As filed with the Securities and Exchange Commission on October 24, 2003
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1933 Act File No. 333-108475
1940 Act File No. 811-21374
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-2
[_] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[X] Pre-Effective Amendment No. 1
[_] Post-Effective Amendment No.
and
[X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[X] Amendment No. 5
PIMCO Floating Rate Income Fund
(Exact Name of Registrant as Specified in Declaration of Trust)
c/o PIMCO Advisors Fund Management LLC
1345 Avenue of the Americas
New York, New York 10105
(Address of Principal Executive Offices)
(Number, Street, City, State, Zip Code)
(212) 739-3369
(Registrant's Telephone Number, including Area Code)
Newton B. Schott, Jr.
c/o PIMCO Advisors Distributors LLC
2187 Atlantic Street
Stamford, Connecticut 06902
(Name and Address (Number, Street, City, State, Zip Code) of Agent for Service)
Copies of Communications to:
Joseph B. Kittredge, Jr., Esq.
Ropes & Gray LLP
One International Place
Boston, Massachusetts 02110
Approximate Date of Proposed Public Offering:
As soon as practicable after the effective date of this Registration Statement
---------------------------
If any of the securities being registered on this form will be offered on a
delayed or continuous basis in reliance on Rule 415 under the Securities Act of
1933, other than securities offered in connection with a dividend reinvestment
plan, check the following box. [_]
It is proposed that this filing will become effective (check appropriate
box)
[X] when declared effective pursuant to section 8(c)
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CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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Proposed Maximum Proposed Maximum
Amount Being Offering Price Per Aggregate Amount of
Title of Securities Being Registered Registered Unit Offering Price/1/ Registration Fee
------------------------------------ ------------ ------------------ ---------------- ----------------
Preferred Shares, par value $0.00001 10 Shares $ 25,000 $ 250,000 $ 20.23
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/1/ Estimated solely for the purpose of calculating the registration fee.
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states this Registration Statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the Registration Statement shall become
effective on such dates as the Commission, acting pursuant to said Section 8(a),
may determine.
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The information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus
is not an offer to sell these securities and it is not soliciting an offer to
buy these securities in any state where the offer or sale is not permitted.
Subject to Completion
Preliminary Prospectus dated October 24, 2003
PROSPECTUS
[LOGO] PIMCO
ADVISORS
$210,000,000
PIMCO Floating Rate Income Fund
Auction Market Preferred Shares ("AMPS")
2,800 Shares, Series T
2,800 Shares, Series W
2,800 Shares, Series TH
Liquidation Preference $25,000 per share
----------------
Investment Objective. PIMCO Floating Rate Income Fund (the "Fund") is a
recently organized, diversified, closed-end management investment company. The
Fund's investment objective is to seek high current income, consistent with the
preservation of capital.
The Offering. The Fund is simultaneously offering 2,800 Series T Auction
Market Preferred Shares ("Series T AMPS"), 2,800 Series W Auction Market
Preferred Shares ("Series W AMPS") and 2,800 Series TH Auction Market Preferred
Shares ("Series TH AMPS"). These shares are referred to together in this
prospectus as "AMPS" or "the AMPS." The AMPS will not be listed on any
exchange. Generally, investors may only buy and sell the AMPS through an order
placed at an auction with or through a broker-dealer that has entered into an
agreement with the auction agent or in a secondary market that certain
broker-dealers may maintain. These broker-dealers are not required to maintain
a market in the AMPS, and a secondary market, if one develops, may not provide
investors with liquidity.
Limited Operating History. The Fund is a recently organized,
diversified, closed-end management investment company which has been
operational for less than 2 months. The common shares are listed on the New
York Stock Exchange ("NYSE") under the symbol "PFL."
Portfolio Management Strategies. The Fund is actively managed in
accordance with the portfolio manager's top down cyclical and secular economic
outlook, using strategies that focus on credit quality analysis, broad market
diversification among industries and sectors and other risk management
techniques. The portfolio manager attempts to identify investments that provide
high current income through fundamental research, driven by independent credit
analysis and proprietary analytical tools, and also uses a variety of
techniques designed to control risk and minimize exposure to issues that the
portfolio manager believes are more likely to default or otherwise depreciate
in value over time. Under normal market conditions, the Fund seeks to achieve
its investment objective by investing at least 80% of its net assets (plus any
borrowings for investment purposes) in a diversified portfolio of floating rate
debt instruments, a substantial portion of which will be senior floating rate
loans. Senior floating rate loans generally hold the most senior position in
the capital structure of a borrower and are often secured with collateral. The
Fund may invest without limit and ordinarily expects to invest a substantial
portion of its assets in senior floating rate loans and other debt securities
that are, at the time of purchase, rated below investment grade (below Baa3 by
Moody's Investors Service, Inc. ("Moody's"), below BBB- by either Standard &
Poor's ("S&P") or Fitch, Inc. ("Fitch Ratings"), or below a comparable rating
by Dominion Bond Rating Service Limited ("Dominion")), or unrated but judged by
the portfolio manager to be of comparable quality. The Fund will not invest
more than 10% of its total assets in securities that are, at the time of
purchase, rated CCC+/Caa1 or lower by each agency rating the security or that
are unrated but judged by the portfolio manager to be of comparable quality.
Debt securities of below investment grade quality are regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal, and are commonly referred to as "high yield"
securities or "junk bonds." Due to the risks involved in investing in high
yield securities, an investment in the Fund should be considered speculative.
(continued on following page)
Investing in AMPS involves certain risks. You should read the discussion
of material risks of investing in the Fund in "Risks" beginning on page 37 of
this prospectus. Certain of these risks are summarized in "Prospectus
Summary--Special Risk Considerations" beginning on page 9. The minimum purchase
amount of the AMPS is $25,000.
----------------
Per Share Total
--------- -----
Public offering price.. $25,000 $210,000,000
Sales load............. $250 $2,100,000
Proceeds to the Fund(1) $24,750 $207,900,000
(1) Not including offering expenses payable by the Fund estimated to be
$500,000, or $59.52 per share.
The public offering price per share will be increased by the amount of
dividends, if any, that have accumulated from the date the AMPS are first
issued.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
The Underwriters are offering the AMPS subject to the condition that the
AMPS be rated "Aaa" by Moody's and "AAA" by Fitch Ratings as of the time of
delivery of the AMPS to the broker-dealers and subject to certain other
conditions. The Underwriters expect to deliver the AMPS to an investor's
broker-dealer, in book-entry form through the facilities of The Depository
Trust Company, on or about , 2003.
----------------
Merrill Lynch & Co.
Wachovia Securities
A.G. Edwards & Sons, Inc.
Quick & Reilly, Inc.
----------------
The date of this prospectus is , 2003.
(continued from previous page)
Because most of the debt instruments held by the Fund will have variable
interest rates, the Fund's portfolio is generally expected to have less
interest rate risk (i.e., sensitivity to fluctuations in market interest rates)
and a more stable net asset value than funds with portfolios that invest in
fixed-income securities, although the net asset value will vary due to
fluctuations in interest rates and other factors such as changes in the credit
quality of securities in the portfolio.
Portfolio Contents. As noted above, a substantial portion of the Fund's
investment assets will ordinarily consist of senior floating rate debt
securities and interests in senior floating rate loans ("Senior Loans") made to
or issued by U.S. or non-U.S. banks or other corporations. Senior Loans
typically pay interest at rates which are re-determined periodically on the
basis of a floating base lending rate (such as the London Inter-Bank Offered
Rate, "LIBOR") plus a premium. Although Senior Loans are typically of below
investment grade quality, they tend to have more favorable recovery rates than
those of other types of below investment grade quality debt obligations. Other
floating rate debt instruments in which the Fund may invest include catastrophe
and other event-linked bonds, bank capital securities, unsecured bank loans,
corporate bonds, money market instruments and certain types of mortgage-backed
and other asset-backed securities that pay interest at rates which adjust
whenever a specified interest rate changes and/or reset on predetermined dates
(such as the last day of a month or calendar quarter). The Fund may invest
without limit and ordinarily expects to invest a substantial portion of its
assets in Senior Loans and other floating rate debt instruments that are, at
the time of purchase, rated below investment grade or unrated but judged by the
portfolio manager to be of comparable quality. To the extent consistent with
the Fund's floating rate investment policy specified above, the Fund may invest
a portion of its assets in securities and instruments other than floating rate
debt instruments, including fixed income debt securities such as convertible
securities, high-yield bonds and mortgage-backed and other asset-backed
securities issued on a public or private basis. The Fund expects to invest
predominantly in U.S. dollar-denominated debt securities and will not invest
more than 25% of its total assets in debt securities denominated in currencies
other than the U.S. dollar. The Fund reserves the right to invest without limit
in debt securities of non-U.S. issuers, although it will not invest more than
10% of its total assets in debt securities of issuers located in emerging
markets. The Fund may make use of a variety of other instruments, including
collateralized debt obligations, preferred shares, commercial paper, U.S.
Government securities, zero-coupon and inflation-indexed bonds, real estate
investment trusts (REITs), structured notes and other hybrid instruments,
credit-linked trust certificates, total return swaps, credit default swaps and
other derivative instruments. The Fund cannot assure you that it will achieve
its investment objective.
Because of the floating rate feature of most of the Fund's investments,
it is expected that the Fund normally will have an average portfolio duration
of zero to one year. The portfolio manager believes that this duration range
and the Fund's exposure to lower-quality debt securities minimizes exposure to
interest rate risk while still offering the potential for higher current income
than would be expected from a higher quality portfolio.
You should read this prospectus, which contains important information
about the Fund, before deciding whether to invest, and retain it for future
reference. A Statement of Additional Information, dated , 2003 (the
"SAI"), containing additional information about the Fund and the AMPS, has been
filed with the Securities and Exchange Commission and is incorporated by
reference in its entirety into this prospectus, which means that it is part of
this prospectus for legal purposes. You can review the table of contents of the
SAI on page 71 of this prospectus. You may request a free copy of the SAI by
calling (877) 819-2224 or by writing to the Fund, or obtain a copy (and other
information regarding the Fund) from the Securities and Exchange Commission's
web site (http://www.sec.gov).
Investors in AMPS will be entitled to receive cash dividends at an annual
rate that may vary for the successive dividend periods for the AMPS. The
dividend rate for the initial rate period will be % for Series T AMPS, %
for Series W AMPS and % for Series TH AMPS. The initial rate period for the
AMPS is from the date of issuance through , 2003 for Series T AMPS,
through , 2003 for Series W AMPS and through , 2003 for Series TH
AMPS. For subsequent dividend periods, the AMPS will pay dividends based on a
rate generally set at auctions held every seven days for each series of AMPS.
Generally, investors may only buy or sell AMPS through an order placed at an
auction with or through a broker-dealer in accordance with the procedures
specified in this prospectus. Prospective purchasers should carefully review
the auction procedures described in this prospectus, and should note:
. a buy order (called a "bid") or sell order is a commitment to buy or
sell AMPS based on the results of an auction; and
. purchases and sales will be settled on the next business day after
the auction.
The AMPS, which have no history of public trading, are not listed on an
exchange. Broker-dealers may maintain a secondary trading market in the AMPS
outside of the auctions; however, they have no obligation to do so, and there
can be no assurance that a secondary market for the AMPS will develop or, if it
does develop, that it will provide holders with a liquid trading market (i.e.,
trading will depend on the presence of willing buyers and sellers, and the
trading price will be subject to variables to be determined at the time of the
trade by such broker dealers). A general increase in the level of interest
rates may have an adverse effect on the secondary market price of the AMPS, and
an investor that sells AMPS between auctions may receive a price per share of
less than $25,000.
The AMPS will be senior to the Fund's outstanding common shares of
beneficial interest ("Common Shares"), which are traded on the New York Stock
Exchange under the symbol "PFL." The AMPS have a liquidation preference of
$25,000 per share, plus any accumulated, unpaid dividends. The AMPS also have
priority over the Fund's Common Shares as to distribution of assets. See
"Description of AMPS." The Fund may redeem AMPS as described under "Description
of AMPS--Redemption." It is a condition of closing this offering that the AMPS
be offered with a rating of "Aaa" from Moody's and "AAA" from Fitch Ratings.
The AMPS do not represent a deposit or obligation of, and are not
guaranteed or endorsed by, any bank or other insured depository institution,
and are not federally insured by the Federal Deposit Insurance Corporation, the
Federal Reserve Board or any other government agency.
2
TABLE OF CONTENTS
Page
----
Prospectus Summary............................................ 4
Financial Highlights.......................................... 21
The Fund...................................................... 22
Use of Proceeds............................................... 22
Capitalization................................................ 22
Portfolio Composition......................................... 23
Investment Objective and Strategies........................... 23
Risks......................................................... 37
How the Fund Manages Risk..................................... 44
Description of AMPS........................................... 45
Management of the Fund........................................ 60
Net Asset Value............................................... 62
Tax Matters................................................... 63
Description of Capital Structure.............................. 65
Anti-Takeover and Other Provisions in the Declaration of Trust 66
Repurchase of Common Shares; Conversion to Open-End Fund...... 67
Underwriting.................................................. 69
Custodian and Transfer Agent.................................. 69
Legal Matters................................................. 70
Table of Contents for the Statement of Additional Information. 71
Appendix A--Description of Securities Ratings................. A-1
----------------
You should rely only on the information contained or incorporated by
reference in this prospectus. The Fund has not, and the Underwriters have not,
authorized anyone to provide you with different information. If anyone provides
you with different or inconsistent information, you should not rely on it. The
Fund is not, and the Underwriters are not, making an offer of the AMPS in any
state where the offer is not permitted. You should not assume that the
information contained in this prospectus is accurate as of any date other than
the date on the front of this prospectus. The Fund's business, financial
condition, results of operations and prospects may have changed since that date.
PROSPECTUS SUMMARY
This is only a summary. This summary may not contain all of the
information that you should consider before investing in the Fund's AMPS.
Certain of the capitalized terms used herein are defined in the Amended Bylaws
(as defined below under "Special Risk Considerations--Anti-Takeover
Provisions") . You should review the more detailed information contained in
this prospectus and in the SAI, especially the information set forth under the
heading "Risks."
The Fund.................... PIMCO Floating Rate Income Fund (the "Fund") is a
recently organized, diversified, closed-end
management investment company. The Fund commenced
investment operations on August 29, 2003, upon
the closing of an initial public offering of
16,250,000 Common Shares. As of October 14, 2003,
the Fund had 17,755,168 Common Shares outstanding
and total net assets of approximately
$344,957,024. The Fund's Common Shares are traded
on the New York Stock Exchange under the symbol
"PFL." See "The Fund." The Fund's principal
office is located at 1345 Avenue of the Americas,
New York, NY 10105, and its telephone number is
(800) 331-1710.
The Offering................ The Fund is offering 2,800 Series T AMPS, 2,800
Series W AMPS, and 2,800 Series TH AMPS, each
share of each series having a par value of
$.00001 and a purchase price of $25,000 per share
plus dividends, if any, that have accumulated
from the date the Fund first issues the AMPS. The
AMPS are being offered by a group of underwriters
(the "Underwriters") led by Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("Merrill
Lynch").
The AMPS entitle their holders to receive cash
dividends at an annual rate that may vary for the
successive dividend periods for the AMPS. In
general, except as described under "Dividends on
AMPS" below and "Description of AMPS--Dividends
and Dividend Periods," the dividend period for
each series of AMPS will be seven days. The
auction agent will determine the dividend rate
for a particular dividend period by an auction
conducted on the Business Day immediately prior
to the start of that dividend period. See
"Description of AMPS--The Auction."
The AMPS are not listed on an exchange. Instead,
investors will generally buy or sell AMPS in an
auction by submitting orders to broker-dealers
that have entered into an agreement with the
auction agent.
Generally, investors in AMPS will not receive
certificates representing ownership of their
shares. The securities depository (The Depository
Trust Company or any successor) (the "Securities
Depository") or its nominee for the account of
the investor's broker-dealer will maintain record
ownership of AMPS in book-entry form. An
investor's broker-dealer, in turn, will maintain
records of that investor's beneficial ownership
of AMPS.
4
Investment Objective and
Strategies................ Investment Objective. The Fund's investment
objective is to seek high current income,
consistent with the preservation of capital. The
Fund attempts to achieve this objective by
normally investing at least 80% of its net assets
(plus any borrowings for investment purposes) in
a diversified portfolio of floating rate debt
instruments. The Fund expects that a substantial
portion of its investments will consist of Senior
Loans. See "Portfolio Contents" below. The Fund
may invest without limit, and ordinarily expects
to invest a substantial portion of its assets, in
Senior Loans and other floating rate debt
instruments that are, at the time of purchase,
rated below investment grade (or unrated but
judged by the portfolio manager to be of
comparable quality) as described under "Credit
Quality" below. The Fund cannot assure you that
it will achieve its investment objective.
Portfolio Management Strategies. In selecting
investments for the Fund, Pacific Investment
Management Company LLC ("PIMCO"), the Fund's
portfolio manager, attempts to identify floating
rate debt instruments that provide high current
income through fundamental research, driven by
independent credit analysis and proprietary
analytical tools. Investment decisions are based
primarily on PIMCO's assessment of the issuer's
credit characteristics and the position of the
security in the issuer's capital structure in
light of PIMCO's outlook for particular
industries, the economy and the market generally.
At the same time, PIMCO uses a variety of
techniques, such as credit default swaps,
designed to control risk and minimize the Fund's
exposure to debt instruments that PIMCO believes
are more likely to default or otherwise
depreciate in value over time and detract from
the Fund's overall return to investors. Because
most of the debt instruments held by the Fund
will have variable interest rates, the Fund's
portfolio is generally expected to have less
interest rate risk (i.e., sensitivity to
fluctuations in market interest rates) and a more
stable net asset value than portfolios of funds
that invest in fixed-income securities, although
the net asset value will vary due to fluctuations
in interest rates and other factors such as
changes in the credit quality of securities in
the portfolio. The Fund also attempts to preserve
capital based on PIMCO's assessment of the
issuer's credit characteristics and
macro-economic factors. Subject to the guidelines
under "Credit Quality" below, the Fund has the
flexibility to invest in debt obligations of any
credit quality based on its assessment of the
particular issuer.
Within the floating rate debt investment
universe, the Fund does not invest its assets
according to predetermined weightings in
particular issuers, industries or sectors.
Instead, PIMCO attempts to identify quality
investments in any industry or sector through
fundamental research, driven by independent
credit analysis and proprietary analytical tools.
5
Credit Quality. Under normal market conditions,
the Fund may invest without limit, and ordinarily
expects to invest a substantial portion of its
assets, in Senior Loans and other floating rate
debt instruments that are, at the time of
purchase, rated below investment grade (below
Baa3 by Moody's, below BBB- by either S&P or
Fitch Ratings, or below a comparable rating by
Dominion), or unrated but judged by PIMCO to be
of comparable quality. The Fund will not invest
more than 10% of its total assets in securities
that are, at the time of purchase, rated
CCC+/Caa1 or lower by each agency rating the
security or that are unrated but judged by PIMCO
to be of comparable quality. Debt securities of
below investment grade quality are regarded as
having predominantly speculative characteristics
with respect to capacity to pay interest and
repay principal and are commonly referred to as
"high yield" securities or "junk bonds." Debt
securities in the lowest investment grade
category may also be considered to possess some
speculative characteristics.
Independent Credit Analysis. PIMCO relies
heavily on its own analysis of the credit quality
and risks associated with individual debt
obligations considered for the Fund, rather than
relying exclusively on rating agencies or
third-party research. In the case of Senior
Loans, PIMCO analyzes and takes into account the
legal/protective features associated with the
securities (such as their position in the
borrower's capital structure and any security
through collateral) in assessing their credit
characteristics. The individuals managing the
Fund utilize this information in an attempt to
manage credit risk and identify issuers,
industries or sectors that offer attractive
yields relative to PIMCO's assessment of their
credit characteristics. This aspect of PIMCO's
capabilities will be particularly important
because of the Fund's emphasis on Senior Loans
and other below investment grade debt securities.
Duration. The average portfolio duration of the
Fund will normally be within a short range (i.e.,
a zero to one-year time frame) due to the Fund's
predominant investment in floating rate debt
instruments, although it may be longer at any
time and from time to time to the extent that the
Fund invests in fixed-income securities. Duration
is a measure of the expected life of a debt
security that is used to determine the
sensitivity of the security's price to changes in
interest rates. PIMCO believes that the Fund's
short duration range minimizes exposure to price
changes of its portfolio securities due to
interest rate volatility and related risk while
still offering the potential opportunity for high
current income.
Diversification. Subject to the availability of
suitable investment opportunities, PIMCO will
attempt to diversify the Fund's investments
broadly in an attempt to minimize the portfolio's
sensitivity to credit and other risks associated
with a particular issuer, industry or sector, or
to the impact of a single economic, political,
corporate or regulatory occurrence.
6
Portfolio Contents. Under normal market
conditions, the Fund seeks to achieve its
investment objective by investing at least 80% of
its net assets (plus any borrowings for
investment purposes) in a diversified portfolio
of floating rate debt instruments, a substantial
portion of which will be Senior Loans. Senior
Loans are typically originated, negotiated and
structured by a U.S. or foreign commercial bank,
insurance company, finance company or other
financial institution for a lending syndicate of
financial institutions. Senior Loans are normally
accessible only to financial institutions and
large corporate and institutional investors and
are not widely available to individual investors.
Floating rate debt instruments are debt
instruments that pay interest at rates which
adjust whenever a specified interest rate changes
and/or reset on predetermined dates (such as the
last day of a month or calendar quarter). These
floating rate debt instruments may include, in
addition to Senior Loans, instruments such as
catastrophe and other event-linked bonds, bank
capital securities, unsecured bank loans,
corporate bonds, money market instruments and
certain types of mortgage-backed and other
asset-backed securities. As noted above, the Fund
may invest without limit and ordinarily expects
to invest a substantial portion of its assets in
Senior Loans and other floating rate debt
instruments that are, at the time of purchase,
rated below investment grade or unrated but
judged by PIMCO to be of comparable quality. The
Fund may invest the remainder of its assets in
securities and instruments other than floating
rate debt instruments, including fixed-income
debt securities such as convertible securities,
high-yield bonds and mortgage-backed and other
asset-backed securities issued on a public or
private basis. The Fund expects to invest
predominantly in U.S. dollar-denominated debt
securities and will not invest more than 25% of
its total assets in debt securities denominated
in currencies other than the U.S. dollar. The
Fund reserves the right to invest without limit
in debt securities of non-U.S. issuers, although
it will not invest more than 10% of its total
assets in debt securities of issuers located in
emerging markets. The Fund may make use of a
variety of other instruments, including preferred
shares, commercial paper, U.S. Government
securities, zero-coupon and inflation-indexed
bonds, structured notes and other hybrid
instruments, credit-linked trust certificates,
real estate investment trusts (REITs), total
return swaps, credit default swaps and other
derivative instruments. The Fund may invest in
securities of companies with small market
capitalizations. The Fund may invest without
limit in illiquid securities. As a diversified
fund, the Fund generally may not, with respect to
75% of its total assets, purchase the securities
of any issuer, except securities issued or
guaranteed by the U.S. Government or any of its
agencies or instrumentalities or securities of
other investment companies, if, as a result, (i)
more than 5% of the Fund's total assets would be
invested in the securities of that issuer, or
(ii) the Fund would hold more than 10% of the
outstanding voting securities of that issuer. The
Fund will not concentrate its investments in a
particular industry by investing more than 25% of
its total assets in that industry. The Fund's
industry
7
concentration policy does not preclude it from
focusing investments in issuers in a group of
related industrial sectors (such as different
types of utilities).
Investment Manager.......... PIMCO Advisors Fund Management LLC (the
"Manager") serves as the investment manager of
the Fund. Subject to the supervision of the
Fund's Board of Trustees, the Manager is
responsible for managing, either directly or
through others selected by it, the investment
activities of the Fund and the Fund's business
affairs and other administrative matters. The
Manager will receive an annual fee, payable
monthly, in an amount equal to .75% of the Fund's
average weekly total managed assets. "Total
managed assets" means the total assets of the
Fund (including any assets attributable to any
AMPS or other forms of leverage that may be
outstanding) minus accrued liabilities (other
than liabilities representing leverage). The
Manager is located at 1345 Avenue of the
Americas, New York, New York 10105. Organized in
2000 as a subsidiary successor of a business
originally organized in 1987, the Manager
provides investment management and advisory
services to a number of closed-end and open-end
investment company clients. As of September 30,
2003, the Manager had approximately $27.7 billion
in assets under management. Allianz Dresdner
Asset Management of America L.P. is the direct
parent company of PIMCO Advisors Retail Holdings
LLC, of which the Manager is a wholly-owned
subsidiary. As of September 30, 2003, Allianz
Dresdner Asset Management of America L.P. and its
subsidiaries, including PIMCO, had approximately
$415 billion in assets under management.
The Manager has retained its affiliate, PIMCO, as
a sub-adviser to manage the Fund's portfolio
investments. See "Portfolio Manager" below.
Portfolio Manager........... PIMCO serves as the Fund's sub-adviser
responsible for managing the Fund's portfolio
investments, and is sometimes referred to herein
as the "portfolio manager." Subject to the
supervision of the Manager, PIMCO has full
investment discretion and makes all
determinations with respect to the investment of
the Fund's assets.
PIMCO is located at 840 Newport Center Drive,
Newport Beach, California 92660. Organized in
1971, PIMCO provides investment management and
advisory services to private accounts of
institutional and individual clients and to
mutual funds. As of September 30, 2003, PIMCO had
approximately $357 billion in assets under
management.
The Manager (and not the Fund) will pay a portion
of the fees it receives to PIMCO in return for
PIMCO's services.
Leverage.................... The Fund expects to utilize financial leverage on
an ongoing basis for investment purposes. After
completion of the offering of AMPS, the Fund
anticipates its total leverage from the issuance
of AMPS will be
8
approximately 38%. Although the Fund may in the
future offer other preferred shares, the Fund
does not currently intend to offer preferred
shares other than Series T AMPS, Series W AMPS
and Series TH AMPS. The Fund may also use a
variety of additional strategies to leverage the
portfolio, including borrowing money, issuing
debt securities or using reverse repurchase
agreements, loans of portfolio securities, credit
default swap contracts and other derivatives, as
well as when-issued, delayed delivery or forward
commitment transactions. However, these forms of
leverage will only be used, if at all, as a
substitute for, rather than in addition to, the
leverage obtained through the issuance of the
AMPS.
The Fund generally will not utilize leverage if
it anticipates that it would result in a lower
return to holders of the Fund's Common Shares
("Common Shareholders") over time than if
leverage were not used. Use of financial leverage
creates an opportunity for increased income for
Common Shareholders, but, at the same time,
creates the possibility for greater loss
(including the likelihood of greater volatility
of net asset value and market price of the Common
Shares and of dividends), and there can be no
assurance that a leveraging strategy will be used
or that it will be successful during any period
in which it is employed. Because the fees
received by the Manager are based on the total
managed assets of the Fund (including assets
attributable to the AMPS and other forms of
leverage that may be outstanding), the fees will
be higher when leverage is utilized and the
Manager therefore has a financial incentive for
the Fund to issue AMPS or utilize other forms of
leverage. See "Risks--General Risks of Investing
in the Fund--Leverage Risk."
Special Risk Considerations. The following describes various principal risks
of investing in the Fund. A more detailed
description of these and other risks of investing
in the Fund are described under "Risks" in this
prospectus and under "Investment Objective and
Policies" in the SAI.
Risks of Investing in the AMPS. Before investing
in the AMPS, you should consider certain risks
carefully. The primary risks of investing in AMPS
are:
. the Fund will generally not be permitted to
declare dividends or other distributions with
respect to your AMPS or redeem your AMPS
unless the Fund meets certain asset coverage
requirements, as discussed in "Description of
AMPS--Rating Agency Guidelines and Asset
Coverage";
. if you try to sell your AMPS between auctions,
you may not be able to sell any or all of your
shares, or you may receive a purchase price of
less than $25,000 per share plus any
accumulated or unpaid dividends. An increase
in the level of interest rates, particularly
during any Long Term Special Rate Period,
likely would have an adverse effect on the
secondary market price of the AMPS. You may
transfer shares outside of an
9
auction only to or through certain
broker-dealers, as discussed in "Description
of AMPS--The Auction--Secondary Market Trading
and Transfer of AMPS";
. if an auction fails, you may not be able to
sell any or all of your AMPS;
. a rating agency could downgrade the rating
assigned to the AMPS, which could affect the
liquidity of your investment;
. the Fund may be forced to redeem your AMPS to
meet regulatory or rating agency requirements,
and may voluntarily redeem your shares in
certain circumstances;
. in certain extraordinary circumstances the
Fund may not earn sufficient income from its
investments to pay dividends on AMPS;
. the value of the Fund's investment portfolio
may decline, reducing the asset coverage for
the AMPS; and
. if an issuer of a security in which the Fund
invests experiences financial difficulties or
defaults, or if an issuer in which the Fund
invests is affected by other adverse market
factors, there may be a negative impact on the
income and/or asset value of the Fund's
investment portfolio, which will reduce asset
coverage for the AMPS, making it more
difficult for the Fund to pay dividends on the
AMPS.
In addition to the risks described above, certain
general risks relating to an investment in the
Fund may under certain circumstances reduce the
Fund's ability to pay dividends and meet its
asset coverage requirements on the AMPS. These
risks include:
Limited Operating History. The Fund is a
recently organized, diversified, closed-end
management investment company which has been
operational for less than two months.
Credit Risk/High Yield Risk. Credit risk is the
risk that one or more debt obligations in the
Fund's portfolio will decline in price, or fail
to pay interest or principal when due, because
the issuer of the obligation or borrower
experiences an actual or perceived decline in its
financial status. The Fund may invest without
limit and ordinarily expects to invest a
substantial portion of its assets in debt
instruments that are, at the time of purchase,
rated below investment grade (below Baa3 by
Moody's, below BBB- by either S&P or Fitch
Ratings or below a comparable rating by Dominion)
or that are unrated but judged by PIMCO to be of
comparable quality, including debt securities
that are in default or the issuers of which are
in bankruptcy. Debt obligations of below
investment grade quality are commonly referred to
as "high yield" securities or "junk bonds" and
are predominantly speculative with respect to the
issuer's capacity to pay interest and repay
principal when due, and therefore involve a
greater
10
risk of default. Debt securities in the lowest
investment grade category may also be considered
to possess some speculative characteristics. The
prices of these lower grade obligations are
generally more volatile and sensitive to actual
or perceived negative developments, such as a
decline in the revenues of the borrowers
underlying Senior Loans or a general economic
downturn, than are the prices of higher grade
securities.
Although Senior Loans in which the Fund will
invest will often be secured by collateral, there
can be no assurance that liquidation of any such
collateral would satisfy the borrower's
obligation in the event of default or that such
collateral could be readily liquidated. However,
PIMCO believes that Senior Loans generally tend
to have more favorable recovery rates than most
other types of loans. In the event of bankruptcy
of a borrower, the Fund could experience delays
or limitations in its ability to realize the
benefits of any collateral securing a Senior
Loan. Because of the Fund's emphasis on Senior
Loans and other below investment grade debt
securities, PIMCO's capabilities in analyzing
credit quality and associated risks will be
particularly important, and there can be no
assurance that PIMCO will be successful in this
regard. See "Investment Objective and
Strategies--High Yield Securities ("Junk Bonds")"
and "Risks--General Risks of Investing in the
Fund--Credit Risk/High Yield Risk" for additional
information. Due to the risks involved in
investing in high yield securities, an investment
in the Fund should be considered speculative.
Liquidity Risk. The Fund may invest without
limit in securities which are illiquid at the
time of investment (generally determined using
the Securities and Exchange Commission's standard
applicable to open-end investment companies,
i.e., securities that cannot be disposed of
within seven days in the ordinary course of
business at approximately the value at which the
Fund has valued the securities). Illiquid
securities may trade at a discount from
comparable, more liquid investments, and may be
subject to wide fluctuations in market value.
Also, the Fund may not be able to dispose of
illiquid securities when that would be beneficial
at a favorable time or price. Below investment
grade debt securities tend to be less liquid than
higher-rated securities. The Senior Loans in
which the Fund invests will likely not be
registered with the Securities and Exchange
Commission or any state securities commission and
generally will not be listed on a national
securities exchange. PIMCO will determine the
liquidity of the Fund's investments by reference
to market conditions and contractual provisions.
For example, PIMCO will generally not consider
Senior Loans that are part of an issue of at
least $250 million in par value to be illiquid.
Leverage Risk. The Fund utilizes financial
leverage for investment purposes. Leverage risk
includes the risk associated with the issuance of
AMPS to leverage the Fund's Common Shares. The
Fund may also
11
leverage the portfolio by borrowing money,
issuing debt securities or using reverse
repurchase agreements, loans of portfolio
securities, credit default swap contracts and
other derivatives, as well as when-issued,
delayed delivery or forward commitment
transactions. However, these forms of leverage
will only be used, if at all, as a substitute
for, rather than in addition to, the leverage
obtained through the issuance of the AMPS. If the
dividend rate on the AMPS and interest rates (if
applicable) on other forms of leverage, as reset
periodically, exceeds the net rate of return on
the Fund's portfolio, the leverage will result in
a lower net asset value than if the Fund were not
leveraged, and the Fund's ability to pay
dividends and to meet its asset coverage
requirements on the AMPS would be reduced. It is
expected that this risk should be partially
mitigated because the dividend rates on the AMPS
and the interest rates on the Fund's portfolio of
Senior Loans and other debt instruments will vary
in a similar manner.
Because the fees received by the Manager are
based on the total managed assets of the Fund
(including assets attributable to any AMPS and
other forms of leverage that may be outstanding),
the fees will be higher when leverage is utilized
and the Manager has a financial incentive for the
Fund to issue AMPS or utilize other forms of
leverage.
Issuer Risk. The value of floating rate and
other debt instruments may decline for a number
of reasons which directly relate to the issuer or
borrower, such as management performance,
financial leverage and reduced demand for the
issuer's goods and services.
Smaller Company Risk. The general risks
associated with floating rate and other debt
instruments are particularly pronounced for
securities issued by companies with smaller
market capitalizations. These companies may have
limited product lines, markets or financial
resources or they may depend on a few key
employees. As a result, they may be subject to
greater levels of credit, market and issuer risk.
Management Risk. The Fund is subject to
management risk because it is an actively managed
portfolio. PIMCO and the individual portfolio
managers will apply investment techniques and
risk analyses in making investment decisions for
the Fund, but there can be no guarantee that
these will produce the desired results.
Foreign (Non-U.S.) Investment Risk. The Fund
expects to invest predominantly in U.S.
dollar-denominated debt securities and will not
invest more than 25% of its total assets in debt
securities denominated in currencies other than
the U.S. dollar. The Fund reserves the right to
invest without limit in debt securities of
foreign (non-U.S.) issuers, although it will not
invest more than 10% of its total assets in debt
securities of issuers located in emerging
markets. The Fund's investments in foreign
issuers and in securities denominated in foreign
currencies involve special risks. For example,
the value of
12
these investments may decline in response to
unfavorable political and legal developments,
unreliable or untimely information or economic
and financial instability. The value of
securities denominated in foreign currencies may
fluctuate based on changes in the value of those
currencies relative to the U.S. dollar, and a
decline in applicable foreign exchange rates
could reduce the value of such securities held by
the Fund. Foreign settlement procedures also may
involve additional risks.
Emerging Markets Risk. The Fund may invest up to
10% of its total assets in debt securities of
issuers located in developing or emerging
markets. Foreign investment risk may be
particularly high to the extent that the Fund
invests in securities of issuers based in or
securities denominated in the currencies of
emerging market countries. Investing in
securities of issuers based in underdeveloped
emerging markets entails all of the risks of
investing in securities of foreign issuers to a
heightened degree. These heightened risks
include: (i) greater risks of expropriation,
confiscatory taxation, nationalization and less
social, political and economic stability; (ii)
the smaller size of the market for such
securities and a lower volume of trading,
resulting in lack of liquidity and in price
volatility; and (iii) certain national policies
which may restrict the Fund's investment
opportunities, including restrictions on
investing in issuers or industries deemed
sensitive to relevant national interests.
Derivatives Risk. The Fund may utilize a variety
of derivative instruments for hedging, investment
or risk management purposes. The Fund may also
use derivatives to gain exposure to securities
markets in which it will invest (e.g., pending
investment of the proceeds of this offering and
the Fund's Common Share offering in individual
securities) or to add leverage to the portfolio
(but only as a substitute for the leverage
obtained from preferred shares). The types of
derivative instruments the Fund may utilize
include, but are not limited to, option contacts,
futures contracts, options on future contracts,
swap agreements (including total return and
credit default swaps) and short sales. The Fund
may also have exposure to derivatives, such as
interest rate or credit-default swaps, through
investment in credit-linked trust certificates
and other securities issued by special purpose or
structured vehicles. Derivatives are subject to a
number of risks described elsewhere in this
prospectus, such as liquidity risk, issuer risk,
interest rate risk, credit risk, leverage risk,
counterparty risk, smaller company risk and
management risk. They also involve the risk of
mispricing or improper valuation, the risk of
ambiguous documentation and the risk that changes
in the value of a derivative may not correlate
perfectly with an underlying asset, interest rate
or index. Suitable derivative transactions may
not be available in all circumstances and there
can be no assurance that the Fund will engage in
these transactions to reduce exposure to other
risks when that would be beneficial.
13
Counterparty Risk. In addition to credit risk
with respect to the counterparties to the Senior
Loans in which the Fund invests, the Fund will
also be subject to credit risk with respect to
derivative contracts entered into directly by the
Fund or held by special purpose or structured
vehicles in which the Fund invests. If a
counterparty becomes bankrupt or otherwise fails
to perform its obligations due to financial
difficulties, the Fund may experience significant
delays in obtaining any recovery in a bankruptcy
or other reorganization proceeding. The Fund may
obtain only a limited recovery or may obtain no
recovery in such circumstances.
Mortgage-Related and Asset-Backed Risk. The Fund
may invest in a variety of mortgage-related and
other asset-backed securities, including both
commercial and residential mortgage securities
and other mortgage-backed instruments (public or
private). Asset-backed securities are subject to
a number of risks described elsewhere in this
prospectus, such as credit risk and liquidity
risk. Generally, rising interest rates tend to
extend the duration of fixed-rate
mortgage-related securities, making them more
sensitive to changes in interest rates, and may
reduce the market value of the securities. PIMCO
expects that the Fund will focus its
mortgage-related investments principally in
adjustable rate mortgage-related and other
asset-backed securities, which should minimize
the Fund's overall sensitivity to interest rate
volatility. However, because interest rates on
most adjustable rate mortgage- and asset-backed
securities typically only reset periodically
(e.g., monthly or quarterly), changes in
prevailing interest rates (and particularly
sudden and significant changes) can be expected
to cause some fluctuation in the market value of
these securities, including declines in value as
market interest rates rise. In addition,
adjustable and fixed-rate mortgage-related
securities are subject to prepayment risk - the
risk that borrowers may pay off their mortgages
sooner than expected, particularly when interest
rates decline. This can reduce the Fund's returns
because the Fund may have to reinvest that money
at lower prevailing interest rates. The Fund's
investments in other asset-backed securities,
such as collateralized debt obligations, are
subject to risks similar to those associated with
mortgage-backed securities, as well as additional
risks associated with the nature of the assets
and the servicing of those assets.
Risk of Investing in REITs. Investing in REITs
involves certain unique risks in addition to
investing in the real estate industry in general.
REITs are subject to interest rate risks
(especially mortgage REITs) and the risk of
default by lessees or borrowers. An equity REIT
may be affected by changes in the value of the
underlying properties owned by the REIT. A
mortgage REIT may be affected by the ability of
the issuers of its portfolio mortgages to repay
their obligations. REITs whose underlying assets
are concentrated in properties used by a
particular industry are also subject to risks
associated with such industry. REITs may have
limited financial
14
resources, their securities trade less frequently
and in a limited volume, and may be subject to
more abrupt or erratic price movements than
larger company securities.
Interest Rate Risk. Generally, when market
interest rates rise, the prices of debt
obligations (and particularly fixed-rate debt
obligations) fall, and vice versa. This interest
rate risk is the risk that the debt obligations
in the Fund's portfolio will decline in value
because of increases in market interest rates.
The prices of short-term floating rate debt
obligations generally fluctuate less than prices
of long-term debt obligations as interest rates
change. Because the Fund will normally have a
short portfolio duration (i.e., a zero to
one-year time frame), the Fund's net asset value
will tend to fluctuate less in response to
changes in market interest rates than if the Fund
invested mainly in long-term debt securities.
Although the Fund's net asset value will vary,
PIMCO expects the Fund's policy of investing
principally in floating rate debt instruments
will minimize the Fund's overall sensitivity to
market interest rate fluctuations. However,
because rates on certain floating rate debt
instruments typically only reset periodically
(e.g., monthly or quarterly), changes in
prevailing interest rates (and particularly
sudden and significant changes) can be expected
to cause some fluctuation in the Fund's net asset
value. Moreover, a portion of the Fund's assets
may be invested in debt instruments with fixed
rates of interest, which will generally lose
value in direct response to rising interest
rates. The Fund's use of leverage, as described
below, will tend to increase interest rate risk.
Reinvestment Risk. Income from the Fund's
portfolio will decline if and when the Fund
invests the proceeds from prepaid, matured,
traded or called debt obligations at market
interest rates that are below the current
earnings rate on those obligations. This could
impact the Fund's net asset value and reduce
asset coverage on the AMPS.
Inflation/Deflation Risk. Inflation risk is the
risk that the value of assets or income from the
Fund's investments will be worth less in the
future as inflation decreases the value of
payments at future dates. As inflation increases,
the real, or inflation-adjusted, value of the
AMPS and distributions, as well as the real value
of the Fund's portfolio, could decline. Deflation
risk is the risk that prices throughout the
economy decline over time--the opposite of
inflation. Deflation may have an adverse effect
on the creditworthiness of issuers and may make
issuer default more likely, which may result in a
decline in the value of the Fund's portfolio.
Deflation may also result in a decline in the
dividend rate of the AMPS.
Regulatory Changes. To the extent that
legislation or state or federal bank or other
regulators impose additional requirements or
restrictions on the ability of certain financial
institutions to make loans, particularly in
connection with highly leverage transactions, the
availability of Senior Loans and other related
investments sought after
15
by the Fund may be reduced. Further, such
legislation or regulation could depress the
market value of Senior Loans and other
instruments held by the Fund.
Market Disruption and Geopolitical Risk. The war
with Iraq, its aftermath and the continuing
occupation of Iraq is likely to have a
substantial impact on the U.S. and world
economies and securities markets. The nature,
scope and duration of the war and occupation
cannot be predicted with any certainty. Terrorist
attacks on the World Trade Center and the
Pentagon on September 11, 2001 closed some of the
U.S. securities markets for a four-day period and
similar future events cannot be ruled out. The
war and occupation, terrorism and related
geopolitical risks have led, and may in the
future lead to, increased short-term market
volatility and may have adverse long-term effects
on U.S. and world economies and markets
generally. Those events could also have an acute
effect on individual issuers or related groups of
issuers. These risks could also adversely affect
individual issuers and securities markets,
interest rates, auctions, secondary trading,
ratings, credit risk, inflation and other factors
relating to the AMPS.
Certain Affiliations. Certain broker-dealers may
be considered to be affiliated persons of the
Fund, the Manager and/or PIMCO due to their
possible affiliations with Allianz AG, the
ultimate parent of the Manager and PIMCO. Absent
an exemption from the Securities and Exchange
Commission or other regulatory relief, the Fund
is generally precluded from effecting certain
principal transactions with affiliated brokers,
and its ability to purchase securities being
underwritten by an affiliated broker or a
syndicate including an affiliated broker, or to
utilize affiliated brokers for agency
transactions, is subject to restrictions. This
could limit the Fund's ability to engage in
securities transactions and take advantage of
market opportunities. In addition, unless and
until the underwriting syndicate is broken in
connection with the initial public offering of
the AMPS, the Fund will be precluded from
effecting principal transactions with brokers who
are members of the syndicate.
Anti-Takeover Provisions. The Fund's Amended and
Restated Agreement and Declaration of Trust dated
August 14, 2003 (the "Declaration") and Second
Amended and Restated Bylaws (the "Amended
Bylaws") include provisions that could limit the
ability of other entities or persons to acquire
control of the Fund or convert the Fund to
open-end status. See "Anti-Takeover and Other
Provisions in the Declaration of Trust."
Trading Market.............. The AMPS will not be listed on a stock exchange.
Instead, you may buy or sell AMPS at a periodic
auction by submitting orders to a broker-dealer
that has entered into a separate agreement with
the auction agent (a "Broker-Dealer") or to a
broker-dealer that has entered into an agreement
with a Broker-Dealer. In addition to the
auctions, Broker-Dealers and other broker-dealers
may (but are not
16
required to) maintain a separate secondary
trading market in AMPS, but may discontinue this
activity at any time. You may transfer shares
outside of auctions only to or through a
Broker-Dealer, a broker-dealer that has entered
into a separate agreement with a Broker-Dealer,
or other persons as the Fund permits. There can
be no assurance that a secondary trading market
for the AMPS will develop or, if it does develop,
that it will provide holders of AMPS with
liquidity of investment. See "Description of
AMPS--The Auction."
Ratings..................... The Fund will issue the AMPS only if the AMPS
have received a credit quality rating of "Aaa"
from Moody's and "AAA" from Fitch Ratings. These
ratings are an assessment of the capacity and the
willingness of an issuer to pay preferred share
obligations, and is not a recommendation to
purchase, hold or sell those shares inasmuch as
the ratings do not comment as to the market price
or suitability for a particular investor. Ratings
issued by nationally recognized statistical
rating agencies such as Moody's and Fitch Ratings
do not eliminate or mitigate the risks of
investing in the AMPS. These ratings may be
changed, suspended or withdrawn in each rating
agency's discretion. See "Description of
AMPS--Rating Agency Guidelines and Asset
Coverage."
Dividends on AMPS........... The table below shows the dividend rates, the
dividend payment dates and the number of days for
the initial rate periods on each series of AMPS
offered in this prospectus. For subsequent
dividend periods, AMPS will pay dividends based
on a rate set at auctions normally held every
seven days. In most instances, dividends are
payable on the first Business Day following the
end of the dividend period. The rate set at
auction will not exceed the maximum applicable
rate. See "Description of AMPS--Dividends and
Rate Periods."
Dividends on AMPS will be cumulative from the
date the shares are first issued and will be paid
out of legally available funds.
Number
of Days
Dividend Subsequent in
Initial Date of Payment Dividend Initial
Dividend Accumulation Date for Initial Payment Rate
AMPS Rate at Initial Rate* Rate Period* Day Period
---- -------- ---------------- ---------------- ---------- -------
Series T % Wednesday
Series W % Thursday
Series TH % Friday
* All dates 2003.
Notwithstanding the schedule above, the Fund may,
subject to certain conditions, designate special
rate periods of more than seven days. The Fund
may not designate a special rate period unless
sufficient clearing bids were made in the most
recent auction. In addition, full cumulative
dividends and any amounts due with respect to
mandatory redemptions or optional redemptions
must be paid in full or deposited with the
auction agent. The Fund also must have received
17
confirmation from Moody's and Fitch Ratings or
any substitute rating agency that the proposed
special rate period will not impair such agency's
then-current rating on the AMPS. The dividend
payment date for a special rate period will be
set out in the notice designating the special
rate period.
The Fund may declare a special rate period under
circumstances in which it believes it has the
opportunity to secure an advantageous dividend
rate on the AMPS, although it may choose not to
do so. These circumstances could include, among
others (i) if the Manager believes that interest
rates will rise more than market expectations
over a particular period or (ii) if long-term
interest and dividend rates are lower than
short-term interest and dividend rates for a
particular period.
Determination of Maximum
Applicable Rates.......... Except during a non-payment period, the
applicable rate for any dividend period for AMPS
will not be more than the maximum applicable rate
attributable to such shares. The maximum
applicable rate for each series of AMPS will
depend on the credit rating assigned to such
shares and on the duration of the dividend
period. The maximum applicable rate will be the
higher of the applicable percentage of the
reference rate or the applicable spread plus the
reference rate. The reference rate is the
applicable LIBOR Rate (for a dividend period of
fewer than 365 days) or the applicable Treasury
Rate Index (for a dividend period of 365 days or
more). The applicable percentage or applicable
spread as so determined is further subject to
upward but not downward adjustment in the
discretion of the Board of Trustees after
consultation with the Broker-Dealers. The
applicable percentage and spread is as follows:
Moody's Credit Fitch Ratings' Applicable Applicable
Rating Credit Rating Percentage Spread
-------------- ------------- ---------- ----------
Aaa AAA 125% 125 bps
Aa3 to Aa1 AA- to AA+ 150% 150 bps
A3 to A1 A- to A+ 200% 200 bps
Baa3 to Baa1 BBB- to BBB+ 250% 250 bps
Ba1 and below BB+ and below 300% 300 bps
There is no minimum applicable rate in respect of
any dividend period. See "Description of
AMPS--Dividends and Rate Periods."
Liquidation Preference...... If the Fund is liquidated, the Fund must pay to
holders of AMPS $25,000 per share, plus
accumulated but unpaid dividends, if any, whether
or not earned or declared. See "Description of
AMPS--General."
Asset Maintenance........... Under Article 11 of the Amended Bylaws attached
as Appendix A to the SAI, which establishes and
fixes the rights and preferences of each series
of AMPS, the Fund must maintain:
. asset coverage on the AMPS as required by the
rating agency or agencies rating the AMPS; and
18
. asset coverage of at least 200% with respect
to senior securities that are stock, including
the AMPS, as discussed in "Description of
AMPS--Rating Agency Guidelines and Asset
Coverage."
In the event that the Fund does not maintain (or
cure a failure to maintain) these coverage tests,
some or all of the AMPS will be subject to
mandatory redemption. See "Description of
AMPS--Redemption--Mandatory Redemption."
Based on the composition of the Fund's portfolio
as of October 14, 2003, the Fund estimates that
the asset coverage of the AMPS, as measured
pursuant to the Investment Company Act of 1940,
as amended (the "1940 Act"), would be
approximately 263% if the Fund were to issue all
of the AMPS offered in this prospectus,
representing approximately 38% of the Fund's
capital (including the capital attributable to
the AMPS). This asset coverage will change from
time to time.
Mandatory Redemption........ If the Preferred Shares Basic Maintenance Amount
or the 1940 Act Preferred Shares Asset Coverage
(each as defined in the Amended Bylaws and
discussed in "Description of AMPS--Rating Agency
Guidelines and Asset Coverage") is not maintained
or restored as specified herein, the AMPS will be
subject to mandatory redemption, out of funds
legally available therefor, at the redemption
price of $25,000 per share plus an amount equal
to dividends thereon (whether or not earned or
declared) accumulated but unpaid to (but not
including) the date fixed for redemption. Any
such redemption will be limited to the minimum
number of AMPS necessary to restore the Preferred
Shares Basic Maintenance Amount or the 1940 Act
Preferred Shares Asset Coverage, as the case may
be. The Fund's ability to make such a mandatory
redemption may be restricted by the provisions of
the 1940 Act. See "Description of
AMPS--Redemption--Mandatory Redemption."
Optional Redemption......... The AMPS are redeemable at the option of the
Fund, as a whole or in part, on any dividend
payment date (except during the initial rate
period or a non-call period) at the redemption
price of $25,000 per share, plus an amount equal
to the accumulated but unpaid dividends (whether
or not earned or declared) to (but not including)
the date fixed for redemption. See "Description
of AMPS--Redemption--Optional Redemption."
Although the AMPS are subject to redemption under
certain circumstances as described above and
under "Description of AMPS--Redemption," the AMPS
may not be redeemed at a shareholder's option at
net asset value, unlike the shares of an open-end
mutual fund.
Voting Rights............... The 1940 Act requires that the holders of any
outstanding series of AMPS and any other
outstanding preferred shares, voting as a class,
have the right to elect at least two trustees at
all times and to elect a majority of the trustees
at any time when two years' dividends on the
19
AMPS or any other preferred shares are unpaid.
The holders of AMPS and any other preferred
shares will vote as a separate class (and, in
certain circumstances, the holders of each series
of AMPS will vote as a separate class) on certain
other matters as required under the Fund's
Declaration and Amended Bylaws and under the 1940
Act. See "Description of AMPS--Voting Rights,"
"Description of Capital Structure" and
"Anti-Takeover and Other Provisions in the
Declaration of Trust."
Federal Income Taxation..... The distributions with respect to any series of
AMPS (other than distributions in redemption of
AMPS subject to Section 302(b) of the Internal
Revenue Code of 1986, as amended (the "Code"))
will constitute dividends to the extent of the
Fund's current or accumulated earnings and
profits, as calculated for federal income tax
purposes. Such dividends generally will be
taxable as ordinary income to holders. For
taxable years beginning on or before December 31,
2008, provided holding period and other
requirements are met, the Fund may designate
distributions of investment income derived from
dividends of U.S. corporations and some foreign
corporations as "qualified dividend income."
Qualified dividend income will be taxed in the
hands of individuals at the rates applicable to
long-term capital gain, provided these same
holding period and other requirements are met by
the shareholder. The Fund does not expect a
significant portion of Fund distributions to be
derived from qualified dividend income.
Distributions of net capital gains (i.e., the
excess of net long-term capital gains over net
short-term capital losses) that are designated by
the Fund as capital gain dividends will be
treated as long-term capital gains in the hands
of holders receiving such distributions. The
Internal Revenue Service (the "IRS") currently
requires that a regulated investment company that
has two or more classes of stock allocate to each
such class proportionate amounts of each type of
its income (such as ordinary income and capital
gains) based upon the percentage of total
dividends distributed to each class for the tax
year. Accordingly, the Fund intends each year to
allocate capital gain dividends between and among
its Common Shares and each series of the AMPS in
proportion to the total dividends paid to each
class during or with respect to such year.
Dividends qualifying and not qualifying for (a)
treatment as qualified dividend income and (b)
the dividends received deduction, if any, will
similarly be allocated between and among classes.
See "Tax Matters."
Custodian, Auction Agent,
Transfer Agent, Registrar,
Dividend Paying Agent and
Redemption Agent.......... State Street Bank & Trust Co. ("State Street")
will act as the Fund's custodian. Deutsche Bank
Trust Company Americas ("Deutsche Bank") will act
as auction agent, and as the transfer agent,
registrar, dividend paying agent and redemption
agent for the AMPS.
20
FINANCIAL HIGHLIGHTS (UNAUDITED)
The financial highlights table set forth below is intended to help you
understand the Fund's recent financial performance. Information contained in
the table below under the headings "Per Share Operating Performance" and
"Ratios/Supplemental Data" shows the unaudited operating performance of the
Fund from the commencement of the Fund's investment operations on August 29,
2003 through October 5, 2003. Because the Fund is recently organized and
commenced investment operations on August 29, 2003, the table covers five weeks
of operations, during which a substantial portion of the Fund's portfolio was
held in temporary investments pending investment in securities that meet the
Fund's investment objective and policies. Accordingly, the information
presented may not provide a meaningful picture of the Fund's operating
performance.
For the Period August 29, 2003*
through October 5, 2003
(Unaudited)
-------------------------------
Per Share Operating Performance
Net Asset Value, Beginning of Period....................................... $ 19.35**
--------
Investment Operations:
Net Investment Income................................................... .03
Net Realized and Unrealized Gain on Investments and Swaps............... .03
--------
Net Increase in Net Assets Resulting from Investment Operations..... .06
Capital Share Transactions:
Common Stock Offering Expenses Charged to Paid-in-Capital in Excess of Par. (.04)
--------
Net Asset Value, End of Period............................................. $ 19.37
========
Market Price, End of Period................................................ $ 20.01
========
Total Investment Return.................................................... .1%(1)
Ratios/Supplemental Data:
Net Assets, End of Period (in thousands)................................ $330,436
Ratio of Expenses to Average Net Assets................................. .84%(2)
Ratio of Net Investment Income to Average Net Assets.................... 1.80%(2)
Portfolio Turnover...................................................... 3%
--------
* Date of commencement of operations.
** Initial public offering price of $20.00 per share less underwriting discount
of $.65 per share.
(1) Total Investment Return is calculated assuming a purchase of common stock
at the current market price on the first day of the period and a sale at
the current market price on the last day of the period reported. Total
Investment Return does not reflect brokerage commissions. Total Investment
Return for a period less than one year is not annualized.
(2) Annualized.
21
THE FUND
The Fund is a recently organized, diversified, closed-end management
investment company registered under the 1940 Act. The Fund was organized as a
Massachusetts business trust on June 19, 2003 and is registered as an
investment company under the 1940 Act. As a recently-organized entity, the Fund
has a limited operating history. The Fund's principal office is located at 1345
Avenue of the Americas, New York, New York 10105, and its telephone number is
(800) 331-1710.
The Fund commenced operations on August 29, 2003, upon the closing of an
initial public offering of 16,250,000 of its Common Shares. The proceeds of
such offering were approximately $313,787,500 after the payment of
organizational and offering expenses. In connection with the initial public
offering of the Fund's Common Shares, the Underwriters were granted an option
to purchase up to an additional 2,437,500 Common Shares to cover
overallotments. On September 15 and October 10, 2003, the Underwriters
purchased an additional 800,000 and 700,000 Common Shares of the Fund,
respectively, pursuant to the overallotment option. These purchases yielded net
proceeds to the Fund of approximately $28,965,000. The Fund's Common Shares are
traded on the New York Stock Exchange under the symbol "PFL."
USE OF PROCEEDS
The net proceeds of the offering of AMPS will be approximately
$207,400,000 after payment of the estimated offering costs and sales load. The
Fund will invest the net proceeds of the offering in accordance with the Fund's
investment objective and policies as stated below. It is presently anticipated
that the Fund will be able to invest substantially all of the net proceeds in
floating rate debt instruments and other securities that meet its investment
objective and policies within three months after the completion of the
offering. Pending such investment, it is anticipated that the proceeds will be
invested in high grade, short-term securities, credit-linked trust certificates
and/or index futures contracts or similar derivative instruments designed to
give the Fund exposure to the markets in which it intends to invest while PIMCO
selects specific securities.
CAPITALIZATION
The following table sets forth the unaudited capitalization of the Fund
as of October 14, 2003, and as adjusted to give effect to the issuance of the
AMPS offered hereby (including estimated offering expenses and sales load of
$2,600,000).
Actual As Adjusted
------------ ------------
Series T AMPS, $.00001 par value (no shares issued; 2,800 shares issued, as
adjusted, at $25,000 per share liquidation preference).................... $ 0 $ 70,000,000
Series W AMPS, $.00001 par value (no shares issued; 2,800 shares issued, as
adjusted, at $25,000 per share liquidation preference).................... $ 0 $ 70,000,000
Series TH AMPS, $.00001 par value (no shares issued; 2,800 shares issued, as
adjusted, at $25,000 per share liquidation preference).................... $ 0 $ 70,000,000
------------ ------------
Total AMPS.................................................................. $ 0 $210,000,000
============ ============
Common Shares, $.00001 par value, 17,755,168 shares outstanding............. $342,852,501 $340,252,501
Undistributed net investment income......................................... $ 821,169 $ 821,169
Accumulated net realized gain on investment transactions.................... $ 39,145 $ 39,145
Net unrealized appreciation on investments.................................. $ 1,244,209 $ 1,244,209
------------ ------------
Net assets applicable to Common Shares...................................... $344,957,024 $342,357,024
============ ============
22
PORTFOLIO COMPOSITION
The following table sets forth certain information with respect to the
composition of the Fund's investment portfolio as of October 14, 2003, based on
the highest rating assigned.
Value
S&P+ Moody's+ Number of Issues (in Thousands) Percent
--- -------- ---------------- -------------- -------
AAA Aaa 10 $115,024 29.1%
AA Aa 0 0 0
A A 0 0 0
BBB Baa 0 0 0
BB Ba 9 19,937 5.0
B B 6 18,821 4.8
CCC Caa 2 14,015 3.5
CC Ca 0 0 0
C C 0 0 0
NR* NR* 93 228,187 57.7
Cash (722) (.1)
--- -------- -----
Total 120 395,262 100.0%
--- -------- -----
--------
+ Ratings: Using the higher of S&P's or Moody's ratings on the Fund's portfolio
securities. S&P rating categories may be further modified by a plus (+) or
minus (-) in AA, A, BBB, BB, B and CCC ratings. Moody's rating categories may
be further modified by a 1, 2 or 3 in Aa, A, Baa, Ba, B and Caa ratings.
* Refers to securities that have not been rated by Moody's or S&P but that have
been assessed by PIMCO as being of comparable credit quality to rated
securities in which the Fund may invest. See "Investment Objective and
Strategies."
INVESTMENT OBJECTIVE AND STRATEGIES
Investment Objective
The Fund's investment objective is to seek high current income,
consistent with the preservation of capital. Under normal market conditions,
the Fund seeks to achieve its investment objective by investing at least 80% of
its net assets (plus any borrowings for investment purposes) in a diversified
portfolio of floating rate debt instruments, a substantial portion of which
will be Senior Loans. The Fund may invest without limit and ordinarily expects
to invest a substantial portion of its assets in debt securities that are, at
the time of purchase, rated below investment grade (below Baa3 by Moody's,
below BBB- by either S&P or Fitch Ratings, or below a comparable rating by
Dominion) or that are unrated but judged by PIMCO to be of comparable quality.
Various types of securities and other instruments in which the Fund may invest
in are described under "Portfolio Contents and Other Information" below. The
Fund cannot assure you that it will achieve its investment objective.
Portfolio Management Strategies
The Fund is actively managed in accordance with PIMCO's top down cyclical
and secular economic outlook, using strategies that focus on credit quality
analysis, broad market diversification among industries and sectors and other
risk management techniques. In selecting investments for the Fund, PIMCO
attempts to identify floating rate debt instruments and other debt securities
that provide high current income through fundamental research, driven by
independent credit analysis and proprietary analytical tools. Investment
decisions are based primarily on PIMCO's assessment of the issuer's credit
characteristics and the position of the particular security in the issuer's
capital structure, in light of PIMCO's outlook for particular industries, the
economy and the market generally. At the same time, PIMCO uses a variety of
techniques, such as credit default swaps, designed
23
to control risk and minimize the Fund's exposure to issues that PIMCO believes
are more likely to default or otherwise depreciate in value over time and
detract from the Fund's overall return to investors. The Fund cannot assure you
that such securities will ultimately continue to pay current income or be paid
in full at maturity.
Because most of the debt instruments held by the Fund will have variable
interest rates, the Fund's portfolio is generally expected to have less
interest rate risk (i.e., sensitivity to fluctuations in market interest rates)
and a more stable net asset value than funds with portfolios that invest in
fixed-income securities, although the net asset value will vary due to
fluctuations in interest rates and other factors such as changes in the credit
quality of securities in the portfolio.
Credit Quality. The Fund may invest without limit and ordinarily expects
to invest a substantial portion of its assets in debt securities that are, at
the time of purchase, rated below investment grade or that are unrated but
judged by PIMCO to be of comparable quality. The Fund will not invest more than
10% of its total assets in securities that are, at the time of purchase, rated
CCC+/Caa1 or lower by each agency rating the security or that are unrated but
judged by PIMCO to be of comparable quality. The Fund may invest in issuers of
any credit quality (including bonds in the lowest ratings categories) if PIMCO
determines that the particular obligation offers an attractive yield relative
to its risk profile. As described under "High Yield Securities ("Junk Bonds")"
below, debt securities of below investment grade quality (including many Senior
Loans) are regarded as having predominantly speculative characteristics with
respect to capacity to pay interest and repay principal, and are commonly
referred to as "high yield" securities or "junk bonds." The Fund's credit
quality policies apply only at the time a security is purchased, and the Fund
is not required to dispose of a security in the event that a rating agency or
PIMCO downgrades its assessment of the credit characteristics of a particular
issue.
Independent Credit Analysis. PIMCO relies heavily on its own analysis of
the credit quality and risks associated with individual debt obligations
considered for the Fund, rather than relying exclusively on rating agencies or
third-party research. In the case of Senior Loans, PIMCO analyzes and takes
into account the legal/protective features associated with the securities (such
as their position in the borrower's capital structure and any security through
collateral) in assessing their credit characteristics. PIMCO has a devoted team
of professionals that conducts fundamental credit research and analysis of
individual issuers, industries and sectors and uses proprietary analytical
tools (such as computer databases and Web-based applications) to assess and
monitor credit risk. The individuals managing the Fund utilize this information
in an attempt to manage credit risk and identify issuers, industries or sectors
that offer attractive yields relative to PIMCO's assessment of their credit
characteristics. This aspect of PIMCO's capabilities will be particularly
important because of the Fund's emphasis on Senior Loans and other below
investment grade securities.
Duration. The average portfolio duration of the Fund will normally be
within a short range (i.e., a zero to one-year time frame) due to the Fund's
predominant investment in floating rate debt instruments, although it may be
longer at any time and from time to time to the extent that the Fund invests in
fixed-income securities. PIMCO believes that the Fund's short duration range
minimizes exposure to price changes of its portfolio securities due to interest
rate volatility and related risk while still offering the potential opportunity
for high current income.
Duration is a measure of the expected life of a debt security that is
used to determine the sensitivity of the security's price to changes in
interest rates. The longer a security's duration, the more sensitive it will be
to changes in interest rates. For example, the market price of a bond with a
duration of two years would be expected to decline 2% if interest rates were to
rise 1%. Conversely, the market price of the same bond would be expected to
increase 2% if interest rates were to fall 1%. The market price of a bond with
a duration of one year would be expected to increase or decline half as much as
the market price of a bond with a two-year duration. The maturity of a security
measures only the time until final payment is due. Duration, on the other hand,
takes into account the pattern of all payments of interest and principal on a
security over time, including how these payments are affected by prepayments
and by changes in interest rates, as well as the time until an interest rate on
a security is reset (in the case of variable rate securities).
24
Portfolio Contents and Other Information
Under normal market conditions, the Fund seeks to achieve its investment
objective by investing at least 80% of its net assets (plus any borrowings for
investment purposes) in a diversified portfolio of floating rate debt
instruments, a substantial portion of which will be Senior Loans. Other
floating rate debt instruments in which the Fund may invest include catastrophe
and other event-linked bonds, bank capital securities, unsecured bank loans,
corporate bonds, money market instruments and certain types of mortgage-backed
and other asset-backed securities that pay interest at rates which adjust
whenever a specified interest rate changes and/or reset on predetermined dates
(such as the last day of a month or calendar quarter). The Fund may invest the
remainder of its assets in securities and instruments other than floating rate
debt instruments, including fixed income debt securities such as convertible
securities, high-yield bonds and mortgage-backed and other asset-backed
securities issued on a public or private basis. The Fund may make use of a
variety of other instruments, including collateralized debt obligations,
preferred shares, commercial paper, U.S. Government securities, zero-coupon and
inflation-indexed bonds, real estate investment trusts (REITs), structured
notes and other hybrid instruments, credit-linked trust certificates, total
return swaps, credit default swaps and other derivative instruments. Certain
debt instruments, such as convertible bonds, also may include the right to
participate in equity appreciation, and PIMCO will generally evaluate those
instruments based primarily on their debt characteristics. The Fund may invest
in securities of companies with small market capitalizations. The principal
and/or interest rate on some debt instruments may be determined by reference to
the performance of a benchmark asset or market, such as an index of securities,
or the differential performance of two assets or markets, such as the level of
exchange rates between the U.S. dollar and a foreign currency or currencies.
The Fund may invest without limit, and ordinarily expects to invest a
substantial portion of its assets, in debt securities that are, at the time of
purchase, rated below investment grade. See "High Yield Securities ("Junk
Bonds")" below. The Fund may also invest in investment grade securities.
The Fund expects to invest predominantly in U.S. dollar-denominated debt
securities, which may include those issued by foreign corporations or
supra-national government agencies. The Fund may invest up to 25% of its total
assets in debt instruments denominated in foreign currencies, including
obligations of non-U.S. governments and their respective sub-divisions,
agencies and government-sponsored enterprises. The Fund may invest up to 10% of
its total assets in securities of issuers located in "emerging markets." The
Fund may utilize a variety of derivative instruments for hedging, investment
and risk management purposes, such as option contracts (including options on
futures contracts), futures contracts, swap agreements (including total return
and credit default swaps) and short sales, and may seek to obtain market
exposure to the securities in which it primarily invests by entering into a
series of purchase and sales contracts. The Fund may also use derivatives to
leverage the portfolio, but only as a substitute for leverage attained through
preferred shares. The Fund may invest without limit in illiquid securities
(which are generally determined using the Securities and Exchange Commission's
standard applicable to open-end investment companies, i.e., securities that
cannot be disposed of within seven days in the ordinary course of business at
approximately the value at which the Fund has valued the securities). PIMCO
will determine the liquidity of the Fund's investments by reference to market
conditions and contractual provisions. For example, PIMCO will generally not
consider Senior Loans that are part of an issue of at least $250 million in par
value to be illiquid.
The Fund cannot change its investment objective without the approval of
the holders of a "majority of the outstanding" Common Shares and any preferred
shares (including any AMPS) voting together as a single class, and of the
holders of a "majority of the outstanding" preferred shares (including any
AMPS) voting as a separate class. A "majority of the outstanding" shares
(whether voting together as a single class or voting as a separate class) means
(i) 67% or more of such shares present at a meeting, if the holders of more
than 50% of those shares are present or represented by proxy, or (ii) more than
50% of such shares, whichever is less. See "Description of AMPS--Voting Rights"
for additional information with respect to the voting rights of holders of
AMPS. The Fund may not change its policy to normally invest at least 80% of its
net assets (plus any borrowings for investment purposes) in floating rate debt
instruments unless it provides shareholders with at least 60 days' written
notice of such change.
25
Other than the issuance of AMPS, the Fund may use a variety of strategies
to add leverage to the portfolio. These include borrowing money, issuing debt
securities or using reverse repurchase agreements, loans of portfolio
securities, credit default swap contracts and other derivatives, as well as
when-issued, delayed delivery and forward commitment transactions. However,
these forms of leverage will only be used, if at all, as a substitute for,
rather than in addition to, the leverage obtained through the issuance of
preferred shares. See "Risks--General Risks of Investing in the Fund--Leverage
Risk."
Upon PIMCO's recommendation, for temporary defensive purposes and in
order to keep the Fund's cash fully invested, including during the period in
which the net proceeds of this offering are being invested, the Fund may
deviate from its investment objective and policies and invest some or all of
its total assets in fixed-rate investment grade debt securities, including high
quality, short-term debt securities. The Fund may not achieve its investment
objective when it does so.
The following provides additional information regarding the types of
securities and other instruments in which the Fund will ordinarily invest. A
more detailed discussion of these and other instruments and investment
techniques that may be used by the Fund is provided under "Investment Objective
and Policies" in the SAI. The ability of the Fund to use some of the strategies
discussed below and in the SAI, such as derivatives, is limited by the rating
agency guidelines. See "Description of AMPS--Rating Agency Guidelines and Asset
Coverage" below.
Floating Rate Debt Instruments
Under normal market conditions, the Fund will invest at least 80% of its
net assets (plus any borrowings for investment purposes) in a diversified
portfolio of floating rate debt instruments. Floating rate debt instruments are
debt instruments that pay interest at rates which adjust whenever a specified
interest rate changes and/or which reset on predetermined dates (such as the
last day of a month or calendar quarter). In addition to Senior Loans, these
floating rate debt instruments may include, without limitation, instruments
such as catastrophe and other event-linked bonds, bank capital securities,
unsecured bank loans, corporate bonds, money market instruments and certain
types of mortgage-backed and other asset-backed securities. Due to their
floating rate features, these instruments will generally pay higher levels of
income in a rising interest rate environment and lower levels of income as
interest rates decline. For the same reason, the market value of a floating
rate debt instrument is generally expected to have less sensitivity to
fluctuations in market interest rates than a fixed-rate debt instrument,
although the value of a floating rate instrument may nonetheless decline as
interest rates rise and due to other factors, such as changes in credit quality.
Senior Loans
The Fund expects to ordinarily invest a substantial portion of its assets
in Senior Loans. Senior Loans include senior floating rate loans and
institutionally traded senior floating rate debt obligations issued by an
asset-backed pool or other issuers, as well as interests therein. Loan
interests generally take the form of direct interests acquired during a primary
distribution and may also take the form of assignments of, novations of, or
participations in a Senior Loan acquired in secondary markets.
Senior Loans typically pay interest at rates which are re-determined
periodically on the basis of a floating base lending rate (such as the LIBOR
Rate) plus a premium. Although Senior Loans are typically of below investment
grade quality, they tend to have more favorable recovery rates than other types
of below investment grade quality debt obligations. Senior Loans generally (but
not always) hold the most senior position in the capital structure of a
borrower and are often secured with collateral. 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 lending syndicate of financial institutions ("Lenders"). The Agent
typically administers and enforces the Senior Loan on behalf of the other
Lenders in the syndicate. In addition, an institution, typically but not always
the Agent, holds any collateral on behalf of the Lenders. A financial
26
institution's employment as an Agent might be terminated in the event that it
fails to observe a requisite standard of care or becomes insolvent. A successor
Agent would generally be appointed to replace the terminated Agent, and assets
held by the Agent under the loan agreement would likely remain available to
holders of such indebtedness. 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 loan or loan participation and could suffer a loss of principal
and/or interest. In situations involving other interposed financial
institutions (e.g., an insurance company or government agency) similar risks
may arise.
The Fund may purchase "assignments" of Senior Loans from Lenders. The
purchaser of an assignment typically succeeds to all the rights and obligations
under the loan agreement with the same rights and obligations as the assigning
Lender. 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 Lender.
The Fund may also invest in "participations" in Senior Loans, although it
expects to do so on a limited basis. Participations by the Fund in a Lender's
portion of a Senior Loan typically will result in the Fund having a contractual
relationship only with such Lender, 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 Lender selling the participation and only
upon receipt by such Lender 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 Lenders through set-off
against the borrower, and the Fund may not directly benefit from any 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 Lender
selling the participation.
Purchasers of Senior Loans and other forms of direct indebtedness depend
primarily upon the creditworthiness of the corporate or other borrower for
payment of principal and interest. If the Fund does not receive scheduled
interest or principal payments on such indebtedness, the Fund's share price and
yield could be adversely affected. Senior Loans that are fully secured may
offer the Fund more protection than an unsecured loan in the event of
non-payment of scheduled interest or principal. However, there is no assurance
that the liquidation of any collateral from a secured Senior Loan would satisfy
the borrower's obligation, or that such collateral could be liquidated. Also,
the Fund may invest in Senior Loans that are unsecured.
Senior Loans may not be readily marketable and may be subject to
restrictions on resale. In some cases, negotiations involved in disposing of
indebtedness may require weeks to complete. Consequently, some indebtedness may
be difficult or impossible to dispose of readily at what PIMCO believes to be a
fair price.
Senior Loans usually require, in addition to scheduled payments of
interest and principal, the prepayment of the Senior Loan from free cash flow.
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 lenders, 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 prepaying borrower and
a facility fee upon the purchase of a new Senior Loan with the proceeds from
the prepayment of the former. The effect of prepayments on the Fund's
performance may be mitigated by the receipt of prepayment fees and the Fund's
ability to reinvest prepayments in other Senior Loans that have similar or
identical yields.
High Yield Securities ("Junk Bonds")
As noted above, the Fund may invest without limit and ordinarily expects
to invest a substantial portion of its assets in Senior Loans and other debt
securities that are, at the time of purchase, rated below investment
27
grade (below Baa3 by Moody's, below BBB- by either S&P or Fitch Ratings, or
below a comparable rating by Dominion) or that are unrated but judged by PIMCO
to be of comparable quality. These securities are sometimes referred to as
"high yield" securities or "junk bonds." Investing in high yield securities
involves greater risks (in particular, greater risk of default) and special
risks in addition to the risks associated with investments in investment grade
debt obligations. While offering a greater potential opportunity for capital
appreciation and higher yields, high yield securities typically entail greater
potential price volatility and may be less liquid than higher-rated securities.
High yield securities may be regarded as predominantly speculative with respect
to the issuer's continuing ability to meet principal and interest payments.
They also may be more susceptible to real or perceived adverse economic and
competitive industry conditions than higher-rated securities. Debt securities
in the lowest investment grade category also may be considered to possess some
speculative characteristics.
The market values of high yield securities tend to reflect individual
developments of the issuer to a greater extent than do higher-quality
securities, which tend to react mainly to fluctuations in the general level of
interest rates. In addition, lower-quality debt securities tend to be more
sensitive to economic conditions. Certain "emerging market" governments that
issue high yield securities are among the largest debtors to commercial banks,
foreign governments and supra-national organizations such as the World Bank,
and may not be able or willing to make principal and/or interest payments as
they come due.
Senior Loans generally tend to have more favorable recovery rates than
most other types of loans. Although Senior Loans in which the Fund will invest
will often be secured by collateral, there can be no assurance that liquidation
of such collateral would satisfy the borrower's obligation in the event of
default or that such collateral could be readily liquidated.
Credit Ratings and Unrated Securities. Rating agencies are private
services that provide ratings of the credit quality of debt obligations,
including convertible securities. Appendix A to this prospectus describes the
various ratings assigned to debt obligations by Moody's, S&P, Fitch Ratings and
Dominion. Ratings assigned by a rating agency are not absolute standards of
credit quality and do not evaluate market risks. Rating agencies may fail to
make timely changes in credit ratings and an issuer's current financial
condition may be better or worse than a rating indicates. PIMCO relies heavily
on its own analysis of the credit quality and risks associated with individual
debt obligations considered for the Fund, rather than relying exclusively on
rating agencies or third-party research. See "Portfolio Management
Strategies--Independent Credit Analysis." In the case of Senior Loans, PIMCO
analyzes and takes into account the legal/protective features associated with
the securities (such as their position in the borrower's capital structure and
any security through collateral) in assessing their credit characteristics. The
Fund will not necessarily sell a security when its rating is reduced below its
rating at the time of purchase. The ratings of a debt security may change over
time. Moody's, S&P, Fitch Ratings and Dominion monitor and evaluate the ratings
assigned to securities on an ongoing basis. As a result, debt instruments held
by the Fund could receive a higher rating (which would tend to increase their
value) or a lower rating (which would tend to decrease their value) during the
period in which they are held.
The Fund may purchase unrated securities (which are not rated by a rating
agency) if PIMCO determines that the securities are of comparable quality to
rated securities that the Fund may purchase. Many of the Senior Loans and other
debt instruments in which the Fund invests may be unrated. Unrated securities
may be less liquid than comparable rated securities and involve the risk that
PIMCO may not accurately evaluate the security's comparative credit rating.
Analysis of the creditworthiness of issuers of high yield securities may be
more complex than for issuers of higher-quality debt obligations. The Fund's
success in achieving its investment objective may depend more heavily on
PIMCO's credit analysis than if the Fund invested primarily in higher-quality
and rated securities.
Bonds
The Fund may invest in bonds of varying maturities (with predominantly
low durations) issued by U.S. and foreign corporations, domestic and foreign
banks and other business entities. Bonds can be variable or fixed
28
rate debt obligations, including bills, notes, debentures, money market
instruments and similar instruments and securities. Bonds generally are used by
corporations as well as governments and other issuers to borrow money from
investors. The issuer pays the investor a variable or fixed rate of interest
and normally must repay the amount borrowed on or before maturity. Certain
bonds are "perpetual" in that they have no maturity date. The Fund may also
invest in catastrophe or other "event-linked" bonds. Although the Fund will
ordinarily invest in floating rate bonds, it may invest a portion of its assets
in fixed rate bonds. Please see "Bonds" and "Event-Linked Bonds" in the SAI for
a more detailed description of the investments described in this paragraph.
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.
Preferred Stocks
Preferred stock represents an equity interest in a company that generally
entitles the holder to receive, in preference to the holders of other stocks
such as common stocks, dividends and a fixed share of the proceeds resulting
from liquidation of the company. Some preferred stocks also entitle their
holders to receive additional liquidation proceeds on the same basis as holders
of a company's common stock, and thus also represent an ownership interest in
the company. The preferred stocks in which the Fund invests will ordinarily
have a variable dividend, generally determined on a quarterly or other periodic
basis, either according to a formula based upon a specified premium or discount
to the yield on particular U.S. Treasury securities or based on an auction
process, involving bids submitted by holders and prospective purchasers of such
stocks. Some preferred stocks offer a fixed rate of return with no maturity
date. Because they never mature, these preferred stocks act like long-term
bonds and can be more volatile than other types of preferred stocks and may
have heightened sensitivity to changes in interest rates. Because preferred
stocks represent an equity ownership interest in a company, their value usually
will react more strongly than bonds and other debt instruments to actual or
perceived changes in a company's financial condition or prospects, or to
fluctuations in the equity markets.
Convertible Securities and Synthetic Convertible Securities
The Fund may invest in convertible securities, which are debt securities
that may be converted at either a stated price or stated rate into underlying
shares of common stock. Convertible securities have general characteristics
similar to both debt securities and equity securities. PIMCO will generally
evaluate these instruments based primarily on their debt characteristics.
Because most convertible securities are fixed-rate instruments, the market
value of convertible securities tends to decline as interest rates increase
and, conversely, tends to increase as interest rates decline. In addition,
because of the conversion feature, the market value of convertible securities
tends to vary with fluctuations in the market value of the underlying common
stocks and, therefore, also will react to variations in the general market for
equity securities.
The Fund may also invest in synthetic convertible securities, which
differ from convertible securities in certain respects. Unlike a true
convertible security, which is a single security having a unitary market value,
a synthetic convertible comprises two or more separate securities, each with
its own market value. Therefore, the "market value" of a synthetic convertible
security is the sum of the values of its debt component and its convertibility
component. Synthetic convertible securities can be variable or fixed rate
instruments. For these reasons, the values of a synthetic convertible and a
true convertible security may respond differently to market fluctuations.
Convertible securities generally have higher yields than common stocks.
There can be no assurance of current income because the issuers of the
convertible securities may default on their obligations. A convertible
security, in addition to providing current income, offers the potential for
capital appreciation through the
29
conversion feature, which enables the holder to benefit from increases in the
market price of the underlying common stock.
Bank Capital Securities and Obligations
The Fund may invest in bank capital securities. Bank capital securities
are issued by banks to help fulfill their regulatory capital requirements.
There are three common types of bank capital: Lower Tier II, Upper Tier II and
Tier I. To the extent that the Fund invests in bank capital, it expects to
primarily invest in floating rate Upper Tier II and Tier I bank capital. Bank
capital is generally, but not always, of investment grade quality. Upper Tier
II securities are commonly thought of as hybrids of debt and preferred stock.
Upper Tier II securities are often perpetual (with no maturity date), callable
and have a cumulative interest deferral feature. This means that under certain
conditions, the issuer bank can withhold payment of interest until a later
date. However, such deferred interest payments generally earn interest. Tier I
securities often take the form of trust preferred securities.
The Fund may also invest in bank obligations, including certificates of
deposit, bankers' acceptances and fixed time deposits. Certificates of deposit
are negotiable certificates issued against funds deposited in a commercial bank
for a definite period of time and earning a specified return. Bankers'
acceptances are negotiable drafts or bills of exchange, normally drawn by an
importer or exporter to pay for specific merchandise, which are "accepted" by a
bank, meaning, in effect, that the bank unconditionally agrees to pay the face
value of the instrument on maturity. Fixed time deposits are bank obligations
payable at a stated maturity date and bearing interest at a fixed rate. Fixed
time deposits may be withdrawn on demand by the investor, but may be subject to
early withdrawal penalties which vary depending upon market conditions and the
remaining maturity of the obligation.
Zero-Coupon Bonds, Step-Ups and Payment-In-Kind Securities
Zero-coupon bonds pay interest only at maturity rather than at intervals
during the life of the security. Like zero-coupon bonds, "step up" bonds pay no
interest initially but eventually begin to pay a coupon rate prior to maturity,
which rate may increase at stated intervals during the life of the security.
Payment-in-kind securities ("PIKs") are debt obligations that pay "interest" in
the form of other debt obligations, instead of in cash. Each of these
instruments is normally issued and traded at a deep discount from face value.
Zero-coupon bonds, step-ups and PIKs allow an issuer to avoid or delay the need
to generate cash to meet current interest payments and, as a result, may
involve greater credit risk than bonds that pay interest currently or in cash.
The Fund would be required to distribute the income on these instruments as it
accrues, even though the Fund will not receive the income on a current basis or
in cash. Thus, the Fund may have to sell other investments, including when it
may not be advisable to do so, to make income distributions to its shareholders.
Foreign (Non-U.S.) Investments and Currencies
The Fund may invest some or all of its assets in U.S. dollar-denominated
debt obligations of foreign issuers and of supra-national government entities.
Supra-national entities include international organizations that are organized
or supported by one or more government entities to promote economic
reconstruction or development and by international banking institutions and
related governmental agencies. The Fund may invest up to 25% of its total
assets in debt instruments denominated in foreign currencies, including
obligations of non-U.S. governments and their respective sub-divisions,
agencies and government-sponsored enterprises. Up to 10% of the Fund's total
assets may be invested in debt securities of issuers located in "emerging
markets." Investing in foreign securities involves special risks and
considerations not typically associated with investing in U.S. securities. See
"Risks--General Risks of Investing in the Fund--Foreign (Non-U.S.) Investment
Risk."
Most of the foreign investments of the Fund will consist of Senior Loans
originated in a foreign jurisdiction or to which a foreign lender or borrower
is a party, or other floating rate debt instruments of non-U.S. corporate
issuers.
30
The U.S. dollar-denominated foreign securities in which the Fund may
invest include Eurodollar obligations and "Yankee Dollar" obligations.
Eurodollar obligations are U.S. dollar-denominated certificates of deposit and
time deposits issued outside the U.S. capital markets by foreign branches of
U.S. banks and by foreign banks. Yankee Dollar obligations are U.S.
dollar-denominated obligations issued in the U.S. capital markets by foreign
banks. Eurodollar and Yankee Dollar obligations are generally subject to the
same risks that apply to domestic debt issues, notably credit risk, market risk
and liquidity risk. Additionally, Eurodollar (and to a limited extent, Yankee
Dollar) obligations are subject to certain sovereign risks. One such risk is
the possibility that a sovereign country might prevent capital, in the form of
U.S. dollars, from flowing across its borders. Other risks include adverse
political and economic developments; the extent and quality of government
regulation of financial markets and institutions; the imposition of foreign
withholding taxes; and the expropriation or nationalization of foreign issuers.
The Fund also may invest in sovereign debt issued by foreign governments,
their agencies or instrumentalities, or other government-related entities. As a
holder of sovereign debt, the Fund may be requested to participate in the
rescheduling of such debt and to extend further loans to governmental entities.
In addition, there are generally no bankruptcy proceedings similar to those in
the United States by which defaulted sovereign debt may be collected. The Fund
also may invest in Brady Bonds, which are securities created through the
exchange of existing commercial bank loans to sovereign entities for new
obligations in connection with a debt restructuring. Investments in Brady Bonds
may be viewed as speculative. Brady Bonds acquired by the Fund may be subject
to restructuring arrangements or to requests for new credit, which may cause
the Fund to realize a loss of interest or principal on any of its portfolio
holdings.
Foreign Currencies and Related Transactions. The Fund's investments in
securities that trade in, or receive revenues in, foreign currencies will be
subject to currency risk, which is the risk that fluctuations in the exchange
rates between the U.S. dollar and foreign currencies may negatively affect any
investment. The Fund may engage in a variety of transactions involving foreign
currencies in order to hedge against foreign currency risk, to increase
exposure to a foreign currency or to shift exposure to foreign currency
fluctuations from one currency to another. For instance, the Fund may purchase
foreign currencies on a spot (cash) basis and enter into forward foreign
currency exchange contracts, foreign currency futures contracts and options on
foreign currencies and futures. Suitable hedging transactions may not be
available in all circumstances and there can be no assurance that the Fund will
engage in such transactions at any given time or from time to time. Also, these
transactions may not be successful and may eliminate any chance for the Fund to
benefit from favorable fluctuations in relevant foreign currencies.
Please see "Investment Objective and Policies--Foreign (Non-U.S.)
Securities," "Investment Objective and Policies--Foreign Currency Transactions"
and "Investment Objective and Policies--Foreign Currency Exchange-Related
Securities" in the SAI for a more detailed description of the types of foreign
investments and foreign currency transactions in which the Fund may invest and
their related risks.
Derivatives
The Fund may, but is not required to, use a variety of derivative
instruments for hedging or risk management purposes or as part of its
investment strategies. Generally, derivatives are financial contracts whose
value depends upon, or is derived from, the value of an underlying asset,
reference rate or index, and may relate to individual debt instruments,
interest rates, currencies or currency exchange rates, commodities and related
indexes. The Fund may use derivatives to gain exposure to floating rate or high
yield securities and other securities in which the Fund may invest (including
pending investment of the proceeds of this offering). Examples of derivative
instruments that the Fund may use include, but are not limited to, options,
futures contracts, options on futures contracts, swap agreements (including
total return and credit default swaps) and short sales. The Fund may also
engage in credit spread trades. A credit spread trade is an investment position
relating to a difference in the prices or interest rates of two bonds or other
securities, where the value of the investment position is determined by changes
in the difference between such prices or interest rates, as the case
31
may be, of the respective securities. The Fund may also have exposure to
derivatives, such as interest rate or credit-default swaps, through investment
in credit-linked trust certificates and other securities issued by special
purpose or structured vehicles. The Fund may also use derivatives to add
leverage to the portfolio, but only as a substitute for leverage obtained
through preferred shares. The Fund's use of derivative instruments involves
risks different from, or possibly greater than, the risks associated with
investment directly in securities and other more traditional investments. See
"Risks--General Risks of Investing in the Fund--Derivatives Risk." Certain
types of derivative instruments that the Fund may utilize with some frequency
are described elsewhere in this section, including those described under
"Certain Interest Rate Transactions," "Structured Notes and Related
Instruments," "Credit Default Swaps" and "Credit-Linked Trust Certificates."
Please see "Investment Objective and Policies--Derivative Instruments" in the
SAI for additional information about these and other derivative instruments
that the Fund may use and the risks associated with such instruments. There is
no assurance that these derivative strategies will be available at any time or
that PIMCO will determine to use them for the Fund or, if used, that the
strategies will be successful. In addition, the Fund will be subject to certain
restrictions on its use of derivative strategies imposed by Moody's and Fitch
Ratings (or any rating agency that may in the future rate the AMPS) in
connection with their expected issuance of ratings for AMPS issued by the Fund.
See "Description of AMPS--Rating Agency Guidelines and Asset Coverage."
Credit Default Swaps
The Fund may enter into credit default swap contracts for hedging
purposes, to add leverage to the portfolio or for general investment purposes.
When used for hedging purposes, the Fund would be the buyer of a credit default
swap contract. In that case, the Fund would be entitled to receive the par (or
other agreed-upon) value of a referenced debt obligation from the counterparty
to the contract in the event of a default by a third party, such as a U.S. or
foreign issuer, on the debt obligation. In return, the Fund would pay to the
counterparty a periodic stream of payments over the term of the contract
provided that no event of default has occurred. If no default occurs, the Fund
would have spent the stream of payments and received no benefit from the
contract. When the Fund is the seller of a credit default swap contract, it
receives the stream of 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 assets, the Fund
would be subject to investment exposure on the notional amount of the swap.
Commercial and Other Mortgage-Related and Asset-Backed Securities
Mortgage-related securities are debt instruments which provide periodic
payments consisting of interest and/or principal that are derived from or
related to payments of interest and/or principal on underlying mortgages.
Additional payments on mortgage-related securities may be made out of
unscheduled prepayments of principal resulting from the sale of the underlying
property, or from refinancing or foreclosure, net of fees or costs that may be
incurred. The mortgage-related securities in which the Fund invests will
typically pay variable rates of interest, although the Fund may invest in
fixed-rate obligations as well.
The Fund may invest in commercial mortgage-related securities issued by
corporations. These are securities that represent an interest in, or are
secured by, mortgage loans secured by commercial property, such as industrial
and warehouse properties, office buildings, retail space and shopping malls,
multifamily properties and cooperative apartments, hotels and motels, nursing
homes, hospitals and senior living centers. The commercial mortgage loans that
underlie commercial mortgage-related securities have certain distinct risk
characteristics. Commercial mortgage loans generally lack standardized terms,
which may complicate their structure. Commercial properties themselves tend to
be unique and difficult to value. Commercial mortgage loans tend to have
shorter maturities than residential mortgage loans, and may not be fully
amortizing, meaning that they may have a significant principal balance, or
"balloon" payment, due on maturity. In addition, commercial properties,
particularly industrial and warehouse properties, are subject to environmental
risks and the burdens and costs of compliance with environmental laws and
regulations.
Other mortgage-related securities in which the Fund may invest include
mortgage pass-through securities, collateralized mortgage obligations ("CMOs"),
mortgage dollar rolls, CMO residuals (other than
32
residual interests in real estate mortgage investment conduits), stripped
mortgage-backed securities and other securities that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage
loans on real property.
The Fund may invest in other types of asset-backed securities that are
offered in the marketplace, including Enhanced Equipment Trust Certificates
("EETCs") and collateralized debt obligations ("CDOs"). Although any entity may
issue EETCs, to date, U.S. airlines are the primary issuers. An airline EETC is
an obligation secured directly by aircraft or aircraft engines as collateral.
EETCs tend to be less liquid than bonds. CDOs include collateralized bond
obligations ("CBOs"), collateralized loan obligations ("CLOs") and other
similarly structured securities. A CBO is a trust typically backed by a
diversified pool of high-risk, below investment grade fixed income securities.
A CLO is a trust typically collateralized by a pool of loans, which may
include, among others, domestic and foreign senior secured loans, senior
unsecured loans, and subordinate corporate loans, including loans that may be
rated below investment grade or equivalent unrated loans. While the trusts that
issue CDOs may themselves be leveraged and may invest in lower-quality
instruments, the Fund will generally purchase only senior CDOs, will not
purchase residual CDOs and will only purchase CDOs that meet the Fund's credit
policies.
Other asset-backed securities may be collateralized by the fees earned by
service providers. The value of asset-backed securities may be substantially
dependent on the servicing of the underlying asset pools and are therefore
subject to risks associated with the negligence of, or defalcation by, their
servicers. In certain circumstances, the mishandling of related documentation
may also affect the rights of the security holders in and to the underlying
collateral. The insolvency of entities that generate receivables or that
utilize the assets may result in added costs and delays in addition to losses
associated with a decline in the value of the underlying assets. The issuers of
certain asset-backed securities bear various expenses, including, without
limitation, servicing and advisory fees.
Please see "Investment Objective and Policies--Mortgage-Related and Other
Asset-Backed Securities" in the SAI and "Risks--General Risks of Investing in
the Fund--Mortgage-Related and Asset-Backed Risk" in this prospectus for a more
detailed description of the types of mortgage-related and other asset-backed
securities in which the Fund may invest and their related risks.
Real Estate Investment Trusts (REITs)
The Fund may invest in REITs. REITs primarily invest in income-producing
real estate or real estate related loans or interests. REITs are generally
classified as equity REITs, mortgage REITs or a combination of equity and
mortgage REITs. Equity REITs invest the majority of their assets directly in
real property and derive income primarily from the collection of rents. Equity
REITs can also realize capital gains by selling properties that have
appreciated in value. Mortgage REITs invest the majority of their assets in
real estate mortgages and derive income from the collection of interest
payments. REITs are not taxed on income distributed to shareholders provided
they comply with the applicable requirements of the Code. The Fund will
indirectly bear its proportionate share of any management and other expenses
paid by REITs in which it invests in addition to the expenses paid by the Fund.
Debt securities issued by REITs are, for the most part, general and unsecured
obligations and are subject to risks associated with REITs. Please see
"Investment Objective and Policies--Real Estate Investment Trusts ("REITs")" in
the SAI for a more detailed description of these instruments and their related
risks.
Delayed Funding Loans and Revolving Credit Facilities
The Fund may enter into, or acquire participations in, delayed funding
loans and revolving credit facilities, in which a lender agrees to make loans
up to a maximum amount upon demand by the borrower during a specified term.
These commitments may have the effect of requiring the Fund to increase its
investment in a company at a time when it might not be desirable to do so
(including at a time when the company's financial
33
condition makes it unlikely that such amounts will be repaid). Delayed funding
loans and revolving credit facilities are subject to credit, interest rate and
liquidity risk and the risks of being a lender.
Certain Interest Rate Transactions
The Fund may enter into long and short interest rate swap, cap or floor
transactions. One possible use of interest rate swaps involves the Fund's
agreement with the swap counterparty to pay a fixed rate payment in exchange
for the counterparty paying the Fund a variable rate payment. The payment
obligation would be based on the notional amount of the swap. The Fund may use
an interest rate cap or floor, which would require the Fund to pay a premium to
the cap or floor counterparty and would entitle the Fund, to the extent that a
specified variable rate index exceeds a predetermined fixed rate, to receive
from the counterparty payment of the difference based on the notional amount.
The Fund may use interest rate swaps, caps and floors for hedging or general
investment purposes. The Fund may choose or be required to redeem some or all
of the AMPS. This redemption may result in the Fund seeking to terminate early
all or a portion of any swap, cap or floor transaction. Such early termination
of a swap could result in a termination payment by or to the Fund. Any
termination of a cap or floor could result in a termination payment by or to
the Fund.
Structured Notes and Related Instruments
The Fund may invest in "structured" notes and other related instruments,
which are privately negotiated debt obligations where the principal and/or
interest is determined by reference to the performance of a benchmark asset,
market or interest rate (an "embedded index"), such as selected securities, an
index of securities or specified interest rates, or the differential
performance of two assets or markets, such as indexes reflecting bonds.
Structured instruments may be issued by corporations, including banks, as well
as by governmental agencies. The terms of such structured instruments normally
provide that their principal and/or interest payments are to be adjusted
upwards or downwards (but ordinarily not below zero) to reflect changes in the
embedded index while the structured instruments are outstanding. As a result,
the interest and/or principal payments that may be made on a structured product
may vary widely, depending on a variety of factors, including the volatility of
the embedded index and the effect of changes in the embedded index on principal
and/or interest payments. The rate of return on structured notes may be
determined by applying a multiplier to the performance or differential
performance of the referenced index(es) or other asset(s). Application of a
multiplier involves leverage that will serve to magnify the potential for gain
and the risk of loss.
PIMCO may utilize structured instruments for investment purposes and also
for risk management purposes. While structured instruments may offer the
potential for a favorable rate of return from time to time, they also entail
certain risks. Structured instruments may be less liquid than other debt
securities, and the price of structured instruments may be more volatile. In
some cases, depending on the terms of the embedded index, a structured
instrument may provide that the principal and/or interest payments may be
adjusted below zero. Structured instruments also may involve significant credit
risk and risk of default by the counterparty. Although structured instruments
are not necessarily illiquid, PIMCO believes that currently most structured
instruments are illiquid. Like other sophisticated strategies, the Fund's use
of structured instruments may not work as intended. If the value of the
embedded index changes in a manner other than that expected by PIMCO, principal
and/or interest payments received on the structured instrument may be
substantially less than expected.
Reverse Repurchase Agreements
The Fund may utilize reverse repurchase agreements in order to add
leverage to the portfolio as a substitute for, rather than in addition to,
leverage obtained through the issuance of preferred shares. In a reverse
repurchase agreement, the Fund sells securities to a bank or broker-dealer and
agrees to repurchase the securities at a mutually agreed date and price.
Generally, the effect of such a transaction is that the Fund can recover and
reinvest all or most of the cash invested in the portfolio securities involved
during the term of the reverse repurchase agreement and still be entitled to
the returns associated with those
34
portfolio securities. Such transactions are advantageous if the interest cost
to the Fund of the reverse repurchase transaction is less than the returns it
obtains on investments purchased with the cash.
Unless the Fund covers its positions in reverse repurchase agreements (by
segregating liquid assets at least equal in amount to the forward purchase
commitment), its obligations under the agreements will be subject to the Fund's
limitations on borrowings. Reverse repurchase agreements involve leverage risk
and also the risk that the market value of the securities that the Fund is
obligated to repurchase under the agreement may decline below the repurchase
price. In the event the buyer of securities under a reverse repurchase
agreement files for bankruptcy or becomes insolvent, the Fund's use of the
proceeds of the agreement may be restricted pending a determination by the
other party, or its trustee or receiver, whether to enforce the Fund's
obligation to repurchase the securities.
Repurchase Agreements
The Fund may enter into repurchase agreements, in which the Fund
purchases a security from a bank or broker-dealer and the bank or broker-dealer
agrees to repurchase the security at the Fund's cost plus interest within a
specified time. If the party agreeing to repurchase should default, the Fund
will seek to sell the securities which it holds. This could involve transaction
costs or delays in addition to a loss on the securities if their value should
fall below their repurchase price. Repurchase agreements maturing in more than
seven days are considered to be illiquid securities.
U.S. Government Securities
The Fund may invest in U.S. Government securities, which are obligations
of, or guaranteed by, the U.S. Government, its agencies or government-sponsored
enterprises. U.S. Government securities include a variety of securities that
differ in their interest rates, maturities and dates of issue. Securities
issued or guaranteed by agencies or instrumentalities of the U.S. Government
may or may not be supported by the full faith and credit of the United States
or by the right of the issuer to borrow from the U.S. Treasury.
Municipal Bonds
Municipal bonds are generally issued by states, municipalities and other
political subdivisions, agencies, authorities and instrumentalities of states
and multi-state agencies or authorities. Like other debt obligations, municipal
bonds are subject to interest rate, credit and market risk. The ability of a
municipal issuer to make payments could be affected by litigation, legislation
or other political events or the bankruptcy of the issuer. The types of
municipal bonds in which the Fund may invest include municipal lease
obligations. The Fund also may invest in securities issued by entities whose
underlying assets are municipal bonds.
When Issued, Delayed Delivery and Forward Commitment Transactions
The Fund may purchase securities which it is eligible to purchase on a
when-issued basis, may purchase and sell such securities for delayed delivery
and may make contracts to purchase such securities for a fixed price at a
future date beyond normal settlement time (forward commitments). When-issued
transactions, delayed delivery purchases and forward commitments involve a risk
of loss if the value of the securities declines prior to the settlement date.
This risk is in addition to the risk that the Fund's other assets will decline
in value. Therefore, these transactions may result in a form of leverage and
increase the Fund's overall investment exposure. Typically, no income accrues
on securities the Fund has committed to purchase prior to the time delivery of
the securities is made, although the Fund may earn income on securities it has
segregated to cover these positions.
35
Credit-Linked Trust Certificates
Among the income-producing securities in which the Fund may invest are
credit-linked trust certificates, which are investments in a limited purpose
trust or other vehicle formed under state law which, in turn, invests in a
basket of derivative instruments, such as credit default swaps, interest rate
swaps and other securities, in order to provide exposure to the high yield or
another fixed income market. For instance, the Fund may invest in credit-linked
trust certificates as a cash management tool in order to gain exposure to the
high yield markets and/or to remain fully invested when more traditional
income-producing securities are not available, including during the period when
the net proceeds of this offering of AMPS are being invested.
Like an investment in a bond, investments in these credit-linked trust
certificates represent the right to receive periodic income payments (in the
form of distributions) and payment of principal at the end of the term of the
certificate. However, these payments are conditioned on the trust's receipt of
payments from, and the trust's potential obligations to, the counterparties to
the derivative instruments and other securities in which the trust invests. For
instance, the trust may sell one or more credit default swaps, under which the
trust would receive a stream of payments over the term of the swap agreements
provided that no event of default has occurred with respect to the referenced
debt obligation upon which the swap is based. If a default occurs, the stream
of payments may stop and the trust would be obligated to pay to the
counterparty the par (or other agreed upon value) of the referenced debt
obligation. This, in turn, would reduce the amount of income and principal that
the Fund would receive as an investor in the trust. Please see "Credit Default
Swaps" above for additional information about credit default swaps. The Fund's
investments in these instruments are indirectly subject to the risks associated
with derivative instruments, including, among others, credit risk, default or
similar event risk, counterparty risk, interest rate risk, leverage risk and
management risk. It is expected that the trusts which issue credit-linked trust
certificates will constitute "private" investment companies, exempt from
registration under the 1940 Act. Therefore, the certificates will be subject to
the risks described under "Other Investment Companies" in the SAI, and will not
be subject to applicable investment limitations and other regulation imposed by
the 1940 Act (although the Fund will remain subject to such limitations and
regulation, including with respect to its investments in the certificates).
Although the trusts are typically private investment companies, they are
generally not actively managed such as a "hedge fund" might be. It is also
expected that the certificates will be exempt from registration under the
Securities Act of 1933. Accordingly, there may be no established trading market
for the certificates and they may constitute illiquid investments. See
"Risks--General Risks of Investing in the Fund--Liquidity Risk." If market
quotations are not readily available for the certificates, they will be valued
by the Fund at fair value as determined by the Board of Trustees or persons
acting at its direction. See "Net Asset Value." The Fund may lose its entire
investment in a credit-linked trust certificate.
Short Sales
A short sale is a transaction in which the Fund sells an instrument that
it does not own in anticipation that the market price will decline. The Fund
may use short sales for investment and risk management purposes. When the Fund
engages in a short sale, it must borrow the security sold short and deliver it
to the counterparty. The Fund may have to pay a fee to borrow particular
securities and would often be obligated to pay over any payments received on
such borrowed securities. The Fund's obligation to replace the borrowed
security will be secured by collateral deposited with the lender, which is
usually a broker-dealer, and/or with the Fund's custodian. The Fund may not
receive any payments (including interest) on its collateral. Short sales expose
the Fund to the risk that it will be required to cover its short position at a
time when the securities have appreciated in value, thus resulting in a loss to
the Fund. The Fund may engage in so-called "naked" short sales where it does
not own or have the immediate right to acquire the security sold short at no
additional cost, in which case the Fund's losses could theoretically be
unlimited.
36
Lending of Portfolio Securities
For the purpose of achieving income, the Fund may lend its portfolio
securities to brokers, dealers, and other financial institutions provided a
number of conditions are satisfied, including that the loan is fully
collateralized. Please see "Investment Objective and Policies--Securities
Loans" in the SAI for details. When the Fund lends portfolio securities, its
investment performance will continue to reflect changes in the value of the
securities loaned, and the Fund will also receive a fee or interest on the
collateral. Securities lending involves the risk of loss of rights in the
collateral or delay in recovery of the collateral if the borrower fails to
return the security loaned or becomes insolvent. The Fund may pay lending fees
to the party arranging the loan.
Rating Agency Requirements
In connection with rating the AMPS, Moody's and Fitch Ratings will impose
asset coverage tests and other restrictions that may limit the Fund's ability
to engage in certain of the transactions described above. See "Description of
AMPS--Rating Agency Guidelines and Asset Coverage."
Please see "Investment Objective and Policies" in the SAI for additional
information regarding the investments of the Fund and their related risks.
RISKS
Risk is inherent in all investing. Investing in any investment company
security involves risk, including the risk that you may receive little or no
return on your investment or even that you may lose part or all of your
investment. Therefore, before purchasing AMPS, you should consider carefully
the following risks that you assume when you invest in the Fund.
Risks of Investing in the AMPS
Auction Risk. You may not be able to sell your AMPS at an auction if the
auction fails; that is, if there are more AMPS offered for sale than there are
buyers for those shares. If sufficient clearing bids do not exist in an
auction, the Applicable Rate will be the maximum applicable rate, and in such
event, owners of AMPS wishing to sell will not be able to sell all, and may not
be able to sell any, of such shares in the auction. As a result, your
investment in AMPS may be illiquid. Neither the Broker-Dealers nor the Fund is
obligated to purchase AMPS in an auction or otherwise, nor is the Fund required
to redeem AMPS in the event of a failed auction. Also, if you place bid orders
(orders to retain AMPS) at an auction only at a specified rate, and that bid
rate exceeds the Applicable Rate set at the auction, you will not retain your
AMPS. If you elect to retain AMPS without specifying a rate below which you
would not wish to continue to hold those AMPS, and the auction sets a
below-market rate, you may receive a lower rate of return on your AMPS than the
market rate. The dividend period for the AMPS may be changed by the Fund,
subject to certain conditions and with notice to the holders of the AMPS, which
could also affect the liquidity of your investment. See "Description of
AMPS--The Auction."
Ratings and Asset Coverage Risk. While it is a condition to the closing
of the offering that Moody's assigns a rating of "Aaa" and Fitch Ratings
assigns a rating of "AAA" to the AMPS, these ratings will not eliminate or
necessarily mitigate the risks of investing in the AMPS. Moody's, Fitch Ratings
or another rating agency then rating the AMPS could downgrade the AMPS, which
may make your shares less liquid at an auction or in the secondary market. If a
rating agency downgrades the AMPS, the Fund may (but is not required to) alter
its portfolio in an effort to improve the rating, although there is no
assurance that it will be able to do so to the extent necessary to restore the
prior rating. In addition, the Fund may be forced to redeem your AMPS to meet
regulatory or rating agency requirements. The Fund may also voluntarily redeem
AMPS under certain circumstances. See "Description of AMPS--Redemption." The
Fund may not redeem AMPS if such a redemption would cause the Fund to fail to
meet regulatory or rating agency asset coverage requirements, and the
37
Fund may not declare, pay or set apart for payment any dividend or other
distribution if immediately thereafter the Fund would fail to meet regulatory
asset coverage requirements. In addition, as a condition to its receipt of a
"Aaa" rating (by Moody's) and a "AAA" rating (by Fitch Ratings) on the AMPS,
the Fund has agreed to certain investment limitations, which may restrict the
Fund from making investments that PIMCO believes would benefit the Fund. See
"Description of AMPS--Rating Agency Guidelines and Asset Coverage" for
descriptions of the significance and limitations of the ratings on the AMPS and
of the asset maintenance and other tests the Fund must meet.
Secondary Market Risk. If you try to sell your AMPS between auctions,
you may not be able to sell any or all of your shares, or you may not be able
to sell them for $25,000 per share or $25,000 per share plus accumulated
dividends. Changes in interest rates could affect the price you would receive
if you sold your shares in the secondary market, particularly if the Fund has
designated a special rate period (a dividend period of more than seven days).
Broker-dealers that maintain a secondary trading market (if any) for the AMPS
are not required to maintain this market, and the Fund is not required to
redeem shares if either an auction or an attempted secondary market sale fails
because of a lack of buyers. The AMPS are not registered on a stock exchange or
the Nasdaq Stock Market, Inc. ("NASDAQ"). If you sell your AMPS to a
broker-dealer between auctions, you may receive less than the price you paid
for them, especially when market interest rates have risen since the last
auction or during a special rate period.
Restrictions on Dividends and Other Distributions. Restrictions imposed
on the declaration and payment of dividends or other distributions to the
holders of the Fund's Common Shares and AMPS, both by the 1940 Act and by
requirements imposed by rating agencies, might impair the Fund's ability to
maintain its qualification as a regulated investment company for federal income
tax purposes. While the Fund intends to redeem AMPS to enable the Fund to
distribute its income as required to maintain its qualification as a regulated
investment company under the Code, there can be no assurance that such
redemptions can be effected in time to meet the requirements of the Code. See
"Tax Matters."
General Risks of Investing in the Fund
Limited Operating History. The Fund is a recently organized,
diversified, closed-end management investment company which has been
operational for less than two months.
Credit Risk/High Yield Risk. In general, lower rated debt securities
(including many Senior Loans) carry a greater degree of risk that the issuer
will lose its ability to make interest and principal payments, which could have
a negative impact on the Fund's net asset value or dividends. The Fund may
invest without limit and ordinarily expects to invest a substantial portion of
its assets in debt securities that are, at the time of purchase, rated below
investment grade (below Baa3 by Moody's, below BBB- by either S&P or Fitch
Ratings, or below a comparable rating by Dominion) or that are unrated but
judged by PIMCO to be of comparable quality, including debt securities that are
in default or the issuers of which are in bankruptcy. Debt securities rated
below investment grade quality are regarded as having predominantly speculative
characteristics with respect to capacity to pay interest and repay principal,
and are commonly referred to as "high yield" securities or "junk bonds." The
prices of these lower grade bonds are generally more volatile and sensitive to
actual or perceived negative developments, such as a decline in the issuer's
revenues or revenues of the borrowers underlying Senior Loans or a general
economic downturn, than are the prices of higher grade securities. In addition,
the secondary market on which high yield securities are traded may be less
liquid than the market for investment grade securities, meaning these
securities are subject to greater liquidity risk than investment grade
securities. Bonds in the lowest investment grade category also may be
considered to possess some speculative characteristics by certain rating
agencies.
High yield securities may be more susceptible to real or perceived
adverse economic and competitive industry conditions than investment grade
securities. A projection of an economic downturn or of a period of rising
interest rates, for example, could cause a decline in high yield security
prices because the advent of a
38
recession could lessen the ability of an issuer to make principal and interest
payments on its debt obligations. If an issuer of high yield securities
defaults, in addition to risking non-payment of all or a portion of interest
and principal, the Fund may incur additional expenses to seek recovery.
Although Senior Loans in which the Fund will invest will often be secured by
collateral, there can be no assurance that liquidation of such collateral would
satisfy the borrower's obligation in the event of a default or that such
collateral could be readily liquidated. In the event of bankruptcy of a
borrower, the Fund could experience delays or limitations in its ability to
realize the benefits of any collateral securing a Senior Loan. The Fund may
also invest in Senior Loans that are not secured. In addition, the Fund may
purchase interests in Senior Loans from financial intermediaries whereby the
Fund depends on the intermediary for payment of principal and interest on the
Senior Loan. A decline in the financial soundness of the intermediary may
adversely affect the Fund. The market prices of high yield securities
structured as zero-coupon, step-up or payment-in-kind securities will normally
be affected to a greater extent by interest rate changes, and therefore tend to
be more volatile than the prices of securities that pay interest currently and
in cash. PIMCO seeks to reduce these risks through diversification, credit
analysis and attention to current developments and trends in both the economy
and financial markets.
The Fund's credit quality policies apply only at the time a security is
purchased, and the Fund is not required to dispose of a security in the event
that a rating agency or PIMCO downgrades its assessment of the credit
characteristics of a particular issue. In determining whether to retain or sell
such a security, PIMCO may consider such factors as PIMCO'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. Analysis of creditworthiness may be more complex for issuers of high
yield securities than for issuers of higher quality debt securities. Because of
the Fund's emphasis on Senior Loans and other below investment grade debt
obligations, PIMCO's capabilities in this area will be particularly important.
In addition to the credit risks associated with high yield securities,
the Fund could also lose money if the issuer of other debt obligations, or the
counterparty to a derivatives contract, repurchase agreement, loan of portfolio
securities or other obligation, is, or is perceived to be, unable or unwilling
to make timely principal and/or interest payments, or to otherwise honor its
obligations. The downgrade of a security may further decrease its value.
Liquidity Risk. The Fund may invest without limit in securities which
are illiquid at the time of investment. The term "illiquid securities" for this
purpose is generally determined using the Securities and Exchange Commission's
standard applicable to open-end investment companies, i.e., securities that
cannot be disposed of within seven days in the ordinary course of business at
approximately the value at which the Fund has valued the securities. Illiquid
securities may be subject to wide fluctuations in market value. The Fund may be
subject to significant delays in disposing of illiquid securities. Accordingly,
the Fund may be forced to sell these securities at less than fair market value
or may not be able to sell them when PIMCO believes it is desirable to do so.
Illiquid securities also may entail registration expenses and other transaction
costs that are higher than those for liquid securities. Restricted securities,
i.e., securities subject to legal or contractual restrictions on resale, may
also be illiquid. In general, below investment grade debt securities tend to be
less liquid than higher-rated securities. PIMCO will determine the liquidity of
the Fund's investments by reference to market conditions and contractual
provisions. For example, PIMCO will generally not consider Senior Loans that
are part of an issue of at least $250 million in par value to be illiquid.
Leverage Risk. The Fund utilizes leverage on an ongoing basis for
investment purposes. Leverage risk includes the risk associated with the
issuance of the AMPS in order to leverage the Common Shares. As a substitute
for AMPS or other preferred shares, the Fund may also leverage the Common
Shares through the borrowing of money, the issuance of debt securities or the
use of credit default swaps, reverse repurchase agreements and other
derivatives, as well as when-issued, delayed delivery or forward commitment
transactions. After completion of the offering of AMPS, the Fund anticipates
that its total leverage from the issuance of AMPS will represent approximately
38% of the Fund's total assets. The precise amount of leverage used by the Fund
may vary from time to time, but the Fund will not incur leverage (including
preferred shares) in an amount
39
exceeding 50% of its total assets. Although the Fund may in the future offer
other preferred shares, the Fund does not currently intend to offer preferred
shares other than the AMPS offered in this prospectus. Any AMPS or borrowings
will have seniority over the Common Shares.
If the dividend rate on the AMPS exceeds the net rate of return on the
Fund's portfolio, the leverage will result in a lower net asset value than if
the Fund were not leveraged, and the Fund's ability to pay dividends and meet
its asset coverage requirements on the AMPS would be reduced. It is expected
that this risk should be partially mitigated because the dividend rates on the
AMPS and the interest rates on the Fund's portfolio of Senior Loans and other
floating rate debt instruments will vary in a similar manner. Any decline in
the net asset value of the Fund's investments could result in the Fund being in
danger of failing to meet its asset coverage requirements or of losing its
expected "Aaa" rating (in the case of Moody's) or "AAA" rating (in the case of
Fitch Ratings) on the AMPS. In an extreme case, the Fund's current investment
income might not be sufficient to meet the dividend requirements on the AMPS.
In order to counteract such an event, the Fund might need to liquidate
investments in order to fund a redemption of some or all of the AMPS.
Liquidation at times of adverse economic conditions may result in a capital
loss to the Fund. There is no assurance that the Fund's leveraging strategy
will be successful.
While the Fund may from time to time consider reducing leverage in
response to actual or anticipated changes in interest rates in an effort to
mitigate the increased volatility of current income and net asset value
associated with leverage, there can be no assurance that the Fund will actually
reduce leverage in the future or that any reduction, if undertaken, will be
effective. Changes in the future direction of interest rates are very difficult
to predict accurately. If the Fund were to reduce leverage based on a
prediction about future changes to interest rates, and that prediction turned
out to be incorrect, the reduction in leverage would likely operate to reduce
the Fund's net asset value relative to the circumstance where the Fund had not
reduced leverage. The Fund may decide that this risk outweighs the likelihood
of achieving the desired reduction to volatility in income and net asset value
if the prediction were to turn out to be correct, and determine not to reduce
leverage as described above.
Because the fees received by the Manager are based on the total managed
assets of the Fund (including assets attributable to any AMPS and other forms
of leverage that may be outstanding), the fees will be higher when leverage is
utilized and the Manager therefore has a financial incentive for the Fund to
issue AMPS or utilize other forms of leverage.
Issuer Risk. The value of floating rate and other debt instruments may
decline for a number of reasons which directly relate to the issuer, such as
management performance, financial leverage and reduced demand for the issuer's
goods and services.
Smaller Company Risk. The Fund may invest in smaller companies. The
general risks associated with floating rate and other debt instruments are
particularly pronounced for securities issued by companies with smaller market
capitalizations. These companies may have limited product lines, markets or
financial resources or they may depend on a few key employees. As a result,
they may be subject to greater levels of credit, market and issuer risk.
Securities of smaller companies may trade less frequently and in lesser volume
than more widely held securities and their values may fluctuate more sharply
than other securities. Companies with medium-sized market capitalizations may
have risks similar to those of smaller companies.
Management Risk. The Fund is subject to management risk because it is an
actively managed investment portfolio. PIMCO and the individual portfolio
managers will apply investment techniques and risk analyses in making
investment decisions for the Fund, but there can be no guarantee that these
will produce the desired results.
Foreign (Non-U.S.) Investment Risk. The Fund may invest some or all of
its assets in U.S. dollar-denominated debt obligations of foreign issuers or
supra-national government agencies. The Fund may invest up to 25% of its total
assets in debt instruments denominated in foreign currencies, including
obligations of non-U.S. governments and their respective sub-divisions,
agencies and government-sponsored enterprises. The Fund's investments in
foreign issuers and in securities denominated in foreign currencies involve
special risks.
40
There may be less information publicly available about a foreign issuer than
about a U.S. issuer, and foreign issuers are not generally subject to
accounting, auditing and financial reporting standards and practices comparable
to those in the United States. The securities of some foreign issuers are less
liquid and at times more volatile than securities of comparable U.S. issuers.
Foreign brokerage costs, custodial expenses and other fees are also generally
higher than for securities traded in the United States. With respect to certain
foreign countries, there is also a possibility of expropriation of assets,
confiscatory taxation, political or financial instability and diplomatic
developments which could affect the value of investments in those countries. In
addition, income received by the Fund from sources within foreign countries may
be reduced by withholding and other taxes imposed by such countries.
The value of securities denominated in foreign currencies may fluctuate
based on changes in the value of those currencies relative to the U.S. dollar,
and a decline in applicable foreign exchange rates could reduce the value of
such securities held by the Fund. The values of foreign investments and the
investment income derived from them also may be affected unfavorably by changes
in currency exchange control regulations. In addition, although a portion of
the Fund's investment income may be received or realized in foreign currencies,
the Fund will be required to compute and distribute its income in U.S. dollars.
Therefore, if the exchange rate for any such currency declines after the Fund's
income has been earned and translated into U.S. dollars but before payment, the
Fund could be required to liquidate portfolio securities to make such
distributions.
Emerging Markets Risk. The Fund may invest up to 10% of its total assets
in debt securities of issuers located in emerging markets. Foreign investment
risk may be particularly high to the extent that the Fund invests in securities
of issuers based in or securities denominated in the currencies of emerging
market countries. These securities may present market, credit, currency,
liquidity, legal, political and other risks different from, and greater than,
the risks of investing in developed foreign countries. Investing in securities
of issuers based in underdeveloped emerging markets entails all of the risks of
investing in securities of foreign issuers to a heightened degree. These
heightened risks include: (i) greater risks of expropriation, confiscatory
taxation, nationalization and less social, political and economic stability;
(ii) the smaller size of the market for such securities and a lower volume of
trading, resulting in lack of liquidity and in price volatility; and (iii)
certain national policies which may restrict the Fund's investment
opportunities, including restrictions on investing in issuers or industries
deemed sensitive to relevant national interests.
Derivatives Risk. Derivatives are financial contracts whose value
depends on, or is derived from, the value of an underlying asset, reference
rate or index (or relationship between two indexes). The Fund may invest in a
variety of derivative instruments for hedging or risk management purposes or as
part of its investment strategies, such as options contracts (including options
on futures contracts), futures contracts, swap agreements (including total
return and credit-default swaps) and short sales. The Fund may also have
exposure to derivatives, such as interest rate or credit default swaps, through
investment in credit-linked trust certificates and other securities issued by
special purpose or structured vehicles. The Fund may use derivatives as a
substitute for taking a position in an underlying debt instrument or other
asset and/or as part of a strategy designed to reduce exposure to other risks,
such as interest rate or currency risk. The Fund also may use derivatives to
add leverage to the portfolio, but only as a substitute for leverage obtained
through preferred shares. The Fund's use of derivative instruments involves
risks different from, and possibly greater than, the risks associated with
investing directly in securities and other traditional investments. Derivatives
are subject to a number of risks described elsewhere in this prospectus, such
as liquidity risk, interest rate risk, issuer risk, credit risk, leveraging
risk, counterparty risk, management risk and, if applicable, smaller company
risk. They also involve the risk of mispricing or improper valuation, the risk
of ambiguous documentation, and the risk that changes in the value of the
derivative may not correlate perfectly with the underlying asset, rate or
index. If the Fund invests in a derivative instrument, it could lose more than
the principal amount invested. Also, suitable derivative transactions may not
be available in all circumstances and there can be no assurance that the Fund
will engage in these transactions to reduce exposure to other risks when that
would be beneficial. In addition, the Fund will be subject to certain
restrictions on its use of derivative strategies imposed by Moody's and Fitch
Ratings (or any rating agency that may in the future rate the AMPS) in
connection with their expected issuance of ratings for
41
AMPS issued by the Fund. See "Description of AMPS--Rating Agency Guidelines and
Asset Coverage." The use of derivatives also may increase the amount of taxes
payable by shareholders. In addition to the risks applicable to derivatives
generally, credit default swaps involve special risks because they are
difficult to value, are highly susceptible to liquidity and credit risk, and
generally pay a return to the party that has paid the premium only in the event
of an actual default by the issuer of the underlying obligation (as opposed to
a credit downgrade or other indication of financial difficulty).
Counterparty Risk. In addition to credit risk with respect to the
counterparties to the Senior Loans in which the Fund invests, the Fund will
also be subject to credit risk with respect to the derivative contracts entered
into directly by the Fund or held by special purpose or structured vehicles in
which the Fund invests. If a counterparty becomes bankrupt or otherwise fails
to perform its obligations due to financial difficulties, the Fund may
experience significant delays in obtaining any recovery in a bankruptcy or
other reorganization proceeding. The Fund may obtain only a limited recovery or
may obtain no recovery in such circumstances.
Mortgage-Related and Asset-Backed Risk. The Fund may invest in a variety
of mortgage-related securities, including commercial mortgage securities and
other mortgage-backed instruments. Generally, rising interest rates tend to
extend the duration of fixed-rate mortgage-related securities, making them more
sensitive to changes in interest rates. As a result, in a period of rising
interest rates, mortgage-related securities held by the Fund may exhibit
additional volatility. This is known as extension risk. PIMCO expects that the
Fund will focus its mortgage-related investments principally in floating rate
mortgage-related and other asset-backed securities, which should minimize the
Fund's overall sensitivity to interest rate volatility and extension risk.
However, because interest rates on most adjustable rate mortgage- and other
asset-backed securities typically only reset periodically (e.g., monthly or
quarterly), changes in prevailing interest rates (and particularly sudden and
significant changes) can be expected to cause some fluctuation in the market
value of these securities, including declines in market value as interest rates
rise. In addition, adjustable and fixed-rate mortgage-related securities are
subject to prepayment risk--the risk that borrowers may pay off their mortgages
sooner than expected, particularly when interest rates decline. This can reduce
the Fund's returns because the Fund may have to reinvest that money at lower
prevailing interest rates. The Fund's investments in other asset-backed
securities are subject to risks similar to those associated with
mortgage-related securities, as well as additional risks associated with the
nature of the assets and the servicing of those assets.
Risk of Investing in REITs. Like other mortgage-related securities,
REITs are subject to interest rate risk and prepayment risk. Investing in REITs
also involves certain unique risks in addition to those risks associated with
investing in the real estate industry in general. An equity REIT may be
affected by changes in the value of the underlying properties owned by the
REIT. A mortgage REIT may be affected by changes in interest rates and the
ability of the issuers of its portfolio mortgages to repay their obligations.
REITs are dependent upon the skills of their managers and are not diversified.
REITs are generally dependent upon maintaining cash flows to repay borrowings
and to make distributions to shareholders and are subject to the risk of
default by lessees or borrowers. REITs whose underlying assets are concentrated
in properties used by a particular industry, such as health care, are also
subject to risks associated with such industry.
REITs may have limited financial resources, may trade less frequently and
in a limited volume and may be subject to more abrupt or erratic price
movements than larger company securities. Historically, REITs have been more
volatile in price than the larger capitalization stocks included in Standard &
Poor's 500 Stock Index.
Interest Rate Risk. Generally, when market interest rates rise, the
prices of debt obligations (and particularly fixed-rate obligations) fall, and
vice versa. This interest rate risk is the risk that the debt obligations in
the Fund's portfolio will decline in value because of increases in market
interest rates. The prices of short-term floating rate debt obligations
generally fluctuate less than prices of long-term debt obligations as interest
rates change. Because the Fund will normally have a short portfolio duration
(i.e., a zero to one-year time frame), the Fund's net asset value will tend to
fluctuate less in response to changes in market interest rates than if the Fund
invested mainly in long-term debt securities. Although the Fund's net asset
value will vary, PIMCO expects the Fund's policy of investing principally in
floating rate debt instruments will substantially reduce the Fund's overall
sensitivity to market interest rate fluctuations. However, because rates on
certain floating rate debt
42
instruments typically only reset periodically (e.g., monthly or quarterly),
changes in prevailing interest rates (and particularly sudden and significant
changes) can be expected to cause some fluctuation in the Fund's net asset
value. Moreover, a portion of the Fund's assets may be invested in debt
instruments with fixed rates of interest, which will generally lose value in
direct response to rising interest rates. The Fund's use of leverage will tend
to increase interest rate risk.
The AMPS pay dividends based on short-term interest rates for higher
quality obligations, which will be reset frequently. The Fund will use the
proceeds from the issuance of AMPS to buy floating rate high yield debt
obligations and other investments in accordance with the Fund's investment
objectives and policies. The yields on the floating rate debt and other
obligations purchased by the Fund are ordinarily expected to be higher than the
short-term interest rates payable on the AMPS. If short-term interest rates
rise, the dividend rate on the AMPS may rise so that the amount of dividends
paid to the holders of AMPS may approach or exceed the income from the
portfolio securities purchased with the proceeds from the AMPS, although this
risk should be partially mitigated due to the variable rate nature of the
Fund's portfolio investments. Also, as described above, if long-term rates
rise, the value of the Fund's investment portfolio may decline, reducing the
amount of assets serving as asset coverage for the AMPS.
Reinvestment Risk. Reinvestment risk is the risk that income from the
Fund's portfolio will decline if and when the Fund invests the proceeds from
prepaid, matured, traded or called debt obligations at market interest rates
that are below the portfolio's current earnings rate. A decline in income could
affect the Fund's net asset value or reduce asset coverage on the AMPS.
Inflation/Deflation Risk. Inflation risk is the risk that the value of
assets or income from the Fund's investments will be worth less in the future
as inflation decreases the value of payments at future dates. As inflation
increases, the real, or inflation-adjusted, value of the AMPS and distributions
as well as the real value of the Fund's portfolio could decline. Deflation risk
is the risk that prices throughout the economy decline over time--the opposite
of inflation. Deflation may have an adverse effect on the creditworthiness of
issuers and may make issuer default more likely, which may result in a decline
in the value of the Fund's portfolio. Deflation may also result in a decline in
the dividend rate of the AMPS.
Regulatory Changes. To the extent that legislation or state or federal
bank or other regulators impose additional requirements or restrictions on the
ability of certain financial institutions to make loans, particularly in
connection with highly leverage transactions, the availability of Senior Loans
and other related investments sought after by the Fund may be reduced. Further,
such legislation or regulation could depress the market value of Senior Loans
and other instruments held by the Fund.
Market Disruption and Geopolitical Risk. The war with Iraq, its
aftermath and the continuing occupation of Iraq is likely to have a substantial
impact on the U.S. and world economies and securities markets. The nature,
scope and duration of the war and occupation cannot be predicted with any
certainty. Terrorist attacks on the World Trade Center and the Pentagon on
September 11, 2001 closed some of the U.S. securities markets for a four-day
period and similar future events cannot be ruled out. The war and occupation,
terrorism and related geopolitical risks have led, and may in the future lead
to, increased short-term market volatility and may have adverse long-term
effects on U.S. and world economies and markets generally. Those events could
also have an acute effect on individual issuers or related groups of issuers.
These risks could also adversely affect individual issuers and securities
markets, interest rates, auctions and auction participants, secondary trading,
ratings, credit risk, inflation, deflation and other factors relating to the
AMPS.
Certain Affiliations. Certain broker-dealers may be considered to be
affiliated persons of the Fund, the Manager and/or PIMCO due to their possible
affiliations with Allianz AG, the ultimate parent of the Manager and PIMCO.
Absent an exemption from the Securities and Exchange Commission or other
regulatory relief, the Fund is generally precluded from effecting certain
principal transactions with affiliated brokers, and its ability to purchase
securities being underwritten by an affiliated broker or a syndicate including
an affiliated broker, or to
43
utilize affiliated brokers for agency transactions, is subject to restrictions.
This could limit the Fund's ability to engage in securities transactions and
take advantage of market opportunities. In addition, unless and until the
underwriting syndicate is broken in connection with the initial public offering
of the AMPS, the Fund will be precluded from effecting principal transactions
with brokers who are members of the syndicate.
Anti-Takeover Provisions. The Fund's Declaration and Amended Bylaws
include provisions that could limit the ability of other entities or persons to
acquire control of the Fund, convert the Fund to open-end status or change the
composition of the Board of Trustees. See "Anti-Takeover and Other Provisions
in the Declaration of Trust."
HOW THE FUND MANAGES RISK
Investment Limitations
The Fund has adopted certain investment limitations designed to limit
investment risk and maintain portfolio diversification. These limitations (two
of which are listed below) are fundamental and may not be changed without the
approval of the holders of a majority of the outstanding Common Shares and any
preferred shares (including the AMPS) voting together as a single class, and
the approval of the holders of a majority of any preferred shares (including
the AMPS) voting as a separate class. The Fund may not:
. Concentrate its investments in a particular "industry," as that term
is used in the 1940 Act and as interpreted, modified, or otherwise
permitted by regulatory authority having jurisdiction, from time to
time; and
. With respect to 75% of the Fund's total assets, purchase the
securities of any issuer, except securities issued or guaranteed by
the U.S. Government or any of its agencies or instrumentalities or
securities of other investment companies, if, as a result, (i) more
than 5% of the Fund's total assets would be invested in the
securities of that issuer, or (ii) the Fund would hold more than 10%
of the outstanding voting securities of that issuer. For the purpose
of this restriction, each state and each separate political
subdivision, agency, authority or instrumentality of such state, each
multi-state agency or authority, and each obligor, if any, is treated
as a separate issuer of municipal bonds.
The Fund would be deemed to "concentrate" its investments in a particular
industry if it invested more than 25% of its net assets in that industry. The
Fund's industry concentration policy does not preclude it from focusing
investments in issuers in a group of related industrial sectors (such as
different types of utilities).
The Fund is expected to become subject to guidelines which are more
limiting than the investment restrictions set forth above and other
restrictions set forth in the SAI in order to obtain and maintain ratings on
the AMPS of "Aaa" from Moody's and "AAA" from Fitch Ratings and may become
subject to additional guidelines in the future. See "Description of
AMPS--Rating Agency Guidelines and Asset Coverage." The Fund does not
anticipate that such guidelines would have a material adverse effect on the
Fund's ability to achieve its investment objective. See "Rating Agency
Guidelines" in this prospectus and "Investment Objective and Policies" and
"Investment Restrictions" in the SAI for information about these guidelines and
a complete list of the fundamental investment policies of the Fund.
Management of Investment Portfolio and Capital Structure to Limit Leverage Risk
The Fund may take certain actions if market conditions change (or the
Fund anticipates such change) and the Fund's leverage begins (or is expected)
to adversely affect Common Shareholders. In order to attempt to offset such a
negative impact of leverage on Common Shareholders, the Fund may invest in
short-term, high
44
quality securities, implement certain hedging strategies or extend the maturity
of the AMPS. The Fund also may attempt to reduce leverage by redeeming or
otherwise purchasing AMPS (subject to any restrictions discussed under
"Description of AMPS--Redemption") or by reducing any holdings in other
instruments that create leverage. As explained under "Risks--Leverage Risk,"
the success of any such attempt to limit leverage risk depends on PIMCO's
ability to accurately predict interest rate or other market changes. Because of
the difficulty of making such predictions, the Fund may not be successful in
managing its exposure to risks in the manner described above.
If market conditions suggest that additional leverage would be
beneficial, the Fund may issue additional preferred shares (including AMPS) or
preferred shares (including AMPS) that the Fund previously issued but later
repurchased. The Fund may also leverage the portfolio by borrowing money,
issuing debt securities or using reverse repurchase agreements, loans of
portfolio securities, credit default swap contracts and other derivatives, as
well as when-issued, delayed delivery and forward commitment transactions.
However, these forms of leverage will only be used, if at all, as a substitute
for, rather than in addition to, the leverage obtained through the issuance of
preferred shares. See "Investment Objective and Strategies--Portfolio Contents
and Other Information" and "Risks--General Risks of Investing in the
Fund--Liquidity Risk."
Hedging and Related Strategies
The Fund may use various investment strategies designed to limit the risk
of price fluctuations of its portfolio securities and to preserve capital. For
instance, the Fund may purchase credit default swap contracts for the purpose
of hedging the Fund's exposure to certain issuers and, thereby, decreasing its
exposure to credit risk. See "Investment Objective and Strategies--Credit
Default Swaps" in this prospectus. Other hedging strategies that the Fund may
use include: financial futures contracts; short sales; other types of swap
agreements or options thereon; options on financial futures; and options based
on either an index or individual debt securities whose prices, PIMCO believes,
correlate with the prices of the Fund's investments. Income earned by the Fund
from many hedging activities will be treated as capital gain and, if not offset
by net realized capital loss, will be distributed to shareholders in taxable
distributions. If effectively used, hedging strategies will offset in varying
percentages losses incurred on the Fund's investments due to adverse changes
involving issuers or economic conditions. There is no assurance that these
hedging strategies will be available at any time or that PIMCO will determine
to use them for the Fund or, if used, that the strategies will be successful.
In addition, the Fund will be subject to certain restrictions on its use of
hedging strategies imposed by Moody's and Fitch Ratings (or any rating agency
that may in the future rate the AMPS) in connection with their expected
issuance of ratings for AMPS issued by the Fund. See "Description of
AMPS--Rating Agency Guidelines and Asset Coverage."
DESCRIPTION OF AMPS
The following is a brief description of the terms of the AMPS. For a more
complete description of the AMPS, please refer to Article 11 of the Amended
Bylaws, which is attached as Appendix A to the SAI. Certain of the capitalized
terms used herein are defined in the Amended Bylaws. This description does not
purport to be complete and is subject to and qualified in its entirety by
reference to the Fund's Declaration and Amended Bylaws. The Fund's Declaration
and the form of Amended Bylaws have been filed as exhibits to the Registration
Statement of which this prospectus is a part.
General
Under the Declaration, the Fund is authorized to issue preferred shares
having such par value and such preferences, voting powers, terms of redemption,
if any, and special or relative rights or privileges (including conversion
rights, if any) as determined by the Board of Trustees, without the approval of
Common Shareholders. The AMPS are preferred shares of beneficial interest with
$.00001 par value. Each series of AMPS will have a liquidation preference of
$25,000 per share, plus an amount equal to accumulated but unpaid dividends
(whether or not earned or declared). The AMPS of each series will rank on a
parity with shares of any
45
other series of preferred shares of the Fund as to the payment of dividends and
the distribution of assets upon liquidation. The AMPS carry one vote per share
on all matters on which such shares are entitled to vote. The AMPS, when issued
by the Fund and paid for pursuant to the terms of this prospectus, will be
fully paid and, subject to matters discussed in "Anti-Takeover and Other
Provisions in the Declaration of Trust," non-assessable and will have no
preemptive, exchange or conversion rights. Any AMPS repurchased or redeemed by
the Fund will be classified as authorized and unissued preferred shares without
designation as to series. The AMPS will not be convertible into Common Shares
or other shares of beneficial interest of the Fund. The AMPS will not be
subject to any sinking fund, but will be subject to mandatory redemption and
optional redemption under certain circumstances as described below.
Dividends And Rate Periods
General. Each series of AMPS entitles its holders to receive dividends
when, as and if declared by the Board of Trustees, out of funds legally
available therefor, at a rate per annum that may vary for the successive
dividend periods for each such series. The following is a general description
of dividends and rate periods for the AMPS. The initial rate period for the
Series T AMPS will be days, and the dividend rate for this period will be
%. The initial rate period for the Series W AMPS will be days, and the
dividend rate for this period will be %. The initial rate period for the
Series TH AMPS will be days, and the dividend rate for this period will be
%. Subsequent dividend periods generally will be seven days, and the
dividend rates for those periods will generally be determined by auction.
Further description of the auction procedures can be found below under "The
Auction" and in Article 11 of the Amended Bylaws attached as Appendix A to the
SAI. The Fund, subject to certain conditions, may change the length of
subsequent dividend periods by designating them as special rate periods. See
"Designation and Notification of Special Rate Periods" below in this section.
Dividend Payment Dates. As noted above, dividends on AMPS will be payable
when, as and if declared by the Board of Trustees, out of legally available
funds in accordance with the Declaration, the Amended Bylaws and applicable
law. Dividend periods generally will begin on the first Business Day after an
auction. If dividends are scheduled to be payable on a day that is not a
Business Day, then dividends will generally be payable on the next Business
Day, or as otherwise specified in the Amended Bylaws. No dividend period of any
series of AMPS shall be co-extensive with any dividend period of any other
series of AMPS unless the Fund has received an opinion of tax counsel that
having such co-extensive periods will not affect the deductibility, for federal
income tax purposes, of dividends paid on the different series of AMPS. If for
any reason a dividend period for a series of AMPS is scheduled to begin on the
same day and end on the same day as a dividend period for another series of
AMPS, then the last day of the dividend period for such other series of AMPS
shall be the second Business Day next succeeding such scheduled day unless the
Fund obtains the opinion of tax counsel referred to in the preceding sentence.
The Fund, in its discretion, may establish dividend payment dates in respect of
any special rate period of AMPS consisting of more than seven days, provided
that such dates shall be set forth in the related notice of special rate period
and that certain conditions are met. See "Designation and Notification of
Special Rate Periods" below in this section.
If a dividend payment date is not a Business Day because the NYSE is
closed for business for more than three consecutive Business Days due to an act
of God, natural disaster, act of war, civil or military disturbance, act of
terrorism, sabotage, riots or a loss or malfunction of utilities or
communications services, or the dividend payable on such date can not be paid
for any such reason, then:
. the dividend payment date for the affected dividend period will be
the next Business Day on which the Fund and its paying agent, if any,
are able to cause the dividend to be paid using their reasonable best
efforts;
. the affected dividend period will end on the day it would have ended
had such event not occurred and the dividend payment date had
remained the schedule date; and
46
. the next dividend period will begin and end on the dates it would
have begun and ended had such event not occurred and the dividend
payment date had remained the scheduled date, and the dividend rate
shall be the same as for the prior dividend period.
Dividends will be paid through the Securities Depository on each dividend
payment date. The dividend payment date will normally be the first Business Day
after the dividend period ends. The Securities Depository, in accordance with
its current procedures, is expected to distribute dividends received from the
auction agent in same-day funds on each dividend payment date to members of the
Securities Depository that will act on behalf of existing or potential holders
of AMPS ("Agent Members"). These Agent Members are in turn expected to
distribute such dividends to the persons for whom they are acting as agents.
However, each of the current Broker-Dealers has currently indicated to the Fund
that dividend payments will be available in same-day funds on each dividend
payment date to customers that use a Broker-Dealer or a Broker-Dealer's
designee as Agent Member.
The nominee of the Securities Depository is expected to be the sole
holder of record of each series of AMPS. Accordingly, each purchaser of AMPS
must rely on (i) the procedures of the Securities Depository and, if such
purchaser is not a member of the Securities Depository, such purchaser's Agent
Member, to receive dividends, distributions and notices and to exercise voting
rights (if and when applicable) and (ii) the records of the Securities
Depository and, if such purchaser is not a member of the Securities Depository,
such purchaser's Agent Member, to evidence its beneficial ownership of the AMPS.
Calculation of Dividend Payment. The Fund computes the dividend per
share of each series of AMPS by multiplying the applicable rate for such series
of shares in effect by a fraction. The numerator of this fraction will normally
be seven (i.e., the number of days in the dividend period) and the denominator
will normally be 365. If the Fund has designated a special rate period, then
the numerator will be the number of days in the special rate period, and the
denominator will normally be 360. In either case, this rate is then multiplied
by $25,000 to arrive at the dividend per share.
Dividends on the AMPS will accumulate from the date of their original
issue. For each dividend payment period after the initial rate period, the
dividend rate will be the dividend rate determined at auction, except as
provided in the Amended Bylaws, as described below. The dividend rate that
results from an auction will not be greater than the maximum applicable rate
described below.
The maximum applicable rate for any regular dividend period will be the
higher of the applicable percentage of the reference rate, or the applicable
spread plus the reference rate. The reference rate will be the applicable LIBOR
Rate (as defined below) (for a dividend period of fewer than 365 days) or the
Treasury Index Rate (as defined below) (for a dividend period of 365 days or
more). The applicable percentage and applicable spread for any regular dividend
period will generally be determined based on the credit ratings assigned to the
AMPS by Moody's and Fitch Ratings on the auction date for such period (as set
forth in the table below). If Moody's and/or Fitch Ratings shall not make such
rating available, the rate shall be determined by reference to equivalent
ratings issued by a substitute rating agency. In the case of a special rate
period, (1) the maximum applicable rate will be specified by the Fund in the
notice of special rate period for such dividend payment period, (2) the
applicable percentage and applicable spread will be determined on the date two
Business Days before the first day of such special rate period, and (3) the
reference rate will be the applicable LIBOR Rate (for a dividend period of
fewer than 365 days) or the Treasury Index Rate (for a dividend period of 365
days or more).
Moody's Credit Fitch Ratings' Credit Applicable Applicable
Rating Rating Percentage Spread
-------------- --------------------- ---------- ----------
Aaa AAA 125% 125 bps
Aa3 to Aa1 AA- to AA+ 150% 150 bps
A3 to A1 A- to A+ 200% 200 bps
Baa3 to Baa1 BBB- to BBB+ 250% 250 bps
Ba1 and below BB+ and below 300% 300 bps
47
The Fund will take all reasonable action necessary to enable Moody's and
Fitch Ratings to provide ratings for each series of AMPS. If such ratings are
not made available by Moody's or Fitch Ratings, the Underwriters or their
affiliates and successors, after consultation with the Fund, will select one or
more other rating agencies to act as substitute rating agencies.
The "LIBOR Rate" is the applicable London Inter-Bank Offered Rate for
deposits in U.S. dollars for the period most closely approximating the
applicable dividend period for a series of AMPS. For a more detailed
description, please see the Amended Bylaws.
The "Treasury Index Rate" is the average yield to maturity for certain
U.S. Treasury securities having substantially the same length to maturity as
the applicable dividend period for a series of AMPS. For a more detailed
description, please see the Amended Bylaws.
Assuming the Fund maintains an Aaa/AAA rating on the AMPS, the practical
effect of the different methods used to calculate the Maximum Applicable Rate
is shown in the table below:
Maximum Applicable Maximum Applicable
Rate Using the Rate Using the Method Used to Determine the
Reference Rate Applicable Percentage Applicable Spread Maximum Applicable Rate
-------------- --------------------- ------------------ ----------------------------
1% 1.25% 2.25% Spread
2% 2.50% 3.25% Spread
3% 3.75% 4.25% Spread
4% 5.00% 5.25% Spread
5% 6.25% 6.25% Either
6% 7.50% 7.25% Percentage
The Board of Trustees may amend the maximum applicable rate to increase
the percentage amount by which the reference rate described above is
multiplied, or to increase the spread added to the reference rate, to determine
the maximum applicable rate shown without the vote or consent of the holders of
AMPS, including each series, or any other shareholder of the Fund, but only
with confirmation from each rating agency then rating the AMPS that such action
will not impair such agency's then-current rating of the AMPS, and after
consultation with the Broker-Dealers, provided that immediately following any
such increase the Fund could meet the Preferred Shares Basic Maintenance Amount
test discussed below under "--Rating Agency Guidelines and Asset Coverage."
Restrictions on Dividends and Other Distributions. For so long as any
AMPS are outstanding, the Fund generally may not declare, pay or set apart for
payment any dividend or other distribution (other than a dividend or
distribution paid in shares of additional Common Shares or rights to purchase
Common Shares or other shares, if any, ranking junior to the AMPS as to
dividends or upon liquidation) in respect of Common Shares or any other shares
of the Fund ranking junior to or on a parity with the AMPS as to dividends or
upon liquidation, or call for redemption, redeem, purchase or otherwise acquire
for consideration any Common Shares or any other such junior shares (except by
conversion into or exchange for shares of beneficial interest of the Fund
ranking junior to AMPS as to dividends and upon liquidation) or any such parity
shares (except by conversion into or exchange for shares of beneficial interest
of the Fund ranking junior to or on a parity with AMPS as to dividends and upon
liquidation), unless and only if:
. 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 Preferred Shares Basic
Maintenance Amount, and the 1940 Act Preferred Shares Asset Coverage
would be satisfied;
. full cumulative dividends on the AMPS due on or prior to the Fund's
most recently ended dividend period have been declared and paid or
shall have been declared and sufficient funds for the payment thereof
deposited with the auction agent; and
48
. the Fund has redeemed the full number of AMPS required to be redeemed
by any provision for mandatory redemption contained in the Amended
Bylaws.
The Fund generally will not declare, pay or set apart for payment any
dividend on any class or series of shares of the Fund ranking, as to the
payment of dividends, on a parity with the AMPS unless the Fund has declared
and paid full cumulative or the same proportionate share of dividends on the
AMPS through the most recent dividend payment date. When the Fund has not paid
dividends in full upon a series of the AMPS through the most recent dividend
payment date or upon any class or series of shares of the Fund ranking, as to
the payment of dividends, on a parity with such series of AMPS through their
most recent respective dividend payment dates, the amount of dividends declared
per share on such series of AMPS and such other class or series of shares will
in all cases bear to each other the same ratio that accumulated dividends per
share on such series of AMPS and such other class or series of shares bear to
each other.
Designation and Notification of Special Rate Periods. The Fund, at its
sole option and to the extent permitted by law, by telephonic and written
notice to the auction agent and to each Broker-Dealer, may request that the
next succeeding dividend period for a series of AMPS be a special rate period,
with a number of days greater than seven but evenly divisible by seven, and no
more than 364 (a "Short Term Special Rate Period") or one whole year or more
but not greater than five years (a "Long Term Special Rate Period") specified
in such notice, provided that the Fund may not give a request for a special
rate period of greater than 28 days (and any such request will be null and
void) unless, for any auction occurring after the initial auction, sufficient
clearing bids (as described in "The Auction--Auction Procedures" below) were
made in the last occurring auction and unless full cumulative dividends and any
amounts due with respect to redemptions payable prior to such date have been
paid in full. The Fund also must have received confirmation from Moody's and
Fitch Ratings or any substitute rating agency that the proposed special rate
period will not impair the agency's then-current rating of the AMPS. Such
request for a special rate period shall be given on or prior to the second
Business Day but, in the case of a Short Term Special Rate Period, not more
than seven Business Days prior to an auction date for the AMPS of that series
and, in the case of a Long Term Special Rate Period, not more than 28 days
prior to an auction date for the AMPS of that series. Upon receiving any such
request, the Broker-Dealers jointly shall determine the optional redemption
price of the AMPS of that series during such special rate 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 AMPS, (iv) industry
and financial conditions which may affect the AMPS of that series, (v) the
investment objectives of the Fund and (vi) the dividend periods and dividend
rates at which current and potential beneficial holders of the AMPS would
remain or become beneficial holders.
After providing a request for special rate period to the auction agent
and each Broker-Dealer as set forth above, the Fund, by no later than the
second Business Day prior to such auction date, may give a notice to the
auction agent, the Securities Depository and each Broker-Dealer, which notice
will specify (i) the duration of the special rate period, (ii) the optional
redemption price, if any, as specified in the related Response and (iii) the
specific redemption provisions, if any, as specified in the related Response.
The Fund has agreed to provide a copy of such notice of special rate period to
Moody's and Fitch Ratings (or to any substitute rating agency then rating the
AMPS). The Fund will not give a notice of a special rate period, and, if such
notice of a special rate period was given already, will give telephonic and
written notice of its 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 Preferred Shares Asset Coverage is not
satisfied or the Fund fails to maintain Moody's Eligible Assets and Fitch
Eligible Assets with an aggregate discounted value at least equal to the
Preferred Shares 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
rate period (using as a pro forma dividend rate with respect to such special
rate period the dividend rate which the
49
Broker-Dealers shall advise the Fund is an approximately equal rate for
securities similar to the AMPS with an equal dividend period) or (y) sufficient
funds for the payment of dividends payable on the immediately succeeding
dividend payment date have not been irrevocably deposited with the auction
agent by the close of business on the third Business Day preceding the auction
date immediately preceding such dividend payment date. The Fund also shall
provide a copy of such notice of revocation to Moody's and Fitch Ratings (or to
any substitute rating agency then rating the AMPS). If the Fund is prohibited
from giving a notice of special rate period as a result of the factors
enumerated in clause (x) or (y) above or if the Fund gives a notice of
revocation with respect to a notice of special rate period, the next succeeding
dividend period for that series will be a seven-day dividend period. In
addition, in the event that sufficient clearing bids are not made in an auction
or an auction is not held for any reason, the next succeeding dividend period
will be a seven-day dividend period, and the Fund may not again give a notice
of special rate period (and any such attempted notice will be null and void)
until sufficient clearing bids have been made in an auction with respect to a
seven-day dividend period.
The Fund may provide that, in order to redeem AMPS at the Fund's option
during a special rate period, the Fund must pay to holders of the AMPS a
"redemption premium" in addition to the redemption price per share of $25,000,
plus an amount equal to the accumulated but unpaid dividends. A notice of
special rate period will specify whether the shares of a particular series of
AMPS will be subject to optional redemption during such special rate period
and, if so, the redemption premium, if any, required to be paid by the Fund in
connection with such optional redemption.
The Fund's declaration of a special rate period may affect the liquidity
of your investment. A special rate period would be longer than a regular
dividend period, and you would be unable to sell AMPS in an auction for a
correspondingly longer period of time. If you sell your AMPS between auctions,
you may receive less than the price you paid for them, especially when market
interest rates have risen. The risks described in this paragraph will become
greater as the length of the special rate period increases.
Voting Rights
Except as otherwise described in this prospectus and in the SAI or as
otherwise set forth in the Declaration or the Amended Bylaws or as required by
law, holders of AMPS will have equal voting rights with Common Shareholders and
holders of any other preferred shares of the Fund (each class having one vote
per share) and will vote together with Common Shareholders and any other
preferred shares as a single class.
Holders of outstanding preferred shares of the Fund, including AMPS,
voting as a separate class, are entitled to elect two of the Fund's Trustees.
The remaining Trustees are elected by Common Shareholders and holders of
preferred shares, including AMPS, voting together as a single class. In
addition, if at any time dividends (whether or not earned or declared) on any
outstanding preferred shares of the Fund, including AMPS, are due and unpaid in
an amount equal to two full years of dividends, and sufficient cash or
specified securities have not been deposited with the auction agent for the
payment of such dividends, the sole remedy of holders of the outstanding
preferred shares of the Fund shall be an automatic increase in the number of
Trustees constituting the Board of Trustees by the smallest number that, when
added to the two trustees elected exclusively by the holders of AMPS and any
other preferred shares as described above, would constitute a majority of the
Board of Trustees as so increased, and at a special meeting of shareholders
which will be called and held as soon as practicable thereafter, and at all
subsequent meetings at which trustees are to be elected until all dividends in
arrears have been paid or otherwise provided for, the holders of the AMPS and
any other preferred shares, voting as a separate class, will be entitled to
elect the smallest number of additional trustees that, together with the two
trustees that such holders in any event will be entitled to elect, constitutes
a majority of the total number of trustees of the Fund as so increased. The
terms of office of the persons who are Trustees at the time of that election
will continue, unless otherwise terminated pursuant to the Declaration or
Amended Bylaws. If the Fund thereafter pays in full (or otherwise provides for)
all dividends payable on all outstanding preferred shares of the Fund, the
special voting rights stated above will cease and the terms of office of the
additional Trustees elected by the holders of the preferred shares (but not of
the trustees with respect to whose election the holders of
50
Common Shares were entitled to vote or the two trustees the holders of AMPS and
any other preferred shares have the right to elect in any event) will
automatically terminate.
Unless a higher percentage is provided for under the Declaration or the
Amended Bylaws or applicable law, the affirmative vote of a majority of the
votes entitled to be cast by holders of outstanding AMPS and any other
preferred shares, voting together as one class, will be required to
(i) authorize, create or issue any class or series of shares of
beneficial interest ranking prior to the AMPS or any other series of
preferred shares with respect to the payment of dividends or the
distribution of assets on liquidation or authorize, create or issue
additional shares of AMPS; or
(ii) amend, alter or repeal the provisions of the Declaration or the
Amended Bylaws, whether by merger, consolidation or otherwise, so as
to adversely affect any of the powers, rights or preferences
expressly set forth in the Declaration or the Amended Bylaws of
holders of AMPS or any other preferred shares.
To the extent permitted under the 1940 Act, in the event shares of more
than one series of AMPS 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 or the Amended Bylaws of a holder
of shares of a series of AMPS differently than those of a holder of shares of
any other series of AMPS without the affirmative vote of at least a majority of
votes entitled to be cast by holders of the AMPS 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 Moody's and Fitch Ratings (or any applicable substitute
rating agency) that any such amendment, alteration or repeal would not impair
the rating then assigned to the AMPS by such rating agency.
Unless a higher percentage is provided for under the Declaration or the
Amended Bylaws, the affirmative vote of a majority of the votes entitled to be
cast by holders of outstanding AMPS 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 investment restrictions described
as fundamental policies under "Investment Restrictions" in the SAI. To the
extent permitted under the 1940 Act, the Amended Bylaws provide that, in the
event shares of more than one series of AMPS are outstanding, with respect to
any action requiring shareholder approval pursuant to the operation of Section
2 or Section 3 of Article V of the Declaration, the affirmative vote of at
least seventy-five percent of the AMPS of each series outstanding at such time
(each such series voting separately as a class) shall also be required. The
class (and, where applicable, series) vote of holders of AMPS 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 AMPS and any other
preferred shares, voting together as a single class, necessary to authorize the
action in question.
The foregoing voting provisions will not apply with respect to AMPS if,
at or prior to the time when a vote is required, such shares have been (i)
redeemed or (ii) called for redemption and sufficient funds have been deposited
in trust to effect such redemption.
If a series of preferred shares other than the AMPS is issued in the
future, it is anticipated that such series would have voting rights comparable
to those described above.
Rating Agency Guidelines and Asset Coverage
The Fund will be required to satisfy two separate asset maintenance
requirements under the terms of the Amended Bylaws. These requirements are
summarized below.
51
1940 Act Preferred Shares Asset Coverage. The Fund will be required
under the 1940 Act and the Amended Bylaws to maintain, with respect to the
AMPS, as of the last Business Day of each month in which any AMPS are
outstanding, the 1940 Act Preferred Shares Asset Coverage (as defined below) of
at least 200% with respect to senior securities that are equity securities,
including the preferred shares. If the Fund fails to maintain the 1940 Act
Preferred Shares 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 AMPS. See
"Redemption" below.
The 1940 Act Preferred Shares Asset Coverage immediately following the
issuance of AMPS offered hereby (after giving effect to the deduction of the
sales load and offering expenses for the AMPS), computed using the Fund's net
assets as of October 14, 2003, and assuming the AMPS had been issued as of such
date, will be as follows:
Value of the Fund's total assets less all liabilities and $ 552,357,024 = 263%
indebtedness not represented by senior securities =
---------------------------------------------------------- --------------
Senior securities representing indebtedness plus $210,000,000
liquidation value of the AMPS
Preferred Shares Basic Maintenance Amount. In connection with the Fund's
receipt of ratings of "Aaa" from Moody's and "AAA" from Fitch Ratings with
respect to the AMPS, the Fund is required to maintain assets having in the
aggregate a discounted value at least equal to the Preferred Shares Basic
Maintenance Amount. The Preferred Shares Basic Maintenance Amount includes the
sum of (a) the aggregate liquidation preference of the preferred shares then
outstanding (including the AMPS) and (b) certain accrued and projected payment
obligations of the Fund, including without limitation any accrued and projected
dividends on the preferred shares then outstanding (including the AMPS).
Moody's and Fitch Ratings have established separate guidelines for
calculating discounted value. These guidelines specify discount factors that
the Fund must apply to various types of securities in its portfolio for
purposes of calculating whether the discounted value of the Fund's assets
equals the Preferred Shares Basic Maintenance Amount (with the level of
discount generally becoming greater as the credit quality of a security becomes
lower). In addition, under the guidelines, certain types of securities
(including securities in which the Fund may otherwise invest) are not eligible
for inclusion in the calculation of the discounted value of the Fund's
portfolio. Such ineligible securities may include, for example, certain
privately placed debt securities (other than Rule 144A securities) and debt
securities of certain non-U.S. issuers. Accordingly, although the Fund may
invest in such securities to the extent set forth herein, it is currently
anticipated that they will not constitute a significant portion of the Fund's
portfolio under normal circumstances. The rating agency guidelines for
calculating discounted value do not impose any limitations on the percentage of
the Fund's assets that may be invested in ineligible assets, and the amount of
ineligible assets included in the Fund's portfolio at any time may vary
depending upon the rating, diversification and other characteristics of the
eligible assets included in the portfolio.
In the event the Fund does not timely cure a failure to maintain (a) a
discounted value of its portfolio equal to the Preferred Shares Basic
Maintenance Amount or (b) the 1940 Act Preferred Shares Asset Coverage, in each
case in accordance with the requirements of the rating agency or agencies then
rating the AMPS, the Fund will be required to redeem AMPS as described under
"--Redemption--Mandatory Redemption" below.
In addition to the requirements described above, the rating agency
guidelines impose restrictions on the Fund's use of certain financial
instruments or investment techniques that the Fund might otherwise utilize in
order to obtain and maintain a rating from Moody's and Fitch Ratings on the
AMPS. For example, the guidelines limit the use of certain hedging transactions
such as futures contracts, options and other derivative transactions for
hedging or investment purposes. The guidelines also limit the use of certain
other investment techniques, including borrowing of money, short sales, loans
of portfolio securities, reverse repurchase agreements, issuing
52
any class or series of shares ranking prior to or on a parity with the AMPS
with respect to the payment of dividends or the distribution of assets upon
dissolution, liquidation or winding up of the Fund or merging or consolidating
into or with any other entity. It is not currently anticipated that these
guidelines will materially impede PIMCO from managing the Fund's portfolio in
accordance with the Fund's investment objectives and policies. For a complete
description of such restrictions, see Article 11 of the Amended Bylaws, which
is attached as Appendix A to the Fund's SAI.
The Fund may, but is not required to, adopt any modifications to the
guidelines that may be established by Moody's and/or Fitch Ratings. Failure to
adopt any such modifications, however, may result in a change in the ratings
described above or a withdrawal of ratings altogether. In addition, any rating
agency providing a rating for the AMPS may, at any time, change or withdraw any
such rating. The Trustees may, without shareholder approval, amend, alter or
repeal any or all of the definitions and related provisions that have been
adopted by the Fund pursuant to the rating agency guidelines in the event the
Fund receives written confirmation from Moody's and Fitch Ratings (or any
substitute rating agency) that any such amendment, alteration or repeal would
not impair the rating then assigned to the AMPS.
As recently described by Moody's, a preferred stock rating is an
assessment of the capacity and willingness of an issuer to pay preferred stock
obligations. The rating on the AMPS is not a recommendation to purchase, hold
or sell those shares, inasmuch as the rating does not comment as to market
price or suitability for a particular investor. The rating agency guidelines
described above also do not address the likelihood that an owner of AMPS will
be able to sell such shares in an auction or otherwise. The ratings are based
on current information furnished to Moody's and Fitch Ratings by the Fund, the
Manager and/or PIMCO or information obtained from other sources. The ratings
may be changed, suspended or withdrawn as a result of changes in, or the
unavailability of, such information. The Fund's Common Shares have not been
rated by a nationally recognized statistical rating organization.
A rating agency's guidelines will apply to the AMPS only so long as the
rating agency is rating the shares. The Fund will pay certain fees to Moody's
and Fitch Ratings for rating the AMPS. A more detailed description of how
Moody's and Fitch Ratings calculate discounted value and the other limitations
imposed by the rating agencies is contained in Article 11 of the Amended
Bylaws, which is attached as Appendix A to the Fund's SAI.
Liquidation
Subject to the rights of holders of any series or class or classes of
shares ranking on a parity with AMPS with respect to the distribution of assets
upon liquidation of the Fund, upon a liquidation of the Fund (whether voluntary
or involuntary), the holders of AMPS then outstanding will be entitled to
receive and to be paid, out of the assets of the Fund available for
distribution to its shareholders, before any payment or distribution will be
made on the Common Shares or any other class of shares of the Fund ranking
junior in right of payment upon liquidation to the AMPS, an amount equal to the
liquidation preference with respect to such AMPS ($25,000 per share), plus an
amount equal to all dividends thereon (whether or not earned or declared by the
Fund, but excluding the interest thereon) accumulated but unpaid to (but not
including) the date of final distribution in same-day funds in connection with
the liquidation of the Fund. If such assets of the Fund are insufficient to
make the full liquidation payment on outstanding AMPS and liquidation payments
on any other outstanding class or series of preferred shares of the Fund
ranking on parity with the AMPS as to payment upon liquidation, then such
assets will be distributed among the holders of AMPS 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 the payment to the
holders of AMPS of the full preferential amounts provided for as described
herein, the holders of AMPS as such will have no right or claim to any of the
remaining assets of the Fund.
53
For purposes of the foregoing paragraph, a liquidation of the Fund does
not include:
. the sale of all or any portion of the property or business of the
Fund;
. the merger or consolidation of the Fund into or with any business
trust or other entity; or
. the merger or consolidation of any business trust or other entity
into or with the Fund.
Redemption
Mandatory Redemption. As noted above, the Fund is required under the
Amended Bylaws to maintain (a) a discounted value of eligible portfolio
securities equal to the Preferred Shares Basic Maintenance Amount and (b) the
1940 Act Preferred Shares Asset Coverage. Eligible portfolio securities for the
purposes of (a) above will be determined from time to time by the rating agency
then rating the AMPS. If the Fund fails to maintain such asset coverage amounts
and does not timely cure such failure in accordance with the Amended Bylaws,
the Fund must redeem all or a portion of the AMPS. This mandatory redemption
will take place on a date that the Trustees specify out of legally available
funds in accordance with the Declaration, the Amended Bylaws and applicable
law, at the redemption price of $25,000 per share, plus accumulated but unpaid
dividends (whether or not earned or declared) to (but not including) the date
fixed for redemption. In determining the number of AMPS required to be redeemed
in accordance with the foregoing, the Fund will redeem the lesser of (a) the
minimum number of AMPS necessary to satisfy the Preferred Shares Basic
Maintenance Amount or the 1940 Act Preferred Shares Asset Coverage, as the case
may be, and (b) the maximum number of AMPS and any other preferred shares of
the Fund subject to redemption or retirement that can be redeemed out of funds
expected to be legally available therefore at the time of redemption, and in
any case will redeem such AMPS pro rata among the AMPS and any other preferred
shares of the Fund subject to redemption or retirement. The mandatory
redemption will be limited to the number of AMPS and any other preferred shares
necessary to restore the required discounted value or the 1940 Act Preferred
Shares Asset Coverage, as the case may be.
Optional Redemption. To the extent permitted under the 1940 Act and
under Massachusetts law, upon giving notice of redemption, as provided below,
the Fund, at its option, may redeem the AMPS, in whole or in part, out of funds
legally available therefore, at the Optional Redemption Price per share on any
dividend payment date; provided that no AMPS may be redeemed at the option of
the Fund during (a) the initial rate period with respect to the AMPS or (b) a
non-call period to which such shares are subject. "Optional Redemption Price"
means $25,000 per AMPS plus an amount equal to accumulated but unpaid dividends
(whether or not earned or declared) to the date fixed for redemption plus the
applicable redemption premium, if any. The Fund has the authority to redeem the
AMPS for any reason and may redeem all or part of the outstanding AMPS if it
anticipates that the Fund's leveraged capital structure will result, for a
significant period of time, in a lower rate of return to holders or Common
Shares than that obtainable if the Common Shares were unleveraged.
The Fund will not make any optional redemption unless the Fund has
eligible assets with an aggregate discounted value at least equal to the
Preferred Shares Basic Maintenance Amount (both before and after giving effect
to such redemption).
Although the AMPS are subject to redemption under certain circumstances
as described above, unlike the shares of an open-end mutual fund, the AMPS may
not be redeemed at a shareholder's option at net asset value.
The Auction
General
Under the Amended Bylaws, the applicable rate for the AMPS for each
dividend period after the initial rate period will generally be the rate that
results from an auction conducted as set forth in the Amended Bylaws
54
and summarized below. In such an auction, persons determine to hold or offer to
sell AMPS regardless of the rate set by the auction or offer to purchase or
sell AMPS based on specific dividend rates bid by them. See the Amended Bylaws
for a more complete description of the auction process.
Auction Agency Agreement. The Fund will enter into an auction agency
agreement with the auction agent (initially, Deutsche Bank) which provides,
among other things, that the auction agent will follow the auction procedures
set forth in the Amended Bylaws to determine the applicable rate for AMPS so
long as the applicable rate for AMPS is to be based on the results of an
auction.
The auction agent will act as agent for the Fund in connection with
auctions. In the absence of bad faith or negligence on its part, the auction
agent will not be liable for any action taken, suffered or omitted, or for any
error of judgment made, by it in the performance of its duties under the
auction agency agreement. Pursuant to the auction agency agreement, the Fund is
required to indemnify the auction agent for certain losses and liabilities
incurred by the auction agent without negligence or bad faith on its part in
connection with the performance of its duties under such agreement.
The auction agent may terminate the auction agency agreement upon notice
to the Fund no earlier than 60 days after such notice. If the auction agent
should resign, the Fund will attempt to appoint another qualified institution
to act as auction agent. The Fund may remove the auction agent provided that
prior to such removal the Fund has entered into an agreement with a successor
auction agent to perform substantially similar services.
Except in an auction, the Fund will have the right (to the extent
permitted by applicable law) to purchase or otherwise acquire any AMPS so long
as the Fund is current in the payment of dividends on AMPS and on any other
shares of beneficial interest of the Fund ranking on a parity with the AMPS
with respect to the payment of dividends or upon liquidation.
Broker-Dealer Agreements. Each auction requires the participation of one
or more Broker-Dealers. The auction agent will enter into agreements with one
or more Broker-Dealers selected by the Fund that provide for the participation
of those Broker-Dealers in auctions for AMPS ("Broker-Dealer Agreements").
The auction agent will pay to each Broker-Dealer after each auction, from
funds provided by the Fund, a service charge that will generally be at the
annual rate of 1/4 of 1% of the stated value ($25,000 per share) of the AMPS
placed by a Broker-Dealer at such auction. For any special rate period, the
service charge shall be determined by mutual consent of the Fund and any such
Broker-Dealer or Broker-Dealers. For purposes of the foregoing, the AMPS 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 Fund may request the auction agent to terminate one or more
Broker-Dealer Agreements at any time upon five days' notice, provided that at
least one Broker-Dealer Agreement is in effect after such termination.
The Depository Trust Company ("DTC") initially will act as the securities
depository for the Agent Members with respect to the AMPS. All of the shares of
each series of AMPS initially will be registered in the name of Cede & Co., as
nominee of the Securities Depository. Such shares will be subject to the
provisions restricting transfers of the AMPS contained in the Amended Bylaws.
Cede & Co. initially will be the holder of record of all AMPS, and beneficial
owners will not be entitled to receive certificates representing their
ownership interest in such shares. See Appendix A (Article 11 of the Amended
Bylaws) to the SAI. The Securities Depository will maintain lists of its
participants and will maintain the positions (ownership interests) of the
55
AMPS 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 AMPS will be duly made by making payments to the nominee
of the Securities Depository.
Auction Procedures
The following is a brief summary of the procedures to be used in
conducting auctions. This summary is qualified in its entirety by reference to
Article 11 of the Amended Bylaws set forth in Appendix A to the SAI. The
Settlement Procedures to be used with respect to auctions are set forth in
Exhibit A to each Broker-Dealer Agreement, the form of which has been filed as
an exhibit to the Registration Statement of which this prospectus is a part.
Prior to the submission deadline on each auction date for the AMPS, each
customer of a Broker-Dealer who is listed on the records of that Broker-Dealer
(or, if applicable, the auction agent) as a Beneficial Owner of AMPS may submit
the following types of orders with respect to AMPS to that Broker-Dealer:
1. Hold Order--indicating its desire to hold the indicated number of
AMPS without regard to the applicable rate for shares of such series
for the next dividend period.
2. Bid--indicating its desire to purchase or hold the indicated number
of AMPS at $25,000 per share if the applicable rate for shares of
such series for the next dividend period is not less than the rate
specified in the bid. A bid order by an existing holder will be
deemed an irrevocable offer to sell AMPS at $25,000 per share if the
applicable rate for shares of such series for the next dividend
period is less than the rate specified in the bid.
3. Sell Order--indicating its desire to sell AMPS at $25,000 per share
without regard to the applicable rate for shares of such series for
the next dividend period.
A Beneficial Owner of AMPS may submit different types of orders to its
Broker-Dealer with respect to different AMPS then held by the Beneficial Qwner.
A Beneficial Owner that submits a bid to its Broker-Dealer having a rate higher
than the maximum applicable rate on the auction date will be treated as having
submitted a sell order to its Broker-Dealer. A Beneficial Owner that fails to
submit an order to its Broker-Dealer will ordinarily be deemed to have
submitted a hold order to its Broker-Dealer. However, if a Beneficial Owner
fails to submit an order for some or all of its shares to its Broker-Dealer for
an auction relating to a dividend period of more than 91 days, such Beneficial
Owner will be deemed to have submitted a sell order for such shares to its
Broker-Dealer. A sell order constitutes an irrevocable offer to sell the AMPS
subject to the sell order.
In an auction, a Beneficial Owner may submit different types of orders
with respect to AMPS then held by such Beneficial Owner, as well as bids for
additional AMPS. A Beneficial Owner that offers to become the Beneficial Owner
of additional AMPS is, for the purposes of such offer, a potential holder as
discussed below.
A potential holder is either a customer of a Broker-Dealer that is not a
Beneficial Owner of AMPS but wishes to purchase AMPS or a Beneficial Owner that
wishes to purchase additional AMPS. A potential holder may submit bids to its
Broker-Dealer in which it offers to purchase AMPS at $25,000 per share if the
applicable rate for the next dividend period is not less than the rate
specified in such bid. A bid placed by a potential holder specifying a rate
higher than the maximum applicable rate on the auction date will not be
accepted.
The Broker-Dealers in turn will submit the orders of their respective
customers who are beneficial owners and potential holders to the auction agent.
Unless otherwise permitted by the Fund, the Broker-Dealers will designate
themselves as existing holders of shares subject to orders submitted or deemed
submitted to them by beneficial owners. They will also designate themselves as
potential holders of shares subject to orders submitted to them by potential
holders. However, neither the Fund nor the auction agent will be responsible
for a Broker-Dealer's failure to comply with these procedures. Any order placed
with the auction agent by a Broker-
56
Dealer as or on behalf of an existing holder or a potential holder will be
treated the same way as an order placed with a Broker-Dealer by a Beneficial
Owner or potential holder. Similarly, any failure by a Broker-Dealer to submit
to the auction agent an order for any AMPS held by it or its customers who are
Beneficial Owners will be treated as a Beneficial Owner's failure to submit to
its Broker-Dealer an order in respect of AMPS held by it. A Broker-Dealer may
also submit orders to the auction agent for its own account as an existing
holder or potential holder. If a Broker-Dealer submits an order for its own
account in any auction of AMPS, 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. A Broker-Dealer may submit orders to the
auction agent for its own account as an existing holder or potential holder,
provided that it is not an affiliate of the Fund.
There are sufficient clearing bids in an auction if the number of shares
of a series of AMPS subject to bids submitted or deemed submitted to the
auction agent by Broker-Dealers for potential holders with rates equal to or
lower than the maximum applicable rate for shares of such series is at least
equal to the sum of the number of applicable AMPS subject to sell orders
submitted or deemed submitted to the auction agent by Broker-Dealers for
existing holders and the number of applicable AMPS subject to bids specifying
rates higher than the maximum applicable rate for shares of such series
submitted or deemed submitted to the auction agent by Broker-Dealers for
existing holders. If there are sufficient clearing bids, the applicable rate
for the relevant AMPS for the next succeeding dividend period thereof will be
the lowest rate specified in the submitted bids that, taking into account such
rate and all lower rates bid by Broker-Dealers as or on behalf of existing
holders and potential holders, would result in such existing holders and
potential holders owning the relevant AMPS available for purchase in the
auction.
If there are not sufficient clearing bids, the applicable rate for the
next dividend period will be the maximum applicable rate on the auction date.
If there are not sufficient clearing bids, beneficial owners of AMPS that have
submitted or are deemed to have submitted sell orders may not be able to sell
in the auction all shares subject to such sell orders. If all existing holders
of AMPS submit (or are deemed to have submitted) hold orders in an auction, the
dividend period next following the auction automatically shall be the same
length as the immediately preceding dividend period, and the applicable rate
will be 80% of the Reference Rate (as defined in the Amended Bylaws).
The auction procedures include a pro rata allocation of shares for
purchase and sale, which may result in an existing holder continuing to hold or
selling, or a potential holder purchasing, a number of AMPS that is different
from the number of shares specified in its order. To the extent the allocation
procedures have that result, Broker-Dealers that have designated themselves as
existing holders or potential holders in respect of customer orders will be
required to make appropriate pro rata allocations among their respective
customers.
Settlement of purchases and sales will be made on the next Business Day
(which is also a dividend payment date) after the auction date through DTC.
Purchasers will make payment through their Agent Members in same-day funds to
DTC against delivery to their respective Agent Members. DTC will make payment
to the sellers' Agent Members in accordance with DTC's normal procedures, which
currently provide for payment against delivery by their Agent Members in
same-day funds.
If any existing holder selling AMPS in an auction fails to deliver such
shares, the Broker- Dealer of any person that was to have purchased AMPS in
such auction may deliver to such person a number of whole AMPS that is less
than the number of shares that otherwise was to be purchased by such person. In
such event, the number of AMPS to be so delivered will be determined by such
Broker-Dealer. Delivery of such lesser number of shares will constitute good
delivery. Each Broker-Dealer Agreement also will provide that neither the fund
nor the auction agent will have any responsibility or liability with respect to
the failure of a Beneficial Owner, potential Beneficial Owner or their
respective Agent Members to deliver AMPS or to pay for AMPS purchased or sold
pursuant to an auction or otherwise.
The auctions for AMPS will normally be held every seven days, and each
subsequent dividend period will normally begin on the following Business Day.
57
The auctions for the Series T AMPS will normally be held on every Tuesday
beginning on , 2003, the Business Day preceding the dividend
payment date for the initial rate period, and each subsequent dividend period
will normally begin on the following Wednesday. Thereafter, except during
special rate periods, auctions for the Series T AMPS normally will be held
every seven days thereafter, and each subsequent dividend period for the Series
T AMPS normally will begin on the following Business Day.
The auctions for the Series W AMPS will normally be held on every
Wednesday beginning on , 2003, the Business Day preceding the
dividend payment date for the initial rate period, and each subsequent dividend
period will normally begin on the following Thursday. Thereafter, except during
special rate periods, auctions for the Series W AMPS normally will be held
every seven days thereafter, and each subsequent dividend period for the Series
W AMPS normally will begin on the following Business Day.
The auctions for the Series TH AMPS will normally be held on every
Thursday beginning on , 2003, the Business Day preceding the
dividend payment date for the initial rate period, and each subsequent dividend
period will normally begin on the following Friday. Thereafter, except during
special rate periods, auctions for the Series TH AMPS normally will be held
every seven days thereafter, and each subsequent dividend period for the Series
TH AMPS normally will begin on the following Business Day.
The following is a simplified example of how a typical auction works.
Assume that the Fund has 1,000 outstanding AMPS of a series and three current
holders of those shares. 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
all 500 shares if auction rate is for all 500 shares
less than 2.1%
Current Holder B.. Owns 300 shares, wants to hold Hold order--will take
the auction rate
Current Holder C.. Owns 200 shares, wants to sell Bid order of 1.9% rate
all 200 shares if auction rate is for all 200 shares
less than 1.9%
Potential Holder D Wants to buy 200 shares if Places order to buy
auction rate is 2.0% or above 200 shares at or above
2.0%
Potential Holder E Wants to buy 300 shares if Places order to buy
auction rate is 1.9% or above 300 shares at or above
1.9%
Potential Holder F Wants to buy 200 shares if Places order to buy
auction rate is 2.1% or above 200 shares at or above
2.1%
58
The lowest dividend rate that will result in all 1,000 AMPS continuing to
be held is 2.0% (the offer by D). Therefore, the dividend rate will be 2.0%.
Current holders B and C will continue to own their shares. Current holder A
will sell its shares because A's dividend rate bid was higher than the dividend
rate. Potential holder D will buy 200 shares and potential holder E will buy
300 shares because their bid rates were at or below the dividend rate.
Potential holder F will not buy any shares because its bid rate was above the
dividend rate.
The example above is not meant to be an indication of the dividend rates
that may be payable on the AMPS.
For further description of the auction procedures, please see Article 11
of the Amended Bylaws, which is attached as Appendix A to the SAI. In the event
of any conflict between the Amended Bylaws and the description of the AMPS and
the auction procedures in this prospectus or the SAI, the Amended Bylaws will
control.
Secondary Market Trading and Transfer of AMPS
The Underwriters are not required to make a market in the AMPS. The
Broker-Dealers (including the Underwriters) may maintain a secondary trading
market for the AMPS outside of auctions, but they are not required to do so.
There can be no assurance that a secondary trading market for AMPS will develop
or, if it does develop, that it will provide holders of AMPS with liquidity of
investment. AMPS will not be registered on any stock exchange or on the NASDAQ
market. Investors who purchase AMPS in an auction (particularly if the Fund has
declared a special rate period) should note that, because the dividend rate on
such shares will be fixed for the length of that dividend period, the value of
such shares may fluctuate in response to the changes in interest rates, and may
be more or less than their original cost if sold on the open market in advance
of the next auction thereof, depending on market conditions.
You may sell, transfer, or otherwise dispose of AMPS only in whole shares
and only:
. pursuant to a bid or sell order placed with the auction agent in
accordance with the auction procedures;
. to a Broker-Dealer; or
. to such other persons as may be permitted by the Fund; provided,
however, that (x) if you hold your AMPS in the name of a
Broker-Dealer, a sale or transfer of your AMPS to that Broker-Dealer,
or to another customer of that Broker-Dealer, will not be considered
a sale or transfer for purposes of the foregoing limitation if that
Broker-Dealer remains the existing holder of the AMPS immediately
after the transaction; and (y) in the case of all transfers, other
than through an auction, the Broker-Dealer (or other person, if the
Fund permits) receiving the transfer will advise the auction agent of
the transfer.
59
MANAGEMENT OF THE FUND
Trustees and Officers
The Board of Trustees is responsible for the management of the Fund,
including supervision of the duties performed by the Manager and PIMCO. There
are currently five Trustees of the Fund, one of whom is treated by the Fund as
an "interested person" (as defined in the 1940 Act). The names and business
addresses of the Trustees and officers of the Fund and their principal
occupations and other affiliations during the past five years are set forth
under "Management of the Fund" in the SAI.
Investment Manager
The Manager serves as the investment manager of the Fund. Subject to the
supervision of the Board of Trustees, the Manager is responsible for managing,
either directly or through others selected by it, the investment activities of
the Fund and the Fund's business affairs and other administrative matters. The
Manager is located at 1345 Avenue of the Americas, New York, New York 10105.
Organized in 2000 as a subsidiary successor of a business originally
organized in 1987, the Manager provides investment management and advisory
services to a number of closed-end and open-end investment company clients. As
of September 30, 2003, the Manager had approximately $27.7 billion in assets
under management. Allianz Dresdner Asset Management of America L.P. is the
direct parent company of PIMCO Advisors Retail Holdings LLC, of which the
Manager is a wholly-owned subsidiary. As of September 30, 2003, Allianz
Dresdner Asset Management of America L.P. and its subsidiaries, including
PIMCO, had approximately $415 billion in assets under management.
The Manager has retained its affiliate, PIMCO, to manage the Fund's
investments. See "--Portfolio Manager" below. The Manager and PIMCO are each
majority-owned indirect subsidiaries of Allianz AG, a publicly traded German
insurance and financial services company.
Portfolio Manager
PIMCO serves as the portfolio manager for the Fund. Subject to the
supervision of the Manager, PIMCO has full investment discretion and makes all
determinations with respect to the investment of the Fund's assets.
PIMCO is located at 840 Newport Center Drive, Newport Beach, California
92660. Organized in 1971, PIMCO provides investment management and advisory
services to private accounts of institutional and individual clients and to
mutual funds. As of September 30, 2003, PIMCO had approximately $357 billion in
assets under management.
The Manager (and not the Fund) will pay a portion of the fees it receives
to PIMCO in return for PIMCO's services. For the period from the commencement
of Fund operations through August 31, 2008 (i.e., roughly the first five years
of Fund operations), the fee will be paid monthly at the annual rate of .39% of
the Fund's average weekly total managed assets, provided, however, that the
amounts payable for each month shall be reduced to reflect that PIMCO will bear
65% of the fees payable by the Manager to certain underwriters involved in the
initial public offering of the Fund's Common Shares (other than Merrill Lynch)
for such month. Beginning September 1, 2008 and thereafter, the Manager will
pay a monthly fee to PIMCO at the annual rate of .55% of the Fund's average
weekly total managed assets, provided, however, that the amounts payable for
each month shall be reduced by the amount of all fees payable by the Manager to
the Common Share underwriters referenced above for such month (such that the
Manager retains from its management fee, on an annual basis, .05% of the Fund's
average weekly total managed assets, after having paid PIMCO and the
underwriters).
60
Bill Gross, a founder of PIMCO, serves as Managing Director and Chief
Investment Officer of PIMCO. In his role as Chief Investment Officer, he serves
as the head of the Investment Committee, which oversees setting investment
policy decisions, including duration positioning, yield curve management,
sector rotation, credit quality and overall portfolio composition, for all
PIMCO portfolios and strategies, including the Fund. The following individuals
at PIMCO share primary responsibility for the day-to-day portfolio management
of the Fund:
Name Since Recent Professional Experience
---- ---------- -----------------------------------------------------------------
Raymond G. Kennedy, CFA 2003 Mr. Kennedy is a Managing Director, portfolio manager and
(Inception) senior member of PIMCO's investment strategy group. He also
manages high yield funds and oversees bank loan trading and
collateralized debt obligations. Mr. Kennedy joined PIMCO in
1996, having previously been associated with the Prudential
Insurance Company of America as a private placement asset
manager, where he was responsible for investing and
managing a portfolio of investment grade and high yield
privately-placed fixed income securities. Prior to that, he was a
consultant for Arthur Andersen in Los Angeles and London.
He has 16 years of investment management experience and
holds a bachelor's degree from Stanford University and an
MBA from the Anderson Graduate School of Management at
the University of California, Los Angeles. Mr. Kennedy is also
a member of LSTA.
David C. Hinman, CFA... 2003 Mr. Hinman is an Executive Vice President and portfolio
(Inception) manager at PIMCO. He focuses on high yield corporate bonds
and co-manages high yield funds and structured-credit
products at PIMCO. He joined PIMCO in 1995, having been
previously associated with Merrill Lynch & Co. in New York
where he underwrote high yield corporate bonds. Prior to that,
he was a credit analyst with First Union Corporation. Mr.
Hinman has 11 years of investment management experience
and holds a bachelor's degree in Finance from the University
of Alabama and an MBA in Finance and Accounting from The
Wharton School at the University of Pennsylvania.
Jason R. Rosiak........ 2003 Mr. Rosiak is a Vice President and portfolio manager at
(Inception) PIMCO. He focuses on high yield corporate bonds and bank
loans, oversees the construction of PIMCO's Structured
Products and manages a trade desk research group. He joined
PIMCO in 1996, having been previously associated with
Bankers Trust NA, where he worked in their mortgage-backed
securities division. He has 8 years of investment management
experience and holds a bachelor's degree in Economics from
the University of California, Los Angeles and an MBA from
the Marshall School of Business at the University of Southern
California.
Mr. Kennedy oversees Messrs. Hinman and Rosiak regarding the management
of the Fund.
61
Investment Management Agreement
Pursuant to an investment management agreement between the Manager and
the Fund (the "Investment Management Agreement"), the Fund has agreed to pay
the Manager an annual management fee payable on a monthly basis at the annual
rate of .75% of the Fund's average weekly total managed assets (including
assets attributable to AMPS and any other forms of leverage that may be
outstanding) for the services and facilities it provides.
In addition to the fees of the Manager, the Fund pays all other costs and
expenses of its operations, including compensation of its Trustees (other than
those affiliated with the Manager), custodial expenses, shareholder servicing
expenses, transfer agency and dividend disbursing expenses, legal fees,
expenses of independent auditors, expenses of repurchasing shares, expenses of
issuing any AMPS, expenses of preparing, printing and distributing
prospectuses, shareholder reports, notices, proxy statements and reports to
governmental agencies, and taxes, if any.
Because the fees received by the Manager are based on the total managed
assets of the Fund (including assets attributable to AMPS and any other forms
of leverage that may be outstanding), the Manager has a financial incentive for
the Fund to issue AMPS and utilize other forms of leverage, which may create a
conflict of interest between the Manager and the Common Shareholders.
NET ASSET VALUE
The net asset value ("NAV") of the Fund equals the total value of the
Fund's portfolio investments and other assets, less any liabilities. For
purposes of calculating NAV, portfolio securities and other assets for which
market quotes are available are stated at market value. Market value is
generally determined on the basis of the last reported sales price or, if
available, the closing price reported for an issue traded on an
over-the-counter stock market (including the NASDAQ Official Closing Price for
NASD traded securities), or if no sales or closing prices are reported, based
on quotes obtained from a quotation reporting system, established market makers
or pricing services. Certain securities or investments for which market
quotations are not readily available (such as most Senior Loans) may be valued,
pursuant to guidelines established by the Board of Trustees, with reference to
other securities or indexes. For instance, a pricing service may recommend a
fair market value based on prices of comparable securities. Short-term
investments having a maturity of 60 days or less are generally valued at
amortized cost. Exchange traded options, futures and options on futures are
valued at the settlement price determined by the exchange. Other securities for
which market quotes are not readily available are valued at fair value as
determined in good faith by the Board of Trustees or persons acting at their
direction.
The NAV of the Fund will be determined weekly, generally on the last day
of the week that the New York Stock Exchange is open for trading, as of the
close of regular trading on the New York Stock Exchange that day (normally 4:00
p.m., Eastern time) (the "NYSE Close"). Domestic debt securities and foreign
securities are normally priced using data reflecting the earlier closing of the
principal markets for those securities. Information that becomes known to the
Fund or its agent after the Fund's NAV has been calculated on a particular day
will not be used to retroactively adjust the price of a security or the Fund's
NAV determined earlier that day.
Investments initially valued in currencies other than the U.S. dollar are
converted to U.S. dollars using exchange rates obtained from pricing services.
As a result, the NAV of the Fund's shares may be affected by changes in the
value of currencies in relation to the U.S. dollar. The value of securities
traded in markets outside the United States or denominated in currencies other
than the U.S. dollar may be affected significantly on a day that the New York
Stock Exchange is closed.
62
In unusual circumstances, instead of valuing securities in the usual
manner, the Fund may value securities at fair value as determined in good faith
by the Board of Trustees, generally based upon recommendations provided by
PIMCO. Fair valuation also may be required due to material events that occur
after the close of the relevant market but prior to the NYSE Close.
TAX MATTERS
Federal Income Tax Matters
The following federal income tax discussion is based on the advice of
Ropes & Gray LLP, counsel to the Fund, and reflects provisions of the Code,
existing U.S. Treasury regulations, rulings published by the IRS, and other
applicable authority, as of the date of this prospectus. These authorities are
subject to change by legislative or administrative action, possibly with
retroactive effect. The following discussion is only a summary of some of the
important tax considerations generally applicable to investments in the Fund.
For more detailed information regarding tax considerations, see the SAI. There
may be other tax considerations applicable to particular investors. In
addition, income earned through an investment in the Fund may be subject to
state, local and foreign taxes.
The Fund intends to elect to be treated and to qualify each year for
taxation as a regulated investment company eligible for treatment under the
provisions of Subchapter M of the Code. If the Fund so qualifies and satisfies
certain distribution requirements, the Fund will not be subject to federal
income tax on income distributed in a timely manner to its shareholders in the
form of dividends or capital gain distributions.
In order for any portion of any distributions to holders of AMPS to be
eligible for favorable tax treatment (in this instance, capital gain
dividends), the AMPS must be treated as equity for federal income tax purposes.
Based in part on certain representations made by the Fund to Ropes & Gray LLP
relating to the lack of any present intention to redeem or purchase AMPS at any
time in the future, it is the opinion of Ropes & Gray LLP that the AMPS will
constitute equity for federal income tax purposes. This opinion relies in part
on a published ruling of the IRS stating that certain auction preferred stock
similar in many material respects to the
AMPS represents equity. The opinion of Ropes & Gray LLP represents only its
best legal judgment and is not binding on the IRS or the courts. If the IRS
were to assert successfully that variable rate preferred stock such as the AMPS
should be treated as debt for federal income tax purposes, distributions on
AMPS (including distributions designated by the Fund as capital gain dividends)
would be interest income (as opposed to dividend income or capital gain). Ropes
& Gray LLP has advised the Fund that, should the IRS pursue in court the
position that the AMPS should be treated as debt for federal income tax
purposes, the IRS would be unlikely to prevail.
To satisfy the distribution requirements applicable to regulated
investment companies, amounts paid as dividends by the Fund to its
shareholders, including holders of AMPS, must qualify for the dividends-paid
deduction. If the Fund realizes a long-term capital gain, it will be required
to allocate such gain between and among the Common Shares and any AMPS issued
by the Fund in proportion to the total dividends paid to each class during the
year in which the income is realized. In certain circumstances, the IRS could
take the position that dividends paid on the AMPS constitute preferential
dividends under Section 562(c) of the Code, and thus do not qualify for the
dividends-paid deduction. The Fund believes this position, if asserted, would
be unlikely to prevail.
If at any time when AMPS are outstanding the Fund does not meet
applicable asset coverage requirements, it will be required to suspend
distributions to Common Shareholders until the requisite asset coverage is
restored. Any such suspension may cause the Fund to pay a 4% federal excise tax
(imposed on regulated investment companies that fail to distribute for a given
calendar year, generally, at least 98% of their net investment income and
capital gain net income) and income tax on undistributed income or gains, and
may,
63
in certain circumstances, prevent the Fund from qualifying for treatment as a
regulated investment company. The Fund may redeem AMPS in an effort to comply
with the distribution requirement applicable to regulated investment companies
and to avoid income and excise taxes. The Fund may have to dispose of portfolio
securities to generate cash for such redemption, which may result in
transaction expenses and gain at the Fund level and in further distributions.
The Fund's investments in certain debt obligations may cause the Fund to
recognize taxable income in excess of the cash generated by such obligations.
Thus, the Fund could be required at times to liquidate other investments in
order to satisfy its distribution requirements.
For federal income tax purposes, distributions of investment income
generally are taxable as ordinary income. Taxes on distributions of capital
gains are determined by how long the Fund owned the investments that generated
them, rather than how long a shareholder has owned his or her shares.
Distributions of net capital gains from the sale of investments that the Fund
owned for more than one year and that are properly designated by the Fund as
capital gain dividends will be taxable as long-term capital gains.
Distributions of gains from the sale of investments that the Fund owned for one
year or less will be taxable as ordinary income. For taxable years beginning on
or before December 31, 2008, distributions of investment income designated by
the Fund as derived from "qualified dividend income" will be taxed in the hands
of individuals at the rates applicable to long-term capital gain, provided
holding period and other requirements are met at both the shareholder and Fund
level. The Fund does not expect a significant portion of Fund distributions to
be derived from qualified dividend income.
Distributions are taxable to shareholders even if they are paid from
income or gains earned by the Fund before a shareholder's investment (and thus
were included in the price the shareholder paid). Any gain resulting from the
sale or exchange of Fund shares generally will be taxable as capital gain.
Long-term capital gain rates applicable to individuals have been
temporarily reduced - in general, to 15% with lower rates applying to taxpayers
in the 10% and 15% brackets - for taxable years beginning on or before December
31, 2008.
The Fund's investments in foreign securities may be subject to foreign
withholding taxes. In that case, the Fund's yield on those securities would be
decreased. Shareholders will not be entitled to claim a credit or deduction
with respect to foreign taxes paid by the Fund. In addition, the Fund's
investments in foreign securities or foreign currencies may increase or
accelerate the Fund's recognition of ordinary income and may affect the timing
or amount of the Fund's distributions.
Under current law, the backup withholding tax rate is 28% for amounts
paid through 2010. The Fund may be required to apply backup withholding to
taxable distributions or redemption proceeds payable to a shareholder. Please
see "Tax Matters" in the SAI for additional information about (and changes to)
the new backup withholding tax rates.
If, in connection with the designation of a Special Rate Period, (i) the
Fund provides in a Notice of Special Rate Period that the Fund may redeem all
or part of a series of AMPS and that upon such redemption the holders of that
series of AMPS may receive a premium in addition to receipt of a redemption
price per share equal to the sum of $25,000 plus an amount equal to the
accumulated but unpaid dividends thereon during the whole or any part of the
Special Rate Period, (ii) based on all the facts and circumstances at the time
of the designation of the Special Rate Period the Fund is more likely than not
to redeem such series of AMPS during the Special Rate Period, and (iii) the
premium to be paid upon redemption during such Special Rate Period exceeds a
specified de minimis amount, it is possible that the holders of such series
will be required to accrue the premium as a dividend (to the extent of the
Fund's earnings and profits).
64
This section relates only to federal income tax consequences of investing
in the Fund; the consequences under other tax laws may differ. You should
consult your tax advisor as to the possible application of foreign, state and
local income tax laws to Fund dividends and capital distributions. Please see
"Tax Matters" in the SAI for additional information regarding the tax aspects
of investing in the Fund.
DESCRIPTION OF CAPITAL STRUCTURE
The Fund is an unincorporated business trust established under the laws
of The Commonwealth of Massachusetts by the Declaration. The Declaration
provides that the Trustees of the Fund may authorize separate classes of shares
of beneficial interest. The Trustees have authorized an unlimited number of
common shares of beneficial interest and preferred shares of beneficial
interest. Preferred shares (such as the AMPS) may be issued in one or more
series, with such par value and with such rights as determined by the Board of
Trustees, by action of the Board of Trustees without the approval of the Common
Shareholders. For a description of the AMPS, see "Description of AMPS" above.
The following table shows the amount of (i) shares authorized and (ii) shares
outstanding, for each class of authorized securities of the Fund as of October
14, 2003:
Amount Amount
Title of Class Authorized Outstanding
-------------- ---------- ------------
Common Shares . . ...... Unlimited 17,755,168
AMPS
Series T . . . . . .. 2,800* 0
Series W . . . . .... 2,800* 0
Series TH . . . ..... 2,800* 0
--------
* Assumes the authorization of 8,400 AMPS by the Board of Trustees prior to
issuance of the AMPS.
Holders of Common Shares are entitled to share equally in dividends
declared by the Board of Trustees payable to holders of Common Shares and in
the net assets of the Fund available for distribution to holders of Common
Shares after payment of the preferential amounts payable to holders of any
outstanding preferred shares of beneficial interest. Neither holders of Common
Shares nor holders of preferred shares have preemptive or conversion rights or
have the right to cause the Fund to redeem their shares. Upon liquidation of
the Fund, after paying or adequately providing for the payment of all
liabilities of the Fund and the liquidation preference with respect to any
outstanding preferred shares, and upon receipt of such releases, indemnities
and refunding agreements as they deem necessary for their protection, the
Trustees may distribute the remaining assets of the Fund among the holders of
the Fund's Common Shares.
Pursuant to the Fund's Dividend Reinvestment Plan, all Common
Shareholders whose shares are registered in their own names will have all
dividends, including any capital gain dividends, reinvested automatically in
additional Common Shares by PFPC Inc., as agent for the Common Shareholders,
unless the shareholder elects to receive cash. The Fund and PFPC Inc. reserve
the right to amend or terminate the Dividend Reinvestment Plan.
Holders of Common Shares are entitled to one vote for each share held and
will vote with the holders of any outstanding AMPS or other preferred shares on
each matter submitted to a vote of holders of Common Shares, except as
described under "Description of AMPS--Voting Rights" and except as otherwise
required by the Declaration, the Amended Bylaws or applicable law.
Shareholders of each class are entitled to one vote for each share held.
Except as provided under "Description of AMPS--Voting Rights" and except as
otherwise required by the Declaration, the Amended Bylaws or applicable law,
holders of AMPS are (voting as a separate class) entitled to elect two
trustees, and the remaining trustees shall be elected by holders of Common
Shares and AMPS, voting as a single class.
65
So long as any AMPS 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 AMPS and any other preferred shares of beneficial
interest or accrued interest on borrowings (if any) have been paid and (2) the
value of the Fund's total assets (determined after deducting the amount of such
dividend or other distribution), less all liabilities and indebtedness of the
Fund not represented by senior securities, is at least 300% of the aggregate
amount of senior securities representing indebtedness and at least 200% of the
aggregate amount of senior securities representing indebtedness plus the
aggregate liquidation value of the outstanding preferred shares (expected to
equal the aggregate original purchase price of the outstanding preferred shares
plus the redemption premium, if any, together with any accrued and unpaid
dividends thereon, whether or not earned or declared and on a cumulative
basis). In addition to the requirements of the 1940 Act, the Fund is required
to comply with other asset coverage requirements as a condition of the Fund
obtaining a rating of the AMPS from a rating agency. These requirements include
an asset coverage test more stringent than under the 1940 Act. See "Description
of AMPS--Dividends--Restrictions on Dividends and Other Distributions."
The Fund will send unaudited reports at least semi-annually and audited
financial statements annually to all of its shareholders.
The Common Shares of the Fund commenced trading on the NYSE on August 29,
2003. As of October 10, 2003, the net asset value per share of Common Shares
was $19.42, and the closing price per share of Common Shares on the NYSE was
$20.03.
Other Issues Relating to AMPS
Under the 1940 Act, the Fund is permitted to have outstanding more than
one series of preferred shares of beneficial interest as long as no single
series has priority over another series as to the distribution of assets of the
Fund or the payment of dividends. Neither holders of Common Shares nor holders
of preferred shares have pre-emptive rights to purchase any AMPS or any other
preferred shares that might be issued. It is anticipated that the net asset
value per Preferred Share will equal its original purchase price per share plus
accumulated dividends per share.
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST
The Declaration and Amended Bylaws include provisions that could limit
the ability of other entities or persons to acquire control of the Fund or to
convert the Fund to open-end status. The Fund's Trustees are divided into three
classes. At each annual meeting of shareholders, the term of one class will
expire and each Trustee elected to that class will hold office for a term of
three years. The classification of the Board of Trustees in this manner could
delay for an additional year the replacement of a majority of the Board of
Trustees. In addition, the Declaration provides that a Trustee may be removed
only for cause and only (i) by action of at least seventy-five percent (75%) of
the outstanding shares of the classes or series of shares entitled to vote for
the election of such Trustee, or (ii) by at least seventy-five percent (75%) of
the remaining Trustees.
As described below, the Declaration grants special approval rights with
respect to certain matters to members of the Board who qualify as "Continuing
Trustees," which term means a Trustee who either (i) has been a member of the
Board for a period of at least thirty-six months (or since the commencement of
the Fund's operations, if less than thirty-six months) or (ii) was nominated to
serve as a member of the Board of Trustees by a majority of the Continuing
Trustees then members of the Board.
The Declaration requires the affirmative vote or consent of at least
seventy-five percent (75%) of the Board of Trustees and holders of at least
seventy-five percent (75%) of the Fund's shares (including common and preferred
shares of beneficial interest) to authorize certain Fund transactions not in
the ordinary course of
66
business, including a merger or consolidation, issuance or transfer by the Fund
of the Fund's shares (except as may be pursuant to a public offering, the
Fund's dividend reinvestment plan or upon exercise of any stock subscription
rights), a sale, transfer or other disposition of Fund assets, or any
shareholder proposal regarding specific investment decisions, unless the
transaction is authorized by both a majority of the Trustees and seventy-five
percent (75%) of the Continuing Trustees (in which case no shareholder
authorization would be required by the Declaration, but may be required in
certain cases under the 1940 Act). The Declaration also requires the
affirmative vote or consent of holders of at least seventy-five percent (75%)
of each class of the Fund's shares entitled to vote on the matter to authorize
a conversion of the Fund from a closed-end to an open-end investment company,
unless the conversion is authorized by both a majority of the Trustees and
seventy-five percent (75%) of the Continuing Trustees (in which case
shareholders would have only the minimum voting rights required by the 1940 Act
with respect to the conversion). Also, the Declaration provides that the Fund
may be terminated at any time by vote or consent of at least seventy-five
percent (75%) of the Fund's shares or, alternatively, by vote or consent of
both a majority of the Trustees and seventy-five percent (75%) of the
Continuing Trustees. See "Anti-Takeover and Other Provisions in the Declaration
of Trust" in the SAI for a more detailed summary of these provisions.
The Trustees may from time to time grant other voting rights to
shareholders with respect to these and other matters in the Fund's Amended
Bylaws certain of which are required by the 1940 Act. For example, the Amended
Bylaws grant holders of AMPS and any other preferred shares special voting
rights with respect to certain matters described in the preceding paragraph.
See "Description of AMPS--Voting Rights."
The overall effect of these provisions is to render more difficult the
accomplishment of a merger or the assumption of control by a third party. These
provisions also provide, however, the advantage of potentially requiring
persons seeking control of the Fund to negotiate with its management regarding
the price to be paid and facilitating the continuity of the Fund's investment
objective and policies. The provisions of the Declaration and Amended Bylaws
described above could have the effect of discouraging a third party from
seeking to obtain control of the Fund in a tender offer or similar transaction.
The Board of Trustees of the Fund has considered the foregoing anti-takeover
provisions and concluded that they are in the best interests of the Fund and
its Common Shareholders.
The foregoing is intended only as a summary and is qualified in its
entirety by reference to the full text of the Declaration and the form of the
Fund's Amended Bylaws, both of which are on file with the Securities and
Exchange Commission.
Under Massachusetts law, shareholders could, in certain circumstances, be
held personally liable for the obligations of the Fund. However, the
Declaration contains an express disclaimer of shareholder liability for debts
or obligations of the Fund and requires that notice of such limited liability
be given in each agreement, obligation or instrument entered into or executed
by the Fund or the Trustees. The Declaration further provides for
indemnification out of the assets and property of the Fund for all loss and
expense of any shareholder held personally liable for the obligations of the
Fund. Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which the Fund would be
unable to meet its obligations. The Fund believes that the likelihood of such
circumstances is remote.
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such holders of its
Common Shares do not have the right to cause the Fund to redeem their shares.
Instead, the Common Shares trade in the open market at a price that is a
function of several factors, including dividend levels (which are in turn
affected by changes in the floating rates of interest on the Fund's investments
and expenses), net asset value, call protection, portfolio credit quality,
relative demand for and supply of such shares in the market, general market and
economic conditions, conditions affecting individual issuers and other factors.
Shares of a closed-end investment company may
67
frequently trade at prices lower than net asset value. The Fund's Board of
Trustees regularly monitors the relationship between the market price and net
asset value of the Common Shares. If the Common Shares were to trade at a
substantial discount to net asset value for an extended period of time, the
Board may consider the repurchase of its Common Shares on the open market or in
private transactions, the making of a tender offer for such shares, or the
conversion of the Fund to an open-end investment company. The Fund cannot
assure you that its Board of Trustees will decide to take or propose any of
these actions, or that share repurchases or tender offers will actually reduce
market discount.
If the Fund were to convert to an open-end company, it would be required
to redeem all AMPS and other preferred shares then outstanding (requiring in
turn that it liquidate a portion of its investment portfolio), and the Common
Shares would no longer be listed on the New York Stock Exchange. In contrast to
a closed-end investment company, shareholders of an open-end investment company
may require the company to redeem their shares at any time (except in certain
circumstances as authorized by or under the 1940 Act) at their net asset value,
less any redemption charge that is in effect at the time of redemption.
Before deciding whether to take any action to convert the Fund to an
open-end investment company, the Board would consider all relevant factors,
including the extent and duration of the discount, the liquidity of the Fund's
portfolio, the impact of any action that might be taken on the Fund or its
shareholders, and market considerations. Based on these considerations, even if
the Fund's shares should trade at a discount, the Board of Trustees may
determine that, in the interest of the Fund and its shareholders, no action
should be taken. See the SAI under "Repurchase of Common Shares; Conversion to
Open-End Fund" for a further discussion of possible action to reduce or
eliminate such discount to net asset value.
68
UNDERWRITING
Subject to the terms and conditions of a purchase agreement dated
, 2003, each Underwriter named below has agreed to purchase, and the
Fund has agreed to sell to such Underwriter, the number of AMPS set forth
opposite the name of such Underwriter.
Number of AMPS
---------------------------
Underwriter Series T Series W Series TH
----------- -------- -------- ---------
Merrill Lynch, Pierce, Ferrer & Smith
Incorporated................
Wachovia Capital Markets, LLC........
A.G. Edwards & Sons, Inc.............
Quick & Reilly, Inc..................
------- ------- -------
Total....................... 2,800 2,800 2,800
======= ======= =======
The purchase agreement provides that the obligations of the Underwriters
to purchase the shares included in this offering are subject to the approval of
certain legal matters by counsel and to other conditions, including, without
limitation, the receipt by the Underwriters of customary closing certificates,
opinions and other documents and the receipt by the Fund of an "Aaa" rating on
the AMPS from Moody's and of an "AAA" rating on the AMPS from Fitch Ratings as
of the time of the offering. The Underwriters are obligated to purchase all the
AMPS sold under the purchase agreement if they purchase any of the AMPS. In the
purchase agreement, the Fund and the Manager have agreed to indemnify the
Underwriters against certain liabilities, including certain liabilities arising
under the Securities Act of 1933, as amended, or to contribute to payments the
Underwriters may be required to make for any of those liabilities.
The Underwriters propose to initially offer some of the AMPS directly to
the public at the public offering price set forth on the cover page of this
prospectus and some of the AMPS to certain dealers at the public offering price
less a concession not in excess of $ per share. The sales load the Fund
will pay of $250 per share is equal to 1% of the initial offering price of the
AMPS. After the initial public offering, the underwriters may change the public
offering price and the concession. Investors must pay for any AMPS purchased on
or before , 2003.
The Fund anticipates that the Underwriters may from time to time act as
brokers or dealers in executing the Fund's portfolio transactions after they
have ceased to be Underwriters. The Underwriters are active underwriters of,
and dealers in, securities and act as market makers in a number of such
securities, and therefore can be expected to engage in portfolio transactions
with, and perform services for, the Fund.
The Fund anticipates that the Underwriters or their affiliates may, from
time to time, act in auctions as broker-dealers and receive fees as set forth
under "Description of AMPS--The Auction" and in the SAI.
The principal business address of Merrill Lynch, Pierce, Fenner & Smith
Incorporated is 4 World Financial Center, New York, New York 10080.
The settlement date for the purchase of the AMPS will be ,
2003, as agreed upon by the Underwriters, the Fund and Manager pursuant to Rule
15c6-1 under the Securities Exchange Act of 1934.
CUSTODIAN AND TRANSFER AGENT
The custodian of the assets of the Fund is State Street Bank and Trust
Co., 801 Pennsylvania Avenue, Kansas City, Missouri 64105. The Custodian
performs custodial and fund accounting services.
Deutsche Bank Trust Company Americas, 280 Park Avenue, 9/th/ Floor, New
York, NY 10017, serves as the Fund's transfer agent, registrar, dividend paying
agent and redemption agent.
69
LEGAL MATTERS
Certain legal matters in connection with the AMPS will be passed upon for
the Fund by Ropes & Gray LLP, Boston, Massachusetts, and for the Underwriters
by Clifford Chance US LLP, New York, New York. Clifford Chance US LLP may rely
as to certain matters of Massachusetts law on the opinion of Ropes & Gray LLP.
70
TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION
Page
----
Use of Proceeds................................................. 1
Investment Objective and Policies............................... 1
Investment Restrictions......................................... 47
Management of the Fund.......................................... 49
Investment Manager and Portfolio Manager........................ 61
Portfolio Transactions.......................................... 66
Distributions................................................... 68
Description of Shares........................................... 68
Additional Information Concerning the Auctions for AMPS......... 70
Anti-Takeover and Other Provisions in the Declaration of Trust.. 71
Repurchase of Common Shares; Conversion to Open-End Fund........ 73
Tax Matters..................................................... 75
Performance Related and Comparative Information................. 83
Custodian, Transfer Agent and Dividend Paying Agent............. 84
Independent Auditors............................................ 84
Counsel......................................................... 84
Registration Statement.......................................... 84
Financial Statements............................................ 85
Appendix A--Article 11 of the Second Amended and Restated Bylaws A-1
Appendix B--Proxy Voting Policies and Procedures................ B-1
71
APPENDIX A
DESCRIPTION OF SECURITIES RATINGS
The Fund's investments may range in quality from securities rated in the
lowest category to securities rated in the highest category (as rated by
Moody's, S&P, Fitch Ratings, or Dominion or, if unrated, judged by PIMCO to be
of comparable quality). The percentage of a Fund's assets invested in
securities in a particular rating category will vary. The following terms are
generally used to describe the credit quality of debt securities:
High Quality Debt Securities are those rated in one of the two highest
rating categories (the highest category for commercial paper) or, if unrated,
deemed comparable by PIMCO.
Investment Grade Debt Securities are those rated in one of the four
highest rating categories or, if unrated, deemed comparable by PIMCO.
Below Investment Grade, High Yield Securities ("Junk Bonds") are those
rated lower than Baa by Moody's, BBB by S&P, Fitch Ratings, or Dominion, and
comparable securities. They are deemed predominantly speculative with respect
to the issuer's ability to repay principal and interest.
Following is a description of Moody's, S&P's, Fitch Ratings', and
Dominion's rating categories applicable to debt securities.
Moody's Investors Service, Inc.
Corporate and Municipal Bond Ratings
Aaa: Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high-grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present that make the long-term risks appear somewhat larger than with Aaa
securities.
A: Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper-medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present that suggest a susceptibility to impairment sometime in the future.
Baa: Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba: Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
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B: Bonds which are rated B generally lack characteristics of a desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest.
Ca: Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing.
Moody's bond ratings, where specified, are applicable to financial
contracts, senior bank obligations and insurance company senior policyholder
and claims obligations with an original maturity in excess of one year.
Obligations relying upon support mechanisms such as letter-of-credit and bonds
of indemnity are excluded unless explicitly rated. Obligations of a branch of a
bank are considered to be domiciled in the country in which the branch is
located.
Unless noted as an exception, Moody's rating on a bank's ability to repay
senior obligations extends only to branches located in countries which carry a
Moody's Sovereign Rating for Bank Deposits. Such branch obligations are rated
at the lower of the bank's rating or Moody's Sovereign Rating for the Bank
Deposits for the country in which the branch is located. When the currency in
which an obligation is denominated is not the same as the currency of the
country in which the obligation is domiciled, Moody's ratings do not
incorporate an opinion as to whether payment of the obligation will be affected
by the actions of the government controlling the currency of denomination. In
addition, risk associated with bilateral conflicts between an investor's home
country and either the issuer's home country or the country where an issuer
branch is located are not incorporated into Moody's ratings.
Moody's makes no representation that rated bank obligations or insurance
company obligations are exempt from registration under the U.S. Securities Act
of 1933 or issued in conformity with any other applicable law or regulation.
Nor does Moody's represent any specific bank or insurance company obligation is
legally enforceable or a valid senior obligation of a rated issuer.
Moody's applies numerical modifiers, 1, 2, and 3, in each generic rating
classified from Aa through Caa in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
Corporate Short-Term Debt Ratings
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
PRIME-1: Issuers rated Prime-1 (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of the following
characteristics: leading market positions in well-established industries; high
rates of return on funds employed;
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conservative capitalization structure with moderate reliance on debt and ample
asset protection; broad margins in earnings coverage of fixed financial charges
and high internal cash generation; and well-established access to a range of
financial markets and assured sources of alternate liquidity.
PRIME-2: Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
PRIME-3: Issuers rated Prime-3 (or supporting institutions) have an
acceptable ability for repayment of senior short-term obligations. The effect
of industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require relatively high financial
leverage. Adequate alternate liquidity is maintained.
NOT PRIME: Issuers rated Not Prime do not fall within any of the Prime
rating categories.
Standard & Poor's
Issue Credit Rating Definitions
A Standard & Poor's issue credit rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations, or a specific financial program
(including ratings on medium term note programs and commercial paper programs).
It takes into consideration the creditworthiness of guarantors, insurers, or
other forms of credit enhancement on the obligation and takes into account the
currency in which the obligation is denominated. The issue credit rating is not
a recommendation to purchase, sell, or hold a financial obligation, inasmuch as
it does not comment as to market price or suitability for a particular investor.
Issue credit ratings are based on current information furnished by the
obligors or obtained by Standard & Poor's from other sources it considers
reliable. Standard & Poor's does not perform an audit in connection with any
credit rating and may, on occasion, rely on unaudited financial information.
Credit ratings may be changed, suspended, or withdrawn as a result of changes
in, or unavailability of, such information, or based on other circumstances.
Issue credit ratings can be either long-term or short-term. Short-term
ratings are generally assigned to those obligations considered short-term in
the relevant market. In the U.S., for example, that means obligations with an
original maturity of no more than 365 days--including commercial paper.
Short-term ratings are also used to indicate the creditworthiness of an obligor
with respect to put features on long-term obligations. The result is a dual
rating, in which the short-term rating addresses the put feature, in addition
to the usual long-term rating. Medium-term notes are assigned long-term ratings.
Issue credit ratings are based, in varying degrees, on the following
considerations: likelihood of payment--capacity and willingness of the obligor
to meet its financial commitment on an obligation in accordance with the terms
of the obligation; nature of and provisions of the obligation; protection
afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization, or other arrangement under the laws of bankruptcy
and other laws affecting creditors' rights.
The issue rating definitions are expressed in terms of default risk. As
such, they pertain to senior obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to reflect the lower priority in
bankruptcy, as noted above. (Such differentiation applies when an entity has
both senior and
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subordinated obligations, secured and unsecured obligations, or operating
company and holding company obligations.) Accordingly, in the case of junior
debt, the rating may not conform exactly with the category definition.
Corporate and Municipal Bond Ratings
Investment Grade
AAA: An obligation rated AAA has the highest rating assigned by Standard
& Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA: An obligation rated AA differs from the highest rated obligations
only in small degree. The obligor's capacity to meet its financial commitment
on the obligation is very strong.
A: An obligation rated A is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations in
higher rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB: An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing \circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
Speculative Grade
Obligations rated BB, B, CCC, CC, and C are regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. BB indicates the least degree of speculation and
C the highest. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major exposures
to adverse conditions.
BB: An obligation rated BB is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B: An obligation rated B is more vulnerable to nonpayment than
obligations rated BB, but the obligor currently has the capacity to meet its
financial commitment on the obligation. Adverse business, financial, or
economic conditions will likely impair the obligor's capacity or willingness to
meet its financial commitment on the obligation.
CCC: An obligation rated CCC is currently vulnerable to nonpayment, and
is dependent upon favorable business, financial, and economic conditions for
the obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC: An obligation rated CC is currently highly vulnerable to nonpayment.
C: A subordinated debt or preferred stock obligation rated C is CURRENTLY
HIGHLY VULNERABLE to nonpayment. The C rating may be used to cover a situation
where a bankruptcy petition has been filed or similar action taken, but
payments on this obligation are being continued. A C also will be assigned to a
preferred stock issue in arrears on dividends or sinking fund payments, but
that is currently paying.
CI: The rating CI is reserved for income bonds on which no interest is
being paid.
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D: An obligation rated D is in payment default. The D rating category is
used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poor's believes that
such payments will be made during such grace period. The D rating also will be
used upon the filing of a bankruptcy petition or the taking of a similar action
if payments on an obligation are jeopardized.
Plus (+) or Minus (-): The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Provisional ratings: The letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of the
project being financed by the debt being rated and indicates that payment of
debt service requirements is largely or entirely dependent upon the successful
and timely completion of the project. This rating, however, while addressing
credit quality subsequent to completion of the project, makes no comment on the
likelihood of, or the risk of default upon failure of, such completion. The
investor should exercise his own judgment with respect to such likelihood and
risk.
r: This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk--such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
The absence of an "r" symbol should not be taken as an indication that an
obligation will exhibit no volatility or variability in total return.
N.R.: This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that Standard & Poor's
does not rate a particular obligation as a matter of policy.
Debt obligations of issuers outside the United States and its territories
are rated on the same basis as domestic corporate and municipal issues. The
ratings measure the creditworthiness of the obligor but do not take into
account currency exchange and related uncertainties.
Commercial Paper Rating Definitions
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt having an original maturity of no more
than 365 days. Ratings are graded into several categories, ranging from A for
the highest quality obligations to D for the lowest. These categories are as
follows:
A-1: A short-term obligation rated A-1 is rated in the highest category
by Standard & Poor's. The obligor's capacity to meet its financial commitment
on the obligation is strong. Within this category, certain obligations are
designated with a plus sign (+). This indicates that the obligor's capacity to
meet its financial commitment on these obligations is extremely strong.
A-2: A short-term obligation rated A-2 is somewhat more susceptible to
the adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to
meet its financial commitment on the obligation is satisfactory.
A-3: A short-term obligation rated A-3 exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
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
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ongoing uncertainties which could lead to the obligor's inadequate capacity to
meet its financial commitment on the obligation.
C: A short-term obligation rated C is currently vulnerable to nonpayment
and is dependent upon favorable business, financial, and economic conditions
for the obligor to meet its financial commitment on the obligation.
D: A short-term obligation rated D is in payment default. The D rating
category is used when payments on an obligation are not made on the date due
even if the applicable grace period has not expired, unless Standard & Poor's
believes that such payments will be made during such grace period. The D rating
also will be used upon the filing of a bankruptcy petition or the taking of a
similar action if payments on an obligation are jeopardized.
A commercial paper rating is not a recommendation to purchase, sell or
hold a security inasmuch as it does not comment as to market price or
suitability for a particular investor. The ratings are based on current
information furnished to Standard & Poor's by the issuer or obtained from other
sources it considers reliable. Standard & Poor's does not perform an audit in
connection with any rating and may, on occasion, rely on unaudited financial
information. The ratings may be changed, suspended, or withdrawn as a result of
changes in or unavailability of such information.
Fitch, Inc.
A brief description of the applicable Fitch Ratings' ratings symbols and
meanings (as published by Fitch Ratings) follows:
Long-Term Credit Ratings
Investment Grade
AAA: Highest credit quality. "AAA" ratings denote the lowest expectation
of credit risk. They are assigned only in case of exceptionally strong capacity
for timely payment of financial commitments. This capacity is highly unlikely
to be adversely affected by foreseeable events.
AA: Very high credit quality. "AA" ratings denote a very low expectation
of credit risk. They indicate very strong capacity for timely payment of
financial commitments. This capacity is not significantly vulnerable to
foreseeable events.
A: High credit quality. "A" ratings denote a low expectation of credit
risk. The capacity for timely payment of financial commitments is considered
strong. This capacity may, nevertheless, be more vulnerable to changes in
circumstances or in economic conditions than is the case for higher ratings.
BBB: Good credit quality. "BBB" ratings indicate that there is currently
a low expectation of credit risk. The capacity for timely payment of financial
commitments is considered adequate, but adverse changes in circumstances and in
economic conditions are more likely to impair this capacity. This is the lowest
investment-grade category.
Speculative Grade
BB: Speculative. "BB" ratings indicate that there is a possibility of
credit risk developing, particularly as the result of adverse economic change
over time; however, business or financial alternatives may be available to
allow financial commitments to be met. Securities rated in this category are
not investment grade.
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B: Highly speculative. "B" ratings indicate that significant credit risk
is present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is contingent upon
a sustained, favorable business and economic environment.
CCC, CC, C: High default risk. Default is a real possibility. Capacity
for meeting financial commitments is solely reliant upon sustained, favorable
business or economic developments. A "CC" rating indicates that default of some
kind appears probable. "C" ratings signal imminent default.
DDD, DD, D: Default. The ratings of obligations in this category are
based on their prospects for achieving partial or full recovery in a
reorganization or liquidation of the obligor. While expected recovery values
are highly speculative and cannot be estimated with any precision, the
following serve as general guidelines. "DDD" obligations have the highest
potential for recovery, around 90%-100% of outstanding amounts and accrued
interest. "DD" indicates potential recoveries in the range of 50%-90%, and "D"
the lowest recovery potential, i.e., below 50%. Entities rated in this category
have defaulted on some or all of their obligations. Entities rated "DDD" have
the highest prospect for resumption of performance or continued operation with
or without a formal reorganization process. Entities rated "DD" and "D" are
generally undergoing a formal reorganization or liquidation process; those
rated "DD" are likely to satisfy a higher portion of their outstanding
obligations, while entities rated "D" have a poor prospect for repaying all
obligations.
Short-Term Credit Ratings
A short-term rating has a time horizon of less than 12 months for most
obligations, or up to three years for U.S. public finance securities, and thus
places greater emphasis on the liquidity necessary to meet financial
commitments in a timely manner.
F1: Highest credit quality . Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
F2: Good credit quality. A satisfactory capacity for timely payment of
financial commitments, but the margin of safety is not as great as in the case
of the higher ratings.
F3: Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.
B: Speculative. Minimal capacity for timely payment of financial
commitments, plus vulnerability to near-term adverse changes in financial and
economic conditions.
C: High default risk. Default is a real possibility. Capacity for meeting
financial commitments is solely reliant upon a sustained, favorable business
and economic environment.
D: Default. Denotes actual or imminent payment default.
"+" or "-" may be appended to a rating to denote relative status within
major rating categories. Such suffixes are not added to the "AAA" long-term
rating category, to categories below "CCC," or to short-term ratings other than
"F1."
"NR" indicates that Fitch Ratings does not rate the issuer or issue in
question.
Withdrawn: A rating is withdrawn when Fitch Ratings deems the amount of
information available to be inadequate for rating purposes, or when an
obligation matures, is called, or refinanced.
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Rating Watch: Ratings are placed on Rating Watch to notify investors that
there is a reasonable probability of a rating change and the likely direction
of such change. These are designated as "Positive", indicating a potential
upgrade, "Negative," for a potential downgrade, or "Evolving," if ratings may
be raised, lowered or maintained. Rating Watch is typically resolved over a
relatively short period.
A Rating Outlook indicates the direction a rating is likely to move over
a one to two year period. Outlooks may be positive, stable, or negative. A
positive or negative Rating Outlook does not imply a rating change is
inevitable. Similarly, companies whose outlooks are "stable" could be
downgraded before an outlook moves to positive or negative if circumstances
warrant such an action. Occasionally, Fitch Ratings may be unable to identify
the fundamental trend. In these cases, the Rating Outlook may be described as
evolving.
Dominion Bond Rating Service Limited
DBRS ratings are meant to give an indication of the risk that the
borrower will not fulfill its obligations in a timely manner. DBRS ratings do
not take factors such as pricing or market risk into consideration and are
expected to be used by purchasers as one part of their investment process.
Every DBRS rating is based on quantitative and qualitative considerations which
are relevant for the borrowing entity.
DBRS Bond and Long Term Debt Rating Scale
AAA: Bonds rated "AAA" are of the highest credit quality, with
exceptionally strong protection for the timely repayment of principal and
interest. Earnings are considered stable, the structure of the industry in
which the entity operates is strong, and the outlook for future profitability
is favorable. There are few qualifying factors present which would detract from
the performance of the entity, the strength of liquidity and coverage ratios is
unquestioned and the entity has established a creditable track record of
superior performance. Given the extremely tough definition which DBRS has
established for this category, few entities are able to achieve a AAA rating.
AA: Bonds rated "AA" are of superior credit quality, and protection of
interest and principal is considered high. In many cases, they differ from
bonds rated AAA only to a small degree. Given the extremely tough definition
which DBRS has for the AAA category (which few companies are able to achieve),
entities rated AA are also considered to be strong credits which typically
exemplify above-average strength in key areas of consideration and are unlikely
to be significantly affected by reasonably foreseeable events.
A: Bonds rated "A" are of satisfactory credit quality. Protection of
interest and principal is still substantial, but the degree of strength is less
than with AA rated entities. While a respectable rating, entities in the "A"
category are considered to be more susceptible to adverse economic conditions
and have greater cyclical tendencies than higher rated companies.
BBB: Bonds rated "BBB" are of adequate credit quality. Protection of
interest and principal is considered adequate, but the entity is more
susceptible to adverse changes in financial and economic conditions, or there
may be other adversities present which reduce the strength of the entity and
its rated securities.
BB: Bonds rated "BB" are defined to be speculative, where the degree of
protection afforded interest and principal is uncertain, particularly during
periods of economic recession. Entities in the BB area typically have limited
access to capital markets and additional liquidity support and, in many cases,
small size or lack of competitive strength may be additional negative
considerations.
B: Bonds rated "B" are highly speculative and there is a reasonably high
level of uncertainty which exists as to the ability of the entity to pay
interest and principal on a continuing basis in the future, especially in
periods of economic recession or industry adversity.
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CCC, CC, C: Bonds rated in any of these categories are very highly
speculative and are in danger of default of interest and principal. The degree
of adverse elements present is more severe than bonds rated "B." Bonds rated
below "B" often have characteristics which, if not remedied, may lead to
default. In practice, there is little difference between the "C" to "CCC"
categories, with "CC" and "C" normally used to lower ranking debt of companies
where the senior debt is rated in the "CCC" to "B" range.
D: This category indicates Bonds in default of either interest or
principal.
High, Low: "high" and "low" grades are used to indicate the relative
standing of a credit within a particular rating category. The lack of one of
these designations indicates a rating which is essentially in the middle of the
category. Note that "high" and "low" grades are not used for the AAA category.
DBRS Commercial Paper and Short Term Debt Rating Scale
All three DBRS rating categories for short term debt use "high", "middle"
or "low" as subset grades to designate the relative standing of the credit
within a particular rating category.
Prime Credit Quality
R-1 (high): Short term debt rated "R-1 (high)" is of the highest credit
quality, and indicates an entity which possesses unquestioned ability to repay
current liabilities as they fall due. Entities rated in this category normally
maintain strong liquidity positions, conservative debt levels and profitability
which is both stable and above average. Companies achieving an "R-1 (high)"
rating are normally leaders in structurally sound industry segments with proven
track records, sustainable positive future results and no substantial
qualifying negative factors. Given the extremely tough definition which DBRS
has established for an "R-1 (high)," few entities are strong enough to achieve
this rating.
R-1 (middle): Short term debt rated "R-1 (middle)" is of superior credit
quality and, in most cases, ratings in this category differ from "R-1 (high)"
credits to only a small degree. Given the extremely tough definition which DBRS
has for the "R-1 (high)" category (which few companies are able to achieve),
entities rated "R-1 (middle)" are also considered strong credits which
typically exemplify above average strength in key areas of consideration for
debt protection.
R-1 (low): Short term debt rated "R-1 (low)" is of satisfactory credit
quality. The overall strength and outlook for key liquidity, debt and
profitability ratios is not normally as favorable as with higher rating
categories, but these considerations are still respectable. Any qualifying
negative factors which exist are considered manageable, and the entity is
normally of sufficient size to have some influence in its industry.
Adequate Credit Quality
R-2 (high), R-2 (middle), R-2 (low): Short term debt rated "R-2" is of
adequate credit quality and within the three subset grades, debt protection
ranges from having reasonable ability for timely repayment to a level which is
considered only just adequate. The liquidity and debt ratios of entities in the
"R-2" classification are not as strong as those in the "R-1" category, and the
past and future trend may suggest some risk of maintaining the strength of key
ratios in these areas. Alternative sources of liquidity support are considered
satisfactory; however,
even the strongest liquidity support will not improve the commercial paper
rating of the issuer. The size of the entity may restrict its flexibility, and
its relative position in the industry is not typically as strong as an "R-1
credit." Profitability trends, past and future, may be less favorable, earnings
not as stable, and there are often negative qualifying factors present which
could also make the entity more vulnerable to adverse changes in financial and
economic conditions.
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Speculative
R-3 (high), R-3 (middle), R-3 (low): Short term debt rated "R-3" is
speculative, and within the three subset grades, the capacity for timely
payment ranges from mildly speculative to doubtful. "R-3" credits tend to have
weak liquidity and debt ratios, and the future trend of these ratios is also
unclear. Due to its speculative nature, companies with "R-3" ratings would
normally have very limited access to alternative sources of liquidity. Earnings
would typically be very unstable, and the level of overall profitability of the
entity is also likely to be low. The industry environment may be weak, and
strong negative qualifying factors are also likely to be present.
DBRS Preferred Share Rating Scale
Pfd-1: Preferred shares rated "Pfd-1" are of superior credit quality, and
are supported by entities with strong earnings and balance sheet
characteristics. "Pfd-1" generally corresponds with companies whose senior
bonds are rated in the "AAA" or "AA" categories. As is the case with all rating
categories, the relationship between senior debt ratings and preferred share
ratings should be understood as one where the senior debt rating effectively
sets a ceiling for the preferred shares issued by the entity. However, there
are cases where the preferred share rating could be lower than the normal
relationship with the issuer's senior debt rating.
Pfd-2: Preferred shares rated "Pfd-2" are of satisfactory credit quality.
Protection of dividends and principal is still substantial, but earnings, the
balance sheet, and coverage ratios are not as strong as Pfd-1 rated companies.
Generally, "Pfd-2" ratings correspond with companies whose senior bonds are
rated in the "A" category.
Pfd-3: Preferred shares rated "Pfd-3" are of adequate credit quality.
While protection of dividends and principal is still considered acceptable, the
issuing entity is more susceptible to adverse changes in financial and economic
conditions, and there may be other adversities present which detract from debt
protection. "Pfd-3" ratings generally correspond with companies whose senior
bonds are rated in the higher end of the "BBB" category.
Pfd-4: Preferred shares rated "Pfd-4" are speculative, where the degree
of protection afforded to dividends and principal is uncertain, particularly
during periods of economic adversity. Companies with preferred shares rated
"Pfd-4" generally coincide with entities that have senior bond ratings ranging
from the lower end of the "BBB" category through the "BB" category.
Pfd-5: Preferred shares rated "Pfd-5" are highly speculative and the
ability of the entity to maintain timely dividend and principal payments in the
future is highly uncertain. The "Pfd-5" rating generally coincides with
companies with senior bond ratings of "B" or lower. Preferred shares rated
"Pfd-5" often have characteristics which, if not remedied, may lead to default.
D: This category indicates preferred shares that are in arrears of paying
either dividends or principal.
High, Low: "high" and "low" grades are used to indicate the relative
standing of a credit within a particular rating category. The lack of one of
these designations indicates a rating that is essentially in the middle of the
category.
n: Non-Cumulative Risk. In the past several years, DBRS had designated
all non-cumulative preferred shares as "low" to alert subscribers to the fact
that non-cumulative shares have a higher risk of loss once dividend payments
have been missed. In the future, "high" and "low" designations will be used on
preferred share ratings to indicate the relative standing of a credit within a
particular rating category, and we will no longer use "low" to alert holders to
the non-cumulative nature of the shares. Rather, the "n" designation will be
attached to all ratings for securities that are non-cumulative. The risk with
non-cumulative securities is essentially no different than with cumulative
securities unless there is a default situation, in which case, the
non-cumulative shares have the
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added risk of missing dividend payments that have no potential of being made up
in the future. However, non-cumulative shares do not have a higher risk of
default than do equivalently ranking cumulative shares of the same issuer. We
believe that the risk added under the non-cumulative covenant is a market risk
and not a credit risk. This supports our view that the ratings on equally
ranking cumulative and non-cumulative securities should be the same, with the
"n" used to alert subscribers to the additional potential for missed dividend
payments that exists with non-cumulative issues, if default should occur. After
several years of using our present scale, our
conclusion is that trying to provide all of this information with one rating
symbol is confusing to the market. We believe that it is more valuable to our
subscribers if the rating symbol simply provides our base evaluation of the
credit, along with information that alerts the holder to any unique covenants
that can add market risk.
y: Hybrid Instruments. While DBRS credit ratings are focused on providing
a measure of the issuer's ability to meet its obligations in a timely manner,
there are situations where securities carry unique covenants that can add a
variety of risks that are not captured in the DBRS rating. By definition,
hybrids are instruments that combine certain characteristics of debt and equity
and have been issued under various acronyms such as LYONS, PERCS, COPrS, TOPrS,
PRYDES, MIDS and MIPS. In some cases, holders of these instruments have agreed
that under set circumstances, the Company may repay certain obligations with
more of the security or with another security, such as common equity. In other
cases, the terms allow the Company to defer interest or dividend payments for a
period of time. While these are obviously important considerations for the
holder to understand, they normally do not cause any change in the likelihood
of default and, as such, DBRS has chosen not to penalize the instrument for the
special features associated with the hybrid. In order to alert hybrid holders
of the unique factors inherent in the security, DBRS will attach the "y"
appendage to the rating. Note that DBRS will not be adding the "y" to issues
that simply have more normal soft retraction or conversion features.
m: Market Risk. DBRS ratings represent an evaluation which is based on
only credit related factors and not market risk factors. The most obvious
example of a market risk factor would be the potential impact that changing
interest rates could have on a fixed pay security. While the absence of market
risk considerations in DBRS credit ratings should be well understood by
investors who use DBRS as part of their investment process, there are cases
where DBRS desires to draw attention to market risk for a given security
because the potential for volatility due to market risk factors greatly exceeds
what would be considered normal. To accomplish this, DBRS attaches the letter
"m" (market risk) to a rated security. Given the understanding that market risk
is present in every investment decision, it is important to note that the
absence of "m" does not indicate that there will be no volatility of returns
related to non-credit factors. DBRS uses "m" only in cases where market risk is
considered exceptionally high, or in cases where there are unusual
circumstances.
p: The symbol "p" indicates that the report and rating rely on public
information only.
A-11
================================================================================
$210,000,000
[LOGO] PIMCO
ADVISORS
PIMCO Floating Rate Income Fund
Auction Market Preferred Shares ("AMPS")
2,800 Shares, Series T
2,800 Shares, Series W
2,800 Shares, Series TH
$25,000 Liquidation Preference Per Share
----------------
PROSPECTUS
----------------
Merrill Lynch & Co.
Wachovia Securities
A.G. Edwards & Sons, Inc.
Quick & Reilly, Inc.
, 2003
================================================================================
"The information in this Statement of Additional Information is not
complete and may be changed. We may not sell these securities until the
registration statement filed with the Securities and Exchange Commission is
effective. This Statement of Additional Information is not an offer to sell
these securities and it is not soliciting an offer to buy these securities in
any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION - DATED , 2003
----
PIMCO FLOATING RATE INCOME FUND
STATEMENT OF ADDITIONAL INFORMATION
, 2003
-----
PIMCO Floating Rate Income Fund (the "Fund") is a recently organized,
diversified, closed-end management investment company.
This Statement of Additional Information relating to auction market
preferred shares of the Fund ("AMPS") is not a prospectus, and should be read in
conjunction with the Fund's prospectus relating to the AMPS dated , 2003 (the
---
"Prospectus"). This Statement of Additional Information does not include all
information that a prospective investor should consider before purchasing AMPS,
and investors should obtain and read the Prospectus prior to purchasing such
shares. A copy of the Prospectus may be obtained without charge by calling (877)
819-2224. You may also obtain a copy of the Prospectus on the web site
(http://www.sec.gov) of the Securities and Exchange Commission ("SEC").
Capitalized terms used but not defined in this Statement of Additional
Information have the meanings ascribed to them in the Prospectus.
TABLE OF CONTENTS
USE OF PROCEEDS................................................................1
INVESTMENT OBJECTIVE AND POLICIES..............................................1
INVESTMENT RESTRICTIONS.......................................................47
MANAGEMENT OF THE FUND........................................................49
INVESTMENT MANAGER AND PORTFOLIO MANAGER......................................61
PORTFOLIO TRANSACTIONS........................................................66
DISTRIBUTIONS.................................................................68
DESCRIPTION OF SHARES.........................................................68
ADDITIONAL INFORMATION CONCERNING THE AUCTIONS FOR PREFERRED SHARES...........70
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST................71
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND......................73
TAX MATTERS...................................................................75
PERFORMANCE RELATED AND COMPARATIVE INFORMATION...............................83
CUSTODIAN, TRANSFER AGENT AND DIVIDEND PAYING AGENT...........................84
INDEPENDENT AUDITORS..........................................................84
COUNSEL ......................................................................84
REGISTRATION STATEMENT........................................................84
FINANCIAL STATEMENTS..........................................................85
APPENDIX A...................................................................A-1
APPENDIX B...................................................................B-1
This Statement of Additional Information is dated , 2003.
-----------------------
i
USE OF PROCEEDS
The net proceeds of the offering of AMPS of the Fund will be approximately
$207,400,000 after payment of offering costs and the sales load.
Pending investment in floating rate debt instruments and other securities
that meet the Fund's investment objective and policies, it is anticipated that
the net proceeds of the offering will be invested in high grade, short-term
securities, credit-linked trust certificates and/or index futures contracts or
similar derivative instruments designed to give the Fund exposure to the markets
in which it intends to invest while Pacific Investment Management Company LLC
("PIMCO"), the Fund's portfolio manager, selects specific securities.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective and general investment policies of the Fund are
described in the Prospectus. Additional information concerning the
characteristics of certain of the Fund's investments is set forth below.
Floating Rate Debt Instruments
Under normal market conditions, the Fund will invest at least 80% of its
net assets (plus any borrowings for investment purposes) in a diversified
portfolio of floating rate debt instruments, a substantial portion of which will
be senior floating rate loans ("Senior Loans"). Floating rate debt instruments
are debt instruments that pay interest at rates which adjust whenever a
specified interest rate changes and/or which reset on predetermined dates (such
as the last day of a month or calendar quarter). These floating rate debt
instruments may include, in addition to Senior Loans, instruments such as
catastrophe bonds, bank capital securities, unsecured bank loans, corporate
bonds, money market instruments and certain types of mortgage-backed and other
asset-backed securities. Due to their floating rate features, these instruments
will generally pay higher levels of income in a rising interest rate environment
and lower levels of income as interest rates decline. For the same reason, the
market value of a floating rate debt instrument is generally expected to have
less sensitivity to fluctuations in market interest rates than a fixed-rate debt
instrument, although the value of a floating rate instrument may nonetheless
decline as interest rates rise and due to other factors, such as changes in
credit quality.
Senior Loans
The Fund expects to ordinarily invest a substantial portion of its assets
in Senior Loans. Senior Loans include senior floating rate loans and
institutionally traded senior floating rate debt obligations issued by
asset-backed pools and other issues, and interests therein. Loan interests
generally take the form of direct interests acquired during a primary
distribution and may also take the form of assignments of, novations of, or
participations in a Senior Loan acquired in secondary markets. 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
members of a lending syndicate or from other holders of loan interests.
1
Senior Loans typically pay interest at rates which are re-determined
periodically on the basis of a floating base lending rate (such as the London
Inter-Bank Offered Rate, "LIBOR") plus a premium. Although Senior Loans are
typically of below investment grade quality, they tend to have more favorable
recovery rates than other types of below investment grade quality debt
obligations. Senior Loans generally (but not always) hold the most senior
position in the capital structure of a borrower and are often secured with
collateral. 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 lending syndicate of financial
institutions ("Lenders"). The Agent typically administers and enforces the
Senior Loan on behalf of the other Lenders in the syndicate. In addition, an
institution, typically but not always the Agent, holds any collateral on behalf
of the Lenders.
The Fund may purchase assignments and participations in commercial loans,
as well as debtor-in-possession 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 or other 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.
Unless, under the terms of the loan or other indebtedness (such as may be
the case in an assignment), the Fund has direct recourse against the borrower,
the Fund may have to rely on the Agent or other financial intermediary to apply
appropriate credit remedies against a borrower.
Purchasers of loans and other forms of direct indebtedness depend primarily
upon the creditworthiness of the corporate or other borrower for payment of
principal and interest. If the Fund does not receive scheduled interest or
principal payments on such indebtedness, the Fund's share price and yield could
be adversely affected. Senior Loans that are fully secured offer the Fund more
protection than an unsecured loan in the event of non-payment of scheduled
interest or principal. However, there is no assurance that the liquidation of
collateral from a secured Senior Loan would satisfy the borrower's obligation,
or that such collateral could be liquidated.
The Fund may invest in loan participations with credit quality comparable
to that of many issuers of its other debt securities investments. Indebtedness
of companies whose creditworthiness is poor involves substantially greater
risks, and may be highly speculative.
Some companies may never pay off their indebtedness, or may pay only a
small fraction of the amount owed. Consequently, when investing in indebtedness
of companies with poor credit, the Fund bears a substantial risk of losing the
entire amount invested.
The Fund limits the amount of its total assets that it will invest in any
one issuer or in issuers within the same industry. See "Investment
Restrictions." For purposes of these limits, the Fund generally will treat the
corporate or other borrower as the "issuer" of indebtedness held by the Fund. In
the case of loan participations where a bank or other lending institution serves
as a financial intermediary between the Fund and the borrower, if the
participation does not shift to
2
the Fund the direct debtor-creditor relationship with the borrower, SEC
interpretations may take the position that the Fund should treat both the
lending bank or other lending institution and the borrower as "issuers" for the
purposes of determining whether the Fund has invested more than 5% of its total
assets in a single issuer. Treating a financial intermediary as an issuer of
indebtedness may restrict the Fund's ability to invest in indebtedness related
to a single financial intermediary, or a group of intermediaries engaged in the
same industry, even if the underlying borrowers represent many different
companies and industries.
Loans and other types of direct indebtedness may not be readily marketable
and may be subject to restrictions on resale. In some cases, negotiations
involved in disposing of indebtedness may require weeks to complete.
Consequently, some indebtedness may be difficult or impossible to dispose of
readily at what PIMCO believes to be a fair price. In addition, valuation of
illiquid indebtedness involves a greater degree of judgment in determining the
Fund's net asset value than if that value were based on available market
quotations. At the same time, many loan interests are actively traded among
certain financial institutions and considered to be liquid. PIMCO will determine
the liquidity of the Fund's investments by reference to market conditions and
contractual provisions. For example, PIMCO will generally not consider Senior
Loans that are part of an issue of at least $250 million in par value to be
illiquid. Investments in loan participations are considered to be debt
obligations for purposes of the Fund's investment restriction relating to the
lending of funds or assets.
Investments in loans through a direct assignment of the financial
institution's interests with respect to the loan may involve additional risks to
the Fund. For example, if a loan is foreclosed, the Fund could become part owner
of any collateral, and would bear the costs and liabilities associated with
owning and disposing of the collateral. In addition, it is conceivable that,
under emerging legal theories of lender liability, the Fund could be held liable
as co-lender. It is unclear whether loans and other forms of direct indebtedness
offer securities law protections against fraud and misrepresentation. In the
absence of definitive regulatory guidance, the Fund relies on PIMCO's research
in an attempt to avoid situations where fraud or misrepresentations could
adversely affect the Fund.
From time to time, PIMCO and its affiliates may borrow money from various
banks in connection with their business activities. Such banks may also sell
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.
Lending Fees. 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,
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 the 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.
3
Borrower Covenants. A borrower under a Senior Loan typically must comply
with various restrictive covenants contained in a loan agreement or note
purchase agreement between the borrower and the Lender or lending syndicate (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 Senior Loan with any free cash flow. Free cash flow is generally
defined as net cash flow after scheduled debt service 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 lenders directly, as the case may be, is normally an event of acceleration;
i.e., the Agent, or the lenders directly, as the case may be, has the right to
call the outstanding Senior Loan. The typical practice of an Agent or a Lender
in relying exclusively or primarily on reports from the borrower 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 of a Senior Loan 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 members of the lending syndicate 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, if any, and if
the value of such 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, PIMCO will perform such tasks on behalf of the Fund,
although a collateral bank will typically hold any collateral on behalf of the
Fund and the other lenders 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
4
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
other intermediate participants similar risks may arise.
Prepayments. Senior Loans 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 lenders, 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
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 should be able to
reinvest prepayments in other Senior Loans that have similar or identical yields
and because receipt of such fees may mitigate any adverse impact on the Fund's
yield.
Bridge Financings. 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 who 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.
Secured Senior Loans. To the extent that the collateral, if any, securing a
Senior Loan consists of the stock of the borrower's subsidiaries or other
affiliates, the Fund will be subject to the risk that this stock will decline in
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
fully secured by assets of, shareholders or owners, even if the Senior Loans are
not otherwise collateralized by assets of the borrower. 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 secured Senior Loan. On
occasions when such stock cannot be pledged, the secured 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 such 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 secured Senior Loans.
If a borrower becomes involved in bankruptcy proceedings, a court may
invalidate the Fund's security interest in any loan collateral or subordinate
the Fund's rights under a secured Senior Loan to the interests of the borrower's
unsecured creditors. 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 secured Senior Loans made in connection with a highly leveraged
transaction, consideration for
5
granting a security interest may be deemed inadequate if the proceeds of such
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 any loan collateral. If the Fund's security
interest in loan collateral is invalidated or a secured Senior Loan is
subordinated to other debt of a borrower in bankruptcy or other proceedings, it
is unlikely that the Fund would be able to recover the full amount of the
principal and interest due on the secured Senior Loan.
The Fund may also invest in Senior Loans that are not secured by collateral
or otherwise.
High Yield Securities ("Junk Bonds")
The Fund may invest without limit and ordinarily expects to invest a
substantial portion of its assets in Senior Loans and other debt securities that
are, at the time of purchase, rated below investment grade (below Baa3 by
Moody's Investors Service, Inc. ("Moody's"), below BBB- by either Standard &
Poor's ("S&P") or Fitch, Inc. ("Fitch Ratings"), or below a comparable rating by
Dominion Bond Rating Service Limited ("Dominion")) or unrated but judged by
PIMCO to be of comparable quality. These securities are sometimes referred to as
"high yield" securities or "junk bonds." The Fund will not invest more than 10%
of its total assets in securities that are, at the time of purchase, rated
CCC+/Caa1 or lower by each agency rating the security or that are unrated but
judged by PIMCO to be of comparable quality.
Many of the Senior Loans in which the Fund invests will be high yield
securities. See "Senior Loans."
Investments in high yield securities generally provide greater income and
increased opportunity for capital appreciation than investments in higher
quality securities, but they also typically entail greater price volatility and
principal and income risk, including the possibility of issuer default and
bankruptcy. High yield securities are regarded as predominantly speculative with
respect to the issuer's continuing ability to meet principal and interest
payments. Debt securities in the lowest investment grade category also may be
considered to possess some speculative characteristics by certain rating
agencies. In addition, analysis of the creditworthiness of issuers of high yield
securities may be more complex than for issuers of higher quality securities.
High yield securities may be more susceptible to real or perceived adverse
economic and competitive industry conditions than investment grade securities. A
projection of an economic downturn or of a period of rising interest rates, for
example, could cause a decline in high yield security prices because the advent
of a recession could lessen the ability of an issuer to make principal and
interest payments on its debt obligations. If an issuer of high yield securities
defaults, in addition to risking non-payment of all or a portion of interest and
principal, the Fund may incur additional expenses to seek recovery. The market
prices of high yield securities structured as zero-coupon, step-up or
payment-in-kind securities will normally be affected to a greater extent by
interest rate changes, and therefore tend to be more volatile than the prices of
securities that pay interest currently and in cash.
6
The secondary market on which high yield securities are traded may be less
liquid than the market for investment grade securities. Less liquidity in the
secondary trading market could adversely affect the price at which the Fund
could sell a high yield security, and could adversely affect the net asset value
of the shares. Adverse publicity and investor perceptions, whether or not based
on fundamental analysis, may decrease the values and liquidity of high yield
securities, especially in a thinly-traded market. When secondary markets for
high yield securities are less liquid than the market for investment grade
securities, it may be more difficult to value the securities because such
valuation may require more research, and elements of judgment may play a greater
role in the valuation because there is less reliable, objective data available.
During periods of thin trading in these markets, the spread between bid and
asked prices is likely to increase significantly and the Fund may have greater
difficulty selling its portfolio securities. The Fund will be more dependent on
PIMCO's research and analysis when investing in high yield securities. PIMCO
seeks to minimize the risks of investing through in-depth credit analysis and
attention to current developments in interest rates and market conditions.
A general description of the ratings of securities by Moody's, S&P, Fitch
and Dominion is set forth in Appendix A to the Prospectus. The ratings of
Moody's, S&P, Fitch Ratings and Dominion represent their opinions as to the
quality of the securities they rate. It should be emphasized, however, that
ratings are general and are not absolute standards of quality. Consequently,
debt obligations with the same maturity, coupon and rating may have different
yields while obligations with the same maturity and coupon with different
ratings may have the same yield. For these reasons, the use of credit ratings as
the sole method of evaluating high yield securities can involve certain risks.
For example, credit ratings evaluate the safety of principal and interest
payments, not the market value risk of high yield securities. Also, credit
rating agencies may fail to change credit ratings in a timely fashion to reflect
events since the security was last rated. PIMCO does not rely solely on credit
ratings when selecting securities for the Fund, and develops its own independent
analysis of issuer credit quality.
The Fund's credit quality policies apply only at the time a security is
purchased, and the Fund is not required to dispose of a security in the event
that a rating agency or PIMCO downgrades its assessment of the credit
characteristics of a particular issue. In determining whether to retain or sell
such a security, PIMCO may consider such factors as PIMCO's assessment of the
credit quality of the issuer of such security, the price at which such security
could be sold and the rating, if any, assigned to such security by other rating
agencies. However, analysis of creditworthiness may be more complex for issuers
of Senior Loans and other high yield securities than for issuers of higher
quality debt securities.
Distressed Securities
Securities in which the Fund invests may be subject to significant risk of
an issuer's inability to meet principal and interest payments on the obligations
and also may be subject to price volatility due to such factors as market
perception of the creditworthiness of an issuer and general market liquidity. If
PIMCO's evaluation of the anticipated outcome of an investment situation should
prove incorrect, such Fund investments could experience a loss.
7
Bonds
The Fund may invest in a variety of bonds and related debt obligations of
varying maturities (with predominantly low durations) issued by U.S.
corporations, foreign corporations, domestic banks, foreign banks and other
business entities. Bonds include bills, notes, debentures, money market
instruments and similar instruments and securities. Bonds generally are used by
corporations and other issuers to borrow money from investors. The issuer pays
the investor a variable or fixed rate of interest and normally must repay the
amount borrowed on or before maturity. Certain bonds are "perpetual" in that
they have no maturity date.
The Fund's investments in bonds are often subject to a number of risks
described in the Prospectus and elaborated upon elsewhere in this section of the
Statement of Additional Information, including credit risk, high yield risk,
interest rate risk, issuer risk, foreign (non-U.S.) investment risk, inflation
risk, liquidity risk, smaller company risk and management risk.
Event-Linked Bonds
The Fund may invest in "event-linked bonds." Event-linked bonds, which are
sometimes referred to as "catastrophe bonds," are debt obligations for which the
return of principal and payment of interest is contingent on the non-occurrence
of a specific "trigger" event, such as a hurricane or an earthquake. They may be
issued by government agencies, insurance companies, reinsurers, special purpose
corporations or other on-shore or off-shore entities. If a trigger event causes
losses exceeding a specific amount in the geographic region and time period
specified in a bond, the Fund may lose a portion or all of its principal
invested in the bond. If no trigger event occurs, the Fund will recover its
principal plus interest. For some event-linked bonds, the trigger event or
losses may be based on company-wide losses, index-portfolio losses, industry
indexes or readings of scientific instruments rather than specified actual
losses. Often event-linked bonds provide for extensions of maturity that are
mandatory, or optional at the discretion of the issuer, in order to process and
audit loss claims in those cases when a trigger event has, or possibly has,
occurred. In addition to the specified trigger events, event-linked bonds may
also expose the Fund to certain unanticipated risks including but not limited to
issuer (credit) default, adverse regulatory or jurisdictional interpretations
and adverse tax consequences.
Event-linked bonds are a relatively new type of financial instrument. As
such, there is no significant trading history of these securities, and there can
be no assurance that a liquid market in these instruments will develop. Lack of
a liquid market may impose the risk of higher transaction costs and the
possibility that the Fund may be forced to liquidate positions when it would not
be advantageous to do so. Event-linked bonds are typically rated.
Inflation-Indexed Bonds
The Fund may invest in inflation-indexed bonds, which are debt obligations
whose value is periodically adjusted according to the rate of inflation. Two
structures are common. The U.S. Treasury and some other issuers utilize a
structure that accrues inflation into the principal value of the bond. Most
other issuers pay out the Consumer Price Index accruals as part of a semiannual
coupon.
8
Inflation-indexed securities issued by the U.S. Treasury have maturities of
approximately five, ten or thirty years, although it is possible that securities
with other maturities will be issued in the future. The U.S. Treasury securities
pay interest on a semi-annual basis equal to a fixed percentage of the
inflation-adjusted principal amount. For example, if the Fund purchased an
inflation-indexed bond with a par value of $1,000 and a 3% real rate of return
coupon (payable 1.5% semi-annually), and the rate of inflation over the first
six months was 1%, the mid-year par value of the bond would be $1,010 and the
first semi-annual interest payment would be $15.15 ($1,010 times 1.5%). If
inflation during the second half of the year resulted in the whole year's
inflation equaling 3%, the end-of-year par value of the bond would be $1,030 and
the second semi-annual interest payment would be $15.45 ($1,030 times 1.5%).
If the periodic adjustment rate measuring inflation falls, the principal
value of inflation-indexed bonds will be adjusted downward, and consequently the
interest payable on these securities (calculated with respect to a smaller
principal amount) will be reduced. Repayment of the original bond principal upon
maturity (as adjusted for inflation) is guaranteed in the case of U.S. Treasury
inflation-indexed bonds, even during a period of deflation. However, the current
market value of the bonds is not guaranteed and will fluctuate. The Fund may
also invest in other inflation-related bonds which may or may not provide a
similar guarantee. If a guarantee of principal is not provided, the adjusted
principal value of the bond repaid at maturity may be less than the original
principal amount.
The value of inflation-indexed bonds is expected to change in response to
changes in real interest rates. Real interest rates in turn are tied to the
relationship between nominal interest rates and the rate of inflation.
Therefore, if the rate of inflation rises at a faster rate than nominal interest
rates, real interest rates might decline, leading to an increase in value of
inflation-indexed bonds. In contrast, if nominal interest rates increase at a
faster rate than inflation, real interest rates might rise, leading to a
decrease in value of inflation-indexed bonds.
While these securities are expected to be protected from long-term
inflationary trends, short-term increases in inflation may lead to a decline in
value If interest rates rise due to reasons other than inflation (for example,
due to changes in currency exchange rates), investors in these securities may
not be protected to the extent that the increase is not reflected in the bond's
inflation measure.
The periodic adjustment of U.S. inflation-indexed bonds is tied to the
Consumer Price Index for Urban Consumers ("CPI-U"), which is calculated monthly
by the U.S. Bureau of Labor Statistics. The CPI-U is a measurement of changes in
the cost of living, made up of components such as housing, food, transportation
and energy. Inflation-indexed bonds issued by a foreign government are generally
adjusted to reflect a comparable inflation index calculated by that government.
There can be no assurance that the CPI-U or any foreign inflation index will
accurately measure the real rate of inflation in the prices of goods and
services. Moreover, there can be no assurance that the rate of inflation in a
foreign country will be correlated to the rate of inflation in the United
States.
For federal income tax purposes, any increase in the principal amount of an
inflation-indexed bond will be original issue discount which is taxable as
ordinary income in the year
9
accrued, even though investors do not receive their principal, including any
increases thereto, until maturity. See "Tax Matters--Original Issue Discount and
Payment-in-Kind Securities."
Mortgage-Related and Other Asset-Backed Securities
The Fund may invest in mortgage-related securities, and may also invest in
other asset-backed securities (unrelated to mortgage loans) that are offered to
investors currently or in the future. Mortgage-related securities are interests
in pools of residential or commercial mortgage loans, including mortgage loans
made by savings and loan institutions, mortgage bankers, commercial banks and
others. Pools of mortgage loans are assembled as securities for sale to
investors by various governmental, government-related and private organizations.
Like other debt obligations, the ability of the Fund to successfully utilize
these instruments may depend in part upon the ability of PIMCO to forecast
certain macro-economic factors correctly. See "--Mortgage Pass-Through
Securities" below. Certain debt obligations are also secured with collateral
consisting of mortgage-related securities. See "--Collateralized Mortgage
Obligations ("CMOs")" below.
The mortgage-related securities in which the Fund will invest will
typically pay variable rates of interest, although the Fund may invest in
fixed-rate obligations as well.
Commercial Mortgage-Backed Securities. Commercial mortgage-backed
securities include securities that reflect an interest in, and are secured by,
mortgage loans on commercial real property. The market for commercial
mortgage-backed securities developed more recently and in terms of total
outstanding principal amount of issues is relatively small compared to the
market for residential single-family mortgage-backed securities. Many of the
risks of investing in commercial mortgage-backed securities reflect the risks of
investing in the real estate securing the underlying mortgage loans. These risks
reflect the effects of local and other economic conditions on real estate
markets, the ability of tenants to make loan payments, and the ability of a
property to attract and retain tenants. Commercial mortgage-backed securities
may be less liquid and exhibit greater price volatility than other types of
mortgage- or asset-backed securities.
Mortgage Pass-Through Securities. Mortgage pass-through securities are
securities representing interests in "pools" of mortgage loans secured by
residential or commercial real property. Interests in pools of mortgage-related
securities differ from other forms of debt obligations, which normally provide
for periodic payment of interest in fixed or variable amounts with principal
payments at maturity or specified call dates. Instead, these securities provide
a monthly payment which consists of both interest and principal payments. In
effect, these payments are a "pass-through" of the monthly payments made by the
individual borrowers on their residential or commercial mortgage loans, net of
any fees paid to the issuer or guarantor of such securities. Additional payments
are caused by repayments of principal resulting from the sale of the underlying
property, refinancing or foreclosure, net of fees or costs which may be
incurred. Some mortgage-related securities (such as securities issued by the
Government National Mortgage Association (the "GNMA")) are described as
"modified pass-through." These securities entitle the holder to receive all
interest and principal payments owed on the mortgage pool, net of certain fees,
at the scheduled payment dates regardless of whether or not the mortgagor
actually makes the payment.
10
The rate of prepayments on underlying mortgages will affect the price and
volatility of a mortgage-related security, and may have the effect of shortening
or extending the effective maturity of the security beyond what was anticipated
at the time of purchase. Early repayment of principal on some mortgage-related
securities (arising from prepayments of principal due to the sale of the
underlying property, refinancing, or foreclosure, net of fees and costs which
may be incurred) may expose the Fund to a lower rate of return upon reinvestment
of principal. Also, if a security subject to prepayment has been purchased at a
premium, the value of the premium would be lost in the event of prepayment. Like
other fixed-rate debt obligations, when interest rates rise, the value of a
fixed-rate mortgage-related security generally will decline; however, when
interest rates are declining, the value of fixed-rate mortgage-related
securities with prepayment features may not increase as much as other debt
obligations. The Fund's policy of investing mostly in mortgage-backed and other
asset-backed securities with variable rates of interest minimizes the Fund's
sensitivity to such interest rate volatility. However, adjustable rate
mortgage-related and other asset-backed securities are also subject to some
interest rate risk. For example, because interest rates on most adjustable rate
mortgage- and other asset-backed securities only reset periodically (e.g.,
monthly or quarterly), changes in prevailing interest rates (and particularly
sudden and significant changes) can be expected to cause some fluctuations in
the market value of these securities, including declines in value as interest
rates rise. In addition, to the extent that unanticipated rates of prepayment on
underlying mortgages increase the effective maturity of a mortgage-related
security, the volatility of such security can be expected to increase.
Payment of principal and interest on some mortgage pass-through securities
(but not the market value of the securities themselves) may be guaranteed by the
full faith and credit of the U.S. Government (in the case of securities
guaranteed by the GNMA) or guaranteed by agencies or instrumentalities of the
U.S. Government (in the case of securities guaranteed by the Federal National
Mortgage Association (the "FNMA") or the Federal Home Loan Mortgage Corporation
(the "FHLMC"). The principal governmental guarantor of mortgage-related
securities is the GNMA. GNMA is a wholly-owned U.S. Government corporation
within the Department of Housing and Urban Development. GNMA is authorized to
guarantee, with the full faith and credit of the U.S. Government, the timely
payment of principal and interest on securities issued by institutions approved
by GNMA (such as savings and loan institutions, commercial banks and mortgage
bankers) and backed by pools of mortgages insured by the Federal Housing
Administration (the "FHA"), or guaranteed by the Department of Veterans Affairs
(the "VA").
Government-related guarantors (i.e., not backed by the full faith and
credit of the U.S. Government) include the FNMA and the FHLMC. FNMA is a
government-sponsored corporation owned entirely by private stockholders. It is
subject to general regulation by the Secretary of Housing and Urban Development.
FNMA purchases conventional (i.e., not insured or guaranteed by any government
agency) residential mortgages from a list of approved sellers/servicers which
include state and federally chartered savings and loan associations, mutual
savings banks, commercial banks, and credit unions and mortgage bankers.
Pass-through securities issued by FNMA are guaranteed as to timely payment of
principal and interest by FNMA but are not backed by the full faith and credit
of the U.S. Government. Instead, they are supported only by the discretionary
authority of the U.S. Government to purchase the agency's obligations.
11
FHLMC was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. It is a
government-sponsored corporation formerly owned by the twelve Federal Home Loan
Banks and now owned entirely by private stockholders. FHLMC issues Participation
Certificates ("PCs") which represent interests in conventional mortgages from
FHLMC's national portfolio. FHLMC guarantees the timely payment of interest and
ultimate collection of principal, but PCs are not backed by the full faith and
credit of the U.S. Government. Instead, they are supported only by the
discretionary authority of the U.S. Government to purchase the agency's
obligations.
Commercial banks, savings and loan institutions, private mortgage insurance
companies, mortgage bankers and other secondary market issuers also create
pass-through pools of conventional residential mortgage loans. Such issuers may,
in addition, be the originators and/or servicers of the underlying mortgage
loans as well as the guarantors of the mortgage-related securities. Pools
created by such non-governmental issuers generally offer a higher rate of
interest than government and government-related pools because there are no
direct or indirect government or agency guarantees of payments in such pools.
However, timely payment of interest and principal of these pools may be
supported by various forms of insurance or guarantees, including individual
loan, title, pool and hazard insurance and letters of credit. The insurance and
guarantees are issued by governmental entities, private insurers and the
mortgage poolers. There can be no assurance that the private insurers or
guarantors can meet their obligations under the insurance policies or guarantee
arrangements. Although the market for such securities is becoming increasingly
liquid, securities issued by certain private organizations may not be readily
marketable.
Mortgage-related securities that are issued or guaranteed by the U.S.
Government, its agencies or instrumentalities, are not subject to the Fund's
industry concentration restriction (see "Investment Restrictions") by virtue of
the exclusion from that restriction available to all U.S. Government securities.
In the case of privately issued mortgage-related securities, the Fund takes the
position that mortgage-related securities do not represent interests in any
particular "industry" or group of industries. The assets underlying such
securities may be represented by a portfolio of first lien residential mortgages
(including both whole mortgage loans and mortgage participation interests) or
portfolios of mortgage pass-through securities issued or guaranteed by GNMA,
FNMA or FHLMC. Mortgage loans underlying a mortgage-related security may in turn
be insured or guaranteed by the FHA or the VA. In the case of private issue
mortgage-related securities whose underlying assets are neither U.S. Government
securities nor U.S. Government insured mortgages, to the extent that real
properties securing such assets may be located in the same geographical region,
the security may be subject to a greater risk of default than other comparable
securities in the event of adverse economic, political or business developments
that may affect such region and, ultimately, the ability of residential
homeowners to make payments of principal and interest on the underlying
mortgages.
Collateralized Mortgage Obligations ("CMOs"). A CMO is a hybrid between a
mortgage-backed bond and a mortgage pass-through security. Similar to a bond,
interest and prepaid principal is paid, in most cases, semi-annually. CMOs may
be collateralized by whole mortgage loans, but are more typically collateralized
by portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or
FNMA, and their income streams.
12
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal
received from the pool of underlying mortgages, including prepayments, is first
returned to investors holding the shortest maturity class. Investors holding the
longer maturity classes receive principal only after the first class has been
retired. An investor is partially guarded against a sooner than desired return
of principal because of the sequential payments.
In a typical CMO transaction, a corporation ("issuer") issues multiple
series (e.g., A, B, C, Z) of CMO bonds (the "Bonds"). Proceeds of the Bond
offering are used to purchase mortgages or mortgage pass-through certificates
(the "Collateral"). The Collateral is pledged to a third party trustee as
security for the Bonds. Principal and interest payments from the Collateral are
used to pay principal on the Bonds in the order A, B, C, Z. The Series A, B and
C Bonds all bear current interest. Interest on the Series Z Bond is accrued and
added to principal and a like amount is paid as principal on the Series A, B or
C Bond currently being paid off. When the Series A, B and C Bonds are paid in
full, interest and principal on the Series Z Bond begin to be paid currently.
With some CMOs, the issuer serves as a conduit to allow loan originators
(primarily builders or savings and loan associations) to borrow against their
loan portfolios.
CMOs that are issued or guaranteed by the U.S. Government or by any of its
agencies or instrumentalities will be considered U.S. Government securities by
the Fund, while other CMOs, even if collateralized by U.S. Government
securities, will have the same status as other privately issued securities for
purposes of applying the Fund's diversification tests.
FHLMC Collateralized Mortgage Obligations. FHLMC CMOs are debt obligations
of FHLMC issued in multiple classes having different maturity dates which are
secured by the pledge of a pool of conventional mortgage loans purchased by
FHLMC. Unlike FHLMC PCs, payments of principal and interest on the CMOs are made
semi-annually, as opposed to monthly. The amount of principal payable on each
semi-annual payment date is determined in accordance with FHLMC's mandatory
sinking fund schedule, which in turn, is equal to approximately 100% of FHA
prepayment experience applied to the mortgage collateral pool. All sinking fund
payments in the CMOs are allocated to the retirement of the individual classes
of bonds in the order of their stated maturities. Payments of principal on the
mortgage loans in the collateral pool in excess of the amount of FHLMC's minimum
sinking fund obligation for any payment date are paid to the holders of the CMOs
as additional sinking fund payments. Because of the "pass-through" nature of all
principal payments received on the collateral pool in excess of FHLMC's minimum
sinking fund requirement, the rate at which principal of the CMOs is actually
repaid is likely to be such that each class of bonds will be retired in advance
of its scheduled maturity date.
If collection of principal (including prepayments) on the mortgage loans
during any semi-annual payment period is not sufficient to meet FHLMC's minimum
sinking fund obligation on the next sinking fund payment date, FHLMC agrees to
make up the deficiency from its general funds.
13
Criteria for the mortgage loans in the pool backing the FHLMC CMOs are
identical to those of FHLMC PCs. FHLMC has the right to substitute collateral in
the event of delinquencies and/or defaults.
Other Mortgage-Related Securities. Other mortgage-related securities
include securities other than those described above that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage loans
on real property, including CMO residuals and stripped mortgage-backed
securities. Other mortgage-related securities may be equity or debt securities
issued by agencies or instrumentalities of the U.S. Government or by private
originators of, or investors in, mortgage loans, including savings and loan
associations, homebuilders, mortgage banks, commercial banks, investment banks,
partnerships, trusts and special purpose entities of the foregoing.
CMO Residuals. CMO residuals are mortgage securities issued by agencies or
instrumentalities of the U.S. Government or by private originators of, or
investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
particular, the yield to maturity on CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets. In addition, if a series
of a CMO includes a class that bears interest at an adjustable rate, the yield
to maturity on the related CMO residual will also be extremely sensitive to
changes in the level of the index upon which interest rate adjustments are
based. The Fund may fail to recoup some or all of its initial investment in a
CMO residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has developed fairly recently and CMO residuals currently may
not have the liquidity of other more established securities trading in other
markets. Transactions in CMO residuals are generally completed only after
careful review of the characteristics of the securities in question. In
addition, CMO residuals may, or pursuant to an exemption therefrom, may not,
have been registered under the Securities Act of 1933, as amended (the "1933
Act"). CMO residuals, whether or not registered under the 1933 Act, may be
subject to certain restrictions on transferability, and may be deemed
"illiquid." As used in this Statement of Additional Information, the term CMO
residual does not include residual interests in real estate mortgage investment
conduits.
Other Asset-Backed Securities. Similarly, PIMCO expects that other
asset-backed securities (unrelated to mortgage loans) will be offered to
investors in the future and may be
14
purchased by the Fund. Several types of asset-backed securities have already
been offered to investors, including Enhanced Equipment Trust Certificates
("EETCs"), Certificates for Automobile Receivables(SM) ("CARS(SM)") and
Collateralized Debt Obligations ("CDOs").
Although any entity may issue EETCs, to date, U.S. airlines are the primary
issuers. An airline EETC is an obligation secured directly by aircraft or
aircraft engines as collateral. Airline EETCs generally have credit enhancement
in the form of over-collateralization and cross-subordination (i.e., multiple
tranches and multiple aircraft as collateral). They also generally have a
dedicated liquidity facility provided by a third-party insurer to insure that
coupon payments are made on a timely basis until collateral is liquidated in the
event of a default by the lessor of the collateral. Aircraft EETCs issued by
registered U.S. carriers also benefit from a special section of the U.S.
Bankruptcy Code, which allows the aircraft to be sold by the trust holding the
collateral to repay note holders without participating in bankruptcy
proceedings. EETCs tend to be less liquid than bonds.
CARS(SM) represent undivided fractional interests in a trust whose assets
consist of a pool of motor vehicle retail installment sales contracts and
security interests in the vehicles securing the contracts. Payments of principal
and interest on CARS(SM) are passed through monthly to certificate holders, and
are guaranteed up to certain amounts and for a certain time period by a letter
of credit issued by a financial institution unaffiliated with the trustee or
originator of the trust. An investor's return on CARS(SM) may be affected by
early prepayment of principal on the underlying vehicle sales contracts. If the
letter of credit is exhausted, the trust may be prevented from realizing the
full amount due on a sales contract because of state law requirements and
restrictions relating to foreclosure sales of vehicles and the obtaining of
deficiency judgments following such sales or because of depreciation, damage or
loss of a vehicle, the application of federal and state bankruptcy and
insolvency laws, or other factors. As a result, certificate holders may
experience delays in payments or losses if the letter of credit is exhausted.
The Fund may invest in CDOs, which includes collateralized bond obligations
("CBOs"), collateralized loan obligations ("CLOs") and other similarly
structured securities. CBOs and CLOs are types of asset-backed securities. A CBO
is a trust which is backed by a diversified pool of high risk, below investment
grade fixed income securities. A CLO is a trust typically collateralized by a
pool of loans, which may include, among others, domestic and foreign senior
secured loans, senior unsecured loans, and subordinate corporate loans,
including loans that may be rated below investment grade or equivalent unrated
loans.
For both CBOs and CLOs, the cash flows from the trust are split into two or
more portions, called tranches, varying in risk and yield. The riskiest portion
is the residual or "equity" tranche which bears the bulk of defaults from the
bonds or loans in the trust and serves to protect the other, more senior
tranches from default in all but the most severe circumstances. Since it is
partially protected from defaults, a senior tranche from a CBO trust or CLO
trust typically have higher ratings and lower yields than their underlying
securities, and can be rated investment grade. Despite the protection from the
equity tranche, CBO or CLO tranches can experience substantial losses due to
actual defaults, increased sensitivity to defaults due to collateral default and
disappearance of protecting tranches, market anticipation of defaults, as well
as aversion to CBO or CLO securities as a class.
15
The risks of an investment in a CDO depend largely on the type of the
collateral securities and the class of the CDO in which the Fund invests.
Normally, CBOs, CLOs and other CDOs are privately offered and sold, and thus,
are not registered under the securities laws. As a result, investments in CDOs
may be characterized by the Fund as illiquid securities; however, an active
dealer market may exist for CDOs allowing a CDO to qualify for Rule 144A
transactions. In addition to the normal risks associated with debt instruments
discussed elsewhere in this Statement of Additional Information and the
Prospectus (e.g., interest rate risk and default risk), CDOs carry additional
risks including, but not limited to, (i) the possibility that distributions from
collateral securities will not be adequate to make interest or other payments,
(ii) the quality of the collateral may decline in value or default, (iii) the
Fund may invest in CDOs that are subordinate to other classes, and (iv) the
complex structure of the security may not be fully understood at the time of
investment and may produce disputes with the issuer or unexpected investment
results.
Consistent with the Fund's investment objective and policies, PIMCO also
may invest in other types of asset-backed securities. Other asset-backed
securities may be collateralized by the fees earned by service providers. The
value of asset-backed securities may be substantially dependent on the servicing
of the underlying asset pools and are therefore subject to risks associated with
the negligence by, or defalcation of, their servicers. In certain circumstances,
the mishandling of related documentation may also affect the rights of the
security holders in and to the underlying collateral. The insolvency of entities
that generate receivables or that utilize the assets may result in added costs
and delays in addition to losses associated with a decline in the value of the
underlying assets.
Real Estate Investment Trusts ("REITs")
REITs are pooled investment vehicles which invest primarily in
income-producing real estate or real estate related loans or interests. REITs
are generally classified as equity REITs, mortgage REITs or a combination of
equity and mortgage REITs. Equity REITs invest the majority of their assets
directly in real property and derive income primarily from the collection of
rents. Equity REITs can also realize capital gains by selling properties that
have appreciated in value. Mortgage REITs invest the majority of their assets in
real estate mortgages and derive income from the collection of interest
payments. REITs are not taxed on income distributed to shareholders provided
they comply with the applicable requirements of the Code. The Fund will
indirectly bear its proportionate share of any management and other expenses
paid by REITs in which it invests in addition to the expenses paid by the Fund.
Debt securities issued by REITs are, for the most part, general and unsecured
obligations and are subject to risks associated with REITs.
Investing in REITs involves certain unique risks in addition to those risks
associated with investing in the real estate industry in general. An equity REIT
may be affected by changes in the value of the underlying properties owned by
the REIT. A mortgage REIT may be affected by changes in interest rates and the
ability of the issuers of its portfolio mortgages to repay their obligations.
REITs are dependent upon the skills of their managers and are not diversified.
REITs are generally dependent upon maintaining cash flows to repay borrowings
and to make distributions to shareholders and are subject to the risk of default
by lessees or borrowers. REITs
16
whose underlying assets are concentrated in properties used by a particular
industry, such as health care, are also subject to risks associated with such
industry.
REITs (especially fixed-rate mortgage REITs) are also subject to interest
rate risks that apply generally to mortgage-related securities and other debt
instruments, as described above.
REITs may have limited financial resources, may trade less frequently and
in a limited volume and may be subject to more abrupt or erratic price movements
than larger company securities. Historically REITs have been more volatile in
price than the larger capitalization stocks included in Standard & Poor's 500
Stock Index.
Bank Capital Securities and Obligations
The Fund may invest in bank capital securities. Bank capital securities are
issued by banks to help fulfill their regulatory capital requirements. There are
three common types of bank capital: Lower Tier II, Upper Tier II and Tier I. To
the extent that the Fund invests in bank capital, it expects to primarily invest
in floating rate Upper Tier II and Tier I bank capital. Bank capital is
generally, but not always, of investment grade quality. Upper Tier II securities
are commonly thought of as hybrids of debt and preferred stock. Upper Tier II
securities are often perpetual (with no maturity date), callable and have a
cumulative interest deferral feature. This means that under certain conditions,
the issuer bank can withhold payment of interest until a later date. However,
such deferred interest payments generally earn interest. Tier I securities often
take the form of trust preferred securities.
The Fund may also invest in other bank obligations including certificates
of deposit, bankers' acceptances, and fixed time deposits. Certificates of
deposit are negotiable certificates that are issued against funds deposited in a
commercial bank for a definite period of time and earning a specified return.
Bankers' acceptances are negotiable drafts or bills of exchange, normally drawn
by an importer or exporter to pay for specific merchandise, which are "accepted"
by a bank, meaning, in effect, that the bank unconditionally agrees to pay the
face value of the instrument on maturity. Fixed time deposits are bank
obligations payable at a stated maturity date and bearing interest at a fixed
rate. Fixed time deposits may be withdrawn on demand by the investor, but may be
subject to early withdrawal penalties which vary depending upon market
conditions and the remaining maturity of the obligation. There are generally no
contractual restrictions on the right to transfer a beneficial interest in a
fixed time deposit to a third party, although there is no market for such
deposits. The Fund may also hold funds on deposit with its custodian bank in an
interest-bearing account for temporary purposes.
Subject to the Fund's limitation on concentration of no more than 25% of
its total assets in the securities of issuers in a particular industry, the Fund
may invest without limit in U.S. dollar-denominated obligations of foreign banks
and may invest up to 25% of its total assets in foreign bank obligations
denominated in foreign currencies, subject to the restriction that a maximum of
10% of the Fund's total assets may be invested in securities of "emerging
market" countries. Obligations of foreign banks involve certain risks associated
with investing in foreign securities described under "--Foreign (Non-U.S.)
Securities" below. Foreign banks are not generally subject to examination by any
U.S. Government agency or instrumentality.
17
Delayed Funding Loans and Revolving Credit Facilities
The Fund may also enter into, or acquire participations in, delayed funding
loans and revolving credit facilities. Delayed funding loans and revolving
credit facilities are borrowing arrangements in which the lender agrees to make
loans up to a maximum amount upon demand by the borrower during a specified
term. A revolving credit facility differs from a delayed funding loan in that as
the borrower repays the loan, an amount equal to the repayment may be borrowed
again during the term of the revolving credit facility. Delayed funding loans
and revolving credit facilities usually provide for floating or variable rates
of interest. These commitments may have the effect of requiring the Fund to
increase its investment in a company at a time when it might not otherwise be
desirable to do so (including a time when the company's financial condition
makes it unlikely that such amounts will be repaid).
The Fund may invest in delayed funding loans and revolving credit
facilities with credit quality comparable to that of issuers of its securities
investments. Delayed funding loans and revolving credit facilities may be
subject to restrictions on transfer, and only limited opportunities may exist to
resell such instruments. As a result, the Fund may be unable to sell such
investments at an opportune time or may have to resell them at less than fair
market value. Delayed funding loans and revolving credit facilities are
considered to be debt obligations for the purposes of the Fund's investment
restriction relating to the lending of funds or assets by the Fund.
Commercial Paper
Commercial paper represents short-term unsecured promissory notes issued in
bearer form by corporations such as banks or bank holding companies and finance
companies. The Fund may invest in commercial paper of any credit quality
consistent with the Fund's investment objective and policies, including unrated
commercial paper for which PIMCO has made a credit quality assessment. See
Appendix A to the Prospectus for a description of the ratings assigned by
Moody's, S&P, Fitch Ratings and Dominion to commercial paper. The rate of return
on commercial paper may be linked or indexed to the level of exchange rates
between the U.S. dollar and a foreign currency or currencies.
U.S. Government Securities
U.S. Government securities are obligations of, or guaranteed by, the U.S.
Government, its agencies or instrumentalities. The U.S. Government does not
guarantee the net asset value of the Fund's shares. Some U.S. Government
securities, such as Treasury bills, notes and bonds, and securities guaranteed
by the GNMA, are supported by the full faith and credit of the United States;
others, such as those of the Federal Home Loan Banks, are supported by the right
of the issuer to borrow from the U.S. Treasury; others, such as those of the
FNMA, are supported by the discretionary authority of the U.S. Government to
purchase the agency's obligations; and still others, such as those of the
Student Loan Marketing Association, are supported only by the credit of the
instrumentality. U.S. Government securities include securities that have no
coupons, or have been stripped of their unmatured interest coupons, individual
interest coupons from such securities that trade separately, and evidences of
receipt of such securities. Such securities may pay no cash income, and are
purchased at a deep discount from their value at maturity. See "--
18
Zero-Coupon Bonds, Step-Ups and Payment-In-Kind Securities." Custodial receipts
issued in connection with so-called trademark zero-coupon securities, such as
CATs and TIGRs, are not issued by the U.S. Treasury, and are therefore not U.S.
Government securities, although the underlying bond represented by such receipt
is a debt obligation of the U.S. Treasury. Other zero-coupon Treasury securities
(e.g., STRIPs and CUBEs) are direct obligations of the U.S. Government.
Preferred Stock
Preferred stock represents an equity interest in a company that generally
entitles the holder to receive, in preference to the holders of other stocks
such as common stocks, dividends and a fixed share of the proceeds resulting
from a liquidation of the company. Some preferred stocks also entitle their
holders to receive additional liquidation proceeds on the same basis as holders
of a company's common stock, and thus also represent an ownership interest in
that company. The Fund will ordinarily invest in preferred stocks that pay
variable rates of return, but may also invest in fixed-rate preferred stocks.
See below. The value of a company's preferred stock may fall as a result of
factors relating directly to that company's products or services. A preferred
stock's value may also fall because of factors affecting not just the company,
but companies in the same industry or in a number of different industries, such
as increases in production costs. The value of preferred stock may also be
affected by changes in financial markets that are relatively unrelated to the
company or its industry, such as changes in interest rates or currency exchange
rates. In addition, a company's preferred stock generally pays dividends only
after the company makes required payments to holders of its bonds and other
debt. For this reason, the value of the preferred stock will usually react more
strongly than bonds and other debt to actual or perceived changes in the
company's financial condition or prospects. Preferred stocks of smaller
companies may be more vulnerable to adverse developments than those of larger
companies.
Adjustable Rate and Auction Preferred Stocks. Typically, the dividend rate
on an adjustable rate preferred stock is determined prospectively each quarter
by applying an adjustment formula established at the time of issuance of the
stock. Although adjustment formulas vary among issues, they typically involve a
fixed premium or discount relative to rates on specified debt securities issued
by the U.S. Treasury. Typically, an adjustment formula will provide for a fixed
premium or discount adjustment relative to the highest base yield of three
specified U.S. Treasury securities: the 90-day Treasury bill, the 10-year
Treasury note and the 20-year Treasury bond. The premium or discount adjustment
to be added to or subtracted from this highest U.S. Treasury base rate yield is
fixed at the time of issue and cannot be changed without the approval of the
holders of the stock. The dividend rate on other preferred stocks in which the
Fund may invest, commonly known as auction preferred stocks, is adjusted at
intervals that may be more frequent than quarterly, such as every 49 days, based
on bids submitted by holders and prospective purchasers of such stocks and may
be subject to stated maximum and minimum dividend rates. The issues of most
adjustable rate and auction preferred stocks currently outstanding are
perpetual, but are redeemable after a specified date at the option of the
issuer. Certain issues supported by the credit of a high-rated financial
institution provide for mandatory redemption prior to expiration of the credit
arrangement. No redemption can occur if full cumulative dividends are not paid.
Although the dividend rates on adjustable and auction preferred stocks are
generally adjusted or reset frequently, the market values of these preferred
19
stocks may still fluctuate in response to changes in interest rates. Market
values of adjustable preferred stocks also may substantially fluctuate if
interest rates increase or decrease once the maximum or minimum dividend rate
for a particular stock is approached.
Fixed Rate Preferred Stocks. Some fixed rate preferred stocks in which the
Fund may invest, known as perpetual preferred stocks, offer a fixed return with
no maturity date. Because they never mature, perpetual preferred stocks act like
long-term bonds, can be more volatile than other types of preferred stocks that
have a maturity date and may have heightened sensitivity to changes in interest
rates. The Fund may also invest in sinking fund preferred stocks. These
preferred stocks also offer a fixed return, but have a maturity date and are
retired or redeemed on a predetermined schedule. The shorter duration of sinking
fund preferred stocks makes them perform somewhat like intermediate-term bonds
and they typically have lower yields than perpetual preferred stocks.
Zero-Coupon Bonds, Step-Ups and Payment-In-Kind Securities
Zero-coupon securities are debt obligations that do not entitle the holder
to any periodic payments of interest either for the entire life of the
obligation or for an initial period after the issuance of the obligations. Like
zero-coupon bonds, "step-up" bonds pay no interest initially but eventually
begin to pay a coupon rate prior to maturity, which rate may increase at stated
intervals during the life of the security. Payment-in-kind securities ("PIKs")
pay dividends or interest in the form of additional securities of the issuer,
rather than in cash. Each of these instruments is typically issued and traded at
a deep discount from its face amount. The amount of the discount varies
depending on such factors as the time remaining until maturity of the
securities, prevailing interest rates, the liquidity of the security and the
perceived credit quality of the issuer. The market prices of zero-coupon bonds,
step-ups and PIKs generally are more volatile than the market prices of debt
instruments that pay interest currently and in cash and are likely to respond to
changes in interest rates to a greater degree than do other types of securities
having similar maturities and credit quality. In order to satisfy a requirement
for qualification as a "regulated investment company" under the Internal Revenue
Code of 1986, as amended (the "Code"), an investment company, such as the Fund,
must distribute each year at least 90% of its net investment income, including
the original issue discount accrued on zero-coupon bonds, step-ups and PIKs.
Because the Fund will not, on a current basis, receive cash payments from the
issuer of these securities in respect of any accrued original issue discount, in
some years the Fund may have to distribute cash obtained from selling other
portfolio holdings of the Fund. In some circumstances, such sales might be
necessary in order to satisfy cash distribution requirements even though
investment considerations might otherwise make it undesirable for the Fund to
sell securities at such time. Under many market conditions, investments in
zero-coupon bonds, step-ups and PIKs may be illiquid, making it difficult for
the Fund to dispose of them or determine their current value.
Convertible Securities and Synthetic Convertible Securities
The Fund may invest in convertible securities, which are debt securities
that may be converted at either a stated price or stated rate into underlying
shares of common stock. Convertible securities have general characteristics
similar to both debt securities and equity securities. PIMCO will generally
evaluate these instruments based primarily on their debt
20
characteristics. Because most convertible securities are fixed-rate instruments,
the market value of convertible securities tends to decline as interest rates
increase and, conversely, tends to increase as interest rates decline. In
addition, because of the conversion feature, the market value of convertible
securities tends to vary with fluctuations in the market value of the underlying
common stocks and, therefore, also will react to variations in the general
market for equity securities.
The Fund may also invest in synthetic convertible securities, which differ
from convertible securities in certain respects. Unlike a true convertible
security, which is a single security having a unitary market value, a synthetic
convertible comprises two or more separate securities, each with its own market
value. Therefore, the "market value" of a synthetic convertible security is the
sum of the values of its debt component and its convertibility component.
Synthetic convertible securities can be variable or fixed rate instruments. For
these reasons, the values of a synthetic convertible and a true convertible
security may respond differently to market fluctuations.
Convertible securities generally have higher yields than common stocks.
There can be no assurance of current income because the issuers of the
convertible securities may default on their obligations. A convertible security,
in addition to providing current income, offers the potential for capital
appreciation through the conversion feature, which enables the holder to benefit
from increases in the market price of the underlying common stock.
Municipal Bonds
The Fund may invest in municipal bonds which pay interest that, in the
opinion of bond counsel to the issuer (or on the basis of other authority
believed by PIMCO to be reliable), is exempt from federal income taxes
("municipal bonds"), although dividends that the Fund pays that are attributable
to such interest will not be tax-exempt to shareholders of the Fund.
Municipal bonds share the attributes of debt obligations in general, but
are generally issued by states, municipalities and other political subdivisions,
agencies, authorities and instrumentalities of states and multi-state agencies
or authorities. The municipal bonds that the Fund may purchase include general
obligation bonds and limited obligation bonds (or revenue bonds), including
industrial development bonds issued pursuant to former federal tax law. General
obligation bonds are obligations involving the credit of an issuer possessing
taxing power and are payable from such issuer's general revenues and not from
any particular source. Limited obligation bonds are payable only from the
revenues derived from a particular facility or class of facilities or, in some
cases, from the proceeds of a special excise or other specific revenue source.
Tax-exempt private activity bonds and industrial development bonds generally are
also revenue bonds and thus are not payable from the issuer's general revenues.
The credit and quality of private activity bonds and industrial development
bonds are usually related to the credit of the user of the facilities. Payment
of interest on and repayment of principal of such bonds is the responsibility of
the user (and/or any guarantor).
Municipal bonds are subject to credit and market risk. Generally, prices of
higher quality issues tend to fluctuate less with changes in market interest
rates than prices of lower quality issues and prices of longer maturity issues
tend to fluctuate more than prices of shorter maturity
21
issues. Prices and yields on municipal bonds are dependent on a variety of
factors, including general money-market conditions, the financial condition of
the issuer, general conditions of the municipal bond market, the size of a
particular offering, the maturity of the obligation and the rating of the issue.
A number of these factors, including the ratings of particular issues, are
subject to change from time to time. Information about the financial condition
of an issuer of municipal bonds may not be as extensive as that which is made
available by corporations whose securities are publicly traded. Obligations of
issuers of municipal bonds are subject to the provisions of bankruptcy,
insolvency and other laws, such as the Federal Bankruptcy Reform Act of 1978,
affecting the rights and remedies of creditors. Congress or state legislatures
may seek to extend the time for payment of principal or interest, or both, or to
impose other constraints upon enforcement of such obligations. There is also the
possibility that as a result of litigation or other conditions, the power or
ability of issuers to meet their obligations for the payment of interest and
principal on their municipal bonds may be materially affected or their
obligations may be found to be invalid or unenforceable.
The Fund may also invest in residual interest municipal bonds ("RIBS")
whose interest rates bear an inverse relationship to the interest rate on
another security or the value of an index. RIBS are created by dividing the
income stream provided by the underlying bonds to create two securities, one
short-term and one long-term. The interest rate on the short-term component is
reset by an index or auction process normally every seven to 35 days. After
income is paid on the short-term securities at current rates, the residual
income from the underlying bond(s) goes to the long-term securities. Therefore,
rising short-term interest rates result in lower income for the longer-term
portion, and vice versa. The longer-term bonds can be very volatile and may be
less liquid than other municipal bonds of comparable maturity. An investment in
RIBS typically will involve greater risk than an investment in a fixed rate
bond. Because increases in the interest rate on the other security or index
reduce the residual interest paid on a RIB, the value of a RIB is generally more
volatile than that of a fixed rate bond. RIBS have interest rate adjustment
formulas that generally reduce or, in the extreme, eliminate the interest paid
to the Fund when short-term interest rates rise, and increase the interest paid
to the Fund when short-term interest rates fall. RIBS have varying degrees of
liquidity that approximate the liquidity of the underlying bond(s), and the
market price for these securities is volatile. These securities generally will
underperform the market of fixed rate bonds in a rising interest rate
environment, but tend to outperform the market of fixed rate bonds when interest
rates decline or remain relatively stable. Although volatile, RIBS typically
offer the potential for yields exceeding the yields available on fixed rate
bonds with comparable credit quality, coupon, call provisions and maturity. The
Fund may also invest in RIBS for the purpose of increasing the Fund's leverage
as a more flexible alternative to the issuance of the AMPS. Should short-term
and long-term interest rates rise, the combination of the Fund's investment in
RIBS and its use of other forms of leverage (including through the issuance of
AMPS or the use of other derivative instruments) likely will adversely affect
the Fund's net asset value per share and income, distributions and total returns
to shareholders. Trusts in which RIBS may be held could be terminated, in which
case the residual bond holder would take possession of the underlying bond(s) on
an unleveraged basis.
22
Foreign (Non-U.S.) Securities
The Fund may invest some or all of its assets in U.S. dollar-denominated
debt obligations of corporate and other foreign (non-U. S.) issuers, including
obligations of foreign banks (see "--Bank Obligations" above), foreign
governments or their subdivisions, agencies and instrumentalities, international
agencies and supra-national government entities. The Fund may invest up to 25%
of its total assets in securities denominated in currencies other than the U.S.
dollar.
The foreign securities in which the Fund may invest include Eurodollar
obligations and "Yankee Dollar" obligations. Eurodollar obligations are U.S.
dollar-denominated certificates of deposit and time deposits issued outside the
U.S. capital markets by foreign branches of U.S. banks and by foreign banks.
Yankee Dollar obligations are U.S. dollar-denominated obligations issued in the
U.S. capital markets by foreign banks. Eurodollar and Yankee Dollar obligations
are generally subject to the same risks that apply to domestic debt issues,
notably credit risk, market risk and liquidity risk. Additionally, Eurodollar
(and to a limited extent, Yankee Dollar) obligations are subject to certain
sovereign risks. One such risk is the possibility that a sovereign country might
prevent capital, in the form of U.S. dollars, from flowing across its borders.
Other risks include adverse political and economic developments; the extent and
quality of government regulation of financial markets and institutions; the
imposition of foreign withholding taxes; and the expropriation or
nationalization of foreign issuers.
The Fund may invest in American Depository Receipts ("ADRs"), European
Depository Receipts ("EDRs") or Global Depository Receipts ("GDRs"). ADRs are
U.S. dollar-denominated receipts issued generally by domestic banks and
represent the deposit with the bank of a security of a foreign issuer. EDRs are
foreign currency-denominated receipts similar to ADRs and are issued and traded
in Europe, and are publicly traded on exchanges or over-the-counter in the
United States. GDRs may be offered privately in the United States and also trade
in public or private markets in other countries. ADRs, EDRs and GDRs may be
issued as sponsored or unsponsored programs. In sponsored programs, an issuer
has made arrangements to have its securities trade in the form of ADRs, EDRs or
GDRs. In unsponsored programs, the issuer may not be directly involved in the
creation of the program. Although regulatory requirements with respect to
sponsored and unsponsored programs are generally similar, in some cases it may
be easier to obtain financial information from an issuer that has participated
in the creation of a sponsored program.
The Fund may invest in Brady Bonds. Brady Bonds are securities created
through the exchange of existing commercial bank loans to sovereign entities for
new obligations in connection with debt restructurings under a debt
restructuring plan introduced by former U.S. Secretary of the Treasury, Nicholas
F. Brady (the "Brady Plan"). Brady Plan debt restructurings have been
implemented in a number of countries, including: Argentina, Bolivia, Brazil,
Bulgaria, Costa Rica, the Dominican Republic, Ecuador, Jordan, Mexico, Niger,
Nigeria, Panama, Peru, the Philippines, Poland, Uruguay and Venezuela.
Brady Bonds may be collateralized or uncollateralized, are issued in
various currencies (primarily the U.S. dollar) and are actively traded in the
over-the-counter secondary market. Brady Bonds are not considered to be U.S.
Government securities. U.S. dollar-denominated,
23
collateralized Brady Bonds, which may be fixed rate par bonds or floating rate
discount bonds, are generally collateralized in full as to principal by U.S.
Treasury zero-coupon bonds having the same maturity as the Brady Bonds. Interest
payments on these Brady Bonds generally are collateralized on a one-year or
longer rolling-forward basis by cash or securities in an amount that, in the
case of fixed rate bonds, is equal to at least one year of interest payments or,
in the case of floating rate bonds, initially is equal to at least one year's
interest payments based on the applicable interest rate at that time and is
adjusted at regular intervals thereafter. Certain Brady Bonds are entitled to
"value recovery payments" in certain circumstances, which in effect constitute
supplemental interest payments but generally are not collateralized. Brady Bonds
are often viewed as having three or four valuation components: (i) the
collateralized repayment of principal at final maturity; (ii) the collateralized
interest payments; (iii) the uncollateralized interest payments; and (iv) any
uncollateralized repayment of principal at maturity (the uncollateralized
amounts constitute the "residual risk").
Most Mexican Brady Bonds issued to date have principal repayments at final
maturity fully collateralized by U.S. Treasury zero-coupon bonds (or comparable
collateral denominated in other currencies) and interest coupon payments
collateralized on an 18-month rolling-forward basis by funds held in escrow by
an agent for the bondholders. A significant portion of the Venezuelan Brady
Bonds and the Argentine Brady Bonds issued to date have repayments at final
maturity collateralized by U.S. Treasury zero-coupon bonds (or comparable
collateral denominated in other currencies) and/or interest coupon payments
collateralized on a 14-month (for Venezuela) or 12-month (for Argentina)
rolling-forward basis by securities held by the Federal Reserve Bank of New York
as collateral agent.
Brady Bonds involve various risk factors including residual risk and the
history of defaults with respect to commercial bank loans by public and private
entities of countries issuing Brady Bonds. There can be no assurance that Brady
Bonds in which the Fund may invest will not be subject to restructuring
arrangements or to requests for new credit, which may cause the Fund to suffer a
loss of interest or principal on any of its holdings.
Investing in the securities of foreign issuers involves special risks and
considerations not typically associated with investing in U.S. companies. These
include: differences in accounting; auditing and financial reporting standards;
generally higher commission rates on foreign portfolio transactions; the
possibility of expropriation or confiscatory taxation; adverse changes in
investment or exchange control regulations (which may include suspension of the
ability to transfer currency from a country); political instability which can
affect U.S. investments in foreign countries; and potential restrictions on the
flow of international capital. In addition, foreign securities and dividends and
interest payable on those securities may be subject to foreign taxes, including
taxes withheld from payments on those securities. Foreign securities often trade
with less frequency and volume than domestic securities and therefore may
exhibit greater price volatility. Changes in foreign exchange rates will affect
the value of those securities which are denominated or quoted in currencies
other than the U.S. dollar.
Emerging Market Securities. The Fund may invest up to 10% of its total
assets in issuers located in "emerging markets." PIMCO generally considers an
emerging market to be one located in any country that is defined as an emerging
or developing economy by the World Bank or its related organizations, or the
United Nations or its subsidiaries. The risks of investing in
24
foreign securities are particularly high when securities of issuers based in or
denominated in currencies of developing or emerging market countries are
involved. Investing in emerging market countries involves certain risks not
typically associated with investing in U.S. securities, and imposes risks
greater than, or in addition to, risks of investing in foreign, developed
countries. These risks include: greater risks of nationalization or
expropriation of assets or confiscatory taxation; currency devaluations and
other currency exchange rate fluctuations; greater social, economic and
political uncertainty and instability (including the risk of war); more
substantial government involvement in the economy; less government supervision
and regulation of the securities markets and participants in those markets;
controls on foreign investment and limitations on repatriation of invested
capital and on the Fund's ability to exchange local currencies for U.S. dollars;
unavailability of currency hedging techniques in certain emerging market
countries; the fact that companies in emerging market countries may be smaller,
less seasoned and newly organized; the difference in, or lack of, auditing and
financial reporting standards, which may result in unavailability of material
information about issuers; the risk that it may be more difficult to obtain
and/or enforce a judgment in a court outside the United States; and greater
price volatility, substantially less liquidity and significantly smaller market
capitalization of securities markets. In addition, a number of emerging market
countries restrict, to various degrees, foreign investment in securities, and
high rates of inflation and rapid fluctuations in inflation rates have had, and
may continue to have, negative effects on the economies and securities markets
of certain emerging market countries. Also, any change in the leadership or
politics of emerging market countries, or the countries that exercise a
significant influence over those countries, may halt the expansion of or reverse
the liberalization of foreign investment policies now occurring and adversely
affect existing investment opportunities.
Sovereign Debt. The Fund may invest in sovereign debt issued by foreign
developed and emerging market governments and their respective sub-divisions,
agencies or instrumentalities, government sponsored enterprises and
supra-national government entities. Supra-national entities include
international organizations that are organized or supported by one or more
government entities to promote economic reconstruction or development and by
international banking institutions and related governmental agencies. Investment
in sovereign debt can involve a high degree of risk. The governmental entity
that controls the repayment of sovereign debt may not be able or willing to
repay the principal and/or interest when due in accordance with the terms of the
debt. A governmental entity's willingness or ability to repay principal and
interest due in a timely manner may be affected by, among other factors, its
cash flow situation, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the governmental entity's
policy toward the International Monetary Fund, and the political constraints to
which a governmental entity may be subject. Governmental entities may also
depend on expected disbursements from foreign governments, multilateral agencies
and others to reduce principal and interest arrearages on their debt. The
commitment on the part of these governments, agencies and others to make such
disbursements may be conditioned on a governmental entity's implementation of
economic reforms and/or economic performance and the timely service of such
debtor's obligations. Failure to implement such reforms, achieve such levels of
economic performance or repay principal or interest when due may result in the
cancellation of such third parties' commitments to lend funds to the
governmental entity, which may further impair such debtor's ability or
willingness to service its debts in a timely manner. Consequently, governmental
entities may default on their sovereign debt. Holders of sovereign
25
debt (including the Fund) may be requested to participate in the rescheduling of
such debt and to extend further loans to governmental entities. There is no
bankruptcy proceeding by which sovereign debt on which governmental entities
have defaulted may be collected in whole or in part.
The Fund's investments in foreign currency-denominated debt obligations and
hedging activities will likely produce a difference between its book income and
its taxable income. This difference may cause a portion of the Fund's income
distributions to constitute returns of capital for tax purposes or require the
Fund to make distributions exceeding book income to qualify as a regulated
investment company for federal income tax purposes.
Foreign Currency Transactions
Subject to the limitations discussed above and in the Prospectus, the Fund
also may purchase and sell foreign currency options and foreign currency futures
contracts and related options (see "--Derivative Instruments" below), and may
engage in foreign currency transactions either on a spot (cash) basis at the
rate prevailing in the currency exchange market at the time or through forward
foreign currency exchange contracts ("forwards") with terms generally of less
than one year. The Fund may engage in these transactions in order to protect
against uncertainty in the level of future foreign exchange rates in the
purchase and sale of securities. The Fund may also use foreign currency options
and foreign currency forward contracts to increase exposure to a foreign
currency or to shift exposure to foreign currency fluctuations from one country
to another. Suitable currency hedging transactions may not be available in all
circumstances and PIMCO may decide not to use hedging transactions that are
available.
A forward involves an obligation to purchase or sell a specific currency at
a future date, which may be any fixed number of days from the date of the
contract agreed upon by the parties, at a price set at the time of the contract.
These contracts may be bought or sold to protect the Fund against a possible
loss resulting from an adverse change in the relationship between foreign
currencies and the U.S. dollar or to increase exposure to a particular foreign
currency. Although forwards are intended to minimize the risk of loss due to a
decline in the value of the hedged currencies, at the same time, they tend to
limit any potential gain which might result should the value of such currencies
increase. Forwards will be used primarily to adjust the foreign exchange
exposure of the Fund with a view to protecting the outlook, and the Fund might
be expected to enter into such contracts under the following circumstances:
Lock In. When PIMCO desires to lock in the U.S. dollar price on the
purchase or sale of a security denominated in a foreign currency.
Cross Hedge. If a particular currency is expected to decrease against
another currency, the Fund may sell the currency expected to decrease and
purchase a currency that is expected to increase against the currency sold in an
amount approximately equal to some or all of the Fund's portfolio holdings
denominated in the currency sold.
Direct Hedge. If PIMCO wants to eliminate substantially all of the risk of
owning a particular currency, and/or if PIMCO believes that the Fund can benefit
from price appreciation
26
in a given country's debt obligations but does not want to hold the currency, it
may employ a direct hedge back into the U.S. dollar. In either case, the Fund
would enter into a forward contract to sell the currency in which a portfolio
security is denominated and purchase U.S. dollars at an exchange rate
established at the time it initiated a contract. The cost of the direct hedge
transaction may offset most, if not all, of the yield advantage offered by the
foreign security, but the Fund would hope to benefit from an increase (if any)
in the value of the debt obligation.
Proxy Hedge. PIMCO might choose to use a proxy hedge, which may be less
costly than a direct hedge. In this case, the Fund, having purchased a security,
will sell a currency whose value is believed to be closely linked to the
currency in which the security is denominated. Interest rates prevailing in the
country whose currency was sold would be expected to be close to those in the
United States and lower than those of securities denominated in the currency of
the original holding. This type of hedging entails greater risk than a direct
hedge because it is dependent on a stable relationship between the two
currencies paired as proxies and the relationships can be very unstable at
times.
Costs of Hedging. When the Fund purchases a foreign bond with a higher
interest rate than is available on U.S. bonds of a similar maturity, the
additional yield on the foreign bond could be substantially reduced or lost if
the Fund were to enter into a direct hedge by selling the foreign currency and
purchasing the U.S. dollar. This is what is known as the "cost" of hedging.
Proxy hedging attempts to reduce this cost through an indirect hedge back to the
U.S. dollar.
It is important to note that hedging costs are treated as capital
transactions and are not, therefore, deducted from the Fund's dividend
distribution and are not reflected in its yield.
Tax Consequences of Hedging. Under applicable tax law, the Fund's hedging
activities may result in the application of the mark-to-market and straddle
provisions of the Code. Those provisions could result in an increase (or
decrease) in the amount of taxable dividends paid by the Fund and could affect
whether dividends paid by the Fund are classified as capital gains or ordinary
income.
Foreign Currency Exchange-Related Securities
Foreign Currency Warrants. Foreign currency warrants, such as Currency
Exchange Warrants(SM) ("CEWs(SM)"), are warrants that entitle their holders to
receive from their issuer an amount of cash (generally, for warrants issued in
the United States, in U.S. dollars) that is calculated pursuant to a
predetermined formula and based on the exchange rate between a specified foreign
currency and the U.S. dollar as of the exercise date of the warrant. Foreign
currency warrants generally are exercisable upon their issuance and expire as of
a specific date and time. Foreign currency warrants have been issued in
connection with U.S. dollar-denominated debt offerings by major issuers in an
attempt to reduce the foreign currency exchange risk that, from the point of
view of the prospective purchasers of the securities, is inherent in the
international debt obligation marketplace. Foreign currency warrants may attempt
to reduce the foreign exchange risk assumed by purchasers of a security by, for
example, providing for a supplement payment in the event that the U.S. dollar
depreciates against the value of a major foreign currency such as the Japanese
yen. The formula used to determine the
27
amount payable upon exercise of a foreign currency warrant may make the warrant
worthless unless the applicable foreign currency exchange rate moves in a
particular direction (e.g., unless the U.S. dollar appreciates or depreciates
against the particular foreign currency to which the warrant is linked or
indexed). Foreign currency warrants are severable from the debt obligations with
which they may be offered, and may be listed on exchanges. Foreign currency
warrants may be exercisable only in certain minimum amounts, and an investor
wishing to exercise warrants who possesses less than the minimum number required
for exercise may be required either to sell the warrants or to purchase
additional warrants, thereby incurring additional transaction costs. In the case
of any exercise of warrants, there may be a time delay between the time a holder
of warrants gives instructions to exercise and the time the exchange rate
relating to exercise is determined, during which time the exchange rate could
change significantly, thereby affecting both the market and cash settlement
values of the warrants being exercised. The expiration date of the warrants may
be accelerated if the warrants should be delisted from an exchange or if their
trading should be suspended permanently, which would result in the loss of any
remaining "time values" of the warrants (i.e., the difference between the
current market value and the exercise value of the warrants), and, if the
warrants were "out-of-the-money," in a total loss of the purchase price of the
warrants. Warrants are generally unsecured obligations of their issuers and are
not standardized foreign currency options issued by the Options Clearing
Corporation ("OCC"). Unlike foreign currency options issued by the OCC, the
terms of foreign exchange warrants generally will not be amended in the event of
government or regulatory actions affecting exchange rates or in the event of the
imposition of other regulatory controls affecting the international currency
markets. The initial public offering price of foreign currency warrants is
generally considerably in excess of the price that a commercial user of foreign
currencies might pay in the interbank market for a comparable option involving
significantly larger amounts of foreign currencies. Foreign currency warrants
are subject to significant foreign exchange risk, including risks arising from
complex political or economic factors.
Principal Exchange Rate Linked Securities. Principal exchange rate linked
securities ("PERLs(SM)") are debt obligations the principal on which is payable
at maturity in an amount that may vary based on the exchange rate between the
U.S. dollar and a particular foreign currency at or about that time. The return
on "standard" principal exchange rate linked' securities is enhanced if the
foreign currency to which the security is linked appreciates against the U.S.
dollar, and is adversely affected by increases in the foreign exchange value of
the U.S. dollar; "reverse" principal exchange rate linked securities are like
"standard" securities, except that their return is enhanced by increases in the
value of the U.S. dollar and adversely impacted by increases in the value of
foreign currency. Interest payments on the securities are generally made in U.S.
dollars at rates that reflect the degree of foreign currency risk assumed or
given up by the purchaser of the notes (i.e., at relatively higher interest
rates if the purchaser has assumed some of the foreign exchange risk, or
relatively lower interest rates if the issuer has assumed some of the foreign
exchange risk, based on the expectations of the current market). Principal
exchange rate linked securities may in limited cases be subject to acceleration
of maturity (generally, not without the consent of the holders of the
securities), which may have an adverse impact on the value of the principal
payment to be made at maturity.
Performance Indexed Paper. Performance indexed paper ("PIPs(SM)") is U.S.
dollar-denominated commercial paper the yield of which is linked to certain
foreign exchange rate movements. The yield to the investor on performance
indexed paper is established at maturity as
28
a function of spot exchange rates between the U.S. dollar and a designated
currency as of or about that time (generally, the index maturity two days prior
to maturity). The yield to the investor will be within a range stipulated at the
time of purchase of the obligation, generally with a guaranteed minimum rate of
return that is below, and a potential maximum rate of return that is above,
market yields on U.S. dollar-denominated commercial paper, with both the minimum
and maximum rates of return on the investment corresponding to the minimum and
maximum values of the spot exchange rate two business days prior to maturity.
Derivative Instruments
The Fund may, but is not required to, use a variety of derivative
instruments for hedging or risk management purposes or as part of its investment
strategies. Generally, derivatives are financial contracts whose value depends
upon, or is derived from, the value of an underlying asset, reference rate or
index, and may relate to individual debt instruments, interest rates, currencies
or currency exchange rates, commodities or related indexes. The Fund may use
derivatives to gain exposure to floating rate or high yield securities and other
securities in which the Fund may invest (including pending investment of the
proceeds of this offering). Examples of derivative instruments that the Fund may
use include, but are not limited to, options contracts, futures contracts,
options on futures contracts, swap agreements (including total return and credit
default swaps) and short sales. The Fund may also engage in credit spread
trades. A credit spread trade is an investment position relating to a difference
in the prices or interest rates of two bonds or other securities, where the
value of the investment position is determined by changes in the difference
between such prices or interest rates, as the case may be, of the respective
securities. The Fund may also have exposure to derivatives, such as interest
rate or credit-default swaps, through investment in credit-linked trust
certificates and other securities issued by special purpose or structured
vehicles. The Fund may also use derivatives to add leverage to the portfolio,
but only as a substitute for leverage obtained through AMPS. If other types of
financial instruments, including other types of options, futures contracts or
futures options are traded in the future, the Fund may also use those
instruments, provided that their use is consistent with the Fund's investment
objective and policies.
Like the other investments of the Fund, the ability of the Fund to
successfully utilize derivative instruments may depend in part upon the ability
of PIMCO to assess the issuer's credit characteristics and other macro-economic
factors correctly. If PIMCO incorrectly forecasts such factors and has taken
positions in derivative instruments contrary to prevailing market trends, the
Fund could be exposed to the risk of loss.
The Fund might not employ any of the strategies described below, and no
assurance can be given that any strategy used will succeed. If PIMCO incorrectly
forecasts market values or other economic factors in utilizing a derivatives
strategy for the Fund, the Fund might have been in a better position if it had
not entered into the transaction at all. Also, suitable derivative transactions
may not be available in all circumstances. The use of these strategies involves
certain special risks, including a possible imperfect correlation, or even no
correlation, between price movements of derivative instruments and price
movements of related investments. While some strategies involving derivative
instruments can reduce the risk of loss, they can also reduce the opportunity
for gain or even result in losses by offsetting favorable price movements in
related investments or otherwise, due to the possible inability of the Fund to
purchase or sell a
29
portfolio security at a time that otherwise would be favorable or the possible
need to sell a portfolio security at a disadvantageous time because the Fund is
required to maintain asset coverage or offsetting positions in connection with
transactions in derivative instruments, and the possible inability of the Fund
to close out or to liquidate its derivatives positions. Income earned by the
Fund from many derivative strategies will be treated as capital gain and, if not
offset by net realized capital loss, will be distributed to shareholders in
taxable distributions.
Options on Securities, Swap Agreements and Indexes. The Fund may purchase
and sell both put and call options on securities, swap agreements or indexes in
standardized contracts traded on domestic or other securities exchanges, boards
of trade, or similar entities, or quoted on NASDAQ or on an over-the-counter
market, and agreements, sometimes called cash puts, which may accompany the
purchase of a new issue of debt obligations from a dealer.
An option on a security (or an index) is a contract that gives the holder
of the option, in return for a premium, the right to buy from (in the case of a
call) or sell to (in the case of a put) the writer of the option the security
underlying the option (or the cash value of the index) at a specified exercise
price at any time during the term of the option. The writer of an option on a
security has the obligation upon exercise of the option to deliver the
underlying security upon payment of the exercise price or to pay the exercise
price upon delivery of the underlying security. Upon exercise, the writer of an
option on an index is obligated to pay the difference between the cash value of
the index and the exercise price multiplied by the specified multiplier for the
index option. (An index is designed to reflect features of a particular
securities market, a specific group of financial instruments or securities, or
certain economic indicators.)
The Fund may (but is not required to) cover its obligations when it writes
call options or put options. In the case of a call option on a debt obligation
or other security, the option is covered if the Fund owns the security
underlying the call or has an absolute and immediate right to acquire that
security without additional cash consideration (or, if additional cash
consideration is required, cash or other assets determined to be liquid by PIMCO
in accordance with procedures established by the Board of Trustees, in such
amount are segregated by its custodian) upon conversion or exchange of other
securities held by the Fund. For a call option on an index, the option is
covered if the Fund maintains with its custodian assets determined to be liquid
by PIMCO in accordance with procedures established by the Board of Trustees, in
an amount equal to the contract value of the index. A call option is also
covered if the Fund holds a call on the same security or index as the call
written where the exercise price of the call held is (i) equal to or less than
the exercise price of the call written, or (ii) greater than the exercise price
of the call written, provided the difference is maintained by the Fund in
segregated assets determined to be liquid by PIMCO in accordance with procedures
established by the Board of Trustees. A put option on a security or an index is
covered if the Fund segregates assets determined to be liquid by PIMCO in
accordance with procedures established by the Board of Trustees equal to the
exercise price. A put option is also covered if the Fund holds a put on the same
security or index as the put written where the exercise price of the put held is
(i) equal to or greater than the exercise price of the put written, or (ii) less
than the exercise price of the put written, provided the difference is
maintained by the Fund in segregated assets determined to be liquid by PIMCO in
accordance with procedures established by the Board of Trustees. Obligations
under written call and put options so covered will not be construed to be
"senior securities" for purposes of the Fund's investment restrictions
concerning senior securities and borrowings.
30
If an option written by the Fund expires unexercised, the Fund realizes on
the expiration date a capital gain equal to the premium the Fund received at the
time the option was written. If an option purchased by the Fund expires
unexercised, the Fund realizes a capital loss equal to the premium paid. Prior
to the earlier of exercise or expiration, an exchange-traded option may be
closed out by an offsetting purchase or sale of an option of the same series
(type, exchange, underlying security or index, exercise price, and expiration).
There can be no assurance, however, that a closing purchase or sale transaction
can be effected when the Fund desires.
The Fund may sell put or call options it has previously purchased, which
could result in a net gain or loss depending on whether the amount realized on
the sale is more or less than the premium and other transaction costs paid on
the put or call option which is sold. Prior to exercise or expiration, an option
may be closed out by an offsetting purchase or sale of an option of the same
series. The Fund will realize a capital gain from a closing purchase transaction
if the cost of the closing option is less than the premium received from writing
the option, or, if it is more, the Fund will realize a capital loss. If the
premium received from a closing sale transaction is more than the premium paid
to purchase the option, the Fund will realize a capital gain or, if it is less,
the Fund will realize a capital loss. The principal factors affecting the market
value of a put or a call option include supply and demand, interest rates, the
current market price of the underlying security or index in relation to the
exercise price of the option, the volatility of the underlying security or index
and the time remaining until the expiration date.
The premium paid for a put or call option purchased by the Fund is an asset
of the Fund. The premium received for an option written by the Fund is recorded
as a deferred credit. The value of an option purchased or written is marked to
market daily and is valued at the closing price on the exchange on which it is
traded or, if not traded on an exchange or no closing price is available, at the
mean between the last bid and asked prices.
The Fund may write straddles (covered or uncovered) consisting of a
combination of a call and a put written on the same underlying security. A
straddle will be covered when sufficient assets are deposited to meet the Fund's
immediate obligations. The Fund may use the same liquid assets to cover both the
call and put options where the exercise price of the call and put are the same,
or the exercise price of the call is higher than that of the put. In such cases,
the Fund will also segregate liquid assets equivalent to the amount, if any, by
which the put is "in the money."
Risks Associated with Options on Securities and Indexes. There are several
risks associated with transactions in options on securities and on indexes. For
example, there are significant differences between the securities and options
markets that could result in an imperfect correlation between these markets,
causing a given transaction not to achieve its objective. A decision as to
whether, when and how to use options involves the exercise of skill and
judgment, and even a well-conceived transaction may be unsuccessful to some
degree because of market behavior or unexpected events.
During the option period, the covered call writer has, in return for the
premium on the option, given up the opportunity to profit from a price increase
in the underlying security above the exercise price, but, as long as its
obligation as a writer continues, has retained the risk of loss should the price
of the underlying security decline. The writer of an option has no control over
31
the time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying security at the exercise price. If a put
or call option purchased by the Fund is not sold when it has remaining value,
and if the market price of the underlying security remains equal to or greater
than the exercise price (in the case of a put), or remains less than or equal to
the exercise price (in the case of a call), the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it has purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
Foreign Currency Options. The Fund may buy or sell put and call options on
foreign currencies for investment purposes or as a hedge against changes in the
value of the U.S. dollar (or another currency) in relation to a foreign currency
in which the Fund's securities may be denominated. The Fund may buy or sell put
and call options on foreign currencies either on exchanges or in the
over-the-counter market. A put option on a foreign currency gives the purchaser
of the option the right to sell a foreign currency at the exercise price until
the option expires. A call option on a foreign currency gives the purchaser of
the option the right to purchase the currency at the exercise price until the
option expires. Currency options traded on U.S. or other exchanges may be
subject to position limits which may limit the ability of the Fund to reduce
foreign currency risk using such options.
Futures Contracts and Options on Futures Contracts. The Fund may invest in
futures contracts and options thereon ("futures options"), including interest
rates, securities indexes, debt obligations (to the extent they are available)
and U.S. Government and agency securities, as well as purchase put and call
options on such futures contracts.
A futures contract provides for the future sale by one party and purchase
by another party of a specified quantity of the security or other financial
instrument at a specified price and time. A futures contract on an index is an
agreement pursuant to which two parties agree to take or make delivery of an
amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract was
32
originally written. Although the value of an index might be a function of the
value of certain specified securities, physical delivery of these securities is
not always made. A public market exists in futures contracts covering a number
of indexes as well as financial instruments, including, without limitation: U.S.
Treasury bonds; U.S. Treasury notes; GNMA Certificates; three-month U.S.
Treasury bills; 90-day commercial paper; bank certificates of deposit;
Eurodollar certificates of deposit; the Australian dollar; the Canadian dollar;
the British pound; the Japanese yen; the Swiss franc; the Mexican peso; and
certain multinational currencies, such as the euro. It is expected that other
futures contracts will be developed and traded in the future.
The Fund may purchase and write call and put futures options. Futures
options possess many of the same characteristics as options on securities and
indexes (discussed above). A futures option gives the holder the right, in
return for the premium paid, to assume a long position (call) or short position
(put) in a futures contract at a specified exercise price at any time during the
period of the option. Upon exercise of a call option, the holder acquires a long
position in the futures contract and the writer is assigned the opposite short
position. In the case of a put option, the opposite is true.
The Fund may enter into futures contracts and futures options that are
standardized and traded on a U.S. or other exchange, board of trade, or similar
entity, or quoted on an automated quotation system, and the Fund may also enter
into OTC options on futures contracts.
When a purchase or sale of a futures contract is made by the Fund, the Fund
is required to deposit with its custodian (or broker, if legally permitted) a
specified amount of assets determined to be liquid by PIMCO in accordance with
procedures established by the Board of Trustees ("initial margin"). The margin
required for a futures contract is set by the exchange on which the contract is
traded and may be modified during the term of the contract. The initial margin
is in the nature of a performance bond or good faith deposit on the futures
contract that is returned to the Fund upon termination of the contract, assuming
all contractual obligations have been satisfied. The Fund expects to earn
taxable interest income on its initial margin deposits. A futures contract held
by the Fund is valued daily at the official settlement price of the exchange on
which it is traded. Each day the Fund pays or receives cash, called "variation
margin," equal to the daily change in value of the futures contract. This
process is known as "marking to market." Variation margin does not represent a
borrowing or loan by the Fund but is instead a settlement between the Fund and
the broker of the amount one would owe the other if the futures
33
contract expired. In computing daily net asset value, the Fund will mark to
market its open futures positions.
The Fund is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures contract (and the
related initial margin requirements), the current market value of the option,
and other futures positions held by the Fund.
Although some futures contracts call for making or taking delivery of the
underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts
(involving the same exchange, underlying security or index, and delivery month).
If an offsetting purchase price is less than the original sale price, the Fund
realizes a capital gain, or if it is more, the Fund realizes a capital loss.
Conversely, if an offsetting sale price is more than the original purchase
price, the Fund realizes a capital gain, or if it is less, the Fund realizes a
capital loss. The transaction costs must also be included in these calculations.
The Fund may write straddles (covered or uncovered) consisting of a call
and a put written on the same underlying futures contract. A straddle will be
covered when sufficient assets are deposited to meet the Fund's immediate
obligations. The Fund may use the same liquid assets to cover both the call and
put options where the exercise price of the call and put are the same, or the
exercise price of the call is higher than that of the put. In such cases, the
Fund will also segregate liquid assets equivalent to the amount, if any, by
which the put is "in the money."
The Fund is operated by a person who has claimed an exclusion from the
definition of the term "commodity pool operator" under the Commodity Exchange
Act (the "CEA"), and, therefore, such person is not subject to registration or
regulation as a pool operator under the CEA.
Limitations on Use of Futures and Futures Options. When purchasing a
futures contract, the Fund will maintain with its custodian (and mark to market
on a daily basis) assets determined to be liquid by PIMCO in accordance with
procedures established by the Board of Trustees, that, when
34
added to the amounts deposited with a futures commission merchant as margin, are
equal to the market value of the futures contract. Alternatively, the Fund may
"cover" its position by purchasing a put option on the same futures contract
with a strike price as high as or higher than the price of the contract held by
the Fund.
When selling a futures contract, the Fund will maintain with its custodian
(and mark to market on a daily basis) assets determined to be liquid by PIMCO in
accordance with procedures established by the Board of Trustees, that are equal
to the market value of the instruments underlying the contract. Alternatively,
the Fund may "cover" its position by owning the instruments underlying the
contract (or, in the case of an index futures contract, a portfolio with a
volatility substantially similar to that of the index on which the futures
contract is based), or by holding a call option permitting the Fund to purchase
the same futures contract at a price no higher than the price of the contract
written by the Fund (or at a higher price if the difference is maintained in
liquid assets with the Fund's custodian).
When selling a call option on a futures contract, the Fund will maintain
with its custodian (and mark to market on a daily basis) assets determined to be
liquid by PIMCO in accordance with procedures established by the Board of
Trustees, that, when added to the amounts deposited with a futures commission
merchant as margin, equal the total market value of the futures contract
underlying the call option. Alternatively, the Fund may cover its position by
entering into a long position in the same futures contract at a price no higher
than the strike price of the call option, by owning the instruments underlying
the futures contract, or by holding a separate call option permitting the Fund
to purchase the same futures contract at a price not higher than the strike
price of the call option sold by the Fund.
When selling a put option on a futures contract, the Fund will maintain
with its custodian (and mark to market on a daily basis) assets determined to be
liquid by PIMCO in accordance with procedures established by the Board of
Trustees, that equal the purchase price of the futures contract, less any margin
on deposit. Alternatively, the Fund may cover the position either by entering
into a short position in the same futures contract, or by owning a separate put
option permitting it to sell the same futures contract so long as the strike
price of the purchased put option is the same as or higher than the strike price
of the put option sold by the Fund.
To the extent that securities with maturities greater than one year are
used to segregate assets to cover the Fund's obligations under futures contracts
and related options, such use will not eliminate the leverage risk arising from
such use, which may tend to exaggerate the effect on net asset value of any
increase or decrease in the market value of the Fund's portfolio, and may
require liquidation of portfolio positions when it is not advantageous to do so.
The requirements for qualification as a regulated investment company also
may limit the extent to which the Fund may enter into futures, futures options
or forward contracts. See "Tax Matters."
Risks Associated with Futures and Futures Options. There are several risks
associated with the use of futures contracts and futures options as hedging
techniques. A purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract. There can be no guarantee
that there will be a correlation between price movements in the
35
hedging vehicle and in the Fund securities being hedged. In addition, there are
significant differences between the securities and futures markets that could
result in an imperfect correlation between the markets, causing a given hedge
not to achieve its objective. The degree of imperfection of correlation depends
on circumstances such as variations in speculative market demand for futures and
futures options on securities, including technical influences in futures trading
and futures options, and differences between the financial instruments being
hedged and the instruments underlying the standard contracts available for
trading in such respects as interest rate levels, maturities, and
creditworthiness of issuers. A decision as to whether, when and how to hedge
involves the exercise of skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of market behavior or unexpected interest
rate trends.
Futures contracts on U.S. Government securities historically have reacted
to an increase or decrease in interest rates in a manner similar to that in
which the underlying U.S. Government securities reacted. To the extent, however,
that the Fund enters into such futures contracts, the value of such futures will
not vary in direct proportion to the value of the Fund's holdings of debt
obligations. Thus, the anticipated spread between the price of the futures
contract and the hedged security may be distorted due to differences in the
nature of the markets. The spread also may be distorted by differences in
initial and variation margin requirements, the liquidity of such markets and the
participation of speculators in such markets.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of the current trading
session. Once the daily limit has been reached in a futures contract subject to
the limit, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may work to prevent
the liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial losses.
There can be no assurance that a liquid market will exist at a time when
the Fund seeks to close out a futures contract or a futures option position, and
the Fund would remain obligated to meet margin requirements until the position
is closed. In addition, many of the contracts discussed above are relatively new
instruments without a significant trading history. As a result, there can be no
assurance that an active secondary market will develop or continue to exist.
Additional Risks of Options on Securities, Futures Contracts, Options on
Futures Contracts and Forward Currency Exchange Contracts and Options thereon.
Options on securities, futures contracts, options on futures contracts, and
options on currencies may be traded on foreign exchanges. Such transactions may
not be regulated as effectively as similar transactions in the United States,
may not involve a clearing mechanism and related guarantees, and are subject to
the risk of governmental actions affecting trading in, or the prices of, foreign
securities. Some foreign exchanges may be principal markets so that no common
clearing facility exists and a trader may look only to the broker for
performance of the contract. The value of such positions also could be adversely
affected by (i) other complex foreign political, legal and economic factors,
(ii) lesser availability than in the United States of data on which to
36
make trading decisions, (iii) delays in the Fund's ability to act upon economic
events occurring in foreign markets during non-business hours in the United
States, (iv) the imposition of different exercise and settlement terms and
procedures and margin requirements than in the United States and (v) lesser
trading volume. In addition, unless the Fund hedges against fluctuations in the
exchange rate between the U.S. dollar and the currencies in which trading is
done on foreign exchanges, any profits that the Fund might realize in trading
could be eliminated by adverse changes in the exchange rate, or the Fund could
incur losses as a result of those changes. The Fund's use of such instruments
may cause the Fund to realize higher amounts of short-term capital gains
(generally taxed to shareholders at ordinary income tax rates) than if the Fund
had not used such instruments.
Swap Agreements. The Fund may enter into total return swap agreements,
credit default swap agreements and other swap agreements made with respect to
interest rates, currencies, indexes of securities and other assets or measures
of risk or return. The Fund may also enter into options on swap agreements
("swaptions"). These transactions are entered into in an attempt to obtain a
particular return when it is considered desirable to do so, possibly at a lower
cost to the Fund than if the Fund had invested directly in an instrument that
yielded that desired return. Swap agreements are two-party contracts entered
into primarily by institutional investors for periods ranging from a few weeks
to more than one year. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized on
particular predetermined investments or instruments, which may be adjusted for
an interest factor. The gross returns to be exchanged or "swapped" between the
parties are generally calculated with respect to a "notional amount," i.e., the
return on or increase in value of a particular dollar amount invested at a
particular interest rate or in a "basket" of securities representing a
particular index. Forms of swap agreements include interest rate caps, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates exceed a specified rate, or "cap"; interest
rate floors, under which, in return for a premium, one party agrees to make
payments to the other to the extent that interest rates fall below a specified
rate, or "floor"; and interest rate collars, under which a party sells a cap and
purchases a floor or vice versa in an attempt to protect itself against interest
rate movements exceeding given minimum or maximum levels. The Fund may use
interest rate caps, floors and collars to a substantial degree in connection
with its leveraging strategies. See "--Certain Interest Rate Transactions" below
and "Investment Objective and Strategies--Certain Interest Rate Transactions" in
the Prospectus. A swaption is a contract that gives a counterparty the right
(but not the obligation) to enter into a new swap agreement or to shorten,
extend, cancel or otherwise modify an existing swap agreement, at some
designated future time on specified terms. The Fund may write (sell) and
purchase put and call swaptions.
Most swap agreements entered into by the Fund would calculate the
obligations of the parties to the agreement on a "net basis." Consequently, the
Fund's current obligations (or rights) under a swap agreement will generally be
equal only to the net amount to be paid or received under the agreement based on
the relative values of the positions held by each party to the agreement (the
"net amount"). The Fund's current obligations under a swap agreement will be
accrued daily (offset against any amounts owed to the Fund). The Fund may (but
is not required to) cover any accrued but unpaid net amounts owed to a swap
counterparty through the segregation of assets determined to be liquid by PIMCO
in accordance with procedures established by the Board of Trustees. Obligations
under swap agreements so covered will not be
37
construed to be "senior securities" for purposes of the Fund's investment
restriction concerning senior securities and borrowings.
Whether the Fund's use of swap agreements or swaptions will be successful
in furthering its investment objective will depend on PIMCO's ability to predict
correctly whether certain types of investments are likely to produce greater
returns than other investments. Because they are two-party contracts and because
they may have terms of greater than seven days, swap agreements may be
considered to be illiquid. Moreover, the Fund bears the risk of loss of the
amount expected to be received under a swap agreement in the event of the
default or bankruptcy of a swap agreement counterparty. The Fund will enter into
swap agreements only with counterparties that meet certain standards of
creditworthiness. The swaps market is a relatively new market and is largely
unregulated. It is possible that developments in the swaps market, including
potential government regulation, could adversely affect the Fund's ability to
terminate existing swap agreements or to realize amounts to be received under
such agreements.
Depending on the terms of the particular option agreement, the Fund will
generally incur a greater degree of risk when it writes a swaption than it will
incur when it purchases a swaption. When the Fund purchases a swaption, it risks
losing only the amount of the premium it has paid should it decide to let the
option expire unexercised. However, when the Fund writes a swaption, upon
exercise of the option the Fund will become obligated according to the terms of
the underlying agreement.
Certain swap agreements are exempt from most provisions of the CEA and,
therefore, are not regulated as futures or commodity option transactions under
the CEA.
Credit Default Swaps
The Fund may enter into credit default swap contracts for both investment
and risk management purposes. As the seller in a credit default swap contract,
the Fund would be required to pay the par (or other agreed-upon) value of a
referenced debt obligation to the counterparty in the event of a default by a
third party, such as a U.S. or foreign issuer, on the debt obligation. In
return, the Fund would receive from the counterparty a periodic stream of
payments over the term of the contract provided that no event of default has
occurred. If no default occurs, the Fund would keep the stream of payments and
would have no payment obligations. As the seller, the Fund would effectively add
leverage to its portfolio because, in addition to its total net assets, the Fund
would be subject to investment exposure on the notional amount of the swap.
The Fund may also purchase credit default swap contracts in order to hedge
against the risk of default of debt securities held in its portfolio, in which
case the Fund would function as the counterparty referenced in the preceding
paragraph. This would involve the risk that the investment may expire worthless
and would generate income only in the event of an actual default by the issuer
of the underlying obligation (as opposed to a credit downgrade or other
indication of financial instability). It would also involve credit risk - that
the seller may fail to satisfy its payment obligations to the Fund in the event
of a default.
38
Credit-Linked Trust Certificates
Among the income-producing securities in which the Fund may invest are
credit-linked trust certificates, which are investments in a limited purpose
trust or other vehicle formed under State law which, in turn, invests in a
basket of derivative instruments, such as credit default swaps, interest rate
swaps and other securities, in order to provide exposure to the high yield or
another fixed income market. For instance, the Fund may invest in credit-linked
trust certificates as a cash management tool in order to gain exposure to the
high yield markets and/or to remain fully invested when more traditional
income-producing securities are not available, including during the period when
the net proceeds of this offering and any offering of AMPS are being invested.
Like an investment in a bond, investments in these credit-linked trust
certificates represent the right to receive periodic income payments (in the
form of distributions) and payment of principal at the end of the term of the
certificate. However, these payments are conditioned on the trust's receipt of
payments from, and the trust's potential obligations to, the counterparties to
the derivative instruments and other securities in which the trust invests. For
instance, the trust may sell one or more credit default swaps, under which the
trust would receive a stream of payments over the term of the swap agreements
provided that no event of default has occurred with respect to the referenced
debt obligation upon which the swap is based. If a default occurs, the stream of
payments may stop and the trust would be obligated to pay to the counterparty
the par (or other agreed upon value) of the referenced debt obligation. This, in
turn, would reduce the amount of income and principal that the Fund would
receive as an investor in the trust. Please see "Investment Objective and
Policies--Credit Default Swaps" in this Statement of Additional Information for
additional information about credit default swaps. The Fund's investments in
these instruments are indirectly subject to the risks associated with derivative
instruments, including, among others, credit risk, default or similar event
risk, counterparty risk, interest rate risk, leverage risk and management risk.
It is expected that the trusts which issue credit-linked trust certificates will
constitute "private" investment companies, exempt from registration under the
Investment Company Act of 1940, as amended (the "1940 Act"). Therefore, the
certificates will be subject to the risks described under "Other Investment
Companies" below, and will not be subject to applicable investment limitations
and other regulation imposed by the 1940 Act (although the Fund will remain
subject to such limitations and regulation, including with respect to its
investments in the certificates). Although the trusts are typically private
investment companies, they are generally not actively managed such as a "hedge
fund" might be. It is also expected that the certificates will be exempt from
registration under the 1933 Act. Accordingly, there may be no established
trading market for the certificates and they may constitute illiquid
investments. See "Risks--General Risks of Investing in the Fund--Liquidity
Risk" in the Prospectus. If market quotations are not readily available for the
certificates, they will be valued by the Fund at fair value as determined by the
Board of Trustees or persons acting at its direction. See "Net Asset Value" in
the Prospectus.
Structured Notes and Other Hybrid Instruments
The Fund may invest in "structured" notes, which are privately negotiated
debt obligations where the principal and/or interest is determined by reference
to the performance of a benchmark asset, market or interest rate, such as
selected securities, an index of securities or
39
specified interest rates, or the differential performance of two assets or
markets, such as indexes reflecting bonds. Depending on the terms of the note,
the Fund may forgo all or part of the interest and principal that would be
payable on a comparable conventional note. The rate of return on structured
notes may be determined by applying a multiplier to the performance or
differential performance of the referenced index(es) or other asset(s).
Application of a multiplier involves leverage which will serve to magnify the
potential for gain and the risk of loss. The Fund may use structured notes to
add leverage to the portfolio (as a substitute for AMPS) and for investment as
well as risk management purposes. Like other sophisticated strategies, the
Fund's use of structured notes may not work as intended. Although structured
instruments are not necessarily illiquid, PIMCO believes that currently most
structured instruments are illiquid.
The Fund may invest in other types of "hybrid" instruments which combine
the characteristics of securities, futures, and options. For example, the
principal amount or interest rate of a hybrid could be tied (positively or
negatively) to the price of some commodity, currency or securities index or
another interest rate (each a "benchmark"). The interest rate or (unlike most
debt obligations) the principal amount payable at maturity of a hybrid security
may be increased or decreased, depending on changes in the value of the
benchmark. Hybrids can be used as an efficient means of pursuing a variety of
investment goals, including duration management and increased total return.
Hybrids may not bear interest or pay dividends. The value of a hybrid or its
interest rate may be a multiple of a benchmark and, as a result, may be
leveraged and move (up or down) more steeply and rapidly than the benchmark.
These benchmarks may be sensitive to economic and political events that cannot
be readily foreseen by the purchaser of a hybrid. Under certain conditions, the
redemption value of a hybrid could be zero. Thus, an investment in a hybrid may
entail significant market risks that are not associated with a similar
investment in a traditional, U.S. dollar-denominated bond that has a fixed
principal amount and pays a floating rate or fixed rate of interest. The
purchase of hybrids also exposes the Fund to the credit risk of the issuer of
the hybrids. These risks may cause significant fluctuations in the net asset
value of the Fund.
Certain issuers of structured products such as hybrid instruments may be
deemed to be investment companies as defined in the 1940 Act. As a result, the
Fund's investments in these products may be subject to limits applicable to
investments in investment companies and may be subject to restrictions contained
in the 1940 Act.
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements and economically
similar transactions in order to add leverage to the portfolio (as a substitute
for AMPS) or for hedging or cash management purposes. A reverse repurchase
agreement involves the sale of a portfolio-eligible security by the Fund,
coupled with its agreement to repurchase the instrument at a specified time and
price. Under a reverse repurchase agreement, the Fund continues to receive any
principal and interest payments on the underlying security during the term of
the agreement. Reverse repurchase agreements involve leverage risk and the risk
that the market value of securities retained by the Fund may decline below the
repurchase price of the securities sold by the Fund which it is obligated to
repurchase. The Fund may (but is not required to) segregate assets determined to
be liquid by PIMCO in accordance with procedures
40
established by the Board of Trustees, equal (on a daily mark-to-market basis) to
its obligations under reverse repurchase agreements. To the extent that
positions in reverse repurchase agreements are not so covered, such transactions
would be subject to the Fund's limitations on borrowings, which would, among
other things, restrict the aggregate of such transactions (plus any other
borrowings) to one-third of the Fund's total assets.
The Fund also may effect simultaneous purchase and sale transactions that
are known as "sale-buybacks." A sale-buyback is similar to a reverse repurchase
agreement, except that in a sale-buyback, the counterparty who purchases the
security is entitled to receive any principal or interest payments made on the
underlying security pending settlement of the Fund's repurchase of the
underlying security.
Mortgage Dollar Rolls
A "mortgage dollar roll" is similar to a reverse repurchase agreement in
certain respects. In a "dollar roll" transaction, the Fund sells a
mortgage-related security, such as a security issued by GNMA, to a dealer and
simultaneously agrees to repurchase a similar security (but not the same
security) in the future at a pre-determined price. A "dollar roll" can be
viewed, like a reverse repurchase agreement, as a collateralized borrowing in
which the Fund pledges a mortgage-related security to a dealer to obtain cash.
However, unlike reverse repurchase agreements, the dealer with which the Fund
enters into a dollar roll transaction is not obligated to return the same
securities as those originally sold by the Fund, but only securities which are
"substantially identical." To be considered "substantially identical," the
securities returned to the Fund generally must: (1) be collateralized by the
same types of underlying mortgages; (2) be issued by the same agency and be part
of the same program; (3) have a similar original stated maturity; (4) have
identical net coupon rates; (5) have similar market yields (and therefore
price); and (6) satisfy "good delivery" requirements, meaning that the aggregate
principal amounts of the securities delivered and received back must be within
2.5% of the initial amount delivered.
As with reverse repurchase agreements, to the extent that positions in
dollar roll agreements are not covered by segregated liquid assets at least
equal to the amount of any forward purchase commitment, such transactions would
be subject to the Fund's restrictions on borrowings. Furthermore, because dollar
roll transactions may be for terms ranging between one and six months, dollar
roll transactions may be deemed "illiquid."
Repurchase Agreements
For the purposes of maintaining liquidity and achieving income, the Fund
may enter into repurchase agreements with domestic commercial banks or
registered broker/dealers. A repurchase agreement is a contract under which the
Fund would acquire a security for a relatively short period (usually not more
than one week) subject to the obligation of the seller to repurchase and the
Fund to resell such security at a fixed time and price (representing the Fund's
cost plus interest). In the case of repurchase agreements with broker-dealers,
the value of the underlying securities (or collateral) will be at least equal at
all times to the total amount of the repurchase obligation, including the
interest factor. The Fund bears a risk of loss in the event that the other party
to a repurchase agreement defaults on its obligations and the Fund is delayed or
prevented from exercising its rights to dispose of the collateral securities.
This risk includes
41
the risk of procedural costs or delays in addition to a loss on the securities
if their value should fall below their repurchase price. PIMCO will monitor the
creditworthiness of the counter parties.
When-Issued, Delayed Delivery and Forward Commitment Transactions
The Fund may purchase or sell securities on a when-issued, delayed
delivery, or forward commitment basis. When such purchases are outstanding, the
Fund will segregate until the settlement date assets determined to be liquid by
PIMCO in accordance with procedures established by the Board of Trustees, in an
amount sufficient to meet the purchase price. Typically, no income accrues on
securities the Fund has committed to purchase prior to the time delivery of the
securities is made, although the Fund may earn income on securities it has
segregated.
When purchasing a security on a when-issued, delayed delivery, or forward
commitment basis, the Fund assumes the rights and risks of ownership of the
security, including the risk of price and yield fluctuations, and takes such
fluctuations into account when determining its net asset value. Because the Fund
is not required to pay for the security until the delivery date, these risks are
in addition to the risks associated with the Fund's other investments. If the
Fund remains substantially fully invested at a time when when-issued, delayed
delivery, or forward commitment purchases are outstanding, the purchases may
result in a form of leverage.
When the Fund has sold a security on a when-issued, delayed delivery, or
forward commitment basis, the Fund does not participate in future gains or
losses with respect to the security. If the other party to a transaction fails
to deliver or pay for the securities, the Fund could miss a favorable price or
yield opportunity or could suffer a loss. The Fund may dispose of or renegotiate
a transaction after it is entered into, and may sell when-issued, delayed
delivery or forward commitment securities before they are delivered, which may
result in a capital gain or loss. There is no percentage limitation on the
extent to which the Fund may purchase or sell securities on a when-issued,
delayed delivery, or forward commitment basis.
Borrowing
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 as a substitute for the leverage obtained with
AMPS. The Fund may also borrow money for temporary administrative purposes.
Under the 1940 Act, the Fund generally is not permitted to engage in
borrowings unless immediately after a borrowing the value of the Fund's total
assets less liabilities (other than the borrowing) is at least 300% of the
principal amount of such borrowing (i.e., such principal amount may not exceed
33 1/3% of the Fund's total assets). In addition, the Fund is not permitted to
declare any cash dividend or other distribution on Common Shares unless, at the
time of such declaration, the value of the Fund's total assets, less liabilities
other than borrowing, is at least 300% of such principal amount. If the Fund
borrows it intends, to the extent possible, to prepay all or a portion of the
principal amount of the borrowing to the extent necessary in order to
42
maintain the required asset coverage. Failure to maintain certain asset coverage
requirements could result in an event of default and entitle the holders of AMPS
("Preferred Shareholders") and holders of any other senior securities of the
Fund to elect a majority of the Trustees of the Fund.
As described elsewhere in this section and in the Prospectus, the Fund may
also enter into transactions that may give rise to a form of leverage. Such
transactions may include, among others, issuing debt securities or using reverse
repurchase agreements, loans of portfolio securities, credit default swap
contracts and other derivatives, as well as when-issued, delayed delivery or
forward commitment transactions. However, borrowings and these other forms of
leverage will only be used, if at all, as a substitute for, rather than in
addition to, the leverage obtained through the issuance of AMPS. See
"Risks--Leverage Risk" in the Prospectus.
As described above, the Fund will, under certain circumstances, cover its
commitment under these instruments by the segregation of assets determined to be
liquid by PIMCO in accordance with procedures adopted by the Trustees, equal in
value to the amount of the Fund's commitment, or by entering into offsetting
transactions or owning positions covering its obligations. In such cases, the
instruments will not be considered "senior securities" under the 1940 Act for
purposes of the asset coverage requirements otherwise applicable to borrowings
by the Fund or the Fund's issuance of AMPS. Borrowing will tend to exaggerate
the effect on net asset value of any increase or decrease in the market value of
the Fund's portfolio. Money borrowed will be subject to interest costs which may
or may not be recovered by appreciation of the securities purchased. The Fund
also may be required to maintain minimum average balances in connection with
such borrowing or to pay a commitment or other fee to maintain a line of credit;
either of these requirements would increase the cost of borrowing over the
stated interest rate.
Short Sales
The Fund may make short sales of securities as part of its overall
portfolio management strategy and to offset potential declines in long positions
in securities in the Fund's portfolio. A short sale is a transaction in which
the Fund sells a security it does not own in anticipation that the market price
of that security will decline.
When the Fund makes a short sale on a security, it must borrow the security
sold short and deliver it to the broker-dealer through which it made the short
sale as collateral for its obligation to deliver the security upon conclusion of
the sale. The Fund may have to pay a fee to borrow particular securities and is
often obligated to pay over any accrued interest and dividends on such borrowed
securities.
If the price of the security sold short increases between the time of the
short sale and the time the Fund replaces the borrowed security, the Fund will
incur a loss; conversely, if the price declines, the Fund will realize a capital
gain. Any gain will be decreased, and any loss increased, by the transaction
costs described above. The successful use of short selling may be adversely
43
affected by imperfect correlation between movements in the price of the security
sold short and the securities being hedged.
To the extent that the Fund engages in short sales, it will provide
collateral to the broker-dealer. A short sale is "against the box" to the extent
that the Fund contemporaneously owns, or has the right to obtain at no added
cost, securities identical to those sold short. The Fund may engage in so-called
"naked" short sales where it does not own or have the immediate right to acquire
the security sold short at no additional cost, in which case the Fund's losses
could theoretically be unlimited.
Illiquid Securities
The Fund may invest without limit in illiquid securities (determined using
the Securities and Exchange Commission's standard applicable to open-end
investment companies, i.e., securities that cannot be disposed of within seven
days in the ordinary course of business at approximately the value at which the
Fund has valued the securities). Illiquid securities are considered to include,
among other things, written over-the-counter options, securities or other liquid
assets being used as cover for such options, repurchase agreements with
maturities in excess of seven days, certain loan participation interests, fixed
time deposits which are not subject to prepayment or provide for withdrawal
penalties upon prepayment (other than overnight deposits), and other securities
whose disposition is restricted under the federal securities laws (other than
securities issued pursuant to Rule 144A under the 1933 Act and certain
commercial paper that PIMCO has determined to be liquid under procedures
approved by the Board of Trustees). PIMCO will determine the liquidity of the
Fund's investments by reference to market conditions and contractual provisions.
For example, PIMCO will generally not consider Senior Loans that are part of an
issue of at least $250 million in par value to be illiquid.
Illiquid securities may include privately placed securities, which are sold
directly to a small number of investors, usually institutions. Unlike public
offerings, such securities are not registered under the federal securities laws.
Although certain of these securities may be readily sold, others may be
illiquid, and their sale may involve substantial delays and additional costs.
Portfolio Trading and Turnover Rate
Portfolio trading may be undertaken to accomplish the investment objective
of the Fund. In addition, a security may be sold and another of comparable
quality purchased at approximately the same time to take advantage of what PIMCO
believes to be a temporary price disparity between the two securities. Temporary
price disparities between two comparable securities may result from supply and
demand imbalances where, for example, a temporary oversupply of certain bonds
may cause a temporarily low price for such bonds, as compared with other bonds
of like quality and characteristics. The Fund may also engage in short-term
trading consistent with its investment objective. Securities may be sold in
anticipation of a market decline (a rise in interest rates) or purchased in
anticipation of a market rise (a decline in interest rates) and later sold, or
to recognize a gain.
44
A change in the securities held by the Fund is known as "portfolio
turnover." PIMCO manages the Fund without regard generally to restrictions on
portfolio turnover. The use of certain derivative instruments with relatively
short maturities may tend to exaggerate the portfolio turnover rate for the
Fund. Trading in debt obligations does not generally involve the payment of
brokerage commissions, but does involve indirect transaction costs. The use of
futures contracts may involve the payment of commissions to futures commission
merchants. High portfolio turnover (e.g., greater than 100%) involves
correspondingly greater expenses to the Fund, including brokerage commissions or
dealer mark-ups and other transaction costs on the sale of securities and
reinvestments in other securities. The higher the rate of portfolio turnover of
the Fund, the higher these transaction costs borne by the Fund generally will
be. Transactions in the Fund's portfolio securities may result in realization of
taxable capital gains (including short-term capital gains which are generally
taxed to shareholders at ordinary income tax rates). The trading costs and tax
effects associated with portfolio turnover may adversely affect the Fund's
performance.
The portfolio turnover rate of the Fund is calculated by dividing (a) the
lesser of purchases or sales of portfolio securities for the particular fiscal
year by (b) the monthly average of the value of the portfolio securities owned
by the Fund during the particular fiscal year. In calculating the rate of
portfolio turnover, there is excluded from both (a) and (b) all securities,
including options, whose maturities or expiration dates at the time of
acquisition were one year or less.
Warrants to Purchase Securities
The Fund may invest in warrants to purchase debt securities. Debt
obligations with warrants attached to purchase equity securities have many
characteristics of convertible bonds and their prices may, to some degree,
reflect the performance of the underlying stock. Debt obligations also may be
issued with warrants attached to purchase additional debt securities at the same
coupon rate. A decline in interest rates would permit the Fund to buy additional
bonds at the favorable rate or to sell the warrants at a profit. If interest
rates rise, the warrants would generally expire with no value.
Other Investment Companies
The Fund may invest in securities of open- or closed-end investment
companies to the extent that such investments are consistent with the Fund's
investment objective and policies and permissible under the 1940 Act. In
general, under the 1940 Act, an investment company such as the Fund may not (i)
invest more than 10% of its total assets in securities of other registered
investment companies, (ii) own more than 3% of the outstanding voting securities
of any one registered investment company or (iii) invest more than 5% of its
total assets in the securities of any single registered investment company. The
Fund may invest in other investment companies either during periods when it has
large amounts of uninvested cash, such as the period shortly after the Fund
receives the proceeds of the offering of its Common Shares or AMPS, during
periods when there is a shortage of attractive variable rate and other debt
instruments available in the market, or when PIMCO believes share prices of
other investment companies offer attractive values. The Fund may invest in
investment companies that are advised by PIMCO or its affiliates to the extent
permitted by applicable law and/or pursuant to
45
exemptive relief from the SEC. As a stockholder in an investment company, the
Fund will bear its ratable share of that investment company's expenses and would
remain subject to payment of the Fund's management fees with respect to assets
so invested. Holders of the Common Shares would therefore be subject to
duplicative expenses to the extent the Fund invests in other investment
companies. PIMCO will take expenses into account when evaluating the investment
merits of an investment in an investment company relative to available debt
instruments. In addition, the securities of other investment companies may also
be leveraged and will therefore be subject to the same leverage risks described
in the Prospectus and herein. As described in the Prospectus in the section
entitled "Risks--General Risks of Investing in the Fund--Leverage Risk," the net
asset value and market value of leveraged shares will be more volatile and the
yield to shareholders will tend to fluctuate more than the yield generated by
unleveraged shares.
Securities Loans
Subject to the Fund's "Investment Restrictions" listed below, the Fund may
make secured loans of its portfolio securities to brokers, dealers and other
financial institutions amounting to no more than one-third of its total assets.
The risks in lending portfolio securities, as with other extensions of credit,
consist of possible delay in recovery of the securities or possible loss of
rights in the collateral should the borrower fail financially. However, such
loans will be made only to broker-dealers that are believed by PIMCO to be of
relatively high credit standing. Securities loans are made to broker-dealers
pursuant to agreements requiring that loans be continuously secured by
collateral consisting of U.S. Government securities, cash or cash equivalents
(negotiable certificates of deposit, bankers' acceptances or letters of credit)
maintained on a daily mark-to-market basis in an amount at least equal at all
times to the market value of the securities lent. The borrower pays to the Fund,
as the lender, an amount equal to any dividends or interest received on the
securities lent. The Fund may invest only the cash collateral received in
interest-bearing, short-term securities or receive a fee from the borrower. In
the case of cash collateral, the Fund typically pays a rebate to the lender.
Although voting rights or rights to consent with respect to the loaned
securities pass to the borrower, the Fund, as the lender, retains the right to
call the loans and obtain the return of the securities loaned at any time on
reasonable notice, and it will do so in order that the securities may be voted
by the Fund if the holders of such securities are asked to vote upon or consent
to matters materially affecting the investment. The Fund may also call such
loans in order to sell the securities involved. When engaged in securities
lending, the Fund's performance will continue to reflect changes in the value of
the securities loaned and will also reflect the receipt of either interest,
through investment of cash collateral by the Fund in permissible investments, or
a fee, if the collateral is U.S. Government securities.
Participation on Creditors Committees
The Fund may from time to time participate on committees formed by
creditors to negotiate with the management of financially troubled issuers of
securities held by the Fund. Such participation may subject the Fund to expenses
such as legal fees and may make the Fund an "insider" of the issuer for purposes
of the federal securities laws, and therefore may restrict the Fund's ability to
trade in or acquire additional positions in a particular security when it might
otherwise desire to do so. Participation by the Fund on such committees also may
expose the Fund to potential liabilities under the federal bankruptcy laws or
other laws governing the rights
46
of creditors and debtors. The Fund would participate on such committees only
when PIMCO believes that such participation is necessary or desirable to enforce
the Fund's rights as a creditor or to protect the value of securities held by
the Fund.
Short-Term Investments / Temporary Defensive Strategies
Upon PIMCO's recommendation, for temporary defensive purposes and in order
to keep the Fund's cash fully invested, including the period during which the
net proceeds of the offering are being invested, the Fund may invest up to 100%
of its net assets in investment grade debt securities, including high quality,
short-term debt instruments, credit-linked trust certificates and/or index
futures contracts or similar derivative instruments. Such investments may
prevent the Fund from achieving its investment objective.
INVESTMENT RESTRICTIONS
Fundamental Investment Restrictions
Except as described below, the Fund, as a fundamental policy, may not,
without the approval of the holders of a majority of the outstanding Common
Shares and any outstanding preferred shares of beneficial interest (including
the AMPS) voting together as a single class, and of the holders of a majority of
any outstanding preferred shares of beneficial interest (including the AMPS)
voting as a separate class:
(1) Concentrate its investments in a particular "industry," as that
term is used in the 1940 Act, and as interpreted, modified, or otherwise
permitted by regulatory authority having jurisdiction, from time to time.
(2) With respect to 75% of the Fund's total assets, purchase the
securities of any issuer, except securities issued or guaranteed by the
U.S. Government or any of its agencies or instrumentalities or securities
issued by other investment companies, if, as a result, (i) more than 5% of
the Fund's total assets would be invested in the securities of that issuer,
or (ii) the Fund would hold more than 10% of the outstanding voting
securities of that issuer.
(3) Purchase or sell real estate, although it may purchase securities
secured by real estate or interests therein, or securities issued by
companies which invest in real estate, or interests therein.
(4) Purchase or sell commodities or commodities contracts or oil, gas
or mineral programs. This restriction shall not prohibit the Fund, subject
to restrictions described in the Prospectus and elsewhere in this Statement
of Additional Information, from purchasing, selling or entering into
futures contracts, options on futures contracts, forward contracts, or any
interest rate, securities-related or other hedging instrument, including
swap agreements and other derivative instruments, subject to compliance
with any applicable provisions of the federal securities or commodities
laws.
47
(5) Borrow money or issue any senior security, except to the extent
permitted under the 1940 Act and as interpreted, modified, or otherwise
permitted by regulatory authority having jurisdiction, from time to time.
(6) Make loans, except to the extent permitted under the 1940 Act, and
as interpreted, modified, or otherwise permitted by regulatory authority
having jurisdiction, from time to time.
(7) Act as an underwriter of securities of other issuers, except to
the extent that in connection with the disposition of portfolio securities,
it may be deemed to be an underwriter under the federal securities laws.
Currently, under the 1940 Act, the Fund generally is not permitted to
engage in borrowings unless immediately after a borrowing the value of the
Fund's total assets less liabilities (other than the borrowing) is at least 300%
of the principal amount of such borrowing (i.e., such principal amount may not
exceed 33 1/3% of the Fund's total assets). In addition, the Fund is not
permitted to declare any cash dividend or other distribution on Common Shares
unless, at the time of such declaration, the value of the Fund's total assets,
less liabilities other than the borrowing, is at least 300% of such principal
amount.
Currently, under the 1940 Act, the Fund may generally not lend money or
property to any person, directly or indirectly, if such person controls or is
under common control with the Fund, except for a loan from the Fund to a company
which owns all of the outstanding securities of the Fund, except directors' and
qualifying shares.
For purposes of the foregoing, "majority of the outstanding," when used
with respect to particular shares of the Fund (whether voting together as a
single class or voting as separate classes), means (i) 67% or more of such
shares present at a meeting, if the holders of more than 50% of such shares are
present or represented by proxy, or (ii) more than 50% of such shares, whichever
is less.
Unless otherwise indicated, all limitations applicable to the Fund's
investments (as stated above and elsewhere in this Statement of Additional
Information) apply only at the time a transaction is entered into. Any
subsequent change in a rating assigned by any rating service to a security (or,
if unrated, deemed by PIMCO to be of comparable quality), or change in the
percentage of the Fund's total assets invested in certain securities or other
instruments, or change in the average maturity or duration of the Fund's
investment portfolio, resulting from market fluctuations or other changes in the
Fund's total assets, will not require the Fund to dispose of an investment until
PIMCO determines that it is practicable to sell or close out the investment
without undue market or tax consequences to the Fund. In the event that rating
agencies assign different ratings to the same security, PIMCO will determine
which rating it believes best reflects the security's quality and risk at that
time, which may be the higher of the several assigned ratings.
Under the 1940 Act, a "senior security" does not include any promissory
note or evidence of indebtedness where such loan is for temporary purposes only
and in an amount not exceeding
48
5% of the value of the total assets of the issuer at the time the loan is made.
A loan is presumed to be for temporary purposes if it is repaid within sixty
days and is not extended or renewed.
The Fund would be deemed to "concentrate" in a particular industry if it
invested 25% or more of its total assets in that industry. The Fund's industry
concentration policy does not preclude it from focusing investments in issuers
in a group of related industrial sectors (such as different types of utilities).
The Fund may not change its policy to normally invest at least 80% of its
net assets (plus any borrowings for investment purposes) in a diversified
portfolio of floating rate debt instruments, unless it provides shareholders
with at least 60 days' written notice of such change.
To the extent the Fund covers its commitment under a reverse repurchase
agreement, credit default swap or other derivative instrument by the segregation
of assets determined by PIMCO to be liquid in accordance with procedures adopted
by the Trustees, equal in value to the amount of the Fund's commitment, such
instrument will not be considered a "senior security" for purposes of the asset
coverage requirements otherwise applicable to borrowings by the Fund or the
Fund's issuance of AMPS.
The Fund interprets its policies with respect to borrowing and lending to
permit such activities as may be lawful for the Fund, to the full extent
permitted by the 1940 Act or by exemption from the provisions therefrom pursuant
to exemptive order of the SEC.
It is a condition of the issuance of the AMPS that they be issued with a
credit quality rating of "Aaa" from Moody's and "AAA" from Fitch Ratings. To
obtain and maintain the required ratings, the Fund will be required to comply
with investment quality, diversification and other guidelines established by
Moody's and Fitch Ratings. Such guidelines will likely be more restrictive than
the restrictions set forth above. The Fund does not anticipate that such
guidelines would have a material adverse effect on the Fund's ability to achieve
its investment objective. Moody's and Fitch Ratings receive fees in connection
with their ratings issuances.
MANAGEMENT OF THE FUND
Trustees and Officers
The business of the Fund is managed under the direction of the Fund's Board
of Trustees. Subject to the provisions of the Fund's Amended and Restated
Agreement and Declaration of Trust (the "Declaration"), its Second Amended and
Restated Bylaws (the "Bylaws") and Massachusetts law, the Trustees have all
powers necessary and convenient to carry out this responsibility, including the
election and removal of the Fund's officers.
The Trustees and officers of the Fund, their ages, the position they hold
with the Fund, their term of office and length of time served, a description of
their principal occupations during the past five years, the number of portfolios
in the fund complex (as defined in SEC regulations) that the Trustee oversees
and any other directorships held by the Trustee are listed in the two tables
immediately following. Except as shown, each Trustee's and officer's principal
49
occupation and business experience for the last five years have been with the
employer(s) indicated, although in some cases the Trustee may have held
different positions with such employer(s). Unless otherwise indicated, the
business address of the persons listed below is c/o PIMCO Advisors Fund
Management LLC, 1345 Avenue of the Americas, New York, New York 10105.
50
Independent Trustees
Number of
Portfolios in
Fund Other
Position(s) Term of Office Complex Directorships
Held with and Length of Principal Occupation(s) During Overseen by Held by
Name, Address and Age Fund Time Served the Past 5 Years Trustee Trustee
--------------------- ----------- -------------- --------------------------------------------- ------------- -------------
Paul Belica Trustee Since Trustee, Fixed Income SHares, 14 None.
Age 81 July, 2003 Nicholas-Applegate Convertible & Income Fund,
PIMCO Corporate Opportunity Fund, PIMCO
Corporate Income Fund, PIMCO Municipal Income
Fund, PIMCO California Municipal Income Fund,
PIMCO New York Municipal Income Fund, PIMCO
Municipal Income Fund II, PIMCO California
Municipal Income Fund II, PIMCO New York
Municipal Income Fund II, PIMCO Municipal
Income Fund III, PIMCO California Municipal
Income Fund III, PIMCO New York Municipal
Income Fund III; Manager, Stratigos Fund,
LLC, Whistler Fund, LLC, Xanthus Fund, LLC
and Wynstone Fund, LLC; Director, Student
Loan Finance Corp., Education Loans, Inc.,
Goal Funding, Inc., Goal Funding II, Inc.;
Formerly, Advisor, Salomon Smith Barney Inc.;
Director, Central European Value Fund, Inc.,
Deck House Inc., The Czech Republic Fund,
Inc.
Robert E. Connor* Trustee Since Trustee, Fixed Income SHares, 18 None.
Age 68 July, 2003. Nicholas-Applegate Convertible & Income Fund,
Nicholas Applegate Convertible & Income Fund
II, PIMCO Corporate Opportunity Fund, PIMCO
Corporate Income Fund, PIMCO High Income
Fund, PIMCO Municipal Income Fund, PIMCO
California Municipal Income Fund, PIMCO New
York Municipal Income Fund, PIMCO Municipal
Income Fund II, PIMCO California Municipal
Income Fund II, PIMCO New York Municipal
Income Fund II, PIMCO Municipal Income Fund
III, PIMCO California Municipal
51
Number of
Portfolios in
Fund Other
Position(s) Term of Office Complex Directorships
Held with and Length of Principal Occupation(s) During Overseen by Held by
Name, Address and Age Fund Time Served the Past 5 Years Trustee Trustee
--------------------- ----------- -------------- --------------------------------------------- ------------- -------------
Income Fund III, PIMCO New York Municipal
Income Fund III; Director, Municipal
Advantage Fund, Inc.; Corporate Affairs
Consultant. Formerly, Senior Vice President,
Corporate Office, Citigroup Global Markets
Inc. (formerly, Salomon Smith Barney Inc.).
John J. Dalessandro Trustee Since President and Director, J.J. Dalessandro II 15 None.
II** July, 2003 Ltd., registered broker-dealer and member of
Age 65 the New York Stock Exchange; Trustee,
Nicholas-Applegate Convertible & Income Fund,
Nicholas-Applegate Convertible & Income Fund
II, PIMCO Corporate Opportunity Fund, PIMCO
Corporate Income Fund, PIMCO High Income
Fund, PIMCO Municipal Income Fund, PIMCO
California Municipal Income Fund, PIMCO New
York Municipal Income Fund, PIMCO Municipal
Income Fund II, PIMCO California Municipal
Income Fund II, PIMCO New York Municipal
Income Fund II, PIMCO Municipal Income Fund
III, PIMCO California Municipal Income Fund
III, PIMCO New York Municipal Income Fund
III.
Hans W. Kertess Trustee Since President, H. Kertess & Co.; Trustee, PIMCO 10 None.
Age 64 (June, 2003) Corporate Income Fund, PIMCO High Income
Fund, Nicholas Applegate Convertible & Income
Fund II, PIMCO Municipal Income Fund, PIMCO
California Municipal Income Fund, PIMCO New
York Municipal Income Fund, PIMCO Municipal
Income Fund II, PIMCO California Municipal
Income Fund II and PIMCO New York Municipal
Income Fund II. Formerly, Managing Director
and Consultant, Royal Bank of Canada Capital
Markets.
52
* In addition to the positions noted, Mr. Connor previously provided
occasional editorial consulting services as an independent contractor to an
administrative unit of Smith Barney, an affiliate of Citigroup Inc., the parent
company of Citigroup Global Markets Inc.
* * Mr. Dalessandro is treated by the Fund as not being an "interested
person" (as defined in Section 2(a)(19) of the 1940 Act) of the Fund, the
Manager, PIMCO or the Underwriters, despite his affiliation with J.J.
Dalessandro II Ltd., a member of the New York Stock Exchange, Inc. (the
"Exchange") that operates as a floor broker and effects portfolio transactions
for other brokers, generally other members of the Exchange, and one unrelated
investment adviser.
Interested Trustees
Number of
Portfolios in
Fund Other
Position(s) Term of Office Complex Directorships
Held with and Length of Principal Occupation(s) During Overseen by Held by
Name, Address and Age Fund Time Served the Past 5 Years Trustee Trustee
--------------------- ----------- -------------- --------------------------------------------- ------------- -------------
Stephen J. Treadway Chairman Since Managing Director, Allianz Dresdner Asset 53 None.
2187 Atlantic Street and July, 2003 Management of America L.P.; Managing Director
Stamford, CT 06902 Trustee and Chief Executive Officer, PIMCO Advisors
Age 55 Fund Management LLC; Managing Director and
Chief Executive Officer, PIMCO Advisors
Distributors LLC ("PAD"); Trustee and
Chairman, PIMCO Funds: Multi-Manager Series;
Chairman, Fixed Income SHares; Trustee,
Chairman and President, PIMCO Advisors VIT
(formerly OCC Accumulation Trust); Trustee
and Chairman, PIMCO Corporate Income Fund,
PIMCO Municipal Income Fund, PIMCO California
Municipal Income Fund, PIMCO New York
Municipal Income Fund, PIMCO Municipal Income
Fund II, PIMCO California Municipal Income
Fund II, PIMCO New York Municipal Income Fund
II and Municipal Advantage Fund, Inc.;
Chairman, Nicholas-Applegate Convertible &
Income Fund, Nicholas-Applegate Convertible &
Income Fund II, PIMCO Corporate Opportunity
Fund, PIMCO Municipal Income Fund III, PIMCO
California Municipal Income Fund III, PIMCO
New York Municipal Income Fund III and PIMCO
53
High Income Fund; Member of the Board of
Management, Allianz Dresdner Asset Management
GmbH.
Mr. Treadway is an "interested person" (as defined in Section 2(a)(19) of
the 1940 Act) of the Fund because, in addition to his service as Chairman and
Trustee of the Fund, he is also a Managing Director and the Chief Executive
Officer of the Manager and holds various other positions with affiliates of the
Manager.
In accordance with the Fund's staggered board (see "Anti-Takeover and Other
Provisions in the Declaration of Trust"), the Common Shareholders of the Fund
will elect Trustees to fill the vacancies of Trustees whose terms expire at each
annual meeting of Common Shareholders, unless any AMPS or any other preferred
shares of beneficial interest are outstanding, in which event Preferred
Shareholders (including holders of AMPS), voting as a separate class, will elect
two Trustees and the remaining two Trustees shall be elected by Common
Shareholders and Preferred Shareholders, voting together as a single class.
Preferred Shareholders (including holders of AMPS) will be entitled to elect a
majority of the Fund's Trustees under certain circumstances.
Officers
Position(s) Term of Office
Held with and Length of Principal Occupation(s) During
Name, Address and Age Fund Time Served the Past 5 Years
--------------------- ----------- -------------- ---------------------------------------------
Stephen J. Treadway Chairman Chairman, See above.
2187 Atlantic Street and Trustee since
Stamford, CT 06902 inception
Age 55 (June, 2003);
Trustee,
since July,
2003.
Brian S. Shlissel President Since Senior Vice President, PIMCO Advisors Fund
Age 38 and Chief inception Management LLC; Executive Vice President and
Executive (June, 2003). Treasurer, PIMCO Advisors VIT (formerly OCC
Officer Accumulation Trust); President and Chief
Executive Officer, Fixed Income SHares,
Nicholas-Applegate Convertible & Income Fund,
Nicholas-Applegate Convertible & Income Fund
II, PIMCO Corporate Opportunity Fund, PIMCO
Corporate Income Fund, PIMCO Municipal Income
Fund, PIMCO California Municipal Income Fund,
PIMCO New York Municipal Income Fund, PIMCO
Municipal Income Fund II, PIMCO California
Municipal Income Fund II, PIMCO New York
Municipal Income Fund II, PIMCO Municipal
Income Fund III, PIMCO California Municipal
Income Fund III, PIMCO New York Municipal
Income Fund III, Municipal Advantage Fund,
Inc., and PIMCO High Income Fund; Formerly,
Vice President, Mitchell Hutchins Asset
Management Inc.
54
Position(s) Term of Office
Held with and Length of Principal Occupation(s) During
Name, Address and Age Fund Time Served the Past 5 Years
--------------------- ----------- -------------- ---------------------------------------------
Lawrence G. Altadonna Treasurer, Since Vice President, PIMCO Advisors Fund
Age 37 Principal inception Management LLC; Treasurer and Principal
Financial (June, 2003). Financial and Accounting Officer, Nicholas
and Applegate Convertible & Income Fund,
Accounting Nicholas-Applegate Convertible & Income Fund
Officer II, PIMCO Corporate Opportunity Fund, PIMCO
Corporate Income Fund, PIMCO Municipal Income
Fund, PIMCO California Municipal Income Fund,
PIMCO New York Municipal Income Fund, PIMCO
Municipal Income Fund II, PIMCO California
Municipal Income Fund II, PIMCO New York
Municipal Income Fund II, PIMCO Municipal
Income Fund III, PIMCO California Municipal
Income Fund III, PIMCO New York Municipal
Income Fund III, Municipal Advantage Fund,
Inc. and PIMCO High Income Fund; Treasurer,
Fixed Income SHares; Assistant Treasurer,
PIMCO Advisors VIT (formerly OCC Accumulation
Trust). Formerly, Director of Fund
Administration, Prudential Investments.
Newton B. Schott, Jr. Vice Since Managing Director, Chief Administrative
2187 Atlantic Street President, inception Officer, Secretary and General Counsel, PAD;
Stamford, CT 06902 Secretary (June, 2003). Managing Director, Chief Legal Officer and
Age 60 Secretary, PIMCO Advisors Fund Management
LLC; President, Chief Executive Officer and
Secretary, PIMCO Funds: Multi-Manager Series;
Vice President and Secretary, Nicholas
Applegate Convertible & Income Fund,
Nicholas-Applegate Convertible & Income Fund
II, PIMCO Corporate Opportunity Fund, PIMCO
Corporate Income Fund, PIMCO Municipal Income
Fund, PIMCO California Municipal Income Fund,
PIMCO New York Municipal Income Fund, PIMCO
Municipal Income Fund II, PIMCO California
Municipal Income Fund II, PIMCO New York
Municipal Income Fund II, PIMCO Municipal
Income Fund III, PIMCO California Municipal
Income Fund III, PIMCO New York Municipal
Income Fund III, Municipal Advantage Fund,
Inc. and PIMCO High Income Fund; Secretary,
Fixed Income SHares.
Raymond Kennedy Vice Since Managing Director, PIMCO; co-portfolio
840 Newport Center President inception manager of the Fund and other investment
Drive Newport Beach, (June, 2003). vehicles managed by PIMCO; joined PIMCO in
CA 92660 1996.
Age 41
55
For interested Trustees and officers, positions held with affiliated
persons or principal underwriters of the Fund are listed in the following table:
Positions Held with Affiliated Persons or
Name Principal Underwriters of the Fund
--------------------- -----------------------------------------
Stephen J. Treadway See above.
Brian S. Shlissel See above.
Lawrence Altadonna See above.
Newton B. Schott, Jr. See above.
Raymond Kennedy See above.
Committees of the Board of Trustees
Audit Oversight Committee
Provides oversight with respect to the internal and external accounting and
auditing procedures of the Fund and, among other things, considers the selection
of independent public accountants for the Fund and the scope of the audit,
approves all audit and permitted non-audit services proposed to be performed by
those auditors on behalf of the Fund and certain affiliates, including the
Manager and PIMCO, and the possible effect of those services on the independence
of those auditors. Messrs. Belica, Kertess and Connor, each of whom is an
Independent Trustee, serve on this committee.
Nominating Committee
Responsible for reviewing and recommending qualified candidates to the
Board in the event that a position is vacated or created. The Nominating
Committee will review and consider nominees recommended by shareholders to serve
as Trustee, provided any such recommendation is submitted in writing to the
Fund, c/o Newton B. Schott, Jr., Secretary, at the address of the principal
executive offices of the Fund. The Nominating Committee has full discretion to
reject nominees recommended by shareholders, and there is no assurance that any
such person so recommended and considered by a committee will be nominated for
election to the Board. Messrs. Belica, Kertess and Connor, each of whom is an
Independent Trustee, and Mr. Treadway, who is an Interested Trustee, serve on
this committee.
Valuation Committee
Reviews procedures for the valuation of securities and periodically reviews
information from the Manager and PIMCO regarding fair value and liquidity
determination made pursuant to the Board-approved procedures, and makes related
recommendations to the full Board and assists the full Board in resolving
particular valuation matters. Messrs. Belica, Kertess and Connor, each of whom
is an Independent Trustee, serve on this committee.
56
Compensation Committee
The Compensation Committee periodically reviews and sets compensation
payable to the Trustees of the Fund who are not directors, officers, partners or
employees of the Manager, PIMCO or any entity controlling, controlled by or
under common control with the Manager or PIMCO. Messrs. Belica, Kertess and
Connor, each of whom is an Independent Trustee, serve on this committee.
Securities Ownership
For each Trustee, the following table discloses the dollar range of equity
securities beneficially owned by the Trustee in the Fund and, on an aggregate
basis, in any registered investment companies overseen by the Trustee within the
Fund's family of investment companies as of December 31, 2002:
Aggregate Dollar Range of Equity Securities in All
Dollar Range of Equity Registered Investment Companies Overseen by Trustee in
Name of Trustee Securities in the Fund Family of Investment Companies
----------------------- ---------------------- ------------------------------------------------------
Paul Belica None. > $100,000
Robert E. Connor None. None.
John J. Dalessandro II None. None.
Hans W. Kertess None. None.
Stephen J. Treadway None. > $100,000
For independent Trustees and their immediate family members, the following
table provides information regarding each class of securities owned beneficially
in an investment adviser or principal underwriter of the Fund, or a person
(other than a registered investment company) directly or indirectly controlling,
controlled by, or under common control with an investment adviser or principal
underwriter of the Fund as of December 31, 2002:
Name of Owners
and Relationships Value of Percent of
Name of Trustee to Trustee Company Title of Class Securities Class
---------------------- ----------------- ------- -------------- ---------- ----------
Paul Belica None.
Robert E. Connor None.
John J. Dalessandro II None.
Hans W. Kertess None.
As of 2003, the Fund's officers and Trustees as a group owned less than 1%
of the outstanding Common Shares.
57
As of October 1, 2003, the following persons owned of record the number of
Common Shares noted below, representing the indicated percentage of the Fund's
outstanding equity securities as of such date. Many of these shares are believed
to be held only as nominee. To the knowledge of the Fund, no other person owned
of record or beneficially 5% or more of the Fund's outstanding equity securities
on such date.
Percentage of the Fund's
Number of Common outstanding shares as of
Shareholder Shares October 1, 2003
-------------------------------------------------- ---------------- ------------------------
Merrill Lynch, Pierce, Fenner & Smith Incorporated
101 Hudson St., 9th Floor Jersey City, NJ 07302 7,616,306 44.72%
Wachovia Securities, LLC
111 8th Avenue, 4th Floor, New York, NY 10011 2,205,141 12.95%
First Clearing, LLC
901 E. Byrd St., Richmond, VA 23219 1,854,801 10.89%
National Financial Services
200 Liberty Street, New York, NY 10281 860,580 5.05%
Compensation
Messrs. Connor and Dalessandro also serve as Trustees of PIMCO Municipal
Income Fund, PIMCO California Municipal Income Fund, PIMCO New York Municipal
Income Fund, PIMCO Municipal Income Fund II, PIMCO California Municipal Income
Fund II, PIMCO New York Municipal Income Fund II, PIMCO Municipal Income Fund
III, PIMCO California Municipal Income Fund III and PIMCO New York Municipal
Income Fund III (together, the "Municipal Funds"), Nicholas-Applegate
Convertible & Income Fund, Nicholas-Applegate Convertible & Income Fund II,
PIMCO Corporate Opportunity Fund, PIMCO High Income and PIMCO Corporate Income
Fund, fourteen closed-end funds for which the Manager serves as investment
manager and PIMCO or Nicholas-Applegate Capital Management LLC, each an
affiliate of the Manager, serves as portfolio manager. Mr. Belica serves as a
Trustee of each of these Funds except for PIMCO High Income Fund and
Nicholas-Applegate Convertible & Income Fund II. Mr. Kertess serves as a Trustee
of each of these Funds except for Nicholas-Applegate Convertible & Income Fund,
PIMCO Municipal Income Fund III, PIMCO California Municipal Income Fund III,
PIMCO New York Municipal Income Fund III and PIMCO Corporate Opportunity Fund.
Mr. Connor is a director or trustee, as the case may be, of one open-end
investment company (comprising two separate investment portfolios) and one
closed-end investment company advised by the Manager. Mr. Belica is also a
trustee of one open-end investment company (comprising two separate investment
portfolios) advised by the Manager. Mr. Treadway is also a trustee of two
open-end investment companies advised by the Manager.
58
As indicated above, certain of the officers and Trustees of the Fund are
affiliated with the Manager and/or PIMCO.
The Municipal Funds, Nicholas-Applegate Convertible & Income Fund,
Nicholas-Applegate Convertible & Income Fund II, PIMCO Corporate Opportunity
Fund, PIMCO High Income Fund, PIMCO Corporate Income Fund and the Fund
(together, the "PIMCO Closed-End Funds") are expected to hold joint meetings of
their Boards of Trustees whenever possible. Each Trustee, other than any Trustee
who is a director, officer, partner or employee of the Manager, PIMCO or any
entity controlling, controlled by or under common control with the Manager or
PIMCO, receives compensation for their attendance at joint meetings and their
service on Board committees. For their service as Trustees of the PIMCO
Closed-End Funds, Messrs. Connor and Dalessandro receive $25,000 for each joint
meeting for the first four joint meetings in each year and $5,000 for each
additional joint meeting in such year if the meetings are attended in person.
Messrs. Connor and Dalessandro receive $1,000 per joint meeting if the meetings
are attended telephonically. For his service as a Trustee of the PIMCO
Closed-End Funds (other than the PIMCO High Income Fund and the
Nicholas-Applegate Convertible & Income Fund II, for which he does not serve as
Trustee), Mr. Belica receives approximately $17,250 for each joint meeting for
the first four joint meetings in each year and approximately $3,500 for each
additional joint meeting in such year if the meetings are attended in person.
Mr. Belica receives approximately $700 per joint meeting if the meetings are
attended telephonically. For his service as a Trustee of the PIMCO Closed-End
Funds (other than the Nicholas-Applegate Convertible & Income Fund, PIMCO
Municipal Income Fund III, PIMCO California Municipal Income Fund III, PIMCO New
York Municipal Income Fund III and PIMCO Corporate Opportunity Fund, for which
he does not serve as Trustee), Mr. Kertess receives approximately $17,000 for
each joint meeting for the first four joint meetings in each year and
approximately $3,400 for each additional joint meeting in such year if the
meetings are attended in person. Mr. Kertess receives approximately $700 per
meeting if the meetings are attended telephonically. For their services as
members of various Audit Oversight Committees, Messrs. Belica, Connor and
Kertess will each receive $1,000, respectively, per meeting for each of those
PIMCO Closed-End Funds for which they serve as Trustee. Trustees will also be
reimbursed for meeting-related expenses.
Each Trustee's compensation and other costs of joint meetings will be
allocated pro rata among the PIMCO Closed-End Funds for which such Trustee
serves as Trustee based on each such Fund's relative net assets, including
assets attributable to any AMPS.
It is estimated that the Trustees will receive the amounts set forth in the
following table from the Fund for its initial fiscal year ending July 31, 2004.
For the calendar year ended December 31, 2002, the Trustees received the
compensation set forth in the following table for serving as trustees of other
funds in the "Fund Complex." Each officer and Trustee who is a director,
officer, partner or employee of the Manager, PIMCO or any entity controlling,
controlled by or under common control with the Manager or PIMCO serves without
any compensation from the Fund.
59
Total Compensation
Estimated Compensation from the Fund Complex
from the Fund for the Paid to the Trustees for the
Fiscal Year Ending Calendar Year Ending
Name of Trustee July 31, 2004* December 31, 2002**
---------------------- ---------------------- ----------------------------
Paul Belica $5,500 $78,400
Robert E. Connor $5,500 $87,170
John J. Dalessandro II $4,500 $76,400
Hans W. Kertess $5,500 $62,000
----------
* Since the Fund has not completed its first full fiscal year, compensation
is estimated based upon future payments to be made by the Fund during the
current fiscal year and upon estimated relative net assets of the PIMCO
Closed-End Funds.
** In addition to the PIMCO Closed-End Funds, during the year ended
December 31, 2002, Mr. Belica served as a Trustee of one open-end investment
company (comprising two separate investment portfolios) advised by the Manager,
and Mr. Connor served as a director or trustee of one open-end investment
company (comprising two separate investment portfolios) and one closed-end
investment company advised by the Manager. These investment companies are
considered to be in the same "Fund Complex" as the Fund, and the amounts listed
in this column include compensation received by Mr. Belica and Mr. Connor from
these investment companies and the PIMCO Closed-End Funds for services provided
as a trustee or director as the case may be.
The Fund has no employees. Its officers are compensated by the Manager
and/or PIMCO.
Codes of Ethics
The Fund, the Manager and PIMCO have each adopted a separate code of ethics
governing personal trading activities of, as applicable, all Trustees and
officers of the Fund, and directors, officers and employees of the Manager and
PIMCO, who, in connection with their regular functions, play a role in the
recommendation of any purchase or sale of a security by the Fund or obtain
information pertaining to such purchase or sale or who have the power to
influence the management or policies of the Fund, the Manager or PIMCO, as
applicable. Such persons are prohibited from effecting certain transactions,
allowed to effect certain exempt transactions (including with respect to
securities that may be purchased or held by the Fund), and are required to
preclear certain security transactions with the applicable compliance officer or
his designee and to report certain transactions on a regular basis. The Fund,
the Manager and PIMCO have each developed procedures for administration of their
respective codes. Text-only versions of the codes of ethics can be viewed online
or downloaded from the EDGAR Database on the SEC's internet web site at
www.sec.gov. You may also review and copy those documents by visiting the SEC's
Public Reference Room in Washington, DC. Information on the operation
60
of the Public Reference Room may be obtained by calling the SEC at (202)
942-8090. In addition, copies of the codes of ethics may be obtained, after
mailing the appropriate duplicating fee, by writing to the SEC's Public
Reference Section, 450 5th Street, N.W., Washington, DC 20549-0102 or by e-mail
request at publicinfo@sec.gov.
INVESTMENT MANAGER AND PORTFOLIO MANAGER
Investment Manager
The Manager serves as investment manager to the Fund pursuant to an
investment management agreement (the "Investment Management Agreement") between
it and the Fund. The Manager, a Delaware limited liability company organized in
2000 as a subsidiary successor of a business originally organized in 1987, is
wholly-owned by PIMCO Advisors Retail Holdings LLC, a wholly-owned subsidiary of
Allianz Dresdner Asset Management of America L.P. ("ADAM of America"). ADAM of
America was organized as a limited partnership under Delaware law in 1987. ADAM
of America's sole general partner is Allianz-Paclife Partners LLC.
Allianz-Paclife Partners LLC is a Delaware limited liability company with three
members, ADAM U.S. Holding LLC, a Delaware limited liability company, Pacific
Asset Management LLC, a Delaware limited liability company, and Pacific Life
Insurance Company ("Pacific Life"), a California stock life insurance company.
Pacific Asset Management LLC is a wholly-owned subsidiary of Pacific Life, which
is a wholly-owned subsidiary of Pacific Mutual Holding Company. Pacific Life
also owns an indirect minority equity interest in ADAM of America. The sole
member of ADAM U.S. Holding LLC is Allianz Dresdner Asset Management of America
LLC. Allianz Dresdner Asset Management of America LLC has two members, Allianz
of America, Inc. ("Allianz of America"), a Delaware corporation which owns a
99.9% non-managing interest, and Allianz Dresdner Asset Management of America
Holding Inc., a Delaware corporation which owns a 0.01% managing interest.
Allianz of America is a wholly-owned subsidiary of Allianz Aktiengesellschaft
("Allianz AG"). Allianz Dresdner Asset Management of America Holding Inc. is a
wholly-owned subsidiary of Allianz Dresdner Asset Management Aktiengesellschaft,
which is a wholly-owned subsidiary of Allianz AG. Allianz AG indirectly holds a
controlling interest in ADAM of America. Allianz AG is a European-based,
multinational insurance and financial services holding company. Allianz AG's
address is Koeniginstrasse 28, D-80802, Munich, Germany. Pacific Life's address
is 700 Newport Center Drive, Newport Beach, California 92660. ADAM of America's
address is 888 San Clemente Drive, Suite 100, Newport Beach, California 92660.
The general partner of ADAM of America has substantially delegated its
management and control of ADAM of America to an Executive Committee. The
Executive Committee of ADAM of America is comprised of William S. Thompson, Jr.
and David C. Flattum.
The Manager is located at 1345 Avenue of the Americas, New York, New York
10105. As of September 30, 2003, the Manager had approximately $27.7 billion in
assets under management. As of September 30, 2003, ADAM of America and its
subsidiaries, including PIMCO, had approximately $415 billion in assets under
management.
In connection with the acquisition of ADAM of America by Allianz of America
in May of 2000, the Pacific Life interest in ADAM of America was converted into
an interest in 3,722 Class E Units in ADAM of America. The Class E Units are
entitled to distributions based
61
largely on the performance of Pacific Investment Management Company, a
subsidiary of ADAM of America, and for periods after January 31, 2003, the
distributions are capped at a maximum of $98 million (annualized) for 2003, $96
million for 2004, $94 million for 2005, $92 million for 2006 and $90 million in
2007 and thereafter. Pursuant to a Continuing Investment Agreement dated May 5,
2000, as amended and restated March 10, 2003, Allianz of America, Pacific Asset
Management LLC and Pacific Life are party to a call and put arrangement
regarding the Class E Units. Under the restated agreement, the quarterly put
and/or call options are limited in amount to a maximum of $250 million per
quarter through March 2004. In any month subsequent to March 2004, Pacific Life
and Allianz of America can put or call, respectively, all Allianz of America's
units owned directly or indirectly by Pacific Life. The repurchase price for the
Class E Units is calculated based on the financial performance of Pacific
Investment Management Company over the preceding four calendar quarters prior to
repurchase, but the amount can increase or decrease in value by a maximum of 2%
per year from the per unit amount as defined in the Continuing Investment
Agreement, calculated as of December 31 of the preceding calendar year. The
initial per unit amount as of December 31, 2002 was approximately $551,900 per
unit ($2.054 billion in aggregate). The per unit amount is also subject to a cap
and a floor of $600,000 and $500,000 per unit, respectively.
As of the date of this Statement of Additional Information, significant
institutional shareholders of Allianz AG currently include Munchener
Ruckversicherungs-Gesellschaft AG ("Munich Re") and HypoVereinsbank. Allianz AG
in turn owns more than 95% of Dresdner Bank AG. Certain broker-dealers that
might be controlled by or affiliated with these entities or Dresdner Bank AG,
including Dresdner Klienwort Wasserstein, Dresdner Kleinwort Benson and
Grantchester Securities, Inc., may be considered to be affiliated persons of the
Manager and PIMCO. (Broker-dealer affiliates of such significant institutional
shareholders are sometimes referred to herein as "Affiliated Brokers.") Absent
an SEC exemption or other relief, the Fund generally is precluded from effecting
principal transactions with the Affiliated Brokers, and its ability to purchase
securities being underwritten by an Affiliated Broker or a syndicate including
an Affiliated Broker is subject to restrictions. Similarly, the Fund's ability
to utilize the Affiliated Brokers for agency transactions is subject to the
restrictions of Rule 17e-1 under the 1940 Act. PIMCO does not believe that the
restrictions on transactions with the Affiliated Brokers described above will
materially adversely affect its ability to provide services to the Fund, the
Fund's ability to take advantage of market opportunities, or the Fund's overall
performance.
The Manager, subject to the supervision of the Board of Trustees, is
responsible for managing, either directly or through others selected by the
Manager, the investments of the Fund. The Manager also furnishes to the Board of
Trustees periodic reports on the investment performance of the Fund. As more
fully discussed below, the Manager has retained PIMCO to serve as the Fund's
portfolio manager.
Under the terms of the Investment Management Agreement, subject to such
policies as the Trustees of the Fund may determine, the Manager, at its expense,
will furnish continuously an investment program for the Fund and will make
investment decisions on behalf of the Fund and place all orders for the purchase
and sale of portfolio securities subject always to the Fund's investment
objective, policies and restrictions; provided that, so long as PIMCO serves as
the portfolio manager for the Fund, the Manager's obligation under the
Investment Management
62
Agreement with respect to the Fund is, subject always to the control of the
Trustees, to determine and review with PIMCO the investment policies of the
Fund.
Subject to the control of the Trustees, the Manager also manages,
supervises and conducts the other affairs and business of the Fund, furnishes
office space and equipment, provides bookkeeping and certain clerical services
(excluding determination of the net asset value of the Fund, shareholder
accounting services and the accounting services for the Fund) and pays all
salaries, fees and expenses of officers and Trustees of the Fund who are
affiliated with the Manager. As indicated under "Portfolio
Transactions--Brokerage and Research Services," the Fund's portfolio
transactions may be placed with broker-dealers which furnish the Manager and
PIMCO, without cost, certain research, statistical and quotation services of
value to them or their respective affiliates in advising the Fund or their other
clients. In so doing, the Fund may incur greater brokerage commissions and other
transactions costs than it might otherwise pay.
Pursuant to the Investment Management Agreement, the Fund has agreed to pay
the Manager an annual management fee, payable on a monthly basis, at the annual
rate of .75% of the Fund's average weekly total managed assets for the services
and facilities it provides. "Total managed assets" means the total assets of the
Fund (including any assets attributable to AMPS or other forms of leverage that
may be outstanding) minus accrued liabilities (other than liabilities
representing leverage). All fees and expenses are accrued daily and deducted
before payment of dividends to investors.
Except as otherwise described in the Prospectus, the Fund pays, in addition
to the investment management fee described above, all expenses not assumed by
the Manager, including, without limitation, fees and expenses of Trustees who
are not "interested persons" of the Manager or the Fund, interest charges,
taxes, brokerage commissions, expenses of issue of shares, fees and expenses of
registering and qualifying the Fund and its classes of shares for distribution
under federal and state laws and regulations, charges of custodians, auditing
and legal expenses, expenses of determining net asset value of the Fund, reports
to shareholders, expenses of meetings of shareholders, expenses of printing and
mailing prospectuses, proxy statements and proxies to existing shareholders, and
its proportionate share of insurance premiums and professional association dues
or assessments. The Fund is also responsible for such nonrecurring expenses as
may arise, including litigation in which the Fund may be a party, and other
expenses as determined by the Trustees. The Fund may have an obligation to
indemnify its officers and Trustees with respect to such litigation.
Portfolio Manager
PIMCO serves as portfolio manager for the Fund pursuant to a portfolio
management agreement (the "Portfolio Management Agreement") between PIMCO and
the Manager. Under the Portfolio Management Agreement, subject always to the
control of the Trustees and the supervision of the Manager, PIMCO's obligation
is to furnish continuously an investment program for the Fund, to make
investment decisions on behalf of the Fund and to place all orders for the
purchase and sale of portfolio securities and all other investments for the
Fund.
The Manager (and not the Fund) will pay a portion of the fees it receives
to PIMCO in return for PIMCO's services. For the period from the commencement of
Fund operations through
63
August 31, 2008 (i.e., roughly the first five years of Fund operations), the fee
will be paid monthly at the annual rate of .39% of the Fund's average weekly
total managed assets, provided, however, that the amounts payable for each month
shall be reduced to reflect that PIMCO will bear 65% of the fees payable by the
Manager to certain underwriters (other than Merrill Lynch, Pierce, Fenner &
Smith Incorporated) for such month as described under "Underwriting" in the
Prospectus. Beginning September 1, 2008 and thereafter, the Manager will pay a
monthly fee to PIMCO at the annual rate of .55% of the Fund's average weekly
total managed assets, provided, however, that the amounts payable for each month
shall be reduced by the amount of all fees payable by the Manager to certain
underwriters other than Merrill Lynch, Pierce, Fenner & Smith Incorporated for
such month as described under "Underwriting" in the Prospectus (such that the
Manager retains from its management fee, on an annual basis, .05% of the Fund's
average weekly total managed assets, after having paid PIMCO and the
underwriters).
Originally organized in 1971, reorganized as a Delaware general partnership
in 1994 and reorganized as a Delaware limited liability company in 2000, PIMCO
provides investment management and advisory services to private accounts of
institutional and individual clients and to mutual funds. The membership
interests of PIMCO as of December 1, 2002, were held 91% by ADAM of America and
9% by the managing directors of PIMCO. As of September 30, 2003, PIMCO had
approximately $357 billion in assets under management. PIMCO is located at 840
Newport Center Drive, Newport Beach, California 92660.
Certain Terms of the Investment Management and Portfolio Management Agreements
The Investment Management Agreement and the Portfolio Management Agreement
were each approved by the Trustees of the Fund (including all of the Trustees
who are not "interested persons" of the Manager or PIMCO). The Investment
Management Agreement and Portfolio Management Agreement will each continue in
force with respect to the Fund for two years from their respective dates, and
from year to year thereafter, but only so long as their continuance is approved
at least annually by (i) vote, cast in person at a meeting called for that
purpose, of a majority of those Trustees who are not "interested persons" of the
Manager, PIMCO or the Fund, and (ii) the majority vote of either the full Board
of Trustees or the vote of a majority of the outstanding shares of all classes
of the Fund. Each of the Investment Management Agreement and Portfolio
Management Agreement automatically terminates on assignment. The Investment
Management Agreement may be terminated on not less than 60 days' notice by the
Manager to the Fund or by the Fund to the Manager. The Portfolio Management
Agreement may be terminated on not less than 60 days' notice by the Manager to
PIMCO or by PIMCO to the Manager, or by the Fund at any time by notice to the
Manager and PIMCO.
The Investment Management Agreement and the Portfolio Management Agreement
each provide that the Manager or PIMCO, as applicable, shall not be subject to
any liability in connection with the performance of its services thereunder in
the absence of willful misfeasance, bad faith, gross negligence or reckless
disregard of its obligations and duties.
Basis for Approval of the Investment Management and Portfolio Management
Agreements
In determining to approve the Investment Management Agreement and the
Portfolio Management Agreement, the Trustees met with the relevant investment
advisory personnel from
64
the Manager and PIMCO and considered information relating to the education,
experience and number of investment professionals and other personnel who would
provide services under the applicable agreement. See "Management of the Fund" in
the Prospectus and this Statement of Additional Information. The Trustees also
took into account the time and attention to be devoted by senior management to
the Fund and the other funds in the complex. The Trustees evaluated the level of
skill required to manage the Fund and concluded that the human resources to be
available at the Manager and PIMCO were appropriate to fulfill effectively the
duties of the Manager and PIMCO on behalf of the Fund under the applicable
agreement. The Trustees also considered the business reputation of the Manager
and PIMCO, their financial resources and professional liability insurance
coverage and concluded that they would be able to meet any reasonably
foreseeable obligations under the applicable agreement.
The Trustees received information concerning the investment philosophy and
investment process to be applied by PIMCO in managing the Fund. In this
connection, the Trustees considered PIMCO's in-house research capabilities as
well as other resources available to PIMCO's personnel, including research
services available to PIMCO as a result of securities transactions effected for
the Fund and other investment advisory clients. The Trustees concluded that
PIMCO's investment process, research capabilities and philosophy were well
suited to the Fund, given the Fund's investment objective and policies.
The Trustees considered the scope of the services provided by the Manager
and PIMCO to the Fund under the Investment Management Agreement and Portfolio
Management Agreement, respectively, relative to services provided by third
parties to other mutual funds. The Trustees noted that the Manager's and PIMCO's
standard of care was comparable to that found in most investment company
advisory agreements. See "--Certain Terms of the Investment Management and
Portfolio Management Agreements" above. The Trustees concluded that the scope of
the Manager's and PIMCO's services to be provided to the Fund was consistent
with the Fund's operational requirements, including, in addition to its
investment objective, compliance with the Fund's investment restrictions, tax
and reporting requirements and related shareholder services.
The Trustees considered the quality of the services to be provided by the
Manager and PIMCO to the Fund. The Trustees also evaluated the procedures of the
Manager and PIMCO designed to fulfill their fiduciary duty to the Fund with
respect to possible conflicts of interest, including their codes of ethics
(regulating the personal trading of their officers and employees) (see
"Management of the Fund--Code of Ethics" above), the procedures by which PIMCO
allocates trades among its various investment advisory clients, the integrity of
the systems in place to ensure compliance with the foregoing and the record of
PIMCO in these matters. The Trustees also received information concerning
standards of the Manager and PIMCO with respect to the execution of portfolio
transactions. See "Portfolio Transactions" below.
In approving the agreements, the Trustees also gave substantial
consideration to the fees payable under the agreements. The Trustees reviewed
information concerning fees paid to investment advisers of similar bond funds.
The Trustees also considered the fees of the Fund as a percentage of assets at
different asset levels and possible economies of scale to the Manager. The
Trustees evaluated the Manager's profitability with respect to the Fund,
concluding that such
65
profitability was not inconsistent with levels of profitability that had been
determined by courts not to be "excessive." In evaluating the Fund's advisory
fees, the Trustees also took into account the complexity of investment
management for the Fund relative to other types of funds.
Proxy Voting Policies
The Fund and its Board of Trustees have delegated to the Manager, and the
Manager has in turn delegated to PIMCO, responsibility for voting any proxies
relating to portfolio securities held by the Fund in accordance with PIMCO's
proxy voting policies and procedures. A copy of the proxy voting policies and
procedures to be followed by PIMCO on behalf of the Fund, including procedures
to be used when a vote represents a conflict of interest, is attached hereto as
Appendix B ("Proxy Voting Policies").
PORTFOLIO TRANSACTIONS
Investment Decisions and Portfolio Transactions
Investment decisions for the Fund and for the other investment advisory
clients of the Manager and PIMCO are made with a view to achieving their
respective investment objective. Investment decisions are the product of many
factors in addition to basic suitability for the particular client involved
(including the Fund). Some securities considered for investments by the Fund may
also be appropriate for other clients served by the Manager and PIMCO. Thus, a
particular security may be bought or sold for certain clients even though it
could have been bought or sold for other clients at the same time. If a purchase
or sale of securities consistent with the investment policies of the Fund and
one or more of these clients served by the Manager or PIMCO is considered at or
about the same time, transactions in such securities will be allocated among the
Fund and clients in a manner deemed fair and reasonable by the Manager or PIMCO,
as applicable. The Manager or PIMCO may aggregate orders for the Fund with
simultaneous transactions entered into on behalf of its other clients so long as
price and transaction expenses are averaged either for that transaction or for
the day. Likewise, a particular security may be bought for one or more clients
when one or more clients are selling the security. In some instances, one client
may sell a particular security to another client. It also sometimes happens that
two or more clients simultaneously purchase or sell the same security, in which
event each day's transactions in such security are, insofar as possible,
averaged as to price and allocated between such clients in a manner which the
Manager or PIMCO believes is equitable to each and in accordance with the amount
being purchased or sold by each. There may be circumstances when purchases or
sales of portfolio securities for one or more clients will have an adverse
effect on other clients.
Brokerage and Research Services
There is generally no stated commission in the case of debt securities,
which are traded in the over-the-counter markets, but the price paid by the Fund
usually includes an undisclosed dealer commission or mark-up. In underwritten
offerings, the price paid by the Fund includes a disclosed, fixed commission or
discount retained by the underwriter or dealer. Transactions on U.S. stock
exchanges and other agency transactions involve the payment by the Fund of
negotiated brokerage commissions. Such commissions vary among different brokers.
Also, a
66
particular broker may charge different commissions according to such factors as
the difficulty and size of the transaction.
Subject to the supervision of the Manager, PIMCO places all orders for the
purchase and sale of portfolio securities, options, futures contracts and other
instruments for the Fund and buys and sells such securities, options, futures
contracts and other instruments for the Fund through a substantial number of
brokers and dealers. In so doing, PIMCO uses its best efforts to obtain for the
Fund the most favorable price and execution available, except to the extent it
may be permitted to pay higher brokerage commissions as described below. In
seeking the most favorable price and execution, PIMCO, having in mind the Fund's
best interests, considers all factors it deems relevant, including, by way of
illustration, price, the size of the transaction, the nature of the market for
the security, the amount of the commission, the timing of the transaction taking
into account market prices and trends, the reputation, experience and financial
stability of the broker-dealer involved and the quality of service rendered by
the broker-dealer in other transactions.
Subject to the supervision of the Manager, PIMCO places orders for the
purchase and sale of portfolio investments for the Fund's account with brokers
or dealers selected by it in its discretion. In effecting purchases and sales of
portfolio securities for the account of the Fund, PIMCO will seek the best price
and execution of the Fund's orders. In doing so, the Fund may pay higher
commission rates than the lowest available when PIMCO believes it is reasonable
to do so in light of the value of the brokerage and research services provided
by the broker effecting the transaction, as discussed below.
It has for many years been a common practice in the investment advisory
business for advisers of investment companies and other institutional investors
to receive research services from broker-dealers which execute portfolio
transactions for the clients of such advisers. Consistent with this practice,
PIMCO may receive research services from many broker-dealers with which PIMCO
places the Fund's portfolio transactions. PIMCO may also receive research or
research credits from brokers which are generated from underwriting commissions
when purchasing new issues of debt securities or other assets for the Fund.
These services, which in some cases may also be purchased for cash, include such
matters as general economic and security market reviews, industry and company
reviews, evaluations of securities and recommendations as to the purchase and
sale of securities. Some of these services are of value to PIMCO in advising
various of its clients (including the Fund), although not all of these services
are necessarily useful and of value in managing the Fund. Neither the management
fee paid by the Fund to the Manager nor the portfolio management fee paid by the
Manager to PIMCO is reduced because PIMCO and its affiliates receive such
services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, PIMCO
may cause the Fund to pay a broker-dealer which provides "brokerage and research
services" (as defined in such Act) to PIMCO an amount of disclosed commission
for effecting a securities transaction for the Fund in excess of the commission
which another broker-dealer would have charged for effecting that transaction.
67
The Fund may use broker-dealers that are affiliates (or affiliates of
affiliates) of the Fund, the Manager and/or PIMCO, subject to certain
restrictions discussed above under "Investment Manager and Portfolio
Manager--Investment Manager."
References to PIMCO in this section would apply equally to the Manager if
the Manager were to assume portfolio management responsibilities for the Fund
and place orders for the purchase and sale of the Fund's portfolio investments.
DISTRIBUTIONS
See "Description of AMPS--Dividends" and "Description of Capital Structure"
in the Prospectus for information relating to distributions made to Fund
shareholders.
For tax purposes, the Fund is currently required to allocate net capital
gain and other taxable income, if any, between and among Common Shares, the
Series T AMPS, the Series W AMPS and the Series TH AMPS in proportion to total
distributions paid to each class for the year in which such net capital gain or
other taxable income is realized.
While any AMPS are outstanding, the Fund may not declare any cash dividend
or other distribution on its Common Shares unless at the time of such
declaration (1) all accumulated dividends on the AMPS have been paid and (2) the
net asset value of the Fund's portfolio (determined after deducting the amount
of such dividend or other distribution) is at least 200% of the liquidation
value of any outstanding AMPS. This latter limitation on the Fund's ability to
make distributions on its Common Shares could cause the Fund to incur income and
excise tax and, under certain circumstances, impair the ability of the Fund to
maintain its qualification for taxation as a regulated investment company. See
"Tax Matters."
The Board of Trustees has declared a dividend of $0.0775 per Common Share
payable on November 3, 2003.
DESCRIPTION OF SHARES
Common Shares
The Fund's Declaration authorizes the issuance of an unlimited number of
Common Shares. The Common Shares currently outstanding have been issued with a
par value of $0.00001 per share. All Common Shares of the Fund have equal rights
as to the payment of dividends and the distribution of assets upon liquidation
of the Fund. The Common Shares currently outstanding have been fully paid and,
subject to matters discussed in "Anti-Takeover and Other Provisions in the
Declaration of Trust--Shareholder Liability" below, are non-assessable, and have
no pre-emptive or conversion rights or rights to cumulative voting. At any time
when the Fund's AMPS or any other preferred shares of beneficial interest are
outstanding, Common Shareholders will not be entitled to receive any
distributions from the Fund unless all accrued dividends on AMPS and any other
preferred shares of beneficial interest have been paid, and unless asset
coverage (as defined in the 1940 Act) with
68
respect to AMPS and any other preferred shares of beneficial interest would be
at least 200% after giving effect to such distributions. See "AMPS" below and
"Description of AMPS--Dividends and Dividend Periods--Restrictions on Dividends
and Other Distributions" and "Description of Capital Structure" in the
Prospectus.
The Common Shares are listed on the New York Stock Exchange. The Fund
intends to hold annual meetings of shareholders so long as the Common Shares are
listed on a national securities exchange and such meetings are required as a
condition to such listing.
Shares of closed-end investment companies may frequently trade at prices
lower than net asset value. Shares of closed-end investment companies have
during some periods traded at prices higher than net asset value and during
other periods traded at prices lower than net asset value. There can be no
assurance that Common Shares or shares of other similar funds will trade at a
price higher than net asset value in the future. Net asset value will be reduced
immediately following any offering of AMPS by the costs of that offering paid by
the Fund. Net asset value generally increases when interest rates decline, and
decreases when interest rates rise, and these changes are likely to be greater
in the case of a fund, such as the Fund, having a leveraged capital structure.
Whether investors will realize gains or losses upon the sale of Common Shares
will not depend upon the Fund's net asset value but will depend entirely upon
whether the market price of the Common Shares at the time of sale is above or
below the original purchase price for such Common Shares. Since the market price
of the Fund's Common Shares will be determined by factors beyond the control of
the Fund, the Fund cannot predict whether the Common Shares will trade at,
below, or above net asset value or at, below or above the initial public
offering price. Accordingly, the Common Shares are designed primarily for
long-term investors, and investors in the Common Shares should not view the Fund
as a vehicle for trading purposes. See "Repurchase of Common Shares; Conversion
to Open-End Fund."
AMPS
See "Description of AMPS" and "Description of Capital Structure" in the
Prospectus for information relating to the AMPS.
As used in this Statement of Additional Information and in the Prospectus,
unless otherwise noted, the Fund's "net assets" include assets of the Fund
attributable to any outstanding AMPS, with no deduction for the liquidation
preference of the AMPS. Solely for financial reporting purposes, however, the
Fund is required to exclude the liquidation preference of AMPS from "net
assets," so long as the AMPS have redemption features that are not solely within
the control of the Fund. For all regulatory and tax purposes, the Fund's AMPS
will be treated as stock (rather than indebtedness).
69
ADDITIONAL INFORMATION CONCERNING
THE AUCTIONS FOR PREFERRED SHARES
General
Auction Agency Agreement. The Fund will enter into an auction agency
agreement with the auction agent (currently Deutsche Bank Trust Company
Americas) which provides, among other things, that the auction agent will follow
the auction procedures set forth in the Bylaws for purposes of determining the
applicable rate for AMPS whenever the applicable rate for such shares is to be
based on the results of an auction.
Broker-Dealer Agreements. Each auction requires the participation of one or
more broker-dealers that have entered into separate agreements with the auction
agent. The auction agent will enter into broker-dealer agreements with one or
more broker-dealers selected by the Fund that provide for the participation of
those broker-dealers in auctions for AMPS.
Securities Depository. The Depository Trust Company ("DTC") will act as
securities depository for the agent members (defined below) with respect to the
AMPS. One certificate for the AMPS will be registered in the name of Cede & Co.,
as nominee of DTC. Such certificate will bear a legend to the effect that such
certificate is issued subject to the provisions restricting transfers of AMPS
contained in the Bylaws. Cede & Co. will be the holder of record of all AMPS,
and owners of the AMPS will not be entitled to receive certificates representing
their ownership interest in the AMPS.
DTC, a New York-chartered limited purpose trust company, performs services
for its participants, some of whom (and/or their representatives) own DTC. DTC
maintains lists of its participants and will maintain the positions (ownership
interests) held by each applicable participant (the "agent member") in AMPS,
whether for its own account or as a nominee for another person. A copy of the
Fund's agreement with DTC is included as an Exhibit to the Registration
Statement of which this Statement of Additional Information forms a part.
Auction Agent
The auction agent will act as agent for the Fund in connection with
auctions. In the absence of bad faith or negligence on its part, the auction
agent will not be liable for any action taken, suffered, or omitted or for any
error of judgment made by it in the performance of its duties under the auction
agency agreement.
The auction agent shall maintain a current registry of the existing holders
of the AMPS for purposes of each individual auction. The auction agent may rely
upon, as evidence of the identities of the existing holders, the list of the
initial existing holders of AMPS and the broker-dealer of each such existing
holder through which such existing holder purchased such shares, supplied to it
by the Fund. The auction agent may also rely upon, as evidence of the identities
of the existing holders the results of each auction and notices from any
existing holder, the agent member of any existing holder or the broker-dealer of
70
any existing holder with respect to such existing holder's transfer of any AMPS
to another person.
The auction agent may terminate the auction agency agreement upon notice to
the Fund on a date no earlier than 60 days after such notice. If the auction
agent should resign, the Fund will attempt to appoint a successor auction agent.
The Fund may remove the auction agent provided that prior to such removal the
Fund shall have entered into an agreement with a successor auction agent.
Broker-Dealers
After each auction for the AMPS, the auction agent will pay to each
broker-dealer, from funds provided by the Fund, a service charge that will
generally be at the annual rate of 1/4 of 1% of the stated value ($25,000) of
the AMPS held by such broker-dealer's customers upon settlement in such auction.
The broker-dealer agreement provides that a broker-dealer may submit orders
in auctions for its own account. If a broker-dealer submits an order for its own
account in any auction, it might have an advantage over other bidders because it
would have knowledge of all orders submitted by it in that auction; such
broker-dealer, however, would not have knowledge of orders submitted by other
broker-dealers in that auction.
The Fund may request the auction agent to terminate one or more
broker-dealer agreements at any time, provided that at least one broker-dealer
agreement is in effect after such termination.
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST
Shareholder Liability
Under Massachusetts law, shareholders could, under certain circumstances,
be held personally liable for the obligations of the Fund. However, the
Declaration contains an express disclaimer of shareholder liability for acts or
obligations of the Fund and requires that notice of such disclaimer be given in
each agreement, obligation or instrument entered into or executed by the Fund or
the Trustees. The Declaration also provides for indemnification out of the
Fund's property for all loss and expense of any shareholder held personally
liable on account of being or having been a shareholder. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which such disclaimer is inoperative or the Fund is
unable to meet its obligations, and thus should be considered remote.
Anti-Takeover Provisions
As described below, the Declaration includes provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Trustees, and could
have the effect of depriving shareholders of opportunities to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund.
71
The Fund's Trustees are divided into three classes (Class I, Class II and
Class III), having initial terms of one, two and three years, respectively. At
each annual meeting of shareholders, the term of one class will expire and each
Trustee elected to that class will hold office for a term of three years. The
classification of the Board of Trustees in this manner could delay for an
additional year the replacement of a majority of the Board of Trustees. In
addition, the Declaration provides that a Trustee may be removed only for cause
and only (i) by action of at least seventy-five percent (75%) of the outstanding
shares of the classes or series of shares entitled to vote for the election of
such Trustee, or (ii) by at least seventy-five percent (75%) of the remaining
Trustees.
Except as provided in the next paragraph, the affirmative vote or consent
of at least seventy-five percent (75%) of the Board of Trustees and at least
seventy-five percent (75%) of the shares of the Fund outstanding and entitled to
vote thereon are required to authorize any of the following transactions (each a
"Material Transaction"): (1) a merger, consolidation or share exchange of the
Fund or any series or class of shares of the Fund with or into any other person
or company, or of any such person or company with or into the Fund or any such
series or class of shares; (2) the issuance or transfer by the Fund or any
series or class of shares (in one or a series of transactions in any
twelve-month period) of any securities of the Fund or such series or class to
any other person or entity for cash, securities or other property (or
combination thereof) having an aggregate fair market value of $1,000,000 or
more, excluding sales of securities of the Fund or such series or class in
connection with a public offering, issuances of securities of the Fund or such
series or class pursuant to a dividend reinvestment plan adopted by the Fund and
issuances of securities of the Fund or such series or class upon the exercise of
any stock subscription rights distributed by the Fund; or (3) a sale, lease,
exchange, mortgage, pledge, transfer or other disposition by the Fund or any
series or class of shares (in one or a series of transactions in any
twelve-month period) to or with any person of any assets of the Fund or such
series or class having an aggregate fair market value of $1,000,000 or more,
except for transactions in securities effected by the Fund or such series or
class in the ordinary course of its business. The same affirmative votes are
required with respect to any shareholder proposal as to specific investment
decisions made or to be made with respect to the Fund's assets or the assets of
any series or class of shares of the Fund.
Notwithstanding the approval requirements specified in the preceding
paragraph, the Declaration requires no vote or consent of the Fund's
shareholders to authorize a Material Transaction if the transaction is approved
by a vote of both a majority of the Board of Trustees and seventy-five percent
(75%) of the Continuing Trustees (as defined below), so long as all other
conditions and requirements, if any, provided for in the Fund's Bylaws and
applicable law (including any shareholder voting rights under the 1940 Act) have
been satisfied.
In addition, the Declaration provides that the Fund may be terminated at
any time by vote or consent of at least seventy-five percent (75%) of the Fund's
shares or, alternatively, by vote or consent of both a majority of the Board of
Trustees and seventy-five percent (75%) of the Continuing Trustees (as defined
below).
In certain circumstances, the Declaration also imposes shareholder voting
requirements that are more demanding than those required under the 1940 Act in
order to authorize a
72
conversion of the Fund from a closed-end to an open-end investment company. See
"Repurchase of Common Shares; Conversion to Open-End Fund" below.
As noted, the voting provisions described above could have the effect of
depriving Common Shareholders of an opportunity to sell their Common Shares at a
premium over prevailing market prices by discouraging a third party from seeking
to obtain control of the Fund in a tender offer or similar transaction. In the
view of the Fund's Board of Trustees, however, these provisions offer several
possible advantages, including: (1) requiring persons seeking control of the
Fund to negotiate with its management regarding the price to be paid for the
amount of Common Shares required to obtain control; (2) promoting continuity and
stability; and (3) enhancing the Fund's ability to pursue long-term strategies
that are consistent with its investment objective and management policies. The
Board of Trustees has determined that the voting requirements described above,
which are generally greater than the minimum requirements under the 1940 Act,
are in the best interests of the Fund's Common Shareholders generally.
A "Continuing Trustee," as used in the discussion above, is any member of
the Fund's Board of Trustees who either (i) has been a member of the Board for a
period of at least thirty-six months (or since the commencement of the Fund's
operations, if less than thirty-six months) or (ii) was nominated to serve as a
member of the Board of Trustees by a majority of the Continuing Trustees then
members of the Board.
The foregoing is intended only as a summary and is qualified in its
entirety by reference to the full text of the Declaration and the Fund's Bylaws,
both of which have been filed as exhibits to the Fund's registration statement
on file with the SEC.
Liability of Trustees
The Declaration provides that the obligations of the Fund are not binding
upon the Trustees of the Fund individually, but only upon the assets and
property of the Fund, and that the Trustees shall not be liable for errors of
judgment or mistakes of fact or law. Nothing in the Declaration, however,
protects a Trustee against any liability to which he would otherwise be subject
by reason of willful misfeasance, bad faith, gross negligence or reckless
disregard of the duties involved in the conduct of his office.
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its shareholders
will not have the right to cause the Fund to redeem their shares. Instead, the
Fund's Common Shares will trade in the open market at a price that will be a
function of several factors, including dividend levels (which are in turn
affected by changes in the floating rates of interest on the Fund's investments
and expenses), net asset value, call protection, price, relative demand for and
supply of such shares in the market, general market and economic conditions and
other factors. Shares of a closed-end investment company may frequently trade at
prices lower than net asset value. The Fund's Board of Trustees regularly
monitors the relationship between the market price and net asset value of the
Common Shares. If the Common Shares were to trade at a substantial discount to
net asset value for an extended period of time, the Board may consider the
repurchase
73
of its Common Shares on the open market or in private transactions, or the
making of a tender offer for such shares. There can be no assurance, however,
that the Board of Trustees will decide to take or propose any of these actions,
or that share repurchases or tender offers, if undertaken, will reduce market
discount. The Fund has no present intention to repurchase its Common Shares and
would do so only in the circumstances described in this section.
Notwithstanding the foregoing, at any time when the Fund's AMPS are
outstanding, the Fund may not purchase, redeem or otherwise acquire any of its
Common Shares unless (1) all accrued dividends on AMPS have been paid and (2) at
the time of such purchase, redemption or acquisition, the net asset value of the
Fund's portfolio (determined after deducting the acquisition price of the Common
Shares) is at least 200% of the liquidation value of the outstanding AMPS
(expected to equal the original purchase price per share plus any accrued and
unpaid dividends thereon).
Subject to its investment limitations, the Fund may borrow to finance the
repurchase of shares or to make a tender offer. Interest on any borrowings to
finance share repurchase transactions or the accumulation of cash by the Fund in
anticipation of share repurchases or tenders will reduce the Fund's net income.
Any share repurchase, tender offer or borrowing that might be approved by the
Board of Trustees would have to comply with the Securities Exchange Act of 1934,
as amended, and the 1940 Act and the rules and regulations thereunder.
The Fund's Board of Trustees may also from time to time consider submitting
to the holders of the shares of beneficial interest of the Fund a proposal to
convert the Fund to an open-end investment company. In determining whether to
exercise its sole discretion to submit this issue to shareholders, the Board of
Trustees would consider all factors then relevant, including the relationship of
the market price of the Common Shares to net asset value, the extent to which
the Fund's capital structure is leveraged and the possibility of re-leveraging,
the spread, if any, between the yields on securities in the Fund's portfolio and
interest and dividend charges on AMPS issued by the Fund and general market and
economic conditions.
The Declaration requires the affirmative vote or consent of holders of at
least seventy-five percent (75%) of each class of the Fund's shares entitled to
vote on the matter to authorize a conversion of the Fund from a closed-end to an
open-end investment company, unless the conversion is authorized by both a
majority of the Board of Trustees and seventy-five percent (75%) of the
Continuing Trustees (as defined above under "Anti-Takeover and Other Provisions
in the Declaration of Trust--Anti-Takeover Provisions"). This seventy-five
percent (75%) shareholder approval requirement is higher than is required under
the 1940 Act. In the event that a conversion is approved by the Trustees and the
Continuing Trustees as described above, the minimum shareholder vote required
under the 1940 Act would be necessary to authorize the conversion. Currently,
the 1940 Act would require approval of the holders of a "majority of the
outstanding" Common Shares and, if issued, AMPS voting together as a single
class, and the holders of a "majority of the outstanding" AMPS voting as a
separate class, in order to authorize a conversion.
If the Fund converted to an open-end company, it would be required to
redeem all AMPS then outstanding (requiring in turn that it liquidate a portion
of its investment portfolio), and the Fund's Common Shares likely would no
longer be listed on the
74
New York Stock Exchange. Shareholders of an open-end investment company may
require the company to redeem their shares on any business day (except in
certain circumstances as authorized by or under the 1940 Act) at their net asset
value, less such redemption charge, if any, as might be in effect at the time of
redemption. In order to avoid maintaining large cash positions or liquidating
favorable investments to meet redemptions, open-end companies typically engage
in a continuous offering of their shares. Open-end companies are thus subject to
periodic asset in-flows and out-flows that can complicate portfolio management.
The repurchase by the Fund of its shares at prices below net asset value
will result in an increase in the net asset value of those shares that remain
outstanding. However, there can be no assurance that share repurchases or
tenders at or below net asset value will result in the Fund's shares trading at
a price equal to their net asset value. Nevertheless, the fact that the Fund's
shares may be the subject of repurchase or tender offers at net asset value from
time to time, or that the Fund may be converted to an open-end company, may
reduce any spread between market price and net asset value that might otherwise
exist.
In addition, a purchase by the Fund of its Common Shares will decrease the
Fund's total assets. This would likely have the effect of increasing the Fund's
expense ratio. Any purchase by the Fund of its Common Shares at a time when AMPS
are outstanding will increase the leverage applicable to the outstanding Common
Shares then remaining. See the Prospectus under "Risks--Leverage Risk."
Before deciding whether to take any action if the Fund's Common Shares
trade below net asset value, the Board of Trustees would consider all relevant
factors, including the extent and duration of the discount, the liquidity of the
Fund's portfolio, the impact of any action that might be taken on the Fund or
its shareholders and market considerations. Based on these considerations, even
if the Fund's shares should trade at a discount, the Board of Trustees may
determine that, in the interest of the Fund and its shareholders, no action
should be taken.
TAX MATTERS
Taxation of the Fund. The Fund intends to elect to be treated and to
qualify each year as a regulated investment company under Subchapter M of the
Code. In order to qualify for the special tax treatment accorded regulated
investment companies and their shareholders, the Fund must, among other things:
(a) derive at least 90% of its gross income for each taxable year
from dividends, interest, payments with respect to certain securities
loans, and gains from the sale or other disposition of stock,
securities or foreign currencies, or other income (including but not
limited to gains from options, futures, or forward contracts) derived
with respect to its business of investing in such stock, securities,
or currencies;
(b) distribute with respect to each taxable year at least 90% of
the sum of its investment company taxable income (as that term is
defined in the Code without regard to the deduction for dividends
paid--generally taxable ordinary income and the excess, if any, of net
short-term capital gains over net long-term capital losses) and net
tax-exempt interest income, for such year; and
75
(c) diversify its holdings so that, at the end of each quarter of
the Fund's taxable year, (i) at least 50% of the market value of the
Fund's total assets is represented by cash and cash items, U.S.
Government securities, securities of other regulated investment
companies, and other securities limited in respect of any one issuer
to a value not greater than 5% of the value of the Fund's total assets
and not more than 10% of the outstanding voting securities of such
issuer, and (ii) not more than 25% of the value of the Fund's total
assets is invested in the securities (other than those of the U.S.
Government or other regulated investment companies) of any one issuer
or of two or more issuers which the Fund controls and which are
engaged in the same, similar, or related trades or businesses.
If the Fund qualifies as a regulated investment company that is accorded
special tax treatment, the Fund will not be subject to federal income tax on
income distributed in a timely manner to its shareholders in the form of
dividends (including Capital Gain Dividends, as defined below).
If the Fund failed to qualify as a regulated investment company accorded
special tax treatment in any taxable year, the Fund would be subject to tax on
its taxable income at corporate rates, and all distributions from earnings and
profits, including any distributions of net tax-exempt income and net long-term
capital gains, generally would be taxable to shareholders as ordinary income.
Some portions of such distributions generally would be eligible (i) to be
treated as qualified dividend income in the case of shareholders taxed as
individuals, and (ii) for the dividends received deduction in the case of
corporate shareholders. In addition, if the Fund qualifies as a regulated
investment company and then in a subsequent period fails to so qualify, the Fund
could be required to recognize unrealized gains, pay substantial taxes and
interest and make substantial distributions before requalifying as a regulated
investment company that is accorded special tax treatment.
The Fund intends to distribute at least annually to its shareholders all or
substantially all of its investment company taxable income and any net
tax-exempt interest, and may distribute its net capital gain. The Fund may also
retain for investment its net capital gain. If the Fund does retain any net
capital gain or any investment company taxable income, it will be subject to tax
at regular corporate rates on the amount retained. If the Fund retains any net
capital gain, it will designate within 60 days of the close of its taxable year
the retained amount as undistributed capital gains in a notice to its
shareholders who, if subject to federal income tax on long-term capital gains,
(i) will be required to include in income for federal income tax purposes, as
long-term capital gain, their shares of such undistributed amount, and (ii) will
be entitled to credit their proportionate shares of the tax paid by the Fund on
such undistributed amount against their federal income tax liabilities, if any,
and to claim refunds to the extent the credit exceeds such liabilities. For
federal income tax purposes, the tax basis of shares owned by a shareholder of
the Fund will be increased by an amount equal under current law to the
difference between the amount of undistributed capital gains included in the
shareholder's gross income and the tax deemed paid by the shareholder under
clause (ii) of the preceding sentence. Although the Fund may generate tax-exempt
income, it does not expect to satisfy the criteria necessary to pass through the
tax-free nature of the income to its shareholders.
Treasury regulations permit a regulated investment company, in determining
its investment company taxable income and net capital gain, to elect to treat
all or part of any net
76
capital loss, any net long-term capital loss or any net foreign currency loss
incurred after October 31 as if it had been incurred in the succeeding year.
If the Fund fails to distribute in a calendar year at least an amount equal
to the sum of 98% of its ordinary income for such year and 98% of its capital
gain net income for the one-year period ending October 31 of such year, plus any
retained amount from the prior year, the Fund will be subject to a nondeductible
4% excise tax on the undistributed amounts. For these purposes, the Fund will be
treated as having distributed any amount for which it is subject to income tax.
A dividend paid to shareholders in January of a year generally is deemed to have
been paid by the Fund on December 31 of the preceding year, if the dividend was
declared and payable to shareholders of record on a date in October, November or
December of that preceding year. The Fund intends generally to make
distributions sufficient to avoid imposition of the 4% excise tax.
Fund Distributions. For federal income tax purposes, distributions of
investment income are generally taxable as ordinary income. Taxes on
distributions of capital gains are determined by how long the Fund owned the
investments that generated them, rather than how long a shareholder has owned
his or her shares. Distributions of net capital gains from the sale of
investments that the Fund owned for more than one year and that are properly
designated by the Fund within 60 days of the close of its taxable year as
capital gain dividends ("Capital Gain Dividends") will be taxable as long-term
capital gains. Distributions from capital gains are generally made after
applying any available capital loss carryovers. Distributions of gains from the
sale of investments that the Fund owned for one year or less will be taxable as
ordinary income.
For taxable years beginning on or before December 31, 2008, the Fund may
designate distributions of investment income derived from dividends of U.S.
corporations and some foreign corporations as "qualified dividend income,"
provided holding period and other requirements are met by the Fund. Qualified
dividend income will be taxed in the hands of individuals at the rates
applicable to long-term capital gain, provided the same holding period and other
requirements are met by the shareholder. Fund dividends representing
distributions of interest income and short-term capital gains cannot be
designated as qualified dividend income and will not qualify for the reduced
rates. In light of this, the Fund does not expect a significant portion of Fund
distributions to be derived from qualified dividend income.
Long-term capital gain rates applicable to individuals have been
temporarily reduced--in general, to 15% with lower rates applying to taxpayers
in the 10% and 15% rate brackets--for taxable years beginning on or before
December 31, 2008.
Dividends of net investment income designated by the Fund and received by
corporate shareholders of the Fund will qualify for the 70% dividends received
deduction generally available to corporations to the extent of the amount of
qualifying dividends received by the Fund from domestic corporations for the
taxable year. It is not expected that any significant percentage of the Fund's
distributions will so qualify.
Although the Fund may generate tax-exempt income, it does not expect to
satisfy the criteria necessary to pass through the tax-free nature of the income
to its shareholders.
The Internal Revenue Service currently requires that a regulated investment
company that has two or more classes of stock allocate to each such class
proportionate amounts of each type of its income (such as ordinary income and
capital gains) based upon the percentage of total
77
dividends distributed to each class for the tax year. Accordingly, the Fund
intends each year to allocate Capital Gain Dividends between and among its
Common Shares, Series T AMPS, Series W AMPS and Series TH AMPS in proportion to
the total dividends paid to each class with respect to such tax year. Dividends
qualifying and not qualifying for (a) treatment as qualified dividend income and
(b) the dividends received deduction, if any, will similarly be allocated
between and among any such classes.
Existing authorities do not specifically address whether dividends that are
paid following the close of a taxable year, but that are treated for tax
purposes as derived from the income of such prior taxable year, are treated as
dividends paid during such prior taxable year for purposes of determining each
class' proportionate share of a particular type of income. Existing authorities
also do not specifically address the allocation of taxable income among the
dividends paid to holders of a class of shares during or with respect to a
taxable year. It is possible that the IRS could disagree with the Fund's
position concerning the treatment of dividends paid after the close of a taxable
year or with the Fund's method of allocation, in which case the IRS could
attempt to recharacterize a portion of the dividends paid to the holders of
AMPS. If the IRS were to prevail with respect to any such attempted
recharacterization, holders of AMPS could be subject to additional tax on
amounts so recharacterized and the Fund could be subject to federal income and
excise tax.
Return of Capital Distributions. If the Fund makes a distribution to a
shareholder in excess of the Fund's current and accumulated earnings and profits
(including earnings and profits arising from tax-exempt income) in any taxable
year, the excess distribution will be treated as a return of capital to the
extent of such shareholder's tax basis in its shares, and thereafter as capital
gain. A return of capital is not taxable, but it reduces a shareholder's tax
basis in its shares, thus reducing any loss or increasing any gain on a
subsequent taxable disposition by the shareholder of its shares. Where one or
more such distributions occur in any taxable year of the Fund, the available
earnings and profits will be allocated, first, to the distributions made to the
holders of AMPS, and only thereafter to distributions made to holders of Common
Shares. As a result, the holders of AMPS will receive a disproportionate share
of the distributions treated as dividends, and the holders of the Common Shares
will receive a disproportionate share of the distributions treated as a return
of capital.
Dividends and distributions on the Fund's shares are generally subject to
federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, even though such dividends and distributions
may economically represent a return of a particular shareholder's investment.
Such distributions are likely to occur in respect of shares purchased at a time
when the Fund's net asset value reflects gains that are either unrealized, or
realized but not distributed. Such realized gains may be required to be
distributed even when the Fund's net asset value also reflects unrealized
losses.
78
Sale or Redemption of Shares. The sale, exchange or redemption of Fund
shares may give rise to a gain or loss. In general, any gain or loss realized
upon a taxable disposition of shares will be treated as long-term capital gain
or loss if the shares have been held for more than one year. Otherwise, the gain
or loss on the taxable disposition of Fund shares will be treated as short-term
capital gain or loss. However, any loss realized upon a taxable disposition of
shares held for six months or less will be treated as long-term, rather than
short-term, to the extent of any long-term capital gain distributions received
(or deemed received) by the shareholder with respect to the shares. All or a
portion of any loss realized upon a taxable disposition of Fund shares will be
disallowed if other substantially identical shares of the Fund are purchased
within 30 days before or after the disposition. In such a case, the basis of the
newly purchased shares will be adjusted to reflect the disallowed loss.
From time to time the Fund may make a tender offer for its Common Shares.
It is expected that the terms of any such offer will require a tendering
shareholder to tender all Common Shares and dispose of all AMPS held, or
considered under certain attribution rules of the Code to be held, by such
shareholder. Shareholders who tender all Common Shares and dispose of all AMPS
held, or considered to be held, by them will be treated as having sold their
shares and generally will realize a capital gain or loss. If a shareholder
tenders fewer than all of its Common Shares, or retains a substantial portion of
its AMPS, such shareholder may be treated as having received a taxable dividend
upon the tender of its Common Shares. In such a case, there is a remote risk
that non-tendering shareholders will be treated as having received taxable
distributions from the Fund. Likewise, if the Fund redeems some but not all of
the AMPS held by a Preferred Shareholder and such shareholder is treated as
having received a taxable dividend upon such redemption, there is a remote risk
that Common Shareholders and non-redeeming Preferred Shareholders will be
treated as having received taxable distributions from the Fund. To the extent
that the Fund recognizes net gains on the liquidation of portfolio securities to
meet such tenders of Common Shares, the Fund will be required to make additional
distributions to its Common Shareholders.
Original Issue Discount and Payment-in-Kind Securities. Some of the debt
obligations (with a fixed maturity date of more than one year from the date of
issuance) that may be acquired by the Fund may be (and all zero-coupon debt
obligations acquired by the Fund will be) treated as debt obligations that are
issued originally at a discount. Generally, the amount of the original issue
discount ("OID") is treated as interest income and is included in taxable income
(and required to be distributed) over the term of the debt security, even though
payment of that amount is not received until a later time, usually when the debt
security matures. Increases in the principal amount of an inflation indexed bond
will generally be treated as OID. In addition, payment-in-kind securities will
give rise to income which is required to be distributed and is taxable even
though the Fund holding the security receives no interest payment in cash on the
security during the year.
Some of the debt obligations (with a fixed maturity date of more than one
year from the date of issuance) that may be acquired by the Fund in the
secondary market may be treated as having market discount. Generally, any gain
recognized on the disposition of, and any partial payment of principal on, a
debt security having market discount is treated as ordinary income to the extent
the gain, or principal payment, does not exceed the "accrued market discount" on
such
79
debt security. Market discount generally accrues in equal daily installments.
The Fund may make one or more of the elections applicable to debt obligations
having market discount, which could affect the character and timing of
recognition of income.
Some debt obligations (with a fixed maturity date of one year or less from
the date of issuance) that may be acquired by the Fund may be treated as having
acquisition discount, or OID in the case of certain types of debt obligations.
Generally, the Fund will be required to include the acquisition discount, or
OID, in income over the term of the debt security, even though payment of that
amount is not received until a later time, usually when the debt security
matures. The Fund may make one or more of the elections applicable to debt
obligations having acquisition discount, or OID, which could affect the
character and timing of recognition of income.
If the Fund holds the foregoing kinds of securities, it may be required to
pay out as an income distribution each year an amount which is greater than the
total amount of cash interest the Fund actually received. Such distributions may
be made from the cash assets of the Fund or by liquidation of portfolio
securities, if necessary. The Fund may realize gains or losses from such
liquidations. In the event the Fund realizes net capital gains from such
transactions, its shareholders may receive a larger capital gain distribution
than they would in the absence of such transactions.
Higher-Risk Securities. The Fund may invest to a significant extent in debt
obligations that are in the lowest rating categories or are unrated, including
debt obligations of issuers not currently paying interest or who are in default.
Investments in debt obligations that are at risk of or in default present
special tax issues for the Fund. Tax rules are not entirely clear about issues
such as when the Fund may cease to accrue interest, original issue discount or
market discount, when and to what extent deductions may be taken for bad debts
or worthless securities and how payments received on obligations in default
should be allocated between principal and income. These and other related issues
will be addressed by the Fund when, as and if it invests in such securities, in
order to seek to ensure that it distributes sufficient income to preserve its
status as a regulated investment company and does not become subject to U.S.
federal income or excise tax.
Issuer Deductibility of Interest. A portion of the interest paid or accrued
on certain high yield discount obligations owned by the Fund may not be
deductible to the issuer. This may affect the cash flow of the issuer. If a
portion of the interest paid or accrued on certain high yield discount
obligations is not deductible, that portion will be treated as a dividend for
purposes of the corporate dividends received deduction. In such cases, if the
issuer of the high yield discount obligations is a domestic corporation,
dividend payments by the Fund may be eligible for the dividends received
deduction to the extent of the deemed dividend portion of such accrued interest.
Interest paid on debt obligations owned by the Fund, if any, that are
considered for tax purposes to be payable in the equity of the issuer or a
related party will not be deductible to the issuer, possibly affecting the cash
flow of the issuer.
Certain Investments in REITs. The Fund may invest in REITs that hold
residual interests in real estate mortgage investment conduits ("REMICs"). Under
Treasury regulations that have
80
not yet been issued, but may apply retroactively, a portion of the Fund's income
from a REIT that is attributable to the REIT's residual interest in a REMIC
(referred to in the Code as an "excess inclusion") will be subject to federal
income tax in all events. These regulations are also expected to provide that
excess inclusion income of a regulated investment company, such as the Fund,
will be allocated to shareholders of the regulated investment company in
proportion to the dividends received by such shareholders, with the same
consequences as if the shareholders held the related REMIC residual interest
directly. Dividends paid by REITs generally will not be eligible to be treated
as "qualified dividend income."
In general, excess inclusion income allocated to shareholders (i) cannot be
offset by net operating losses (subject to a limited exception for certain
thrift institutions), (ii) will constitute unrelated business taxable income to
entities (including a qualified pension plan, an individual retirement account,
a 401(k) plan, a Keogh plan or other tax-exempt entity) subject to tax on
unrelated business income, thereby potentially requiring such an entity that is
allocated excess inclusion income, and otherwise might not be required to file a
tax return, to file a tax return and pay tax on such income, and (iii) in the
case of a non-U.S. shareholder, will not qualify for any reduction in U.S.
federal withholding tax (discussed below). In addition, if at any time during
any taxable year a "disqualified organization" (as defined in the Code) is a
record holder of a share in a regulated investment company, then the regulated
investment company will be subject to a tax equal to that portion of its excess
inclusion income for the taxable year that is allocable to the disqualified
organization, multiplied by the highest federal income tax rate imposed on
corporations. The Fund does not intend to invest directly in residual interests
in REMICs or to invest in REITS in which a substantial portion of the assets
will consist of residual interests in REMICs.
Options, Futures, Forward Contracts and Swap Agreements. The Fund's
transactions in options, futures contracts, hedging transactions, forward
contracts, swap agreements, straddles and foreign currencies will be subject to
special tax rules (including mark-to-market, constructive sale, straddle, wash
sale and short sale rules), the effect of which may be to accelerate income to
the Fund, defer losses to the Fund, cause adjustments in the holding periods of
the Fund's securities, convert long-term capital gains into short-term capital
gains and convert short-term capital losses into long-term capital losses. These
rules could therefore affect the amount, timing and character of distributions
to shareholders. The Fund will monitor its transactions, will make appropriate
tax elections and will make appropriate entries in its books and records in
order to mitigate the effect of these rules.
Certain of the Fund's hedging activities (including its transactions, if
any, in foreign currencies or foreign currency-denominated instruments) are
likely to produce a difference between its book income and its taxable income.
If the Fund's book income exceeds its taxable income, the distribution (if any)
of such excess generally will be treated as described under "--Return of Capital
Distributions." If the Fund's book income is less than taxable income, the Fund
could be required to make distributions exceeding book income to qualify as a
regulated investment company that is accorded special tax treatment.
Foreign Currency Transactions. The Fund's transactions in foreign
currencies, foreign currency-denominated debt obligations and certain foreign
currency options, futures contracts and forward contracts (and similar
instruments) may give rise to ordinary income or loss to the
81
extent such income or loss results from fluctuations in the value of the foreign
currency concerned.
Foreign Taxation. Income received by the Fund from sources within foreign
countries may be subject to withholding and other taxes imposed by such
countries. Tax conventions between certain countries and the U.S. may reduce or
eliminate such taxes. Shareholders generally will not be entitled to claim a
credit or deduction with respect to foreign taxes.
Shares Purchased Through Tax-Qualified Plans. Special tax rules apply to
investments through defined contribution plans and other tax-qualified plans.
Shareholders should consult their tax advisers to determine the suitability of
shares of the Fund as an investment through such plans and the precise effect of
an investment on their particular tax situation.
Non-U.S. Shareholders. Under U.S. federal tax law, dividends other than
Capital Gain Dividends paid on shares beneficially held by a person who is not a
U.S. person within the meaning of the Code (i.e., a "foreign person"), are, in
general, subject to withholding of U.S. federal income tax at a rate of 30% of
the gross dividend, which rate may, in some cases, be reduced by an applicable
tax treaty. Dividends are subject to withholding even if they are funded by
income or gains (such as portfolio interest, short-term capital gains, or
foreign-source dividend and interest income) that, if paid to a foreign person
directly, would not be subject to withholding. However, Capital Gain Dividends
will not be subject to withholding of U.S. federal income tax. If a beneficial
holder who is a foreign person has a trade or business in the United States, and
the dividends are effectively connected with the conduct by the beneficial
holder of a trade or business in the United States, the dividend will be subject
to U.S. federal net income taxation at regular income tax rates.
Under U.S. federal tax law, a beneficial holder of shares who is a foreign
person is not, in general, subject to U.S. federal income tax on gains (and is
not allowed a deduction for losses) realized on the sale of shares of the Fund
or on Capital Gain Dividends unless (i) such gain or Capital Gain Dividend is
effectively connected with the conduct of a trade or business carried on by such
holder within the United States or (ii) in the case of an individual holder, the
holder is present in the United States for a period or periods aggregating 183
days or more during the year of the sale or Capital Gain Dividend and certain
other conditions are met.
If you are eligible for the benefits of a tax treaty, any effectively
connected income or gain will generally be subject to U.S. federal income tax on
a net basis only if it is also attributable to a permanent establishment
maintained by you in the United States.
A beneficial holder of shares who is a foreign person may be subject to
state and local tax and to the U.S. federal estate tax in addition to the
federal tax on income referred to above.
Backup Withholding. The Fund generally is required to withhold and remit to
the U.S. Treasury a percentage of the taxable distributions and redemption
proceeds paid to any individual shareholder who fails to properly furnish the
Fund with a correct taxpayer identification number, who has under-reported
dividend or interest income, or who fails to certify to the Fund that he or she
is not subject to such withholding. The backup withholding tax
82
rate is 28% for amounts paid through 2010. The backup withholding tax rate will
be 31% for amounts paid after December 31, 2010.
In order for a foreign investor to qualify for exemption from the backup
withholding tax rates under income tax treaties, the foreign investor must
comply with special certification and filing requirements. Foreign investors in
the Fund should consult their tax advisers in this regard. Backup withholding is
not an additional tax. Any amounts withheld may be credited against the
shareholder's U.S. federal income tax liability, provided the appropriate
information is furnished to the Internal Revenue Service.
Recent Tax Shelter Reporting Regulations. Under recently promulgated
Treasury regulations, if a shareholder recognizes a loss with respect to Fund
shares of $2 million or more for an individual shareholder or $10 million or
more for a corporate shareholder, the shareholder must file with the Internal
Revenue Service a disclosure statement on Form 8886. Direct shareholders of
portfolio securities are in many cases excepted from this reporting requirement,
but under current guidance, shareholders of a regulated investment company are
not excepted. Future guidance may extend the current exception from this
reporting requirement to shareholders of most or all regulated investment
companies. The fact that a loss is reportable under these regulations does not
affect the legal determination of whether the taxpayer's treatment of the loss
is proper. Shareholders should consult their tax advisers to determine the
applicability of these regulations in light of their individual circumstances.
General. The federal income tax discussion set forth above is for general
information only. Prospective investors should consult their tax advisers
regarding the specific federal tax consequences of purchasing, holding, and
disposing of shares of the Fund, as well as the effects of state, local and
foreign tax law and any proposed tax law changes.
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
The Fund may quote certain performance-related information and may compare
certain aspects of its portfolio and structure to other substantially similar
closed-end funds as categorized by Lipper, Inc. ("Lipper"), Morningstar Inc. or
other independent services. Comparison of the Fund to an alternative investment
should be made with consideration of differences in features and expected
performance. The Fund may obtain data from sources or reporting services, such
as Bloomberg Financial ("Bloomberg") and Lipper, that the Fund believes to be
generally accurate.
The Fund, in its advertisements, may refer to pending legislation from time
to time and the possible impact of such legislation on investors, investment
strategy and related matters. At any time in the future, yields and total return
may be higher or lower than past yields and there can be no assurance that any
historical results will continue.
Past performance is not indicative of future results.
For the period from August 29, 2003 (the commencement of the Fund's
operations) through October 3, 2003, the Fund's net increase in net assets
resulting from investment operations was $1,100,739.
83
CUSTODIAN, TRANSFER AGENT AND DIVIDEND PAYING AGENT
State Street Bank and Trust Co., 801 Pennsylvania Avenue, Kansas City,
Missouri 64105, serves as custodian for assets of the Fund. The custodian
performs custodial and fund accounting services.
PFPC Inc., 400 Bellevue Parkway, Wilmington, Delaware 19809, serves as the
transfer agent, registrar and dividend disbursement agent for the Common Shares,
as well as agent for the Dividend Reinvestment Plan relating to the Common
Shares.
Deutsche Bank Trust Company Americas, 280 Park Avenue, 9th Floor, New York,
New York 10017, serves as auction agent, transfer agent, registrar, dividend
paying agent and redemption agent for the AMPS.
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York
10036, serves as independent auditors for the Fund. PricewaterhouseCoopers LLP
provides audit services, tax return preparation and assistance and consultation
in connection with review of SEC filings to the Fund.
COUNSEL
Ropes & Gray LLP, One International Place, Boston, Massachusetts 02110,
passes upon certain legal matters in connection with shares offered by the Fund,
and also acts as counsel to the Fund.
REGISTRATION STATEMENT
A Registration Statement on Form N-2, including any amendments thereto (the
"Registration Statement"), relating to the shares of the Fund offered hereby,
has been filed by the Fund with the SEC, Washington, D.C. The Prospectus and
this Statement of Additional Information are parts of, but do not contain all of
the information set forth in, the Registration Statement, including any exhibits
and schedules thereto. For further information with respect to the Fund and the
shares offered or to be offered hereby, reference is made to the Fund's
Registration Statement. Statements contained in the Prospectus and this
Statement of Additional Information as to the contents of any contract or other
document referred to are not necessarily complete and in each instance reference
is made to the copy of such contract or other document filed as an exhibit to
the Registration Statement, each such statement being qualified in all respects
by such reference. Copies of the Registration Statement may be inspected without
charge at the SEC's principal office in Washington, D.C., and copies of all or
any part thereof may be obtained from the SEC upon the payment of certain fees
prescribed by the SEC.
84
FINANCIAL STATEMENTS
The Statement of Net Assets of the Fund dated as of August 19 2003,
including the Notes thereto, and the report of PricewaterhouseCoopers LLP
thereon dated August 20, 2003, as included in the Fund's Statement of Additional
Information dated August 25, 2003, relating to the Common Shares, is hereby
incorporated by reference into this Statement of Additional Information, which
means that such Statement of Net Assets and the Notes thereto are considered to
be a part of this Statement of Additional Information. The Statement of
Additional Information for the Common Shares was filed electronically with the
SEC on August 25, 2003 (Accession No. 0001193125-03041279).
85
PIMCO FLOATING RATE INCOME FUND
STATEMENT OF ASSETS AND LIABILITIES
October 5, 2003
(unaudited)
Assets:
Investments, at value (cost - $374,202,378) $374,636,014
Cash 545,260
Receivable for investments sold 1,511,250
Interest receivable 1,046,294
Premium receivable from swaps 310,000
Interest receivable from swaps 79,226
Net unrealized appreciation on swaps 33,104
Prepaid expenses 10,451
------------
Total Assets 378,171,599
------------
Liabilities:
Payable for investments purchased 47,247,730
Common stock and preferred shares offering costs payable 426,072
Investment management fee payable 33,922
Accrued expenses 27,635
------------
Total Liabilities 47,735,359
------------
Net Assets $330,436,240
============
Composition of Net Assets:
Par value ($0.00001 per share) $ 171
Paid-in-capital in excess of par 329,335,330
Undistributed net investment income 597,740
Net realized gain on investments 36,259
Net unrealized appreciation of investments and swaps 466,740
------------
Net Assets $330,436,240
============
Shares Outstanding 17,055,168
------------
Net Asset Value Per Common Share $ 19.37
See accompanying notes to financial statements.
86
PIMCO FLOATING RATE INCOME FUND
STATEMENT OF OPERATIONS
For the period August 29, 2003* through October 5, 2003
(unaudited)
Investment Income:
Interest $ 878,578
----------
Expenses:
Investment management fees 249,691
Custodian and accounting agent fees 8,360
Audit and tax service fees 7,410
Reports to shareholders 4,560
Transfer agent fees 3,116
Trustees' fees 2,850
Legal fees 2,280
Investor relations expense 760
Miscellaneous 1,811
----------
Total expenses 280,838
----------
Net Investment Income 597,740
----------
Realized and Unrealized Gain:
Net realized gain on investments 36,259
Net unrealized appreciation of investments and swaps 466,740
----------
Net realized and unrealized gain on investments and swaps 502,999
----------
Net increase in net assets resulting from investment operations $1,100,739
==========
STATEMENT OF CHANGES IN NET ASSETS
For the period August 29, 2003* through October 5, 2003
(unaudited)
Investment Operations:
Net investment income $ 597,740
Net realized gain on investments 36,259
Net unrealized appreciation of investments and swaps 466,740
------------
Net increase in net assets resulting from investment
operations 1,100,739
------------
Capital Share Transactions:
Net proceeds from the sale of common stock 329,917,500
Common stock offering expenses charged to paid-in-capital in
excess of par (682,000)
------------
Total capital share transactions 329,235,500
------------
Total increase in net assets 330,336,239
Net Assets:
Beginning of period 100,001
------------
End of period (including undistributed net investment income
of $597,740) $330,436,240
============
Shares Issued: 17,050,000
------------
* Commencement of operations
See accompanying notes to financial statements.
87
PIMCO FLOATING RATE INCOME FUND
FINANCIAL HIGHLIGHTS (Unaudited)
For a Share of Common Stock outstanding for the period August 29, 2003*
through October 5, 2003:
Net Asset Value, Beginning of Period** $19.35
------
Investment Operations:
Net Investment Income .03
Net Realized and Unrealized Gain on Investments and Swaps .03
------
Net Increase in Net Assets resulting from Investment Operations .06
Capital Share Transactions:
Common Stock Offering Expenses Charged to Paid-in-Capital in Excess of Par (.04)
------
Net Asset Value, End of Period $19.37
======
Market Price, End of Period $20.01
======
Total Investment Return (1) .1%
Ratios/Supplemental Data:
Net Assets, End of Period (000) $330,436
Ratio of Expenses to Average Net Assets (2) .84%
Ratio of Net Investment Income to Average Net Assets (2) 1.80%
Portfolio Turnover 3%
------
* Date of commencement of operations.
** Initial public offering price of $20.00 per share less underwriting discount
of $.65 per share.
(1) Total Investment Return is calculated assuming a purchase of common stock at
the current market price on the first day of the period and a sale at the
current market price on the last day of the period reported. Total Investment
Return does not reflect brokerage commissions. Total Investment Return for a
period less than one year is not annualized.
(2) Annualized.
88
PIMCO FLOATING RATE INCOME FUND
STATEMENT OF CASH FLOWS
For the period August 29, 2003* through October 5, 2003
(unaudited)
Increase (Decrease) in Cash
----------------------------------------------------------------------------------------------
Cash Flows From (Used For) Operating Activities
Purchases of long-term investments (170,723,836)
Proceeds from sales of long-term investments 3,223,608
Interest purchased in excess of interest and swap income received (616,113)
Miscellaneous income received 86,678
Prepaid expenses (10,451)
Operating expenses paid (219,281)
Net increase in short-term investments (160,956,918)
-------------
Net Cash used for operating activities (329,216,313)
Cash Flows From (Used For) Financing Activities
Proceeds from shares sold 329,917,500
Offering costs paid (255,928)
-------------
Net Cash for financing activities 329,661,572
Net Increase in Cash 445,259
Cash at beginning of period 100,001
-------------
Cash at end of period 545,260
-------------
Reconciliation of Net Increase in Net Assets From Operations to Net Cash Used for Operating
Activities
----------------------------------------------------------------------------------------------
Net increase in net assets from operations $1,100,739
Increase in receivable for investments sold (1,511,250)
Increase in interest and swap income receivable (1,435,520)
Increase in prepaid expenses (10,451)
Increase in payable to Investment Manager 33,922
Increased in unrealized appreciation on swaps (33,104)
Increase in accrued expenses 27,635
Increase in payable for investments purchased 47,247,730
Net increase in investments (374,636,014)
-------------
Net cash used for operating activities ($329,216,313)
-------------
* Commencement of operations
89
PIMCO FLOATING RATE INCOME FUND
NOTES TO FINANCIAL STATEMENTS
October 5, 2003
(unaudited)
1. Organization and Significant Accounting Policies
PIMCO Floating Rate Income Fund (the "Fund") was organized as a Massachusetts
business trust on June 19, 2003. Prior to commencing operations on August 29,
2003, the Fund had no operations other than matters relating to its organization
and registration as a diversified, closed-end management investment company
under the Investment Company Act of 1940, as amended, and the sale and issuance
of 5,168 shares of beneficial interest at an aggregate purchase price of
$100,001 to Allianz Dresdner Asset Management of America, L.P. ("ADAM"). PIMCO
Advisors Fund Management LLC (the "Investment Manager") serves as the Fund's
investment manager and is an indirect, wholly-owned subsidiary of ADAM and an
indirect, majority-owned subsidiary of Allianz AG, a publicly traded insurance
and financial services company. The Fund invests substantially all of its assets
in a diversified portfolio of floating rate debt instruments, a substantial
portion of which will be senior floating rate loans. There is an unlimited
number of $0.00001 per share par value common stock authorized.
The Investment Manager agreed to pay the Fund's organizational expenses of
approximately $25,000, except the Fund has agreed to reimburse the Investment
Manager for such organizational expenses to the extent that the aggregate of all
such organizational expenses and all offering costs (other than the sales load)
does not exceed $0.04 per common share issued.
The Fund issued 16,250,000 shares of common stock in its initial public
offering. An additional 800,000 shares were issued in connection with the
underwriter's over-allotment option. These shares were all issued at $20.00 per
share before an underwriting discount of $0.65 per share. Aggregate offering
costs of $682,000 (representing $0.04 per share) were offset against the
proceeds of the initial offering and over-allotment option and have been charged
to paid-in capital in excess of par.
The preparation of the financial statements in accordance with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
and disclosures in the financial statements. Actual results could differ from
these estimates. In the normal course of business, the Fund enters into
contracts that contain a variety of representations which provide general
indemnifications. The Fund's maximum exposure under these arrangements is
unknown as this would involve future claims that may be made against the Fund
that have not yet occurred. However, the Fund expects the risk of any loss to be
remote.
The following is a summary of significant accounting policies followed by the
Fund:
(a) Valuation of Investments
Portfolio securities and other assets for which market quotations are
readily available are valued at market value on the last day of the week that
the New York Stock Exchange is open for trading based on quotes obtained from an
independent pricing service approved by the Board of Trustees. Domestic debt
securities and foreign securities are normally priced using data reflecting the
earlier closing of the principal markets for those securities. Any security or
other asset for which market quotations are not readily available is valued at
fair value as determined in good faith under procedures established by the Board
of Trustees. Short-term debt securities having a remaining maturity of sixty
days or less are valued at amortized cost or amortized value, which approximates
market value.
90
PIMCO FLOATING RATE INCOME FUND
NOTES TO FINANCIAL STATEMENTS
October 5, 2003
(unaudited)(concluded)
(b) Investment Transactions and Investment Income
Investment transactions are accounted for on the trade date. Realized gains
and losses on investments are determined on the identified cost basis. Interest
income is recorded on an accrual basis. Discounts or premiums on debt securities
purchased are accreted or amortized daily to interest income over the lives of
the respective securities using the effective interest method.
(c) Repurchase Agreements
The Fund's custodian takes possession of the collateral pledged for
investments in repurchase agreements. The underlying collateral is valued daily
on a mark-to-market basis to ensure that the value, including accrued interest,
is at least equal to the repurchase price. In the event of default of the
obligation to repurchase, the Fund has the right to liquidate the collateral and
apply the proceeds in satisfaction of the obligations. Under certain
circumstances, in the even of default or bankruptcy by the other party to the
agreement, realization and/or retention of the collateral may be subject to
legal proceedings.
(d) Swap Agreements
A swap is an agreement between two parties to exchange a series of cash
flows at specified intervals. Based on a notional amount, each party pays an
interest rate or the change in the value of a security. Dividends and interest
on the securities in the swap are included in the value of the exchange. The
swaps are valued daily at current market value and any unrealized gain or loss
is included in net unrealized appreciation or depreciation of investments. Gain
or loss is realized on the termination date of the swap and is equal to the
difference between the Fund's basis in the swap and the proceeds of the closing
transaction, including any fees. During the period that the swap agreement is
open, the Fund may be subject to risk from the potential inability of the
counterparty to meet the terms of the agreement.
In a credit default swap, one party makes a stream of payments to another
party in exchange for the right to receive a specified return in the event of a
default by a third party, typically corporate issues or sovereign issues of an
emerging country, on its obligation. The Fund may use credit default swaps to
provide a measure of protection against defaults of sovereign issuers (i.e., to
reduce risk where the Fund owns or has exposure to the sovereign issuer) or to
take an active long or short position with respect to the likelihood of a
particular issuer's default.
Credit default swaps outstanding at October 5, 2003 were as follows:
Notional Fixed
Swap Amount Payable Payments Unrealized
Counterparty/Referenced on Default Termination received by Appreciation
Debt Obligation (000) Date the Fund (Depreciation)
--------------- ----- ---- -------- --------------
JP Morgan Chase Bank/
JP Morgan Emerging
Market Yield Debt Index $10,000 12/20/08 4.07% $63,980
JP Morgan Chase Bank/
JP Morgan High Yield
Debt Index 4,000 6/20/08 4.50% (39,939)
Lehman Brothers, Inc./
Triton PCS Inc. Revolver 5,000 6/20/08 3.00% 8
Merrill Lynch/
Williams Co. Inc. 3,000 11/15/04 5.25% 9,055
-------
$33,104
-------
2. Investment Manager and Sub-Adviser
The Fund has entered into an Investment Management Agreement (the
"Agreement'), with the Investment Manager to serve as investment manager to the
Fund. Pursuant to the Agreement, the Fund will pay the Investment Manager an
annual management fee, payable monthly, at the annual rate of 0.75% of the
Fund's average weekly total managed assets. Total managed assets refers to the
total assets of the Fund (including any assets attributable to any Preferred
Shares or other forms of leverage that may be outstanding) minus accrued
liabilities (other than liabilities representing leverage). The Investment
Manager has retained its affiliate, Pacific Investment Management Company LLC
("PIMCO"), to manage the Fund's investments. For its services, the Investment
Manager (not the Fund) will pay a portion of the fees it receives as investment
manager to PIMCO at the annual rate of 0.39% of the Fund's average weekly total
managed assets, provided, however, that the amounts payable for each month shall
be reduced to reflect that PIMCO will bear 65% of the fees payable by the
Investment Manager to certain underwriters (other than Merrill Lynch, Pierce,
Fenner & Smith Inc.). Commencing September 1, 2008 and thereafter, the
Investment Manager will pay a monthly fee to PIMCO at the annual rate of 0.55%
of the Fund's average weekly total managed assets, provided, however, that the
amounts payable for each month shall be reduced by the amounts of all fees
payable by the Investment Manager to certain underwriters other than Merrill
Lynch, Pierce, Fenner & Smith Inc. for such month, such that the Investment
Manager retains from its management fee, 0.05% of the Fund's average weekly
total managed assets, on an annual basis, after having paid PIMCO and the
underwriters.
3. Federal Income Taxes
The Fund intends to comply with the requirements of the Internal Revenue
Code of 1986, as amended, applicable to regulated investment companies.
Accordingly, no provision for U.S. federal income taxes is required. In
addition, by distributing substantially all of its ordinary income and long-term
capital gains, if any, during each calendar year, the Fund intends not to be
subject to U. S. federal excise tax.
4. Investments in Securities
For the period August 29, 2003 through October 5, 2003, purchases and sales
of investments, other than short-term securities, aggregated $217,971,566 and
$4,734,858, respectively.
91
PIMCO FLOATING RATE INCOME FUND
NOTES TO FINANCIAL STATEMENTS
October 5, 2003
(unaudited)(concluded)
5. Commitments and Contingencies
At October 3, 2003, the Fund had unfunded loan commitments pursuant to the
following loan agreements:
Borrower Unfunded Commitment
-------- -------------------
Houghton Mifflin $2,707,692
Primedia Term Loan B 1,292,740
6. Subsequent Events
On October 10, 2003, the underwriters exercised an additional 700,000 shares
pursuant to the Fund's over-allotment option, at a price of $20.00 per common
share, less an underwriting discount of $0.65 per share.
On October 14, 2003, the Board of Trustees declared the Fund's initial common
share income dividend of $0.0775 per common share. The dividend will be payable
on November 3, 2003 to shareholders of record on October 24, 2003
92
PIMCO FLOATING RATE INCOME FUND
SCHEDULE OF INVESTMENTS
October 5, 2003
(unaudited)
Principal
Amount Credit Rating
(000) (Moody's/S&P) Value*
----------------------------------------------------------------------------------------------------------------------------------
LOAN PARTICIPATIONS (c)(d) - 42.3%
Advertising-0.5%
$ 2,000 Lamar Media Corp., 3.4375%, 6/30/10, Term B (Morgan Stanley & Co.) NR/NR $ 2,017,084
------------
Automotive Products-1.6%
2,000 Pacificare Systems Inc., 4.63%, 6/30/08, Term B (JP Morgan Chase Bank) NR/NR 2,015,834
66 Rexnord Corp., 3.00%, 11/25/09, (JP Morgan Chase Bank) NR/NR 65,574
4,000 TRW Automotive Inc., 4.13%, 7/22/11, Term C 9(JP Morgan Chase Bank) NR/NR 4,034,064
------------
6,115,472
------------
Chemicals-0.4%
1,500 Resolution Performance Products LLC, 3.89%, 11/30/08, Term B (Morgan Stanley & Co.) NR/NR 1,500,000
------------
Consumer Products-1.1%
4,000 Rayovac Corp., 4.88%, 10/1/09, Term B (Bank of America) NR/NR 4,015,832
------------
Containers-4.4%
3,000 Crown Cork & Seal Co., Inc., 4.14%, 9/15/08 (Citigroup Global Markets) NR/NR 3,027,750
4,000 Graphic Packaging International Corp., 3.86%, 8/8/10, Term B (JP Morgan Chase Bank) NR/NR 4,026,500
4,250 Owens-Illinois Inc., 4.39%, 4/1/08 (DeutscheBank AG) NR/NR 4,275,236
5,000 Stone Container Corp., 3.625%, 6/30/09, Term B & C (Deutsche Bank AG) NR/NR 5,039,375
------------
16,368,861
------------
Energy-0.6%
2,000 Calpine Corp., 7.50%, 8/13/09, Term Loan (Goldman Sachs & Co.) NR/NR 2,063,334
------------
Food Services-1.0%
3,559 Del Monte Foods Co., 4.85%-4.86%, 12/20/10, Term B (Bank of America) NR/NR 3,605,625
------------
Health & Hospitals-1.9%
2,000 Community Health Systems Inc., 3.64%, 7/16/10, Term B (Morgan Stanley & Co.) NR/NR 2,010,156
4,987 Davita, Inc. 3.6031%-3.68%, 6/23/09, Term B (Credit Suisse First Boston) NR/NR 5,024,554
------------
7,034,710
------------
Hotels/Gaming-1.2%
2,565 Extended Stay America, Inc., 4.86%, 1/15/08 (Morgan Stanley & Co.) NR/NR 2,583,186
2,000 MGM Mirage, Inc., 4.10%, 6/30/08 (Bank of America) NR/NR 2,010,000
------------
4,593,186
------------
Household Products-1.0%
3,800 Springer S.A., 1.00%+4.371%, 9/16/11, Term B2+C2 (Barclays Bank plc) NR/NR 3,788,199
------------
Manuafacturing-0.5%
2,000 SPX Corp., 3.375%, 9/30/09, Term B (JP Morgan Chase Bank) NR/NR 2,016,250
------------
Miscellaneous-0.5%
2,000 American Tower Corp., zero coupon 6/30/07, Term A (Toronto Dominion) NR/NR 2,005,000
------------
93
PIMCO FLOATING RATE INCOME FUND
SCHEDULE OF INVESTMENTS
October 5, 2003
(unaudited) (continued)
Principal
Amount Credit Rating
(000) (Moody's/S&P) Value*
----------------------------------------------------------------------------------------------------------------------------------
Multimedia-8.1%
$3,000 Adelphia Communications Inc., 6.75%, 6/30/09, Term B (Credit Suisse First Boston) NR/NR $ 2,618,304
3,000 Canwest Media Inc., 3.87%, 11/15/08, Term D (Scotia Capital) NR/NR 3,028,125
2,992 Charter Communications Holdings, LLC, 3.86%, 3/18/08 Term B (Bank of Ameirca) NR/NR 2,865,228
4,000 DirectTV Holdings LLC, 3.99%-4.02%, 3/6/10, Term B (Deutsche Bank AG) NR/NR 4,026,000
6,000 Insight Midwest Holdings LLC., 4.0625%, 12/31/09, Term B (JP Morgan Bank) NR/NR 6,018,750
5,000 MediaCom Broadband LLC, 3.62%, 9/30/10, Term B (Morgan Stanley & Co.) NR/NR 5,028,125
2,707 Primedia Inc., 2.8125%-4.125%, 6/30/08-3/2/09, Term A & B (JP Morgan Chase Bank) NR/NR 2,644,227
2,000 Time Warner Telecommunications Inc., 5.14%, 3/31/08, Term B (Harold Stein Associates) NR/NR 2,000,000
2,000 Univision Communications, Inc. 2.37125%-2.39%, 7/18/06 (JP Morgan Chase Bank) NR/NR 1,983,334
------------
30,212,093
------------
Office Equipment-1.1%
4,000 Xerox Corp., 3.35%, 9/30/08, Term B (JP Morgan Chase Bank) NR/NR 4,010,000
------------
Oil & Gas-2.4%
4,000 Aquila, Inc. 8.75%, 5/15/06, Term Loan (Credit Suisse First Boston) NR/NR 4,070,000
2,000 Citgo Petroleum Corp., 8.25%, 2/27/06, Term B (Credit Suisse First Boston) NR/NR 2,067,500
2,970 WH Energy Services, Inc. 4.11%-4.39%, 6/1/06-4/16/07, Term C (Credit Suisse First Boston) NR/NR 2,960,715
------------
9,098,215
------------
Paper Products-0.8%
3,000 Georgia-Pacific Corp., 3.225%, 11/13/05, Term A (Bank of America) NR/NR 2,968,125
------------
Pipelines-1.2%
4,493 Kinetics Group, Inc., 3.87%, 7/14/10, Term B (Credit Suisse Frist Boston) NR/NR 4,526,194
------------
Printing/Publishing-2.6%
2,750 Houghton Mifflin Co., 4.36%, 12/30/08-7/31/31 (Canadian Imperial) NR/NR 2,605,625
3,950 Readers Digest Association Inc., 3.9375%-4.10%, 5/20/08, Term B (JP Morgan Chase Bank) NR/NR 3,939,117
3,000 RH Donnelley Corp., 5.10%-5.28%, 6/30/10, Term B (Deutsche Bank AG) NR/NR 3,055,548
------------
9,600,290
------------
Retail-0.5%
2,000 Levi Strauss & Co., 5.37%, 7/31/06, Term B (Citigroup Global Markets) NR/NR 1,999,000
------------
Telecommunications-6.2%
3,000 Centennial Cellular Communications, 4.39%-4.84%, 5/31/07-11/30/07 Term B (Bank of America) NR/NR 2,958,982
1,756 Dex Media East LLC, 5.14%-5.26%, 5/8/09, Term B (JP Morgan Chase Bank) NR/NR 1,784,634
3,950 Dex Media West LLC, 3.87%, 9/10/10, Term B (JP Morgan Chase Bank) NR/NR 3,990,322
5,000 Nextel Communications, 4.50%-4.8125%, 6/30/08-12/31/08, Term B & C (Toronto Dominion) NR/NR 5,029,465
2,275 Panamsat Corp., 4.61%, 12/31/08 (Credit Suisse First Boston) NR/NR 2,287,797
6,000 Qwest Corp., 6.50%-6.95%, 6/30/07-6/5/10, Term A & B (Morgan Stanley & Co) NR/NR 6,058,750
1,000 Rural Cellular 4.63%, 10/3/08, Term B (Toronto Dominion) NR/NR 991,696
------------
23,101,646
------------
Tobacco-0.4%
1,705 Commonwealth Brands, Inc. 5.1875%, 8/28/07 (DB Clearing Services) NR/NR 1,710,138
------------
Utilities-2.7%
5,500 AES Corp. 5.13%-5.32%, 7/25/08-7/29/08, Term B (Citigroup Global Markets) NR/NR 5,513,750
3,000 Southern California Edison, 4.375%, 3/1/05, Term B (JP Morgan Chase Bank) NR/NR 3,023,439
1,500 Tucson Electric Power, 6.60%, 11/14/06, Term B (Toronto Dominion) NR/NR 1,512,187
------------
10,049,376
------------
Waste Disposal-1.6%
6,000 Allied Waste North America, 4.39%-4.40%, 4/30/10, Term B (JP Morgan Chase Bank) NR/NR 6,078,216
------------
Total Loan Participations (cost-$158,365,860) 158,476,846
------------
94
PIMCO FLOATING RATE INCOME FUND
SCHEDULE OF INVESTMENTS
October 5, 2003
(unaudited)(continued)
Principal
Amount Credit Rating
(000) (Moody's/S&P) Value*
----------------------------------------------------------------------------------------------------------------------------------
CORPORATE BONDS & NOTES-5.7%
$1,500 Arco Chemical Co., 9.375%, 12/15/05 Ba3/BB- $ 1,522,500
------------
Energy-0.7%
2,500 Dynegy Holdings, Inc., 7.70%, 7/15/08 (a)(C) B3/B- 2,581,192
------------
Financial Services-0.8%
3,000 Fiat Finance North America Inc. 3.25%, 1/9/07 (a)(C) Ba3/NR 2,962,500
------------
Hotels/Gaming-0.3%
1,337 HMH Properties, Inc. 7.875%, 8/1/05 Ba3/B+ 1,380,453
------------
Insurance-0.9%
1,500 Parametric Re Ltd., 5.54%, 11/19/07 FRN (a)(b)(C) Ba2/NR 1,527,960
2,000 Residential Reinsurance Ltd., 6.09%, 6/18/06 (a)(b)(C) Ba2/BB+ 2,002,500
------------
3,530,460
------------
Miscellaneous-0.9%
3,000 Gemstone Investors Ltd., 7.71%, 10/31/04 (a)(C) Caa1/B 2,996,250
------------
Telecommunications-1.4%
5,000 Echostar DBS Corp., 4.41%, 10/1/08 (a)(b)(C) Ba3/BB- 5,125,000
------------
Tobacco-0.3%
1,000 Commonwealth Brands, Inc. 8.73625%, 4/18/08 (a)(b)(C) NR/B- 1,055,000
------------
Total Corporate Bonds & Notes (cost-$20,953,163) 21,153,355
------------
SOVEREIGN DEBT OBLIGATIONS-1.8%
Brazil-1.1%
4,447 Federal Republic of Brazil, 2.1875%, 4/15/09 FRN (b) B2/B+ 4,019,352
------------
Panama-0.7%
2,890 Republic of Panama, 1.9375%, 7/17/14-7/17/16 FRN (b) Ba1/BB 2,600,953
------------
Total Sovereign Debt Obligations (cost-$6,583,403) 6,620,305
------------
SHORT-TERM INVESTMENTS-50.2%
Corporate Notes-12.1%
Banking-2.5%
9,000 Wells Fargo Bank NA., 1.06%, 10/14/03 NR/NR 9,000,000
------------
Engineering-1.0%
3,900 ABB Finance Inc. 6.75%, 6/30/04 B1/BB- 3,925,350
------------
Hotels-0.3%
1,300 ITT Corp., 6.75%, 11/15/03 NR/NR 1,304,875
------------
Machinery-0.4%
1,625 Case Corp., 6.25%, 12/1/03, Ser. B Ba3/BB- 1,633,125
------------
95
PIMCO FLOATING RATE INCOME FUND
SCHEDULE OF INVESTMENTS
October 5, 2003
(unaudited) (concluded)
Principal
Amount Credit Rating
(000) (Moody's/S&P) Value*
----------------------------------------------------------------------------------------------------------------------------------
SHORT-TERM INVESTMENTS (continued)
Miscellaneous-2.7%
$ 9,000 HBOS Treasury Services plc, 1.075%, 12/11/03 NR/NR $ 8,981,820
1,000 Trinom Ltd. 9.14%, 6/18/04 (b)(C) NR/BB 1,005,270
------------
9,987,090
------------
Office Equipment-0.8%
3,000 Xerox Capital Europe PLC., 5.875%, 5/15/04 B1/B+ 3,045,000
------------
Special Purpose Entity-0.8%
1,000 Concentric Ltd., 4.36%, 5/13/04 FRN (b)(C) Ba1/BB+ 999,070
2,000 Concentric Ltd., 4.36%, 7/28/04 (a) NR/NR 2,008,400
------------
3,007,470
------------
Telecommunications-2.9%
11,000 Qwest Capital Funding, 5.875%, 8/3/04 (a) (c) Caa2/CCC+ 10,945,000
------------
Utilities-0.7%
2,500 Edison International, 6.875%, 9/15/04 B3/B- 2,562,500
------------
Total Corporate Notes(cost-$47,325,085) 45,410,410
------------
U.S. Government Agency Securities-37.3%
Fannie Mae-34.7%
130,400 1.045%-1.137%, 12/3/03-3/10/04 AAA/Aaa 130,041,073
------------
Federal Home Loan Bank -2.6%
9,900 1.075%, 3/26/04 AAA/Aaa 9,848,025
------------
Total U.S. Government Agency Securities (cost-$139,897,076) 139,889,098
------------
Repurchase Agreement-0.8%
3,086 State Street Bank & Trust Co. dated 10/3/03, 0.80%, due 10/6/03,
proceeds:$3,086,206; collateralized by Federal Home Loan Bank,12/15/04,
valued at $3,148,338 (cost-$3,086,000) 3,086,000
------------
Total Short-Term Investments (cost-$188,299,952) 188,385,508
------------
Total Investments, (cost-$374,202,378+)-100.0% $374,636,014
------------
----------------------------------------------------------------------------------------------------------------------------------
+ The cost basis of portfolio securities for federal income tax purposes is
$374,202,378. Aggregate gross unrealized appreciation for securities in which
there is an excess of value over tax cost is $839,728; aggregate gross
unrealized depreciation for securities in which there is an excess of tax cost
over value is $406,092; net unrealized appreciation for federal income tax
purposes is $433,636.
* Long-term debt securities are valued by an independent pricing service
authorized by the Board of Trustees.
(a) Security exempt from registration under Rule 144a of the Securities Act of
1933. These securities may be resold in transactions exempt from registration,
typically to qualified institutional investors. At October 5, 2003, these
securities amounted to $31,203,802 or 8.3% of investments.
(b) Floating Rate Security. Interest rate shown is the rate in effect at October
5, 2003.
(c) Private Placement. Restricted as to resale and does not have a readily
available market; the aggregate cost and value of such securities is
$189,676,588 or 50.6% of investments.
(d) Participation interests were acquired through the financial institution
indicated parenthetically.
See accompanying notes to financial statements
GLOSSARY:
FRN - Floating Rate Note
NR - Not Rated
96
APPENDIX A
ARTICLE 11 OF THE SECOND AMENDED AND RESTATED BYLAWS
The following provisions will be set forth in the Bylaws relating to the
AMPS, and will be incorporated by reference in the Auction Agency Agreement and
each Broker-Dealer Agreement. The capitalized terms not defined below are
defined in the remaining articles of the Bylaws, which are filed as an exhibit
to this Registration Statement. Nothing contained in this Appendix A constitutes
a representation by the Fund that in each Auction each party referred to herein
actually will perform the procedures described herein to be performed by such
party.
ARTICLE II
Statement Creating Five Series of Auction Market Preferred Shares
A series of Auction Market Preferred Shares, Series T: preferred shares
of beneficial interest, par value $.00001 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
Market Preferred Shares, Series T." Each share of Auction Market Preferred
Shares, Series T (sometimes referred to herein as "Series T AMPS") may be issued
on a date to be determined by the Board of Trustees of the Trust or pursuant to
their delegated authority; has 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 has
such other preferences, voting powers, limitations as to dividends,
qualifications and terms and conditions of redemption as are set forth in these
Bylaws. The Series T AMPS shall constitute a separate series of preferred shares
of beneficial interest of the Trust, and each share of Series T AMPS shall be
identical.
A series of Auction Market Preferred Shares, Series W: preferred shares
of beneficial interest, par value $.00001 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
Market Preferred Shares, Series W." Each share of Auction Market Preferred
Shares, Series W (sometimes referred to herein as "Series W AMPS") may be issued
on a date to be determined by the Board of Trustees of the Trust or pursuant to
their delegated authority; has 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 has
such other preferences, voting powers, limitations as to dividends,
qualifications and terms and conditions of redemption as are set forth in these
Bylaws. The Series W AMPS shall constitute a separate series of preferred shares
of beneficial interest of the Trust, and each share of Series W AMPS shall be
identical.
A series of Auction Market Preferred Shares, Series TH: preferred shares
of beneficial interest, par value $.00001 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
Market Preferred Shares, Series TH." Each share of Auction Market Preferred
Shares, Series TH (sometimes referred to herein as "Series TH AMPS") may be
issued on a date to be determined by the Board of Trustees of the Trust or
pursuant to their delegated authority; has an Initial Dividend Rate and an
Initial Dividend Payment Date as shall
A-1
be determined in advance of the issuance thereof by the Board of Trustees of the
Trust or pursuant to their delegated authority; and has such other preferences,
voting powers, limitations as to dividends, qualifications and terms and
conditions of redemption as are set forth in these Bylaws. The Series TH AMPS
shall constitute a separate series of preferred shares of beneficial interest of
the Trust, and each share of Series TH AMPS shall be identical.
11.1 Definitions. (a) Unless the context or use clearly indicates another
or different meaning or intent, in Article 11 of these Bylaws the following
terms have the following meanings, whether used in the singular or plural:
"Accountant's Confirmation" has the meaning set forth in Section 11.7(c) of
these Bylaws.
"Additional Trustees" has the meaning set forth in Section 11.5(b) of these
Bylaws.
"ADR" has the meaning set forth in paragraph (iii) of the definition of
"Fitch Eligible Assets."
"Affiliate" means any Person known to the Auction Agent to be controlled
by, in control of, or under common control with, the Trust.
"Agent Member" means a member of or a participant in the Securities
Depository that will act on behalf of a Beneficial Owner of one or more AMPS or
on behalf of a Potential Beneficial Owner.
"AMPS" means the Series T AMPS, the Series W AMPS and the Series TH AMPS.
"Applicable Percentage" has the meaning set forth in Section 11.10(a)(vii)
of these Bylaws.
"Applicable Rate" means the rate per annum at which cash dividends are
payable on the AMPS for any Dividend Period.
"Applicable Spread" has the meaning set forth in Section 11.10(a)(vii) of
these Bylaws.
"Approved Foreign Nations" has the meaning set forth in the definition of
"Fitch Eligible Assets."
"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 mark-to-market price
(which, for the purpose of clarity, shall not mean Market Value) from an
independent source at least semi-annually.
"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 Trust or a duly authorized
committee thereof enters into an
A-2
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 paying agent and redemption agent for the AMPS.
"Auction Date" has the meaning set forth in Section 11.10(a)(ii) of these
Bylaws.
"Auction Procedures" means the procedures for conducting Auctions, as set
forth in Section 11.10 of these Bylaws.
"Bank Loans" means direct purchases of, assignments of, participations in
and other interests in (a) any bank loan or (b) any loan made by an investment
bank, investment fund or other financial institution, provided that such loan
under this clause (b) is similar to those typically made, syndicated, purchased
or participated by a commercial bank or institutional loan investor in the
ordinary course of business.
"Beneficial Owner" means a customer of a Broker-Dealer who is listed on the
records of that Broker-Dealer (or, if applicable, the Auction Agent) as a holder
of AMPS or a Broker-Dealer that holds AMPS 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 pursuant to Section 11.10
of these Bylaws, 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 Section 11.10 of these Bylaws.
"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.
"Canadian Bonds" has the meaning set forth in the definition of "Fitch
Eligible Assets."
"Catastrophe Bonds" means securities that entitle the holders thereof to
receive a fixed principal or similar amount and a specific return on such
amount, generally having the following characteristics: (1) the issuer of such
asset backed security has entered into a swap, insurance contract or similar
arrangement with a counterparty pursuant to which such issuer agrees to pay
amounts to the counterparty upon the occurrence of certain specified events
including: hurricanes, earthquakes and other events and (2) payments on such
security depend primarily upon the occurrence and/or severity of such events.
"Closing Transactions" has the meaning set forth in Section 11.8(a)(i) of
these Bylaws.
"Common Shares" means the shares of beneficial interest designated as
common shares, par value $.00001 per share, of the Trust.
"Cure Date" has the meaning set forth in Section 11.4(a)(ii) of these
Bylaws.
"Date of Original Issue" means, with respect to any Auction Market
Preferred Share, the date on which the Trust first issues such share.
"Debt Securities" has the meaning set forth in paragraph (vi) of the
definition of "Fitch Eligible Assets."
A-3
"Declaration of Trust" means the Amended and Restated Agreement and
Declaration of Trust of the Trust dated August 14, 2003, as from time to time
amended and supplemented.
"Deposit Securities" means cash and portfolio securities rated at least A2
(having a remaining maturity of 12 months or less), P-1, VMIG-1 or MIG-1 by
Moody's or A (having a remaining maturity of 12 months or less), A-1+ or SP-1+
by S&P.
"Discount Factor" means a Fitch Discount Factor or a Moody's Discount
Factor, as applicable.
"Discounted Value" of any asset of the Trust means the quotient of the
Market Value of an Eligible Asset divided by the applicable Discount Factor,
provided that with respect to an Eligible Asset that is currently callable, the
Discounted Value will be equal to the quotient as calculated above or the call
price, whichever is lower, and that with respect to an Eligible Asset that is
prepayable, the Discounted Value will be equal to the quotient as calculated
above or the par value, whichever is lower.
"Dividend Payment Date," with respect to AMPS, has the meaning set forth in
Section 11.2(b)(i) of these Bylaws.
"Dividend Period" means the Initial Dividend Period, any Seven-Day Dividend
Period and any Special Dividend Period.
"Eligible Asset" means a Fitch Eligible Asset (if Fitch Ratings is then
rating the AMPS), a Moody's Eligible Asset (if Moody's is then rating the AMPS)
and/or any asset included in the calculations used by any Rating Agency then
rating the AMPS for purposes of determining such Rating Agency's rating on the
AMPS, as applicable.
"Existing Holder" means a Broker-Dealer, or any such other Person that may
be permitted by the Trust, that is listed as the holder of record of AMPS in the
Share Books.
"Extension Period" has the meaning set forth in Section 11.2(c)(iii) of
these Bylaws.
"FHLB, FNMA and FFCB Debentures" has the meaning set forth in paragraph
(ix) of the definition of "Moody's Eligible Assets."
"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 Ratings.
(i) Debt Securities: The percentage determined by reference to the
rating of the Debt Security with reference to the remaining term to
maturity of the Debt Security (other than short-term Debt Securities
covered by clause (iii) below), in accordance with the table set forth
below.
A-4
Fitch Rating Category
Not rated
Term to Maturity of or below
Debt Security AAA AA A BBB BB BB/1/
----------------------- ------ ------ ------ ------ ------ ---------
3 years or less (but
longer than 1 year).... 106.38% 108.11% 109.89% 111.73% 129.87% 151.52%
5 years or less (but
longer than 3 years)... 111.11 112.99 114.94 116.96 134.24 151.52
7 years or less (but
longer than 5 years)... 113.64 115.61 117.65 119.76 135.66 151.52
10 years or less (but
longer than 7 years)... 115.61 117.65 119.76 121.95 136.74 151.52
15 years or less (but
longer than 10 years).. 119.76 121.95 124.22 126.58 139.05 151.52
More than 15 years..... 124.22 126.58 129.03 131.58 144.55 151.52
----------
/1/ If a security is not rated by Fitch Ratings 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 rating by Fitch Ratings
of BBB+ will be used). If a security is not rated by Fitch Ratings but is rated
by only one other 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 rating by Fitch
Ratings of AAA- will be used, and where the only rating on a security is a
Moody's rating of Ba3, a rating by Fitch Ratings of BB- will be used). If a
security is not rated by any Rating Agency, the Trust will use the percentage
set forth under "Not rated or below BB" in this table.
The Fitch Discount Factors presented in the immediately preceding
table apply to 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 not rated or rated
below BB by Fitch Ratings shall apply to any non-Performing Debt Security
with a price equal to or greater than $.20 per security. If a Debt
Security does not have a Market Value determined by a Pricing Service or an
Approved Price, a rating one rating category 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 BBB- 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 (i) interest rate swaps and caps, whereby the
rating of the counterparty to the swap or cap will be the rating used to
determine the Fitch Discount Factor in the table; and (ii) TRACERs and
TRAINs, whereby the ratings in the table will be applied to the underlying
securities and the Market Value of each underlying security will be its
proportionate amount of the Market Value of the TRACER or TRAIN. The Fitch
Discount Factors presented in the immediately preceding table will also
apply to corporate obligations backed by a guaranty, a letter of credit or
insurance issued by a third party. If the third-party credit rating is the
basis for the rating on the obligation, then the rating on the third party
will be used to determine the Fitch Discount Factor in the table. The Fitch
Discount Factors presented in the immediately preceding table will
A-5
also apply to preferred trust certificates, the rating on which will be
determined by the underlying debt instruments in the trust, unless such
preferred trust certificates are determined by Fitch Ratings to qualify for
a traditional equity discount factor, in which case the Fitch Discount
Factor shall be 370%.
(ii) Preferred shares: The percentage determined by reference to the
rating of the preferred shares in accordance with the table set forth
below.
Discount
Preferred Shares Factor
---------------------------------------------------------- --------
AAA Taxable Preferred..................................... 130%
AA Taxable Preferred...................................... 133%
A Taxable Preferred....................................... 135%
BBB Taxable Preferred..................................... 139%
BB Taxable Preferred...................................... 154%
Not rated or below BB Taxable Preferred................... 161%
Investment Grade DRD Preferred............................ 164%
Not rated or below Investment Grade DRD Preferred......... 200%/1/
----------
/1/ If a security is not rated by Fitch Ratings 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 rating by Fitch Ratings
of BBB+ will be used). If a security is not rated by Fitch Ratings but is rated
by only one other 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 rating by Fitch Rating
of AAA- will be used, and where the only rating on a security is a Moody's
rating of Ba3, a rating by Fitch Ratings of BB- will be used). If a security is
not rated by any Rating Agency, the Trust will use the percentage set forth
under "Not rated or below Investment Grade DRD Preferred" in this table.
(iii) Short-term instruments: The Fitch Discount Factor applied to
short-term portfolio securities, including without limitation Debt
Securities with terms to maturity of one year or less, Short Term Money
Market Instruments and municipal debt obligations with terms to maturity
within the Fitch Exposure Period, 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 neither mature nor have a demand feature exercisable at par
within the Fitch Exposure Period; and (C) 125%, so long as such portfolio
securities neither mature within the Fitch Exposure Period nor have a
demand feature at par. A Fitch Discount factor of 100% will be applied to
cash.
A-6
(iv) U.S. Government Securities and U.S. Treasury Strips: The
percentage determined by reference to the remaining term to maturity of the
security in accordance with the table below.
Discount
Time Remaining to Maturity 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
Greater than 10 years 122
(v) Convertible securities: The Fitch Discount Factor applied to
convertible securities will be (a) 200% for investment grade convertible
securities and (b) 222% for below investment grade convertible securities
so long as such convertible securities have neither (x) a conversion
premium greater than 100% nor (y) a yield to maturity or yield to worst of
greater than 15.00% above the corresponding Treasury curve.
The Fitch Discount Factor applied to convertible securities which have
conversion premiums of greater than 100% will be (a) 152% for investment
grade convertible securities and (b) 179% for below investment grade
convertible securities so long as such convertible securities do not have a
yield to maturity or yield to worst of greater than 15.00% above the
corresponding Treasury curve.
The Fitch Discount Factor applied to convertible securities which have
a yield to maturity or yield to worst of greater than 15.00% above the
corresponding Treasury curve will be 370%.
If a security is not rated by Fitch Ratings 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 rating
by Fitch Ratings of BBB+ will be used). If a security is not rated by Fitch
Ratings but is rated by only one other 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 rating by Fitch Ratings of AAA will be used, and where the
only rating on a security is a Moody's rating of Ba3, a rating by Fitch
Ratings of BB- will be used). If a security is not rated by any Rating
Agency, the Trust will treat the security as if it were below investment
grade.
(vi) Rule 144A Securities: The Fitch Discount Factor applied to Rule
144A Securities will be 110% of the Fitch Discount Factor which would apply
were the securities registered under the Securities Act.
(vii) Asset-backed and mortgage-backed securities: The percentage
determined by reference to the asset type in accordance with the table set
forth below.
A-7
Discount
Asset Type (with time remaining to maturity, if applicable) Factor
--------
U.S. Treasury/agency securities (10 years or less).................. 118%
U.S. Treasury/agency securities (greater than 10 years)............. 127%
U.S. agency sequentials (10 years or less).......................... 128%
U.S. agency sequentials (greater than 10 years)..................... 142%
U.S. agency principal only securities............................... 236%
U.S. agency interest only securities
(with Market Value greater than $.40)............................. 696%
U.S. agency interest only securities
(with Market Value less than or equal to $.40).................... 214%
AAA LockOut securities, interest only............................... 236%
U.S. agency planned amortization class bonds (10 years or less)..... 115%
U.S. agency planned amortization class bonds
(greater than 10 years)............................................ 136%
AAA sequentials (10 years or less).................................. 118%
AAA sequentials (greater than 10 years)............................. 135%
AAA planned amortization class bonds (10 years or less)............. 115%
AAA planned amortization class bonds (greater than 10 years)........ 140%
Jumbo mortgages rated AAA/1/........................................ 123%
Jumbo mortgages rated AA/1/......................................... 130%
Jumbo mortgages rated A/1/.......................................... 136%
Jumbo mortgages rated BBB/1/........................................ 159%
Commercial mortgage-backed securities rated AAA..................... 131%
Commercial mortgage-backed securities rated AA...................... 139%
Commercial mortgage-backed securities rated A....................... 148%
Commercial mortgage-backed securities rated BBB..................... 177%
Commercial mortgage-backed securities rated BB...................... 283%
Commercial mortgage-backed securities rated B....................... 379%
Commercial mortgage-backed securities rated CCC or not rated........ 950%
----------
/1/ Applies to jumbo mortgages, credit cards, auto loans, home equity loans,
manufactured housing and prime mortgage-backed securities not issued by a U.S.
agency or instrumentality.
(viii) Bank Loans: The percentage determined by reference to the Fitch
Loan Category in accordance with the table set forth below.
Discount
Fitch Loan Category Factor
------------------------------ --------
A ............................ 126%
B ............................ 157
C ............................ 184
D ............................ 433
(ix) REITs:
(a) Common stock and preferred stock of REITs and other real
estate companies:
Discount
Factor
--------
REIT or other real estate company preferred stock........... 154%
REIT or other real estate company common stock.............. 196%
(b) Corporate debt securities of REITs:
A-8
Term to Maturity AAA AA A BBB BB B CCC
---------------- ------ ------ ------ ------ ------ ------ ------
1 year.......... 111% 114% 117% 120% 121% 127% 227%
2 year.......... 116% 125% 125% 127% 132% 137% 137%
3 year.......... 121% 123% 127% 131% 133% 140% 225%
4 year.......... 126% 126% 129% 132% 136% 140% 164%
5 year.......... 131% 132% 135% 139% 144% 149% 185%
7 year.......... 140% 143% 146% 152% 159% 167% 228%
10 year......... 141% 143% 147% 153% 160% 168% 232%
12 year......... 144% 144% 150% 157% 165% 174% 249%
15 year......... 148% 151% 155% 163% 172% 182% 274%
20-30 year...... 152% 156% 160% 169% 180% 191% 306%
If a security is not rated by Fitch Ratings 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 rating
by Fitch Ratings of BBB+ will be used). If a security is not rated by Fitch
Ratings but is rated by only one other 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 rating by Fitch Ratings of AAA will be used, and where the
only rating on a security is a Moody's rating of Ba3, a rating by Fitch
Ratings of BB- will be used). If a security is not rated by any Rating
Agency, the Trust will treat the security as if it were below investment
grade.
(x) Municipal debt obligations: The Fitch Discount Factor applied
to municipal debt obligations will be the percentage determined by
reference to the table set forth below.
Fitch Rating Category
Fitch Exposure Period AAA AA A BBB F1/1/ Unrated/2/
------------------------ --- --- --- --- ----- ----------
7 weeks................. 151% 159% 166% 173% 136% 225%
8 weeks or less but
greater than 7 weeks.... 154 161 168 176 137 231
9 weeks or less but
greater than 8 weeks.... 158 163 170 177 138 240
------------
/1/ Municipal debt obligations rated by Fitch Ratings which do not mature or
have a demand feature at par exercisable in 30 days and which do not have a
long-term rating.
/2/ If a security is not rated by Fitch Ratings 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 rating by Fitch
Ratings of BBB+ will be used). If a security is not rated by Fitch Ratings but
is rated by only one other 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 rating by
Fitch Ratings of AAA- will be used, and where the only rating on a security is a
Moody's rating of Ba3, a rating by Fitch Ratings of BB- will be used). If a
security is not rated by any Rating Agency, the Trust will use the percentage
set forth under "Unrated" in this table.
(xi) Foreign Bonds: The Fitch Discount Factor (A) for a Foreign Bond
the principal of which (if not denominated in U.S. dollars) is subject to a
currency hedging transaction will be the Fitch Discount Factor that would
otherwise apply to such Foreign Bonds in accordance with this definition
and (B) for (1) a Foreign Bond the principal of which (if not denominated
in U.S. dollars) is not subject to a currency hedging transaction and (2) a
A-9
bond issued in a currency other than U.S. dollars by a corporation, limited
liability company or limited partnership domiciled in, or the government or
any agency, instrumentality or political subdivision of, a nation other
than an Approved Foreign Nation, will be 370%.
(xii) Structured Notes: The Fitch Discount Factor applied to
Structured Notes will be (A) in the case of a corporate issuer, the Fitch
Discount Factor determined in accordance with paragraph (i) under this
definition, whereby the rating on the issuer of the Structured Note will be
the rating on the Structured Note for purposes of determining the Fitch
Discount Factor in the table in paragraph (i); and (B) in the case of an
issuer that is the U.S. government or an agency or instrumentality thereof,
the Fitch Discount Factor determined in accordance with paragraph (iii)
under this definition.
(xiii) Unhedged foreign investments: A discount factor of 105% shall
be applied to the Market Value of unhedged foreign investments otherwise
determined in accordance with the preceding paragraphs; provided, however,
if the foreign issuer of such unhedged foreign investment is from a country
whose sovereign debt rating in a non-local currency is not assigned a
rating of 'AA' or better by Fitch, a discount factor of 117% shall be
applied to the Market Value thereof otherwise determined in accordance with
the preceding paragraphs.
(xiv) Catastrophe Bonds: The Fitch Discount Factor applied to
Catastrophe Bonds will be 333.33%.
"Fitch Eligible Assets" means
(i) cash (including interest and dividends due on assets rated (A)
BBB or higher by Fitch Ratings or the equivalent by another Rating Agency
if the payment date is within five Business Days of the Valuation Date, (B)
A or higher by Fitch Ratings 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 Ratings or the equivalent by another Rating Agency if the
payment date is within the Fitch Exposure Period) and receivables for Fitch
Eligible Assets sold if the receivable is due within five Business Days of
the Valuation Date, and if the trades which generated such receivables are
(A) settled through clearing house firms with respect to which the Trust
has received prior written authorization from Fitch Ratings or (B) (1) with
counterparties having a long-term debt rating of at least BBB- from Fitch
Ratings or the equivalent from another Rating Agency or (2) with
counterparties having a Short Term Money Market Instrument rating of at
least F1+ by Fitch Ratings or the equivalent by another Rating Agency;
(ii) preferred shares if (A) dividends on such preferred shares 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 common stock or its equivalent at any time over the respective
lives of such securities, (C) the issuer of such a preferred shares has
common stock listed on either the New York Stock Exchange or the American
Stock Exchange, (D) the issuer of such preferred shares has a senior debt
rating or preferred stock rating from Fitch Ratings of BBB- or higher or
the equivalent rating by another Rating Agency and (E) the preferred shares
are part of an issue that is at least $50 million;
A-10
(iii) (A) common stocks (1) which are traded on the New York Stock
Exchange or the American Stock Exchange or in the over-the-counter market,
(2) which, if cash dividend paying, pay cash dividends in U.S. dollars, and
(3) which may be sold without restriction by the Trust; provided, however,
that (a) common stock which, while a Fitch Eligible Asset owned by the
Trust, ceases paying any regular cash dividend will no longer be considered
a Fitch Eligible Asset until 60 calendar days after the date of the
announcement of such cessation, unless the issuer of the common stock has
senior debt securities rated at least A- by Fitch and (b) the aggregate
Market Value of the Trust's holdings of the common stock of any issuer in
excess of 5% per U.S. issuer of the number of outstanding shares of such
issuer times the Market Value of such common stock shall not be a Fitch's
Eligible Asset; and (B) common stocks or their equivalent denominated in
any currency other than the U.S. dollar and common stocks or their
equivalent of issuers formed under the laws of jurisdictions other than the
United States, its states and the District of Columbia for which there are
dollar-denominated American Depository Receipts ("ADRs") which are traded
in the United States on exchanges or over-the-counter and are issued by
banks formed under the laws of the United States, its states or the
District of Columbia; provided, however, that the aggregate Market Value of
the Trust's holdings of securities denominated in currencies other than the
U.S. dollar and ADRs in excess of 3% of the aggregate Market Value of the
outstanding shares of common stock or its equivalent of such issuer or in
excess of 10% of the Market Value of the Trust's Fitch Eligible Assets with
respect to issuers formed under the laws of any single such non-U.S.
jurisdiction other than Argentina, Australia, Brazil, Chile, France,
Germany, Italy, Japan, Korea, Mexico, Spain or the United Kingdom (each an
"Approved Foreign Nation," and collectively the "Approved Foreign Nations")
or Canada shall not be a Fitch Eligible Asset;
(iv) Short Term Money Market Instruments so long as (A) such
securities are rated at least F1+ by Fitch Ratings 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
Ratings or the equivalent by another Rating Agency, or (C) in all other
cases, the supporting entity (1) is rated at least A by Fitch Ratings or
the equivalent by another Rating Agency and the security matures within one
month, (2) is rated at least A by Fitch Ratings or the equivalent by
another Rating Agency and the security matures within three months or (3)
is rated at least AA by Fitch Ratings or the equivalent by another Rating
Agency and the security matures within six months;
(v) U.S. Government Securities and U.S. Treasury Strips;
(vi) debt securities if (A) such securities have been registered
under the Securities Act or are restricted as to resale under federal
securities laws but are eligible for resale pursuant to Rule 144A under the
Securities Act as determined by the Trust's investment manager or portfolio
manager acting pursuant to procedures approved by the Board of Trustees of
the Trust; and (B) such securities are issued by (1) a U.S. corporation,
limited liability company or limited partnership, (2) a corporation,
limited liability company or limited partnership domiciled in an Approved
Foreign Nation, (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
A-11
collectively as "Foreign Bonds"), (4) a corporation, limited liability
company or limited partnership domiciled in Canada or (5) the Canadian
government or any of its agencies, instrumentalities or political
subdivisions (the debt securities of Canadian issuers being referred to
collectively as "Canadian Bonds"). Foreign Bonds held by the Trust will
qualify as Fitch Eligible Assets only up to a maximum of 20% of the
aggregate Market Value of all assets constituting Fitch Eligible Assets.
Similarly, Canadian Bonds held by the Trust will qualify as Fitch Eligible
Assets only up to a maximum of 20% of the aggregate Market Value of all
assets constituting Fitch Eligible Assets. Notwithstanding the limitations
in the two preceding sentences, Foreign Bonds and Canadian Bonds held by
the Trust will qualify as Fitch Eligible Assets only up to a maximum of 30%
of the aggregate Market Value of all assets constituting Fitch Eligible
Assets. In addition, bonds which are issued in connection with a
reorganization under U.S. federal bankruptcy law ("Reorganization Bonds")
will be considered debt securities constituting Fitch Eligible Assets if
(a) they provide for periodic payment of interest in cash in U.S. dollars
or euros; (b) they do not provide for conversion or exchange into equity
capital at any time over their lives; (c) they have been registered under
the Securities Act or are restricted as to resale under federal securities
laws but are eligible for trading under Rule 144A promulgated pursuant to
the Securities Act as determined by the Trust's investment manager or
portfolio manager acting pursuant to procedures approved by the Board of
Trustees of the Trust; (d) they were issued by a U.S. corporation, limited
liability company or limited partnership; and (e) at the time of purchase
at least one year had elapsed since the issuer's reorganization.
Reorganization Bonds may also be considered debt securities constituting
Fitch Eligible Assets if they have been approved by Fitch Ratings, which
approval shall not be unreasonably withheld. All debt securities satisfying
the foregoing requirements and restrictions of this paragraph (vi) are
herein referred to as "Debt Securities."
(vii) asset-backed and mortgage-backed securities;
(viii) Rule 144A Securities;
(ix) Bank Loans;
(x) municipal debt obligations;
(xi) TRACERs, TRAINs and Structured Notes;
(xii) interest rate swaps entered into according to International
Swap Dealers Association standards if (A) the counterparty to the swap
transaction has a short-term rating of not less than F1 from Fitch Ratings
or the equivalent by another Rating Agency, or, if the swap counterparty
does not have a short-term rating, the counterparty has a senior unsecured
long-term debt rating of AA or higher from Fitch Ratings or the equivalent
from another Rating Agency and (B) the original aggregate notional amount
of the interest rate swap transaction or transactions is not greater than
the liquidation preference of the Preferred Shares originally issued;
A-12
(xiii) any common stock, preferred stock or any debt security of REITs
or real estate companies; and
(xiv) Catastrophe Bonds; and
(xv) unrated debt securities issued by an issuer which (A) has not
filed for bankruptcy in the past three years; (B) is current on all
interest and principal on its fixed income obligations; and (C) is current
on all preferred stock dividends.
Financial contracts, as such term is defined in Section 3(c)(2)(B)(ii) of
the 1940 Act, not otherwise provided for in this definition may be included in
Fitch Eligible Assets, but, with respect to any financial contract, only upon
receipt by the Trust of a writing from Fitch Ratings 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 Ratings to the AMPS.
In addition, 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:
Security Rated At Maximum Single Maximum Single Minimum Issue Size
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 for all rating
categories in the table.
Where the Trust sells an asset and agrees to repurchase such asset in the
future, the Discounted Value of such asset will constitute a Fitch Eligible
Asset and the amount the Trust is required to pay upon repurchase of such asset
will count as a liability for the purposes of the Preferred Shares Basic
Maintenance Amount. Where the Trust purchases an asset and agrees to sell it to
a third party in the future, cash receivable by the Trust thereby will
constitute a Fitch Eligible Asset if the long-term debt of such other party is
rated at least A- by Fitch Ratings or the equivalent by another Rating Agency
and such agreement has a term of 30 days or less; otherwise the Discounted Value
of such purchased asset will constitute a Fitch Eligible Asset.
Notwithstanding the foregoing, an asset will not be considered a Fitch
Eligible Asset to the extent that it has been irrevocably deposited for the
payment of (i)(A) through (i)(E) under the definition of Preferred Shares Basic
Maintenance Amount or to the extent it is subject to any Liens, except for (A)
Liens which are being contested in good faith by appropriate proceedings and
which Fitch Ratings 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
A-13
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 Exposure Period" means the period commencing on (and including) a
given Valuation Date and ending 49 days thereafter.
"Fitch Hedging Transactions" has the meaning set forth in Section 11.8(f)
of these Bylaws.
"Fitch Industry Classifications" means, for the purposes of determining
Fitch Eligible Assets, each of the following industry classifications (or such
other classifications as Fitch Ratings may from time to time approve for
application to the AMPS):
1. Aerospace & Defense
2. Automobiles
3. Banking, Finance & Real Estate
4. Broadcasting & Media
5. Building & Materials
6. Business Services
7. Cable
8. Chemicals
9. Computers & Electronics
10. Consumer Products
11. Energy
12. Environmental Services
13. Farming & Agriculture
14. Food, Beverage & Tobacco
15. Gaming, Lodging & Restaurants
16. Healthcare & Pharmaceuticals
17. Industrial/Manufacturing
18. Insurance
19. Leisure & Entertainment
20. Metals & Mining
21. Miscellaneous
22. Packaging and Containers
23. Paper & Forest Products
24. Retail
25. Sovereign
26. Structured Finance Obligations
27. Supermarkets & Drugstores
28. Telecommunications
29. Textiles & Furniture
30. Transportation
31. Utilities
The Trust shall use its discretion in determining which industry
classification is applicable to a particular investment.
A-14
"Fitch Loan Category" means the following four categories (and, for
purposes of this categorization, the Market Value of a Fitch Eligible Asset
trading at par is equal to $1.00):
(i) "Fitch Loan Category A" means Performing Bank Loans which have
a Market Value or an Approved Price greater than or equal to $.90.
(ii) "Fitch Loan Category B" means: (A) Performing Bank Loans which
have a Market Value or an Approved Price of greater than or equal to $.80
but less than $.90; and (B) non-Performing Bank Loans which have a Market
Value or an Approved Price greater than or equal to $.85.
(iii) "Fitch Loan Category C" means: (A) Performing Bank Loans which
have a Market Value or an Approved Price of greater than or equal to $.70
but less than $.80; (B) non-Performing Bank Loans which have a Market Value
or an Approved Price of greater than or equal to $.75 but less than $.85;
and (C) Performing Bank Loans without an Approved Price rated BB- or higher
by Fitch Ratings. If a security is not rated by Fitch Ratings but is rated
by two other 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 rating by Fitch Ratings of BBB+ will be used). If a security is not
rated by Fitch Ratings but is rated by only one other 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 rating by Fitch Ratings of AAA- will
be used, and where the only rating on a security is a Moody's rating of
Ba3, a rating by Fitch Ratings of BB- will be used).
(iv) "Fitch Loan Category D" means Bank Loans not described in any
of the foregoing categories.
Notwithstanding any other provision contained above, for purposes of
determining whether a Fitch Eligible Asset falls within a specific Fitch Loan
Category, to the extent that any Fitch Eligible Asset would fall 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.
"Fitch Ratings" means Fitch, Inc., doing business as Fitch Ratings, or its
successors.
"Foreign Bonds" has the meaning set forth in clause (vi) of the definition
of "Fitch Eligible Assets."
"Forward Commitment" has the meaning set forth in Section 11.8(d) of these
Bylaws.
"Holder" means a Person identified as a holder of record of AMPS 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
and serving as such for the Trust.
A-15
"Initial Dividend Payment Date" means, with respect to a series of AMPS,
the initial dividend payment date with respect to the Initial Dividend Period as
determined by the Board of Trustees of the Trust or pursuant to their delegated
authority with respect to such series.
"Initial Dividend Period" has the meaning set forth in Section 11.2(c)(i)
of these Bylaws.
"Initial Dividend Rate" means, with respect to a series of AMPS, the rate
per annum applicable to the Initial Dividend Period for such series of AMPS.
"LIBOR Dealers" means Merrill Lynch, Pierce, Fenner and Smith Incorporated
and such other dealer or dealers as the Fund may from time to time appoint, or,
in lieu of any thereof, their respective affiliates or successors.
"LIBOR Rate," on any Auction Date, means (i) the rate for deposits in U.S.
dollars for the designated Dividend Period, which appears on display page 3750
of Moneyline's Telerate Service ("Telerate Page 3750") (or such other page as
may replace that page on that service, or such other service as may be selected
by the LIBOR Dealer or its successors that are LIBOR Dealers) as of 11:00 a.m.,
London time, on the day that is the London Business Day preceding the Auction
Date (the "LIBOR Determination Date"), or (ii) if such rate does not appear on
Telerate Page 3750 or such other page as may replace such Telerate Page 3750,
(A) the LIBOR Dealer will determine the arithmetic mean of the offered
quotations of the Reference Banks to leading banks in the London interbank
market for deposits in U.S. dollars for the designated Dividend Period in an
amount determined by such LIBOR Dealer by reference to requests for quotations
as of approximately 11:00 a.m. (London time) on such date made by such LIBOR
Dealer to the Reference Banks, (B) if at least two of the Reference Banks
provide such quotations, LIBOR Rate will equal such arithmetic mean of such
quotations, (C) if only one or none of the Reference Banks provide such
quotations, LIBOR Rate will be deemed to be the arithmetic mean of the offered
quotations that leading banks in The City of New York selected by the LIBOR
Dealer (after obtaining the Fund's approval) are quoting on the relevant LIBOR
Determination Date for deposits in U.S. dollars for the designated Dividend
Period in an amount determined by the LIBOR Dealer (after obtaining the Fund's
approval) that is representative of a single transaction in such market at such
time by reference to the principal London offices of leading banks in the London
interbank market; provided, however, that if one of the LIBOR Dealers does not
quote a rate required to determine the LIBOR Rate, the LIBOR Rate will be
determined on the basis of the quotation or quotations furnished by any
Substitute LIBOR Dealer or Substitute LIBOR Dealers selected by the Fund to
provide such rate or rates not being supplied by the LIBOR Dealer; provided
further, that if the LIBOR Dealer and Substitute LIBOR Dealers are required but
unable to determine a rate in accordance with at least one of the procedures
provided above, LIBOR Rate will be LIBOR Rate as determined on the previous
Auction Date. If the number of Dividend Period days will be (i) 7 or more but
fewer than 21 days, such rate will be the seven-day LIBOR rate; (ii) more than
21 but fewer than 49 days, such rate will be the one-month LIBOR rate; (iii) 49
or more but fewer than 77 days, such rate will be the two-month LIBOR rate; (iv)
77 or more but fewer than 112 days, such rate will be the three-month LIBOR
rate; (v) 112 or more but fewer than 140 days, such rate will be the four-month
LIBOR rate; (vi) 140 or more but fewer than 168 days, such rate will be the
five-month LIBOR rate; (vii) 168 or more but fewer than 189 days, such rate will
be the six-month LIBOR rate; (viii) 189 or more but fewer than 217 days, such
rate will be the seven-month LIBOR rate; (ix)
A-16
217or more but fewer than 252 days, such rate will be the eight-month LIBOR
rate; (x) 252 or more but fewer than 287 days, such rate will be the nine-month
LIBOR rate; (xi)287 or more but fewer than 315 days, such rate will be the
ten-month LIBOR rate; (xii) 315 or more but fewer than 343 days, such rate will
be the eleven-month LIBOR rate; and (xiii) 343 or more but fewer than 365 days,
such rate will be the twelve-month LIBOR rate.
"Lien" means any material lien, mortgage, pledge, security interest or
security agreement of any kind.
"London Business Day" means any day on which commercial banks are generally
open for business in London.
"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
(sometimes referred to as a "Long Term Special Rate Period").
"Mandatory Redemption Price" means $25,000 per Auction Market Preferred
Share plus an amount equal to accumulated but unpaid dividends (whether or not
earned or declared) to (but not including) the date fixed for redemption.
"Market Value" of any asset of the Trust shall be the market value thereof
determined by a Pricing Service. The Market Value of any asset shall include any
interest accrued thereon. A Pricing Service shall value portfolio securities at
the quoted bid prices or the mean between the quoted bid and asked prices or the
yield equivalent when quotations are not readily available. Securities for which
quotations are not readily available shall be valued at fair value as determined
by a Pricing Service using methods which include consideration of: yields or
prices of securities of comparable quality, type of issue, coupon, maturity and
rating; indications as to value from dealers; and general market conditions. A
Pricing Service may employ electronic data processing techniques and/or a matrix
system to determine valuations. In the event a Pricing Service is unable to
value a security, the security shall be valued at the lower of two bid
quotations obtained by the 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. If two bid quotations are not readily
available for any securities, such securities shall be valued in good faith at
fair value pursuant to procedures approved by the Board of Trustees of the
Trust. Futures contracts and options are valued at the closing prices for such
instruments established by the exchange or board of trade on which they are
traded, or if market quotations are not readily available, are valued at fair
value in good faith pursuant to procedures approved by the Board of Trustees of
the Trust. All other assets will be valued at fair value on a consistent basis
using methods determined in good faith by the Board of Trustees of the Trust.
"Maximum Applicable Rate," with respect to AMPS, has the meaning set forth
in Section 11.10(a)(vii) of these Bylaws.
"Moody's" means Moody's Investors Service, Inc. or its successors.
"Moody's Discount Factor" means, for purposes of determining the Discounted
Value of any Moody's Eligible Asset, the percentage determined as follows. 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.
A-17
(i) Convertible securities (including convertible preferred stock):
The percentage determined by reference to the sector groupings of the
issuer of the convertible security with reference to the rating of such
security, in accordance with the table set forth below.
Rating/1/ Discount Factors/2/
--------- -------------------
Utility Industrial Financial Transportation
------- ---------- --------- --------------
Aaa 162% 256% 233% 250%
Aa 167 261 238 265
A 172 266 243 275
Baa 188 282 259 285
Ba 195 290 265 290
B 199 293 270 295
Unrated 300 300 300 300
---------
/1/ Unless conclusions regarding liquidity risk as well as estimates of both the
probability and severity of default for applicable Trust assets can be derived
from other sources as well as combined with a number of sources, unrated
fixed-income and convertible securities (which are securities that are not rated
by any of Moody's, S&P or Fitch Ratings) are limited to 10% of Moody's Eligible
Assets for purposes of calculations related to the Preferred Shares Basic
Maintenance Amount. If a convertible security is not rated by any of Moody's,
S&P or Fitch Ratings, the Trust will use the applicable percentage set forth in
the row entitled "Unrated" in the table above. Ratings assigned by S&P and/or
Fitch Ratings are generally accepted at face value. However, adjustments to face
value may be made to particular categories of credits for which the ratings by
S&P and/or Fitch Ratings do not seem to approximate a Moody's rating equivalent.
Split-rated securities assigned by S&P and Fitch Ratings (i.e., these Rating
Agencies assign different rating categories to the security) will be accepted at
the lower of the two ratings.
/2/ Discount factors are for seven-week exposure period.
Upon conversion to common stock, the Discount Factors applicable to common stock
will apply:
Common Stocks Utility Industrial Financial
-------------------------- ------- ---------- ---------
Seven week exposure period 170% 264% 241%
A-18
(ii) Corporate debt securities (non-convertible): The percentage
determined by reference to the rating on such asset with reference to the
remaining term to maturity of such asset, in accordance with the table set
forth below.
Moody's Rating Category
Below B and
Term to Maturity of -----------
Corporate Debt Security Aaa Aa A Baa Ba B Unrated/1/
--------------------------------------------- --- --- --- --- --- --- -----------
1 year or less............................... 109% 112% 115% 118% 137% 150% 250%
2 years or less (but longer than 1 year)..... 115 118 122 125 146 160 250
3 years or less (but longer than 2 years).... 120 123 127 131 153 168 250
4 years or less (but longer than 3 years).... 126 129 133 138 161 176 250
5 years or less (but longer than 4 years).... 132 135 139 144 168 185 250
7 years or less (but longer than 5 years).... 139 143 147 152 179 197 250
10 years or less (but longer than 7 years)... 145 150 155 160 189 208 250
15 years or less (but longer than 10 years).. 150 155 160 165 196 216 250
20 years or less (but longer than 15 years).. 150 155 160 165 196 228 250
30 years or less (but longer than 20 years).. 150 155 160 165 196 229 250
Greater than 30 years........................ 165 173 181 189 205 240 250
/1/ Unless conclusions regarding liquidity risk as well as estimates of
both the probability and severity of default for applicable Trust assets
can be derived from other sources as well as combined with a number of
sources as presented by the Trust to Moody's, securities rated below B by
Moody's and, unrated fixed-income and convertible securities (which are
securities that are not rated by any of Moody's, S&P or Fitch Ratings) are
limited to 10% of Moody's Eligible Assets for purposes of calculations
related to the Preferred Shares Basic Maintenance Amount. If a corporate
debt security is not rated by any of Moody's, S&P or Fitch Ratings, the
Trust will use the applicable percentage set forth under the column
entitled "Below B and Unrated" in the table above. Ratings assigned by S&P
and/or Fitch Ratings 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 ratings by S&P and/or Fitch Ratings do not seem to
approximate a Moody's rating equivalent. Split-rated securities assigned by
S&P and Fitch Ratings (i.e., these Rating Agencies assign different rating
categories to the security) will be accepted at the lower of the two
ratings.
The Moody's Discount Factors presented in the immediately preceding table
will also apply to Moody's Eligible Assets that are FHLB, FNMA and FFCB
Debentures and to rated TRACERs and TRAINs, whereby the ratings in the
table will be applied to the underlying securities and the Market Value of
each underlying security will be its proportionate amount of the Market
Value of the TRACER or TRAIN, provided that (i) the Moody's Discount Factor
for any TRAIN or TRACER rated by Moody's will be the percentage determined,
based on the Moody's rating of the TRAIN or TRACER, in accordance with the
table set forth above and (ii) the Moody's Discount Factors determined from
the table shall be multiplied by a factor of 120% for purposes of
calculating the Discounted Value of TRAINs. 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. The
Trust will consult with Moody's to determine incremental discount factors
for non-U.S. dollar and non-euro denominated bonds.
(iii) Preferred stock (other than convertible preferred stock, which
is subject to paragraph (i) above): The Moody's Discount Factor for
A-19
preferred stock shall be (A) for preferred stocks issued by a utility,
155%; (B) for preferred stocks of industrial and financial issuers, 209%;
and (C) for auction rate preferred stocks, 350%.
(iv) Short-term instruments: The Moody's Discount Factor applied to
short-term portfolio securities, including without limitation short-term
corporate debt securities, Short Term Money Market Instruments and
short-term municipal debt obligations, will be (A) 100%, so long as such
portfolio securities mature or have a demand feature at par exercisable
within the Moody's Exposure Period; (B) 115%, so long as such portfolio
securities do not mature within the Moody's Exposure Period, or have a
demand feature at par not exercisable within the Moody's Exposure Period;
and (C) 125%, if such securities are not rated by Moody's, so long as such
portfolio securities are rated at least A-1+/AA or SP-1+/AA by S&P or Fitch
Ratings and mature or have a demand feature at par exercisable within the
Moody's Exposure Period. A Moody's Discount Factor of 100% will be applied
to cash.
(v) U.S. Government Securities and U.S. Treasury Strips: The
percentage determined by reference to the remaining term to maturity of
such asset, in accordance with the table set forth below.
U.S. Government U.S. Treasury
Securities Strips
Remaining Term to Maturity Discount Factor Discount Factor
------------------------------------------- --------------- ---------------
1 year or less 107% 107%
2 years or less (but longer than 1 year) 113 115
3 years or less (but longer than 2 years) 118 121
4 years or less (but longer than 3 years) 123 128
5 years or less (but longer than 4 years) 128 135
7 years or less (but longer than 5 years) 135 147
10 years or less (but longer than 7 years) 141 163
15 years or less (but longer than 10 years) 146 191
20 years or less (but longer than 15 years) 154 218
30 years or less (but longer than 20 years) 154 244
(vi) Rule 144A Securities: The Moody's Discount Factor applied to
Rule 144A Securities for Rule 144A Securities whose terms include rights to
registration under the Securities Act within one year and Rule 144A
Securities which do not have registration rights within one year will be
120% and 130%, respectively, of the Moody's Discount Factor which would
apply were the securities registered under the Securities Act.
(vii) Bank Loans: The Moody's Discount Factor applied to senior Bank
Loans ("Senior Loans") shall be the percentage specified in accordance with
the table set forth below (or such lower percentage as Moody's may approve
in writing from time to time):
Moody's Rating Category
----------------------- Caa and below (including
Type of Loan Aaa-A Baa and Ba/1/ B/1/ distressed and unrated)/1/
------------ ----- ------------- ---- --------------------------
Senior Loans Greater
than $250 MM 118% 136% 149% 250%
Non-Senior Loans
greater than
$250 MM 128% 146% 159% 260%
Loans less than
$250 MM 138% 156% 169% 270%
/1/ If a Senior Loan is not rated by any of Moody's, S&P or Fitch Ratings, the
Trust will use the applicable percentage set forth under the column entitled
"Caa and below (including distressed and unrated)" in the table above. Ratings
assigned by S&P and/or Fitch Ratings are generally accepted by Moody's at face
value. However, adjustments to face value may be made to particular categories
of securities for which the ratings by S&P and/or Fitch Ratings do not seem to
approximate a Moody's rating equivalent. Split-rated securities assigned by S&P
and Fitch Ratings (i.e., these Rating Agencies assign different rating
categories to the security) will be accepted at the lower of the two ratings;
provided however, that, in a situation where a security is rated "B" (or
equivalent) by a given Rating Agency and rated "Caa" (or equivalent) by another
Rating Agency, the Trust will use the applicable percentage set forth under the
column entitled "B" in the table above.
A-20
(viii) Asset-backed and mortgage-backed securities: The Moody's
Discount Factor applied to asset-backed securities shall be 131%. The
Moody's Discount Factor applied to collateralized mortgage obligations,
planned amortization class bonds and targeted amortization class bonds
shall be determined by reference to the weighted average life of the
security and whether cash flow is retained (i.e., controlled by a trustee)
or excluded (i.e., not controlled by a trustee), in accordance with the
table set forth below.
Cash Flow Cash Flow
--------- ---------
Remaining Term to Maturity Retained Excluded
------------------------------------------- -------- --------
3 years or less 133% 141%
7 years or less (but longer than 3 years) 142 151
10 years or less (but longer than 7 years) 158 168
20 years or less (but longer than 10 years) 174 185
The Moody's Discount Factor applied to residential mortgage
pass-throughs (including private-placement mortgage pass-throughs) shall be
determined by reference to the coupon paid by such security and whether
cash flow is retained (i.e., controlled by a trustee) or excluded (i.e.,
not controlled by a trustee), in accordance with the table set forth below.
Coupon Cash Flow Retained Cash Flow Excluded
---------- ------------------ ------------------
5% 166% 173%
6 162 169
7 158 165
8 154 161
9 151 157
10 148 154
11 144 154
12 142 151
13 139 148
adjustable 165 172
The Moody's Discount Factor applied to fixed-rate pass-throughs that are
not rated by Moody's and are serviced by a servicer approved by Moody's
shall be determined by reference to the table in the following paragraph
(relating to whole loans).
The Moody's Discount Factor applied to whole loans shall be determined
by reference to the coupon paid by such security and whether cash flow is
retained (i.e., controlled by a trustee) or excluded (i.e., not controlled
by a trustee), in accordance with the table set forth below.
Coupon Cash Flow Retained Cash Flow Excluded
---------- ------------------ ------------------
5% 172% 179%
6 167 174
7 163 170
8 159 165
9 155 161
10 151 158
11 148 157
12 145 154
13 142 151
adjustable 170 177
A-21
(ix) Municipal debt obligations: The Moody's Discount Factor applied
to municipal debt obligations shall be the percentage determined by
reference to the rating on such asset and the shortest Exposure Period set
forth opposite such rating that is the same length as or is longer than the
Moody's Exposure Period, in accordance with the table set forth below
(provided that, except as provided in the following table, any municipal
obligation:
Exposure Period Aaa Aa A Baa other (V)MIG-1/1/ SP-1+/2/ Unrated/3/
----------------- ---- --- --- --- ----- ----------- -------- ----------
7 weeks 151% 159% 166% 173% 187% 136% 148% 225%
8 weeks or less but 154 161 168 176 190 137 149 231
greater than seven
weeks
9 weeks or less but 158 163 170 177 192 138 150 240
greater than eight
weeks
------------
/1/ Municipal debt obligations not rated by Moody's but rated equivalent to
MIG-1, (V)MIG-1, or P-1, by S&P and Fitch Ratings that have a maturity less
than or equal to 49 days.
/2/ Municipal debt obligations not rated by Moody's but rated equivalent to
MIG-1, (V)MIG-1, or P-1 by S&P and Fitch Ratings that have a maturity
greater than 49 days.
/3/ Unless conclusions regarding liquidity risk as well as estimates of
both the probability and severity of default for the corporation's or
municipal issuer's assets can be derived from other sources as well as
combined with a number of sources as presented by the Trust to Moody's
securities rated below B by Moody's and unrated securities, which are
securities rated by neither Moody's, S&P nor Fitch Ratings, are limited to
10% of Moody's Eligible Assets. If a municipal debt security is unrated by
Moody's, S&P or Fitch, the Trust will use the percentage set forth under
"Other" in the Municipal Debt Table. Ratings assigned by S&P or Fitch are
generally accepted by Moody's at face value (e.g., treating a rating of AAA
by S&P or Fitch Ratings as Aaa for purposes of the table above and a rating
of AA by S&P or Fitch Ratings as Aa for purposes of the table above.
However, adjustments to face value may be made to particular categories of
credits for which the ratings by S&P and/or Fitch Rating do not seem to
approximate a Moody's rating equivalent. Split-rated securities assigned by
S&P and Fitch Ratings (i.e., these Rating Agencies assign different rating
categories to the security) will be accepted at the lower of the two
ratings.
(x) Structured Notes: The Moody's Discount Factor applied to
Structured Notes will be (A) in the case of a corporate issuer, the Moody's
Discount Factor determined in accordance with paragraph (ii) under this
definition, whereby the rating on the issuer of the Structured Note will be
the rating on the Structured Note for purposes of determining the Moody's
Discount Factor in the table in paragraph (ii); and (B) in the case of an
issuer that is the U.S. government or an agency or instrumentality thereof,
the Moody's Discount Factor determined in accordance with paragraph (v)
under this definition.
The Moody's Discount Factor for any Moody's Eligible Asset other than
the securities set forth above will be the percentage provided in writing
by Moody's. Additionally, in order to merit consideration as a Moody's
Eligible Asset, securities
A-22
should be issued by entities which: (a) have not filed for bankruptcy
within the past three years, (b) are current on all principal and interest
in their fixed income obligations, (c) are current on all preferred stock
dividends, and (d) possess a current, unqualified auditor's report without
qualified, explanatory language.
"Moody's Eligible Assets" means
(i) cash (including interest and dividends due on assets rated (A)
Baa3 or higher by Moody's if the payment date is within five Business Days
of the Valuation Date, (B) A2 or higher if the payment date is within
thirty days of the Valuation Date, and (C) A1 or higher if the payment date
is within the Moody's Exposure Period) and receivables for Moody's Eligible
Assets sold if the receivable is due within five Business Days of the
Valuation Date, and if the trades which generated such receivables are (A)
settled through clearing house firms or (B) (1) with counterparties having
a Moody's long-term debt rating of at least Baa3 or (2) with counterparties
having a Moody's Short Term Money Market Instrument rating of at least P-1;
(ii) Short Term Money Market Instruments so long as (A) such
securities are rated at least P-1, (B) in the case of demand deposits, time
deposits and overnight funds, the supporting entity is rated at least A2,
or (C) in all other cases, the supporting entity (1) is rated A2 and the
security matures within one month, (2) is rated A1 and the security matures
within three months or (3) is rated at least Aa3 and the security matures
within six months; provided, however, that for purposes of this definition,
such instruments (other than commercial paper rated by S&P or Fitch Ratings
and not rated by Moody's) need not meet any otherwise applicable rating
criteria of S&P or Fitch Ratings;
(iii) U.S. Government Securities and U.S. Treasury Strips;
(iv) Rule 144A Securities;
(v) Senior Loans and other Bank Loans approved by Moody's;
(vi) Corporate debt securities if (A) such securities are rated Caa
or higher by Moody's; (B) such securities provide for the periodic payment
of interest in cash in U.S. dollars or euros, except that such securities
that do not pay interest in U.S. dollars or euros shall be considered
Moody's Eligible Assets if they are rated by Moody's, S&P or Fitch Ratings;
(C) for securities which provide for conversion or exchange into equity
capital at some time over their lives, the issuer must be rated at least B3
by Moody's and the discount factor will be 250%; (D) for debt securities
rated Ba1 and below, no more than 10% of the original amount of such issue
may constitute Moody's Eligible Assets; (E) such securities have been
registered under the Securities Act 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.
A-23
Notwithstanding the foregoing limitations, (x) corporate debt
securities not rated at least Caa 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 none of Moody's, S&P, or Fitch Ratings
shall be considered to be Moody's Eligible Assets only to the extent such
securities are issued by entities which (i) have not filed for bankruptcy
within the past three years, (ii) are current on all principal and interest
in their fixed income obligations, (iii) are current on all preferred stock
dividends and (iv) possess a current, unqualified auditor's report without
qualified, explanatory language.
(vii) Convertible securities (including convertible preferred stock),
provided that (A) the issuer of common stock must have a Moody's senior
unsecured debt of Caa or better, or a rating of CCC or better by S&P or
Fitch Ratings, (B) the common stocks must be traded on the New York Stock
Exchange, the American Stock Exchange, or the NASDAQ, (C) dividends must be
paid in U.S. dollars, (D) the portfolio of convertible bonds must be
diversified as set forth in the table set forth below, (E) the company
shall not hold shares exceeding the average weekly trading volume during
the preceding month and (F) synthetic convertibles are excluded from asset
eligibility.
Convertible Bonds Diversification Guidelines
--------------------------------------------
Maximum Single Maximum Single Maximum Single
Type Issuer (%)/1/ Industry (%) State (%)/1/
------- -------------- -------------- --------------
Utility 4 50 7/2/
Other 6 20 n/a
------------
/1/ Percentage represent a portion of the aggregate market value and number of
outstanding shares of the convertible stock portfolio.
/2/ Utility companies operating in more than one state should be diversified
according to the state in which they generate the largest part of their
revenues. Publicly available information on utility company revenues by state is
available from the Uniform Statistical Report (USR) or the Federal Energy
Regulation Commission (FERC).
(viii) Preferred stocks if (A) dividends on such preferred stock are
cumulative, (B) such securities provide for the periodic payment of
dividends thereon in cash in U.S. dollars or euros and do not provide for
conversion or exchange into, or have warrants attached entitling the holder
to receive, equity capital at any time over the respective lives of such
securities, (C) the issuer of such a preferred stock has common stock
listed on either the New York Stock Exchange, the American Stock Exchange
or the NASDAQ, (D) the issuer of such a preferred stock has a senior debt
rating from Moody's of Baa1 or higher or a preferred stock rating from
Moody's of Baa3 or higher and (E) such preferred stock has paid consistent
cash dividends in U.S. dollars or euros over the last three years
A-24
or has a minimum rating of A1 (if the issuer of such preferred stock has
other preferred issues outstanding that have been paying dividends
consistently for the last three years, then a preferred stock without such
a dividend history would also be eligible); provided, however, that
convertible preferred stock shall be treated as convertible securities in
accordance with paragraph (vii) above. In addition, the preferred stocks
must have the following diversification requirements: (X) the preferred
stock issue must be greater than $50 million and (Y) the minimum holding by
the 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;
(ix) Asset-backed and mortgage-backed securities:
(A) Asset-backed securities if (1) such securities are rated at
least Aa3 by Moody's or at least AA by S&P or Fitch Ratings, (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) has been rated Aaa by Moody's or AAA by S&P or
Fitch Ratings, (2) does not have a coupon which floats inversely, (3)
is not portioned as an interest-only or principal-only strip and (4)
is part of an issuance that had an original issue size of at least
$100 million;
(C) Planned amortization class bonds ("PACs") and targeted
amortization class bonds ("TACs") provided that such PACs or TACs are
(1) backed by certificates of either the Federal National Mortgage
Association ("FNMA"), the Government National Mortgage Association
("GNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC")
representing ownership in single-family first lien mortgage loans with
original terms of 30 years, (2) part of an issuance that had an
original issue size of at least $10 million, (3) part of PAC or TAC
classes that have payment priority over other PAC or TAC classes, (4)
if TACs, TACs that do not support PAC classes, and (5) if TACs, not
considered reverse TACs (i.e., do not protect against extension risk);
(D) Consolidated senior debt obligations of Federal Home Loan
Banks ("FHLBs"), senior long-term debt of the FNMA, and consolidated
systemwide bonds and FCS Financial Assistance Corporation Bonds of
Federal Farm Credit Banks ("FFCBs") (collectively, "FHLB, FNMA and
FFCB Debentures"), provided that such FHLB, FNMA and FFCB Debentures
are (1) direct issuance corporate debt rated Aaa by Moody's, (2)
senior debt obligations backed by the FHLBs, FFCBs or FNMA, (3) part
of an issue entirely denominated in U.S. dollars and (4) not callable
or exchangeable debt issues;
A-25
(E) Mortgage pass-throughs rated at least Aa by Moody's and
pass-throughs issued prior to 1987 (if rated AA by S&P or Fitch
Ratings and based on fixed-rate mortgage loans) by Travelers Mortgage
Services, Citicorp Homeowners, Citibank, N.A., Sears Mortgage Security
or RFC - Salomon Brothers Mortgage Securities, Inc., provided that (1)
certificates must evidence a proportional, undivided interest in
specified pools of fixed or adjustable rate mortgage loans, secured by
a valid first lien, on one- to four-family residential properties and
(2) the securities are publicly registered (not issued by FNMA, GNMA
or FHLMC);
(F) Private-placement mortgage pass-throughs provided that (1)
certificates represent a proportional undivided interest in specified
pools of fixed-rate mortgage loans, secured by a valid first lien, on
one- to four-family residential properties, (2) documentation is held
by a trustee or independent custodian, (3) pools of mortgage loans are
serviced by servicers that have been approved by FNMA or FHLMC and
funds shall be advanced to meet deficiencies to the extent provided in
the pooling and servicing agreements creating such certificates, and
(4) pools have been rated Aa or better by Moody's; and
(G) Whole loans (e.g., direct investments in mortgages) provided
that (1) at least 65% of such loans (a) have seasoning of no less than
6 months, (b) are secured by single-family detached residences, (c)
are owner-occupied primary residences, (d) are secured by a
first-lien, fully-documented mortgage, (e) are neither currently
delinquent (30 days or more) nor delinquent during the preceding year,
(f) have loan-to-value ratios of 80% or below, (g) carry normal hazard
insurance and title insurance, as well as special hazard insurance, if
applicable, (h) have original terms to maturity not greater than 30
years, with at least one year remaining to maturity, (i) have a
minimum of $10,000 remaining principal balance, (j) for loans
underwritten after January 1, 1978, FNMA and/or FHLMC forms are used
for fixed-rate loans, and (k) 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 that 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
A-26
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 .15% and
.25% for either cost-of-funds index and between .175% and .325% for
Treasuries, (c) the maximum yearly interest rate increase is 2%, (d)
the maximum life-time interest rate increase is 6.25% and (e) ARMs may
include Federal Housing Administration and Department of Veterans
Affairs loans; and (6) for "teaser" loans, (a) the initial discount
from the current ARM market rate is no greater than 2%, (b) the loan
is underwritten at the market rate for ARMs, not the "teaser" rate,
and (c) the loan is seasoned six months beyond the "teaser" period.
(x) Any municipal debt obligation that (A) pays interest in cash,
(B) does not have a Moody's rating, as applicable, suspended by Moody's,
and (C) is part of an issue of municipal debt obligations of at least
$5,000,000, except for municipal debt obligations rated below A by Moody's,
in which case the minimum issue size is $10,000,000;
(xi) Structured Notes, rated TRACERs and TRAINs;
(xii) Financial contracts, as such term is defined in Section
3(c)(2)(B)(ii) of the 1940 Act, not otherwise provided for in this
definition but only upon receipt by the Trust of a letter from Moody's
specifying any conditions on including such financial contract in Moody's
Eligible Assets and assuring the Trust that including such financial
contract in the manner so specified would not affect the credit rating
assigned by Moody's to the AMPS; and
(xiii) Common stock, preferred stock or any debt security of REITs or
real estate companies.
In addition, portfolio holdings as described below must be within the
following diversification and issue size requirements in order to be included in
Moody's Eligible Assets:
Maximum Maximum Minimum Issue
Single Single Size
Ratings /1/ Issuer /2,3/ Industry /3,4/ ($ in million) /5/
----------- ------------ -------------- ------------------
Aaa 100% 100% $ 100
Aa 20 60 100
A 10 40 100
Baa 6 20 100
Ba 4 12 50/6/
B1-B2 3 8 50/6/
B3 or below 2 5 50/6/
------------
/1/ Refers to the preferred stock and senior debt rating of the portfolio
holding.
/2/ Companies subject to common ownership of 25% or more are considered as one
issuer.
/3/ Percentages represent a portion of the aggregate Market Value of corporate
debt securities.
/4/ Industries are determined according to Moody's Industry Classifications, as
defined herein.
/5/ Except for preferred stock, which has a minimum issue size of $50 million.
/6/ Portfolio holdings from issues ranging from $50 million to $100 million are
limited to 20% of the Trust's total assets.
A-27
Where the Trust sells an asset and agrees to repurchase such asset in the
future, the Discounted Value of such asset will constitute a Moody's Eligible
Asset and the amount the Trust is required to pay upon repurchase of such asset
will count as a liability for the purposes of the Preferred Shares Basic
Maintenance Amount. Where the Trust purchases an asset and agrees to sell it to
a third party in the future, cash receivable by the Trust thereby will
constitute a Moody's Eligible Asset if the long-term debt of such other party is
rated at least A2 by Moody's and such agreement has a term of 30 days or less;
otherwise the Discounted Value of such purchased asset will constitute a Moody's
Eligible Asset. For the purposes of calculation of Moody's Eligible Assets,
portfolio securities which have been called for redemption by the issuer thereof
shall be valued at the lower of Market Value or the call price of such portfolio
securities.
Notwithstanding the foregoing, an asset will not be considered a Moody's
Eligible Asset to the extent that it (i) has been irrevocably deposited for the
payment of (i)(A) through (i)(E) under the definition of Preferred Shares Basic
Maintenance Amount or to the extent it is subject to any Liens, except for (A)
Liens which are being contested in good faith by appropriate proceedings and
which Moody's has indicated to the Trust will not affect the status of such
asset as a Moody's Eligible Asset, (B) Liens for taxes that are not then due and
payable or that can be paid thereafter without penalty, (C) Liens to secure
payment for services rendered or cash advanced to the Trust by its investment
manager or portfolio manager, the Trust's custodian, transfer agent or registrar
or the Auction Agent and (D) Liens arising by virtue of any repurchase
agreement, or (ii) has been segregated against obligations of the Trust in
connection with an outstanding derivative transaction.
"Moody's Exposure Period" means the period commencing on a given Valuation
Date and ending 49 days thereafter.
"Moody's Hedging Transactions" has the meaning set forth in Section 11.8(a)
of these Bylaws.
"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 AMPS):
1. Aerospace and Defense: Major Contractor, Subsystems, Research,
Aircraft Manufacturing, Arms, Ammunition
2. Automobile: Automobile Equipment, Auto-Manufacturing, Auto Parts
Manufacturing, Personal Use Trailers, Motor Homes, Dealers
3. Banking: Bank Holding, Savings and Loans, Consumer Credit, Small Loan,
Agency, Factoring, Receivables
4. Beverage, Food and Tobacco: Beer and Ale, Distillers, Wines and
Liquors, Distributors, Soft Drink Syrup, Bottlers, Bakery, Mill Sugar,
Canned Foods, Corn Refiners, Dairy Products, Meat Products, Poultry
Products, Snacks, Packaged Foods, Candy, Gum, Seafood, Frozen Food,
Cigarettes, Cigars, Leaf/Snuff, Vegetable Oil
A-28
5. Buildings and Real Estate: Brick, Cement, Climate Controls,
Contracting, Engineering, Construction, Hardware, Forest Products
(building-related only), Plumbing, Roofing, Wallboard, Real Estate,
Real Estate Development, REITs, Land Development
6. Chemicals, Plastics and Rubber: Chemicals (non-agricultural),
Industrial Gases, Sulfur, Plastics, Plastic Products, Abrasives,
Coatings, Paints, Varnish, Fabricating
7. Containers, Packaging and Glass: Glass, Fiberglass, Containers made
of: Glass, Metal, Paper, Plastic, Wood or Fiberglass
8. Personal and Non-Durable Consumer Products (manufacturing only):
Soaps, Perfumes, Cosmetics, Toiletries, Cleaning Supplies, School
Supplies
9. Diversified/Conglomerate Manufacturing
10. Diversified/Conglomerate Service
11. Diversified Natural Resources, Precious Metals and Minerals:
Fabricating, Distribution
12. Ecological: Pollution Control, Waste Removal, Waste Treatment and
Waste Disposal
13. Electronics: Computer Hardware, Electric Equipment, Components,
Controllers, Motors, Household Appliances, Information Service
Communicating Systems, Radios, TVs, Tape Machines, Speakers, Printers,
Drivers, Technology
14. Finance: Investment Brokerage, Leasing, Syndication, Securities
15. Farming and Agriculture: Livestock, Grains, Produce, Agriculture
Chemicals, Agricultural Equipment, Fertilizers
16. Grocery: Grocery Stores, Convenience Food Stores
17. Healthcare, Education and Childcare: Ethical Drugs, Proprietary Drugs,
Research, Health Care Centers, Nursing Homes, HMOs, Hospitals,
Hospital Supplies, Medical Equipment
18. Home and Office Furnishings, Housewares, and Durable Consumer
Products: Carpets, Floor Coverings, Furniture, Cooking, Ranges
19. Hotels, Motels, Inns and Gaming
20. Insurance: Life, Property and Casualty, Broker, Agent, Surety
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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. Printing, Publishing, and Broadcasting: Graphic Arts, Paper, Paper
Products, Business Forms, Magazines, Books, Periodicals, Newspapers,
Textbooks, Radio, TV, Cable Broadcasting Equipment
26. Cargo Transport: Rail, Shipping, Railroads, Railcar Builders, Ship
Builders, Containers, Container Builders, Parts, Overnight Mail,
Trucking, Truck Manufacturing, Trailer Manufacturing, Air Cargo,
Transport
27. Retail Stores: Apparel, Toy, Variety, Drug, Department, Mail Order
Catalog, Showroom
28. Telecommunications: Local, Long Distance, Independent, Telephone,
Telegraph, Satellite, Equipment, Research, Cellular
29. Textiles and Leather: Producer, Synthetic Fiber, Apparel Manufacturer,
Leather Shoes
30. Personal Transportation: Air, Bus, Rail, Car Rental
31. Utilities: Electric, Water, Hydro Power, Gas
32. Diversified Sovereigns: Semi-sovereigns, Canadian Provinces,
Supra-national Agencies
The Trust will use its discretion in determining which industry
classification is applicable to a particular investment in consultation with the
Independent Accountant and Moody's, to the extent the Trust considers necessary.
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"1940 Act" means the Investment Company Act of 1940, as amended from time
to time.
"1940 Act Cure Date," with respect to the failure by the Trust to maintain
the 1940 Act Preferred Shares Asset Coverage (as required by these Bylaws) as of
the last Business Day of each month, means the last Business Day of the
following month.
"1940 Act Preferred Shares 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 beneficial
interest, including AMPS (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).
"Non-Call Period" has the meaning set forth under the definition of
"Specific Redemption Provisions."
"Non-Payment Period" means a period commencing on and including a Dividend
Payment Date or redemption date for which the Trust shall fail to (i) declare,
prior to the close of business on the second Business Day preceding such
Dividend Payment Date, for payment (to the extent permitted by Section
11.2(c)(i) of these Bylaws) 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 AMPS payable on such Dividend Payment Date, provided, however, that
if the Trust is not able to make such declaration in compliance with the
foregoing because an unforeseen event or unforeseen events
A-31
causes or cause a day that otherwise would have been a Business Day not to be a
Business Day, then the Trust may make such declaration on the Business Day
immediately preceding the Dividend Payment Date, if possible, or, if not
possible, on the Dividend Payment Date, and in such case the Trust shall not be
deemed to have failed to declare a dividend otherwise required to be declared,
or (ii) deposit, irrevocably in trust, in same-day funds, with the Auction Agent
by 12:00 noon, New York City time, (A) on such Dividend Payment Date the full
amount of any cash dividend on such shares payable (if declared) on such
Dividend Payment Date or (B) on any such redemption date for any AMPS called for
redemption, the Mandatory Redemption Price per share of such AMPS 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 Section 11.2(c)(i) of these Bylaws, shall not
constitute a "Non-Payment Period."
"Non-Payment Period Rate" means, initially, 300% 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
each of Fitch Ratings and Moody's (and any Substitute Rating Agency in lieu of
Fitch Ratings or Moody's in the event Fitch Ratings or Moody's shall not rate
the AMPS) advises the Trust in writing that such adjustment, modification,
alteration or change will not adversely affect its then current ratings on the
AMPS.
"Normal Dividend Payment Date" has the meaning set forth in Section
11.2(b)(i) of these Bylaws.
"Notice of Redemption" means any notice with respect to the redemption of
AMPS pursuant to Section 11.4 of these Bylaws.
"Notice of Revocation" has the meaning set forth in Section 11.2(c)(iii) of
these Bylaws.
"Notice of Special Dividend Period" has the meaning set forth in Section
11.2(c)(iii) of these Bylaws.
"Optional Redemption Price" means $25,000 per Auction Market Preferred
Share plus an amount equal to accumulated but unpaid dividends (whether or not
earned or declared) to the date fixed for redemption plus any applicable
redemption premium attributable to the designation of a Premium Call Period.
"Outstanding" means, as of any date, (i) with respect to AMPS, AMPS
theretofore issued by the Trust except, without duplication, (A) any AMPS
theretofore canceled or delivered to the Auction Agent for cancellation, or
redeemed by the Trust, or as to which a Notice of Redemption
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shall have been given and Deposit Securities shall have been deposited in trust
or segregated by the Trust pursuant to Section 11.4(c) hereto and (B) any AMPS
as to which the Trust or any Affiliate (other than an Affiliate that is a
Broker-Dealer) thereof shall be a Beneficial Owner, provided that AMPS held by
an Affiliate shall be deemed outstanding for purposes of calculating the
Preferred Shares Basic Maintenance Amount and (ii) with respect to other
preferred shares of beneficial interest of the Trust, the meaning equivalent to
that for AMPS as set forth in clause (i).
"Parity Shares" means the AMPS and each other outstanding series of
preferred shares of beneficial interest of the Trust the holders of which,
together with the holders of the AMPS, 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 with respect to the issuer of any asset that is a Bank
Loan, Corporate Debt Security or other debt, the issuer of such investment is
not in default of any payment obligations in respect thereof.
"Person" means and includes an individual, a corporation, a partnership, 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 AMPS but that wishes to purchase
such shares, or that is a Beneficial Owner that wishes to purchase additional
AMPS.
"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 AMPS (or, in the case of an Existing Holder, additional AMPS).
"Preferred Share Basic Maintenance Amount," as of any Valuation Date, means
the dollar amount equal to the sum of (i)(A) the product of the number of AMPS
Outstanding on such date multiplied by $25,000, plus any redemption premium
applicable to AMPS then subject to redemption; (B) the aggregate amount of
dividends that will have accumulated at the respective Applicable Rates (whether
or not earned or declared) to (but not including) the first respective Dividend
Payment Dates for each series of AMPS Outstanding that follow such Valuation
Date (plus the aggregate amount of dividends, whether or not earned or declared,
that will have accumulated in respect of other outstanding preferred shares to,
but not including, the first respective dividend payment dates for such other
shares that follow such Valuation Date); (C) the aggregate amount of dividends
that would accumulate on shares of each series of AMPS Outstanding from such
first respective Dividend Payment Date therefor through the 49th day after such
Valuation Date, at the Maximum Applicable Rate (calculated as if such Valuation
Date were the Auction Date for the Dividend Period commencing on such Dividend
Payment Date) for a 7-Day Dividend Period of shares of such series to commence
on such Dividend Payment Date, multiplied by the Volatility Factor (except that
(1) if such Valuation Date occurs during a Non-Payment Period, the dividend for
purposes of calculation would accumulate at the then current Non-Payment Period
Rate and (2) for those days during the period described in this clause (C) in
respect of which the Applicable Rate in effect immediately prior to such
Dividend
A-33
Payment Date will remain in effect, the dividend for purposes of calculation
would accumulate at such Applicable Rate in respect of those days); (D) the
amount of anticipated expenses of the Trust for the 90 days subsequent to such
Valuation Date; and (E) any current liabilities as of such Valuation Date to the
extent not reflected in any of (i)(A) through (i)(D) (including, without
limitation, any payables for portfolio securities of the Trust purchased as of
such Valuation Date and any liabilities incurred for the purpose of clearing
securities transactions) less (ii) the value (i.e., the face value of cash,
short-term securities rated MIG-1, VMIG-1 or P-1, and short-term securities that
are the direct obligation of the U.S. government, provided in each case that
such securities mature on or prior to the date upon which any of (i)(A) through
(i)(E) become payable, otherwise the Discounted Value) of any of the Trust's
assets irrevocably deposited by the Trust for the payment of any of (i)(A)
through (i)(E).
"Preferred Share Basic Maintenance Cure Date," with respect to the failure
by the Trust to satisfy the Preferred Shares Basic Maintenance Amount (as
required by Section 11.7(a) of these Bylaws) as of a given Valuation Date, means
the sixth Business Day following such Valuation Date.
"Preferred Shares 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 Preferred Shares Basic Maintenance Amount.
"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 and approved by Fitch Ratings, Moody's or any Substitute
Rating Agency, as applicable, for purposes of determining whether the Trust has
Eligible Assets with an aggregate Discounted Value that equals or exceeds the
Preferred Shares Basic Maintenance Amount.
"Quarterly Valuation Date" means the last Business Day of the last month of
each fiscal quarter of the Trust in each fiscal year of the Trust, commencing
October __, 2003.
"Rating Agency" means a nationally recognized statistical rating
organization.
"Reference Banks" means four major banks in the London interbank market
selected by Merrill Lynch, Pierce, Fenner and Smith Incorporated or its
affiliates or successors or such other party as the Fund may from time to time
appoint.
"Reference Rate" means the LIBOR rate (for a Dividend Period of fewer than
365 days) or the applicable Treasury Index Rate (for a Dividend Period of 365
days or more).
"REITs" means real estate investment trusts.
"Reorganization Bonds" has the meaning set forth under the definition of
"Fitch Eligible Assets."
A-34
"Request for Special Dividend Period" has the meaning set forth in Section
11.2(c)(iii) of these Bylaws.
"Response" has the meaning set forth in Section 11.2(c)(iii) of these
Bylaws.
"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, a division of The McGraw-Hill Companies,
Inc., or its successors.
"Securities Act" means the Securities Act of 1933, as amended from time to
time.
"Securities Depository" means The Depository Trust Company and its
successors and assigns or any successor securities depository selected by the
Trust as securities depository for the AMPS that agrees to follow the procedures
required to be followed by such securities depository in connection with the
AMPS.
"Senior Loans" has the meaning set forth in paragraph (vii) of the
definition of "Moody's Discount Factor."
"Series T AMPS" means the Auction Market Preferred Shares, Series T.
"Series W AMPS" means the Auction Market Preferred Shares, Series W.
"Series TH AMPS" means the Auction Market Preferred Shares, Series TH.
"Seven-Day Dividend Period" means a Subsequent Dividend Period that (a)
consists of seven days or (b) would consist of seven days but for the fact that
the Dividend Payment Date which immediately follows, or the Dividend Payment
Date which falls within, such Subsequent Dividend Period is not a Business Day.
"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 AMPS.
"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 AMPS.
"Short Term Dividend Period" means a Special Dividend Period consisting of
a specified number of days, evenly divisible by seven and not fewer than
fourteen 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):
A-35
(i) commercial paper rated either F-1 by Fitch Ratings 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 Ratings or A-1+ by S&P if such commercial paper
matures in over 30 days;
(ii) demand or time deposits in, and banker's acceptances and
certificates of deposit of, (A) a depository institution or trust company
incorporated under the laws of the United States of America or any state
thereof or the District of Columbia or (B) a United States branch office or
agency of a foreign depository institution (provided that such branch
office or agency is subject to banking regulation under the laws of the
United States, any state thereof or the District of Columbia);
(iii) overnight funds;
(iv) U.S. Government Securities; and
(v) Eurodollar demand or time deposits in, or certificates of
deposit of, the head office or the London branch office of a depository
institution or trust company if the certificates of deposit, if any, and
the long-term unsecured debt obligations (other than such obligations the
ratings of which are based on the credit of a person or entity other than
such depository institution or trust company) of such depository
institution or trust company that have (1) credit ratings on each Valuation
Date of at least P-1 from Moody's and either F-1+ from Fitch Ratings 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 Ratings 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 Ratings 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 Ratings 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" (sometimes referred to as a "Special Rate
Period") means a Short Term Dividend Period or a Long Term Dividend Period.
"Specific Redemption Provisions" means, with respect to a Special Dividend
Period either, or both, of (i) a period (a "Non-Call Period") determined by the
Board of Trustees of the Trust, after consultation with the Auction Agent and
the Broker-Dealers, during which the
A-36
AMPS subject to such Special 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 AMPS subject to such Special Dividend Period shall
be redeemable at the Trust's option at a price per share equal to $25,000, plus
accumulated but unpaid dividends (whether or not earned or declared) to (but not
including) the date fixed for redemption, plus a premium expressed as a
percentage or percentages of $25,000, as determined by the Board of Trustees of
the Trust after consultation with the Auction Agent and the Broker-Dealers.
"Structured Notes" means privately negotiated debt obligations where the
principal and/or interest is determined by reference to the performance of a
benchmark asset or market (an "embedded index"), such as selected securities or
an index of securities, or the differential performance of two assets or
markets, such as indices reflecting bonds.
"Subsequent Dividend Period" has the meaning set forth in Section
11.2(c)(i) of these Bylaws.
"Substitute Rating Agency" means a Rating Agency selected by Merrill Lynch,
Pierce, Fenner and Smith Incorporated or its affiliates and successors, after
consultation with the Trust, to act as the substitute Rating Agency to determine
the credit ratings of the AMPS.
"Sufficient Clearing Bids" has the meaning set forth in Section 11.10(d)(i)
of these Bylaws.
"TRACERs" means traded custody receipts representing direct ownership in a
portfolio of underlying securities.
"TRAINs" means Targeted Return Index Securities, which are trust
certificates comprised of bonds that are chosen to track a particular index.
"Treasury Bill" means a direct obligation of the U.S. government having a
maturity at the time of issuance of 364 days or less.
"Treasury Bonds" means United States Treasury Bonds or Notes.
"Treasury Index Rate" means the average yield to maturity for actively
traded marketable U.S. Treasury fixed interest rate securities having the same
number of 30-day periods to maturity as the length of the applicable Dividend
Period, determined, to the extent necessary, by linear interpolation based upon
the yield for such securities having the next shorter and next longer number of
30-day periods to maturity treating all Dividend Periods with a length greater
than the longest maturity for such securities as having a length equal to such
longest maturity, in all cases based upon data set forth in the most recent
weekly statistical release published by the Board of Governors of the Federal
Reserve System (currently in H.15 (519)); provided, however, if the most recent
such statistical release shall not have been published during the 15 days
preceding the date of computation, the foregoing computations shall be based
upon the average of comparable data as quoted to the Trust by at least three
recognized dealers in U.S. government securities selected by the Trust.
A-37
"Trust" means the PIMCO Floating Rate Income Fund.
"U.S. Government Securities" means direct obligations of the United States
or of its agencies or instrumentalities that are entitled to the full faith and
credit of the United States and that, other than Treasury Bills, provide for the
periodic payment of interest and the full payment of principal at maturity or
call for redemption.
"U.S. Treasury Securities" means direct obligations of the United States
Treasury that are entitled to the full faith and credit of the United States.
"U.S. Treasury Strips" means securities based on U.S. Treasury Securities
created through the Separate Trading of Registered Interest and Principal of
Securities program.
"Valuation Date" means, for purposes of determining whether the Trust is
maintaining the Preferred Shares Basic Maintenance Amount, the last Business Day
of each week commencing with the Date of Original Issue.
"Volatility Factor" means 1.89.
"Voting Period" has the meaning set forth in Section 11.5(b) of these
Bylaws.
(b) The foregoing definitions of Accountant's Confirmation, Preferred
Shares Basic Maintenance Amount, Preferred Shares Basic Maintenance Cure Date,
Preferred Shares Basic Maintenance Report, Bank Loans, Closing Transactions,
Cure Date, Debt Securities, Deposit Securities, Discounted Value, Fitch Discount
Factor, Fitch Eligible Assets, Fitch Exposure Period, Fitch Hedging
Transactions, Fitch Industry Classifications, Forward Commitment, Independent
Accountant, Market Value, Maximum Applicable Rate, Moody's Advance Rate, Moody's
Discount Factor, Moody's Eligible Assets, Moody's Exposure Period, Moody's
Hedging Transactions, Moody's Industry Classification, Moody's Loan Category,
1940 Act Cure Date, 1940 Act Preferred Shares Asset Coverage, Performing, Senior
Loans, Short Term Money Market Instruments, Structured Notes, TRACERs, Treasury
Bill, Treasury Bonds, U.S. Government Securities, U.S. Treasury Securities, U.S.
Treasury Strips, Valuation Date and Volatility Factor (and any terms defined
within such definitions) have been determined by the Board of Trustees of the
Trust in order to obtain a rating of "AAA" from Fitch Ratings and a rating of
"Aaa" from Moody's on the AMPS 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 any
terms defined within such definitions) and the restrictions and guidelines set
forth thereunder if Fitch Ratings, Moody's 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 AMPS.
11.2 Dividends.
(a) The Holders of a particular series of AMPS 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
AMPS so
A-38
declared and payable shall be paid in preference to and in priority over
any dividends declared and payable on the Common Shares.
(b) (i) Cash dividends on shares of each series of AMPS shall
accumulate at the relevant Applicable Rate(s) from the Date of Original
Issue and shall be payable, when, as and if declared by the Board of
Trustees of the Trust, out of funds legally available therefor, commencing
on the Initial Dividend Payment Date. Following the Initial Dividend
Payment Date for a series of AMPS, dividends on that series of AMPS will be
payable, at the option of the Trust, either (i) with respect to any
Seven-Day Dividend Period and any Short Term Dividend Period of 35 or fewer
days, on the day next succeeding the last day thereof, or (ii) with respect
to any Short Term Dividend Period of more than 35 days and with respect to
any Long Term Dividend Period, monthly on the first Business Day of each
calendar month during such Short Term Dividend Period or Long Term Dividend
Period and on the day next succeeding the last day thereof (each such date
referred to in clause (i) or (ii) being 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 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
Period for a series of AMPS is scheduled to begin on the same day and end
on the same day as a Dividend Period for another series of AMPS, then the
last day of such Dividend Period for such other series of AMPS shall be the
second Business Day next succeeding such scheduled day unless the Trust
obtains the opinion of tax counsel referred to in this paragraph. Subject
to the limitation in the next sentence, if for any reason a Dividend
Payment Date cannot be fixed as described above, then the Board of Trustees
of the Trust shall fix the Dividend Payment Date. However, no Dividend
Period of any series of AMPS shall be co-extensive with any Dividend Period
of any other series of AMPS unless the Trust has received an opinion of tax
counsel that having such co-extensive periods will not affect the
deductibility, for federal income tax purposes, of dividends paid on the
different series of AMPS. The Board of Trustees of the Trust before
authorizing a dividend may change a Dividend Payment Date if such change
does not adversely affect the contract rights of the Holders of AMPS set
forth in the Declaration of Trust or the Bylaws. The Initial Dividend
Period, 7-Day Dividend Periods and Special Dividend Periods with respect to
a series of AMPS 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."
(ii) Each dividend shall be paid to the Holders as they appear
in the Share 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 Share 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 a series of
AMPS (the "Initial Dividend Period"), the Applicable Rate for such series
of AMPS shall be the Initial Dividend Rate.
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Commencing on the Initial Dividend Payment Date for a series of AMPS, the
Applicable Rate on that series 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.
For a series of AMPS, the Applicable Rate for such series 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, but not after the end of, a Non-Payment Period
shall be a Seven-Day Dividend Period. Except in the case of the willful
failure of the Trust to pay a dividend on a Dividend Payment Date or to
redeem any AMPS 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 AMPS 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 AMPS 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 (excluding any days that would have
been Business Days but for the occurrence of any unforeseen event or
unforeseen events that caused such days not to be Business Days) divided by
365, and in such case such period shall not constitute a Non-Payment
Period; provided, however, that the Trust shall not be required to pay any
late charge if it declares a dividend on the Dividend Payment Date or the
Business Day immediately preceding such Dividend Payment Date in accordance
with clause (i) of the definition of "Non-Payment Period" and deposits
payment for such dividend as contemplated by clause (ii)(A) of the
definition of "Non-Payment Period" on or before the second Business Day
succeeding the day on which the dividend was declared. In the case of a
willful failure of the Trust to pay a dividend on a Dividend Payment Date
or to redeem any AMPS 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 dividends per share of any series of AMPS
payable (if declared) on the Initial Dividend Payment Date, each
Dividend Payment Date of each 7-Day Dividend Period and each Dividend
Payment Date of each Short Term Dividend Period shall be computed by
multiplying the Applicable Rate for such Dividend Period
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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 365, multiplying the amount so
obtained by $25,000, and rounding the amount so obtained to the
nearest cent. During any Long Term Dividend Period, the amount of cash
dividends per share of a series of AMPS 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.
(iii) 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 AMPS be a number of days (other than seven), evenly
divisible by seven and not fewer than fourteen nor more than 364 in
the case of a Short Term Dividend Period or one whole year or more but
not greater than five years in the case of a Long Term Dividend
Period, specified in such notice, provided that the Trust may not give
a Request for Special Dividend Period for a 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
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 AMPS 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 AMPS. Upon receiving such Request for Special Dividend
Period, the Broker-Dealer(s) shall jointly determine the Optional
Redemption Price of the AMPS of the applicable series of AMPS 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 AMPS, (4) industry and financial
conditions which may affect the AMPS of the applicable series, (5) the
investment objective of the Trust, and (6) the Dividend Periods and
dividend rates at which current and potential beneficial holders of
the AMPS would remain or become beneficial holders. After providing
the Request for Special Dividend Period to the Auction Agent and each
Broker-Dealer as set forth above, the 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, if any, 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 Fitch Ratings, Moody's and any
Substitute Rating Agency.
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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 Preferred Shares
Asset Coverage is not satisfied or the Trust shall fail to maintain
Fitch Eligible Assets and Moody's Eligible Assets each with an
aggregate Discounted Value at least equal to the Preferred Shares
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 AMPS with an equal dividend period)
or (y) sufficient funds for the payment of dividends payable on the
immediately succeeding Dividend Payment Date have not been irrevocably
deposited with the Auction Agent by the close of business on the third
Business Day preceding the Auction Date immediately preceding such
Dividend Payment Date. The Trust also shall provide a copy of such
Notice of Revocation to Fitch Ratings, Moody's and any Substitute
Rating Agency. 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) or (y) above or if the Trust gives a Notice of
Revocation with respect to a Notice of Special Dividend Period for any
series of AMPS, the next succeeding Dividend Period for that series
will be a 7-Day Dividend Period. In addition, in the event Sufficient
Clearing Bids are not made in an Auction, or if an Auction is not held
for any reason, 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 AMPS (and any such attempted notice shall be
null and void) until Sufficient Clearing Bids have been made in an
Auction with respect to a Seven-Day Dividend Period. If an Auction is
not held because an unforeseen event or unforeseen events cause a day
that otherwise would have been a Dividend Payment Date or an Auction
Date not to be a Business Day, then the length of the Dividend Period
relating to such Dividend Payment Date shall be extended by seven days
(or a multiple thereof if necessary because of such unforeseen event
or events) (an "Extension Period"), the Applicable Rate for such
Extension Period shall be the Applicable Rate for the Dividend Period
so extended and the Dividend Payment Date for such Dividend Period
shall be the first Business Day next succeeding the end of such
Extension Period.
(d) (i) Holders shall not be entitled to any dividends, whether
payable in cash, property or AMPS, in excess of full cumulative dividends
as herein provided. Except for the late charge payable pursuant to Section
11.2(c)(i) hereof, no interest, or sum of money in lieu of interest, shall
be payable in respect of any dividend payment on the AMPS that may be in
arrears.
(ii) For so long as any AMPS are 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 AMPS as to dividends or upon liquidation) in respect of the
Common Shares or any other shares
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of beneficial interest of the Trust ranking junior to or on a parity
with the AMPS as to dividends or upon liquidation, or call for
redemption, redeem, purchase or otherwise acquire for consideration
any Common Shares or any other such junior shares (except by
conversion into or exchange for shares of the Trust ranking junior to
the AMPS 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 AMPS as to dividends
and upon liquidation), unless (A) immediately after such transaction,
the Trust shall have Fitch Eligible Assets and Moody's Eligible Assets
each with an aggregate Discounted Value equal to or greater than the
Preferred Shares Basic Maintenance Amount and the Trust shall maintain
the 1940 Act Preferred Shares Asset Coverage, (B) full cumulative
dividends on AMPS 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 AMPS required to be redeemed
by any provision for mandatory redemption contained herein. Further,
for so long as any AMPS are Outstanding, the Trust shall not declare,
pay or set apart for payment any dividend or other distribution on any
Parity Shares other than the AMPS unless contemporaneously herewith it
declares, pays or sets apart for payment, as the case may be, the same
proportionate share of dividends on the AMPS.
(e) Each dividend shall consist of cash at the Applicable Rate.
(f) No fractional AMPS shall be issued.
(g) Solely for purposes of the proviso in clause (i) under the
definition of "Non-Payment Period," the second parenthetical in the
second sentence of the second paragraph of Section 11.2(c)(i) of these
Bylaws and the last sentence of Section 11.2(c)(iii) of these Bylaws,
any day on which banks in New York City generally are closed, for any
reason, while the New York Stock Exchange remains open for trading and
any day which otherwise would be a Business Day as defined in these
Bylaws on which the Auction Agent is closed for business, for any
reason, shall be considered a day which is not a Business Day.
11.3 Liquidation Rights. Upon any liquidation, dissolution or winding
up of the Trust, whether voluntary or involuntary, the Holders of AMPS then
outstanding 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 AMPS,
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 AMPS and any other Outstanding class or series of
preferred shares of beneficial interest of the Trust ranking on a parity
with the AMPS 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 have no right or claim to any of the remaining assets of the
Trust. A consolidation, merger or statutory share exchange of the Trust
with or into any other Trust or
A-43
entity 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
Trust shall not be deemed or construed to be a liquidation, dissolution or
winding up of the Trust.
11.4 Redemption.
(a) AMPS 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 AMPS, 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 AMPS 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.
(ii) The Trust shall redeem, out of funds legally available
therefor, at the Mandatory Redemption Price per share, AMPS to
the extent permitted under the 1940 Act and Massachusetts law, on
a date fixed by the Board of Trustees of the Trust, if the Trust
fails to maintain Fitch Eligible Assets and Moody's Eligible
Assets each with an aggregate Discounted Value equal to or
greater than the Preferred Shares Basic Maintenance Amount as
provided in Section 11.7(a) or to satisfy the 1940 Act Preferred
Shares Asset Coverage as provided in Section 11.6 and such
failure is not cured on or before the Preferred Shares Basic
Maintenance Cure Date or the 1940 Act Cure Date (herein
collectively referred to as a "Cure Date"), as the case may be.
The number of AMPS to be redeemed shall be equal to the lesser of
(i) the minimum number of AMPS the redemption of which, if deemed
to have occurred immediately prior to the opening of business on
the Cure Date, together with all other preferred shares of
beneficial interest of the Trust subject to redemption or
retirement, would result in the Trust having Fitch Eligible
Assets and Moody's Eligible Assets each with an aggregate
Discounted Value equal to or greater than the Preferred Shares
Basic Maintenance Amount or satisfaction of the 1940 Act
Preferred Shares Asset Coverage, as the case may be, on such Cure
Date (provided that, if there is no such minimum number of AMPS
and other preferred shares of beneficial interest of the Trust
the redemption of which would have such result, all AMPS and
other preferred shares of beneficial interest of the Trust then
Outstanding shall be redeemed), and (ii) the maximum number of
AMPS, together with all other preferred shares of beneficial
interest of the Trust 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
AMPS 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 each with an aggregate Discounted Value
equal to or greater than the Preferred Shares Basic Maintenance
Amount or satisfaction of the 1940 Act Preferred Shares Asset
Coverage, as the case may be, pro rata among AMPS of all series
and other preferred shares of beneficial interest of the Trust
subject to redemption pursuant to provisions similar to those
contained in this Section 11.4(a)(ii); provided that AMPS which
may not be redeemed at the option of the Trust due to the
designation of a Non-Call Period
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applicable to such shares (A) will be subject to mandatory
redemption only to the extent that other shares are not available
to satisfy the number of shares required to be redeemed and (B)
will be selected for redemption in an ascending order of
outstanding number of days remaining in the Non-Call Period (with
shares with the lowest number of days to be redeemed first) and
by lot in the event of shares having an equal number of days
remaining 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 AMPS and other preferred shares of beneficial interest
of the Trust which are subject to mandatory 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
AMPS 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 Section 11.4, no
AMPS may be redeemed pursuant to Section 11.4(a)(i) of these Bylaws
unless (i) all dividends in arrears on all remaining outstanding
Parity Shares shall have been or are being contemporaneously paid or
declared and set apart for payment, and (ii) redemption thereof would
not result in the Trust's failure to maintain Fitch Eligible Assets or
Moody's Eligible Assets with an aggregate Discounted Value equal to or
greater than the Preferred Shares Basic Maintenance Amount. In the
event that less than all the outstanding shares of a series of AMPS
are to be redeemed and there is more than one Holder, the shares of
that series of AMPS to be redeemed shall be selected by lot or such
other method as the Trust shall deem fair and equitable.
(c) Whenever AMPS 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 AMPS to be redeemed and to the Auction
Agent. The Notice of Redemption shall set forth (i) the redemption
date, (ii) the amount of the redemption price, (iii) the aggregate
number of AMPS of such series to be redeemed, (iv) the place or places
where AMPS 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 and (vi)
the provision of these Bylaws 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 equal to the redemption payment (including any
applicable premiums) for the AMPS 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 (including without
limitation voting 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,
A-45
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.
11.5 Voting Rights.
(a) General. Except as otherwise provided in the Declaration of
Trust or Bylaws or as otherwise required by applicable law, each
Holder of AMPS 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 preferred shares of beneficial interest of the
Trust, including AMPS, and 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
preferred shares of beneficial interest of the Trust, including AMPS,
shall be entitled, as a class, to the exclusion of the holders of all
other securities and classes of shares of beneficial interest of the
Trust, to elect two trustees of the Trust. Subject to Section 11.5(b)
hereof, the holders of shares of beneficial interest of the Trust,
including the holders of preferred shares of beneficial interest of
the Trust, including AMPS, voting as a single class, shall elect the
balance of the trustees.
(b) Right to Elect Majority of Board of Trustees. Except as
otherwise required by law, 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 of the Trust shall be automatically
increased by the smallest number that, when added to the two trustees
elected exclusively by the holders of preferred shares of beneficial
interest of the Trust, including the AMPS, would constitute a majority
of the Board of Trustees of the Trust as so increased by such smallest
number; and the holders of preferred shares of beneficial interest of
the Trust 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 (as so elected, the "Additional Trustees"), in
addition to 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 any outstanding
preferred shares, including the AMPS, 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
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(ii) if at any time holders of any preferred shares of
beneficial interest of the Trust, including the holders of AMPS,
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 Section 11.5(b) shall cease, subject always,
however, to the revesting of such voting rights in the Holders
upon the further occurrence of any of the events described in
this Section 11.5(b), the terms of the Additional Trustees shall
terminate automatically, and the remaining Trustees shall
constitute the Trustees of the Trust.
(c) Right to Vote with Respect to Certain Other Matters. So long
as any AMPS are Outstanding, the Trust shall not, without the
affirmative vote or consent of the holders of a majority of the
preferred shares of the Trust, including the AMPS, Outstanding at the
time, voting separately as one class: (i) authorize, create or issue
any class or series of shares of beneficial interest ranking prior to
the AMPS or any other series of preferred shares of beneficial
interest of the Trust with respect to payment of dividends or the
distribution of assets upon dissolution, liquidation or winding up the
affairs of the Trust; provided, however, that no vote is required to
authorize the issuance of another series of AMPS or another class of
preferred shares of beneficial interest of the Trust that is
substantially identical in all respects to the AMPS; or (ii) amend,
alter or repeal the provisions of the Declaration of Trust or Bylaws,
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 Bylaws of holders of AMPS or any other
preferred shares of beneficial interest of the Trust. To the extent
permitted under the 1940 Act, in the event shares of more than one
series of preferred shares of the Trust, including the AMPS, 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 or Bylaws of a Holder
of a series of AMPS differently than those of a Holder of any other
series of preferred shares of of the Trust, including the AMPS,
without the affirmative vote of the holders of at least a majority of
the AMPS of each series adversely affected and Outstanding at such
time (each such adversely affected series voting separately as a
class). Unless a higher percentage is provided for under the
Declaration of Trust or these Bylaws, the affirmative vote of the
holders of a majority of the outstanding preferred shares of
beneficial interest of the Trust, including AMPS, voting together as a
single class, will be required to approve any plan of reorganization
(including bankruptcy proceedings) adversely affecting such shares or
any action requiring a vote of security holders under Section 13(a) of
the 1940 Act. To the extent permitted under the 1940 Act, in the event
shares of more than one series of AMPS are outstanding, with respect
to any action requiring Shareholder approval pursuant to the operation
of Section 2 or Section 3 of Article V of the Declaration of Trust,
the affirmative vote of at least seventy-five percent of the AMPS of
each series Outstanding at such time (each such series voting
separately as a class) shall also be required. The class (and, where
applicable, the series) vote of holders of preferred shares of
beneficial interest of the Trust, including AMPS, described above will
in each case be in addition to a separate vote of the requisite
percentage of Common Shares and preferred shares of beneficial
interest of the Trust, including AMPS, 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 preferred shares of beneficial interest of the Trust to
elect additional trustees as described in Section 11.5(b) above, the
Trust shall call a special meeting of such holders and instruct the
Auction Agent and any other registrar for preferred shares of
beneficial interest of the Trust other than AMPS 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
and any other applicable registrar, 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 at which trustees are to be elected, such holders, voting
together as a class (to the exclusion of the holders of all other
securities and classes of shares of beneficial interest of the Trust),
shall be entitled to elect the number of Trustees prescribed in
Section 11.5(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) Except as otherwise required by applicable law, 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 Bylaws, by the other provisions
of the Declaration of Trust, by statute or otherwise, an Auction
Market Preferred Share 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 of beneficial interest of the Trust 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 of beneficial
interest of the Trust and the remaining incumbent trustees elected by
the holders of the Common Shares and preferred shares of beneficial
interest of the Trust, shall constitute the duly elected trustees of
the Trust.
(iv) Simultaneously with the termination of a Voting Period,
the terms of office of the Additional Trustees shall automatically
terminate, the remaining trustees shall constitute the trustees of the
Trust and the voting rights of the Holders and such other holders to
elect additional trustees pursuant to Section 11.5(b) above shall
cease, subject to the provisions of the last sentence of Section
11.5(b).
(e) Exclusive Remedy. Unless otherwise required by law, the Holders
shall not have any rights or preferences other than those specifically set
forth herein. The Holders shall have no preemptive rights or rights to
cumulative voting. In the event that the Trust fails to pay any dividends
on the AMPS, the exclusive remedy of the Holders shall be the right to vote
for trustees pursuant to the provisions of this Section 11.5.
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11.6 1940 Act Preferred Shares Asset Coverage . The Trust shall maintain,
as of the last Business Day of each month in which any AMPS are outstanding, the
1940 Act Preferred Shares Asset Coverage.
11.7 Preferred Shares Basic Maintenance Amount.
(a) So long as any AMPS are outstanding and any Rating Agency so
requires, 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 each having an aggregate
Discounted Value equal to or greater than the Preferred Shares Basic
Maintenance Amount. Upon any failure to maintain the required Discounted
Value, the Trust will use its best efforts to alter the composition of its
portfolio to retain a Discounted Value of both Fitch Eligible Assets and
Moody's Eligible Assets at least equal to the Preferred Shares Basic
Maintenance Amount on or prior to the Preferred Shares 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
Preferred Shares Basic Maintenance Amount, the Trust shall complete and
deliver to (i) the Auction Agent and (ii) Fitch Ratings, Moody's and any
other Rating Agency then rating the AMPS the Discounted Value of whose
Eligible Assets fails to satisfy the Preferred Shares Basic Maintenance
Amount, as applicable, a complete Preferred Shares Basic Maintenance Report
as of the date of such failure, which will be deemed to have been delivered
to such recipient if the recipient receives a copy or telecopy, telex or
other electronic transcription thereof and on the same day the Trust mails
to the recipient for delivery on the next Business Day the complete
Preferred Shares Basic Maintenance Report. The Trust will deliver a
Preferred Shares Basic Maintenance Report to each applicable Rating Agency
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 Eligible
Assets of each applicable Rating Agency with an aggregate Discounted Value
equal to or greater than the Preferred Shares Basic Maintenance Amount or
on which the Trust fails to maintain Eligible Assets of each applicable
Rating Agency with an aggregate Discounted Value which exceeds the
Preferred Shares Basic Maintenance Amount by 5% or more. The Trust will
also deliver a Preferred Shares Basic Maintenance Report to the Auction
Agent, Fitch Ratings and Moody's as of each Quarterly 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 a Preferred Shares
Basic Maintenance Report to the Auction Agent, Fitch Ratings and Moody's.
The Trust shall also provide Fitch Ratings or Moody's with a Preferred
Shares Basic Maintenance Report when specifically requested by Fitch
Ratings or Moody's, respectively.
(c) Within ten Business Days after the date of delivery of a
Preferred Shares Basic Maintenance Report in accordance with Section
11.7(b) above relating to a Quarterly Valuation Date (except as described
in the following sentence), the Independent Accountant will confirm in
writing to the Auction Agent, Fitch Ratings and Moody's, (i) the
mathematical accuracy of the calculations reflected in such Report (and in
any other Preferred Shares Basic Maintenance Report, randomly selected by
the Independent Accountant, that was delivered by the Trust during the
quarter ending on such Quarterly Valuation Date), (ii) that, in such
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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 Quarterly Valuation Date in accordance
with these Bylaws, (iii) that, in such Report (and in such randomly
selected Report), the Trust determined whether the Trust had, at such
Quarterly Valuation Date (and at the Valuation Date addressed in such
randomly selected Report) in accordance with these Bylaws, Fitch Eligible
Assets and Moody's Eligible Assets each with an aggregate Discounted Value
at least equal to the Preferred Shares Basic Maintenance Amount, (iv) with
respect to the ratings by S&P of Fitch Ratings on portfolio securities of
the Trust, the issuer name, issue size and coupon rate, if any, listed in
such Report, that the Independent Accountant has requested that S&P or
Fitch Ratings verify such information and the Independent Accountant shall
provide a listing in its letter of any differences, (v) with respect to the
Fitch Ratings' ratings on portfolio securities of the Trust, the issuer
name, issue size and coupon rate, if any, listed in such Report, that such
information has been verified by Fitch Ratings (in the event such
information is not verified by Fitch Ratings, the Independent Accountant
will inquire of Fitch Ratings what such information is, and provide a
listing in its letter of any differences), (vi) with respect to the Moody's
ratings on portfolio securities of the Trust, the issuer name, issue size
and coupon rate, if any, 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) and
(vii) 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) (such
confirmation is herein called the "Accountant's Confirmation").
Notwithstanding the foregoing sentence, the Independent Accountant will
provide the confirmation described in the foregoing sentence with respect
to Preferred Shares Basic Maintenance Reports delivered pursuant to the
third sentence of Section 11.7(b) above only for such Preferred Shares
Basic Maintenance Reports relating to the last fiscal quarter of each
fiscal year.
(d) Within ten Business Days after the date of delivery to the
Auction Agent and any applicable Rating Agency of a Preferred Shares Basic
Maintenance Report in accordance with Section 11.7(b) above relating to any
Valuation Date on which the Trust failed to maintain Eligible Assets of
such applicable Rating Agency with an aggregate Discounted Value equal to
or greater than the Preferred Shares Basic Maintenance Amount, and relating
to the AMPS Basic Maintenance Cure Date with respect to such failure, the
Trust shall cause the Independent Accountant to provide to the Auction
Agent and each applicable Rating Agency an Accountant's Confirmation as to
such Preferred Shares Basic Maintenance Report.
(e) If any Accountant's Confirmation delivered pursuant to
subparagraph (c) or (d) of this Section 11.7 shows that an error was made
in the Preferred Shares Basic Maintenance Report for a particular Valuation
Date for which such Accountant's Confirmation was required to be delivered,
or shows that a lower aggregate Discounted Value for the aggregate of all
Fitch Eligible Assets or Moody's Eligible Assets of the Trust was
determined by the Independent Accountant, the calculation or determination
made by such Independent
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Accountant shall be final and conclusive and shall be binding on the Trust,
and the Trust shall accordingly amend and deliver the Preferred Shares
Basic Maintenance Report to the Auction Agent and each applicable Rating
Agency promptly following receipt by the Trust of such Accountant's
Confirmation.
(f) Within five Business Days after the Date of Original Issue of the
AMPS, the Trust will complete and deliver to Moody's a Preferred Shares
Basic Maintenance Report as of the close of business on such Date of
Original Issue. Also, on or before 5:00 p.m., New York City time, on the
first Business Day after any Common Shares are repurchased by the Trust,
the Trust will complete and deliver to Fitch Ratings and Moody's a
Preferred Shares Basic Maintenance Report as of the close of business on
such date that Common Shares are repurchased.
11.8 Certain Other Restrictions.
(a) For so long as any AMPS are rated by Moody's, the Trust will not
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 (except covered call options) on
portfolio securities unless it receives written confirmation from Moody's
that engaging in such transactions would not impair the ratings then
assigned to the AMPS by Moody's, except that the Trust may purchase or sell
exchange-traded financial futures contracts based on any index approved by
Moody's or Treasury Bonds, and purchase, write or sell exchange-traded put
options on such financial futures contracts, any index approved by Moody's
or Treasury Bonds, and purchase, write or sell exchange-traded call options
on such financial futures contracts, any index approved by Moody's or
Treasury Bonds (collectively "Moody's Hedging Transactions"), subject to
the following limitations:
(i) the Trust will not engage in any Moody's Hedging
Transaction based on any index approved by Moody's (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:
(A) outstanding financial futures contracts based on such
index exceeding in number 10% (or such higher percentage as
Moody's may approve) of the average number of daily traded
financial futures contracts based on such index in the 30 days
preceding the time of effecting such transaction as reported by
The Wall Street Journal; or
(B) outstanding financial futures contracts based on any
index approved by Moody's having a Market Value exceeding 50% (or
such higher percentage as Moody's may approve) of the Market
Value of all portfolio securities of the Trust constituting
Moody's Eligible Assets owned by the Trust (other than Moody's
Eligible Assets already subject to a Moody's Hedging
Transaction);
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(ii) the Trust will not engage in any Moody's Hedging
Transaction based on Treasury Bonds (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 with such contracts having an aggregate Market
Value exceeding 20% (or such higher percentage as Moody's may
approve) of the aggregate Market Value of Moody's Eligible Assets
owned by the Trust and rated Aa or higher by Moody's (or, if not
rated by Moody's but rated by S&P or Fitch Ratings, rated AAA by
S&P or Fitch Ratings); or
(B) outstanding financial futures contracts based on
Treasury Bonds with such contracts having an aggregate Market
Value exceeding 80% of the aggregate Market Value of all
portfolio securities of the Trust constituting Moody's Eligible
Assets owned by the Trust (other than Moody's Eligible Assets
already subject to a Moody's Hedging Transaction) and rated Baa
or A by Moody's (or, if not rated by Moody's but rated by S&P or
Fitch Ratings, rated A or AA by S&P or Fitch Ratings)
(for purposes of the foregoing clauses (i) and (ii), the Trust shall
be deemed to own the number of financial futures contracts that
underlie any outstanding options written by the Trust);
(iii) the Trust will engage in Closing Transactions to close out
any outstanding financial futures contract based on any index approved
by Moody's if the amount of open interest in such index as reported by
The Wall Street Journal is less than an amount to be mutually
determined by Moody's and the Trust;
(iv) the Trust will engage in a Closing Transaction to close
out any outstanding financial futures contract by no later than the
fifth Business Day of the month in which such contract expires and
will engage in a Closing Transaction to close out any outstanding
option on a financial futures contract by no later than the first
Business Day of the month in which such option expires;
(v) the Trust will engage in Moody's Hedging Transactions only
with respect to financial futures contracts or options thereon having
the next settlement date or the settlement date immediately
thereafter;
(vi) the Trust (A) will not engage in options and futures
transactions for leveraging or speculative purposes, except that an
option or futures transaction shall not for these purposes be
considered a leveraged position or speculative so long as the
combination of the Trust's non-derivative positions, together with the
relevant option or futures transaction, produces a synthetic
investment position, or the same economic result, that could be
achieved by an investment, consistent with the Trust's investment
objectives and policies, in a security that is not an option or
futures transaction, and (B) will not write any call options or sell
any financial futures contracts for the purpose of hedging the
anticipated purchase of an asset prior to completion of such purchase;
and
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(vii) while the Trust may use options and futures transactions
for hedging and risk management purposes, it will not enter into an
option or futures transaction unless, after giving effect thereto, the
Trust would continue to have Moody's Eligible Assets with an aggregate
Discounted Value equal to or greater than the Preferred Shares Basic
Maintenance Amount.
(b) For purposes of determining whether the Trust has Moody's
Eligible Assets with an aggregate Discounted Value that equals or exceeds
the Preferred Shares Basic Maintenance Amount, the Discounted Value of
Moody's Eligible Assets that the Trust is obligated to deliver or receive
pursuant to an outstanding futures contract or option shall be as follows:
(i) assets subject to call options written by the Trust that
are either exchange-traded and "readily reversible" or that expire
within 49 days after the date as of which such valuation is made shall
be valued at the lesser of (A) Discounted Value and (B) the exercise
price of the call option written by the Trust;
(ii) assets subject to call options written by the Trust not
meeting the requirements of clause (i) of this sentence shall have no
value;
(iii) assets subject to put options written by the Trust shall
be valued at the lesser of (A) the exercise price and (B) the
Discounted Value of the assets subject to the option;
(iv) futures contracts shall be valued at the lesser of (A)
settlement price and (B) the Discounted Value of the assets subject to
the futures contract, provided that, if a contract matures within 49
days after the date as of which such valuation is made, where the
Trust is the seller the contract may be valued at the settlement price
and where the Trust is the buyer the contract may be valued at the
Discounted Value of the assets subject to the futures contract; and
(v) where delivery may be made to the Trust with any security
of a class of securities, the Trust shall assume that it will take
delivery of the security with the lowest Discounted Value.
(c) For purposes of determining whether the Trust has Moody's
Eligible Assets with an aggregate Discounted Value that equals or exceeds
the Preferred Shares Basic Maintenance Amount, the following amounts shall
be subtracted from the aggregate Discounted Value of the Moody's Eligible
Assets held by the Trust to the extent the relevant asset is a Moody's
Eligible Asset:
(i) 10% of the exercise price of a written call option;
(ii) the exercise price of any written put option;
(iii) where the Trust is the seller under a financial futures
contract, 10% of the settlement price of the financial futures
contract;
A-53
(iv) where the Trust is the purchaser under a financial futures
contract, any amounts payable by the Trust under such financial
futures contract;
(v) the settlement price of the underlying financial futures
contract if the Trust writes put options on a financial futures
contract; and
(vi) 105% of the Market Value of the underlying financial
futures contract if the Trust writes call options on a financial
futures contract and does not own the underlying contract.
(d) For so long as any AMPS are rated by Moody's, the Trust will not
enter into any "Forward Commitment," herein defined as any contract to
purchase securities for a fixed price at a future date beyond customary
settlement time (other than such contracts that constitute Fitch Hedging
Transactions or Moody's Hedging Transactions, as applicable), except that
the Trust may enter into Forward Commitments subject to the following
limitations:
(i) for each Forward Commitment, the Trust will maintain with
its custodian (A) cash, cash equivalents or short-term, fixed-income
securities rated P-1, MIG-1 or VMIG-1 by Moody's or A-1 by S&P or
Fitch Ratings and maturing in one year or less with a fair market
value that equals or exceeds the amount by which the Trust's
obligations under any Forward Commitments to which it is from time to
time a party exceed obligations to the Trust arising from securities
sales by the Trust that are scheduled to settle at a future date, or
(B) long-term, fixed-income securities with a then current market
value that equals or exceeds the amount by which the Trust's
obligations under any Forward Commitments to which it is from time to
time a party exceed obligations to the Trust arising from securities
sales by the Trust that are scheduled to settle on a future date, or
(C) a combination of assets described in (A) and (B) above that in the
aggregate equals or exceeds the amount by which the Trust's
obligations under any Forward Commitments to which it is from time to
time a party exceed obligations to the Trust arising from securities
sales by the Trust that are scheduled to settle on a future date; and
(ii) the Trust will not enter into a Forward Commitment unless,
after giving effect thereto, the Trust would continue to have Moody's
Eligible Assets with an aggregate Discounted Value equal to or greater
than the Preferred Shares Basic Maintenance Amount.
For purposes of determining whether the Trust has Moody's Eligible
Assets with an aggregate Discounted Value that equals or exceeds the
Preferred Shares Basic Maintenance Amount, the Discounted Value of all
Forward Commitments to which the Trust is a party and of all
securities deliverable to the Trust pursuant to such Forward
Commitments shall be zero.
(e) For so long as any AMPS are Outstanding and Fitch Ratings or
Moody's or both are rating such shares, the Trust, unless it has received
written confirmation from Fitch
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Ratings or Moody's or both, as applicable, that such action would not
impair the rating then assigned to the AMPS by Fitch Ratings or Moody's or
both, as applicable, will not:
(i) borrow money except for the purpose of clearing
transactions in portfolio securities (which borrowings under any
circumstances shall be limited to an amount equal to 5% of the Market
Value of the Trust's assets at the time of such borrowings and which
borrowings shall be repaid within 60 days and not be extended or
renewed and shall not cause the aggregate Discounted Value of Fitch
Eligible Assets or Moody's Eligible Assets, as applicable, to be less
than the Preferred Shares Basic Maintenance Amount);
(ii) engage in short sales of securities;
(iii) lend any securities;
(iv) issue any class or series of shares of beneficial interest
ranking prior to or on a parity with the AMPS with respect to the
payment of dividends or the distribution of assets upon dissolution,
liquidation or winding up of the Trust;
(iv) merge or consolidate into or with any other corporation or
entity; and
(vi) change any Pricing Service of the Trust.
(f) For so long as any AMPS are rated by Fitch Ratings, the Trust
will not 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 (except covered call
options) on portfolio securities unless it receives written confirmation
from Fitch Ratings that engaging in such transactions would not impair the
ratings then assigned to the AMPS by Fitch Ratings, except that the Trust
may purchase or sell exchange-traded financial futures contracts based on
any index approved by Fitch Ratings or Treasury Bonds, and purchase, write
or sell exchange-traded put options on such financial futures contracts,
any index approved by Fitch Ratings or Treasury Bonds and purchase, write
or sell exchange-traded call options on such financial futures contracts,
any index approved by Fitch Ratings or Treasury Bonds (collectively "Fitch
Hedging Transactions"), subject to the following limitations:
(i) the Trust will not engage in any Fitch Hedging Transaction
based on any index approved by Fitch Ratings (other than 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 (other than Closing Transactions) that would
cause the Trust at the time of such transaction to own or have sold:
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(A) outstanding financial futures contracts based on
Treasury Bonds with such contracts having an aggregate Market
Value exceeding 20% of the aggregate Market Value of Fitch
Eligible Assets owned by the Trust and rated at least AA by Fitch
Ratings (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 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 Ratings (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 will engage in Closing Transactions to close out
any outstanding financial futures contract based on any index approved
by Fitch Ratings 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 Ratings and the Trust; and
(iv) the Trust will not enter into an option or futures
transaction unless, after giving effect thereto, the Trust would
continue to have Fitch Eligible Assets with an aggregate Discounted
Value equal to or greater than the Preferred Shares Basic Maintenance
Amount.
(g) For purposes of determining whether the Trust has Fitch Eligible
Assets with an aggregate Discounted Value that equals or exceeds the
Preferred Shares Basic Maintenance Amount, the Discounted Value of Fitch
Eligible Assets that the Trust is obligated to deliver or receive pursuant
to an outstanding futures contract or option shall be as follows:
(i) assets subject to call options written by the Trust that
are either exchange-traded and "readily reversible" or that expire
within 49 days after the date as of which such valuation is made shall
be valued at the lesser of (A) Discounted Value and (B) the exercise
price of the call option written by the Trust;
(ii) assets subject to call options written by the Trust not
meeting the requirements of clause (i) of this sentence shall have no
value;
(iii) assets subject to put options written by the Trust shall
be valued at the lesser of (A) the exercise price and (B) the
Discounted Value of the assets subject to the option;
(iv) futures contracts shall be valued at the lesser of (A)
settlement price and (B) the Discounted Value of the assets subject to
the futures contract, provided that, if a contract matures within 49
days after the date as of which such valuation is made, where the
Trust is the seller the contract may be valued at the settlement price
and
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where the Trust is the buyer the contract may be valued at the
Discounted Value of the assets subject to the futures contract; and
(v) where delivery may be made to the Trust with any security
of a class of securities, the Trust shall assume that it will take
delivery of the security with the lowest Discounted Value.
(h) For purposes of determining whether the Trust has Fitch Eligible
Assets with an aggregate Discounted Value that equals or exceeds the
Preferred Shares Basic Maintenance Amount, the following amounts shall be
subtracted from the aggregate Discounted Value of the Fitch Eligible Assets
held by the Trust to the extent the relevant asset is a Fitch Eligible
Asset:
(i) 10% of the exercise price of a written call option;
(ii) the exercise price of any written put option;
(iii) where the Trust is the seller under a financial futures
contract, 10% of the settlement price of the financial futures
contract;
(iv) where the Trust is the purchaser under a financial futures
contract, the settlement price of assets purchased under such
financial futures contract;
(v) the settlement price of the underlying financial futures
contract if the Trust writes put options on a financial futures
contract and does not own the underlying contract; and
(vi) 105% of the Market Value of the underlying financial
futures contracts if the Trust writes call options on a financial
futures contract and does not own the underlying contract.
(i) For so long as any AMPS are rated by Fitch Ratings, the Trust
will not enter into any Forward Commitments, except that the Trust may
enter into Forward Commitments subject to the following limitations:
(i) the Trust will maintain in a segregated account with its
custodian cash, cash equivalents or short-term, fixed-income
securities rated F1 or better by Fitch Ratings (or, if not rated by
Fitch Ratings, rated P-1 by Moody's) and maturing prior to the date of
the Forward Commitment with a Market Value that equals or exceeds the
amount of the Trust's obligations under any Forward Commitments to
which it is from time to time a party or long-term fixed income
securities with a Discounted Value that equals or exceeds the amount
of the Trust's obligations under any Forward Commitment to which it is
from time to time a party; and
(ii) the Trust will not enter into a Forward Commitment unless,
after giving effect thereto, the Trust would continue to have Fitch
Eligible Assets with an aggregate Discounted Value equal to or greater
than the Preferred Shares Basic Maintenance Amount.
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For purposes of determining whether the Trust has Fitch Eligible Assets with an
aggregate Discounted Value that equals or exceeds the Preferred Shares Basic
Maintenance Amount, the Discounted Value of all Forward Commitments to which the
Trust is a party and of all securities deliverable to the Trust pursuant to such
Forward Commitments shall be zero.
11.9 Notice. All notices or communications, unless otherwise specified in
these Bylaws, 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 seven days after which such notice
is mailed.
11.10 Auction Procedures.
(a) Certain Definitions. As used in this Section 11.10, the
following terms shall have the following meanings, unless the context
otherwise requires:
(i) "AMPS" means the AMPS being auctioned pursuant to this Section
11.10
(ii) "Auction Date" means the first Business Day preceding the first
day of a Dividend Period.
(iii) "Available AMPS" has the meaning specified in Section
11.10(d)(i)(A) below.
(iv) "Bid" has the meaning specified in Section 11.10(b)(i)(B) below.
(v) "Bidder" has the meaning specified in Section 11.10(b)(i)(B)
below.
(vi) "Hold Order" has the meaning specified in Section 11.10(b)(i)(B)
below.
(vii) "Maximum Applicable Rate" for any Dividend Period will be the
greater of the Applicable Percentage of the Reference Rate or the
Applicable Spread plus the Reference Rate. The Auction Agent will round
each applicable Maximum Applicable Rate to the nearest one-thousandth
(.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 (.001) of one percent. The Auction Agent will not round the
applicable Reference Rate as part of its calculation of the Maximum
Applicable Rate.
The "Applicable Percentage" shall be the percentage determined based
on the lower of the credit ratings assigned on such date by Moody's and
Fitch Ratings as follows:
Credit Ratings
----------------------------------- Applicable
Moody's Fitch Percentage
--------------- ------------- ----------
Aaa AAA 125%
Aa3 to Aa1 AA- to AA+ 150%
A3 to A1 A- to A+ 200%
Baa3 to Baa1 BBB- to BBB+ 250%
Ba1 and lower BB+ and lower 300%
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The Applicable Percentage as so determined shall be further subject to
upward but not downward adjustment in the discretion of the Board of
Trustees of the Trust after consultation with the Broker-Dealers, provided
that the Board of Trustees has received assurance from Moody's, Fitch
Ratings and from any other Rating Agency then rating the APMS that such
increase will not impair such Rating Agency's rating thereof, and further
provided that immediately following any such increase the Trust would be in
compliance with the Preferred Shares Basic Maintenance Amount. The Trust
shall take all reasonable action necessary to enable Moody's or Fitch
Ratings to provide a rating for each series of AMPS. If Moody's or Fitch
Ratings shall not make such a rating available, Merrill Lynch, Pierce,
Fenner and Smith Incorporated or its affiliates and successors, after
consultation with the Trust, shall select another Rating Agency to act as a
Substitute Rating Agency.
"Applicable Spread" means the spread determined based on the credit
rating assigned to the series of AMPS on such date by Moody's and Fitch
Ratings as follows:
Credit Ratings
------------------------------------------------ Applicable Spread
Moody's Fitch over Reference Rate
----------------------- --------------------- ---------------------
Aaa AAA 125 bps
Aa3 to Aa1 AA- to AA+ 150 bps
A3 to A1 A- to A+ 200 bps
Baa3 to Baa1 BBB- to BBB+ 250 bps
Ba1 and lower BB+ and lower 300 bps
The Applicable Spread as so determined will be further subject to
upward but not downward adjustment in the discretion of the Board of
Directors after consultation with the Broker-Dealers, provided that that
immediately following any such increase the Fund would be in compliance
with the Preferred Shares Basic Maintenance Amount. The Fund will take all
reasonable action necessary to enable either Moody's or Fitch to provide a
rating for each series of AMPS. If neither Moody's nor Fitch will make such
a rating available, the Fund will select another Rating Agency to act as a
substitute Rating Agency.
For purposes of this definition, the "prevailing rating" of shares of
a series of AMPS will be (i) AAA if such shares have a rating of AAA by
Moody's or Fitch or the equivalent of such ratings by such agencies or
substitute rating agencies selected as provided below; (ii) if not AAA,
then AA- if such shares have a rating of AA- or better by Moody's or Fitch
or the equivalent of such ratings by such agencies or substitute rating
agencies selected as provided below, (iii) if not AA- or higher, than A- if
such shares have a rating of A- or better by Moody's or Fitch or the
equivalent of such ratings by such agencies or substitute rating agencies
selected as provided below, (iv) if not A- or higher then BBB- if such
shares have a rating of BBB- or better by Moody's or Fitch or the
equivalent of such ratings by such agencies or substitute rating agencies
selected as
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provided below, (v) if not BBB- or higher, then below BBB-; provided,
however, that if such shares are rated by only one rating agency, the
prevailing rating will be determined without reference to the rating of any
other rating agency.
(viii) "Order" has the meaning specified in Section 11.10(b)(i)(B)
below.
(ix) "Sell Order" has the meaning specified in Section 11.10(b)(i)
(B) below.
(x) "Submission Deadline" means 1:00 p.m., New York City time, on
any Auction Date or such other time on any Auction Date as may be specified
by the Auction Agent from time to time as the time by which each
Broker-Dealer must submit to the Auction Agent in writing all Orders
obtained by it for the Auction to be conducted on such Auction Date.
(xi) "Submitted Bid" has the meaning specified in Section 11.10(d)
(i) below.
(xii) "Submitted Hold Order" has the meaning specified in Section
11.10(d)(i) below.
(xiii) "Submitted Order" has the meaning specified in Section
11.10(d)(i) below.
(xiv) "Submitted Sell Order" has the meaning specified in Section
11.10(d)(i) below.
(xv) "Sufficient Clearing Bids" has the meaning specified in Section
11.10(d) (i) below.
(xvi) "Winning Bid Rate" has the meaning specified in Section
11.10(d)(i)(C) below.
(b) Orders by Beneficial Owners, Potential Beneficial Owners,
Existing Holders and Potential Holders.
(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 AMPS 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 AMPS, if any, held by
such Beneficial Owner which such Beneficial Owner desires
to continue
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to hold without regard to the Applicable Rate for the next
succeeding Dividend Period for such shares;
(2) the number of Outstanding AMPS, if any, held by
such Beneficial Owner which such Beneficial Owner desires
to continue to hold, provided that the Applicable Rate for
the next succeeding Dividend Period for such shares shall
not be less than the rate per annum specified by such
Beneficial Owner; and/or
(3) the number of Outstanding AMPS, if any, held by
such Beneficial Owner which such Beneficial Owner offers
to sell without regard to the Applicable Rate for the next
succeeding Dividend Period; and
(B) each Broker-Dealer, using a list of Potential
Beneficial Owners that shall be maintained in good faith in a
commercially reasonable manner for the purpose of conducting a
competitive Auction, shall contact Potential Beneficial Owners,
including Persons that are not Beneficial Owners, on such list
to determine the number of Outstanding AMPS, if any, which each
such Potential Beneficial Owner offers to purchase, provided
that the Applicable Rate for the next succeeding Dividend
Period shall not be less than the rate per annum specified by
such Potential Beneficial Owner.
For the purposes hereof, the communication by a Beneficial
Owner or Potential Beneficial Owner to a Broker-Dealer, or the
communication by a Broker-Dealer acting for its own account to
the Auction Agent, of information referred to in clause (A) or
(B) of this Section 11.10(b)(i) is hereinafter referred to as
an "Order" and each Beneficial Owner and each Potential
Beneficial Owner placing an Order, including a Broker-Dealer
acting in such capacity for its own account, is hereinafter
referred to as a "Bidder"; an Order containing the information
referred to in clause (A)(1) of this Section 11.10(b)(i) is
hereinafter referred to as a "Hold Order"; an Order containing
the information referred to in clause (A)(2) or (B) of this
Section 11.10(b)(i) is hereinafter referred to as a "Bid"; and
an Order containing the information referred to in clause
(A)(3) of this Section 11.10(b)(i) is hereinafter referred to
as a "Sell Order." Inasmuch as a Broker-Dealer participates in
an Auction as an Existing Holder or a Potential Holder only to
represent the interests of a Beneficial Owner or Potential
Beneficial Owner, whether it be its customers or itself, all
discussion herein relating to the consequences of an Auction
for Existing Holders and Potential Holders also applies to the
underlying beneficial ownership interests represented.
(ii) (A) A Bid by a Beneficial Owner or an Existing Holder
shall constitute an irrevocable offer to sell:
(1) the number of Outstanding AMPS 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
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(2) such number or a lesser number of Outstanding AMPS to
be determined as set forth in Section 11.10(e)(i)(D) if the
Applicable Rate determined on such Auction Date shall be equal
to the rate per annum specified therein; or
(3) a lesser number of Outstanding AMPS to be determined
as set forth in Section 11.10(e)(ii)(C) if such specified rate
per annum shall be higher than the Maximum Applicable Rate and
Sufficient Clearing Bids do not exist.
(B) A Sell Order by a Beneficial Owner or an Existing Holder
shall constitute an irrevocable offer to sell:
(1) the number of Outstanding AMPS specified in such Sell
Order; or
(2) such number or a lesser number of Outstanding AMPS to
be determined as set forth in Section 11.10(e)(ii)(C) if
Sufficient Clearing Bids do not exist.
(C) A Bid by a Potential Holder shall constitute an
irrevocable offer to purchase:
(1) the number of Outstanding AMPS 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 AMPS to
be determined as set forth in Section 11.10(e)(i)(E) if the
Applicable Rate determined on such Auction Date shall be equal
to the rate per annum specified therein.
(c) Submission of Orders by Broker-Dealers to Auction Agent.
(i) Each Broker-Dealer shall submit in writing or through the
Auction Agent's auction processing system to the Auction Agent prior to the
Submission Deadline on each Auction Date all Orders obtained by such
Broker-Dealer, designating itself (unless otherwise permitted by the Trust)
as an Existing Holder in respect of shares subject to Orders submitted or
deemed submitted to it by Beneficial Owners and as a Potential Holder in
respect of shares subject to Orders submitted to it by Potential Beneficial
Owners, and specifying with respect to each Order:
(A) the name of the Bidder placing such Order (which shall be
the Broker-Dealer unless otherwise permitted by the Trust);
(B) the aggregate number of Outstanding AMPS that are the
subject of such Order;
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(C) to the extent that such Bidder is a Beneficial Owner or an
Existing Holder:
(1) the number of Outstanding AMPS, if any, subject to
any Hold Order placed by such Beneficial Owner or Existing
Holder;
(2) the number of Outstanding AMPS, if any, subject to
any Bid placed by such Beneficial Owner or Existing Holder and
the rate per annum specified in such Bid; and
(3) the number of Outstanding AMPS, if any, subject to
any Sell Order placed by such Beneficial Owner or Existing
Holder; and
(D) to the extent such Bidder is a Potential Holder, the rate
per annum specified in such Potential Holder's Bid.
(ii) If any rate per annum specified in any Bid contains more than
three figures to the right of the decimal point, the Auction Agent shall
round such rate up to the next highest one-thousandth (.001) of 1%.
(iii) If an Order or Orders covering all of the Outstanding AMPS held
by an Existing Holder are not submitted to the Auction Agent prior to the
Submission Deadline, the Auction Agent shall deem a Hold Order (in the case
of any Auction other than an Auction relating to a Special Dividend Period
of 91 days or less) or a Sell Order (in the case of an Auction relating to
a Special Dividend Period of longer than 91 days) to have been submitted on
behalf of such Existing Holder covering the number of Outstanding AMPS 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 AMPS 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 AMPS 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 AMPS subject to such Hold Orders exceeds the number of
Outstanding AMPS held by such Existing Holder, the number of AMPS
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 AMPS 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
AMPS held by such Existing
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Holder over the number of AMPS subject to any Hold Order referred to
in Section 11.10(c)(iv)(A) above (and if more than one Bid submitted
on behalf of such Existing Holder specifies the same rate per annum
and together they cover more than the remaining number of shares that
can be the subject of valid Bids after application of Section
11.10(c)(iv)(A) above and of the foregoing portion of this Section
11.10(c)(iv)(B) to any Bid or Bids specifying a lower rate or rates
per annum, the number of shares subject to each of such Bids shall be
reduced pro rata so that such Bids, in the aggregate, cover exactly
such remaining number of shares); and the number of shares, if any,
subject to Bids not valid under this Section 11.10(c)(iv)(B) shall be
treated as the subject of a Bid by a Potential Holder; and
(C) any Sell Order shall be considered valid up to and
including the excess of the number of Outstanding AMPS held by such
Existing Holder over the number of AMPS subject to Hold Orders
referred to in Section 11.10(c)(iv)(A) and Bids referred to in Section
11.10(c)(iv)(B); provided that if more than one Sell Order is
submitted on behalf of any Existing Holder and the number of AMPS
subject to such Sell Orders is greater than such excess, the number of
AMPS 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
AMPS 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 AMPS therein specified.
(vi) Any Order submitted by a Beneficial Owner as a Potential
Beneficial Owner to its Broker-Dealer, or by a Broker-Dealer to the Auction
Agent, prior to the Submission Deadline on any Auction Date shall be
irrevocable.
(vii) The Trust shall not be responsible for a Broker-Dealer's
failure to act in accordance with the instructions of Beneficial Owners or
Potential Beneficial Owners or failure to comply with the provisions of
this Section 11.10.
(d) Determination of Sufficient Clearing Bids, Winning Bid Rate and
Applicable Rate.
(i) Not earlier than the Submission Deadline on each Auction Date,
the Auction Agent shall assemble all Orders submitted or deemed submitted
to it by the Broker-Dealers (each such Order as submitted or deemed
submitted by a Broker-Dealer being hereinafter referred to individually as
a "Submitted Hold Order," a "Submitted Bid" or a "Submitted Sell Order," as
the case may be, or, more generally, as a "Submitted Order") and shall
determine:
(A) the excess of the total number of Outstanding AMPS over
the number of Outstanding AMPS that are the subject of Submitted Hold
Orders (such excess being hereinafter referred to as the "Available
AMPS");
A-64
(B) from the Submitted Orders whether the number of
Outstanding AMPS 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 AMPS 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 AMPS that are subject to
Submitted Sell Orders (if such excess or such equality exists
(other than because the number of Outstanding AMPS in clause
(1) above and this clause (2) are each zero because all of the
Outstanding AMPS 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 AMPS
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
AMPS 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 AMPS.
(ii) Promptly after the Auction Agent has made the determinations
pursuant to Section 11.10(d)(i), the Auction Agent shall advise the Trust
of the Maximum Applicable Rate and, based on such determinations, the
Applicable Rate for the next succeeding Dividend Period as follows:
(A) if Sufficient Clearing Bids exist, that the Applicable
Rate for the next succeeding Dividend Period shall be equal to the
Winning Bid Rate;
(B) if Sufficient Clearing Bids do not exist (other than
because all of the Outstanding AMPS 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
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(C) if all of the Outstanding AMPS are the subject of
Submitted Hold Orders, that the Dividend Period next succeeding the
Auction shall automatically be the same length as the immediately
preceding Dividend Period and the Applicable Rate for the next
succeeding Dividend Period shall be equal to 80% of the Reference Rate
on the date of the Auction.
(e) Acceptance and Rejection of Submitted Bids and Submitted Sell Orders
and Allocation of Shares. Existing Holders shall continue to hold the AMPS that
are subject to Submitted Hold Orders, and, based on the determinations made
pursuant to Section 11.10(d)(i), the Submitted Bids and Submitted Sell Orders
shall be accepted or rejected and the Auction Agent shall take such other action
as set forth below:
(i) If Sufficient Clearing Bids have been made, subject to the
provisions of Section 11.10(e)(iii) and Section 11.10(e)(iv), Submitted
Bids and Submitted Sell Orders shall be accepted or rejected in the
following order of priority and all other Submitted Bids shall be rejected:
(A) the Submitted Sell Orders of Existing Holders shall be
accepted and the Submitted Bid of each of the Existing Holders
specifying any rate per annum that is higher than the Winning Bid Rate
shall be accepted, thus requiring each such Existing Holder to sell
the Outstanding AMPS 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 AMPS 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 AMPS that are the subject of such
Submitted Bid, unless the number of Outstanding AMPS subject to all
such Submitted Bids shall be greater than the number of Outstanding
AMPS ("Remaining Shares") equal to the excess of the Available AMPS
over the number of Outstanding AMPS subject to Submitted Bids
described in Section 11.10(e)(i)(B) and Section 11.10(e)(i)(C), in
which event the Submitted Bids of each such Existing Holder shall be
accepted, and each such Existing Holder shall be required to sell
Outstanding AMPS, but only in an amount equal to the difference
between (1) the number of Outstanding AMPS then held by such Existing
Holder subject to such Submitted Bid and (2) the number of AMPS
obtained by multiplying (x) the number of Remaining Shares by (y) a
fraction the numerator of which shall be the number of Outstanding
AMPS held by such Existing Holder subject to such Submitted Bid and
the denominator of which shall be the sum of the number of Outstanding
AMPS subject to such Submitted Bids
A-66
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 AMPS obtained by multiplying (x) the difference between
the Available AMPS and the number of Outstanding AMPS subject to
Submitted Bids described in Section 11.10(e)(i)(B), Section
11.10(e)(i)(C) and Section 11.10(e)(i)(D) by (y) a fraction the
numerator of which shall be the number of Outstanding AMPS subject to
such Submitted Bid and the denominator of which shall be the number of
Outstanding AMPS subject to such Submitted Bids made by all such
Potential Holders that specified rates per annum equal to the Winning
Bid Rate.
(ii) If Sufficient Clearing Bids have not been made (other than
because all of the Outstanding AMPS are subject to Submitted Hold Orders),
subject to the provisions of Section 11.10(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 AMPS 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 AMPS that are the subject of such Submitted
Bid; and
(C) the Submitted Bids of each Existing Holder specifying any
rate per annum that is higher than the Maximum Applicable Rate shall
be accepted and the Submitted Sell Orders of each Existing Holder
shall be accepted, in both cases only in an amount equal to the
difference between (1) the number of Outstanding AMPS then held by
such Existing Holder subject to such Submitted Bid or Submitted Sell
Order and (2) the number of AMPS obtained by multiplying (x) the
difference between the Available AMPS and the aggregate number of
Outstanding AMPS subject to Submitted Bids described in Section
11.10(e)(ii)(A) and Section 11.10(e)(ii)(B) by (y) a fraction the
numerator of which shall be the number of Outstanding AMPS 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
AMPS subject to all such Submitted Bids and Submitted Sell Orders. If
all of the Outstanding shares of a series of AMPS are subject to
Submitted Hold Orders, all Submitted Bids for shares of such series
shall be rejected.
(iii) If, as a result of the procedures described in Section
11.10(e), any Existing Holder would be entitled or required to sell, or any
Potential Holder would be entitled
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or required to purchase, a fraction of an Auction Market Preferred Share on
any Auction Date, the Auction Agent shall, in such manner as in its sole
discretion it shall determine, round up or down the number of AMPS to be
purchased or sold by any Existing Holder or Potential Holder on such
Auction Date so that each Outstanding Auction Market Preferred Share
purchased or sold by each Existing Holder or Potential Holder on such
Auction Date shall be a whole Auction Market Preferred Share.
(iv) If, as a result of the procedures described in Section
11.10(e), any Potential Holder would be entitled or required to purchase
less than a whole Auction Market Preferred Share on any Auction Date, the
Auction Agent shall, in such manner as in its sole discretion it shall
determine, allocate AMPS for purchase among Potential Holders so that only
whole AMPS 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 AMPS 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 AMPS to be purchased and the aggregate number of the
Outstanding AMPS 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 AMPS.
(f) Miscellaneous.
(i) To the extent permitted by applicable law, the Trust may in its
sole discretion interpret the provisions of this Section 11.10 to resolve
any inconsistency or ambiguity, remedy any formal defect or make any other
change or modification that does not substantially adversely affect the
rights of Beneficial Owners of AMPS.
(ii) Unless otherwise permitted by the Trust, a Beneficial Owner or
an Existing Holder (A) may sell, transfer or otherwise dispose of AMPS only
pursuant to a Bid or Sell Order in accordance with the procedures described
in this Section 11.10 or to or through a Broker-Dealer or to such other
persons as may be permitted by the Trust, provided that in the case of all
transfers other than pursuant to Auctions such Beneficial Owner or Existing
Holder, its Broker-Dealer, if applicable, or its Agent Member advises the
Auction Agent of such transfer and (B) except as otherwise required by law,
shall have the ownership of the AMPS held by it maintained in book entry
form by the Securities Depository in the account of its Agent Member, which
in turn will maintain records of such Beneficial Owner's beneficial
ownership. The Trust may not submit an Order in any Auction.
(iii) All of the Outstanding AMPS of a series shall be registered in
the name of the nominee of the Securities Depository unless otherwise
required by law or unless
A-68
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 AMPS may be registered in the Share Register in the name
of the Beneficial Owner thereof and such Beneficial Owner thereupon will be
entitled to receive certificates therefor and required to deliver
certificates therefor upon transfer or exchange thereof.
11.11 Securities Depository; Stock Certificates.
(a) If there is a Securities Depository, all of the AMPS of each series
shall be issued to the Securities Depository and registered in the name of the
Securities Depository or its nominee. Certificates may be issued as necessary to
represent AMPS. All such certificates shall bear a legend to the effect that
such certificates are issued subject to the provisions restricting the transfer
of AMPS contained in these Bylaws. 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 AMPS. 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 AMPS 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 Section 11.11(a)) registered in the names of
the Beneficial Owners or their nominees and rescind the stop-transfer
instructions referred to in Section 11.11(a) with respect to such shares.
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APPENDIX B
PROXY VOTING POLICIES
PACIFIC INVESTMENT MANAGEMENT COMPANY LLC
PROXY VOTING POLICIES AND PROCEDURES
The following are general proxy voting policies and procedures ("Policies and
Procedures") adopted by Pacific Investment Management Company LLC ("PIMCO"), an
investment adviser registered under the Investment Advisers Act of 1940, as
amended ("Advisers Act")./1/ PIMCO serves as the investment adviser to a wide
range of domestic and international clients, including investment companies
registered under the Investment Company Act of 1940, as amended ("1940 Act") and
separate investment accounts for other clients./2/ These Policies and Procedures
are adopted to ensure compliance with Rule 206(4)-6 under the Advisers Act,
other applicable fiduciary obligations of PIMCO and the applicable rules and
regulations of the Securities and Exchange Commission ("SEC") and
interpretations of its staff. In addition to SEC requirements governing
advisers, PIMCO's Policies and Procedures reflect the long-standing fiduciary
standards and responsibilities applicable to investment advisers with respect to
accounts subject to the Employee Retirement Income Security Act of 1974
("ERISA"), as set forth in the Department of Labor's rules and regulations./3/
PIMCO will implement these Policies and Procedures for each of its respective
clients as required under applicable law, unless expressly directed by a client
in writing to refrain from voting that client's proxies. PIMCO's authority to
vote proxies on behalf of its clients is established by its advisory contracts,
comparable documents or by an overall delegation of discretionary authority over
its client's assets. Recognizing that proxy voting is a rare event in the realm
of fixed income investing and is typically limited to solicitation of consent to
changes in features of debt securities, these Policies and Procedures also apply
to any voting rights and/or consent rights of PIMCO, on behalf of its clients,
with respect to debt securities,
----------
/1/ These Policies and Procedures are adopted by PIMCO pursuant to Rule 206(4)-6
under the Advisers Act, effective August 6, 2003. See Proxy Voting by Investment
Advisers, IA Release No. 2106 (January 31, 2003).
/2/ These Policies and Procedures address proxy voting considerations under U.S.
law and regulations and do not address the laws or requirements of other
jurisdictions.
/3/ Department of Labor Bulletin 94-2, 29 C.F.R. 2509.94-2 (July 29, 1994). If a
client is subject to ERISA, PIMCO will be responsible for voting proxies with
respect to the client's account, unless the client has expressly retained the
right and obligation to vote the proxies, and provided prior written notice to
PIMCO of this retention.
B-1
including but not limited to, plans of reorganization, and waivers and consents
under applicable indentures./4/
Set forth below are PIMCO's Policies and Procedures with respect to any voting
or consent rights of advisory clients over which PIMCO has discretionary voting
authority. These Policies and Procedures may be revised from time to time.
General Statements of Policy
These Policies and Procedures are designed and implemented in a manner
reasonably expected to ensure that voting and consent rights are exercised in
the best interest of PIMCO's clients. Each proxy is voted on a case-by-case
basis taking into consideration any relevant contractual obligations as well as
other relevant facts and circumstances.
PIMCO may abstain from voting a client proxy under the following circumstances:
(1) when the economic effect on shareholders' interests or the value of the
portfolio holding is indeterminable or insignificant; or (2) when the cost of
voting the proxies outweighs the benefits.
Conflicts of Interest
PIMCO seeks to resolve any material conflicts of interest by voting in good
faith in the best interest of its clients. If a material conflict of interest
should arise, PIMCO will seek to resolve such conflict in the client's best
interest by pursuing any one of the following courses of action:
1. convening an ad-hoc committee to assess and resolve the conflict;/5/
2. voting in accordance with the instructions/consent of a client after
providing notice of and disclosing the conflict to that client;
3. voting the proxy in accordance with the recommendation of an
independent third-party service provider;
4. suggesting that the client engage another party to determine how the
proxies should be voted;
5. delegating the vote to an independent third-party service provider; or
----------
/4/ For purposes of these Policies and Procedures, proxy voting includes any
voting rights, consent rights or other voting authority of PIMCO on behalf of
its clients.
/5/ Any committee must be comprised of personnel who have no direct interest in
the outcome of the potential conflict.
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6. voting in accordance with the factors discussed in these Policies and
Procedures.
PIMCO will document the process of resolving any identified material conflict of
interest.
Reporting Requirements and the Availability of Proxy Voting Records
Except to the extent required by applicable law or otherwise approved by PIMCO,
PIMCO will not disclose to third parties how it voted a proxy on behalf of a
client. However, upon request from an appropriately authorized individual, PIMCO
will disclose to its clients or the entity delegating the voting authority to
PIMCO for such clients (e.g., trustees or consultants retained by the client),
how PIMCO voted such client's proxy. In addition, PIMCO provides its clients
with a copy of these Policies and Procedures or a concise summary of these
Policies and Procedures: (i) in Part II of Form ADV; (ii) together with a
periodic account statement in a separate mailing; or (iii) any other means as
determined by PIMCO. The summary will state that these Policies and Procedures
are available upon request and will inform clients that information about how
PIMCO voted that client's proxies is available upon request.
PIMCO Record Keeping
PIMCO or its agent maintains proxy voting records as required by Rule 204-2(c)
of the Advisers Act. These records include: (1) a copy of all proxy voting
policies and procedures; (2) proxy statements (or other disclosures accompanying
requests for client consent) received regarding client securities (which may be
satisfied by relying on obtaining a copy of a proxy statement from the SEC's
Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system or a third
party provided that the third party undertakes to provide a copy promptly upon
request); (3) a record of each vote cast by PIMCO on behalf of a client; (4) a
copy of any document created by PIMCO that was material to making a decision on
how to vote proxies on behalf of a client or that memorializes the basis for
that decision; and (5) a copy of each written client request for proxy voting
records and any written response from PIMCO to any (written or oral) client
request for such records. Additionally, PIMCO or its agent maintains any
documentation related to an identified material conflict of interest.
Proxy voting books and records are maintained by PIMCO or its agent in an easily
accessible place for a period of five years from the end of the fiscal year
during which the last entry was made on such record, the first two years in the
offices of PIMCO or its agent.
Review and Oversight
PIMCO's proxy voting procedures are described below. PIMCO's Compliance Group
will provide for the supervision and periodic review, no less than on a
quarterly basis, of its proxy voting activities and the implementation of these
Policies and Procedures.
Because PIMCO has contracted with State Street Investment Manager Solutions, LLC
("IMS West") to perform portfolio accounting, securities processing and
settlement processing on behalf of PIMCO, certain of the following procedures
involve IMS West in administering and
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implementing the proxy voting process. IMS West will review and monitor the
proxy voting process to ensure that proxies are voted on a timely basis.
1. Transmit Proxy to PIMCO. IMS West will forward to PIMCO's Middle Office
Group each proxy received from registered owners of record (e.g., custodian bank
and other third party service providers).
2. Conflicts of Interest. PIMCO's Middle Office Group will review each
proxy to determine whether there may be a material conflict between PIMCO and
its client. As part of this review, the group will determine whether the issuer
of the security or proponent of the proposal is a client of PIMCO, or if a
client has actively solicited PIMCO to support a particular position. If no
conflict exists, this group will forward each proxy to the appropriate portfolio
manager for consideration. However, if a conflict does exist, PIMCO's Middle
Office Group will seek to resolve any such conflict in accordance with these
Policies and Procedures.
3. Vote. The portfolio manager will review the information, will vote the
proxy in accordance with these Policies and Procedures and will return the voted
proxy to PIMCO's Middle Office Group.
4. Review. PIMCO's Middle Office Group will review each proxy that was
submitted to and completed by the appropriate portfolio manager. PIMCO's Middle
Office Group will forward the voted proxy back to IMS West with the portfolio
manager's decision as to how it should be voted.
5. Transmittal to Third Parties. IMS West will document the portfolio
manager's decision for each proxy received from PIMCO's Middle Office Group in a
format designated by the custodian bank or other third party service provider.
IMS West will maintain a log of all corporate actions, including proxy voting,
which indicates, among other things, the date the notice was received and
verified, PIMCO's response, the date and time the custodian bank or other third
party service provider was notified, the expiration date and any action taken.
6. Information Barriers. Certain entities controlling, controlled by, or
under common control with PIMCO ("Affiliates") may be engaged in banking,
investment advisory, broker-dealer and investment banking activities. PIMCO
personnel and PIMCO's agents are prohibited from disclosing information
regarding PIMCO's voting intentions to any Affiliate. Any PIMCO personnel
involved in the proxy voting process who are contacted by an Affiliate regarding
the manner in which PIMCO or its delegate intend to vote on a specific issue
must terminate the contact and notify the Compliance Group immediately.
Categories of Proxy Voting Issues
In general, PIMCO reviews and considers corporate governance issues related to
proxy matters and generally supports proposals that foster good corporate
governance practices. PIMCO considers each proposal on a case-by-case basis,
taking into consideration various factors and all relevant facts and
circumstances at the time of the vote. PIMCO may vote
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proxies as recommended by management on routine matters related to the operation
of the issuer and on matters not expected to have a significant economic impact
on the issuer and/or shareholders, because PIMCO believes the recommendations by
the issuer generally are in the shareholders' best interests, and therefore in
the best economic interest of PIMCO's clients. The following is a non-exhaustive
list of issues that may be included in proxy materials submitted to clients of
PIMCO, and a non-exhaustive list of factors that PIMCO may consider in
determining how to vote the client's proxies.
Board of Directors
1. Independence. PIMCO may consider the following factors when voting on
director independence issues: (i) majority requirements for the board and the
audit, nominating, compensation and/or other board committees; and (ii) whether
the issuer adheres to and/or is subject to legal and regulatory requirements.
2. Director Tenure and Retirement. PIMCO may consider the following factors
when voting on limiting the term of outside directors: (i) the introduction of
new viewpoints on the board; (ii) a reasonable retirement age for the outside
directors; and (iii) the impact on the board's stability and continuity.
3. Nominations in Elections. PIMCO may consider the following factors when
voting on uncontested elections: (i) composition of the board; (ii) nominee
availability and attendance at meetings; (iii) any investment made by the
nominee in the issuer; and (iv) long-term corporate performance and the price of
the issuer's securities.
4. Separation of Chairman and CEO Positions. PIMCO may consider the
following factors when voting on proposals requiring that the positions of
chairman of the board and the chief executive officer not be filled by the same
person: (i) any potential conflict of interest with respect to the board's
ability to review and oversee management's actions; and (ii) any potential
effect on the issuer's productivity and efficiency.
5. D&O Indemnification and Liability Protection. PIMCO may consider the
following factors when voting on proposals that include director and officer
indemnification and liability protection: (i) indemnifying directors for conduct
in the normal course of business; (ii) limiting liability for monetary damages
for violating the duty of care; (iii) expanding coverage beyond legal expenses
to acts that represent more serious violations of fiduciary obligation than
carelessness (e.g. negligence); and (iv) providing expanded coverage in cases
where a director's legal defense was unsuccessful if the director was found to
have acted in good faith and in a manner that he or she reasonably believed was
in the best interests of the company.
6. Stock Ownership. PIMCO may consider the following factors when voting on
proposals on mandatory share ownership requirements for directors: (i) the
benefits of additional vested interest in the issuer's stock; (ii) the ability
of a director to fulfill his duties to the issuer regardless of the extent of
his stock ownership; and (iii) the impact of limiting the number of persons
qualified to be directors.
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Proxy Contests and Proxy Contest Defenses
1. Contested Director Nominations. PIMCO may consider the following factors
when voting on proposals for director nominees in a contested election: (i)
background and reason for the proxy contest; (ii) qualifications of the director
nominees; (iii) management's track record; (iv) the issuer's long-term financial
performance within its industry; (v) assessment of what each side is offering
shareholders; (vi) the likelihood that the proposed objectives and goals can be
met; and (vii) stock ownership positions of the director nominees.
2. Reimbursement for Proxy Solicitation Expenses. PIMCO may consider the
following factors when voting on reimbursement for proxy solicitation expenses:
(i) identity of the persons who will pay the expenses; (ii) estimated total cost
of solicitation; (iii) total expenditures to date, (iv) fees to be paid to proxy
solicitation firms; and (v) when applicable, terms of a proxy contest
settlement.
3. Ability to Alter the Size of the Board by Shareholders. PIMCO may
consider whether the proposal seeks to fix the size of the board and/or require
shareholder approval to alter the size of the board.
4. Ability to Remove Directors by Shareholders. PIMCO may consider whether
the proposal allows shareholders to remove directors with or without cause
and/or allow shareholders to elect directors and fill board vacancies.
5. Cumulative Voting. PIMCO may consider the following factors when voting
on cumulative voting proposals: (i) the ability of significant stockholders to
elect a director of their choosing; (ii) the ability of minority shareholders to
concentrate their support in favor of a director(s) of their choosing; and (iii)
any potential limitation placed on the director's ability to work for all
shareholders.
6. Supermajority Shareholder Requirements. PIMCO may consider all relevant
factors, including but not limited to limiting the ability of shareholders to
effect change when voting on supermajority requirements to approve an issuer's
charter or bylaws, or to approve a merger or other significant business
combination that would require a level of voting approval in excess of a simple
majority.
Tender Offer Defenses
1. Classified Boards. PIMCO may consider the following factors when voting
on classified boards: (i) providing continuity to the issuer; (ii) promoting
long-term planning for the issuer; and (iii) guarding against unsolicited
takeovers.
2. Poison Pills. PIMCO may consider the following factors when voting on
poison pills: (i) supporting proposals to require a shareholder vote on other
shareholder rights plans; (ii) ratifying or redeeming a poison pill in the
interest of protecting the value of
B-6
the issuer; and (iii) other alternatives to prevent a takeover at a price
clearly below the true value of the issuer.
3. Fair Price Provisions. PIMCO may consider the following factors when
voting on proposals with respect to fair price provisions: (i) the vote required
to approve the proposed acquisition; (ii) the vote required to repeal the fair
price provision; (iii) the mechanism for determining fair price; and (iv)
whether these provisions are bundled with other anti-takeover measures (e.g.,
supermajority voting requirements) that may entrench management and discourage
attractive tender offers.
Capital Structure
1. Stock Authorizations. PIMCO may consider the following factors to help
distinguish between legitimate proposals to authorize increases in common stock
for expansion and other corporate purchases and those proposals designed
primarily as an anti-takeover device: (i) the purpose and need for the stock
increase; (ii) the percentage increase with respect to the authorization
currently in place; (iii) voting rights of the stock; and (iv) overall
capitalization structure of the issuer.
2. Issuance of Preferred Stock. PIMCO may consider the following factors
when voting on the issuance of preferred stock: (i) whether the new class of
preferred stock has unspecified voting, conversion, dividend distribution, and
other rights; (ii) whether the issuer expressly states that the stock will not
be used as a takeover defense or carry superior voting rights; (iii) whether the
issuer specifies the voting, dividend, conversion, an other rights of such stock
and the terms of the preferred stock appear reasonable; and (iv) whether the
stated purpose is to raise capital or make acquisitions in the normal course of
business.
3. Stock Splits. PIMCO may consider the following factors when voting on
stock splits: (i) the percentage increase in the number of shares with respect
to the issuer's existing authorized shares; and (ii) the industry that the
issuer is in and the issuer's performance in that industry.
4. Reversed Stock Splits. PIMCO may consider the following factors when
voting on reverse stock splits: (i) the percentage increase in the shares with
respect to the issuer's existing authorized stock; and (ii) issues related to
delisting the issuer's stock.
Executive and Director Compensation
1. Stock Option Plans. PIMCO may consider the following factors when voting
on stock option plans: (i) whether the stock option plan expressly permits the
repricing of options; (ii) whether the plan could result in earnings dilution of
greater than a specified percentage of shares outstanding; (iii) whether the
plan has an option exercise price below the market price on the date of grant;
(iv) whether the proposal relates to an amendment to extend the term of options
for persons leaving the firm voluntarily or for cause; and (v) whether the stock
option plan has certain other embedded features.
B-7
2. Director Compensation. PIMCO may consider the following factors when
voting on director compensation: (i) whether director shares are at the same
market risk as those of the issuer's shareholders; and (ii) how stock option
programs for outside directors compare with the standards of internal stock
option programs.
3. Golden and Tin Parachutes. PIMCO may consider the following factors when
voting on golden and/or tin parachutes: (i) whether they will be submitted for
shareholder approval; and (ii) the employees covered by the plan and the quality
of management.
State of Incorporation
State Takeover Statutes. PIMCO may consider the following factors when
voting on proposals to opt out of a state takeover statute: (i) the power the
statute vests with the issuer's board; (ii) the potential of the statute to
stifle bids; and (iii) the potential for the statute to empower the board to
negotiate a better deal for shareholders.
Mergers and Restructurings
1. Mergers and Acquisitions. PIMCO may consider the following factors when
voting on a merger and/or acquisition: (i) anticipated financial and operating
benefits as a result of the merger or acquisition; (ii) offer price; (iii)
prospects of the combined companies; (iv) how the deal was negotiated; and (v)
changes in corporate governance and the potential impact on shareholder rights.
PIMCO may also consider what impact the merger or acquisition may have on
groups/organizations other than the issuer's shareholders.
2. Corporate Restructurings. With respect to a proxy proposal that includes
a spin-off, PIMCO may consider the tax and regulatory advantages, planned use of
sale proceeds, market focus, and managerial incentives. With respect to a proxy
proposal that includes an asset sale, PIMCO may consider the impact on the
balance sheet or working capital and the value received for the asset. With
respect to a proxy proposal that includes a liquidation, PIMCO may consider
management's efforts to pursue alternatives, the appraisal value of assets, and
the compensation plan for executives managing the liquidation.
Investment Company Proxies
For a client that is invested in an investment company, PIMCO votes each proxy
of the investment company on a case-by-case basis and takes all reasonable steps
to ensure that proxies are voted consistent with all applicable investment
policies of the client and in accordance with any resolutions or other
instructions approved by authorized persons of the client.
For a client that is invested in an investment company that is advised by PIMCO
or its affiliates, if there is a conflict of interest which may be presented
when voting for the client (e.g., a proposal to approve a contract between PIMCO
and the investment company), PIMCO will resolve the conflict by doing any one of
the following: (i) voting in accordance with the instructions/consent of the
client after providing notice of and disclosing the conflict to that
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client; (ii) voting the proxy in accordance with the recommendation of an
independent third-party service provider; or (iii) delegating the vote to an
independent third-party service provider.
1. Election of Directors or Trustees. PIMCO may consider the following
factors when voting on the director or trustee nominees of a mutual fund: (i)
board structure, director independence and qualifications, and compensation paid
by the fund and the family of funds; (ii) availability and attendance at board
and committee meetings; (iii) investments made by the nominees in the fund; and
(iv) the fund's performance.
2. Converting Closed-end Fund to Open-end Fund. PIMCO may consider the
following factors when voting on converting a closed-end fund to an open-end
fund: (i) past performance as a closed-end fund; (ii) the market in which the
fund invests; (iii) measures taken by the board to address any discount of the
fund's shares; (iv) past shareholder activism; (v) board activity; and (vi)
votes on related proposals.
3. Proxy Contests. PIMCO may consider the following factors related to a
proxy contest: (i) past performance of the fund; (ii) the market in which the
fund invests; (iii) measures taken by the board to address past shareholder
activism; (iv) board activity; and (v) votes on related proposals.
4. Investment Advisory Agreements. PIMCO may consider the following factors
related to approval of an investment advisory agreement: (i) proposed and
current fee arrangements/schedules; (ii) fund category/investment objective;
(iii) performance benchmarks; (iv) share price performance as compared with
peers; and (v) the magnitude of any fee increase and the reasons for such fee
increase.
5. Policies Established in Accordance with the 1940 Act. PIMCO may consider
the following factors: (i) the extent to which the proposed changes
fundamentally alter the investment focus of the fund and comply with SEC
interpretation; (ii) potential competitiveness; (iii) regulatory developments;
and (iv) current and potential returns and risks.
6. Changing a Fundamental Restriction to a Non-fundamental Restriction.
PIMCO may consider the following when voting on a proposal to change a
fundamental restriction to a non-fundamental restriction: (i) reasons given by
the board and management for the change; and (ii) the projected impact of the
change on the fund's portfolio.
7. Distribution Agreements. PIMCO may consider the following when voting on
a proposal to approve a distribution agreement: (i) fees charged to comparably
sized funds with similar investment objectives; (ii) the distributor's
reputation and past performance; and (iii) competitiveness of the fund among
other similar funds in the industry.
8. Names Rule Proposals. PIMCO may consider the following factors when
voting on a proposal to change a fund name, consistent with Rule 35d-1 of the
1940 Act: (i) whether the fund invests a minimum of 80% of its assets in the
type of investments suggested
B-9
by the proposed name; (ii) the political and economic changes in the target
market; and (iii) current asset composition.
9. Disposition of Assets/Termination/Liquidation. PIMCO may consider the
following when voting on a proposal to dispose of fund assets, terminate, or
liquidate the fund: (i) strategies employed to salvage the fund; (ii) the fund's
past performance; and (iii) the terms of the liquidation.
10. Changes to Charter Documents. PIMCO may consider the following when
voting on a proposal to change a fund's charter documents: (i) degree of change
implied by the proposal; (ii) efficiencies that could result; (iii) state of
incorporation; and (iv) regulatory standards and implications.
11. Changing the Domicile of a Fund. PIMCO may consider the following when
voting on a proposal to change the domicile of a fund: (i) regulations of both
states; (ii) required fundamental policies of both states; and (iii) the
increased flexibility available.
12. Change in Fund's Subclassification. PIMCO may consider the following
when voting on a change in a fund's subclassification from diversified to
non-diversified or to permit concentration in an industry: (i) potential
competitiveness; (ii) current and potential returns; (iii) risk of
concentration; and (iv) consolidation in the target industry.
Distressed and Defaulted Securities
1. Waivers and Consents. PIMCO may consider the following when determining
whether to support a waiver or consent to changes in provisions of indentures
governing debt securities which are held on behalf of clients: (i) likelihood
that the granting of such waiver or consent will potentially increase recovery
to clients; (ii) potential for avoiding cross-defaults under other agreements;
and (iii) likelihood that deferral of default will give the obligor an
opportunity to improve its business operations.
2. Voting on Chapter 11 Plans of Liquidation or Reorganization. PIMCO may
consider the following when determining whether to vote for or against a Chapter
11 plan in a case pending with respect to an obligor under debt securities which
are held on behalf of clients: (i) other alternatives to the proposed plan; (ii)
whether clients are treated appropriately and in accordance with applicable law
with respect to their distributions; (iii) whether the vote is likely to
increase or decrease recoveries to clients.
Miscellaneous Provisions
1. Such Other Business. Proxy ballots sometimes contain a proposal granting
the board authority to "transact such other business as may properly come before
the meeting." PIMCO may consider the following factors when developing a
position on proxy ballots that contain a proposal granting the board authority
to "transact such other business as may properly come before the meeting": (i)
whether the board is limited in what actions it may
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legally take within such authority; and (ii) PIMCO's responsibility to consider
actions before supporting them.
2. Equal Access. PIMCO may consider the following factors when voting on
equal access: (i) the opportunity for significant company shareholders to
evaluate and propose voting recommendations on proxy proposals and director
nominees, and to nominate candidates to the board; and (ii) the added complexity
and burden of providing shareholders with access to proxy materials.
3. Charitable Contributions. PIMCO may consider the following factors when
voting on charitable contributions: (i) the potential benefits to shareholders;
and (ii) the potential impact on the issuer's resources that could have been
used to increase shareholder value.
4. Special Interest Issues. PIMCO may consider the following factors when
voting on special interest issues: (i) the long-term benefit to shareholders of
promoting corporate accountability and responsibility on social issues; (ii)
management's responsibility with respect to special interest issues; (iii) any
economic costs and restrictions on management; (iv) a client's instruction to
vote proxies in a specific manner and/or in a manner different from these
Policies and Procedures; and (v) the responsibility to vote proxies for the
greatest long-term shareholder value.
* * * * *
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PART C - OTHER INFORMATION
Item 24: Financial Statements and Exhibits
1. Financial Statements:
Included in Part A: Not applicable.
Included in Part B: Financial Statements.
Unaudited Statement of Assets and Liabilities as of October 5, 2003.
Unaudited Statement of Operations for the Period August 29, 2003
through October 5, 2003.
Unaudited of Statement of Changes in Net Assets for the Period
August 29, 2003 through October 5, 2003.
Unaudited Financial Highlights for the Period August 29
through October 5, 2003.
Unaudited Statement of Cash Flows for the period August 29 through
October 5, 2003.
Unaudited Notes to Financial Statements as of October 5, 2003.
Unaudited Schedule of Investments as of October 5, 2003.
The Registrant's audited Statement of Net Assets dated as of
August 19, 2003, including the Notes thereto, and the report of
PricewaterhouseCoopers LLP thereon dated August 20, 2003, is hereby
incorporated by reference into Part B from the Statement of
Additional Information dated August 25, 2003 for the offering of the
Registrant's common shares, which was filed with the SEC on August
25, 2003 (File No. 333-106334)
2. Exhibits:
a.1 Agreement and Declaration of Trust dated June 19, 2003.(1)
a.2 Amended and Restated Agreement and Declaration of Trust dated August 14,
2003.(2)
b.1 Bylaws of Registrant dated June 19, 2003.(1)
b.2 Amended and Restated Bylaws of the Registrant, dated August 14, 2003.(2)
b.3 Second Amended and Restated Bylaws of the Registrant*
c. None.
d.1 Article III (Shares) and Article V (Shareholders' Voting Powers and
Meetings) of the Amended and Restated Agreement and Declaration of
Trust.(2)
d.2 Article 10 (Shareholders' Voting Powers and Meetings) of the Amended and
Restated Bylaws of Registrant.(2)
d.3 Form of Share Certificate of the Common Shares.(2)
d.4 Specimen certificate representing the Registrant's Auction Preferred
Shares of beneficial interest ("Preferred Shares"), filed herewith.
e. Terms and Conditions of Dividend Reinvestment Plan.(2)
f. None.
g.1 Investment Management Agreement between Registrant and PIMCO Advisors
Fund Management LLC.(2)
g.2 Form of Portfolio Management Agreement between PIMCO Advisors Fund
Management LLC and Pacific Investment Management Company LLC. (2)
h.1 Form of Purchase Agreement for the Preferred Shares, to be filed by pre-
effective amendment.*
i. None.
j. Form of Custodian and Investment Accounting Agreement between Registrant
and State Street Bank & Trust Co.(2)
k.1 Form of Transfer Agency Services Agreement between Registrant and
PFPC Inc.(2)
C-1
k.2 Organizational and Offering Expenses Reimbursement Agreement between
Registrant and PIMCO Advisors Fund Management LLC.(2)
k.3 Auction Agency Agreement between the Registrant and the Auction Agent as
to the Registrant's Preferred Shares, filed herewith.
k.4 Broker-Dealer Agreement as to the Registrant's Preferred Shares, filed
herewith.
k.5 Depository Trust Company Representations letter as to the Registrant's
Preferred Shares, field herewith.
l. Opinion and consent of Ropes & Gray LLP*
m. None.
n. Consent of Registrant's independent accountants, filed herewith.
o. None.
p. Subscription Agreement of Allianz Dresdner Asset Management of America
L.P. dated August 19, 2003.(2)
q. None.
r.1 Code of Ethics of Registrant dated August 14, 2003.(2)
r.2 Code of Ethics of PIMCO Advisors Fund Management LLC.(2)
r.3 Code of Ethics of Pacific Investment Management Company LLC.(2)
s.1 Power of Attorney for Messrs. Shlissel, Belica, Conner, Dalessandro,
Kertess, Altadonna and Schott. (3)
s.2 Power of Attorney for Stephen J. Treadway. (3)
--------------------------
(1) Incorporated by reference to the Registrant's Initial Registration
Statement on Form N-2 relating to its common shares of beneficial interest,
File No. 333-106334, filed on June 20, 2003.
(2) Incorporated by reference to Pre-Effective Amendment No. 2 to the
Registrant's Initial Registration Statement on Form N-2 relating to its
common shares of beneficial interest, File No. 333-106334, filed on August
25, 2003.
(3) Incorporated by reference to the Registrant's Initial Registration
Statement on Form N-2 relating to its preferred shares of beneficial
interest, File No. 333-108475, filed on September 3, 2003.
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Item 25: Marketing Arrangements
Marketing arrangements relating to Registrant's Preferred Shares will
be filed by amendment.
Item 26: Other Expenses of Issuance and Distribution
Securities and Exchange Commission Fees $ 16,989
Printing and engraving expenses $ 95,000
Legal fees $ 230,000
Accounting expenses $ 10,500
Credit Rating Registration Fee $ 126,000
Directors Fees $ 20,000
Miscellaneous expenses $ 1,511
---------
Total 500,000
* Estimated Expenses.
Item 27: Persons Controlled by or under Common Control with Registrant
Not applicable.
Item 28: Number of Holders of Securities
At October 1, 2003
Number of
Title of Class Record Holders
-------------- --------------
Preferred Shares, par value $0.00001 0
Common Shares, par value $0.00001 45
Item 29: Indemnification
Reference is made to Article VIII, Sections 1 through 4, of the
Registrant's Amended and Restated Agreement and Declaration of Trust, which is
incorporated by reference herein.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "Act"), may be permitted to trustees, officers and
controlling persons of the Registrant by the Registrant pursuant to the Trust's
Amended and Restated Agreement and Declaration of Trust, its Amended and
Restated Bylaws or otherwise, the Registrant is aware that in the opinion of the
Securities and Exchange Commission, such indemnification is against public
policy as expressed in the Act and, therefore, is unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by trustees, officers or
controlling persons of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such trustees, officers or controlling
persons in connection with the securities being registered, the Registrant will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
C-3
Item 30: Business and Other Connections of Investment Adviser
Descriptions of the business of PIMCO Advisors Fund Management LLC, the
Registrant's investment manager, and Pacific Investment Management Company LLC,
the Registrant's portfolio manager, are set forth under the captions "Investment
Manager" and "Portfolio Manager" under "Management of the Fund" in both the
prospectus and Statement of Additional Information forming part of this
Registration Statement. The following sets forth business and other connections
of each director and executive officer (and persons performing similar
functions) of PIMCO Advisors Fund Management LLC and Pacific Investment
Management Company LLC.
PIMCO Advisors Fund Management LLC
1345 Avenue of the Americas
New York, NY 10105
Name Position with Advisor Other Connections
---------------- -------------------------- ------------------------------
Larry Altadonna Vice President Vice President, OpCap Advisors
LLC
Andrew Bocko Senior Vice President and Senior Vice President,
Director of IT PIMCO Advisors Fund Management
LLC, Allianz Dresdner Asset
Management U.S. Equities LLC,
PIMCO Advisors Fund Management
LLC, Allianz Dresdner Asset
Management of America L.P.
Tim Clark Managing Director
Cindy Columbo Vice President
Patrick Coyne Vice President
Derek Hayes Senior Vice President
Steve Jobe Senior Vice President
Alan Kwan Vice President
John C. Maney Chief Financial Officer Executive Vice President and
Chief Financial Officer,
Allianz Dresdner Asset
Management of America L.P.,
Chief Financial Officer, PIMCO
Advisors Fund Management
LLC, Allianz Dresdner Asset
Management U.S. Equities
LLC, Cadence Capital
Management LLC, NFJ
Investment Group L.P., OCC
Distributors LLC, OpCap
Advisors LLC, Oppenheimer
Capital LLC, Pacific
Investment Management
Company LLC, PIMCO Advisors
Managed Accounts LLC, PIMCO
Advisors CD Distributors
LLC, PIMCO Equity Advisors
LLC, PIMCO Equity Partners
LLC, PIMCO Advisors
Advertising Agency Inc.,
PIMCO Advisors Distributors
LLC, Allianz Private Client
Services LLC, and StocksPLUS
Management Inc. and Value
Advisors LLC
Vinh T. Nguyen Vice President and Vice President and Controller,
Controller PIMCO Advisors Fund Management
LLC, Allianz Dresdner Asset
Management of America L.P.,
Allianz Dresdner Asset
Management U.S. Equities LLC,
Cadence Capital Management
LLC, NFJ Investment Group
L.P., OCC Distributors LLC,
OpCap Advisors LLC,
Oppenheimer Capital LLC,
Pacific Investment Management
Company LLC, PIMCO Advisors
Managed Accounts LLC, PIMCO
Advisors CD Distributors LLC,
PIMCO Equity Advisors LLC,
C-4
PIMCO Equity Partners LLC,
PIMCO Advisors Advertising
Agency Inc., PIMCO Advisors
Distributors LLC, Allianz
Private Client Services LLC,
and StocksPLUS Management Inc.
Francis C. Poli Executive Vice President, Chief Legal and Compliance
Director of Compliance Officer, PIMCO Advisors Fund
and Assistant Secretary Management LLC, Allianz
Dresdner Asset Management of
America L.P., Allianz Dresdner
Asset Management U.S. Equities
LLC, Allianz Hedge Fund
Partners L.P., Allianz Private
Client Services LLC, Cadence
Capital Management LLC, NFJ
Investment Group L.P., OCC
Distributors LLC, OpCap
Advisors LLC, Oppenheimer
Capital LLC, PIMCO Advisors
Retail Holdings LLC, PIMCO
Advisors Managed Accounts LLC,
PIMCO Advisors CD Distributors
LLC, PIMCO Equity Advisors LLC
Bob Rokose Vice President and
Assistant Controller
Newton B. Schott, Jr. Managing Director, Vice President, PIMCO Advisors
Chief Legal Officer Managed Accounts LLC,
and Secretary Executive Vice President,
Chief Legal Officer and
Secretary, PIMCO Advisors
Advertising Agency Inc.,
Managing Director,
Executive Vice President,
General Counsel and Secretary,
PIMCO Advisors Distributors
LLC
Brian S. Shlissel Senior Vice President Senior Vice President and
Treasurer, OpCap Advisors LLC
Stewart A. Smith Vice President and Secretary, PIMCO Advisors Fund
Assistant Secretary Management LLC, Allianz
Dresdner Asset Management of
America L.P., Allianz Dresdner
Asset Management U.S.
Equities LLC, Allianz Hedge
Fund Partners L.P., Allianz
Private Client Services LLC,
Cadence Capital Management
LLC, NFJ Investment Group
L.P., PIMCO Advisors Retail
Holdings LLC, PIMCO Advisors
Managed Accounts LLC, PIMCO
Advisors CD Distributors LLC
and PIMCO Equity Advisors LLC,
Assistant Secretary,
Oppenheimer Capital LLC, OpCap
Advisors and OCC Distributors
LLC
Stephen J. Treadway Managing Director and Chairman, President and Chief
Chief Executive Officer Executive Officer, PIMCO
Advisors Advertising Agency
Inc.; Managing Director and
Chief Executive Officer,
PIMCO Advisors Distributors
LLC, Managing Director,
PIMCO Advisors Managed
Accounts LLC, Allianz
Private Client Services LLC,
Allianz Dresdner Asset
Management of America L.P.,
Member, Board of Management of
Allianz Dresdner Asset
Management GmbH
James G. Ward Executive Vice President Executive Vice President,
and Director of Human Allianz Asset Management of
Resources America L.P., Director of
Human Resources, Allianz Asset
Management U.S. Equities LLC,
PIMCO Advisors Distributors
LLC
C-5
Pacific Investment Management Company LLC
("PIMCO")
840 Newport Center Drive
Newport Beach, CA 92660
Name Business and Other Connections
----------------------------- --------------------------------------------------
Arnold, Tammie J. Executive Vice President, PIMCO
Benz, William R. II Managing Director, Executive Committee Member,
PIMCO
Bhansali, Vineer Executive Vice President, PIMCO
Brynjolfsson, John B. Executive Vice President, PIMCO
Burns, R. Wesley Managing Director, PIMCO; President and Trustee of
PIMCO Funds and PIMCO Variable Insurance Trust;
President and Director of PIMCO Commercial
Mortgage Securities Trust, Inc.; Director, PIMCO
Funds: Global Investors Series plc and PIMCO
Global Advisors (Ireland) Limited
Cupps, Wendy W. Executive Vice President, PIMCO
Dialynas, Chris P. Managing Director, PIMCO
El-Erian, Mohamed A. Managing Director, PIMCO
Gross, William H. Managing Director and Executive Committee Member,
PIMCO; Director and Vice President, StocksPLUS
Management, Inc.; Senior Vice President of PIMCO
Funds and PIMCO Variable Insurance Trust
Hague, John L. Managing Director, PIMCO
Hally, Gordon C. Executive Vice President, PIMCO
Hamalainen, Pasi M. Managing Director, PIMCO
Harris, Brent R. Managing Director and Executive Committee Member,
PIMCO; Director and Vice President, StocksPLUS
Management, Inc.; Trustee and Chairman of PIMCO
Funds and PIMCO Variable Insurance Trust; Director
and Chairman, PIMCO Commercial Mortgage Securities
Trust, Inc.; Managing Director, PIMCO Specialty
Markets LLC
Hinman, David C. Executive Vice President, PIMCO
Hodge, Douglas M. Executive Vice President, PIMCO; Director,
PIMCO JAPAN LTD
Holden, Brent L. Managing Director, PIMCO
Isberg, Margaret E. Managing Director, PIMCO; Senior Vice President of
PIMCO Funds
Keller, James M. Managing Director, PIMCO
Kennedy, Raymond G. Managing Director, PIMCO
Kiesel, Mark Executive Vice President, PIMCO
Loftus, John S. Managing Director, PIMCO; Senior Vice President of
PIMCO Funds; Vice President and Assistant
Secretary, StocksPLUS Management, Inc.
Mariappa, Sudesh N. Executive Vice President, PIMCO
C-6
Mather, Scott A. Executive Vice President, PIMCO; Senior Vice
President, PIMCO Commercial Mortgage Securities
Trust, Inc.
McCray, Mark V. Executive Vice President, PIMCO
McCulley, Paul A. Managing Director, PIMCO
McDevitt, Joseph E. Executive Vice President, PIMCO; Director and
Chief Executive Officer, PIMCO Europe Ltd
Meiling, Dean S. Managing Director, PIMCO
Monson, Kristen S. Executive Vice President, PIMCO
Muzzy, James F. Managing Director, PIMCO; Director and Vice
President, StocksPLUS Management, Inc.; Senior
Vice President, PIMCO Variable Insurance Trust;
Vice President of PIMCO Funds; Director, PIMCO
Europe Ltd., PIMCO JAPAN LTD., PIMCO Asia Pte
Ltd., PIMCO Australia Pty Ltd.
Otterbein, Thomas J. Executive Vice President, PIMCO
Phansalkar, Mohan V. Executive Vice President, Secretary and Chief
Legal Officer, PIMCO; Vice President and
Secretary, StocksPLUS Management, Inc.
Podlich, William F. Managing Director, PIMCO
Powers, William C. Managing Director and Executive Committee Member,
PIMCO; Senior Vice President, PIMCO Commercial
Mortgage Securities Trust, Inc.
Schmider, Ernest L. Managing Director, PIMCO
Simon, W. Scott Executive Vice President, PIMCO
Thomas, Lee R. Managing Director, PIMCO
Thompson, William S. Managing Director and Executive Committee Member,
PIMCO; Director and President, StocksPLUS
Management, Inc.; Senior Vice President of PIMCO
Variable Insurance Trust; Vice President of PIMCO
Funds and PIMCO Commercial Mortgage Securities
Trust, Inc.
Trosky, Benjamin L. Managing Director, PIMCO; Senior Vice President,
PIMCO Commercial Mortgage Securities Trust, Inc.
Weil, Richard M. Managing Director, Chief Operating Officer and
Executive Committee Member, PIMCO
Wood, George H. Executive Vice President, PIMCO
Wyman, Charles C. Executive Vice President, PIMCO
C-7
Item 31: Location of Accounts and Records
The account books and other documents required to be maintained by the
Registrant pursuant to Section 31(a) of the Investment Company Act of 1940 and
the Rules thereunder will be maintained at the offices of State Street Bank &
Trust Co., 225 Franklin Street, Boston, MA 02110 and/or PFPC Inc., 400 Bellevue
Parkway, Wilmington, Delaware 19809.
Item 32: Management Services
Not applicable.
Item 33: Undertakings
1. Registrant undertakes to suspend the offering of its shares until it
amends the prospectus filed herewith if (1) subsequent to the effective date of
its registration statement, the net asset value declines more than 10 percent
from its net asset value as of the effective date of the registration statement,
or (2) the net asset value increases to an amount greater than its net proceeds
as stated in the prospectus.
2. Not applicable.
3. Not applicable.
4. Not applicable.
5. The Registrant undertakes that:
a. For purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed as
part of this registration statement in reliance upon Rule 430A and
contained in the form of prospectus filed by the Registrant under Rule
497(h) under the Securities Act of 1933 shall be deemed to be part of this
registration statement as of the time it was declared effective; and
b. For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of the securities at that
time shall be deemed to be the initial bona fide offering thereof.
6. The Registrant undertakes to send by first class mail or other means
designed to ensure equally prompt delivery, within two business days of receipt
of a written or oral request, any Statement of Additional Information.
Notice
A copy of the Agreement and Declaration of Trust of PIMCO Floating Rate
Income Fund (the "Fund"), together with all amendments thereto, is on file with
the Secretary of State of The Commonwealth of Massachusetts, and notice is
hereby given that this instrument is executed on behalf of the Fund by any
officer of the Fund as an officer and not individually and that the obligations
of or arising out of this instrument are not binding upon any of the Trustees of
the Fund or shareholders of the Fund individually, but are binding only upon the
assets and property of the Fund.
C-8
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the Investment
Company Act of 1940, the Registrant has duly caused this Registration Statement
to be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of New York, and the State of New York on the 24th day of October, 2003.
PIMCO Floating Rate Income Fund
By: /s/ Brian S. Shlissel
-------------------------------------
Brian S. Shlissel,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this Registration
Statement has been signed by the following persons in the capacities and on the
dates indicated.
Name Capacity Date
---- -------- ----
/s/ Brian S. Shlissel President, Chief Executive Officer October 24, 2003
----------------------------------
Brian S. Shlissel
Stephen J. Treadway* Chairman and Trustee October 24, 2003
----------------------------------
Stephen J. Treadway
Paul Belica* Trustee October 24, 2003
----------------------------------
Paul Belica
Robert E. Connor* Trustee October 24, 2003
----------------------------------
Robert E. Connor
John J. Dalessandro II* Trustee October 24, 2003
----------------------------------
John J. Dalessandro II
Hans W. Kertess* Trustee October 24, 2003
----------------------------------
Hans W. Kertess
/s/ Lawrence G. Altadonna Treasurer, Principal Financial and October 24, 2003
---------------------------------- Accounting Officer
Lawrence G. Altadonna
*By: /s/ Brian S. Shlissel
---------------------
Brian S. Shlissel
Attorney-In-Fact
Date: October 24, 2003
INDEX TO EXHIBITS
Exhibit Exhibit Name
------- ------------
d.4 Specimen Certificate representing the Registrant's Auction Preferred
Shares of beneficial interest ("Preferred Shares")
k.3 Auction Agency Agreement between the Registrant and the Auction Agent
as to the Registrant's Preferred Shares.
k.4 Broker-Dealer Agreement as to the Registrant's Preferred Shares
k.5 Depository Trust Company Representations Letter as to the Registrant's
Preferred Shares
n. Consent of Independent Accountants.