UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT
COMPANIES
Investment Company Act file number 811-21506
Name of Fund: Capital and Income Strategies Fund, Inc.
Fund Address: P.O. Box 9011
Princeton, NJ 08543-9011
Name and address of agent for service: Robert C. Doll, Jr., Chief
Executive Officer, Capital and Income Strategies Fund, Inc.,
800 Scudders Mill Road, Plainsboro, NJ, 08536. Mailing
address: P.O. Box 9011, Princeton, NJ, 08543-9011
Registrant's telephone number, including area code: (609) 282-2800
Date of fiscal year end: 12/31/04
Date of reporting period: 01/01/04 - 12/31/04
Item 1 - Report to Stockholders
(BULL LOGO)
Merrill Lynch Investment Managers
www.mlim.ml.com
Capital and Income
Strategies Fund, Inc.
Annual Report
December 31, 2004
Capital and Income Strategies Fund, Inc. seeks to provide
shareholders with current income and capital appreciation. The Fund
seeks to achieve its investment objectives by investing in a
portfolio of equity and debt securities of U.S. and foreign issuers.
This report, including the financial information herein, is
transmitted to shareholders of Capital and Income Strategies Fund,
Inc. for their information. It is not a prospectus. The Fund
leverages its Common Stock to provide Common Stock shareholders with
a potentially higher rate of return. Leverage creates risk for
Common Stock shareholders, including the likelihood of greater
volatility of net asset value and market price of Common Stock
shares, and the risk that fluctuations in short-term interest rates
may reduce the Common Stock's yield. Past performance results shown
in this report should not be considered a representation of future
performance. Statements and other information herein are as dated
and are subject to change.
A description of the policies and procedures that the Fund uses
to determine how to vote proxies relating to portfolio securities
is available (1) without charge, upon request, by calling toll-free
1-800-MER-FUND (1-800-637-3863); (2) at www.mutualfunds.ml.com;
and (3) on the Securities and Exchange Commission's Web site at
http://www.sec.gov. Information about how the Fund voted proxies
relating to securities held in the Fund's portfolio during the
most recent 12-month period ended June 30 is available (1) at
www.mutualfunds.ml.com and (2) on the Securities and Exchange
Commission's Web site at http://www.sec.gov.
Capital and Income Strategies Fund, Inc.
Box 9011
Princeton, NJ
08543-9011
(GO PAPERLESS LOGO)
It's Fast, Convenient, & Timely!
To sign up today, go to www.icsdelivery.com/live.
Capital and Income Strategies Fund, Inc.
The Benefits and Risks of Leveraging
Capital and Income Strategies Fund, Inc. utilizes leveraging through
borrowings or issuance of short-term debt securities or shares of
Preferred Stock. The concept of leveraging is based on the premise
that the cost of assets to be obtained from leverage will be based
on short-term interest or dividend rates, which normally will be
lower than the income earned by the Fund on its longer-term
portfolio investments. To the extent that the total assets of the
Fund (including the assets obtained from leverage) are invested in
higher-yielding portfolio investments, the Fund's Common Stock
shareholders are the beneficiaries of the incremental yield.
Leverage creates risks for holders of Common Stock including the
likelihood of greater net asset value and market price volatility.
In addition, there is the risk that fluctuations in interest rates
on borrowings (or in the dividend rates on any Preferred Stock, if
the Fund were to issue the Preferred Stock) may reduce the Common
Stock's yield and negatively impact its net asset value and market
price. If the income derived from securities purchased with assets
received from leverage exceeds the cost of leverage, the Fund's
net income will be greater than if leverage had not been used.
Conversely, if the income from the securities purchased is not
sufficient to cover the cost of leverage, the Fund's net income will
be less than if leverage had not been used, and therefore the amount
available for distribution to Common Stock shareholders will be
reduced.
Portfolio Holdings as of December 31, 2004
Percent of
Total
Asset Mix Investments
Common Stocks 54.3%
Preferred Stocks 22.0
Fixed Income Securities 14.7
Capital Trusts 6.2
Trust Preferred 2.4
Other* 0.4
* Includes portfolio holdings in short-term investments.
Availability of Quarterly Schedule of Investments
The Fund files its complete schedule of portfolio holdings with the
Securities and Exchange Commission ("SEC") for the first and third
quarters of each fiscal year on Form N-Q. The Fund's Forms N-Q are
available on the SEC's Web site at http://www.sec.gov. The Fund's
Forms N-Q may also be reviewed and copied at the SEC's Public
Reference Room in Washington, DC. Information on the operation of
the Public Reference Room may be obtained by calling 1-800-SEC-0330.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
A Letter From the President and Chief Investment Officer
Dear Shareholder
The U.S. equity market ended 2004 in positive territory, although
not without some suspense along the way. Fixed income markets also
performed well, with high yield bond investors enjoying some of the
greatest returns.
Over the past year, the equity market generally found support from a
healthy economic environment, above-average corporate earnings,
increased capital spending and still-low interest rates. Stalling
the momentum somewhat throughout the year was a contentious
election, negligible inflation amid a rising federal funds interest
rate, record-high oil prices and the seemingly ever-present worries
over terrorism and the war in Iraq.
Still, the Standard & Poor's 500 Index posted a 12-month return of
+10.88% and a six-month return of +7.19% as of December 31, 2004.
The fourth quarter of the year proved to be the most telling, as the
S&P 500 Index was up only 1.51% year-to-date as of September 30,
2004. As the price of oil relaxed and election uncertainties
subsided, the market headed more convincingly upward in the last
quarter of the year.
Given the relatively positive environment for equities, the
favorable performance of the bond market came as somewhat of a
surprise. The Lehman Brothers Aggregate Bond Index posted a 12-month
return of +4.34% and a six-month return of +4.18% as of December 31,
2004. The tax-exempt market performed just as well, with a 12-month
return of +4.48% and a six-month return of +5.19%, as measured by
the Lehman Brothers Municipal Bond Index. Those comfortable with a
higher degree of risk benefited this past year, as the Credit Suisse
First Boston High Yield Index posted a 12-month return of +11.95%
and a six-month return of +9.26%. Interestingly, as the Federal
Reserve Board began raising its target short-term interest rate,
long-term bond yields were little changed. In fact, the yield on the
10-year Treasury was 4.24% at year-end compared to 4.27% at December
31, 2003. The yield on the two-year Treasury climbed to 3.08% at
year-end 2004 from 1.84% a year earlier.
As always, our investment professionals are closely monitoring the
markets, the economy and the overall environment in an effort to
make well-informed decisions for the portfolios they manage. For the
individual investor, the key to investment success - particularly
during uncertain times - is to maintain a long-term perspective and
adhere to the disciplines of asset allocation, diversification and
rebalancing. We encourage you to work with your financial advisor to
ensure these time-tested techniques are incorporated into your
investment plan.
We thank you for trusting Merrill Lynch Investment Managers with
your investment assets, and we look forward to serving you in the
new year and beyond.
Sincerely,
(Robert C. Doll, Jr.)
Robert C. Doll, Jr.
President and Chief Investment Officer
Merrill Lynch Investment Managers
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
A Discussion With Your Fund's Portfolio Managers
Since its inception through December 31, 2004, the Fund has outpaced
the total return performance of its composite benchmark while also
providing shareholders with attractive income.
How has the Fund performed since its inception in light of the
existing market and economic conditions?
The Fund was introduced on April 30, 2004, amid market uncertainty
fueled by geopolitical concerns, rising oil prices, rising short-
term interest rates and somewhat mixed economic data in the United
States.
From April 30, 2004, through December 31, 2004, the Common Stock of
Capital and Income Strategies Fund, Inc. had net annualized yields
of 3.46% and 3.92%, based on a year-end per share net asset value of
$20.76 and a per share market price of $18.32, and $.484 per share
income dividends. Over the same period, the total investment return
on the Fund's Common Stock was +12.30%, based on a change in per
share net asset value from $19.10 to $20.76, and assuming
reinvestment of all distributions.
For the same period, the Fund's composite benchmark returned
+9.69%,* while its comparable Lipper category of Income and
Preferred Stock Funds had an average return of +13.57%. (Funds in
this Lipper category normally seek a high level of current income
through investing in income-producing stocks, bonds and money market
instruments, or funds in the category may invest primarily in
preferred securities, often considering tax-code implications.)
Relative to the benchmark, the Fund's allocation to preferred
securities drove most of the positive performance. This was largely
due to strong security selection, a consistent underweight to the
agency sector and an overweight position in cash. As Treasury issues
sold off in April and May, the Fund was able to invest much of the
cash at higher yields. In the quarter ended September 30, 2004, the
Fund also generated income from its option (call-writing) program.
This strategy also was particularly helpful during the Fund's ramp-
up phase, which concluded at the end of May. Essentially, the call-
writing program generated additional income, thereby helping the
Fund to meet its goal of providing shareholders with quarterly
distributions at an annualized rate of 6% of the initial public
offering price per share. In the quarter ended December 31, 2004,
the call-writing program did not generate income, as the equity
market rallied and the Fund closed the program. The Fund's common
stock and emerging market components slightly underperformed their
respective benchmarks during the period, although both allocations
contributed positive returns and income.
* The Fund's composite benchmark is a blend of the Merrill Lynch
Preferred Stock, DRD Eligible Index; the JP Morgan Emerging
Markets Bond Global Index; three-month LIBOR; and the S&P 500
Barra Value Index.
For the six-month period ended December 31, 2004, the total
investment return on the Fund's Common Stock was +9.27%, based
on a change in per share net asset value from $19.63 to $20.76,
and assuming reinvestment of all distributions.
For a description of the Fund's total investment return based on a
change in the per share market value of the Fund's Common Stock (as
measured by the trading price of the Fund's shares on the New York
Stock Exchange), and assuming reinvestment of dividends, please
refer to the Financial Highlights section of this report. As a
closed-end fund, the Fund's shares may trade in the secondary market
at a premium or discount to the Fund's net asset value. As a result,
total investment returns based on changes in the market value of the
Fund's Common Stock can vary significantly from total investment
returns based on changes in the Fund's net asset value.
How has the Fund been managed since its inception?
The Fund was created with the following strategic allocation: 55%
equities, 30% preferred stock (eligible for either qualified
dividend income or dividends received deduction), 10% short-term
investment grade bonds, and 5% emerging market bonds. The Fund has
the flexibility to vary the asset allocation from time to time based
on market and economic conditions or relative valuation and yield
considerations. The Fund was initiated in May with a tactical
allocation that substituted short-term emerging market debt for
short-term investment grade debt. This was based on the Fund's
belief that short-term emerging market debt offered the potential
for additional income and price appreciation. Over the course of the
period, the Fund maintained its equity, preferred, emerging market
and short-term bond allocations at approximately the same weightings
as the benchmark.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
At December 31, 2004, the Fund was approximately 31% leveraged. For
a more complete discussion of the benefits and risks of leveraging,
see page 2 of this report to shareholders.
How would you characterize the Fund's position at the close of the
period?
Despite outstanding corporate earnings in 2004, expectations for
continued solid earnings in 2005, and generally strong worldwide
economies, several concerns weighed on the markets at period-end.
Specifically, in China - a country that has been a vital catalyst
for global growth - it appears the government is attempting to
orchestrate an economic slowdown in an effort to control inflation.
In the United States, uncertainty over the future pace of economic
growth, interest rate and energy price increases, and geopolitical
events continues to weigh on the market.
Nevertheless, while the U.S. economy may have reached its high-water
mark, as measured by year-over-year earnings growth, this may not
signal the end of the stock market uptrend. Hence, the Fund
maintains a 55% allocation to stocks, with a current bias toward
dividend-paying stocks. Within the equity portion of the portfolio,
the Fund is overweight relative to the composite benchmark in the
consumer staples, information technology, energy and materials
sectors, and underweight in financials, consumer discretionary,
telecommunications, utilities and healthcare.
Generally speaking, we anticipate higher Treasury yields over the
course of 2005 and foresee a continued favorable domestic and
international credit environment. As such, the Fund maintains a 30%
allocation to preferred securities. Within the preferred allocation,
we ended the period with a short duration position relative to the
benchmark. (Duration is a measure of a Fund's sensitivity to
interest rate movements. Generally, the longer an investment's
duration, the more that investment's value will fluctuate with
increases in interest rates. Therefore, we believe a short duration
profile is prudent in this rising interest rate environment.) The
preferred allocation is more diversified in sectors relative to the
benchmark which, while positive from a credit diversification
perspective, leaves the Fund underweight in the utilities and bank
sectors. The average credit-quality rating of the portfolio was A3
at period-end.
In terms of the Fund's emerging market allocation, most of the risks
going forward are likely to be found in the global economy, global
interest rates, oil and commodity prices, and geopolitical factors.
If the world economy were to see a rapid increase in global interest
rates, it is likely to occur in the context of a boom in world
growth, in which emerging market economies would be major
beneficiaries. Such a development would result in emerging market
credit upgrades and spread compression, which should offset the
initial increase in U.S. Treasury yields. This reaction seems
logical from a historical perspective, as there tends to be little
medium-term statistical correlation between U.S. Treasury yields and
emerging market bond returns. Based on this scenario, the Fund
remains neutral to its intermediate-term to long-term emerging
market bond allocation and continues its allocation to short-term
emerging market debt.
Last, the Fund had closed the call-writing strategy by year-end.
Going forward, we will continue to monitor market conditions to
evaluate the prudent use of the call-writing strategy.
Brian Fullerton
Vice President and Co-Portfolio Manager
Kevin Rendino
Vice President and Co-Portfolio Manager,
Equity Investments
Robert J. Martorelli
Vice President and Co-Portfolio Manager,
Equity Investments
John Burger
Vice President and Co-Portfolio Manager,
Fixed Income Investments
Romualdo Roldan
Vice President and Co-Portfolio Manager,
Fixed Income Investments
Patrick Maldari
Vice President and Co-Portfolio Manager,
Fixed Income Investments
January 19, 2005
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Schedule of Investments (in U.S. dollars)
Preferred Securities
Face
Industry++ Amount Capital Trusts Value
Commercial $ 3,000,000 Dresdner Funding Trust I, 8.151% due 6/30/2031 (a) $ 3,708,483
Banks--3.8% 3,000,000 Lloyds TSB Bank Plc, 6.90% (d) 3,147,300
3,000,000 Westpac Capital Trust III, 5.819% (a)(c)(d) 3,145,950
--------------
10,001,733
Diversified Financial 3,000,000 Mizuho JGB Investment LLC, 9.87% (a)(c)(d) 3,509,553
Services--3.8% 3,000,000 SB Treasury Co. LLC, 9.40% (a)(c)(d) 3,456,213
3,000,000 Svensk Exportkredit AB, 6.375% (a)(d) 3,036,984
--------------
10,002,750
Electric Utilities-- 3,000,000 Avista Capital Trust III, 6.50% due 4/01/2034 (c) 3,052,500
1.1%
Total Investments in Capital Trusts (Cost--$21,981,118)--8.7% 23,056,983
Shares
Held Preferred Stocks
Capital Markets-- 120,000 Lehman Brothers Holdings, Inc., 6.50% 3,256,800
2.4% 120,000 Lehman Brothers Holdings, Inc. Series G, 3% (c) 3,048,756
--------------
6,305,556
Commercial 60,000 Banco Santander Central Hispano SA, 6.41% 1,555,800
Banks--3.2% 160,000 Royal Bank of Scotland Group Plc Series L, 5.75% 3,921,600
3,000 SG Preferred Capital II, 6.302% 3,144,000
--------------
8,621,400
Consumer 190,151 MBNA Corp. Series B, 5.50% (c) 4,919,206
Finance--1.8%
Diversified Financial 160,000 Prudential Plc, 6.75% 4,148,800
Services--1.6%
Electric Utilities-- 11,109 Connecticut Light & Power, 5.28% 523,859
4.3% 11,394 Delmarva Power & Light, 4.20% 919,710
21,250 Delmarva Power & Light, 4.28% 1,748,478
60,000 Duquesne Light Co., 6.50% 3,150,000
120,000 Interstate Power & Light Co. Series B, 8.375% 4,020,000
12,400 Public Service Electric & Gas Series E, 5.28% 1,128,400
--------------
11,490,447
Food Products--3.0% 5,000 General Mills, Inc., 4.50% 4,835,000
30 HJ Heinz Finance Co., 6.226% (a) 3,229,689
--------------
8,064,689
Gas Utilities--2.1% 195,000 Southern Union Co., 7.55% 5,450,250
Insurance--6.7% 200,000 ACE Ltd. Series C, 7.80% 5,336,000
100,000 Genworth Financial, Inc. Series A, 5.25% 5,137,500
60,000 RenaissanceRe Holdings Ltd. Series C, 6.08% 1,432,200
2,660 Zurich RegCaPS Funding Trust, 6.01% (a)(c) 2,702,560
3,200 Zurich RegCaPS Funding Trust, 6.58% (a)(c) 3,312,000
--------------
17,920,260
Oil & Gas--2.1% 54,500 Apache Corp. Series B, 5.68% 5,710,581
Real Estate--0.5% 52,000 Alexandria Real Estate Equities, Inc. Series C, 8.375% 1,376,440
Thrifts & Mortgage 85,000 Fannie Mae, 7% 4,818,438
Finance--3.2% 25,000 Fannie Mae Series I, 5.375% 1,112,500
59,350 Fannie Mae Series L, 5.125% 2,538,399
--------------
8,469,337
Total Investments in Preferred Stocks (Cost--$78,730,350)--30.9% 82,476,966
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Schedule of Investments (continued) (in U.S. dollars)
Preferred Securities (concluded)
Face
Industry++ Amount Trust Preferred Value
Diversified Financial $ 5,000,000 ABN AMRO North America Capital Funding Trust I, 6.968%
Services--2.1% due 9/15/2010 (c) $ 5,545,315
Gas Utilities--1.2% 3,000,000 Southwest Gas Capital II, 7.70% due 9/15/2043 3,263,199
Total Investments in Trust Preferred (Cost--$8,393,298)--3.3% 8,808,514
Total Investments in Preferred Securities (Cost--$109,104,766)--42.9% 114,342,463
Fixed Income Securities
Beverages--0.3% 650,000 Coca-Cola Femsa SA de CV, 8.95% due 11/01/2006 710,938
Commercial 1,000,000 Banco Nacional de Desenvolvimento Economico e Social, 11.25%
Banks--3.7% due 9/20/2005 1,052,500
450,000 Bancomext Trust Division, 11.25% due 5/30/2006 502,875
700,000 Bangko Sentral ng Pilipinas, 9% due 11/14/2005 754,250
1,500,000 Bangkok Bank Public Company Ltd. (Hong Kong), 8.75% due 3/15/2007 1,637,874
500,000 Export Credit Bank of Turkey AS, 11.50% due 2/25/2005 505,300
700,000 The Export-Import Bank of Korea, 4.25% due 11/27/2007 703,779
300,000 ICICI Bank Limited, 4.75% due 10/22/2008 300,136
572,000 Industrial Bank of Korea, 3.50% due 9/26/2005 574,233
Korea Development Bank:
465,000 7.25% due 5/15/2006 489,664
575,000 5.25% due 11/16/2006 591,259
1,080,000 MDM Bank, 10.75% due 12/16/2005 1,106,028
1,070,000 Sberbank, 3.86% due 10/24/2006 1,077,811
465,000 Siam Commercial Bank Public Company of Singapore, 7.50% due
3/15/2006 484,012
--------------
9,779,721
Diversified Financial 1,440,000 AC International Finance Ltd., 8.75% due 1/17/2005 1,440,932
Services--1.9% 750,000 Aries Vermoegensverwaltungs GmbH, 9.60% due 10/25/2014 (a) 922,500
175,000 Excelcomindo Finance Company BV, 8% due 1/27/2009 183,969
560,000 Morgan Stanley (Gazprom), 9.625% due 3/01/2013 663,992
1,075,000 Open Joint Stock Company Vimpel-Communication, 10.45% due 4/26/2005 1,075,000
750,000 Salomon Bros. (Gazprom), 9.125% due 4/25/2007 816,825
--------------
5,103,218
Diversified 750,000 Cellco Finance NV, 12.75% due 8/01/2005 780,000
Telecommunication 1,410,000 Philippine Long Distance Telephone, 9.25% due 6/30/2006 1,491,075
Services--1.4% 500,000 Telefonica de Argentina SA, 9.875% due 7/01/2006 530,000
600,000 Telefonos de Mexico SA de CV, 8.25% due 1/26/2006 629,902
430,000 Telekom Malaysia Berhad, 7.125% due 8/01/2005 441,790
--------------
3,872,767
Electric Utilities-- 1,000,000 Centrais Eletricas Brasileiras SA (Eletrobras), 12% due 6/09/2005 1,036,300
0.7% 250,000 Electricidad de Caracas Finance BV, 10.25% due 10/15/2014 (a) 261,875
500,000 Singapore Power Limited, 7.25% due 4/28/2005 506,885
--------------
1,805,060
Food Products-- 100,000 Cosan SA Industria e Comercio, 9% due 11/01/2009 (a) 104,500
0.0%
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Schedule of Investments (continued) (in U.S. dollars)
Face
Industry++ Amount Fixed Income Securities Value
Foreign Government $ 580,000 Argentina Government International Bond, 1.98% due 8/03/2012 $ 493,000
Obligations--10.8% Brazilian Government International Bond:
500,000 9.625% due 7/15/2005 516,500
1,140,000 10.25% due 1/11/2006 1,214,100
450,000 10% due 1/16/2007 498,825
725,000 11.50% due 3/12/2008 850,787
725,000 14.50% due 10/15/2009 966,715
290,000 10% due 8/07/2011 336,110
639,711 3.125% due 4/15/2012 609,325
585,000 10.125% due 5/15/2027 666,022
200,000 8.25% due 1/20/2034 194,700
200,000 11% due 8/17/2040 237,300
260,000 Bulgaria Government International Bond, 8.25% due 1/15/2015 326,924
230,000 Chile Government International Bond, 6.875% due 4/28/2009 255,829
Colombia Government International Bond:
1,440,000 10.50% due 6/13/2006 1,576,800
290,000 9.75% due 4/23/2009 330,600
280,000 10% due 1/23/2012 323,400
360,000 Ecuador Government International Bond, 12% due 11/15/2012 367,200
965,000 Indonesia Government International Bond, 7.75% due 8/01/2006 1,010,838
180,000 Malaysia Government International Bond, 8.75% due 6/01/2009 213,516
Mexico Government International Bond:
450,000 9.875% due 1/15/2007 506,025
140,000 8.625% due 3/12/2008 158,900
870,000 2.753% due 1/13/2009 (c) 881,745
435,000 9.875% due 2/01/2010 534,615
500,000 8.375% due 1/14/2011 587,250
360,000 6.375% due 1/16/2013 383,400
200,000 5.875% due 1/15/2014 204,900
390,000 8.30% due 8/15/2031 457,080
100,000 7.50% due 4/08/2033 108,000
435,000 Panama Government International Bond, 8.875% due 9/30/2027 478,500
Peru Government International Bond:
240,000 9.125% due 2/21/2012 279,600
140,000 4.50% due 3/07/2017 130,900
Philippine Government International Bond:
1,000,000 4.129%* due 10/03/2005 965,000
250,000 5.625% due 11/19/2006 254,829
435,000 9.875% due 3/16/2010 473,062
175,000 9.875% due 1/15/2019 179,375
65,000 10.625% due 3/16/2025 69,387
Russia Government International Bond:
1,000,000 8.75% due 7/24/2005 1,027,400
375,000 10% due 6/26/2007 423,788
100,000 10% due 6/26/2007 (Regulation S) 113,010
775,000 11% due 7/24/2018 (Regulation S) 1,083,605
580,000 5% due 3/31/2030 599,952
225,000 South Africa Government International Bond, 7.375% due 4/25/2012 257,625
Turkey Government International Bond:
1,000,000 10% due 9/19/2007 (a) 1,126,250
500,000 10.50% due 1/13/2008 572,500
580,000 11.50% due 1/23/2012 745,300
250,000 11% due 1/14/2013 318,125
340,000 8% due 2/14/2034 352,750
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Schedule of Investments (continued) (in U.S. dollars)
Face
Industry++ Amount Fixed Income Securities Value
Foreign Government Ukraine Government International Bond:
Obligations $ 200,000 6.875% due 3/04/2011 $ 205,040
(concluded) 250,000 7.65% due 6/11/2013 (a) 266,250
310,000 7.65% due 6/11/2013 (Regulation S) 331,080
260,099 Uruguay Government International Bond, 7.875% due 1/15/2033 230,838
Venezuela Government International Bond:
1,071,381 3.625% due 12/18/2007 1,066,023
900,000 9.125% due 6/18/2007 976,500
725,000 10.75% due 9/19/2013 868,187
175,000 8.50% due 10/08/2014 185,500
275,000 9.25% due 9/15/2027 290,125
--------------
28,680,907
Gas Utilities--0.2% 500,000 Gazprom International SA, 7.201% due 2/01/2020 (a) 528,750
Media--0.2% 500,000 Grupo Televisa SA, 8.625% due 8/08/2005 517,500
Oil & Gas--0.7% Petrobras Energia SA:
250,000 9% due 1/30/2007 266,875
780,000 6.56% due 10/04/2007 803,400
530,000 Petroleos Mexicanos, 6.50% due 2/01/2005 531,696
325,000 Petroliam Nasional Berhad, 7.75% due 8/15/2015 396,281
--------------
1,998,252
Paper & Forest 250,000 SINO-FOREST Corp., 9.125% due 8/17/2011 (a) 273,125
Products--0.1%
Road & Rail--0.1% 294,000 MTR Corp., 7.25% due 10/01/2005 302,674
Wireless 1,425,000 Total Access Communication Public Co. Ltd., 8.375% due 11/04/2006 1,538,863
Telecommunication
Services--0.6%
Total Investments in Fixed Income Securities
(Cost--$53,209,044)--20.7% 55,216,275
Shares
Held Common Stocks
Aerospace 92,300 Honeywell International, Inc. 3,268,343
& Defense--4.7% 68,600 Lockheed Martin Corp. 3,810,730
137,800 Raytheon Co. 5,350,774
--------------
12,429,847
Automobiles--0.4% 70,900 Ford Motor Co. 1,037,976
Beverages--0.6% 73,500 Coca-Cola Enterprises, Inc. 1,532,475
Capital Markets-- 88,000 The Bank of New York Co., Inc. 2,940,960
4.5% 20,800 Goldman Sachs Group, Inc. 2,164,032
72,300 Mellon Financial Corp. 2,249,253
85,100 Morgan Stanley 4,724,752
--------------
12,078,997
Chemicals--1.8% 99,700 EI Du Pont de Nemours & Co. 4,890,285
Commercial 91,100 Bank of America Corp. 4,280,789
Banks--5.4% 57,100 Wachovia Corp. 3,003,460
115,200 Wells Fargo & Co. 7,159,680
--------------
14,443,929
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Schedule of Investments (continued) (in U.S. dollars)
Shares
Industry++ Held Common Stocks Value
Communications 144,700 3Com Corp. (b) $ 603,399
Equipment--1.6% 313,300 Lucent Technologies, Inc. (b) 1,178,008
83,200 Motorola, Inc. 1,431,040
74,400 Nokia OYJ 1,165,848
--------------
4,378,295
Computers & 166,800 Hewlett-Packard Co. 3,497,796
Peripherals--3.2% 36,100 International Business Machines Corp. 3,558,738
260,700 Sun Microsystems, Inc. (b) 1,402,566
--------------
8,459,100
Diversified Financial 144,390 Citigroup, Inc. 6,956,710
Services--4.9% 154,072 JPMorgan Chase & Co. 6,010,349
--------------
12,967,059
Diversified 111,200 BCE, Inc. 2,683,256
Telecommunication 171,700 SBC Communications, Inc. 4,424,709
Services--4.4% 114,900 Verizon Communications, Inc. 4,654,599
--------------
11,762,564
Electric Utilities--3.2% 52,000 Consolidated Edison, Inc. 2,275,000
33,500 FPL Group, Inc. 2,504,125
111,400 The Southern Co. 3,734,128
--------------
8,513,253
Energy Equipment & 70,400 Diamond Offshore Drilling 2,819,520
Services--3.3% 97,000 GlobalSantaFe Corp. 3,211,670
67,000 Halliburton Co. 2,629,080
--------------
8,660,270
Food & Staples 91,000 Albertson's, Inc. 2,173,080
Retailing--0.8%
Food Products--4.4% 46,600 ConAgra Foods, Inc. 1,372,370
52,500 General Mills, Inc. 2,609,775
76,800 Kraft Foods, Inc. 2,734,848
79,900 Sara Lee Corp. 1,928,786
44,500 Unilever NV 2,968,595
--------------
11,614,374
Health Care Equipment 67,900 Baxter International, Inc. 2,345,266
& Supplies--0.9%
Health Care Providers 18,900 AmerisourceBergen Corp. 1,109,052
& Services--0.4%
Hotels, Restaurants 90,300 McDonald's Corp. 2,895,018
& Leisure--1.1%
Household 101,100 Koninklijke Philips Electronics NV 2,679,150
Durables--1.0%
Household 67,400 Kimberly-Clark Corp. 4,435,594
Products--1.7%
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Schedule of Investments (continued) (in U.S. dollars)
Shares
Industry++ Held Common Stocks Value
IT Services--0.9% 45,000 Electronic Data Systems Corp. $ 1,039,500
145,900 Unisys Corp. (b) 1,485,262
--------------
2,524,762
Insurance--4.5% 44,800 The Allstate Corp. 2,317,056
61,200 American International Group, Inc. 4,019,004
33,500 Hartford Financial Services Group, Inc. 2,321,885
92,100 The St. Paul Travelers Cos., Inc. 3,414,147
--------------
12,072,092
Media--6.2% 110,100 Comcast Corp. Special Class A (b) 3,615,684
234,800 Liberty Media Corp. Class A (b) 2,578,104
207,600 Time Warner, Inc. (b) 4,035,744
106,600 Viacom, Inc. Class B 3,879,174
90,300 Walt Disney Co. 2,510,340
--------------
16,619,046
Metals & Mining-- 110,300 Alcoa, Inc. 3,465,626
1.3%
Multi-Utilities 90,600 Energy East Corp. 2,417,208
& Unregulated
Power--0.9%
Oil & Gas--5.5% 33,300 Anadarko Petroleum Corp. 2,158,173
202,400 Exxon Mobil Corp. 10,375,024
34,800 Royal Dutch Petroleum Co. 1,996,824
--------------
14,530,021
Paper & Forest 73,500 International Paper Co. 3,087,000
Products--2.0% 34,900 Weyerhaeuser Co. 2,345,987
--------------
5,432,987
Personal Products-- 53,400 The Gillette Co. 2,391,252
0.9%
Pharmaceuticals--2.9% 54,200 Abbott Laboratories 2,528,430
54,600 GlaxoSmithKline Plc 2,587,494
129,000 Schering-Plough Corp. 2,693,520
--------------
7,809,444
Semiconductors & 179,600 Advanced Micro Devices, Inc. (b) 3,954,797
Semiconductor 225,700 LSI Logic Corp. (b) 1,236,836
Equipment--2.5% 117,800 Micron Technology, Inc. (b) 1,454,830
--------------
6,646,463
Software--0.5% 39,200 Computer Associates International, Inc. 1,217,552
Total Investments in Common Stocks (Cost--$186,941,651)--76.4% 203,532,037
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Schedule of Investments (concluded) (in U.S. dollars)
Beneficial
Interest Short-Term Securities Value
$ 1,559,723 Merrill Lynch Liquidity Series, LLC Cash Sweep Series I (e) $ 1,559,723
Total Investments in Short-Term Securities (Cost--$1,559,723)--0.7% 1,559,723
Total Investments (Cost--$350,815,184**)--140.7% 374,650,498
Liabilities in Excess of Other Assets--(40.7%) (108,305,533)
--------------
Net Assets--100.0% $ 266,344,965
==============
++ For Fund compliance purposes, "Industry" means any one or more of
the industry sub-classifications used by one or more widely recognized
market indexes or ratings group indexes, and/or as defined by Fund
management. This definition may not apply for purposes of this report
which may combine such industry sub-classifications for reporting ease.
These industry classifications are unaudited.
* Represents a zero coupon bond; the interest rate shown reflects the
effective yield at the time of purchase of the Fund.
** The cost and unrealized appreciation/depreciation of investments as of
December 31, 2004, as computed for federal income tax purposes,
were as follows:
Aggregate cost $ 350,861,023
==============
Gross unrealized appreciation $ 26,730,611
Gross unrealized depreciation (2,941,136)
--------------
Net unrealized appreciation $ 23,789,475
==============
(a) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(b) Non-income producing security.
(c) Floating rate note.
(d) The security is a perpetual bond and has no definite maturity date.
(e) Investments in companies considered to be an affiliate of the Fund
(such companies are defined as "Affiliated Companies" in Section
2(a)(3) of the Investment Company Act of 1940) were as follows:
Net Interest
Affiliate Activity Income
Merrill Lynch Liquidity Series,
LLC Cash Sweep Series I $1,559,723 $89,636
See Notes to Financial Statements.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Statement of Assets, Liabilities and Capital
As of December 31, 2004
Assets
Investments in unaffiliated securities, at value
(identified cost--$349,255,461) $ 373,090,775
Investments in affiliated securities, at value (identified cost--$1,559,723) 1,559,723
Cash 38,017
Receivables:
Interest (including $10,991 from affiliates) $ 1,374,941
Securities sold 762,683
Dividends 497,673 2,635,297
---------------
Prepaid expenses 5,370
---------------
Total assets 377,329,182
---------------
Liabilities
Loans 109,000,000
Payables:
Dividends and distributions to shareholders 1,293,819
Investment adviser 305,205
Offering costs 232,568
Interest on loans 75,836
Other affiliates 1,359
Distributor 53 1,908,840
---------------
Accrued expenses 75,377
---------------
Total liabilities 110,984,217
---------------
Net Assets
Net assets $ 266,344,965
===============
Capital
Common Stock, $.10 par value; 200,000,000 shares authorized $ 1,283,024
Paid-in capital in excess of par 243,115,117
Accumulated distributions in excess of investment income--net $ (44,301)
Accumulated realized capital losses--net (1,844,189)
Unrealized appreciation--net 23,835,314
---------------
Total accumulated earnings--net 21,946,824
---------------
Total capital--Equivalent to $20.76 per share based on 12,830,236 shares
of capital stock outstanding (market price--$18.32) $ 266,344,965
===============
See Notes to Financial Statements.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Statement of Operations
For the Period April 30, 2004++ to December 31, 2004
Investment Income
Dividends (net of $32,998 foreign withholding tax) $ 5,961,696
Interest (including $89,636 from affiliates) 3,337,102
---------------
Total income 9,298,798
---------------
Expenses
Investment advisory fees $ 2,012,038
Loan interest expense 1,294,799
Borrowing costs 121,751
Professional fees 88,410
Accounting services 69,810
Custodian fees 57,417
Printing and shareholder reports 24,588
Transfer agent fees 12,487
Directors' fees and expenses 12,334
Pricing services 5,540
Other 21,699
---------------
Total expenses before waiver 3,720,873
Waiver of expenses (395,632)
---------------
Total expenses after waiver 3,325,241
---------------
Investment income--net 5,973,557
---------------
Realized & Unrealized Gain (Loss)--Net
Realized gain (loss) on:
Investments--net 126,422
Options written--net (482,472) (356,050)
---------------
Unrealized appreciation on investments--net 23,835,314
---------------
Total realized and unrealized gain--net 23,479,264
---------------
Net Increase in Net Assets Resulting from Operations $ 29,452,821
===============
++ Commencement of operations.
See Notes to Financial Statements.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Statement of Changes in Net Assets
For the Period
April 30, 2004++
to December 31,
Increase (Decrease) in Net Assets: 2004
Operations
Investment income--net $ 5,973,557
Realized loss--net (356,050)
Unrealized appreciation--net 23,835,314
---------------
Net increase in net assets resulting from operations 29,452,821
---------------
Dividends & Distributions to Shareholders
Investment income--net (6,210,003)
Realized gain--net (1,295,994)
Tax return of capital (192,145)
---------------
Net decrease in net assets resulting from dividends and distributions to shareholders (7,698,142)
---------------
Capital Stock Transactions
Proceeds from issuance of Common Stock 244,957,500
Offering costs resulting from the issuance of Common Stock (467,222)
---------------
Net increase in net assets resulting from capital stock transactions 244,490,278
---------------
Net Assets
Total increase in net assets 266,244,957
Beginning of period 100,008
---------------
End of period* $ 266,344,965
===============
* Accumulated distributions in excess of investment income--net $ (44,301)
===============
++ Commencement of operations.
See Notes to Financial Statements.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Statement of Cash Flows
For the Period April 30, 2004++ to December 31, 2004
Cash Used for Operating Activities
Net increase in net assets resulting from operations $ 29,452,821
Adjustments to reconcile net increase in net assets resulting from operations to net
cash provided by operating activities:
Increase in receivables (1,872,614)
Increase in prepaid expenses and other assets (5,370)
Increase in other liabilities 457,830
Realized and unrealized gain--net (24,054,725)
Amortization of premium 886,227
Proceeds from sales of long-term investments 65,348,782
Purchases of long-term investments (416,058,221)
Purchases of short-term investments--net (1,535,244)
---------------
Net cash used for operating activities (347,380,514)
---------------
Cash Provided by Financing Activities
Proceeds from issuance of Common Stock 244,957,500
Offering costs resulting from the issuance of Common Stock (234,654)
Cash receipts from borrowings 109,000,000
Dividends paid to shareholders (6,404,323)
---------------
Net cash provided by financing activities 347,318,523
---------------
Cash
Net decrease in cash (61,991)
Cash at beginning of period 100,008
---------------
Cash at end of period $ 38,017
===============
Cash Flow Information
Cash paid for interest $ 1,218,963
===============
++ Commencement of operations.
See Notes to Financial Statements.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Financial Highlights
The following per share data and ratios have been derived For the Period
from information provided in the financial statements. April 30, 2004++
to December 31,
Increase (Decrease) in Net Asset Value: 2004
Per Share Operating Performance
Net asset value, beginning of period $ 19.10
---------------
Investment income--net .46
Realized and unrealized gain--net 1.84
---------------
Total from investment operations 2.30
---------------
Less dividends and distributions:
Investment income--net (.48)
Realized gain--net (.11)
Tax return of capital (.01)
---------------
Total dividends and distributions (.60)
---------------
Offering costs resulting from the issuance of Common Stock (.04)
---------------
Net asset value, end of period $ 20.76
===============
Market price per share, end of period $ 18.32
===============
Total Investment Return**
Based on net asset value per share 12.30%+++
===============
Based on market price per share (5.36%)+++
===============
Ratios to Average Net Assets
Expenses, net of waiver and excluding interest expense 1.20%*
===============
Expenses, net of waiver 1.96%*
===============
Expenses 2.19%*
===============
Investment income--net 3.52%*
===============
Leverage
Amount of borrowings outstanding, end of period (in thousands) $ 109,000
===============
Average amount of borrowings outstanding during the period (in thousands) $ 98,750
===============
Average amount of borrowings outstanding per share during the period $ 7.70
===============
Supplemental Data
Net assets, end of period (in thousands) $ 266,345
===============
Portfolio turnover 19.88%
===============
* Annualized.
** Total investment returns based on market price, which can be significantly greater or lesser
than the net asset value, may result in substantially different returns. Total investment
returns exclude the effects of sales charges. The Fund's Investment Adviser waived a portion
of its management fee. Without such waiver, the Fund's performance would have been lower.
++ Commencement of operations.
+++ Aggregate total investment return.
See Notes to Financial Statements.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Notes to Financial Statements
1. Significant Accounting Policies:
Capital and Income Strategies Fund, Inc. (the "Fund") is registered
under the Investment Company Act of 1940, as amended, as a
diversified, closed-end management investment company. Prior to
commencement of operations on April 30, 2004, the Fund had no
operations other than those relating to organizational matters and
the sale of 5,236 shares of Common Stock on April 13, 2004 to Fund
Asset Management, L.P. ("FAM") for $100,008. The Fund's financial
statements are prepared in conformity with U.S. generally accepted
accounting principles, which may require the use of management
accruals and estimates. Actual results may differ from these
estimates. The Fund determines and makes available for publication
the net asset value of its Common Stock on a daily basis. The Fund's
Common Stock is listed on the New York Stock Exchange ("NYSE") under
the symbol CII. The following is a summary of significant accounting
policies followed by the Fund.
(a) Valuation of investments--Debt securities are traded primarily
in the over-the-counter markets and are valued at the last available
bid price in the over-the-counter market or on the basis of values
as obtained by a pricing service. Pricing services use valuation
matrixes that incorporate both dealer-supplied valuations and
valuation models. The procedures of the pricing service and its
valuations are reviewed by the officers of the Fund under the
general direction of the Board of Directors. Such valuations and
procedures will be reviewed periodically by the Board of Directors
of the Fund. Financial futures contracts and options thereon, which
are traded on exchanges, are valued at their closing prices as of
the close of such exchanges. Options written or purchased are valued
at the last sales price in the case of exchange-traded options. In
the case of options traded in the over-the-counter ("OTC") market,
valuation is the last asked price (options written) or the last bid
price (options purchased). Swap agreements are valued by quoted fair
valuations received daily by the Fund from the counterparty. Short-
term investments with a remaining maturity of 60 days or less are
valued at amortized cost, which approximates market value, under
which method the investment is valued at cost and any premium or
discount is amortized on a straight line basis to maturity.
Repurchase agreements are valued at cost plus accrued interest. The
Fund employs pricing services to provide certain securities prices
for the Fund. Securities and assets for which market quotations are
not readily available are valued at fair value as determined in good
faith by or under the direction of the Board of Directors of the
Fund, including valuations furnished by the pricing services
retained by the Fund, which may utilize a matrix system for
valuations.
Equity securities that are held by the Fund, which are traded on
stock exchanges or the Nasdaq National Market, are valued at the
last sale price or official close price on the exchange, as of the
close of business on the day the securities are being valued or,
lacking any sales, at the last available bid price for long
positions, and at the last available ask price for short positions.
In cases where equity securities are traded on more than one
exchange, the securities are valued on the exchange designated as
the primary market by or under the authority of the Board of
Directors of the Fund. Long positions traded in the OTC market,
Nasdaq Small Cap or Bulletin Board are valued at the last available
bid price obtained from one or more dealers or pricing services
approved by the Board of Directors of the Fund. Short positions
traded in the OTC market are valued at the last available ask price.
Portfolio securities that are traded both in the OTC market and on a
stock exchange are valued according to the broadest and most
representative market.
Generally, trading in foreign securities is substantially completed
each day at various times prior to the close of business on the New
York Stock Exchange ("NYSE"). The values of such securities used in
computing the net asset value of the Fund's shares are determined as
of such times. Foreign currency exchange rates also are generally
determined prior to the close of business on the NYSE. Occasionally,
events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and
the close of business on the NYSE that may not be reflected in the
computation of the Fund's net asset value. If events (for example, a
company announcement, market volatility or a natural disaster) occur
during such periods that are expected to materially affect the value
of such securities, those securities may be valued at their fair
value as determined in good faith by the Fund's Board of Directors
or by the Investment Adviser using a pricing service and/or
procedures approved by the Fund's Board of Directors.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Notes to Financial Statements (continued)
(b) Derivative financial instruments--The Fund may engage in various
portfolio investment strategies both to increase the return of the
Fund and to hedge, or protect, its exposure to interest rate
movements and movements in the securities markets. Losses may arise
due to changes in the value of the contract or if the counterparty
does not perform under the contract.
* Options--The Fund may write and purchase call and put options.
When the Fund writes an option, an amount equal to the premium
received by the Fund is reflected as an asset and an equivalent
liability. The amount of the liability is subsequently marked-to-
market to reflect the current market value of the option written.
When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
* Financial futures contracts--The Fund may purchase or sell
financial futures contracts and options on such futures contracts.
Futures contracts are contracts for delayed delivery of securities
at a specific future date and at a specific price or yield. Upon
entering into a contract, the Fund deposits and maintains as
collateral such initial margin as required by the exchange on which
the transaction is effected. Pursuant to the contract, the Fund
agrees to receive from or pay to the broker an amount of cash equal
to the daily fluctuation in value of the contract. Such receipts or
payments are known as variation margin and are recorded by the Fund
as unrealized gains or losses. When the contract is closed, the Fund
records a realized gain or loss equal to the difference between the
value of the contract at the time it was opened and the value at the
time it was closed.
* Swaps--The Fund may enter into swap agreements, which are over-the-
counter contracts in which the Fund and a counterparty agree to make
periodic net payments on a specified notional amount. The net
payments can be made for a set period of time or may be triggered by
a predetermined credit event. The net periodic payments may be based
on a fixed or variable interest rate; the change in market value of
a specified security, basket of securities, or index; or the return
generated by a security.
(c) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no federal income tax
provision is required.
(d) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Realized gains and losses on security
transactions are determined on the identified cost basis. Dividend
income is recorded on the ex-dividend dates. Interest income is
recognized on the accrual basis. The Fund amortizes all premiums and
discounts on debt securities.
(e) Offering expenses--Direct expenses relating to the public
offering of the Fund's Common Stock were charged to capital at the
time of issuance of the shares.
(f) Dividends and distributions--Dividends from net investment
income are declared and paid quarterly, commencing in September
2004. Distributions of capital gains are recorded on the ex-dividend
dates.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Notes to Financial Statements (continued)
(g) Securities lending--The Fund may lend securities to financial
institutions that provide cash or securities issued or guaranteed by
the U.S. government as collateral, which will be maintained at all
times in an amount equal to at least 100% of the current market
value of the loaned securities. The market value of the loaned
securities is determined at the close of business of the Fund and
any additional required collateral is delivered to the Fund on the
next business day. Where the Fund receives securities as collateral
for the loaned securities, it collects a fee from the borrower. The
Fund typically receives the income on the loaned securities but does
not receive the income on the collateral. Where the Fund receives
cash collateral it may invest such collateral and retain the amount
earned on such investment, net of any amount rebated to the
borrower. Loans of securities are terminable at any time and the
borrower, after notice, is required to return the borrowed
securities within five business days. The Fund may pay reasonable
finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults
on its obligation to return borrowed securities because of
insolvency or for any other reason, the Fund could experience delays
and costs in gaining access to the collateral. The Fund also could
suffer a loss where the value of the collateral falls below the
market value of the borrowed securities, in the event of borrower
default or in the event of losses on investments made with cash
collateral.
(h) Reclassification--U.S. generally accepted accounting principles
require that certain components of net assets be adjusted to reflect
permanent differences between financial and tax reporting.
Accordingly, during the current year, $192,145 has been reclassified
between paid-in capital in excess of par and accumulated
distributions in excess of net investment income as a result of
permanent differences attributable to a tax return of capital.
This reclassification has no effect on net assets or net asset
values per share.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with FAM.
The general partner of FAM is Princeton Services, Inc. ("PSI"), an
indirect, wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML
& Co."), which is the limited partner.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee at an annual rate of .85% of
the Fund's average daily net assets, including the proceeds of any
outstanding borrowings used for leverage. During the Fund's start-up
phase, FAM elected to waive a portion of its management fee. For the
period April 30, 2004 to December 31, 2004, FAM earned fees of
$2,012,038, of which $395,632 was waived.
The Fund has received an exemptive order from the Securities and
Exchange Commission permitting it to lend portfolio securities to
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), a
subsidiary of ML & Co., or its affiliates. Pursuant to that order,
the Fund also has retained Merrill Lynch Investment Managers, LLC
("MLIM, LLC"), an affiliate of FAM, as the securities lending agent
for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Fund, invest cash
collateral received by the Fund for such loans, among other things,
in a private investment company managed by MLIM, LLC or in
registered money market funds advised by FAM or its affiliates.
For the period April 30, 2004 to December 31, 2004, MLPF&S received
underwriting fees of $9,405,728 in connection with the issuance of
the Fund's Common Stock.
For the period April 30, 2004 to December 31, 2004, the Fund
reimbursed the underwriters $85,543 as a partial reimbursement of
expenses incurred in connection with the issuance of the Fund's
Common Stock.
In addition, MLPF&S received $6,579 in commissions on the execution
of portfolio security transactions for the Fund for the period April
30, 2004 to December 31, 2004.
For the period April 30, 2004 to December 31, 2004, the Fund
reimbursed FAM $3,874 for certain accounting services.
Certain officers and/or directors of the Fund are officers and/or
directors of FAM, PSI, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the period April 30, 2004 to December 31, 2004 were $416,058,222
and $66,111,465, respectively.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Notes to Financial Statements (concluded)
Transactions in options written for the period April 30, 2004 to
December 31, 2004 were as follows:
Number of Premiums
Call Options Written Contracts Received
Outstanding call options written,
beginning of period -- --
Options written 125,892 $ 5,963,176
Options closed (42,542) (2,084,480)
Options expired (83,350) (3,878,696)
------------- -------------
Outstanding call options written,
end of period -- --
============= =============
4. Capital Share Transactions:
The Fund is authorized to issue 200,000,000 shares of capital stock,
par value $.10 per share, all of which were initially classified as
Common Stock. The Board of Directors is authorized, however, to
reclassify any unissued shares of stock without approval of holders
of Common Stock.
Common Stock
Shares issued and outstanding during the period April 30, 2004 to
December 31, 2004 increased 12,825,000 from shares sold.
5. Short-Term Borrowings:
On May 26, 2004, the Fund entered into a $135,000,000 revolving
credit and security agreement with Citibank, N.A. and other lenders
(the "Lenders"). Under the revolving credit and security agreement,
the Fund may borrow money through (i) a line of credit from certain
Lenders at the euro-dollar rate plus .75% or the highest of the
federal funds rate plus .50%, a base rate as determined by Citibank,
N.A. and/or the latest three-week moving average of secondary market
morning offering rates in the United States for three-month
certificates of deposit of major United States money market banks
plus .50%, or (ii) the issuance of commercial paper notes by certain
Lenders at rates of interest based upon the weighted average of the
per annum rates paid or payable by such Lenders in respect of those
commercial paper notes. As security for its obligations to the
Lenders under the revolving credit and security agreement, the Fund
has granted a security interest in substantially all of its assets
to and in favor of the Lenders. The Fund also pays additional
borrowing costs which include a commitment fee for this facility at
the annual rate of .10% and a program fee of .24% on the borrowings
outstanding.
For the period April 30, 2004 to December 31, 2004, the average
amount borrowed was approximately $98,750,000 and the daily weighted
average borrowing rate was 1.93%.
6. Distributions to Shareholders:
The tax character of distributions paid during the period April 30,
2004 to December 31, 2004 was as follows:
4/30/2004++
to
12/31/2004
Distributions paid from:
Ordinary income $ 7,505,997
Tax return of capital 192,145
---------------
Total taxable distributions $ 7,698,142
===============
++ Commencement of operations.
As of December 31, 2004, the components of accumulated earnings on a
tax basis were as follows:
Undistributed ordinary income--net $ --
Undistributed long-term capital gains--net --
---------------
Total undistributed earnings--net --
Capital loss carryforward --
Unrealized gains--net 21,946,824*
---------------
Total accumulated earnings--net $ 21,946,824
===============
* The difference between book-basis and tax-basis net unrealized
gains is attributable primarily to the tax deferral of losses on
wash sales, the difference between book and tax amortization
methods for premiums and discounts on fixed income securities, the
deferral of post-October capital losses for tax purposes and other
book/tax temporary differences.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of
Capital and Income Strategies Fund, Inc.:
We have audited the accompanying statement of assets, liabilities
and capital, including the schedule of investments of Capital and
Income Strategies Fund, Inc. as of December 31, 2004 and the related
statements of operations, cash flows, changes in net assets and the
financal highlights for the period April 30, 2004 (commencement of
operations) through December 31, 2004. These financial statements
and and financial highlights are the responsibility of the Fund's
management. Our responsibility is to express an opinion on these
financial statements and financial highlights based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit
includes consideration of internal control over financial reporting
as a basis for designing audit procedures that are appropriate in
the circumstances, but not for the purpose of expressing an opinion
on the effectiveness of the Fund's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. Our procedures included confirmation of securities
owned as of December 31, 2004, by corresondence with the custodian.
We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights
referred to above present fairly, in all material respects, the
financial position of Capital and Income Strategies Fund, Inc. as of
December 31, 2004, the results of its operations, its cash flows,
the changes in its net assets, and its financial highlights for the
period April 30, 2004 through December 31, 2004, in conformity with
U.S. generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
February 23, 2005
Important Tax Information (unaudited)
The following information is provided with respect to the ordinary
income distribution paid by Capital and Income Strategies Fund, Inc.
to shareholders of record on December 23, 2004:
Qualified Dividend Income for Individuals 92.75%*
Dividends Qualifying for the Dividends Received Deduction for Corporations 63.07%*
* The Fund hereby designates the percentage indicated above or the
maximum amount allowable by law.
Please retain this information for your records.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Managed Distribution Policy
The Fund has adopted a policy of paying regular distributions on its
Common Stock (the "Managed Distribution Policy"). The Fund's Board
of Directors has initially determined to pay quarterly distributions
at an annualized rate of 6% of the initial public offering price per
share ($.30 per share, per quarter). The Fund's Board of Directors
has determined to pay additional distributions on an annual basis
equal to any income earned by the Fund in excess of the quarterly
distributions as may be necessary to distribute substantially all of
the Fund's net investment company taxable income for that year.
The Fund generally is not permitted to distribute net realized long-
term capital gains more than once per year without exemptive relief
from the Securities and Exchange Commission. As a result, the Fund
has applied for an exemption that will permit the Fund to make
periodic distributions of realized long-term capital gains to its
stockholders. Until such time, if any, as the exemptive relief is
granted, the Fund intends to make distributions from its net
investment income on a quarterly basis and from its net realized
long-term capital gains, if any, on an annual basis. If such
exemptive relief is granted, the Fund intends to make distributions
from its net investment income and its realized long-term capital
gains, if any, on a quarterly basis.
If the total distributions paid by the Fund to its stockholders for
any calendar year exceed the Fund's net investment company taxable
income and net realized capital gain for that year, the excess will
generally be treated as a tax-free return of capital up to the
amount of a shareholder's tax basis in his or her stock. Any
distributions that constitute tax-free return of capital will reduce
a stockholder's tax basis in his or her stock. In effect, a return
of capital is the return of a stockholder's investment in the Fund
and will result in a corresponding decline in the Fund's net asset
value. Return of capital distributions also may have the effect of
increasing the Fund's operating expense ratio. Any amounts
distributed to a stockholder in excess of such stockholder's tax
basis in his or her stock will generally be taxable to the
stockholder as capital gain.
The Fund currently expects that the amount of distributions made
under the Managed Distribution Policy generally will be independent
of, and not contingent upon, the Fund's performance in any of the
first three quarters of the Fund's fiscal year. Distribution rates
under the Managed Distribution Policy may be increased in the Fund's
fourth fiscal quarter in light of the Fund's performance for the
fiscal year and to enable the Fund to comply with the distribution
requirements applicable to regulated investment companies. It also
is currently expected that the Fund's investment portfolio initially
will not produce sufficient dividend and interest income to fully
fund distributions under the Managed Distribution Policy.
Consequently, if the Fund does not realize sufficient short-term
capital gains and long-term capital gains to make up any shortfall,
distributions to the Fund's common stockholders will include returns
of capital. Prior to receipt of the above-referenced exemptive
order, long-term capital gains will be available to make up any
shortfall in funding distributions only on an annual basis, thereby
increasing the likelihood that distributions will include returns of
capital to stockholders. The Fund is not required to maintain the
Managed Distribution Policy and such policy (including the amount of
the quarterly distribution) may be modified or terminated at any
time without notice. Any such modification or termination of the
Managed Distribution Policy may have an adverse effect on the market
price of the Fund's common stock.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Automatic Dividend Reinvestment Plan
The following description of the Fund's Automatic Dividend
Reinvestment Plan (the "Plan") is sent to you annually as required
by federal securities laws.
Pursuant to the Fund's Plan, unless a holder of Common Stock
otherwise elects, all dividend and capital gains distributions will
be automatically reinvested by The Bank of New York (the "Plan
Agent"), as agent for shareholders in administering the Plan, in
additional shares of Common Stock of the Fund. Holders of Common
Stock who elect not to participate in the Plan will receive all
distributions in cash paid by check mailed directly to the
shareholder of record (or, if the shares are held in street or other
nominee name then to such nominee) by The Bank of New York, as
dividend paying agent. Such participants may elect not to
participate in the Plan and to receive all distributions of
dividends and capital gains in cash by sending written instructions
to The Bank of New York, as dividend paying agent, at the address
set forth below. Participation in the Plan is completely voluntary
and may be terminated or resumed at any time without penalty by
written notice if received by the Plan Agent not less than ten days
prior to any dividend record date; otherwise such termination will
be effective with respect to any subsequently declared dividend or
distribution.
Whenever the Fund declares an income dividend or capital gains
distribution (collectively referred to as "dividends") payable
either in shares or in cash, non-participants in the Plan will
receive cash and participants in the Plan will receive the
equivalent in shares of Common Stock. The shares will be acquired by
the Plan Agent for the participant's account, depending upon the
circumstances described below, either (i) through receipt of
additional unissued but authorized shares of Common Stock from the
Fund ("newly issued shares") or (ii) by purchase of outstanding
shares of Common Stock on the open market ("open-market purchases")
on the American Stock Exchange or elsewhere. If on the payment date
for the dividend, the net asset value per share of the Common Stock
is equal to or less than the market price per share of the Common
Stock plus estimated brokerage commissions (such conditions being
referred to herein as "market premium"), the Plan Agent will invest
the dividend amount in newly issued shares on behalf of the
participant. The number of newly issued shares of Common Stock to be
credited to the participant's account will be determined by dividing
the dollar amount of the dividend by the net asset value per share
on the date the shares are issued, provided that the maximum
discount from the then current market price per share on the date of
issuance may not exceed 5%. If, on the dividend payment date, the
net asset value per share is greater than the market value (such
condition being referred to herein as "market discount"), the Plan
Agent will invest the dividend amount in shares acquired on behalf
of the participant in open-market purchases.
In the event of a market discount on the dividend payment date, the
Plan Agent will have until the last business day before the next
date on which the shares trade on an "ex-dividend" basis or in no
event more than 30 days after the dividend payment date (the "last
purchase date") to invest the dividend amount in shares acquired in
open-market purchases. It is contemplated that the Fund will pay
monthly income dividends. Therefore, the period during which open-
market purchases can be made will exist only from the payment date
on the dividend through the date before the next "ex-dividend" date,
which typically will be approximately ten days. If, before the Plan
Agent has completed its open-market purchases, the market price of a
share of Common Stock exceeds the net asset value per share, the
average per share purchase price paid by the Plan Agent may exceed
the net asset value of the Fund's shares, resulting in the
acquisitions of fewer shares than if the dividend had been paid in
newly issued shares on the dividend payment date. Because of the
foregoing difficulty with respect to open-market purchases, the Plan
provides that if the Plan Agent is unable to invest the full
dividend amount in open-market purchases during the purchase period
or if the market discount shifts to a market premium during the
purchase period, the Plan Agent will cease making open-market
purchases and will invest the uninvested portion of the dividend
amount in newly issued shares at the close of business on the last
purchase date determined by dividing the uninvested portion of the
dividend by the net asset value per share.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
The Plan Agent maintains all shareholders' accounts in the Plan and
furnishes written confirmation of all transactions in the account,
including information needed by shareholders for tax records. Shares
in the account of each Plan participant will be held by the Plan
Agent in non-certificated form in the name of the participant, and
each shareholder's proxy will include those shares purchased or
received pursuant to the Plan. The Plan Agent will forward all proxy
solicitation materials to participants and vote proxies for shares
held pursuant to the Plan in accordance with the instructions of the
participants.
In the case of shareholders such as banks, brokers or nominees which
hold shares of others who are the beneficial owners, the Plan Agent
will administer the Plan on the basis of the number of shares
certified from time to time by the record shareholders as
representing the total amount registered in the record shareholder's
name and held for the account of beneficial owners who are to
participate in the Plan.
There will be no brokerage charges with respect to shares issued
directly by the Fund as a result of dividends or capital gains
distributions payable either in shares or in cash. However, each
participant will pay a pro rata share of brokerage commissions
incurred with respect to the Plan Agent's open-market purchases in
connection with the reinvestment of dividends.
The automatic reinvestment of dividends and distributions will not
relieve participants of any federal, state or local income tax that
may be payable (or required to be withheld) on such dividends.
Shareholders participating in the Plan may receive benefits not
available to shareholders not participating in the Plan. If the
market price plus commissions of the Fund's shares is above the net
asset value, participants in the Plan will receive shares of the
Fund at less than they could otherwise purchase them and will have
shares with a cash value greater than the value of any cash
distribution they would have received on their shares. If the market
price plus commissions is below the net asset value, participants
will receive distributions in shares with a net asset value greater
than the value of any cash distribution they would have received on
their shares. However, there may be insufficient shares available in
the market to make distributions in shares at prices below the net
asset value. Also, since the Fund does not redeem shares, the price
on resale may be more or less than the net asset value.
The value of shares acquired pursuant to the Plan will generally be
excluded from gross income to the extent that the cash amount
reinvested would be excluded from gross income. If, when the Fund's
shares are trading at a premium over net asset value, the Fund
issues shares pursuant to the Plan that have a greater fair market
value than the amount of cash reinvested, it is possible that all or
a portion of such discount (which may not exceed 5% of the fair
market value of the Fund's shares) could be viewed as a taxable
distribution. If the discount is viewed as a taxable distribution,
it is also possible that the taxable character of this discount
would be allocable to all the shareholders, including shareholders
who do not participate in the Plan. Thus, shareholders who do not
participate in the Plan might be required to report as ordinary
income a portion of their distributions equal to their allocable
share of the discount.
Experience under the Plan may indicate that changes are desirable.
Accordingly, the Fund reserves the right to amend or terminate the
Plan. There is no direct service charge to participants in the Plan;
however, the Fund reserves the right to amend the Plan to include a
service charge payable by the participants.
All correspondence concerning the Plan should be directed to the
Plan Agent at The Bank of New York, Church Street Station, P.O. Box
11258, New York, NY 10286-1258, Telephone: 800-432-8224.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Officers and Directors
Number of
Portfolios in Other Public
Position(s) Length of Fund Complex Directorships
Held with Time Overseen by Held by
Name, Address & Age Fund Served Principal Occupation(s) During Past 5 Years Director Director
Interested Director
Terry K. Glenn* President 2004 to President of the Merrill Lynch Investment 124 Funds None
P.O. Box 9011 and present Managers, L.P. ("MLIM")/Fund Asset 163 Portfolios
Princeton, Director Management, L.P. ("FAM")-advised funds
NJ 08543-9011 since 1999; Chairman (Americas Region)
Age: 64 of MLIM from 2000 to 2002; Executive Vice
President of MLIM and FAM (which terms as
used herein include their corporate
predecessors) from 1983 to 2002; President
of FAM Distributors, Inc. ("FAMD") from
1986 to 2002 and Director thereof from 1991
to 2002; Executive Vice President and
Director of Princeton Services, Inc.
("Princeton Services") from 1993 to 2002;
President of Princeton Administrators, L.P.
from 1989 to 2002; Director of Financial
Data Services, Inc. since 1985.
* Mr. Glenn is a director, trustee or member of an advisory board of
certain other investment companies for which MLIM or FAM acts as
investment adviser. Mr. Glenn is an "interested person," as
described in the Investment Company Act, of the Fund based on his
present and former positions with MLIM, FAM, FAMD, Princeton
Services and Princeton Administrators, L.P. The Director's term is
unlimited. Directors serve until their resignation, removal or
death, or until December 31 of the year in which they turn 72. As
Fund President, Mr. Glenn serves at the pleasure of the Board of
Directors.
Independent Directors*
David O. Beim Director 2004 to Professor of Finance and Economics at the 14 Funds None
P.O. Box 9095 present Columbia University Graduate School of 17 Portfolios
Princeton, Business since 1991; Chairman of Outward
NJ 08543-9095 Bound U.S.A. from 1997 to 2002; Chairman
Age: 64 of Wave Hill, Inc. since 1990.
James T. Flynn Director 2004 to Chief Financial Officer of JP Morgan & Co., 14 Funds None
P.O. Box 9095 present Inc. from 1990 to 1995 and an employee of 17 Portfolios
Princeton, JP Morgan in various capacities from 1967
NJ 08543-9095 to 1995.
Age: 65
W. Carl Kester Director 2004 to Mizuho Financial Group Professor of 14 Funds None
P.O. Box 9095 present Finance; Senior Associate Dean and Chairman 17 Portfolios
Princeton, of the MBA Program of Harvard University
NJ 08543-9095 Graduate School of Business Administration
Age: 53 since 1999; James R. Williston Professor of
Business Administration of Harvard University
Graduate School of Business from 1997 to
1999; MBA Class of 1977, Professor of Business
Administration of Harvard University Graduate
School of Business Administration from 1981
to 1997; Independent Consultant since 1978.
Karen P. Robards Director 2004 to President of Robards & Company, a financial 14 Funds None
P.O. Box 9095 present advisory since 1987; formerly an investment 17 Portfolios
Princeton, banker with Morgan Stanley for more than ten
NJ 08543-9095 years; Director of Enable Medical Corp. since
Age: 54 1996; Director of Atricure, Inc. since 2000;
Director of CineMuse Inc. from 1996 to 2000;
Director of the Cooke Center for Learning and
Development, a not-for-profit organization,
since 1987.
* The Director's term is unlimited. Directors serve untill their
resignation, removal or death, or until December 31 of the year in
which they turn 72.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Officers and Directors (concluded)
Position(s) Length of
Held with Time
Name, Address & Age Fund Served Principal Occupation(s) During Past 5 Years
Fund Officers*
Donald C. Burke Vice 2004 to First Vice President of MLIM and FAM since 1997 and Treasurer thereof since
P.O. Box 9011 President present 1999; Senior Vice President and Treasurer of Princeton Services since 1999
Princeton, and and Director since 2004; Vice President of FAMD since 1999; Vice President
NJ 08543-9011 Treasurer of MLIM and FAM from 1990 to 1997; Director of Taxation of MLIM from 1990
Age: 44 to 2001.
John Burger Vice 2004 to Managing Director (Global Fixed Income) of MLIM since 2004; and Director of
P.O. Box 9011 President present MLIM from 1998 to 2004.
Princeton,
NJ 08543-9011
Age: 42
Brian J. Fullerton Vice 2004 to Chief Investment Officer for MLIM Americas region and Head of MLIM Global
P.O. Box 9011 President present Risk Management and Performance Measurement since 2001; and Head of Risk
Princeton, Management for MLIM Americas from 1999 to 2001.
NJ 08543-9011
Age: 44
Kevin M. Rendino Vice 2004 to Managing Director (Equities) of MLIM since 2000; and Director of MLIM from
P.O. Box 9011 President present 1997 to 2000.
Princeton,
NJ 08543-9011
Age: 38
Patrick Maldari Vice 2004 to Managing Director (Global Fixed Income) of MLIM since 2000; and Director of
P.O. Box 9011 President present MLIM from 1997 to 2000.
Princeton,
NJ 08543-9011
Age: 42
Robert J. Martorelli Vice 2004 to Managing Director (Equities) of MLIM since 2000; and Director of MLIM from
P.O. Box 9011 President present 1997 to 2000.
Princeton,
NJ 08543-9011
Age: 47
Romualdo Roldan Vice 2004 to Managing Director (Global Fixed Income) of MLIM since 2000; Vice President
P.O. Box 9011 President present of MLIM from 1998 to 2000.
Princeton,
NJ 08543-9011
Age: 58
Jeffrey Hiller Chief 2004 to Chief Compliance Officer of the MLIM/FAM-advised funds and First Vice
P.O. Box 9011 Compliance present President and Chief Compliance Officer of MLIM since 2004; Global Director
Princeton, Officer of Compliance at Morgan Stanley Investment Management from 2002 to 2004;
NJ 08543-9011 Managing Director and Global Director.
Age: 53
Alice A. Pellegrino Secretary 2004 to Secretary of MLIM, FAM, FAMD and Princeton Services since 2004; Director
P.O. Box 9011 present (Legal Advisory) of MLIM since 2002; Vice President of MLIM from 1999 to
Princeton, 2002; Attorney associated with MLIM since 1997.
NJ 08543-9011
Age: 44
* Officers of the Fund serve at the pleasure of the Board of Directors.
Custodian
Brown Brothers Harriman & Co.
40 Water Street
Boston, MA 02109
Transfer Agent
The Bank of New York
101 Barclay Street--11 East
New York, NY 10286
NYSE Symbol
CII
Effective January 1, 2005, Terry K. Glenn retired as President and
Director of Capital and Income Strategies Fund, Inc. The Fund's
Board of Directors wishes Mr. Glenn well in his retirement.
Effective January 1, 2005, Robert C. Doll, Jr. became President and
Director of the Fund.
CAPITAL AND INCOME STRATEGIES FUND, INC., DECEMBER 31, 2004
Item 2 - Code of Ethics - The registrant has adopted a code of
ethics, as of the end of the period covered by this report,
that applies to the registrant's principal executive officer,
principal financial officer and principal accounting officer,
or persons performing similar functions. A copy of the code of
ethics is available without charge upon request by calling toll-free
1-800-MER-FUND (1-800-637-3863).
Item 3 - Audit Committee Financial Expert - The registrant's board
of directors has determined that (i) the registrant has the
following audit committee financial experts serving on its audit
committee and (ii) each audit committee financial expert is
independent: (1) David O. Beim, (2) W. Carl Kester, (3) James T.
Flynn and (4) Karen P. Robards.
The registrant's board of directors has determined that David O.
Beim, W. Carl Kester and Karen P. Robards qualify as financial
experts pursuant to Item 3(c)(4) of Form N-CSR.
Mr. Beim has a thorough understanding of generally accepted
accounting principles, financial statements and internal control
over financial reporting as well as audit committee functions. For
25 years, Mr. Beim was an investment banker actively engaged in
financial analysis for securities transactions and mergers. These
transactions presented a breadth and level of complexity of
accounting issues that are generally comparable to the breadth and
complexity of issues that can reasonably be expected to be raised by
the Registrant's financial statements. Mr. Beim has also been a
professor of finance and economics at the Columbia University
Graduate School of Business for the past 11 years.
Prof. Kester has a thorough understanding of generally accepted
accounting principles, financial statements and internal control
over financial reporting as well as audit committee functions.
Prof. Kester has been involved in providing valuation and other
financial consulting services to corporate clients since 1978.
Prof. Kester's financial consulting services present a breadth and
level of complexity of accounting issues that are generally
comparable to the breadth and complexity of issues that can
reasonably be expected to be raised by the Registrant's financial
statements.
Ms. Robards has a thorough understanding of generally accepted
accounting principles, financial statements and internal control
over financial reporting as well as audit committee functions.
Ms. Robards has been President of Robards & Company, a financial
advisory firm, since 1987. Ms. Robards was formerly an investment
banker for more than 10 years where she was responsible for
evaluating and assessing the performance of companies based on their
financial results. Ms. Robards has over 30 years of experience
analyzing financial statements. She also is the member of the Audit
Committees of two privately held companies and a non-profit
organization.
Item 4 - Principal Accountant Fees and Services
(a) Audit Fees - Fiscal Year Ending December 31, 2004 - $42,400
Fiscal Year Ending December 31, 2003 - $N/A
(b) Audit-Related Fees -
Fiscal Year Ending December 31, 2004 - $0
Fiscal Year Ending December 31, 2003 - $N/A
(c) Tax Fees - Fiscal Year Ending December 31, 2004 - $5,200
Fiscal Year Ending December 31, 2003 - $N/A
The nature of the services include tax compliance, tax advice and
tax planning.
(d) All Other Fees - Fiscal Year Ending December 31, 2004 - $0
Fiscal Year Ending December 31, 2003 - $0
(e)(1) The registrant's audit committee (the "Committee") has
adopted policies and procedures with regard to the pre-approval of
services. Audit, audit-related and tax compliance services provided
to the registrant on an annual basis require specific pre-approval
by the Committee. The Committee also must approve other non-audit
services provided to the registrant and those non-audit services
provided to the registrant's affiliated service providers that
relate directly to the operations and the financial reporting of the
registrant. Certain of these non-audit services that the Committee
believes are a) consistent with the SEC's auditor independence rules
and b) routine and recurring services that will not impair the
independence of the independent accountants may be approved by the
Committee without consideration on a specific case-by-case basis
("general pre-approval"). However, such services will only be
deemed pre-approved provided that any individual project does not
exceed $5,000 attributable to the registrant or $50,000 for all of
the registrants the Committee oversees. Any proposed services
exceeding the pre-approved cost levels will require specific pre-
approval by the Committee, as will any other services not subject to
general pre-approval (e.g., unanticipated but permissible services).
The Committee is informed of each service approved subject to
general pre-approval at the next regularly scheduled in-person board
meeting.
(e)(2) 0%
(f) Not Applicable
(g) Fiscal Year Ending December 31, 2004 - $11,926,355
Fiscal Year Ending December 31, 2003 - $18,621,495
(h) The registrant's audit committee has considered and determined
that the provision of non-audit services that were rendered to the
registrant's investment adviser and any entity controlling,
controlled by, or under common control with the investment adviser
that provides ongoing services to the registrant that were not pre-
approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation
S-X is compatible with maintaining the principal accountant's
independence.
Regulation S-X Rule 2-01(c)(7)(ii) - $945,000, 0%
Item 5 - Audit Committee of Listed Registrants - The following
individuals are members of the registrant's separately-designated
standing audit committee established in accordance with Section
3(a)(58)(A) of the Exchange Act (15 U.S.C. 78c(a)(58)(A)):
David O. Beim
James T. Flynn
W. Carl Kester
Karen P. Robards
Item 6 - Schedule of Investments - Not Applicable
Item 7 - Disclosure of Proxy Voting Policies and Procedures for
Closed-End Management Investment Companies -
Proxy Voting Policies and Procedures
Each Fund's Board of Directors/Trustees has delegated to Merrill
Lynch Investment Managers, L.P. and/or Fund Asset Management, L.P.
(the "Investment Adviser") authority to vote all proxies relating to
the Fund's portfolio securities. The Investment Adviser has adopted
policies and procedures ("Proxy Voting Procedures") with respect to
the voting of proxies related to the portfolio securities held in
the account of one or more of its clients, including a Fund.
Pursuant to these Proxy Voting Procedures, the Investment Adviser's
primary objective when voting proxies is to make proxy voting
decisions solely in the best interests of each Fund and its
shareholders, and to act in a manner that the Investment Adviser
believes is most likely to enhance the economic value of the
securities held by the Fund. The Proxy Voting Procedures are
designed to ensure that that the Investment Adviser considers the
interests of its clients, including the Funds, and not the interests
of the Investment Adviser, when voting proxies and that real (or
perceived) material conflicts that may arise between the Investment
Adviser's interest and those of the Investment Adviser's clients are
properly addressed and resolved.
In order to implement the Proxy Voting Procedures, the Investment
Adviser has formed a Proxy Voting Committee (the "Committee"). The
Committee is comprised of the Investment Adviser's Chief Investment
Officer (the "CIO"), one or more other senior investment
professionals appointed by the CIO, portfolio managers and
investment analysts appointed by the CIO and any other personnel the
CIO deems appropriate. The Committee will also include two non-
voting representatives from the Investment Adviser's Legal
department appointed by the Investment Adviser's General Counsel.
The Committee's membership shall be limited to full-time employees
of the Investment Adviser. No person with any investment banking,
trading, retail brokerage or research responsibilities for the
Investment Adviser's affiliates may serve as a member of the
Committee or participate in its decision making (except to the
extent such person is asked by the Committee to present information
to the Committee, on the same basis as other interested
knowledgeable parties not affiliated with the Investment Adviser
might be asked to do so). The Committee determines how to vote the
proxies of all clients, including a Fund, that have delegated proxy
voting authority to the Investment Adviser and seeks to ensure that
all votes are consistent with the best interests of those clients
and are free from unwarranted and inappropriate influences. The
Committee establishes general proxy voting policies for the
Investment Adviser and is responsible for determining how those
policies are applied to specific proxy votes, in light of each
issuer's unique structure, management, strategic options and, in
certain circumstances, probable economic and other anticipated
consequences of alternate actions. In so doing, the Committee may
determine to vote a particular proxy in a manner contrary to its
generally stated policies. In addition, the Committee will be
responsible for ensuring that all reporting and recordkeeping
requirements related to proxy voting are fulfilled.
The Committee may determine that the subject matter of a recurring
proxy issue is not suitable for general voting policies and requires
a case-by-case determination. In such cases, the Committee may
elect not to adopt a specific voting policy applicable to that
issue. The Investment Adviser believes that certain proxy voting
issues require investment analysis - such as approval of mergers and
other significant corporate transactions - akin to investment
decisions, and are, therefore, not suitable for general guidelines.
The Committee may elect to adopt a common position for the
Investment Adviser on certain proxy votes that are akin to
investment decisions, or determine to permit the portfolio manager
to make individual decisions on how best to maximize economic value
for a Fund (similar to normal buy/sell investment decisions made by
such portfolio managers). While it is expected that the Investment
Adviser will generally seek to vote proxies over which the
Investment Adviser exercises voting authority in a uniform manner
for all the Investment Adviser's clients, the Committee, in
conjunction with a Fund's portfolio manager, may determine that the
Fund's specific circumstances require that its proxies be voted
differently.
To assist the Investment Adviser in voting proxies, the Committee
has retained Institutional Shareholder Services ("ISS"). ISS is an
independent adviser that specializes in providing a variety of
fiduciary-level proxy-related services to institutional investment
managers, plan sponsors, custodians, consultants, and other
institutional investors. The services provided to the Investment
Adviser by ISS include in-depth research, voting recommendations
(although the Investment Adviser is not obligated to follow such
recommendations), vote execution, and recordkeeping. ISS will also
assist the Fund in fulfilling its reporting and recordkeeping
obligations under the Investment Company Act.
The Investment Adviser's Proxy Voting Procedures also address
special circumstances that can arise in connection with proxy
voting. For instance, under the Proxy Voting Procedures, the
Investment Adviser generally will not seek to vote proxies related
to portfolio securities that are on loan, although it may do so
under certain circumstances. In addition, the Investment Adviser
will vote proxies related to securities of foreign issuers only on a
best efforts basis and may elect not to vote at all in certain
countries where the Committee determines that the costs associated
with voting generally outweigh the benefits. The Committee may at
any time override these general policies if it determines that such
action is in the best interests of a Fund.
From time to time, the Investment Adviser may be required to vote
proxies in respect of an issuer where an affiliate of the Investment
Adviser (each, an "Affiliate"), or a money management or other
client of the Investment Adviser (each, a "Client") is involved.
The Proxy Voting Procedures and the Investment Adviser's adherence
to those procedures are designed to address such conflicts of
interest. The Committee intends to strictly adhere to the Proxy
Voting Procedures in all proxy matters, including matters involving
Affiliates and Clients. If, however, an issue representing a non-
routine matter that is material to an Affiliate or a widely known
Client is involved such that the Committee does not reasonably
believe it is able to follow its guidelines (or if the particular
proxy matter is not addressed by the guidelines) and vote
impartially, the Committee may, in its discretion for the purposes
of ensuring that an independent determination is reached, retain an
independent fiduciary to advise the Committee on how to vote or to
cast votes on behalf of the Investment Adviser's clients.
In the event that the Committee determines not to retain an
independent fiduciary, or it does not follow the advice of such an
independent fiduciary, the powers of the Committee shall pass to a
subcommittee, appointed by the CIO (with advice from the Secretary
of the Committee), consisting solely of Committee members selected
by the CIO. The CIO shall appoint to the subcommittee, where
appropriate, only persons whose job responsibilities do not include
contact with the Client and whose job evaluations would not be
affected by the Investment Adviser's relationship with the Client
(or failure to retain such relationship). The subcommittee shall
determine whether and how to vote all proxies on behalf of the
Investment Adviser's clients or, if the proxy matter is, in their
judgment, akin to an investment decision, to defer to the applicable
portfolio managers, provided that, if the subcommittee determines to
alter the Investment Adviser's normal voting guidelines or, on
matters where the Investment Adviser's policy is case-by-case, does
not follow the voting recommendation of any proxy voting service or
other independent fiduciary that may be retained to provide research
or advice to the Investment Adviser on that matter, no proxies
relating to the Client may be voted unless the Secretary, or in the
Secretary's absence, the Assistant Secretary of the Committee
concurs that the subcommittee's determination is consistent with the
Investment Adviser's fiduciary duties
In addition to the general principles outlined above, the Investment
Adviser has adopted voting guidelines with respect to certain
recurring proxy issues that are not expected to involve unusual
circumstances. These policies are guidelines only, and the
Investment Adviser may elect to vote differently from the
recommendation set forth in a voting guideline if the Committee
determines that it is in a Fund's best interest to do so. In
addition, the guidelines may be reviewed at any time upon the
request of a Committee member and may be amended or deleted upon the
vote of a majority of Committee members present at a Committee
meeting at which there is a quorum.
The Investment Adviser has adopted specific voting guidelines with
respect to the following proxy issues:
* Proposals related to the composition of the Board of Directors of
issuers other than investment companies. As a general matter, the
Committee believes that a company's Board of Directors (rather than
shareholders) is most likely to have access to important, nonpublic
information regarding a company's business and prospects, and is
therefore best-positioned to set corporate policy and oversee
management. The Committee, therefore, believes that the foundation
of good corporate governance is the election of qualified,
independent corporate directors who are likely to diligently
represent the interests of shareholders and oversee management of
the corporation in a manner that will seek to maximize shareholder
value over time. In individual cases, the Committee may look at a
nominee's history of representing shareholder interests as a
director of other companies or other factors, to the extent the
Committee deems relevant.
* Proposals related to the selection of an issuer's independent
auditors. As a general matter, the Committee believes that
corporate auditors have a responsibility to represent the interests
of shareholders and provide an independent view on the propriety of
financial reporting decisions of corporate management. While the
Committee will generally defer to a corporation's choice of auditor,
in individual cases, the Committee may look at an auditors' history
of representing shareholder interests as auditor of other companies,
to the extent the Committee deems relevant.
* Proposals related to management compensation and employee
benefits. As a general matter, the Committee favors disclosure of
an issuer's compensation and benefit policies and opposes excessive
compensation, but believes that compensation matters are normally
best determined by an issuer's board of directors, rather than
shareholders. Proposals to "micro-manage" an issuer's compensation
practices or to set arbitrary restrictions on compensation or
benefits will, therefore, generally not be supported.
* Proposals related to requests, principally from management, for
approval of amendments that would alter an issuer's capital
structure. As a general matter, the Committee will support requests
that enhance the rights of common shareholders and oppose requests
that appear to be unreasonably dilutive.
* Proposals related to requests for approval of amendments to an
issuer's charter or by-laws. As a general matter, the Committee
opposes poison pill provisions.
* Routine proposals related to requests regarding the formalities of
corporate meetings.
* Proposals related to proxy issues associated solely with holdings
of investment company shares. As with other types of companies, the
Committee believes that a fund's Board of Directors (rather than its
shareholders) is best-positioned to set fund policy and oversee
management. However, the Committee opposes granting Boards of
Directors authority over certain matters, such as changes to a
fund's investment objective, that the Investment Company Act
envisions will be approved directly by shareholders.
* Proposals related to limiting corporate conduct in some manner
that relates to the shareholder's environmental or social concerns.
The Committee generally believes that annual shareholder meetings
are inappropriate forums for discussion of larger social issues, and
opposes shareholder resolutions "micromanaging" corporate conduct or
requesting release of information that would not help a shareholder
evaluate an investment in the corporation as an economic matter.
While the Committee is generally supportive of proposals to require
corporate disclosure of matters that seem relevant and material to
the economic interests of shareholders, the Committee is generally
not supportive of proposals to require disclosure of corporate
matters for other purposes.
Item 8 - Portfolio Managers of Closed-End Management Investment
Companies - Not Applicable at this time
Item 9 - Purchases of Equity Securities by Closed-End Management
Investment Company and Affiliated Purchasers - Not Applicable
Item 10 - Submission of Matters to a Vote of Security Holders - Not
Applicable
Item 11 - Controls and Procedures
11(a) -The registrant's certifying officers have reasonably
designed such disclosure controls and procedures to ensure material
information relating to the registrant is made known to us by others
particularly during the period in which this report is being
prepared. The registrant's certifying officers have determined that
the registrant's disclosure controls and procedures are effective
based on our evaluation of these controls and procedures as of a
date within 90 days prior to the filing date of this report.
11(b) - There were no changes in the registrant's internal control
over financial reporting (as defined in Rule 30a-3(d) under the Act
(17 CFR 270.30a-3(d)) that occurred during the second fiscal half-
year of the period covered by this report that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
Item 12 - Exhibits attached hereto
12(a)(1) - Code of Ethics - See Item 2
12(a)(2) - Certifications - Attached hereto
12(a)(3) - Not Applicable
12(b) - Certifications - Attached hereto
Pursuant to the requirements of the Securities Exchange Act of 1934
and the Investment Company Act of 1940, the registrant has duly
caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Capital and Income Strategies Fund, Inc.
By: _/s/ Robert C. Doll, Jr._______
Robert C. Doll, Jr.,
Chief Executive Officer of
Capital and Income Strategies Fund, Inc.
Date: February 24, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934
and the Investment Company Act of 1940, this report has been signed
below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.
By: _/s/ Robert C. Doll, Jr.________
Robert C. Doll, Jr.,
Chief Executive Officer of
Capital and Income Strategies Fund, Inc.
Date: February 24, 2005
By: _/s/ Donald C. Burke________
Donald C. Burke,
Chief Financial Officer of
Capital and Income Strategies Fund, Inc.
Date: February 24, 2005