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: 811-06052
Morgan Stanley Municipal Income Opportunities Trust III
(Exact name of registrant as specified in charter)
522 Fifth Avenue, New York, New York 10036
(Address of principal executive offices) (Zip code)
Ronald E. Robison
522 Fifth Avenue, New York, New York 10036
(Name and address of agent for service)
Registrant's telephone number, including area code: 212-296-6990
Date of fiscal year end: March 31, 2008
Date of reporting period: September 30, 2007
Item 1 - Report to Shareholders
Welcome, Shareholder:
In this report, you'll learn about how your investment in Morgan Stanley
Municipal Income Opportunities Trust III performed during the semiannual period.
We will provide an overview of the market conditions, and discuss some of the
factors that affected performance during the reporting period. In addition, this
report includes the Fund's financial statements and a list of Fund investments.
MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE
IS NO ASSURANCE THAT THE FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE FUND IS
SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF
SECURITIES OWNED BY THE FUND WILL DECLINE AND, THEREFORE, THE VALUE OF THE
FUND'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE
MONEY INVESTING IN THIS FUND.
INCOME EARNED BY CERTAIN SECURITIES IN THE PORTFOLIO MAY BE SUBJECT TO THE
FEDERAL ALTERNATIVE MINIMUM TAX (AMT).
FUND REPORT
For the six months ended September 30, 2007
MARKET CONDITIONS
Strong fundamental and technical factors supported the municipal bond market
throughout the first three months of the reporting period, helping it to
outperform Treasuries. In July of this year, however, contagion from the
troubled subprime mortgage market led to an increasingly illiquid and volatile
market and a flight to quality that led Treasury bonds to outperform all other
sectors of the fixed income market, including both investment grade and below
investment grade municipal bonds.
Until that time, demand for municipal bonds had been quite strong as
institutional investors and non-traditional buyers such as hedge funds and
arbitrage investors continued to flock to the market. Given the low prevailing
interest rates, demand for higher-yielding municipal bonds was particularly
robust, which served to keep credit spreads tight. As market liquidity began to
dry up, however, institutional demand fell off and refunding activity, which had
been high, virtually halted. Although the supply of municipal bonds was
declining as well, the decrease in demand put significant pressure on prices at
the same time that the Treasury market was rallying. As a result, credit spreads
widened, with the most significant widening occurring in the lower-rated
segments of the market, where spreads on municipal bonds rated BBB and below
(including non-rated bonds) widened by 40 to 50 basis points.
In mid-September, following the 50 basis point reduction in the target federal
funds rate by the Federal Open Market Committee (the "Fed"), the market began to
stabilize, liquidity improved, and municipal credit spreads began to tighten
again. Despite these improvements, however, municipal bonds underperformed
Treasuries for the overall reporting period. The 30-year municipal-to-Treasury
ratio, which measures the relative attractiveness of these two sectors, rose
from 85 percent to 92 percent by the end of the period, indicating that
municipals underperformed Treasuries while at the same time becoming cheaper
(more attractive) on a relative basis.
Overall, municipal bond yields ended the period higher, but most of the yield
increases occurred in the intermediate-to-long maturity portion of the yield
curve. Representative yields on 30-year AAA-rated municipal bonds rose from 4.12
percent at the start of the period to 4.44 percent by the end of September.
Short-term municipal bond yields, however, ended the period slightly lower with
yields on one-year bonds falling from 3.55 percent to 3.41 percent. Accordingly,
the spread between long-term and short-term yields, which began the period at 57
basis points, widened to 103 basis points by the end of the period, causing the
slope of the municipal yield curve to shift from relatively flat to fairly
steep.
PERFORMANCE ANALYSIS
For the six-month period ended September 30, 2007, the net asset value (NAV) of
Morgan Stanley Municipal Income Opportunities Trust III (OIC) decreased from
$10.08 to $9.60 per share. Based on this change, plus reinvestment of tax-free
dividends totaling $0.27 per share, the Fund's total NAV return was -2.11
percent. OIC's value on the New York Stock Exchange (NYSE) moved from $10.21 to
$9.89 per share during the same period. Based on this change, plus reinvestment
of dividends and distributions, the Fund's total market return was -0.43
percent. OIC's NYSE market price was at a 3.02 percent premium to its NAV.
During the fiscal period, the Fund purchased and retired 300 shares of common
stock at a weighted
2
average market discount of 5.31 percent. Past performance is no guarantee of
future results.
Monthly dividends for the fourth quarter of 2007, declared in September, were
unchanged at $0.045 per share. The dividend reflects the current level of the
Fund's net investment income. OIC's level of undistributed net investment income
was $0.084 per share on September 30, 2007 versus $0.097 per share six months
earlier.(1)
Our anticipation of higher interest rates led us to maintain the Fund's lower
option-adjusted duration* through June. In July and August we began to gradually
lengthen the duration to a more neutral stance. This defensive interest-rate
positioning was additive to performance for the overall period as interest rates
generally rose.
The Fund invests primarily in higher yielding municipal bonds. During the
period, we slightly increased the Fund's exposure to these below investment
grade and non-rated issues, which represented more than three-fourths of assets
by period end. This credit quality profile had a positive impact on performance
for the first half of the period as the lower rated segment of the market,
boosted by strong demand and a limited supply, outperformed the investment grade
sector. In the last half of the period, however, the performance of lower rated
bonds waned and the sector underperformed higher quality securities.
Another boost to the Fund's performance was its pre-refunded holdings,
representing over 7 percent of net assets. These securities benefited from their
short maturities in that they did not experience the sell off that longer
maturity bonds did when yields rose on the long end of the curve. Conversely,
the Fund's exposure to the single family housing and tobacco sectors detracted
from overall performance. Spreads in these sectors widened considerably during
the period, dampening their performance.
Overall, the Fund's investments remained well-diversified across a broad range
of sectors. As of the end of the period, life care, hospital, and tax allocation
represented the Fund's largest sector weightings.
OIC's procedure for reinvesting all dividends and distributions in common shares
is through purchases in the open market. This method helps support the market
value of the Fund's shares. In addition, we would like to remind you that the
Trustees have approved a procedure whereby the Fund may, when appropriate,
purchase shares in the open market or in privately negotiated transactions at a
price not above market value or net asset value, whichever is lower at the time
of purchase.
- ----------------------------------------------------
PERFORMANCE DATA QUOTED REPRESENTS PAST PERFORMANCE, WHICH IS NO GUARANTEE OF
FUTURE RESULTS, AND CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THE FIGURES
SHOWN. INVESTMENT RETURN, NET ASSET VALUE AND COMMON SHARE MARKET PRICE WILL
FLUCTUATE AND FUND SHARES, WHEN SOLD, MAY BE WORTH MORE OR LESS THAN THEIR
ORIGINAL COST.
There is no guarantee that any sectors mentioned will continue to perform as
discussed herein or that securities in such sectors will be held by the Fund in
the future.
(1) Income earned by certain securities in the portfolio may be subject to the
federal alternative minimum tax (AMT).
* A measure of the sensitivity of a bond's price to changes in interest rates,
expressed in years. Each year of duration represents an expected 1 percent
change in the price of a bond for every 1 percent change in interest rates. The
longer a bond's duration, the greater the effect of interest-rate movements on
its price. Typically, funds with shorter durations perform better in
rising-interest-rate environments, while funds with longer durations perform
better when rates decline.
3
<Table>
<Caption>
TOP FIVE SECTORS
Retirement & Life Care Facilities 29.7%
Hospital 17.3
Special Tax Districts 12.3
IDR/PCR* 9.5
Education Facilities 7.6
</Table>
<Table>
<Caption>
LONG-TERM CREDIT ANALYSIS
Aaa/AAA 1.7%
Aa/AA 1.7
Baa/BBB 18.3
Ba/BB or Less 9.4
NR 68.9
</Table>
* Industrial Development/Pollution Control Revenue
Data as of September 30, 2007. Subject to change daily. All percentages for top
five sectors are as a percentage of net assets and all percentages for long-term
credit analysis are as a percentage of total long-term investments. These data
are provided for informational purposes only and should not be deemed a
recommendation to buy or sell the securities mentioned. Morgan Stanley is a
full-service securities firm engaged in securities trading and brokerage
activities, investment banking, research and analysis, financing and financial
advisory services.
FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS
EACH MORGAN STANLEY FUND PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN
ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE FUND'S SECOND
AND FOURTH FISCAL QUARTERS. THE SEMIANNUAL REPORTS AND THE ANNUAL REPORTS ARE
FILED ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC) ON FORM
N-CSRS AND FORM N-CSR, RESPECTIVELY. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL
AND ANNUAL REPORTS TO FUND SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS
PUBLIC WEB SITE, WWW.MORGANSTANLEY.COM. EACH MORGAN STANLEY FUND ALSO FILES A
COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS WITH THE SEC FOR THE FUND'S FIRST AND
THIRD FISCAL QUARTERS ON FORM N-Q. MORGAN STANLEY DOES NOT DELIVER THE REPORTS
FOR THE FIRST AND THIRD FISCAL QUARTERS TO SHAREHOLDERS, NOR ARE THE REPORTS
POSTED TO THE MORGAN STANLEY PUBLIC WEB SITE. YOU MAY, HOWEVER, OBTAIN THE FORM
N-Q FILINGS (AS WELL AS THE FORM N-CSR AND N-CSRS FILINGS) BY ACCESSING THE
SEC'S WEB SITE, HTTP://WWW.SEC.GOV. YOU MAY ALSO REVIEW AND COPY THEM AT THE
SEC'S PUBLIC REFERENCE ROOM IN WASHINGTON, DC. INFORMATION ON THE OPERATION OF
THE SEC'S PUBLIC REFERENCE ROOM MAY BE OBTAINED BY CALLING THE SEC AT (800)
SEC-0330. YOU CAN ALSO REQUEST COPIES OF THESE MATERIALS, UPON PAYMENT OF A
DUPLICATING FEE, BY ELECTRONIC REQUEST AT THE SEC'S E-MAIL ADDRESS
(PUBLICINFO@SEC.GOV) OR BY WRITING THE PUBLIC REFERENCE SECTION OF THE SEC,
WASHINGTON, DC 20549-0102.
4
DISTRIBUTION BY MATURITY
(% of Long-Term Portfolio) As of September 30, 2007
WEIGHTED AVERAGE MATURITY: 22 YEARS(A)
<Table>
0-5 10
6-10 3
11-15 5
16-20 16
21-25 26
26-30 32
31+ 8
</Table>
(a) Where applicable maturities reflect mandatory tenders, puts and call dates.
Portfolio structure is subject to change.
Summary of Investments by State Classification as of 9/30/07
<Table>
Florida............ 12.3% Tennessee.......... 2.7% Michigan......................................... 1.2%
California......... 9.9 Colorado........... 2.6 North Carolina................................... 1.2
Pennsylvania....... 9.3 Kansas............. 2.5 Georgia.......................................... 1.1
New Jersey......... 6.0 South Carolina..... 2.5 District of Columbia............................. 1.1
Virginia........... 4.8 Maryland........... 2.4 Ohio............................................. 0.9
Illinois........... 4.6 Nevada............. 2.4 Alaska........................................... 0.5
Missouri........... 4.0 Minnesota.......... 2.4 Washington....................................... 0.4
New York........... 3.9 Wyoming............ 1.9 North Dakota..................................... 0.3
-----
Massachusetts...... 3.6 Hawaii............. 1.8 Total Long-Term Investments(+)................... 103.6
Iowa............... 3.1 Oklahoma........... 1.3 Short-Term Investment............................ 0.6
Texas.............. 3.1 Arizona............ 1.3 Liability for Floating Rate Note Obligations..... (5.3)
Connecticut........ 3.0 Alabama............ 1.3 Other Assets in Excess of Liabilities............ 1.1
-----
Indiana............ 3.0 New Hampshire...... 1.2 Net Assets....................................... 100.0%
=====
</Table>
- -------------------
+ Does not include open futures contracts with an underlying face amount of
$3,451,656 with unrealized appreciation of $23,649.
5
5
CALL AND COST (BOOK) YIELD STRUCTURE
(Based on Long-Term Portfolio) As of September 30, 2007
YEARS BONDS CALLABLE -- WEIGHTED AVERAGE CALL PROTECTION: 6 YEARS
<Table>
2007(a) 1
2008 10
2009 10
2010 7
2011 8
2012 8
2013 9
2014 7
2015 7
2016 17
2017+ 16
</Table>
COST (BOOK) YIELD(B) -- WEIGHTED AVERAGE BOOK YIELD: 6.4%
<Table>
2007(a) 7.00
2008 6.60
2009 6.20
2010 7.30
2011 7.50
2012 6.50
2013 6.50
2014 6.20
2015 5.60
2016 6.00
2017+ 5.90
</Table>
(a) May include issues initially callable in previous years.
(b) Cost or "book" yield is the annual income earned on a portfolio investment
based on its original purchase price before the Fund's operating expenses.
For example, the Fund is earning a book yield of 7.0% on 1% of the
long-term portfolio that is callable in 2007.
Portfolio structure is subject to change.
6
INVESTMENT ADVISORY AGREEMENT APPROVAL
NATURE, EXTENT AND QUALITY OF SERVICES
The Board reviewed and considered the nature and extent of the investment
advisory services provided by the Investment Adviser under the Advisory
Agreement, including portfolio management, investment research and fixed income
securities trading. The Board also reviewed and considered the nature and extent
of the non-advisory, administrative services provided by the Fund's
Administrator under the Administration Agreement, including accounting,
clerical, bookkeeping, compliance, business management and planning, and the
provision of supplies, office space and utilities at the Investment Adviser's
expense. (The Investment Adviser and the Administrator together are referred to
as the "Adviser" and the Advisory and Administration Agreements together are
referred to as the "Management Agreement.") The Board also compared the nature
of the services provided by the Adviser with similar services provided by
non-affiliated advisers as reported to the Board by Lipper Inc. ("Lipper").
The Board reviewed and considered the qualifications of the portfolio managers,
the senior administrative managers and other key personnel of the Adviser who
provide the advisory and administrative services to the Fund. The Board
determined that the Adviser's portfolio managers and key personnel are well
qualified by education and/or training and experience to perform the services in
an efficient and professional manner. The Board concluded that the nature and
extent of the advisory and administrative services provided were necessary and
appropriate for the conduct of the business and investment activities of the
Fund. The Board also concluded that the overall quality of the advisory and
administrative services was satisfactory.
PERFORMANCE RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS
On a regular basis, the Board reviews the performance of all funds in the Morgan
Stanley Fund Complex, including the Fund, compared to their peers, paying
specific attention to the underperforming funds. In addition, the Board
specifically reviewed the Fund's performance for the one-, three- and five-year
periods ended November 30, 2006, as shown in a report provided by Lipper (the
"Lipper Report"), compared to the performance of comparable funds selected by
Lipper. The Board also discussed with the Adviser the performance goals and the
actual results achieved in managing the Fund. The Board concluded that the
Fund's performance was competitive with that of its performance peer group.
FEES RELATIVE TO OTHER PROPRIETARY FUNDS MANAGED BY THE ADVISER WITH COMPARABLE
INVESTMENT STRATEGIES
The Board reviewed the advisory and administrative fee (together, the
"management fee") rate paid by the Fund under the Management Agreement. The
Board noted that the management fee rate was comparable to
7
the management fee rates charged by the Adviser to other proprietary funds it
manages with investment strategies comparable to those of the Fund.
FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS
The Board reviewed the management fee rate and total expense ratio of the Fund
as compared to the average management fee rate and average total expense ratio
for funds, selected by Lipper (the "expense peer group"), managed by other
advisers with investment strategies comparable to those of the Fund, as shown in
the Lipper Report. The Board concluded that the Fund's management fee rate and
total expense ratio were competitive with those of its expense peer group.
BREAKPOINTS AND ECONOMIES OF SCALE
The Board reviewed the structure of the Fund's management fee schedule under the
Management Agreement and noted that it does not include any breakpoints. The
Board considered that the Fund is a closed-end fund and, therefore, that the
Fund's assets are not likely to grow with new sales or grow significantly as a
result of capital appreciation. The Board concluded that economies of scale for
the Fund were not a factor that needed to be considered at the present time.
PROFITABILITY OF THE ADVISER AND AFFILIATES
The Board considered information concerning the costs incurred and profits
realized by the Adviser and affiliates during the last year from their
relationship with the Fund and during the last two years from their relationship
with the Morgan Stanley Fund Complex and reviewed with the Adviser the cost
allocation methodology used to determine the profitability of the Adviser and
affiliates. Based on its review of the information it received, the Board
concluded that the profits earned by the Adviser and affiliates were not
excessive in light of the advisory, administrative and other services provided
to the Fund.
FALL-OUT BENEFITS
The Board considered so-called "fall-out benefits" derived by the Adviser and
affiliates from their relationship with the Fund and the Morgan Stanley Fund
Complex, such as commissions on the purchase and sale of Fund shares and "float"
benefits derived from handling of checks for purchases and sales of Fund shares,
through a broker-dealer affiliate of the Adviser. The Board concluded that the
commissions were competitive with those of other broker-dealers and the float
benefits were relatively small.
8
SOFT DOLLAR BENEFITS
The Board considered whether the Adviser realizes any benefits from commissions
paid to brokers who execute securities transactions for the Fund ("soft
dollars"). The Board noted that the Fund invests only in fixed income
securities, which do not generate soft dollars.
ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE FUND'S NEEDS
The Board considered whether the Adviser is financially sound and has the
resources necessary to perform its obligations under the Management Agreement.
The Board concluded that the Adviser has the financial resources necessary to
fulfill its obligations under the Management Agreement.
HISTORICAL RELATIONSHIP BETWEEN THE FUND AND THE ADVISER
The Board also reviewed and considered the historical relationship between the
Fund and the Adviser, including the organizational structure of the Adviser, the
policies and procedures formulated and adopted by the Adviser for managing the
Fund's operations and the Board's confidence in the competence and integrity of
the senior managers and key personnel of the Adviser. The Board concluded that
it is beneficial for the Fund to continue its relationship with the Adviser.
OTHER FACTORS AND CURRENT TRENDS
The Board considered the controls and procedures adopted and implemented by the
Adviser and monitored by the Fund's Chief Compliance Officer and concluded that
the conduct of business by the Adviser indicates a good faith effort on its part
to adhere to high ethical standards in the conduct of the Fund's business.
GENERAL CONCLUSION
On April 25, 2007, after considering and weighing all of the above factors, the
Board concluded that it would be in the best interest of the Fund and its
shareholders to approve renewal of the Management Agreement for another year
until April 30, 2008. On June 20, 2007, the Board again considered and weighed
all of the above factors and concluded that it would be in the best interest of
the Fund and its shareholders to approve renewal of the Management Agreement to
continue until June 30, 2008.
9
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2007 (UNAUDITED)
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Tax-Exempt Municipal Bonds (103.6%)
Alabama (1.3%)
$ 1,000 Colbert County - Northwest Health Care Authority, Alabama,
Helen Keller Hospital Ser 2003........................... 5.75% 06/01/27 $ 1,024,090
-----------
Alaska (0.5%)
500 Northern Tobacco Securitization Corporation, Alaska, Asset
Backed Ser 2006 A........................................ 5.00 06/01/46 417,025
-----------
Arizona (1.3%)
5 Maricopa County Industrial Development Authority, Arizona,
Ser 2000-1C (AMT)........................................ 6.25 12/01/30 5,104
1,000 Pima County Industrial Development Authority, Arizona, Noah
Webster Basic School Ser 2004 A.......................... 6.125 12/15/34 1,035,800
-----------
1,040,904
-----------
California (9.9%)
980 California County Tobacco Securitization Agency, Gold
County Settlement Funding Corp Ser 2006.................. 0.00 06/01/33 182,035
500 California Housing Finance Agency, RITES PA 1417 Ser 2006
(AMT).................................................... 6.54** 08/01/31 404,820
500 California Housing Finance Agency, RITES PA 1417 Ser 2006
(AMT).................................................... 6.74** 08/01/36 399,090
1,500 California Statewide Communities Development Authority,
Lancer Educational Student Housing LLC Ser 2007.......... 5.625 06/01/33 1,478,820
475 Carlsbad Community Facilities District #3, California, Ser
2006..................................................... 5.30 09/01/36 453,701
2,000 Golden State Tobacco Securitization Corporation,
California, Asset Backed Ser Refg 2007 A+................ 5.125 06/01/47 1,722,734
1,000 Sacramento Financing Authority, California, Convention
Center Hotel 1999 Ser A.................................. 6.25 01/01/30 1,007,490
1,300 San Diego County, California, San Diego Natural History
Museum COPs.............................................. 5.60 02/01/18 1,283,347
1,000 San Marcos Community Facilities District # 2002-01,
California, University Commons Ser 2004.................. 5.90 09/01/28 1,016,790
5,000 Silicon Valley Tobacco Securitization Authority,
California, Santa Clara Tobacco Securitization Corp Ser
2007 C................................................... 0.00 06/01/56 160,200
-----------
8,109,027
-----------
</Table>
10
See Notes to Financial Statements
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Colorado (2.6%)
$ 155 Colorado Housing Finance Authority, 1998 Ser B-2 (AMT)..... 7.25% 10/01/31 $ 165,410
1,000 Copperleaf Metropolitan District # 2, Colorado, Ser 2006... 5.95 12/01/36 947,700
500 Elk Valley Public Improvement Corporation, Colorado, Ser
2001 A................................................... 7.30 09/01/22 523,710
500 Elk Valley Public Improvement Corporation, Colorado, Ser
2001 A................................................... 7.35 09/01/31 521,730
-----------
2,158,550
-----------
Connecticut (3.0%)
1,000 Georgetown Special Taxing District, Connecticut, Ser 2006 A
(a)...................................................... 5.125 10/01/36 910,330
1,500 Mohegan Tribe of Indians, Connecticut, Gaming Authority
Ser 2001 (a)............................................. 6.25 01/01/31 1,570,665
-----------
2,480,995
-----------
District of Columbia (1.1%)
905 Metropolitan Washington Airports Authority, District of
Columbia & Virginia, CaterAir International Corp Ser 1991
(AMT)*................................................... 10.125 09/01/11 906,186
-----------
Florida (12.3%)
500 Alachua County Industrial Development, Florida, North
Florida Retirement Village Ser 2007...................... 5.875 11/15/36 506,240
495 Bellalago Educational Facilities Benefits District,
Florida, Bellalago Charter School Ser 2004 B............. 5.80 05/01/34 477,126
500 Fiddlers Creek Community Development District #1, Florida,
Ser 2005................................................. 6.00 05/01/38 497,535
250 Fountainbleau Lakes Community Development District,
Florida, Ser 2007 B...................................... 6.00 05/01/15 251,572
1,000 Grand Bay at Doral Community Development District, Florida,
Ser 2007 A............................................... 6.00 05/01/39 937,640
1,000 Midtown Miami Community Development District, Florida,
Parking Garage Ser 2004 A................................ 6.25 05/01/37 996,580
1,100 Orange County Health Facilities Authority, Florida, Orlando
Lutheran Towers Inc Ser 2005............................. 5.375 07/01/20 1,078,528
2,000 Orange County Health Facilities Authority, Florida,
Westminister Community Care Services Inc Ser 1999........ 6.75 04/01/34 2,056,460
1,000 Pinellas County Health Facilities Authority, Florida, Oaks
of Clearwater Ser 2004................................... 6.25 06/01/34 1,044,310
2,000 St Johns County Industrial Development Authority, Florida,
Glenmoor Ser 1999 A...................................... 8.00 01/01/10++ 2,222,960
-----------
10,068,951
-----------
Georgia (1.1%)
1,000 Medical Center Hospital Authority, Georgia, Spring Harbor
Green Island, Ser 2007................................... 5.25 07/01/27 933,490
-----------
</Table>
11
See Notes to Financial Statements
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Hawaii (1.8%)
$ 1,500 Hawaii Department of Budget & Finance, Wilcox Memorial
Hospital Ser 1998........................................ 5.50% 07/01/28 $ 1,512,255
-----------
Illinois (4.6%)
500 Bolingbrook, Illinois, Sales Tax Ser 2005.................. 0.00++ 01/01/24 506,690
240 Chicago, Illinois, GNMA-Collateralized Ser 1998 A-1
(AMT).................................................... 6.45 09/01/29 243,266
500 Chicago, Illinois, Lake Shore East Ser 2002................ 6.75 12/01/32 527,655
260 Hampshire Special Service Area #18, Illinois, Ser 2007 A... 6.00 03/01/44 257,514
1,000 Illinois Finance Authority, Friendship Village of
Schaumburg Ser 2005 A.................................... 5.625 02/15/37 949,090
750 Illinois Health Facilities Authority, Villa St Benedict Ser
2003 A-1................................................. 6.90 11/15/33 751,335
500 Pingree Grove Special Service Area # 7, Illinois, Cambridge
Lakes Ser 2006........................................... 6.00 03/01/36 492,930
-----------
3,728,480
-----------
Indiana (3.0%)
500 Indiana Health Facility Financing Authority, Riverview
Hospital Ser 2002........................................ 6.125 08/01/31 524,540
275 Saint Joseph County, Indiana, Holy Cross Village at Notre
Dame Ser 2006 A.......................................... 6.00 05/15/26 280,728
1,500 Upland, Indiana, Taylor University Ser 2002................ 6.25 09/01/28 1,629,105
-----------
2,434,373
-----------
Iowa (3.1%)
1,000 Iowa Finance Authority Senior Living Facility, Deerfield
Retirement Community Inc, Ser 2007 A..................... 5.50 11/15/37 932,590
935 Iowa Health Facilities Development Financing Authority,
Care Initiatives Ser 1996................................ 9.25 07/01/11++ 1,126,217
500 Washington County Hospital, Iowa, Ser 2006................. 5.375 07/01/26 487,560
-----------
2,546,367
-----------
Kansas (2.5%)
1,000 Olathe, Kansas, Catholic Care Ser 2006 A................... 6.00 11/15/38 1,007,600
1,000 Overland Park Development Corporation, Kansas, Convention
Center Hotel Ser 2000 A.................................. 7.375 01/01/32 1,057,520
-----------
2,065,120
-----------
</Table>
12
See Notes to Financial Statements
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Maryland (2.4%)
$ 500 Howard County, Maryland, Vantage House Ser 2007 B.......... 5.25% 04/01/37 $ 459,050
1,235 Maryland Industrial Development Financing Authority,
Medical Waste Associates LP 1989 Ser (AMT)............... 8.75 11/15/10 1,037,067
500 Maryland Health & Higher Educational Facilities Authority,
King Farm Presbyterian Community Ser 2007 A.............. 5.30 01/01/37 465,935
-----------
1,962,052
-----------
Massachusetts (3.6%)
935 Massachusetts Development Finance Agency, Kennedy-Donovan
Center Inc 1990 Issue.................................... 7.50 06/01/10 962,517
1,425 Massachusetts Development Finance Agency, Loomis
Communities Ser 1999 A................................... 5.625 07/01/15 1,464,130
500 Massachusetts Development Finance Authority, Evergreen
Center Ser 2005.......................................... 5.50 01/01/35 494,040
-----------
2,920,687
-----------
Michigan (1.2%)
1,000 Michigan Tobacco Settlement Finance Authority Ser 2007 A... 6.00 06/01/48 999,750
-----------
Minnesota (2.4%)
1,250 Aitkin, Minnesota, Riverwood Healthcare Center Ser 2006.... 5.60 02/01/32 1,227,100
500 Buffalo, Minnesota, Central Minnesota Senior Housing Ser
2006 A................................................... 5.50 09/01/33 475,175
250 North Oaks, Minnesota, Presbyterian Homes of North Oaks Ser
2007..................................................... 6.125 10/01/39 252,043
-----------
1,954,318
-----------
Missouri (4.0%)
1,000 Des Peres, Missouri, West County Center Ser 2002........... 5.75 04/15/20 1,011,310
1,000 Kansas City Industrial Development Authority, Missouri,
Bishop Spencer 2004 Ser I................................ 6.25 01/01/24 1,027,730
1,000 Kansas City Industrial Development Authority, Missouri,
Plaza Library Ser 2004................................... 5.90 03/01/24 989,180
250 St Louis County Industrial Development Authority, Missouri,
St Andrews Resources for Seniors Ser 2007 A.............. 6.375 12/01/41 252,205
-----------
3,280,425
-----------
</Table>
13
See Notes to Financial Statements
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Nevada (2.4%)
$ 500 Clark County Special Improvement District #142, Nevada,
Mountain's Edge Ser 2003................................. 6.375% 08/01/23 $ 516,270
500 Henderson, Nevada, Local Improvement District #T-18, Ser
2006..................................................... 5.30 09/01/35 451,275
1,000 Nevada Department of Business & Industry, Las Vegas
Monorail 2nd Tier Ser 2000............................... 7.375 01/01/40 988,190
-----------
1,955,735
-----------
New Hampshire (1.2%)
1,000 New Hampshire Higher Educational & Health Facilities
Authority, Littleton Hospital Association Ser 1998 A..... 6.00 05/01/28 1,008,270
-----------
New Jersey (6.0%)
1,000 New Jersey Economic Development Authority, Cedar Crest
Village Inc Ser 2001 A................................... 7.25 11/15/11++ 1,143,980
1,000 New Jersey Economic Development Authority, Franciscan Oaks
Ser 1997................................................. 5.70 10/01/17 1,012,710
1,000 New Jersey Economic Development Authority, Franciscan Oaks
Ser 1997................................................. 5.75 10/01/23 1,008,100
500 New Jersey Economic Development Authority, Lions Gate Ser
2005 A................................................... 5.875 01/01/37 502,730
1,000 New Jersey Health Care Facilities Financing Authority,
Raritan Bay Medical Center Ser 1994...................... 7.25 07/01/27 1,020,810
2,000 Tobacco Settlement Financing Corporation, New Jersey, Ser
2007-1B.................................................. 0.00 06/01/41 224,220
-----------
4,912,550
-----------
New York (3.9%)
1,000 Mount Vernon Industrial Development Agency, New York,
Meadowview at the Wartburg Ser 1999...................... 6.20 06/01/29 1,013,130
1,000 New York City Industrial Development Agency, New York, 7
World Trade Center LLC Ser 2005 A........................ 6.50 03/01/35 1,045,680
1,000 New York City Industrial Development Agency, New York,
American Airlines Inc Ser 2005 (AMT)..................... 7.75 08/01/31 1,143,810
-----------
3,202,620
-----------
North Carolina (1.2%)
1,000 North Carolina Medical Care Commission Healthcare
Facilities, Presbyterian Homes Ser 2006.................. 5.50 10/01/31 997,350
-----------
North Dakota (0.3%)
250 Ward County, North Dakota, Trinity Health Ser 2006......... 5.125 07/01/29 247,072
-----------
</Table>
14
See Notes to Financial Statements
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Ohio (0.9%)
$ 450 Cuyahoga County, Health Care & Independent Living
Facilities, Ohio, Eliza Jennings Senior Care Ser 2007
A........................................................ 5.75% 05/15/27 $ 443,718
300 Tuscarawas County Hospital Facilities, Ohio, The Twin City
Hospital Corporation Ser 2007............................ 6.35 11/01/37 301,530
-----------
745,248
-----------
Oklahoma (1.3%)
1,000 Oklahoma Development Finance Authority, Comanche County
Hospital 2000 Ser B...................................... 6.60 07/01/31 1,065,570
-----------
Pennsylvania (9.3%)
2,000 Allegheny County Development Authority, Pennsylvania, West
Penn Ser 2007 A+......................................... 5.375 11/15/40 1,933,870
500 Allegheny County Redevelopment Authority, Pennsylvania,
Pittsburgh Mills Ser 2004................................ 5.60 07/01/23 508,080
750 Bucks County Industrial Development Authority,
Pennsylvania, Ann's Choice Ser 2005 A.................... 6.25 01/01/35 762,705
425 Carbon County Industrial Development Authority,
Pennsylvania, Panther Creek Partners Refg 2000 Ser
(AMT).................................................... 6.65 05/01/10 441,414
1,000 Harrisburg Authority, Pennsylvania, Harrisburg University
of Science & Technology Ser 2007 B....................... 6.00 09/01/36 1,016,010
500 Montgomery County Industrial Development Authority,
Pennsylvania, Whitemarsh Community Ser 2005.............. 6.25 02/01/35 512,650
500 Pennsylvania Economic Development Financing Authority,
Reliant Energy Inc Ser 2001 A (AMT)...................... 6.75 12/01/36 543,720
880 Pennsylvania Housing Finance Agency, Ser 2006-96 A
(AMT)+................................................... 4.65 10/01/31 825,411
1,120 Pennsylvania Housing Finance Agency, Ser 2006-96 A
(AMT)+................................................... 4.70 10/01/37 1,050,524
-----------
7,594,384
-----------
South Carolina (2.5%)
1,100 South Carolina Jobs-Economic Development Authority,
Lutheran Homes, Ser 2007................................. 5.50 05/01/28 1,051,028
750 South Carolina Jobs-Economic Development Authority, Wesley
Commons Ser 2006......................................... 5.30 10/01/36 671,175
325 South Carolina Jobs-Economic Development Authority,
Woodlands at Furman Ser 2007 A........................... 6.00 11/15/37 325,000
-----------
2,047,203
-----------
</Table>
15
See Notes to Financial Statements
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Tennessee (2.7%)
$ 1,000 Chattanooga Health Educational & Housing Facilities Board,
Tennessee, Student Housing Refg Ser 2005 A***............ 5.00% 10/01/25 $ 957,070
500 Shelby County Health, Educational & Housing Facilities
Board, Tennessee, Trezevant Manor Ser 2006 A............. 5.75 09/01/37 500,665
750 Shelby County Health, Educational & Housing Facilities
Board, Tennessee, Village at Germantown Ser 2003 A....... 7.25 12/01/34 756,330
-----------
2,214,065
-----------
Texas (3.1%)
500 Austin Convention Enterprises Inc, Texas, Convention Center
Hotel Ser 2006 B......................................... 5.75 01/01/34 489,345
500 Decatur Hospital Authority, Texas, Wise Regional Health Ser
2004 A................................................... 7.125 09/01/34 535,635
500 HFDC Central Texas Inc, Legacy at Willow Bend, Ser 2006
A........................................................ 5.75 11/01/36 471,100
1,000 Lubbock, Health Facilities Development Corporation, Texas,
Carillon Ser 2005 A...................................... 6.50 07/01/26 1,029,710
-----------
2,525,790
-----------
Virginia (4.8%)
2,527 Chesterfield County Industrial Development Authority,
Virginia, Brandermill Woods Ser 1998..................... 6.50 01/01/28 2,620,721
1,000 Peninsula Ports Authority of Virginia, Baptist Homes Ser
2006 C................................................... 5.40 12/01/33 971,950
300 Peninsula Town Center Community Development Authority,
Virginia, Ser 2007....................................... 6.45 09/01/37 310,536
-----------
3,903,207
-----------
Washington (0.4%)
290 Washington Housing Finance Commission, FNMA Collateralized
Refg Ser 1990 A.......................................... 7.50 07/01/23 290,519
-----------
Wyoming (1.9%)
1,500 Teton County Hospital District, Wyoming, St John's Medical
Center Ser 2002.......................................... 6.75 12/01/27 1,573,815
-----------
Total Tax-Exempt Municipal Bonds (Cost $84,360,043)........................... 84,826,443
-----------
</Table>
<Table>
<Caption>
NUMBER OF
SHARES (000)
- ------------
Short-Term Investment (b) (0.6%)
Investment Company
505 Morgan Stanley Institutional Liquidity Tax-Exempt Portfolio - Institutional
Class
(Cost $504,592)........................................................... 504,592
-----------
Total Investments (Cost $84,864,635)........................................ 85,331,035
-----------
</Table>
16
See Notes to Financial Statements
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2007 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN
THOUSANDS VALUE
- -----------------------------------------------------------------------------------------------
Floating Rate Notes Related to Securities Held (-5.3%)
$(4,330) Notes with interest rates ranging from 3.88% to 3.96% at
September 30, 2007 and contractual maturities of
collateral ranging from 10/01/31 to 06/01/47 (see Note
1D)+++ (Cost $(4,330,000))................................ $(4,330,000)
-----------
Total Net Investments (Cost $80,534,635) (c) (d)............ 98.9% 81,001,035
Other Assets in Excess of Liabilities....................... 1.1 892,916
----- -----------
Net Assets.................................................. 100.0% $81,893,951
===== ===========
</Table>
- ---------------------
<Table>
AMT Alternative Minimum Tax.
COPs Certificates of Participation.
RITES Residual Interest Tax-Exempt Security.
WI Securities purchased on a when-issued basis.
* Joint exemption.
** Current coupon rate for inverse floating rate municipal
obligation (see Note 7). This rate resets periodically as
the auction rate on the related security changes. Positions
in inverse floating rate municipal obligations have a total
value of $803,910 which represents 1.0% of net assets.
*** A portion of this security has been physically segregated in
connection with open futures contracts in the amount of
$37,200.
++ Prerefunded to call date shown.
+ Underlying security related to inverse floater entered into
by the Fund (see Note 1D).
++ Security is a "step-up" bond where the coupon increases on a
predetermined future date.
+++ Floating rate note obligations related to securities held.
The interest rates shown reflect the rates in effect at
September 30, 2007.
(a) Resale is restricted to qualified institutional investors.
(b) See Note 3 to the financial statements regarding investments
in Morgan Stanley Institutional Liquidity Tax-Exempt
Portfolio -- Institutional Class.
(c) Securities have been designated as collateral in an amount
equal to $3,763,191 in connection with open futures
contracts and a purchase of a when-issued security.
(d) The aggregate cost for federal income tax purposes
approximates the aggregate cost for book purposes. The
aggregate gross unrealized appreciation is $2,672,189 and
the aggregate gross unrealized depreciation is $2,205,789,
resulting in net unrealized appreciation of $466,400.
</Table>
FUTURES CONTRACTS OPEN AT SEPTEMBER 30, 2007:
<Table>
<Caption>
NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE UNREALIZED
CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE APPRECIATION
- ------------------------------------------------------------------------------------------
31 Short U.S. Treasury Bonds 20
Year
December 2007 $(3,451,656) $23,649
=======
</Table>
17
See Notes to Financial Statements
Morgan Stanley Municipal Income Opportunities Trust III
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
September 30, 2007 (unaudited)
<Table>
Assets:
Investments in securities, at value (cost $84,360,043)...... $84,826,443
Investments in affiliate, at value (cost $504,592).......... 504,592
Receivable for:
Interest................................................ 1,333,927
Investments sold........................................ 25,000
Dividends from affiliate................................ 3,927
Prepaid expenses and other assets........................... 8,910
-----------
Total Assets............................................ 86,702,799
-----------
Liabilities:
Floating rate note obligations.............................. 4,330,000
Payable for:
Investments purchased................................... 325,000
Investment advisory fee................................. 33,485
Administration fee...................................... 5,376
Transfer agent fee...................................... 1,945
Accrued expenses and other payables......................... 113,042
-----------
Total Liabilities....................................... 4,808,848
-----------
Net Assets.............................................. $81,893,951
===========
Composition of Net Assets:
Paid-in-capital............................................. $81,399,383
Net unrealized appreciation................................. 490,049
Accumulated undistributed net investment income............. 719,565
Accumulated net realized loss............................... (715,046)
-----------
Net Assets.............................................. $81,893,951
===========
Net Asset Value Per Share,
8,532,557 shares outstanding (unlimited shares authorized of
$.01 par value)............................................. $9.60
===========
</Table>
18
See Notes to Financial Statements
Morgan Stanley Municipal Income Opportunities Trust III
FINANCIAL STATEMENTS continued
Statement of Operations
For the six months ended September 30, 2007 (unaudited)
<Table>
Net Investment Income:
Income
Interest.................................................... $ 2,594,525
Dividends from affiliate.................................... 13,365
-----------
Total Income............................................ 2,607,890
-----------
Expenses
Investment advisory fee..................................... 211,181
Interest and residual trust expenses........................ 76,521
Professional fees........................................... 34,932
Administration fee.......................................... 33,789
Shareholder reports and notices............................. 23,538
Listing fees................................................ 10,020
Transfer agent fees and expenses............................ 3,970
Trustees' fees and expenses................................. 3,865
Custodian fees.............................................. 2,875
Other....................................................... 11,243
-----------
Total Expenses.......................................... 411,934
Less: amounts waived/reimbursed............................. (240)
Less: expense offset........................................ (2,837)
-----------
Net Expenses............................................ 408,857
-----------
Net Investment Income................................... 2,199,033
-----------
Net Realized and Unrealized Gain (Loss):
Net Realized Loss on:
Investments................................................. (106,975)
Futures contracts........................................... (207,780)
Swap contract............................................... 86,923
-----------
Net Realized Loss....................................... (227,832)
-----------
Net Change in Unrealized Appreciation/Depreciation on:
Investments................................................. (3,791,760)
Futures contracts........................................... 18,651
Swap contract............................................... (9,804)
-----------
Net Change in Unrealized Appreciation/Depreciation...... (3,782,913)
-----------
Net Loss................................................ (4,010,745)
-----------
Net Decrease................................................ $(1,811,712)
===========
</Table>
19
See Notes to Financial Statements
Morgan Stanley Municipal Income Opportunities Trust III
FINANCIAL STATEMENTS continued
Statements of Changes in Net Assets
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
SEPTEMBER 30, 2007 MARCH 31, 2007
------------------ --------------
(unaudited)
Increase (Decrease) in Net Assets:
Operations:
Net investment income....................................... $ 2,199,033 $ 4,476,022
Net realized gain (loss).................................... (227,832) 856,527
Net change in unrealized appreciation/depreciation.......... (3,782,913) 2,005,686
----------- -----------
Net Increase (Decrease)................................. (1,811,712) 7,338,235
Dividends to shareholders from net investment income........ (2,303,824) (4,715,902)
Decrease from transactions in shares of beneficial
interest.................................................. (2,673) (407,092)
----------- -----------
Net Increase (Decrease)................................. (4,118,209) 2,215,241
Net Assets:
Beginning of period......................................... 86,012,160 83,796,919
----------- -----------
End of Period
(Including accumulated undistributed net investment income
of $719,565 and $824,356, respectively)..................... $81,893,951 $86,012,160
=========== ===========
</Table>
20
See Notes to Financial Statements
Morgan Stanley Municipal Income Opportunities Trust III
NOTES TO FINANCIAL STATEMENTS - SEPTEMBER 30, 2007 (UNAUDITED)
1. Organization and Accounting Policies
Morgan Stanley Municipal Income Opportunities Trust III (the "Fund"), is
registered under the Investment Company Act of 1940, as amended, as a
diversified, closed-end management investment company. The Fund's investment
objective is to provide a high level of current income which is exempt from
federal income tax. The Fund was organized as a Massachusetts business trust on
February 20, 1990 and commenced operations on April 30, 1990.
The following is a summary of significant accounting policies:
A. Valuation of Investments -- (1) portfolio securities are valued by an outside
independent pricing service approved by the Trustees. The pricing service uses
both a computerized grid matrix of tax-exempt securities and evaluations by its
staff, in each case based on information concerning market transactions and
quotations from dealers which reflect the mean between the last reported bid and
asked price. The portfolio securities are thus valued by reference to a
combination of transactions and quotations for the same or other securities
believed to be comparable in quality, coupon, maturity, type of issue, call
provisions, trading characteristics and other features deemed to be relevant.
The Trustees believe that timely and reliable market quotations are generally
not readily available for purposes of valuing tax-exempt securities and that the
valuations supplied by the pricing service are more likely to approximate the
fair value of such securities; (2) futures are valued at the latest sale price
on the commodities exchange on which they trade unless it is determined that
such price does not reflect their market value, in which case they will be
valued at their fair value as determined in good faith under procedures
established by and under the supervision of the Trustees; (3) interest rate
swaps are marked-to-market daily based upon quotations from market makers and
the change, if any, is recorded as unrealized appreciation or depreciation in
the Statement of Operations; (4) investments in open-end mutual funds, including
the Morgan Stanley Institutional Liquidity Funds, are valued at the net asset
value as of the close of each business day; and (5) short-term debt securities
having a maturity date of more than sixty days at time of purchase are valued on
a mark-to-market basis until sixty days prior to maturity and thereafter at
amortized cost based on their value on the 61st day. Short-term debt securities
having a maturity date of sixty days or less at the time of purchase are valued
at amortized cost.
B. Accounting for Investments -- Security transactions are accounted for on the
trade date (date the order to buy or sell is executed). Realized gains and
losses on security transactions are determined by the identified cost method.
Discounts are accreted and premiums are amortized over the life of the
respective securities and are included in interest income. Interest income is
accrued daily.
21
Morgan Stanley Municipal Income Opportunities Trust III
NOTES TO FINANCIAL STATEMENTS - SEPTEMBER 30, 2007 (UNAUDITED) continued
C. Futures Contracts -- A futures contract is an agreement between two parties
to buy and sell financial instruments or contracts based on financial indices at
a set price on a future date. Upon entering into such a contract, the Fund is
required to pledge to the broker cash, U.S. Government securities or other
liquid portfolio securities equal to the minimum initial margin requirements of
the applicable futures exchange. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in the value of the contract. Such receipts or payments known as
variation margin are recorded by the Fund as unrealized gains and losses. Upon
closing of the contract, the Fund realizes a gain or loss equal to the
difference between the value of the contract at the time it was opened and the
value at the time it was closed.
D. Floating Rate Note Obligations Related to Securities Held -- The Fund enters
into transactions in which it transfers to Dealer Trusts ("Dealer Trusts"),
fixed rate bonds in exchange for cash and residual interests in the Dealer
Trusts' assets and cash flows, which are in the form of inverse floating rate
investments. The Dealer Trusts fund the purchases of the fixed rate bonds by
issuing floating rate notes to third parties and allowing the Fund to retain
residual interest in the bonds. The Fund enters into shortfall agreements with
the Dealer Trusts which commit the Fund to pay the Dealer Trusts, in certain
circumstances, the difference between the liquidation value of the fixed rate
bonds held by the Dealer Trusts and the liquidation value of the floating rate
notes held by third parties, as well as any shortfalls in interest cash flows.
The residual interests held by the Fund (inverse floating rate investments)
include the right of the Fund (1) to cause the holders of the floating rate
notes to tender their notes at par at the next interest rate reset date, and (2)
to transfer the municipal bond from the Dealer Trusts to the Fund, thereby
collapsing the Dealer Trusts. The Fund accounts for the transfer of bonds to the
Dealer Trusts as secured borrowings, with the securities transferred remaining
in the Fund's investment assets, and the related floating rate notes reflected
as Fund liabilities under the caption "floating rate note obligations" on the
Statement of Assets and Liabilities. The Fund records the interest income from
the fixed rate bonds under the caption "Interest Income" and records the
expenses related to floating rate note obligations and any administrative
expenses of the Dealer Trusts under the caption "Interest and residual trust
expenses" in the Fund's Statement of Operations. The notes issued by the Dealer
Trusts have interest rates that reset weekly and the floating rate note holders
have the option to tender their notes to the Dealer Trusts for redemption at par
at each reset date. At September 30, 2007, Fund investments with a value of
$5,532,539 are held by the Dealer Trusts and serve as collateral for the
$4,330,000 in floating rate note obligations outstanding at that date.
Contractual maturities of the floating rate note obligations and interest rates
in effect at September 30, 2007 are presented in the Portfolio of Investments.
22
Morgan Stanley Municipal Income Opportunities Trust III
NOTES TO FINANCIAL STATEMENTS - SEPTEMBER 30, 2007 (UNAUDITED) continued
E. Interest Rate Swaps -- Interest rate swaps involve the exchange of
commitments to pay and receive interest based on a notional principal amount.
Net periodic interest payments to be received or paid are accrued daily and are
recorded as realized gains or losses in the Statement of Operations.
F. Federal Income Tax Policy -- It is the Fund's policy to comply with the
requirements of Subchapter M of the Internal Revenue Code applicable to
regulated investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no provision for federal income
taxes is required. The Fund files tax returns with the U.S. Internal Revenue
Service and various states. Generally, the tax authorities can examine all tax
returns filed for the last three years. If applicable, the Fund recognizes
interest accrued related to unrecognized tax benefits in interest expense and
penalties in other expenses in the Statement of Operations. The Fund adopted the
provisions of the Financial Accounting Standards Board's (FASB) Interpretation
number 48 Accounting for Uncertainty in Income Taxes, on June 30, 2007. As of
September 30, 2007, this did not result in an impact to the Fund's financial
statements.
G. Dividends and Distributions to Shareholders -- Dividends and distributions to
shareholders are recorded on the ex-dividend date.
H. Use of Estimates -- The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts and disclosures.
Actual results could differ from those estimates.
2. Investment Advisory/Administration Agreements
Pursuant to an Investment Advisory Agreement with Morgan Stanley Investment
Advisors Inc. (the "Investment Adviser") the Fund pays the Investment Adviser an
advisory fee, calculated weekly and payable monthly, by applying the annual rate
of 0.50% to the Fund's weekly net assets.
Pursuant to an Administration Agreement with Morgan Stanley Services Company
Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Fund
pays an administration fee, calculated weekly and payable monthly, by applying
the annual rate of 0.08% to the Fund's weekly net assets.
3. Security Transactions and Transactions with Affiliates
The Fund invests in Morgan Stanley Institutional Liquidity Tax-Exempt
Portfolio -- Institutional Class, an open-end management investment company
managed by the Investment Adviser. Investment advisory fees paid by the Fund are
reduced by an amount equal to the advisory and administrative services fees paid
by Morgan Stanley Institutional Liquidity Tax-Exempt Portfolio -- Institutional
Class
23
Morgan Stanley Municipal Income Opportunities Trust III
NOTES TO FINANCIAL STATEMENTS - SEPTEMBER 30, 2007 (UNAUDITED) continued
with respect to assets invested by the Fund in Morgan Stanley Institutional
Liquidity Tax-Exempt Portfolio -- Institutional Class. For the six months ended
September 30, 2007, advisory fees paid were reduced by $240 relating to the
Fund's investment in Morgan Stanley Institutional Liquidity Tax-Exempt
Portfolio -- Institutional Class. Income distributions earned by the Fund are
recorded as dividends from affiliate in the Statement of Operations and totaled
$13,365. During the six months ended September 30, 2007, cost of purchases and
sales in Morgan Stanley Institutional Liquidity Tax-Exempt
Portfolio -- Institutional Class were $9,179,218 and $8,674,626, respectively.
The cost of purchases and proceeds from sales of portfolio securities, excluding
short-term investments, for the six months ended September 30, 2007 aggregated
$13,906,749 and $10,207,073, respectively. Included in the aforementioned
transactions is a sale of $461,005 with another Morgan Stanley fund including a
net realized loss of $38,995.
Morgan Stanley Trust, an affiliate of the Investment Adviser and Administrator,
is the Fund's transfer agent. Effective September 28, 2007, the transfer agent
services previously provided to the Funds by Morgan Stanley Trust was assumed by
Computershare Trust Company, N.A. (the "Transfer Agent").
The Fund has an unfunded noncontributory defined benefit pension plan covering
certain independent Trustees of the Fund who will have served as independent
Trustees for at least five years at the time of retirement. Benefits under this
plan are based on factors which include years of service and compensation. The
Trustees voted to close the plan to new participants and eliminate the future
benefits growth due to increases to compensation after July 31, 2003. Aggregate
pension costs for the six months ended September 30, 2007, included in Trustees'
fees and expenses in the Statement of Operations amounted to $2,873. At
September 30, 2007, the Fund had an accrued pension liability of $59,408 which
is included in accrued expenses in the Statement of Assets and Liabilities.
The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan")
which allows each independent Trustee to defer payment of all, or a portion, of
the fees he or she receives for serving on the Board of Trustees. Each eligible
Trustee generally may elect to have the deferred amounts credited with a return
equal to the total return on one or more of the Morgan Stanley funds that are
offered as investment options under the Compensation Plan.
Appreciation/depreciation and distributions received from these investments are
recorded with an offsetting increase/decrease in the deferred compensation
obligation and do not affect the net asset value of the Fund.
24
Morgan Stanley Municipal Income Opportunities Trust III
NOTES TO FINANCIAL STATEMENTS - SEPTEMBER 30, 2007 (UNAUDITED) continued
4. Shares of Beneficial Interest
Transactions in shares of beneficial interest were as follows:
<Table>
<Caption>
CAPITAL
PAID IN
PAR VALUE EXCESS OF
SHARES OF SHARES PAR VALUE
--------- --------- -----------
Balance, March 31, 2006..................................... 8,575,757 $85,758 $81,723,390
Treasury shares purchased and retired (weighted average
discount 3.73%)*.......................................... (42,900) (429) (406,663)
--------- ------- -----------
Balance, March 31, 2007..................................... 8,532,857 85,329 81,316,727
Treasury shares purchased and retired (weighted average
discount 5.31%)*.......................................... (300) (3) (2,670)
--------- ------- -----------
Balance, September 30, 2007................................. 8,532,557 $85,326 $81,314,057
========= ======= ===========
</Table>
- ---------------------
* The Trustees have voted to retire the shares purchased.
5. Dividends
On September 25, 2007, the Fund declared the following dividends from net
investment income:
<Table>
<Caption>
AMOUNT RECORD PAYABLE
PER SHARE DATE DATE
- --------- ---------------- -----------------
$0.045 October 5, 2007 October 19, 2007
$0.045 November 9, 2007 November 23, 2007
$0.045 December 7, 2007 December 21, 2007
</Table>
6. Expense Offset
The expense offset represents a reduction of the fees and expenses for interest
earned on cash balances maintained by the Fund with the transfer agent and
custodian.
7. Purposes of and Risks Relating to Certain Financial Instruments
The Fund may invest a portion of its assets in inverse floating rate
instruments, either through outright purchases of inverse floating rate
securities or through the transfer of bonds to a Dealer Trust in exchange for
cash and residual interests in the Dealer Trust. These investments are typically
used by the Fund in seeking to enhance the yield of the portfolio. These
instruments typically involve greater risks than a fixed rate municipal bond. In
particular, these instruments are acquired through leverage or may have leverage
embedded in them and therefore involve many of the risks associated with
leverage. Leverage is a speculative technique that may expose the Fund to
greater risk and increased costs. Leverage may cause the Fund's net asset value
to be more volatile than if it had not been leveraged because leverage tends to
magnify the effect of any increases or decreases in the value of the Fund's
portfolio securities. The use of leverage may also cause the
25
Morgan Stanley Municipal Income Opportunities Trust III
NOTES TO FINANCIAL STATEMENTS - SEPTEMBER 30, 2007 (UNAUDITED) continued
Fund to liquidate portfolio positions when it may not be advantageous to do so
in order to satisfy its obligations with respect to inverse floating rate
instruments.
To hedge against adverse interest rate changes, the Fund may invest in financial
futures contracts or municipal bond index futures contracts ("futures
contracts").
These futures contracts involve elements of market risk in excess of the amount
reflected in the Statement of Assets and Liabilities. The Fund bears the risk of
an unfavorable change in the value of the underlying securities. Risks may also
arise upon entering into these contracts from the potential inability of the
counterparties to meet the terms of their contracts.
The Fund may enter into interest rate swaps and may purchase or sell interest
rate caps, floors and collars. The Fund expects to enter into these transactions
primarily to manage interest rate risk, hedge portfolio positions and preserve a
return or spread on a particular investment or portion of its portfolio. The
Fund may also enter into these transactions to protect against any increase in
the price of securities the Fund anticipates purchasing at a later date.
Interest rate swap transactions are subject to market risk, risk of default by
the other party to the transaction, risk of imperfect correlation and manager
risk. Such risks may exceed the related amounts shown in the Statement of Assets
and Liabilities.
8. Federal Income Tax Status
The amount of dividends and distributions from net investment income and net
realized capital gains are determined in accordance with federal income tax
regulations which may differ from generally accepted accounting principles.
These "book/tax" differences are either considered temporary or permanent in
nature. To the extent these differences are permanent in nature, such amounts
are reclassified within the capital accounts based on their federal tax-basis
treatment; temporary differences do not require reclassification. Dividends and
distributions which exceed net investment income and net realized capital gains
for tax purposes are reported as distributions of paid-in-capital.
As of March 31, 2007, the Fund had a net capital loss carryforward of $482,196
which will expire on March 31, 2013 to offset future capital gains to the extent
provided by regulations.
As of March 31, 2007, the Fund had temporary book/tax differences primarily
attributable to book amortization of discounts on debt securities and
mark-to-market of open futures contracts.
9. Accounting Pronouncement
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.
26
Morgan Stanley Municipal Income Opportunities Trust III
NOTES TO FINANCIAL STATEMENTS - SEPTEMBER 30, 2007 (UNAUDITED) continued
SFAS 157 defines fair value, establishes a framework for measuring fair value
and expands disclosures about fair value measurements. Management is currently
evaluating the impact the adoption of SFAS 157 will have on the Fund's financial
statement disclosures.
27
Morgan Stanley Municipal Income Opportunities Trust III
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED MARCH 31,
MONTHS ENDED -----------------------------------------------
SEPTEMBER 30, 2007 2007 2006 2005 2004 2003
------------------ ------- ------- ------- ------- -------
(unaudited)
Selected Per Share Data:
Net asset value, beginning of period........ $10.08 $ 9.77 $9.51 $9.39 $9.33 $9.32
------ ------ ----- ----- ----- -----
Income (loss) from investment operations:
Net investment income*.................. 0.26 0.52 0.55 0.53 0.52 0.56
Net realized and unrealized gain
(loss).................................. (0.47) 0.34 0.22 0.10 0.09 0.01
------ ------ ----- ----- ----- -----
Total income (loss) from investment
operations................................. (0.21) 0.86 0.77 0.63 0.61 0.57
------ ------ ----- ----- ----- -----
Less dividends from net investment income... (0.27) (0.55) (0.53) (0.53) (0.56) (0.57)
------ ------ ----- ----- ----- -----
Anti-dilutive effect of acquiring treasury
shares*.................................... 0.00(5) 0.00(5) 0.02 0.02 0.01 0.01
------ ------ ----- ----- ----- -----
Net asset value, end of period.............. $ 9.60 $10.08 $9.77 $9.51 $9.39 $9.33
====== ====== ===== ===== ===== =====
Market value, end of period................. $ 9.89 $10.21 $9.60 $8.27 $8.92 $8.63
====== ====== ===== ===== ===== =====
Total Return+............................... (0.43)%(1) 12.42% 22.84% (1.27)% 10.00% 5.58%
Ratios to Average Net Assets:
Total expenses (before expense offset)...... 0.97 %(2)(3)(4) 0.82%(4) 0.79%(4) 0.93%(4) 1.02%(4) 0.98%(4)
Total expenses (before expense offset,
exclusive of interest and residual trust
expenses).................................. 0.79 %(2)(3)(4) 0.79%(4) 0.79%(4) 0.93%(4) 1.02%(4) 0.98%(4)
Net investment income....................... 5.21 %(2)(3) 5.25% 5.74% 5.68% 5.59% 5.96%
Supplemental Data:
Net assets, end of period, in thousands..... $81,894 $86,012 $83,797 $84,380 $85,549 $86,567
Portfolio turnover rate..................... 12 %(1) 28% 20% 17% 12% 8%
</Table>
- ---------------------
<Table>
* The per share amounts were computed using an average number
of shares outstanding during the period.
+ Total return is based upon the current market value on the
last day of each period reported. Dividends and
distributions are assumed to be reinvested at the prices
obtained under the Fund's dividend reinvestment plan. Total
return does not reflect brokerage commissions.
(1) Not annualized.
(2) Annualized.
(3) Reflects waivers of certain Fund expenses in connection with
the investments in Morgan Stanley Institutional Liquidity
Tax-Exempt Portfolio -- Institutional Class during the
period. As a result of such waivers the expenses as a
percentage of its net assets had an effect of less than
0.005%.
(4) Does not reflect the effect of expense offset of 0.01%.
(5) Includes anti-dilutive effect of acquiring treasury shares
of less than $0.01.
</Table>
28
See Notes to Financial Statements
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO MANAGEMENT/REVISED INVESTMENT POLICY (UNAUDITED)
Portfolio Management
As of the date of this report, the Fund is managed within the Morgan Stanley
Municipals team. The team consists of portfolio managers and analysts. Current
members of the team jointly and primarily responsible for the day-to-day
management of the Fund's portfolio are Wayne Godlin, a Managing Director of the
Investment Adviser, Gerard J. Lian, an Executive Director of the Investment
Adviser, and Robert Stryker, a Vice President of the Investment Adviser.
Mr. Godlin has been associated with the Investment Adviser in an investment
management capacity since July 2001 and began managing the Fund in October 2001.
Mr. Lian has been associated with the Investment Adviser in an investment
management capacity since December 1991 and began managing the Fund in May 2003.
Mr. Stryker has been associated with the Investment Adviser in an investment
management capacity since February 1994 and began managing the Fund in September
2007.
The composition of the team may change from time to time.
Revised Investment Policy
To the extent permitted by applicable law and the Fund's investment objectives,
policies, and restrictions, the Fund may invest all or some of its short-term
cash investments in any money market fund advised or managed by the Investment
Adviser or its affiliates. In connection with any such investments, the Fund, to
the extent permitted by the Investment Company Act, will pay its share of all
expenses (other than advisory and administrative fees) of a money market fund in
which it invests which may result in the Fund bearing some additional expenses.
29
(This Page Intentionally Left Blank)
(This Page Intentionally Left Blank)
TRUSTEES
Frank L. Bowman
Michael Bozic
Kathleen A. Dennis
James F. Higgins
Dr. Manuel H. Johnson
Joseph J. Kearns
Michael F. Klein
Michael E. Nugent
W. Allen Reed
Fergus Reid
OFFICERS
Michael E. Nugent
Chairperson of the Board
Ronald E. Robison
President and Principal Executive Officer
J. David Germany
Vice President
Dennis F. Shea
Vice President
Amy R. Doberman
Vice President
Carsten Otto
Chief Compliance Officer
Stefanie V. Chang Yu
Vice President
Francis J. Smith
Treasurer and Chief Financial Officer
Mary E. Mullin
Secretary
TRANSFER AGENT
Computershare Trust Company, N.A.
P.O. Box 43078
Providence, RI 02940-3078
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
Two World Financial Center
New York, New York 10281
LEGAL COUNSEL
Clifford Chance US LLP
31 West 52nd Street
New York, New York 10019
COUNSEL TO THE INDEPENDENT TRUSTEES
Kramer Levin Naftalis & Frankel LLP
1177 Avenue of the Americas
New York, New York 10036
INVESTMENT ADVISER
Morgan Stanley Investment Advisors Inc.
522 Fifth Avenue
New York, New York 10036
The financial statements included herein have been taken from the records of the
Fund without examination by the independent auditors and accordingly they do not
express an opinion thereon.
(c) 2007 Morgan Stanley
[MORGAN STANLEY LOGO]
MORGAN STANLEY FUNDS
Morgan Stanley
Municipal Income Opportunities Trust III
Semiannual Report
September 30, 2007
[MORGAN STANLEY LOGO]
OICSAN
IU07-04803P-Y09/07
Item 2. Code of Ethics.
Not applicable for semiannual reports.
Item 3. Audit Committee Financial Expert.
Not applicable for semiannual reports.
Item 4. Principal Accountant Fees and Services
Not applicable for semiannual reports.
Item 5. Audit Committee of Listed Registrants.
Not applicable for semiannual reports.
Item 6.
Refer to Item 1.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies.
Not applicable for semiannual reports.
Item 8. Portfolio Managers of Closed-End Management Investment Companies
Applicable only to reports covering periods ending on or after December 31,
2005.
Item 9. Closed-End Fund Repurchases
REGISTRANT PURCHASE OF EQUITY SECURITIES
(c) Total (d) Maximum
Number of Number (or
Shares (or Approximate
Units) Dollar Value)
Purchased as of Shares (or
(a) Total Part of Units) that May
Number of Publicly Yet Be
Shares (or (b) Average Announced Purchased
Units) Price Paid per Plans or Under the Plans
Period Purchased Share (or Unit) Programs or Programs
- ------ ---------- --------------- ------------ ---------------
March 1, 2007 -
March 31, 2007 -- -- N/A N/A
April 1, 2007 -
April 30, 2007 -- -- N/A N/A
May 1, 2007 -
May 31, 2007 -- -- N/A N/A
June 1, 2007
- - June 30, 2007 -- -- N/A N/A
July 1, 2007
- -July 31, 2007 -- -- N/A N/A
August 1, 2007
- - August 31, 2007 300 $8.9100 N/A N/A
--- ------- --- ---
Total 300 $8.9100 N/A N/A
=== ======= === ===
Item 10. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 11. Controls and Procedures
(a) The Fund's principal executive officer and principal financial officer have
concluded that the Fund's disclosure controls and procedures are sufficient to
ensure that information required to be disclosed by the Fund in this Form N-CSR
was recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, based
upon such officers' evaluation of these controls and procedures as of a date
within 90 days of the filing date of the report.
2
(b) There were no changes in the registrant's internal control over financial
reporting that occurred during the 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) Code of Ethics - Not applicable for semiannual reports.
(b) A separate certification for each principal executive officer and principal
financial officer of the registrant are attached hereto as part of EX-99.CERT.
3
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.
Morgan Stanley Municipal Income Opportunities Trust III
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
November 20, 2007
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed by the following
persons on behalf of the registrant and in the capacities and on the dates
indicated.
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
November 20, 2007
/s/ Francis Smith
Francis Smith
Principal Financial Officer
November 20, 2007
4