of APS will
--------------------------------------------------------------------------------
29
DESCRIPTION OF APS
--------------------------------------------------------------------------------
be entitled to no other payment. If such assets of the Fund shall be
insufficient to make the full liquidation payment on outstanding APS and
liquidation payments on any other outstanding class or series of Preferred
Shares of the Fund ranking on a parity with the APS as to payment upon
liquidation, then such assets will be distributed among the holders of APS and
the holders of shares of such other class or series ratably in proportion to the
respective preferential amounts to which they are entitled. After payment of the
full amount of liquidation distribution to which they are entitled, the holders
of APS will not be entitled to any further participation in any distribution of
assets by the Fund. A consolidation, merger or share exchange of the Fund with
or into any other entity or entities or a sale, whether for cash, shares of
stock, securities or properties, of all or substantially all or any part of the
assets of the Fund shall not be deemed or construed to be a liquidation,
dissolution or winding up of the Fund.
RATING AGENCY GUIDELINES AND ASSET COVERAGE
The Fund will be required to satisfy two separate asset maintenance requirements
under the terms of the Amended By-Laws. These requirements are summarized below.
1940 ACT APS ASSET COVERAGE
The Fund will be required under the Amended By-Laws 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 beneficial interests in the Fund, including the APS (or such other
asset coverage as in the future may be specified in or under the 1940 Act as the
minimum asset coverage for senior securities which are beneficial interests of a
closed-end investment company as a condition of paying dividends on its common
shares) ("1940 Act APS Asset Coverage"). If the Fund fails to maintain 1940 Act
APS Asset Coverage and such failure is not cured as of the last Business Day of
the following month (the "1940 Act Cure Date"), the Fund will be required under
certain circumstances to redeem certain of the APS. See "Redemption" below.
The 1940 Act APS Asset Coverage immediately following the issuance of APS
offered hereby (after giving effect to the deduction of the sales load and
offering expenses for the APS) computed using the Fund's net assets as of June
30, 2003 and assuming the Over-allotment Common Shares and the APS had been
issued as of such date will be as follows:
Value of Fund assets less liabilities
not $2,980,595,496 = 314%
constituting senior securities --------------
---------------------------------------
Senior securities representing $ 950,000,000
indebtedness
plus liquidation value of APS
APS BASIC MAINTENANCE AMOUNT
The Fund intends that, so long as APS are outstanding, the composition of its
portfolio will reflect guidelines established by Moody's and Fitch in connection
with the Fund's receipt of a rating for such shares on or prior to their Date of
Original Issue of at least AAA from Moody's and Fitch. Fitch and Moody's, which
are rating agencies, issue ratings for various securities reflecting the
perceived creditworthiness of such securities. The guidelines described below
have been developed by Fitch and Moody's in connection with issuances of
asset-backed and similar securities, including debt obligations and variable
rate preferred shares, 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 shares will be varied
sufficiently and will be of sufficient quality and amount to justify investment
grade ratings. The guidelines do not have the force of law but have been adopted
by the Fund in order to satisfy current requirements necessary for Moody's and
Fitch to issue the above-described ratings for APS, which ratings generally are
relied upon by institutional investors in purchasing such securities. The
guidelines provide a set of tests for portfolio composition and asset
--------------------------------------------------------------------------------
30
DESCRIPTION OF APS
--------------------------------------------------------------------------------
coverage that supplement (and in some cases are more restrictive than) the
applicable requirements under the 1940 Act.
The Fund intends to maintain a Discounted Value for its portfolio at least equal
to the APS Basic Maintenance Amount. Both Moody's and Fitch have established
guidelines for determining Discounted Value. These guidelines define eligible
portfolio assets ("Moody's Eligible Assets" and "Fitch Eligible Assets"). To the
extent any particular portfolio holding does not satisfy these guidelines, all
or a portion of such holding's value will not be included in the calculation of
Discounted Value of the Fund's portfolio assets. The Moody's and Fitch
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 of the Fund at any time may vary depending upon the rating,
diversification and other characteristics of eligible assets included in the
portfolio, although it is not anticipated in the normal course of business the
value of such assets will exceed 20% of the Fund's total assets. The APS basic
maintenance amount includes the sum of (a) the aggregate liquidation preference
of APS then outstanding and (b) certain accrued and projected payment
obligations of the Fund.
Upon any failure to maintain the required aggregate Discounted Value, the Fund
will seek to alter the composition of its portfolio to retain a Discounted Value
at least equal to the APS Basic Maintenance Amount on or prior to the APS Basic
Maintenance Cure Date, 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, the APS will be subject
to mandatory redemption. See "Description of APS--Redemption." The APS Basic
Maintenance Amount includes the sum of (i) the aggregate liquidation value of
APS then outstanding and (ii) certain accrued and projected payment obligations
of the Fund.
The Fund may, but is not required to, adopt any modifications to these
guidelines that hereafter may be established by Moody's and Fitch. Failure to
adopt any such modifications, however, may result in a change in the ratings
described above or a withdrawal of ratings altogether. In addition, any rating
agency providing a rating for the APS, at any time, may change or withdraw any
such rating. As set forth in the Amended By-Laws, the Fund's Board of Trustees,
without shareholder approval, may modify certain definitions or restrictions
that have been adopted by the Fund pursuant to the rating agency guidelines,
provided the Board of Trustees has obtained written confirmation from Moody's or
Fitch that any such change would not impair the ratings then assigned by Moody's
or Fitch to the APS as applicable.
As recently described by Moody's and Fitch, a preferred shares rating is an
assessment of the capacity and willingness of an issuer to pay preferred shares
obligations. The ratings on the APS are not recommendations to purchase, hold or
sell 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 APS will be able to sell
such shares in an Auction. The ratings are based on current information
furnished to Moody's and Fitch by the Fund and the Adviser and information
obtained from other sources. The ratings may be changed, suspended or withdrawn
as a result of changes in, or the unavailability of, such information. The
Common Shares have not been rated by a rating agency.
A rating agency's guidelines will apply to the Fund's APS only so long as such
agency is rating such shares. The Fund will pay certain fees to each rating
agency that rates the Fund's APS.
VOTING RIGHTS
Except as otherwise indicated in this Prospectus and except as otherwise
required by applicable law, holders of APS of the Fund will be entitled to one
vote per share on each matter submitted to a vote
--------------------------------------------------------------------------------
31
DESCRIPTION OF APS
--------------------------------------------------------------------------------
of shareholders and will vote together with holders of Common Shares and other
Preferred Shares of that Fund as a single class.
In connection with the election of the Fund's Trustees, holders of the APS and
any other Preferred Shares, voting as a separate class, shall be entitled at all
times to elect two of the Fund's Trustees, and the remaining Trustees will be
elected by holders of Common Shares and APS and any other Preferred Shares,
voting together as a single class. In addition, if at any time dividends on
outstanding APS shall be unpaid in an amount equal to at least two full years'
dividends thereon or if at any time holders of any shares of Preferred Shares
are entitled, together with the holders of APS, to elect a majority of the
Trustees of the Fund under the 1940 Act, then the number of Trustees
constituting the Board of Trustees automatically shall be increased by the
smallest number that, when added to the two Trustees elected exclusively by the
holders of APS and any other Preferred Shares as described above, would
constitute a majority of the Board of Trustees as so increased by such smallest
number, and at a special meeting of shareholders which will be called and held
as soon as practicable, and at all subsequent meetings at which Trustees are to
be elected, the holders of the APS and any other Preferred Shares, voting as a
separate class, will be entitled to elect the smallest number of additional
Trustees that, together with the two Trustees which such holders in any event
will be entitled to elect, constitutes a majority of the total number of
Trustees of the Fund as so increased. The terms of office of the persons who are
Trustees at the time of that election will continue. If the Fund thereafter
shall pay, or declare and set apart for payment in full, all dividends payable
on all outstanding APS and any other Preferred Shares for all past Dividend
Periods, the additional voting rights of the holders of APS and any other
Preferred Shares as described above shall cease, and the terms of office of all
of the additional Trustees elected by the holders of APS and any other Preferred
Shares (but not of the Trustees with respect to whose election the holders of
Common Shares were entitled to vote or the two Trustees the holders of APS and
any other Preferred Shares have the right to elect in any event) will terminate
automatically.
The affirmative vote of a majority of the votes entitled to be cast by holders
of outstanding APS and any other Preferred Shares, voting as a separate class,
will be required to (i) authorize, create or issue any class or series of shares
ranking prior to the APS or any other series of Preferred Shares with respect to
the payment of dividends or the distribution of assets on liquidation; provided,
however, that no vote is required to authorize the issuance of another class of
Preferred Shares which are substantially identical in all respects to the APS or
(ii) amend, alter or repeal the provisions of the Declaration of Trust or the
Amended By-Laws, whether by merger, consolidation or otherwise, so as to
adversely affect any of the contract rights expressly set forth in the
Declaration of Trust or the Amended By-Laws of holders of APS or any other
Preferred Shares. To the extent permitted under the 1940 Act, in the event
shares of more than one series of APS are outstanding, the Fund shall not
approve any of the actions set forth in clause (i) or (ii) which adversely
affects the contract rights expressly set forth in the Declaration of Trust of a
holder of shares of a series of APS differently than those of a holder of shares
of any other series of APS without the affirmative vote of at least a majority
of votes entitled to be cast by holders of APS of each series adversely affected
and outstanding at such time (each such adversely affected series voting
separately as a class). The Board of Trustees, however, without shareholder
approval, may amend, alter or repeal any or all of the various rating agency
guidelines described herein in the event the Fund receives confirmation from the
rating agencies that any such amendment, alteration or repeal would not impair
the ratings then assigned to the APS. Unless a higher percentage is provided for
under "Certain provisions in the Declaration of Trust," the affirmative vote of
a majority of the votes entitled to be cast by holders of outstanding APS and
any other Preferred Shares, voting as a separate class, will be required to
approve any plan of reorganization (including bankruptcy proceedings) adversely
affecting such shares or any action requiring a vote of security holders under
Section 13(a) of the 1940 Act including, among other things, changes in the
Fund's investment objective or changes in the investment restrictions described
as
--------------------------------------------------------------------------------
32
DESCRIPTION OF APS
--------------------------------------------------------------------------------
fundamental policies under "Investment objectives and policies." The class vote
of holders of APS and any other Preferred Shares described above in each case
will be in addition to a separate vote of the requisite percentage of Common
Shares and APS and any other Preferred Shares, voting together as a single
class, necessary to authorize the action in question.
The foregoing voting provisions will not apply to the APS if, at or prior to the
time when the act with respect to which such vote otherwise would be required
shall be effected, such shares shall have been (i) redeemed or (ii) called for
redemption and sufficient funds shall have been deposited in trust to effect
such redemption.
The Auctions
GENERAL
Holders of the APS will be entitled to receive cumulative cash dividends on
their shares when, as and if declared by the Board of Trustees of the Fund, out
of the funds legally available therefor, on the Initial Dividend Payment Date
with respect to the Initial Dividend Period and, thereafter, on each Dividend
Payment Date with respect to a Subsequent Dividend Period (generally a period of
seven days subject to certain exceptions set forth under "Description of
APS--Dividends and Dividend Periods--General") at the rate per annum equal to
the Applicable Rate for each such Dividend Period.
The provisions of the Amended By-Laws establishing the terms of the APS offered
hereby will provide that the Applicable Rate for each Dividend Period after the
Initial Dividend Period therefor will be equal to the rate per annum that the
Auction Agent advises has resulted on the Business Day preceding the first day
of such Dividend Period due to implementation of the auction procedures set
forth in the Amended By-Laws (the "Auction Procedures") in which persons
determine to hold or offer to purchase or sell the APS. The Amended Bylaws,
which contain the Auction Procedures, are attached as Appendix B to the Fund's
Statement of Additional Information. Each periodic operation of such procedures
with respect to the APS is referred to hereinafter as an "Auction." If, however,
the Fund should fail to pay or duly provide for the full amount of any dividend
on or the redemption price of the APS called for redemption, the Applicable Rate
for the APS will be determined as set forth under "Description of APS--Dividends
and Dividend Periods--Determination of dividend rate."
AUCTION AGENT AGREEMENT
The Fund will enter into an agreement (the "Auction Agent Agreement") with
Deutsche Bank Trust Company Americas ("Auction Agent" and together with any
successor bank or trust company or other entity entering into a similar
agreement with the Fund, the "Auction Agent"), which provides, among other
things, that the Auction Agent will follow the Auction Procedures for the
purpose of determining the Applicable Rate for the APS. The Fund will pay the
Auction Agent compensation for its services under the Auction Agent Agreement.
The Auction Agent may terminate the Auction Agent Agreement upon notice to the
Fund, which termination may be no earlier than 60 days following delivery of
such notice. If the Auction Agent resigns, the Fund will use its best efforts to
enter into an agreement with a successor Auction Agent containing substantially
the same terms and conditions as the Auction Agent Agreement. The Fund may
terminate the Auction Agent Agreement, provided that prior to such termination
the Fund shall have entered into such an agreement with respect thereto with a
successor Auction Agent.
In addition to serving as the Auction Agent, Auction Agent will be the transfer
agent, registrar, dividend disbursing agent and redemption agent for the APS.
The Auction Agent, however, will serve
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THE AUCTIONS
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merely as the agent of the Fund, acting in accordance with the Fund's
instructions, and will not be responsible for any evaluation or verification of
any matters certified to it.
BROKER-DEALER AGREEMENTS
The Auctions require the participation of one or more broker-dealers. The
Auction Agent will enter into agreements with UBS Securities LLC, Citigroup
Global Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, A.G.
Edwards & Sons, Inc. and Wachovia Capital Markets, LLC with respect to the Fund
and may enter into similar agreements (collectively, the "Broker-Dealer
Agreements") with one or more other broker-dealers (collectively, the
"Broker-Dealers") selected by the Fund, which provide for the participation of
such Broker-Dealers in Auctions. A Broker-Dealer Agreement may be terminated by
the Auction Agent or a Broker-Dealer on five days' notice to the other party,
provided that the Broker-Dealer Agreement with UBS Securities LLC, Citigroup
Global Markets Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated may
not be terminated without the prior written consent of the Fund, which consent
may not be unreasonably withheld.
The Auction Agent after each Auction will pay a service charge from funds
provided by the Fund to each Broker-Dealer on the basis of the purchase price of
APS placed by such Broker-Dealer at such Auction. The service charge (i) for any
7-Day Dividend Period shall be payable at the annual rate of 0.25% of the
purchase price of the APS placed by such Broker-Dealer in any such Auction and
(ii) for any Special Dividend Period shall be determined by mutual consent of
the Fund and any such Broker-Dealer or Broker-Dealers and shall be based upon a
selling concession that would be applicable to an underwriting of fixed or
variable rate preferred shares with a similar final maturity or variable rate
dividend period, respectively, at the commencement of the Dividend Period with
respect to such Auction. For the purposes of the preceding sentence, the APS
will be placed by a Broker-Dealer if such shares were (i) the subject of Hold
Orders deemed to have been made by Beneficial Owners that were acquired by such
Beneficial Owners through such Broker-Dealer or (ii) the subject of the
following Orders submitted by such Broker-Dealer: (A) a Submitted Bid of a
Beneficial Owner that resulted in such Beneficial Owner continuing to hold such
shares as a result of the Auction, (B) a Submitted Bid of a Potential Beneficial
Owner that resulted in such Potential Beneficial Owner purchasing such shares as
a result of the Auction or (C) a Submitted Hold Order.
The Broker-Dealer Agreements provide that a Broker-Dealer may submit Orders in
Auctions for its own account, unless the Fund notifies all Broker-Dealers that
they no longer may do so; provided that Broker-Dealers may continue to submit
Hold Orders and Sell Orders. If a Broker-Dealer submits an Order for its own
account in any Auction of APS, it may have knowledge of Orders placed through it
in that Auction and therefore have an advantage over other Bidders, but such
Broker-Dealer would not have knowledge of Orders submitted by other
Broker-Dealers in that Auction.
SECURITIES DEPOSITORY
The Depository Trust Company initially will act as the Securities Depository for
the Agent Members with respect to the APS. One or more registered certificates
for all of the shares of each series of APS initially will be registered in the
name of Cede & Co., as nominee of the Securities Depository. The certificate
will bear a legend to the effect that such certificate is issued subject to the
provisions restricting transfers of the APS contained in the Amended By-Laws.
Cede & Co. initially will be the holder of record of all APS, and Beneficial
Owners will not be entitled to receive certificates representing their ownership
interest in such shares. The Securities Depository will maintain lists of its
participants and will maintain the positions (ownership interests) of the APS
held by each Agent Member, whether as the Beneficial Owner thereof for its own
account or as nominee for the Beneficial Owner thereof. Payments made by the
Fund to holders of APS will be duly made by making payments to the nominee of
the Securities Depository.
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THE AUCTIONS
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AUCTION PROCEDURES
The following is a brief summary of the procedures to be used in conducting
Auctions. This summary is qualified by reference to the Amended By-Laws set
forth in Appendix B to the Fund's Statement of Additional Information.
AUCTION DATE
An Auction to determine the Applicable Rate for the APS offered hereby for each
Dividend Period for such shares (other than the Initial Dividend Period
therefor) will be held on the last Business Day preceding the first day of such
Dividend Period, which first day is also the Dividend Payment Date for the
preceding Dividend Period (the date of each Auction being referred to herein as
an "Auction Date").
The Auction Date and the first day of the related Dividend Period (both of which
must be Business Days) need not be consecutive calendar days. See "Description
of APS--Dividends and Dividend Periods" for information concerning the
circumstances under which a Dividend Payment Date may fall on a date other than
the days specified above, which may affect the Auction Date.
ORDERS BY BENEFICIAL OWNERS, POTENTIAL BENEFICIAL OWNERS, EXISTING HOLDERS AND
POTENTIAL HOLDERS
On or prior to each Auction Date for a series of APS:
(a) each Beneficial Owner may submit to its Broker-Dealer by telephone
orders ("Orders") with respect to a series of APS as follows:
(i) Hold Order--indicating the number of outstanding APS, if any, that
such Beneficial Owner desires to continue to hold without regard to
the Applicable Rate for the next Dividend Period for such shares;
(ii) Bid--indicating the number of outstanding APS, if any, that such
Beneficial Owner desires to continue to hold, provided that the
Applicable Rate for the next Dividend Period for such shares is
not less than the rate per annum then specified by such Beneficial
Owner; and/or
(iii) Sell Order--indicating the number of outstanding APS, if any, that
such Beneficial Owner offers to sell without regard to the
Applicable Rate for the next Dividend Period for such shares; and
(b) Broker-Dealers will contact customers who are Potential Beneficial
Owners of APS to determine whether such Potential Beneficial Owners
desire to submit Bids indicating the number of APS which they offer to
purchase provided that the Applicable Rate for the next Dividend Period
for such shares is not less than the rates per annum specified in such
Bids.
A Beneficial Owner or a Potential Beneficial Owner placing an Order, including a
Broker-Dealer acting in such capacity for its own account, is hereinafter
referred to as a "Bidder" and collectively as "Bidders." Any Order submitted by
a Beneficial Owner or a Potential Beneficial Owner to its Broker-Dealer, or by a
Broker-Dealer to the Auction Agent, prior to the Submission Deadline on any
Auction Date shall be irrevocable.
In an Auction, a Beneficial Owner may submit different types of Orders with
respect to APS then held by such Beneficial Owner, as well as Bids for
additional APS. For information concerning the priority given to different types
of Orders placed by Beneficial Owners, see "Submission of Orders by Broker-
Dealers to Auction Agent" below.
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THE AUCTIONS
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The Maximum Applicable Rate for the APS will be the Applicable Percentage of the
Reference Rate. The Auction Agent will round each applicable Maximum Applicable
Rate to the nearest one-thousandth (0.001) of one percent per annum, with any
such number ending in five ten-thousandths of one percent being rounded upwards
to the nearest one-thousandth (0.001) of one percent. The Auction Agent will not
round the applicable Reference Rate as part of its calculation of the Maximum
Applicable Rate.
The Maximum Applicable Rate for the APS will depend on the credit rating or
ratings assigned to such shares. The Applicable Percentage will be determined
based on (i) the credit ratings assigned on such date to such shares by Moody's
and Fitch (or if either shall not make such rating available, the equivalent of
such rating by a Substitute Rating Agency), and (ii) whether the Fund has
provided notification to the Auction Agent prior to the Auction establishing the
Applicable Rate for any dividend that net capital gains or other taxable income
will be included in such dividend on the APS as follows:
APPLICABLE PERCENTAGE
FITCH CREDIT RATINGS MOODY'S CREDIT RATINGS OF REFERENCE RATE
-------------------- ---------------------- ---------------------
AA- or higher Aa3 or above 150%
A- to A+ A3 to A1 160
BBB- to BBB+ Baa3 to Baa1 250
Below BBB- Below Baa3 275
There is no minimum Applicable Rate in respect of any Dividend Period.
The Fund will take all reasonable action necessary to enable Moody's and Fitch
to provide a rating for the APS. If Moody's or Fitch shall not make such a
rating available, the Underwriters or their affiliates and successors, after
consultation with the Fund, will select another rating agency (a "Substitute
Rating Agency") to act as a Substitute Rating Agency.
Any Bid by a Beneficial Owner specifying a rate per annum higher than the
Maximum Applicable Rate will be treated as a Sell Order, and any Bid by a
Potential Beneficial Owner specifying a rate per annum higher than the Maximum
Applicable Rate will not be considered. See "Determination of Sufficient
Clearing Bids, Winning Bid Rate and Applicable Rate" and "Acceptance and
rejection of Submitted Bids and Submitted Sell Orders and allocation of Shares."
Neither the Fund nor the Auction Agent will be responsible for a Broker-Dealer's
failure to comply with the foregoing. A Broker-Dealer also may hold APS in its
own account as a Beneficial Owner. A Broker-Dealer thus may submit Orders to the
Auction Agent as a Beneficial Owner or a Potential Beneficial Owner and
therefore participate in an Auction as an Existing Holder or Potential Holder on
behalf of both itself and its customers. Any Order placed with the Auction Agent
by a Broker-Dealer as or on behalf of a Beneficial Owner or a Potential
Beneficial Owner will be treated in the same manner as an Order placed with a
Broker-Dealer by a Beneficial Owner or a Potential Beneficial Owner. Similarly,
any failure by a Broker-Dealer to submit to the Auction Agent an Order in
respect of any APS held by it or its customers who are Beneficial Owners will be
treated in the same manner as a Beneficial Owner's failure to submit to its
Broker-Dealer an Order in respect of APS held by it, as described in the next
paragraph. Inasmuch as a Broker-Dealer participates in an Auction as an Existing
Holder or a Potential Holder only to represent the interests of a Beneficial
Owner or Potential Beneficial Owner, whether it be its customers or itself, all
discussion herein relating to the consequences of an Auction for Existing
Holders and Potential Holders also applies to the underlying beneficial
ownership interests represented thereby. For information concerning the priority
given to different types of Orders placed by Existing Holders, see "Submission
of Orders by Broker-Dealers to Auction Agent." Each purchase or sale in an
Auction will be settled on the Business Day next
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36
THE AUCTIONS
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succeeding the Auction Date at a price per share equal to $25,000. See
"Notification of results; settlement."
If one or more Orders covering in the aggregate all of the outstanding APS held
by a Beneficial Owner are not submitted to the Auction Agent prior to the
Submission Deadline, either because a Broker-Dealer failed to contact such
Beneficial Owner or otherwise, the Auction Agent shall deem a Hold Order (in the
case of an Auction relating to a Dividend Period of 91 days or less) and a Sell
Order (in the case of an Auction relating to a Special Dividend Period of longer
than 91 days) to have been submitted on behalf of such Beneficial Owner covering
the number of outstanding the APS held by such Beneficial Owner and not subject
to Orders submitted to the Auction Agent.
If all of the outstanding APS are subject to Submitted Hold Orders, the Dividend
Period next succeeding the Auction automatically shall be the same length as the
immediately preceding Dividend Period, and the Applicable Rate for the next
Dividend Period for all the APS will be 60% of the Reference Rate on the date of
the applicable Auction.
For the purposes of an Auction, the APS for which the Fund shall have given
notice of redemption and deposited moneys therefor with the Auction Agent in
trust or segregated in an account at the Fund's custodian bank for the benefit
of the Auction Agent, as set forth under "Description of APS--Redemption," will
not be considered as outstanding and will not be included in such Auction.
Pursuant to the Amended By-Laws of the Fund, the Fund will be prohibited from
reissuing and its affiliates (other than the Underwriter) will be prohibited
from transferring (other than to the Fund) any APS they may acquire. Neither the
Fund nor any affiliate of the Fund (other than the Underwriter) may submit an
Order in any Auction, except that an affiliate of the Fund that is a
Broker-Dealer may submit an Order.
SUBMISSION OF ORDERS BY BROKER-DEALERS TO AUCTION AGENT
Prior to 1:30 p.m., New York City time, on each Auction Date, or such other time
on the Auction Date as may be specified by the Auction Agent (the "Submission
Deadline"), each Broker-Dealer will submit to the Auction Agent in writing all
Orders obtained by it for the Auction to be conducted on such Auction Date,
designating itself (unless otherwise permitted by the Fund) as the Existing
Holder or Potential Holder in respect of the APS subject to such Orders. Any
Order submitted by a Beneficial Owner or a Potential Beneficial Owner to its
Broker-Dealer, or by a Broker-Dealer to the Auction Agent, prior to the
Submission Deadline on any Auction Date, shall be irrevocable.
If the rate per annum specified in any Bid contains more than three figures to
the right of the decimal point, the Auction Agent will round such rate per annum
up to the next highest one-thousandth (0.001) of 1%. If one or more Orders of an
Existing Holder are submitted to the Auction Agent and such Orders cover in the
aggregate more than the number of outstanding APS held by such Existing Holder,
such Orders will be considered valid in the following order of priority:
(i) any Hold Order will be considered valid up to and including the number
of outstanding APS held by such Existing Holder, provided that if more
than one Hold Order is submitted by such Existing Holder and the
number of APS subject to such Hold Orders exceeds the number of
outstanding APS held by such Existing Holder, the number of APS
subject to each of such Hold Orders will be reduced pro rata so that
such Hold Orders, in the aggregate, will cover exactly the number of
outstanding APS held by such Existing Holder;
(ii) any Bids will be considered valid, in the ascending order of their
respective rates per annum if more than one Bid is submitted by such
Existing Holder, up to and including the excess of the number of
outstanding APS held by such Existing Holder over the number of
outstanding APS subject to any Hold Order referred to in clause (i)
above (and if more than one Bid submitted by such Existing Holder
specifies the same rate per annum and together they cover
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37
THE AUCTIONS
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more than the remaining number of shares that can be the subject of
valid Bids after application of clause (i) above and of the foregoing
portion of this clause (ii) to any Bid or Bids specifying a lower
rate or rates per annum, the number of shares subject to each of such
Bids will be reduced pro rata so that such Bids, in the aggregate,
cover exactly such remaining number of outstanding shares); and the
number of outstanding shares, if any, subject to Bids not valid under
this clause (ii) shall be treated as the subject of a Bid by a
Potential Holder; and
(iii) any Sell Order will be considered valid up to and including the
excess of the number of outstanding APS held by such Existing Holder
over the sum of the number of APS subject to Hold Orders referred to
in clause (i) above and the number of APS subject to valid Bids by
such Existing Holder referred to in clause (ii) above; provided that,
if more than one Sell Order is submitted by any Existing Holder and
the number of APS subject to such Sell Orders is greater than such
excess, the number of APS subject to each of such Sell Orders will be
reduced pro rata so that such Sell Orders, in the aggregate, will
cover exactly the number of APS equal to such excess.
If more than one Bid of any Potential Holder is submitted in any Auction, each
Bid submitted in such Auction will be considered a separate Bid with the rate
per annum and number of APS therein specified.
DETERMINATION OF SUFFICIENT CLEARING BIDS, WINNING BID RATE AND APPLICABLE RATE
Not earlier than the Submission Deadline for each Auction, the Auction Agent
will assemble all Orders submitted or deemed submitted to it by the
Broker-Dealers (each such "Hold Order," "Bid" or "Sell Order" as submitted or
deemed submitted by a Broker-Dealer hereinafter being referred to as a
"Submitted Hold Order," a "Submitted Bid" or a "Submitted Sell Order," as the
case may be, or as a "Submitted Order") and will determine the excess of the
number of outstanding APS over the number of outstanding APS subject to
Submitted Hold Orders (such excess being referred to as the "Available APS") and
whether Sufficient Clearing Bids have been made in such Auction. Sufficient
Clearing Bids will have been made if the number of outstanding APS that are the
subject of Submitted Bids of Potential Holders with rates per annum not higher
than the Maximum Applicable Rate equals or exceeds the number of outstanding
shares that are the subject of Submitted Sell Orders (including the number of
shares subject to Bids of Existing Holders specifying rates per annum higher
than the Maximum Applicable Rate). If Sufficient Clearing Bids have been made,
the Auction Agent will determine the lowest rate per annum specified in the
Submitted Bids (the "Winning Bid Rate") which would result in the number of
shares subject to Submitted Bids specifying such rate per annum or a lower rate
per annum being at least equal to the available APS. If Sufficient Clearing Bids
have been made, the Winning Bid Rate will be the Applicable Rate for the next
Dividend Period for the APS then outstanding. If Sufficient Clearing Bids have
not been made (other than because all outstanding APS are the subject of
Submitted Hold Orders), the Dividend Period next following the Auction
automatically will be a 7-Day Dividend Period, and the Applicable Rate for such
Dividend Period will be equal to the Maximum Applicable Rate.
If Sufficient Clearing Bids have not been made, Beneficial Owners that have
Submitted Sell Orders will not be able to sell in the Auction all, and may not
be able to sell any, of the APS subject to such Submitted Sell Orders. See
"Acceptance and rejection of Submitted Bids and Submitted Sell Orders and
allocation of Shares." Thus, under some circumstances, Beneficial Owners may not
have liquidity of investment.
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THE AUCTIONS
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ACCEPTANCE AND REJECTION OF SUBMITTED BIDS AND SUBMITTED SELL ORDERS AND
ALLOCATION OF SHARES
Based on the determinations described under "Determination of Sufficient
Clearing Bids, Winning Bid Rate and Applicable Rate" and subject to the
discretion of the Auction Agent to round, the Auction Procedures include a pro
rata allocation of shares for purchase and sale, which may result in an Existing
Holder continuing to hold or selling or a Potential Holder purchasing, a number
of shares of a series of APS that is fewer than the number of shares of such
series specified in its Order. To the extent the allocation procedures have that
result, Broker-Dealers that have designated themselves as Existing Holders or
Potential Holders in respect of customer Orders will be required to make
appropriate pro rata allocations among their respective customers. See the
Fund's Amended By-Laws set forth in Appendix B to the Fund's Statement of
Additional Information.
NOTIFICATION OF RESULTS; SETTLEMENT
The Auction Agent will advise each Broker-Dealer who submitted a Bid or Sell
Order in an Auction whether such Bid or Sell Order was accepted or rejected in
whole or in part and of the Applicable Rate for the next Dividend Period for the
related APS by telephone at approximately 3:00 p.m., New York City time, on the
Auction Date for such Auction. Each such Broker-Dealer that submitted an Order
for the account of a customer then will advise such customer whether such Bid or
Sell Order was accepted or rejected, will confirm purchases and sales with each
customer purchasing or selling APS as a result of the Auction and will advise
each customer purchasing or selling APS to give instructions to its Agent Member
of the Securities Depository to pay the purchase price against delivery of such
shares or to deliver such shares against payment therefor as appropriate.
In accordance with the Securities Depository's normal procedures, on the day
after each Auction Date, the transactions described above will be executed
through the Securities Depository, and the accounts of the respective Agent
Members at the Securities Depository will be debited and credited as necessary
to effect the purchases and sales of APS as determined in such Auction.
Purchasers will make payment through their Agent Members in same-day funds to
the Securities Depository against delivery through their Agent Members; the
Securities Depository will make payment in accordance with its normal
procedures, which now provide for payment in same-day funds. If the procedures
of the Securities Depository applicable to APS shall be changed to provide for
payment in next-day funds, then purchasers may be required to make payment in
next-day funds. If the certificates for the APS are not held by the Securities
Depository or its nominee, payment will be made in same-day funds to the Auction
Agent against delivery of such certificates.
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THE AUCTIONS
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The following is a simplified example of how a typical Auction works. Assume
that the Fund has 1,000 outstanding APS and three current holders. The three
current holders and three potential holders submit orders through Broker-Dealers
at the Auction:
Current Holder A....................... Owns 500 shares, wants to sell Bid order of 2.1% rate for all
all 500 shares if Applicable 500 shares
Rate is less than 2.1%
Current Holder B....................... Owns 300 shares, wants to hold Hold Order--will take the
Applicable Rate
Current Holder C....................... Owns 200 shares, wants to sell Bid order of 1.9% rate for all
all 200 shares if Applicable 200 shares
Rate is less than 1.9%
Potential Holder D..................... Wants to buy 200 shares Places order to buy at or above
2.0%
Potential Holder E..................... Wants to buy 300 shares Places order to buy at or above
1.9%
Potential Holder F..................... Wants to buy 200 shares Places order to buy at or above
2.1%
The lowest dividend rate that will result in all 1,000 APS continuing to be held
is 2.0% (the offer by D). Therefore, the Applicable Rate will be 2.0%. Current
Holders B and C will continue to own their shares. Current Holder A will sell
its shares because A's dividend rate bid was higher than the Applicable Rate.
Potential Holder D will buy 200 shares and Potential Holder E will buy 300
shares because their bid rates were at or below the Applicable Rate. Potential
Holder F will not buy shares because its bid rate was above the Applicable Rate.
SECONDARY MARKET TRADING AND TRANSFER OF APS
The Broker-Dealers may maintain a secondary trading market in the APS outside of
Auctions; however, they have no obligation to do so and there can be no
assurance that a secondary market for the APS will develop or, if it does
develop, that it will provide holders with a liquid trading market (i.e.,
trading will depend on the presence of willing buyers and sellers and the
trading price is subject to variables to be determined at the time of the trade
by the Broker-Dealers). The APS will not be registered on any stock exchange or
on any automated quotation system. An increase in the level of interest rates,
particularly during any Long-Term Dividend Period, likely will have an adverse
effect on the secondary market price of the APS, and a selling shareholder may
sell APS between Auctions at a price per share of less than $25,000.
Taxes
GENERAL
The Fund intends to elect and to qualify for the special tax treatment afforded
regulated investment companies ("RICs") under the Code. As long as the Fund so
qualifies, in any taxable year in which it distributes at least 90% of the sum
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 certain other income the Fund (but not its
shareholders) will not be subject to federal income tax to the extent that it
distributes its investment company taxable income and net capital gain (the
excess of net long-term capital gain over net short-term capital loss). The Fund
intends to distribute substantially all of such income and gain each year.
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40
TAXES
--------------------------------------------------------------------------------
The APS will constitute stock of the Fund, and distributions by the Fund with
respect to its APS (other than distributions in redemption of APS that are
treated as exchanges of stock under Section 302(b) of the Code) thus will
constitute dividends to the extent of that Fund's current and accumulated
earnings and profits as calculated for federal income tax purposes. It is
possible, however, that the Internal Revenue Service (the "IRS") might take a
contrary position, 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. Instead, distributions by the Fund to
holders of APS would constitute interest, whether or not they exceeded the
earnings and profits of the Fund, would be included in full in the income of the
recipient and would be taxed as ordinary income. Kirkpatrick & Lockhart LLP,
counsel to the Fund, believes that such a position, if asserted by the IRS,
would be unlikely to prevail if the issue were properly litigated.
Distributions of any taxable net investment income and net short-term capital
gain will be taxable as ordinary income. Distributions of the Fund's net capital
gain, if any, will be taxable to shareholders as long-term capital gains,
regardless of the length of time they held their shares. Distributions, if any,
in excess of the Fund's earnings and profits will first reduce the adjusted tax
basis of a holder's shares and, after that basis has been reduced to zero, will
constitute capital gains to the shareholder (assuming the shares are held as a
capital asset).
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 inform shareholders of the source and tax status of all
distributions promptly after the close of each calendar year. The IRS has taken
the position that if a RIC has more than one class of shares, it may designate
distributions made to each class in any year as consisting of no more than that
class's proportionate share of particular types of income for that year,
including ordinary income and net capital gain. A class's proportionate share of
a particular type of income for a year is determined according to the percentage
of total dividends paid by the RIC during that year to the class. Accordingly,
the Fund intends to designate a portion of its distributions as capital gain
dividends in compliance with the IRS position.
Although the matter is not free from doubt, due to the absence of direct
regulatory or judicial authority, in the opinion of Kirkpatrick & Lockhart LLP,
counsel to the Fund, under current law the manner in which the Fund intends to
allocate items of ordinary income and net capital gain among the Fund's Common
Shares and APS will be respected for federal income tax purposes. It is possible
that the IRS could disagree with counsel's opinion and attempt to reallocate the
Fund's net capital gain or other taxable income.
If at any time when APS are outstanding the Fund does not meet the asset
coverage requirements of the 1940 Act, the Fund will be required to suspend
distributions to holders of Common Shares until the asset coverage is restored.
See "Description of APS--Dividends and Dividend Periods--Restrictions on
Dividends and other payments." Such a suspension may prevent the Fund from
distributing at least 90% of the sum of its investment company taxable income
and certain other income and may, therefore, jeopardize the Fund's qualification
for taxation as a RIC. Upon any failure to meet the asset coverage requirements
of the 1940 Act, the Fund, in its sole discretion, may redeem APS in order to
maintain or restore the requisite asset coverage and avoid the adverse
consequences to the Fund and its shareholders of failing to qualify for
treatment as a RIC. See "Description of APS--Redemption." There can be no
assurance, however, that any such action would achieve that objective.
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41
TAXES
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Certain of the Fund's investment practices are subject to special Code
provisions that, among other things, may defer the use of certain losses of the
Fund and affect the holding period of securities held by the Fund and the
character of the gains or losses realized by the Fund. These provisions may also
require the Fund to recognize income or gain without receiving cash with which
to make distributions in the amounts necessary to satisfy the requirements for
maintaining RIC status and for avoiding income and excise taxes. The Fund will
monitor its transactions and may make certain tax elections in order to mitigate
the effect of these rules and prevent disqualification of the Fund as a RIC.
Under the recently enacted "Jobs and Growth Tax Relief Reconciliation Act of
2003" (the "Tax Act"), the U.S. federal income tax rate on long-term capital
gains recognized by individuals has been reduced to 15% (or 5% for individuals
in the 10% or 15% tax brackets), and "qualified dividend income" received by
individuals from certain domestic and foreign corporations will also be taxed at
this reduced capital gains tax rate. The reduced long-term capital gains tax
rate will apply to capital gains realized by shareholders who sell common shares
of the Fund that they have held for more than one year. The reduced rates, which
do not apply to short-term capital gains, generally apply to long-term capital
gains from sales or exchanges recognized on or after May 6, 2003 (and to Fund
distributions of such gain), and will cease to apply for taxable years beginning
after December 31, 2008. Distributions from the Fund designated as capital gain
dividends should be eligible for the reduced rate applicable to long-term
capital gains. Ordinary income dividends paid by the Fund would be eligible to
be treated by Fund shareholders as qualified dividend income taxed at the
reduced capital gains rate to the extent that some portion of the Fund's
dividends were attributable to such qualified dividend income received by the
Fund and to the extent that the Fund were to designate such portion as qualified
dividend income. Because the Fund intends to invest primarily in MBS, Senior
Loans and Non-Investment Grade Bonds, however, the Fund does not expect to
receive qualified dividend income and, therefore, ordinary income dividends paid
by the Fund generally are not expected to be eligible for the reduced rates
applicable to qualified dividend income.
SALES OF APS
The sale of APS (including transfers in connection with a redemption or
repurchase of APS) will be a taxable transaction for federal income tax
purposes. A selling shareholder generally will recognize gain or loss equal to
the difference between the amount received and the holder's adjusted tax basis
in the APS. If the APS are held as a capital asset, the gain or loss will be a
capital gain or loss and will be long-term if the APS have been held for more
than one year. Any loss realized on a disposition of APS held for six months or
less will be treated as a long-term, rather than a short-term, capital loss to
the extent of any capital gain distributions received with respect to those APS.
A shareholder's holding period for APS is suspended for any periods during which
the shareholder's risk of loss is diminished as a result of holding one or more
other positions in substantially similar or related property, or through certain
options, sales contracts or short sales. Any loss realized on a sale or exchange
of APS will be disallowed to the extent those APS are replaced by other APS
within a period of 61 days beginning 30 days before and ending 30 days after the
date of disposition of the original APS. In that event, the basis of the
replacement APS will be adjusted to reflect the disallowed loss.
BACKUP WITHHOLDING
The Fund is required to withhold a percentage of all taxable dividends, capital
gain distributions and repurchase proceeds payable to any individuals and
certain other non-corporate shareholders who do not provide the Fund with a
correct taxpayer identification number. Such withholding from taxable dividends
and capital gain distributions is also required for such shareholders who fail
to provide certain certifications or otherwise are subject to backup
withholding. Backup withholding is not an additional tax. Any amounts withheld
from payments made to a shareholder may be refunded or
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42
TAXES
--------------------------------------------------------------------------------
credited against the shareholder's U.S. federal income tax liability, provided
that the required information is furnished to the IRS.
Description of capital structure
The Fund is an unincorporated business trust established under the laws of the
Commonwealth of Massachusetts by an Agreement and Declaration of Trust dated
March 12, 2003 ("Declaration of Trust"). The Declaration of Trust provides that
the Trustees of the Fund may authorize separate classes of shares of beneficial
interest. The Trustees of the Fund have authorized an unlimited number of shares
of beneficial interest stock, par value $0.01 per share, all of which shares
were initially classified as Common Shares. The Declaration of Trust also
authorizes the issuance of an unlimited number of shares of beneficial interest
with preference rights, including Preferred Shares, having a par value of $0.01
per share, in one or more series, with rights as determined by the Board of
Trustees, by action of the Board of Trustees without the approval of the
Shareholders. For a description of the APS, see "Description of APS." The
following table shows the amount of (i) shares authorized, (ii) shares held by
the Fund for its own account and (iii) shares outstanding, for each class of
authorized securities of the Fund as of July 11, 2003.
AMOUNT
OUTSTANDING
(EXCLUSIVE OF
AMOUNT HELD BY AMOUNT HELD BY
FUND FOR ITS OWN FUND FOR ITS OWN
TITLE OF CLASS AMOUNT AUTHORIZED ACCOUNT ACCOUNT)
----------------------------------------------------------------------------------------------------
Common Shares.............................. Unlimited -0- 111,005,000
Auction Preferred Shares
Series A................................. 7,600 -0- -0-
Series B................................. 7,600 -0- -0-
Series C................................. 7,600 -0- -0-
Series D................................. 7,600 -0- -0-
Series E................................. 7,600 -0- -0-
Holders of Common Shares are entitled to share equally in dividends declared by
a Board of Trustees payable to holders of Common Shares and in the net assets of
the Fund available for distribution to holders of Common Shares after payment of
the preferential amounts payable to holders of any outstanding Preferred Shares.
Neither holders of Common Shares nor holders of Preferred Shares have
pre-emptive or conversion rights and Common Shares are not redeemable. Upon
liquidation of the Fund, after paying or adequately providing for the payment of
all liabilities of the Fund and the liquidation preference with respect to any
outstanding Preferred Shares, and upon receipt of such releases, indemnities and
refunding agreements as they deem necessary for their protection, the Trustees
may distribute the remaining assets of the Fund among the holders of the Common
Shares. The Declaration of Trust provides that Shareholders are not liable for
any liabilities of the Fund, requires inclusion of a clause to that effect in
every agreement entered into by the Fund and indemnifies shareholders against
any such liability. Although shareholders of an unincorporated business trust
established under Massachusetts law, in certain limited circumstances, may be
held personally liable for the obligations of the Fund as though they were
general partners, the provisions of the Declaration of Trust described in the
foregoing sentence make the likelihood of such personal liability remote.
Holders of Common Shares are entitled to one vote for each share held and will
vote with the holders of any outstanding APS or other Preferred Shares on each
matter submitted to a vote of holders of Common Shares, except as described
under "Description of APS--Voting rights."
--------------------------------------------------------------------------------
43
DESCRIPTION OF CAPITAL STRUCTURE
--------------------------------------------------------------------------------
Shareholders are entitled to one vote for each share held. The Common Shares,
APS and any other Preferred Shares do not have cumulative voting rights, which
means that the holders of more than 50% of the Common Shares, APS and any other
Preferred Shares voting for the election of Trustees can elect all of the
Trustees standing for election by such holders, and, in such event, the holders
of the remaining Common Shares, APS and any other Preferred Shares will not be
able to elect any of such Trustees.
So long as any APS or any other Preferred Shares are outstanding, holders of
Common Shares will not be entitled to receive any dividends of or other
distributions from the Fund, unless at the time of such declaration, (1) all
accrued dividends on Preferred Shares or accrued interest on borrowings has been
paid and (2) the value of the Fund's total assets (determined after deducting
the amount of such dividend or other distribution), less all liabilities and
indebtedness of the Fund not represented by senior securities, is at least 300%
of the aggregate amount of such securities representing indebtedness and at
least 200% of the aggregate amount of securities representing indebtedness plus
the aggregate liquidation value of the outstanding Preferred Shares (expected to
equal the aggregate original purchase price of the outstanding Preferred Shares
plus redemption premium, if any, together with any accrued and unpaid dividends
thereon, whether or not earned or declared and on a cumulative basis). In
addition to the requirements of the 1940 Act, the Fund is required to comply
with other asset coverage requirements as a condition of the Fund obtaining a
rating of the Preferred Shares from a rating agency. These requirements include
an asset coverage test more stringent than under the 1940 Act. See "Description
of APS--Dividends and Dividend Periods--Restrictions on Dividends and other
payments."
The Fund will send unaudited reports at least semi-annually and audited
financial statements annually to all of its shareholders.
The Common Shares of the Fund commenced trading on the AMEX on May 28, 2003. At
July 11, 2003, the net asset value per share of Common Shares and the closing
price per share of Common Shares on the AMEX were $19.28, and $19.99,
respectively.
PREFERRED SHARES
Under the 1940 Act, the Fund is permitted to have outstanding more than one
series of Preferred Shares as long as no single series has priority over another
series as to the distribution of assets of the Fund or the payment of dividends.
Neither holders of Common Shares nor holders of Preferred Shares have
pre-emptive rights to purchase any APS or any other Preferred Shares that might
be issued. It is anticipated that the net asset value per share of the APS will
equal its original purchase price per share plus accumulated dividends per
share.
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44
--------------------------------------------------------------------------------
Certain provisions of the Declaration of Trust
ANTI-TAKEOVER PROVISIONS IN THE DECLARATION OF TRUST
The Declaration of Trust includes provisions that could have the effect of
limiting the ability of other entities or persons to acquire control of the Fund
or to change the composition of its Board, and could have the effect of
depriving holders of Common Shares of an opportunity to sell their shares at a
premium over prevailing market prices by discouraging a third party from seeking
to obtain control of the Fund. These provisions may have the effect of
discouraging attempts to acquire control of the Fund, which attempts could have
the effect of increasing the expenses of the Fund and interfering with the
normal operation of the Fund. The Board is divided into three classes, with the
term of one class expiring at each annual meeting of holders of Common Shares
and Preferred Shares. At each annual meeting, one class of Trustees is elected
to a three-year term. This provision could delay for up to two years the
replacement of a majority of the Board of Trustees. A Trustee may be removed
from office only for cause by a written instrument signed by the remaining
Trustees or by a vote of the holders of at least two-thirds of the class of
shares of the Fund that elected such Trustee and is entitled to vote on the
matter.
In addition, the Declaration of Trust requires the favorable vote of the holders
of at least 75% of the outstanding shares of each class of the Fund, voting as a
class, then entitled to vote to approve, adopt or authorize certain transactions
with 5%-or-greater holders of a class of shares and their associates, unless the
Board shall by resolution have approved a memorandum of understanding with such
holders, in which case normal voting requirements would be in effect. For
purposes of these provisions, a 5%-or-greater holder of a class of shares (a
"Principal Shareholder") refers to any person who, whether directly or
indirectly and whether alone or together with its affiliates and associates,
beneficially owns 5% or more of the outstanding shares of any class of
beneficial interest of the Fund. The transactions subject to these special
approval requirements are: (i) the merger or consolidation of the Fund or any
subsidiary of the Fund with or into any Principal Shareholder; (ii) the issuance
of any securities of the Fund to any Principal Shareholder for cash; (iii) the
sale, lease or exchange of all or any substantial part of the assets of the Fund
to any Principal Shareholder (except assets having an aggregate fair market
value of less than $1,000,000, aggregating for the purpose of such computation
all assets sold, leased or exchanged in any series of similar transactions
within a twelve-month period); or (iv) the sale, lease or exchange to the Fund
or any subsidiary thereof, in exchange for securities of the Fund, of any assets
of any Principal Shareholder (except assets having an aggregate fair market
value of less than $1,000,000, aggregating for the purposes of such computation
all assets sold, leased or exchanged in any series of similar transactions
within a twelve-month period).
The Board has determined that provisions with respect to the Board and the 75%
voting requirements described above, which voting requirements are greater than
the minimum requirements under Massachusetts law or the 1940 Act, are in the
best interest of holders of Common Shares and Preferred Shares generally.
Reference should be made to the Declaration of Trust on file with the SEC for
the full text of these provisions.
CONVERSION TO OPEN-END FUND
The Fund may be converted to an open-end investment company at any time if
approved by the lesser of (i) two-thirds or more of the Fund's then outstanding
Common Shares and Preferred Shares (if any), each voting separately as a class,
or (ii) more than 50% of the then outstanding Common Shares and Preferred Shares
(if any), voting separately as a class if such conversion is recommended by at
least 75% of the Trustees then in office. If approved in the foregoing manner,
conversion of the Fund could not occur until 90 days after the Shareholders'
meeting at which such conversion was approved and would also require at least 30
days' prior notice to all Shareholders. The composition of the Fund's
--------------------------------------------------------------------------------
45
CERTAIN PROVISIONS OF THE DECLARATION OF TRUST
--------------------------------------------------------------------------------
portfolio likely would prohibit it from complying with regulations of the SEC
applicable to open-end investment companies. Accordingly, conversion likely
would require significant changes in the Fund's investment policies and
liquidation of a substantial portion of its relatively illiquid portfolio.
Conversion of the Fund to an open-end investment company also would require the
redemption of any outstanding Preferred Shares and could require the repayment
of borrowings. The Board believes, however, that the closed-end structure is
desirable, given the Fund's investment objective and policies. Investors should
assume, therefore, that it is unlikely that a Board would vote to convert the
Fund to an open-end investment company.
--------------------------------------------------------------------------------
46
--------------------------------------------------------------------------------
Underwriting
The underwriters named below (the "Underwriters"), acting through UBS Securities
LLC, 299 Park Avenue, New York, New York, Citigroup Global Markets Inc., 388
Greenwich Street, New York, New York and Merrill Lynch, Pierce, Fenner & Smith
Incorporated, 4 World Financial Center, New York, New York as lead managers and
A.G. Edwards & Sons, Inc. and Wachovia Capital Markets, LLC as their
representatives (together with the lead managers, the "Representatives"), have
severally 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 below their respective names. The Underwriters are committed to
purchase and pay for all of the Fund's APS if any are purchased.
UNDERWRITERS NUMBER OF SHARES
------------------------------------------------------------------------------
UBS Securities LLC.......................................... 13,300
Citigroup Global Markets Inc. .............................. 9,500
Merrill Lynch, Pierce, Fenner & Smith
Incorporated................................... 9,500
A.G. Edwards & Sons, Inc. .................................. 3,800
Wachovia Capital Markets, LLC............................... 1,900
----------------
Total.................................................. 38,000
================
The Underwriters have advised the Fund that they propose initially to offer the
APS of the Fund to the public at the public offering price set forth on the
cover page of this Prospectus, and to certain dealers at such price less a
concession not in excess of $137.50 per share. The Underwriters may allow, and
such dealers may reallow, a discount not in excess of $100.00 per share to other
dealers. After the initial public offering, the public offering price,
concession and discount may be changed. Investors must pay for any APS purchased
on or before July 30, 2003.
The Underwriters will act in Auctions as Broker-Dealers as set forth under "The
Auctions--General--Broker-Dealer Agreements" and will be entitled to fees for
services as Broker-Dealers as set forth therein. The Underwriters also may
provide information to be used in ascertaining the Reference Rate.
The Fund anticipates that the Representatives and certain other Underwriters may
from time to time act as brokers and dealers in connection with the execution of
the Fund's portfolio transactions after they have ceased to be principal
underwriters of the Fund under the 1940 Act and, subject to certain conditions,
may act as such brokers while they are principal underwriters.
In connection with this offering, certain of the Underwriters or selected
dealers may distribute prospectuses electronically.
The Fund and the Adviser have agreed to indemnify the Underwriters against
certain liabilities including liabilities under the Securities Act of 1933, as
amended.
Shareholder Servicing Agent, custodian and transfer agent
Pursuant to a shareholder servicing agreement ("Shareholder Servicing
Agreement") between UBS Securities LLC (the "Shareholder Servicing Agent") and
Eaton Vance, the Shareholder Servicing Agent will (i) undertake to make public
information pertaining to the Fund on an ongoing basis and to communicate to
investors and prospective investors the Fund's features and benefits (including
periodic seminars or conference calls, responses to questions from current or
prospective shareholders and specific shareholder contact where appropriate);
(ii) make available to investors and prospective
--------------------------------------------------------------------------------
47
SHAREHOLDER SERVICING AGENT, CUSTODIAN AND TRANSFER AGENT
--------------------------------------------------------------------------------
investors market price, net asset value, yield and other information regarding
the Fund, if reasonably obtainable, for the purpose of maintaining the
visibility of the Fund in the investor community; (iii) at the request of Eaton
Vance, provide certain economic research and statistical information and
reports, if reasonably obtainable, on behalf of the Fund, and consult with
representatives and Trustees of the Fund in connection therewith, which
information and reports shall include: (a) statistical and financial market
information with respect to the Fund's market performance and (b) comparative
information regarding the Fund and other closed-end management investment
companies with respect to (1) the net asset value of their respective shares,
(2) the respective market performance of the Fund and such other companies and
(3) other relevant performance indicators; and (iv) at the request of Eaton
Vance, provide information to and consult with the Board with respect to
applicable modifications to dividend policies or capital structure,
repositioning or restructuring of the Fund, conversion of the Fund to an
open-end management investment company, liquidation or merger; provided,
however, that under the terms of the Shareholder Servicing Agreement, the
Shareholder Servicing Agent is not obligated to render any opinions, valuations
or recommendations of any kind or to perform any such similar services. For
these services, Eaton Vance will pay the Shareholder Servicing Agent a fee
computed weekly and payable quarterly equal on an annual basis up to 0.10% of
the Fund's average weekly gross assets. Under the terms of the Shareholder
Servicing Agreement, the Shareholder Servicing Agent is relieved from liability
to Eaton Vance for any act or omission in the course of its performances under
the Shareholder Servicing Agreement in the absence of gross negligence or
willful misconduct by the Shareholder Servicing Agent. The Shareholder Servicing
Agreement will continue so long as the Advisory Agreement remains in effect
between the Fund and the Adviser or any successor in interest or affiliate of
the Adviser, as and to the extent that such Advisory Agreement is renewed
periodically in accordance with the 1940 Act.
Investors Bank & Trust Company ("IBT"), 200 Clarendon Street, Boston, MA 02116
is the custodian of the Fund and will maintain custody of the securities and
cash of the Fund. IBT maintains the Fund's general ledger and computes net asset
value per share at least weekly. IBT also attends to details in connection with
the sale, exchange, substitution, transfer and other dealings with the Fund's
investments, and receives and disburses all funds. IBT also assists in
preparation of shareholder reports and the electronic filing of such reports
with the SEC.
PFPC Inc., P.O. Box 43027, Providence, RI 02940-3027 is the transfer agent and
dividend disbursing agent of the Fund.
Legal opinions
Certain legal matters in connection with the APS will be passed upon for the
Fund by Kirkpatrick & Lockhart LLP, Boston, Massachusetts, and for the
Underwriters by Skadden, Arps, Slate, Meagher & Flom (Illinois), Chicago,
Illinois and its affiliated entities. Skadden, Arps, Slate, Meagher & Flom
(Illinois) and its affiliated entities may rely as to certain matters of
Massachusetts law on the opinion of Kirkpatrick & Lockhart LLP.
Independent auditors
Deloitte & Touche LLP, Boston, Massachusetts, are the independent auditors for
the Fund and will audit the Fund's financial statements.
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48
--------------------------------------------------------------------------------
Additional information
The Prospectus and the Statement of Additional Information do not contain all of
the information set forth in the Registration Statement that the Fund has filed
with the SEC. The complete Registration Statement may be obtained from the SEC
upon payment of the fee prescribed by its rules and regulations. The Statement
of Additional Information can be obtained without charge by calling
1-800-225-6265.
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 of which this Prospectus forms a part,
each such statement being qualified in all respects by such reference.
--------------------------------------------------------------------------------
49
--------------------------------------------------------------------------------
Table of contents for the
Statement of Additional Information
Additional investment information and restrictions.......... 2
Trustees and officers....................................... 15
Investment advisory and other services...................... 21
Determination of net asset value............................ 23
Portfolio trading........................................... 24
Taxes....................................................... 27
Other information........................................... 29
Independent auditors........................................ 30
Independent auditors' report................................ 31
Financial statements........................................ 32
Appendix A: Ratings of bonds................................ A-1
Appendix B: Amended By-Laws................................. B-1
The Fund's privacy policy
The Fund is committed to ensuring your financial privacy. This notice is being
sent to comply with privacy regulations of the Securities and Exchange
Commission. The Fund has in effect the following policy with respect to
nonpublic personal information about its customers:
- Only such information received from you, through application forms or
otherwise, and information about your Fund transactions will be collected.
- None of such information about you (or former customers) will be disclosed to
anyone, except as permitted by law (which includes disclosure to employees
necessary to service your account).
- Policies and procedures (including physical, electronic and procedural
safeguards) are in place that are designed to protect the confidentiality of
such information.
For more information about the Fund's privacy policies call 1-800-262-1122.
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50
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Glossary
"7-Day Dividend Period" means a Dividend Period consisting of seven days.
"1940 Act" means the Investment Company Act of 1940, as amended from time to
time.
"1940 Act APS Asset Coverage" has the meaning set forth on page 30 of this
Prospectus.
"1940 Act Cure Date" has the meaning set forth on page 30 of this Prospectus.
"Adviser" means Eaton Vance Management.
"Agent Member" means the member of the Securities Depository that will act on
behalf of a Beneficial Owner of one or more APS or on behalf of a Potential
Beneficial Owner.
"Alternate Treasury Bill Rate" on any date means the Interest Equivalent of the
yield as calculated by reference to the arithmetic average of the bid price
quotations of the actively traded Treasury Bill with a maturity most nearly
comparable to the length of the related Dividend Period, as determined by bid
price quotations as of any time on the Business Day immediately preceding such
date, obtained from at least three recognized primary U.S. Government securities
dealers selected by the Auction Agent.
"Amended By-Laws" means the By-laws of the Fund, as amended July 9, 2003,
specifying the powers, preferences and rights of the APS. The Fund's Amended
By-Laws are contained in Appendix B to the Fund's Statement of Additional
Information.
"Applicable Percentage" has the meaning set forth on page 36 of this Prospectus.
"Applicable Rate" means the rate per annum at which cash dividends are payable
on APS for any Dividend Period.
"APS" means the Auction Preferred Shares with a par value of $0.01 per share and
a liquidation preference of $25,000 per share, plus an amount equal to
accumulated but unpaid dividends thereon (whether or not earned or declared), of
the Fund.
"APS Basic Maintenance Amount" has the meaning set forth on pages 30 and 31 of
this Prospectus.
"APS Basic Maintenance Cure Date" has the meaning set forth on page 29 of this
Prospectus.
"Auction" means a periodic operation of the Auction Procedures.
"Auction Agent" means Deutsche Bank Trust Company Americas, unless and until
another commercial bank, trust company or other financial institution appointed
by a resolution of the Board of Trustees of the Fund or a duly authorized
committee thereof enters into an agreement with each to follow the Auction
Procedures for the purpose of determining the Applicable Rate and to act as
transfer agent, registrar, dividend disbursing agent and redemption agent for
the APS.
"Auction Agent Agreement" means the agreement entered into between the Fund and
the Auction Agent which provides, among other things, that the Auction Agent
will follow the Auction Procedures for the purpose of determining the Applicable
Rate.
"Auction Date" has the meaning set forth on page 35 of this Prospectus.
"Auction Procedures" means the procedures for conducting Auctions set forth in
Section 10 of the Fund's Amended By-Laws contained in Appendix B to the Fund's
Statement of Additional Information.
"Available APS" has the meaning specified in Paragraph 10(d)(i) of the Auction
Procedures.
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51
GLOSSARY
--------------------------------------------------------------------------------
"Beneficial Owner" means a customer of a Broker-Dealer who is listed on the
records of that Broker-Dealer (or if applicable, the Auction Agent) as a holder
of APS or a Broker-Dealer that holds APS for its own account.
"Bid" has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
"Bidder" has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
"Board of Trustees" or "Board" means the Board of Trustees of the Fund.
"Broker-Dealer" means any broker-dealer, or other entity permitted by law to
perform the functions required of a Broker-Dealer in the Auction Procedures,
that has been selected by the Fund and has entered into a Broker-Dealer
Agreement with the Auction Agent that remains effective.
"Broker-Dealer Agreement" means an agreement entered into between the Auction
Agent and a Broker-Dealer, including UBS Securities LLC, Citigroup Global
Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, A.G. Edwards &
Sons, Inc. and Wachovia Capital Markets, LLC pursuant to which such
Broker-Dealer agrees to follow the Auction Procedures.
"Business Day" means a day on which the New York Stock Exchange is open for
trading and which is not a Saturday, Sunday or other day on which banks in New
York City are authorized or obligated by law to close.
"Cede & Co." means the nominee of DTC, and in whose name the shares of APS
initially will be registered.
"Code" means the Internal Revenue Code of 1986, as amended.
"Common Shares" means the Common Shares, par value $0.01 per share, of the Fund.
"Date of Original Issue" means, with respect to each APS, the date on which such
share first is issued by the Fund.
"Declaration of Trust" means the Agreement and Declaration of Trust of the Fund.
"Discounted Value" of any asset of each means with respect to a Moody's Eligible
Asset and Fitch Eligible Asset, the quotient of the market value thereof divided
by the applicable Moody's Discount Factor and Fitch Discount Factor.
"Dividend Payment Date" has the meaning set forth on page 25 of this Prospectus.
"Dividend Periods" has the meaning set forth on page 25 of this Prospectus.
"DTC" means The Depository Trust Company.
"Eligible Assets" means Moody's Eligible Assets and Fitch Eligible Assets.
"Existing Holder" means a Broker-Dealer or any such other person as may be
permitted by the Fund that is listed as the holder of record of APS in the
records of the Auction Agent.
"Fitch" means Fitch Ratings or its successors.
"Fitch Eligible Assets" has the meaning set forth on page 31 of this Prospectus.
"Fund" means each Eaton Vance Limited Duration Income Fund, a Massachusetts
business trust that is the issuer of APS.
"Hold Order" has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
"IBT" means Investors Bank & Trust Company, the custodian of the Fund's assets.
--------------------------------------------------------------------------------
52
GLOSSARY
--------------------------------------------------------------------------------
"Initial Dividend Payment Date" has the meaning set forth on the inside cover
page of this Prospectus.
"Initial Dividend Period" means, with respect to the APS, the period from and
including the Date of Original Issue to but excluding the Initial Dividend
Payment Date of the APS.
"IRS" means the Internal Revenue Service.
"Long Term Dividend Period" has the meaning set forth on page 26 of this
Prospectus.
"Mandatory Redemption Price" has the meaning set forth on page 29 of this
Prospectus.
"Marginal Tax Rate" means the maximum marginal federal income tax rate
applicable to an individual's or a corporation's ordinary income, whichever is
greater.
"Maximum Applicable Rate" has the meaning specified under "The Auction--Orders
by Beneficial Owners, Potential Beneficial Owners, Existing Holders and
Potential Holders" in this Prospectus.
"Moody's" means Moody's Investors Service, Inc. or its successors.
"Moody's Eligible Assets" has the meaning set forth on page 31 of this
Prospectus.
"Non-Call Period" has the meaning set forth under "Specific Redemption
Provisions" below.
"Non-Payment Period" has the meaning set forth on page 27 of this Prospectus.
"Non-Payment Period Rate" has the meaning set forth on page 28 of this
Prospectus.
"Notice of Revocation" has the meaning set forth on page 26 of this Prospectus.
"Notice of Special Dividend Period" has the meaning set forth on page 26 of this
Prospectus.
"Optional Redemption Price" has the meaning set forth on page 29 of this
Prospectus.
"Order" has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
"Potential Beneficial Owner" means a customer of a Broker-Dealer or a
Broker-Dealer that is not a Beneficial Owner of APS but that wishes to purchase
such shares, or that is a Beneficial Owner that wishes to purchase additional
APS.
"Potential Holder" means any Broker-Dealer or any such other person as may be
permitted by the Fund, including any Existing Holder, who may be interested in
acquiring APS (or, in the case of an Existing Holder, additional APS).
"Preferred Shares" means preferred shares of beneficial interest, par value
$0.01 per share, of the Fund.
"Premium Call Period" has the meaning set forth under "Specific Redemption
Provisions" below.
"Reference Rate" means, with respect to a Dividend Period, the applicable "AA"
Composite Commercial Paper Rate.
"Request for Special Dividend Period" has the meaning set forth on page 25 of
this Prospectus.
"Response" has the meaning set forth on page 26 of this Prospectus.
"S&P" means Standard & Poor's, or its successors.
"Securities Depository" means The Depository Trust Company and its successors
and assigns or any successor securities depository selected by the Fund that
agrees to follow the procedures required to be followed by such securities
depository in connection with the APS.
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53
GLOSSARY
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"Sell Order" has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
"Short Term Dividend Period" has the meaning set forth on page 26 of this
Prospectus.
"Special Dividend Period" has the meaning set forth on page 19 of this
Prospectus.
"Specific Redemption Provisions" means, with respect to a Special Dividend
Period, either, or any combination of, (i) a period (a "Non-Call Period")
determined by the Board of Trustees of the Fund, after consultation with the
Auction Agent and the Broker-Dealers, during which the APS subject to such
Dividend Period shall not be subject to redemption at the option of the Fund and
(ii) a period (a "Premium Call Period"), consisting of a number of whole years
and determined by the Board of Trustees of the Fund, after consultation with the
Auction Agent and the Broker-Dealers, during each year of which the APS subject
to such Dividend Period shall be redeemable at the Fund's option at a price per
share equal to $25,000 plus accumulated but unpaid dividends plus a premium
expressed as a percentage of $25,000, as determined by the Board of Trustees of
the Fund after consultation with the Auction Agent and the Broker-Dealers.
"Submission Deadline" has the meaning specified in Subsection 10(a)(x) of the
Auction Procedures.
"Submitted Bid" has the meaning specified in Subsection 10(d)(i) of the Auction
Procedures.
"Submitted Hold Order" has the meaning specified in Subsection 10(d)(i) of the
Auction Procedures.
"Submitted Order" has the meaning specified in Subsection 10(d)(i) of the
Auction Procedures.
"Submitted Sell Order" has the meaning specified in Subsection 10(d)(i) of the
Auction Procedures.
"Subsequent Dividend Period" means each Dividend Period after the Initial
Dividend Period.
"Substitute Rating Agency" and "Substitute Rating Agencies" shall mean a
nationally recognized statistical rating organization or two nationally
recognized statistical rating organizations, respectively, selected by UBS
Securities LLC, or its respective affiliates and successors, after consultation
with the Fund, to act as a substitute rating agency or substitute rating
agencies, as the case may be, to determine the credit ratings of the APS.
"Sufficient Clearing Bids" has the meaning specified in Subsection 10(d)(i) of
the Auction Procedures.
"U.S. Treasury Bill Rate" on any date means (i) the Interest Equivalent of the
rate on the actively traded Treasury Bill with a maturity most nearly comparable
to the length of the related Dividend Period, as such rate is made available on
a discount basis or otherwise by the Federal Reserve Bank of New York in its
Composite 3:30 p.m. Quotations for U.S. Government Securities report for such
Business Day, or (ii) if such yield as so calculated is not available, the
Alternate Treasury Bill Rate on such date.
"U.S. Treasury Note Rate" on any date means (i) the yield as calculated by
reference to the bid price quotation of the actively traded, current coupon
Treasury Note with a maturity most nearly comparable to the length of the
related Dividend Period, as such bid price quotation is published on the
Business Day immediately preceding such date by the Federal Reserve Bank of New
York in its Composite 3:30 p.m. Quotations for U.S. Government Securities report
for such Business Day, or (ii) if such yield as so calculated is not available,
the Alternate Treasury Note Rate on such date. "Alternate Treasury Note Rate" on
any date means the yield as calculated by reference to the arithmetic average of
the bid price quotations of the actively traded, current coupon Treasury Note
with a maturity most nearly comparable to the length of the related Dividend
Period, as determined by the bid price quotations as of any time on the Business
Day immediately preceding such date, obtained from at least three recognized
primary U.S. Government securities dealers selected by the Auction Agent.
"Valuation Date" means, for purposes of determining whether the Fund is
maintaining the APS Basic Maintenance Amount, each Business Day commencing with
July 30, 2003.
"Winning Bid Rate" has the meaning specified in Subsection 10(d)(i) of the
Auction Procedures.
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54
[EATON VANCE LOGO]
STATEMENT OF ADDITIONAL INFORMATION July 25, 2003
--------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
JULY 25, 2003
EATON VANCE LIMITED DURATION INCOME FUND
THE EATON VANCE BUILDING
255 STATE STREET
BOSTON, MASSACHUSETTS 02109
(800) 225-6265
TABLE OF CONTENTS
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PAGE
----
Additional investment information and restrictions.......... 2
Trustees and officers....................................... 15
Investment advisory and other services...................... 21
Determination of net asset value............................ 23
Portfolio trading........................................... 24
Taxes....................................................... 27
Other information........................................... 29
Independent auditors........................................ 30
Independent auditors' report................................ 31
Financial statements........................................ 32
Appendix A: Ratings......................................... A-1
Appendix B: Amended By-Laws................................. B-1
THIS STATEMENT OF ADDITIONAL INFORMATION ("SAI") IS NOT A PROSPECTUS AND IS
AUTHORIZED FOR DISTRIBUTION TO PROSPECTIVE INVESTORS ONLY IF PRECEDED OR
ACCOMPANIED BY THE PROSPECTUS OF EATON VANCE LIMITED DURATION INCOME FUND (THE
"FUND") DATED JULY 25, 2003, AS SUPPLEMENTED FROM TIME TO TIME, WHICH IS
INCORPORATED HEREIN BY REFERENCE. THIS SAI SHOULD BE READ IN CONJUNCTION WITH
SUCH PROSPECTUS, A COPY OF WHICH MAY BE OBTAINED WITHOUT CHARGE BY CONTACTING
YOUR FINANCIAL INTERMEDIARY OR CALLING THE FUND AT 1-800-225-6265.
Capitalized terms used in this SAI and not otherwise defined have the meanings
given them in the Fund's Prospectus.
Additional investment information and restrictions
Primary investment strategies are described in the Prospectus. The following is
a description of the various investment policies that may be engaged in, whether
as a primary or secondary strategy, and a summary of certain attendant risks.
Eaton Vance may not buy any of the following instruments or use any of the
following techniques unless it believes that doing so will help to achieve the
Fund's investment objectives.
MORTGAGE-BACKED SECURITIES
GENERAL
The Fund's investments in mortgage-backed securities may include conventional
mortgage pass-through securities, floating rate mortgage-backed securities and
certain classes of multiple class CMOs (as described below). Mortgage-backed
securities differ from bonds in that the principal is paid back by the borrower
over the length of the loan rather than returned in a lump sum at maturity.
Government National Mortgage Association ("GNMA") Certificates and Federal
National Mortgage Association ("FNMA") Mortgage-Backed Certificates are
mortgage-backed securities representing part ownership of a pool of mortgage
loans. GNMA loans -- issued by lenders such as mortgage bankers, commercial
banks and savings and loan associations -- are either insured by the Federal
Housing Administration or guaranteed by the Veterans Administration. A "pool" or
group of such mortgages is assembled and, after being approved by GNMA, is
offered to investors through securities dealers. Once such pool is approved by
GNMA, the timely payment of interest and principal on the Certificates issued
representing such pool is guaranteed by the full faith and credit of the U.S.
Government. FNMA, a federally chartered corporation owned entirely by private
stockholders, purchases both conventional and federally insured or guaranteed
residential mortgages from various entities, including savings and loan
associations, savings banks, commercial banks, credit unions and mortgage
bankers, and packages pools of such mortgages in the form of pass-through
securities generally called FNMA Mortgage-Backed Certificates, which are
guaranteed as to timely payment of principal and interest by FNMA but are not
backed by the full faith and credit of the U.S. Government. GNMA Certificates
and FNMA Mortgage-Backed Certificates are called "pass-through" securities
because a pro rata share of both regular interest and principal payments, as
well as unscheduled early prepayments, on the underlying mortgage pool is passed
through monthly to the holder of the Certificate (i.e., the Fund). The Fund may
purchase GNMA Certificates, FNMA Mortgage-Backed Certificates and various other
mortgage-backed securities on a when-issued basis subject to certain limitations
and requirements.
The Federal Home Loan Mortgage Corporation ("FHLMC"), a corporate
instrumentality of the U.S. Government created by Congress for the purposes of
increasing the availability of mortgage credit for residential housing, issues
participation certificates ("PCs") representing undivided interest in FHLMC'S
mortgage portfolio. While FHLMC guarantees the timely payment of interest and
ultimate collection of the principal of its PCs, its PCs are not backed by the
full faith and credit of the U.S. Government. FHLMC PCs differ from GNMA
Certificates in that the mortgages underlying the PCs are monthly "conventional"
mortgages rather than mortgages insured or guaranteed by a federal agency or
instrumentality. However, in several other respects, such as the monthly
pass-through of interest and principal (including unscheduled prepayments) and
the unpredictability of future unscheduled prepayments on the underlying
mortgage pools, FHLMC PCs are similar to GNMA Certificates.
While it is not possible to accurately predict the life of a particular issue of
a mortgage-backed "pass-through" security held by the Fund, the actual life of
any such security is likely to be substantially less than the average final
maturities of the mortgage loans underlying the security. This is because
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ADDITIONAL INVESTMENT INFORMATION AND RESTRICTIONS
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unscheduled early prepayments of principal on the security owned by the Fund
will result from the prepayment, refinancings or foreclosure of the underlying
mortgage loans in the mortgage pool. The Fund, when the monthly payments (which
may include unscheduled prepayments) on such a security are passed through to
it, may be able to reinvest them only at a lower rate of interest. Because of
the regular scheduled payments of principal and the early unscheduled
prepayments of principal, the mortgage-backed "pass-through" security is less
effective than other types of obligations as a means of "locking-in" attractive
long-term interest rates. As a result, this type of security may have less
potential for capital appreciation during periods of declining interest rates
than other U.S. Government securities of comparable maturities, although many
issues of mortgage-backed "pass-through" securities may have a comparable risk
of decline in market value during periods of rising interest rates. If such a
security has been purchased by the Fund at a premium above its par value, both a
scheduled payment of principal and an unscheduled prepayment of principal, which
would be made at par, will accelerate the realization of a loss equal to that
portion of the premium applicable to the payment or prepayment. If such a
security has been purchased by the Fund at a discount from its par value, both a
scheduled payment of principal and an unscheduled prepayment of principal will
increase current returns and will accelerate the recognition of income, which,
when distributed to Fund shareholders, will be taxable as ordinary income.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS")
The CMO classes in which the Fund may invest include sequential and parallel pay
CMOs, including planned amortization class and target amortization class
securities. CMOs are debt securities issued by the FHLMC and by financial
institutions and other mortgage lenders which are generally fully collateralized
by a pool of mortgages held under an indenture. The key feature of the CMO
structure is the prioritization of the cash flows from a pool of mortgages among
the several classes of CMO holders, thereby creating a series of obligations
with varying rates and maturities appealing to a wide range of investors. CMOs
generally are secured by an assignment to a trustee under the indenture pursuant
to which the bonds are issued of collateral consisting of a pool of mortgages.
Payments with respect to the underlying mortgages generally are made to the
trustee under the indenture. Payments of principal and interest on the
underlying mortgages are not passed through to the holders of the CMOs as such
(that is, the character of payments of principal and interest is not passed
through and therefore payments to holders of CMOs attributable to interest paid
and principal repaid on the underlying mortgages do not necessarily constitute
income and return of capital, respectively, to such holders), but such payments
are dedicated to payment of interest on and repayment of principal of the CMOs.
CMOs are issued in two or more classes or series with varying maturities and
stated rates of interest determined by the issuer. Senior CMO classes will
typically have priority over residual CMO classes as to the receipt of principal
and/or interest payments on the underlying mortgages. Because the interest and
principal payments on the underlying mortgages are not passed through to holders
of CMOs, CMOs of varying maturities may be secured by the same pool of
mortgages, the payments on which are used to pay interest to each class and to
retire successive maturities in sequence. CMOs are designed to be retired as the
underlying mortgages are repaid. In the event of sufficient early prepayments on
such mortgages, the class or series of CMO first to mature generally will be
retired prior to maturity. Therefore, although in most cases the issuer of CMOs
will not supply additional collateral in the event of such prepayments, there
will be sufficient collateral to secure CMOs that remain outstanding. Currently,
the Adviser will consider privately issued CMOs or other mortgage-backed
securities as possible investments for the Fund only when the mortgage
collateral is insured, guaranteed or otherwise backed by the U.S. Government or
one or more of its agencies or instrumentalities (e.g., insured by the Federal
Housing Administration or Farmers Home Administration or guaranteed by the
Administrator of Veterans Affairs or consisting in whole or in part of U.S.
Government securities).
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ADDITIONAL INVESTMENT INFORMATION AND RESTRICTIONS
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RISKS OF CERTAIN MORTGAGE-BACKED AND INDEXED SECURITIES
Although not mortgage-backed securities, index amortizing notes and other
callable securities are subject to extension risk resulting from the issuer's
failure to exercise its option to call or redeem the notes before their stated
maturity date. The residual classes of CMOs are subject to both prepayment and
extension risk.
Other types of floating rate derivative debt securities present more complex
types of interest rate risks. For example, range floaters are subject to the
risk that the coupon will be reduced to below market rates if a designated
interest rate floats outside of a specified interest rate band or collar. Dual
index or yield curve floaters are subject to depreciation in the event of an
unfavorable change in the spread between two designated interest rates. The
market values of currency-linked securities may be very volatile and may decline
during periods of unstable currency exchange rates.
SENIOR LOANS
STRUCTURE OF SENIOR LOANS
A Senior Loan is typically originated, negotiated and structured by a U.S. or
foreign commercial bank, insurance company, finance company or other financial
institution (the "Agent") for a group of loan investors ("Loan Investors"). The
Agent typically administers and enforces the Senior Loan on behalf of the other
Loan Investors in the syndicate. In addition, an institution, typically but not
always the Agent, holds any collateral on behalf of the Loan Investors.
Senior Loans primarily include senior floating rate loans to corporations and
secondarily institutionally traded senior floating rate debt obligations issued
by an asset-backed pool, and interests therein. Loan interests primarily take
the form of assignments purchased in the primary or secondary market. Loan
interests may also take the form of participation interests in a Senior Loan.
Such loan interests may be acquired from U.S. or foreign commercial banks,
insurance companies, finance companies or other financial institutions who have
made loans or are Loan Investors or from other investors in loan interests.
The Fund typically purchases "Assignments" from the Agent or other Loan
Investors. The purchaser of an Assignment typically succeeds to all the rights
and obligations under the Loan Agreement of the assigning Loan Investor and
becomes a Loan Investor under the Loan Agreement with the same rights and
obligations as the assigning Loan Investor. Assignments may, however, be
arranged through private negotiations between potential assignees and potential
assignors, and the rights and obligations acquired by the purchaser of an
Assignment may differ from, and be more limited than, those held by the
assigning Loan Investor.
The Fund also may invest in "Participations." Participations by the Fund in a
Loan Investor's portion of a Senior Loan typically will result in the Fund
having a contractual relationship only with such Loan Investor, not with the
Borrower. As a result, the Fund may have the right to receive payments of
principal, interest and any fees to which it is entitled only from the Loan
Investor selling the Participation and only upon receipt by such Loan Investor
of such payments from the Borrower. In connection with purchasing
Participations, the Fund generally will have no right to enforce compliance by
the Borrower with the terms of the loan agreement, nor any rights with respect
to any funds acquired by other Loan Investors through set-off against the
Borrower and the Fund may not directly benefit from the collateral supporting
the Senior Loan in which it has purchased the Participation. As a result, the
Fund may assume the credit risk of both the Borrower and the Loan Investor
selling the Participation. In the event of the insolvency of the Loan Investor
selling a Participation, the Fund may be treated as a general creditor of such
Loan Investor. The selling Loan Investors and other persons interpositioned
between such Loan Investors and the Fund with respect to such Participations
will likely conduct their principal business activities in the banking, finance
and financial services industries. Persons engaged in such industries may be
more susceptible to, among other things, fluctuations in interest rates, changes
in the Federal Open Market Committee's monetary policy, governmental
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ADDITIONAL INVESTMENT INFORMATION AND RESTRICTIONS
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regulations concerning such industries and concerning capital raising activities
generally and fluctuations in the financial markets generally.
The Fund will only acquire Participations if the Loan Investor selling the
Participation, and any other persons interpositioned between the Fund and the
Loan Investor, at the time of investment has outstanding debt or deposit
obligations rated investment grade (BBB or A-3 or higher by Standard & Poor's
Ratings Group ("S&P") or Baa or P-3 or higher by Moody's Investors Service, Inc.
("Moody's") or comparably rated by another nationally recognized rating agency)
or determined by the Adviser to be of comparable quality. Securities rated Baa
by Moody's have speculative characteristics. Long-term debt rated BBB by S&P is
regarded by S&P as having adequate capacity to pay interest and repay principal
and debt rated Baa by Moody's is regarded by Moody's as a medium grade
obligation, i.e., it is neither highly protected nor poorly secured. Commercial
paper rated A-3 by S&P indicates that S&P believes such obligations exhibit
adequate protection parameters but that adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity of the obligor to
meet its financial commitment on the obligation and issues of commercial paper
rated P-3 by Moody's are considered by Moody's to have an acceptable ability for
repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Indebtedness of
companies whose creditworthiness is poor involves substantially greater risks,
and may be highly speculative. Some companies may never pay off their
indebtedness, or may pay only a small fraction of the amount owed. Consequently,
when investing in indebtedness of companies with poor credit, the Fund bears a
substantial risk of losing the entire amount invested.
LOAN COLLATERAL
In order to borrow money pursuant to a Senior Loan, a Borrower will frequently,
for the term of the Senior Loan, pledge collateral, including but not limited
to, (i) working capital assets, such as accounts receivable and inventory; (ii)
tangible fixed assets, such as real property, buildings and equipment; (iii)
intangible assets, such as trademarks and patent rights (but excluding
goodwill); and (iv) security interests in shares of stock of subsidiaries or
affiliates. In the case of Senior Loans made to non-public companies, the
company's shareholders or owners may provide collateral in the form of secured
guarantees and/or security interests in assets that they own. In many instances,
a Senior Loan may be secured only by stock in the Borrower or its subsidiaries.
Collateral may consist of assets that may not be readily liquidated, and there
is no assurance that the liquidation of such assets would satisfy fully a
Borrower's obligations under a Senior Loan.
CERTAIN FEES PAID TO THE FUND
In the process of buying, selling and holding Senior Loans, the Fund may receive
and/or pay certain fees. These fees are in addition to interest payments
received and may include facility fees, commitment fees, amendment fees,
commissions and prepayment penalty fees. When the Fund buys a Senior Loan it may
receive a facility fee and when it sells a Senior Loan it may pay a facility
fee. On an ongoing basis, the Fund may receive a commitment fee based on the
undrawn portion of the underlying line of credit portion of a Senior Loan. In
certain circumstances, the Fund may receive a prepayment penalty fee upon the
prepayment of a Senior Loan by a Borrower. Other fees received by the Fund may
include covenant waiver fees and covenant modification fees.
BORROWER COVENANTS
A Borrower must comply with various restrictive covenants contained in a loan
agreement or note purchase agreement between the Borrower and the holders of the
Senior Loan (the "Loan Agreement"). Such covenants, in addition to requiring the
scheduled payment of interest and principal, may include restrictions on
dividend payments and other distributions to stockholders, provisions requiring
the Borrower to maintain specific minimum financial ratios, and limits on total
debt. In addition, the Loan Agreement may contain a covenant requiring the
Borrower to prepay the Loan with any free cash flow. Free cash flow is generally
defined as net cash flow after scheduled debt service
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ADDITIONAL INVESTMENT INFORMATION AND RESTRICTIONS
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payments and permitted capital expenditures, and includes the proceeds from
asset dispositions or sales of securities. A breach of a covenant which is not
waived by the Agent, or by the Loan Investors directly, as the case may be, is
normally an event of acceleration; i.e., the Agent, or the Loan Investors
directly, as the case may be, has the right to call the outstanding Senior Loan.
The typical practice of an Agent or a Loan Investor in relying exclusively or
primarily on reports from the Borrower to monitor the Borrower's compliance with
covenants may involve a risk of fraud by the Borrower. In the case of a Senior
Loan in the form of a Participation, the agreement between the buyer and seller
may limit the rights of the holder to vote on certain changes which may be made
to the Loan Agreement, such as waiving a breach of a covenant. However, the
holder of the Participation will, in almost all cases, have the right to vote on
certain fundamental issues such as changes in principal amount, payment dates
and interest rate.
ADMINISTRATION OF LOANS
In a typical Senior Loan the Agent administers the terms of the Loan Agreement.
In such cases, the Agent is normally responsible for the collection of principal
and interest payments from the Borrower and the apportionment of these payments
to the credit of all institutions which are parties to the Loan Agreement. The
Fund will generally rely upon the Agent or an intermediate participant to
receive and forward to the Fund its portion of the principal and interest
payments on the Senior Loan. Furthermore, unless under the terms of a
Participation Agreement the Fund has direct recourse against the Borrower, the
Fund will rely on the Agent and the other Loan Investors to use appropriate
credit remedies against the Borrower. The Agent is typically responsible for
monitoring compliance with covenants contained in the Loan Agreement based upon
reports prepared by the Borrower. The seller of the Senior Loan usually does,
but is often not obligated to, notify holders of Senior Loans of any failures of
compliance. The Agent may monitor the value of the collateral and, if the value
of the collateral declines, may accelerate the Senior Loan, may give the
Borrower an opportunity to provide additional collateral or may seek other
protection for the benefit of the participants in the Senior Loan. The Agent is
compensated by the Borrower for providing these services under a Loan Agreement,
and such compensation may include special fees paid upon structuring and funding
the Senior Loan and other fees paid on a continuing basis. With respect to
Senior Loans for which the Agent does not perform such administrative and
enforcement functions, the Fund will perform such tasks on its own behalf,
although a collateral bank will typically hold any collateral on behalf of the
Fund and the other Loan Investors pursuant to the applicable Loan Agreement.
A financial institution's appointment as Agent may usually be terminated in the
event that it fails to observe the requisite standard of care or becomes
insolvent, enters Federal Deposit Insurance Corporation ("FDIC") receivership,
or, if not FDIC insured, enters into bankruptcy proceedings. A successor Agent
would generally be appointed to replace the terminated Agent, and assets held by
the Agent under the Loan Agreement should remain available to holders of Senior
Loans. However, if assets held by the Agent for the benefit of the Fund were
determined to be subject to the claims of the Agent's general creditors, the
Fund might incur certain costs and delays in realizing payment on a Senior Loan,
or suffer a loss of principal and/or interest. In situations involving
intermediate participants similar risks may arise.
PREPAYMENTS
Senior Loans will usually require, in addition to scheduled payments of interest
and principal, the prepayment of the Senior Loan from free cash flow, as defined
above. The degree to which Borrowers prepay Senior Loans, whether as a
contractual requirement or at their election, may be affected by general
business conditions, the financial condition of the Borrower and competitive
conditions among Loan Investors, among others. As such, prepayments cannot be
predicted with accuracy. Upon a prepayment, either in part or in full, the
actual outstanding debt on which the Fund derives interest income will be
reduced. However, the Fund may receive both a prepayment penalty fee from the
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ADDITIONAL INVESTMENT INFORMATION AND RESTRICTIONS
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prepaying Borrower and a facility fee upon the purchase of a new Senior Loan
with the proceeds from the prepayment of the former. Prepayments generally will
not materially affect the Fund's performance because the Fund typically is able
to reinvest prepayments in other Senior Loans that have similar yields and
because receipt of such fees may mitigate any adverse impact on the Fund's
yield.
OTHER INFORMATION REGARDING SENIOR LOANS
From time to time the Adviser and its affiliates may borrow money from various
banks in connection with their business activities. Such banks may also sell
interests in Senior Loans to or acquire them from the Fund or may be
intermediate participants with respect to Senior Loans in which the Fund owns
interests. Such banks may also act as Agents for Senior Loans held by the Fund.
The Fund may acquire interests in Senior Loans which are designed to provide
temporary or "bridge" financing to a Borrower pending the sale of identified
assets or the arrangement of longer-term loans or the issuance and sale of debt
obligations. The Fund may also invest in Senior Loans of Borrowers that have
obtained bridge loans from other parties. A Borrower's use of bridge loans
involves a risk that the Borrower may be unable to locate permanent financing to
replace the bridge loan, which may impair the Borrower's perceived
creditworthiness.
The Fund will be subject to the risk that collateral securing a loan will
decline in value or have no value. Such a decline, whether as a result of
bankruptcy proceedings or otherwise, could cause the Senior Loan to be
undercollateralized or unsecured. In most credit agreements there is no formal
requirement to pledge additional collateral. In addition, the Fund may invest in
Senior Loans guaranteed by, or secured by assets of, shareholders or owners,
even if the Senior Loans are not otherwise collateralized by assets of the
Borrower; provided, however, that such guarantees are fully secured. There may
be temporary periods when the principal asset held by a Borrower is the stock of
a related company, which may not legally be pledged to secure a Senior Loan. On
occasions when such stock cannot be pledged, the Senior Loan will be temporarily
unsecured until the stock can be pledged or is exchanged for or replaced by
other assets, which will be pledged as security for the Senior Loan. However,
the Borrower's ability to dispose of such securities, other than in connection
with such pledge or replacement, will be strictly limited for the protection of
the holders of Senior Loans and, indirectly, Senior Loans themselves.
If a Borrower becomes involved in bankruptcy proceedings, a court may invalidate
the Fund's security interest in the loan collateral or subordinate the Fund's
rights under the Senior Loan to the interests of the Borrower's unsecured
creditors or cause interest previously paid to be refunded to the Borrower. If a
court required interest to be refunded, it could negatively affect the Fund's
performance. Such action by a court could be based, for example, on a
"fraudulent conveyance" claim to the effect that the Borrower did not receive
fair consideration for granting the security interest in the loan collateral to
the Fund. For Senior Loans made in connection with a highly leveraged
transaction, consideration for granting a security interest may be deemed
inadequate if the proceeds of the Loan were not received or retained by the
Borrower, but were instead paid to other persons (such as shareholders of the
Borrower) in an amount which left the Borrower insolvent or without sufficient
working capital. There are also other events, such as the failure to perfect a
security interest due to faulty documentation or faulty official filings, which
could lead to the invalidation of the Fund's security interest in loan
collateral. If the Fund's security interest in loan collateral is invalidated or
the Senior Loan is subordinated to other debt of a Borrower in bankruptcy or
other proceedings, the Fund would have substantially lower recovery, and perhaps
no recovery on the full amount of the principal and interest due on the Loan.
The Fund may acquire warrants and other equity securities as part of a unit
combining a Senior Loan and equity securities of a Borrower or its affiliates.
The acquisition of such equity securities will only be incidental to the Fund's
purchase of a Senior Loan. The Fund may also acquire equity securities or debt
securities (including non-dollar denominated debt securities) issued in exchange
for a Senior Loan
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ADDITIONAL INVESTMENT INFORMATION AND RESTRICTIONS
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or issued in connection with the debt restructuring or reorganization of a
Borrower, or if such acquisition, in the judgment of the Adviser, may enhance
the value of a Senior Loan or would otherwise be consistent with the Fund's
investment policies.
DEBTOR-IN-POSSESSION FINANCING
The Fund may invest in debtor-in-possession financing (commonly called "DIP
financings"). DIP financings are arranged when an entity seeks the protections
of then bankruptcy court under chapter 11 of the U.S. Bankruptcy Code. These
financings allow the entity to continue its business operations while
reorganizing under chapter 11. Such financings are senior liens on unemcumbered
security (i.e., security not subject to other creditors claims. There is a risk
that the entity will not emerge from chapter 11 and be forced to liquidate its
assets under chapter 7 of the Bankruptcy Code. In such event, the Fund's only
recourse will be against the property securing the DIP financing.
LITIGATION INVOLVING EATON VANCE
On October 15, 2001, an amended consolidated complaint was filed in the United
States District Court for the District of Massachusetts against four Eaton Vance
closed-end interval funds (the "Interval Funds"); their Trustees and certain
officers of the Interval Funds; Eaton Vance, the Interval Funds' administrator;
Boston Management and Research, the Interval Funds' investment adviser; and
Eaton Vance Corp., the parent of Eaton Vance and Boston Management and Research.
The Complaint, framed as a class action, alleges that for the period between May
25, 1998 and March 5, 2001, the Interval Funds' assets were incorrectly valued
and certain matters were not properly disclosed, in violation of the federal
securities laws. The Complaint seeks unspecified damages. The named defendants
believe that the Complaint is without merit and are vigorously contesting the
lawsuit. Eaton Vance believes that the lawsuit is not likely to have a material
adverse affect on its ability to render services to the Fund.
REGULATORY CHANGES
To the extent that legislation or state or federal regulators that regulate
certain financial institutions impose additional requirements or restrictions
with respect to the ability of such institutions to make loans, particularly in
connection with highly leveraged transactions, the availability of Senior Loans
for investment may be adversely affected. Further, such legislation or
regulation could depress the market value of Senior Loans.
CREDIT QUALITY
Many Senior Loans in which the Fund may invest are of below investment grade
credit quality. Accordingly, these Senior Loans are subject to similar or
identical risks and other characteristics described below in relation to
Non-Investment Grade Bonds.
NON-INVESTMENT GRADE BONDS
Investments in Non-Investment Grade Bonds generally provide greater income and
increased opportunity for capital appreciation than investments in higher
quality securities, but they also typically entail greater price volatility and
principal and income risk, including the possibility of issuer default and
bankruptcy. Non-Investment Grade Bonds are regarded as predominantly speculative
with respect to the issuer's continuing ability to meet principal and interest
payments. Debt securities in the lowest investment grade category also may be
considered to possess some speculative characteristics by certain rating
agencies. In addition, analysis of the creditworthiness of issuers of
Non-Investment Grade Bonds may be more complex than for issuers of higher
quality securities.
Non-Investment Grade Bonds may be more susceptible to real or perceived adverse
economic and competitive industry conditions than investment grade securities. A
projection of an economic downturn or of a period of rising interest rates, for
example, could cause a decline in Non-Investment
--------------------------------------------------------------------------------
8
ADDITIONAL INVESTMENT INFORMATION AND RESTRICTIONS
--------------------------------------------------------------------------------
Grade Bond prices because the advent of recession could lessen the ability of an
issuer to make principal and interest payments on its debt obligations. If an
issuer of Non-Investment Grade Bonds defaults, in addition to risking payment of
all or a portion of interest and principal, the Fund may incur additional
expenses to seek recovery. In the case of Non-Investment Grade Bonds structured
as zero-coupon, step-up or payment-in-kind securities, their market prices will
normally be affected to a greater extent by interest rate changes, and therefore
tend to be more volatile than securities which pay interest currently and in
cash. Eaton Vance seeks to reduce these risks through diversification, credit
analysis and attention to current developments in both the economy and financial
markets.
The secondary market on which Non-Investment Grade Bonds are traded may be less
liquid than the market for investment grade securities. Less liquidity in the
secondary trading market could adversely affect the net asset value of the
Shares. Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of Non-Investment
Grade Bonds, especially in a thinly traded market. When secondary markets for
Non-Investment Grade Bonds are less liquid than the market for investment grade
securities, it may be more difficult to value the securities because such
valuation may require more research, and elements of judgment may play a greater
role in the valuation because there is no reliable, objective data available.
During periods of thin trading in these markets, the spread between bid and
asked prices is likely to increase significantly and the Fund may have greater
difficulty selling these securities. The Fund will be more dependent on Eaton
Vance's research and analysis when investing in Non-Investment Grade Bonds.
Eaton Vance seeks to minimize the risks of investing in all securities through
in-depth credit analysis and attention to current developments in interest rate
and market conditions.
A general description of the ratings of securities by S&P, Fitch and Moody's is
set forth in Appendix A to this Statement of Additional Information. Such
ratings represent these rating organizations' opinions as to the quality of the
securities they rate. It should be emphasized, however, that ratings are general
and are not absolute standards of quality. Consequently, debt obligations with
the same maturity, coupon and rating may have different yields while obligations
with the same maturity and coupon may have the same yield. For these reasons,
the use of credit ratings as the sole method of evaluating Non-Investment Grade
Bonds can involve certain risks. For example, credit ratings evaluate the safety
or principal and interest payments, not the market value risk of Non-Investment
Grade Bonds. Also, credit rating agencies may fail to change credit ratings in a
timely fashion to reflect events since the security was last rated. Eaton Vance
does not rely solely on credit ratings when selecting securities for the Fund,
and develops its own independent analysis of issuer credit quality.
In the event that a rating agency or Eaton Vance downgrades its assessment of
the credit characteristics of a particular issue, the Fund is not required to
dispose of such security. In determining whether to retain or sell a downgraded
security, Eaton Vance may consider such factors as Eaton Vance's assessment of
the credit quality of the issuer of such security, the price at which such
security could be sold and the rating, if any, assigned to such security by
other rating agencies. However, analysis of the creditworthiness of issuers of
Non-Investment Grade Bonds may be more complex than for issuers of high quality
debt securities.
OTHER INVESTMENTS
FIXED INCOME SECURITIES
Fixed income securities include preferred, preference and convertible
securities, equipment lease certificates, equipment trust certificates and
conditional sales contracts. Preference stocks are stocks that have many
characteristics of preferred stocks, but are typically junior to an existing
class of preferred stocks. Equipment lease certificates are debt obligations
secured by leases on equipment (such as railroad cars, airplanes or office
equipment), with the issuer of the certificate being the owner and lessor of the
equipment. Equipment trust certificates are debt obligations secured by an
interest in
--------------------------------------------------------------------------------
9
ADDITIONAL INVESTMENT INFORMATION AND RESTRICTIONS
--------------------------------------------------------------------------------
property (such as railroad cars or airplanes), the title of which is held by a
trustee while the property is being used by the borrower. Conditional sales
contracts are agreements under which the seller of property continues to hold
title to the property until the purchase price is fully paid or other conditions
are met by the buyer.
Fixed-rate bonds may have a demand feature allowing the holder to redeem the
bonds at specified times. These bonds are more defensive than conventional
long-term bonds (protecting to some degree against a rise in interest rates)
while providing greater opportunity than comparable intermediate term bonds,
since they may be retained if interest rates decline. Acquiring these kinds of
bonds provides the contractual right to require the issuer of the bonds to
purchase the security at an agreed upon price, which right is contained in the
obligation itself rather than in a separate agreement or instrument. Since this
right is assignable only with the bond, it will not be assigned any separate
value.
Certain securities may permit the issuer at its option to "call," or redeem, the
securities. If an issuer were to redeem securities during a time of declining
interest rates, the Fund may not be able to reinvest the proceeds in securities
providing the same investment return as the securities redeemed.
The rating assigned to a security by a rating agency does not reflect assessment
of the volatility of the security's market value or of the liquidity of an
investment in the securities. Credit ratings are based largely on the issuer's
historical financial condition and the rating agency's investment analysis at
the time of rating, and the rating assigned to any particular security is not
necessarily a reflection of the issuer's current financial condition. Credit
quality in the high yield, high risk bond market can change from time to time,
and recently issued credit ratings may not fully reflect the actual risks posed
by a particular high yield security. In addition to lower rated securities, the
Fund also may invest in higher rated securities. For a description of corporate
bond ratings, see Appendix A.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements (the purchase of a security
coupled with an agreement to resell at a higher price) with respect to its
permitted investments. In the event of the bankruptcy of the other party to a
repurchase agreement, the Fund might experience delays in recovering its cash.
To the extent that, in the meantime, the value of the securities the Fund
purchased may have decreased, the Fund could experience a loss. Repurchase
agreements which mature in more than seven days will be treated as illiquid. The
Fund's repurchase agreements will provide that the value of the collateral
underlying the repurchase agreement will always be at least equal to the
repurchase price, including any accrued interest earned on the agreement, and
will be marked to market daily.
ZERO COUPONS BONDS
Zero coupon bonds are debt obligations which do not require the periodic payment
of interest and are issued at a significant discount from face value. The
discount approximates the total amount of interest the bonds will accrue and
compound over the period until maturity at a rate of interest reflecting the
market rate of the security at the time of issuance. The Fund is required to
accrue income from zero coupon bonds on a current basis, even though it does not
receive that income currently in cash and the Fund is required to distribute its
income for each taxable year. Thus, the Fund may have to sell other investments
to obtain cash needed to make income distributions.
INDEXED SECURITIES
The Fund may invest in securities that fluctuate in value with an index. Such
securities generally will either be issued by the U.S. Government or one of its
agencies or instrumentalities or, if privately issued, collateralized by
mortgages that are insured, guaranteed or otherwise backed by the U.S.
Government, its agencies or instrumentalities. The interest rate or, in some
cases, the principal payable at the maturity of an indexed security may change
positively or inversely in relation to one or more interest rates, financial
indices, securities prices or other financial indicators ("reference prices").
An indexed security may be leveraged to the extent that the magnitude of any
change in the interest
--------------------------------------------------------------------------------
10
ADDITIONAL INVESTMENT INFORMATION AND RESTRICTIONS
--------------------------------------------------------------------------------
rate or principal payable on an indexed security is a multiple of the change in
the reference price. Thus, indexed securities may decline in value due to
adverse market changes in reference prices. Because indexed securities derive
their value from another instrument, security or index, they are considered
derivative debt securities, and are subject to different combinations of
prepayment, extension, interest rate and/or other market risks.
SHORT SALES
The Fund may utilize short sales for hedging purposes. A short sale is affected
by selling a security which the Fund does not own, or, if the Fund does own the
security, is not to be delivered upon consummation of the sale. The Fund may
engage in short sales "against the box" (i.e., short sales of securities the
Fund already owns) for hedging purposes. If the price of the security in the
short sale decreases, the Fund will realize a profit to the extent that the
short sale price for the security exceeds the market price. If the price of the
security increases, the Fund will realize a loss to the extent that the market
price exceeds the short sale price. Selling securities short runs the risk of
losing an amount greater than the initial investment therein.
Purchasing securities to close out the short position can itself cause the price
of the securities to rise further, thereby exacerbating the loss. Short-selling
exposes the Fund to unlimited risk with respect to that security due to the lack
of an upper limit on the price to which an instrument can rise. Although the
Fund reserves the right to utilize short sales, the Adviser is under no
obligation to utilize shorts at all.
FOREIGN INVESTMENTS
The Fund may invest up to 5% of its total assets in U.S. dollar denominated
securities of non-U.S. issuers. Because foreign companies are not subject to
uniform accounting, auditing and financial reporting standards, practices and
requirements comparable to those applicable to U.S. companies, there may be less
publicly available information about a foreign company than about a domestic
company. Volume and liquidity in most foreign debt markets is less than in the
United States and securities of some foreign companies are less liquid and more
volatile than securities of comparable U.S. companies. There is generally less
government supervision and regulation of securities exchanges, broker-dealers
and listed companies than in the United States. Mail service between the United
States and foreign countries may be slower or less reliable than within the
United States, thus increasing the risk of delayed settlements of portfolio
transactions or loss of certificates for portfolio securities. Payment for
securities before delivery may be required. In addition, with respect to certain
foreign countries, there is the possibility of expropriation or confiscatory
taxation, political or social instability, or diplomatic developments which
could affect investments in those countries. Moreover, individual foreign
economies may differ favorably or unfavorably from the U.S. economy in such
respects as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments position.
Foreign securities markets, while growing in volume and sophistication, are
generally not as developed as those in the United States, and securities of some
foreign issuers (particularly those located in developing countries) may be less
liquid and more volatile than securities of comparable U.S. companies.
American Depositary Receipts (ADRs), European Depositary Receipts (EDRs) and
Global Depositary Receipts (GDRs) may be purchased. ADRs, EDRs and GDRs are
certificates evidencing ownership of shares of a foreign issuer and are
alternatives to directly purchasing the underlying foreign securities in their
national markets and currencies. However, they continue to be subject to many of
the risks associated with investing directly in foreign securities. These risks
include foreign exchange risk as well as the political and economic risks of the
underlying issuer's country. ADRs, EDRs and GDRs may be sponsored or
unsponsored. Unsponsored receipts are established without the participation of
the issuer. Unsponsored receipts may involve higher expenses, they may not
pass-through voting or other shareholder rights, and they may be less liquid.
--------------------------------------------------------------------------------
11
ADDITIONAL INVESTMENT INFORMATION AND RESTRICTIONS
--------------------------------------------------------------------------------
OPTIONS
Call options may be purchased to provide exposure to increases in the market
(e.g., with respect to temporary cash positions) or to hedge against an increase
in the price of securities or other investments that the Fund intends to
purchase or has sold short. Similarly, put options may be purchased for
speculative purposes or to hedge against a decrease in the market generally or
in the price of securities or other investments held by the Fund. Buying options
may reduce the Fund's returns, but by no more than the amount of the premiums
paid for the options.
The Fund may write covered call options (i.e., where the Fund owns the security
or other investment that is subject to the call) to enhance returns when the
Adviser perceives that the option premium offered is in excess of the premium
that the Adviser would expect to be offered under existing market conditions, or
if the exercise price of the option is in excess of the price that the Adviser
expects the security or other underlying investment to reach during the life of
the option. Writing covered call options may limit the Fund's gain on portfolio
investments if the option is exercised because the Fund will have to sell the
underlying investments below the current market price. Purchasing and writing
put and call options are highly specialized activities and entail greater than
ordinary market risks.
SECURITIES LENDING
As described in the Prospectus, the Fund may lend a portion of its portfolio
securities to broker-dealers or other institutional borrowers. Loans will be
made only to organizations whose credit quality or claims paying ability is
considered by the Adviser ton be at least investment grade. All securities loans
will be collateralized on a continuous basis by cash or U.S. government
securities having a value, marked to market daily, of at least 100% of the
market value of the loaned securities. The Fund may receive loan fees in
connection with loans that are collateralized by securities or on loans of
securities for which there is special demand. The Fund may also seek to earn
income on securities loans by reinvesting cash collateral in MBS or other
securities consistent with its investment objective and policies, seeking to
invest at rates that are higher than the "rebate" rate that it normally will pay
to the borrower with respect to such cash collateral. Any such reinvestment will
be subject to the investment policies, restrictions and risk considerations
described in the Prospectus and in this Statement of Additional Information.
Securities loans may result in delays in recovering, or a failure of the
borrower to return, the loaned securities. The defaulting borrower ordinarily
would be liable to the Fund for any losses resulting from such delays or
failures, and the collateral provided in connection with the loan normally would
also be available for that purpose. Securities loans normally may be terminated
by either the Fund or the borrower at any time. Upon termination and the return
of the loaned securities, the Fund would be required to return the related cash
or securities collateral to the borrower and it may be required to liquidate
longer term portfolio securities in order to do so. To the extent that such
securities have decreased in value, this may result in the Fund realizing a loss
at a time when it would not otherwise do so. The Fund also may incur losses if
it is unable to reinvest cash collateral at rates higher than applicable rebate
rates paid to borrowers and related administrative costs. These risks are
substantially the same as those incurred through investment leverage, and will
be subject to the investment policies, restrictions and risk considerations
described in the Prospectus and in this Statement of Additional Information.
The Fund will receive amounts equivalent to any interest or other distributions
paid on securities while they are on loan, and the Fund will not be entitled to
exercise voting or other beneficial rights on loaned securities. The Fund will
exercise its right to terminate loans and thereby regain these rights whenever
the Adviser considers it to be in the Fund's interest to do so, taking into
account the related loss of reinvestment income and other factors.
--------------------------------------------------------------------------------
12
ADDITIONAL INVESTMENT INFORMATION AND RESTRICTIONS
--------------------------------------------------------------------------------
SHORT-TERM TRADING
Securities may be sold in anticipation of market decline (a rise in interest
rates) or purchased in anticipation of a market rise (a decline in interest
rates) and later sold. In addition, a security may be sold and another purchased
at approximately the same time to take advantage of what the Adviser believes to
be a temporary disparity in the normal yield relationship between the two
securities. Yield disparities may occur for reasons not directly related to the
investment quality of particular issues or the general movement of interest
rates, such as changes in the overall demand for or supply of various types of
fixed income securities or changes in the investment objectives of investors.
TEMPORARY INVESTMENTS
The Fund may invest temporarily in cash or cash equivalents. Cash equivalents
are highly liquid, short-term securities such as commercial paper, certificates
of deposit, short-term notes and short-term U.S. Government obligations.
INVESTMENT RESTRICTIONS
The following investment restrictions of the Fund are designated as fundamental
policies and as such cannot be changed without the approval of the holders of a
majority of the Fund's outstanding voting securities, which as used in this SAI
means the lesser of (a) 67% of the shares of the Fund present or represented by
proxy at a meeting if the holders of more than 50% of the outstanding shares are
present or represented at the meeting or (b) more than 50% of outstanding shares
of the Fund. As a matter of fundamental policy the Fund may not:
(1) Borrow money, except as permitted by the Investment Company Act of 1940
(the "1940 Act"). The 1940 Act currently requires that any indebtedness
incurred by a closed-end investment company have an asset coverage of at
least 300%;
(2) Issue senior securities, as defined in the 1940 Act, other than (i)
preferred shares which immediately after issuance will have asset coverage
of at least 200%, (ii) indebtedness which immediately after issuance will
have asset coverage of at least 300%, or (iii) the borrowings permitted by
investment restriction (1) above. The 1940 Act currently defines "senior
security" as any bond, debenture, note or similar obligation or instrument
constituting a security and evidencing indebtedness, and any stock of a
class having priority over any other class as to distribution of assets or
payment of dividends. Debt and equity securities issued by a closed-end
investment company meeting the foregoing asset coverage provisions are
excluded from the general 1940 Act prohibition on the issuance of senior
securities;
(3) Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of purchases and sales of
securities). The purchase of investment assets with the proceeds of a
permitted borrowing or securities offering will not be deemed to be the
purchase of securities on margin;
(4) Underwrite securities issued by other persons, except insofar as it may
technically be deemed to be an underwriter under the Securities Act of 1933
in selling or disposing of a portfolio investment;
(5) Make loans to other persons, except by (a) the acquisition of loan
interests, debt securities and other obligations in which the Fund is
authorized to invest in accordance with its investment objectives and
policies, (b) entering into repurchase agreements, and (c) lending its
portfolio securities;
(6) Purchase or sell real estate, although it may purchase and sell securities
which are secured by interests in real estate and securities of issuers
which invest or deal in real estate. The Fund reserves the freedom of
action to hold and to sell real estate acquired as a result of the
ownership of securities;
--------------------------------------------------------------------------------
13
ADDITIONAL INVESTMENT INFORMATION AND RESTRICTIONS
--------------------------------------------------------------------------------
(7) Purchase or sell physical commodities or contracts for the purchase or sale
of physical commodities. Physical commodities do not include futures
contracts with respect to securities, securities indices or other financial
instruments; and
(8) With respect to 75% of its total assets, invest more than 5% of its total
assets in the securities of a single issuer or purchase more than 10% of
the outstanding voting securities of a single issuer, except obligations
issued or guaranteed by the U.S. government, its agencies or
instrumentalities and except securities of other investment companies; or
invest more 25% or more of its total assets in any single industry (other
than securities issued or guaranteed by the U.S. government or its agencies
or instrumentalities.
The Fund may borrow money as a temporary measure for extraordinary or emergency
purposes, including the payment of dividends and the settlement of securities
transactions which otherwise might require untimely dispositions of Fund
securities. The 1940 Act currently requires that the Fund have 300% asset
coverage with respect to all borrowings other than temporary borrowings.
For purposes of construing restriction (8), securities of the U.S. Government,
its agencies, or instrumentalities are not considered to represent industries.
Municipal obligations backed by the credit of a governmental entity are also not
considered to represent industries.
The Fund has adopted the following nonfundamental investment policy which may be
changed by the Board without approval of the Fund's shareholders. As a matter of
nonfundamental policy, the Fund may not make short sales of securities or
maintain a short position, unless at all times when a short position is open it
either owns an equal amount of such securities or owns securities convertible
into or exchangeable, without payment of any further consideration, for
securities of the same issue as, and equal in amount to, the securities sold
short.
Upon the Board's approval, the Fund may invest more than 10% of its total assets
in one or more other management investment companies (or may invest in
affiliated investment companies) to the extent permitted by the 1940 Act and
rules thereunder.
Whenever an investment policy or investment restriction set forth in the
Prospectus or this SAI states a maximum percentage of assets that may be
invested in any security or other asset or describes a policy regarding quality
standards, such percentage limitation or standard shall be determined
immediately after and as a result of the Fund's acquisition of such security or
asset. Accordingly, any later increase or decrease resulting from a change in
values, assets or other circumstances or any subsequent rating change made by a
rating service (or as determined by the Adviser if the security is not rated by
a rating agency) will not compel the Fund to dispose of such security or other
asset. Notwithstanding the foregoing, the Fund must always be in compliance with
the borrowing policies set forth above.
As described in the Prospectus, under normal market circumstances, the Fund
expects to maintain a weighted average portfolio credit quality of investment
grade. In determining the average credit quality of the Fund, Eaton Vance
intends to use a methodology, based structurally on the S&P or Moody's rating
system (or both) described in Appendix A to this SAI, which assumes a linear
relationship in the credit quality ratings for ratings between C and AAA (Aaa).
Securities with a rating below C will not be assigned any value in the
calculation of average credit quality. For the purpose of determining the Fund's
average credit quality, when a security is rated by more than one nationally
recognized statistical rating agency, the Adviser generally will use the highest
rating available. Within this general guideline, the Fund may invest in
individual securities of any credit quality. The Fund's holdings of
Non-Investment Grade Bonds and Senior Loans with lower credit ratings generally
will be offset by MBS with very high credit ratings. A "barbell" portfolio of
lower rated and higher rated securities may have risk characteristics that
differ from fixed income securities with credit ratings equivalent to the
portfolio average.
--------------------------------------------------------------------------------
14
--------------------------------------------------------------------------------
Trustees and officers
The Trustees of the Fund are responsible for the overall management and
supervision of the affairs of the Fund. The Trustees and officers of the Fund
are listed below. Except as indicated, each individual has held the office shown
or other offices in the same company for the last five years. The "noninterested
Trustees" consist of those Trustees who are not "interested persons" of the
Fund, as that term is defined under the 1940 Act. The business address of each
Trustee and officer is The Eaton Vance Building, 255 State Street, Boston,
Massachusetts 02109. As used in this SAI, "EVC" refers to Eaton Vance Corp.,
"EV" refers to Eaton Vance, Inc., "BMR" refers to Boston Management and
Research, and "EVD" refers to Eaton Vance Distributors Inc. EVC and EV are the
corporate parent and trustee, respectively, of Eaton Vance and BMR.
NUMBER OF
PORTFOLIOS IN
TERM OF OFFICE FUND COMPLEX OTHER
NAME AND POSITION(S) AND LENGTH PRINCIPAL OCCUPATION(S) OVERSEEN BY DIRECTORSHIPS
DATE OF BIRTH WITH THE FUND OF SERVICE DURING PAST FIVE YEARS TRUSTEE(1) HELD
-----------------------------------------------------------------------------------------------------------------
INTERESTED TRUSTEES
Jessica M. Bibliowicz Trustee(2) Since 4/8/03 President and Chief 194 None
11/28/59 Three Years Executive Officer of
National Financial
Partners (financial
services company)
(since April 1999).
President and Chief
Operating Officer of
John A. Levin & Co.
(registered investment
adviser) (July 1997 to
April 1999) and a
Director of Baker,
Fentress & Company
which owns John A.
Levin & Co. (July 1997
to April 1999). Ms.
Bibliowicz is an
interested person
because of her
affiliation with a
brokerage firm.
James B. Hawkes Trustee(2) and Since 3/12/03 Chairman, President and 194 Director of EVC
11/9/41 Vice President Three Years Chief Executive Officer
of BMR, Eaton Vance,
EVC and EV; Director of
EV and EVC; Vice
President and Director
of EVD. Trustee and/or
officer of 194
registered investment
companies in the Eaton
Vance Fund Complex. Mr.
Hawkes is an interested
person because of his
positions with BMR,
Eaton Vance, EVC and
EV, which are
affiliates of the Fund.
--------------------------------------------------------------------------------
15
TRUSTEES AND OFFICERS
--------------------------------------------------------------------------------
NUMBER OF
PORTFOLIOS IN
TERM OF OFFICE FUND COMPLEX OTHER
NAME AND POSITION(S) AND LENGTH PRINCIPAL OCCUPATION(S) OVERSEEN BY DIRECTORSHIPS
DATE OF BIRTH WITH THE FUND OF SERVICE DURING PAST FIVE YEARS TRUSTEE(1) HELD
-----------------------------------------------------------------------------------------------------------------
NON INTERESTED TRUSTEES
Samuel L. Hayes, Trustee(3) Since 4/8/03 Jacob H. Schiff 194 Director of
III(A) Three Years Professor of Investment Tiffany & Co.
2/23/35 Banking Emeritus, (specialty
Harvard University retailer) and
Graduate School of Telect, Inc.
Business (telecommunication
Administration. services company)
William H. Park Trustee(4) Since 6/16/03 President and Chief 194 None
9/19/47 Three Years Executive Officer,
Prizm Capital
Management, LLC
(investment management
firm) (since 2002).
Executive Vice
President and Chief
Financial Officer,
United Asset Management
Corporation (a holding
company owning
institutional
investment management
firms) (1982-2001).
Ronald A. Pearlman Trustee(4) Since 6/16/03 Professor of Law, 194 None
7/10/40 Three Years Georgetown University
Law Center (since
1999). Tax Partner,
Covington & Burling,
Washington, DC (1991-
2000).
Norton H. Reamer(A) Trustee(3) Since 4/8/03 President, Unicorn 194 None
9/21/35 Three Years Corporation (an
investment and
financial advisory
services company)
(since September 2000).
Chairman, Hellman,
Jordan Management Co.,
Inc. (an investment
management company)
(since November 2000).
Advisory Director of
Berkshire Capital
Corporation (investment
banking firm) (since
June 2002). Formerly,
Chairman of the Board,
United Asset Management
Corporation (a holding
company owning
institutional
investment management
firms) and Chairman,
President and Director,
UAM Funds (mutual
funds).
--------------------------------------------------------------------------------
16
TRUSTEES AND OFFICERS
--------------------------------------------------------------------------------
NUMBER OF
PORTFOLIOS IN
TERM OF OFFICE FUND COMPLEX OTHER
NAME AND POSITION(S) AND LENGTH PRINCIPAL OCCUPATION(S) OVERSEEN BY DIRECTORSHIPS
DATE OF BIRTH WITH THE FUND OF SERVICE DURING PAST FIVE YEARS TRUSTEE(1) HELD
-----------------------------------------------------------------------------------------------------------------
Lynn A. Stout Trustee(4) Since 4/8/03 Professor of Law, 194 None
9/14/57 Three Years University of
California at Los
Angeles School of Law
(since July 2001).
Formerly, Professor of
Law, Georgetown
University Law Center.
------------
(1) Includes both master and feeder funds in master-feeder structure.
(2) Class I Trustees whose term expires in 2004.
(3) Class II Trustees whose term expires in 2005.
(4) Class III Trustees whose term expires in 2006.
(A) Auction Preferred Share Trustee.
PRINCIPAL OFFICERS WHO ARE NOT TRUSTEES
TERM OF OFFICE
POSITION(S) AND LENGTH
NAME AND DATE OF BIRTH WITH THE FUND OF SERVICE PRINCIPAL OCCUPATIONS DURING PAST FIVE YEARS
--------------------------------------------------------------------------------------------------------
Thomas E. Faust Jr. President Since 3/12/03 Executive Vice President of Eaton Vance,
5/31/58 BMR, EVC and EV; Chief Investment Officer of
Eaton Vance and BMR and Director of EVC.
Chief Executive Officer of Belair Capital
Fund LLC, Belcrest Capital Fund LLC, Belmar
Capital Fund LLC; Belport Capital Fund LLC
and Belrose Capital Fund LLC (private
investment companies sponsored by Eaton
Vance). Officer of 54 registered investment
companies Managed by Eaton Vance or BMR.
James L. O'Connor Treasurer Since 3/12/03 Vice President of BMR, Eaton Vance and EVD.
4/1/45 Officer of 116 registered investment
companies managed by Eaton Vance or BMR.
Alan R. Dynner Secretary Since 3/12/03 Vice President, Secretary and Chief Legal
10/10/40 Officer of BMR, Eaton Vance, EVD, EV and
EVC. Officer of 194 registered investment
companies managed by Eaton Vance or BMR.
Scott H. Page Vice President Since 3/12/03 Vice President of Eaton Vance and BMR.
11/30/59 Officer of 14 registered investment
companies managed by Eaton Vance or BMR.
Susan Schiff Vice President Since 3/12/03 Vice President of Eaton Vance and BMR.
3/13/61 Officer of 26 registered investment
companies managed by Eaton Vance or BMR.
Payson F. Swaffield Vice President Since 3/12/03 Vice President of Eaton Vance and BMR.
8/13/56 Officer of 14 registered investment
companies managed by Eaton Vance or BMR.
--------------------------------------------------------------------------------
17
TRUSTEES AND OFFICERS
--------------------------------------------------------------------------------
TERM OF OFFICE
POSITION(S) AND LENGTH
NAME AND DATE OF BIRTH WITH THE FUND OF SERVICE PRINCIPAL OCCUPATIONS DURING PAST FIVE YEARS
--------------------------------------------------------------------------------------------------------
Michael W. Weilheimer Vice President Since 3/12/03 Vice President of Eaton Vance and BMR.
2/11/61 Officer of 11 registered investment
companies managed by Eaton Vance or BMR.
The Governance Committee of the Board of Trustees of the Fund is comprised of
the noninterested Trustees. Ms. Stout currently serves as chairperson of the
Governance Committee. The purpose of the Committee is to undertake a periodic
review of, and make recommendations with respect to, the Board's performance,
Trustee compensation, appointment of new Trustees, identity, duties and
composition of the various Board committees, development and maintenance of the
Board's membership, structure and operations; policies and procedures adopted or
approved by the Board to comply with regulatory requirements that relate to fund
governance; and any other matters related to fund governance.
The Trustees will, when a vacancy exists or is anticipated, consider any nominee
for Trustee recommended by a shareholder if such recommendation is submitted to
the Trustees in writing and contains sufficient background information
concerning the individual to enable a proper judgement to be made as to such
individual's qualifications.
Messrs. Reamer (Chair), Hayes, Park and Ms. Stout are members of the Audit
Committee of the Board of Trustees of the Fund. The Audit Committee's functions
include making recommendations to the Trustees regarding the selection and
performance of the independent accountants, and reviewing matters relative to
accounting and auditing practices and procedures, accounting records, and the
internal accounting controls, of the Fund, and certain service providers.
Messrs. Hayes (Chair), Park, Pearlman and Reamer are members of the Special
Committee of the Board of Trustees of the Fund. The purpose of the Special
Committee is to consider, evaluate and make recommendations to the full Board of
Trustees concerning (i) all contractual arrangements with service providers to
the Fund, including investment advisory, administrative, transfer agency,
custodial and fund accounting and distribution services, and (ii) all other
matters in which Eaton Vance or its affiliates has any actual or potential
conflict of interest with the Fund.
As of the date of this SAI, each of the Committees had held one meeting.
When considering approval of the Advisory Agreement between the Fund and the
Adviser, the Special Committee considered, among other things, the following:
+ An independent report comparing the fees and expenses of the Fund;
+ Information on the relevant peer group(s) of funds;
+ The economic outlook and the general investment outlook in the relevant
investment markets;
+ Eaton Vance's results and financial condition and the overall organization of
the Adviser;
+ Arrangements regarding the distribution of Fund shares;
+ The procedures used to determine the fair value of the Fund's assets;
+ The allocation of brokerage, including allocations to soft dollar brokerage
and allocations to firms that sell Eaton Vance fund shares;
+ Eaton Vance's management of the relationship with the custodian,
subcustodians and fund accountants;
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18
TRUSTEES AND OFFICERS
--------------------------------------------------------------------------------
+ The resources devoted to Eaton Vance's compliance efforts undertaken on
behalf of the funds it manages and the record of compliance with the
investment policies and restrictions and with policies on personal securities
transactions;
+ The quality nature, cost and character of the administrative and other
non-investment management services provided by Eaton Vance and its
affiliates;
+ Investment management staffing;
+ Operating expenses (including transfer agency expenses) to be paid to third
parties; and
+ Information to be provided to investors, including the Fund's shareholders.
In addition to the factors mentioned above, the Special Committee also reviewed
the level of the Adviser's profits in respect of the management of the Eaton
Vance funds, including the Fund. The noninterested Trustees considered the
profits realized by Eaton Vance and its affiliates in connection with the
operation of the Fund. The noninterested Trustees also considered Eaton Vance's
profit margins in comparison with available industry data.
The Special Committee did not consider any single factor as controlling in
determining whether or not to approve the Advisory Agreement. Nor are the items
described herein all encompassing of the matters considered by the noninterested
Trustees. In assessing the information provided by Eaton Vance and its
affiliates, the Special Committee also took into consideration the benefits to
shareholders of investing in a fund that is part of large family of funds which
provides a large variety of shareholder services.
Based on their consideration of all factors that it deemed material and assisted
by the advice of its independent counsel, the Special Committee concluded that
the approval of the Advisory Agreement, including the fee structure (described
herein) is in the interests of shareholders.
SHARE OWNERSHIP
The following table shows the dollar range of equity securities beneficially
owned by each Trustee in the Fund and all Eaton Vance Funds overseen by the
Trustee as of December 31, 2002.
AGGREGATE DOLLAR RANGE OF EQUITY
DOLLAR RANGE OF SECURITIES OWNED IN ALL REGISTERED
EQUITY SECURITIES FUNDS OVERSEEN BY TRUSTEE IN THE
NAME OF TRUSTEE OWNED IN THE FUND EATON VANCE FUND COMPLEX
-------------------------------------------------------------------------------------------------
INTERESTED TRUSTEES
Jessica M. Bibliowicz................. None $10,001--$50,000
James B. Hawkes....................... None over $100,000
NONINTERESTED TRUSTEES
Samuel L. Hayes, III.................. None over $100,000
William H. Park*...................... None None
Ronald A. Pearlman*................... None None
Norton H. Reamer...................... None over $100,000
Lynn A. Stout......................... None $10,001--$50,000
------------
* Messrs. Park and Pearlman were elected Trustees in 2003, and thus had no
beneficial ownership of securities in the Fund or in the Eaton Vance Fund
Complex as of December 31, 2002.
As of December 31, 2002, no noninterested Trustee or any of their immediate
family members owned beneficially or of record any class of securities of EVC,
EVD or any person controlling, controlled by or under common control with EVC or
EVD.
--------------------------------------------------------------------------------
19
TRUSTEES AND OFFICERS
--------------------------------------------------------------------------------
During the calendar years ended December 31, 2001 and December 31, 2002, no
noninterested Trustee (or their immediate family members) had:
1. Any direct or indirect interest in Eaton Vance, EVC, EVD or any person
controlling, controlled by or under common control with EVC or EVD;
2. Any direct or indirect material interest in any transaction or series of
similar transactions with (i) the Trust or any Fund; (ii) another fund
managed by EVC, distributed by EVD or a person controlling, controlled by or
under common control with EVC or EVD; (iii) EVC or EVD; (iv) a person
controlling, controlled by or under common control with EVC or EVD; or (v)
an officer of any of the above; or
3. Any direct or indirect relationship with (i) the Trust or any Fund; (ii)
another fund managed by EVC, distributed by EVD or a person controlling,
controlled by or under common control with EVC or EVD; (iii) EVC or EVD;
(iv) a person controlling, controlled by or under common control with EVC or
EVD; or (v) an officer of any of the above.
During the calendar years ended December 31, 2001 and December 31, 2002, no
officer of EVC, EVD or any person controlling, controlled by or under common
control with EVC or EVD served on the Board of Directors of a company where a
noninterested Trustee of the Fund or any of their immediate family members
served as an officer.
Trustees of the Fund who are not affiliated with the Adviser may elect to defer
receipt of all or a percentage of their annual fees in accordance with the terms
of a Trustees Deferred Compensation Plan (the "Trustees' Plan"). Under the
Trustees' Plan, an eligible Trustee may elect to have his deferred fees invested
by the Fund in the shares of one or more funds in the Eaton Vance Family of
Funds, and the amount paid to the Trustees under the Trustees' Plan will be
determined based upon the performance of such investments. Deferral of Trustees'
fees in accordance with the Trustees' Plan will have a negligible effect on the
Fund's assets, liabilities, and net income per share, and will not obligate the
Fund to retain the services of any Trustee or obligate the Fund to pay any
particular level of compensation to the Trustee. The Fund does not have a
retirement plan for its Trustees.
The fees and expenses of the Trustees of the Fund are paid by the Fund. (A
Trustee of the Fund who is a member of the Eaton Vance organization receives no
compensation from the Fund.) During the Fund's fiscal year ending April 30,
2004, it is anticipated that the Trustees of the Fund will earn the following
compensation in their capacities as Trustees. For the year ended December 31,
2002, the Trustees earned the compensation set forth below in their capacities
as Trustees from the funds in the Eaton Vance fund complex(1).
JESSICA M. SAMUEL L. WILLIAM H. RONALD A. NORTON H. LYNN A.
SOURCE OF COMPENSATION BIBLIOWICZ HAYES, III PARK PEARLMAN REAMER STOUT
---------------------------------------------------------------------------------------------------
Fund*..................... $ 1,000 $ 1,000 $1,000 $1,000 $ 1,000 $ 1,000
Fund Complex.............. $160,000 $180,000 None(3) None(3) $160,000 $160,000
------------
* Estimated
(1) As of July 18, 2003, the Eaton Vance fund complex consisted of 194
registered investment companies or series thereof.
(2) Includes $16,000 of deferred compensation.
(3) Messrs. Park and Pearlman were elected as Trustees in 2003, and thus did
not receive fees for the period.
PROXY VOTING POLICY. The Board of Trustees of the Fund has adopted a proxy
voting policy and procedure (the "Fund Policy"), pursuant to which the Trustees
have delegated proxy voting responsibility to the Adviser and adopted the
Adviser's proxy voting policies and procedures (the "Policies") which are
described below. The Trustees will review the Fund's proxy voting records from
time to time and will annually consider approving the Policies for the upcoming
year. In the event that
--------------------------------------------------------------------------------
20
TRUSTEES AND OFFICERS
--------------------------------------------------------------------------------
a conflict of interest arises between the Fund's Shareholders and the Adviser or
any of its affiliates or any affiliate of the Fund, the Adviser will generally
refrain from voting the proxies related to the companies giving rise to such
conflict until it consults with the Board of the Fund except as contemplated
under the Fund Policy. The Board's Special Committee will instruct the Adviser
on the appropriate course of action.
The Policies are designed to promote accountability of a company's management to
its shareholders and to align the interests of management with those
shareholders. The Adviser will generally support company management on proposals
relating to environmental and social policy issues, on matters regarding the
state of organization of the company and routine matters related to corporate
administration which are not expected to have a significant economic impact on
the company or its shareholders. On all other matters, the Adviser will review
each matter on a case-by-case basis and reserves the right to deviate from the
Policies' guidelines when it believes the situation warrants such a deviation.
The Policies include voting guidelines for matters relating to, among other
things, the election of directors, approval of independent auditors, executive
compensation, corporate structure and anti-takeover defenses. The Adviser may
abstain from voting from time to time where it determines that the costs
associated with voting a proxy outweigh the benefits derived from exercising the
right to vote.
In addition, the Adviser will monitor situations that may result in a conflict
of interest between the Fund's shareholders and the Adviser or any of its
affiliates or any affiliate of the Fund by maintaining a list of significant
existing and prospective corporate clients. The Adviser's personnel responsible
for reviewing and voting proxies on behalf of the Fund will report any proxy
received or expected to be received from a company included on that list to
members of senior management of the investment adviser identified in the
Policies. Such members of senior management will determine if a conflict exists.
If a conflict does exist, the proxy will either be voted strictly in accordance
with the Policies or the Adviser will seek instruction on how to vote from the
Special Committee. Effective August 31, 2004, information on how the Fund voted
proxies relating to portfolio securities during the 12 month period ended June
30, 2004 will be available (1) without charge, upon request, by calling
1-800-262-1122, and (2) on the Securities and Exchange Commission's website at
http://www.sec.gov.
Investment advisory and other services
Eaton Vance, its affiliates and its predecessor companies have been managing
assets of individuals and institutions since 1924 and of investment companies
since 1931. They maintain a large staff of experienced fixed-income, senior loan
and equity investment professionals to service the needs of their clients. The
fixed-income group focuses on all kinds of taxable investment-grade and
high-yield securities, tax-exempt investment-grade and high-yield securities,
and U.S. Government securities. The senior loan group focuses on senior floating
rate loans, unsecured loans and other floating rate debt securities such as
notes, bonds and asset backed securities. The equity group covers stocks ranging
from blue chip to emerging growth companies. Eaton Vance and its affiliates act
as adviser to a family of mutual funds, and individual and various institutional
accounts, including corporations, hospitals, retirement plans, universities,
foundations and trusts.
The Fund will be responsible for all of its costs and expenses not expressly
stated to be payable by Eaton Vance under the Advisory Agreement or
Administration Agreement. Such costs and expenses to be borne by the Fund
include, without limitation: custody and transfer agency fees and expenses,
including those incurred for determining net asset value and keeping accounting
books and records; expenses of pricing and valuation services; the cost of share
certificates; membership dues in investment company organizations; expenses of
acquiring, holding and disposing of securities and other investments; fees and
expenses of registering under the securities laws, stock exchange listing fees
and
--------------------------------------------------------------------------------
21
INVESTMENT ADVISORY AND OTHER SERVICES
--------------------------------------------------------------------------------
governmental fees; rating agency fees and preferred share remarketing expenses;
expenses of reports to shareholders, proxy statements and other expenses of
shareholders' meetings; insurance premiums; printing and mailing expenses;
interest, taxes and corporate fees; legal and accounting expenses; compensation
and expenses of Trustees not affiliated with Eaton Vance; expenses of conducting
repurchase offers for the purpose of repurchasing Fund shares; and investment
advisory and administration fees. The Fund will also bear expenses incurred in
connection with any litigation in which the Fund is a party and any legal
obligation to indemnify its officers and Trustees with respect thereto, to the
extent not covered by insurance.
The Advisory Agreement with the Adviser continues in effect to April 14, 2005
and from year to year so long as such continuance is approved at least annually
(i) by the vote of a majority of the noninterested Trustees of the Fund or of
the Adviser cast in person at a meeting specifically called for the purpose of
voting on such approval and (ii) by the Board of Trustees of the Fund or by vote
of a majority of the outstanding interests of the Fund. The Fund's
Administration Agreement continues in effect from year to year so long as such
continuance is approved at least annually by the vote of a majority of the
Fund's Trustees. Each agreement may be terminated at any time without penalty on
sixty (60) days' written notice by the Trustees of the Fund or Eaton Vance, as
applicable, or by vote of the majority of the outstanding shares of the Fund.
Each agreement will terminate automatically in the event of its assignment. Each
agreement provides that, in the absence of willful misfeasance, bad faith, gross
negligence or reckless disregard of its obligations or duties to the Fund under
such agreements on the part of Eaton Vance, Eaton Vance shall not be liable to
the Fund for any loss incurred, to the extent not covered by insurance.
Eaton Vance is a business trust organized under Massachusetts law. EV serves as
trustee of Eaton Vance. Eaton Vance and EV are subsidiaries of EVC, a Maryland
corporation and publicly-held holding company. EVC through its subsidiaries and
affiliates engages primarily in investment management, administration and
marketing activities. The Directors of EVC are James B. Hawkes, John G. L.
Cabot, Thomas E. Faust Jr., Leo I. Higdon, Jr., John M. Nelson, Vincent M.
O'Reilly and Ralph Z. Sorenson. All shares of the outstanding Voting Common
Stock of EVC are deposited in a voting trust, the voting trustees of which are
Messrs. James B. Hawkes, Jeffrey P. Beale, Alan R. Dynner, Thomas E. Faust, Jr.,
Thomas J. Fetter, Scott H. Page, Duncan W. Richardson, William M. Steul, Payson
F. Swaffield, Michael W. Weilheimer and Wharton P. Whitaker (all of whom are
officers of Eaton Vance). The voting trustees have unrestricted voting rights
for the election of Directors of EVC. All of the outstanding voting trust
receipts issued under said voting trust are owned by certain of the officers of
BMR and Eaton Vance who are also officers, or officers and Directors of EVC and
EV. As indicated under "Trustees and Officers", all of the officers of the Fund
(as well as Mr. Hawkes who is also a Trustee) hold positions in the Eaton Vance
organization.
EVC and its affiliates and their officers and employees from time to time have
transactions with various banks, including the custodian of the Fund, IBT. It is
Eaton Vance's opinion that the terms and conditions of such transactions were
not and will not be influenced by existing or potential custodial or other
relationships between the Fund and such banks.
CODE OF ETHICS
The Adviser and the Fund have adopted a Code of Ethics governing personal
securities transactions. Under the Code, Eaton Vance employees may purchase and
sell securities (including securities held or eligible for purchase by the Fund)
subject to certain pre-clearance and reporting requirements and other
procedures.
The Code can be reviewed and copied at the Securities and Exchange Commission's
public reference room in Washington, DC (call 1-202-942-8090 for information on
the operation of the public reference room); on the EDGAR Database on the SEC's
Internet site (http:/www.sec.gov); or, upon
--------------------------------------------------------------------------------
22
INVESTMENT ADVISORY AND OTHER SERVICES
--------------------------------------------------------------------------------
payment of copying fees, by writing the SEC's public reference section,
Washington, DC 20549-0102, or by electronic mail at publicinfo@sec.gov.
INVESTMENT ADVISORY SERVICES
Under the general supervision of the Fund's Board of Trustees, Eaton Vance will
carry out the investment and reinvestment of the assets of the Fund, will
furnish continuously an investment program with respect to the Fund, will
determine which securities should be purchased, sold or exchanged, and will
implement such determinations. Eaton Vance will furnish to the Fund investment
advice and provide related office facilities and personnel for servicing the
investments of the Fund. Eaton Vance will compensate all Trustees and officers
of the Fund who are members of the Eaton Vance organization and who render
investment services to the Fund, and will also compensate all other Eaton Vance
personnel who provide research and investment services to the Fund.
ADMINISTRATIVE SERVICES
Under the Administration Agreement, Eaton Vance is responsible for managing the
business affairs of the Fund, subject to the supervision of the Fund's Board of
Trustees. Eaton Vance will furnish to the Fund all office facilities, equipment
and personnel for administering the affairs of the Fund. Eaton Vance will
compensate all Trustees and officers of the Fund who are members of the Eaton
Vance organization and who render executive and administrative services to the
Fund, and will also compensate all other Eaton Vance personnel who perform
management and administrative services for the Fund. Eaton Vance's
administrative services include recordkeeping, preparation and filing of
documents required to comply with federal and state securities laws, supervising
the activities of the Fund's custodian and transfer agent, providing assistance
in connection with the Trustees and shareholders' meetings, providing services
in connection with any repurchase offers and other administrative services
necessary to conduct the Fund's business.
Determination of net asset value
The net asset value per Share of the Fund is determined no less frequently than
weekly, generally on the last day of the week that the New York Stock Exchange
(the "Exchange") is open for trading, as of the close of regular trading on the
Exchange (normally 4:00 p.m. New York time). The Fund's net asset value per
Share is determined by IBT, in the manner authorized by the Trustees of the
Fund. Net asset value is computed by dividing the value of the Fund's total
assets, less its liabilities by the number of shares outstanding.
The Adviser uses an independent pricing service to value most loans,
mortgage-backed securities (other than seasoned mortgage-backed securities) and
other debt securities at their market value. Seasoned mortgage-backed securities
are valued through the use of an independent matrix pricing system which takes
into account bond prices, yield differentials, anticipated prepayment and
interest rates provided by dealers. The Adviser may use the fair value method to
value loans or other securities if market quotations for them are not readily
available or are deemed unreliable, or if events occurring after the close of a
securities market and before the Fund values its assets would materially affect
net asset value. A security that is fair valued may be valued at a price higher
or lower than actual market quotations or the value determined by other funds
using their own fair valuation procedures.
The Trustees have approved and monitor the procedures under which Senior Loans
are valued. The Adviser and the Valuation Committee may implement new pricing
methodologies or expand mark-to-market valuation of Senior Loans in the future,
which may result in a change in the Fund's net asset value per share. The Fund's
net asset value per share will also be affected by fair value pricing decisions
and by changes in the market for Senior Loans. In determining the fair value of
a Senior
--------------------------------------------------------------------------------
23
DETERMINATION OF NET ASSET VALUE
--------------------------------------------------------------------------------
Loan, the Adviser will consider relevant factors, data, and information,
including: (i) the characteristics of and fundamental analytical data relating
to the Senior Loan, including the cost, size, current interest rate, period
until next interest rate reset, maturity and base lending rate of the Senior
Loan, the terms and conditions of the Senior Loan and any related agreements,
and the position of the Senior Loan in the Borrower's debt structure; (ii) the
nature, adequacy and value of the collateral, including the Fund's rights,
remedies and interests with respect to the collateral; (iii) the
creditworthiness of the Borrower, based on an evaluation of its financial
condition, financial statements and information about the Borrower's business,
cash flows, capital structure and future prospects; (iv) information relating to
the market for the Senior Loan, including price quotations for and trading in
the Senior Loan and interests in similar Senior Loans and the market environment
and investor attitudes towards the Senior Loan and interests in similar Senior
Loans; (v) the experience, reputation, stability and financial condition of the
Agent and any intermediate participants in the Senior Loan; and (vi) general
economic and market conditions affecting the fair value of the Senior Loan. The
fair value of each Senior Loan is reviewed and approved by the Adviser's
Valuation Committee and the Fund's Trustees.
Non-loan holdings (other than debt securities, including short term obligations)
may be valued on the basis of prices furnished by one or more pricing services
which determine prices for normal, institutional-size trading units of such
securities using market information, transactions for comparable securities and
various relationships between securities which are generally recognized by
institutional traders. In certain circumstances, portfolio securities will be
valued at the last sale price on the exchange that is the primary market for
such securities, or the average of the last quoted bid price and asked price for
those securities for which the over-the-counter market is the primary market or
for listed securities in which there were no sales during the day. Marketable
securities listed on the NASDAQ National Market System are valued at the NASDAQ
official closing price. The value of interest rate swaps will be based upon a
dealer quotation.
Debt securities for which the over-the-counter market is the primary market are
normally valued on the basis of prices furnished by one or more pricing services
at the mean between the latest available bid and asked prices. OTC options are
valued at the mean between the bid and asked prices provided by dealers.
Financial futures contracts listed on commodity exchanges and exchange-traded
options are valued at closing settlement prices. Short-term obligations having
remaining maturities of less than 60 days are valued at amortized cost, which
approximates value, unless the Trustees determine that under particular
circumstances such method does not result in fair value. As authorized by the
Trustees, debt securities (other than short-term obligations) may be valued on
the basis of valuations furnished by a pricing service which determines
valuations based upon market transactions for normal, institutional-size trading
units of such securities. Mortgage-backed "pass-through" securities are valued
through use of an independent matrix pricing system applied by the Adviser which
takes into account closing bond valuations, yield differentials, anticipated
prepayments and interest rates provided by dealers. Securities for which there
is no such quotation or valuation and all other assets are valued at fair value
as determined in good faith by or at the direction of the Fund's Trustees.
Generally, trading in the foreign securities owned by the Fund is substantially
completed each day at various times prior to the close of the Exchange. The
values of these securities used in determining the net asset value of the Fund
generally are computed as of such times. Occasionally, events affecting the
value of foreign securities may occur between such times and the close of the
New York Stock Exchange which will not be reflected in the computation of the
Fund's net asset value (unless the Fund deems that such events would materially
affect its net asset value, in which case an adjustment would be made and
reflected in such computation).
--------------------------------------------------------------------------------
24
Portfolio trading
Decisions concerning the execution of portfolio security transactions, including
the selection of the market and the executing firm, are made by the Adviser. The
Adviser is also responsible for the execution of transactions for all other
accounts managed by it. The Adviser places the portfolio security transactions
of the Fund and of all other accounts managed by it for execution with many
firms. The Adviser uses its best efforts to obtain execution of portfolio
security transactions at prices which are advantageous to the Fund and at
reasonably competitive spreads or (when a disclosed commission is being charged)
at reasonably competitive commission rates. In seeking such execution, the
Adviser will use its best judgment in evaluating the terms of a transaction, and
will give consideration to various relevant factors, including without
limitation the full range and quality of the executing firm's services, the
value of the brokerage and research services provided, the responsiveness of the
firm to the Adviser, the size and type of the transaction, the nature and
character of the market for the security, the confidentiality, speed and
certainty of effective execution required for the transaction, the general
execution and operational capabilities of the executing firm, the reputation,
reliability, experience and financial condition of the firm, the value and
quality of the services rendered by the firm in this and other transactions, and
the reasonableness of the spread or commission, if any.
The Fund will acquire Senior Loans from major international banks, selected
domestic regional banks, insurance companies, finance companies and other
financial institutions. In selecting financial institutions from which Senior
Loans may be acquired, the Adviser will consider, among other factors, the
financial strength, professional ability, level of service and research
capability of the institution. While these financial institutions are generally
not required to repurchase Senior Loans which they have sold, they may act as
principal or on an agency basis in connection with their sale by the Fund.
Other fixed income obligations which may be purchased and sold by the Fund are
generally traded in the over-the-counter market on a net basis (i.e., without
commission) through broker-dealers or banks acting for their own account rather
than as brokers, or otherwise involve transactions directly with the issuers of
such obligations. The Fund may also purchase fixed income and other securities
from underwriters, the cost of which may include undisclosed fees and
concessions to the underwriters.
Transactions on stock exchanges and other agency transactions involve the
payment of negotiated brokerage commissions. Such commissions vary among
different broker-dealer firms, and a particular broker-dealer may charge
different commissions according to such factors as the difficulty and size of
the transaction and the volume of business done with such broker-dealer.
Transactions in foreign securities often involve the payment of brokerage
commissions, which may be higher than those in the United States. There is
generally no stated commission in the case of securities traded in the over-the-
counter markets, but the price paid or received usually includes an undisclosed
dealer markup or markdown.
Although spreads or commissions paid on portfolio security transactions will, in
the judgment of the Adviser, be reasonable in relation to the value of the
services provided, commissions exceeding those which another firm might charge
may be paid to broker-dealers who were selected to execute transactions on
behalf of the Adviser's clients in part for providing brokerage and research
services to the Adviser.
As authorized in Section 28(e) of the Securities Exchange Act of 1934, a broker
or dealer who executes a portfolio transaction on behalf of the Fund may receive
a commission which is in excess of the amount of commission another broker or
dealer would have charged for effecting that transaction if the Adviser
determines in good faith that such compensation was reasonable in relation to
the value of the brokerage and research services provided. This determination
may be made on the basis of that particular transaction or on the basis of
overall responsibilities which the Adviser and its affiliates have
--------------------------------------------------------------------------------
25
PORTFOLIO TRADING
--------------------------------------------------------------------------------
for accounts over which they exercise investment discretion. In making any such
determination, the Adviser will not attempt to place a specific dollar value on
the brokerage and research services provided or to determine what portion of the
commission should be related to such services. Brokerage and research services
may include advice as to the value of securities, the advisability of investing
in, purchasing, or selling securities, and the availability of securities or
purchasers or sellers of securities; furnishing analyses and reports concerning
issuers, industries, securities, economic factors and trends, portfolio strategy
and the performance of accounts; effecting securities transactions and
performing functions incidental thereto (such as clearance and settlement); and
the "Research Services" referred to in the next paragraph.
It is a common practice of the investment advisory industry and of the advisers
of investment companies, institutions and other investors to receive research,
analytical, statistical and quotation services, data, information and other
services, products and materials which assist such advisers in the performance
of their investment responsibilities ("Research Services") from broker-dealer
firms which execute portfolio transactions for the clients of such advisers and
from third parties with which such broker-dealers have arrangements. Consistent
with this practice, the Adviser receives Research Services from many
broker-dealer firms with which the Adviser places the Fund's transactions and
from third parties with which these broker-dealers have arrangements. These
Research Services include such matters as general economic, political, business
and market information, industry and company reviews, evaluations of securities
and portfolio strategies and transactions, proxy voting data and analysis
services, technical analysis of various aspects of the securities market,
recommendations as to the purchase and sale of securities and other portfolio
transactions, financial, industry and trade publications, news and information
services, pricing and quotation equipment and services, and research oriented
computer hardware, software, data bases and services. Any particular Research
Service obtained through a broker-dealer may be used by the Adviser in
connection with client accounts other than those accounts which pay commissions
to such broker-dealer. Any such Research Service may be broadly useful and of
value to the Adviser in rendering investment advisory services to all or a
significant portion of its clients, or may be relevant and useful for the
management of only one client's account or of a few clients' accounts, or may be
useful for the management of merely a segment of certain clients' accounts,
regardless of whether any such account or accounts paid commissions to the
broker-dealer through which such Research Service was obtained. The advisory fee
paid by the Fund is not reduced because the Adviser receives such Research
Services. The Adviser evaluates the nature and quality of the various Research
Services obtained through broker-dealer firms and attempts to allocate
sufficient portfolio security transactions to such firms to ensure the continued
receipt of Research Services which the Adviser believes are useful or of value
to it in rendering investment advisory services to its clients.
The Fund and the Adviser may also receive Research Services from underwriters
and dealers in fixed-price offerings, which Research Services are reviewed and
evaluated by the Adviser in connection with its investment responsibilities. The
investment companies sponsored by the Adviser or its affiliates may allocate
trades in such offerings to acquire information relating to the performance,
fees and expenses of such companies and other mutual funds, which information is
used by the Trustees of such companies to fulfill their responsibility to
oversee the quality of the services provided by various entities, including the
Adviser, to such companies. Such companies may also pay cash for such
information.
Subject to the requirement that the Adviser shall use its best efforts to seek
and execute portfolio security transactions at advantageous prices and at
reasonably competitive spreads or commission rates, the Adviser is authorized to
consider as a factor in the selection of any broker-dealer firm with whom
portfolio orders may be placed the fact that such firm has sold or is selling
shares of the Fund or of other investment companies sponsored by the Adviser.
This policy is not inconsistent with a rule
--------------------------------------------------------------------------------
26
PORTFOLIO TRADING
--------------------------------------------------------------------------------
of the National Association of Securities Dealers, Inc. ("NASD"), which rule
provides that no firm which is a member of the NASD shall favor or disfavor the
distribution of shares of any particular investment company or group of
investment companies on the basis of brokerage commissions received or expected
by such firm from any source.
Securities considered as investments for the Fund may also be appropriate for
other investment accounts managed by the Adviser or its affiliates. Whenever
decisions are made to buy or sell securities by the Fund and one or more of such
other accounts simultaneously, the Adviser will allocate the security
transactions (including "hot" issues) in a manner which it believes to be
equitable under the circumstances. As a result of such allocations, there may be
instances where the Fund will not participate in a transaction that is allocated
among other accounts. If an aggregated order cannot be filled completely,
allocations will generally be made on a pro rata basis. An order may not be
allocated on a pro rata basis where, for example: (i) consideration is given to
portfolio managers who have been instrumental in developing or negotiating a
particular investment; (ii) consideration is given to an account with
specialized investment policies that coincide with the particulars of a specific
investment; (iii) pro rata allocation would result in odd-lot or de minimis
amounts being allocated to a portfolio or other client; or (iv) where the
Adviser reasonably determines that departure from a pro rata allocation is
advisable. While these aggregation and allocation policies could have a
detrimental effect on the price or amount of the securities available to the
Fund from time to time, it is the opinion of the Trustees of the Fund that the
benefits from the Adviser's organization outweigh any disadvantage that may
arise from exposure to simultaneous transactions.
Taxes
The following discussion of federal income tax matters is based on the advice of
Kirkpatrick & Lockhart LLP, counsel to the Fund. The Fund intends to elect to be
treated and to qualify each year as a RIC under the Code. Accordingly, the Fund
intends to satisfy certain requirements relating to sources of its income and
diversification of its assets and to distribute substantially all of its net
income and net short-term and long-term capital gains (after reduction by any
available capital loss carryforwards) in accordance with the timing requirements
imposed by the Code, so as to maintain its RIC status and to avoid paying any
federal income or excise tax. To the extent it qualifies for treatment as a RIC
and satisfies the above-mentioned distribution requirements, the Fund will not
be subject to federal income tax on income paid to its shareholders in the form
of dividends or capital gain distributions.
In order to avoid incurring a federal excise tax obligation, the Code requires
that the Fund distribute (or be deemed to have distributed) by December 31 of
each calendar year an amount at least equal to the sum of (i) 98% of its
ordinary income for such year and (ii) 98% of its capital gain net income (which
is the excess of its realized net long-term capital gain over its realized net
short-term capital loss), generally computed on the basis of the one-year period
ending on October 31 of such year, after reduction by any available capital loss
carryforwards, plus 100% of any ordinary income and capital gain net income from
the prior year (as previously computed) that were not paid out during such year
and on which the Fund paid no federal income tax. Under current law, provided
that the Fund qualifies as a RIC for federal income tax purposes, the Fund
should not be liable for any income, corporate excise or franchise tax in The
Commonwealth of Massachusetts.
If the Fund does not qualify as a RIC for any taxable year, the Fund's taxable
income will be subject to corporate income taxes, and all distributions from
earnings and profits, including distributions of net capital gain (if any), will
be taxable to the shareholder as ordinary income. In addition, in order to
requalify for taxation as a RIC, the Fund may be required to recognize
unrealized gains, pay substantial taxes and interest, and make certain
distributions.
--------------------------------------------------------------------------------
27
TAXES
--------------------------------------------------------------------------------
The Fund's investment in zero coupon and certain other securities will cause it
to realize income prior to the receipt of cash payments with respect to these
securities. Such income will be accrued daily by the Fund and, in order to avoid
a tax payable by the Fund, the Fund may be required to liquidate securities that
it might otherwise have continued to hold in order to generate cash so that the
Fund may make required distributions to its shareholders.
Investments in lower rated or unrated securities may present special tax issues
for the Fund to the extent that the issuers of these securities default on their
obligations pertaining thereto. The Code is not entirely clear regarding the
federal income tax consequences of the Fund's taking certain positions in
connection with ownership of such distressed securities.
Any recognized gain or income attributable to market discount on long-term debt
obligations (i.e., obligations with a term of more than one year except to the
extent of a portion of the discount attributable to original issue discount)
purchased by the Fund is taxable as ordinary income. A long-term debt obligation
is generally treated as acquired at a market discount if purchased after its
original issue at a price less than (i) the stated principal amount payable at
maturity, in the case of an obligation that does not have original issue
discount or (ii) in the case of an obligation that does have original issue
discount, the sum of the issue price and any original issue discount that
accrued before the obligation was purchased, subject to a de minimis exclusion.
The Fund's investments in options, futures contracts, hedging transactions,
forward contracts (to the extent permitted) and certain other transactions will
be subject to special tax rules (including mark-to-market, constructive sale,
straddle, wash sale, short sale and other rules), the effect of which may be to
accelerate income to the Fund, defer Fund losses, cause adjustments in the
holding periods of securities held by the Fund, convert capital gain into
ordinary income and convert short-term capital losses into long-term capital
losses. These rules could therefore affect the amount, timing and character of
distributions to shareholders. The Fund may be required to limit its activities
in options and futures contracts in order to enable it to maintain its RIC
status.
Any loss realized upon the sale or exchange of Fund shares with a holding period
of 6 months or less will be treated as a long-term capital loss to the extent of
any capital gain distributions received with respect to such shares. In
addition, all or a portion of a loss realized on a redemption or other
disposition of Fund shares may be disallowed under "wash sale" rules to the
extent the shareholder acquires other shares of the same Fund (whether through
the reinvestment of distributions or otherwise) within the period beginning 30
days before the redemption of the loss shares and ending 30 days after such
date. Any disallowed loss will result in an adjustment to the shareholder's tax
basis in some or all of the other shares acquired.
Sales charges paid upon a purchase of shares cannot be taken into account for
purposes of determining gain or loss on a sale of the shares before the 91st day
after their purchase to the extent a sales charge is reduced or eliminated in a
subsequent acquisition of shares of the Fund (or of another fund) pursuant to
the reinvestment or exchange privilege. Any disregarded amounts will result in
an adjustment to the shareholder's tax basis in some or all of any other shares
acquired.
Dividends and distributions on the Fund's shares are generally subject to
federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, even though such dividends and distributions
may economically represent a return of a particular shareholder's investment.
Such distributions are likely to occur in respect of shares purchased at a time
when the Fund's net asset value reflects gains that are either unrealized, or
realized but not distributed. Such realized gains may be required to be
distributed even when the Fund's net asset value also reflects unrealized
losses. Certain distributions declared in October, November or December and paid
in the following January will be taxed to shareholders as if received on
December 31 of the year in which they were declared. In addition, certain other
distributions made after the close of a taxable year of the
--------------------------------------------------------------------------------
28
TAXES
--------------------------------------------------------------------------------
Fund may be "spilled back" and treated as paid by the Fund (except for purposes
of the 4% excise tax) during such taxable year. In such case, Shareholders will
be treated as having received such dividends in the taxable year in which the
distributions were actually made.
Amounts paid by the Fund to individuals and certain other shareholders who have
not provided the Fund with their correct taxpayer identification number ("TIN")
and certain certifications required by the Internal Revenue Service (the "IRS")
as well as shareholders with respect to whom the Fund has received certain
information from the IRS or a broker may be subject to "backup" withholding of
federal income tax arising from the Fund's taxable dividends and other
distributions as well as the gross proceeds of sales of shares, at a rate of up
to 30% for amounts paid during 2003. An individual's TIN is generally his or her
social security number. Backup withholding is not an additional tax. Any amounts
withheld under the backup withholding rules from payments made to a Shareholder
may be refunded or credited against such Shareholder's U.S. federal income tax
liability, if any, provided that the required information is furnished to the
IRS.
The foregoing discussion does not address the special tax rules applicable to
certain classes of investors, such as tax-exempt entities, foreign investors,
insurance companies and financial institutions. Shareholders should consult
their own tax advisers with respect to special tax rules that may apply in their
particular situations, as well as the state, local, and, where applicable,
foreign tax consequences of investing in the Fund.
The Fund will inform Shareholders of the source and tax status of all
distributions promptly after the close of each calendar year. The IRS has taken
the position that if a RIC has more than one class of shares, it may designate
distributions made to each class in any year as consisting of no more than that
class's proportionate share of particular types of income for that year,
including ordinary income and net capital gain. A class's proportionate share of
a particular type of income for a year is determined according to the percentage
of total dividends paid by the RIC during that year to the class. Accordingly,
the Fund intends to designate apportion of its distributions in capital gain
dividends in accordance with the IRS position.
Although the matter is not free from doubt, due to the absence of direct
regulatory or judicial authority, in the opinion of Kirkpatrick & Lockhart LLP,
counsel to the Fund, under current law the manner in which the Fund intends to
allocate items of ordinary income and net capital gain among the Fund's Common
Shares and APS will be respected for federal income tax purposes. It is possible
that the IRS could disagree with counsel's opinion and attempt to reallocate the
Fund's net capital gain or other taxable income.
STATE AND LOCAL TAXES
Shareholders should consult their own tax advisers as the state or local tax
consequences of investing in the Fund.
Other information
The Fund is an organization of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders of such a trust may, in
certain circumstances, be held personally liable as partners for the obligations
of the trust. The Declaration of Trust contains an express disclaimer of
shareholder liability in connection with the Fund property or the acts,
obligations or affairs of the Fund. The Declaration of Trust also provides for
indemnification out of the Fund property of any shareholder held personally
liable for the claims and liabilities to which a shareholder may become subject
by reason of being or having been a shareholder. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Fund itself is
--------------------------------------------------------------------------------
29
OTHER INFORMATION
--------------------------------------------------------------------------------
unable to meet its obligations. The Fund has been advised by its counsel that
the risk of any shareholder incurring any liability for the obligations of the
Fund is remote.
The Declaration of Trust provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law; but nothing in the Declaration of
Trust protects a Trustee against any liability to the Fund or its shareholders
to which he would otherwise be subject by reason of willful misfeasance, bad
faith, gross negligence, or reckless disregard of the duties involved in the
conduct of his office. Voting rights are not cumulative, which means that the
holders of more than 50% of the shares voting for the election of Trustees can
elect 100% of the Trustees and, in such event, the holders of the remaining less
than 50% of the shares voting on the matter will not be able to elect any
Trustees.
The Declaration of Trust provides that no person shall serve as a Trustee if
shareholders holding two-thirds of the outstanding shares have removed him from
that office either by a written declaration filed with the Fund's custodian or
by votes cast at a meeting called for that purpose. The Declaration of Trust
further provides that the Trustees of the Fund shall promptly call a meeting of
the shareholders for the purpose of voting upon a question of removal of any
such Trustee or Trustees when requested in writing so to do by the record
holders of not less than 10 per centum of the outstanding shares.
The Fund's Prospectus and this SAI do not contain all of the information set
forth in the Registration Statement that the Fund has filed with the SEC. The
complete Registration Statement may be obtained from the SEC upon payment of the
fee prescribed by its Rules and Regulations.
Independent auditors
Deloitte & Touche LLP, Boston, Massachusetts are the independent auditors for
the Fund, providing audit services, tax return preparation, and assistance and
consultation with respect to the preparation of filings with the SEC.
--------------------------------------------------------------------------------
30
--------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
To the Trustees and Shareholder of
Eaton Vance Limited Duration Income Fund:
We have audited the accompanying statement of assets and liabilities of Eaton
Vance Limited Duration Income Fund (the "Fund") as of May 6, 2003 and the
related statement of operations for the period from March 12, 2003 (date of
organization) through May 6, 2003. These financial statements are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Eaton Vance Limited Duration
Income Fund as of May 6, 2003, and the result of its operations for the period
from March 12, 2003 (date of organization) through May 6, 2003 in conformity
with accounting principles generally accepted in the United States of America.
Deloitte & Touche LLP
Boston, Massachusetts
May 7, 2003
--------------------------------------------------------------------------------
31
--------------------------------------------------------------------------------
Eaton Vance Limited Duration Income Fund
STATEMENT OF ASSETS AND LIABILITIES
MAY 6, 2003
ASSETS
Cash...................................................... $100,000
Offering costs............................................ 800,000
Receivable from Adviser................................... 7,500
--------
Total assets.............................................. $907,500
========
LIABILITIES
Accrued offering costs.................................... $800,000
Accrued organizational costs.............................. 7,500
--------
Total liabilities......................................... $807,500
========
Net assets applicable to 5,000 common shares of beneficial
interest issued and outstanding........................... $100,000
========
NET ASSET VALUE AND OFFERING PRICE PER SHARE................ $ 20.00
========
STATEMENT OF OPERATIONS
PERIOD FROM MARCH 12, 2003 (DATE OF ORGANIZATION) THROUGH MAY 6, 2003
INVESTMENT INCOME........................................... $ --
--------
EXPENSES
Organization costs........................................ $ 7,500
Expense reimbursement..................................... (7,500)
--------
Net expenses........................................... $ --
--------
NET INVESTMENT INCOME....................................... $ --
========
See notes to financial statements.
--------------------------------------------------------------------------------
32
Notes to financial statements
NOTE 1: ORGANIZATION
The Fund was organized as a Massachusetts business trust on March 12, 2003, and
has been inactive since that date except for matters relating to its
organization and registration as a diversified, closed-end management investment
company under the Investment Company Act of 1940, as amended, and the Securities
Act of 1933, as amended, and the sale of 5,000 common shares to Eaton Vance
Management, the Fund's Investment Adviser.
Eaton Vance Management, or an affiliate, has agreed to reimburse all
organizational costs, estimated at approximately $7,500.
Eaton Vance Management, or an affiliate, has agreed to pay all offering costs
(other than sales loads) that exceed $0.04 per common share.
The Fund's investment objective is to provide a high level of current income.
The Fund may, as a secondary objective, also seek capital appreciation to the
extent consistent with its primary goal of high current income.
NOTE 2: ACCOUNTING POLICIES
The Fund's financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America which require the
use of management estimates. Actual results may differ from those estimates.
The Fund's share of offering costs will be recorded within paid in capital as a
reduction of the proceeds from the sale of common shares upon the commencement
of Fund operations. The offering costs reflected above assume the sale of
20,000,000 common shares.
NOTE 3: INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an investment advisory agreement between the Adviser and the Fund,
the Fund has agreed to pay an investment advisory fee, payable on a monthly
basis, at an annual rate of 0.75% of the average weekly gross assets of the
Fund. Gross assets of the Fund shall be calculated by deducting accrued
liabilities of the Fund not including the amount of any preferred shares
outstanding or the principal amount of any indebtedness for money borrowed.
In addition, Eaton Vance has contractually agreed to reimburse the Fund for fees
and other expenses in the amount of 0.20% of the average weekly gross assets for
the first 5 full years of the Fund's operations, 0.15% of average weekly gross
assets in year 6, 0.10% in year 7 and 0.05% in year 8.
NOTE 4: FEDERAL INCOME TAXES
The Fund intends to comply with the requirements of the Internal Revenue Code
applicable to regulated investment companies and to distribute all of its
taxable income, including any net realized gain on investments.
--------------------------------------------------------------------------------
33
Portfolio of investments (unaudited) as of June 30, 2003
CORPORATE BONDS & NOTES--29.3%
PRINCIPAL
AMOUNT
(000'S
SECURITY OMITTED) VALUE
------------------------------------------------------------------------------------------
ADVERTISING SERVICES--0.1%
Vertis, Inc., 9.75%, 4/1/09(1).............................. 1,000 1,045,000
--------------
$ 1,045,000
==============
AEROSPACE AND DEFENSE--0.5%
Dunlop Stand Aero Holdings, Sr. Notes, 11.875%, 5/15/09..... 2,500 2,700,000
Sequa Corp., Sr. Notes, 8.875%, 4/1/08(1)................... 5,000 5,250,000
Titan Corp., Sr. Sub. Notes, 8.00%, 5/15/11(1).............. 2,000 2,130,000
Vought Aircraft, Inc., Sr. Notes, 8.00%, 7/15/11(1)......... 1,150 1,161,500
--------------
$ 11,241,500
==============
AIRLINES--0.3%
Delta Air Lines, 7.70%, 12/15/05............................ 6,000 5,280,000
--------------
$ 5,280,000
==============
APPAREL--0.1%
Phillips Van-Heusen, Sr. Notes, 8.125%, 5/1/13(1)........... 2,500 2,578,125
--------------
$ 2,578,125
==============
AUTO AND PARTS--1.5%
CSK Auto, Inc., 12.00%, 6/15/06............................. 6,000 6,690,000
Dana Corp., 10.125%, 3/15/10................................ 1,000 1,107,500
NA United Rentals, Inc., Sr. Notes, 10.75%, 4/15/08(1)...... 5,000 5,487,500
RJ Tower Corp., 12.00%, 6/1/13(1)........................... 5,000 4,825,000
TRW Automotive, Inc., Sr. Notes, 9.375%, 2/15/13(1)......... 2,500 2,725,000
TRW Automotive, Inc., Sr. Sub. Notes, 11.00%, 2/15/13(1).... 6,000 6,570,000
United Components, Inc., Sr. Sub. Notes, 9.375%,
6/15/13(1)................................................ 990 1,032,075
United Rentals N.A., Inc., 10.75%, 4/15/08.................. 2,000 2,195,000
--------------
$ 30,632,075
==============
AUTO MANUFACTURER--0.0%
General Motors, Sr. Notes, 7.125%, 7/15/13.................. 925 919,413
--------------
$ 919,413
==============
BEVERAGES--0.0%
Le-Natures, Inc., Sr. Sub. Notes, 9.00%, 6/15/13(1)......... 930 962,550
--------------
$ 962,550
==============
--------------------------------------------------------------------------------
34
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
AMOUNT
(000'S
SECURITY OMITTED) VALUE
------------------------------------------------------------------------------------------
BROADCASTING AND CABLE--2.0%
CSC Holdings, Inc., Sr. Notes, 8.125%, 7/15/09.............. 5,000 5,187,500
CSC Holdings, Inc., Sr. Sub. Notes, 10.50%, 5/15/16......... 4,000 4,380,000
Insight Communications, Sr. Disc. Notes, 12.25%, (0% until
2006) 2/15/11............................................. 5,460 4,559,100
Lodgenet Entertainment, Sr. Sub. Debs., 9.50%, 6/15/13...... 935 963,050
Mediacom LLC/Capital Corp., Sr. Notes, 9.50%, 1/15/13....... 5,000 5,312,500
Muzak Holdings LLC, 9.875%, 3/15/09......................... 2,000 1,910,000
Muzak LLC/Muzak Finance, Sr. Notes, 10.00%, 2/15/09(1)...... 7,365 7,751,682
Nexstar Finance Holding LLC, Inc., Sr. Disc. Notes, 0.00%,
4/1/13(1)................................................. 1,810 1,214,962
Paxson Communications, 10.75%, 7/15/08...................... 5,000 5,400,000
Pegasus Satellite, 12.375%, 8/1/06.......................... 2,000 1,880,000
Pegasus Satellite, Sr. Notes, 11.25%, 1/15/10(1)............ 2,000 1,880,000
--------------
$ 40,438,774
==============
BUILDING AND CONSTRUCTION-MISCELLANEOUS--0.3%
Dayton Superior Corp., 10.75%, 9/15/08(1)................... 7,000 6,965,000
--------------
$ 6,965,000
==============
BUSINESS SERVICES--0.6%
MDP Acquisitions/JSG Funding PLC, Sr. Notes,
9.625%, 10/1/12........................................... 10,400 11,544,000
--------------
$ 11,544,000
==============
BUSINESS SERVICES-MISCELLANEOUS--1.1%
PCA LLC/PCA Finance Corp., Sr. Notes, 11.875%, 8/1/09....... 5,000 5,475,000
Trico Marine Services, Sr. Notes, 8.875%, 5/15/12........... 5,750 4,973,750
Universal City Development, Sr. Notes, 11.75%, 4/1/10(1).... 10,500 11,576,250
--------------
$ 22,025,000
==============
CHEMICALS--1.1%
Equistar Chemical, Sr. Notes, 10.625%, 5/1/11(1)............ 7,000 7,210,000
Lyondell Chemical Co., 9.50%, 12/15/08(1)................... 4,790 4,574,450
OM Group, Inc. 9.25%, 12/15/11.............................. 10,000 9,800,000
--------------
$ 21,584,450
==============
CHEMICALS-SPECIALTY--0.8%
Huntsman Adventure Materials, 11.00%, 7/15/10(1)............ 3,815 3,986,675
Huntsman International LLC, 9.875%, 3/1/09.................. 6,000 6,270,000
IMC Global, Inc., 11.25%, 6/1/11............................ 6,775 7,079,875
--------------
$ 17,336,550
==============
--------------------------------------------------------------------------------
35
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
AMOUNT
(000'S
SECURITY OMITTED) VALUE
------------------------------------------------------------------------------------------
COMPUTER SERVICES--0.3%
Cooperative Computing, Sr. Notes, 10.50%, 6/15/11(1)........ 1,125 1,158,750
Digitalnet, Inc., Sr. Notes, 9.00%, 7/15/10(1).............. 4,190 4,190,000
--------------
$ 5,348,750
==============
CONSUMER PRODUCTS--0.2%
Amscan Holdings, Inc., Sr. Sub. Notes, 9.875% 12/15/07...... 3,465 3,534,300
--------------
$ 3,534,300
==============
CONTAINERS AND PACKAGING--0.8%
BWAY Corp., Sr. Sub. Notes, 10.00%, 10/15/10(1)............. 2,000 2,040,000
Crown Holdings SA, 10.875%, 3/1/13(1)....................... 12,500 13,687,500
--------------
$ 15,727,500
==============
DISTRIBUTION/WHOLESALE--0.0%
Aviall, Inc., Sr. Notes, 7.625%, 7/1/11(1).................. 925 942,344
--------------
$ 942,344
==============
DIVERSIFIED MANUFACTURING--0.2%
Jacuzzi Brands, Inc., 9.625%, 7/1/10(1)..................... 3,465 3,560,287
--------------
$ 3,560,287
==============
ELECTRICAL EQUIPMENT--0.1%
Xerox Corp., Sr. Notes, 7.625%, 6/15/13..................... 1,855 1,866,594
--------------
$ 1,866,594
==============
ELECTRONIC COMPONENTS--0.3%
Sanmina-Sci Corp., 10.375%, 1/15/10(1)...................... 5,000 5,600,000
--------------
$ 5,600,000
==============
ELECTRONIC EQUIPMENT--0.2%
Danka Business Systems, Sr. Notes, 11.00% 6/15/10(1)........ 1,610 1,593,900
Hexcel Corp., 9.875%, 10/1/08(1)............................ 1,250 1,381,250
Xerox Corp., Sr. Notes, 7.125%, 6/15/10..................... 1,855 1,861,956
--------------
$ 4,837,106
==============
ENTERTAINMENT--1.5%
Carmike Cinemas, 10.375%, 2/1/09............................ 2,475 2,611,125
Hollywood Entertainment, 9.625%, 3/15/11.................... 9,000 9,888,750
Premier Parks, Inc., Sr. Notes, 9.75%, 6/15/07.............. 2,500 2,487,500
Royal Caribbean Cruises, Sr. Notes, 8.75%, 2/2/11........... 9,200 9,798,000
Six Flags, Inc., Sr. Notes, 8.875%, 2/1/10.................. 1,000 965,000
--------------------------------------------------------------------------------
36
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
AMOUNT
(000'S
SECURITY OMITTED) VALUE
------------------------------------------------------------------------------------------
Six Flags, Inc., Sr. Notes, 9.75%, 4/15/13(1)............... 4,000 3,980,000
--------------
$ 29,730,375
==============
FINANCE-OTHER SERVICES--0.1%
IOS Capital LLC, Sr. Notes, 7.25%, 6/30/08.................. 1,875 1,842,187
--------------
$ 1,842,187
==============
FOODS--0.6%
B&G Foods, Inc., 9.625%, 8/1/07............................. 4,000 4,140,000
Burns Philp Capital, 9.50%, 11/15/10(1)..................... 2,000 2,110,000
Burns Philp Capital, Sr. Sub Notes, 10.75%, 2/15/11(1)...... 2,000 2,090,000
Doane Pet Care Company, 10.75%, 3/1/10...................... 2,000 2,190,000
Merisant Co., Sr. Sub Notes, 9.50%, 7/15/13(1).............. 960 998,400
--------------
$ 11,528,400
==============
GAMING--0.9%
Argosy Gaming Co., 10.75%, 6/1/09........................... 2,224 2,446,400
Chukchansi EDA, Sr. Notes, 14.50%, 6/15/09(1)............... 800 886,000
Peninsula Gaming LLC, 12.25%, 7/1/06........................ 3,100 3,239,500
Penn National Gaming, Inc., 11.125%, 3/1/08................. 1,000 1,112,500
Waterford Gaming LLC, Sr. Notes, 8.625%, 9/15/12(1)......... 10,000 10,550,000
--------------
$ 18,234,400
==============
HEALTH AND PERSONAL CARE--0.2%
Bally Total Fitness Holdings, Sr. Notes, 10.50%
7/15/11(1)................................................ 5,000 5,025,000
--------------
$ 5,025,000
==============
HEALTH SERVICES--1.5%
Alliance Imaging, Sr. Sub Notes, 10.375%, 4/15/11........... 6,870 7,213,500
Pacificare Health System, 10.75%, 6/1/09.................... 6,195 7,139,737
Rotech Healthcare, Inc., Sr. Sub. Notes, 9.50%, 4/1/12...... 7,550 7,795,375
Vanguard Health Systems, 9.75%, 8/1/11...................... 8,000 8,000,000
--------------
$ 30,148,612
==============
HOUSEHOLD PRODUCTS--0.0%
Playtex Products, Inc., 9.375%, 6/1/11...................... 1,000 1,005,000
--------------
$ 1,005,000
==============
LODGING--0.4%
Host Marriott L.P., 9.50%, 1/15/07.......................... 7,000 7,560,000
--------------
$ 7,560,000
==============
--------------------------------------------------------------------------------
37
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
AMOUNT
(000'S
SECURITY OMITTED) VALUE
------------------------------------------------------------------------------------------
LODGING AND GAMING--1.0%
Extended Stay America, Sr. Sub Notes, 9.15% 3/15/08......... 2,000 2,097,500
John Q Hamons Hotels/Finance, Series B, 8.875% 5/15/12...... 3,500 3,692,500
Majestic Star LLC, 10.875%, 7/1/06.......................... 3,270 3,437,588
MTR Gaming Group, 9.75% 4/1/10(1)........................... 2,500 2,587,500
Sun International Hotels, Sr. Sub. Notes, 8.875% 8/15/11.... 4,000 4,350,000
Venetian Casino/Las Vegas Sands, 11.00%, 6/15/10............ 4,000 4,530,000
--------------
$ 20,695,088
==============
MACHINERY--0.6%
Terex Corp., 10.375%, 4/1/11................................ 9,500 10,545,000
Terex Corp., Series D, 8.875%, 4/1/08....................... 1,000 1,045,000
--------------
$ 11,590,000
==============
MANUFACTURING--1.0%
Avondale Mills Inc., Sr. Sub. Notes, 10.25%, 7/1/13(1)...... 3,700 3,709,250
Dresser, Inc., 9.375%, 4/15/11.............................. 9,200 9,522,000
Oxford Industries Inc., Sr. Notes, 8.875%, 6/1/11(1)........ 6,500 6,857,500
--------------
$ 20,088,750
==============
MANUFACTURING-DIVERSIFIED--0.2%
Tenneco Automotive, Inc., 10.25%, 7/15/13(1)................ 3,505 3,566,338
--------------
$ 3,566,338
==============
MEDICAL PRODUCTS--0.3%
Alaris Medical, Inc. Sr. Sub Notes, 7.25%, 7/1/11........... 645 656,288
Medquest, Inc., 11.875%, 8/15/12............................ 6,000 6,270,000
--------------
$ 6,926,288
--------------
METALS-INDUSTRIAL--0.1%
AK Steel Corp., 7.75%, 6/15/12.............................. 2,000 1,670,000
--------------
$ 1,670,000
--------------
OIL AND GAS-EQUIPMENT AND SERVICES--1.4%
Dynegy Holdings, Inc., Sr. Notes, 6.875%, 4/1/11............ 2,945 2,488,525
Dynegy Holdings, Inc., Sr. Notes, 7.45%, 7/15/06............ 760 727,700
Dynegy Holdings, Inc., Sr. Notes, 8.125%, 3/15/05........... 570 557,175
El Paso Energy Partners, Sr. Sub. Notes, 8.50% 6/1/10(1).... 1,500 1,612,500
Sonat, Inc., 7.625%, 7/15/11................................ 5,000 4,575,000
Transmontaigne, Inc., Sr. Sub. Notes, 9.125%, 6/1/10(1)..... 3,000 3,176,250
Williams Cos., Inc., Sr. Notes, 8.625%, 6/1/10.............. 14,760 15,498,000
--------------
$ 28,635,150
==============
--------------------------------------------------------------------------------
38
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
AMOUNT
(000'S
SECURITY OMITTED) VALUE
------------------------------------------------------------------------------------------
OIL AND GAS-EXPLORATION AND PRODUCTION--0.4%
Chesapeake Energy Corp., Sr. Notes, 8.50%, 3/15/12.......... 5,000 5,312,500
Continental Resources, 10.25%, 8/1/08....................... 2,000 2,020,000
--------------
$ 7,332,500
==============
OIL AND GAS-REFINING--0.4%
Clark R&M, Inc., Sr. Sub. Notes, 8.875%, 11/15/07........... 7,500 7,687,500
--------------
$ 7,687,500
==============
PAPER AND FOREST PRODUCTS--0.6%
Georgia-Pacific Corp., Debs, 9.50%, 12/1/11................. 12,000 13,275,000
--------------
$ 13,275,000
==============
PRINTING--0.1%
American Color Graphics, 10.00%, 6/15/10(1)................. 1,330 1,330,000
--------------
$ 1,330,000
--------------
PUBLISHING--0.4%
Canwest Media, Inc., Sr. Sub. Notes, 10.625%, 5/15/11....... 2,000 2,290,000
CBD Media/CBD Finance, Sr. Sub. Notes, 8.625% 6/1/11(1)..... 4,200 4,347,000
Liberty Group Operating, 9.375%, 2/1/08..................... 1,380 1,400,700
--------------
$ 8,037,700
==============
RETAIL-APPAREL--0.1%
Mothers Work, Inc., 11.25%, 8/1/10.......................... 1,800 1,944,000
--------------
$ 1,944,000
==============
RETAIL-FOOD--0.1%
Dominos, Inc., Sr. Sub. Notes, 8.25%, 7/1/11(1)............. 1,490 1,545,875
--------------
$ 1,545,875
==============
SEMICONDUCTORS--0.5%
Amkor Technologies, Inc., Sr. Sub. Notes, 10.50%, 5/1/09.... 9,000 9,135,000
ON Semiconductor Corp., 12%, 5/15/08........................ 2,000 2,030,000
--------------
$ 11,165,000
==============
SERVICES--0.2%
Kindercare Learning Centers, Inc., Sr. Sub. Notes, 9.50%,
2/15/09................................................... 5,000 5,062,500
--------------
$ 5,062,500
==============
--------------------------------------------------------------------------------
39
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
AMOUNT
(000'S
SECURITY OMITTED) VALUE
------------------------------------------------------------------------------------------
STORAGE--0.0%
Mobile Mini, Inc., Sr. Notes, 9.50%, 7/1/13(1).............. 925 962,000
--------------
$ 962,000
==============
TELECOMMUNICATION EQUIPMENT--0.1%
Nortel Networks Ltd., 6.125%, 2/15/06....................... 2,000 1,950,000
--------------
$ 1,950,000
==============
TELECOMMUNICATIONS-CELLULAR--0.0%
Centennial Cellular Communications, Sr. Sub. Notes, 10.75%,
12/15/08.................................................. 385 356,125
--------------
$ 356,125
==============
TELECOMMUNICATIONS-SERVICES--0.1%
Avaya, Inc., 11.125%, 4/1/09................................ 2,000 2,200,000
--------------
$ 2,200,000
==============
TRANSPORT-SERVICES--0.1%
Offshore Logistic, Sr. Notes, 6.125%, 6/15/13(1)............ 1,260 1,269,450
--------------
$ 1,269,450
==============
TRAVEL SERVICES--0.1%
Worldspan LP/WS Finance Corp., Sr. Notes, 9.625%,
6/15/11(1)................................................ 2,925 3,027,375
--------------
$ 3,027,375
==============
UTILITIES--1.1%
El Paso Corp., Sr. Notes, 7.00%, 5/15/11.................... 11,000 10,065,000
Orion Power Holdings, Inc., Sr. Notes, 12.00%, 5/1/10....... 11,000 12,815,000
--------------
$ 22,880,000
==============
UTILITY-ELECTRIC POWER GENERATION--1.1%
AES Corp., Sr. Notes, 8.75%, 6/15/08........................ 4,500 4,477,500
AES Corp., Sr. Notes, 9.50%, 6/1/09......................... 6,000 6,090,000
AES Corp., Sr. Sub. Notes, 10.25%, 7/15/06.................. 3,000 2,985,000
Calpine Corp., Sr. Notes, 8.25%, 8/15/05.................... 4,725 4,417,875
Calpine Corp., Sr. Notes, 8.50%, 2/15/11.................... 6,315 4,767,825
--------------
$ 22,738,200
==============
WASTE MANAGEMENT--0.8%
Allied Waste, 10.00%, 8/1/09................................ 15,000 16,012,500
--------------
$ 16,012,500
--------------
--------------------------------------------------------------------------------
40
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
AMOUNT
(000'S
SECURITY OMITTED) VALUE
------------------------------------------------------------------------------------------
WIRELESS COMMUNICATION SERVICES--2.3%
American Tower Corp., Sr. Notes, 9.375%, 2/1/09............. 9,000 9,090,000
Centennial Cellular Communications, Sr. Notes 10.125%,
6/15/13(1)................................................ 1,880 1,870,600
Crown Castle International Corp., Sr. Notes, 10.75%,
8/1/11.................................................... 5,000 5,475,000
Dobson/Sygnet Communications, Inc., Sr. Notes, 12.25%,
12/15/08.................................................. 6,000 6,450,000
Insight Midwest/Insight Capital, Sr. Notes, 10.50%
11/1/10................................................... 5,000 5,512,500
Nextel Communications, Inc., Sr. Disc. Notes, 9.95%,
2/15/08................................................... 1,500 1,575,000
Nextel Communications, Inc., Sr. Notes, 12.00%, 11/1/08..... 7,500 8,100,000
Nextel Partners, Inc., 12.50%, 11/15/09..................... 760 858,800
Nextel Partners, Inc., Sr. Notes, 8.125%, 7/1/11(1)......... 2,085 2,090,213
Rural Cellular Corp., Sr. Sub. Notes, 9.75%, 1/15/10........ 955 849,950
Triton PCS, Inc., Sr. Notes, 8.50%, 6/1/13(1)............... 2,765 2,986,200
TSI Telecommunication, Series B, 12.75%, 2/1/09............. 2,000 1,990,000
--------------
$ 46,848,263
==============
WIRELINE COMMUNICATION SERVICES--0.5%
Colt Telecom Group PLC, Sr. Disc. Notes, 12.00%, 12/15/06... 3,000 3,045,000
Qwest Services Corp., 13.50%, 12/15/10(1)................... 7,015 7,962,025
--------------
$ 11,007,025
==============
TOTAL CORPORATE BONDS & NOTES (IDENTIFIED COST, $590,222,205)............ $ 598,845,919
==============
MORTGAGE PASS-THROUGHS--32.0%
Federal Home Loan Mortgage Corp.:
6.50%, with various maturities to 2025.................... 42,014 45,057,722
7.00%, with various maturities to 2024.................... 53,923 58,262,518
7.13%, with maturity at 2023.............................. 3,088 3,336,845
7.50%, with various maturities to 2033.................... 22,850 24,857,205
8.00%, with various maturities to 2030.................... 54,096 59,715,721
8.50%, with various maturities to 2022.................... 17,631 19,822,329
8.75%, with maturity at 2010.............................. 627 689,796
9.00%, with various maturities to 2022.................... 2,167 2,435,488
9.50%, with various maturities to 2025.................... 4,281 4,859,869
10.00%, with various maturities to 2020................... 3,943 4,619,261
10.50%, with various maturities to 2021................... 4,036 4,778,232
11.00%, with maturity at 2015............................. 355 418,557
11.50%, with various maturities to 2020................... 617 736,257
12.00%, with maturity at 2019............................. 358 435,892
12.50%, with maturity at 2014............................. 90 110,017
13.00%, with maturity at 2015............................. 954 1,186,192
13.50%, with maturity at 2014............................. 90 111,010
--------------------------------------------------------------------------------
41
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
AMOUNT
(000'S
SECURITY OMITTED) VALUE
------------------------------------------------------------------------------------------
14.00%, with maturity at 2014............................. 240 305,903
--------------
$ 231,738,814
==============
Federal National Mortgage Assn.:
6.50%, with various maturities to 2024(2)................. 53,460 57,107,720
7.00%, with various maturities to 2025.................... 16,761 18,090,505
7.50%, with maturity at 2024.............................. 6,576 7,174,703
8.00%, with various maturities to 2024.................... 10,121 11,199,535
8.25%, with various maturities to 2018.................... 476 527,828
8.50%, with maturity at 2023.............................. 395 442,329
9.00%, with various maturities to 2026.................... 36,531 41,197,514
9.50%, with various maturities to 2033.................... 8,614 9,885,500
10.00%, with various maturities to 2021................... 3,524 4,124,925
10.50%, with various maturities to 2025................... 2,997 3,599,069
11.00%, with various maturities to 2020................... 1,598 1,911,902
11.25%, with maturity at 2016............................. 384 463,742
11.50%, with various maturities to 2021................... 7,926 9,619,219
11.75%, with maturity at 2014............................. 92 111,900
12.00%, with various maturities to 2016................... 1,377 1,687,075
12.50%, with various maturities to 2015................... 992 1,218,700
13.00%, with various maturities to 2015................... 943 1,170,772
13.50%, with various maturities to 2017................... 473 602,475
14.50%, with maturity at 2014............................. 134 170,786
--------------
$ 170,306,199
==============
Government National Mortgage Assn.:
6.00%, with maturity at 2024.............................. 17,646 18,682,244
6.50%, with various maturities to 2024(2)................. 148,925 159,657,770
7.00%, with maturity at 2022.............................. 7,075 7,655,948
8.00%, with various maturities to 2023.................... 18,150 20,114,974
9.00%, with various maturities to 2033.................... 16,294 18,410,098
--------------
$ 224,521,034
==============
Collateralized Mortgage Obligations:
Federal National Mortgage Assn., Series 1993-16, Class Z,
7.50%, due 2023........................................ 9,751 10,478,620
Federal National Mortgage Assn., Series G93-29, Class Z,
7.00%, due 2023........................................ 14,485 15,394,420
--------------
$ 25,873,040
==============
TOTAL MORTGAGE PASS-THROUGHS (IDENTIFIED COST, $651,262,659)............. $ 652,439,087
==============
--------------------------------------------------------------------------------
42
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
AMOUNT
(000'S
SECURITY OMITTED) VALUE
------------------------------------------------------------------------------------------
U.S. TREASURY OBLIGATIONS--10.1%
United States Treasury Bond, 12.375%, 5/15/04............... 184,556 202,701,731
United States Treasury Bond, 11.875%, 11/15/03.............. 2,384 2,480,757
--------------
TOTAL U.S. TREASURY OBLIGATIONS (IDENTIFIED COST, $205,013,422).......... $ 205,182,488
==============
SENIOR, SECURED, FLOATING RATE INTERESTS--25.2%(3)
PRINCIPAL
BORROWER/TRANCHE DESCRIPTION AMOUNT VALUE
------------------------------------------------------------------------------------------
AEROSPACE AND DEFENSE--0.2%
United States Defense Industries, Inc., Term Loan, Maturing
6/30/09................................................... 4,495,806 4,509,455
--------------
$ 4,509,455
==============
AUTOMOBILE--2.3%
Accuride Corporation, Term Loan, Maturing 6/13/07........... 4,900,000 4,918,375
Collins & Aikman, Term Loan, Maturing 12/31/05.............. 1,994,937 1,985,211
Federal-Mogul Corporation, Term Loan, Maturing 2/24/04...... 5,626,706 5,612,639
HLI Operating Company, Inc., Term Loan, Maturing 6/3/09..... 6,000,000 6,030,000
Keystone Automotive Operations, Inc., Term Loan, Maturing
3/31/06................................................... 3,000,000 2,977,500
Metaldyne, Inc., Term Loan, Maturing 12/31/09............... 2,996,245 2,823,961
Tenneco Automotive,
Term Loan, Maturing 12/31/06.............................. 359,906 359,756
Term Loan, Maturing 12/31/07.............................. 1,349,876 1,338,487
Term Loan, Maturing 12/31/08.............................. 1,349,876 1,338,487
The Goodyear Tire & Rubber Company, Term Loan, Maturing
3/31/06................................................... 8,000,000 7,840,000
TRW Automotive Holdings Corp.,
Term Loan, Maturing 2/28/10............................... 5,000,000 4,995,835
Term Loan, Maturing 2/28/11............................... 5,000,000 5,045,835
United Components, Inc., Term Loan, Maturing 6/30/10........ 2,000,000 2,016,250
--------------
$ 47,282,336
==============
BEVERAGE, FOOD, AND TOBACCO--0.9%
American Seafood Holdings Inc., Term Loan, Maturing
3/31/09................................................... 2,455,693 2,461,832
Aurora Foods, Inc., Term Loan, Maturing 3/31/07............. 4,987,047 4,548,187
Dean Foods Company, Term Loan, Maturing 7/15/08............. 1,994,962 2,005,956
Dr. Pepper/Seven Up Bottling Group, Inc., Term Loan,
Maturing 10/7/07.......................................... 1,994,819 1,988,896
Interstate Brands Corporations, Term Loan, Maturing
7/19/07................................................... 2,967,519 2,963,809
Southern Wine & Spirits of America, Inc., Term Loan,
Maturing 6/28/08.......................................... 4,418,866 4,435,437
--------------
$ 18,404,117
==============
--------------------------------------------------------------------------------
43
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
BORROWER/TRANCHE DESCRIPTION AMOUNT VALUE
------------------------------------------------------------------------------------------
BROADCASTING & ENTERTAINMENT--2.6%
Bresnan Communications, LLC, Term Loan, Maturing 9/30/10.... 6,500,000 6,497,290
Charter Communications Operating, LLC.,
Term Loan, Maturing 3/18/08............................... 15,402,229 14,458,842
Term Loan, Maturing 2/2/08................................ 2,404,992 2,260,262
DirectTV Holdings, LLC, Term Loan, Maturing 3/6/10.......... 6,000,000 6,048,378
Emmis Communication Corporation, Term Loan, Maturing
8/31/08................................................... 500,000 501,042
Falcon Holding Group, L.P., Term Loan, Maturing 12/31/07.... 997,389 908,871
Gray Television, Inc., Term Loan, Maturing 12/31/10......... 4,300,000 4,322,394
Insight Midwest Holdings, LLC, Term Loan, Maturing
12/31/09.................................................. 3,500,000 3,504,374
Metro-Goldwyn-Mayer Studios, Inc., Term Loan, Maturing
6/11/08................................................... 9,500,000 9,513,357
Sinclair Broadcast Group, Inc.,
Term Loan, Maturing 12/31/09.............................. 500,000 502,835
Term Loan, Maturing 12/31/10.............................. 2,500,000 2,513,058
Videotron LTEE, Term Loan, Maturing 12/1/09................. 2,530,758 2,512,833
--------------
$ 53,543,536
==============
BUILDINGS AND REAL ESTATE--1.2%
AIMCO Properties, L.P.,
Term Loan, Maturing 2/28/04............................... 4,394,456 4,399,949
Term Loan, Maturing 5/30/08............................... 5,000,000 5,009,375
Interline Brands, Inc., Term Loan, Maturing 11/30/09........ 4,500,000 4,516,875
iStar Walden, Term Loan, Maturing 12/30/03.................. 2,500,000 2,503,125
NCI Building Systems, Inc., Term Loan, Maturing 7/31/08..... 2,887,500 2,900,133
WFP Tower A Co. L.P., Term Loan, Maturing 6/12/06........... 4,500,000 4,497,187
--------------
$ 23,826,644
==============
CARGO TRANSPORT--0.2%
RailAmerica Transportation Corp., Term Loan, Maturing
5/31/09................................................... 5,000,000 5,005,625
--------------
$ 5,005,625
==============
CHEMICALS, PLASTICS AND RUBBER--1.2%
CP Kelco U.S., Inc.,
Term Loan, Maturing 3/31/08............................... 1,590,508 1,590,508
Term Loan, Maturing 9/30/08............................... 531,109 531,109
Huntsman Int'l,
Term Loan, Maturing 6/30/07............................... 3,507,084 3,522,428
Term Loan, Maturing 6/30/08............................... 3,507,325 3,523,399
IMC Global, Inc, Term Loan, Maturing 11/17/06............... 4,986,665 5,008,481
NOVEON, Term Loan, Maturing 09/30/08........................ 473,827 474,843
Polymer Group, Inc., Term Loan, Maturing 12/31/06........... 10,575,987 10,311,588
--------------
$ 24,962,356
==============
--------------------------------------------------------------------------------
44
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
BORROWER/TRANCHE DESCRIPTION AMOUNT VALUE
------------------------------------------------------------------------------------------
CONTAINERS, PACKAGING AND GLASS--1.7%
Berry Plastics Corporation, Term Loan, Maturing 6/30/10..... 1,994,962 2,005,935
Consolidated Container Holdings LLC, Term Loan, Maturing
6/30/07................................................... 2,494,316 2,336,344
Crown Cork & Seal Americas, Inc., Term Loan, Maturing
9/15/08................................................... 15,000,000 15,098,445
Owens-Illinois Inc.,
Term Loan, Maturing 4/1/07................................ 7,000,000 6,979,581
Term Loan, Maturing 4/1/08................................ 2,000,000 2,007,500
Stone Container Corporation,
Term Loan, Maturing 6/30/09............................... 3,472,404 3,480,001
Term Loan, Maturing 6/30/10............................... 1,394,712 1,399,767
Tekni-Plex, Inc., Term Loan, Maturing 6/30/08............... 2,314,375 2,282,553
--------------
$ 35,590,126
==============
DIVERSIFIED NATURAL RESOURCES, PRECIOUS METALS, AND
MINERALS--0.0%
Peabody Energy Corporation, Term Loan, Maturing 3/21/10..... 997,500 1,006,021
--------------
$ 1,006,021
==============
DIVERSIFIED/CONGLOMERATE MANUFACTURING--0.5%
Dresser, Inc., Term Loan, Maturing 3/31/07.................. 2,000,000 2,010,892
JohnsonDiversey, Inc., Term Loan, Maturing 11/30/08......... 1,379,882 1,384,482
National Waterworks Holdings, Inc., Term Loan, Maturing
11/22/09.................................................. 989,899 1,000,416
Trimas Corporation, Term Loan, Maturing 12/31/09............ 5,441,725 5,447,575
--------------
$ 9,843,365
==============
DIVERSIFIED/CONGLOMERATE SERVICE--0.1%
Advanstar Communications Inc., Term Loan, Maturing
11/17/07.................................................. 1,685,714 1,639,357
Iron Mountain Incorporated, Term Loan, Maturing 2/15/08..... 1,000,000 1,005,804
--------------
$ 2,645,161
==============
ECOLOGICAL--0.8%
Allied Waste Industries, Inc.,
Term Loan, Maturing 1/15/09............................... 6,570,711 6,620,812
Term Loan, Maturing 1/15/10............................... 9,833,143 9,917,138
--------------
$ 16,537,950
==============
ELECTRONICS--0.1%
Fairchild Semiconductor Corporation, Term Loan, Maturing
6/19/08................................................... 1,000,000 1,011,563
Global Imaging Systems, Inc., Term Loan, Maturing 6/25/09... 500,000 499,375
--------------
$ 1,510,938
==============
--------------------------------------------------------------------------------
45
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
BORROWER/TRANCHE DESCRIPTION AMOUNT VALUE
------------------------------------------------------------------------------------------
HEALTHCARE, EDUCATION, AND CHILDCARE--2.4%
Alliance Imaging, Inc., Term Loan, Maturing 6/10/08......... 5,000,000 4,851,250
Community Health Systems, Inc., Term Loan, Maturing
7/5/10.................................................... 4,967,487 4,957,398
Concentra Managed Care, Inc.,
Term Loan, Maturing 12/31/05.............................. 3,324,675 3,312,623
Term Loan, Maturing 12/31/06.............................. 1,662,338 1,656,312
Cross Country Healthcare, Inc., Term Loan, Maturing
6/5/09.................................................... 3,250,000 3,274,375
DaVita, Inc., Term Loan, Maturing 3/31/09................... 10,473,485 10,501,124
FHC Health Systems, Inc.,
Term Loan, Maturing 4/30/05............................... 1,500,000 1,410,000
Term Loan, Maturing 4/30/06............................... 1,500,000 1,410,000
Fisher Scientific International, LLC, Term Loan, Maturing
3/31/10................................................... 5,985,000 6,020,910
Fresenius Medical Care Holdings, Inc., Term Loan, Maturing
2/21/10................................................... 1,995,000 2,007,261
Knowledge Learning Corporation, Term Loan, Maturing
5/15/10................................................... 3,000,000 2,973,750
Team Health, Term Loan, Maturing 10/31/08................... 3,807,593 3,752,858
Triad Hospitals Holdings, Inc., Term Loan, Maturing
3/31/08................................................... 2,712,155 2,731,111
--------------
$ 48,858,972
==============
HOME AND OFFICE FURNISHINGS, HOUSEWARES, AND DURABLE
CONSUMER GOODS--0.3%
Simmons Company, Term Loan, Maturing 10/30/06............... 1,000,000 1,004,750
Werner Holding Co., Term Loan, Maturing 6/11/09............. 4,500,000 4,559,999
--------------
$ 5,564,749
==============
HOTELS, MOTELS, INNS, AND GAMING--0.6%
Boyd Gaming Corporation, Term Loan, Maturing 6/24/08........ 1,987,481 1,993,940
Extended Stay America, Term Loan, Maturing 12/31/07......... 2,969,697 2,978,182
Penn National Gaming, Inc., Term Loan, Maturing 12/31/09.... 4,000,000 4,009,500
Vail Resorts, Inc., Term Loan, Maturing 12/10/08............ 4,000,000 4,031,252
--------------
$ 13,012,874
==============
LEISURE, AMUSEMENT, ENTERTAINMENT--1.5%
Cinemark USA, Inc., Term Loan, Maturing 3/31/08............. 498,750 502,647
Loews Cineplex Entertainment Corporation, Term Loan,
Maturing 9/30/06.......................................... 15,374,811 15,293,140
Regal Cinemas Inc., Term Loan, Maturing 6/30/09............. 10,500,000 10,591,875
Six Flags Theme Parks Inc., Term Loan, Maturing 6/30/09..... 5,000,000 4,994,270
--------------
$ 31,381,932
==============
--------------------------------------------------------------------------------
46
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
BORROWER/TRANCHE DESCRIPTION AMOUNT VALUE
------------------------------------------------------------------------------------------
MACHINERY (NON-AGRICULTURAL, NON-CONSTRUCTION,
NON-ELECTRONIC)--0.6%
Coinmach Laundry Corporation, Term Loan, Maturing 7/25/09... 3,666,000 3,682,038
Colfax Corporation, Term Loan, Maturing 5/30/09............. 1,875,000 1,870,313
Flowserve Corporation, Term Loan, Maturing 6/30/09.......... 918,796 923,390
Thermadyne Holdings Corporation, Term Loan, Maturing
3/31/08................................................... 5,000,000 5,000,000
--------------
$ 11,475,741
==============
OIL AND GAS--1.1%
Citgo Petroleum Company, Term Loan, Maturing 2/27/06........ 4,858,379 4,991,985
WEG Acquisition, L.P., Term Loan, Maturing 6/17/08.......... 4,100,000 4,141,000
Williams Production RMT Company, Term Loan, Maturing
5/30/07................................................... 13,500,000 13,601,250
--------------
$ 22,734,235
==============
PERSONAL TRANSPORTATION--0.2%
Laidlaw International, Inc., Term Loan, Maturing 6/19/09.... 4,455,000 4,488,413
--------------
$ 4,488,413
==============
PERSONAL AND NON-DURABLE CONSUMER PRODUCTS (MANUFACTURING
ONLY)--0.7%
AMSCAN Holdings, Inc., Term Loan, Maturing 6/15/07.......... 1,977,500 1,997,500
Armkel, LLC, Term Loan, Maturing 3/31/09.................... 547,265 550,985
Mary Kay Cosmetics, Inc., Term Loan, Maturing 9/30/07....... 5,870,531 5,899,884
Playtex Products, Inc., Term Loan, Maturing 5/31/09......... 2,000,000 1,991,250
Rayovac Corporation, Term Loan, Maturing 9/30/09............ 4,012,468 4,020,826
--------------
$ 14,460,445
==============
PERSONAL, FOOD, AND MISCELLANEOUS--0.3%
Buffets, Inc., Term Loan, Maturing 6/30/09.................. 2,593,761 2,568,472
Jack in the Box, Inc., Term Loan, Maturing 7/22/07.......... 3,486,250 3,516,754
--------------
$ 6,085,226
==============
--------------------------------------------------------------------------------
47
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
BORROWER/TRANCHE DESCRIPTION AMOUNT VALUE
------------------------------------------------------------------------------------------
PRINTING AND PUBLISHING--2.1%
American Media Operations Inc., Term Loan, Maturing
4/1/07.................................................... 2,493,639 2,503,770
Bell Actimedia, Inc., Term Loan, Maturing 11/29/10.......... 2,821,422 2,847,520
Dex Media, Inc., Term Loan, Maturing 11/8/09................ 6,314,856 6,410,709
Hollinger International Publishing, Inc, Term Loan, Maturing
9/30/09................................................... 2,977,500 3,018,441
Liberty Group Operating, Inc., Term Loan, Maturing
4/30/07................................................... 5,048,974 5,042,663
Moore Holdings U.S.A. Inc., Term Loan, Maturing 3/15/10..... 8,000,000 8,071,248
QwestDex, Inc., Term Loan, Maturing 8/30/04................. 4,250,000 4,319,063
R.H. Donnelley Inc., Term Loan, Maturing 6/30/10............ 4,987,469 5,080,984
The Reader's Digest Association, Inc.,
Term Loan, Maturing 5/20/07............................... 1,063,503 1,055,526
Term Loan, Maturing 5/20/08............................... 5,061,743 5,022,874
--------------
$ 43,372,798
==============
RETAIL STORES--0.2%
CSK Auto, Inc., Term Loan, Maturing 6/20/09................. 2,750,000 2,777,500
Rite Aid Corporation, Term Loan, Maturing 4/30/08........... 2,000,000 2,029,000
--------------
$ 4,806,500
==============
TELECOMMUNICATIONS--2.7%
Alec Holdings, Inc.,
Term Loan, Maturing 11/30/06.............................. 1,811,133 1,806,605
Term Loan, Maturing 11/30/07.............................. 1,622,653 1,618,596
American Tower, L.P., Term Loan, Maturing 12/31/07.......... 5,984,962 6,001,966
Broadwing Inc.,
Term Loan, Maturing 12/31/04.............................. 8,039,680 8,043,033
Term Loan, Maturing 12/31/05.............................. 3,402,799 3,395,506
Nextel Communications, Inc.,
Term Loan, Maturing 6/30/08............................... 6,320,349 6,306,981
Term Loan, Maturing 12/30/08.............................. 6,320,349 6,306,981
Qwest Corporation, Term Loan, Maturing 6/4/07............... 11,500,000 11,638,000
Spectrasite Communications, Inc., Term Loan, Maturing
12/31/07.................................................. 4,682,899 4,713,633
Western Wireless, Term Loan, Maturing 9/30/08............... 4,488,722 4,289,934
--------------
$ 54,121,235
==============
TEXTILES AND LEATHER--0.1%
St. John Knits International, Inc., Term Loan, Maturing
7/31/07................................................... 2,500,000 2,504,688
--------------
$ 2,504,688
==============
--------------------------------------------------------------------------------
48
PORTFOLIO OF INVESTMENTS (UNAUDITED)
--------------------------------------------------------------------------------
PRINCIPAL
BORROWER/TRANCHE DESCRIPTION AMOUNT VALUE
------------------------------------------------------------------------------------------
UTILITIES--0.3%
Michigan Electric Transmission Company, LLC, Term Loan,
Maturing 6/30/07.......................................... 2,984,925 2,994,563
Pacific Energy Group, LLC, Term Loan, Maturing 7/26/09...... 3,000,000 3,022,500
--------------
$ 6,017,063
==============
TOTAL SENIOR, SECURED, FLOATING RATE INTERESTS (IDENTIFIED COST,
$512,908,759).......................................................... $ 513,552,501
==============
COMMERCIAL PAPER--1.7%
PRINCIPAL
AMOUNT
(000'S
SECURITY OMITTED) VALUE
------------------------------------------------------------------------------------------
Autobahn Funding, 1.45%, 7/1/03............................. 33,097 33,097,000
Jefferson Smurfitt, 1.25%, 7/2/03........................... 1,208 1,207,958
--------------
TOTAL COMMERCIAL PAPER (AT AMORTIZED COST, $34,304,958).................. $ 34,304,958
==============
SHORT-TERM INVESTMENTS--6.9%
PRINCIPAL
AMOUNT
(000'S
SECURITY OMITTED) VALUE
------------------------------------------------------------------------------------------
INVESTORS BANK AND TRUST TIME-DEPOSIT, 1.37%, 7/1/03........ 140,832 140,832,000
--------------
TOTAL SHORT-TERM INVESTMENTS (AT AMORTIZED COST, $140,832,000)........... $ 140,832,000
==============
TOTAL INVESTMENTS--105.2% (IDENTIFIED COST, $2,134,544,003).............. $2,145,156,953
==============
OTHER ASSETS, LESS LIABILITIES--5.2%..................................... $ (104,479,602)
==============
NET ASSETS--100.0%....................................................... $2,040,677,351
==============
------------
(1) Security exempt from registration under Rule 144A of the Securities Act of
1933. These securities may be resold in transactions exempt from
registration, normally to qualified institutional buyers.
(2) A portion of this security is on loan at June 30, 2003.
(3) Senior floating rate interests often require prepayments from excess cash
flows or permit the borrower to repay at its election. The degree to which
borrowers repay, whether as a contractual requirement or at their election,
cannot be predicted with accuracy. As a result, the actual remaining
maturity may be substantially less than the stated maturities shown.
However, it is anticipated that the senior floating rate interests will
have an expected average life of approximately two to four years.
Note: At June 30, 2003, the Trust had unfunded commitments amounting to
$1,875,000 under various revolving credit agreements.
See notes to financial statements.
--------------------------------------------------------------------------------
49
Financial statements (unaudited)
STATEMENT OF ASSETS AND LIABILITIES
AS OF JUNE 30, 2003
ASSETS
Investments, at value (identified cost, $2,134,544,003)... $2,145,156,953
Cash...................................................... 9,012,945
Receivable for investments sold........................... 1,766,044
Receivable from the Investment Adviser.................... 7,500
Interest receivable....................................... 19,119,751
--------------
TOTAL ASSETS................................................ $2,175,063,193
==============
LIABILITIES
Collateral for securities loaned.......................... $ 81,742,000
Payable for investments purchased......................... 51,605,519
Payable to affiliate for Trustees' fees................... 2,560
Accrued organization costs................................ 7,500
Accrued offering costs.................................... 916,094
Accrued expenses.......................................... 112,169
--------------
TOTAL LIABILITIES........................................... $ 134,385,842
==============
NET ASSETS FOR 106,005,000 COMMON SHARES OUTSTANDING........ $2,040,677,351
==============
SOURCES OF NET ASSETS
Paid-in capital........................................... $2,023,491,910
Accumulated undistributed net realized gain (computed on
the basis of identified cost).......................... 709,571
Accumulated undistributed net investment income........... 5,862,920
Net unrealized appreciation (computed on the basis of
identified cost)....................................... 10,612,950
--------------
TOTAL....................................................... $2,040,677,351
==============
NET ASSET VALUE PER COMMON SHARE
($2,040,677,351 / 106,005,000 COMMON SHARES ISSUED AND
OUTSTANDING).............................................. $ 19.25
==============
See notes to financial statements.
--------------------------------------------------------------------------------
50
FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
STATEMENT OF OPERATIONS
FOR THE PERIOD ENDED JUNE 30, 2003(1)
INVESTMENT INCOME
Interest.................................................. $ 6,629,490
Security lending income................................... 273,014
-----------
TOTAL INVESTMENT INCOME..................................... $ 6,902,504
===========
EXPENSES
Investment adviser fee.................................... $ 1,279,883
Trustee's fees and expenses............................... 2,560
Custodian fee............................................. 42,663
Legal and accounting services............................. 21,540
Printing and postage...................................... 12,800
Amortization of organization expenses..................... 7,500
Transfer and dividend disbursing agent fees............... 5,440
Miscellaneous............................................. 16,000
-----------
TOTAL EXPENSES.............................................. $ 1,388,386
===========
Deduct--
Reduction of investment adviser fee....................... $ 341,302
Expense reimbursement..................................... 7,500
-----------
TOTAL EXPENSE REDUCTIONS.................................... $ 348,802
===========
NET EXPENSES................................................ $ 1,039,584
===========
NET INVESTMENT INCOME....................................... $ 5,862,920
===========
REALIZED AND UNREALIZED GAIN (LOSS)
Net realized gain (loss)--
Investment transactions (identified cost basis)........ $ 709,571
-----------
NET REALIZED GAIN........................................... $ 709,571
===========
Change in unrealized appreciation (depreciation)--
Investments (identified cost basis).................... $10,612,950
-----------
NET CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)........ $10,612,950
===========
NET REALIZED AND UNREALIZED GAIN............................ $11,322,521
===========
NET INCREASE IN NET ASSETS FROM OPERATIONS.................. $17,185,441
===========
------------
(1) For the period from the start of business, May 30, 2003, to June 30, 2003.
See notes to financial statements.
--------------------------------------------------------------------------------
51
FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
PERIOD ENDED
JUNE 30, 2003(1)
----------------
INCREASE (DECREASE) IN NET ASSETS
From operations--
Net investment income..................................... $ 5,862,920
Net realized gain......................................... 709,571
Net change in unrealized appreciation (depreciation)...... 10,612,950
--------------
NET INCREASE IN NET ASSETS FROM OPERATIONS.................. $ 17,185,441
==============
Transactions in shares of beneficial interest--
Proceeds from sale of shares(2)........................... $2,024,600,000
Offering Cost............................................. (1,208,090)
--------------
NET INCREASE IN NET ASSETS FROM FUND SHARE TRANSACTIONS..... $2,023,391,910
==============
NET INCREASE IN NET ASSETS.................................. $2,040,577,351
==============
NET ASSETS
At beginning of period...................................... $ 100,000
--------------
AT END OF PERIOD............................................ $2,040,677,351
==============
ACCUMULATED UNDISTRIBUTED NET INVESTMENT INCOME INCLUDED IN
NET ASSETS
AT END OF PERIOD............................................ $ 5,862,920
==============
------------
(1) For the period from the start of business, May 30, 2003, to June 30, 2003.
(2) Proceeds from sales of shares net of sales load paid of $95,400,000.
See notes to financial statements.
--------------------------------------------------------------------------------
52
FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
PERIOD ENDED
JUNE 30,
2003(1)(2)
-------------------
Net asset value--beginning of period(3)..................... $ 19.100
----------
INCOME (LOSS) FROM OPERATIONS
Net investment income....................................... $ 0.058
Net realized and unrealized gain............................ 0.104
----------
TOTAL INCOME FROM OPERATIONS................................ $ 0.162
==========
OFFERING COSTS.............................................. $ (0.012)
==========
NET ASSET VALUE--END OF PERIOD.............................. $ 19.250
==========
MARKET VALUE--END OF PERIOD................................. $ 20.000
==========
TOTAL INVESTMENT RETURN ON NET ASSET VALUE(4)............... 0.78%
==========
TOTAL INVESTMENT RETURN ON MARKET VALUE(4).................. 4.71%
==========
RATIOS/SUPPLEMENTAL DATA+
Net assets, end of period (000's omitted)................... $2,040,677
Ratios (as a percentage of average daily net assets):
Net expenses.............................................. 0.61%(5)
Net investment income..................................... 3.44%(5)
Portfolio turnover.......................................... 43%
------------
+ The operating expenses of the Fund reflect a reduction of the investment
adviser fee and a reimbursement of expenses by the Adviser. Had such actions
not been taken, the ratios and net investment income per share would have
been as follows:
Ratios (as a percentage of average daily net assets):
Expenses.................................................. 0.81%(5)
Net investment income..................................... 3.24%(5)
Net investment income per share............................. $0.055
(1) For the period from the start of business, May 30, 2003, to June 30, 2003.
(2) Computed using average common shares outstanding.
(3) Net asset value at beginning of period reflects the deduction of the sales
load of $0.90 per share paid by the shareholder from the $20.00 offering
price.
(4) Total investment return on net asset value is calculated assuming a
purchase at the offering price of $20.00 less the sales load of $0.90 per
share paid by the shareholder on the first day and a sale at the net asset
value on the last day of the period reported. Total investment return on
market value is calculated assuming a purchase at the offering price of
$20.00 less the sales load of $0.90 per share paid by the shareholder on
the first day and a sale at the current market price on the last day of the
period reported. Total investment return on net asset value and total
investment return on market value are not computed on an annualized basis.
(5) Annualized.
See notes to financial statements.
--------------------------------------------------------------------------------
53
Notes to financial statements (unaudited)
1: SIGNIFICANT ACCOUNTING POLICIES
Eaton Vance Limited Duration Income Fund (the Fund) is registered under the
Investment Company Act of 1940, as amended, as a diversified closed-end
management investment company. The Fund, which was organized as a Massachusetts
business trust on March 12, 2003, seek to provide a high level of current income
consistent with the preservation of capital by investing primarily in, mortgage-
backed securities (MBS) issued, backed or otherwise guaranteed by the U.S.
government or its agencies or instrumentalities, senior, secured floating rate
loans made to corporate and other business entities (Senior Loans), and
corporate bonds of below investment grade quality (Non-Investment Grade Bonds).
The following is a summary of significant accounting policies of the Fund. The
policies are in conformity with accounting principles generally accepted in the
United States of America.
A: INVESTMENT VALUATION
Mortgage backed, pass-through securities are valued using an independent matrix
pricing system applied by the adviser which takes into account closing bond
valuations, yield differentials, anticipated prepayments and interest rates
provided by dealers. Debt securities (other than seasoned mortgage backed,
pass-through securities) are normally valued on the basis of valuations
furnished by dealers or a pricing service. Certain senior loans are deemed to be
liquid if reliable market quotations are readily available for them. Liquid
Senior Loans are valued on the basis of prices furnished by a pricing service.
Other Senior Loans are valued at fair value by the Fund's investment advisor,
Boston Management and Research (BMR), under procedures established by the
Trustees as permitted by Section 2(a)(41) of the Investment Company Act of 1940.
Such procedures include the consideration of relevant factors, data and
information relating to fair value, including (i) the characteristics of and
fundamental analytical data relating to the Senior Loan, including the cost,
size, current interest rate, period until next interest rate reset, maturity and
base lending rate of the Senior Loan, the terms and conditions of the Senior
Loan and any related agreements, and the position of the Senior Loan in the
Borrower's debt structure; (ii) the nature, adequacy and value of the
collateral, including the Fund's rights, remedies and interests with respect to
the collateral; (iii) the creditworthiness of the Borrower, based on an
evaluation of its financial condition, financial statements and information
about the Borrower's business, cash flows, capital structure and future
prospects; (iv) information relating to the market for the Senior Loan including
price quotations for and trading in the Senior Loan, and interests in similar
Senior Loans and the market environment and investor attitudes towards the
Senior Loan and interests in similar Senior Loans; (v) the reputation and
financial condition of the agent and any intermediate participant in the Senior
Loan; and (vi) general economic and market conditions affecting the fair value
of the Senior Loan. Other portfolio's securities (other than short-term
obligations, but including listed issues) may be valued on the basis of prices
furnished by one or more pricing services which determine prices for normal,
institutional-size trading units of such securities which may use market
information, transactions for comparable securities and various relationships
between securities which are generally recognized by institutional traders. In
certain circumstances, portfolio securities will be valued at the last price on
the exchange that is the primary market for such securities, or the last quoted
bid price for those securities for which the over-the-counter market is the
primary market or for listed securities in which there were no sales during the
day. The value of interest rate swaps is determined by changes in the
relationship between two rates of interest. Short-term obligations which mature
in sixty days or less, are valued at amortized cost, if their original term to
maturity when acquired by the Fund was 60 days or less or are valued at
amortized cost using their value on the 61st day prior to maturity, if their
original term to maturity when acquired by the Fund was more than 60 days,
unless in each case this is determined not to represent fair value. Options are
valued at last sale price on a U.S. exchange or board of trade or, in the
absence of a sale, at the mean between the last bid and asked price. Financial
futures contracts listed on commodity exchanges are valued at closing settlement
prices. Securities for which there is no such quotation or valuation are valued
at fair
--------------------------------------------------------------------------------
54
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
value using methods determined in good faith by or at the direction of the
Trustees. Repurchase agreements are valued at cost plus accrued interest. Other
portfolio securities for which there are no quotations or valuations are valued
at fair value as determined in good faith by or on behalf of the Trustees.
B: INCOME
Interest income from Senior Loans is recorded on the accrual basis at the
then-current interest rate, while all other interest income is determined on the
basis of interest accrued, adjusted for amortization of premium or accretion of
discount. Facility fees received are recognized as income over the expected term
of the loan. Dividend income is recorded on the ex-dividend date for dividends
received in cash and/or securities.
C: FEDERAL TAXES
The Fund's policy is to comply with the provisions of the Internal Revenue Code
applicable to regulated investment companies and to distribute to shareholders
each year all of its taxable income, including any net realized gain on
investments. Accordingly, no provision for federal income or excise tax is
necessary.
D: INVESTMENT TRANSACTIONS
Investment transactions are recorded on a trade date basis. Realized gains and
losses from such transactions are determined using the specific identification
method. Securities purchased or sold on a when-issued or delayed delivery basis
may be settled a month or more after the transaction date. The securities so
purchased are subject to market fluctuations during this period. To the extent
that when-issued or delayed delivery purchases are outstanding, the Fund
instructs the custodian to segregate assets in a separate account, with a
current value at least equal to the amount of its purchase commitments.
E: OFFERINGS COSTS
Costs incurred by the Fund in connection with the offering of the common shares
were recorded as a reduction of capital paid in excess of par applicable to
common shares.
F: EXPENSE REDUCTION
Investors Bank & Trust Company (IBT) serves as custodian of the Fund. Pursuant
to the custodian agreement, IBT receives a fee reduced by credits which are
determined based on the average daily cash balances the Fund maintains with IBT.
All significant credit balances used to reduce the Fund's custodian fees are
reported as a reduction of expenses on the Statement of Operations.
G: WRITTEN OPTIONS
Upon the writing of a call or a put option, an amount equal to the premium
received by the Fund is included in the Statement of Assets and Liabilities as a
liability. The amount of the liability is subsequently marked-to-market to
reflect the current value of the option written in accordance with the Fund's
policies on investment valuations discussed above. Premiums received from
writing options which expire are treated as realized gains. Premiums received
from writing options which are exercised or are closed are added to or offset
against the proceeds or amount paid on the transaction to determine the realized
gain or loss. If a put option is exercised, the premium reduces the cost basis
of the securities purchased by the Fund. The Fund, as writer of an option, may
have no control over
--------------------------------------------------------------------------------
55
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
whether the underlying securities may be sold (call) or purchased (put) and, as
a result, bears the market risk of an unfavorable change in the price of the
securities underlying the written option.
H: PURCHASED OPTIONS
Upon the purchase of a call or put option, the premium paid by the Fund is
included in the Statement of Assets and Liabilities as an investment. The amount
of the investment is subsequently marked-to-market to reflect the current market
value of the option purchased, in accordance with the Fund's policies on
investment valuations discussed above. If an option which the Fund has purchased
expires on the stipulated expiration date, the Fund will realize a loss in the
amount of the cost of the option. If the Fund enters into a closing sale
transaction, the Fund will realize a gain or loss, depending on whether the
sales proceeds from the closing sale transaction are greater or less than the
cost of the option. If a Fund exercises a put option, it will realize a gain or
loss from the sale of the underlying security, and the proceeds from such sale
will be decreased by the premium originally paid. If the Fund exercises a call
option, the cost of the security which the Fund purchases upon exercise will be
increased by the premium originally paid. For tax purposes, the Fund's options
are generally subject to the mixed straddle rules described in Note 1C, and
unrealized gains or losses are recognized on a daily basis.
I: FINANCIAL FUTURES CONTRACTS
Upon entering into a financial futures contract, the Fund is required to deposit
an amount (initial margin) either in cash or securities equal to a certain
percentage of the purchase price indicated in the financial futures contract.
Subsequent payments are made or received by the Fund (margin maintenance) each
day, dependent on the daily fluctuations in the value of the underlying
securities, and are recorded for book purposes as unrealized gains or losses by
the Fund.
If the Fund enters into a closing transaction, the Fund will realize, for book
purposes, a gain or loss equal to the difference between the value of the
financial futures contract to sell and the financial futures contract to buy.
The Fund's investment in financial futures contracts is designed only to hedge
against anticipated future changes in interest rates. Should interest rates move
unexpectedly, the Fund may not achieve the anticipated benefits of the financial
futures contracts and may realize a loss. For tax purposes, such futures
contracts are generally subject to the mixed straddle rules described in Note
1F, and unrealized gains or losses are recognized on a daily basis.
J: REVERSE REPURCHASE AGREEMENTS
The Fund may enter into reverse repurchase agreements. Under such an agreement,
the Fund temporarily transfers possession, but not ownership, of a security to a
counterparty, in return for cash. At the same time, the Fund agrees to
repurchase the security at an agreed-upon price and time in the future. The Fund
may enter into reverse repurchase agreements for temporary purposes, such as to
fund withdrawals, or for use as hedging instruments where the underlying
security is denominated in a foreign currency. As a form of leverage, reverse
repurchase agreements may increase the risk of fluctuation in the market value
of the Fund's assets or in its yield. Liabilities to counterparties under
reverse repurchase agreements are recognized in the Statement of Assets and
Liabilities at the same time at which cash is received by the Fund. The
securities underlying such agreements continue to be treated as owned by the
Fund and remain in the Fund of Investments. Interest charged on amounts borrowed
by the Fund under reverse repurchase agreements is accrued daily.
--------------------------------------------------------------------------------
56
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
K: TOTAL RETURN SWAPS
The Fund may enter into swap agreements to enhance return, to hedge against
fluctuations in securities prices or interest rates or as substitution for the
purchase or sale of securities. Pursuant to these agreements, the Fund makes
monthly payments at a rate equal to a predetermined spread to the one-month
LIBOR. In exchange, the Fund receives payments based on the rate of return of a
benchmark industry index. During the term of the outstanding swap agreement,
changes in the underlying value of the swap are recorded as unrealized gains and
losses. Payments received or made at the end of the measurement period are
recorded as realized gains and losses. The value of the swap is determined by
changes in the relationship between the rate of interest and the benchmark
industry index. The Fund is exposed to credit loss in the event of
non-performance by the swap counterparty. However, the Fund does not anticipate
non-performance by the counterparty. Risk may also arise from the unanticipated
movements in value of interest rates or the index.
L: OTHER
Investment transactions are accounted for on the date the securities are
purchased or sold. Realized gains and losses are computed based on the specific
identification of securities sold.
M: USE OF ESTIMATES
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and the reported
amounts of income and expense during the reporting period. Actual results could
differ from those estimates.
N: INTERIM FINANCIAL STATEMENTS
The interim financial statements relating to June 30, 2003 and for the period
then ended have not been audited by independent certified public accountants,
but in the opinion of the Fund's management reflect all adjustments, consisting
only of normal recurring adjustments, necessary for the fair presentation of the
financial statements.
2: DISTRIBUTION TO SHAREHOLDERS
The Fund intends to make monthly distributions of net investment income.
Distributions are recorded on the ex-dividend date. In addition, at least
annually, the Funds intend to distribute net capital gain, if any.
3: INVESTMENT ADVISER FEE AND OTHER TRANSACTIONS WITH AFFILIATES
The investment adviser fee, computed at an annual rate of 0.75% of the Fund's
average weekly gross assets, was earned by Eaton Vance Management (EVM), as
compensation for management and investment advisory services rendered to the
Fund. For the period from the start of business, May 30, 2003, to June 30, 2003
the fee was equivalent to 0.75% (annualized) of the Fund's average weekly gross
assets for such period and amounted to $1,279,883.
In addition, the Adviser has contractually agreed to reimburse the Fund for fees
and other expenses in the amount of 0.20% of average weekly gross assets of the
Fund for the first five years of the Fund's operations. For the period from the
start of business, May 30, 2003, to June 30, 2003 the Investment Adviser waived
$341,302 of its advisory fee.
--------------------------------------------------------------------------------
57
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
Trustees of the Fund that are not affiliated with the Investment Adviser may
elect to defer receipt of all or a percentage of their annual fees in accordance
with the terms of the Trustees Deferred Compensation Plan. For the period from
the start of business, May 30, 2003, to June 30, 2003, no significant amounts
have been deferred.
Certain officers and Trustees of the Fund are officers of the above
organizations.
4: PURCHASES AND SALES OF INVESTMENTS
Purchases, sales and paydowns of investments, other than short-term obligations,
aggregated $2,419,710,839 and $456,875,348, respectively.
5: SECURITIES LENDING AGREEMENT
The Fund has established a securities lending agreement with brokers in which
the Fund lends portfolio securities to a broker in exchange for collateral
consisting of either cash or U.S. government securities in an amount at least
equal to the market value of the securities on loan. Under the agreement, the
Fund continues to earn interest on the securities loaned. Collateral received is
generally cash, and the Fund invests in cash and receives any interest on the
amount invested but it must also pay the broker a loan rebate fee computed as a
varying percentage of the collateral received. The loan rebate fee paid by the
Fund offsets a portion of the interest income received and amounted to $9,808
for the period from the start of business, May 30, 2003, to June 30, 2003. At
June 30, 2003, the value of the securities loaned and the value of the
collateral amounted to $63,458,039 and $81,742,000, respectively. In the event
of counterparty default, the Fund is subject to potential loss if it is delayed
or prevented from exercising its right to dispose of the collateral. The Fund
bears risk in the event that invested collateral is not sufficient to meet
obligations due on the loans.
6: COMMON SHARES OF BENEFICIAL INTEREST
The Agreement and Declaration of Trust permits the Trustees to issue an
unlimited number of full and fractional $0.01 par value common shares of
beneficial interest. Transactions in common shares were as follows:
PERIOD ENDED
JUNE 30, 2003
(UNAUDITED)(1)
----------------------------------------------------------------------------
Sales....................................................... 106,005,000
-----------
NET INCREASE................................................ 106,005,000
===========
------------
(1) For the period from the start of business, May 30, 2003, to June 20, 2003.
7: FEDERAL INCOME TAX BASIS OF UNREALIZED APPRECIATION (DEPRECIATION)
The cost and unrealized appreciation (depreciation) in value of the investments
owned at June 30, 2003, as computed on a federal income tax basis, were as
follows:
AGGREGATE COST.............................................. $2,136,574,812
==============
Gross unrealized appreciation............................... $ 14,514,018
Gross unrealized depreciation............................... (5,931,877)
--------------
NET UNREALIZED APPRECIATION................................. $ 8,582,141
==============
--------------------------------------------------------------------------------
58
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
--------------------------------------------------------------------------------
8: FINANCIAL INSTRUMENTS
The Fund regularly trades in financial instruments with off-balance sheet risk
in the normal course of its investing activities to assist in managing exposure
to various market risks. These financial instruments include written options and
financial futures contracts, and may involve, to a varying degree, elements of
risk in excess of the amounts recognized for financial statement purposes. The
notional or contractual amounts of these instruments represent the investment
the Fund has in particular classes of financial instruments and does not
necessarily represent the amounts potentially subject to risk. The measurement
of the risks associated with these instruments is meaningful only when all
related and offsetting transactions are considered. At June 30, 2003 there were
no outstanding obligations under these financial interments.
--------------------------------------------------------------------------------
59
APPENDIX A
--------------------------------------------------------------------------------
Description of securities ratings+
Moody's Investors Service, Inc.
LONG-TERM DEBT SECURITIES RATINGS
AAA: Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
AA: Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long term risk appear somewhat larger than the Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
BAA: Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
BA: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during other good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
CAA: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
CA: Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
---------------
+ The ratings indicated herein are believed to be the most recent ratings
available at the date of this SAI for the securities listed. Ratings are
generally given to securities at the time of issuance. While the rating
agencies may from time to time revise such ratings, they undertake no
obligation to do so, and the ratings indicated do not necessarily represent
ratings which would be given to these securities on the date of the Fund's
fiscal year end.
--------------------------------------------------------------------------------
A-1
DESCRIPTION OF SECURITIES RATINGS
--------------------------------------------------------------------------------
Absence of Rating: Where no rating has been assigned or where a rating has been
suspended or withdrawn, it may be for reasons unrelated to the quality of the
issue.
Should no rating be assigned, the reason may be one of the following:
1. An application for rating was not received or accepted.
2. The issue or issuer belongs to a group of securities or companies that are
not rated as a matter of policy.
3. There is a lack of essential data pertaining to the issue or issuer.
4. The issue was privately placed, in which case the rating is not published in
Moody's publications.
Suspension or withdrawal may occur if new and material circumstances arise, the
effects of which preclude satisfactory analysis; if there is no longer available
reasonable up-to-date data to permit a judgment to be formed; if a bond is
called for redemption; or for other reasons.
Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through B in its bond rating system. The modifier 1
indicates that the security ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates that the issue ranks in the lower end of its generic rating category.
SHORT-TERM DEBT SECURITIES RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be investment
grade, to indicate the relative repayment ability of rated issuers:
PRIME-1: Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1 repayment
ability will often be evidenced by many of the following characteristics:
leading market positions in well-established industries; high rates of return on
funds employed; conservative capitalization structure with moderate reliance on
debt and ample asset protection; broad margins in earnings coverage of fixed
financial charges and high internal cash generation; and well-established access
to a range of financial markets and assured sources of alternate liquidity.
PRIME-2: Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
PRIME-3: Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt protection
measurements and may require relatively high financial leverage. Adequate
alternate liquidity is maintained.
NOT PRIME: Issuers rated Not Prime do not fall within any of the Prime rating
categories.
--------------------------------------------------------------------------------
A-2
DESCRIPTION OF SECURITIES RATINGS
--------------------------------------------------------------------------------
STANDARD & POOR'S RATINGS GROUP
INVESTMENT GRADE
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 an adequate capacity to pay interest
and repay principal. Whereas it normally exhibit adequate protection parameters,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to pay interest and repay principal for debt in this
category than in higher rated categories.
SPECULATIVE GRADE
Debt rated BB, B, CCC, CC and C is regarded as having predominantly speculative
characteristics with respect to capacity to pay interest and repay principal. BB
indicates the least degree of speculation and C the highest. While such debt
will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major exposures to adverse conditions.
BB: Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB- rating.
B: Debt rated B has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The B rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied BB or BB-
rating.
CCC: Debt rated CCC has a currently identifiable vulnerability to default, and
is dependent upon favorable business, financial, and economic conditions to meet
timely payment of interest and repayment of principal. In the event of adverse
business, financial, or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The CCC rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
B or B- rating.
CC: The rating CC is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC debt rating.
C: The rating C is typically applied to debt subordinated to senior debt which
is assigned an actual or implied CCC- debt rating. The C rating may be used to
cover a situation where a bankruptcy petition has been filed, but debt service
payments are continued.
C1: The Rating C1 is reserved for income bonds on which no interest is being
paid.
D: Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating also will be used upon the
filing of a bankruptcy petition if debt service payments are jeopardized.
--------------------------------------------------------------------------------
A-3
DESCRIPTION OF SECURITIES RATINGS
--------------------------------------------------------------------------------
PLUS (+) OR MINUS (-): The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
P: The letter "p" indicates that the rating is provisional. A provisional
rating assumes the successful completion of the project being financed by the
debt being rated and indicates that payment of debt service requirements is
largely or entirely dependent upon the successful and timely completion of the
project. This rating, however, while addressing credit quality subsequent to
completion of the project, makes no comment on the likelihood of, or the risk of
default upon failure of such completion. The investor should exercise his own
judgment with respect to such likelihood and risk.
L: The letter "L" indicates that the rating pertains to the principal amount of
those bonds to the extent that the underlying deposit collateral is insured by
the Federal Deposit Insurance Corp. and interest is adequately collateralized.
In the case of certificates of deposit, the letter "L" indicates that the
deposit, combined with other deposits being held in the same right and capacity,
will be honored for principal and accrued pre-default interest up to the federal
insurance limits within 30 days after closing of the insured institution or, in
the event that the deposit is assumed by a successor insured institution, upon
maturity.
NR: NR indicates no rating has been requested, that there is insufficient
information on which to base a rating, or that S&P does not rate a particular
type of obligation as a matter of policy.
COMMERCIAL PAPER
COMMERCIAL PAPER RATING DEFINITIONS
A S&P's commercial paper rating is a current assessment of the likelihood of
timely payment of debt having an original maturity of no more than 365 days.
Ratings are graded into several categories, ranging from A for the highest
quality obligations to D for the lowest. These categories are as follows:
A-1: A short-term obligation rated A-1 is rated in the highest category by S&P.
The obligor's capacity to meet its financial commitment on the obligation is
strong. Within this category, certain obligations are designated with a plus
sign (+). This indicates that the obligor's capacity to meet its financial
commitment on these obligations is extremely strong.
A-2: A short-term obligation rated A-2 is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to meet
its financial commitment on the obligation is satisfactory.
A-3: A short-term obligation rated A-3 exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
B: A short-term obligation rated B is regarded as having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet its
financial commitment on the obligation.
C: A short-term obligation rated C is currently vulnerable to nonpayment and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation.
D: A short-term obligation rated D is in payment default. The D rating category
is used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating also will be used upon the
filing of a bankruptcy petition or the taking of a similar action if payments on
an obligation are jeopardized.
--------------------------------------------------------------------------------
A-4
DESCRIPTION OF SECURITIES RATINGS
--------------------------------------------------------------------------------
A commercial paper rating is not a recommendation to purchase, sell or hold a
security inasmuch as it does not comment as to market price or suitability for a
particular investor. The ratings are based on current information furnished to
S&P by the issuer or obtained from other sources it considers reliable. S&P does
not perform an audit in connection with any rating and may, on occasion, rely on
unaudited financial information. The ratings may be changed, suspended, or
withdrawn as a result of changes in or unavailability of such information.
FITCH RATINGS
INVESTMENT GRADE BOND RATINGS
AAA: Bonds considered to be investment grade and of the highest credit quality.
The obligor has an exceptionally strong ability to pay interest and repay
principal, which is unlikely to be affected by reasonably foreseeable events.
AA: Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated 'AAA'. Because bonds rated in the
'AAA' and 'AA' categories are not significantly vulnerable to foreseeable future
developments, short-term debt of these issuers is generally rated 'F-1+'.
A: Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB: Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is considered
to be adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these bonds, and therefore,
impair timely payment. The likelihood that the ratings of these bonds will fall
below investment grade is higher than for bonds with higher ratings.
HIGH YIELD BOND RATINGS
BB: Bonds are considered speculative. The obligor's ability to pay interest and
repay principal may be affected over time by adverse economic changes. However,
business and financial alternatives can be identified that could assist the
obligor in satisfying its debt service requirements.
B: Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued timely
payment of principal and interest reflects the obligor's limited margin of
safety and the need for reasonable business and economic activity throughout the
life of the issue.
CCC: Bonds have certain identifiable characteristics which, if not remedied,
may lead to default. The ability to meet obligations requires an advantageous
business and economic environment.
CC: Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
C: Bonds are in imminent default in payment of interest or principal.
DDD, DD AND D: Bonds are in default on interest and/or principal payments. Such
bonds are extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the obligor. 'DDD'
represents the highest potential for recovery on these bonds, and 'D' represents
the lowest potential for recovery.
PLUS (+) OR MINUS (-): The ratings from AA to C may be modified by the addition
of a plus or minus sign to indicate the relative position of a credit within the
rating category.
NR: Indicates that Fitch does not rate the specific issue.
--------------------------------------------------------------------------------
A-5
DESCRIPTION OF SECURITIES RATINGS
--------------------------------------------------------------------------------
CONDITIONAL: A conditional rating is premised on the successful completion of a
project or the occurrence of a specific event.
INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on demand
or have original maturities of generally up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
F-1+: Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
F-1: Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated
'F-1+'.
F-2: Good Credit Quality. Issues carrying this rating have a satisfactory
degree of assurance for timely payment, but the margin of safety is not as great
as the 'F-1+' and 'F-1' categories.
F-3: Fair Credit Quality. Issues carrying this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate, however,
near-term adverse change could cause these securities to be rated below
investment grade.
* * * * * * * *
Notes: Bonds which are unrated expose the investor to risks with respect to
capacity to pay interest or repay principal which are similar to the risks of
lower-rated speculative bonds. The Fund is dependent on the Adviser's judgment,
analysis and experience in the evaluation of such bonds.
Investors should note that the assignment of a rating to a bond by a rating
service may not reflect the effect of recent developments on the issuer's
ability to make interest and principal payments.
--------------------------------------------------------------------------------
A-6
APPENDIX B
--------------------------------------------------------------------------------
EATON VANCE LIMITED DURATION INCOME FUND
AMENDMENT NO. 1 TO BY-LAWS--STATEMENT
CREATING FIVE SERIES OF
AUCTION PREFERRED SHARES
WHEREAS, Section 5.1 of Article VI of the Agreement and Declaration of Trust
dated March 12, 2003 of Eaton Vance Limited Duration Income Fund (the
"Declaration of Trust"), a copy of which is on file in the office of the
Secretary of the Commonwealth of The Commonwealth of Massachusetts, provides
that the Trustees may, without shareholder approval, authorize one or more
classes of shares (which classes may be divided into two or more series), shares
of each such class or series having such preferences, voting powers,
restrictions, limitations as to dividends, qualifications, and terms and
conditions of redemption, as the Trustees may determine and as shall be set
forth in the By-laws; and
WHEREAS, pursuant to authority expressly vested in the Trustees of the Trust by
Section 5.1 of Article VI of the Declaration of Trust, the Trustees have
authorized, in addition to that Trust's common shares, a class of 38,000
preferred shares which are now to be issued divided into one series of 7,600
shares, one series 7,600 shares, one series of 7,600 shares, one series of 7,600
shares and one series of 7,600 shares of its authorized preferred shares, $0.01
par value, liquidation preference $25,000 per share plus accumulated but unpaid
dividends thereon, if any (whether or not earned or declared), plus the premium,
if any, resulting from the designation of a Premium Call Period, designated
respectively Series A Auction Preferred Shares, Series B Auction Preferred
Shares, Series C Auction Preferred Shares, Series D Auction Preferred Shares and
Series E Auction Preferred Shares.
NOW, THEREFORE, the By-laws of Eaton Vance Limited Duration Income Fund are
hereby amended as follows:
1. ARTICLES VII through XIII shall be redesignated as ARTICLES VIII
through XIV and all affected cross references therein hereby are
amended accordingly.
2. A new ARTICLE VII shall be added as follows:
ARTICLE VII
STATEMENT CREATING FIVE SERIES OF AUCTION PREFERRED SHARES
DESIGNATION
Auction Preferred Shares, Series A: 7,600 shares of beneficial interest of
Preferred Shares, par value $0.01 per share, liquidation preference $25,000 per
share plus an amount equal to accumulated but unpaid dividends (whether or not
earned or declared) thereon, is hereby designated "Auction Preferred Shares,
Series A." Each share of Auction Preferred Shares, Series A (sometimes referred
to herein as "Series A APS") may be issued on a date to be determined by the
Board of Trustees of the Trust or pursuant to their delegated authority; have an
Initial Dividend Rate and an Initial Dividend Payment Date as shall be
determined in advance of the issuance thereof by the Board of Trustees of the
Trust or pursuant to their delegated authority; and have such other preferences,
voting powers, limitations as to dividends, qualifications and terms and
conditions of redemption as are set forth in these Amended By-Laws. The Series A
APS shall constitute a separate series of Preferred Shares of the Trust, and
each share of Series A APS shall be identical.
Auction Preferred Shares, Series B: 7,600 shares of beneficial interest of
Preferred Shares, par value $0.01 per share, liquidation preference $25,000 per
share plus an amount equal to accumulated but unpaid dividends (whether or not
earned or declared) thereon, is hereby designated "Auction Preferred
--------------------------------------------------------------------------------
B-1
Shares, Series B." Each share of Auction Preferred Shares, Series B (sometimes
referred to herein as "Series B APS") may be issued on a date to be determined
by the Board of Trustees of the Trust or pursuant to their delegated authority;
have an Initial Dividend Rate and an Initial Dividend Payment Date as shall be
determined in advance of the issuance thereof by the Board of Trustees of the
Trust or pursuant to their delegated authority; and have such other preferences,
voting powers, limitations as to dividends, qualifications and terms and
conditions of redemption as are set forth in these Amended By-Laws. The Series B
APS shall constitute a separate series of Preferred Shares of the Trust, and
each share of Series B APS shall be identical.
Auction Preferred Shares, Series C: 7,600 shares of beneficial interest of
Preferred Shares, par value $0.01 per share, liquidation preference $25,000 per
share plus an amount equal to accumulated but unpaid dividends (whether or not
earned or declared) thereon, is hereby designated "Auction Preferred Shares,
Series C." Each share of Auction Preferred Shares, Series C (sometimes referred
to herein as "Series C APS") may be issued on a date to be determined by the
Board of Trustees of the Trust or pursuant to their delegated authority; have an
Initial Dividend Rate and an Initial Dividend Payment Date as shall be
determined in advance of the issuance thereof by the Board of Trustees of the
Trust or pursuant to their delegated authority; and have such other preferences,
voting powers, limitations as to dividends, qualifications and terms and
conditions of redemption as are set forth in these Amended By-Laws. The Series C
APS shall constitute a separate series of Preferred Shares of the Trust, and
each share of Series C APS shall be identical.
Auction Preferred Shares, Series D: 7,600 shares of beneficial interest of
Preferred Shares, par value $0.01 per share, liquidation preference $25,000 per
share plus an amount equal to accumulated but unpaid dividends (whether or not
earned or declared) thereon, is hereby designated "Auction Preferred Shares,
Series D." Each share of Auction Preferred Shares, Series D (sometimes referred
to herein as "Series D APS") may be issued on a date to be determined by the
Board of Trustees of the Trust or pursuant to their delegated authority; have an
Initial Dividend Rate and an Initial Dividend Payment Date as shall be
determined in advance of the issuance thereof by the Board of Trustees of the
Trust or pursuant to their delegated authority; and have such other preferences,
voting powers, limitations as to dividends, qualifications and terms and
conditions of redemption as are set forth in these Amended By-Laws. The Series D
APS shall constitute a separate series of Preferred Shares of the Trust, and
each share of Series D APS shall be identical.
Auction Preferred Shares, Series E: 7,600 shares of beneficial interest of
Preferred Shares, par value $0.01 per share, liquidation preference $25,000 per
share plus an amount equal to accumulated but unpaid dividends (whether or not
earned or declared) thereon, is hereby designated "Auction Preferred Shares,
Series E." Each share of Auction Preferred Shares, Series E (sometimes referred
to herein as "Series E APS") may be issued on a date to be determined by the
Board of Trustees of the Trust or pursuant to their delegated authority; have an
Initial Dividend Rate and an Initial Dividend Payment Date as shall be
determined in advance of the issuance thereof by the Board of Trustees of the
Trust or pursuant to their delegated authority; and have such other preferences,
voting powers, limitations as to dividends, qualifications and terms and
conditions of redemption as are set forth in these Amended By-Laws. The Series E
APS shall constitute a separate series of Preferred Shares of the Trust, and
each share of Series E APS shall be identical. The Series A APS, the Series B
APS, the Series C APS, the Series D APS and the Series E APS are sometimes
collectively referred to herein as the "APS."
1. DEFINITIONS. (a) Unless the context or use indicates another or different
meaning or intent, in these Amended By-Laws the following terms have the
following meanings, whether used in the singular or plural:
"7-Day Dividend Period" means a Dividend Period consisting of seven days.
"1940 Act" means the Investment Company Act of 1940, as amended from time to
time.
"1940 Act APS Asset Coverage" means asset coverage, as defined in section 18(h)
of the 1940 Act, of at least 200% with respect to all outstanding senior
securities of the Trust which are shares of
--------------------------------------------------------------------------------
B-2
beneficial interest, including all outstanding shares of APS and Other 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 shares of
beneficial interest of a closed-end investment company as a condition of paying
dividends on its Common Shares).
"1940 Act Cure Date," with respect to the failure by the Trust to maintain the
1940 Act APS Asset Coverage (as required by paragraph 6 of these Amended
By-Laws) as of the last Business Day of each month, means the last Business Day
of the following month.
" 'AA' Composite Commercial Paper Rate," on any date of determination, means (i)
the Interest Equivalent of the rate on commercial paper placed on behalf of
issuers whose corporate bonds are rated "AA" by Fitch or "Aa" by Moody's or the
equivalent of such rating by another nationally recognized rating agency, as
such rate is 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 such a rate, then the arithmetic average of the Interest Equivalent of
the rate on commercial paper placed on behalf of such issuers, as quoted on a
discount basis or otherwise by UBS Securities LLC or its successors that are
Commercial Paper Dealers, to the Auction Agent for the close of business on the
Business Day immediately preceding such date. If one of the Commercial Paper
Dealers does not quote a rate required to determine the "AA" Composite
Commercial Paper Rate, the "AA" Composite Commercial Paper Rate will be
determined on the basis of the quotation or quotations furnished by any
Substitute Commercial Paper Dealer or Substitute Commercial Paper Dealers
selected by the Trust to provide such rate or rates not being supplied by the
Commercial Paper Dealer. If the number of Dividend Period days shall be (i) 7 or
more but fewer than 49 days, such rate shall be the Interest Equivalent of the
30-day rate on such commercial paper; (ii) 49 or more but fewer than 70 days,
such rate shall be the Interest Equivalent of the 60-day rate on such commercial
paper; (iii) 70 or more days but fewer than 85 days, such rate shall be the
arithmetic average of the Interest Equivalent on the 60-day and 90-day rates on
such commercial paper; (iv) 85 or more days but fewer than 99 days, such rate
shall be the Interest Equivalent of the 90-day rate on such commercial paper;
(v) 99 or more days but fewer than 120 days, such rate shall be the arithmetic
average of the Interest Equivalent of the 90-day and 120-day rates on such
commercial paper; (vi) 120 or more days but fewer than 141 days, such rate shall
be the Interest Equivalent of the 120-day rate on such commercial paper; (vii)
141 or more days but fewer than 162 days, such rate shall be the arithmetic
average of the Interest Equivalent of the 120-day and 180-day rates on such
commercial paper; and (viii) 162 or more days but fewer than 183 days, such rate
shall be the Interest Equivalent of the 180-day rate on such commercial paper.
"Accountant's Confirmation" has the meaning set forth in paragraph 7(c) of these
Amended By-Laws.
"Adviser" means the Trust's investment adviser, which initially shall be Eaton
Vance Management.
"Affiliate" means any person known to the Auction Agent to be controlled by, in
control of or under common control with the Trust; provided that Eaton Vance
Management shall not be deemed to be an Affiliate nor shall any corporation or
any person controlled by, in control of or under common control with such
entity, one of the trustees, directors or executive officers of which is also a
trustee, director or executive officer of the Trust, be deemed to be an
Affiliate.
"Agent Member" means a member of the Securities Depository that will act on
behalf of a Beneficial Owner of one or more shares of APS or a Potential
Beneficial Owner.
"Amended By-Laws" means the By-Laws of the Trust, as amended by this Statement
creating the APS and as may otherwise be amended from time-to-time.
"Applicable Percentage" has the meaning set forth in paragraph 10(a)(vii) of
these Amended By-Laws.
"Applicable Rates" means the rates per annum at which cash dividends are payable
on each Series of APS or Other APS, as the case may be, for any Dividend Period.
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B-3
"Approved Price" means the "fair value" as determined by the Trust in accordance
with the valuation procedures adopted from time to time by the Board of Trustees
of the Trust and for which the Trust receives a marked-to-market price (which,
for the purpose of clarity, shall not mean Market Value) from an independent
source at least semi-annually.
"APS" means, as the case may be, the Auction Preferred Shares.
"APS Basic Maintenance Amount," as of any Valuation Date, shall mean the dollar
amount equal to the sum of (i)(A) the product of the number of Outstanding
shares of each Series of APS on such date by the Liquidation Preference (and
redemption premium, if any) per share of such Series; (B) the aggregate amount
of dividends that will have accumulated at the respective Applicable Rates
(whether or not earned or declared) to (but not including) the first respective
Dividend Payment Dates for each Series of APS outstanding that follows such
Valuation Date; (C) the aggregate amount of dividends that would accumulate on
Outstanding Preferred Shares from such first Dividend Payment Dates therefor
referenced in (B) of this paragraph through the 45th day after such Valuation
Date at the respective Applicable Rates referenced in (B) of this paragraph; (D)
the amount of anticipated non-interest expenses of the Trust for the 90 days
subsequent to such Valuation Date; (E) the amount of the current outstanding
balances of any indebtedness or obligations of the Trust senior in right of
payment to the Preferred Shares plus interest actually accrued together with 30
days additional interest on the current outstanding balances calculated at the
current rate; and (F) any other current liabilities payable during the 30 days
subsequent to such Valuation Date, including, without limitation, indebtedness
due within one year and any redemption premium due with respect to the Preferred
Shares for which a Notice of Redemption has been sent, as of such Valuation
Date, to the extent not reflected in any of (i)(A) through (i)(E) (including,
without limitation, any liabilities incurred for the purpose of clearing
securities transactions) less (ii) the sum of any cash plus the value of any of
the Trust's assets irrevocably deposited by the Trust for the payment of any of
(i)(A) through (i)(F) ("value," for purposes of this clause (ii), means the
Discounted Value of the security, except that if the security matures prior to
the relevant redemption payment date and is either fully guaranteed by the U.S.
Government or is rated P2 by Moody's and A2 by Fitch, it will be valued at its
face value).
"APS Basic Maintenance Amount Test" means a test which is met if: (a) the
aggregate Discounted Values of the Moody's Eligible Assets meets or exceeds 1.2
times the APS Basic Maintenance Amount and (b) the aggregate Discounted Values
of the Fitch Eligible Assets meets or exceeds 1.0 times the APS Basic
Maintenance Amount.
"APS Basic Maintenance Cure Date," with respect to the failure by the Trust to
satisfy the APS Basic Maintenance Amount (as required by paragraph 7(a) of these
Amended By-Laws) as of a given Valuation Date, means the second Business Day
following such Valuation Date.
"APS Basic Maintenance Report" means a report signed by any of the President,
Treasurer, any Senior Vice President or any Vice President of the Trust which
sets forth, as of the related Valuation Date, the assets of the Trust, the
Market Value and the Discounted Value thereof (seriatim and in aggregate), and
the APS Basic Maintenance Amount.
"Auction" means a periodic operation of the Auction Procedures.
"Auction Agent" means Deutsche Bank Trust Company unless and until another
commercial bank, trust company or other financial institution appointed by a
resolution of the Board of Trustees of the Trust or a duly authorized committee
thereof enters into an agreement with the Trust to follow the Auction Procedures
for the purpose of determining the Applicable Rate and to act as transfer agent,
registrar, dividend disbursing agent and redemption agent for the APS and Other
APS.
"Auction Procedures" means the procedures for conducting Auctions set forth in
paragraph 10 of this Article VII, of these Amended By-Laws.
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B-4
"Beneficial Owner" means a customer of a Broker-Dealer who is listed on the
records of that Broker-Dealer (or, if applicable, the Auction Agent) as a holder
of shares of APS or a Broker-Dealer that holds APS for its own account.
"Broker-Dealer" means any broker-dealer, or other entity permitted by law to
perform the functions required of a Broker-Dealer in paragraph 10 of this
Article VII, of these Amended By-Laws, that has been selected by the Trust and
has entered into a Broker-Dealer Agreement with the Auction Agent 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 paragraph 10 of this Article VII, of these Amended
By-Laws.
"Business Day" means a day on which The American Stock Exchange is open for
trading and which is not a Saturday, Sunday or other day on which banks in The
City of New York are authorized or obligated by law to close.
"Code" means the Internal Revenue Code of 1986, as amended.
"Commercial Paper Dealers" means UBS Securities LLC and such other commercial
paper dealer or dealers as the Trust may from time to time appoint, or, in lieu
of any thereof, their respective affiliates or successors.
"Common Shares" means the shares of beneficial interest designated as common
shares, par value $0.01 per share, of the Trust.
"Date of Original Issue" means, with respect to any share of APS or Other APS,
the date on which the Trust originally issues such share.
"Declaration of Trust" means the Agreement and Declaration of Trust, as amended
and supplemented (including these Amended By-Laws), of the Trust.
"Deposit Securities" means cash and Senior Loans and MBS rated at least A2
(having a remaining maturity of 12 months or less), P-1, VMIG-1 or MIG-1 by
Moody's or A (having a remaining maturity of 12 months or less), F-1+ by Fitch.
"Discounted Value" as of any Valuation Date, means (i) with respect to an Fitch
Eligible Asset, the quotient of the Market Value thereof divided by the
applicable Fitch Discount Factor and (ii)(a) with respect to a Moody's Eligible
Asset that is not currently callable (but including all MBS) as of such
Valuation Date at the option of the issuer thereof, the quotient of the Market
Value thereof divided by the applicable Moody's Discount Factor, or (b) with
respect to a Moody's Eligible Asset that is currently callable as of such
Valuation Date at the option of the issuer thereof, the quotient of (1) the
lesser of the Market Value or call price thereof, including any call premium,
divided by (2) the applicable Moody's Discount Factor.
"Dividend Payment Date," with respect to APS, has the meaning set forth in
paragraph 2(b)(i) of these Amended By-Laws and, with respect to Other APS, has
the equivalent meaning.
"Dividend Period" means the Initial Dividend Period, any 7-Day Dividend Period
and any Special Dividend Period.
"Existing Holder" means a Broker-Dealer or any such other Person as may be
permitted by the Trust that is listed as the holder of record of shares of APS
in the Share Books.
"Fitch" means Fitch Ratings and its successors at law.
"Fitch Discount Factor" means for purposes of determining the Discounted Value
of any Fitch Eligible Asset, the percentage determined as follows. The Fitch
Discount Factor for any Fitch Eligible Asset other than the securities set forth
below will be the percentage provided in writing by Fitch.
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B-5
(i) Corporate Debt Securities: The percentage determined by reference to the
rating on such asset with reference to the remaining term to maturity of such
asset, in accordance with the table set forth below.
DISCOUNT FACTORS FOR CORPORATE DEBT SECURITIES INCLUDING NON-INVESTMENT GRADE
BONDS
(NON-CONVERTIBLES)
TERMS TO MATURITY AAA AA A BBB BB B NR(1)
----------------- --- --- --- --- --- --- -----
1 year or less................................... 106 108 110 112 130 152 152
2 years or less (but longer than 1 year)......... 106 108 110 112 130 152 152
3 years or less (but longer than 2 years)........ 106 108 110 112 130 152 152
4 years or less (but longer than 3 years)........ 111 113 115 117 134 152 152
5 years or less (but longer than 4 years)........ 111 113 115 117 134 152 152
7 years or less (but longer than 5 years)........ 114 116 118 120 136 152 152
10 years or less (but longer than 7 years)....... 116 118 120 122 137 152 152
15 years or less (but longer than 10 years)...... 120 122 124 124 139 152 152
30 years or less (but longer than 15 years)...... 124 127 129 129 145 152 152
Greater than 30 years............................ 124 127 129 129 145 152 152
------------
(1) If a security is not rated by Fitch but is rated by two other Rating
Agencies, then the lower of the ratings on the security from the two other
Rating Agencies will be used to determine the Fitch Discount Factor (e.g.,
where the S&P rating is A and the Moody's rating is Baa, a Fitch rating of
BBB will be used). If a security is not rated by Fitch but is rated by only
one other Rating Agency, then the rating on the security from the other
Rating Agency will be used to determine the Fitch Discount Factor (e.g.,
where the only rating on a security is an S&P rating of AAA, a Fitch rating
of AAA will be used, and where the only rating on a security is a Moody's
rating of Ba, a Fitch rating of BB will be used). If a security is not rated
by any Rating Agency, the Trust will use the percentage set forth under "not
rated" in this table. Securities rated below B by Fitch shall be traded the
same as securities not rated by Fitch.
The Fitch Discount Factors presented in the immediately preceding table apply to
corporate debt securities that are Performing and have a Market Value determined
by a Pricing Service or an Approved Price. The Fitch Discount Factor noted in
the table above for a debt security rated B by Fitch shall apply to any
non-Performing debt security with a price equal to or greater than $0.90. The
Fitch Discount Factor noted in the table above for a debt security rated CCC by
Fitch shall apply to any non-Performing debt security with a price less than
$0.90 but equal to or greater than $0.20. If a debt security does not have a
Market Value determined by a Pricing Service or an Approved Price, a rating two
rating categories below the actual rating on the debt security will be used
(e.g., where the actual rating is A-, the rating for Debt Securities rated BB-
will be used). The Fitch Discount Factor for a debt security issued by a limited
partnership that is not a Rule 144A Security shall be the Discount Factor
determined in accordance with the table set forth above multiplied by 105%.
The Fitch Discount Factors presented in the immediately preceding table will
also apply to corporate obligations backed by a guaranty, a letter of credit or
insurance issued by a third party. If the third-party credit rating is the basis
for the rating on the obligation, then the rating on the third party will be
used to determine the Fitch Discount Factor in the table.
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B-6
(ii) Preferred stock: The percentage determined by references to the rating of
a preferred stock in accordance with the table set forth below.
PREFERRED STOCK(1) DISCOUNT FACTOR
------------------ ---------------
AAA......................................................... 130%
AA.......................................................... 133%
A........................................................... 135%
BBB......................................................... 139%
BB.......................................................... 154%
Not rated or below BB....................................... 161%
Investment Grade DRD........................................ 164%
Not rated or below Investment Grade DRD..................... 200%
------------
(1) If a security is not rated by Fitch but is rated by two other Rating
Agencies, then the lower of the ratings on the security from the two other
Rating Agencies will be used to determine the Fitch Discount Factor (e.g.,
where the S&P rating is A and the Moody's rating is Baa, a Fitch rating of
BBB will be used). If a security is not rated by Fitch but is rated by only
one other Rating Agency, then the rating on the security from the other
Rating Agency will be used to determine the Fitch Discount Factor (e.g.,
where the only rating on a security is an S&P rating of AAA, a Fitch rating
of AAA will be used, and where the only rating on a security is a Moody's
rating of Ba, a Fitch rating of BB will be used). If a security is not rated
by any Rating Agency, the Trust will use the percentage set forth under "not
rated" in this table.
(iii) Convertible securities: The Fitch Discount Factor applied to convertible
securities is (A) 200% for investment grade convertibles and (B) 222% for below
investment grade convertibles so long as such convertible debt securities have
neither (x) conversion premium greater than 100% nor (y) have a yield to
maturity or yield to worst of greater than 15.00% above the relevant Treasury
curve.
The Fitch Discount Factor applied to convertible debt securities which have
conversion premiums of greater than 100% is (A) 152% for investment grade
convertibles and (B) 179% for below investment grade convertibles so long as
such convertible debt securities do not have a yield to maturity or yield to
worst of greater than 15.00% above the relevant Treasury curve.
The Fitch Discount Factor applied to convertible debt securities which have a
yield to maturity or yield to worse of greater than 15.00% above the relevant
Treasury curve is 370%.
If a security is not rated by Fitch but is rated by two other Rating Agencies,
then the lower of the ratings on the security from the two other Rating Agencies
will be used to determine the Fitch Discount Factor (e.g., where the S&P rating
is A and the Moody's rating is Baa, a Fitch rating of BBB will be used). If a
security is not rated by Fitch but is rated by only one other Rating Agency,
then the rating on the security from the other Rating Agency will be used to
determine the Fitch Discount Factor (e.g., where the only rating on a security
is an S&P rating of AAA, a Fitch rating of AAA will be used, and where the only
rating on a security is a Moody's rating of Ba, a Fitch rating of BB will be
used). If a security is not rated by any Rating Agency, the Trust will treat the
security as if it were below investment grade.
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B-7
(iv) U.S. Government Securities:
TIME REMAINING TO MATURITY DISCOUNT FACTOR
-------------------------- ---------------
1 year or less.............................................. 101.5%
2 years or less (but longer than 1 year).................... 103%
3 years or less (but longer than 2 years)................... 105%
4 years or less (but longer than 3 years)................... 107%
5 years or less (but longer than 4 years)................... 109%
7 years or less (but longer than 5 years)................... 112%
10 years or less (but longer than 7 years).................. 114%
15 years or less (but longer than 10 years)................. 122%
20 years or less (but longer than 15 years)................. 130%
25 years or less (but longer than 20 years)................. 146%
Greater than 30 years....................................... 154%
(v) Short-Term Investments and Cash: The Fitch Discount Factor applied to
short-term portfolio securities, including without limitation Debt Securities,
Short Term Money Market Instruments and municipal debt obligations, will be (A)
100%, so long as such portfolio securities mature or have a demand feature at
par exercisable within the Fitch Exposure Period; (B) 115%, so long as such
portfolio securities mature or have a demand feature at par not exercisable
within the Fitch Exposure Period; and (C) 125%, so long as such portfolio
securities neither mature nor have a demand feature at par exercisable within
the Fitch Exposure Period. A Fitch Discount Factor of 100% will be applied to
cash.
(vi) Rule 144A Securities: The Fitch Discount Factor applied to Rule 144A
Securities shall be the Discount Factor determined in accordance with the table
above under Corporate Debt Securities in subsection (i) multiplied by 110% until
such securities are registered under the Securities Act.
(vii) MBS, asset-backed and other mortgage-backed securities:
MBS: U.S. Government Agency (FNMA, FHLMC or GNMA) conforming mortgage-backed
securities with an original stated maturity of more than 15 years shall have a
discount factor of 114% and conforming mortgage-backed securities with an
original stated maturity of 15 years or less shall have a discount factor of
111%.
Asset-backed and other mortgage-backed securities: The percentage determined by
reference to the asset type in accordance with the table set forth below.
ASSET TYPE (WITH TIME REMAINING TO MATURITY, IF APPLICABLE) DISCOUNT FACTOR
----------------------------------------------------------- ---------------
U.S. Treasury/agency securities (10 years or less).......... 118%
U.S. Treasury/agency securities (greater than 10 years)..... 127%
U.S. agency sequentials (10 years or less).................. 120%
U.S. agency sequentials (greater than 10 years)............. 142%
U.S. agency principal only securities....................... 236%
U.S. agency interest only securities (with Market Value
greater than $0.40)....................................... 696%
U.S. agency interest only securities (with Market Value less
than or equal to $0.40)................................... 271%
AAA Lock-Out securities, interest only...................... 236%
U.S. agency planned amortization class bonds (10 years or
less)..................................................... 115%
U.S. agency planned amortization class bonds (greater than
10 years)................................................. 136%
AAA sequentials (10 years or less).......................... 118%
AAA sequentials (greater than 10 years)..................... 135%
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B-8
ASSET TYPE (WITH TIME REMAINING TO MATURITY, IF APPLICABLE) DISCOUNT FACTOR
----------------------------------------------------------- ---------------
AAA planned amortization class bonds (10 years or less)..... 115%
AAA planned amortization class bonds (greater than 10
years).................................................... 140%
Jumbo mortgage rated AAA(1)................................. 123%
Jumbo mortgage rated AA(1).................................. 130%
Jumbo mortgage rated A(1)................................... 136%
Jumbo mortgage rated BBB(1)................................. 159%
Commercial mortgage-backed securities rated AAA............. 131%
Commercial mortgage-backed securities rated AA.............. 139%
Commercial mortgage-backed securities rated A............... 148%
Commercial mortgage-backed securities rated BBB............. 177%
Commercial mortgage-backed securities rated BB.............. 283%
Commercial mortgage-backed securities rated B............... 379%
Commercial mortgage-backed securities rated CCC or not
rated..................................................... 950%
------------
(1) Applies to jumbo mortgages, credit cards, auto loans, home equity loans,
manufactured housing and prime mortgage-backed securities not issued by a
U.S. agency or instrumentality.
(viii) Senior Loans: The Fitch Discount Factor applied to senior, secured
floating rate Loans made to corporate and other business entities ("Senior
Loans") shall be the percentage specified in the table below opposite such Fitch
Loan Category:
FITCH LOAN CATEGORY DISCOUNT FACTOR
------------------- ---------------
A........................................................... 115%
B........................................................... 130%
C........................................................... 152%
D........................................................... 370%
(ix) Futures and call options: For purposes of the APS Basic Maintenance
Amount, futures held by the Trust and call options sold by the Trust shall not
be included as Fitch Eligible Assets. However, such assets shall be valued at
Market Value by subtracting the good faith margin and the maximum daily trading
variance as of a Valuation Date. For call options purchased by the Trust, the
Market Value of the call option will be included as Fitch Eligible Asset subject
to a Fitch Discount Factor mutually agreed to between the Trust and Fitch based
on the characteristics of the option contract such as its maturity and the
underlying security of the contract.
(x) Securities lending: The Trust may engage in securities lending in an
amount not to exceed 15% of the Trust's total gross assets. For purposes of
calculating the APS Basic Maintenance Amount, such securities lent shall be
included as Fitch Eligible Assets with the appropriate Fitch Discount Factor
applied to such lent security. The obligation to return such collateral shall
not be included as an obligation/liability for purposes of calculating the APS
Basic Maintenance Amount. However, the Fund may reinvest cash collateral for
securities lent in conformity with its investment objectives and policies and
the provisions of these bylaws. In such event, to the extent that securities
lending collateral received is invested by the Fund in assets that otherwise
would be Fitch Eligible Assets and the value of such assets exceeds the amount
of the Fund's obligation to return the collateral on a Valuation Date, such
excess amount shall be included in the calculation of Fitch Eligible Assets by
applying the applicable Fitch Discount Factor to this amount and adding the
product to total Fitch Eligible Assets. Conversely, if the value of assets in
which securities lending collateral has been invested is less then the amount of
the Fund's obligation to return the collateral on a Valuation Date, such
difference shall be included as an obligation/liability of the Fund for purposes
of calculating the APS Basic Maintenance Amount. Collateral received by the
Trust in a securities lending transaction and maintained by the
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B-9
Trust in the form received shall not be included as a Fitch Eligible Asset for
purposes of calculating the APS Basic Maintenance Amount.
(xi) Swaps (including Total Return Swaps, Interest Rate Swaps and Credit
Default Swaps): Total Return and Interest Rate Swaps are subject to the
following provisions:
If the Trust has an outstanding gain from a swap transaction on a Valuation
Date, the gain will be included as a Fitch Eligible Asset subject to the Fitch
Discount Factor on the counterparty to the swap transaction. At the time a swap
is executed, the Trust will only enter into swap transactions where the
counterparty has at least a Fitch rating of A- or Moody's rating of A3.
(A) Only the cumulative unsettled profit and loss from a Total Return Swap
transaction will be calculated when determining the APS Basic Maintenance
Amount. If the Trust has an outstanding liability from a swap transaction on a
Valuation Date, the Trust count such liability as an outstanding liability from
the total Fitch Eligible Assets in calculating the APS Basic Maintenance Amount.
(B) In addition, for swaps other than Total Return Swaps, the Market Value of
the position (positive or negative) will be included as a Fitch Eligible Asset.
The aggregate notional value of all swaps will not exceed the Liquidation
Preference of the Outstanding APS.
(C) (1) The underlying securities subject to a Credit Default Swap sold by the
Trust will be subject to the applicable Fitch Discount Factor for each security
subject to the swap;
(2) If the Trust purchases a Credit Default Swap and holds the underlying
security, the Market Value of the Credit Default Swap and the underlying
security will be included as a Fitch Eligible Asset subject to the Fitch
Discount Factor assessed based on the counterparty risk; and
(3) The Trust will not include a Credit Default Swap as a Fitch Eligible Asset
purchased by the Trust without the Trust holding the underlying security or when
the Trust buys a Credit Default Swap for a basket of securities without holding
all the securities in the basket.
"Fitch Eligible Asset" means:
(i) Cash (including interest and dividends due on assets rated (A) BBB or
higher by Fitch or the equivalent by another Rating Agency if the payment date
is within five (5) Business Days of the Valuation Date, (B) A or higher by Fitch
or the equivalent by another Rating Agency if the payment date is within thirty
days of the Valuation Date, and (C) A+ or higher by Fitch or the equivalent by
another Rating Agency if the payment date is within the Fitch Exposure Period)
and receivables for Fitch Eligible Assets sold if the receivable is due within
five (5) Business Days of the Valuation Date, and if the trades which generated
such receivables are settled within five (5) Business Days;
(ii) Short Term Money Market Instruments so long as (A) such securities are
rated at least F1+ by Fitch or the equivalent by another Rating Agency, (B) in
the case of demand deposits, time deposits and overnight funds, the supporting
entity is rated at least A by Fitch or the equivalent by another Rating Agency,
or (C) in all other cases, the supporting entity (1) is rated at least A by
Fitch or the equivalent by another Rating Agency and the security matures within
one month, (2) is rated at least A by Fitch or the equivalent by another Rating
Agency and the security matures within three months or (3) is rated at least AA
by Fitch or the equivalent by another Rating Agency and the security matures
within six months;
(iii) U.S. Government Securities;
(iv) debt securities if such securities have been registered under the
Securities Act or are restricted as to resale under federal securities laws but
are eligible for resale pursuant to Rule 144A under the Securities Act as
determined by the Trust's investment manager or portfolio manager acting
pursuant to procedures approved by the Board of Trustees of the Trust; and such
securities are issued by (1) a U.S. corporation, limited liability company or
limited partnership, (2) a corporation, limited liability company or limited
partnership domiciled in Argentina, Australia, Brazil, Chile, France, Germany,
--------------------------------------------------------------------------------
B-10
Italy, Japan, Korea, Mexico, Spain or the United Kingdom or other country if
Fitch does not inform the Trust that including debt securities from such foreign
country will adversely impact Fitch's rating of the APS (the "Approved Foreign
Nations"), (3) the government of any Approved Foreign Nation or any of its
agencies, instrumentalities or political subdivisions (the debt securities of
Approved Foreign Nation issuers being referred to collectively as "Foreign
Bonds"), (4) a corporation, limited liability company or limited partnership
domiciled in Canada or (5) the Canadian government or any of its agencies,
instrumentalities or political subdivisions (the debt securities of Canadian
issuers being referred to collectively as "Canadian Bonds"). Foreign Bonds held
by the Trust will qualify as Fitch Eligible Assets only up to a maximum of 20%
of the aggregate Market Value of all assets constituting Fitch Eligible Assets.
Similarly, Canadian Bonds held by the Trust will qualify as Fitch Eligible
Assets only up to a maximum of 20% of the aggregate Market Value of all assets
constituting Fitch Eligible Assets. Notwithstanding the limitations in the two
preceding sentences, Foreign Bonds and Canadian Bonds held by the Trust will
qualify as Fitch Eligible Assets only up to a maximum of 30% of the aggregate
Market Value of all assets constituting Fitch Eligible Assets. All debt
securities satisfying the foregoing requirements and restrictions of this
paragraph (iv) are herein referred to as "Debt Securities."
(v) Preferred stocks if (i) dividends on such preferred stock are cumulative,
(ii) such securities provide for the periodic payment of dividends thereon in
cash in U.S. dollars or euros and do not provide for conversion or exchange
into, or have warrants attached entitling the holder to receive equity capital
at any time over the respective lives of such securities, (iii) the issuer of
such a preferred stock has common stock listed on either the New York Stock
Exchange or the American Stock Exchange, (iv) the issuer of such a preferred
stock has a senior debt rating or preferred stock rating from Fitch of BBB- or
higher or the equivalent rating by another Rating Agency. In addition, the
preferred stocks issue must be at least $50 million;
(vi) asset-backed and MBS;
(vii) Rule 144A Securities;
(viii) Interest Rate Swaps entered into according to International Swap Dealers
Association ("ISDA") standards if (1) the counterparty to the swap transaction
has a short-term rating of not less than F1 by Fitch or the equivalent by
another Rating Agency, or, if the swap counterparty does not have a short-term
rating, the counterparty's senior unsecured long-term debt rating is AA or
higher by Fitch or the equivalent by another Rating Agency and (2) the original
aggregate notional amount of the Interest Rate Swap transaction or transactions
is not greater than the liquidation preference of the APS originally issued;
(ix) swaps, including total return and Credit Default Swaps entered into
according to ISDA;
(x) Senior Loans; and
(xi) Fitch Hedging Transactions.
Financial contracts, as such term is defined in Section 3(c)(2)(B)(ii) of the
Investment Company Act, not otherwise provided for in this definition may be
included in Fitch Eligible Assets, but, with respect to any financial contract,
only upon receipt by the Trust of a writing from Fitch specifying any conditions
on including such financial contract in Fitch Eligible Assets and assuring the
Trust that including such financial contract in the manner so specified would
not affect the credit rating assigned by Fitch to the APS.
Where the Trust sells an asset and agrees to repurchase such asset in the
future, the Discounted Value of such asset will constitute a Fitch Eligible
Asset and the amount the Trust is required to pay upon repurchase of such asset
will count as a liability for the purposes of the APS Basic Maintenance Amount.
Where the Trust purchases an asset and agrees to sell it to a third party in the
future, cash receivable by the Trust thereby will constitute a Fitch Eligible
Asset if the long-term debt of such other party is rated at least A- by Fitch or
the equivalent by another Rating Agency and such agreement has
--------------------------------------------------------------------------------
B-11
a term of 30 days or less; otherwise the Discounted Value of such purchased
asset will constitute a Fitch Eligible Asset.
Notwithstanding the foregoing, an asset will not be considered a Fitch Eligible
Asset to the extent that it has been irrevocably deposited for the payment of
(i)(A) through (i)(E) under the definition of APS Basic Maintenance Amount or to
the extent it is subject to any liens, except for (A) liens which are being
contested in good faith by appropriate proceedings and which Fitch has indicated
to the Trust will not affect the status of such asset as a Fitch Eligible Asset,
(B) liens for taxes that are not then due and payable or that can be paid
thereafter without penalty, (C) liens to secure payment for services rendered or
cash advanced to the Trust by its investment manager or portfolio manager, the
Trust's custodian, transfer agent or registrar or the Auction Agent and (D)
liens arising by virtue of any repurchase agreement.
FITCH DIVERSIFICATION LIMITATIONS:
Portfolio holdings as described below must be within the following
diversification and issue size requirements in order to be included in Fitch's
Eligible Assets:
MAXIMUM SINGLE MAXIMUM SINGLE MINIMUM ISSUE SIZE
SECURITY RATED AT LEAST ISSUER(1) INDUSTRY(1),(2) ($ IN MILLION)(3)
----------------------- -------------- --------------- ------------------
AAA................................. 100% 100% $100
AA-................................. 20 75 100
A-.................................. 10 50 100
BBB-................................ 6 25 100
BB-................................. 4 16 50
B-.................................. 3 12 50
CCC................................. 2 8 50
------------
(1) Percentages represent a portion of the aggregate Market Value of corporate
debt securities.
(2) Industries are determined according to Fitch's Industry Classifications, as
defined herein.
(3) Preferred stock has a minimum issue size of $50 million, and mortgage pass
throughs issued by the Federal Home Loan Mortgage Corporation ("FHLMC"), the
Federal National Mortgage Association ("FNMA") or the Government National
Mortgage Association ("GNMA"), which has no minimum issue size.
If a security is not rated by Fitch but is rated by two other Rating Agencies,
then the lower of the ratings on the security from the two other Rating Agencies
will be used to determine the Fitch Discount Factor (e.g., where the S&P rating
is A and the Moody's rating is Baa, a Fitch rating of BBB will be used). If a
security is not rated by Fitch but is rated by only one other Rating Agency,
then the rating on the security from the other Rating Agency will be used to
determine the Fitch Diversification Limitations (e.g., where the only rating on
a security is an S&P rating of AAA, a Fitch rating of AAA will be used, and
where the only rating on a security is a Moody's rating of Ba, a Fitch rating of
BB will be used). If a security is not rated by any Rating Agency, the Trust
will use the percentage set forth under "not rated" in this table.
"Fitch Exposure Period" means the period commencing on (and including) a given
Valuation Date and ending 41 days thereafter.
"Fitch General Portfolio Requirements" means that the Trust's portfolio must
meet the following diversification requirements: (a) no more than 25% by par
value of the Trust's total assets can be invested in the securities of borrowers
and other issuers having their principal business activities in the same Fitch
Industry Classification; provided, that this limitation shall not apply with
respect to U.S. Government Securities and provided further that for purposes of
this subsection (a), the term
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B-12
"issuer" shall not include a lender selling a participation to the Trust or any
other person interpositioned between such lender and the Trust with respect to a
participation and (b) no more than 10% by par value of the Trust's total assets
can be invested in securities of a single issuer, and provided further that for
purposes of this subsection (b), the term "issuer" includes both the borrower
under a loan agreement and the lender selling a participation to the Trust
together with any other persons interpositioned between such lender and the
Trust with respect to such participation.
"Fitch Hedging Transactions" means purchases or sales of exchange-traded
financial futures contracts based on any index approved by Fitch, LIBOR or
Treasury Bonds, and purchases, writings or sales of exchange-traded put options
on such futures contracts, and purchases, writings or sales of exchange-traded
call options on such financial futures contracts, and put and call options on
such financial futures contracts ("Fitch Hedging Transactions"), subject to the
following limitations:
(i) The Trust may not engage in any Fitch Hedging Transaction based on any
index approved by Fitch (other than transactions that terminate a futures
contract or option held by the Trust by the Trust's taking the opposite position
thereto ("closing transactions")) that would cause the Trust at the time of such
transaction to own or have sold outstanding financial futures contracts based on
such index exceeding in number 10% of the average number of daily traded
financial futures contracts based on such index in the 30 days preceding the
time of effecting such transaction as reported by The Wall Street Journal.
(ii) The Trust will not engage in any Fitch Hedging Transaction based on
Treasury Bonds or LIBOR (other than closing transactions) that would cause the
Trust at the time of such transaction to own or have sold:
(A) Outstanding financial futures contracts based on Treasury Bonds or LIBOR
with such contracts having an aggregate Market Value exceeding 60% of the
aggregate Market Value of Fitch Eligible Assets owned by the Trust and at least
rated AA by Fitch (or, if not rated by Fitch Ratings, rated at least Aa by
Moody's; or, if not rated by Moody's, rated AAA by S&P); or
(B) Outstanding financial futures contracts based on Treasury Bonds or LIBOR
with such contracts having an aggregate Market Value exceeding 40% of the
aggregate Market Value of all Fitch Eligible Assets owned by the Trust (other
than Fitch Eligible Assets already subject to a Fitch Hedging Transaction) and
rated at least A or BBB by Fitch (or, if not rated by Fitch Ratings, rated at
least Baa by Moody's; or, if not rated by Moody's, rated at least A or AA by
S&P) (for purposes of the foregoing clauses (i) and (ii), the Trust shall be
deemed to own futures contracts that underlie any outstanding options written by
the Trust);
(iii) The Trust may engage in closing transactions to close out any outstanding
financial futures contract based on any index approved by Fitch if the amount of
open interest in such index as reported by The Wall Street Journal is less than
an amount to be mutually determined by Fitch and the Trust.
(iv) The Trust may not enter into an option or futures transaction unless,
after giving effect thereto, the Trust would continue to have Fitch Eligible
Assets with an aggregate Discounted Value equal to or greater than the APS
Shares Basic Maintenance Amount.
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B-13
"Fitch Industry Classification" means, for the purposes of determining Fitch
Eligible Assets, each of the following industry classifications:
FITCH INDUSTRY CLASSIFICATIONS SIC CODE (MAJOR GROUPS)
------------------------------ -----------------------
Aerospace and Defense....................................... 37, 45
Automobiles................................................. 37, 55
Banking, Finance and Real Estate............................ 60, 65, 67
Broadcasting and Media...................................... 27, 48
Building and Materials...................................... 15-17, 32, 52
Cable....................................................... 48
Chemicals................................................... 28, 30
Computers and Electronics................................... 35, 36
Consumer Products........................................... 23, 51
Energy...................................................... 13, 29, 49
Environmental Services...................................... 87
Farming and Agriculture..................................... 1-3, 7-9
Food, Beverage and Tobacco.................................. 20, 21, 54
Gaming, Lodging and Restaurants............................. 70, 58
Health Care and Pharmaceuticals............................. 38, 28, 80
Industrial/Manufacturing.................................... 35
Insurance................................................... 63, 64
Leisure and Entertainment................................... 78, 79
Metals and Mining........................................... 10, 12, 14, 33, 34
Miscellaneous............................................... 50, 72-76, 99
Paper and Forest Products................................... 8, 24, 26
Retail...................................................... 53, 56, 59
Sovereign................................................... NA
Supermarkets and Drug Stores................................ 54
Telecommunications.......................................... 48
Textiles and Furniture...................................... 22, 25, 31, 57
Transportation.............................................. 40, 42-47
Utilities................................................... 49
Structured Finance Obligations.............................. NA
Packaging and Containers.................................... 26, 32, 34
Business Services........................................... 73, 87
The Trust shall use its discretion in determining which industry classification
is applicable to a particular investment.
"Fitch Loan Category" means the following four categories (and, for purposes of
this categorization, the Market Value of a Fitch Eligible Asset trading at par
is equal to $1.00):
(i) "Fitch Loan Category A" means Performing Loans which have a Market Value or
an Approved Price greater than or equal to $0.90.
(ii) "Fitch Loan Category B" means: (A) Performing Loans which have a Market
Value or an Approved Price of greater than or equal to $0.80 but less than
$0.90; and (B) non-Performing Loans which have a Market Value or an Approved
Price greater than or equal to $0.85.
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B-14
(iii) "Fitch Loan Category C" means: (A) Performing Loans which have a Market
Value or an Approved Price of greater than or equal to $0.70 but less than
$0.80; (B) non-Performing Loans which have a Market Value or an Approved Price
of greater than or equal to $0.75 but less than $0.85; and (C) Performing Loans
without an Approved Price rated BB- or higher by Fitch. If a security is not
rated by Fitch but is rated by two other Rating Agencies, then the lower of the
ratings on the security from the two other Rating Agencies will be used to
determine the Fitch Discount Factor (e.g., where the S&P rating is A- and the
Moody's rating is Baa1, a Fitch rating of BBB+ will be used). If a security is
not rated by Fitch but is rated by only one other Rating Agency, then the rating
on the security from the other Rating Agency will be used to determine the Fitch
Discount Factor (e.g., where the only rating on a security is an S&P rating of
AAA-, a Fitch rating of AAA- will be used, and where the only rating on a
security is a Moody's rating of Ba3, a Fitch rating of BB- will be used).
(iv) "Fitch Loan Category D" means Loans not described in any of the foregoing
categories.
Notwithstanding any other provision contained above, for purposes of determining
whether a Fitch Eligible Asset falls within a specific Fitch Loan Category, to
the extent that any Fitch Eligible Asset would fall within more than one of the
Fitch Loan Categories, such Fitch Eligible Asset shall be deemed to fall into
the Fitch Loan Category with the lowest applicable Fitch Discount Factor.
"Holder" means a Person identified as a holder of record of shares of APS in the
Share Register.
"Independent Accountant" means a nationally recognized accountant, or firm of
accountants, that is, with respect to the Trust, an independent public
accountant or firm of independent public accountants under the Securities Act of
1933, as amended.
"Initial Dividend Payment Date" means the Initial Dividend Payment Date as
determined by the Board of Trustees of the Trust or their designee with respect
to each series of APS or Other APS, as the case may be.
"Initial Dividend Period" has the meaning set forth in paragraph 2(c)(i) of this
Article VII, of these Amended By-Laws and, with respect to Other APS, has the
equivalent meaning.
"Initial Dividend Rate" means the rate per annum established by the Board of
Trustees or their designee, applicable to the Initial Dividend Period for such
series of APS and, with respect to Other APS, has the equivalent meaning.
"Initial Margin" means the amount of cash or securities deposited with a broker
as a margin payment at the time of purchase or sale of a futures contract.
"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.
"Interest Rate Swaps" means the exchange by the Trust with another party of
their respective commitments to pay or receive interest, e.g., an exchange of
fixed rate payments for floating rate payments.
"LIBOR" means the London Interbank Offered Rate.
"Loan" means any assignment of or participation in any bank loan denominated in
U.S. dollars including term loans, the funded and unfunded portions of revolving
credit lines (provided that the Trust shall place in reserve an amount equal to
any unfunded portion of any revolving credit line) and debtor-in possession
financings; provided that such loan (a) is not extended for the purpose of
purchasing or carrying any margin stock and (b) is similar to those typically
made, syndicated, purchased or participated by a commercial bank in the ordinary
course of business.
"Long Term Dividend Period" means a Special Dividend Period consisting of a
specified period of one whole year or more but not greater than five years.
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B-15
"Mandatory Redemption Price" means $25,000 per share of APS plus an amount equal
to accumulated but unpaid dividends (whether or not earned or declared) to the
date fixed for redemption and excluding Additional Dividends.
"Market Value" of any asset of the Trust shall be the market value thereof
determined by the Pricing Service or by the Trust in accordance with procedures
approved by the Board of Trustees. Market Value of any asset shall include any
interest accrued thereon. The Pricing Service shall value portfolio securities
at the quoted bid prices or the mean between the quoted bid and asked price or
the yield equivalent when quotations are not readily available. Securities for
which quotations are not readily available shall be valued at fair value as
determined by the Pricing Service using methods which include consideration of:
yields or prices of municipal obligations of comparable quality, type of issue,
coupon, maturity and rating; indications as to value from dealers; and general
market conditions. The Pricing Service or the Trust may employ electronic data
processing techniques and/or a matrix system to determine valuations. At the
Trust's discretion, in the event the Pricing Service is unable to value a
security, the security shall be valued at the lower of two dealer bids obtained
by the Trust from dealers who are members of the National Association of
Securities Dealers, Inc. and who make a market in the security, at least one of
which shall be in writing. Futures contracts and options are valued at closing
prices for such instruments established by the exchange or board of trade on
which they are traded, or if market quotations are not readily available, are
valued at fair value on a consistent basis using methods determined in good
faith by the Board of Trustees.
"Maximum Applicable Rate," with respect to APS, has the meaning set forth in
paragraph 10(a)(vii) of this Article VII, of these Amended By-Laws and, with
respect to Other APS, has the equivalent meaning.
"MBS" means mortgage backed securities that are issued, backed or otherwise
guaranteed by the U.S. Government or its agencies or instrumentalities or that
are issued by private issuers.
"Bi-Monthly Valuation Date" means the fifteenth day of each month if such day is
a Business Day or the first Business Day preceding the fifteenth and the last
Business Day of each month in each fiscal year of the Trust, commencing from the
Date of Original Issue.
"Moody's" means Moody's Investors Service, Inc., a Delaware corporation, and its
successors.
"Moody's Discount Factor" means for purposes of determining the Discounted Value
of any Moody's Eligible Asset, the percentage determined as follows. The Moody's
Discount Factor for any Moody's Eligible Asset other than the securities set
forth below will be the percentage provided in writing by Moody's.
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B-16
(i) Corporate debt securities: The percentage determined by reference to the
rating on such asset with reference to the remaining term to maturity of such
asset, in accordance with the table set forth below.
DISCOUNT FACTORS FOR CORPORATE DEBT SECURITIES INCLUDING NON-INVESTMENT GRADE
BONDS (NON-CONVERTIBLES)
TERMS TO MATURITY OF NON-INVESTMENT GRADE BONDS AAA AA A BAA BA B NR(1)
----------------------------------------------- --- --- --- --- --- --- -----
1 year or less................................ 109 112 115 118 137 150 250
2 years or less (but longer than 1 year)...... 115 118 122 125 146 160 250
3 years or less (but longer than 2 years)..... 120 123 127 131 153 168 250
4 years or less (but longer than 3 years)..... 126 129 133 138 161 176 250
5 years or less (but longer than 4 years)..... 132 135 139 144 168 185 250
7 years or less (but longer than 5 years)..... 139 143 147 152 179 197 250
10 years or less (but longer than 7 years).... 145 150 155 160 189 208 250
15 years or less (but longer than 10 years)... 150 155 160 165 196 216 250
20 years or less (but longer than 15 years)... 150 155 160 165 196 228 250
30 years or less (but longer than 20 years)... 150 155 160 165 196 229 250
Greater than 30 years......................... 165 173 181 189 205 240 250
------------
(1) Unless conclusions regarding liquidity risk as well as estimates of both the
probability and severity of default for the Fund's assets can be derived
from other sources, securities rated below B by Moody's and unrated
securities, which are securities rated by neither Moody's, S&P nor Fitch,
are limited to 10% of Moody's Eligible Assets. If a corporate, municipal or
other debt security is unrated by Moody's, S&P or Fitch, the Fund will use
the percentage set forth under "Below B and Unrated" in this table. Ratings
assigned by S&P or Fitch are generally accepted by Moody's at face value.
However, adjustments to face value may be made to particular categories of
credits for which the S&P and/or Fitch rating does not seem to approximate a
Moody's rating equivalent.
The Moody's Discount Factors presented in the immediately preceding table will
also apply to corporate debt securities that do not pay interest in U.S. dollars
or euros, provided that the Moody's Discount Factor determined from the table
shall be multiplied by a factor of 1.20% for purposes of calculating the
Discounted Value of such securities.
(ii) Preferred stock: The Moody's Discount Factor for preferred stock shall be
(A) for preferred stocks issued by a utility, 155%; (B) for preferred stocks of
industrial and financial issuers, 197%; and (C) for auction rate preferred
stocks and all other preferred stocks, 350%.
(iii) Short-term instruments: The Moody's Discount Factor applied to
short-term portfolio securities, including without limitation corporate debt
securities, Short Term Money Market Instruments and municipal debt obligations,
will be (A) 100%, so long as such portfolio securities mature or have a demand
feature at par exercisable within the Moody's Exposure Period; (B) 115%, so long
as such portfolio securities mature or have a demand feature at par not
exercisable within the Moody's Exposure Period; and (C) 125%, if such securities
are not rated by Moody's, so long as such portfolio securities are rated at
least A-1+/AA or SP-1+/AA by S&P and mature or have a demand feature at par
exercisable within the Moody's Exposure Period. A Moody's Discount Factor of
100% will be applied to cash.
(v) Rule 144A Securities: The Moody's Discount Factor applied to Rule 144A
Securities for Rule 144A Securities whose terms include rights to registration
under the Securities Act within one year and Rule 144A Securities which do not
have registration rights within one year will be 120% and 130%, respectively, of
the Moody's Discount Factor which would apply were the securities registered
under the Securities Act.
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B-17
(vi) Senior Loans: The Moody's Discount Factor applied to Senior Loans shall
be the percentage specified in the table below opposite such Moody's Loan
Category:
MOODY'S LOAN CATEGORY DISCOUNT FACTOR
--------------------- ---------------
A........................................................... 118%
B........................................................... 137%
C........................................................... 161%
D........................................................... 222%
(vii) MBS: U.S. Government Agency (FNMA, FHLMC or GNMA) conforming
mortgage-backed securities seasoned for 8 years or more based on the security's
stated weighted-average maturity will have a discount factor of 132%. For U.S.
Government Agency conforming mortgage-backed securities seasoned less than 8
years the following discount factors apply:
ISSUED BY GNMA
COUPON RATE DISCOUNT FACTOR
----------- ---------------
0%-5%....................................................... 154%
5.01%-6%.................................................... 150%
6.01%-7%.................................................... 146%
7.01%-8%.................................................... 142%
8.01%-9%.................................................... 139%
9.01%-10%................................................... 138%
10.01-11%................................................... 136%
11.01-12%................................................... 134%
12.01-13%................................................... 133%
Adjustable.................................................. 156%
ISSUED BY FNMA OR FHLMC
COUPON RATE DISCOUNT FACTOR
----------- ---------------
0%-5%....................................................... 160%
5.01%-6%.................................................... 157%
6.01%-7%.................................................... 153%
7.01%-8%.................................................... 150%
8.01%-9%.................................................... 147%
9.01%-10%................................................... 144%
10.01-11%................................................... 141%
11.01-12%................................................... 138%
12.01-13%................................................... 136%
Adjustable.................................................. 160%
A mutually agreed upon Moody's Discount Factor between the Trust and Moody's
shall be applied to mortgage-backed securities privately issued.
"Moody's Eligible Asset" means:
(i) Cash (including interest and dividends due on assets rated (A) Baa3 or
higher by Moody's or the equivalent by another Rating Agency if the payment date
is within five (5) Business Days of the Valuation Date, (B) A2 or higher by
Moody's or the equivalent by another Rating Agency if the payment date is within
thirty days of the Valuation Date, and (C) A1 or higher by Moody's or the
equivalent by another Rating Agency if the payment date is within the Moody's
Exposure Period) and
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B-18
receivables for Moody's Eligible Assets sold if the receivable is due within
five (5) Business Days of the Valuation Date, and if the trades which generated
such receivables are (A) settled through clearing house firms with respect to
which the Trust has received prior written authorization from Moody's or (B)(1)
with counterparties having a Moody's long-term debt rating of at least Baa3 or
the equivalent by another Rating Agency or (2) with counterparties having a
Moody's Short Term Money Market Instrument rating of at least P-1 or the
equivalent by another Rating Agency;
(ii) Short Term Money Market Instruments, so long as (A) such securities are
rated at least P-1 or the equivalent by another Rating Agency, (B) in the case
of demand deposits, time deposits and overnight funds, the supporting entity is
rated at least A2 or the equivalent by another Rating Agency, or (C) in all
other cases, the supporting entity (1) is rated A2 or the equivalent by another
Rating Agency and the security matures within one month, (2) is rated A1 or the
equivalent by another Rating Agency and the security matures within three months
or (3) is rated at least A3 or the equivalent by another Rating Agency and the
security matures within six months; provided, however, that for purposes of this
definition, such instruments (other than commercial paper rated by S&P and not
rated by Moody's) need not meet any otherwise applicable S&P rating criteria;
(iii) U.S. Government Securities;
(iv) Rule 144A Securities;
(v) Senior Loans;
(vi) Corporate debt securities if (A) such securities are rated B3 or higher by
Moody's or the equivalent by another Rating Agency; (B) such securities provide
for the periodic payment of interest in cash in U.S. dollars or euros, except
that such securities that do not pay interest in U.S. dollars or euros shall be
considered Moody's Eligible Assets if they are rated by Moody's, S&P or Fitch;
(C) for securities which provide for conversion or exchange at the option of the
issuer into equity capital at some time over their lives, the issuer must be
rated at least B3 by Moody's or the equivalent by another Rating Agency and the
discount factor will be 250%; (D) for debt securities rated Ba1 and below, no
more than 10% of the original amount of such issue may constitute Moody's
Eligible Assets or the equivalent by another Rating Agency; (E) such securities
have been registered under the Securities Act or are restricted as to resale
under federal securities laws but are eligible for resale pursuant to Rule 144A
under the Securities Act as determined by the Trust's investment manager or
portfolio manager acting pursuant to procedures approved by the Board of
Trustees, except that such securities that are not subject to U.S. federal
securities laws shall be considered Moody's Eligible Assets if they are publicly
traded; and (F) such securities are not subject to extended settlement.
Notwithstanding the foregoing limitations, (x) corporate debt securities not
rated at least B3 by Moody's or not rated by Moody's shall be considered to be
Moody's Eligible Assets only to the extent the Market Value of such corporate
debt securities does not exceed 10% of the aggregate Market Value of all Moody's
Eligible Assets; provided, however, that if the Market Value of such corporate
debt securities exceeds 10% of the aggregate Market Value of all Moody's
Eligible Assets, a portion of such corporate debt securities (selected by the
Trust) shall not be considered Moody's Eligible Assets, so that the Market Value
of such corporate debt securities (excluding such portion) does not exceed 10%
of the aggregate Market Value of all Moody's Eligible Assets; and (y) corporate
debt securities rated by neither Moody's, S&P nor Fitch shall be considered to
be Moody's Eligible Assets only to the extent such securities are issued by
entities which (i) have not filed for bankruptcy within the past three years,
(ii) are current on all principal and interest in their fixed income
obligations, (iii) are current on all preferred stock dividends, and (iv)
possess a current, unqualified auditor's report without qualified, explanatory
language.
(vii) Preferred stocks if (A) dividends on such preferred stock are cumulative,
(B) such securities provide for the periodic payment of dividends thereon in
cash in U.S. dollars or euros and do not provide for conversion or exchange
into, or have warrants attached entitling the holder to receive, equity capital
at any time over the respective lives of such securities, (C) the issuer of such
a preferred
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B-19
stock has common stock listed on either the New York Stock Exchange or the
American Stock Exchange, (D) the issuer of such a preferred stock has a senior
debt rating from Moody's of Baa1 or higher or a preferred stock rating from
Moody's of Baa3 or higher and (E) such preferred stock has paid consistent cash
dividends in U.S. dollars or euros over the last three years or has a minimum
rating of A1 (if the issuer of such preferred stock has other preferred issues
outstanding that have been paying dividends consistently for the last three
years, then a preferred stock without such a dividend history would also be
eligible). In addition, the preferred stocks must have the following
diversification requirements: (X) the preferred stock issue must be greater than
$50 million and (Y) the minimum holding by the Trust of each issue of preferred
stock is $500,000 and the maximum holding of preferred stock of each issue is $5
million. In addition, preferred stocks issued by transportation companies will
not be considered Moody's Eligible Assets;
(viii) Asset-backed securities and MBS:
(A) Asset-backed securities if (1) such securities are rated at least Baa by
Moody's or at least BBB by S&P or Fitch, (2) the securities are part of an issue
that is $250 million or greater, or the issuer of such securities has a total of
$500 million or greater of asset-backed securities outstanding at the time of
purchase of the securities by the Trust and (3) the expected average life of the
securities is not greater than 4 years;
(B) Collateralized mortgage obligations ("CMOs"), including CMOs with interest
rates that float at a multiple of the change in the underlying index according
to a pre-set formula, provided that any CMO held by the Trust (1) if not issued
by FHLMC or FNMA, has been rated Aaa by Moody's or AAA by S&P or Fitch, (2) does
not have a coupon which floats inversely, (3) is not portioned as an interest-
only or principal-only strip and (4) is part of an issuance that had an original
issue size of at least $100 million;
(C) Planned amortization class bonds ("PACs") and targeted amortization class
bonds ("TACs") provided that such PACs or TACs are (1) backed by certificates of
either FNMA, GNMA or FHLMC representing ownership in single-family first lien
mortgage loans with original terms of 30 years, (2) part of an issuance that had
an original issue size of at least $10 million, (3) part of PAC or TAC classes
that have payment priority over other PAC or TAC classes, (4) if TACs, TACs that
do not support PAC classes, and (5) if TACs, not considered reverse TACs (i.e.,
do not protect against extension risk);
(D) Consolidated senior debt obligations of Federal Home Loan Banks ("FHLBs"),
senior long-term debt of the FNMA, and consolidated systemwide bonds and FCS
Financial Assistance Corporation Bonds of Federal Farm Credit Banks ("FFCBs")
(collectively, "FHLB, FNMA and FFCB Debentures"), provided that such FHLB, FNMA
and FFCB Debentures are (1) direct issuance corporate debt rated Aaa by Moody's
or comparably rated by another Rating Agency, (2) senior debt obligations backed
by the FHLBs, FFCBs or FNMA, (3) part of an issue entirely denominated in U.S.
dollars and (4) not callable or exchangeable debt issues;
(E) Mortgage pass-throughs provided that (1) the securities are publicly
registered or issued by FNMA, GNMA or FHLMC; or (2) rated at least Aa by Moody's
or comparably rated by another Rating Agency; and (3) certificates must evidence
a proportional, undivided interest in specified pools of fixed or adjustable
rate mortgage loans, secured by a valid first lien, on one- to four-family
residential properties;
(F) Private-placement mortgage pass-throughs provided that (1) certificates
represent a proportional undivided interest in specified pools of fixed-rate
mortgage loans, secured by a valid first lien, on one-to four-family residential
properties, (2) documentation is held by a trustee or independent custodian, (3)
pools of mortgage loans are serviced by servicers that have been approved by
FNMA or FHLMC and funds shall be advanced to meet deficiencies to the extent
provided in the pooling and servicing agreements creating such certificates, and
(4) pools have been rated Aa or better by Moody's or comparably rated by another
Rating Agency; and
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B-20
(G) Whole loans (e.g., direct investments in mortgages) provided that (1) at
least 65% of such loans (a) have seasoning of no less than 6 months, (b) are
secured by single-family detached residences, (c) are owner-occupied primary
residences, (d) are secured by a first-lien, fully-documented mortgage, (e) are
neither currently delinquent (30 days or more) nor delinquent during the
preceding year, (f) have loan-to-value ratios of 80% or below, (g) carry normal
hazard insurance and title insurance, as well as special hazard insurance, if
applicable, (h) have original terms to maturity not greater than 30 years, with
at least one year remaining to maturity, (i) have a minimum of $10,000 remaining
principal balance, (j) for loans underwritten after January 1, 1978, FNMA and/or
FHLMC forms are used for fixed-rate loans, and (k) such loans are whole loans
and not participations; (2) for loans that do not satisfy the requirements set
forth in the foregoing clause (1), (a) non-owner occupied properties represent
no greater than 15% of the aggregate of either the adjustable-rate pool or the
fixed-rate pool, (b) multi-family properties (those with five or more units)
represent no greater than 15% of the aggregate of either the adjustable-rate
pool or the fixed-rate pool, (c) condominiums represent no greater than 10% of
the aggregate of either the adjustable-rate pool or the fixed-rate pool, and any
condominium project must be 80% occupied at the time the loan is originated, (d)
properties with loan-to-value ratios exceeding 80% represent no greater than 25%
of the aggregate of either the adjustable-rate pool or the fixed-rate pool and
the portion of the mortgage on any such property that exceeds a loan-to-value
ratio of 80% is insured with Primary Mortgage Insurance from an insurer rated at
least Baa3 by Moody's and (e) loan balances in excess of the current FHLMC limit
plus $75,000 represent no greater than 25% of the aggregate of either the
adjustable-rate pool or the fixed-rate pool, loan balances in excess of $350,000
represent no greater than 10% of the aggregate of either the adjustable-rate
pool or the fixed-rate pool, and loan balances in excess of $1,000,000 represent
no greater than 5% of the aggregate of either the adjustable-rate pool or the
fixed-rate pool; (3) no greater than 5% of the pool of loans is concentrated in
any one zip code; (4) the pool of loans contains at least 100 loans or $2
million in loans per servicer; (5) for adjustable-rate mortgages ("ARMs"), (a)
any ARM is indexed to the National Cost of Funds index, the 11th District Cost
of Funds index, the 1-year Treasury or the 6-month Treasury, (b) the margin over
the given index is between 0.15% and 0.25% for either cost-of-funds index and
between 0.175% and 0.325% for Treasuries, (c) the maximum yearly interest rate
increase is 2%, (d) the maximum life-time interest rate increase is 6.25% and
(e) ARMs may include Federal Housing Administration and Department of Veterans
Affairs loans; (6) for "teaser" loans, (a) the initial discount from the current
ARM market rate is no greater than 2%, (b) the loan is underwritten at the
market rate for ARMs, not the "teaser" rate, and (c) the loan is seasoned six
months beyond the "teaser" period;
(ix) Financial contracts, as such term is defined in Section 3(c)(2)(B)(ii) of
the Investment Company Act of 1940, as amended, not otherwise provided for in
this definition but only upon receipt by the Trust of a letter from Moody's
specifying any conditions on including such financial contract in Moody's
Eligible Assets and assuring the Trust that including such financial contract in
the manner so specified would not affect the credit rating assigned by Moody's
to the APS; and
(x) Moody's Hedging Transactions.
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B-21
MOODY'S DIVERSIFICATION LIMITATIONS:
In addition, portfolio holdings as described below must be within the following
diversification and issue size requirements in order to be included in Moody's
Eligible Assets:
MAXIMUM SINGLE MAXIMUM SINGLE MINIMUM ISSUE SIZE
RATINGS(1) ISSUER(2),(3) INDUSTRY(3),(4) ($ IN MILLIONS)(5)
---------- -------------- --------------- ------------------
Aaa................................... 100% 100% $100
Aa.................................... 20 60 100
A..................................... 10 40 100
Baa................................... 6 20 100
Ba.................................... 4 12 50(6)
B1-B2................................. 3 8 50(6)
B3 or below........................... 2 5 50(6)
------------
(1) Refers to the securities of the portfolio holding.
(2) Companies subject to common ownership of 25% or more are considered as one
issuer.
(3) Percentages represent a portion of the aggregate Market Value of securities.
(4) Industries are determined according to Moody's Industry Classifications, as
defined herein.
(5) Except for preferred stock, which has a minimum issue size of $50 million,
and mortgage pass throughs issued by FNMA, FHLMC or GNMA, which has no
minimum issue size.
(6) Portfolio holdings from issues ranging from $50 million to $100 million are
limited to 20% of the Trust's total assets.
Unless conclusions regarding liquidity risk as well as estimates of both the
probability and severity of default for the Fund's assets can be derived from
other sources, securities rated below B by Moody's and unrated securities, which
are securities rated by neither Moody's, S&P nor Fitch, are limited to 10% of
Moody's Eligible Assets. If a corporate, municipal or other debt security is
unrated by Moody's, S&P or Fitch, the Fund will use the percentage set forth
under "Below B and Unrated" in this table. Ratings assigned by S&P or Fitch are
generally accepted by Moody's at face value. However, adjustments to face value
may be made to particular categories of credits for which the S&P and/or Fitch
rating does not seem to approximate a Moody's rating equivalent.
Where the Trust sells an asset and agrees to repurchase such asset in the
future, the Discounted Value of such asset will constitute a Moody's Eligible
Asset and the amount the Trust is required to pay upon repurchase of such asset
will count as a liability for the purposes of the APS Basic Maintenance Amount.
Where the Trust purchases an asset and agrees to sell it to a third party in the
future, cash receivable by the Trust thereby will constitute a Moody's Eligible
Asset if the long-term debt of such other party is rated at least A2 by Moody's
and such agreement has a term of 30 days or less; otherwise the Discounted Value
of such purchased asset will constitute a Moody's Eligible Asset. For the
purposes of calculation of Moody's Eligible Assets, portfolio securities which
have been called for redemption by the issuer thereof shall be valued at the
lower of Market Value or the call price of such portfolio securities.
Notwithstanding the foregoing, an asset will not be considered a Moody's
Eligible Asset to the extent that it has been irrevocably deposited for the
payment of (i)(A) through (i)(E) under the definition of APS Basic Maintenance
Amount or to the extent it is subject to any Liens, except for (A) Liens which
are being contested in good faith by appropriate proceedings and which Moody's
has indicated to the Trust will not affect the status of such asset as a Moody's
Eligible Asset, (B) Liens for taxes that are not then due and payable or that
can be paid thereafter without penalty, (C) Liens to secure payment for services
rendered or cash advanced to the Trust by its investment manager or portfolio
manager,
--------------------------------------------------------------------------------
B-22
the Trust's custodian, transfer agent or registrar or the Auction Agent and (D)
Liens arising by virtue of any repurchase agreement.
"Moody's Exposure Period" means the period commencing on a given Valuation Date
and ending 49 days thereafter.
"Moody's General Portfolio Requirements" means that the Trust's portfolio must
meet the following diversification requirements: (a) no more than 25% by par
value of the Trust's total assets can be invested in the securities of borrowers
and other issuers having their principal business activities in the same Moody's
Industry Classification; provided, that this limitation shall not apply with
respect to U.S. Government Securities and provided further that for purposes of
this subsection (a), the term "issuer" shall not include a lender selling a
participation to the Trust or any other person interpositioned between such
lender and the Trust with respect to a participation and (b) no more than 10% by
par value of the Trust's total assets can be invested in securities of a single
issuer, and provided further that for purposes of this subsection (b), the term
"issuer" includes both the borrower under a loan agreement and the lender
selling a participation to the Trust together with any other persons
interpositioned between such lender and the Trust with respect to such
participation.
"Moody's Hedging Transactions" has the meaning set forth in paragraph 8(a) of
these Amended By-Laws.
"Moody's Industry Classification" means, for the purposes of determining Moody's
Eligible Assets, each of the following industry classifications (or such other
classifications as Moody's may from time to time approve for application to the
Preferred Shares):
1. Aerospace and Defense: Major Contractor, Subsystems, Research,
Aircraft Manufacturing, Arms, Ammunition
2. Automobile: Automobile Equipment, Auto-Manufacturing, Auto Parts
Manufacturing, Personal Use Trailers, Motor Homes, Dealers
3. Banking: Bank Holding, Savings and Loans, Consumer Credit, Small Loan,
Agency, Factoring, Receivables
4. Beverage, Food and Tobacco: Beer and Ale, Distillers, Wines and
Liquors, Distributors, Soft Drink Syrup, Bottlers, Bakery, Mill Sugar,
Canned Foods, Corn Refiners, Dairy Products, Meat Products, Poultry
Products, Snacks, Packaged Foods, Distributors, Candy, Gum, Seafood,
Frozen Food, Cigarettes, Cigars, Leaf/Snuff, Vegetable Oil
5. Buildings and Real Estate: Brick, Cement, Climate Controls,
Contracting, Engineering, Construction, Hardware, Forest Products
(building-related only), Plumbing, Roofing, Wallboard, Real Estate,
Real Estate Development, REITs, Land Development
6. Chemicals, Plastics and Rubber: Chemicals (non-agricultural),
Industrial Gases, Sulphur, Plastics, Plastic Products, Abrasives,
Coatings, Paints, Varnish, Fabricating Containers
7. Containers, Packaging and Glass: Glass, Fiberglass, Containers made
of: Glass, Metal, Paper, Plastic, Wood or Fiberglass
8. Personal and Non-Durable Consumer Products (Manufacturing Only):
Soaps, Perfumes, Cosmetics, Toiletries, Cleaning Supplies, School
Supplies
9. Diversified/Conglomerate Manufacturing
10. Diversified/Conglomerate Service
11. Diversified Natural Resources, Precious Metals and Minerals:
Fabricating, Distribution
12. Ecological: Pollution Control, Waste Removal, Waste Treatment and
Waste Disposal
--------------------------------------------------------------------------------
B-23
13. Electronics: Computer Hardware, Electric Equipment, Components,
Controllers, Motors, Household Appliances, Information Service
Communication Systems, Radios, TVs, Tape Machines, Speakers, Printers,
Drivers, Technology
14. Finance: Investment Brokerage, Leasing, Syndication, Securities
15. Farming and Agriculture: Livestock, Grains, Produce, Agriculture
Chemicals, Agricultural Equipment, Fertilizers
16. Grocery: Grocery Stores, Convenience Food Stores
17. Healthcare, Education and Childcare: Ethical Drugs, Proprietary Drugs,
Research, Health Care Centers, Nursing Homes, HMOs, Hospitals,
Hospital Supplies, Medical Equipment
18. Home and Office Furnishings, Housewares, and Durable Consumer
Products: Carpets, Floor Coverings, Furniture, Cooking, Ranges
19. Hotels, Motels, Inns and Gaming
20. Insurance: Life, Property and Casualty, Broker, Agent, Surety
21. Leisure, Amusement, Motion Pictures, Entertainment: Boating, Bowling,
Billiards, Musical Instruments, Fishing, Photo Equipment, Records,
Tapes, Sports, Outdoor Equipment (Camping), Tourism, Resorts, Games,
Toy Manufacturing, Motion Picture Production Theaters, Motion Picture
Distribution
22. Machinery (Non-Agricultural, Non-Construction, Non-Electronic):
Industrial, Machine Tools, Steam Generators
23. Mining, Steel, Iron and Non-Precious Metals: Coal, Copper, Lead,
Uranium, Zinc, Aluminum, Stainless Steel, Integrated Steel, Ore
Production, Refractories, Steel Mill Machinery, Mini-Mills,
Fabricating, Distribution and Sales of the foregoing
24. Oil and Gas: Crude Producer, Retailer, Well Supply, Service and
Drilling
25. Personal, Food and Miscellaneous
26. Printing, Publishing, and Broadcasting: Graphic Arts, Paper, Paper
Products, Business Forms, Magazines, Books, Periodicals, Newspapers,
Textbooks, Radio, T.V., Cable Broadcasting Equipment
27. Cargo Transport: Rail, Shipping, Railroads, Rail-car Builders, Ship
Builders, Containers, Container Builders, Parts, Overnight Mail,
Trucking, Truck Manufacturing, Trailer Manufacturing, Air Cargo,
Transport
28. Retail Stores: Apparel, Toy, Variety, Drugs, Department, Mail Order
Catalog, Showroom
29. Telecommunications: Local, Long Distance, Independent, Telephone,
Telegraph, Satellite, Equipment, Research, Cellular
30. Textiles and Leather: Producer, Synthetic Fiber, Apparel Manufacturer,
Leather Shoes
31. Personal Transportation: Air, Bus, Rail, Car Rental
32. Utilities: Electric, Water, Hydro Power, Gas
33. Broadcasting and Entertainment: Recording Industry, Motion Exhibition
Theaters, Motion Picture Production and Distribution, Radio, T.V.,
Cable Broadcasting and Broadcasting Equipment
34. Diversified Sovereigns: Semi-sovereigns, Canadian Provinces,
Supra-national Agencies
--------------------------------------------------------------------------------
B-24
The Trust will use its discretion in determining which industry classification
is applicable to a particular investment in consultation with the Independent
Accountant and Moody's, to the extent the Trust considers necessary.
"Moody's Loan Category" means the following five categories (and, for purposes
of this categorization, the Market Value of a Moody's Eligible Asset trading at
par is equal to $1.00):
(i) "Moody's Loan Category A" means Performing Loans which have a value as
determined in accordance with the Trust's valuation procedures greater than or
equal to $0.90.
(ii) "Moody's Loan Category B" means: (A) Performing Loans which have a value
as determined in accordance with the Trust's valuation procedures of greater
than or equal to $0.80 but less than $0.90; and (B) non-Performing Loans which
have a value as determined in accordance with the Trust's valuation procedures
greater than or equal to $0.85.
(iii) "Moody's Loan Category C" means: (A) Performing Senior Loans which have
a value as determined in accordance with the Trust's valuation procedures of
greater than or equal to $0.70 but less than $0.80; and (B) non-Performing Loans
which have a value as determined in accordance with the Trust's valuation
procedures of greater than or equal to $0.75 but less than $0.85.
(iv) "Moody's Loan Category D" means Loans which have a value as determined in
accordance with the Trust's valuation procedures less than $0.75.
Notwithstanding any other provision contained above, for purposes of determining
whether a Moody's Eligible Asset falls within a specific Moody's Loan Category,
to the extent that any Moody's Eligible Asset would fall in more than one of the
Moody's Loan Categories, such Moody's Eligible Asset shall be deemed to fall
into the Moody's Loan Category with the lowest applicable Moody's Discount
Factor.
"Non-Call Period" has the meaning set forth under the definition of "Specific
Redemption Provisions".
"Non-Investment Grade Bonds" means "Non-Investment Grade Bonds" as defined in
the Trust's Registration Statement on Form N-2 (File No. 333-105916) relating to
the APS on file with the Securities Exchange Commission, as such Registration
Statement may be amended from time to time.
"Non-Payment Period" means any period commencing on and including the day on
which the Trust shall fail to (i) declare, prior to the close of business on the
second Business Day preceding any Dividend Payment Date, for payment on or (to
the extent permitted by paragraph 2(c)(i) of this Article VII, of these Amended
By-Laws) within three Business Days after such Dividend Payment Date to the
Holders as of 12:00 noon, New York City time, on the Business Day preceding such
Dividend Payment Date, the full amount of any dividend on shares of APS payable
on such Dividend Payment Date or (ii) deposit, irrevocably in trust, in same-day
funds, with the Auction Agent by 12:00 noon, New York City time, (A) on such
Dividend Payment Date the full amount of any cash dividend on such shares
payable (if declared) on such Dividend Payment Date or (B) on any redemption
date for any shares of APS called for redemption, the Mandatory Redemption Price
per share of such APS or, in the case of an optional redemption, the Optional
Redemption Price per share, and ending on and including the Business Day on
which, by 12:00 noon, New York City time, all unpaid cash dividends and unpaid
redemption prices shall have been so deposited or shall have otherwise been made
available to Holders in same-day funds; provided that, a Non-Payment Period
shall not end unless the Trust shall have given at least five days' but no more
than 30 days' written notice of such deposit or availability to the Auction
Agent, all Existing Holders (at their addresses appearing in the Share Books)
and the Securities Depository. Notwithstanding the foregoing, the failure by the
Trust to deposit funds as provided for by clauses (ii)(A) or (ii)(B) above
within three Business Days after any Dividend Payment Date or redemption date,
as the case may be, in each case to the extent contemplated by paragraph 2(c)(i)
of these Amended By-Laws, shall not constitute a "Non-Payment Period."
--------------------------------------------------------------------------------
B-25
"Non-Payment Period Rate" means, initially, 200% of the applicable Reference
Rate, provided that the Board of Trustees of the Trust shall have the authority
to adjust, modify, alter or change from time to time the initial Non-Payment
Period Rate if the Board of Trustees of the Trust determines and Fitch (and any
Substitute Rating Agency in lieu of Fitch in the event such party shall not rate
the APS) advise the Trust in writing that such adjustment, modification,
alteration or change will not adversely affect its then current ratings on the
APS.
"Normal Dividend Payment Date" has the meaning set forth in paragraph 2(b)(i) of
Article VII, of these Amended By-Laws.
"Notice of Redemption" means any notice with respect to the redemption of shares
of APS pursuant to paragraph 4 of Article VII, of these Amended By-Laws.
"Notice of Revocation" has the meaning set forth in paragraph 2(c)(iii) of
Article VII, of these Amended By-Laws.
"Notice of Special Dividend Period" has the meaning set forth in paragraph
2(c)(iii) of Article VII, of these Amended By-Laws.
"Optional Redemption Price" means $25,000 per share plus an amount equal to
accumulated but unpaid dividends (whether or not earned or declared) to the date
fixed for redemption and excluding Additional Dividends plus any applicable
redemption premium attributable to the designation of a Premium Call Period.
"Other APS" means the auction rate Preferred Shares of the Trust, other than the
APS.
"Outstanding" means, as of any date (i) with respect to APS, shares of APS
therefor issued by the Trust except, without duplication, (A) any shares of APS
theretofore canceled or delivered to the Auction Agent for cancellation, or
redeemed by the Trust, or as to which a Notice of Redemption shall have been
given and Deposit Securities shall have been deposited in trust or segregated by
the Trust pursuant to paragraph 4(c) and (B) any shares of APS as to which the
Trust or any Affiliate thereof shall be a Beneficial Owner, provided that shares
of APS held by an Affiliate shall be deemed outstanding for purposes of
calculating the APS Basic Maintenance Amount and (ii) with respect to shares of
other Preferred Shares, has the equivalent meaning.
"Parity Shares" means the APS and each other outstanding series of Preferred
Shares the holders of which, together with the holders of the APS, shall be
entitled to the receipt of dividends or of amounts distributable upon
liquidation, dissolution or winding up, as the case may be, in proportion to the
full respective preferential amounts to which they are entitled, without
preference or priority one over the other.
"Performing" means that no default as to the payment of principal or interest
has occurred and is continuing.
"Person" means and includes an individual, a partnership, a Trust, a trust, an
unincorporated association, a joint venture or other entity or a government or
any agency or political subdivision thereof.
"Potential Beneficial Owner" means a customer of a Broker-Dealer or a
Broker-Dealer that is not a Beneficial Owner of shares of APS but that wishes to
purchase such shares, or that is a Beneficial Owner that wishes to purchase
additional shares of APS.
"Potential Holder" means any Broker-Dealer or any such other Person as may be
permitted by the Trust, including any Existing Holder, who may be interested in
acquiring shares of APS (or, in the case of an Existing Holder, additional
shares of APS).
"Preferred Shares" means the preferred shares of beneficial interest, par value
$0.01 per share, of the Trust, and includes APS and Other APS.
--------------------------------------------------------------------------------
B-26
"Premium Call Period" has the meaning set forth under the definition of
"Specific Redemption Provisions".
"Pricing Service" means any pricing service designated by the Board of Trustees
of the Trust provided the Trust obtains written assurance from Moody's and Fitch
that such designation will not impair the rating then assigned by Moody's and
Fitch, as applicable, to the APS.
"Rating Agency" means a nationally recognized statistical rating organization.
"Reference Rate" means, with respect to the Non-Payment Period Rate means a
Dividend Period the applicable "AA" Composite Commercial Paper Rate.
"Request for Special Dividend Period" has the meaning set forth in paragraph
2(c)(iii) of Article VII, of these Amended By-Laws.
"Response" has the meaning set forth in paragraph 2(c)(iii) of Article VII, of
these Amended By-Laws.
"Rule 144A Securities" means securities which are restricted as to resale under
federal securities laws but are eligible for resale pursuant to Rule 144A under
the Securities Act as determined by the Trust's investment manager or portfolio
manager acting pursuant to procedures approved by the Board of Trustees of the
Trust.
"S&P" means Standard & Poor's Corporation, a New York Corporation, and its
successors.
"Securities Act" means the Securities Act of 1933, as amended.
"Securities Depository" means The Depository Trust Company or any successor
company or other entities elected by the Trust as securities depository for the
shares of APS that agrees to follow the procedures required to be followed by
such securities depository in connection with the shares of APS.
"Senior Loans" means "Senior Loans" as defined in the Trust's Registration
Statement on Form N-2 (File No. 333-105916) relating to the APS on file with the
Securities Exchange Commission, as such Registration Statement may be amended
from time to time.
"Series A APS" means the Auction Preferred Shares, Series A.
"Series B APS" means the Auction Preferred Shares, Series B.
"Series C APS" means the Auction Preferred Shares, Series C.
"Series D APS" means the Auction Preferred Shares, Series D.
"Series E APS" means the Auction Preferred Shares, Series E.
"Service" means the United States Internal Revenue Service.
"Share Books" means the books maintained by the Auction Agent setting forth at
all times a current list, as determined by the Auction Agent, of Existing
Holders of the APS.
"Share Register" means the register of Holders maintained on behalf of the Trust
by the Auction Agent in its capacity as transfer agent and registrar for the
APS.
"Short Term Dividend Period" means a Special Dividend Period consisting of a
specified number of days (other than seven), evenly divisible by seven and not
fewer than seven nor more than 364.
"Short Term Money Market Instruments" means the following types of instruments
if, on the date of purchase or other acquisition thereof by the Trust, the
remaining term to maturity thereof is not in excess of 180 days (or 270 days for
instruments rated at least Aaa for purposes of determining Moody's Eligible
Assets):
(i) commercial paper rated either F-1 by Fitch or A-1 by S&P if such commercial
paper matures in 30 days or P-1 by Moody's and either F-1+ by Fitch or A-1+ by
S&P if such commercial paper matures in over 30 days;
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B-27
(ii) demand or time deposits in, and banker's acceptances and certificates of
deposit of, (A) a depository institution or trust company incorporated under the
laws of the United States of America or any state thereof or the District of
Columbia or (B) a United States branch office or agency of a foreign depository
institution (provided that such branch office or agency is subject to banking
regulation under the laws of the United States, any state thereof or the
District of Columbia);
(iii) overnight funds;
(iv) U.S. Government Securities; and
(v) Eurodollar demand or time deposits in, or certificates of deposit of, the
head office or the London branch office of a depository institution or trust
company if the certificates of deposit, if any, and the long-term unsecured debt
obligations (other than such obligations the ratings of which are based on the
credit of a person or entity other than such depository institution or trust
company) of such depository institution or trust company that have (1) credit
ratings on each Valuation Date of at least P-1 from Moody's and either F-1+ from
Fitch or A-1+ from S&P, in the case of commercial paper or certificates of
deposit, and (2) credit ratings on each Valuation Date of at least Aa3 from
Moody's and either AA from Fitch or AA- from S&P, in the case of long-term
unsecured debt obligations; provided, however, that in the case of any such
investment that matures in no more than one Business Day from the date of
purchase or other acquisition by the Trust, all of the foregoing requirements
shall be applicable except that the required long-term unsecured debt credit
rating of such depository institution or trust company from Moody's, Fitch and
S&P shall be at least A2, A-2 and A, respectively; and provided further,
however, that the foregoing credit rating requirements shall be deemed to be met
with respect to a depository institution or trust company if (1) such depository
institution or trust company is the principal depository institution in a
holding company system, (2) the certificates of deposit, if any, of such
depository institution or trust company are not rated on any Valuation Date
below P-1 by Moody's, F-1+ by Fitch or A-1+ by S&P and there is no long-term
rating, and (3) the holding company shall meet all of the foregoing credit
rating requirements (including the preceding proviso in the case of investments
that mature in no more than one Business Day from the date of purchase or other
acquisition by the Trust); and provided further, that the interest receivable by
the Trust shall not be subject to any withholding or similar taxes.
"Special Dividend Period" means a Dividend Period consisting of (i) a specified
number of days (other than seven), evenly divisible by seven and not fewer than
seven nor more than 364 or (ii) a specified period of one whole year or more but
not greater than five years (in each case subject to adjustment as provided in
paragraph 2(b)(i)).
"Specific Redemption Provisions" means, with respect to a Special Dividend
Period either, or any combination of, (i) a period (a "Non-Call Period")
determined by the Board of Trustees of the Trust, after consultation with the
Auction Agent and the Broker-Dealers, during which the shares of APS subject to
such Dividend Period shall not be subject to redemption at the option of the
Trust and (ii) a period (a "Premium Call Period"), consisting of a number of
whole years and determined by the Board of Trustees of the Trust, after
consultation with the Auction Agent and the Broker-Dealers, during each year of
which the shares of APS subject to such Dividend Period shall be redeemable at
the Trust's option at a price per share equal to $25,000 plus accumulated but
unpaid dividends plus a premium expressed as a percentage of $25,000, as
determined by the Board of Trustees of the Trust after consultation with the
Auction Agent and the Broker-Dealers.
"Subsequent Dividend Period," with respect to APS, has the meaning set forth in
paragraph 2(c)(i) of Article VII, of these Amended By-Laws and, with respect to
Other APS, has the equivalent meaning.
"Substitute Commercial Paper Dealers" means such Substitute Commercial Paper
Dealer or Dealers as the Trust may from time to time appoint or, in lieu of any
thereof, their respective affiliates or successors.
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B-28
"Substitute Rating Agency" and "Substitute Rating Agencies" mean a nationally
recognized statistical rating organization or two nationally recognized
statistical rating organizations, respectively, selected by Eaton Vance
Management or its affiliates and successors, after consultation with the Trust,
to act as the substitute rating agency or substitute rating agencies, as the
case may be, to determine the credit ratings of the shares of APS.
"Swap" means a derivative transaction between two parties who contractually
agree to exchange the returns (or differentials in rates of return) to be
exchanged or "swapped" between the parties, which returns are calculated with
respect to a "notional amount," i.e., the return on or increase in value of a
particular dollar amount invested at a particular interest rate or in a "basket"
of securities representing a particular index.
(i) "Interest Rate Swap" means an arrangement whereby two parties (called
counterparties) enter into an agreement to exchange periodic interest payments.
The dollar amount the counterparties pay each other is an agreed-upon periodic
interest rate multiplied by some predetermined dollar principal, called the
notional principal amount. No principal (no notional amount) is exchanged
between parties to the transaction; only interest is exchanged.
(ii) "Total Return Swap" means an agreement between counterparties in which one
party agrees to make payments of the total return from the underlying asset(s)
which may include securities, baskets of securities, or securities indices
during the specified period, in return for payments equal to a fixed or floating
rate of interest or the total return from other underlying asset(s).
(iii) "Credit Default Swap" means an agreement between counterparties in which
one party is entitled to receive the par (or other agreed-upon) value of a
referenced debt obligation from the counterparty to the agreement in the event
of a default by a third party on the debt obligation. In return, such party
would pay the counterparty a periodic stream of payments over the term of the
contract provided that no event of default has occurred.
"Treasury Bonds" means United States Treasury Bills, Bonds or Notes.
"Trust" means Eaton Vance Limited Duration Income Fund, a Massachusetts business
trust.
"U.S. Government Securities" means direct obligations of the United States or of
its agencies or instrumentalities that are entitled to the full faith and credit
of the United States and that, other than Treasury bills, provide for the
periodic payment of interest and the full payment of principal at maturity or
call for redemption.
"U.S. Treasury Bill Rate" on any date means (i) the Interest Equivalent of the
rate on the actively traded Treasury Bill with a maturity most nearly comparable
to the length of the related Dividend Period, as such rate is made available on
a discount basis or otherwise by the Federal Reserve Bank of New York in its
Composite 3:30 p.m. Quotations for U.S. Government Securities report for such
Business Day, or (ii) if such yield as so calculated is not available, the
Alternate Treasury Bill Rate on such date. "Alternate Treasury Bill Rate" on any
date means the Interest Equivalent of the yield as calculated by reference to
the arithmetic average of the bid price quotations of the actively traded
Treasury Bill with a maturity most nearly comparable to the length of the
related Dividend Period, as determined by bid price quotations as of any time on
the Business Day immediately preceding such date, obtained from at least three
recognized primary U.S. Government securities dealers selected by the Auction
Agent.
"U.S. Treasury Note Rate" on any date means (i) the yield as calculated by
reference to the bid price quotation of the actively traded, current coupon
Treasury Note with a maturity most nearly comparable to the length of the
related Dividend Period, as such bid price quotation is published on the
Business Day immediately preceding such date by the Federal Reserve Bank of New
York in its Composite 3:30 p.m. Quotations for U.S. Government Securities report
for such Business Day, or (ii) if such yield as so calculated is not available,
the Alternate Treasury Note Rate on such date. "Alternate Treasury Note Rate" on
any date means the yield as calculated by reference to the arithmetic average
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of the bid price quotations of the actively traded, current coupon Treasury Note
with a maturity most nearly comparable to the length of the related Dividend
Period, as determined by the bid price quotations as of any time on the Business
Day immediately preceding such date, obtained from at least three recognized
primary U.S. Government securities dealers selected by the Auction Agent.
"Valuation Date" means, for purposes of determining whether the Trust is
maintaining the APS Basic Maintenance Amount, each Business Day commencing with
the Date of Original Issue.
"Variation Margin" means, in connection with an outstanding futures contract
owned or sold by the Trust, the amount of cash or securities paid to or received
from a broker (subsequent to the Initial Margin payment) from time to time as
the price of such futures contract fluctuates.
(b) The foregoing definitions of Accountant's Confirmation, APS Basic
Maintenance Amount, APS Basic Maintenance Cure Date, APS Basic Maintenance
Report, Deposit Securities, Discounted Value, Independent Accountant, Initial
Margin, Market Value, Maximum Potential Additional Dividend Liability, Moody's
Discount Factor, Fitch Discount Factor, Moody's Eligible Asset, Fitch Eligible
Asset, Moody's Exposure Period, Fitch Exposure Period, Moody's Hedging
Transactions, Fitch Hedging Transactions, Valuation Date and Variation Margin
have been determined by the Board of Trustees of the Trust in order to obtain a
AAA rating from Fitch and Aaa rating from Moody's on the APS on their Date of
Original Issue; and the Board of Trustees of the Trust shall have the authority,
without shareholder approval, to amend, alter or repeal from time to time the
foregoing definitions and the restrictions and guidelines set forth thereunder
if Moody's, Fitch or any Substitute Rating Agency advises the Trust in writing
that such amendment, alteration or repeal will not adversely affect its then
current rating on the APS.
2. DIVIDENDS. (a) The Holders of a particular series of APS shall be entitled
to receive, when, as and if declared by the Board of Trustees of the Trust, out
of funds legally available therefor, cumulative dividends each consisting of
cash at the Applicable Rate, and no more, payable on the respective dates set
forth below. Dividends on the shares of each series of APS so declared and
payable shall be paid (i) in preference to and in priority over any dividends
declared and payable on the Common Shares, and (ii) to the extent permitted
under the Code and to the extent available, out of net tax-exempt income earned
on the Trust's investments. To the extent permitted under the Code, dividends on
shares of APS will be designated as exempt-interest dividends. For the purposes
of this section, the term "net tax-exempt income" shall exclude capital gains of
the Trust.
(b) (i) Cash dividends on shares of each series of APS shall accumulate from
the Date of Original Issue and shall be payable, when, as and if declared by the
Board of Trustees, out of funds legally available therefor, commencing on the
Initial Dividend Payment Date. Following the Initial Dividend Payment Date for a
series of APS, dividends on that series of APS will be payable, at the option of
the Trust, either (i) with respect to any 7-Day Dividend Period and any Short
Term Dividend Period of 28 or fewer days, on the day next succeeding the last
day thereof, or (ii) with respect to any Short Term Dividend Period of more than
28 days and with respect to any Long Term Dividend Period, monthly on the first
Business Day of each calendar month during such Short Term Dividend Period or
Long Term Dividend Period and on the day next succeeding the last day thereof
(each such date referred to in clause (i) or (ii) being herein referred to as a
"Normal Dividend Payment Date"), except that if such Normal Dividend Payment
Date is not a Business Day, then the Dividend Payment Date shall be the first
Business Day next succeeding such Normal Dividend Payment Date. Although any
particular Dividend Payment Date may not occur on the originally scheduled date
because of the exception discussed above, the next succeeding Dividend Payment
Date, subject to such exception, will occur on the next following originally
scheduled date. If for any reason a Dividend Payment Date cannot be fixed as
described above, then the Board of Trustees shall fix the Dividend Payment Date.
The Board of Trustees by resolution prior to authorization of a dividend by the
Board of Trustees may change a Dividend Payment Date if such change does not
adversely affect the contract rights of the Holders of shares of APS set forth
in the Declaration of Trust or the Amended By-Laws. The Initial Dividend Period,
7-Day Dividend Periods and Special Dividend Periods with respect to a series of
APS are
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hereinafter sometimes referred to as Dividend Periods. Each dividend payment
date determined as provided above is hereinafter referred to as a "Dividend
Payment Date."
(ii) Each dividend shall be paid to the Holders as they appear in the Stock
Register as of 12:00 noon, New York City time, on the Business Day preceding the
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 they appear on the Stock Register on a date, not
exceeding 15 days prior to the payment date therefor, as may be fixed by the
Board of Trustees of the Trust.
(c) (i) During the period from and including the Date of Original Issue to but
excluding the Initial Dividend Payment Date for each series of APS (the "Initial
Dividend Period"), the Applicable Rate shall be the Initial Dividend Rate.
Commencing on the Initial Dividend Payment Date for each series of APS, the
Applicable Rate for each subsequent dividend period (hereinafter referred to as
a "Subsequent Dividend Period"), which Subsequent Dividend Period shall commence
on and include a Dividend Payment Date and shall end on and include the calendar
day prior to the next Dividend Payment Date (or last Dividend Payment Date in a
Dividend Period if there is more than one Dividend Payment Date), shall be equal
to the rate per annum that results from implementation of the Auction
Procedures.
The Applicable Rate for each Dividend Period commencing during a Non-Payment
Period shall be equal to the Non-Payment Period Rate; and each Dividend Period,
commencing after the first day of, and during, a Non-Payment Period shall be a
7-Day Dividend Period in the case of each series of APS. Except in the case of
the willful failure of the Trust to pay a dividend on a Dividend Payment Date or
to redeem any shares of APS on the date set for such redemption, any amount of
any dividend due on any Dividend Payment Date (if, prior to the close of
business on the second Business Day preceding such Dividend Payment Date, the
Trust has declared such dividend payable on such Dividend Payment Date to the
Holders of such shares of APS as of 12:00 noon, New York City time, on the
Business Day preceding such Dividend Payment Date) or redemption price with
respect to any shares of APS not paid to such Holders when due may be paid to
such Holders in the same form of funds by 12:00 noon, New York City time, on any
of the first three Business Days after such Dividend Payment Date or due date,
as the case may be, provided that, such amount is accompanied by a late charge
calculated for such period of non-payment at the Non-Payment Period Rate applied
to the amount of such non-payment based on the actual number of days comprising
such period divided by 360. In the case of a willful failure of the Trust to pay
a dividend on a Dividend Payment Date or to redeem any shares of APS on the date
set for such redemption, the preceding sentence shall not apply and the
Applicable Rate for the Dividend Period commencing during the Non-Payment Period
resulting from such failure shall be the Non-Payment Period Rate. For the
purposes of the foregoing, payment to a person in same-day funds on any Business
Day at any time shall be considered equivalent to payment to such person in New
York Clearing House (next-day) funds at the same time on the preceding Business
Day, and any payment made after 12:00 noon, New York City time, on any Business
Day shall be considered to have been made instead in the same form of funds and
to the same person before 12:00 noon, New York City time, on the next Business
Day.
(ii) The amount of cash dividends per share of any series of APS payable (if
declared) on the Initial Dividend Payment Date, each 7-Day Dividend Period and
each Dividend Payment Date of each Short Term Dividend Period shall be computed
by multiplying the Applicable Rate for such Dividend Period by a fraction, the
numerator of which will be the number of days in such Dividend Period or part
thereof that such share was outstanding and the denominator of which will be
360, multiplying the amount so obtained by $25,000, and rounding the amount so
obtained to the nearest cent. During any Long Term Dividend Period, the amount
of cash dividends per share of a series of APS payable (if declared) on any
Dividend Payment Date shall be computed by multiplying the Applicable Rate for
such Dividend Period by a fraction, the numerator of which will be such number
of days in such part of such Dividend Period that such share was outstanding and
for which dividends are payable on such
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Dividend Payment Date and the denominator of which will be 360, multiplying the
amount so obtained by $25,000, and rounding the amount so obtained to the
nearest cent.
(iii) With respect to each Dividend Period that is a Special Dividend Period,
the Trust may, at its sole option and to the extent permitted by law, by
telephonic and written notice (a "Request for Special Dividend Period") to the
Auction Agent and to each Broker-Dealer, request that the next succeeding
Dividend Period for a series of APS be a number of days (other than seven),
evenly divisible by seven and not fewer than 7 nor more than 364 in the case of
a Short Term Dividend Period or one whole year or more but not greater than 5
years in the case of a Long Term Dividend Period, specified in such notice,
provided that the Trust may not give a Request for Special Dividend Period of
greater than 28 days (and any such request shall be null and void) unless, for
any Auction occurring after the initial Auction, Sufficient Clearing Bids were
made in the last occurring Auction and unless full cumulative dividends, any
amounts due with respect to redemption's, and any Additional Dividends payable
prior to such date have been paid in full. Such Request for Special Dividend
Period, in the case of a Short Term Dividend Period, shall be given on or prior
to the second Business Day but not more than seven Business Days prior to an
Auction Date for a series of APS and, in the case of a Long Term Dividend
Period, shall be given on or prior to the second Business Day but not more than
28 days prior to an Auction Date for a series of APS. Upon receiving such
Request for Special Dividend Period, the Broker-Dealer(s) shall jointly
determine whether, given the factors set forth below, it is advisable that the
Trust issue a Notice of Special Dividend Period for the series of APS as
contemplated by such Request for Special Dividend Period and the Optional
Redemption Price of the APS during such Special Dividend Period and the Specific
Redemption Provisions and shall give the Trust and the Auction Agent written
notice (a "Response") of such determination by no later than the second Business
Day prior to such Auction Date. In making such determination the
Broker-Dealer(s) will consider (1) existing short-term and long-term market
rates and indices of such short-term and long-term rates, (2) existing market
supply and demand for short-term and long-term securities, (3) existing yield
curves for short-term and long-term securities comparable to the APS, (4)
industry and financial conditions which may affect the APS, (5) the investment
objective of the Trust, and (6) the Dividend Periods and dividend rates at which
current and potential beneficial holders of the APS would remain or become
beneficial holders. If the Broker-Dealer(s) shall not give the Trust and the
Auction Agent a Response by such second Business Day or if the Response states
that given the factors set forth above it is not advisable that the Trust give a
Notice of Special Dividend Period for the series of APS, the Trust may not give
a Notice of Special Dividend Period in respect of such Request for Special
Dividend Period. In the event the Response indicates that it is advisable that
the Trust give a Notice of Special Dividend Period for the series of APS, the
Trust may by no later than the second Business Day prior to such Auction Date
give a notice (a "Notice of Special Dividend Period") to the Auction Agent, the
Securities Depository and each Broker-Dealer which notice will specify (i) the
duration of the Special Dividend Period, (ii) the Optional Redemption Price as
specified in the related Response and (iii) the Specific Redemption Provisions,
if any, as specified in the related Response. The Trust also shall provide a
copy of such Notice of Special Dividend Period to Moody's and Fitch. The Trust
shall not give a Notice of Special Dividend Period and, if the Trust has given a
Notice of Special Dividend Period, the Trust is required to give telephonic and
written notice of its revocation (a "Notice of Revocation") to the Auction
Agent, each Broker-Dealer, and the Securities Depository on or prior to the
Business Day prior to the relevant Auction Date if (x) either the 1940 Act APS
Asset Coverage is not satisfied or the Trust shall fail to maintain Fitch
Eligible Assets or Moody's Eligible Assets with an aggregate Discounted Value at
least equal to the APS Basic Maintenance Amount, on each of the two Valuation
Dates immediately preceding the Business Day prior to the relevant Auction Date
on an actual basis and on a pro forma basis giving effect to the proposed
Special Dividend Period (using as a pro forma dividend rate with respect to such
Special Dividend Period the dividend rate which the Broker-Dealers shall advise
the Trust is an approximately equal rate for securities similar to the APS with
an equal dividend period), (y) sufficient funds for the payment of dividends
payable on the immediately succeeding Dividend Payment Date have not been
irrevocably deposited with the Auction Agent by the close of business on the
third Business Day
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preceding the related Auction Date or (z) the Broker-Dealer(s) jointly advise
the Trust that after consideration of the factors listed above they have
concluded that it is advisable to give a Notice of Revocation. The Trust also
shall provide a copy of such Notice of Revocation to Fitch and Moody's. If the
Trust is prohibited from giving a Notice of Special Dividend Period as a result
of any of the factors enumerated in clause (x), (y) or (z) above or if the Trust
gives a Notice of Revocation with respect to a Notice of Special Dividend Period
for any series of APS, the next succeeding Dividend Period will be a 7-Day
Dividend Period. In addition, in the event Sufficient Clearing Bids are not made
in the applicable Auction or such Auction is not held for any reason, such next
succeeding Dividend Period will be a 7-Day Dividend Period and the Trust may not
again give a Notice of Special Dividend Period for the APS (and any such
attempted notice shall be null and void) until Sufficient Clearing Bids have
been made in an Auction with respect to a 7-Day Dividend Period.
(d) (i) Holders shall not be entitled to any dividends, whether payable in
cash, property or stock, in excess of full cumulative dividends and applicable
late charges, as herein provided, on the shares of APS. Except for the late
charge payable pursuant to paragraph 2(c)(i) hereof, no interest, or sum of
money in lieu of interest, shall be payable in respect of any dividend payment
on the shares of APS that may be in arrears.
(ii) For so long as any share of APS is Outstanding, the Trust shall not
declare, pay or set apart for payment any dividend or other distribution (other
than a dividend or distribution paid in shares of, or options, warrants or
rights to subscribe for or purchase, Common Shares or other shares of beneficial
interest, if any, ranking junior to the shares of APS as to dividends or upon
liquidation) in respect of the Common Shares or any other shares of beneficial
interest of the Trust ranking junior to or on a parity with the shares of APS as
to dividends or upon liquidation, or call for redemption, redeem, purchase or
otherwise acquire for consideration any shares of the Common Shares or any other
such junior shares (except by conversion into or exchange for shares of the
Trust ranking junior to the shares of APS as to dividends and upon liquidation)
or any other such Parity Shares (except by conversion into or exchange for stock
of the Trust ranking junior to or on a parity with the shares of APS as to
dividends and upon liquidation), unless (A) immediately after such transaction,
the Trust shall have Fitch Eligible Assets and Moody's Eligible Assets with an
aggregate Discounted Value equal to or greater than the APS Basic Maintenance
Amount and the Trust shall maintain the 1940 Act APS Asset Coverage, (B) full
cumulative dividends on shares of APS and shares of Other APS due on or prior to
the date of the transaction have been declared and paid or shall have been
declared and sufficient funds for the payment thereof deposited with the Auction
Agent, and (C) the Trust has redeemed the full number of shares of APS required
to be redeemed by any provision for mandatory redemption contained herein.
(e) No fractional shares of APS shall be issued.
3. LIQUIDATION RIGHTS. Upon any liquidation, dissolution or winding up of the
Trust, whether voluntary or involuntary, the Holders shall be entitled to
receive, out of the assets of the Trust available for distribution to
shareholders, before any distribution or payment is made upon any Common Shares
or any other shares of beneficial interest ranking junior in right of payment
upon liquidation to the APS, the sum of $25,000 per share plus accumulated but
unpaid dividends (whether or not earned or declared) thereon to the date of
distribution, and after such payment the Holders will be entitled to no other
payments. If upon any liquidation, dissolution or winding up of the Trust, the
amounts payable with respect to the APS and any other Outstanding class or
series of Preferred Shares of the Trust ranking on a parity with the APS as to
payment upon liquidation are not paid in full, the Holders and the holders of
such other class or series will share ratably in any such distribution of assets
in proportion to the respective preferential amounts to which they are entitled.
After payment of the full amount of the liquidating distribution to which they
are entitled, the Holders will not be entitled to any further participation in
any distribution of assets by the Trust except for any Additional Dividends. A
consolidation, merger or statutory share exchange of the Trust with or into any
other Trust or entity or a sale, whether for cash, shares of stock, securities
or properties, of all or
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substantially all or any part of the assets of the Trust shall not be deemed or
construed to be a liquidation, dissolution or winding up of the Trust.
4. REDEMPTION. (a) Shares of APS shall be redeemable by the Trust as provided
below:
(i) To the extent permitted under the 1940 Act and Massachusetts law, upon
giving a Notice of Redemption, the Trust at its option may redeem shares of any
series of APS, in whole or in part, out of funds legally available therefor, at
the Optional Redemption Price per share, on any Dividend Payment Date; provided
that no share of APS may be redeemed at the option of the Trust during (A) the
Initial Dividend Period with respect to a series of shares or (B) a Non-Call
Period to which such share is subject. In addition, holders of APS which are
redeemed shall be entitled to receive Additional Dividends to the extent
provided herein. The Trust may not give a Notice of Redemption relating to an
optional redemption as described in this paragraph 4(a)(i) unless, at the time
of giving such Notice of Redemption, the Trust has available Deposit Securities
with maturity or tender dates not later than the day preceding the applicable
redemption date and having a value not less than the amount due to Holders by
reason of the redemption of their shares of APS on such redemption date, and the
Discounted Value of Fitch Eligible Assets at least equals the APS Basic
Maintenance Amount, and would at least equal the APS Basic Maintenance Amount
immediately subsequent to such redemption if such redemption were to occur on
such date.
(ii) The Trust shall redeem, out of funds legally available therefor, at the
Mandatory Redemption Price per share, shares of APS to the extent permitted
under the 1940 Act and Massachusetts law, on a date fixed by the Board of
Trustees, if the Trust fails to maintain Fitch Eligible Assets and Moody's
Eligible Assets with an aggregate Discounted Value equal to or greater than the
APS Basic Maintenance Amount as provided in paragraph 7(a) or to satisfy the
1940 Act APS Asset Coverage as provided in paragraph 6 and such failure is not
cured on or before the APS Basic Maintenance Cure Date or the 1940 Act Cure Date
(herein collectively referred to as a "Cure Date"), as the case may be. In
addition, holders of APS so redeemed shall be entitled to receive Additional
Dividends to the extent provided herein. The number of shares of APS to be
redeemed shall be equal to the lesser of (i) the minimum number of shares 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 shares of other
Preferred Shares subject to redemption or retirement, would result in the Trust
having Fitch Eligible Assets and Moody's Eligible Assets with an aggregate
Discounted Value equal to or greater than the APS Basic Maintenance Amount or
satisfaction of the 1940 Act APS Asset Coverage, as the case may be, on such
Cure Date (provided that, if there is no such minimum number of shares of APS
and shares of other Preferred Shares the redemption of which would have such
result, all shares of APS and shares of other Preferred Shares then Outstanding
shall be redeemed), and (ii) the maximum number of shares of APS, together with
all shares of other Preferred Shares subject to redemption or retirement, that
can be redeemed out of funds expected to be legally available therefor on such
redemption date. In determining the number of shares of APS required to be
redeemed in accordance with the foregoing, the Trust shall allocate the number
required to be redeemed which would result in the Trust having Fitch Eligible
Assets and Moody's Eligible Assets with an aggregate Discounted Value equal to
or greater than the APS Basic Maintenance Amount or satisfaction of the 1940 Act
APS Asset Coverage, as the case may be, pro rata among shares of APS of all
series, Other APS and other Preferred Shares subject to redemption pursuant to
provisions similar to those contained in this paragraph 4(a)(ii); provided that,
shares of APS which may not be redeemed at the option of the Trust due to the
designation of a Non-Call Period applicable to such shares (A) will be subject
to mandatory redemption only to the extent that other shares are not available
to satisfy the number of shares required to be redeemed and (B) will be selected
for redemption in an ascending order of outstanding number of days in the
Non-Call Period (with shares with the lowest number of days to be redeemed
first) and by lot in the event of shares having an equal number of days in such
Non-Call Period. The Trust shall effect such redemption on a Business Day which
is not later than 35 days after such Cure Date, except that if the Trust does
not have funds legally available for the redemption of all of the required
number of shares of APS and shares of other Preferred Shares which are subject
to mandatory
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redemption or the Trust otherwise is unable to effect such redemption on or
prior to 35 days after such Cure Date, the Trust shall redeem those shares of
APS which it is unable to redeem on the earliest practicable date on which it is
able to effect such redemption out of funds legally available therefor.
(b) Notwithstanding any other provision of this paragraph 4, no shares of APS
may be redeemed pursuant to paragraph 4(a)(i) of Article VII, of these Amended
By-Laws (i) unless all dividends in arrears on all remaining outstanding shares
of Parity Shares shall have been or are being contemporaneously paid or declared
and set apart for payment and (ii) if redemption thereof would result in the
Trust's failure to maintain Fitch Eligible Assets and Moody's Eligible Assets
with an aggregate Discounted Value equal to or greater than the APS Basic
Maintenance Amount. In the event that less than all the outstanding shares of a
series of APS are to be redeemed and there is more than one Holder, the shares
of that series of APS to be redeemed shall be selected by lot or such other
method as the Trust shall deem fair and equitable.
(c) Whenever shares of APS are to be redeemed, the Trust, not less than 17 nor
more than 30 days prior to the date fixed for redemption, shall mail a notice
("Notice of Redemption") by first-class mail, postage prepaid, to each Holder of
shares of APS to be redeemed and to the Auction Agent. The Trust shall cause the
Notice of Redemption to also be published in the eastern and national editions
of The Wall Street Journal. The Notice of Redemption shall set forth (i) the
redemption date, (ii) the amount of the redemption price, (iii) the aggregate
number of shares of APS of such series to be redeemed, (iv) the place or places
where shares of APS of such series are to be surrendered for payment of the
redemption price, (v) a statement that dividends on the shares to be redeemed
shall cease to accumulate on such redemption date (except that holders may be
entitled to Additional Dividends) and (vi) the provision of these Amended
By-Laws pursuant to which such shares are being redeemed. No defect in the
Notice of Redemption or in the mailing or publication thereof shall affect the
validity of the redemption proceedings, except as required by applicable law.
If the Notice of Redemption shall have been given as aforesaid and, concurrently
or thereafter, the Trust shall have deposited in trust with the Auction Agent,
or segregated in an account at the Trust's custodian bank for the benefit of the
Auction Agent, Deposit Securities (with a right of substitution) having an
aggregate Discounted Value (utilizing in the case of Fitch the Fitch Exposure
Period of 41 Business Days and in the case of Moody's the Moody's Exposure
Period of 49 days) equal to the redemption payment for the shares of APS as to
which such Notice of Redemption has been given with irrevocable instructions and
authority to pay the redemption price to the Holders of such shares, then upon
the date of such deposit or, if no such deposit is made, then upon such date
fixed for redemption (unless the Trust shall default in making the redemption
payment), all rights of the Holders of such shares as shareholders of the Trust
by reason of the ownership of such shares will cease and terminate (except their
right to receive the redemption price in respect thereof and any Additional
Dividends, but without interest), and such shares shall no longer be deemed
outstanding. The Trust shall be entitled to receive, from time to time, from the
Auction Agent the interest, if any, on such Deposit Securities deposited with it
and the Holders of any shares so redeemed shall have no claim to any of such
interest. In case the Holder of any shares so called for redemption shall not
claim the redemption payment for his shares within one year after the date of
redemption, the Auction Agent shall, upon demand, pay over to the Trust such
amount remaining on deposit and the Auction Agent shall thereupon be relieved of
all responsibility to the Holder of such shares called for redemption and such
Holder thereafter shall look only to the Trust for the redemption payment.
5. VOTING RIGHTS. (a) General. Except as otherwise provided in the Declaration
of Trust or Amended By-Laws, each Holder of shares of APS shall be entitled to
one vote for each share held on each matter submitted to a vote of shareholders
of the Trust, and the holders of outstanding shares of Preferred Shares,
including APS, and of shares of Common Shares shall vote together as a single
class; provided that, at any meeting of the shareholders of the Trust held for
the election of trustees, the holders of outstanding shares of Preferred Shares,
including APS, shall be entitled, as a class, to the exclusion of
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the holders of all other securities and classes of capital stock of the Trust,
to elect two trustees of the Trust. Subject to paragraph 5(b) hereof, the
holders of outstanding shares of capital stock of the Trust, including the
holders of outstanding shares of Preferred Shares, including APS, voting as a
single class, shall elect the balance of the trustees.
(b) Right to Elect Majority of Board of Trustees. During any period in which
any one or more of the conditions described below shall exist (such period being
referred to herein as a "Voting Period"), the number of trustees constituting
the Board of Trustees shall be automatically increased by the smallest number
that, when added to the two directors elected exclusively by the holders of
shares of Preferred Shares, would constitute a majority of the Board of Trustees
as so increased by such smallest number; and the holders of shares of Preferred
Shares shall be entitled, voting separately as one class (to the exclusion of
the holders of all other securities and classes of shares of beneficial interest
of the Trust), to elect such smallest number of additional trustees, together
with the two trustees that such holders are in any event entitled to elect. A
Voting Period shall commence:
(i) if at any time accumulated dividends (whether or not earned or declared,
and whether or not funds are then legally available in an amount sufficient
therefor) on the outstanding shares of APS equal to at least two full years'
dividends shall be due and unpaid and sufficient cash or specified securities
shall not have been deposited with the Auction Agent for the payment of such
accumulated dividends; or
(ii) if at any time holders of any other shares of Preferred Shares are
entitled to elect a majority of the trustees of the Trust under the 1940 Act.
Upon the termination of a Voting Period, the voting rights described in this
paragraph 5(b) shall cease, subject always, however, to the reverting of such
voting rights in the Holders upon the further occurrence of any of the events
described in this paragraph 5(b)
(c) Right to Vote with Respect to Certain Other Matters. So long as any shares
of APS are outstanding, the Trust shall not, without the affirmative vote of the
Holders of at least a majority of the shares of Preferred Shares Outstanding at
the time, voting separately as one class, approve any conversion of the Trust
from a closed-end to an open-end investment company and (i) authorize, create or
issue any class or series of shares of beneficial interest ranking prior to the
APS or any other series of Preferred Shares with respect to payment of dividends
or the distribution of assets on liquidation, or (ii) amend, alter or repeal the
provisions of the Declaration of Trust, whether by merger, consolidation or
otherwise, so as to adversely affect any of the contract rights expressly set
forth in the Declaration of Trust of holders of shares of APS or any other
Preferred Shares. To the extent permitted under the 1940 Act, in the event
shares of more than one series of APS are outstanding, the Trust shall not
approve any of the actions set forth in clause (i) or (ii) which adversely
affects the contract rights expressly set forth in the Declaration of Trust of a
Holder of shares of a series of APS differently than those of a Holder of shares
of any other series of APS without the affirmative vote of the holders of at
least a majority of the shares of APS of each series adversely affected and
outstanding at such time (each such adversely affected series voting separately
as a class). The Trust shall notify Fitch and Moody's ten (10) Business Days
prior to any such vote described in clause (i) or (ii). Unless a higher
percentage is provided for under the Declaration of Trust, the affirmative vote
of the holders of a majority of the outstanding shares of Preferred Shares,
including APS, voting together as a single class, will be required to approve
any plan of reorganization (including bankruptcy proceedings) adversely
affecting such shares or any action requiring a vote of security holders under
Section 13(a) of the 1940 Act. The class vote of holders of shares of Preferred
Shares, including APS, described above will in each case be in addition to a
separate vote of the requisite percentage of shares of Common Shares and shares
of Preferred Shares, including APS, voting together as a single class necessary
to authorize the action in question.
(d) Voting Procedures.
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(i) As soon as practicable after the accrual of any right of the holders of
shares of Preferred Shares to elect additional trustees as described in
paragraph 5(b) above, the Trust shall call a special meeting of such holders and
instruct the Auction Agent to mail a notice of such special meeting to such
holders, such meeting to be held not less than 10 nor more than 20 days after
the date of mailing of such notice. If the Trust fails to send such notice to
the Auction Agent or if the Trust does not call such a special meeting, it may
be called by any such holder on like notice. The record date for determining the
holders entitled to notice of and to vote at such special meeting shall be the
close of business on the fifth Business Day preceding the day on which such
notice is mailed. At any such special meeting and at each meeting held during a
Voting Period, such Holders, voting together as a class (to the exclusion of the
holders of all other securities and classes of shares of beneficial interest of
the Trust), shall be entitled to elect the number of directors prescribed in
paragraph 5(b) above. At any such meeting or adjournment thereof in the absence
of a quorum, a majority of such holders present in person or by proxy shall have
the power to adjourn the meeting without notice, other than by an announcement
at the meeting, to a date not more than 120 days after the original record date.
(ii) For purposes of determining any rights of the Holders to vote on any
matter or the number of shares required to constitute a quorum, whether such
right is created by these Amended By-Laws, by the other provisions of the
Declaration of Trust, by statute or otherwise, a share of APS which is not
Outstanding shall not be counted.
(iii) The terms of office of all persons who are trustees of the Trust at the
time of a special meeting of Holders and holders of other Preferred Shares to
elect trustees shall continue, notwithstanding the election at such meeting by
the Holders and such other holders of the number of trustees that they are
entitled to elect, and the persons so elected by the Holders and such other
holders, together with the two incumbent trustees elected by the Holders and
such other holders of Preferred Shares and the remaining incumbent trustees
elected by the holders of the Common Shares and Preferred Shares, shall
constitute the duly elected trustees of the Trust.
(iv) Simultaneously with the expiration of a Voting Period, the terms of office
of the additional trustees elected by the Holders and holders of other Preferred
Shares pursuant to paragraph 5(b) above shall terminate, the remaining trustees
shall constitute the trustees of the Trust and the voting rights of the Holders
and such other holders to elect additional trustees pursuant to paragraph 5(b)
above shall cease, subject to the provisions of the last sentence of paragraph
5(b).
(e) Exclusive Remedy. Unless otherwise required by law, the Holders of shares
of APS shall not have any rights or preferences other than those specifically
set forth herein. The Holders of shares of APS shall have no preemptive rights
or rights to cumulative voting. In the event that the Trust fails to pay any
dividends on the shares of APS, the exclusive remedy of the Holders shall be the
right to vote for trustees pursuant to the provisions of this paragraph 5.
(f) Notification to Fitch and Moody's. In the event a vote of Holders of APS
is required pursuant to the provisions of Section 13(a) of the 1940 Act, the
Trust shall, not later than ten Business Days prior to the date on which such
vote is to be taken, notify Fitch that such vote is to be taken and the nature
of the action with respect to which such vote is to be taken and, not later than
ten Business Days after the date on which such vote is taken, notify Fitch of
the result of such vote.
6. 1940 ACT APS ASSET COVERAGE. The Trust shall maintain, as of the last
Business Day of each month in which any share of APS is outstanding, the 1940
Act APS Asset Coverage.
7. APS BASIC MAINTENANCE AMOUNT. The following references in this paragraph 7
to Fitch Eligible Assets and/or Moody's Eligible Assets, as the case may be, are
only applicable if Fitch and/or Moody's, as the case may be, is rating the APS.
(a) The Trust shall maintain, on each Valuation Date, and shall verify to its
satisfaction that it is maintaining on such Valuation Date Fitch Eligible Assets
and Moody's Eligible Assets having an aggregate Discounted Value equal to or
greater than the APS Basic Maintenance Amount Test. Upon any failure to maintain
the required Discounted Value, the Trust will
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use its best efforts to alter the composition of its portfolio to retain a
Discounted Value at least equal to the APS Basic Maintenance Amount Test on or
prior to the APS Basic Maintenance Cure Date.
(b) On or before 5:00 p.m., New York City time, on the third Business Day after
a Valuation Date on which the Trust fails to satisfy the APS Basic Maintenance
Amount Test, the Trust shall complete and deliver to the Auction Agent, Moody's
and Fitch, a complete APS Basic Maintenance Report as of the date of such
failure, which will be deemed to have been delivered to the Auction Agent if the
Auction Agent receives a copy or telecopy, telex or other electronic
transcription thereof and on the same day the Trust mails to the Auction Agent
for delivery on the next Business Day the complete APS Basic Maintenance Report.
The Trust will deliver an APS Basic Maintenance Report to the Auction Agent,
Moody's and Fitch, on or before 5:00 p.m., New York City time, on the third
Business Day after a Valuation Date on which the Trust cures its failure to
maintain Fitch Eligible Assets and Moody's, with an aggregate Discounted Value
equal to or greater than the APS Basic Maintenance Amount Test or on which the
Trust fails to maintain Fitch Eligible Assets and Moody's Eligible Assets, with
an aggregate Discounted Value which exceeds the APS Basic Maintenance Amount by
5% or more. The Trust will also deliver an APS Basic Maintenance Report to the
Auction Agent, Fitch, and Moody's as of each Bi-Monthly Valuation Date on or
before the third Business Day after such date. Additionally, on or before 5:00
p.m., New York City time, on the third Business Day after the first day of a
Special Dividend Period, the Trust will deliver an APS Basic Maintenance Report
to Fitch, Moody's and the Auction Agent. The Trust shall also provide Fitch and
Moody's with an APS Basic Maintenance Report when specifically requested by
Fitch or Moody's, as applicable. A failure by the Trust to deliver an APS Basic
Maintenance Report under this paragraph 7(b) shall be deemed to be delivery of
an APS Basic Maintenance Report indicating the Discounted Value for Fitch
Eligible Assets and Moody's Eligible Assets of the Trust is less than the APS
Basic Maintenance Amount Test, as of the relevant Valuation Date.
(c) Within ten (10) Business Days after the date of delivery of an APS Basic
Maintenance Report in accordance with paragraph 7(b) above relating to a
Valuation Date as of the last Business Day of the Trust's fiscal year, the
Independent Accountant will confirm in writing to the Auction Agent, Moody's and
Fitch (i) the mathematical accuracy of the calculations reflected in such Report
(and in any other APS Basic Maintenance Report, randomly selected by the
Independent Accountant, that was delivered by the Trust at year-end on such
Valuation Date), (ii) that, in such Report (and in such randomly selected
Report), the Trust correctly determined the assets of the Trust which constitute
Fitch Eligible Assets and Moody's Eligible Assets at such Monthly Valuation Date
in accordance with these Amended By-Laws, (iii) that, in such Report (and in
such randomly selected Report), the Trust determined whether the Trust had, at
such Valuation Date (and at the Valuation Date addressed in such randomly
selected Report) in accordance with these Amended By-Laws, Fitch Eligible Assets
and Moody's Eligible Assets of an aggregate Discounted Value at least equal to
the APS Basic Maintenance Amount Test, (iv) with respect to the Fitch ratings on
debt securities, the issuer name, issue size and coupon rate listed in such
Report, that the Independent Accountant has requested that Fitch verify such
information and the Independent Accountant shall provide a listing in its letter
of any differences, (v) with respect to the Moody's ratings on debt securities,
the issuer name, issue size and coupon rate listed in such Report, that such
information has been verified by Moody's (in the event such information is not
verified by Moody's, the Independent Accountant will inquire of Moody's what
such information is, and provide a listing in its letter of any differences),
(vi) with respect to the bid or mean price (or such alternative permissible
factor used in calculating the Market Value) provided by the custodian of the
Trust's assets to the Trust for purposes of valuing securities in the Trust's
portfolio, the Independent Accountant has traced the price used in such Report
to the bid or mean price listed in such Report as provided to the Trust and
verified that such information agrees (in the event such information does not
agree, the Independent Accountant will provide a listing in its letter of such
differences) and (vii) with respect to such confirmation to Moody's, that the
Trust has satisfied the requirements of paragraph 8(a) of these Amended By-Laws
(such confirmation is herein called the "Accountant's Confirmation").
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(d) Within ten (10) Business Days after the date of delivery of an APS Basic
Maintenance Report in accordance with paragraph 7(b) above relating to any
Valuation Date on which the Trust failed to maintain Fitch Eligible Assets and
Moody's Eligible Assets with an aggregate Discounted Value equal to or greater
than the APS Basic Maintenance Amount, and relating to the APS Basic Maintenance
Cure Date with respect to such failure, the Independent Accountant will provide
to the Auction Agent, Moody's and Fitch an Accountant's Confirmation as to such
APS Basic Maintenance Report.
(e) If any Accountant's Confirmation delivered pursuant to subparagraphs (c) or
(d) of this paragraph 7 shows that an error was made in the APS Basic
Maintenance Report for a particular Valuation Date for which such Accountant's
Confirmation as required to be delivered, or shows that a lower aggregate
Discounted Value for the aggregate of all Fitch Eligible Assets and Moody's
Eligible Assets of the Trust was determined by the Independent Accountant, the
calculation or determination made by such Independent Accountant shall be final
and conclusive and shall be binding on the Trust, and the Trust shall
accordingly amend and deliver the APS Basic Maintenance Report to the Auction
Agent, Moody's and Fitch promptly following receipt by the Trust of such
Accountant's Confirmation.
(f) On or before 5:00 p.m., New York City time, on the first Business Day after
the Date of Original Issue of the shares of APS, the Trust will complete and
deliver to Fitch and Moody's an APS Basic Maintenance Report as of the close of
business on such Date of Original Issue. Within five Business Days of such Date
of Original Issue, the Independent Accountant will confirm in writing to Fitch
and Moody's (i) the mathematical accuracy of the calculations reflected in such
Report and (ii) that the aggregate Discounted Value of Fitch Eligible Assets or
Moody's Eligible Assets, as applicable reflected thereon equals or exceeds the
APS Basic Maintenance Amount reflected thereon. Also, on or before 5:00 p.m.,
New York City time, on the first Business Day after shares of Common Shares are
repurchased by the Trust, the Trust will complete and deliver to Fitch and
Moody's an APS Basic Maintenance Report as of the close of business on such date
that Common Shares is repurchased.
8. CERTAIN OTHER MOODY'S RESTRICTIONS AND REQUIREMENTS.
(a) For so long as any APS are rated by Moody's, the Trust may buy or sell
financial futures contracts, write, purchase or sell call options on financial
futures contracts or purchase put options on financial futures contracts or
write call options on portfolio securities, swaps and securities lending unless
it receives written confirmation from Moody's that engaging in such transactions
would impair the ratings then assigned to the APS by Moody's, (collectively
"Moody's Hedging Transactions"), subject to the following limitations:
(i) Future and call options: For purposes of the APS Basic Maintenance Amount,
futures held by the Trust and call options sold by the Trust shall not be
included as Moody's Eligible Assets. However, such assets shall be valued at
Market Value by subtracting the good faith margin and the maximum daily trading
variance as of a Valuation Date. For call options purchased by the Trust, the
Market Value of the call option will be included as Moody's Eligible Asset
subject to a Moody's Discount Factor mutually agreed to between the Trust and
Moody's based on the characteristics of the option contract such as its maturity
and the underlying security of the contract.
(ii) Securities lending: The Trust may engage in securities lending in an
amount not to exceed 15% of the Trust's total gross assets. For purposes of
calculating the APS Basic Maintenance Amount, such securities lent shall be
included as Moody's Eligible Assets with the appropriate Moody's Discount Factor
applied to such lent security. The obligation to return such collateral shall
not be included as an obligation/liability for purposes of calculating the APS
Basic Maintenance Amount. However, the Trust may reinvest cash collateral for
securities lent in conformity with its investment objectives and policies and
the provisions of these bylaws. In such event, to the extent that securities
lending collateral received is invested by the Trust in assets that otherwise
would be Moody's Eligible Assets and the value of such assets exceeds the amount
of the Trust's Moody's Eligible Assets by applying the applicable Moody's
Discount Factor to this amount and adding the product to total Moody's Eligible
Assets. Conversely, if the value of assets in which securities lending
collateral has been invested is less
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then the amount of the Trust's obligation to return the collateral on a
Valuation Date, such difference shall be included as an obligation/liability of
the Trust for purposes of calculating the APS Basic Maintenance Amount.
Collateral received by the Trust in a securities lending transaction and
maintained by the Trust in the form received shall not be included as a Moody's
Eligible Asset for purposes of calculating the APS Basic Maintenance Amount.
(iii) Swaps (including Total Return Swaps, Interest Rate Swaps and Credit
Default Swaps): Total return and Interest Rate Swaps are subject to the
following provisions:
(A) Only the cumulative unsettled profit and loss from a Total Return Swap
transaction will be calculated when determining the APS Basic Maintenance
Amount. If the Trust has an outstanding gain from a swap transaction on a
Valuation Date, the gain will be included as a Moody's Eligible Asset subject to
the Moody's Discount Factor on the counterparty to the swap transaction. If the
Trust has an outstanding liability from a swap transaction on a Valuation Date,
the Trust will subtract the outstanding liability from the total Moody's
Eligible Assets in calculating the APS Basic Maintenance Amount.
In addition, for swaps other than Total Return Swaps, the Market Value of the
position (positive or negative) will be included as a Moody's Eligible Asset.
The aggregate notional value of all swaps will not exceed the Liquidation
Preference of the Outstanding APS. At the time a swap is executed, the Trust
will only enter into swap transactions where the counterparty has at least a
Fitch rating of A- or Moody's long-term rating of A3.
(B) (1) The underlying securities subject to a Credit Default Swap sold by the
Trust will be subject to the applicable Moody's Discount Factor for each
security subject to the swap;
(2) If the Trust purchases a Credit Default Swap and holds the underlying
security, the Market Value of the Credit Default Swap and the underlying
security will be included as a Moody's Eligible Asset subject to the Moody's
Discount Factor assessed based on the counterparty risk and the duration of the
swap agreement; and
(3) The Trust will not include a Credit Default Swap as a Moody's Eligible
Asset purchased by the Trust without the Trust holding the underlying security
or when the Trust buys a Credit Default Swap for a basket of securities without
holding all the securities in the basket.
If not otherwise provided for in (a)(i)-(iii) above, derivative instruments
shall be treated as follows: Any derivative instruments will be valued pursuant
to the Trust's valuation procedures on a Valuation Date. The amount of the net
payment obligation and the cost of a closing transaction, as appropriate, on any
derivative instrument on a Valuation Date will be counted as a liability for
purposes of determining the APS Basic Maintenance Amount (e.g,, a written call
option that is in the money for the holder). Any derivative instrument with
respect to which the Trust is owed payment on the Valuation Date that is not
based upon an individual security or securities that are Moody's Eligible Assets
will have a mutually agreed upon valuation by Moody's and the Trust for purposes
of determining Moody's Eligible Assets. Any derivative instrument with respect
to which the Trust is owed payment on the valuation date that is based upon an
individual security or securities that are Moody's Eligible Assets (e.g., a
purchased call option on a bond that is in the money) will be valued as follows
for purposes of determining Moody's Eligible Assets: (A) For such derivative
instruments that are exchange traded, the value of the in-the-money amount of
the payment obligation to the Trust will be reduced by applying the Moody's
Discount Factor (as it would apply to the underlying security or securities) and
then added to Moody's Eligible Assets; and (B) for such derivative instruments
that are not exchange traded, the value of the in-the-money amount of the
payment obligation to the Trust will be (1) reduced as described in (A) and (B)
further reduced by applying to the remaining amount the Moody's Discount Factor
determined by reference to the credit rating of the derivative counterparty with
the remaining amount after these reductions then added to Moody's Eligible
Assets.
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For purposes of determining whether the Trust has Moody's Eligible Assets with
an aggregate Discounted Value that equals or exceeds the APS Basic Maintenance
Amount, the Discounted Value of all Forward Commitments to which the Trust is a
party and of all securities deliverable to the Trust pursuant to such Forward
Commitments shall be zero.
A preferred stock rating is an assessment of the capacity and willingness of an
issuer to pay preferred stock obligations. The ratings on the Preferred Shares
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 Preferred Shares will be able to sell such shares in
an Auction or otherwise.
The Trust agrees to notify Moody's and Fitch with no less than thirty (30) days'
notification of: (i) any material changes to the Trust's organizational
documents and material contracts, as determined by the Trust's officers, in
their sole discretion, (ii) any redemptions of APS by the Trust, or (iii) any
failed Auctions.
9. NOTICE. All notices or communications, unless otherwise specified in the
Amended By-Laws of the Trust or these Amended By-Laws, shall be sufficiently
given if in writing and delivered in person or mailed by first-class mail,
postage prepaid. Notice shall be deemed given on the earlier of the date
received or the date 7 days after which such notice is mailed.
10. AUCTION PROCEDURES. (a) Certain definitions. As used in this paragraph 10,
the following terms shall have the following meanings, unless the context
otherwise requires:
(i) "APS" means the shares of APS being auctioned pursuant to this paragraph
10.
(ii) "Auction Date" means the first Business Day preceding the first day of a
Dividend Period.
(iii) "Available APS" has the meaning specified in paragraph 10(d)(i) below.
(iv) "Bid" has the meaning specified in paragraph 10(b)(i) below.
(v) "Bidder" has the meaning specified in paragraph 10(b)(i) below.
(vi) "Hold Order" has the meaning specified in paragraph 10(b)(i) below.
(vii) "Maximum Applicable Rate" for any Dividend Period will be the Applicable
Percentage of the Reference Rate. The Applicable Percentage will be determined
based on the credit rating assigned on such date to such shares by Fitch and
Moody's (or if Fitch or Moody's shall not make such rating available, the
equivalent of such rating by a Substitute Rating Agency) as follows:
PERCENTAGE OF
CREDIT RATINGS REFERENCE
----------------------------- RATE
MOODY'S FITCH NOTIFICATION
------------- ------------- -------------
Aa3 or higher AA- or higher 150%
A3 to A1 A- to A+ 160%
Baa3 to Baa1 BBB- to BBB+ 250%
Below Baa3 Below BBB- 275%
The Trust shall take all reasonable action necessary to enable Fitch and Moody's
to provide a rating for each series of APS. If Fitch or Moody's shall not make
such a rating available, Eaton Vance Management or its affiliates and
successors, after consultation with the Trust, shall select a nationally
recognized statistical rating organization to act as a Substitute Rating Agency.
(viii) "Order" has the meaning specified in paragraph 10(b)(i) below.
(ix) "Sell Order" has the meaning specified in paragraph 10(b)(i) below.
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(x) "Submission Deadline" means 1:00 p.m., New York City time, on any Auction
Date or such other time on any Auction Date as may be specified by the Auction
Agent from time to time as the time by which each Broker-Dealer must submit to
the Auction Agent in writing all Orders obtained by it for the Auction to be
conducted on such Auction Date.
(xi) "Submitted Bid" has the meaning specified in paragraph 10(d)(i) below.
(xii) "Submitted Hold Order" has the meaning specified in paragraph 10(d)(i)
below.
(xiii) "Submitted Order" has the meaning specified in paragraph 10(d)(i) below.
(xiv) "Submitted Sell Order" has the meaning specified in paragraph 10(d)(i)
below.
(xv) "Sufficient Clearing Bids" has the meaning specified in paragraph 10(d)(i)
below.
(xvi) "Winning Bid Rate" has the meaning specified in paragraph 10(d)(i) below.
(b) Orders by Beneficial Owners, Potential Beneficial Owners, Existing Holders
and Potential Holders.
(i) Unless otherwise permitted by the Trust, Beneficial Owners and Potential
Beneficial Owners may only participate in Auctions through their Broker-Dealers.
Broker-Dealers will submit the Orders of their respective customers who are
Beneficial Owners and Potential Beneficial Owners to the Auction Agent,
designating themselves as Existing Holders in respect of shares subject to
Orders submitted or deemed submitted to them by Beneficial Owners and as
Potential Holders in respect of shares subject to Orders submitted to them by
Potential Beneficial Owners. A Broker-Dealer may also hold shares of APS in its
own account as a Beneficial Owner. A Broker-Dealer may thus submit Orders to the
Auction Agent as a Beneficial Owner or a Potential Beneficial Owner and
therefore participate in an Auction as an Existing Holder or Potential Holder on
behalf of both itself and its customers. On or prior to the Submission Deadline
on each Auction Date:
(A) each Beneficial Owner may submit to its Broker-Dealer information as to:
(1) the number of Outstanding shares, if any, of APS held by such Beneficial
Owner which such Beneficial Owner desires to continue to hold without regard to
the Applicable Rate for the next succeeding Dividend Period;
(2) the number of Outstanding shares, if any, of APS held by such Beneficial
Owner which such Beneficial Owner desires to continue to hold, provided that the
Applicable Rate for the next succeeding Dividend Period shall not be less than
the rate per annum specified by such Beneficial Owner; and/or
(3) the number of Outstanding shares, if any, of APS held by such Beneficial
Owner which such Beneficial Owner offers to sell without regard to the
Applicable Rate for the next succeeding Dividend Period; and
(B) each Broker-Dealer, using a list of Potential Beneficial Owners that shall
be maintained in good faith for the purpose of conducting a competitive Auction,
shall contact Potential Beneficial Owners, including Persons that are not
Beneficial Owners, on such list to determine the number of Outstanding shares,
if any, of APS which each such Potential Beneficial Owner offers to purchase,
provided that the Applicable Rate for the next succeeding Dividend Period shall
not be less than the rate per annum specified by such Potential Beneficial
Owner.
For the purposes hereof, the communication by a Beneficial Owner or Potential
Beneficial Owner to a Broker-Dealer, or the communication by a Broker-Dealer
acting for its own account to the Auction Agent, of information referred to in
clause (A) or (B) of this paragraph 10(b)(i) is hereinafter referred to as an
"Order" and each Beneficial Owner and each Potential Beneficial Owner placing an
Order, including a Broker-Dealer acting in such capacity for its own account, is
hereinafter referred to as a "Bidder"; an Order containing the information
referred to in clause (A)(1) of this paragraph 10(b)(i) is hereinafter referred
to as a "Hold Order"; an Order containing the information referred to in
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clause (A)(2) or (B) of this paragraph 10(b)(i) is hereinafter referred to as a
"Bid"; and an Order containing the information referred to in clause (A)(3) of
this paragraph 10(b)(i) is hereinafter referred to as a "Sell Order". Inasmuch
as a Broker-Dealer participates in an Auction as an Existing Holder or a
Potential Holder only to represent the interests of a Beneficial Owner or
Potential Beneficial Owner, whether it be its customers or itself, all
discussion herein relating to the consequences of an Auction for Existing
Holders and Potential Holders also applies to the underlying beneficial
ownership interests represented.
(ii) (A) A Bid by an Existing Holder shall constitute an irrevocable offer to
sell:
(1) the number of Outstanding shares of APS specified in such Bid if the
Applicable Rate determined on such Auction Date shall be less than the rate per
annum specified in such Bid; or (1) such number or a lesser number of
Outstanding shares of APS to be determined as set forth in paragraph 10(e)(i)(D)
if the Applicable Rate determined on such Auction Date shall be equal to the
rate per annum specified therein; or
(2) a lesser number of Outstanding shares of APS to be determined as set forth
in paragraph 10(e)(ii)(C) if such specified rate per annum shall be higher than
the Maximum Applicable Rate and Sufficient Clearing Bids do not exist.
(B) A Sell Order by an Existing Holder shall constitute an irrevocable offer to
sell:
(1) the number of Outstanding shares of APS specified in such Sell Order; or
(2) such number or a lesser number of Outstanding shares of APS to be
determined as set forth in paragraph 10(e)(ii)(C) if Sufficient Clearing Bids do
not exist.
(C) A Bid by a Potential Holder shall constitute an irrevocable offer to
purchase:
(1) the number of Outstanding shares of APS specified in such Bid if the
Applicable Rate determined on such Auction Date shall be higher than the rate
per annum specified in such Bid; or
(2) such number or a lesser number of Outstanding shares of APS to be
determined as set forth in paragraph 10(e)(i)(E) if the Applicable Rate
determined on such Auction Date shall be equal to the rate per annum specified
therein.
(c) Submission of Orders by Broker-Dealers to Auction Agent
(i) Each Broker-Dealer shall submit in writing or through the Auction Agent's
Auction Processing System to the Auction Agent prior to the Submission Deadline
on each Auction Date all Orders obtained by such Broker-Dealer, designating
itself (unless otherwise permitted by the Trust) as an Existing Holder in
respect of shares subject to Orders submitted or deemed submitted to it by
Beneficial Owners and as a Potential Holder in respect of shares subject to
Orders submitted to it by Potential Beneficial Owners, and specifying with
respect to each Order:
(A) the name of the Bidder placing such Order (which shall be the Broker-Dealer
unless otherwise permitted by the Trust);
(B) the aggregate number of Outstanding shares of APS that are the subject of
such Order;
(C) to the extent that such Bidder is an Existing Holder:
(1) the number of Outstanding shares, if any, of APS subject to any Hold Order
placed by such Existing Holder;
(2) the number of Outstanding shares, if any, of APS subject to any Bid placed
by such Existing Holder and the rate per annum specified in such Bid; and
(3) the number of Outstanding shares, if any, of APS subject to any Sell Order
placed by such Existing Holder; and
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(D) to the extent such Bidder is a Potential Holder, the rate per annum
specified in such Potential Holder's Bid.
(ii) If any rate per annum specified in any Bid contains more than three
figures to the right of the decimal point, the Auction Agent shall round such
rate up to the next highest one-thousandth (.001) of 1%.
(iii) If an Order or Orders covering all of the Outstanding shares of APS held
by an Existing Holder are not submitted to the Auction Agent prior to the
Submission Deadline, the Auction Agent shall deem a Hold Order (in the case of
an Auction relating to a Dividend Period which is not a Special Dividend Period)
and a Sell Order (in the case of an Auction relating to a Special Dividend
Period) to have been submitted on behalf of such Existing Holder covering the
number of Outstanding shares of APS held by such Existing Holder and not subject
to Orders submitted to the Auction Agent.
(iv) If one or more Orders on behalf of an Existing Holder covering in the
aggregate more than the number of Outstanding shares of APS held by such
Existing Holder are submitted to the Auction Agent, such Order shall be
considered valid as follows and in the following order of priority:
(A) any Hold Order submitted on behalf of such Existing Holder shall be
considered valid up to and including the number of Outstanding shares of APS
held by such Existing Holder; provided that if more than one Hold Order is
submitted on behalf of such Existing Holder and the number of shares of APS
subject to such Hold Orders exceeds the number of Outstanding shares of APS held
by such Existing Holder, the number of shares of APS subject to each of such
Hold Orders shall be reduced pro rata so that such Hold Orders, in the
aggregate, will cover exactly the number of Outstanding shares of APS held by
such Existing Holder;
(B) any Bids submitted on behalf of such Existing Holder shall be considered
valid, in the ascending order of their respective rates per annum if more than
one Bid is submitted on behalf of such Existing Holder, up to and including the
excess of the number of Outstanding shares of APS held by such Existing Holder
over the number of shares of APS subject to any Hold Order referred to in
paragraph 10(c)(iv)(A) above (and if more than one Bid submitted on behalf of
such Existing Holder specifies the same rate per annum and together they cover
more than the remaining number of shares that can be the subject of valid Bids
after application of paragraph 10(c)(iv)(A) above and of the foregoing portion
of this paragraph 10(c)(iv)(B) to any Bid or Bids specifying a lower rate or
rates per annum, the number of shares subject to each of such Bids shall be
reduced pro rata so that such Bids, in the aggregate, cover exactly such
remaining number of shares); and the number of shares, if any, subject to Bids
not valid under this paragraph 10(c)(iv)(B) shall be treated as the subject of a
Bid by a Potential Holder; and
(C) any Sell Order shall be considered valid up to and including the excess of
the number of Outstanding shares of APS held by such Existing Holder over the
number of shares of APS subject to Hold Orders referred to in paragraph
10(c)(iv)(A) and Bids referred to in paragraph 10(c)(iv)(B); provided that if
more than one Sell Order is submitted on behalf of any Existing Holder and the
number of shares of APS subject to such Sell Orders is greater than such excess,
the number of shares of APS subject to each of such Sell Orders shall be reduced
pro rata so that such Sell Orders, in the aggregate, cover exactly the number of
shares of APS equal to such excess.
(v) If more than one Bid is submitted on behalf of any Potential Holder, each
Bid submitted shall be a separate Bid with the rate per annum and number of
shares of APS therein specified.
(vi) Any Order submitted by a Beneficial Owner as a Potential Beneficial Owner
to its Broker-Dealer, or by a Broker-Dealer to the Auction Agent, prior to the
Submission Deadline on any Auction Date shall be irrevocable.
(d) Determination of Sufficient Clearing Bids, Winning Bid Rate and Applicable
Rate.
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(i) Not earlier than the Submission Deadline on each Auction Date, the Auction
Agent shall assemble all Orders submitted or deemed submitted to it by the
Broker-Dealers (each such Order as submitted or deemed submitted by a
Broker-Dealer being hereinafter referred to individually as a "Submitted Hold
Order", a "Submitted Bid" or a "Submitted Sell Order", as the case may be, or as
a "Submitted Order") and shall determine:
(A) the excess of the total number of Outstanding shares of APS over the number
of Outstanding shares of APS that are the subject of Submitted Hold Orders (such
excess being hereinafter referred to as the "Available APS");
(B) from the Submitted Orders whether the number of Outstanding shares of APS
that are the subject of Submitted Bids by Potential Holders specifying one or
more rates per annum equal to or lower than the Maximum Applicable Rate exceeds
or is equal to the sum of:
(1) the number of Outstanding shares of APS that are the subject of Submitted
Bids by Existing Holders specifying one or more rates per annum higher than the
Maximum Applicable Rate, and
(2) the number of Outstanding shares of APS that are subject to Submitted Sell
Orders (if such excess or such equality exists (other than because the number of
Outstanding shares of APS in clause (1) above and this clause (2) are each zero
because all of the Outstanding shares of APS are the subject of Submitted Hold
Orders), such Submitted Bids by Potential Holders being hereinafter referred to
collectively as "Sufficient Clearing Bids"); and
(C) if Sufficient Clearing Bids exist, the lowest rate per annum specified in
the Submitted Bids (the "Winning Bid Rate") that if:
(1) each Submitted Bid from Existing Holders specifying the Winning Bid Rate
and all other Submitted Bids from Existing Holders specifying lower rates per
annum were rejected, thus entitling such Existing Holders to continue to hold
the shares of APS that are the subject of such Submitted Bids, and
(2) each Submitted Bid from Potential Holders specifying the Winning Bid Rate
and all other Submitted Bids from Potential Holders specifying lower rates per
annum were accepted, thus entitling the Potential Holders to purchase the shares
of APS that are the subject of such Submitted Bids, would result in the number
of shares subject to all Submitted Bids specifying the Winning Bid Rate or a
lower rate per annum being at least equal to the Available APS.
(ii) Promptly after the Auction Agent has made the determinations pursuant to
paragraph 10(d)(i), the Auction Agent shall advise the Trust of the Maximum
Applicable Rate and, based on such determinations, the Applicable Rate for the
next succeeding Dividend Period as follows:
(A) if Sufficient Clearing Bids exist, that the Applicable Rate for the next
succeeding Dividend Period shall be equal to the Winning Bid Rate;
(B) if Sufficient Clearing Bids do not exist (other than because all of the
Outstanding shares of APS are the subject of Submitted Hold Orders), that the
Applicable Rate for the next succeeding Dividend Period shall be equal to the
Maximum Applicable Rate; or
(C) if all of the Outstanding shares of APS are the subject of Submitted Hold
Orders, that the Dividend Period next succeeding the Auction shall automatically
be the same length as the immediately preceding Dividend Period and the
Applicable Rate for the next succeeding Dividend Period shall be equal to 60% of
the Reference Rate on the date of the Auction.
(e) Acceptance and Rejection of Submitted Bids and Submitted Sell Orders and
Allocation of Shares. Based on the determinations made pursuant to paragraph
10(d)(i), the Submitted Bids and Submitted
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Sell Orders shall be accepted or rejected and the Auction Agent shall take such
other action as set forth below:
(i) If Sufficient Clearing Bids have been made, subject to the provisions of
paragraph 10(e)(iii) and paragraph 10(e)(iv), Submitted Bids and Submitted Sell
Orders shall be accepted or rejected in the following order of priority and all
other Submitted Bids shall be rejected:
(A) the Submitted Sell Orders of Existing Holders shall be accepted and the
Submitted Bid of each of the Existing Holders specifying any rate per annum that
is higher than the Winning Bid Rate shall be accepted, thus requiring each such
Existing Holder to sell the Outstanding shares of APS that are the subject of
such Submitted Sell Order or Submitted Bid;
(B) the Submitted Bid of each of the Existing Holders specifying any rate per
annum that is lower than the Winning Bid Rate shall be rejected, thus entitling
each such Existing Holder to continue to hold the Outstanding shares of APS that
are the subject of such Submitted Bid;
(C) the Submitted Bid of each of the Potential Holders specifying any rate per
annum that is lower than the Winning Bid Rate shall be accepted;
(D) the Submitted Bid of each of the Existing Holders specifying a rate per
annum that is equal to the Winning Bid Rate shall be rejected, thus entitling
each such Existing Holder to continue to hold the Outstanding shares of APS that
are the subject of such Submitted Bid, unless the number of Outstanding shares
of APS subject to all such Submitted Bids shall be greater than the number of
Outstanding shares of APS ("Remaining Shares") equal to the excess of the
Available APS over the number of Outstanding shares of APS subject to Submitted
Bids described in paragraph 10(e)(i)(B) and paragraph 10(e)(i)(C), in which
event the Submitted Bids of each such Existing Holder shall be accepted, and
each such Existing Holder shall be required to sell Outstanding shares of APS,
but only in an amount equal to the difference between (1) the number of
Outstanding shares of APS then held by such Existing Holder subject to such
Submitted Bid and (2) the number of shares of APS obtained by multiplying (x)
the number of Remaining Shares by (y) a fraction the numerator of which shall be
the number of Outstanding shares of APS held by such Existing Holder subject to
such Submitted Bid and the denominator of which shall be the sum of the number
of Outstanding shares of APS subject to such Submitted Bids made by all such
Existing Holders that specified a rate per annum equal to the Winning Bid Rate;
and
(E) the Submitted Bid of each of the Potential Holders specifying a rate per
annum that is equal to the Winning Bid Rate shall be accepted but only in an
amount equal to the number of Outstanding shares of APS obtained by multiplying
(x) the difference between the Available APS and the number of Outstanding
shares of APS subject to Submitted Bids described in paragraph 10(e)(i)(B),
paragraph 10(e)(i)(C) and paragraph 10(e)(i)(D) by (y) a fraction the numerator
of which shall be the number of Outstanding shares of APS subject to such
Submitted Bid and the denominator of which shall be the sum of the number of
Outstanding shares of APS subject to such 74 Submitted Bids made by all such
Potential Holders that specified rates per annum equal to the Winning Bid Rate.
(ii) If Sufficient Clearing Bids have not been made (other than because all of
the Outstanding shares of APS are subject to Submitted Hold Orders), subject to
the provisions of paragraph 10(e)(iii), Submitted Orders shall be accepted or
rejected as follows in the following order of priority and all other Submitted
Bids shall be rejected:
(A) the Submitted Bid of each Existing Holder specifying any rate per annum
that is equal to or lower than the Maximum Applicable Rate shall be rejected,
thus entitling such Existing Holder to continue to hold the Outstanding shares
of APS that are the subject of such Submitted Bid;
(B) the Submitted Bid of each Potential Holder specifying any rate per annum
that is equal to or lower than the Maximum Applicable Rate shall be accepted,
thus requiring such Potential Holder to purchase the Outstanding shares of APS
that are the subject of such Submitted Bid; and
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B-46
(C) the Submitted Bids of each Existing Holder specifying any rate per annum
that is higher than the Maximum Applicable Rate shall be accepted and the
Submitted Sell Orders of each Existing Holder shall be accepted, in both cases
only in an amount equal to the difference between (1) the number of Outstanding
shares of APS then held by such Existing Holder subject to such Submitted Bid or
Submitted Sell Order and (2) the number of shares of APS obtained by multiplying
(x) the difference between the Available APS and the aggregate number of
Outstanding shares of APS subject to Submitted Bids described in paragraph
10(e)(ii)(A) and paragraph 10(e)(ii)(B) by (y) a fraction the numerator of which
shall be the number of Outstanding shares of APS held by such Existing Holder
subject to such Submitted Bid or Submitted Sell Order and the denominator of
which shall be the number of Outstanding shares of APS subject to all such
Submitted Bids and Submitted Sell Orders.
(iii) If, as a result of the procedures described in paragraph 10(e)(i) or
paragraph 10(e)(ii), 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 on any Auction Date, the Auction Agent shall, in such manner as
in its sole discretion it shall determine, round up or down the number of shares
of APS to be purchased or sold by any Existing Holder or Potential Holder on
such Auction Date so that each Outstanding share of APS purchased or sold by
each Existing Holder or Potential Holder on such Auction Date shall be a whole
share of APS.
(iv) If, as a result of the procedures described in paragraph 10(e)(i), any
Potential Holder would be entitled or required to purchase less than a whole
share of APS on any Auction Date, the Auction Agent shall, in such manner as in
its sole discretion it shall determine, allocate shares of APS for purchase
among Potential Holders so that only whole shares of APS are purchased on such
Auction Date by any Potential Holder, even if such allocation results in one or
more of such Potential Holders not purchasing any shares of APS on such Auction
Date.
(v) Based on the results of each Auction, the Auction Agent shall determine,
with respect to each Broker-Dealer that submitted Bids or Sell Orders on behalf
of Existing Holders or Potential Holders, the aggregate number of Outstanding
shares of APS to be purchased and the aggregate number of the Outstanding shares
of APS to be sold by such Potential Holders and Existing Holders and, to the
extent that such aggregate number of Outstanding shares to be purchased and such
aggregate number of Outstanding shares to be sold differ, the Auction Agent
shall determine to which other Broker-Dealer or Broker-Dealers acting for one or
more purchasers such Broker-Dealer shall deliver, or from which other
Broker-Dealer or Broker-Dealers acting for one or more sellers such
Broker-Dealer shall receive, as the case may be, Outstanding shares of APS.
(f) Miscellaneous. The Trust may interpret the provisions of this paragraph 10
to resolve any inconsistency or ambiguity, remedy any formal defect or make any
other change or modification that does not substantially adversely affect the
rights of Beneficial Owners of APS. A Beneficial Owner or an Existing Holder (A)
may sell, transfer or otherwise dispose of shares of APS only pursuant to a Bid
or Sell Order in accordance with the procedures described in this paragraph 10
or to or through a Broker-Dealer, provided that in the case of all transfers
other than pursuant to Auctions such Beneficial Owner or Existing Holder, its
Broker-Dealer, if applicable, or its Agent Member advises the Auction Agent of
such transfer and (B) except as otherwise required by law, shall have the
ownership of the shares of APS held by it maintained in book entry form by the
Securities Depository in the account of its Agent Member, which in turn will
maintain records of such Beneficial Owner's beneficial ownership. Neither the
Trust nor any Affiliate shall submit an Order in any Auction. Any Beneficial
Owner that is an Affiliate shall not sell, transfer or otherwise dispose of
shares of APS to any Person other than the Trust. All of the Outstanding shares
of APS of a series shall be represented by a single certificate registered in
the name of the nominee of the Securities Depository unless otherwise required
by law or unless there is no Securities Depository. If there is no Securities
Depository, at the Trust's option and upon its receipt of such documents as it
deems appropriate, any shares of APS may be registered in the Stock Register in
the name of the Beneficial Owner thereof and such Beneficial Owner
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thereupon will be entitled to receive certificates therefor and required to
deliver certificates therefor upon transfer or exchange thereof.
11. SECURITIES DEPOSITORY; STOCK CERTIFICATES. (a) If there is a Securities
Depository, one certificate for all of the shares of APS of each series shall be
issued to the Securities Depository and registered in the name of the Securities
Depository or its nominee. Additional certificates may be issued as necessary to
represent shares of APS. All such certificates shall bear a legend to the effect
that such certificates are issued subject to the provisions restricting the
transfer of shares of APS contained in these Amended By-Laws. Unless the Trust
shall have elected, during a Non-Payment Period, to waive this requirement, the
Trust will also issue stop-transfer instructions to the Auction Agent for the
shares of APS. Except as provided in paragraph
(b) below, the Securities Depository or its nominee will be the Holder, and no
Beneficial Owner shall receive certificates representing its ownership interest
in such shares. (b) If the Applicable Rate applicable to all shares of APS of a
series shall be the Non-Payment Period Rate or there is no Securities
Depository, the Trust may at its option issue one or more new certificates with
respect to such shares (without the legend referred to in paragraph 11(a))
registered in the names of the Beneficial Owners or their nominees and rescind
the stop-transfer instructions referred to in paragraph 11(a) with respect to
such shares.
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EATON VANCE LIMITED DURATION INCOME FUND
STATEMENT OF ADDITIONAL INFORMATION
JULY 25, 2003
---------------------
INVESTMENT ADVISER AND ADMINISTRATOR
Eaton Vance Management
255 State Street
Boston, MA 02109
CUSTODIAN
Investors Bank & Trust Company
200 Clarendon Street
Boston, MA 02116
TRANSFER AGENT
PFPC Inc.
P.O. Box 43027
Providence, RI 02940-3027
(800) 331-1710
INDEPENDENT AUDITORS
Deloitte & Touche LLP
200 Berkeley Street
Boston, MA 02116