<Page>
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: 811-05654
Morgan Stanley Quality Income Trust
(Exact name of registrant as specified in charter)
1221 Avenue of the Americas, New York, New York 10020
(Address of principal executive offices) (Zip code)
Ronald E. Robison
1221 Avenue of the Americas, New York, New York 10020
(Name and address of agent for service)
Registrant's telephone number, including area code: 212-762-4000
Date of fiscal year end: August 31, 2003
Date of reporting period: August 31, 2003
Item 1 - Report to Shareholders
<Page>
Welcome, Shareholder:
In this report, you'll learn about how your investment in Morgan Stanley Quality
Income Trust performed during the annual 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.
This material must be preceded or accompanied by a prospectus for the Fund being
offered. 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 the market
values of securities owned by the Fund will decline and, therefore, the value of
the Fund shares may be less than what you paid for them. Accordingly, you can
lose money investing in this Fund.
<Page>
Fund Report
For the year ended August 31, 2003
AVERAGE ANNUAL TOTAL RETURN FOR THE 12 MONTHS ENDED AUGUST 31, 2003
<Table>
<Caption>
LEHMAN BROTHERS LIPPER
INTERMEDIATE INTERMEDIATE
U.S. GOVERNMENT/ INVESTMENT
CREDIT GRADE DEBT
CLASS A CLASS B CLASS C CLASS D INDEX(1) FUNDS INDEX(2)
2.17% 1.63% 1.74% 2.39% 5.25% 5.38%
</Table>
THE PERFORMANCE OF THE FUND'S FOUR SHARE CLASSES VARIES BECAUSE EACH HAS
DIFFERENT EXPENSES. THE TOTAL RETURN FIGURES SHOWN ASSUME THE REINVESTMENT OF
ALL DISTRIBUTIONS, BUT DO NO REFLECT THE DEDUCTION OF ANY APPLICABLE SALES
CHARGES. IF SALES CHARGES WERE INCLUDED, RETURNS WOULD BE LOWER. PAST
PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. SEE PERFORMANCE SUMMARY FOR
STANDARDIZED PERFORMANCE INFORMATION.
MARKET CONDITIONS
The 12-month period ended August 31, 2003, was a remarkable period for the
fixed-income markets. Driven by a combination of accommodative Federal Reserve
Bank policy and volatile equity markets, bonds enjoyed a rally that took
interest rates across the curve to record or near-record lows. Some segments of
the yield curve reached levels not seen in more than four decades.
The bond bull market ended when yields reversed course in June. Investors became
more attuned to signs of growth in the economy and the equity market, and their
departure from bonds (coupled with selling activity by mortgage investors)
helped to drive interest rates up rapidly. In July, the 10-year Treasury bond
experienced its worst one-month performance in more than 20 years.
The environment for U.S. investment-grade corporate bonds was largely
constructive during the period. Corporate bonds entered the period with
unusually wide yield spreads following a series of accounting scandals and
several quarters of weak corporate financial results. These low valuations,
along with expectations of economic recovery and signs of improved corporate
profits, drew investors to the corporate market. Spreads had narrowed
considerably by the end of the period, though they remained somewhat wide by
historical standards. The strongest returns were earned by sectors that were
most heavily out of favor during the preceding year. Similarly, lower-quality
bonds generally outperformed their more conservative peers.
PERFORMANCE ANALYSIS
On April 22, 2003, the Fund changed its name from Morgan Stanley Intermediate
Income Securities to Morgan Stanley Quality Income Trust, reflecting a
repositioning of its focus to corporate debt securities with a wide range of
maturities. Prior to May, the Fund was invested across the various short- and
intermediate-term investment-grade sectors of the fixed income market. This
transition was a key driver of the Fund's performance during the period. The
Fund's diversified sector exposure prior to its changeover limited its
participation in the corporate sector's strong performance, though it did
benefit from greater exposure after May.
With rates at historically low levels, our analysis indicated that the Treasury
yield curve appeared to be priced as if the U.S. economy would remain well below
full employment level for five years, and somewhat below full employment for a
decade. We believed this assessment to be unduly pessimistic in light of the
potential for the economy's return to positive growth. Given that such a return
would be likely to result in
2
<Page>
interest rates rising, we kept the Fund's interest-rate sensitivity below that
of its benchmark. We retained this stance through the Fund's transition to its
new focus.
PORTFOLIO COMPOSITION
<Table>
CORPORATE BONDS 67.5%
U.S. GOVERNMENT AGENCIES 36.5
SHORT TERM 17.9
ASSET BACKED 4.8
FOREIGN GOVERNMENT BONDS 1.9
</Table>
LONG-TERM CREDIT ANALYSIS
<Table>
Aaa/AAA 37.1%
Aa/AA 5.2
A/A 28.1
Baa/BBB 39.9
Ba/BB 0.4
</Table>
DATA AS OF AUGUST 31, 2003. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES ARE AS A
PERCENTAGE OF NET ASSETS. PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND SHOULD
NOT BE DEEMED AS A RECOMMENDATION TO BUY 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.
INVESTMENT STRATEGY
1. THE FUND INVESTS IN A PORTFOLIO OF CORPORATE DEBT SECURITIES, PREFERRED
STOCKS, U.S. GOVERNMENT SECURITIES, MORTGAGE-BACKED SECURITIES, INCLUDING
COLLATERALIZED MORTGAGE BACKED SECURITIES ISSUED BY FOREIGN GOVERNMENTS OR
CORPORATIONS.
2. IN DECIDING WHICH SECURITIES TO BUY, HOLD OR SELL, THE TEAM CONSIDERS
DOMESTIC AND INTERNATIONAL ECONOMIC DEVELOPMENTS, INTEREST RATE TRENDS, BOND
RATINGS AND OTHER FACTORS RELATING TO THE ISSUERS.
3. LASTLY, THE FUND'S MANAGERS SEEK TO MAINTAIN BROAD DIVERSIFICATION ACROSS A
WIDE RANGE OF COMPANIES, INDUSTRIES, COUPONS AND MATURITIES.
ANNUAL HOUSEHOLDING NOTICE
TO REDUCE PRINTING AND MAILING COSTS, THE FUND ATTEMPTS TO ELIMINATE DUPLICATE
MAILINGS TO THE SAME ADDRESS. THE FUND DELIVERS A SINGLE COPY OF CERTAIN
SHAREHOLDER DOCUMENTS INCLUDING SHAREHOLDER REPORTS, PROSPECTUSES AND PROXY
MATERIALS TO INVESTORS WITH THE SAME LAST NAME AND WHO RESIDE AT THE SAME
ADDRESS. YOUR PARTICIPATION IN THIS PROGRAM WILL CONTINUE FOR AN UNLIMITED
PERIOD OF TIME, UNLESS YOU INSTRUCT US OTHERWISE. YOU CAN REQUEST MULTIPLE
COPIES OF THESE DOCUMENTS BY CALLING (800) 350-6414, 8:00 AM TO 8:00 PM, ET.
ONCE OUR CUSTOMER SERVICE CENTER HAS RECEIVED YOUR INSTRUCTIONS, WE WILL BEGIN
SENDING INDIVIDUAL COPIES FOR EACH ACCOUNT WITHIN 30 DAYS.
PROXY VOTING POLICIES AND PROCEDURES
A DESCRIPTION OF THE FUND'S POLICIES AND PROCEDURES WITH RESPECT TO THE VOTING
OF PROXIES RELATING TO THE FUND'S PORTFOLIO SECURITIES IS AVAILABLE WITHOUT
CHARGE, UPON REQUEST, BY CALLING (800) 869-NEWS. THIS INFORMATION IS ALSO
AVAILABLE ON THE SECURITIES AND EXCHANGE COMMISSION'S WEBSITE AT
http://www.sec.gov.
RESULTS OF SPECIAL SHAREHOLDER MEETING
ON APRIL 22, 2003, A SPECIAL MEETING OF THE FUND'S SHAREHOLDERS WAS HELD FOR THE
PURPOSE OF APPROVING AMENDMENTS TO THE FUND'S INVESTMENT RESTRICTIONS TO ENABLE
THE FUND TO INVEST IN FINANCIAL FUTURES CONTRACTS AND RELATED OPTIONS THEREON.
THE RESULTS WERE AS FOLLOWS:
<Table>
FOR 5,817,330
- ---------------------------------------------------
AGAINST 378,724
- ---------------------------------------------------
ABSTAIN 673,279
- ---------------------------------------------------
</Table>
3
<Page>
Performance Summary
[CHART]
PERFORMANCE OF A $10,000 INVESTMENT--CLASS B
<Table>
<Caption>
FUND LEHMAN(1) LIPPER(2)
Aug-1993 $ 10,000 $ 10,000 $ 10,000
Aug-1994 $ 9,850 $ 9,967 $ 9,820
Aug-1995 $ 10,693 $ 10,911 $ 10,822
Aug-1996 $ 10,969 $ 11,395 $ 11,248
Aug-1997 $ 11,838 $ 12,357 $ 12,326
Aug-1998 $ 12,611 $ 13,466 $ 13,497
Aug-1999 $ 12,727 $ 13,763 $ 13,557
Aug-2000 $ 12,956 $ 14,626 $ 14,449
Aug-2001 $ 14,194 $ 16,423 $ 16,228
Aug-2002 $ 14,844 $ 17,695 $ 17,172
Aug-2003 $ 15,086@ $ 18,624 $ 18,096
</Table>
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE RETURNS. INVESTMENT RETURN AND
PRINCIPAL VALUE WILL FLUCTUATE. WHEN YOU SELL FUND SHARES, THEY MAY BE WORTH
LESS THAN THEIR ORIGINAL COST. THE GRAPH AND TABLE DO NOT REFLECT THE DEDUCTION
OF TAXES THAT A SHAREHOLDER WOULD PAY ON FUND DISTRIBUTIONS OR THE REDEMPTION OF
FUND SHARES. PERFORMANCE FOR CLASS A, CLASS B, CLASS C, AND CLASS D SHARES WILL
VARY DUE TO DIFFERENCES IN SALES CHARGES AND EXPENSES.
4
<Page>
AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED AUGUST 31, 2003
<Table>
<Caption>
CLASS A SHARES* CLASS B SHARES** CLASS C SHARES+ CLASS D SHARES++
07/28/97 05/03/89 07/28/97 07/28/97
SYMBOL IISAX IISBX IISCX IISDX
1 YEAR 2.17%(3) 1.63%(3) 1.74%(3) 2.39%(3)
(2.17)(4) (3.30)(4) 0.75(4)
5 YEARS 4.46(3) 3.65(3) 3.67(3) 4.46(3)
3.56(4) 3.31(4) 3.67(4)
10 YEARS 4.20(3)
4.20(4)
SINCE INCEPTION 4.77(3) 5.52(3) 4.00(3) 4.80(3)
4.03(4) 5.52(4) 4.00(4)
</Table>
- ----------
Notes on Performance
(1) THE LEHMAN BROTHERS INTERMEDIATE U.S. GOVERNMENT/CREDIT INDEX TRACKS THE
PERFORMANCE OF U.S. GOVERNMENT AND CORPORATE OBLIGATIONS, INCLUDING U.S.
GOVERNMENT AGENCY AND TREASURY SECURITIES, AND CORPORATE AND YANKEE BONDS
WITH MATURITIES OF 1 TO 10 YEARS. INDEXES ARE UNMANAGED AND THEIR RETURNS DO
NOT INCLUDE ANY SALES CHARGES OR FEES. SUCH COSTS WOULD LOWER PERFORMANCE.
IT IS NOT POSSIBLE TO INVEST DIRECTLY IN AN INDEX.
(2) THE LIPPER INTERMEDIATE INVESTMENT GRADE DEBT FUNDS INDEX IS AN EQUALLY
WEIGHTED PERFORMANCE INDEX OF THE LARGEST QUALIFYING FUNDS (BASED ON NET
ASSETS) IN THE LIPPER INTERMEDIATE INVESTMENT GRADE DEBT FUNDS
CLASSIFICATION. THE INDEX, WHICH IS ADJUSTED FOR CAPITAL GAINS DISTRIBUTIONS
AND INCOME DIVIDENDS, IS UNMANAGED AND SHOULD NOT BE CONSIDERED AN
INVESTMENT. THERE ARE CURRENTLY 30 FUNDS REPRESENTED IN THIS INDEX.
(3) FIGURE SHOWN ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS AND DOES NOT REFLECT
THE DEDUCTION OF ANY SALES CHARGES.
(4) FIGURE SHOWN ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS AND THE DEDUCTION OF
THE MAXIMUM APPLICABLE SALES CHARGE. SEE THE FUND'S CURRENT PROSPECTUS FOR
COMPLETE DETAILS ON FEES AND SALES CHARGES.
* THE MAXIMUM FRONT-END SALES CHARGE FOR CLASS A IS 4.25%.
** THE MAXIMUM CONTINGENT DEFERRED SALES CHARGE (CDSC) FOR CLASS B IS 5.0%. THE
CDSC DECLINES TO 0% AFTER SIX YEARS.
+ THE MAXIMUM CONTINGENT DEFERRED SALES CHARGE FOR CLASS C IS 1% FOR SHARES
REDEEMED WITHIN ONE YEAR OF PURCHASE.
++ CLASS D HAS NO SALES CHARGE.
@ CLOSING VALUE ASSUMING A COMPLETE REDEMPTION ON AUGUST 31, 2003.
5
<Page>
Morgan Stanley Quality Income Trust
Portfolio of Investments - August 31, 2003
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
Corporate Bonds (67.5%)
AEROSPACE & DEFENSE (1.5%)
$ 305 Goodrich Corp. 7.625% 12/15/12 $ 332,807
870 Lockheed Martin Corp. 8.50 12/01/29 1,104,646
55 Raytheon Co. 6.75 08/15/07 60,989
60 Raytheon Co. 8.30 03/01/10 70,781
362 Systems 2001 Asset Trust - 144A* 6.664 09/15/13 394,986
-----------
1,964,209
-----------
AIR FREIGHT/COURIERS (0.2%)
280 FedEx Corp. 7.25 02/15/11 312,963
-----------
AIRLINES (0.6%)
356 Continental Airlines, Inc. (Series 991A) 6.545 02/02/19 333,032
370 Southwest Airlines Co. (Series 01-1) 5.496 11/01/06 394,681
-----------
727,713
-----------
AUTO PARTS: O.E.M. (0.5%)
365 Delphi Automotive Systems Corp. 6.125 05/01/04 372,285
265 Johnson Controls, Inc. 5.00 11/15/06 280,273
-----------
652,558
-----------
BEVERAGES: ALCOHOLIC (0.4%)
570 Miller Brewing Co. - 144A* 4.25 08/15/08 568,225
-----------
BROADCASTING (0.6%)
125 Clear Channel Communications, Inc. 7.25 09/15/03 125,207
600 Clear Channel Communications, Inc. 7.65 09/15/10 684,340
-----------
809,547
-----------
BUILDING PRODUCTS (0.3%)
280 Celulosa Arauco Constitution S.A. - 144A* (Chile) 5.125 07/09/13 263,745
160 Masco Corp. 4.625 08/15/07 162,615
-----------
426,360
-----------
CABLE/SATELLITE TV (1.9%)
1,280 Comcast Corp. 6.50 01/15/15 1,342,391
695 Cox Communications, Inc. 7.125 10/01/12 773,225
225 TCI Communications, Inc. 8.00 08/01/05 246,010
-----------
2,361,626
-----------
CASINO/GAMING (0.3%)
290 Harrah's Operating Co., Inc. 8.00 02/01/11 331,771
-----------
CONTAINERS/PACKAGING (0.4%)
540 Sealed Air Corp - 144A* 5.625 07/15/13 521,126
-----------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
6
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
DEPARTMENT STORES (2.0%)
$ 720 Federated Department Stores, Inc. 7.00% 02/15/28 $ 756,479
200 Federated Department Stores, Inc. 8.50 06/01/10 238,428
1,045 May Department Stores Co., Inc. 5.95 11/01/08 1,096,931
170 May Department Stores Co., Inc. 6.70 09/15/28 169,780
130 May Department Stores Co., Inc. 6.875 11/01/05 140,375
125 May Department Stores Co., Inc. 6.90 01/15/32 127,759
-----------
2,529,752
-----------
DRUGSTORE CHAINS (0.4%)
425 CVS Corp. 5.625 03/15/06 455,680
-----------
ELECTRIC UTILITIES (3.1%)
430 Appalachian Power Co. (Series H) 5.95 05/15/33 384,712
105 Cincinnati Gas & Electric Co. 5.70 09/15/12 107,520
500 Cincinnati Gas & Electric Co. (Series B) 5.375 06/15/33 430,490
260 Cincinnati Gas & Electric Co. (Series A) 5.40 06/15/33 224,712
525 Columbus Southern Power Co. - 144A* 6.60 03/01/33 526,690
640 Constellation Energy Group, Inc. 7.60 04/01/32 705,835
55 Detroit Edison Co. 6.125 10/01/10 58,979
365 Detroit Edison Co. 6.35 10/15/32 368,853
535 Duke Energy Corp. 4.50 04/01/10 530,094
50 Florida Power & Light Co. 4.85 02/01/13 49,414
130 Public Service Electric & Gas Co. 5.00 01/01/13 127,991
260 South Carolina Electric & Gas Co. 5.30 05/15/33 232,894
235 Wisconsin Electric Power Co. 5.625 05/15/33 220,928
-----------
3,969,112
-----------
ELECTRICAL PRODUCTS (0.4%)
450 Cooper Industries Inc. 5.25 07/01/07 472,774
-----------
ENVIRONMENTAL SERVICES (0.7%)
544 USA Waste Services, Inc. 7.00 07/15/28 561,553
310 USA Waste Services, Inc. 7.125 10/01/07 341,308
-----------
902,861
-----------
FINANCE/RENTAL/LEASING (6.2%)
625 American General Finance Corp. (Series MTNF) 5.875 07/14/06 675,575
1,245 Countrywide Home Loans, Inc. 3.25 05/21/08 1,188,661
2,885 Ford Motor Credit Co. 7.25 10/25/11 2,915,203
800 Ford Motor Credit Co. 7.375 10/28/09 825,958
70 Household Finance Corp. 6.375 10/15/11 74,926
675 Household Finance Corp. 6.75 05/15/11 740,677
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
7
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
$ 835 MBNA CORP. 6.125% 03/01/13 $ 859,776
525 Toyota Motor Credit Corp. (Series MTN) 5.65 01/15/07 569,046
-----------
7,849,822
-----------
FINANCIAL CONGLOMERATES (8.1%)
1,340 Boeing Capital Corp. 6.10 03/01/11 1,390,849
40 Boeing Capital Corp. 6.50 02/15/12 42,139
630 Chase Manhattan Corp. 6.00 02/15/09 673,333
145 Chase Manhattan Corp. 7.00 11/15/09 160,064
100 Citigroup Inc. 5.625 08/27/12 103,238
265 Citigroup Inc. 6.00 02/21/12 282,388
660 General Electric Capital Corp. (Series MTNA) 5.375 03/15/07 704,297
1,195 General Electric Capital Corp. (Series MTNA) 6.75 03/15/32 1,277,381
385 General Motors Acceptance Corp. 4.50 07/15/06 385,761
1,000 General Motors Acceptance Corp. 6.875 09/15/11 1,000,370
1,080 General Motors Acceptance Corp. 8.00 11/01/31 1,039,062
905 John Hancock Financial Services, Inc. 5.625 12/01/08 959,041
410 Prudential Funding, LLC (Series MTN) - 144A* 6.60 05/15/08 453,494
1,200 Prudential Holdings, LLC (Series C) - 144A* 8.695 12/18/23 1,420,272
360 Prudential Holdings, LLC (Series B) (FSA) - 144A* 7.245 12/18/23 391,648
-----------
10,283,337
-----------
FOOD RETAIL (2.1%)
530 Albertson's, Inc. 7.45 08/01/29 556,327
425 Albertson's, Inc. 7.50 02/15/11 474,032
475 Kroger Co. 6.80 04/01/11 519,230
910 Kroger Co. 7.50 04/01/31 1,004,621
160 Safeway Inc. 6.15 03/01/06 170,422
-----------
2,724,632
-----------
FOOD: MAJOR DIVERSIFIED (0.5%)
505 Kraft Foods Inc. 5.625 11/01/11 507,745
115 Kraft Foods Inc. 6.25 06/01/12 120,019
-----------
627,764
-----------
FOOD: MEAT/FISH/DAIRY (0.2%)
230 Conagra Foods, Inc. 6.00 09/15/06 248,910
-----------
FOREST PRODUCTS (0.8%)
940 Weyerhaeuser Co. 6.75 03/15/12 1,002,954
-----------
GAS DISTRIBUTORS (0.8%)
470 Consolidated Natural Gas Co. 5.375 11/01/06 498,073
215 Consolidated Natural Gas Co. 6.25 11/01/11 230,445
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
8
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
$ 54 Ras Laffan Liquid Natural
Gas Co. Ltd. - 144A* (Qatar) 7.628% 09/15/06 $ 57,137
215 Ras Laffan Liquid Natural
Gas Co. Ltd. - 144A* (Qatar) 8.294 03/15/14 242,434
-----------
1,028,089
-----------
HOME BUILDING (0.5%)
135 Centex Corp. 7.875 02/01/11 154,755
375 Pulte Homes, Inc. 6.375 05/15/33 336,408
115 Pulte Homes, Inc. 7.875 08/01/11 130,814
-----------
621,977
-----------
HOME FURNISHINGS (0.1%)
130 Mohawk Industries, Inc. (Series C) 6.50 04/15/07 141,747
-----------
HOME IMPROVEMENT CHAINS (0.6%)
295 Lowe's Companies, Inc. 6.50 03/15/29 307,214
71 Lowe's Companies, Inc. 6.875 02/15/28 76,707
300 Lowe's Companies, Inc. 7.50 12/15/05 333,767
-----------
717,688
-----------
HOSPITAL/NURSING MANAGEMENT (0.7%)
335 HCA Inc. 7.125 06/01/06 355,510
460 Manor Care, Inc. 8.00 03/01/08 496,800
-----------
852,310
-----------
HOTELS/RESORTS/CRUISELINES (1.1%)
630 Hyatt Equities LLC - 144A* 6.875 06/15/07 650,413
265 Marriott International, Inc. (Series E) 7.00 01/15/08 291,076
195 Marriott International, Inc. (Series D) 8.125 04/01/05 212,036
195 Starwood Hotels & Resorts Worldwide, Inc. 7.375 05/01/07 204,263
-----------
1,357,788
-----------
INDUSTRIAL CONGLOMERATES (0.8%)
515 Honeywell International, Inc. 5.125 11/01/06 548,499
515 Hutchinson Whampoa International Ltd. - 144A*
(Virgin Islands) 6.50 02/13/13 509,341
-----------
1,057,840
-----------
INFORMATION TECHNOLOGY SERVICES (0.6%)
260 Electronic Data Systems Corp. 7.125 10/15/09 267,800
470 Electronic Data Systems Corp. - 144A* 6.00 08/01/13 436,651
-----------
704,451
-----------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
9
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
INSURANCE BROKERS/SERVICES (0.3%)
$ 410 Marsh & McLennan Companies, Inc. 5.375% 03/15/07 $ 437,373
-----------
INTEGRATED OIL (2.1%)
1,025 Amerada Hess Corp. 7.875 10/01/29 1,125,161
305 Conoco Inc. 5.90 04/15/04 313,484
895 Conoco Inc. 6.95 04/15/29 981,746
225 ConocoPhillips 8.50 05/25/05 249,228
-----------
2,669,619
-----------
INVESTMENT BANKS/BROKERS (1.1%)
600 Goldman Sachs Group Inc 6.125 02/15/33 580,949
165 Goldman Sachs Group Inc. 6.60 01/15/12 179,638
580 Goldman Sachs Group Inc. 6.875 01/15/11 644,732
-----------
1,405,319
-----------
INVESTMENT MANAGERS (0.6%)
735 TIAA Global Markets - 144A* 5.00 03/01/07 776,784
-----------
LIFE/HEALTH INSURANCE (2.1%)
365 Equitable Life Assurance Society - 144A* 6.95 12/01/05 398,611
570 Hartford Life, Inc. 7.375 03/01/31 631,931
150 Hartford Life, Inc. 7.65 06/15/27 170,917
475 John Hancock Global Funding II - 144A* 7.90 07/02/10 555,081
500 Metropolitan Life Insurance Co. - 144A* 6.30 11/01/03 503,955
335 Monumental Global Funding II - 144A* 6.05 01/19/06 362,320
-----------
2,622,815
-----------
MAJOR BANKS (1.2%)
305 Bank One Corp. (Series MTNA) 6.00 02/17/09 329,307
670 UFJ Finance Aruba AEC (Aruba) 6.75 07/15/13 663,179
475 Wachovia Bank N.A. (Series BKNT) 7.80 08/18/10 561,127
-----------
1,553,613
-----------
MAJOR TELECOMMUNICATIONS (4.2%)
185 AT&T Corp. 7.80 11/15/11 207,124
960 AT&T Corp. 8.50 11/15/31 1,083,142
150 Deutsche Telekom International Finance Corp.
(Netherlands) 8.50 06/15/10 176,519
725 Deutsche Telekom International Finance Corp.
(Netherlands) 8.75 06/15/30 870,642
80 Verizon Communications 6.36 04/15/06 87,026
165 Verizon Global Funding Corp. 7.25 12/01/10 186,942
1,910 Verizon Global Funding Corp. 7.75 12/01/30 2,191,908
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
10
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
$ 480 Verizon New England Inc. 6.50% 09/15/11 $ 522,039
-----------
5,325,342
-----------
MANAGED HEALTH CARE (1.8%)
340 Aetna, Inc. 7.875 03/01/11 392,027
60 Anthem, Inc. 6.80 08/01/12 65,764
1,115 Health Net, Inc. 8.375 04/15/11 1,283,765
270 UnitedHealth Group Inc. 7.50 11/15/05 299,346
175 Wellpoint Health Network, Inc. 6.375 06/15/06 190,648
-----------
2,231,550
-----------
MEDIA CONGLOMERATES (2.8%)
185 AOL Time Warner Inc. 6.75 04/15/11 200,361
500 AOL Time Warner Inc. 7.625 04/15/31 541,338
195 AOL Time Warner Inc. 7.70 05/01/32 213,902
600 News America Holdings, Inc. 7.75 02/01/24 668,681
50 News America Holdings, Inc. 8.875 04/26/23 61,479
250 News America Inc. 6.625 01/09/08 275,010
65 News America Inc. - 144A* 4.75 03/15/10 64,602
900 News America Inc. 7.28 06/30/28 959,203
530 Time Warner Co., Inc. 7.57 02/01/24 568,705
-----------
3,553,281
-----------
MOTOR VEHICLES (1.9%)
215 DaimlerChrysler North American Holdings Co. 8.00 06/15/10 242,400
665 DaimlerChrysler North American Holdings Co. 8.50 01/18/31 747,668
400 Ford Motor Co. 7.45 07/16/31 355,385
1,000 General Motors Corp. 7.20 01/15/11 1,018,972
-----------
2,364,425
-----------
MULTI-LINE INSURANCE (1.4%)
545 AIG SunAmerica Global Finance VI - 144A* 6.30 05/10/11 589,973
250 Farmers Insurance Exchange - 144A* 8.50 08/01/04 252,696
135 Hartford Financial Services Group, Inc. 2.375 06/01/06 132,596
500 Hartford Financial Services Group, Inc. 7.75 06/15/05 546,946
200 Nationwide Mutual Insurance - 144A* 6.50 02/15/04 204,386
-----------
1,726,597
-----------
OIL & GAS PRODUCTION (2.0%)
35 Devon Financing Corp. 6.875 09/30/11 38,667
410 Kerr-McGee Corp. 5.875 09/15/06 436,008
210 Pemex Project Funding Master Trust 7.875 02/01/09 232,050
1,170 Pemex Project Funding Master Trust 8.00 11/15/11 1,275,300
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
11
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ----------------------------------------------------------------------------------------------------------
$ 90 Pemex Project Funding Master Trust 9.125% 10/13/10 $ 104,850
40 Petro-Canada (Canada) 4.00 07/15/13 35,975
525 Petro-Canada (Canada) 5.35 07/15/33 456,505
-----------
2,579,355
-----------
OIL REFINING/MARKETING (0.5%)
140 Ashland Inc. 7.83 08/15/05 150,692
120 Marathon Oil Corp. 6.00 07/01/12 125,859
380 Marathon Oil Corp. 6.80 03/15/32 391,685
-----------
668,236
-----------
OTHER CONSUMER SERVICES (1.0%)
130 Cendant Corp. 6.25 03/15/10 136,069
1,020 Cendant Corp. 7.375 01/15/13 1,124,331
-----------
1,260,400
-----------
OTHER METALS/MINERALS (1.1%)
125 BHP Finance USA Ltd. (Australia) 4.80 04/15/13 121,200
800 Inco Ltd. (Canada) 7.20 09/15/32 811,731
395 Inco Ltd. (Canada) 7.75 05/15/12 439,561
-----------
1,372,492
-----------
PULP & PAPER (1.5%)
105 Abitibi-Consolidated Inc. (Canada) 8.55 08/01/10 111,405
130 International Paper Co. 5.30 04/01/15 122,787
1,075 International Paper Co. 5.85 10/30/12 1,095,496
105 MeadWestVaco Corp. 6.85 04/01/12 113,866
460 Sappi Papier Holding AG - 144A* (Austria) 6.75 06/15/12 490,205
-----------
1,933,759
-----------
RAILROADS (0.8%)
535 Norfolk Southern Corp. 7.875 02/15/04 550,390
395 Union Pacific Corp. 5.84 05/25/04 405,774
-----------
956,164
-----------
REAL ESTATE DEVELOPMENT (0.8%)
398 World Financial Properties - 144A* 6.91 09/01/13 434,557
588 World Financial Properties - 144A* 6.95 09/01/13 643,561
-----------
1,078,118
-----------
REAL ESTATE INVESTMENT TRUSTS (2.1%)
290 EOP Operating L.P. 6.763 06/15/07 317,609
65 EOP Operating L.P. 7.50 04/19/29 69,000
770 EOP Operating L.P. 7.875 07/15/31 854,034
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
12
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------------
$ 980 Simon Property Group L.P. 6.35% 08/28/12 $ 1,031,319
220 Simon Property Group L.P. 6.375 11/15/07 238,078
115 Vornado Realty Trust 5.625 06/15/07 119,678
-----------
2,629,718
-----------
SAVINGS BANKS (0.2%)
290 Washington Mutual Bank 5.50 01/15/13 291,373
-----------
SERVICES TO THE HEALTH INDUSTRY (1.2%)
235 Anthem Insurance - 144A* 9.00 04/01/27 288,638
885 Anthem Insurance - 144A* 9.125 04/01/10 1,060,616
165 Omnicare, Inc. 6.125 06/01/13 157,575
-----------
1,506,829
-----------
TOBACCO (0.4%)
535 Altria Group, Inc. 7.75 01/15/27 504,692
-----------
Total Corporate Bonds
(COST $87,471,889) 85,673,440
-----------
FOREIGN GOVERNMENT OBLIGATIONS (1.9%)
820 United Mexican States Corp. (Mexico) 8.30 08/15/31 877,400
75 United Mexican States Corp. (Mexico) 8.375 01/14/11 86,325
315 United Mexican States Corp. (Mexico) 8.625 03/12/08 366,503
860 United Mexican States Corp. (Mexico) 9.875 02/01/10 1,064,680
-----------
Total Foreign Government Obligations
(COST $2,478,948) 2,394,908
-----------
U.S. GOVERNMENT AGENCY OBLIGATION (0.3%)
360 Private Export Funding Corp. (Cost $360,201) 6.86 04/30/04 372,895
-----------
MORTGAGE-BACKED SECURITIES (36.2%)
Federal Home Loan Mortgage Corp.
10,000 6.50 ** 10,343,750
109 7.50 09/01/30 115,665
1,945 8.00 08/01/29 - 06/01/31 2,081,765
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
13
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -----------------------------------------------------------------------------------------------------------------
Federal National Mortgage Assoc.
$ 8,750 6.50% ** $ 9,045,313
8,250 7.00 ** 8,688,281
2,322 7.00 02/01/30 - 05/01/32 2,445,599
9,000 7.50 ** 9,565,308
2,752 7.50 09/01/29 - 07/01/32 2,925,324
700 8.00 10/01/29 - 09/01/31 751,124
-----------
Total Mortgage-Backed Securities
(Cost $45,949,552) 45,962,129
-----------
Asset-Backed Securities (4.8%)
700 BMW Vehicle Owner Trust
(Series 2002-A) (Class A4) 4.46 05/25/07 729,299
700 Chase Manhattan Auto Owner Trust
(Series 2002-A) (Class A4) 4.24 09/15/08 726,237
650 Citibank Credit Card Issurance Trust
(Series 2003-A2) (Class A2) 2.70 01/15/08 651,948
700 Citibank Credit Card Issurance Trust
(Series 2001-A8) (Class A8) 4.10 12/07/06 720,996
225 Ford Credit Auto Owner Trust
(Series 2002-B) (Class A4) 4.75 08/15/06 235,199
500 Harley-Davidson Motorcycle Trust
(Series 2003-1) (Class A2) 2.63 11/15/10 501,099
600 Harley-Davidson Motorcycle Trust
(series 2002-2) (Class A2) 3.09 06/15/10 610,080
700 Harley-Davidson Motorcycle Trust
(Series 2002-1) (Class A2) 4.50 01/15/10 727,257
500 Honda Auto Receivables Owner Trust
(Series 2002-4) (Class A4) 2.70 03/17/08 500,505
600 Northstrom Private Label Credit Card Master
(Series 2001-1A) (Class A) - 144A* 4.82 04/15/10 625,863
-----------
Total Asset-Backed Securities
(COST $5,876,073) 6,028,483
-----------
Short-Term Investments (17.9%)
U.S. Government Obligation (a) (0.2%)
300 U.S. Treasury Bill*** (Cost $299,781) 1.095 09/25/03 299,763
-----------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
14
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ------------------------------------------------------------------------------------------------------------
Repurchase Agreement (17.7%)
$ 22,424 Joint repurchase agreement account (dated
08/29/03, proceeds $22,426,616) (b)
(Cost $22,424,000) 1.05% 09/02/03 $ 22,424,000
-------------
Total Short-Term Investments
(COST $22,723,781) 22,723,763
-------------
Total Investments
(COST $164,860,444) (c) (d) 128.6% 163,155,618
Liabilities in Excess of Other Assets (28.6) (36,322,675)
---------- -------------
Net Assets 100.0% $ 126,832,943
========== =============
</Table>
- ----------
* RESALE IS RESTRICTED TO QUALIFIED INSTITUTIONAL INVESTORS.
** SECURITIES PURCHASED ON A FORWARD COMMITMENT BASIS WITH AN APPROXIMATE
PRINCIPAL AMOUNT AND NO DEFINITE MATURITY DATE; THE ACTUAL PRINCIPAL
AMOUNT AND MATURITY DATE WILL BE DETERMINED UPON SETTLEMENT.
*** ALL OF THESE SECURITIES HAVE BEEN PHYSICALLY SEGREGATED IN CONNECTION
WITH OPEN FUTURES CONTRACTS.
(a) PURCHASED ON A DISCOUNT BASIS. THE INTEREST RATE SHOWN HAS BEEN ADJUSTED
TO REFLECT A MONEY MARKET EQUIVALENT YIELD.
(b) COLLATERALIZED BY FEDERAL AGENCY AND U.S. TREASURY OBLIGATIONS.
(c) SECURITIES HAVE BEEN DESIGNATED AS COLLATERAL IN A AMOUNT EQUAL TO
$69,569,704 IN CONNECTION WITH SECURITIES PURCHASED ON A FORWARD
COMMITMENT BASIS AND OPEN FUTURES CONTRACTS.
(d) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES IS $165,130,583. THE
AGGREGATE GROSS UNREALIZED APPRECIATION IS $1,874,411 AND THE AGGREGATE
GROSS UNREALIZED DEPRECIATION IS $3,849,376, RESULTING IN NET UNREALIZED
DEPRECIATION OF $1,974,965.
BOND INSURANCE:
FSA Financial Security Assurance.
FUTURES CONTRACTS OPEN AT AUGUST 31, 2003:
<Table>
<Caption>
UNREALIZED
NUMBER OF DESCRIPTION/DELIVERY UNDERLYING FACE APPRECIATION
CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE (DEPRECIATION)
- ----------------------------------------------------------------------------------------------------------------
43 Short U.S. Treasury Notes 2 year, September/2003 $ (9,227,532) $ 85,697
32 Short U.S. Treasury Notes 5 year, September/2003 (3,567,500) 114,118
59 Short U.S. Treasury Notes 2 year, December/2003 (12,569,766) (17,850)
3 Short U.S. Treasury Notes 5 year, December/2003 (329,578) 493
41 Short U.S. Treasury Bonds, September/2003 (4,403,656) (12,394)
12 Short U.S. Treasury Bonds, December/2003 (1,272,000) 1,701
---------
Net unrealized appreciation $ 171,765
=========
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
15
<Page>
Morgan Stanley Quality Income Trust
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
AUGUST 31, 2003
<Table>
Assets:
Investments in securities, at value (including a repurchase agreement of $22,424,000)
(cost $164,860,444) $ 163,155,618
Receivable for:
Interest 1,719,165
Investments sold 364,378
Shares of beneficial interest sold 214,584
Prepaid expenses and other assets 124,851
---------------
Total Assets 165,578,596
---------------
Liabilities:
Payable for:
Investments purchased 37,813,253
Shares of beneficial interest redeemed 639,338
Distribution fee 81,766
Investment management fee 64,701
Accrued expenses and other payables 146,595
---------------
Total Liabilities 38,745,653
---------------
Net Assets $ 126,832,943
===============
Composition of Net Assets:
Paid-in-capital $ 137,241,623
Net unrealized depreciation (1,533,061)
Dividends in excess of net investment income (248,881)
Accumulated net realized loss (8,626,738)
---------------
Net Assets $ 126,832,943
===============
Class A Shares:
Net Assets $ 9,635,572
Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 1,026,129
Net Asset Value Per Share $ 9.39
===============
Maximum Offering Price Per Share,
(NET ASSET VALUE PLUS 4.44% OF NET ASSET VALUE) $ 9.81
===============
Class B Shares:
Net Assets $ 99,695,005
Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 10,696,130
Net Asset Value Per Share $ 9.32
===============
Class C Shares:
Net Assets $ 10,389,148
Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 1,112,697
Net Asset Value Per Share $ 9.34
===============
Class D Shares:
Net Assets $ 7,113,218
Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 765,513
Net Asset Value Per Share $ 9.29
===============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
16
<Page>
Statement of Operations
FOR THE YEAR ENDED AUGUST 31, 2003
<Table>
Net Investment Income:
Interest Income $ 4,335,311
---------------
Expenses
Distribution fee (Class A shares) 17,867
Distribution fee (Class B shares) 894,013
Distribution fee (Class C shares) 75,251
Investment management fee 792,713
Transfer agent fees and expenses 215,136
Shareholder reports and notices 69,434
Registration fees 67,347
Professional fees 51,541
Trustees' fees and expenses 19,984
Other 21,464
---------------
Total Expenses 2,224,750
---------------
Net Investment Income 2,110,561
---------------
Net Realized and Unrealized Gain (Loss):
Net Realized Gain on:
Investments 1,635,580
Futures contracts 195,074
---------------
Net Realized Gain 1,830,654
---------------
Net Change in Unrealized Appreciation/Depreciation on:
Investments (1,920,256)
Futures contracts 171,765
---------------
Net Depreciation (1,748,491)
---------------
Net Gain 82,163
---------------
Net Increase $ 2,192,724
===============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
17
<Page>
Statement of Changes in Net Assets
<Table>
<Caption>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
AUGUST 31, 2003 AUGUST 31, 2002
--------------- ---------------
Increase (Decrease) in Net Assets:
Operations:
Net investment income $ 2,110,561 $ 3,829,987
Net realized gain 1,830,654 2,245,051
Net change in unrealized depreciation (1,748,491) (1,010,383)
--------------- ---------------
Net Increase 2,192,724 5,064,655
--------------- ---------------
Dividends to Shareholders from Net Investment Income:
Class A shares (316,276) (179,929)
Class B shares (3,155,485) (3,265,862)
Class C shares (264,530) (155,164)
Class D shares (356,548) (218,659)
--------------- ---------------
Total Dividends (4,092,839) (3,819,614)
--------------- ---------------
Net increase (decrease) from transactions in shares of beneficial interest (3,592,687) 22,208,366
--------------- ---------------
Net Increase (Decrease) (5,492,802) 23,453,407
Net Assets:
Beginning of period 132,325,745 108,872,338
--------------- ---------------
End of Period
(INCLUDING DIVIDENDS IN EXCESS OF NET INVESTMENT INCOME OF $248,881
AND ACCUMULATED UNDISTRIBUTED NET INVESTMENT INCOME OF $481,946,
RESPECTIVELY) $ 126,832,943 $ 132,325,745
=============== ===============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
18
<Page>
Morgan Stanley Quality Income Trust
NOTES TO FINANCIAL STATEMENTS - AUGUST 31, 2003
1. Organization and Accounting Policies
Morgan Stanley Quality Income Trust (the "Fund"), formerly Morgan Stanley
Intermediate Income Securities, is registered under the Investment Company Act
of 1940, as amended (the "Act"), as a diversified, open-end management
investment company. The Fund's investment objective is high current income
consistent with safety of principal. The Fund will seek to achieve its objective
by investing at least 80% of its assets in investment grade fixed income
securities. Prior to April 22, 2003, the Fund sought to achieve its objective by
investing at least 80% of its assets in intermediate term, investment grade
fixed income securities. The Fund was organized as a Massachusetts business
trust on September 1, 1988 and commenced operations on May 3, 1989. On July 28,
1997, the Fund converted to a multiple class share structure.
The Fund offers Class A shares, Class B shares, Class C shares and Class D
shares. The four classes are substantially the same except that most Class A
shares are subject to a sales charge imposed at the time of purchase and some
Class A shares, and most Class B shares and Class C shares are subject to a
contingent deferred sales charge imposed on shares redeemed within one year, six
years and one year, respectively. Class D shares are not subject to a sales
charge. Additionally, Class A shares, Class B shares and Class C shares incur
distribution expenses.
The following is a summary of significant accounting policies:
A. Valuation of Investments -- (1) portfolio securities for which
over-the-counter market quotations are readily available are valued at the
latest bid price prior to the time of valuation; (2) when market quotations are
not readily available or Morgan Stanley Investment Advisors Inc. (the
"Investment Manager") determines that the market quotations are not reflective
of a security's market value, portfolio securities are valued at their fair
value as determined in good faith under procedures established by and under the
general supervision of the Fund's Trustees; (3) certain portfolio securities may
be valued by an outside pricing service approved by the Fund's Trustees; and (4)
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. Interest income is accrued daily.
C. Repurchase Agreements -- Pursuant to an Exemptive Order issued by the
Securities and Exchange Commission, the Fund, along with other affiliated
entities managed by the Investment Manager, may
19
<Page>
transfer uninvested cash balances into one or more joint repurchase agreement
accounts. These balances are invested in one or more repurchase agreements and
are collateralized by cash, U.S. Treasury or federal agency obligations. The
Fund may also invest directly with institutions in repurchase agreements. The
Fund's custodian receives the collateral, which is marked-to-market daily to
determine that the value of the collateral does not decrease below the
repurchase price plus accrued interest.
D. Multiple Class Allocations -- Investment income, expenses (other than
distribution fees), and realized and unrealized gains and losses are allocated
to each class of shares based upon the relative net asset value on the date such
items are recognized. Distribution fees are charged directly to the respective
class.
E. 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.
F. Federal Income Tax Policy -- It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Accordingly, no federal income tax provision is required.
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 Management Agreement
Pursuant to an Investment Management Agreement , the Fund pays the Investment
Manager a management fee, calculated daily and payable monthly, by applying the
following annual rates to the net assets of the Fund determined as of the close
of each business day: 0.60% to the portion of daily net assets not exceeding
$500 million; 0.50% to the portion of daily net assets exceeding $500 million
but not exceeding $750 million; 0.40% to the portion of the daily net assets
exceeding $750 million but not exceeding $1 billion; and 0.30% to the portion of
the daily net asset exceeding $1 billion.
20
<Page>
3. Plan of Distribution
Shares of the Fund are distributed by Morgan Stanley Distributors Inc. (the
"Distributor"), an affiliate of the Investment Manager. The Fund has adopted a
Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the Act. The Plan
provides that the Fund will pay the Distributor a fee which is accrued daily and
paid monthly at the following annual rates: (i) Class A -- up to 0.25% of the
average daily net assets of Class A; (ii) Class B - 0.85% of the lesser of: (a)
the average daily aggregate gross sales of the Class B shares since the
inception of the Fund (not including reinvestment of dividend or capital gain
distributions) less the average daily aggregate net asset value of the Class B
shares redeemed since the Fund's inception upon which a contingent deferred
sales charge has been imposed or waived; or (b) the average daily net assets of
Class B; and (iii) Class C -- up to 0.85% of the average daily net assets of
Class C.
In the case of Class B shares, provided that the Plan continues in effect, any
cumulative expenses incurred by the Distributor but not yet recovered may be
recovered through the payment of future distribution fees from the Fund pursuant
to the Plan and contingent deferred sales charges paid by investors upon
redemption of Class B shares. Although there is no legal obligation for the Fund
to pay expenses incurred in excess of payments made to the Distributor under the
Plan and the proceeds of contingent deferred sales charges paid by investors
upon redemption of shares, if for any reason the Plan is terminated, the
Trustees will consider at that time the manner in which to treat such expenses.
The Distributor has advised the Fund that such excess amounts totaled $5,664,859
at August 31, 2003.
In the case of Class A shares and Class C shares, expenses incurred pursuant to
the Plan in any calendar year in excess of 0.25% or 0.85% of the average daily
net assets of Class A or Class C, respectively, will not be reimbursed by the
Fund through payments in any subsequent year, except that expenses representing
a gross sales credit to Morgan Stanley Financial Advisors or other selected
broker-dealer representatives may be reimbursed in the subsequent calendar year.
For the year ended August 31, 2003, the distribution fee was accrued for Class A
shares and Class C shares at the annual rate of 0.20% and 0.85%, respectively.
The Distributor has informed the Fund that for the year ended August 31, 2003,
it received contingent deferred sales charges from certain redemptions of the
Fund's Class A shares, Class B shares and Class C shares of $21,975, $269,673
and $6,194, respectively, and received $92,496 in front-end sales charges from
sales of the Fund's Class A shares. The respective shareholders pay such charges
which are not an expense of the Fund.
4. Security Transactions and Transactions with Affiliates
The cost of purchases and proceeds from sales/prepayments of portfolio
securities, excluding short-term investments, for the year ended August 31,
2003, aggregated $594,680,723, and
21
<Page>
$567,118,909, respectively. Included in the aforementioned are purchases and
sales of U.S. Government securities of $74,892,362 and $101,942,047,
respectively.
Morgan Stanley Trust, an affiliate of the Investment Manager and Distributor, is
the Fund's transfer agent. At August 31, 2003, the Fund had transfer agent fees
and expenses payable of approximately $10,000.
The Fund has an unfunded noncontributory defined benefit pension plan covering
all 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 years of service and compensation during the last five years
of service. Aggregate pension costs for the year ended August 31, 2003 included
in Trustees' fees and expenses in the Statement of Operations amounted to
$7,163. At August 31, 2003, the Fund had an accrued pension liability of $59,375
which is included in accrued expenses in the Statement of Assets and
Liabilities.
5. Shares of Beneficial Interest
Transactions in shares of beneficial interest were as follows:
<Table>
<Caption>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
AUGUST 31, 2003 AUGUST 31, 2002
---------------------------- ----------------------------
SHARES AMOUNT SHARES AMOUNT
------------ ------------ ------------ ------------
CLASS A SHARES
Sold 7,230,344 $ 69,757,478 4,601,318 $ 43,662,281
Reinvestment of dividends 23,096 221,263 16,108 151,661
Redeemed (7,352,712) (70,908,969) (3,938,770) (37,318,849)
------------ ------------ ------------ ------------
Net increase (decrease) -- Class A (99,272) (930,228) 678,656 6,495,093
------------ ------------ ------------ ------------
CLASS B SHARES
Sold 5,576,141 53,136,588 8,301,113 77,663,399
Reinvestment of dividends 224,794 2,137,809 229,053 2,136,654
Redeemed (6,031,461) (57,282,326) (8,023,847) (75,013,877)
------------ ------------ ------------ ------------
Net increase (decrease) -- Class B (230,526) (2,007,929) 506,319 4,786,176
------------ ------------ ------------ ------------
CLASS C SHARES
Sold 1,825,800 17,330,693 1,056,702 9,887,000
Reinvestment of dividends 20,602 196,212 13,255 123,842
Redeemed (1,411,756) (13,429,508) (843,310) (7,894,423)
------------ ------------ ------------ ------------
Net increase -- Class C 434,646 4,097,397 226,647 2,116,419
------------ ------------ ------------ ------------
CLASS D SHARES
Sold 1,942,485 18,431,785 1,856,116 17,358,806
Reinvestment of dividends 22,745 215,756 14,251 132,783
Redeemed (2,466,593) (23,399,468) (926,421) (8,680,911)
------------ ------------ ------------ ------------
Net increase (decrease) -- Class D (501,363) (4,751,927) 943,946 8,810,678
------------ ------------ ------------ ------------
Net increase (decrease) in Fund (396,515) $ (3,592,687) 2,355,568 $ 22,208,366
============ ============ ============ ============
</Table>
22
<Page>
6. 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.
The tax character of distributions paid was as follows:
<Table>
<Caption>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
AUGUST 31, 2003 AUGUST 31, 2002
--------------- ---------------
Ordinary Income $ 4,092,676 $ 3,879,314
</Table>
As of August 31, 2003, the tax-basis components of accumulated losses were as
follows:
<Table>
Undistributed ordinary income $ 101,079
Undistributed long-term gains --
---------------
Net accumulated earnings 101,079
Capital loss carryforward* (7,215,096)
Post-October losses (1,239,877)
Temporary differences (79,821)
Net unrealized depreciation (1,974,965)
---------------
Total accumulated losses $ (10,408,680)
===============
</Table>
* As of August 31, 2003, the Fund had a net capital loss carryforward of
$7,215,096 of which $312,541 will expire on August 31, 2004, $2,351,266 will
expire on August 31, 2005, $199,882 will expire on August 31, 2006, $1,146,203
will expire on August 31, 2008, $2,891,735 will expire on August 31, 2009 and
$313,469 will expire on August 31, 2010 to offset future capital gains to the
extent provided by regulations.
As of August 31, 2003, the Fund had temporary book/tax differences primarily
attributable to post-October losses (capital losses incurred after October 31
within the taxable year which are deemed to arise on the first business day of
the Fund's next taxable year), mark-to-market of open futures contracts and book
amortization of premiums on debt securities and permanent book/tax differences
attributable to losses on paydowns, tax adjustments on debt securities sold by
the Fund and an expired capital loss carryforward. To reflect reclassifications
arising from the permanent differences, paid-in-capital was charged $5,189,389,
dividends in excess of net investment income was credited $1,251,451 and
accumulated net realized loss was credited $3,937,938.
23
<Page>
7. Purposes of and Risks Relating to Certain Financial Instruments
The Fund may enter into forward contracts to facilitate settlement of foreign
currency denominated portfolio transactions or to manage foreign currency
exposure associated with foreign currency denominated securities.
To hedge against adverse interest rate, foreign currency and market risks, the
Fund may purchase and sell interest rate, currency and index futures contracts
("futures contracts").
Forward contracts and futures contracts involve elements of market risk in
excess of the amounts reflected in the Statement of Assets and Liabilities. The
Fund bears the risk of an unfavorable change in foreign exchange rates
underlying the forward contracts. Risks may also arise upon entering into these
contracts from the potential inability of the counterparties to meet the terms
of their contracts.
At August 31, 2003, the Fund had outstanding futures contracts and had no
outstanding forward contracts.
24
<Page>
Morgan Stanley Quality Income Trust
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
<Table>
<Caption>
FOR THE YEAR ENDED AUGUST 31,
----------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
Class A Shares:
Selected Per Share Data:
Net asset value, beginning of period $ 9.53 $ 9.35 $ 8.97 $ 9.30 $ 9.71
---------- ---------- ---------- ---------- ----------
Income (loss) from investment operations:
Net investment income 0.20 0.37 0.52 0.55 0.55
Net realized and unrealized gain (loss) 0.01 0.19 0.38 (0.33) (0.41)
---------- ---------- ---------- ---------- ----------
Total income from investment operations 0.21 0.56 0.90 0.22 0.14
---------- ---------- ---------- ---------- ----------
Less dividends from net investment income (0.35) (0.38) (0.52) (0.55) (0.55)
---------- ---------- ---------- ---------- ----------
Net asset value, end of period $ 9.39 $ 9.53 $ 9.35 $ 8.97 $ 9.30
========== ========== ========== ========== ==========
Total Return+ 2.17% 6.17% 10.34% 2.49% 1.39%
Ratios to Average Net Assets(1):
Expenses 1.14% 1.04% 1.21% 1.10% 1.08%
Net investment income 2.14% 4.03% 5.71% 6.02% 5.67%
Supplemental Data:
Net assets, end of period, in thousands $ 9,636 $ 10,730 $ 4,177 $ 4,196 $ 3,557
Portfolio turnover rate 429% 400% 358% 114% 99%
</Table>
- ----------
+ DOES NOT REFLECT THE DEDUCTION OF SALES CHARGE. CALCULATED BASED ON THE NET
ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD.
(1) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC
EXPENSES.
SEE NOTES TO FINANCIAL STATEMENTS
25
<Page>
<Table>
<Caption>
FOR THE YEAR ENDED AUGUST 31,
----------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
Class B Shares:
Selected Per Share Data:
Net asset value, beginning of period $ 9.45 $ 9.35 $ 8.98 $ 9.31 $ 9.70
---------- ---------- ---------- ---------- ----------
Income (loss) from investment operations:
Net investment income 0.14 0.31 0.47 0.49 0.49
Net realized and unrealized gain (loss) 0.02 0.10 0.37 (0.33) (0.39)
---------- ---------- ---------- ---------- ----------
Total income from investment operations 0.16 0.41 0.84 0.16 0.10
---------- ---------- ---------- ---------- ----------
Less dividends from net investment income (0.29) (0.31) (0.47) (0.49) (0.49)
---------- ---------- ---------- ---------- ----------
Net asset value, end of period $ 9.32 $ 9.45 $ 9.35 $ 8.98 $ 9.31
========== ========== ========== ========== ==========
Total Return+ 1.63% 4.58% 9.55% 1.80% 0.92%
Ratios to Average Net Assets(1):
Expenses 1.79% 1.72% 1.84% 1.77% 1.75%
Net investment income 1.49% 3.35% 5.08% 5.35% 5.00%
Supplemental Data:
Net assets, end of period, in thousands $ 99,695 $ 103,238 $ 97,452 $ 82,964 $ 120,843
Portfolio turnover rate 429% 400% 358% 114% 99%
</Table>
- ----------
+ DOES NOT REFLECT THE DEDUCTION OF SALES CHARGE. CALCULATED BASED ON THE NET
ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD.
(1) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC
EXPENSES.
SEE NOTES TO FINANCIAL STATEMENTS
26
<Page>
<Table>
<Caption>
FOR THE YEAR ENDED AUGUST 31,
----------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
Class C Shares:
Selected Per Share Data:
Net asset value, beginning of period $ 9.46 $ 9.36 $ 8.99 $ 9.32 $ 9.71
---------- ---------- ---------- ---------- ----------
Income (loss) from investment operations:
Net investment income 0.14 0.31 0.47 0.49 0.49
Net realized and unrealized gain (loss) 0.03 0.10 0.37 (0.33) (0.39)
---------- ---------- ---------- ---------- ----------
Total income from investment operations 0.17 0.41 0.84 0.16 0.10
---------- ---------- ---------- ---------- ----------
Less dividends from net investment income (0.29) (0.31) (0.47) (0.49) (0.49)
---------- ---------- ---------- ---------- ----------
Net asset value, end of period $ 9.34 $ 9.46 $ 9.36 $ 8.99 $ 9.32
========== ========== ========== ========== ==========
Total Return+ 1.74% 4.57% 9.54% 1.80% 0.91%
Ratios to Average Net Assets(1):
Expenses 1.79% 1.72% 1.84% 1.77% 1.75%
Net investment income 1.49% 3.35% 5.08% 5.35% 5.00%
Supplemental Data:
Net assets, end of period, in thousands $ 10,389 $ 6,415 $ 4,226 $ 1,738 $ 1,759
Portfolio turnover rate 429% 400% 358% 114% 99%
</Table>
- ----------
+ DOES NOT REFLECT THE DEDUCTION OF SALES CHARGE. CALCULATED BASED ON THE NET
ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE PERIOD.
(1) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC
EXPENSES.
SEE NOTES TO FINANCIAL STATEMENTS
27
<Page>
<Table>
<Caption>
FOR THE YEAR ENDED AUGUST 31,
----------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
Class D Shares:
Selected Per Share Data:
Net asset value, beginning of period $ 9.43 $ 9.35 $ 8.98 $ 9.31 $ 9.70
---------- ---------- ---------- ---------- ----------
Income (loss) from investment operations:
Net investment income 0.22 0.38 0.55 0.57 0.57
Net realized and unrealized gain (loss) 0.01 0.09 0.37 (0.33) (0.39)
---------- ---------- ---------- ---------- ----------
Total income from investment operations 0.23 0.47 0.92 0.24 0.18
---------- ---------- ---------- ---------- ----------
Less dividends from net investment income (0.37) (0.39) (0.55) (0.57) (0.57)
---------- ---------- ---------- ---------- ----------
Net asset value, end of period $ 9.29 $ 9.43 $ 9.35 $ 8.98 $ 9.31
========== ========== ========== ========== ==========
Total Return+ 2.39% 5.23% 10.48% 2.67% 1.79%
Ratios to Average Net Assets(1):
Expenses 0.94% 0.87% 0.99% 0.92% 0.90%
Net investment income 2.34% 4.20% 5.93% 6.20% 5.85%
Supplemental Data:
Net assets, end of period, in thousands $ 7,113 $ 11,943 $ 3,018 $ 6,834 $ 7,493
Portfolio turnover rate 429% 400% 358% 114% 99%
</Table>
- ----------
+ CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE
PERIOD.
(1) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC
EXPENSES.
SEE NOTES TO FINANCIAL STATEMENTS
28
<Page>
Morgan Stanley Quality Income Trust
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Trustees of
Morgan Stanley Quality Income Trust:
We have audited the accompanying statement of assets and liabilities of Morgan
Stanley Quality Income Trust (the "Fund"), formerly Morgan Stanley Intermediate
Income Securities, including the portfolio of investments, as of August 31,
2003, and the related statements of operations for the year then ended and
changes in net assets for each of the two years in the period then ended, and
the financial highlights for each of the five years in the period then ended.
These financial statements and financial highlights are the responsibility of
the Fund's management. Our responsibility is to express an opinion on these
financial statements and financial highlights based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. Our procedures included confirmation of
securities owned as of August 31, 2003, by correspondence with the custodian and
brokers; where replies were not received from brokers, we performed other
auditing procedures. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Morgan
Stanley Quality Income Trust as of August 31, 2003, the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended, and the financial highlights for each of
the five years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America.
Deloitte & Touche LLP
NEW YORK, NEW YORK
OCTOBER 15, 2003
2003 FEDERAL TAX NOTICE (UNAUDITED)
Of the Fund's ordinary income dividends paid during the
fiscal year ended August 31, 2003, 19.15% was attributable
to qualifying Federal obligations. Please consult your tax
advisor to determine if any portion of the dividends you
received is exempt from state income tax.
29
<Page>
Morgan Stanley Quality Income Trust
TRUSTEE AND OFFICER INFORMATION
Independent Trustees:
<Table>
<Caption>
TERM OF
POSITION(S) OFFICE AND
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF
INDEPENDENT TRUSTEE REGISTRANT TIME SERVED* PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS**
- -------------------------------------- ----------- ------------- ---------------------------------------------
Michael Bozic (62) Trustee Since Retired; Director or Trustee of the Retail
c/o Mayer, Brown, Rowe & Maw LLP April 1994 Funds and TCW/DW Term Trust 2003 (since April
Counsel to the Independent Directors 1994) and the Institutional Funds (since July
1675 Broadway 2003); formerly Vice Chairman of Kmart
New York, NY Corporation (December 1998-October 2000),
Chairman and Chief Executive Officer of
Levitz Furniture Corporation (November
1995-November 1998) and President and Chief
Executive Officer of Hills Department Stores
(May 1991-July 1995); formerly variously
Chairman, Chief Executive Officer, President
and Chief Operating Officer (1987-1991) of
the Sears Merchandise Group of Sears, Roebuck
& Co.
Edwin J. Garn (70) Trustee Since Director or Trustee of the Retail Funds and
c/o Summit Ventures LLC January 1993 TCW/DW Term Trust 2003 (since January 1993)
1 Utah Center and the Institutional Funds (since July
201 S. Main Street 2003); member of the Utah Regional Advisory
Salt Lake City, UT Board of Pacific Corp.; formerly United
States Senator (R-Utah) (1974-1992) and
Chairman, Senate Banking Committee
(1980-1986), Mayor of Salt Lake City, Utah
(1971-1974), Astronaut, Space Shuttle
Discovery (April 12-19, 1985), and Vice
Chairman, Huntsman Corporation (chemical
company).
Wayne E. Hedien (69) Trustee Since Retired; Director or Trustee of the Retail
c/o Mayer, Brown, Rowe & Maw LLP September Funds and TCW/DW Term Trust 2003; (Since
Counsel to the Independent Directors 1997 September 1997) and the Institutional Funds
1675 Broadway (since July 2003); formerly associated with
New York, NY the Allstate Companies (1966-1994), most
recently as Chairman of The Allstate
Corporation (March 1993-December 1994) and
Chairman and Chief Executive Officer of its
wholly-owned subsidiary, Allstate Insurance
Company (July 1989-December 1994).
<Caption>
NUMBER OF
PORTFOLIOS
IN FUND
COMPLEX
NAME, AGE AND ADDRESS OF OVERSEEN
INDEPENDENT TRUSTEE BY TRUSTEE*** OTHER DIRECTORSHIPS HELD BY TRUSTEE
- -------------------------------------- ------------- ----------------------------------------
Michael Bozic (62) 216 Director of Weirton Steel Corporation.
c/o Mayer, Brown, Rowe & Maw LLP
Counsel to the Independent Directors
1675 Broadway
New York, NY
Edwin J. Garn (70) 216 Director of Franklin Covey (time
c/o Summit Ventures LLC management systems), BMW Bank of North
1 Utah Center America, Inc. (industrial loan
201 S. Main Street corporation), United Space Alliance
Salt Lake City, UT (joint venture between Lockheed Martin
and the Boeing Company) and Nuskin Asia
Pacific (multilevel marketing); member
of the board of various civic and
charitable organizations.
Wayne E. Hedien (69) 216 Director of The PMI Group Inc. (private
c/o Mayer, Brown, Rowe & Maw LLP mortgage insurance); Trustee and Vice
Counsel to the Independent Directors Chairman of The Field Museum of Natural
1675 Broadway History; director of various other
New York, NY business and charitable organizations.
</Table>
30
<Page>
<Table>
<Caption>
TERM OF
POSITION(S) OFFICE AND
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF
INDEPENDENT TRUSTEE REGISTRANT TIME SERVED* PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS**
- -------------------------------------- ----------- ------------- ---------------------------------------------
Dr. Manuel H. Johnson (54) Trustee Since Chairman of the Audit Committee and Director
c/o Johnson Smick International, Inc. July 1991 or Trustee of the Retail Funds and TCW/DW
2099 Pennsylvania Avenue, N.W. Term Trust 2003 (since July 1991) and the
Suite 950 Institutional Funds (since July 2003); Senior
Washington, D.C. Partner, Johnson Smick International, Inc., a
consulting firm; Co-Chairman and a founder of
the Group of Seven Council (G7C), an
international economic commission; formerly
Vice Chairman of the Board of Governors of
the Federal Reserve System and Assistant
Secretary of the U.S. Treasury.
Joseph J. Kearns (61) Trustee Since Deputy Chairman of the Audit Committee and
PMB754 July 2003 Director or Trustee of the Retail Funds and
23852 Pacific Coast Highway TCW/DW Term Trust 2003 (since July 2003) and
Malibu, CA the Institutional Funds (since August 1994);
previously Chairman of the Audit Committee of
the Institutional Funds (October 2001-July
2003); President, Kearns & Associates LLC
(investment consulting); formerly CFO of the
J. Paul Getty Trust.
Michael E. Nugent (67) Trustee Since Chairman of the Insurance Committee and
c/o Triumph Capital, L.P. July 1991 Director or Trustee of the Retail Funds and
445 Park Avenue TCW/DW Term Trust 2003 (since July 1991) and
New York, NY the Institutional Funds (since July 2001);
General Partner of Triumph Capital, L.P., a
private investment partnership; formerly Vice
President, Bankers Trust Company and BT
Capital Corporation (1984-1988).
Fergus Reid (71) Trustee Since Chairman of the Governance Committee and
85 Charles Colman Blvd. July 2003 Director or Trustee of the Retail Funds and
Pawling, NY TCW/DW Term Trust 2003 (since July 2003) and
the Institutional Funds (since June 1992);
Chairman of Lumelite Plastics Corporation.
<Caption>
NUMBER OF
PORTFOLIOS
IN FUND
COMPLEX
NAME, AGE AND ADDRESS OF OVERSEEN
INDEPENDENT TRUSTEE BY TRUSTEE*** OTHER DIRECTORSHIPS HELD BY TRUSTEE
- -------------------------------------- ------------- ----------------------------------------
Dr. Manuel H. Johnson (54) 216 Director of NVR, Inc. (home
c/o Johnson Smick International, Inc. construction); Chairman and Trustee of
2099 Pennsylvania Avenue, N.W. the Financial Accounting Foundation
Suite 950 (oversight organization of the Financial
Washington, D.C. Accounting Standards Board); Director of
RBS Greenwich Capital Holdings
(financial holding company).
Joseph J. Kearns (61) 217 Director of Electro Rent Corporation
PMB754 (equipment leasing), The Ford Family
23852 Pacific Coast Highway Foundation, and the UCLA Foundation.
Malibu, CA
Michael E. Nugent (67) 216 Director of various business
c/o Triumph Capital, L.P. organizations.
445 Park Avenue
New York, NY
Fergus Reid (71) 217 Trustee and Director of certain
85 Charles Colman Blvd. investment companies in the JPMorgan
Pawling, NY Funds complex managed by JP Morgan
Investment Management Inc.
</Table>
31
<Page>
Interested Trustees:
<Table>
<Caption>
TERM OF
POSITION(S) OFFICE AND
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF
INDEPENDENT TRUSTEE REGISTRANT TIME SERVED* PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS**
- -------------------------------------- ----------- ------------- ---------------------------------------------
Charles A. Fiumefreddo (70) Chairman of Since Chairman and Director or Trustee of the
c/o Morgan Stanley Trust the Board July 1991 Retail Funds and TCW/DW Term Trust 2003
Harborside Financial Center, and Trustee (since July 1991) and the Institutional Funds
Plaza Two, (since July 2003); formerly Chief Executive
Jersey City, NJ Officer of the Retail Funds and the TCW/DW
Term Trust 2003 (until September 2002).
James F. Higgins (55) Trustee Since Director or Trustee of the Retail Funds and
c/o Morgan Stanley Trust June 2000 TCW/DW Term Trust 2003 (since June 2000) and
Harborside Financial Center, the Institutional Funds (since July 2003);
Plaza Two, Senior Advisor of Morgan Stanley (since
Jersey City, NJ August 2000); Director of the Distributor and
Dean Witter Realty Inc.; previously President
and Chief Operating Officer of the Private
Client Group of Morgan Stanley (May
1999-August 2000), and President and Chief
Operating Officer of Individual Securities of
Morgan Stanley (February 1997-May 1999).
Philip J. Purcell (59) Trustee Since Director or Trustee of the Retail Funds and
1585 Broadway April 1994 TCW/DW Term Trust 2003 (since April 1994) and
New York, NY the Institutional Funds (since July 2003);
Chairman of the Board of Directors and Chief
Executive Officer of Morgan Stanley and
Morgan Stanley DW Inc.; Director of the
Distributor; Chairman of the Board of
Directors and Chief Executive Officer of
Novus Credit Services Inc.; Director and/or
officer of various Morgan Stanley
subsidiaries.
<Caption>
NUMBER OF
PORTFOLIOS
IN FUND
COMPLEX
NAME, AGE AND ADDRESS OF OVERSEEN
INDEPENDENT TRUSTEE BY TRUSTEE*** OTHER DIRECTORSHIPS HELD BY TRUSTEE
- -------------------------------------- ------------- ----------------------------------------
Charles A. Fiumefreddo (70) 216 None
c/o Morgan Stanley Trust
Harborside Financial Center,
Plaza Two,
Jersey City, NJ
James F. Higgins (55) 216 Director of AXA Financial, Inc. and The
c/o Morgan Stanley Trust Equitable Life Assurance Society of the
Harborside Financial Center, United States (financial services).
Plaza Two,
Jersey City, NJ
Philip J. Purcell (59) 216 Director of American Airlines, Inc. and
1585 Broadway its parent company, AMR Corporation.
New York, NY
</Table>
- --------------------
* THIS IS THE EARLIEST DATE THE TRUSTEE BEGAN SERVING THE FUNDS ADVISED BY
MORGAN STANLEY INVESTMENT ADVISORS INC. (THE "INVESTMENT MANAGER") (THE
"RETAIL FUNDS").
** THE DATES REFERENCED BELOW INDICATING COMMENCEMENT OF SERVICES AS
DIRECTOR/TRUSTEE FOR THE RETAIL FUNDS AND THE FUNDS ADVISED BY MORGAN
STANLEY INVESTMENT MANAGEMENT INC., MORGAN STANLEY INVESTMENTS LP AND
MORGAN STANLEY AIP GP LP (THE "INSTITUTIONAL FUNDS") REFLECT THE EARLIEST
DATE THE DIRECTOR/TRUSTEE BEGAN SERVING THE RETAIL OR INSTITUTIONAL FUNDS
AS APPLICABLE.
*** THE FUND COMPLEX INCLUDES ALL OPEN-END AND CLOSED-END FUNDS (INCLUDING ALL
OF THEIR PORTFOLIOS) ADVISED BY THE INVESTMENT MANAGER AND ANY FUNDS THAT
HAVE AN INVESTMENT ADVISOR THAT IS AN AFFILIATED PERSON OF THE INVESTMENT
MANAGER (INCLUDING BUT NOT LIMITED TO MORGAN STANLEY INVESTMENT MANAGEMENT
INC. AND MORGAN STANLEY INVESTMENTS LP).
32
<Page>
Officers:
<Table>
<Caption>
TERM OF
POSITION(S) OFFICE AND
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF
EXECUTIVE OFFICER REGISTRANT TIME SERVED* PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS**
- -------------------------------------- --------------- --------------- -----------------------------------------------------------
Mitchell M. Merin (50) President Since May 1999 President and Chief Operating Officer of Morgan Stanley
1221 Avenue of the Americas Investment Management Inc.; President, Director and Chief
New York, NY Executive Officer of the Investment Manager and Morgan
Stanley Services; Chairman, Chief Executive Officer and
Director of the Distributor; Chairman and Director of the
Transfer Agent; Director of various Morgan Stanley
subsidiaries; President Morgan Stanley Investments LP
(since February 2003); President of the Institutional Funds
(since July 2003) and President of the Retail Funds and
TCW/DW Term Trust 2003 (since May 1999); Trustee (since
July 2003) and President (since December 2002) of the Van
Kampen Closed-End Funds; Trustee (since May 1999) and
President (since October 2002) of the Van Kampen Open-End
Funds.
Ronald E. Robison (64) Executive Vice Since Chief Global Operations Officer and Managing Director of
1221 Avenue of the Americas President and April 2003 Morgan Stanley Investment Management Inc.; Managing
New York, NY Principal DIrector of Morgan Stanley & Co. Incorporated; Managing
Executive DIrector of Morgan Stanley; Managing Director, Chief
Officer Administrative Officer and Director of the Investment
Manager and Morgan Stanley Services; Chief Executive
Officer and Director of the Transfer Agent; Executive Vice
President and Principal Executive Officer of the
Institutional Funds (since July 2003); and the TCW/DW Term
Trust 2003 (since April 2003); previously President of the
Institutional Funds (March 2001-July 2003) and Director of
the Institutional Funds (March 2001-July 2003).
Barry Fink (48) Vice President Since General Counsel (since May 2000) and Managing Director
1221 Avenue of the Americas and General February 1997 (since December 2000) of Morgan Stanley Investment
New York, NY Counsel Management; Managing Director (since December 2000),
Secretary (since February 1997) and Director (since July
1998) of the Investment Manager and Morgan Stanley
Services; Assistant Secretary of Morgan Stanley DW; Chief
Legal Officer of Morgan Stanley Investments LP (since July
2002); Vice President of the Institutional Funds (since
July 2003); Vice President and Secretary of the
Distributor; previously Secretary of the Retail Funds
(February 1997-July 2003); previously Vice President and
Assistant General Counsel of the Investment Manager and
Morgan Stanley Services (February 1997-December 2001).
Joseph J. McAlinden (60) Vice President Since July 1995 Managing Director and Chief Investment Officer of the
1221 Avenue of the Americas Investment Manager, Morgan Stanley Investment Management
New York, NY Inc. and Morgan Stanley Investments LP; Director of the
Transfer Agent, Chief Investment Officer of the Van Kampen
Funds; Vice President of the Institutional Funds (since
July 2003) and the Retail Funds (since July 1995).
Stefanie V. Chang (36) Vice President Since July 2003 Executive Director of Morgan Stanley & Co. and Morgan
1221 Avenue of the Americas Stanley Investment Management Inc. and Vice President of
New York, NY the Institutional Funds (since December 1997) and the
Retail Funds (since July 2003); formerly practiced law with
the New York law firm of Rogers & Wells (now Clifford
Chance LLP).
</Table>
33
<Page>
<Table>
<Caption>
TERM OF
POSITION(S) OFFICE AND
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF
EXECUTIVE OFFICER REGISTRANT TIME SERVED* PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS**
- -------------------------------------- --------------- --------------- -----------------------------------------------------------
Francis Smith (38) Treasurer and Treasurer since Executive Director of the Investment Manager and Morgan
c/o Morgan Stanley Trust Chief Financial July 2003 and Stanley Services (since December 2001); previously Vice
Harborside Financial Center, Officer Chief Financial President of the Retail Funds (September 2002-July 2003);
Plaza Two, Officer since previously Vice President of the Investment Manager and
Jersey City, NJ September 2002 Morgan Stanley Services (August 2000-November 2001) and
Senior Manager at PricewaterhouseCoopers LLP (January
1998-August 2000).
Thomas F. Caloia (57) Vice President Since July 2003 Executive Director (since December 2002) and Assistant
c/o Morgan Stanley Trust Treasurer of the Investment Manager, the Distributor and
Harborside Financial Center, Morgan Stanley Services; previously Treasurer of the Retail
Plaza Two, Funds (April 1989-July 2003); formerly First Vice President
Jersey City, NJ of the Investment Manager, the Distributor and Morgan
Stanley Services.
Mary E. Mullin (36) Secretary Since July 2003 Vice President of Morgan Stanley & Co. Incorporated and
1221 Avenue of the Americas Morgan Stanley Investment Management Inc.; Secretary of the
New York, NY Institutional Funds (since June 1999) and the Retail Funds
(since July 2003); formerly practiced law with the New York
law firms of McDermott, Will & Emery and Skadden, Arps,
Slate, Meagher & Flom LLP.
</Table>
- ----------
* THIS IS THE EARLIEST DATE THE OFFICER BEGAN SERVING THE RETAIL FUNDS. EACH
OFFICER SERVES AN INDEFINITE TERM, UNTIL HIS OR HER SUCCESSOR IS ELECTED.
** THE DATES REFERENCED BELOW INDICATING COMMENCEMENT OF SERVICE AS AN OFFICER
FOR THE RETAIL AND INSTITUTIONAL FUNDS REFLECT THE EARLIEST DATE THE
OFFICER BEGAN SERVING THE RETAIL OR INSTITUTIONAL FUNDS AS APPLICABLE.
34
<Page>
TRUSTEES
Michael Bozic
Charles A. Fiumefreddo
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Joseph J. Kearns
Michael E. Nugent
Philip J. Purcell
Fergus Reid
OFFICERS
Charles A. Fiumefreddo
CHAIRMAN OF THE BOARD
Mitchell M. Merin
PRESIDENT
Ronald E. Robison
EXECUTIVE VICE PRESIDENT and PRINCIPAL EXECUTIVE OFFICER
Barry Fink
VICE PRESIDENT and GENERAL COUNSEL
Joseph J. McAlinden
VICE PRESIDENT
Stefanie V. Chang
VICE PRESIDENT
Francis Smith
TREASURER and CHIEF FINANCIAL OFFICER
Thomas F. Caloia
VICE PRESIDENT
Mary E. Mullin
SECRETARY
TRANSFER AGENT
Morgan Stanley Trust
Harborside Financial Center, Plaza Two
Jersey City, New Jersey 07311
INDEPENDENT AUDITORS
Deloitte & Touche LLP
Two World Financial Center
New York, New York 10281
INVESTMENT MANAGER
Morgan Stanley Investment Advisors Inc.
1221 Avenue of the Americas
New York, New York 10020
This report is submitted for the general information of the shareholders of the
Fund. For more detailed information about the Fund, its fees and expenses and
other pertinent information, please read its Prospectus. The Fund's Statement of
Additional Information contains additional information about the Fund, including
its trustees. It is available, without charge, by calling (800) 869-NEWS.
This report is not authorized for distribution to prospective investors in the
Fund unless preceded or accompanied by an effective Prospectus. Read the
Prospectus carefully before investing.
Investments and services offered through Morgan Stanley DW Inc., member SIPC.
Morgan Stanley Distributors Inc., member NASD.
(C) 2003 Morgan Stanley
[MORGAN STANLEY LOGO]
38557RPT-12363J03-ANP-10/03
[MORGAN STANLEY FUNDS LOGO]
MORGAN STANLEY QUALITY INCOME TRUST
ANNUAL REPORT
AUGUST 31, 2003
[MORGAN STANLEY LOGO]
<Page>
Item 2. Code of Ethics.
(a) The Fund has adopted a code of ethics (the "Code of Ethics") that applies
to its principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar functions,
regardless of whether these individuals are employed by the Fund or a third
party.
(b) No information need be disclosed pursuant to this paragraph.
(c) The Fund has amended its Code of Ethics during the period covered by the
shareholder report presented in Item 1 hereto
(d) The Fund has granted a waiver or an implicit waiver from a provision of its
Code of Ethics.
(e) Not applicable.
(f)
(1) The Fund's Code of Ethics is attached hereto as Exhibit A.
(2) Not applicable.
(3) Not applicable.
Item 3. Audit Committee Financial Expert.
The Fund's Board of Trustees has determined that it has two "audit committee
financial experts" serving on its audit committee, each of whom are
"independent" Trustees: Dr. Manuel H. Johnson and Joseph J. Kearns. Under
applicable securities laws, a person who is determined to be an audit committee
financial expert will not be deemed an "expert" for any purpose, including
without limitation for the purposes of Section 11 of the Securities Act of 1933,
as a result of being designated or identified as an audit committee financial
expert. The designation or identification of a person as an audit committee
financial expert does not impose on such person any duties, obligations, or
liabilities that are greater than the duties, obligations, and liabilities
imposed on such person as a member of the audit committee and Board of Trustees
in the absence of such designation or identification.
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Item 9 - 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.
There were no significant changes or corrective actions with regard to
significant deficiencies or material weaknesses in the Fund's internal controls
or in other factors that could significantly affect the Fund's internal controls
subsequent to the date of their evaluation.
(b) There were no changes in the registrant's internal control over financial
reporting that occurred during the registrant's most recent fiscal half-year
(the registrant's second fiscal half-year in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
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Item 10 Exhibits
(a) The Code of Ethics for Principal Executive and Senior Financial Officers is
attached hereto.
(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.
Items 4 - 8 are not applicable
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 Quality Income Trust
Ronald E. Robison
Principal Executive Officer
October 20, 2003
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.
Ronald E. Robison
Principal Executive Officer
October 20, 2003
Francis Smith
Principal Financial Officer
October 20, 2003