<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, 2004
Date of reporting period: February 29, 2004
Item 1 - Report to Shareholders
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Welcome, Shareholder:
In this report, you'll learn about how your investment in Morgan Stanley Quality
Income Trust 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.
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 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.
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FUND REPORT
For the six-month period ended February 29, 2004
TOTAL RETURN FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004
<Table>
<Caption>
LEHMAN
BROTHERS
INTERMEDIATE LIPPER
U.S. GOVERNMENT/ BBB RATED
CLASS A CLASS B CLASS C CLASS D CREDIT INDEX(1) FUNDS INDEX(2)
5.74% 5.45% 5.33% 5.80% 4.32% 6.77%
</Table>
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS AND CURRENT PERFORMANCE MAY
BE LOWER OR HIGHER THAN THE FIGURES SHOWN. FOR MORE UP-TO-DATE INFORMATION,
INCLUDING MONTH-END PERFORMANCE FIGURES, PLEASE VISIT MORGANSTANLEY.COM OR SPEAK
WITH YOUR FINANCIAL ADVISOR. INVESTMENT RETURNS AND PRINCIPAL VALUE WILL
FLUCTUATE AND FUND SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR
ORIGINAL COST. THE PERFORMANCE OF THE FUND'S FOUR SHARE CLASSES VARIES BECAUSE
EACH HAS DIFFERENT EXPENSES. THE FUND'S TOTAL RETURN FIGURES ASSUME THE
REINVESTMENT OF ALL DISTRIBUTIONS BUT DO NOT REFLECT THE DEDUCTION OF ANY
APPLICABLE SALES CHARGES. SUCH COSTS WOULD LOWER PERFORMANCE. SEE PERFORMANCE
SUMMARY FOR STANDARDIZED PERFORMANCE INFORMATION.
MARKET CONDITIONS
The markets during this review period saw a substantial amount of data
indicating a stronger economy, including reports of 8.2 percent GDP growth in
the third quarter and 4.1 percent in the fourth. While such robust growth might
typically lead to higher interest rates, rates instead fell during the review
period, primarily reflecting indications from the Federal Reserve Bank Open
Market Committee (the Fed) that it planned to keep the federal funds rate at low
levels "for a considerable period." The Fed remained concerned by a lack of job
growth, and investors remained deeply concerned about terrorism and other
potentially deflationary forces.
Against this backdrop, sector performance varied considerably. Falling interest
rates were most clearly expressed in the Treasury market, which saw a
significant rally, especially in September. A combination of improving economic
conditions, broad-based profit growth and increased liquidity buoyed the credit
markets, which saw yield spreads over Treasuries compress during the six-month
period. Investors' increasing appetite for risk led to substantial
outperformance by lower-rated issues, with BBB-rated debt outpacing the
highest-quality bonds by more than 300 basis points. The mortgage-backed
securities (MBS) market lagged during the period as falling interest rates and
continued high levels of homeowner refinancing undercut the sector's
performance.
PERFORMANCE ANALYSIS
Morgan Stanley Quality Income Trust outperformed its primary benchmark, the
Lehman Brothers Intermediate U.S. Government/Credit Index (the "Lehman Index"),
but underperformed the Lipper BBB Rated Funds Index (the "Lipper Index"). The
Fund's corporate bond holdings contributed positively to performance relative to
the Lehman Index. However, relative to the Lipper Index, the fund, on average,
tends to invest in somewhat higher quality debt securities which did not perform
as well as lower rated debt securities. Both sector and issue selection also
benefited the Fund's performance. We used our quantitative risk model and
fundamental research to initiate several new positions to increase the credit
sensitivity of the Fund. During the period, the Fund benefited from a strong
position in the insurance sector, which we felt to be one of the few
high-quality areas of the market that still offered good value. We also
deemphasized the banking and food and beverage sectors, both of which
underperformed the market during the period. The Fund's MBS holdings proved less
beneficial to performance. Our analysis indicated that higher-coupon MBSs were
being unfairly penalized because of unrealistically high prepayment
expectations. As a result, we focused the Fund's MBS holdings in such
securities, only to see them lose ground in the Treasury rally as investors
priced in expectations for even faster prepayments. While these securities did
prepay quickly,
2
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they did not do so as quickly as the market had expected, and we maintained our
position throughout the period.
Based on our analysis of the economy and the yield curve, we chose to maintain a
relatively low level of interest-rate sensitivity in anticipation of higher
rates once job growth materializes. We implemented this strategy by
deemphasizing the five-year portion of the yield curve. This stance limited the
Fund's interest-rate sensitivity during a period of generally falling rates,
causing it to miss much of the rally in the five-year section of the curve.
PORTFOLIO COMPOSITION
<Table>
Corporate Debt 78.8%
Mortgage-Backed Securities 12.7
Short Term Investments 6.3
Foreign Government Obligations 2.1
U.S. Government Agencies 0.1
</Table>
LONG-TERM CREDIT ANALYSIS
<Table>
AAA 4.2%
AA 7.2
A 34.0
BBB 40.4
BB 0.3
</Table>
DATA AS OF FEBRUARY 29, 2004. SUBJECT TO CHANGE DAILY. PORTFOLIO COMPOSITION IS
A PERCENTAGE OF TOTAL INVESTMENTS AND LONG-TERM CREDIT ANALYSIS IS A PERCENTAGE
OF TOTAL LONG-TERM INVESTMENTS. 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.
INVESTMENT STRATEGY
THE FUND WILL NORMALLY INVEST AT LEAST 80% OF ITS ASSETS IN INVESTMENT GRADE
FIXED INCOME SECURITIES. THESE SECURITIES MAY INCLUDE CORPORATE DEBT SECURITIES,
PREFERRED STOCKS, U.S. GOVERNMENT SECURITIES, MORTGAGE-BACKED SECURITIES,
INCLUDING COLLATERALIZED MORTGAGE OBLIGATIONS, ASSET-BACKED SECURITIES AND
SECURITIES ISSUED BY FOREIGN GOVERNMENTS OR CORPORATIONS. IN DECIDING WHICH
SECURITIES TO BUY, HOLD OR SELL, THE FUND'S "INVESTMENT MANAGER," MORGAN STANLEY
INVESTMENT ADVISORS INC., CONSIDERS DOMESTIC AND INTERNATIONAL ECONOMIC
DEVELOPMENTS, INTEREST RATE TRENDS, BOND RATINGS AND OTHER FACTORS RELATING TO
THE ISSUERS.
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 WEB SITE AT
http://www.sec.gov.
3
<Page>
PERFORMANCE SUMMARY
AVERAGE ANNUAL TOTAL RETURNS--PERIOD ENDED FEBRUARY 29, 2004
<Table>
<Caption>
CLASS A SHARES* CLASS B SHARES** CLASS C SHARES+ CLASS D SHARES++
(SINCE 07/28/97) (SINCE 05/03/89) (SINCE 07/28/97) (SINCE 07/28/97)
SYMBOL IISAX IISBX IISCX IISDX
1 YEAR 4.72%(3) 4.08%(3) 4.07%(3) 4.85%(3)
0.27(4) (0.92)(4) 3.07(4) --
5 YEARS 5.24(3) 4.38(3) 4.40(3) 5.18(3)
4.33(4) 4.04(4) 4.40(4) --
10 YEARS -- 4.74(3) -- --
-- 4.74(4) -- --
SINCE INCEPTION 5.29(3) 5.71(3) 4.51(3) 5.32(3)
4.60(4) 5.71(4) 4.51(4) --
</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 TABLE DOES 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.
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 BBB Rated Funds Index is an equally weighted performance index
of the largest qualifying funds (based on net assets) in the Lipper BBB
Rated 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.
4
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MORGAN STANLEY QUALITY INCOME TRUST
PORTFOLIO OF INVESTMENTS - FEBRUARY 29, 2004 (UNAUDITED)
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------------------
CORPORATE BONDS (83.9%)
AEROSPACE & DEFENSE (1.5%)
$ 335 Lockheed Martin Corp. 8.50% 12/01/29 $ 449,259
400 Raytheon Co. 4.85 01/15/11 412,687
55 Raytheon Co. 6.75 08/15/07 61,661
100 Raytheon Co. 8.30 03/01/10 121,661
589 Systems 2001 Asset Trust - 144A* 6.664 09/15/13 662,807
---------------
1,708,075
---------------
AIR FREIGHT/COURIERS (0.3%)
280 FedEx Corp. 7.25 02/15/11 325,209
---------------
AIRLINES (1.2%)
257 American West Airlines 7.10 04/02/21 284,795
346 Continental Airlines, Inc. 6.545 02/02/19 349,539
238 Continental Airlines, Inc. 6.648 09/15/17 238,434
450 Southwest Airlines Co. 5.496 11/01/06 483,519
---------------
1,356,287
---------------
AUTO PARTS: O.E.M. (0.6%)
365 Delphi Automotive Systems Corp. 6.125 05/01/04 367,408
265 Johnson Controls, Inc. 5.00 11/15/06 283,432
---------------
650,840
---------------
BEVERAGES: ALCOHOLIC (0.5%)
570 Miller Brewing Co. - 144A* 4.25 08/15/08 588,059
---------------
BROADCASTING (0.5%)
490 Clear Channel Communications, Inc. 7.65 09/15/10 582,994
---------------
BUILDING PRODUCTS (0.1%)
160 Masco Corp. 4.625 08/15/07 168,828
---------------
CABLE/SATELLITE TV (1.2%)
1,040 Comcast Corp. 6.50 01/15/15 1,152,540
225 TCI Communications, Inc. 8.00 08/01/05 243,847
---------------
1,396,387
---------------
CHEMICALS: MAJOR DIVERSIFIED (0.3%)
345 ICI Wilmington Inc. 4.375 12/01/08 351,191
---------------
CONTAINERS/PACKAGING (0.5%)
540 Sealed Air Corp - 144A* 5.625 07/15/13 563,525
---------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
5
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<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------------------
DEPARTMENT STORES (2.3%)
$ 720 Federated Department Stores, Inc. 7.00 % 02/15/28 $ 812,331
200 Federated Department Stores, Inc. 8.50 06/01/10 245,771
1,045 May Department Stores Co., Inc. 5.95 11/01/08 1,143,571
170 May Department Stores Co., Inc. 6.70 09/15/28 185,166
130 May Department Stores Co., Inc. 6.875 11/01/05 139,814
125 May Department Stores Co., Inc. 6.90 01/15/32 139,874
---------------
2,666,527
---------------
DRUGSTORE CHAINS (1.0%)
425 CVS Corp. 5.625 03/15/06 455,413
599 CVS Corp. - 144A* 5.789 01/10/26 613,784
55 CVS Corp. - 144A* 6.204 10/10/25 57,869
---------------
1,127,066
---------------
ELECTRIC UTILITIES (5.6%)
350 Appalachian Power Co. (Series H) 5.95 05/15/33 349,379
755 Carolina Power & Light Co. 5.125 09/15/13 782,056
105 Cincinnati Gas & Electric Co. 5.70 09/15/12 112,557
260 Cincinnati Gas & Electric Co. (Series A) 5.40 06/15/33 245,713
500 Cincinnati Gas & Electric Co. (Series B) 5.375 06/15/33 470,773
525 Columbus Southern Power Co. 6.60 03/01/33 580,833
410 Constellation Energy Group, Inc. 7.60 04/01/32 493,652
470 Consolidated Natural Gas Co. 5.375 11/01/06 503,671
55 Detroit Edison Co. 6.125 10/01/10 61,336
200 Detroit Edison Co. 6.35 10/15/32 215,963
535 Duke Energy Corp. 4.50 04/01/10 550,688
285 Entergy Gulf States, Inc. - 144A* 3.60 06/01/08 278,168
510 Exelon Corp. 6.75 05/01/11 581,755
130 Public Service Electric & Gas Co. 5.00 01/01/13 134,168
260 South Carolina Electric & Gas Co. 5.30 05/15/33 247,921
110 Southern California Edison Co. 5.00 01/15/14 112,105
430 TXU Energy Co. 7.00 03/15/13 489,743
235 Wisconsin Electric Power Co. 5.625 05/15/33 235,280
---------------
6,445,761
---------------
ELECTRICAL PRODUCTS (0.4%)
450 Cooper Industries Inc. 5.25 07/01/07 485,128
---------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
6
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------------------
ENVIRONMENTAL SERVICES (1.1%)
$ 544 USA Waste Services, Inc. 7.00% 07/15/28 $ 604,531
310 USA Waste Services, Inc. 7.125 10/01/07 351,760
255 Waste Management, Inc. 6.875 05/15/09 290,757
---------------
1,247,048
---------------
FINANCE/RENTAL/LEASING (8.0%)
510 CIT Group Inc. 2.875 09/29/06 515,101
1,245 Countrywide Home Loans, Inc. 3.25 05/21/08 1,241,998
2,885 Ford Motor Credit Co. 7.25 10/25/11 3,130,118
800 Ford Motor Credit Co. 7.375 10/28/09 881,103
70 Household Finance Corp. 6.375 10/15/11 79,048
675 Household Finance Corp. 6.75 05/15/11 769,819
1,110 MBNA Corp. 6.125 03/01/13 1,221,945
745 SLM Corp. 5.00 10/01/13 759,582
525 Toyota Motor Credit Corp. 5.65 01/15/07 571,579
---------------
9,170,293
---------------
FINANCIAL CONGLOMERATES (10.0%)
735 Chase Manhattan Corp. 6.00 02/15/09 817,027
165 Chase Manhattan Corp. 7.00 11/15/09 193,316
500 Citicorp 6.375 11/15/08 560,263
465 Citigroup Inc. 5.50 08/09/06 500,879
100 Citigroup Inc. 5.625 08/27/12 108,338
265 Citigroup Inc. 6.00 02/21/12 294,703
660 General Electric Capital Corp. 5.375 03/15/07 714,365
1,195 General Electric Capital Corp. 6.75 03/15/32 1,374,177
385 General Motors Acceptance Corp. 4.50 07/15/06 397,846
2,000 General Motors Acceptance Corp. 6.875 09/15/11 2,160,210
1,080 General Motors Acceptance Corp. 8.00 11/01/31 1,193,341
905 John Hancock Financial Services, Inc. 5.625 12/01/08 989,188
475 John Hancock Global Funding II - 144A* 7.90 07/02/10 573,448
410 Prudential Funding LLC
(Series MTN) - 144A* 6.60 05/15/08 461,166
575 Prudential Holdings, LLC
(Series C) - 144A* 8.695 12/18/23 731,713
360 Prudential Holdings, LLC (Series B)
(FSA) - 144A* 7.245 12/18/23 422,604
---------------
11,492,584
---------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
7
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<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------------------
FOOD RETAIL (1.3%)
$ 395 Albertson's, Inc. 7.50% 02/15/11 $ 462,299
475 Kroger Co. 6.80 04/01/11 541,735
300 Kroger Co. 7.50 04/01/31 358,246
160 Safeway Inc. 6.15 03/01/06 171,779
---------------
1,534,059
---------------
FOOD: MEAT/FISH/DAIRY (0.2%)
230 Conagra Foods, Inc. 6.00 09/15/06 249,685
---------------
FOREST PRODUCTS (1.3%)
150 Weyerhaeuser Co. 6.00 08/01/06 162,012
1,150 Weyerhaeuser Co. 6.75 03/15/12 1,292,664
---------------
1,454,676
---------------
GAS DISTRIBUTORS (0.3%)
46 Ras Laffan Liquid Natural
Gas Co. Ltd. - 144A* (Qatar) 7.628 09/15/06 49,270
215 Ras Laffan Liquid Natural
Gas Co. Ltd. - 144A* (Qatar) 8.294 03/15/14 254,775
---------------
304,045
---------------
HOME BUILDING (0.6%)
135 Centex Corp. 7.875 02/01/11 161,120
375 Pulte Homes, Inc. 6.375 05/15/33 372,008
115 Pulte Homes, Inc. 7.875 08/01/11 137,291
---------------
670,419
---------------
HOME FURNISHINGS (0.2%)
110 Mohawk Industries, Inc. 7.20 04/15/12 127,047
130 Mohawk Industries, Inc. (Class C) 6.50 04/15/07 143,412
---------------
270,459
---------------
HOME IMPROVEMENT CHAINS (0.6%)
295 Lowe's Companies, Inc. 6.50 03/15/29 328,990
71 Lowe's Companies, Inc. 6.875 02/15/28 82,814
300 Lowe's Companies, Inc. 7.50 12/15/05 329,570
---------------
741,374
---------------
HOSPITAL/NURSING MANAGEMENT (0.8%)
335 HCA Inc. 7.125 06/01/06 363,928
460 Manor Care, Inc. 8.00 03/01/08 532,450
---------------
896,378
---------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
8
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- -------------------------------------------------------------------------------------------------------------------------
HOTELS/RESORTS/CRUISELINES (1.3%)
$ 695 Hyatt Equities LLC - 144A* 6.875% 06/15/07 $ 752,158
195 Marriott International, Inc. (Series D) 8.125 04/01/05 208,015
265 Marriott International, Inc. (Series E) 7.00 01/15/08 301,196
195 Starwood Hotels & Resorts Inc. 7.375 05/01/07 212,062
---------------
1,473,431
---------------
INDUSTRIAL CONGLOMERATES (1.8%)
515 Honeywell International, Inc. 5.125 11/01/06 551,855
550 Honeywell International, Inc. 7.50 03/01/10 656,330
315 Hutchison Whampoa International
Ltd. - 144A* (Virgin Islands) 5.45 11/24/10 324,363
515 Hutchison Whampoa International
Ltd. - 144A* (Virgin Islands) 6.50 02/13/13 545,607
---------------
2,078,155
---------------
INFORMATION TECHNOLOGY SERVICES (0.6%)
470 Electronic Data Systems Corp. 6.00 08/01/13 454,128
260 Electronic Data Systems Corp. 7.125 10/15/09 275,666
---------------
729,794
---------------
INSURANCE BROKERS/SERVICES (1.8%)
1,335 Farmers Exchange Capital - 144A* 7.05 07/15/28 1,348,079
250 Farmers Insurance Exchange - 144A* 8.50 08/01/04 254,418
410 Marsh & McLennan Companies Inc. 5.375 03/15/07 442,886
---------------
2,045,383
---------------
INTEGRATED OIL (2.4%)
510 Amerada Hess Corp. 7.875 10/01/29 588,016
305 Conoco Inc. 5.90 04/15/04 306,682
895 Conoco Inc. 6.95 04/15/29 1,044,019
225 ConocoPhillips 8.50 05/25/05 243,746
40 Petro-Canada (Canada) 4.00 07/15/13 37,740
525 Petro-Canada (Canada) 5.35 07/15/33 486,543
---------------
2,706,746
---------------
INVESTMENT BANKS/BROKERS (1.1%)
500 Goldman Sachs Group Inc. 5.25 10/15/13 513,761
90 Goldman Sachs Group Inc. 6.60 01/15/12 102,299
580 Goldman Sachs Group Inc. 6.875 01/15/11 670,098
---------------
1,286,158
---------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
9
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ------------------------------------------------------------------------------------------------------------------------
INVESTMENT MANAGERS (0.7%)
$ 735 TIAA Global Markets - 144A* 5.00% 03/01/07 $ 787,909
---------------
LIFE/HEALTH INSURANCE (1.1%)
875 Mantis Reef Ltd. - 144A* (Australia) 4.692 11/14/08 890,551
335 Monumental Global Funding II - 144A* 6.05 01/19/06 360,670
---------------
1,251,221
---------------
MAJOR BANKS (2.5%)
1,170 Bank of America Corp. 3.375 02/17/09 1,167,686
250 Bank of New York (The) 5.20 07/01/07 270,584
305 Bank One Corp. 6.00 02/17/09 339,330
480 Huntington National Bank 2.75 10/16/06 489,381
475 Wachovia Bank N.A. (Series BKNT) 7.80 08/18/10 581,109
---------------
2,848,090
---------------
MAJOR TELECOMMUNICATIONS (5.8%)
185 AT&T Corp. 8.05 11/15/11 215,859
790 AT&T Corp. 8.75 11/15/31 934,223
390 AT&T Wireless Services, Inc. 7.875 03/01/11 459,678
150 Deutsche Telekom International
Finance Corp. (Netherlands) 8.50 06/15/10 182,708
585 Deutsche Telekom International
Finance Corp. (Netherlands) 8.75 06/15/30 756,338
350 France Telecom S.A. (France) 9.75 03/01/31 464,429
240 Sprint Capital Corp. 8.75 03/15/32 298,752
480 Telecom Italia Capital SpA - 144A* (Italy) 4.00 11/15/08 485,746
80 Verizon Communications, Inc. 6.36 04/15/06 86,838
165 Verizon Global Funding Corp. 7.25 12/01/10 193,041
1,910 Verizon Global Funding Corp. 7.75 12/01/30 2,297,944
235 Verizon New England Inc. 6.50 09/15/11 263,724
---------------
6,639,280
---------------
MANAGED HEALTH CARE (3.0%)
290 Aetna, Inc. 7.875 03/01/11 349,755
60 Anthem, Inc. 6.80 08/01/12 69,128
885 Anthem Insurance Companies, Inc. - 144A* 9.125 04/01/10 1,132,123
1,115 Health Net, Inc. 8.375 04/15/11 1,360,168
270 UnitedHealth Group Inc. 7.50 11/15/05 295,161
175 Wellpoint Health Network, Inc. 6.375 06/15/06 190,866
---------------
3,397,201
---------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
10
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ------------------------------------------------------------------------------------------------------------------------
MEDIA CONGLOMERATES (3.3%)
$ 185 AOL Time Warner Inc. 6.75% 04/15/11 $ 208,370
500 AOL Time Warner Inc. 7.625 04/15/31 583,651
195 AOL Time Warner Inc. 7.70 05/01/32 230,287
900 News America Holdings, Inc. 7.28 06/30/28 1,031,737
600 News America Holdings, Inc. 7.75 02/01/24 704,057
50 News America Holdings, Inc. 8.875 04/26/23 65,357
65 News America Inc. 4.75 03/15/10 67,060
250 News America Inc. 6.625 01/09/08 279,668
530 Time Warner Co., Inc. 7.57 02/01/24 611,279
---------------
3,781,466
---------------
MOTOR VEHICLES (1.7%)
795 DaimlerChrysler North American Holdings Co. 7.30 01/15/12 906,345
215 DaimlerChrysler North American Holdings Co. 8.00 06/15/10 251,633
610 DaimlerChrysler North American Holdings Co. 8.50 01/18/31 742,826
---------------
1,900,804
---------------
MULTI-LINE INSURANCE (3.7%)
1,200 AIG SunAmerica Global Finance VI - 144A* 6.30 05/10/11 1,346,567
565 American General Finance Corp. 4.625 09/01/10 582,748
625 American General Finance Corp. 5.875 07/14/06 676,071
365 Equitable Life Assurance Society - 144A* 6.95 12/01/05 396,399
135 Hartford Financial Services Group, Inc. 2.375 06/01/06 135,282
500 Hartford Financial Services Group, Inc. 7.75 06/15/05 538,357
500 Nationwide Mutual Insurance Co. - 144A* 7.50 02/15/24 517,452
---------------
4,192,876
---------------
OIL & GAS PIPELINES (0.2%)
235 Texas Eastern Transmission, L.P. 7.00 07/15/32 264,552
---------------
OIL & GAS PRODUCTION (2.9%)
410 Kerr-McGee Corp. 5.875 09/15/06 442,266
460 Kerr-McGee Corp. 7.875 09/15/31 556,567
485 Nexen Inc. (Canada) 5.05 11/20/13 490,758
155 PEMEX Project Funding Master Trust 7.375 12/15/14 170,345
210 PEMEX Project Funding Master Trust 7.875 02/01/09 240,660
1,170 PEMEX Project Funding Master Trust 8.00 11/15/11 1,348,425
90 PEMEX Project Funding Master Trust 9.125 10/13/10 109,800
---------------
3,358,821
---------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
11
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ------------------------------------------------------------------------------------------------------------------------
OIL REFINING/MARKETING (0.6%)
$ 140 Ashland Inc. 7.83% 08/15/05 $ 150,751
120 Marathon Oil Corp. 6.00 07/01/12 131,427
300 Marathon Oil Corp. 6.80 03/15/32 334,343
---------------
616,521
---------------
OTHER CONSUMER SERVICES (0.8%)
810 Cendant Corp. 7.375 01/15/13 944,149
---------------
OTHER METALS/MINERALS (1.2%)
800 Inco Ltd. (Canada) 7.20 09/15/32 926,095
395 Inco Ltd. (Canada) 7.75 05/15/12 476,307
---------------
1,402,402
---------------
PHARMACEUTICALS: MAJOR (0.3%)
295 Schering-Plough Corp. 5.30 12/01/13 307,423
---------------
PULP & PAPER (1.0%)
105 Abitibi-Consolidated Inc. (Canada) 8.55 08/01/10 116,955
470 International Paper Co. 4.25 01/15/09 479,381
460 Sappi Papier Holding AG - 144A* (Austria) 6.75 06/15/12 516,194
---------------
1,112,530
---------------
RAILROADS (0.3%)
395 Union Pacific Corp. 5.84 05/25/04 398,581
---------------
REAL ESTATE DEVELOPMENT (0.9%)
384 World Financial Properties - 144A* 6.91 09/01/13 432,126
568 World Financial Properties - 144A* 6.95 09/01/13 639,477
---------------
1,071,603
---------------
REAL ESTATE INVESTMENT TRUSTS (2.3%)
290 EOP Operating L.P. 6.763 06/15/07 324,250
770 EOP Operating L.P. 7.875 07/15/31 931,209
135 Rouse Co. (The) 5.375 11/26/13 137,837
645 Simon Property Group L.P. 6.35 08/28/12 717,319
50 Simon Property Group L.P. 6.375 11/15/07 55,847
440 Vornado Realty Trust 5.625 06/15/07 476,363
---------------
2,642,825
---------------
REGIONAL BANKS (0.2%)
175 US Bancorp 5.10 07/15/07 188,673
---------------
SAVINGS BANKS (0.6%)
685 Washington Mutual Bank 5.50 01/15/13 722,036
---------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
12
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ------------------------------------------------------------------------------------------------------------------------
TOBACCO (1.4%)
$ 305 Altria Group, Inc. 7.00% 11/04/13 $ 335,188
535 Altria Group, Inc. 7.75 01/15/27 595,973
505 Kraft Foods Inc. 5.625 11/01/11 542,555
115 Kraft Foods Inc. 6.25 06/01/12 127,763
---------------
1,601,479
---------------
TOTAL CORPORATE BONDS
(COST $93,190,050) 96,197,006
---------------
FOREIGN GOVERNMENT OBLIGATIONS (2.2%)
820 United Mexican States Corp. (Mexico) 8.30 08/15/31 955,300
75 United Mexican States Corp. (Mexico) 8.375 01/14/11 90,187
315 United Mexican States Corp. (Mexico) 8.625 03/12/08 373,748
860 United Mexican States Corp. (Mexico) 9.875 02/01/10 1,096,930
---------------
TOTAL FOREIGN GOVERNMENT OBLIGATIONS
(COST $2,459,483) 2,516,165
---------------
U.S. GOVERNMENT AGENCY OBLIGATION (0.2%)
180 Private Export Funding Corp.
(COST $180,073) 6.86 04/30/04 181,582
---------------
MORTGAGE-BACKED SECURITIES (13.5%)
56 Federal Home Loan Mortgage Corp. 7.50 09/01/30 59,724
Federal National Mortgage Assoc.
7,750 6.50 ** 8,135,078
3,863 6.50 05/01/32 4,065,236
1,524 7.00 01/01/30 - 05/01/32 1,618,739
1,478 7.50 09/01/29 - 07/01/32 1,584,060
---------------
TOTAL MORTGAGE-BACKED SECURITIES
(COST $15,381,067) 15,462,837
---------------
SHORT-TERM INVESTMENTS (6.7%)
U.S. GOVERNMENT OBLIGATION (a) (0.2%)
300 U.S. Treasury Bill***
(COST $299,783) 1.00 03/25/04 299,783
---------------
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
13
<Page>
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ------------------------------------------------------------------------------------------------------------------------
REPURCHASE AGREEMENT (6.5%)
$ 7,426 Joint repurchase agreement account
(dated 02/27/04, proceeds $7,426,637) (b)
(COST $7,426,000) 1.03% 03/01/04 $ 7,426,000
---------------
TOTAL SHORT-TERM INVESTMENTS
(COST $7,725,783) 7,725,783
---------------
TOTAL INVESTMENTS
(COST $118,936,456) (c)(d) 106.5% 122,083,373
LIABILITIES IN EXCESS OF OTHER ASSETS (6.5) (7,463,263)
------- ---------------
NET ASSETS 100.0% $ 114,620,110
======== ===============
</Table>
- ----------
* RESALE IS RESTRICTED TO QUALIFIED INSTITUTIONAL INVESTORS.
** SECURITIES PURCHASED ON A FORWARD COMMITMENT BASIS WITH AN APPROXIMATEAL
INVESTORS. PRINCIPAL AMOUNT AND NO DEFINITE MATURITY DATE; THE ACTUAL
PRINCIPAL AMOUNTAL INVESTORS. AND MATURITY DATE WILL BE DETERMINED UPON
SETTLEMENT.
*** ALL OF THESE SECURITIES HAVE BEEN PHYSICALLY SEGREGATED IN CONNECTION WITH
OPEN FUTURES CONTRACTS IN THE AMOUNT OF $299,783.
(a) PURCHASED ON A DISCOUNT BASIS. THE INTEREST RATE SHOWN HAS BEEN ADJUSTED
TOSTORS. 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
$35,701,366 IN CONNECTION WITH SECURITIES PURCHASED ON A FORWARD COMMITMENT
BASIS AND OPEN FUTURES CONTRACTS.
(d) THE AGGREGATE COST FOR FEDERAL INCOME TAX PURPOSES APPROXIMATES THE
AGGREGATE COST FOR BOOK PURPOSES. THE AGGREGATE GROSS UNREALIZED
APPRECIATION IS $3,739,087 AND THE AGGREGATE GROSS UNREALIZED DEPRECIATION
IS $592,170, RESULTING IN NET UNREALIZED APPRECIATION OF $3,146,917.
BOND INSURANCE:
FSA Financial Security Assurance.
FUTURES CONTRACTS OPEN AT FEBRUARY 29, 2004:
<Table>
<Caption>
NUMBER OF DESCRIPTION/DELIVERY UNDERLYING FACE UNREALIZED
CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE DEPRECIATION
- -----------------------------------------------------------------------------------------------------------
4 Short U.S. Treasury Notes 5 year, March/2004 $ (455,063) $ (10,472)
53 Short U.S. Treasury Bonds 20 year, June/2004 (5,959,188) (65,380)
26 Short U.S. Treasury Notes 5 year, June/2004 (2,922,563) (20,205)
87 Short U.S. Treasury Notes 2 year, June/2004 (18,664,220) (57,477)
-------------
Total unrealized depreciation $ (153,534)
=============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
14
<Page>
MORGAN STANLEY QUALITY INCOME TRUST
FINANCIAL STATEMENTS
STATEMENT OF ASSETS AND LIABILITIES
FEBRUARY 29, 2004 (UNAUDITED)
<Table>
ASSETS:
Investments in securities, at value (cost $118,936,456) $ 122,083,373
Cash 5,123
Receivable for:
Investments sold 8,497,811
Interest 1,712,574
Shares of beneficial interest sold 172,361
Prepaid expenses and other assets 69,743
---------------
TOTAL ASSETS 132,540,985
---------------
LIABILITIES:
Payable for:
Investments purchased 17,376,637
Shares of beneficial interest redeemed 154,771
Variation margin 77,329
Distribution fee 71,619
Investment management fee 56,880
Dividends and distributions to shareholders 23,563
Accrued expenses and other payables 160,076
---------------
TOTAL LIABILITIES 17,920,875
---------------
NET ASSETS $ 114,620,110
===============
COMPOSITION OF NET ASSETS:
Paid-in-capital $ 120,859,719
Net unrealized appreciation 2,993,383
Dividends in excess of net investment income (694,268)
Accumulated net realized loss (8,538,724)
---------------
NET ASSETS $ 114,620,110
===============
CLASS A SHARES:
Net Assets $ 8,069,448
Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 829,619
NET ASSET VALUE PER SHARE $ 9.73
===============
MAXIMUM OFFERING PRICE PER SHARE,
(NET ASSET VALUE PLUS 4.44% OF NET ASSET VALUE) $ 10.16
===============
CLASS B SHARES:
Net Assets $ 90,687,419
Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 9,399,988
NET ASSET VALUE PER SHARE $ 9.65
===============
CLASS C SHARES:
Net Assets $ 8,695,393
Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 899,719
NET ASSET VALUE PER SHARE $ 9.66
===============
CLASS D SHARES:
Net Assets $ 7,167,850
Shares Outstanding (UNLIMITED AUTHORIZED, $.01 PAR VALUE) 745,520
NET ASSET VALUE PER SHARE $ 9.61
===============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
15
<Page>
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED FEBRUARY 29, 2004 (UNAUDITED)
<Table>
NET INVESTMENT INCOME:
Interest Income $ 2,902,479
---------------
EXPENSES
Distribution fee (Class A shares) 9,498
Distribution fee (Class B shares) 404,115
Distribution fee (Class C shares) 38,274
Investment management fee 356,515
Transfer agent fees and expenses 137,725
Shareholder reports and notices 50,779
Registration fees 42,629
Professional fees 29,653
Custodian fees 13,136
Trustees' fees and expenses 4,207
Other 10,463
---------------
TOTAL EXPENSES 1,096,994
---------------
NET INVESTMENT INCOME 1,805,485
NET REALIZED AND UNREALIZED GAIN (LOSS):
NET REALIZED GAIN/LOSS ON:
Investments 814,051
Futures contracts (726,037)
---------------
NET REALIZED GAIN 88,014
---------------
NET CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION ON:
Investments 4,851,743
Futures contracts (325,299)
---------------
NET APPRECIATION 4,526,444
---------------
NET GAIN 4,614,458
---------------
NET INCREASE $ 6,419,943
===============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
16
<Page>
STATEMENT OF CHANGES IN NET ASSETS
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
FEBRUARY 29, 2004 AUGUST 31, 2003
-------------------- --------------------
(UNAUDITED)
INCREASE (DECREASE) IN NET ASSETS:
OPERATIONS:
Net investment income $ 1,805,485 $ 2,110,561
Net realized gain 88,014 1,830,654
Net change in unrealized appreciation/depreciation 4,526,444 (1,748,491)
-------------------- --------------------
NET INCREASE 6,419,943 2,192,724
-------------------- --------------------
DIVIDENDS TO SHAREHOLDERS FROM NET INVESTMENT INCOME:
Class A shares (163,625) (316,276)
Class B shares (1,758,975) (3,155,485)
Class C shares (166,565) (264,530)
Class D shares (161,707) (356,548)
-------------------- --------------------
TOTAL DIVIDENDS (2,250,872) (4,092,839)
-------------------- --------------------
Net decrease from transactions in shares of beneficial interest (16,381,904) (3,592,687)
-------------------- --------------------
NET DECREASE (12,212,833) (5,492,802)
NET ASSETS:
Beginning of period 126,832,943 132,325,745
-------------------- --------------------
END OF PERIOD
(INCLUDING DIVIDENDS IN EXCESS OF NET INVESTMENT INCOME OF $694,268
AND $248,881, RESPECTIVELY) $ 114,620,110 $ 126,832,943
==================== ====================
</Table>
SEE NOTES TO FINANCIAL STATEMENTs
17
<Page>
MORGAN STANLEY QUALITY INCOME TRUST
NOTES TO FINANCIAL STATEMENTS - FEBRUARY 29, 2004 (UNAUDITED)
1. ORGANIZATION AND ACCOUNTING POLICIES
Morgan Stanley Quality Income Trust (the "Fund") 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 seeks to achieve
its objective by investing at least 80% of its assets in 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) certain portfolio securities may be valued by
an outside pricing service approved by the Fund's Trustees; (2) portfolio
securities for which over-the-counter market quotations are readily available
are valued at the mean between the last reported bid and asked price; (3) 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; 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 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
18
<Page>
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.
19
<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 $5,337,949
at February 29, 2004.
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 six months ended February 29, 2004, the distribution fee was accrued for
Class A shares and Class C shares at the annual rate of 0.25% and 0.85%,
respectively.
The Distributor has informed the Fund that for the six months ended February 29,
2004, it received contingent deferred sales charges from certain redemptions of
the Fund's Class A shares, Class B shares and Class C shares of $16,411,
$100,470 and $3,484, respectively and received $14,516 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.
20
<Page>
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 six months ended February
29, 2004, aggregated $162,196,829, and $193,525,584, respectively.
Morgan Stanley Trust, an affiliate of the Investment Manager and Distributor, is
the Fund's transfer agent. At February 29, 2004, the Fund had transfer agent
fees and expenses payable of approximately $57,000.
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.
Aggregate pension costs for the six months ended February 29, 2004 included in
Trustees' fees and expenses in the Statement of Operations amounted to $3,598.
At February 29, 2004, the Fund had an accrued pension liability of $60,051 which
is included in accrued expenses in the Statement of Assets and Liabilities.
On December 2, 2003, the Trustees voted to close the plan to new participants,
eliminate the future benefits growth due to increases to compensation after July
31, 2003 and effective April 1, 2004, establish an unfunded deferred
compensation plan which allows each independent Trustee to defer payment of all
or a portion of the fees he receives for serving on the Board of Trustees
throughout the year.
5. 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 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.
21
<Page>
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.
6. SHARES OF BENEFICIAL INTEREST
Transactions in shares of beneficial interest were as follows:
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
FEBRUARY 29, 2004 AUGUST 31, 2003
---------------------------------- ----------------------------------
(UNAUDITED)
SHARES AMOUNT SHARES AMOUNT
--------------- --------------- --------------- ---------------
CLASS A SHARES
Sold 545,733 $ 5,183,543 7,230,344 $ 69,757,478
Reinvestment of dividends 11,395 109,752 23,096 221,263
Redeemed (753,638) (7,160,954) (7,352,712) (70,908,969)
--------------- --------------- --------------- ---------------
Net decrease -- Class A (196,510) (1,867,659) (99,272) (930,228)
--------------- --------------- --------------- ---------------
CLASS B SHARES
Sold 546,022 5,190,483 5,576,141 53,136,588
Reinvestment of dividends 121,980 1,164,445 224,794 2,137,809
Redeemed (1,964,144) (18,678,186) (6,031,461) (57,282,326)
--------------- --------------- --------------- ---------------
Net decrease -- Class B (1,296,142) (12,323,258) (230,526) (2,007,929)
--------------- --------------- --------------- ---------------
CLASS C SHARES
Sold 97,473 927,820 1,825,800 17,330,693
Reinvestment of dividends 12,806 122,492 20,602 196,212
Redeemed (323,257) (3,047,233) (1,411,756) (13,429,508)
--------------- --------------- --------------- ---------------
Net increase (decrease) -- Class C (212,978) (1,996,921) 434,646 4,097,397
--------------- --------------- --------------- ---------------
CLASS D SHARES
Sold 177,361 1,681,927 1,942,485 18,431,785
Reinvestment of dividends 11,809 112,350 22,745 215,756
Redeemed (209,163) (1,988,343) (2,466,593) (23,399,468)
--------------- --------------- --------------- ---------------
Net decrease -- Class D (19,993) (194,066) (501,363) (4,751,927)
--------------- --------------- --------------- ---------------
Net decrease in Fund (1,725,623) $ (16,381,904) (396,515) $ (3,592,687)
=============== =============== =============== ===============
</Table>
22
<Page>
7. PURPOSES OF 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 the 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.
8. LEGAL MATTERS
The Investment Manager, certain affiliates of the Investment Manager, certain
officers of such affiliates and certain investment companies advised by the
Investment Manager or its affiliates, including the Fund, are named as
defendants in a number of similar class action complaints which were recently
consolidated. This consolidated action also names as defendants certain
individual Trustees and Directors of the Morgan Stanley funds. The consolidated
amended complaint generally alleges that defendants, including the Fund,
violated their statutory disclosure obligations and fiduciary duties by failing
properly to disclose (i) that the Investment Manager and certain affiliates of
the Investment Manager allegedly offered economic incentives to brokers and
others to recommend to the funds advised by the Investment Manager or its
affiliates rather than funds managed by other companies, and (ii) that the funds
advised by the Investment Manager or its affiliates, including the Fund,
allegedly paid excessive commissions to brokers in return for their efforts to
recommend these funds to investors. The complaint seeks, among other things,
unspecified compensatory damages, rescissionary damages, fees and costs. The
defendants intend to move to dismiss the action and otherwise vigorously to
defend it. While the Fund believes that it has meritorious defenses, the
ultimate outcome of this matter is not presently determinable at this early
stage of the litigation, and no provision has been made in the Fund's financial
statements for the effect, if any, of this matter.
23
<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 SIX FOR THE YEAR ENDED AUGUST 31,
MONTHS ENDED -------------------------------------------------------------------
FEBRUARY 29, 2004 2003 2002 2001 2000 1999
-------------------- ---------- ---------- ---------- ---------- ----------
(UNAUDITED)
CLASS A SHARES:
SELECTED PER SHARE DATA:
Net asset value, beginning of
period $ 9.39 $ 9.53 $ 9.35 $ 8.97 $ 9.30 $ 9.71
-------------------- ---------- ---------- ---------- ---------- ----------
Income (loss) from investment
operations:
Net investment income 0.17 0.20 0.37 0.52 0.55 0.55
Net realized and unrealized
gain (loss) 0.38 0.01 0.19 0.38 (0.33) (0.41)
-------------------- ---------- ---------- ---------- ---------- ----------
Total income from investment
operations 0.55 0.21 0.56 0.90 0.22 0.14
-------------------- ---------- ---------- ---------- ---------- ----------
Less dividends from net investment
income (0.21) (0.35) (0.38) (0.52) (0.55) (0.55)
-------------------- ---------- ---------- ---------- ---------- ----------
Net asset value, end of period $ 9.73 $ 9.39 $ 9.53 $ 9.35 $ 8.97 $ 9.30
==================== ========== ========== ========== ========== ==========
TOTAL RETURN+ 5.74%(1) 2.17% 6.17% 10.34% 2.49% 1.39%
RATIOS TO AVERAGE NET ASSETS(3):
Expenses 1.34%(2) 1.14% 1.04% 1.21% 1.10% 1.08%
Net investment income 3.54%(2) 2.14% 4.03% 5.71% 6.02% 5.67%
SUPPLEMENTAL DATA:
Net assets, end of period, in
thousands $ 8,069 $ 9,636 $ 10,730 $ 4,177 $ 4,196 $ 3,557
Portfolio turnover rate 127%(1) 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) NOT ANNUALIZED.
(2) ANNUALIZED.
(3) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC
EXPENSES.
SEE NOTES TO FINANCIAL STATEMENTS
24
<Page>
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED AUGUST 31,
MONTHS ENDED -------------------------------------------------------------------
FEBRUARY 29, 2004 2003 2002 2001 2000 1999
-------------------- ---------- ---------- ---------- ---------- ----------
(UNAUDITED)
CLASS B SHARES:
SELECTED PER SHARE DATA:
Net asset value, beginning of
period $ 9.32 $ 9.45 $ 9.35 $ 8.98 $ 9.31 $ 9.70
-------------------- ---------- ---------- ---------- ---------- ----------
Income (loss) from investment
operations:
Net investment income 0.14 0.14 0.31 0.47 0.49 0.49
Net realized and unrealized
gain (loss) 0.37 0.02 0.10 0.37 (0.33) (0.39)
-------------------- ---------- ---------- ---------- ---------- ----------
Total income from investment
operations 0.51 0.16 0.41 0.84 0.16 0.10
-------------------- ---------- ---------- ---------- ---------- ----------
Less dividends from net investment
income (0.18) (0.29) (0.31) (0.47) (0.49) (0.49)
-------------------- ---------- ---------- ---------- ---------- ----------
Net asset value, end of period $ 9.65 $ 9.32 $ 9.45 $ 9.35 $ 8.98 $ 9.31
==================== ========== ========== ========== ========== ==========
TOTAL RETURN+ 5.45%(1) 1.63% 4.58% 9.55% 1.80% 0.92%
RATIOS TO AVERAGE NET ASSETS(3):
Expenses 1.94%(2) 1.79% 1.72% 1.84% 1.77% 1.75%
Net investment income 2.94%(2) 1.49% 3.35% 5.08% 5.35% 5.00%
SUPPLEMENTAL DATA:
Net assets, end of period, in
thousands $ 90,687 $ 99,695 $ 103,238 $ 97,452 $ 82,964 $ 120,843
Portfolio turnover rate 127%(1) 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) NOT ANNUALIZED.
(2) ANNUALIZED.
(3) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC
EXPENSES.
SEE NOTES TO FINANCIAL STATEMENTS
25
<Page>
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED AUGUST 31,
MONTHS ENDED ------------------------------------------------------------------
FEBRUARY 29, 2004 2003 2002 2001 2000 1999
-------------------- ---------- ---------- ---------- ---------- ----------
(UNAUDITED)
CLASS C SHARES:
SELECTED PER SHARE DATA:
Net asset value, beginning of
period $ 9.34 $ 9.46 $ 9.36 $ 8.99 $ 9.32 $ 9.71
-------------------- ---------- ---------- ---------- ---------- ----------
Income (loss) from investment
operations:
Net investment income 0.14 0.14 0.31 0.47 0.49 0.49
Net realized and unrealized
gain (loss) 0.36 0.03 0.10 0.37 (0.33) (0.39)
-------------------- ---------- ---------- ---------- ---------- ----------
Total income from investment
operations 0.50 0.17 0.41 0.84 0.16 0.10
-------------------- ---------- ---------- ---------- ---------- ----------
Less dividends from net investment
income (0.18) (0.29) (0.31) (0.47) (0.49) (0.49)
-------------------- ---------- ---------- ---------- ---------- ----------
Net asset value, end of period $ 9.66 $ 9.34 $ 9.46 $ 9.36 $ 8.99 $ 9.32
==================== ========== ========== ========== ========== ==========
TOTAL RETURN+ 5.33%(1) 1.74% 4.57% 9.54% 1.80% 0.91%
RATIOS TO AVERAGE NET ASSETS(3):
Expenses 1.94%(2) 1.79% 1.72% 1.84% 1.77% 1.75%
Net investment income 2.94%(2) 1.49% 3.35% 5.08% 5.35% 5.00%
SUPPLEMENTAL DATA:
Net assets, end of period, in
thousands $ 8,695 $ 10,389 $ 6,415 $ 4,226 $ 1,738 $ 1,759
Portfolio turnover rate 127%(1) 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) NOT ANNUALIZED.
(2) ANNUALIZED.
(3) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC
EXPENSES.
SEE NOTES TO FINANCIAL STATEMENTS
26
<Page>
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED AUGUST 31,
MONTHS ENDED ------------------------------------------------------------------
FEBRUARY 29, 2004 2003 2002 2001 2000 1999
-------------------- ---------- ---------- ---------- ---------- ----------
(unaudited)
CLASS D SHARES:
SELECTED PER SHARE DATA:
Net asset value, beginning of
period $ 9.29 $ 9.43 $ 9.35 $ 8.98 $ 9.31 $ 9.70
-------------------- ---------- ---------- ---------- ---------- ----------
Income (loss) from investment
operations:
Net investment income 0.17 0.22 0.38 0.55 0.57 0.57
Net realized and unrealized
gain (loss) 0.36 0.01 0.09 0.37 (0.33) (0.39)
-------------------- ---------- ---------- ---------- ---------- ----------
Total income from investment
operations 0.53 0.23 0.47 0.92 0.24 0.18
-------------------- ---------- ---------- ---------- ---------- ----------
Less dividends from net investment
income (0.21) (0.37) (0.39) (0.55) (0.57) (0.57)
-------------------- ---------- ---------- ---------- ---------- ----------
Net asset value, end of period $ 9.61 $ 9.29 $ 9.43 $ 9.35 $ 8.98 $ 9.31
==================== ========== ========== ========== ========== ==========
TOTAL RETURN+ 5.80%(1) 2.39% 5.23% 10.48% 2.67% 1.79%
RATIOS TO AVERAGE NET ASSETS(3):
Expenses 1.09%(2) 0.94% 0.87% 0.99% 0.92% 0.90%
Net investment income 3.79%(2) 2.34% 4.20% 5.93% 6.20% 5.85%
SUPPLEMENTAL DATA:
Net assets, end of period, in
thousands $ 7,168 $ 7,113 $ 11,943 $ 3,018 $ 6,834 $ 7,493
Portfolio turnover rate 127%(1) 429% 400% 358% 114% 99%
</Table>
- ----------
+ CALCULATED BASED ON THE NET ASSET VALUE AS OF THE LAST BUSINESS DAY OF THE
PERIOD.
(1) NOT ANNUALIZED.
(2) ANNUALIZED.
(3) REFLECTS OVERALL FUND RATIOS FOR INVESTMENT INCOME AND NON-CLASS SPECIFIC
EXPENSES.
SEE NOTES TO FINANCIAL STATEMENTS
27
<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 J. 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
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.
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) 2004 Morgan Stanley
[MORGAN STANLEY LOGO]
38557RPT-RA04-00022P-A02/04
[GRAPHIC]
MORGAN STANLEY FUNDS
MORGAN STANLEY
QUALITY INCOME TRUST
SEMIANNUAL REPORT
FEBRUARY 29, 2004
[MORGAN STANLEY LOGO]
<Page>
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. [Reserved.]
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies.
Not applicable for semiannual reports.
Item 8. [Reserved.]
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.
<Page>
(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.
Item 10 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.
<Page>
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
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
April 20, 2004
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
April 20, 2004
/s/ Francis Smith
Francis Smith
Principal Financial Officer
April 20, 2004