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 811-08953
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Highland Floating Rate Fund
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(Exact name of registrant as specified in charter)

Two Galleria Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240
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(Address of principal executive offices) (Zip code)

James D. Dondero
Highland Capital Management, L.P.
Two Galleria Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240
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(Name and address of agent for service)

registrant's telephone number, including area code: (877) 665-1287
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Date of fiscal year end: August 31
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Date of reporting period: August 31, 2007
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Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.

A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549. The OMB has reviewed this collection of information under
the clearance requirements of 44 U.S.C. ss. 3507.

ITEM 1. REPORTS TO STOCKHOLDERS.

The Report to Shareholders is attached herewith.

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HIGHLAND FLOATING
RATE FUND
ANNUAL REPORT
AUGUST 31, 2007

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[GRAPHIC OMITTED]

[HIGHLAND FUNDS LOGO]

managed by
Highland Capital Management, L.P.

[LOGO] HIGHLAND FLOATING RATE FUND [LOGO]
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TABLE OF CONTENTS

Portfolio Managers' Letter ................................................ 1
Fund Profile .............................................................. 3
Financial Statements ...................................................... 4
Investment Portfolio ................................................... 5
Portfolio Statement of Assets and Liabilities .......................... 17
Portfolio Statement of Operations ...................................... 18
Portfolio Statements of Changes in Net Assets .......................... 19
Portfolio Statement of Cash Flows ...................................... 20
Portfolio Financial Highlights ......................................... 21
Fund Statement of Assets and Liabilities ............................... 22
Fund Statement of Operations ........................................... 23
Fund Statements of Changes in Net Assets ............................... 24
Fund Financial Highlights .............................................. 26
Notes to Financial Statements .......................................... 30
Report of Independent Registered Public Accounting Firm ................ 36
Additional Information ................................................. 37
Important Information About This Report ................................... 44

Economic and market conditions change frequently.
There is no assurance that the trends described in this report will continue or
commence.

PLEASE READ THE PROSPECTUS CAREFULLY BEFORE YOU INVEST.

PORTFOLIO MANAGERS' LETTER
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OCTOBER 24, 2007 HIGHLAND FLOATING RATE FUND

DEAR SHAREHOLDERS:

Q: HOW HAS THE FUND PERFORMED?

A: For the 12-month period ending August 31, 2007, the Fund's Class A Shares
returned 4.28%. That was greater than the return of the Fund's benchmark, the
Credit Suisse ("CS") Leveraged Loan Index, which was 2.99% for the period, and
the Lipper Loan Participation Loan Category average, which was 2.37% for the
period. During this same time period, the Standard & Poor's ("S&P") 500 index
returned 15.13% and the Lehman Aggregate Bond Index returned 5.26%.

Within the portfolio there were a number of positions that performed well during
the period. The Fund's strongest performers included Calpine Corporation Term
Loan, Nellson Nutraceutical Second Lien Term Loan, Camelbak Products Loan Second
Lien Term Loan, Reliant Pharmaceuticals First Lien Term Loan and Longyear Global
Holdings Second Lien Term Loan. The weakest performers during the period
included Ypso Holding SA (Numericable) B (Recap) 1 Facility, Environmental
Systems Products Holdings Inc. Term Loan Second Lien, Spirit Finance Corporation
Loan, IPC Systems, Inc. Tranche B-1 Term Loan and Generac Acquisition Corp.
Second Lien Term Loan.

Q: WHAT WAS THE INVESTMENT ENVIRONMENT LIKE FOR LEVERAGED LOANS DURING THE
PERIOD?

A: During most of the reporting period, loan spreads tightened while interest
rates remained flat. The Credit Suisse Leveraged Loan Index's spread fell from
255 bps in October of 2006 to a low this year of 244 bps by the end of May 2007.

According to Standard and Poor's Leveraged Commentary and Data ("LCD") Leveraged
Lending Reviews much of the leveraged loan activity in 2007 has been driven by
leveraged buy out ("LBO") transactions, which reached a volume of $248 billion
in the first half of 2007, or 64% of the market.1 Inflows into collateralized
loan obligation ("CLOs"), hedge funds and other non-traditional accounts more
than met the market's liquidity requirements during most of the first half of
the year.

However, July was the worst month for loan performance on record as measured by
the S&P/Loan Syndication Trading Association ("LSTA") index. Weak technical
conditions drove the S&P/LSTA index down to 95.27 by the end of July. The index
posted a record loss, of 3.35% in July, leaving year-to-date loan returns for
the index at -.03%. During August, the market appeared to plateau with the
S&P/LSTA index posting a modest gain of .23%.

The leveraged loan market's performance during July and August was, in our
opinion, technical in nature and impacted by the contagion from the consumer
sub-prime mortgage market. For most of the year the leveraged loan market had
been unaffected by the negative sentiment in the sub-prime market. However,
starting in July some of the levered entities holding sub-prime assets were
forced into liquidation to meet margin calls on their highly levered holdings.
This caused a general repricing of other structured products and took enough
liquidity out of the market to shut down the new issue CLO market, which is a
major source of liquidity in the loan market. That lack of loan demand, coupled
with the large new issue supply, caused a repricing of corporate loans.

In our opinion market performance is being driven by the above mentioned
technical factors. Further reinforcing the technical versus fundamental nature
of the recent repricing is the current default rate. During this summer's
repricing the lagging 12-month default rate remained near an all-time low of
..42% by principal amount, well below the index's historical average of 3.17%.
These low default rates are an indication of just how strong the fundamentals
remain across the credit markets.

Q: HOW IS THE FUND CURRENTLY POSITIONED?

A: The Fund is approximately 96.81% loans, 2.62% equities and .57% other
corporate debt, as a percentage of investments. With regards to diversification,
the Fund is currently invested in approximately 42 industries and 335 issuers.

Q: WHAT IS YOUR OUTLOOK?

A: With the large forward calendar needing to be placed and the state of the CLO
market still in flux, it is difficult to see a quick snap back in spreads.

- ----------
1 S&P Leverage Loan Commentary and Data - 2nd Qtr 2007 Review p. 2.

2 S&P LCD Weekly Wrap August 16 2007 p. 16.

3 S&P LCD Loan Stats August 2007 p. 2.

4 S&P LCD Weekly Wrap September 6 2007 p. 18.

5 S&P LCD Weekly Wrap September 13 2007 p. 19.

Annual Report | 1

PORTFOLIO MANAGERS' LETTER
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OCTOBER 24, 2007 HIGHLAND FLOATING RATE FUND

Some LBO transactions are being delayed while others are offered with larger
than anticipated original issue discount ("OID") and with higher spreads than
initially expected in order to clear the market. We are also seeing covenants
being added to deals. We believe the digestion process will take at least six
months to clear the backlog of underwritten deals.

By extension, loans in the secondary market traded down through August, but have
shown signs of stabilization, at least temporarily, in September. Our analysts
see some good buying opportunities in this price correction during the second
half of the calendar year. In our opinion, repricing of the broader market was
overdone from a fundamental standpoint. For example, the Credit Suisse Leveraged
Loan Index traded at a monthly average of 100.09 during the first ten months of
the performance year but during July and August traded down to 95.87 and 95.37,
respectively. Given the fairly benign fundamental backdrop (i.e., low default
rates, cash flow growth, etc.) we expect a gradual increase in pricing and
tightening of spreads. However, in our opinion, this could take as long as six
months due in part to the large supply of loans on the calendar.

In our fundamental monitoring of our credit portfolios, we do not foresee see a
material increase in default rates until after 2008, but an increase from here
is probable simply due to the extraordinary low numbers today. However, the Fund
holds a well diversified portfolio which should help insulate it against an
increase in default rates. The inevitable market correction could be viewed as a
positive for the Fund by creating some good buying opportunities.

/s/ Mark Okada /s/ Joe Dougherty

MARK OKADA JOE DOUGHERTY
Portfolio Manager Portfolio Manager

Mark Okada and Joe Dougherty have been portfolio managers of the Highland
Floating Rate Fund since April 15, 2004.

Just like any other investment, floating rate loan investments present financial
risks. Defaults on the loans in the portfolio could reduce the Fund's net asset
value and its distributions, as could nonpayment of scheduled interest and
principal. Prepayment of principal by a borrower could mean the Fund's managers
have to replace the loan with a lower-yielding security, which could affect the
valuation of the portfolio's holdings.

The Fund is a continuously offered, closed-end management investment company and
provides limited liquidity through a quarterly tender offer for between 5% and
25% of outstanding shares. Each quarter, the Fund's trustees must approve the
actual tender. Please read the prospectus carefully for more details.

The Fund may invest a high percentage of assets in a limited number of loans, so
the default of any individual holdings can have a greater impact on the Fund's
net asset value than could a default in a more diversified portfolio.

Floating rate loans are not covered by FDIC insurance or other guarantees
relating to timely payment of principal and interest.

Since economic and market conditions change frequently, there can be no
assurance that the trends described here will continue or that the forecasts
will come to pass. The opinions expressed are those of the contributors and are
subject to change.

Prior investment returns are not indicative of future results.

2 | Annual Report

FUND PROFILE
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HIGHLAND FLOATING RATE FUND

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Objective
- ----------------------------------------------

The Highland Floating Rate Fund (the "Fund") invests all of its investable
assets in Highland Floating Rate Limited Liability Company (the
"Portfolio"). The Fund and the Portfolio seek a high level of current
income consistent with preservation of capital.

- ----------------------------------------------
Net Assets as of August 31, 2007
- ----------------------------------------------

$2,328.2 million

- ----------------------------------------------
Portfolio Data as of August 31, 2007
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The information below provides a snapshot of the Portfolio at the end of
the reporting period. The Portfolio is actively managed and the
composition of its investment portfolio will change over time.

-------------------------------------------------
QUALITY BREAKDOWN AS OF 08/31/07 (%)*
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A 0.2
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Baa 0.8
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Ba 25.0
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B 41.0
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Caa 3.0
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NR 30.0
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TOP 5 SECTORS AS OF 08/31/07 (%)*
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Housing -- Real Estate Development 8.2
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Telecommunications 6.6
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Diversified Media 6.4
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Healthcare -- Medical Products 5.9
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Retail 5.4
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TOP 10 HOLDINGS AS OF 08/31/07 (%)*
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Lake at Las Vegas Joint Venture 3.2
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HCA, Inc. 2.4
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Ford Motor Co. 1.7
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Univision Communications, Inc. 1.7
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Cricket Communications, Inc. 1.6
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Delphi Corp. 1.6
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Tribune Co. 1.5
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Charter Communications Operating, LLC 1.5
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Gray Television, Inc. 1.4
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MetroPCS Wireless, Inc. 1.4
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* Quality is calculated as a percentage of total notes and bonds. Sectors and
holdings are calculated as a percentage of net assets.

Annual Report | 3

FINANCIAL STATEMENTS
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AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

A GUIDE TO UNDERSTANDING THE FUND'S FINANCIAL STATEMENTS

INVESTMENT PORTFOLIO The Investment Portfolio details all of the Portfolio's holdings and their market value as of
the last day of the reporting period. Portfolio holdings are organized by type of asset and
industry to demonstrate areas of concentration and diversification.

STATEMENT OF ASSETS AND LIABILITIES These statements detail the Fund's and the Portfolio's assets, liabilities, net assets and,
with respect to the Fund, share price for each share class as of the last day of the reporting
period. Net assets are calculated by subtracting all liabilities (including any unpaid
expenses) from the total of investment and non-investment assets. The net asset value per
share for each class is calculated by dividing net assets for that class by the number of
shares outstanding in that class as of the last day of the reporting period.

STATEMENT OF OPERATIONS These statements detail income earned by the Fund and the Portfolio and the expenses accrued
by the Fund and the Portfolio during the reporting period. The Statement of Operations also
shows any net gain or loss realized on the sales of holdings during the period, as well as any
unrealized gains or losses recognized over the period. The total of these results represents
net increase or decrease in net assets from operations.

STATEMENTS OF CHANGES IN NET ASSETS These statements demonstrate how the Fund's and the Portfolio's net assets were affected by
their operating results, distributions to shareholders and shareholder transactions (e.g.,
subscriptions, redemptions and dividend reinvestments) during the reporting period. The
Statements of Changes in Net Assets, with respect to the Fund, also detail changes in the
number of shares outstanding.

STATEMENT OF CASH FLOWS This statement reports net cash and foreign currency provided or used by operating, investing
and financing activities and the net effect of those flows on cash and foreign currency during
the period.

FINANCIAL HIGHLIGHTS The Financial Highlights demonstrate how the Fund's net asset value per share was affected by
the Fund's operating results. The Financial Highlights also disclose the classes' performance
and certain key ratios of the Fund and the Portfolio (e.g., class expenses and net investment
income as a percentage of average net assets).

NOTES TO FINANCIAL STATEMENTS These notes disclose the organizational background of the Fund and the Portfolio, their
significant accounting policies (including those surrounding security valuation, income
recognition and distributions to shareholders), federal tax information, fees and compensation
paid to affiliates and significant risks and contingencies.

4 | Annual Report

INVESTMENT PORTFOLIO
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AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

AEROSPACE - AEROSPACE/DEFENSE - 2.2%
AWAS Capital, Inc.
13,545,859 First Lien Term Loan,
7.13%, 03/15/13 ................................ 12,936,296
6,550,321 Second Lien Term Loan,
11.38%, 03/15/13 ............................... 6,452,066
2,992,500 DeCrane Aircraft Holdings, Inc.
First Lien Term Loan,
8.10%, 02/21/13 ................................ 2,902,725
1,903,900 Forgings International Holdings
Term D, 9.33%, 03/22/15 ........................ 1,782,526
Forgings International Ltd.
2,349,647 Term B2, 7.61%, 09/22/14 ....................... 2,238,039
2,383,511 Term C2, 7.82%, 09/22/15 ....................... 2,270,294
1,970,000 IAP Worldwide Services, Inc.
First Lien Term Loan,
9.69%, 12/30/12 ................................ 1,708,975
Travelport LLC
3,300,000 Delayed Draw Term Loan,
9.75%, 08/23/13 ................................ 3,176,250
10,000,000 Letter of Credit,
8.00%, 05/23/14 ................................ 9,625,000
357,499 Synthetic Letter of Credit,
7.61%, 08/23/13 ................................ 344,093
415,264 Synthetic Letter of Credit,
7.86%, 08/23/13 ................................ 399,691
4,340,731 Tranche B Dollar Term Loan,
7.75%, 08/23/13 ................................ 4,177,954
2,929,412 Vought Aircraft Industries, Inc.
Term Loan, 7.83%, 12/22/11 ..................... 2,848,853
990,749 Wesco Aircraft Hardware Corp.
First Lien Term Loan,
7.61%, 09/30/13 ................................ 964,741
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51,827,503
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AEROSPACE - AIRLINES - 1.6%
Continental Airlines, Inc.
1,714,286 Tranche A-1 Term Loan,
8.74%, 06/01/11 ................................ 1,690,714
4,285,714 Tranche A-2 Term Loan,
8.74%, 06/01/11 ................................ 4,226,786
Delta Air Lines, Inc.
945,000 Credit-Linked Deposit Loan,
7.36%, 04/30/12 ................................ 907,795
2,000,000 Second Lien Term Loan,
8.61%, 04/24/14 (b) ............................ 1,928,120
4,950,000 Northwest Airlines, Inc.
Term Loan, DIP, 7.34%, 08/21/08 ................ 4,671,563
25,250,000 US Airways, Inc.
Term Loan, 7.85%, 03/23/14 ..................... 23,890,035
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37,315,013
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BROADCASTING - 3.0%
2,883,246 All3Media Intermediate Ltd.
UK Term Loan B,
7.74%, 08/31/14 ................................ 2,739,084
Comcorp Broadcasting, Inc.
43,647 CCB PIK Revolver,
06/04/14 (c) (d) ............................... 47,172
196,684 CCB PIK Term Loan,
06/04/14 (c) (d) ............................... 212,569
350,503 CCB Revolver, 06/04/14 (c) (d) ................. 378,811
1,684,317 CCB Term Loan, 06/04/14 (c) (d) ................ 1,820,347

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PRINCIPAL AMOUNT ($) VALUE ($)
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BROADCASTING (CONTINUED)
Comcorp Broadcasting, Inc. (continued)
78,965 WK PIK Term Loan,
06/04/14 (c) (d) ............................... 85,343
677,065 WK Term Loan, 06/04/14 (c) (d) ................. 731,747
Millennium Digital Media Systems, LLC
764,478 Revolver, 9.00%, 06/30/11 (d) (e) .............. 764,478
28,068,904 Term Facility, 9.36%, 06/30/11 ................. 27,718,043
NextMedia Operating, Inc
1,185,930 Delay Draw Term Loan,
7.32%, 11/15/12 ................................ 1,126,633
2,668,341 Initial First Lien Term Loan,
7.32%, 11/15/12 ................................ 2,534,924
11,000,000 Paxson Communications Corp.
First Lien Term Loan,
8.61%, 01/15/12 ................................ 10,725,000
1,500,000 Persona Communications Corp.
Second Lien Term Loan,
11.32%, 04/12/14 ............................... 1,511,250
19,823,662 Young Broadcasting, Inc.
Term Loan, 7.88%, 11/03/12 ..................... 18,535,124
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68,930,525
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CABLE - INTERNATIONAL CABLE - 0.5%
805,000 San Juan Cable, LLC
Second Lien Term Loan,
10.86%, 10/31/13 ............................... 784,875
9,442,500 UPC Financing Partnership
Facility N1, 7.13%, 12/31/14 ................... 8,893,702
3,000,000 Virgin Media Inc.
B4 Facility, 7.36%, 07/03/12 ................... 2,905,980
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12,584,557
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CABLE - US CABLE - 4.4%
2,675,000 Bresnan Communications, LLC
Additional Term Loan B,
7.36%, 06/30/13 ................................ 2,594,750
CCO Holdings, LLC
1,000,000 Incremental Loan, 7.86%, 09/06/14 .............. 966,250
2,000,000 Incremental Loan, 7.85%, 09/06/14 .............. 1,932,500
Cequel Communications LLC
250,000 Second Lien Tranche A Term Loan,
9.86%, 05/05/14 ................................ 243,125
11,720,625 Term Loan, 7.36%, 11/05/13 ..................... 11,087,711
Charter Communications
Operating, LLC
16,500,000 New Term Loan, 7.35%, 03/06/14 ................. 15,675,000
36,166,667 Term Facility, 7.36%, 04/28/13 ................. 34,358,333
10,000,000 Knology, Inc.
Term Loan, 7.59%, 06/30/12 ..................... 9,800,000
995,000 Mediacom Illinois, LLC
Tranche C Term Loan,
7.10%, 01/31/15 ................................ 933,648
Northland Cable Television, Inc.
4,925,000 First Lien Term Loan B,
9.36%, 12/22/12 ................................ 4,912,688
4,000,000 Second Lien Term Loan,
13.36%, 06/22/13 ............................... 4,000,000
5,000,000 RCN Corp.
Initial Term Loan, 7.69%, 04/25/14 ............. 4,750,000
WideOpenWest Finance, LLC
11,000,000 First Lien Term Loan,
7.85%, 06/30/14 (b) ............................ 10,367,500
1,000,000 Second Lien Term Loan,
06/29/15 (b) ................................... 910,000
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102,531,505
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See accompanying Notes to Financial Statements. | 5

INVESTMENT PORTFOLIO (CONTINUED)
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AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

CHEMICALS - COMMODITY & FERTILIZER - 0.6%
6,982,500 Celanese US Holdings, LLC
Term Loan, 7.11%, 04/02/14 ..................... 6,774,422
5,000,000 Cognis GMBH
Facility C, 7.32%, 09/15/13 .................... 4,604,200
Ferro Corp.
500,472 Term Loan, 7.36%, 06/06/12 ..................... 495,468
1,250,000 Term Loan, 7.42%, 06/06/12 ..................... 1,237,500
267,611 Term Loan, 7.57%, 06/06/12 ..................... 264,935
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13,376,525
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CHEMICALS - SPECIALTY CHEMICALS - 0.3%
997,500 Berry Plastics Holding Corp.
Term C Loan, 7.36%, 04/03/15 (f) ............... 957,600
Hexion Specialty Chemicals, Inc.
2,335,641 Tranche C-1 Term Loan,
7.88%, 05/05/13 (f) ............................ 2,290,096
507,368 Tranche C-2 Term Loan,
7.88%, 05/05/13 (f) ............................ 496,713
481,479 Ineos U S Finance LLC
Term Loan A4 Facility,
7.58%, 12/14/12 ................................ 460,053
1,277,273 Innophos, Inc.
Tranche B Term Loan,
7.57%, 08/13/10 ................................ 1,251,727
970,284 Kraton Polymers Group of Cos.
Term Loan, 7.38%, 12/23/10 ..................... 915,705
848,000 Nusil Technology LLC
Tranche B Term Loan,
8.07%, 10/24/13 ................................ 852,240
1,000,000 Panda Hereford Ethanol, L.P.
Tranche A Term Loan,
9.07%, 07/28/13 ................................ 977,500
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8,201,634
------------
CONSUMER DURABLES - 0.1%
2,654,000 Rexair LLC
First Lien Term Loan,
9.61%, 06/30/10 ................................ 2,627,460
------------
CONSUMER NON-DURABLES - 1.4%
3,990,000 Amscan Holdings, Inc.
Term Loan, 7.63%, 05/27/13 ..................... 3,785,513
995,556 BioTech Research Labs/Philosophy
Merger Sub, Inc.
First Lien Term Loan,
7.36%, 03/16/14 ................................ 910,933
1,555,556 Camelbak Products, Inc.
Second Lien Term Loan,
12.91%, 02/04/12 ............................... 1,438,889
2,985,000 DS Waters of America, Inc.
Term Loan, 7.61%, 10/27/12 ..................... 2,835,750
72 Eastman Kodak Co.
Term B-1 Advance, 10/18/12 ..................... 72
556,429 Hanesbrands, Inc.
Term B Loan, 7.10%, 09/05/13 ................... 542,240
1,693,519 Hillman Group, Inc.
Term Loan B, 8.38%, 03/30/11 ................... 1,651,181
Solo Cup Co.
7,212,593 Term B1 Loan, 8.92%, 02/27/11 .................. 7,111,906
851,796 Term B1 Loan, 8.84%, 02/27/11 .................. 839,905
1,000,000 Term B1 Loan, 02/27/11 (b) ..................... 986,040

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PRINCIPAL AMOUNT ($) VALUE ($)
- --------------------------------------------------------------------------------
CONSUMER NON-DURABLES (CONTINUED)
Spectrum Brands, Inc.
1,739,831 Dollar Term B II Loan,
9.32%, 03/30/13 ................................ 1,652,839
9,776,883 Dollar Term B Loan,
9.36%, 03/30/13 ................................ 9,532,461
483,286 Letter of Credit, 5.17%, 03/30/13 .............. 472,412
992,475 Yankee Candle Co., Inc.
Term Loan, 7.36%, 02/06/14 ..................... 956,498
------------
32,716,639
------------
DIVERSIFIED MEDIA - 5.5%
185,111 Black Press Group Ltd.
Term B-2 Tranche Loan,
7.54%, 08/01/13 ................................ 181,524
304,889 Black Press U S Partnership
Term B-1 Tranche Loan,
7.54%, 08/01/13 ................................ 298,980
2,921,213 Cinemark USA, Inc.
Term Loan, 7.23%, 10/05/13 ..................... 2,805,300
Endurance Business Media, Inc.
2,810,126 First Lien Term Loan,
8.07%, 07/26/13 ................................ 2,683,671
2,000,000 Second Lien Term Loan,
12.57%, 01/26/14 ............................... 1,980,000
994,936 HIT Entertainment PLC
Term Facility, 7.34%, 03/20/12 ................. 950,164
1,000,000 Knowledgepoint360 Group LLC
Second Lien Term Loan,
12.53%, 04/26/15 ............................... 997,500
2,955,000 Merrill Communications LLC
Combined Term Loan,
7.59%, 05/15/11 ................................ 2,892,206
Metro-Goldwyn-Mayer Holdings II, Inc.
13,747,475 Tranche B Term Loan,
8.61%, 04/08/12 ................................ 13,043,054
9,287,607 Tranche B Term Loan,
8.60%, 04/08/12 ................................ 8,811,710
Penton Media, Inc.
6,483,750 First Lien Term Loan,
7.60%, 02/01/13 ................................ 6,167,667
5,500,000 Second Lien Term Loan,
10.36%, 02/01/14 ............................... 5,197,500
Readers Digest Association, Inc.
972,500 Revolver, 8.63%, 02/17/13 (e) .................. 904,425
4,987,500 U.S. Term Loan, 7.36%, 03/02/14 ................ 4,650,844
Riverdeep Interactive Learning USA, Inc.
1,927,099 Bridge Facility, 12.06%, 12/21/14 .............. 1,917,464
14,442,314 Term Loan, 8.11%, 12/20/13 ..................... 14,249,798
Springer Science+Business Media S.A.
562,496 Tranche B-2, 7.75%, 09/16/11 ................... 543,000
562,496 Tranche C-2, 8.12%, 07/05/14 ................... 543,000
366,301 Tranche E-2, 8.12%, 07/05/14 ................... 353,605
338,124 USD Tranche B-2 Add On, 07/05/13 ............... 326,405
338,124 USD Tranche C-2 Add On, 07/05/14 ............... 326,405
Tribune Co.
38,000,000 Initial Tranche B Advance,
8.36%, 05/19/14 ................................ 34,437,500
20,066,667 Tranche X Advance,
7.86%, 05/18/09 ................................ 19,590,083
Valassis Communications, Inc.
213,333 Delayed Draw Term Loan,
03/02/14 (b) ................................... 199,401
718,033 Tranche B Term Loan,
7.11%, 03/02/14 ................................ 668,446
1,980,075 West Corp.
Term B-2 Loan, 7.82%, 10/24/13 ................. 1,916,217

6 | See accompanying Notes to Financial Statements.

INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------

AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

DIVERSIFIED MEDIA (CONTINUED)
936,108 WMG Acquisitions Corp.
Term Loan, 7.48%, 02/28/11 ..................... 911,245
------------
127,547,114
------------
ENERGY - EXPLORATION & PRODUCTION - 0.4%
III Exploration II LP
750,000 Delayed Draw Term Loan,
9.11%, 10/29/13 ................................ 723,750
4,239,375 Initial Draw Term Loan,
8.85%, 10/28/13 ................................ 4,090,997
Targa Resources, Inc.
771,822 Synthetic Letter of Credit,
5.23%, 10/31/12 ................................ 742,879
3,159,638 Term Loan, 7.36%, 10/31/12 ..................... 3,041,151
------------
8,598,777
------------
ENERGY - OTHER ENERGY - 1.5%
Coffeyville Resources, LLC
486,146 Funded Letter of Credit,
5.25%, 12/28/10 ................................ 456,977
2,499,212 Tranche D Term Loan,
8.60%, 12/30/13 ................................ 2,410,190
4,500,000 Endeavour International Holding B.V.
Second Lien Term Loan,
12.36%, 11/01/11 ............................... 4,455,000
7,424,551 Helix Energy Solutions Group, Inc.
Term Loan, 7.33%, 07/01/13 ..................... 7,174,047
994,962 MEG Energy Corp.
Initial Term Loan, 7.36%, 04/03/13 ............. 968,437
Monitor US Finco, Inc.
3,980,000 First Lien Term Loan,
10.86%, 01/11/14 ............................... 3,980,000
3,000,000 Second Lien Term Loan,
17.36%, 12/14/14 ............................... 2,970,000
8,596,862 Value Creation, Inc.
Term Loan, 12.85%, 07/01/12 .................... 8,338,956
975,000 Volnay Acquisition Co. I
Term Loan B1, 7.36%, 01/12/14 .................. 947,583
4,000,000 Willbros USA, Inc.
Syndicate Term Loan,
10.27%, 10/27/09 ............................... 4,020,000
------------
35,721,190
------------
ENERGY - REFINING - 0.4%
846,750 Concho Resources, Inc.
Second Lien Term Loan,
9.74%, 03/27/12 ................................ 834,049
3,000,000 Connacher Finance Corp.
Term Loan, 8.61%, 10/20/13 ..................... 2,992,500
2,000,000 Port Barre Investments, LLC
Term B Loan, 7.49%, 08/14/14 ................... 1,930,000
2,785,714 Western Refining, Inc.
Term Loan, 9.00%, 05/30/14 ..................... 2,657,739
------------
8,414,288
------------
FINANCIAL - 1.6%
1,741,250 AlixPartners, LLP
Tranche C Term Loan,
7.61%, 10/12/13 ................................ 1,697,719
2,604,643 Arias Acquisitions, Inc.
Term Loan, 10.86%, 07/26/11 .................... 2,181,388

- --------------------------------------------------------------------------------
PRINCIPAL AMOUNT ($) VALUE ($)
- --------------------------------------------------------------------------------
FINANCIAL (CONTINUED)
Checksmart Financial Co.
1,913,193 First Lien Tranche B Term Loan,
8.11%, 05/01/12 ................................ 1,831,882
2,500,000 Second Lien Term Loan,
10.87%, 05/01/13 ............................... 2,350,000
Dollar Financial Corp.
1,143,898 Canadian Borrower Term Loan,
8.11%, 10/30/12 ................................ 1,121,020
841,102 Delayed Draw Term Loan,
8.11%, 10/30/12 ................................ 824,280
Emerson Reinsurance Ltd.
3,250,000 Series A Loan, 7.11%, 12/15/11 ................. 3,152,500
1,250,000 Series B Loan, 8.36%, 12/15/11 ................. 1,212,500
992,500 First American Payment Systems, L.P.
Term Loan, 8.63%, 10/06/13 ..................... 977,613
Flatiron Re Ltd.
1,619,945 Closing Date Term Loan,
9.59%, 12/29/10 ................................ 1,605,802
784,661 Delayed Draw Term Loan,
9.59%, 12/29/10 ................................ 777,811
2,078,125 FleetCor Technologies Operating
Co., LLC
Tranche 1 Term Loan,
7.59%, 04/30/13 ................................ 2,005,391
HUB International Holdings, Inc.
287,582 Delayed Draw Term Loan,
8.01%, 06/13/14 (e) ............................ 276,977
4,084,967 Initial Term Loan, 7.86%, 06/13/14 ............. 3,934,314
4,000,000 Kepler Holdings, Ltd.
Term Loan, 10.85%, 06/30/09 .................... 3,880,000
1,000,000 Online Resources Corp.
Term Loan A, 8.07%, 02/09/12 ................... 960,000
8,795,676 Wind Acquisition Holdings Finance S.A.
PIK Term Loan,
12.61%, 12/21/11 ............................... 8,729,708
------------
37,518,905
------------
FOOD AND DRUG - 0.4%
8,000,000 Rite Aid Corp.
Senior Secured Bridge Loan,
10/23/07 (b) ................................... 7,960,000
1,492,500 Weight Watchers International, Inc.
Term Loan B, 6.88%, 01/26/14 ................... 1,477,575
------------
9,437,575
------------
FOOD/TOBACCO - FOOD/TOBACCO PRODUCERS - 0.5%
2,584,905 Chiquita Brands LLC
Term Loan C, 8.56%, 06/28/12 ................... 2,524,573
FSB Holdings, Inc.
1,500,000 First Lien Tranche B Term Loan,
7.88%, 09/29/13 ................................ 1,455,000
1,000,000 Second Lien Term Loan,
11.13%, 03/29/14 ............................... 995,000
LJVH Holdings, Inc.
2,000,000 Second Lien Loan,
10.86%, 01/19/15 ............................... 1,940,000
880,000 Tranche B Term Loan,
7.86%, 07/19/14 ................................ 858,000
120,000 Tranche C Term Loan,
7.86%, 07/19/14 ................................ 117,000
3,826,607 Michelina's
Term Loan, 8.38%, 04/02/11 ..................... 3,750,075
------------
11,639,648
------------

See accompanying Notes to Financial Statements. | 7

INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------

AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

FOOD/TOBACCO - RESTAURANTS - 1.0%
3,980,000 Aramark Canada Ltd.
Canadian Term Loan,
7.35%, 01/26/14 ................................ 3,820,800
Aramark Corp.
120,394 Letter of Credit Facility,
7.36%, 01/26/14 ................................ 116,395
221 U.S. Term Loan, 7.36%, 01/26/14 ................ 214
Buffets Holdings, Inc.
583,243 PF Letter of Credit Commitments,
11/01/13 ....................................... 548,249
1,321,875 Revolver, 10.50%, 11/01/11 (e) ................. 1,201,228
4,394,583 Term Loan, 8.11%, 11/01/13 ..................... 4,130,908
1,433,089 Caribbean Restaurant LLC
Tranche B Term Loan,
8.07%, 06/30/09 ................................ 1,411,593
1,951,597 El Pollo Loco, Inc.
Term Loan, 7.86%, 11/18/11 ..................... 1,907,686
OSI Restaurant Partners LLC
4,644,157 Incremental Term Loan,
7.63%, 06/14/14 ................................ 4,411,949
355,843 Synthetic Revolver,
5.18%, 06/14/13 ................................ 339,830
5,000,000 Pinnacle Foods Finance LLC
Term Loan, 8.11%, 04/02/14 ..................... 4,787,500
997,500 Sbarro, Inc.
Term Loan B, 7.88%, 01/31/14 ................... 955,106
------------
23,631,458
------------
FOREST PRODUCTS - PACKAGING - 0.3%
5,985,000 Graham Packaging Co.
Term Loan B, 7.63%, 10/07/11 ................... 5,825,380
Smurfit Kappa Acquisitions
1,000,000 B1 Term Loan Facility,
7.49%, 12/01/13 ................................ 980,000
1,000,000 C1 Term Loan Facility,
8.11%, 12/01/14 ................................ 980,000
------------
7,785,380
------------
FOREST PRODUCTS - PAPER - 0.1%
1,478,076 NewPage Corp.
Term Loan, 7.63%, 05/02/11 ..................... 1,448,515
------------
GAMING/LEISURE - GAMING - 0.6%
3,936,051 CCM Merger, Inc./MotorCity Casino
Term Loan B, 7.36%, 04/25/12 ................... 3,827,810
1,994,811 Green Valley Ranch Gaming LLC
Term Loan, 7.36%, 02/16/14 ..................... 1,905,045
1,961,759 Riverside Casino & Golf Resort, LLC
Term Loan, 8.88%, 11/30/11 ..................... 1,942,141
6,000,000 VML U S Finance LLC
Term B Funded Project Loan,
7.61%, 05/25/13 ................................ 5,790,000
------------
13,464,996
------------
GAMING/LEISURE - OTHER LEISURE - 1.1%
Alpha Topco Ltd.
1,428,571 Facility B1, 8.13%, 12/31/13 ................... 1,385,714
1,071,429 Facility B2, 8.13%, 12/31/13 ................... 1,039,286
5,000,000 Fontainebleu Florida Hotel LLC
Tranche C Term Loan,
11.38%, 06/06/12 ............................... 4,668,750

- --------------------------------------------------------------------------------
PRINCIPAL AMOUNT ($) VALUE ($)
- --------------------------------------------------------------------------------
GAMING/LEISURE - OTHER LEISURE (CONTINUED)
4,666,667 Fontainebleu Las Vegas LLC
Term Loan, 8.61%, 05/17/14 ..................... 4,357,500
995,000 Greenwood Racing Inc.
Term Loan, 7.57%, 11/28/11 ..................... 957,688
3,660,201 Kuilima Resort Co.
First Lien Term Loan,
9.85%, 09/30/10 ................................ 3,417,713
3,000,000 Orbitz Worldwide, Inc.
Term Loan, 8.34%, 07/25/14 ..................... 2,925,000
Trump Entertainment Resorts
Holdings, L.P.
2,208,703 Term C-1 Facility, 7.90%, 05/20/12 ............. 2,175,572
2,208,703 Term C-2 Facility, 7.86%, 05/20/12 ............. 2,175,572
1,940,000 Wallace Theaters
First Lien Term Loan,
8.60%, 07/31/09 ................................ 1,891,500
882,286 Yellowstone Mountain Club, LLC
First Lien Term Loan,
7.70%, 09/30/10 ................................ 854,344
------------
25,848,639
------------
HEALTHCARE - ACUTE CARE - 2.6%
1,396,862 Alliance Imaging, Inc.
Tranche C1 Term Loan,
7.88%, 12/29/11 ................................ 1,373,297
HCA, Inc.
979,545 Tranche A Term Loan,
7.35%, 11/17/12 ................................ 937,601
57,240,000 Tranche B Term Loan,
7.61%, 11/17/13 (b) ............................ 55,245,758
2,977,500 ReAble Therapeutics Finance, LLC
Term Loan, 7.84%, 11/04/13 ..................... 2,917,950
------------
60,474,606
------------
HEALTHCARE - ALTERNATE SITE SERVICES - 1.7%
1,426,568 American HomePatient, Inc.
Secured Promissory Note,
6.79%, 08/01/09 (g) ............................ 1,426,568
8,912,220 CHS/Community Health Systems, Inc.
Funded Term Loan,
7.57%, 07/25/14 ................................ 8,593,162
FHC Health Systems, Inc.
513,978 Delayed Draw Term Loan,
14.07%, 12/18/09 ............................... 519,117
734,254 Initial Term Loan, 12.07%, 12/18/09 ............ 741,596
1,500,000 Third Lien Additional Term Loan,
15.11%, 02/09/11 ............................... 1,515,000
5,000,000 Third Lien Term Loan,
15.11%, 02/09/11 ............................... 5,050,000
16,335,360 LifeCare Holdings
Term Loan, 8.36%, 08/11/12 ..................... 15,110,208
3,000,000 Medical Staffing Network, Inc.
First Lien Term Loan,
10.75%, 07/02/13 ............................... 2,977,500
1,960,000 Skilled Healthcare LLC
First Lien Term Loan,
7.57%, 06/15/12 ................................ 1,950,200
331,070 Sunrise Medical Holdings, Inc.
Term Loan B-1, 9.47%, 05/13/10 ................. 316,172
1,940,000 WellCare Health Plans, Inc.
Term Loan, 7.88%, 05/13/09 ..................... 1,937,575
------------
40,137,098
------------

8 | See accompanying Notes to Financial Statements.

INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------

AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

HEALTHCARE - MEDICAL PRODUCTS - 5.5%
1,786,106 American Medical Systems, Inc.
Term Loan, 7.69%, 07/20/12 ..................... 1,745,918
CB Diagnostics AB
1,349,530 Facility B2, 7.46%, 01/19/15 ................... 1,298,923
3,959,790 Facility C2, 7.73%, 01/18/16 ................... 3,831,096
CCS Medical, Inc.
29,449,723 First Lien Term Loan,
8.57%, 09/30/12 ................................ 29,099,861
4,750,000 Second Lien Term Loan,
13.32%, 03/30/13 ............................... 4,785,625
1,865,625 CompBenefits Corp.
Tranche B Term Loan,
8.32%, 04/12/12 ................................ 1,849,301
1,467,632 DSI Renal, Inc.
Term Facility, 7.63%, 03/31/13 ................. 1,397,919
8,977,500 Fenwal, Inc.
Initial First Lien Term Loan,
7.57%, 02/28/14 ................................ 8,326,631
1,000,000 Golden Gate National Senior
Care LLC
Second Lien Term Loan,
13.07%, 09/14/11 ............................... 990,000
Graceway Pharmaceuticals LLC
4,958,333 First Lien Term B Loan,
8.07%, 05/03/12 ................................ 4,729,010
4,500,000 Mezzanine Loan, 13.61%, 11/03/13 ............... 3,735,000
9,438,170 HealthSouth Corp.
Term Loan, 7.85%, 03/10/13 ..................... 9,115,762
IM US Holdings LLC
5,000,000 First Lien Term Loan,
9.25%, 06/26/14 (b) ............................ 4,825,000
1,000,000 Second Lien Term Loan,
11.50%, 06/26/15 ............................... 985,000
Nyco Holdings 3 ApS
3,875,000 Facility B2, 7.86%, 12/29/14 ................... 3,589,258
3,875,000 Facility C2, 8.36%, 12/29/15 ................... 3,627,969
Patheon, Inc.
1,197,000 Tranche PB Loan, 7.88%, 04/27/14 ............... 1,161,090
798,000 Tranche USB Loan, 7.88%, 04/27/14 .............. 774,060
3,950,000 Pharmaceutical Holdings Corp.
Term Loan, 8.76%, 01/30/12 ..................... 3,831,500
2,498,369 Psychiatric Solutions, Inc.
Term Loan, 7.11%, 07/02/12 ..................... 2,404,680
Reliant Pharmaceuticals, Inc.
626,337 Delayed Draw Term Loan,
8.61%, 03/31/12 ................................ 598,152
2,366,163 Initial Term Loan, 8.59%, 03/31/12 ............. 2,259,685
Talecris Biotherapeutics
Holdings Corp.
16,417,500 First Lien Term Loan,
9.08%, 12/06/13 ................................ 16,263,668
7,500,000 Second Lien Term Loan,
12.08%, 12/08/14 ............................... 7,514,100
Triumph Healthcare Second
Holdings LLC
1,989,994 First Lien Term Loan,
8.83%, 07/28/13 ................................ 1,940,244
1,000,000 Second Lien Term Loan,
13.57%, 07/28/14 ............................... 962,500
4,540,493 Warner Chilcott Co., Inc.
Tranche B Acquisition Date
Term Loan, 7.36%, 01/18/12 ..................... 4,407,093

- --------------------------------------------------------------------------------
PRINCIPAL AMOUNT ($) VALUE ($)
- --------------------------------------------------------------------------------
HEALTHCARE - MEDICAL PRODUCTS (CONTINUED)
1,356,959 Warner Chilcott Corp.
Tranche C Acquisition Date
Term Loan, 7.36%, 01/18/12 ..................... 1,317,091
------------
127,366,136
------------
HOUSING - BUILDING MATERIALS - 2.6%
1,720,000 Associated Materials Inc.
Term Loan, 7.89%, 08/29/10 ..................... 1,651,200
5,287,241 Atrium Cos., Inc.
Closing Date Term Facility,
8.61%, 06/21/12 ................................ 4,784,953
1,866,523 Custom Building Products, Inc.
First Lien Term Loan,
7.76%, 10/20/11 ................................ 1,754,532
612,171 DESA LLC
Term Loan, 13.00%, 11/26/11 .................... 589,980
Jacuzzi Brands Corp.
917,095 First Lien Term Loan B,
7.62%, 02/07/14 (f) ............................ 831,117
81,081 Pre-Funded Letter of Credit,
5.25%, 02/07/14 (f) ............................ 73,784
4,465,473 Nortek, Inc.
Term Loan, 7.61%, 08/27/11 ..................... 4,281,272
1,485,092 PGT Industries, Inc.
First Lien Tranche A-2 Term Loan,
8.62%, 02/14/12 ................................ 1,451,678
312,297 Professional Paint, Inc.
First Lien Term Loan,
7.78%, 05/31/12 ................................ 295,121
Realogy Corp.
1,969,697 Initial Term B Loan,
8.36%, 10/10/13 (f) ............................ 1,794,276
530,303 Synthetic Letter of Credit,
8.32%, 10/10/13 (f) ............................ 483,074
1,994,975 Roofing Supply Group LLC
First Lien Term Loan,
9.35%, 08/31/13 ................................ 1,915,176
7,000,000 Spirit Finance Corp.
Term Loan, 8.36%, 08/01/13 ..................... 6,405,000
1,000,000 Standard Pacific Corp.
Term Loan B, 7.02%, 05/05/13 ................... 920,000
9,172,092 Stile Acquisition Corp.
Canadian Term Loan,
7.36%, 04/06/13 ................................ 8,518,581
7,934,124 Stile U.S. Acquisition Corp.
U.S. Term Loan, 7.36%, 04/06/13 ................ 7,390,637
WAICCS Las Vegas 3 LLC
11,000,000 First Lien Term Loan,
8.83%, 07/30/08 ................................ 10,890,000
5,000,000 Second Lien Term Loan,
14.33%, 07/30/08 ............................... 4,950,000
2,000,000 Withers Preserve MB-I
B-Note, 9.82%, 12/14/07 ........................ 1,990,000
------------
60,970,381
------------
HOUSING - REAL ESTATE DEVELOPMENT - 7.5%
Ginn LA Conduit Lender, Inc.
5,676,099 First Lien Tranche A Credit-Linked
Deposit, 8.86%, 06/08/11 (b) ................... 4,966,587
12,273,298 First Lien Tranche B Term Loan,
8.86%, 06/08/11 (b) ............................ 10,739,136
2,143,382 Giraffe Intermediate, LLC
Mezzanine Note A-1,
7.07%, 08/09/10 ................................ 2,143,382

See accompanying Notes to Financial Statements. | 9

INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------

AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

HOUSING - REAL ESTATE DEVELOPMENT (CONTINUED)
Kyle Acquisition Group LLC
1,142,857 Facility B, 8.88%, 07/20/09 .................... 1,062,857
857,143 Facility C, 8.88%, 07/20/11 .................... 797,143
Lake at Las Vegas Joint Venture
11,074,074 Synthetic Revolver,
15.46%, 06/20/12 ............................... 10,963,333
80,925,926 Term Loan, 15.42%, 06/20/12 .................... 74,047,222
3,940,000 LBREP/L-Suncal Master I LLC
First Lien Term Loan,
8.61%, 01/19/10 ................................ 3,703,600
3,000,000 LNR Property Corp.
Initial Tranche B Term Loan,
8.11%, 07/12/11 ................................ 2,902,500
3,283,813 Morningside Assisted Living
Senior Mortgage Loan,
8.40%, 10/12/08 ................................ 3,292,023
4,500,000 MPH Mezzanine II, LLC
Mezzanine 2B, 8.85%, 02/09/08 .................. 4,488,750
2,850,000 MPH Mezzanine III, LLC
Mezanine 3, 9.85%, 02/09/08 .................... 2,842,875
15,000,000 MPH Mezzanine IV, LLC
Mezzanine 4, 8.57%, 02/09/08 (b) ............... 14,962,500
606,618 MPO Intermediate LLC
Mezzanine Note A-1,
7.07%, 08/09/10 ................................ 606,618
1,454,555 November 2005 Land Investors, LLC
First Lien Term Loan,
8.07%, 05/09/11 ................................ 1,345,463
1,985,000 Shea Capital I, LLC
Facility B, 7.36%, 10/27/11 .................... 1,806,350
Tamarack Resort LLC
2,697,248 Tranche A Credit-Linked Deposit,
5.25%, 05/19/11 ................................ 2,683,761
3,995,298 Tranche B Term Loan,
8.60%, 05/19/11 ................................ 3,695,651
3,417,857 The Rhodes Cos. LLC
First Lien Term Loan,
8.86%, 11/21/10 ................................ 3,195,696
17,098,651 Westgate Investments, LLC
Senior Secured Loan,
13.00%, 09/25/10 PIK (g) ....................... 17,782,597
4,000,000 Weststate Land Partners LLC
First Lien Term Loan,
8.61%, 05/01/08 ................................ 3,940,000
3,957,333 Woodlands Commercial Properties
Co., LP
Bridge Loan, 8.11%, 02/28/08 ................... 3,962,280
------------
175,930,324
------------
INFORMATION TECHNOLOGY - 4.4%
3,955,000 Applied Systems, Inc.
Term Loan, 7.85%, 09/26/13 ..................... 3,875,900
1,000,000 Aspect Software, Inc.
Second Lien Term Loan,
12.44%, 07/11/12 ............................... 945,000
Ax Acquisition Corp.
1,000,000 First Lien Term Loan B,
8.88%, 08/15/14 ................................ 942,500
1,000,000 Second Lien Term Loan B,
9.31%, 08/15/14 ................................ 965,000
1,875,000 Billing Services Group North
America, Inc.
U.S. Term Loan,
7.88%, 05/05/12 ................................ 1,877,344

- --------------------------------------------------------------------------------
PRINCIPAL AMOUNT ($) VALUE ($)
- --------------------------------------------------------------------------------
INFORMATION TECHNOLOGY (CONTINUED)
480,286 Bridge Information Systems, Inc.
Multidraw Term Loan,
11.00%, 07/07/13 (c) (f) ....................... 36,021
Caritor, Inc.
7,441,860 Closing Date Term Loan,
7.61%, 06/04/13 ................................ 6,809,302
558,140 Synthetic Letter of Credit Loan,
7.61%, 06/04/13 ................................ 510,698
987,450 Deltek Systems, Inc.
Term Loan, 7.59%, 04/22/11 ..................... 952,889
1,977,556 DTN, Inc.
Tranche C Term Loan,
8.35%, 03/10/13 ................................ 1,947,893
19,900,000 Freescale Semiconductor, Inc.
Term Loan, 7.11%, 11/29/13 ..................... 18,686,498
2,000,000 GXS Corp.
Second Lien Term Loan,
14.61%, 01/29/12 ............................... 1,990,000
1,500,000 Hyland Software, Inc.
First Lien Term Loan,
8.07%, 07/31/13 ................................ 1,470,000
Infor Enterprise Solutions
Holdings, Inc.
3,743,996 Delayed Draw Term Loan,
9.11%, 07/28/12 ................................ 3,519,356
7,175,992 Initial U.S. Term Facility,
9.11%, 07/28/12 ................................ 6,709,552
6,165,362 Intergraph Corp.
First Lien Term Loan,
7.32%, 05/29/14 (b) ............................ 5,945,751
IPC Systems, Inc.
3,000,000 Second Lien Tranche B Term Loan,
10.61%, 06/01/15 ............................... 2,628,750
17,250,000 Tranche B-1 Term Loan,
7.61%, 06/02/14 ................................ 15,223,125
4,975 MediMedia USA, Inc.
Tranche B Term Loan,
7.63%, 10/05/13 ................................ 4,984
8,000,000 NameMedia, Inc.
Term Loan, 11.33%, 08/31/08 .................... 7,880,000
2,683,282 Ridgefield Midco Sarl
Facility A2, 13.07%, 09/30/16 PIK .............. 2,558,268
1,000,000 Serena Software, Inc.
Term Loan, 7.34%, 03/10/13 ..................... 976,250
1,946,921 Sitel, LLC
U.S. Term Loan, 7.85%, 01/30/14 ................ 1,854,442
5,560,866 SunGard Data Systems, Inc.
Term Loan B, 7.36%, 02/28/14 ................... 5,409,722
4,738,125 Vangent, Inc.
Term Loan, 7.62%, 02/14/13 ..................... 4,513,064
4,692,308 Verint Systems, Inc.
Term Loan, 8.09%, 05/27/14 ..................... 4,539,808
997,500 Vertafore, Inc.
Term Loan, 7.86%, 01/31/12 ..................... 957,600
------------
103,729,717
------------
MANUFACTURING - 0.7%
1,760,039 Baldor Electric Co.
Term Loan, 7.13%, 03/31/14 ..................... 1,731,438
1,490,921 Coinmach Corp.
Tranche B-1 Term Loan,
7.88%, 12/16/12 ................................ 1,464,830
FCI International S.A.S.
127,374 Term Loan B2A, 7.76%, 03/10/14 ................. 123,659
127,374 Tranche B3C, 7.76%, 11/03/14 ................... 123,659

10 | See accompanying Notes to Financial Statements.

INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------

AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

MANUFACTURING (CONTINUED)
FCI SA
122,626 Term Loan B2B, 7.76%, 03/10/14 ................. 119,049
122,626 Tranche B4B, 7.76%, 11/03/13 ................... 119,216
FCI USA, Inc.
250,000 Facility B1, 7.76%, 03/10/14 ................... 242,708
250,000 Tranche B5B, 7.76%, 11/03/13 ................... 242,708
2,992,500 FR Brand Acquisition Corp.
First Lien Term Loan B,
7.63%, 02/07/14 ................................ 2,797,988
3,250,000 Generac Acquisition Corp.
First Lien Term Loan,
7.85%, 11/11/13 (b) ............................ 2,897,895
1,980,000 Global Petroleum Inc.
Term Loan, 9.90%, 09/18/13 ..................... 1,920,600
1,888,113 Mueller Water Products, Inc.
Term Loan B, 7.10%, 05/26/14 ................... 1,846,235
2,000,000 Polypore, Inc.
US Term Loan, 7.56%, 07/03/14 .................. 1,912,500
------------
15,542,485
------------
METALS/MINERALS - OTHER METALS/MINERALS - 1.1%
2,155,263 Euramax International Holdings B.V.
Second Lien European Loan,
13.36%, 06/29/13 (b) ........................... 2,004,394
Euramax International, Inc.
2,052,012 Domestic Term Loan,
8.38%, 06/29/12 ................................ 1,891,258
4,344,737 Second Lien Domestic Term Loan,
13.36%, 06/29/13 (b) ........................... 3,975,434
5,000,000 Kaiser Aluminum & Fabricated
Products, LLC
Term Loan, 9.57%, 07/06/11 ..................... 4,975,000
8,052,728 Murray Energy Corp.
Tranche B Term Loan,
8.54%, 01/28/10 ................................ 8,012,465
763,307 Oglebay Norton Co.
Tranche B Term Loan,
7.60%, 07/31/12 ................................ 748,041
4,388,194 Universal Buildings Products, Inc.
Term Loan, 8.60%, 04/28/12 ..................... 4,366,254
------------
25,972,846
------------
METALS/MINERALS - STEEL - 0.0%
Standard Steel, LLC
166,667 Delayed Draw Term Loan,
7.93%, 07/02/12 ................................ 160,833
825,000 Initial Term Loan, 7.86%, 07/02/12 ............. 796,125
------------
956,958
------------
RETAIL - 4.4%
20,397,938 Blockbuster Entertainment Corp.
Tranche B Term Loan,
9.46%, 08/20/11 ................................ 19,830,671
31,575,741 Burlington Coat Factory
Warehouse Corp.
Term Loan, 7.61%, 05/28/13 ..................... 29,700,774
5,000,000 Dollar General Corp.
Tranche B-1 Term Loan,
8.07%, 07/07/14 ................................ 4,657,800
945,519 Dollarama Group LP
Term Loan B, 7.11%, 11/18/11 ................... 917,153
2,466,718 Eddie Bauer, Inc.
Term Loan, 8.57%, 04/01/14 ..................... 2,405,050

- --------------------------------------------------------------------------------
PRINCIPAL AMOUNT ($) VALUE ($)
- --------------------------------------------------------------------------------
RETAIL (CONTINUED)
1,496,250 General Nutrition Centers, Inc.
Term Loan, 7.61%, 09/16/13 ..................... 1,410,216
Home Interiors & Gifts, Inc.
2,407,902 Initial Term Loan, 10.35%, 03/31/11 ............ 1,456,781
27,649,391 Initial Term Loan, 10.36%, 03/31/11 ............ 16,727,881
8,478,643 Michaels Stores, Inc.
Replacement Loan, 7.63%, 10/31/13 .............. 8,015,879
1,995,000 Mother's Work, Inc.
Term Loan, 7.86%, 03/13/13 ..................... 1,855,350
Movie Gallery, Inc.
140,000 First Lien Synthetic Letter of Credit,
10.86%, 03/08/12 (b) ........................... 117,775
3,354,000 First Lien Term Loan,
10.86%, 03/08/12 (b) ........................... 2,821,553
1,492,481 Sally Holdings, LLC
Term B Loan, 7.86%, 11/18/13 ................... 1,451,438
990,000 Sports Authority, Inc., The
Term Loan B, 7.61%, 05/03/13 ................... 930,600
Totes Isotoner Corp.
3,482,500 First Lien Term Loan,
7.83%, 01/31/13 ................................ 3,378,025
1,000,000 Second Lien Term Loan,
11.36%, 01/31/14 ............................... 980,000
4,000,000 Toys "R" Us
Tranche B Term Loan,
9.76%, 07/19/12 ................................ 3,973,000
1,000,000 TRU 2005 Holding Co. I, Ltd
Term Loan, 8.32%, 12/09/08 ..................... 985,000
------------
101,614,946
------------
SERVICE - ENVIRONMENTAL SERVICES - 0.4%
997,500 Brickman Group Holdings, Inc.
Tranche B Term Loan,
7.40%, 01/23/14 ................................ 950,119
591,142 Duratek, Inc.
Term Loan, 7.66%, 06/07/13 ..................... 568,235
EnergySolutions, LLC
62,893 Synthetic Letter of Credit,
7.57%, 06/07/13 ................................ 60,456
1,233,178 Term Loan, 7.66%, 09/30/11 ..................... 1,185,393
Safety-Kleen Systems, Inc.
1,220,339 Synthetic Letter of Credit,
7.88%, 08/02/13 ................................ 1,195,932
4,642,881 Term Loan B, 7.88%, 08/02/13 ................... 4,550,024
------------
8,510,159
------------
SERVICE - OTHER SERVICES - 1.8%
2,000,000 Audio Visual Services Group, Inc.
Second Lien Loan,
10.86%, 08/28/14 ............................... 1,920,000
1,900,000 Cydcor, Inc.
First Lien Tranche B Term Loan,
8.61%, 02/05/13 ................................ 1,890,500
3,482,412 Education Management LLC
Tranche C Term Loan,
7.13%, 06/01/13 ................................ 3,330,509
3,451,424 NES Rentals Holdings, Inc.
Second Lien Permanent Term Loan,
12.13%, 07/20/13 ............................... 3,393,164
795,841 Rental Service Corp.
Second Lien Initial Term Loan,
8.86%, 11/30/13 ................................ 787,882
30,266,998 Sabre, Inc.
Initial Term Loan,
7.61%, 09/30/14 ................................ 28,148,308

See accompanying Notes to Financial Statements. | 11

INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------

AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

SERVICE - OTHER SERVICES (CONTINUED)
766,871 Survey Sampling International LLC
Term Loan, 7.85%, 05/06/11 .................... 751,534
1,652,305 United Rentals, Inc.
Initial Term Loan, 7.32%, 02/14/11 ............ 1,621,324
-------------
41,843,221
-------------
TELECOMMUNICATIONS - 5.1%
8,000,000 Discovery Communications
Holding LLC
Term B Loan, 7.36%, 05/14/14 .................. 7,790,000
Global Tel Link Corp.
260,870 Acquisition Synthetic Deposit,
5.26%, 02/13/08 ............................... 254,348
391,304 Acquisition Term Loan,
10.75%, 02/14/13 .............................. 381,522
65,217 Synthetic Deposit,
5.26%, 02/13/08 ............................... 63,587
770,870 Term Facility, 8.86%, 02/14/08 ................ 751,598
34,750,000 Gray Television, Inc.
Term Loan B, 6.86%, 12/31/14 .................. 32,838,750
3,970,000 Intelsat Corp.
Tranche B-2 Term Loan,
7.36%, 01/03/14 ............................... 3,854,870
18,500,000 Level 3 Financing, Inc.
Term Loan, 7.61%, 03/13/14 .................... 17,713,750
6,797,055 Sorenson Communications, Inc.
Tranche C Term Loan,
7.86%, 08/16/13 ............................... 6,593,143
742,500 Stratos Global Corp./Stratos
Funding LP
Term B Facility, 8.11%, 02/13/12 .............. 728,578
5,471,101 Time Warner Telecom Holdings Inc.
Term Loan B, 7.36%, 01/07/13 .................. 5,375,357
60,403 Univision Communications Inc
Delayed Draw Term Loan
09/29/14 (b) (e) .............................. 56,062
Univision Communications, Inc.
41,577,181 Initial Term Loan, 7.61%, 09/29/14 (b) ........ 38,589,029
3,000,000 Second Lien Loan, 7.82%, 03/29/09 ............. 2,970,000
-------------
117,960,594
-------------
TELECOMMUNICATIONS - CLEC - 0.2%
4,937,500 Consolidated Communications, Inc.
Term D Loan, 7.11%, 10/14/11 .................. 4,789,375
-------------
TELECOMMUNICATIONS - DATA/INTERNET - 0.0%
1,000,000 Pine Tree Holdings/Country Road
Communications, Inc.
Second Lien Term Loan,
13.11%, 07/15/13 .............................. 992,500
-------------
TELECOMMUNICATIONS - FIBER/LONG DISTANCE - 0.3%
3,500,000 FairPoint Communications, Inc.
Replacement B Term Loan,
7.13%, 02/08/12 ............................... 3,408,125
3,000,000 Hawaiian Telcom Communications, Inc.
Tranche C Term Loan,
7.61%, 06/02/14 ............................... 2,857,500
-------------
6,265,625
-------------

- --------------------------------------------------------------------------------
PRINCIPAL AMOUNT ($) VALUE ($)
- --------------------------------------------------------------------------------
TRANSPORTATION - AUTO - 5.1%
18,500,000 Dana Corp.
Term Loan, 7.88%, 04/13/08 (b) ................ 18,280,405
Delphi Corp.
5,000,000 Tranche B Term Loan,
7.63%, 12/31/07 ............................... 4,920,800
37,107,500 Tranche C Term Loan,
8.13%, 12/31/07 ............................... 36,643,656
41,300,013 Ford Motor Co.
Term Loan, 8.36%, 12/16/13 (b) ................ 38,860,834
10,945,000 General Motors Corp.
Secured Term Loan,
7.74%, 11/29/13 ............................... 10,496,255
Key Safety Systems, Inc.
7,486,250 First Lien Term Loan,
8.64%, 03/08/14 (b) ........................... 7,111,938
2,000,000 Second Lien Term Loan,
10.32%, 09/08/14 .............................. 1,935,000
1,304,615 Stanadyne Corp.
Term Loan, 8.82%, 08/06/10 .................... 1,311,138
-------------
119,560,026
-------------
TRANSPORTATION - LAND - 0.4%
Quality Distribution, Inc.
1,427,481 Synthetic Letters of Credit,
5.25%, 11/13/09 ............................... 1,420,344
6,904,646 Term Loan, 8.32%, 11/13/09 (f) ................ 6,870,124
-------------
8,290,468
-------------
UTILITIES - 2.2%
2,915,003 Boston Generating LLC
First Lien Term Loan,
7.61%, 12/20/13 ............................... 2,819,042
Boston Generating, LLC
181,483 First Lien Revolving Credit Loan,
7.61%, 12/20/13 ............................... 175,508
648,153 First Lien Synthetic Letter of
Credit Loan, 5.24%, 12/20/13 .................. 626,816
969 Calpine Corp.
First Priority Term Loan,
7.59%, 03/29/09 ............................... 937
Coleto Creek Power, LP
5,628,310 First Lien Term Loan,
8.11%, 06/28/13 ............................... 5,346,894
4,950,000 Second Lien Term Loan,
9.35%, 06/28/13 ............................... 4,752,000
319,857 Synthetic Letter of Credit,
8.11%, 06/28/13 ............................... 303,864
Covanta Energy Corp.
3,750 Delayed Draw Term Loan,
9.50%, 06/30/12 ............................... 3,663
659,794 Funded Letter of Credit,
5.24%, 02/09/14 ............................... 655,670
1,336,856 Term Loan, 6.88%, 02/09/14 .................... 1,305,948
3,891,020 Entegra TC, LLC
Third Lien Term Loan,
11.36%, 04/19/14 .............................. 3,813,199
3,960,000 GBGH LLC
First Lien Term Loan,
10.76%, 08/07/13 .............................. 3,969,900
Mach Gen, LLC
2,696,947 First Lien Term B Loan,
7.36%, 02/22/14 ............................... 2,571,081
280,397 Synthetic Letter of Credit,
7.36%, 02/22/13 ............................... 269,181

12 | See accompanying Notes to Financial Statements.

INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------

AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

UTILITIES (CONTINUED)
3,796,258 Mirant North America, LLC
Term Loan, 7.07%, 01/03/13 .................... 3,691,861
NATG Holdings LLC
65,796 Credit-Linked Certificate of
Deposit, 4.00%, 01/23/09 (c) .................. 57,242
1,001,749 Term Loan A, 11.50%, 01/23/09 (c) ............. 177,810
733,455 Term Loan B-1, 12.25%, 01/23/10 (c) ........... 128,355
NRG Energy, Inc.
2,196,836 Credit-Linked Deposit,
7.07%, 02/01/13 (b) ........................... 2,095,232
5,291,673 Term Loan, 7.07%, 02/01/13 (b) ................ 5,095,458
2,000,000 Primary Energy Operations LLC
Term Loan, 8.11%, 08/24/09 .................... 1,940,000
4,426,190 Riverside Energy Center LLC
Term Loan, 9.57%, 06/24/11 .................... 4,415,125
Rocky Mountain Energy Center LLC
361,073 Credit-Linked Certificate of
Deposit, 5.32%, 06/24/11 ...................... 360,171
2,718,298 Term Loan, 9.57%, 06/24/11 .................... 2,711,502
TECO Panda - Union Power
Partners, L.P.
353,774 Tranche A Term Loan,
06/01/12 (b) (f) .............................. 641,805
339,623 Tranche B Term Loan,
06/01/20 (b) (f) .............................. 616,133
TECO Panda Generating Co. -
Gila River Power L.P.
601,415 Tranche A Term Loan,
06/01/12 (b) (f) .............................. 1,091,069
580,188 Tranche B Term Loan,
06/01/20 (b) (f) .............................. 1,052,560
-------------
50,688,026
-------------
WIRELESS - CELLULAR/PCS - 3.5%
1,822,500 Centennial Cellular Operating Co.
Term Loan, 3.57%, 02/09/11 .................... 1,786,050
38,115,000 Cricket Communications, Inc.
Term B Loan, 7.36%, 06/16/13 .................. 37,114,481
Insight Midwest Holdings, LLC
3,750,000 Term Loan B, 7.35%, 04/06/14 .................. 3,661,875
6,428,302 Term Loan B, 7.36%, 04/06/14 .................. 6,277,237
1,464,844 Maritime Telecommunications
Network, Inc.
First Lien Term Loan,
8.11%, 05/11/12 ............................... 1,435,547
32,774,887 MetroPCS Wireless, Inc.
Tranche B Term Loan,
7.63%, 11/04/13 ............................... 31,969,280
-------------
82,244,470
-------------
Total Senior Loans
(Cost $1,876,993,662) ...................... 1,795,007,807
-------------

PRINCIPAL AMOUNT
- ------------------
FOREIGN DENOMINATED SENIOR LOANS (a) - 12.9%

AUSTRALIA - 1.4%
AUD
PBL Media Finance Pty., Ltd.
5,500,000 Term Loan A, 8.78%, 02/07/13 .................. 4,282,836
15,000,000 Term Loan B, 9.03%, 02/07/13 .................. 11,898,169

- --------------------------------------------------------------------------------
PRINCIPAL AMOUNT VALUE ($)
- --------------------------------------------------------------------------------
AUSTRALIA (CONTINUED)
AUD
19,523,810 Seven Media Group
Facility A Term Loan,
8.86%, 12/22/12 (b) ........................... 15,327,669
-------------
31,508,674
-------------
AUSTRIA - 0.8%
EUR
15,000,000 Sacher Funding Ltd.
Euro Term Loan, 9.96%, 05/14/14 ............... 19,835,319
-------------
DENMARK - 0.1%
EUR
2,000,000 Nyco Holdings 3 ApS
Second Lien Facility D,
9.16%, 12/29/16 ............................... 2,552,690
-------------
FRANCE - 1.9%
GBP
Ristretto Investissements SAS
437,500 Tranche E-B2,
8.43%, 09/30/13 ............................... 859,301
437,500 Tranche E-C2,
8.84%, 09/30/14 ............................... 863,713
EUR
Ypso Holding SA
221,431 Capex Term Loan,
6.23%, 12/15/12 (e) ........................... 286,739
3,452,754 Eur B Acq 1 Facility,
6.12%, 06/15/14 ............................... 4,508,246
5,633,441 Eur B Acq 2 Facility,
6.36%, 06/15/14 ............................... 7,355,559
8,946,874 Eur B Recap 1 Facility,
5.87%, 06/15/14 ............................... 11,607,737
73,323 Eur B Recap 2 Facility,
6.11%, 06/15/14 ............................... 95,737
4,690,407 Eur C Acq, 6.61%, 12/31/15 .................... 6,163,122
8,809,593 Eur C Recap, 6.61%, 12/31/15 .................. 11,575,666
-------------
43,315,820
-------------
GERMANY - 0.5%
EUR
2,500,000 Iesy Hessen/ISH NRW GMBH/
Arena Sport
Euro Senior Secured Term Loan,
7.34%, 10/15/11 ............................... 3,288,846
Kabel Baden Wurttemburg
GMBH & CO. KG
2,500,000 Second Lien Facility,
9.11%, 12/09/15 ............................... 3,308,204
1,826,284 Term B Facility, 6.45%, 06/09/14 .............. 2,401,775
1,826,284 Term C Facility, 6.95%, 06/09/15 .............. 2,409,393
879,378 Schieder Mobel Holding, GMBH
Delayed Draw Term Loan,
9.00%, 07/20/08 (e) ........................... 869,140
-------------
12,277,358
-------------
ITALY - 0.4%
EUR
151,786 Pirelli Cables
Euro Term Loan C2,
6.85%, 07/28/14 ............................... 209,380

See accompanying Notes to Financial Statements. | 13

INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------

AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

ITALY (CONTINUED)
EUR
Wind Telecommunicatione S.p.A.
2,817,754 A1 Term Loan Facility,
6.14%, 05/26/12 ............................... 3,753,689
1,750,000 B1 Term Loan Facility,
6.51%, 05/26/13 ............................... 2,326,049
1,750,000 C1 Term Loan Facility,
7.26%, 05/26/14 ............................... 2,337,977
-------------
8,627,095
-------------
NETHERLANDS - 1.6%
EUR
Amsterdamse Beheer- En
Consultingmaatschappij B.V.
4,388,443 Casema B1 Term Loan,
6.46%, 09/12/14 ............................... 5,840,468
2,279,577 Casema B2 Term Loan,
6.46%, 09/12/14 ............................... 3,061,024
6,668,019 Casema C Term Loan,
6.96%, 09/12/15 ............................... 8,919,751
1,500,000 Casema D Term Loan Second Lien,
8.24%, 03/12/16 ............................... 2,007,171
5,150,162 Kabelcom B Term Loan,
6.11%, 09/12/14 ............................... 6,915,655
5,150,162 Kabelcom C Term Loan,
6.99%, 09/12/15 ............................... 6,915,655
1,000,000 Kabelcom D Term Loan,
6.11%, 03/12/16 ............................... 1,338,114
YBR Acquisition B.V.
806,733 Facility B2 Term Loan,
6.34%, 07/01/13 ............................... 1,076,510
1,250,000 Facility C2 Term Loan,
7.13%, 07/01/14 ............................... 1,674,040
-------------
37,748,388
-------------
SPAIN - 0.4%
EUR
Gasmedi 2000 S.A. / Nattai, S.L.U.
1,666,667 Tranche B Term Loan,
6.65%, 08/11/14 ............................... 2,215,285
1,666,667 Tranche C Term Loan,
7.15%, 08/11/15 ............................... 2,215,285
1,666,667 Tranche E Second Lien Term Loan,
8.90%, 02/11/16 ............................... 2,226,645
2,061,420 Maxi PIX SARL
PIK Loan, 12.11%, 05/31/16 PIK.. .............. 2,741,721
-------------
9,398,936
-------------
SWEDEN - 0.6%
EUR
3,500,000 B-FLY 2 AB
Euro Term Loan B2,
6.41%, 12/30/15 ............................... 4,620,273
SEK
Nordic Cable Acquisition
15,342,466 Facility A Com Hem,
5.61%, 01/31/13 ............................... 2,093,820
15,333,333 Facility B2 Com Hem Comm,
5.88%, 01/31/14 ............................... 2,103,704
9,109,589 Facility B2 Com Hem Comm,
6.11%, 01/31/14 ............................... 1,249,818

- --------------------------------------------------------------------------------
PRINCIPAL AMOUNT VALUE ($)
- --------------------------------------------------------------------------------
SWEDEN (CONTINUED)
SEK
14,666,667 Facility C2 Com Hem,
6.00%, 01/31/15 ............................... 2,017,562
5,513,699 Facility C2 Com Hem,
6.24%, 01/31/15 ............................... 758,470
5,000,000 Facility D Com Hem,
7.75%, 07/31/15 ............................... 695,064
6,750,000 Facility D Com Hem,
7.99%, 07/31/15 ............................... 938,337
-------------
14,477,048
-------------
UNITED KINGDOM - 3.9%
GBP
3,000,000 AA Acquistions Co., Ltd.
Additional Term Loan B,
8.18%, 03/12/15 ............................... 5,986,928
4,000,000 Airport Development & Investment Ltd.
Second Lien Facility,
9.70%, 04/07/11 ............................... 7,851,381
All3Media Intermediate Ltd.
714,753 Facility B, 8.20%, 08/31/14 ................... 1,358,805
2,585,073 Facility C, 8.70%, 08/31/15 ................... 4,914,439
3,000,000 Facility D, 10.57%, 02/29/16 .................. 5,824,272
3,619,829 Mezzanine Loan, 14.54%, 08/31/16 .............. 7,502,216
992,462 Ansco UK Finance CO. Ltd.
Tranche B Term Loan,
8.32%, 03/08/12 ............................... 1,916,781
EUR
2,734,806 Dollar Financial UK Limited
UK Borrower Euro Term Loan,
7.17%, 10/31/12 ............................... 3,653,665
GBP
Forgings International Ltd.
446,537 Term B1 (GBP), 8.09%, 09/22/14 ................ 855,659
478,674 Term C1 (GBP), 8.34%, 09/22/15 ................ 922,068
Highland Acquisitions Ltd.
1,000,000 Facility B, 9.41%, 12/31/14 ................... 1,921,253
1,000,000 Facility C, 9.91%, 12/31/15 ................... 1,931,339
1,000,000 Mezzanine Facility,
16.66%, 12/31/16 .............................. 1,941,424
3,125,000 Osprey Acquisitions Ltd.
Term Tranche 2, 8.21%, 02/18/12 ............... 6,177,259
Peacock Group
2,088,620 Facility B, 9.37%, 10/30/13 ................... 4,075,962
2,088,620 Facility C, 9.87%, 10/30/14 ................... 4,097,027
1,378,368 SunGard UK Holdings, Ltd.
U.K. Term Loan B,
8.00%, 02/12/14 ............................... 2,696,849
Towergate Partnership Ltd.
3,125,000 Facility A, 8.44%, 10/31/12 ................... 6,161,500
3,125,000 Facility B, 8.68%, 10/31/13 ................... 6,240,292
Trinitybrook PLC
2,500,000 Term Loan B1, 9.03%, 07/31/13 .. .............. 4,939,084
2,500,000 Term Loan C1, 9.53%, 07/31/14 .. .............. 4,952,598
Virgin Media Investment Holdings Ltd.
771,045 A Facility, 6.62%, 07/10/11 ................... 1,477,485
1,750,000 C Facility, 8.48%, 03/03/13 ................... 3,406,317
-------------
90,804,603
-------------

14 | See accompanying Notes to Financial Statements.

INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------

AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

UNITED STATES - 1.3%
GBP
1,243,750 Aramark Corp.
U.K. Term Loan,
8.08%, 01/26/14 ............................... 2,408,374
1,357,813 Champion Home Builders Co.
Term Loan, 9.25%, 10/31/12 .................... 2,629,243
EUR
Hayes Lemmerz International, Inc.
218,182 Synthetic Letter of Credit,
6.78%, 05/30/14 ............................... 289,257
3,781,818 Term Loan Facility,
6.87%, 05/30/14 ............................... 5,013,794
GBP
2,250,000 IPC Systems, Inc.
Tranche B-2 Term Loan,
8.27%, 06/02/14 ............................... 4,561,086
4,895,408 PlayPower, Inc.
Tranche B Sterling Term Loan,
8.71%, 06/30/12 (b) ........................... 9,676,864
EUR
2,517,795 RD German Holdings GMBH
Euro Term Loan,
6.01%, 03/02/14 ............................... 3,200,703
GBP
1,689,475 TME UK Acquisition Co. Ltd.
U.K. Term Loan,
9.16%, 04/26/14 ............................... 3,399,259
-------------
31,178,580
-------------

Total Foreign Denominated
Senior Loans
(Cost $296,391,522) ........................ 301,724,511
-------------

PRINCIPAL AMOUNT ($)
- --------------------
ASSET-BACKED SECURITIES (h) - 0.2%
4,800,000 Acacl 2006-2A B
6.08%, 01/20/21 ............................... 4,310,203
-------------
Total Asset-Backed Securities
(Cost $4,310,203) .......................... 4,310,203
-------------
CORPORATE NOTES AND BONDS (g) - 0.1%

HOUSING - REAL ESTATE DEVELOPMENT - 0.0%
596,593 TOUSA, Inc.
14.75%, 07/31/15 (d) .......................... 298,297
-------------
TELECOMMUNICATIONS - 0.1%
1,438,356 American Messaging Services, Inc.
Senior Secured Note, 11.63%,
09/03/08 ...................................... 1,436,558
-------------
Total Corporate Notes and Bonds
(Cost $2,045,894) .......................... 1,734,855
-------------

AEROSPACE - AIRLINES - 0.2%
Delta Air Lines, Inc.
310,290 Comair ALPA Claim, 12/31/10 ................... 159,799
879,660 Delta ALPA Claim, 12/31/10 .................... 393,648
Northwest Airlines, Inc.
5,400,000 ALPA Trade Claim, 08/21/13 .................... 580,500
2,914,735 Bell Atlantic Trade Claim, 08/21/13 ........... 276,900
3,000,000 CIT Leasing Corp Trade Claim,
08/21/13 ...................................... 285,000
2,250,000 Citibank/Airbus Trade Claim,
08/21/13 ...................................... 213,750
2,500,000 EDC Trade Claims, 08/21/13 .................... 268,750
9,587,700 Flight Attendant Claim-Escrow,
08/21/13 ...................................... 910,832
1,000,000 GE Trade Claim, 08/21/13 ...................... 107,500
2,500,000 GE Trade Claim, 08/21/13 (b) .................. 268,750
5,690,250 IAM Trade Claim, 08/21/13 ..................... 611,702
6,250,000 Mesaba Trade Claim, 08/15/08 .................. 671,875
6,322,050 Retiree Claim, 08/21/13 ....................... 679,620
-------------
5,428,626
-------------
UTILITIES - 0.1%
17,500,000 Mirant Corp. ..................................... 918,750
-------------
Total Claims
(Cost $11,705,559) ......................... 6,347,376
-------------
SHARES
- ------
COMMON STOCKS (j) - 2.3%

AEROSPACE - AIRLINES - 0.9%
65,959 Delta Air Lines, Inc. ............................ 1,113,388
1,062,377 Northwest Airlines Corp. ......................... 19,738,969
-------------
20,852,357
-------------
UTILITIES - 1.2%
12,470 CenterPoint Energy, Inc. ......................... 318,110
81,847 Entegra TC LLC ................................... 2,714,579
643,517 Mirant Corp. ..................................... 25,077,857
-------------
28,110,546
-------------
WIRELESS - CELLULAR/PCS - 0.2%
73,363 Leap Wireless International, Inc. ................ 5,318,818
-------------
Total Common Stocks
(Cost $42,778,478) ......................... 54,281,721
-------------
PREFERRED STOCKS - 0.1%

HOUSING - REAL ESTATE DEVELOPMENT - 0.1%
4,903 TOUSA, Inc., Series A (d) ........................ 2,451,500
-------------
MANUFACTURING - 0.0%
14,382 Superior Telecom, Inc., Series A ................. 17,618
-------------
Total Preferred Stocks
(Cost $4,917,632) .......................... 2,469,118
-------------

See accompanying Notes to Financial Statements. | 15

INVESTMENT PORTFOLIO (CONTINUED)
- --------------------------------------------------------------------------------

AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

- --------------------------------------------------------------------------------
UNITS VALUE ($)
- --------------------------------------------------------------------------------
WARRANT - 0.0%

ENERGY - 0.0%
141,093 Monitor Oil (d) .................................. 0
-------------
Total Warrant
(Cost $0) .................................. 0
-------------
TOTAL INVESTMENTS - 92.9% ..................................... 2,165,875,591
(cost of $2,239,142,950) (k) -------------

OTHER ASSETS & LIABILITIES, NET - 7.1% ........................ 165,233,532
-------------
NET ASSETS - 100.0% ........................................... 2,331,109,123
=============

- ----------
Forward foreign currency contracts outstanding as of August 31, 2007 were as
follows:

PRINCIPAL NET
CONTRACTS AMOUNT UNREALIZED
TO BUY OR COVERED BY APPRECIATION
TO SELL CURRENCY CONTRACTS EXPIRATION (DEPRECIATION)
- --------------------------------------------------------------------------------
Sell AUD 9,300,000 02/29/2008 $ (8,370)
Sell AUD 6,000,000 08/28/2008 31,500
Sell EUR 55,000,000 02/04/2008 765,620
Sell GBP 26,000,000 02/07/2008 416,956
--------------
$ 1,205,706
==============

(a) Senior loans in which the Portfolio invests generally pay interest at
rates which are periodically redetermined by reference to a base lending
rate plus a premium. (Unless otherwise identified by footnote (g), all
senior loans carry a variable rate interest.) These base lending rates are
generally (i) the Prime Rate offered by one or more major U.S. banks, (ii)
the lending rate offered by one or more European banks such as the London
Inter-Bank Offered Rate ("LIBOR") or (iii) the certificate of deposit
rate. Rate shown represents the weighted average rate at August 31, 2007.
Senior loans, while exempt from registration under the Securities Act of
1933, as amended (the "1933 Act"), contain certain restrictions on resale
and cannot be sold publicly. Senior secured floating rate loans often
require prepayments from excess cash flow or permit the borrower to repay
at its election. The degree to which borrowers repay, whether as a
contractual requirement or at their election, cannot be predicted with
accuracy. As a result, the actual maturity may be substantially less than
the stated maturities shown.

(b) All or a portion of this position has not settled. Contract rates do not
take effect until settlement date.

(d) Represents fair value as determined in good faith under the direction of
the Portfolio's Board of Managers.

(e) Senior loans have additional unfunded loan commitments. See Note 9.

(f) Loans held on participation. See Note 7

(g) Fixed rate senior loan or corporate note.

(h) Variable rate security. The interest rate shown reflects the rate in
effect at August 31, 2007.

(i) Security represents an unsecured, unfunded claim generated against the
issuer that will be converted into equity upon the completion of court
proceedings.

(j) Non-income producing security.

(k) Cost for U.S. federal income tax purposes is $2,240,186,837.

AUD Australia Dollar
CLEC Competitive Local Exchange Carrier
EUR Euro Currency
GBP Great Britain Pound
PIK Payment in Kind
SEK Swedish Krona

FOREIGN DENOMINATED SENIOR LOANS
INDUSTRY CONCENTRATION TABLE
(% of Total Net Assets)

Cable - International Cable ........................... 4.0%
Other ................................................. 2.1%
Financial ............................................. 1.5%
Telecommunications .................................... 1.4%
Retail ................................................ 1.0%
Broadcasting .......................................... 1.0%
Diversified Media ..................................... 1.0%
Housing - Real Estate Development ..................... 0.5%
Aerospace - Aerospace/Defense ......................... 0.4%
-----
12.9%
=====

16 | See accompanying Notes to Financial Statements.

STATEMENT OF ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------

AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

($)
- --------------------------------------------------------------------------------------------------------------------

ASSETS:
Investments, at value (cost $2,239,142,950) .................................................... 2,165,875,591
Cash ........................................................................................... 153,725,086
Foreign currency (cost $10,355,246) ............................................................ 10,465,968
Net unrealized appreciation on forward currency contracts ...................................... 1,205,706
Receivable for:
Investments sold ............................................................................ 80,825,633
Dividend and interest receivable ............................................................ 20,664,278
-------------
Total assets ............................................................................. 2,432,762,262
-------------
LIABILITIES:
Net discount and unrealized depreciation on unfunded transactions (Note 9) ..................... 1,058,500
Payables for:
Investments purchased ....................................................................... 99,516,033
Investment advisory fee payable (Note 4) .................................................... 950,923
Trustees' fees (Note 4) ..................................................................... 200
Accrued expenses and other liabilities ......................................................... 127,483
-------------
Total liabilities ........................................................................ 101,653,139
-------------
NET ASSETS ........................................................................................ 2,331,109,123
=============

See accompanying Notes to Financial Statements. | 17

STATEMENT OF OPERATIONS
- --------------------------------------------------------------------------------

FOR THE YEAR ENDED AUGUST 31, 2007

HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

($)
- --------------------------------------------------------------------------------------------------------------------

INVESTMENT INCOME:
Interest ....................................................................................... 166,401,817
Dividends ...................................................................................... 9,165,301
Facility and other fees ........................................................................ 9,413
-------------
Total investment income .................................................................. 175,576,531
-------------
EXPENSES:
Investment advisory fees (Note 4) .............................................................. 8,664,405
Accounting service fees ........................................................................ 463,088
Professional fees .............................................................................. 120,660
Trustees' fees (Note 4) ........................................................................ 20,581
Custodian fees ................................................................................. 224,114
Reports to shareholders ........................................................................ 34,332
-------------
Net operating expenses ................................................................... 9,527,180
-------------
Interest expense (Note 8) ...................................................................... 239,479
Facility expense ............................................................................... 294,037
-------------
Net expenses ............................................................................. 10,060,696
-------------
Net investment income .................................................................... 165,515,835
-------------
NET REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS:
Net realized gain/(loss) on investments ........................................................ 3,755,259
Net realized gain/(loss) on foreign currency transactions ...................................... (2,870,738)
Net change in unrealized appreciation/(depreciation) on investments ............................ (80,761,149)
Net change in unrealized appreciation/(depreciation) on unfunded transactions .................. (604,465)
Net change in unrealized appreciation/(depreciation) on forward foreign currency contracts ..... 1,205,706
Net change in unrealized appreciation/(depreciation) on translation of assets and liabilities
denominated in foreign currency ............................................................. 567,925
-------------
Net realized and unrealized gain/(loss) on investments ................................... (78,707,462)
-------------
Net increase in net assets from operations ............................................... 86,808,373
=============

18 | See accompanying Notes to Financial Statements.

STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------

HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

-----------------------------
YEARS ENDED AUGUST 31,
2007 2006
($) ($)
-----------------------------

INCREASE IN NET ASSETS:

FROM OPERATIONS
Net investment income ................................................................ 165,515,835 104,530,900
Net realized gain/(loss) on investments and foreign currency transactions ............ 884,521 12,363,756
Net change in unrealized appreciation/(depreciation) on investments, unfunded
transactions, forward foreign currency transactions and translation of assets and
liabilities denominated in foreign currency ....................................... (79,591,983) (1,281,401)
------------- -------------
Net change in net assets from operations .......................................... 86,808,373 115,613,255
------------- -------------
TRANSACTIONS IN INVESTOR'S BENEFICIAL INTEREST
Contributions ........................................................................ 1,139,327,799 817,426,901
Withdrawals .......................................................................... (621,839,277) (345,645,810)
------------- -------------
Net increase from transactions in investor's beneficial interest .................. 517,488,522 471,781,091
------------- -------------
Total increase in net assets ...................................................... 604,296,895 587,394,346
------------- -------------
NET ASSETS
Beginning of year .................................................................... 1,726,812,228 1,139,417,882
------------- -------------
End of year .......................................................................... 2,331,109,123 1,726,812,228
============= =============

See accompanying Notes to Financial Statements. | 19

STATEMENT OF CASH FLOWS
- --------------------------------------------------------------------------------

FOR THE YEAR ENDED AUGUST 31, 2007

HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

($)
- -------------------------------------------------------------------------------------------------------------

CASH FLOWS USED FOR OPERATING ACTIVITIES
Net investment income .................................................................. 165,515,835

ADJUSTMENTS TO RECONCILE NET INVESTMENT INCOME TO NET CASH USED FOR OPERATING ACTIVITIES
Purchase of investment securities ...................................................... (2,289,064,593)
Proceeds from disposition of investment securities ..................................... 1,697,856,111
Increase in dividends, interest and fees receivable .................................... (2,646,854)
Increase in receivable for investments sold ............................................ (61,922,315)
Decrease in other assets ............................................................... 69,969
Decrease in deferred facility fees ..................................................... (5,300)
Net amortization/(accretion) of premium/(discount) ..................................... (3,826,511)
Decrease in payable for investments purchased .......................................... (13,600,953)
Increase in payables to related parties ................................................ 337,356
Decrease in mark-to-market on realized and unrealized gain (loss) on foreign currency .. (2,302,813)
Decrease in other liabilities .......................................................... (280,321)
--------------
Net cash and foreign currency flow from operating activities ........................ (509,870,389)
--------------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Proceeds from capital contributions .................................................... 1,139,327,799
Payment of capital withdrawals ......................................................... (621,839,277)
--------------
Net cash flow provided by financing activities ...................................... 517,488,522
--------------
Net increase in cash and foreign currency ........................................... 7,618,133
--------------
CASH AND FOREIGN CURRENCY
Beginning of the year .................................................................. 156,572,921
--------------
End of the year ........................................................................ 164,191,054
==============

20 | See accompanying Notes to Financial Statements.

FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------

HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY

SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:

- -----------------------------------------------------------------------------------------
YEARS ENDED AUGUST 31,
----------------------------------------------
2007 2006 2005 2004 2003
- -----------------------------------------------------------------------------------------

TOTAL RETURN 5.29% 8.72% 6.54% 10.39% 11.68%(a)

RATIOS TO AVERAGE NET ASSETS/
SUPPLEMENTAL DATA
Net operating expenses 0.47% 0.52% 0.51%(b) 0.52%(b) 0.57%(b)
Interest expense and facility expense 0.03% 0.04% 0.05% --(c) --(c)
Net expenses 0.50% 0.56% 0.56%(b) 0.52%(b) 0.57%(b)
Net investment income 8.20% 7.74% 5.69%(b) 4.45%(b) 5.96%(b)
Portfolio turnover rate 86% 64% 75% 97% 75%

- ----------
(a) Total return includes a voluntary reimbursement by the Portfolio's
investment adviser for a realized investment loss on an investment not
meeting the Portfolio's investment restrictions. This reimbursement had an
impact of less than 0.01% on the Portfolio's return.

(b) The benefits derived from custody credits and directed brokerage
arrangements, if applicable, had an impact of less than 0.01%.

- --------------------------------------------------------------------------------

See accompanying Notes to Financial Statements. | 21

STATEMENT OF ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------

AS OF AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

($)
- --------------------------------------------------------------------------------------------------------------------------

ASSETS:
Investments in Portfolio ............................................................................ 2,331,109,123
Receivable for:
Fund shares sold ................................................................................. 7,764,716
Other assets ........................................................................................ 74,946
-------------
Total assets .................................................................................. 2,338,948,785
-------------
LIABILITIES:
Payables for:
Distributions .................................................................................... 9,184,488
Administration fee (Note 4) ...................................................................... 390,978
Trustees' fees (Note 4) .......................................................................... 800
Service and distribution fees (Note 4) ........................................................... 1,009,396
Accrued expenses and other liabilities .............................................................. 165,032
-------------
Total liabilities ............................................................................. 10,750,694
-------------
NET ASSETS ............................................................................................. 2,328,198,091
=============
COMPOSITION OF NET ASSETS:
Paid-in capital ..................................................................................... 2,402,895,657
Overdistributed net investment income ............................................................... (120,308)
Accumulated net realized gain/(loss) on investments and foreign currency transactions allocated
from Portfolio ................................................................................... (1,975,104)
Net unrealized appreciation/(depreciation) on investments, unfunded transactions, forward foreign
currency contracts and assets and liabilities denominated in foreign currency allocated from
Portfolio ........................................................................................ (72,602,154)
-------------
NET ASSETS ............................................................................................. 2,328,198,091
=============
CLASS A
Net assets .......................................................................................... 926,800,296
Shares outstanding (unlimited authorization) ........................................................ 96,087,905
Net asset value per share (Net assets/shares outstanding) ........................................... 9.65(a)
Maximum offering price per share (100/96.50 of $9.65) ............................................... 10.00(b)

CLASS B
Net assets .......................................................................................... 123,579,751
Shares outstanding (unlimited authorization) ........................................................ 12,818,317
Net asset value and offering price per share (Net assets/shares outstanding) ........................ 9.64(a)

CLASS C
Net assets .......................................................................................... 931,623,462
Shares outstanding (unlimited authorization) ........................................................ 96,632,528
Net asset value and offering price per share (Net assets/shares outstanding) ........................ 9.64(a)

CLASS Z
Net assets .......................................................................................... 346,194,582
Shares outstanding (unlimited shares authorized) .................................................... 35,911,004
Net asset value, offering and redemption price per share (Net assets/shares outstanding) ............ 9.64

- ----------
(a) Redemption price per share is equal to net asset value less any applicable
contingent deferred sales charge.

(b) On sales of $100,000 or more, the offering price is reduced.

22 | See accompanying Notes to Financial Statements.

STATEMENT OF OPERATIONS
- --------------------------------------------------------------------------------

FOR THE YEAR ENDED AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

($)
- ------------------------------------------------------------------------------------------------------------------

INVESTMENT INCOME ALLOCATED FROM PORTFOLIO (NOTE 1):
Interest ...................................................................................... 166,401,817
Dividends ..................................................................................... 9,165,301
Facility and other fees ....................................................................... 9,413
-----------
Total investment income ................................................................. 175,576,531
-----------
FUND EXPENSES:
Net operating expenses allocated from Portfolio (Note 1) ...................................... 9,527,180
Administration fees (Note 4) .................................................................. 4,038,533
Accounting service fees ....................................................................... 12,500
Distribution fees: (Note 4)
Class A .................................................................................... 807,915
Class B .................................................................................... 617,427
Class C .................................................................................... 4,758,821
Service fee: (Note 4)
Class A .................................................................................... 2,019,787
Class B .................................................................................... 343,015
Class C .................................................................................... 1,982,842
Transfer agent fees ........................................................................... 872,342
Professional fees ............................................................................. 87,942
Trustees' fees (Note 4) ....................................................................... 82,325
Registration fees ............................................................................. 156,887
Reports to shareholders ....................................................................... 652,314
Other expenses ................................................................................ 142,798
-----------
Net operating expenses .................................................................. 26,102,628
-----------
Interest expense allocated from Portfolio (Note 8) ............................................ 239,479
Facility expense allocated from Portfolio ..................................................... 294,037
-----------
Net expenses ............................................................................ 26,636,144
-----------
Net investment income ................................................................... 148,940,387
-----------
NET REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS ALLOCATED FROM PORTFOLIO (NOTE 1):
Net realized gain/(loss) on investments ....................................................... 3,755,259
Net realized gain/(loss) on foreign currency transactions ..................................... (2,870,738)
Net change in unrealized appreciation/(depreciation) on investments ........................... (80,761,149)
Net change in unrealized appreciation/(depreciation) on unfunded transactions ................. (604,465)
Net change in unrealized appreciation/(depreciation) on forward foreign currency contracts .... 1,205,706
Net change in unrealized appreciation/(depreciation) on translation of assets and liabilities
denominated in foreign currency ............................................................ 567,925
-----------
Net realized and unrealized gain/(loss) on investments allocated from Portfolio ......... (78,707,462)
-----------
Net increase in net assets from operations .............................................. 70,232,925
===========

See accompanying Notes to Financial Statements. | 23

STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------

HIGHLAND FLOATING RATE FUND

------------------------------
YEARS ENDED AUGUST 31,
2007 2006
($) ($)
------------------------------

INCREASE IN NET ASSETS:

FROM OPERATIONS
Net investment income ................................................................... 148,940,387 92,524,047
Net realized gain/(loss) on investments and foreign currency transactions allocated
from Portfolio .................................................................... 884,521 12,076,962
Net change in unrealized appreciation/(depreciation) on investments, translation of
assets and liabilities denominated in foreign currency unfunded transactions,
forward foreign currency contracts and allocated from Portfolio ................... (79,591,983) (851,203)
------------- -------------
Net change in net assets from operations .......................................... 70,232,925 103,749,806

DISTRIBUTIONS DECLARED TO SHAREHOLDERS
From net investment income:
Class A .............................................................................. (60,910,569) (36,949,931)
Class B .............................................................................. (9,909,902) (10,607,992)
Class C .............................................................................. (55,784,748) (31,033,409)
Class Z .............................................................................. (22,175,578) (14,588,702)
------------- -------------
Total distributions from net investment income .................................... (148,780,797) (93,180,034)
------------- -------------
SHARE TRANSACTIONS
Class A
Subscriptions ........................................................................ 505,084,021 460,060,712
Distributions reinvested ............................................................. 26,374,679 17,848,900
Redemptions .......................................................................... (306,504,923) (105,237,595)
------------- -------------
Net increase ...................................................................... 224,953,777 372,672,017
Class B
Subscriptions ........................................................................ 191,510 370,397
Distributions reinvested ............................................................. 5,922,934 6,226,923
Redemptions .......................................................................... (29,756,260) (26,685,543)
------------- -------------
Net decrease ...................................................................... (23,641,816) (20,088,223)
Class C
Subscriptions ........................................................................ 420,897,423 307,867,391
Distributions reinvested ............................................................. 26,310,505 15,573,084
Redemptions .......................................................................... (111,844,302) (66,041,445)
------------- -------------
Net increase ...................................................................... 335,363,626 257,399,030
Class Z
Subscriptions ........................................................................ 199,534,434 88,139,842
Distributions reinvested ............................................................. 7,856,463 5,020,371
Redemptions .......................................................................... (74,257,745) (61,876,293)
------------- -------------
Net Increase ...................................................................... 133,133,152 31,283,920
------------- -------------
Net increase from share transactions .............................................. 669,808,739 641,266,744
------------- -------------
Total increase in net assets ...................................................... 591,260,867 651,836,516
------------- -------------
NET ASSETS
Beginning of year ....................................................................... 1,736,937,224 1,085,100,708
------------- -------------
End of year (including undistributed/(overdistributed) net investment income of
$(120,308) and $2,499,928, respectively) .......................................... 2,328,198,091 1,736,937,224
============= =============

24 | See accompanying Notes to Financial Statements.

STATEMENTS OF CHANGES IN NET ASSETS (CONTINUED)
- --------------------------------------------------------------------------------

HIGHLAND FLOATING RATE FUND

------------------------------
YEARS ENDED AUGUST 31,
2007 2006
($) ($)
------------------------------

CHANGE IN SHARES
Class A
Subscriptions ........................................................................ 50,366,690 46,389,131
Issued for distributions reinvested .................................................. 2,645,496 1,799,527
Redemptions .......................................................................... (30,534,216) (10,621,709)
------------- -------------
Net increase ...................................................................... 22,477,970 37,566,949
Class B
Subscriptions ........................................................................ 19,199 37,376
Issued for distributions reinvested .................................................. 593,927 628,285
Redemptions .......................................................................... (2,962,542) (2,694,070)
------------- -------------
Net decrease ...................................................................... (2,349,416) (2,028,409)
Class C
Subscriptions ........................................................................ 42,014,317 31,050,062
Issued for distributions reinvested .................................................. 2,640,751 1,570,587
Redemptions .......................................................................... (11,131,787) (6,667,761)
------------- -------------
Net increase ...................................................................... 33,523,281 25,952,888
Class Z
Subscriptions ........................................................................ 19,881,361 8,891,919
Issued for distributions reinvested .................................................. 789,106 506,341
Redemptions .......................................................................... (7,401,124) (6,252,836)
------------- -------------
Net increase ...................................................................... 13,269,343 3,145,424

See accompanying Notes to Financial Statements. | 25

FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------

HIGHLAND FLOATING RATE FUND

SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:

- -----------------------------------------------------------------------------------------------------------------
YEARS ENDED AUGUST 31, 2007
-----------------------------------------------------------------
CLASS A SHARES 2007 2006 2005 2004 2003
- -----------------------------------------------------------------------------------------------------------------

NET ASSET VALUE, BEGINNING
OF YEAR $ 9.95 $ 9.88 $ 9.80 $ 9.29 $ 8.83
- -----------------------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a) 0.75 0.70 0.49 0.37 0.48
Net realized and unrealized gain/(loss)
allocated from Portfolio(a) (0.29) 0.07 0.08 0.52 0.46
--------- --------- --------- --------- --------
Total from investment operations 0.46 0.77 0.57 0.89 0.94
- -----------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.76) (0.70) (0.49) (0.38) (0.48)
From net realized gains -- -- -- -- --
--------- --------- --------- --------- --------
Total distributions declared to
shareholders (0.76) (0.70) (0.49) (0.38) (0.48)
- -----------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $ 9.65 $ 9.95 $ 9.88 $ 9.80 $ 9.29
Total return(b) 4.28%(c) 8.18% 5.93% 9.65% 11.03%(d)
- -----------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/
SUPPLEMENTAL DATA:
Net operating expenses 1.12% 1.17% 1.15% 1.15% 1.15%
Interest expense & facility expense
allocated from Portfolio 0.03% 0.04% 0.05% --(e) --(e)
Net expenses(f) 1.15% 1.21% 1.20% 1.15% 1.15%
Net investment income 7.55% 7.08% 5.05% 3.78% 5.39%
Waiver/reimbursement -- 0.01% 0.08% 0.17% 0.28%
Net assets, end of year (000's) $ 926,800 $ 732,767 $ 355,998 $ 222,032 $ 97,924
- -----------------------------------------------------------------------------------------------------------------

- ----------
(a) Per share data was calculated using average shares outstanding during the
period.

(b) Total return is at net asset value assuming all distributions are
reinvested and no initial sales charge or contingent deferred sales charge
("CDSC"). For periods with waivers/reimbursements, had the Portfolio's
investment adviser not waived or reimbursed a portion of expenses, total
return would have been reduced.

(d) Total return includes a voluntary reimbursement by the Portfolio's
investment adviser for a realized investment loss on an investment not
meeting the Portfolio's investment restrictions. This reimbursement had an
impact of less than 0.01% on the Fund's Class A Shares return.

(e) Rounds to less than 0.01%.

(f) Net expense ratio has been calculated after applying any
waiver/reimbursement, if applicable.

26 | See accompanying Notes to Financial Statements.

FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------

HIGHLAND FLOATING RATE FUND

SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:

- -------------------------------------------------------------------------------------------------------------
YEARS ENDED AUGUST 31, 2007
-------------------------------------------------------------
CLASS B SHARES 2007 2006 2005 2004 2003
- -------------------------------------------------------------------------------------------------------------

NET ASSET VALUE, BEGINNING
OF YEAR $ 9.95 $ 9.87 $ 9.80 $ 9.29 $ 8.83
- -------------------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a) 0.72 0.67 0.46 0.34 0.45
Net realized and unrealized gain/(loss)
allocated from Portfolio(a) (0.31) 0.08 0.06 0.51 0.46
--------- --------- --------- --------- ---------
Total from investment operations 0.41 0.75 0.52 0.85 0.91
- -------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.72) (0.67) (0.45) (0.34) (0.45)
From net realized gains -- -- -- -- --
--------- --------- --------- --------- ---------
Total distributions declared to
shareholders (0.72) (0.67) (0.45) (0.34) (0.45)
- -------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $ 9.64 $ 9.95 $ 9.87 $ 9.80 $ 9.29
Total return(b) 4.03% 7.82% 5.46% 9.27% 10.65%(c)
- -------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/
SUPPLEMENTAL DATA:
Net operating expenses 1.47% 1.52% 1.50% 1.50% 1.50%
Interest expense & facility expense
allocated from Portfolio 0.03% 0.04% 0.05% --(d) --(d)
Net expenses(e) 1.50% 1.56% 1.55% 1.50% 1.50%
Net investment income 7.20% 6.73% 4.70% 3.51% 5.05%
Waiver/reimbursement -- 0.01% 0.08% 0.17% 0.28%
Net assets, end of year (000's) $ 123,580 $ 150,922 $ 169,780 $ 191,365 $ 163,448
- -------------------------------------------------------------------------------------------------------------

- ----------
(a) Per share data was calculated using average shares outstanding during the
period.

(b) Total return is at net asset value assuming all distributions are
reinvested and no CDSC. For periods with waivers/reimbursements, had the
Portfolio's investment adviser not waived or reimbursed a portion of
expenses, total return would have been reduced.

(c) Total return includes a voluntary reimbursement by the Portfolio's
investment adviser for a realized investment loss on an investment not
meeting the Portfolio's investment restrictions. This reimbursement had an
impact of less than 0.01% on the Fund's Class B Shares return.

(d) Rounds to less than 0.01%.

(e) Net expense ratio has been calculated after applying any
waiver/reimbursement, if applicable.

See accompanying Notes to Financial Statements. | 27

FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------

HIGHLAND FLOATING RATE FUND

SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:

- ---------------------------------------------------------------------------------------------------------------
YEARS ENDED AUGUST 31, 2007
---------------------------------------------------------------
CLASS C SHARES 2007 2006 2005 2004 2003
- ---------------------------------------------------------------------------------------------------------------

NET ASSET VALUE, BEGINNING
OF YEAR $ 9.95 $ 9.87 $ 9.80 $ 9.29 $ 8.83
- ---------------------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a) 0.70 0.65 0.45 0.32 0.44
Net realized and unrealized gain/(loss)
allocated from Portfolio(a) (0.30) 0.08 0.06 0.52 0.46
--------- --------- --------- --------- ---------
Total from investment operations 0.40 0.73 0.51 0.84 0.90
- ---------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.71) (0.65) (0.44) (0.33) (0.44)
From net realized gains -- -- -- -- --
--------- --------- --------- --------- ---------
Total distributions declared to
shareholders (0.71) (0.65) (0.44) (0.33) (0.44)
- ---------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $ 9.64 $ 9.95 $ 9.87 $ 9.80 $ 9.29
Total return(b) 3.87% 7.65% 5.30% 9.10% 10.48%(c)
- ---------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/
SUPPLEMENTAL DATA:
Net operating expenses 1.62% 1.67% 1.65% 1.65% 1.65%
Interest expense & facility expense
allocated from Portfolio 0.03% 0.04% 0.05% --(d) --(d)
Net expenses(e) 1.65% 1.71% 1.70% 1.65% 1.65%
Net investment income 7.05% 6.58% 4.55% 3.28% 4.88%
Waiver/reimbursement -- 0.01% 0.08% 0.17% 0.28%
Net assets, end of year (000's) $ 931,623 $ 627,964 $ 366,841 $ 278,797 $ 132,656
- ---------------------------------------------------------------------------------------------------------------

- ----------
(a) Per share data was calculated using average shares outstanding during the
period.

(d) Rounds to less than 0.01%.

(e) Net expense ratio has been calculated after applying any
waiver/reimbursement, if applicable.

28 | See accompanying Notes to Financial Statements.

FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------

HIGHLAND FLOATING RATE FUND

SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD IS AS FOLLOWS:

- -------------------------------------------------------------------------------------------------------------
YEARS ENDED AUGUST 31, 2007
-------------------------------------------------------------
CLASS Z SHARES 2007 2006 2005 2004 2003
- -------------------------------------------------------------------------------------------------------------

NET ASSET VALUE, BEGINNING
OF YEAR $ 9.95 $ 9.87 $ 9.80 $ 9.29 $ 8.83
- -------------------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income(a) 0.79 0.74 0.53 0.40 0.50
Net realized and unrealized gain/(loss)
allocated from Portfolio(a) (0.31) 0.08 0.06 0.52 0.47
--------- --------- --------- --------- --------
Total from investment operations 0.48 0.82 0.59 0.92 0.97
- -------------------------------------------------------------------------------------------------------------
LESS DISTRIBUTIONS DECLARED TO
SHAREHOLDERS:
From net investment income (0.79) (0.74) (0.52) (0.41) (0.51)
From net realized gains -- -- -- -- --
--------- --------- --------- --------- --------
Total distributions declared to
shareholders (0.79) (0.74) (0.52) (0.41) (0.51)
- -------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $ 9.64 $ 9.95 $ 9.87 $ 9.80 $ 9.29
Total return (b) 4.75% 8.57% 6.20% 10.03% 11.42%(c)
- -------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS/
SUPPLEMENTAL DATA:
Net operating expenses 0.77% 0.82% 0.80% 0.80% 0.80%
Interest expense & facility expense
allocated from Portfolio 0.03% 0.04% 0.05% --(d) --(d)
Net expenses(e) 0.80% 0.86% 0.85% 0.80% 0.80%
Net investment income 7.90% 7.43% 5.40% 4.12% 5.53%
Waiver/reimbursement -- 0.01% 0.08% 0.17% 0.28%
Net assets, end of year (000's) $ 346,195 $ 225,284 $ 192,482 $ 139,577 $ 31,055
- -------------------------------------------------------------------------------------------------------------

- ----------
(a) Per share data was calculated using average shares outstanding during the
period.

(b) Total return is at net asset value assuming all distributions are
reinvested. For periods with waivers/reimbursements, had the Portfolio's
investment adviser not waived or reimbursed a portion of expenses, total
return would have been reduced.

(d) Rounds to less than 0.01%.

(e) Net expense ratio has been calculated after applying any
waiver/reimbursement, if applicable.

See accompanying Notes to Financial Statements. | 29

NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------

AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

NOTE 1. ORGANIZATION

Highland Floating Rate Fund (the "Fund") is a Massachusetts business trust
registered under the Investment Company Act of 1940, as amended (the "1940
Act"), as a non-diversified, closed-end management investment company. The Fund
invests all of its investable assets in Highland Floating Rate Limited Liability
Company (the "Portfolio").

INVESTMENT OBJECTIVE

The Portfolio seeks a high level of current income consistent with preservation
of capital.

THE PORTFOLIO

The Portfolio is registered under the 1940 Act as a non-diversified, closed-end
management investment company and is organized as a Delaware limited liability
company. The Portfolio allocates income, expenses and realized and unrealized
gains and losses to each investor on a daily basis, based on methods in
compliance with the Internal Revenue Code of 1986, as amended (the "Code").
Prior to May 5, 2006, the Fund and Highland Institutional Floating Rate Income
Fund (the "Institutional Fund") were the sole investors in the Portfolio. On May
5, 2006, the Institutional Fund liquidated and the Fund became the sole investor
in the Portfolio. At August 31, 2007, the Fund was the sole investor in the
Portfolio.

FUND SHARES

The Fund may issue an unlimited number of shares and continuously offers three
classes of shares: Class A, Class C and Class Z. The Fund has discontinued
selling Class B Shares to new and existing investors, although existing
investors may still reinvest distributions in Class B Shares. Certain share
classes have their own sales charge and bear class-specific expenses, which
include distribution fees and service fees.

Class A Shares are subject to a maximum front-end sales charge of 3.50% based on
the amount of initial investment. Class A Shares purchased without an initial
sales charge by accounts aggregating $1 million and greater at the time of
purchase are subject to a 1.00% contingent deferred sales charge ("CDSC") on
shares tendered and accepted for repurchase within eighteen months after
purchase. Class B Shares are subject to a maximum CDSC of 3.25% based upon the
holding period after purchase. Class B Shares will convert to Class A Shares
eight years after purchase. Please read the Fund's prospectus for additional
details on the Class B CDSC. Class C Shares are subject to a 1.00% CDSC on
shares tendered and accepted for repurchase within one year after purchase.
Class Z Shares are not subject to a sales charge. There are certain restrictions
on the purchase of Class Z Shares, as described in the Fund's Class Z Shares
prospectus.

NOTE 2. SIGNIFICANT ACCOUNTING POLICIES

The following is a summary of significant accounting policies consistently
followed by the Portfolio and the Fund in the preparation of their financial
statements.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America ("GAAP") requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates.

SECURITY VALUATION

The value of the Fund's assets is based on its proportionate share of the
current market value of the Portfolio's net assets. For securities with readily
available market quotations, the Portfolio uses those quotations for pricing.
When portfolio securities are traded on the relevant day of valuation, the
valuation will be the last reported sale price on that day. If there are no such
sales on that day, the security will be valued at the mean between the most
recently quoted bid and asked prices from principal market makers. If there is
more than one such principal market maker, the value will be the average of such
means. Securities without a sale price or bid and ask quotations from principal
market makers on the valuation day will be valued by an independent pricing
service. If securities do not have readily available market quotations or
pricing service prices, including circumstances under which such are determined
not to be accurate or current (such as when events materially affecting the
value of securities occur between the time when the market price is determined
and calculation of the Portfolio's net asset value), such securities are valued
at their fair value, as determined in good faith by the Portfolio's investment
adviser, Highland Capital Management, L.P. ("Highland" or the "Investment
Adviser"), in accordance with procedures established by the Portfolio's Board of
Managers. In these cases, the Portfolio's net asset value will reflect the
affected portfolio securities' value as determined in the judgment of the Board
of Managers or its designee instead of being

30 | Annual Report

NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------

AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

determined by the market. Using a fair value pricing methodology to price
securities may result in a value that is different from a security's most recent
sale price and from the prices used by other investment companies to calculate
their net asset values. There can be no assurance that the Portfolio's valuation
of a security will not differ from the amount that it realizes upon the sale of
such security. Short-term investments, that is, those with a remaining maturity
of 60 days or less, are valued at amortized cost. Repurchase agreements are
valued at cost plus accrued interest. Foreign price quotations are converted to
U.S. dollar equivalents using the 4:00 PM London Time Spot Rate.

SECURITY TRANSACTIONS

Security transactions are accounted for on the trade date. Costs and gains
(losses) are determined based upon the specific identification method for both
financial statement and U.S. federal income tax purposes.

FOREIGN CURRENCY

Foreign currencies, investments and other assets and liabilities are translated
into U.S. dollars at the exchange rates using the current 4:00 PM London Time
Spot Rate. Fluctuations in the value of the foreign currencies and other assets
and liabilities resulting from changes in exchange rates, between trade and
settlement dates on securities transactions and between the accrual and payment
dates on dividends, interest income and foreign withholding taxes, are recorded
as unrealized foreign currency gains (losses). Realized gains (losses) and
unrealized appreciation (depreciation) on investment securities and income and
expenses are translated on the respective dates of such transactions. The effect
of changes in foreign currency exchange rates on investments in securities are
not segregated in the Statement of Operations from the effects of changes in
market prices of those securities, but are included with the net realized and
unrealized gain or loss on investment securities.

FORWARD FOREIGN CURRENCY CONTRACTS

In order to protect against a possible loss on investments resulting from a
decline or appreciation in the value of a particular foreign currency against
the U.S. dollar or another foreign currency or for other reasons, the Portfolio
is authorized to enter into forward currency exchange contracts. These contracts
involve an obligation to purchase or sell a specified currency at a future date
at a price set at the time of the contract. Forward currency contracts do not
eliminate fluctuations in the values of portfolio securities but rather allow
the Portfolio to establish a rate of exchange for a future point in time.

INCOME RECOGNITION

Interest income is recorded on the accrual basis and includes accretion of
discounts and amortization of premiums, if any. Facility fees received are
recorded as a reduction of cost to the loan and amortized through the maturity
of the loan. Dividend income is recorded on the ex-dividend date.

DETERMINATION OF CLASS NET ASSET VALUES

All income, expenses (other than distribution fees and service fees, which are
class-specific expenses, as shown on the Statement of Operations) and realized
and unrealized gains/(losses) are allocated to each class of shares of the Fund
on a daily basis for purposes of determining the net asset value of each class.
Income and expenses are allocated to each class based on the settled shares
method, while realized and unrealized gains/(losses) are allocated based on the
relative net assets of each class.

U.S. FEDERAL INCOME TAX STATUS

The Fund intends to qualify each year as a "regulated investment company" under
Subchapter M of the Code and will distribute substantially all of its taxable
income and gains, if any, for its tax year, and as such will not be subject to
U.S. federal income taxes. In addition, the Portfolio is treated as a
partnership for U.S. federal income tax purposes and all of its income is
allocated to its owners based on methods in compliance with the Internal Revenue
Service. Therefore, no U.S. federal income tax provision is recorded. The Fund
is the sole member of the Portfolio. For U.S. federal income tax purposes, the
Portfolio is a disregarded entity.

DISTRIBUTIONS TO SHAREHOLDERS

Dividends from net investment income are declared by the Fund daily and paid
monthly. Net realized capital gains, if any, are distributed at least annually.

STATEMENT OF CASH FLOWS

Information on financial transactions which have been settled through the
receipt or disbursement of cash is presented in the Statement of Cash Flows. The
cash and foreign currency amount shown in the Statement of Cash Flows is the
amount included within the Portfolio's Statement of Assets and Liabilities and
includes cash and foreign currency on hand at its custodian bank and
sub-custodian bank, respectively, and does not include any short-term
investments.

Annual Report | 31

NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------

AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

ADDITIONAL ACCOUNTING STANDARDS

In July 2006, the Financial Accounting Standards Board ("FASB") released FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48").
FIN 48 provides guidance on how uncertain tax positions should be recognized,
measured, presented, and disclosed in the financial statements. FIN 48 requires
the evaluation of tax positions taken or expected to be taken in the course of
preparing the Fund's tax returns to determine whether the tax positions are
"more-likely-than-not" of being sustained by the applicable tax authorities. Tax
positions not deemed to satisfy the "more-likely-than-not" threshold would be
recorded as a tax benefit or expense in the current year. FASB required adoption
of FIN 48 for fiscal years beginning after December 15, 2006, and FIN 48 is to
be applied to all open tax years as of the effective date. Implementation of FIN
48 will be required beginning after August 31, 2007.

In September 2006, Statement of Financial Accounting Standards No. 157 FAIR
VALUE MEASUREMENTS ("SFAS 157") was issued and is effective for fiscal years
beginning after November 15, 2007. SFAS 157 defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair value
measurements.

In February 2007, FASB issued Statement of Financial Accounting Standards No.
159, The Fair Value Option for Financial Assets and Financial Liabilities ("SFAS
159"), which provides companies with an option to report selected financial
assets and liabilities at fair value. The objective of SFAS 159 is to reduce
both complexity in accounting for financial instruments and the volatility in
earnings caused by measuring related assets and liabilities differently. SFAS
159 establishes presentation and disclosure requirements designed to facilitate
comparisons between companies that choose different measurement attributes for
similar types of assets and liabilities and to more easily understand the effect
of the Fund's choice to use fair value on its earnings. SFAS 159 also requires
entities to display the fair value of the selected assets and liabilities on the
face of the balance sheet. SFAS 159 does not eliminate disclosure requirements
of other accounting standards, including fair value measurement disclosures in
SFAS 157. SFAS 159 is effective for fiscal years beginning after November 15,
2007.

At this time, management is evaluating the implications of FIN 48, SFAS 157 and
SFAS 159 and their impact on the Fund's financial statements, if any, has not
been determined.

NOTE 3. U.S. FEDERAL TAX INFORMATION

The timing and character of income and capital gain distributions are determined
in accordance with income tax regulations, which may differ from GAAP. As a
result, net investment income/(loss) and net realized gain (loss) on investment
transactions for a reporting period may differ significantly from distributions
during such period.

Reclassifications are made to the Fund's capital accounts for permanent tax
differences to reflect income and gains available for distribution (or available
capital loss carryforwards) under income tax regulations.

For the year ended August 31, 2007, permanent differences resulting from premium
amortization sold, Section 988 gain/(loss) reclass, foreign bond bifurcation and
non-deductible excise tax paid were identified and reclassified among the
components of the Fund's net assets as follows:

- --------------------------------------------------------------------------------
Undistributed
(Overdistributed) Accumulated Net
Net Investment Realized Gain/ Paid-in
Income (Loss) Capital
- --------------------------------------------------------------------------------
$ (2,779,826) $ 2,779,965 $ (139)
- --------------------------------------------------------------------------------

The tax character of distributions paid during the years ended August 31, 2007
and August 31, 2006 were as follows:

- --------------------------------------------------------------------------------
2007 2006
- --------------------------------------------------------------------------------
Distributions paid from:
- --------------------------------------------------------------------------------
Ordinary income* $ 148,780,797 $ 93,180,034
- --------------------------------------------------------------------------------
Long-term capital gains -- --
- --------------------------------------------------------------------------------

* For tax purposes, short-term capital gain distributions, if any, are
considered ordinary income distributions.

As of August 31, 2007, the most recent tax year end, the components of
distributable earnings on a tax basis were as follows:

- --------------------------------------------------------------------------------
Undistributed Undistributed
Ordinary Long-Term Net Unrealized
Income Capital Gains Depreciation*
- --------------------------------------------------------------------------------
$ 13,907,234 $ -- $ (74,814,432)
- --------------------------------------------------------------------------------

* The differences between book-basis and tax-basis net unrealized
appreciation/depreciation are primarily due to deferral of losses from wash
sales, premium amortization and Section 732 adjustments.

Portfolio unrealized appreciation and depreciation at August 31, 2007, based on
cost of investments for U.S. federal income tax purposes, and excluding any
unrealized appreciation and depreciation from changes in the value of other

32 | Annual Report

NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------

AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

assets and liabilities resulting from changes in exchange rates, was:

- --------------------------------------------------------------------------------
Unrealized appreciation $ 22,931,369
Unrealized depreciation (97,242,615)
--------------
Net unrealized depreciation $ (74,311,246)
==============
- --------------------------------------------------------------------------------

POST-OCTOBER LOSSES

Under current laws, certain capital losses realized after October 31 may be
deferred and treated as occurring on the first day of the following fiscal year.
For the fiscal year ended August 31, 2007, the Fund intends to elect to defer
net realized capital losses of $2,311,886 and currency losses of $1,975,686
incurred from November 1, 2006 through August 31, 2007.

NOTE 4. ADVISORY, ADMINISTRATION, SERVICE AND DISTRIBUTION AND TRUSTEE FEES

INVESTMENT ADVISORY FEE

Highland Capital Management, L.P. is the investment adviser to the Portfolio.
Effective August 21, 2007, Highland receives from the Portfolio a monthly
advisory fee, based on the Portfolio's average daily net assets at the following
annual rates:

- --------------------------------------------------------------------------------
Average Daily Net Assets Annual Fee Rate
- --------------------------------------------------------------------------------
First $1 billion 0.65%
- --------------------------------------------------------------------------------
Next $1 billion 0.60%
- --------------------------------------------------------------------------------
Over $2 billion 0.55%
- --------------------------------------------------------------------------------

Prior to August 21, 2007, Highland received a monthly investment advisory fee
from the Portfolio based on the Portfolio's average daily net assets at the
following annual rates:

- --------------------------------------------------------------------------------
Average Daily Net Assets Annual Fee Rate
- --------------------------------------------------------------------------------
First $1 billion 0.45%
- --------------------------------------------------------------------------------
Next $1 billion 0.40%
- --------------------------------------------------------------------------------
Over $2 billion 0.35%
- --------------------------------------------------------------------------------

For the year ended August 31, 2007, the Portfolio's effective investment
advisory fee rate was 0.43%.

ADMINISTRATION FEES

Highland provides administrative services to the Portfolio and the Fund for a
monthly administration fee at the annual rate of 0.20% of the Fund's average
daily net assets. The Fund, but not the Portfolio, pays Highland for these
services. Under separate sub-administration agreements, Highland has delegated
certain administrative functions to PFPC Inc. ("PFPC"). Highland pays PFPC
directly for these services.

SERVICE AND DISTRIBUTION FEES

PFPC Distributors, Inc. (the "Underwriter") serves as the principal underwriter
and distributor of the Fund's shares. The Underwriter receives a CDSC imposed on
certain redemptions of Class A, Class B and Class C Shares. For the year ended
August 31, 2007, the Underwriter received $42,222, $97,693 and $110,851 of CDSCs
on Class A, Class B and Class C Share redemptions, respectively.

The Fund has adopted a plan pursuant to Rule 12b-1 under the 1940 Act (the
"Plan") which requires the payment of a monthly service fee to the Underwriter
at an annual rate of 0.25% of the average daily net assets attributable to Class
A, Class B and Class C Shares of the Fund. The Plan also requires the payment of
a monthly distribution fee to the Underwriter at an annual rate of 0.10%, 0.45%
and 0.60% of the average daily net assets attributable to Class A, Class B and
Class C Shares, respectively. The CDSC and the fees received from the Plan are
used principally as repayment for amounts paid by the Underwriter to dealers who
sold such shares.

EXPENSE LIMITS AND FEE REIMBURSEMENTS

Effective August 21, 2007, Highland voluntarily has agreed to waive advisory
fees and reimburse the Fund for certain expenses (exclusive of distribution and
service fees, brokerage commissions, commitment fees, interest, taxes and
extraordinary expenses, if any) so that total expenses will not exceed 1.00% of
the average daily net assets of the Fund. This arrangement may be modified or
terminated by Highland at any time.

FEES PAID TO OFFICERS AND TRUSTEES/MANAGERS

The Fund and the Portfolio pay no compensation to their one interested
Trustee/Manager or to any of their respective officers, all of whom are
employees of Highland.

Trustees/Managers who are not "interested persons" (as defined in the 1940 Act)
of the Fund and the Portfolio each receive an annual retainer fee of $25,000 for
services provided as Trustees of the Fund and the Portfolio. The Fund pays
$20,000 of this fee and the remaining $5,000 is paid by the Portfolio. Following
the Fund's conversion to a single-fund structure and the liquidation and
dissolution of the

Annual Report | 33

NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------

AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

Portfolio, which is expected to occur by the end of 2007, the Fund will pay the
entire fee for each Trustee.

NOTE 5. PORTFOLIO INFORMATION

For the year ended August 31, 2007, the cost of purchases and proceeds from
sales of securities, excluding short-term obligations, were $2,289,064,593 and
$1,697,856,111, respectively.

NOTE 6. PERIODIC REPURCHASE OFFERS

The Fund has adopted a policy to offer each calendar quarter to repurchase a
specified percentage (between 5% and 25%) of the shares then outstanding at the
Fund's net asset value ("Repurchase Offers"). Repurchase Offers are scheduled to
occur on or about the 15th day (or the next business day if the 15th is not a
business day) in the months of March, June, September, and December. It is
anticipated that normally the date on which the repurchase price of shares will
be determined (the "Repurchase Pricing Date") will be the same date as the
deadline for shareholders to provide their repurchase requests to the
Distributor (the "Repurchase Request Deadline"), and if so, the Repurchase
Request Deadline will be set for a time no later than the close of regular
trading on the New York Stock Exchange on such date. The Repurchase Pricing Date
will occur no later than the 14th day after the Repurchase Request Deadline, or
the next business day if the 14th day is not a business day. Repurchase proceeds
will be paid to shareholders no later than seven days after the Repurchase
Pricing Date. If shareholders tender for repurchase more than the Repurchase
Offer amount for a given Repurchase Offer, the Fund may repurchase an additional
amount of shares of up to 2% of the shares outstanding on the Repurchase Request
Deadline.

For the year ended August 31, 2007, there were four Repurchase Offers. For each
Repurchase Offer, the Fund offered to repurchase 10% of its shares. In the
September 2006, December 2006, March 2007 and June 2007 Repurchase Offers,
8.03%, 7.15%, 5.80% and 5.00%, respectively, of shares outstanding were
repurchased.

NOTE 7. SENIOR LOAN PARTICIPATION COMMITMENTS

The Portfolio invests at least 80% of its net assets (plus any borrowings for
investment purposes) in adjustable rate senior loans ("Senior Loans") the
interest rates of which float or vary periodically based upon a benchmark
indicator of prevailing interest rates to domestic foreign corporations,
partnerships and other entities ("Borrowers"). If the lead lender in a typical
lending syndicate becomes insolvent, enters FDIC receivership or, if not FDIC
insured, enters into bankruptcy, the Portfolio may incur certain costs and
delays in receiving payment or may suffer a loss of principal and/or interest.
When the Portfolio purchases a participation of a Senior Loan interest, the
Portfolio typically enters into a contractual agreement with the lender or other
third party selling the participation, not with the Borrower directly. As such,
the Portfolio assumes the credit risk of the Borrower, selling participant or
other persons interpositioned between the Portfolio and the Borrower. The
ability of Borrowers to meet their obligations may be affected by economic
developments in a specific industry.

At August 31, 2007, the following sets forth the selling participants with
respect to interests in Senior Loans purchased by the Portfolio on a
participation basis.

- --------------------------------------------------------------------------------
Principal
Selling Participant Amount Value
- --------------------------------------------------------------------------------
Credit Suisse:
Berry Plastics Holding Corp.
Term C Loan $ 249,375 $ 239,400
Hexion Specialty Chemicals, Inc.
Tranche C-1 Term Loan 2,335,641 2,290,096
Tranche C-2 Term Loan 507,368 496,713
Jacuzzi Brands Corp
First Lien Term B Loan 917,095 831,117
Pre-Funded Letter of Credit 81,081 73,784
Quality Distributions, Inc.
Term Loan 2,064,887 2,054,562

Goldman Sachs:
Bridge Information Systems, Inc.
Multidraw Term Loan 475,491 36,950

Morgan Stanley Senior Funding, Inc.
Realogy Corp
Initial Term B Loan 1,969,697 1,794,276
Synthetic Letter of Credit 530,303 483,074
- --------------------------------------------------------------------------------

NOTE 8. LINE OF CREDIT

On September 13, 2004, the Portfolio entered into a $150,000,000 credit facility
with the Bank of Nova Scotia, which was increased on September 12, 2005 to
$200,000,000, to be used for temporary or emergency purposes to facilitate
portfolio liquidity. Interest is charged to the Portfolio based on its
borrowings. In addition, the Portfolio has agreed to pay facility expenses on
the unutilized line of credit, which are included on the Statement of
Operations. For the year ended August 31, 2007, the average daily loan balance
outstanding on days where borrowings existed was $80,333,333 at a weighted
average interest rate of 8.89%.

34 | Annual Report

NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------

AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

Interest expense allocated to the Fund of $239,479 was paid for use of the line
of credit and is included on the Statement of Operations.

NOTE 9. UNFUNDED LOAN COMMITMENTS

As of August 31, 2007, the Portfolio had unfunded loan commitments of
$33,736,080, which could be extended at the option of the Borrower, pursuant to
loan agreements with the following borrowers:

- --------------------------------------------------------------------------------
Unfunded
Loan
Borrower Commitment
- --------------------------------------------------------------------------------
American Buildings Co. $ 239,463
- --------------------------------------------------------------------------------
Autocam Corp. 38,773
- --------------------------------------------------------------------------------
Buffets Holdings, Inc. 928,125
- --------------------------------------------------------------------------------
Centennial Cellular Operating Co. 2,250,000
- --------------------------------------------------------------------------------
CHS/Community Health Systems, Inc. 587,780
- --------------------------------------------------------------------------------
Cricket Communications, Inc. 6,500,000
- --------------------------------------------------------------------------------
DeCrane Aircraft Holdings, Inc. 1,000,000
- --------------------------------------------------------------------------------
Federal-Mogul Corp. 102,746
- --------------------------------------------------------------------------------
Fenwal, Inc. 1,500,000
- --------------------------------------------------------------------------------
FleetCor Technologies Operating Co., LLC 416,667
- --------------------------------------------------------------------------------
Fontainebleu Las Vegas LLC 2,333,333
- --------------------------------------------------------------------------------
HUB International Holdings, Inc. 627,451
- --------------------------------------------------------------------------------
Interstate Bakeries Corp. 7,500,000
- --------------------------------------------------------------------------------
Millennium Digital Media Systems, LLC 3,057,912
- --------------------------------------------------------------------------------
Nordic Cable Acquisition 3,068,493
- --------------------------------------------------------------------------------
Readers Digest Association, Inc. 501,500
- --------------------------------------------------------------------------------
Schieder Mobel Holding, GMBH 24,742
- --------------------------------------------------------------------------------
Univision Communications, Inc. 2,612,416
- --------------------------------------------------------------------------------
Ypso Holding SA 446,679
- --------------------------------------------------------------------------------
$ 33,736,080
=============
- --------------------------------------------------------------------------------

NOTE 10. DISCLOSURE OF SIGNIFICANT RISKS AND CONTINGENCIES

INDUSTRY FOCUS

The Portfolio may focus its investments in certain industries, subjecting it to
greater risk than a Portfolio that is more diversified.

NON-PAYMENT RISK

Senior Loans, like other corporate debt obligations, are subject to the risk of
non-payment of scheduled interest and/or principal. Non-payment would result in
a reduction of income to the Portfolio, a reduction in the value of the Senior
Loan experiencing non-payment and a potential decrease in the net asset value of
the Fund.

CREDIT RISK

Securities rated below investment grade are commonly referred to as high-yield,
high risk or "junk debt." They are regarded as predominantly speculative with
respect to the issuing company's continuing ability to meet principal and/or
interest payments. Investments in high-yield Senior Loans may result in greater
net asset value fluctuation than if the Portfolio did not make such investments.

CURRENCY RISK

A portion of the Portfolio's assets may be quoted or denominated in non-U.S.
currencies. These securities may be adversely affected by fluctuations in
relative currency exchange rates and by exchange control regulations. The
Portfolio's investment performance may be negatively affected by a devaluation
of a currency in which the Portfolio's investments are quoted or denominated.
Further, the Portfolio's investment performance may be significantly affected,
either positively or negatively, by currency exchange rates because the U.S.
dollar value of securities quoted or denominated in another currency will
increase or decrease in response to changes in the value of such currency in
relation to the U.S. dollar.

FOREIGN SECURITIES

Investments in foreign securities may involve special risks compared to
investing in securities of U.S. issuers. These risks are more pronounced to the
extent that the Portfolio invests a significant portion of its non-U.S.
investment in one region or in the securities of emerging market issuers. These
risks may include (i) less information about non-U.S. issuers or markets being
available due to less rigorous disclosure, accounting standards or regulatory
requirements; (ii) many non-U.S. markets are smaller, less liquid and more
volatile and Highland may not be able to sell the Portfolio's securities at
times, in amounts and at prices it considers reasonable; (iii) the economies of
non-U.S. markets may grow at slower rates than expected or may experience a
downturn or recession; and (iv) withholdings and other non-U.S. taxes may
decrease the Fund's returns.

Annual Report | 35

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
- --------------------------------------------------------------------------------

TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF HIGHLAND FLOATING RATE FUND AND THE
BOARD OF MANAGERS OF HIGHLAND FLOATING RATE LIMITED LIABILITY COMPANY:

In our opinion, the accompanying statements of assets and liabilities, including
the investment portfolios, and the related statements of operations and of
changes in net assets and of cash flows and the financial highlights present
fairly, in all material respects, the financial position of Highland Floating
Rate Fund (the "Fund") and Highland Floating Rate Limited Liability Company (the
"Portfolio") at August 31, 2007, and the results of each of their operations for
the year then ended, the changes in their net assets, the Portfolio's cash flows
and their financial highlights for period indicated in conformity with
accounting principles generally accepted in the United States of America. These
financial statements and financial highlights (hereafter referred to as
"financial statements") are the responsibility of the Fund's and the Portfolio's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements 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 are free of material misstatement. An audit 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, and evaluating the overall financial statement presentation.
We believe that our audits, which included confirmation of investments at August
31, 2007 by correspondence with the custodian and the banks with whom the
Portfolio owns participations in loans, provide a reasonable basis for our
opinion.

PricewaterhouseCoopers LLP
Dallas, Texas
October 25, 2007

36 | Annual Report

ADDITIONAL INFORMATION (UNAUDITED)
- --------------------------------------------------------------------------------

AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

APPROVAL OF INVESTMENT ADVISORY CONTRACTS

The Portfolio has retained Highland to manage its assets pursuant to an
investment advisory agreement with Highland (the "Current Portfolio Advisory
Agreement"). The Current Portfolio Advisory Agreement has been approved by the
Portfolio's Board of Managers and the Fund's Board of Trustees, including a
majority of the Managers/Trustees who are not "interested persons" (as defined
in the 1940 Act) of the Portfolio or the Fund (the "Independent
Managers/Trustees"). Following an initial term of two years, the Current
Portfolio Advisory Agreement continues in effect with respect to the Portfolio
(unless terminated sooner) if approved at least annually by (i) a majority of
the Portfolio's Independent Managers, cast in person at a meeting for the
purpose of voting on such approval, and (ii) by the vote of a majority of the
outstanding shares of the Fund and any other then existing feeder fund of the
Portfolio, or the Portfolio's Board of Managers. At a meeting held on April 30,
2007, the Independent Managers/Trustees, assisted by their independent legal
counsel, met in executive session to discuss (i) the continuation of the Current
Portfolio Advisory Agreement and (ii) the approval of a new investment advisory
agreement between the Portfolio and Highland (the "New Portfolio Advisory
Agreement" and together with the Current Portfolio Advisory Agreement, the
"Advisory Agreements") and the submission of the New Portfolio Advisory
Agreement to shareholders of the Fund. The Independent Managers/Trustees
discussed the fact that the New Portfolio Advisory Agreement contains
substantially identical terms to the Current Portfolio Advisory Agreement except
that the New Portfolio Advisory Agreement reflects an increase in advisory fees
at each stated asset level of 0.20%. Prior to the meeting, the Independent
Managers/ Trustees had requested detailed information from Highland which
included: (1) information confirming the financial soundness of Highland; (2)
information on the advisory and compliance personnel of Highland; (3)
information on the internal compliance procedures of Highland; (4) comparative
information showing how the Portfolio's proposed advisory fee rate schedule and
anticipated operating expenses of the Fund compare to (i) other registered
closed-end and private funds, in particular investment companies and funds that
follow investment strategies similar to those of the Fund and investment
companies that are comparable in structure and asset size, and (ii) other
private and registered pooled investment vehicles or accounts managed by
Highland, as well as the performance of such vehicles and accounts (in absolute
and market terms); (5) information regarding brokerage and portfolio
transactions; and (6) information on any legal proceedings or regulatory audits
or investigations affecting Highland. The Independent Managers/Trustees reviewed
various factors discussed in independent counsel's legal memorandum, the
detailed information provided by Highland and other relevant information and
factors, including the following:

THE NATURE, EXTENT, AND QUALITY OF THE SERVICES TO BE PROVIDED BY HIGHLAND

The Independent Managers/Trustees considered the portfolio management services
provided by Highland and the activities related to portfolio management,
including use of technology, research capabilities, and investment management
staff. They discussed the experience and qualifications of the personnel who
provide advisory services, including the background and experience of the
members of the portfolio management team. The Independent Managers/Trustees
reviewed the management structure, assets under management and investment
philosophies and processes of Highland. They also reviewed and discussed
Highland's compliance policies and procedures. The Independent Managers/Trustees
concluded that Highland has the quality and depth of personnel and investment
methods essential to performing its duties under the Advisory Agreements and
that the nature of such advisory services is satisfactory.

HIGHLAND'S HISTORICAL PERFORMANCE IN MANAGING THE PORTFOLIO AND THE FUND

The Independent Managers/Trustees reviewed Highland's historical performance in
managing the Portfolio and the Fund based on data set forth in the Lipper
Analytical New Applications database. They noted that, as a result of its
investment in the Portfolio, the Fund is consistently outperforming its
benchmark, the Credit Suisse Leveraged Loan Index, as well as its peers that
employ leverage (other than Highland Floating Rate Advantage Fund ("ADV")) and
those that do not employ leverage. During the 12 months ended March 31, 2007,
the Fund's Class A Shares earned a return of 9.71%, which represents a 33.01%
incremental return or 241 basis points more than its benchmark. During the 12
months ended March 31, 2007, the Fund's Class B Shares earned a return of 9.34%,
which represents a 27.95% incremental return or 204 basis points more than its
benchmark. During the 12 months ended March 31, 2007, the Fund's Class C Shares
earned a return of 9.18%, which represents a 25.75% incremental return or 188
basis points more than its benchmark. During the 12 months ended March 31, 2007,
the Fund's Class Z Shares earned a return of 10.10%, which represents a 38.36%
incremental return or 280 basis points more than its benchmark. Additionally, of
its peer group, only ADV (which employs leverage) outperformed the Fund during
the 12 months ended March 31, 2007. Additionally, in Lipper's Annualized Rate of
Return

Annual Report | 37

ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------

AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

APPROVAL OF INVESTMENT ADVISORY CONTRACTS (CONTINUED)

categories, all of the Fund's share classes were ranked in the Top 9 for the
3-year, 5-year and since inception time frames of the Total Return set.

THE INVESTMENT PERFORMANCE OF OTHER ACCOUNTS OR FUNDS MANAGED BY HIGHLAND

The Independent Managers/Trustees reviewed the performance of Highland for
accounts or funds that are similar to the Portfolio compared with other
investment companies of similar investment objectives and size. They reviewed
the performance of ADV and noted that it is consistently outperforming its
benchmark, the Credit Suisse Leveraged Loan Index, as well as both its peers
that employ leverage and those that do not employ leverage. During the 12 months
ended March 31, 2007, ADV's Class A Shares earned a return of 10.44%, which
represents a 43.01% incremental return or 314 basis points more than its
benchmark. During the 12 months ended March 31, 2007, ADV's Class B Shares
earned a return of 10.05%, which represents a 37.67% incremental return or 275
basis points more than its benchmark. During the 12 months ended March 31, 2007,
ADV's Class C Shares earned a return of 9.89%, which represents a 35.48%
incremental return or 259 basis points more than its benchmark. During the 12
months ended March 31, 2007, ADV's Class Z Shares earned a return of 10.83%,
which represents a 48.36% incremental return or 353 basis points more than its
benchmark. Furthermore, when compared to its peer group, all of ADV's share
classes have been the top performing share classes of any peer, in the
categories 1-Year Total Return, and Total Return since April 15, 2004, as well
as the Annualized Total Rates of Return in 3-Year, 5-Year, since April 15, 2004
(the date on which Highland became ADV's Investment Adviser), and Since
Inception time frames. The Independent Managers/Trustees were satisfied with
Highland's overall performance records.

The Independent Managers/Trustees also reviewed the performance of a private
separate account that is the Fund's only other Highland-advised peer and noted
that it is consistently outperforming its benchmark, the Credit Suisse Leveraged
Loan Index. During the 12 months ended March 31, 2007, the private sector
account earned a return of 8.05%, which represents a 10.27% incremental return
or 75 basis points more than its benchmark. Furthermore, the private separate
account outperformed its benchmark in the categories Total Return since April
15, 2004, as well as the Annualized Total Rates of Return in 3-Year, 5-Year,
since April 15, 2004 and Since Inception time frames.

THE COSTS OF THE SERVICES TO BE PROVIDED BY HIGHLAND AND THE PROFITS TO BE
REALIZED BY HIGHLAND AND ITS AFFILIATES FROM THE RELATIONSHIP WITH THE PORTFOLIO
AND THE FUND

With respect to the Advisory Agreements, the Independent Managers/Trustees also
gave substantial consideration to: (1) the fee rate to be paid to Highland under
the Advisory Agreements as well as under the Administration Services Agreement
between Highland and the Fund; (2) the anticipated expenses Highland would incur
in providing advisory services; (3) so-called "fallout benefits" to Highland
under the Advisory Agreements, such as any incremental increase to its
reputation derived from serving as investment adviser to the Portfolio; and (4)
a comparison of the fees payable to Highland under the Advisory Agreements to
fees paid to Highland by other funds and to investment advisers serving other
investment companies with similar investment programs to that of the Portfolio.
After such review, the Independent Managers/Trustees determined that the
anticipated profitability rate to Highland with respect to the Advisory
Agreements was fair and reasonable.

THE EXTENT TO WHICH ECONOMIES OF SCALE WOULD BE REALIZED AS THE PORTFOLIO GROWS
AND WHETHER FEE LEVELS REFLECT THESE ECONOMIES OF SCALE FOR THE BENEFIT OF
SHAREHOLDERS

The Independent Managers/Trustees considered the effective fees under the
Advisory Agreements, as a percentage of assets at different asset levels, and
possible economies of scale to Highland. They considered the anticipated asset
levels of the Portfolio, the information provided by Highland relating to its
estimated costs, and information comparing the fee rate to be charged by
Highland with fee rates charged by other unaffiliated investment advisers to
their clients. They also considered Highland's willingness, if shareholders
approve the New Portfolio Advisory Agreement, to voluntarily waive advisory fees
and reimburse the Fund for certain expenses (exclusive of distribution and
service fees, brokerage commissions, commitment fees, interest, taxes and
extraordinary expenses, if any) so that total expenses would not exceed an
annual rate of 1.00% of the average daily net assets of the Fund. The
Independent Managers/Trustees concluded that the fee structures are reasonable
and appropriately would result in a sharing of economies of scale in view of the
information provided by Highland.

In determining whether to approve the continuation of the Current Portfolio
Advisory Agreement and to recommend the submission to shareholders of the New
Portfolio

38 | Annual Report

ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------

AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

APPROVAL OF INVESTMENT ADVISORY CONTRACTS (CONTINUED)

Advisory Agreement, the Independent Managers/Trustees drew the following
conclusions:

The Independent Managers/Trustees concluded that an increase in the investment
advisory fee rate would be in the best interests of shareholders because it
would enable Highland to remain committed to the long-term management of the
Fund and the Portfolio at a more appropriate fee level. The Independent
Managers/Trustees determined that the current fee rate and the increased
advisory fee rate proposal are fair and reasonable, in light of the resources
that Highland has devoted to managing the Portfolio during the period Highland
has served as the investment adviser to the Portfolio and in view of the fact
that the current advisory fee rate for the Portfolio is substantially below the
average advisory/management fee rate in the Portfolio's peer groups. The Board
also noted that the proposed advisory fee rate increase would still be below the
average of other funds with similar investment programs to that of the
Portfolio. They also noted the Portfolio's excellent performance under
Highland's management.

The Fund's Board noted that at its May 19, 2006 board meeting it had approved an
advisory agreement substantially identical to the New Portfolio Advisory
Agreement and that the Fund had held a shareholder meeting but did not obtain
the requisite shareholder approval by a very slim margin. The Board noted that
only 55% of the shares entitled to vote on the proposal had been represented at
the meeting and, therefore, a significant portion of the shareholders did not
vote on the proposal. The Board also noted the ADV shareholder approval of a
similar advisory fee rate increase and Highland's continued belief that a fee
rate increase is appropriate and necessary to maintain the high level of service
it provides to Fund and the Portfolio. The Board considered whether any of the
factors that led to its approval at the May 19, 2006 meeting had changed. In
light of the continued high level of service that Highland provides to Fund and
the Portfolio, the Board determined that the New Portfolio Advisory Agreement
should be submitted for shareholder approvals.

SHAREHOLDER VOTING RESULTS

At a Special Meeting of the Shareholders of the Fund originally scheduled for
July 20, 2007 and adjourned until August 21, 2007 (the "Meeting"), the
shareholders of record of the Fund as of June 4, 2007 ("Record Date") were asked
to approve (i) the New Portfolio Advisory Agreement; (ii) an Agreement and Plan
of Reorganization, pursuant to which the Fund would be reorganized into a newly
formed Delaware statutory trust, also named Highland Floating Rate Fund; and
(iii) the Fund's conversion to a single-fund structure and the liquidation and
dissolution of the Portfolio (collectively, the "Proposals"). As of the Record
Date, the Fund had the following shares outstanding:

- --------------------------------------------------------------------------------
Class A 90,322,341.92
- --------------------------------------------------------------------------------
Class B 13,272,971.86
- --------------------------------------------------------------------------------
Class C 89,155,983.56
- --------------------------------------------------------------------------------
Class Z 30,995,064.52
- --------------------------------------------------------------------------------

On July 20, 2007, the date of the Meeting, there was not present, in person or
by proxy, a majority of the outstanding shares entitled to vote at the Meeting.
Therefore, the Fund's quorum requirement was not met and the Meeting was
adjourned to August 21, 2007. On August 21, 2007, a majority of the total number
of outstanding shares of the Fund entitled to vote was represented at the
Meeting and the Fund's quorum requirement was met. On August 21, 2007, the
Proposals were voted on and each was approved by the shareholders of the Fund.
The shares represented at the Meeting on August 21, 2007 voted on the Proposals
as follows:

With respect to the approval of the New Portfolio Advisory Agreement:

- --------------------------------------------------------------------------------
For: 86,523,909
- --------------------------------------------------------------------------------
Against: 20,673,537
- --------------------------------------------------------------------------------
Abstain: 5,746,557
- --------------------------------------------------------------------------------

With respect to the approval of the Agreement and Plan of Reorganization:

- --------------------------------------------------------------------------------
For: 95,833,921
- --------------------------------------------------------------------------------
Against: 8,919,328
- --------------------------------------------------------------------------------
Abstain: 8,190,754
- --------------------------------------------------------------------------------

With respect to the approval of the Fund's conversion to a single-fund structure
and the liquidation and dissolution of the Portfolio:

- --------------------------------------------------------------------------------
For: 95,893,621
- --------------------------------------------------------------------------------
Against: 8,530,404
- --------------------------------------------------------------------------------
Abstain: 8,519,981
- --------------------------------------------------------------------------------

Annual Report | 39

ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------

AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

ADDITIONAL PORTFOLIO INFORMATION

The Investment Adviser and its affiliates manage other accounts, including
registered and private funds and individual accounts. Although investment
decisions for the Portfolio are made independently from those of such other
accounts, the Investment Adviser may, consistent with applicable law, make
investment recommendations to other clients or accounts that may be the same or
different from those made to the Portfolio, including investments in different
levels of the capital structure of a company, such as equity versus senior
loans, or that take contrary provisions in multiple levels of the capital
structure. The Investment Adviser has adopted policies and procedures that
address the allocation of investment opportunities, execution of portfolio
transactions, personal trading by employees and other potential conflicts of
interest that are designed to ensure that all client accounts are treated
equitably over time. Nevertheless, this may create situations where a client
could be disadvantaged because of the investment activities conducted by the
Investment Adviser for other client accounts. When the Portfolio and one or more
of such other accounts is prepared to invest in, or desires to dispose of, the
same security, available investments or opportunities for each will be allocated
in a manner believed by the Investment Adviser to be equitable to the Portfolio
and such other accounts. The Investment Adviser also may aggregate orders to
purchase and sell securities for the Portfolio and such other accounts. Although
the Investment Adviser believes that, over time, the potential benefits of
participating in volume transactions and negotiating lower transaction costs
should benefit all accounts including the Portfolio, in some cases these
activities may adversely affect the price paid or received by the Portfolio or
the size of the position obtained or disposed of by the Portfolio.

40 | Annual Report

ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------

AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

TRUSTEES AND OFFICERS

The Board of Trustees of the Fund provides broad oversight over the operations
and affairs of the Fund and protects the interests of shareholders. The Board
has overall responsibility to manage and control the business affairs of the
Fund, including the complete and exclusive authority to establish policies
regarding the management, conduct and operation of the Fund's business. The
names and ages of the Trustees and officers of the Fund, the year each was first
elected or appointed to office, their principal business occupations during the
last five years, the number of funds overseen by each Trustee and other
directorships they hold are shown below. The business address for each Trustee
and officer of the Fund is c/o Highland Capital Management, L.P., Two Galleria
Tower, 13455 Noel Road, Suite 800, Dallas, TX 75240. Each Trustee of the Fund
also serves in the same role as a member of the Board of Managers of the
Portfolio. Each officer of the Fund also serves in the same role as an officer
of the Portfolio.

- ------------------------------------------------------------------------------------------------------------------------------------
YEAR FIRST PRINCIPAL NUMBER OF PORTFOLIOS
ELECTED OR OCCUPATION(S) IN HIGHLAND FUNDS OTHER
NAME, ADDRESS, POSITION APPOINTED DURING PAST COMPLEX OVERSEEN DIRECTORSHIPS
AND AGE WITH FUND TO OFFICE FIVE YEARS BY TRUSTEE 1 HELD
- ------------------------------------------------------------------------------------------------------------------------------------

INDEPENDENT TRUSTEES

Timothy K. Hui Trustee Indefinite Dean of Educational Resources 12 None
(Age 59) Term; since July 2006; Assistant
Trustee Provost for Graduate Education
since from July 2004 to June 2006,
2004 and Assistant Provost for
Educational Resources from
July 2001 to June 2004,
Philadelphia Biblical University.

Scott F. Kavanaugh Trustee Indefinite Private Investor since February 12 None
(Age 46) Term; 2004. Sales Representative at
Trustee Round Hill Securities from
since March 2003 to January 2004;
2004 Executive at Provident Funding
Mortgage Corporation, February
2003 to July 2003; Executive
Vice President. Director and
CAO, Commercial Capital Bank,
January 2000 to February 2003;
Managing Principal and Chief
Operating Officer, Financial
Institutional Partners Mortgage
Company and the Managing
Principal and President of
Financial Institutional Partners,
LLC (an investment banking
firm), April 1998 to February
2003.

James F. Leary Trustee Indefinite Managing Director, Benefit 12 Board Member of
(Age 77) Term; Capital Southwest, Inc. (a Capstone Group
Trustee financial consulting firm) since of Funds (7
since January 1999. portfolios)
2004
- ------------------------------------------------------------------------------------------------------------------------------------

Annual Report | 41

ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------

AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

TRUSTEES AND OFFICERS

INDEPENDENT TRUSTEES

Bryan A. Ward Trustee Indefinite Senior Manager since January 12 None
(Age 52) Term; 2002 and Special Projects
Trustee Advisor, Accenture, LLP
since (consulting firm) with focus on
2004 the oil and gas industry, from
September 1998 to December
2001.

INTERESTED TRUSTEE 2

R. Joseph Dougherty 2 Trustee and Indefinite Senior Portfolio Manager of the 12 None
(Age 37) Chairman of the Term; Investment Adviser since 2000.
Board Trustee Director and Senior Vice
and President of the funds in the
Chairman Highland Fund Complex.
of the
Board
since
2004

OFFICERS

James D. Dondero Chief Executive 1 year President and Director of Strand N/A N/A
(Age 45) Officer and Term; Advisors, Inc. ("Strand"), the
President Chief General Partner of the
Executive Investment Adviser. President
Officer of the funds in the Highland
and Fund Complex.
President
since
2004

Mark Okada Executive Vice 1 year Executive Vice President of N/A N/A
(Age 45) President Term; Strand and the funds in the
Executive Highland Fund Complex.
Vice
President
since
2004

R. Joseph Dougherty Senior Vice 1 year Senior Portfolio Manager of the N/A N/A
(Age 37) President Term; Investment Adviser since 2000.
Senior Director and Senior Vice
Vice President of the funds in the
President Highland Fund Complex.
since
2004
- ------------------------------------------------------------------------------------------------------------------------------------

42 | Annual Report

ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
- --------------------------------------------------------------------------------

AUGUST 31, 2007 HIGHLAND FLOATING RATE FUND

TRUSTEES AND OFFICERS

OFFICERS

M. Jason Blackburn Chief Financial 1 year Assistant Controller of the N/A N/A
(Age 31) Officer (Principal Term; Adviser since November 2001.
Accounting Secretary, Treasurer and Secretary of the
Officer), Treasurer Chief funds in the Highland Fund
and Secretary Financial Complex.
Officer
and
Treasurer
since
2004

Michael Colvin Chief Compliance 1 year General Counsel and Chief N/A N/A
(Age 38) Officer Term; Chief Compliance Officer of the
Compliance Investment Adviser since June
Officer 2007 and Chief Compliance
since July Officer of the funds in the
2007 Highland Fund Complex since
July 2007, Shareholder in the
Corporate and Securities Group
at Greenberg Traurig, LLP, from
January 2007 to June 2007,
Partner from January 2003 to
January 2007 and Associate
from 1995 to 2002 in the Private
Equity Practice Group at Weil,
Gotshal & Manges, LLP.
- ------------------------------------------------------------------------------------------------------------------------------------

1 The Highland Fund Complex consists of all of the registered investment
companies advised by the Investment Adviser as of the date of this report.

2 Mr. Dougherty is deemed to be an "interested person" of the Fund and the
Portfolio under the 1940 Act because of his position with the Investment
Adviser.

Annual Report | 43

IMPORTANT INFORMATION ABOUT THIS REPORT
- --------------------------------------------------------------------------------

INVESTMENT ADVISER
Highland Capital Management, L.P.
Two Galleria Tower
13455 Noel Road, Suite 800
Dallas, TX 75240

TRANSFER AGENT
PFPC Inc.
101 Sabin Street
Pawtucket, RI 02860

DISTRIBUTOR
PFPC Distributors, Inc.
760 Moore Road
King of Prussia, PA 19406

CUSTODIAN
PFPC Trust Company
8800 Tinicum Boulevard
Philadelphia, PA 19153

INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
PricewaterhouseCoopers LLP
2001 Ross Avenue, Suite 1800
Dallas, TX 75201

LEGAL ADVISOR
Skadden, Arps, Slate, Meagher & Flom LLP
Four Times Square
New York, NY 10036

This report has been prepared for shareholders of Highland Floating Rate Fund.

The Fund mails one shareholder report to each shareholder address. If you would
like more than one report, please call shareholder services at 1-877-665-1287 to
request that additional reports be sent to you.

A description of the policies and procedures that the Fund uses to determine how
to vote proxies relating to its portfolio securities, and the Fund's proxy
voting record for the most recent 12-month period ended June 30, are available
(i) without charge, upon request, by calling 1-877-665-1287 and (ii) on the
Securities and Exchange Commission's website at http://www.sec.gov.

The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission for the first and third quarters of each fiscal year on
Form N-Q. The Fund's Forms N-Q are available on the Commission's website at
http://www.sec.gov and also may be reviewed and copied at the Commission's
Public Reference Room in Washington, DC. Information on the Public Reference
Room may be obtained by calling 1-800-SEC-0330.

The Statement of Additional Information includes information about Fund Trustees
and is available upon request without charge by calling 1-877-665-1287.

44 | Annual Report

- --------------------------------------------------------------------------------

HIGHLAND FLOATING RATE FUND Annual Report, August 31, 2007

[HIGHLAND FUNDS LOGO]

managed by
Highland Capital Management, L.P.

www.highlandfunds.com HLC-FR AR-08/07

ITEM 2. CODE OF ETHICS.

(a) The registrant, as of the end of the period covered by this report,
has adopted a code of ethics that applies to the registrant's
principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar
functions.

(b) Not applicable.

(c) There have been no amendments, during the period covered by this
report, to a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions.

(d) The registrant has not granted any waiver, including any implicit
waiver, from a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller.

(e) Not applicable.

(f) The registrant's code of ethics is incorporated by reference to
Exhibit (a)(1) to the registrant's Form N-CSR filed with the
Securities and Exchange Commission on November 9, 2004 (Accession No.
0001047469-04-033535).

ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.

The Registrant's Board of Trustees (the "Board") has determined that James
Leary, a member of the Audit Committee of the Board, is an audit committee
financial expert as defined by the Securities and Exchange Commission (the
"SEC"). Mr. Leary is "independent" as defined by the SEC for purposes of this
Item 3 of Form N-CSR.

ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

AUDIT FEES

(a) The aggregate fees billed for each of the last two fiscal years for
professional services rendered by the principal accountant for the
audit of the registrant's annual financial statements or services that
are normally provided by the accountant in connection with statutory
and regulatory filings or engagements for those fiscal years are
$12,000 for 2006 and $40,000 for 2007.

AUDIT-RELATED FEES

(b) The aggregate fees billed in each of the last two fiscal years for
assurance and related services by the principal accountant that are
reasonably related to the performance of the audit of the registrant's

financial statements and are not reported under paragraph (a) of this
Item are $5,500 for 2006 and $3,500 for 2007. The nature of the
services related to agreed-upon procedures, performed on the Fund's
semi-annual financial statements.

TAX FEES

(c) The aggregate fees billed in each of the last two fiscal years for
professional services rendered by the principal accountant for tax
compliance, tax advice, and tax planning are $3,700 for 2006 and
$2,850 for 2007. The nature of the services related to assistance on
the Fund's tax returns and excise tax calculations.

ALL OTHER FEES

(d) The aggregate fees billed in each of the last two fiscal years for
products and services provided by the principal accountant, other than
the services reported in paragraphs (a) through (c) of this Item are
$0 for 2006 and $0 for 2007.

(e)(1) Disclose the audit committee's pre-approval policies and procedures
described in paragraph (c)(7) of Rule 2-01 of Regulation S-X.

The Audit Committee shall:

(a) have direct responsibility for the appointment, compensation,
retention and oversight of the Fund's independent auditors and,
in connection therewith, to review and evaluate matters
potentially affecting the independence and capabilities of the
auditors; and

(b) review and pre-approve (including associated fees) all audit and
other services to be provided by the independent auditors to the
Fund and all non-audit services to be provided by the independent
auditors to the Fund's investment adviser or any entity
controlling, controlled by or under common control with the
investment adviser (an "Adviser Affiliate") that provides ongoing
services to the Fund, if the engagement relates directly to the
operations and financial reporting of the Fund; and

(c) establish, to the extent permitted by law and deemed appropriate
by the Audit Committee, detailed pre-approval policies and
procedures for such services; and

(d) consider whether the independent auditors' provision of any
non-audit services to the Fund, the Fund's investment adviser or
an Adviser Affiliate not pre-approved by the Audit Committee are
compatible with maintaining the independence of the independent
auditors.

(e)(2) The percentage of services described in each of paragraphs (b) through
(d) of this Item that were approved by the audit committee pursuant to
paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X are as follows:

(b) 100%

(d) N/A

(f) The percentage of hours expended on the principal accountant's
engagement to audit the registrant's financial statements for the most
recent fiscal year that were attributed to work performed by persons
other than the principal accountant's full-time, permanent employees
was less than fifty percent.

(g) The aggregate non-audit fees billed by the registrant's accountant for
services rendered to the registrant, and rendered to the registrant's
investment adviser (not including any sub-adviser whose role is
primarily portfolio management and is subcontracted with or overseen
by another investment adviser), and any entity controlling, controlled
by, or under common control with the adviser that provides ongoing
services to the registrant for each of the last two fiscal years of
the registrant was $81,000 for 2006 and $1,417,420 for 2007.

(h) The registrant's audit committee of the board of directors has
considered whether the provision of non-audit services that were
rendered to the registrant's investment adviser (not including any
sub-adviser whose role is primarily portfolio management and is
subcontracted with or overseen by another 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.

ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.

Not applicable.

ITEM 6. SCHEDULE OF INVESTMENTS.

Schedule of Investments in securities of unaffiliated issuers as of the close of
the reporting period is included as part of the report to shareholders filed
under Item 1 of this form.

ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.

Highland Capital Management, L.P. (the "Company") has adopted proxy voting
policies (the "Policy") that provide as follows:

1. Application; General Principles

1.1 This Policy applies to securities held in Client accounts as to
which the Company has voting authority, directly or indirectly. Indirect voting
authority exists where the Company's voting authority is implied by a general
delegation of investment authority without reservation of proxy voting
authority.

1.2 The Company shall vote proxies in respect of securities owned by
or on behalf of a Client in the Client's best economic interests and without
regard to the interests of the Company or any other Client of the Company.

2. Voting; Procedures

2.1 MONITORING. A settlement designee of the Company shall have
responsibility for monitoring portfolios managed by the Company for securities
subject to a proxy vote. Upon the receipt of a proxy notice related to a
security held in a portfolio managed by the Company, the settlement designee
shall forward all relevant information to the portfolio manager(s) with
responsibility for the security.

2.2 VOTING.

2.2.1. Upon receipt of notice from the settlement designee,
the portfolio manager(s) with responsibility for purchasing the
security subject to a proxy vote shall evaluate the subject matter of
the proxy and cause the proxy to be voted on behalf of the Client. In
determining how to vote a particular proxy, the portfolio manager (s)
shall consider, among other things, the interests of each Client
account as it relates to the subject matter of the proxy, any potential
conflict of interest the Company may have in voting the proxy on behalf
of the Client and the procedures set forth in this Policy.

2.2.2 If a proxy relates to a security held in a registered
investment company or business development company ("Retail Fund")
portfolio, the portfolio manager(s) shall notify the Compliance
Department and a designee from the Retail Funds group. Proxies for
securities held in the Retail Funds will be voted by the designee from
the Retail Funds group in a manner consistent with the best interests
of the applicable Retail Fund and a record of each vote will be
reported to the Retail Fund's Board of Directors in accordance with the
procedures set forth in Section 4 of this Policy.

2.3 CONFLICTS OF INTEREST. If the portfolio manager(s) determine that
the Company may have a potential material conflict of interest (as defined in
Section 3 of this Policy) in voting a particular proxy, the portfolio manager(s)
shall contact the Company's Compliance Department prior to causing the proxy to
be voted.

2.3.1. For a security held by a Retail Fund, the Company shall
disclose the conflict and the determination of the manner in which it
proposes to vote to the Retail Fund's Board of Directors. The Company's
determination shall take into account only the interests of the Retail
Fund, and the Compliance Department shall document the basis for the
decision and furnish the documentation to the Board of Directors.

2.3.2. For a security held by an unregistered investment
company, such as a hedge fund and structured products ("Non-Retail
Funds"), where a material conflict of interest has been identified the
Company may resolve the conflict by following the recommendation of a
disinterested third party or by abstaining from voting.

2.4 NON-VOTES. The Company may determine not to vote proxies in respect
of securities of any issuer if it determines it would be in its Client's overall
best interests not to vote. Such determination may apply in respect of all
Client holdings of the securities or only certain specified Clients, as the
Company deems appropriate under the circumstances. As examples, the portfolio
manager(s) may determine: (a) not to recall securities on loan if, in its
judgment, the negative consequences to Clients of disrupting the securities
lending program would outweigh the benefits of voting in the particular instance
or (b) not to vote certain foreign securities positions if, in its judgment, the
expense and administrative inconvenience outweighs the benefits to Clients of
voting the securities.

2.5 RECORDKEEPING. Following the submission of a proxy vote, the
applicable portfolio manager(s) shall submit a report of the vote to a
settlement designee of the Company. Records of proxy votes by the Company shall
be maintained in accordance with Section 4 of this Policy.

2.6 CERTIFICATION. On a quarterly basis, each portfolio manager shall
certify to the Compliance Department that they have complied with this Policy in
connection with proxy votes during the period.

3. Conflicts of Interest

3.1 Voting the securities of an issuer where the following
relationships or circumstances exist are deemed to give rise to a material
conflict of interest for purposes of this Policy:

3.1.1 The issuer is a Client of the Company accounting for
more than 5% of the Company's annual revenues.

3.1.2 The issuer is an entity that reasonably could be
expected to pay the Company more than $1 million through the end of the
Company's next two full fiscal years.

3.1.3 The issuer is an entity in which a "Covered Person" (as
defined in the Retail Funds' and the Company's Policies and Procedures
Designed to Detect and Prevent Insider Trading and to Comply with Rule
17j-1 of the Investment Company Act of 1940, as amended (each, a "Code
of Ethics")) has a beneficial interest contrary to the position held by
the Company on behalf of Clients.

3.1.4 The issuer is an entity in which an officer or partner
of the Company or a relative 1 of any such person is or was an
officer, director or employee, or such person or relative otherwise has
received more than $150,000 in fees, compensation and other payment
from the issuer during the Company's last three fiscal years; PROVIDED,
HOWEVER, that the Compliance Department may deem such a relationship
not to be a material conflict of interest if the Company representative
serves as an officer or director of the issuer at the direction of the
Company for purposes of seeking control over the issuer.

3.1.5 The matter under consideration could reasonably be
expected to result in a material financial benefit to the Company
through the end of the Company's next two full fiscal years (for
example, a vote to increase an investment advisory fee for a Retail
Fund advised by the Company or an affiliate).

3.1.6 Another Client or prospective Client of the Company,
directly or indirectly, conditions future engagement of the Company on
voting proxies in respect of any Client's securities on a particular
matter in a particular way.

3.1.7 The Company holds various classes and types of equity
and debt securities of the same issuer contemporaneously in different
Client portfolios.

3.1.8 Any other circumstance where the Company's duty to serve
its Clients' interests, typically referred to as its "duty of loyalty,"
could be compromised.

3.2 Notwithstanding the foregoing, a conflict of interest described in
Section 3.1 shall not be considered material for the purposes of this Policy in
respect of a specific vote or circumstance if:

3.2.1 The securities in respect of which the Company has the
power to vote account for less than 1% of the issuer's outstanding
voting securities, but only if: (i) such securities do not represent

- -------------------

1 For the purposes of this Policy, "relative" includes the following
family members: spouse, minor children or stepchildren or children or
stepchildren sharing the person's home.

one of the 10 largest holdings of such issuer's outstanding voting
securities and (ii) such securities do not represent more than 2% of
the Client's holdings with the Company.

3.2.2 The matter to be voted on relates to a restructuring of
the terms of existing securities or the issuance of new securities or a
similar matter arising out of the holding of securities, other than
common equity, in the context of a bankruptcy or threatened bankruptcy
of the issuer.

4. RECORDKEEPING AND RETENTION

4.1 The Company shall retain records relating to the voting of
proxies, including:

4.1.1 Copies of this Policy and any amendments thereto.

4.1.2 A copy of each proxy statement that the Company receives
regarding Client securities.

4.1.3 Records of each vote cast by the Company on behalf of
Clients.

4.1.4 A copy of any documents created by the Company that were
material to making a decision how to vote or that memorializes the
basis for that decision.

4.1.5 A copy of each written request for information on how
the Company voted proxies on behalf of the Client, and a copy of any
written response by the Company to any (oral or written) request for
information on how the Company voted.

4.2 These records shall be maintained and preserved in an easily
accessible place for a period of not less than five years from the end of the
Company's fiscal year during which the last entry was made in the records, the
first two years in an appropriate office of the Company.

4.3 The Company may rely on proxy statements filed on the SEC's EDGAR
system or on proxy statements and records of votes cast by the Company
maintained by a third party, such as a proxy voting service (provided the
Company had obtained an undertaking from the third party to provide a copy of
the proxy statement or record promptly on request).

4.4 Records relating to the voting of proxies for securities held by
the Retail Funds will be reported periodically to the Retail Funds' Boards of
Directors/Trustees/Managers and, with respect to Retail Funds other than
business development companies, to the SEC on an annual basis pursuant to Form
N-PX.

Revised: February 21, 2007

ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.

(A)(1) IDENTIFICATION OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS AND
DESCRIPTION OF ROLE OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS

The Fund's portfolio is managed by a portfolio management team. As of
the date of this filing, the members of the team who are primarily responsible
for the day-to-day management of the Fund's portfolio are R. Joseph Dougherty
and Mark Okada.

JOE DOUGHERTY, CFA, CPA - PARTNER, HEAD OF RETAIL PRODUCTS, SENIOR PORTFOLIO
MANAGER

Mr. Dougherty is Head of Retail Products at Highland Capital
Management, L.P., and is a Senior Portfolio Manager. Prior to joining Highland
in March 1998, Mr. Dougherty served as an Investment Analyst with Sandera
Capital Management from 1997 to 1998. Formerly, he was a Business Development
Manager at Akzo Nobel from 1994 to 1996 and a Senior Accountant at Deloitte &
Touche, LLP from 1992 to 1994. Mr. Dougherty is a Partner, Senior Portfolio
Manager, and heads Highland's retail products business unit ("Highland Funds").
He serves as Portfolio Manager, Senior Vice President and/or Director of the
Firm's NYSE-listed funds and 1940 Act Registered Funds. He also serves as
Portfolio Manager for the Firm's sub-advised closed-end funds. In this capacity,
Mr. Dougherty oversees investment decisions for the retail funds, alongside
several other Portfolio Managers, and manages the team dedicated to their
day-to-day operations. Prior to his current duties, Mr. Dougherty served as
Portfolio Analyst for Highland from 1998 to 1999. As a Portfolio Analyst, Mr.
Dougherty helped follow companies within the chemical, retail, supermarket,
wireless and restaurant sectors. He received an MBA from Southern Methodist
University, and a BS in Accounting from Villanova University. Mr. Dougherty is a
Certified Public Accountant, and has earned the right to use the Chartered
Financial Analyst designation.

MARK OKADA, CFA - MANAGING PARTNER, CHIEF INVESTMENT OFFICER

Mr. Okada is a Founder and Chief Investment Officer of Highland Capital
Management, L.P. He is responsible for overseeing Highland's investment
activities for its various strategies, and has over 20 years of experience in
the credit markets. Prior to founding Highland, Mr. Okada served as Manager of
Fixed Income for Protective Life Insurance's GIC subsidiary from 1990 to 1993.
He was primarily responsible for the bank loan portfolio and other risk assets.
Protective was one of the first non-bank entrants into the syndicated loan
market. From 1986 to 1990, he served as Vice President at Hibernia National
Bank, managing a portfolio of high yield loans in excess of $1 billion. Mr.
Okada is an honors graduate of the University of California Los Angeles with
degrees in Economics and Psychology. He has earned the right to use the
Chartered Financial Analyst designation. Mr. Okada is a Director of NexBank and
Highland Financial Partners, and Chairman of the Board of Directors of Common
Grace Ministries, Inc.

(A)(2) OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM
MEMBER AND POTENTIAL CONFLICTS OF INTEREST

OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM
MEMBER

The following tables provide information about funds and accounts,
other than the Fund, for which the Fund's portfolio managers are primarily
responsible for the day-to-day portfolio management as of August 31, 2007.

R. JOSEPH DOUGHERTY

- --------------------------------------------------------------------------------------------------------------------------
Total # of Accounts Managed Total Assets with
# of Accounts Total Assets with Performance-Based Performance-Based
Type of Accounts Managed (millions) Advisory Fee Advisory Fee (millions)
- --------------------------------------------------------------------------------------------------------------------------

Registered Investment 12 $6,155 -- --
Companies:
- --------------------------------------------------------------------------------------------------------------------------
Other Pooled Investment 1 $357 -- --
Vehicles:
- --------------------------------------------------------------------------------------------------------------------------
Other Accounts: -- -- -- --
- --------------------------------------------------------------------------------------------------------------------------

MARK OKADA

- --------------------------------------------------------------------------------------------------------------------------
Type of Accounts Total Total Assets # of Accounts Managed Total Assets with
# of Accounts with Performance-Based Performance-Based
Managed (millions) Advisory Fee Advisory Fee (millions)
- --------------------------------------------------------------------------------------------------------------------------

Registered Investment 13 $7,091 -- --
Companies:
- --------------------------------------------------------------------------------------------------------------------------
Other Pooled Investment 30 $17,536 24 $15,686
Vehicles:
- --------------------------------------------------------------------------------------------------------------------------
Other Accounts: -- -- -- --
- --------------------------------------------------------------------------------------------------------------------------

POTENTIAL CONFLICTS OF INTERESTS

The Adviser has built a professional working environment, a firm-wide
compliance culture and compliance procedures and systems designed to protect
against potential incentives that may favor one account over another. Highland
has adopted policies and procedures that address the allocation of investment
opportunities, execution of portfolio transactions, personal trading by
employees and other potential conflicts of interest that are designed to ensure
that all client accounts are treated equitably over time. Nevertheless, the
Adviser furnishes advisory services to numerous clients in addition to the Fund,
and the Adviser may, consistent with applicable law, make investment
recommendations to other clients or accounts (including accounts that are hedge
funds or have performance or higher fees paid to the Adviser or in which
portfolio managers have a personal interest in the receipt of such fees) that
may be the same as or different from those made to the Fund. In addition, the
Adviser, its affiliates and any of their partners, directors, officers,
stockholders or employees may or may not have an interest in the securities
whose purchase and sale the Adviser recommends to the Fund. Actions with respect
to securities of the same kind may be the same as or different from the action
that the Adviser, or any of its affiliates, or any of their partners, directors,
officers, stockholders or employees or any member of their families may take
with respect to the same securities. Moreover, the Adviser may refrain from
rendering any advice or services concerning securities of companies of which any
of the Adviser's (or its affiliates') partners, directors, officers or employees
are directors or officers, or companies as to which the Adviser or any of its
affiliates or the partners, directors, officers and employees of any of them has
any substantial economic interest or possesses material non-public information.
In addition to its various policies and procedures designed to address these
issues, the Adviser includes disclosure regarding these matters to its clients
in both its Form ADV and investment advisory agreements.

The Adviser, its affiliates or their partners, directors, officers and
employees similarly serve or may similarly serve other entities that operate in
the same or related lines of business. Accordingly, these individuals may have
obligations to investors in those entities or funds or to other clients, the
fulfillment of which might not be in the best interests of the Fund. As a
result, the Adviser will face conflicts in the allocation of investment
opportunities to the Fund and other funds and clients. In order to enable such
affiliates to fulfill their fiduciary duties to each of the clients for which
they have responsibility, the Adviser will endeavor to allocate investment
opportunities in a fair and equitable manner which may, subject to applicable
regulatory constraints, involve pro rata co-investment by the Fund and such
other clients or may involve a rotation of opportunities among the Fund and such
other clients.

While the Adviser does not believe there will be frequent conflicts of
interest, if any, the Adviser and its affiliates have both subjective and
objective procedures and policies in place designed to manage the potential
conflicts of interest between the Adviser's fiduciary obligations to the Fund
and their similar

fiduciary obligations to other clients so that, for example, investment
opportunities are allocated in a fair and equitable manner among the Fund and
such other clients. An investment opportunity that is suitable for multiple
clients of the Adviser and its affiliates may not be capable of being shared
among some or all of such clients due to the limited scale of the opportunity or
other factors, including regulatory restrictions imposed by the 1940 Act. There
can be no assurance that the Adviser's or its affiliates' efforts to allocate
any particular investment opportunity fairly among all clients for whom such
opportunity is appropriate will result in an allocation of all or part of such
opportunity to the Fund. Not all conflicts of interest can be expected to be
resolved in favor of the Fund.

The Adviser expects to apply to the SEC for exemptive relief to enable
the Fund and registered investment companies advised by the Adviser to co-invest
with other accounts and funds managed by the Adviser and its affiliates in
certain privately-placed securities and other situations. There are no
assurances that the Adviser will receive the requested relief. If such relief is
not obtained and until it is obtained, the Adviser may be required to allocate
some investments solely to any of the Fund, a registered fund, or another
account or fund advised by the Adviser or its affiliates. This restriction could
preclude the Fund from investing in certain securities it would otherwise be
interested in and could adversely affect the speed at which the Fund is able to
invest its assets and, consequently, the performance of the Fund.

(A)(3) COMPENSATION STRUCTURE OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM
MEMBERS

Highland's financial arrangements with its portfolio managers, its
competitive compensation and its career path emphasis at all levels reflect the
value senior management places on key resources. Compensation may include a
variety of components and may vary from year to year based on a number of
factors including the relative performance of a portfolio managers underlying
account, the combined performance of the portfolio managers underlying accounts,
and the relative performance of the portfolio managers underlying accounts
measured against other employees. The principal components of compensation
include a base salary, a discretionary bonus, various retirement benefits and
one or more of the incentive compensation programs established by Highland such
as the Option It Plan and the Long-Term Incentive Plan.

BASE COMPENSATION. Generally, portfolio managers receive base
compensation based on their seniority and/or their position with the firm, which
may include the amount of assets supervised and other management roles within
the firm.

DISCRETIONARY COMPENSATION. In addition to base compensation, portfolio
managers may receive discretionary compensation, which can be a substantial
portion of total compensation. Discretionary compensation can include a
discretionary cash bonus as well as one or more of the following:

OPTION IT PLAN. The purpose of the Plan is to attract and
retain the highest quality employees for positions of
substantial responsibility, and to provide additional
incentives to a select group of management or highly
compensated employees of the Fund so as to promote the success
of the Fund.

LONG TERM INCENTIVE PLAN. The purpose of the Plan is to create
positive morale and teamwork, to attract and retain key
talent, and to encourage the achievement of common goals. The
Plan seeks to reward participating employees based on the
increased value of Highland through the use of Long-term
Incentive Units.

Senior portfolio managers who perform additional management functions
may receive additional compensation in these other capacities.
Compensation is structured such that key professionals benefit from
remaining with the firm.

(A)(4) DISCLOSURE OF SECURITIES OWNERSHIP

The following table sets forth the dollar range of equity securities
beneficially owned by each portfolio manager in the Fund as of August 31, 2007.

- ------------------------------------------------------------------------------------------
Dollar Ranges of Equity Securities Beneficially Owned
Name of Portfolio Manager by Portfolio Manager
- ------------------------------------------------------------------------------------------

R. Joseph Dougherty $10,001 - $50,000
- ------------------------------------------------------------------------------------------
Mark Okada $10,001 - $50,000
- ------------------------------------------------------------------------------------------

(B) NOT APPLICABLE.

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.

There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors.

ITEM 11. CONTROLS AND PROCEDURES.

(a) The registrant's principal executive and principal financial officers,
or persons performing similar functions, have concluded that the
registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the
"1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date within
90 days of the filing date of the report that includes the disclosure
required by this paragraph, based on their evaluation of these
controls and procedures required by Rule 30a-3(b) under the 1940 Act
(17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the
Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or
240.15d-15(b)).

(b) There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act
(17 CFR 270.30a-3(d)) that occurred during the registrant's second
fiscal quarter 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.

(a)(1) Not applicable.

(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.

(a)(3) Not applicable.

(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and
Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto.

SIGNATURES

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.

(Registrant) Highland Floating Rate Fund
--------------------------------------------------------------------

By (Signature and Title)* /s/ James D. Dondero
-------------------------------------------------------
James D. Dondero, Chief Executive Officer
(principal executive officer)

Date October 31, 2007
----------------------------------------------------------------------------

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 (Signature and Title)* /s/ James D. Dondero
-------------------------------------------------------
James D. Dondero, Chief Executive Officer
(principal executive officer)

Date October 31, 2007
----------------------------------------------------------------------------

By (Signature and Title)* /s/ M. Jason Blackburn
-------------------------------------------------------
M. Jason Blackburn, Chief Financial Officer
(principal financial officer)

Date October 31, 2007
----------------------------------------------------------------------------

* Print the name and title of each signing officer under his or her signature.