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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: 811-02575
Morgan Stanley Liquid Asset Fund Inc.
(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, 2006
Date of reporting period: August 31, 2006
Item 1 - Report to Shareholders
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Welcome, Shareholder:
In this report, you'll learn about how your investment in Morgan Stanley Liquid
Asset Fund Inc. 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 A MUTUAL FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE. AN
INVESTMENT IN A MONEY MARKET FUND IS NOT INSURED OR GUARANTEED BY THE FEDERAL
DEPOSIT INSURANCE CORPORATION OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE FUND
SEEKS TO PRESERVE THE VALUE OF AN INVESTMENT AT $1.00 PER SHARE, IT IS POSSIBLE
TO LOSE MONEY BY INVESTING IN THE FUND. PLEASE SEE THE PROSPECTUS FOR MORE
COMPLETE INFORMATION ON INVESTMENT RISKS.
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FUND REPORT
FOR THE YEAR ENDED AUGUST 31, 2006
MARKET CONDITIONS
During most of the 12-month period ended August 31, 2006, the Federal Open
Market Committee (the "Fed") continued the pattern of raising short-term rates
it began in June of 2004. Through 17 steps of 25 basis points each -- including
seven in the 12 months covered by this report -- the Fed increased its target
rate for federal funds from 1.00 percent to 5.25 percent, a five-year high.
As a consequence, short-term rates on money market securities rose, which
provided higher return opportunities for investors in money market funds.
However, at its August 8, 2006 meeting the Fed paused by holding its target of
5.25 percent steady. At this juncture, the Fed has made clear that it is closely
monitoring economic data, which reports inflation trends as well as housing,
manufacturing and many other economic indicators. Future decisions from the Fed
will reflect its evaluation of what changes, if any, it should make in its
target as the pace of economic activity unfolds.
PERFORMANCE ANALYSIS
As of August 31, 2006, Morgan Stanley Liquid Asset Fund had net assets of
approximately $17 billion and an average portfolio maturity of 42 days. For the
12-month period ended August 31, 2006, the Fund provided a total return of 4.10
percent. For the seven-day period ended August 31, 2006, the Fund provided an
effective annualized yield of 4.96 percent and a current yield of 4.85 percent,
while its 30-day moving average yield for August was 4.84 percent. PAST
PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.
Our strategy in managing the Fund remained consistent with our long-term focus
on preservation of capital and liquidity. We adhered to a conservative approach
which emphasized high-quality money market obligations, while avoiding the use
of derivatives or structured notes that might fluctuate excessively with
changing interest rates.
We also took advantage of the rising yields available on the money market
securities over the course of the period. As short-term interest rates climbed,
we reinvested the proceeds of maturing short-term holdings into higher-yielding
securities. Should rates continue to rise during the months ahead, we intend to
continue with this approach.
THERE IS NO GUARANTEE THAT ANY SECTORS MENTIONED WILL CONTINUE TO PERFORM AS
DISCUSSED HEREIN OR THAT SECURITIES IN SUCH SECTORS WILL BE HELD BY THE FUND IN
THE FUTURE.
PORTFOLIO COMPOSITION
Commercial Paper 86.3%
Certificates of Deposit 9.3
U.S. Government Agencies 2.9
Bank Note 1.5
MATURITY SCHEDULE
1 - 30 Days 45.6%
31 - 60 Days 31.5
61 - 90 Days 15.0
91 - 120 Days 7.0
120 + Days 0.9
DATA AS OF AUGUST 31, 2006. SUBJECT TO CHANGE DAILY. ALL PERCENTAGES FOR
PORTFOLIO COMPOSITION AND MATURITY SCHEDULE ARE AS A PERCENTAGE OF TOTAL
INVESTMENTS. THESE DATA ARE PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND SHOULD
NOT BE DEEMED A RECOMMENDATION TO BUY OR SELL THE SECURITIES MENTIONED. MORGAN
STANLEY IS A FULL-SERVICE SECURITIES FIRM ENGAGED IN SECURITIES TRADING AND
BROKERAGE ACTIVITIES, INVESTMENT BANKING, RESEARCH AND ANALYSIS, FINANCING AND
FINANCIAL ADVISORY SERVICES.
2
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INVESTMENT STRATEGY
THE FUND INVESTS IN HIGH QUALITY, SHORT-TERM DEBT OBLIGATIONS. IN SELECTING
INVESTMENTS, THE FUND'S "INVESTMENT ADVISER," MORGAN STANLEY INVESTMENT ADVISORS
INC., SEEKS TO MAINTAIN THE FUND'S SHARE PRICE AT $1.00. THE SHARE PRICE
REMAINING STABLE AT $1.00 MEANS THAT THE FUND WOULD PRESERVE THE PRINCIPAL VALUE
OF YOUR INVESTMENT.
AN INVESTMENT IN THE FUND IS NOT INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT
INSURANCE CORPORATION OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE FUND SEEKS TO
PRESERVE THE VALUE OF YOUR INVESTMENT AT $1.00 PER SHARE, IT IS POSSIBLE TO LOSE
MONEY BY INVESTING IN THE FUND.
FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS
EACH MORGAN STANLEY FUND PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN
ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE FUND'S SECOND
AND FOURTH FISCAL QUARTERS. THE SEMIANNUAL REPORTS AND THE ANNUAL REPORTS ARE
FILED ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC) ON FORM
N-CSRS AND FORM N-CSR, RESPECTIVELY. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL
AND ANNUAL REPORTS TO FUND SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS
PUBLIC WEB SITE, www.morganstanley.com. EACH MORGAN STANLEY FUND ALSO FILES A
COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS WITH THE SEC FOR THE FUND'S FIRST AND
THIRD FISCAL QUARTERS ON FORM N-Q. MORGAN STANLEY DOES NOT DELIVER THE REPORTS
FOR THE FIRST AND THIRD FISCAL QUARTERS TO SHAREHOLDERS, NOR ARE THE REPORTS
POSTED TO THE MORGAN STANLEY PUBLIC WEB SITE. YOU MAY, HOWEVER, OBTAIN THE FORM
N-Q FILINGS (AS WELL AS THE FORM N-CSR AND N-CSRS FILINGS) BY ACCESSING THE
SEC'S WEB SITE, http://www.sec.gov. YOU MAY ALSO REVIEW AND COPY THEM AT THE
SEC'S PUBLIC REFERENCE ROOM IN WASHINGTON, DC. INFORMATION ON THE OPERATION OF
THE SEC'S PUBLIC REFERENCE ROOM MAY BE OBTAINED BY CALLING THE SEC AT (800)
SEC-0330. YOU CAN ALSO REQUEST COPIES OF THESE MATERIALS, UPON PAYMENT OF A
DUPLICATING FEE, BY ELECTRONIC REQUEST AT THE SEC'S E-MAIL ADDRESS
(publicinfo@sec.gov) OR BY WRITING THE PUBLIC REFERENCE SECTION OF THE SEC,
WASHINGTON, DC 20549-0102.
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 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 A.M. TO 8:00 P.M., ET. ONCE OUR
CUSTOMER SERVICE CENTER HAS RECEIVED YOUR INSTRUCTIONS, WE WILL BEGIN SENDING
INDIVIDUAL COPIES FOR EACH ACCOUNT WITHIN 30 DAYS.
3
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EXPENSE EXAMPLE
As a shareholder of the Fund, you incur ongoing costs, including advisory fees;
distribution and service (12b-1) fees; and other Fund expenses. This example is
intended to help you understand your ongoing costs (in dollars) of investing in
the Fund and to compare these costs with the ongoing costs of investing in other
mutual funds.
The example is based on an investment of $1,000 invested at the beginning of the
period and held for the entire period 03/01/06 - 08/31/06.
ACTUAL EXPENSES
The first line of the table below provides information about actual account
values and actual expenses. You may use the information in this line, together
with the amount you invested, to estimate the expenses that you paid over the
period. Simply divide your account value by $1,000 (for example, an $8,600
account value divided by $1,000 = 8.6), then multiply the result by the number
in the first line under the heading entitled "Expenses Paid During Period" to
estimate the expenses you paid on your account during this period.
HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES
The second line of the table below provides information about hypothetical
expenses based on the Fund's actual expense ratio and an assumed rate of return
of 5% per year before expenses, which is not the Fund's actual return. The
hypothetical account values and expenses may not be used to estimate the actual
ending account balance or expenses you paid for the period. You may use this
information to compare the ongoing cost of investing in the Fund and other
funds. To do so, compare this 5% hypothetical example with the 5% hypothetical
examples that appear in the shareholder reports of the other funds.
Please note that the expenses shown in the table are meant to highlight your
ongoing costs only. Therefore, the second line of the table is useful in
comparing ongoing costs, and will not help you determine the relative total cost
of owning different funds that have transactional costs, such as sales charges
(loads), and redemption fees, or exchange fees.
<Table>
<Caption>
BEGINNING ENDING EXPENSES PAID
ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD *
------------- ------------- ---------------
03/01/06 -
03/01/06 08/31/06 08/31/06
------------- ------------- ---------------
Actual (2.29% return) $1,000.00 $1,022.90 $3.06
Hypothetical (5% annual return before expenses) $1,000.00 $1,022.18 $3.06
</Table>
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* EXPENSES ARE EQUAL TO THE FUND'S ANNUALIZED EXPENSE RATIO OF 0.60%
MULTIPLIED BY THE AVERAGE ACCOUNT VALUE OVER THE PERIOD, MULTIPLIED BY
184/365 (TO REFLECT THE ONE-HALF YEAR PERIOD).
4
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INVESTMENT ADVISORY AGREEMENT APPROVAL
NATURE, EXTENT AND QUALITY OF SERVICES
The Board reviewed and considered the nature and extent of the investment
advisory services provided by the Investment Adviser under the Advisory
Agreement, including portfolio management, investment research and fixed income
securities trading. The Board also reviewed and considered the nature and extent
of the non-advisory, administrative services provided by the Fund's
Administrator under the Administration Agreement, including accounting,
clerical, bookkeeping, compliance, business management and planning, and the
provision of supplies, office space and utilities at the Investment Adviser's
expense. (The Investment Adviser and the Administrator together are referred to
as the "Adviser" and the Advisory and Administration Agreements together are
referred to as the "Management Agreement.") The Board also compared the nature
of the services provided by the Adviser with similar services provided by
non-affiliated advisers as reported to the Board by Lipper Inc. ("Lipper").
The Board reviewed and considered the qualifications of the portfolio managers,
the senior administrative managers and other key personnel of the Adviser who
provide the advisory and administrative services to the Fund. The Board
determined that the Adviser's portfolio managers and key personnel are well
qualified by education and/or training and experience to perform the services in
an efficient and professional manner. The Board concluded that the nature and
extent of the advisory and administrative services provided were necessary and
appropriate for the conduct of the business and investment activities of the
Fund. The Board also concluded that the overall quality of the advisory and
administrative services was satisfactory.
PERFORMANCE RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS
On a regular basis, the Board reviews the performance of all funds in the Morgan
Stanley Fund Complex, including the Fund, compared to their peers, paying
specific attention to the underperforming funds. In addition, the Board
specifically reviewed the Fund's performance for the one-, three- and five-year
periods ended November 30, 2005, as shown in a report provided by Lipper (the
"Lipper Report"), compared to the performance of comparable funds selected by
Lipper (the "performance peer group"). The Board also discussed with the Adviser
the performance goals and the actual results achieved in managing the Fund. The
Board concluded that the Fund's performance was competitive with that of its
performance peer group.
FEES RELATIVE TO OTHER PROPRIETARY FUNDS MANAGED BY THE ADVISER WITH COMPARABLE
INVESTMENT STRATEGIES
The Board reviewed the advisory and administrative fee (together, the
"management fee") rate paid by the Fund under the Management Agreement. The
Board noted that the management fee rate was comparable to the management fee
rates charged by the Adviser to other proprietary funds it manages with
investment strategies comparable to those of the Fund.
5
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FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS
The Board reviewed the management fee rate and total expense ratio of the Fund
as compared to the average management fee rate and average total expense ratio
for funds, selected by Lipper (the "expense peer group"), managed by other
advisers with investment strategies comparable to those of the Fund, as shown in
the Lipper Report. The Board concluded that the Fund's management fee rate and
total expense ratio were competitive with those of its expense peer group.
BREAKPOINTS AND ECONOMIES OF SCALE
The Board reviewed the structure of the Fund's management fee schedule under the
Management Agreement and noted that it includes breakpoints. The Board also
reviewed the level of the Fund's management fee and noted that the fee, as a
percentage of the Fund's net assets, would decrease as net assets increase
because the management fee includes breakpoints. The Board concluded that the
Fund's management fee would reflect economies of scale as assets increase.
PROFITABILITY OF THE ADVISER AND AFFILIATES
The Board considered information concerning the costs incurred and profits
realized by the Adviser and affiliates during the last year from their
relationship with the Fund and during the last two years from their relationship
with the Morgan Stanley Fund Complex and reviewed with the Adviser the cost
allocation methodology used to determine the profitability of the Adviser and
affiliates. Based on its review of the information it received, the Board
concluded that the profits earned by the Adviser and affiliates were not
excessive in light of the advisory, administrative and other services provided
to the Fund.
FALL-OUT BENEFITS
The Board considered so-called "fall-out benefits" derived by the Adviser and
affiliates from their relationship with the Fund and the Morgan Stanley Fund
Complex, such as "float" benefits derived from handling of checks for purchases
and sales of Fund shares, through a broker-dealer affiliate of the Adviser. The
Board also considered that a broker-dealer affiliate of the Adviser receives
from the Fund 12b-1 fees for distribution and shareholder services. The Board
concluded that the float benefits were relatively small and the 12b-1 fees were
competitive with those of other broker-dealers.
SOFT DOLLAR BENEFITS
The Board considered whether the Adviser realizes any benefits from commissions
paid to brokers who execute securities transactions for the Fund ("soft
dollars"). The Board noted that the Fund invests only in fixed income
securities, which do not generate soft dollars.
6
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ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE FUND'S NEEDS
The Board considered whether the Adviser is financially sound and has the
resources necessary to perform its obligations under the Management Agreement.
The Board noted that the Adviser's operations remain profitable, although
increased expenses in recent years have reduced the Adviser's profitability. The
Board concluded that the Adviser has the financial resources necessary to
fulfill its obligations under the Management Agreement.
HISTORICAL RELATIONSHIP BETWEEN THE FUND AND THE ADVISER
The Board also reviewed and considered the historical relationship between the
Fund and the Adviser, including the organizational structure of the Adviser, the
policies and procedures formulated and adopted by the Adviser for managing the
Fund's operations and the Board's confidence in the competence and integrity of
the senior managers and key personnel of the Adviser. The Board concluded that
it is beneficial for the Fund to continue its relationship with the Adviser.
OTHER FACTORS AND CURRENT TRENDS
The Board considered the controls and procedures adopted and implemented by the
Adviser and monitored by the Fund's Chief Compliance Officer and concluded that
the conduct of business by the Adviser indicates a good faith effort on its part
to adhere to high ethical standards in the conduct of the Fund's business.
GENERAL CONCLUSION
After considering and weighing all of the above factors, the Board concluded
that it would be in the best interest of the Fund and its shareholders to
approve renewal of the Management Agreement for another year.
7
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MORGAN STANLEY LIQUID ASSET FUND INC.
PORTFOLIO OF INVESTMENTS - AUGUST 31, 2006
<Table>
<Caption>
ANNUALIZED
PRINCIPAL YIELD
AMOUNT IN ON DATE OF MATURITY
THOUSANDS PURCHASE DATE VALUE
- -----------------------------------------------------------------------------------------------------
Commercial Paper (87.4%)
BANKING (6.0%)
$565,000 Bank of America Corp. 5.18 - 5.41% 09/18/06 - 11/28/06 $ 562,216,606
457,000 Citigroup Funding Inc. 5.18 - 5.49 09/22/06 - 02/12/07 453,588,690
--------------
1,015,805,296
--------------
FINANCE - AUTOMOTIVE (1.0%)
177,000 Toyota Motor Credit Corp. 5.38 - 5.44 09/18/06 - 03/13/07 174,986,367
--------------
FINANCE - CONSUMER (1.0%)
14,000 American Express Credit Corp. 5.37 09/01/06 14,000,000
150,000 HSBC Finance Corp. 5.40 10/11/06 149,110,000
--------------
163,110,000
--------------
FINANCE - CORPORATE (0.7%)
125,000 CIT Group, Inc. 5.40 09/21/06 - 09/26/06 124,591,320
--------------
FINANCIAL CONGLOMERATES (3.6%)
605,000 General Electric Capital Corp. 4.97 - 5.49 09/08/06 - 02/23/07 601,570,521
--------------
INSURANCE (0.3%)
55,000 ING America Insurance Holdings Inc. 5.29 09/07/06 54,952,150
--------------
INTERNATIONAL BANKS (73.9%)
100,000 ABN AMRO N.A. Finance, Inc. 5.32 11/24/06 98,775,000
455,000 ANZ (DE) Inc. 5.15 - 5.43 10/05/06 - 12/05/06 451,139,931
695,000 Abbey National North America LLC 5.22 - 5.39 09/06/06 - 11/29/06 691,793,906
750,000 BNP Paribas Finance, Inc. 5.33 - 5.42 10/23/06 - 12/01/06 741,485,406
711,000 Barclays U.S. Funding Corp. 5.36 - 5.47 09/19/06 - 12/26/06 707,273,279
150,000 CBA (Delaware) Finance Inc. 5.33 - 5.35 09/15/06 - 11/21/06 148,713,833
727,000 Calyon North America, Inc. 5.30 - 5.41 09/11/06 - 11/15/06 722,534,618
500,000 Deutsche Bank Financial LLC 4.76 - 5.44 09/28/06 - 10/17/06 497,300,708
500,000 Dexia Delaware LLC 5.32 - 5.38 09/22/06 - 11/30/06 495,741,583
570,000 DnB NOR Bank ASA 5.31 - 5.39 09/20/06 - 12/28/06 564,873,153
550,000 Fortis Banque Luxembourg 5.33 - 5.39 09/01/06 - 01/22/07 546,464,014
579,000 HBOS Treasury Services plc 5.25 - 5.44 09/12/06 - 11/30/06 573,947,998
396,000 ING (U.S.) Funding LLC 5.31 - 5.55 09/07/06 - 12/22/06 393,784,917
450,000 Lloyds TSB Bank plc 5.31 10/12/06 - 10/13/06 447,281,458
705,000 Natexis Banques Populaires
U.S. Finance Co. LLC 5.11 - 5.39 09/14/06 - 11/02/06 701,996,417
282,000 Nordea North America, Inc. 5.15 - 5.27 09/05/06 - 10/02/06 281,659,384
615,000 Rabobank USA Financial Corp. 5.11 - 5.47 09/29/06 - 10/31/06 611,326,610
650,000 Royal Bank of Canada 5.30 10/04/06 - 10/05/06 646,836,694
150,000 Royal Bank of Scotland plc 5.39 09/28/06 149,398,687
545,000 Sanpaolo IMI U.S. Financial Co. 5.35 - 5.46 09/08/06 - 09/28/06 543,461,628
769,000 Societe Generale N.A., Inc. 5.34 - 5.43 09/19/06 - 11/01/06 765,205,128
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
8
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<Table>
<Caption>
ANNUALIZED
PRINCIPAL YIELD
AMOUNT IN ON DATE OF MATURITY
THOUSANDS PURCHASE DATE VALUE
- ------------------------------------------------------------------------------------------------------
$393,000 Spintab AB 5.25 - 5.43% 09/07/06 - 12/21/06 $ 390,244,811
170,000 Svenska Handelsbanken Inc.. 5.39 09/12/06 169,722,617
385,000 Swedbank 5.33 - 5.41 09/27/06 - 12/04/06 381,586,961
750,000 UBS Finance (Delaware) LLC. 5.24 - 5.38 09/25/06 - 10/25/06 746,217,889
---------------
12,468,766,630
---------------
MULTI-SECTOR COMPANIES (0.9%)
150,000 General Electric Company 5.40 09/26/06 149,442,708
---------------
Total Commercial Paper (COST
$14,753,224,992) 14,753,224,992
---------------
Certificates of Deposit (9.4%)
50,000 Citibank, N.A. 5.29 09/13/06 50,000,000
750,000 First Tennessee Bank, N.A. 5.34 - 5.45 09/13/06 - 10/10/06 750,000,000
485,000 Washington Mutual Bank, F.A. 5.38 - 5.39 09/22/06 - 09/29/06 485,000,000
150,000 Wells Fargo Bank, N.A. 5.41 09/21/06 150,000,000
150,000 World Savings Bank, FSB 5.42 10/04/06 150,000,000
---------------
Total Certificates of Deposit (COST
$1,585,000,000) 1,585,000,000
---------------
U.S. Government Agencies (2.9%)
160,000 Federal National Mortgage Assoc. 5.33 - 5.44 10/11/06 - 12/20/06 158,806,521
338,000 Freddie Mac 4.72 - 5.36 09/26/06 - 12/29/06 334,374,866
---------------
Total U.S. Government Agencies
(COST $493,181,387) 493,181,387
---------------
Short-Term Bank Note (1.5%)
250,000 World Savings Bank, FSB
(COST $250,000,000) 5.34 - 5.41 10/03/06 - 10/16/06 250,000,000
---------------
Repurchase Agreement (0.0%)
4,322 The Bank of New York (dated
08/31/06; proceeds $4,322,658)(a)
(COST $4,322,043) 5.125 09/01/06 4,322,043
---------------
Total Investments (COST
$17,085,728,422)(b) 101.2% 17,085,728,422
Liabilities in Excess of Other
Assets (1.2) (199,809,886)
----- ---------------
Net Assets 100.0% $16,885,918,536
===== ===============
</Table>
- ----------
(a) COLLATERALIZED BY FEDERAL NATIONAL MORTGAGE ASSOC. 5.50% DUE 08/01/36
VALUED AT $4,408,484.
(b) COST IS THE SAME FOR FEDERAL INCOME TAX PURPOSES.
SEE NOTES TO FINANCIAL STATEMENTS
9
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MORGAN STANLEY LIQUID ASSET FUND INC.
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
AUGUST 31, 2006
Assets:
Investments in securities, at value
(cost $17,085,728,422) $17,085,728,422
Cash 90,000
Receivable for:
Interest 11,754,535
Capital stock sold 324,738
Prepaid expenses and other assets 551,282
---------------
Total Assets 17,098,448,977
---------------
Liabilities:
Payable for:
Capital stock redeemed 205,901,539
Investment advisory fee 3,147,222
Distribution fee 1,449,746
Administration fee 724,873
Transfer agent fee 475,277
Accrued expenses and other payables 831,784
---------------
Total Liabilities 212,530,441
---------------
Net Assets $16,885,918,536
===============
Composition of Net Assets:
Paid-in-capital $16,885,238,515
Accumulated undistributed net
investment income 680,021
---------------
Net Assets $16,885,918,536
===============
Net Asset Value Per Share
16,885,909,689 SHARES
OUTSTANDING (50,000,000,000
SHARES AUTHORIZED OF $.01 PAR VALUE) $ 1.00
===============
Statement of Operations
FOR THE YEAR ENDED AUGUST 31, 2006
Net Investment Income:
Interest Income $794,165,262
------------
Expenses
Transfer agent fees and expenses 37,726,213
Investment advisory fee 37,466,654
Distribution fee 17,057,707
Administration fee 8,638,160
Shareholder reports and notices 1,525,791
Custodian fees 395,917
Directors' fees and expenses 231,275
Registration fees 209,056
Professional fees 93,015
Other 1,011,019
------------
Total Expenses 104,354,807
Less: expense offset (130,523)
------------
Net Expenses 104,224,284
------------
Net Investment Income $689,940,978
============
SEE NOTES TO FINANCIAL STATEMENTS
10
<Page>
Statements of Changes in Net Assets
<Table>
<Caption>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
AUGUST 31, 2006 AUGUST 31, 2005
--------------- ---------------
Increase (Decrease) in Net Assets:
Operations:
Net investment income $ 689,940,978 $ 381,295,276
Net realized gain -- 117
--------------- ---------------
Net Increase 689,940,978 381,295,393
--------------- ---------------
Dividends and Distributions to Shareholders from:
Net investment income (689,943,341) (381,300,392)
Net realized gain -- (117)
--------------- ---------------
Total Dividends and Distributions (689,943,341) (381,300,509)
--------------- ---------------
Net decrease from capital stock transactions (1,185,752,868) (2,403,078,668)
--------------- ---------------
Net Decrease (1,185,755,231) (2,403,083,784)
--------------- ---------------
Net Assets:
Beginning of period 18,071,673,767 20,474,757,551
--------------- ---------------
End of Period
(INCLUDING ACCUMULATED UNDISTRIBUTED NET INVESTMENT INCOME OF
$680,021 AND $682,384, RESPECTIVELY) $16,885,918,536 $18,071,673,767
=============== ===============
</Table>
SEE NOTES TO FINANCIAL STATEMENTS
11
<Page>
MORGAN STANLEY LIQUID ASSET FUND INC.
NOTES TO FINANCIAL STATEMENTS - AUGUST 31, 2006
1. ORGANIZATION AND ACCOUNTING POLICIES
Morgan Stanley Liquid Asset Fund Inc. (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 objectives are
high current income, preservation of capital and liquidity. The Fund was
incorporated in Maryland on September 3, 1974 and commenced operations on
September 22, 1975.
The following is a summary of significant accounting policies:
A. Valuation of Investments -- Portfolio securities are valued at amortized
cost, which approximates market value, in accordance with Rule 2a-7 under the
Act.
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 -- The Fund may 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. 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.
E. Dividends and Distributions to Shareholders -- The Fund records dividends and
distributions to shareholders as of the close of each business day.
F. Use of Estimates -- The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts and disclosures.
Actual results could differ from those estimates.
2. INVESTMENT ADVISORY/ADMINISTRATION AGREEMENTS
Pursuant to an Investment Advisory Agreement with Morgan Stanley Investment
Advisors Inc. (the "Investment Adviser"), the Fund pays the Investment Adviser
an advisory fee, accrued 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: 0.45% to the portion of the daily net assets not exceeding $250
million; 0.375% to the portion of the daily net assets exceeding $250 million
but not exceeding $750 million; 0.325% to the portion of the daily net assets
exceeding $750 million but not exceeding $1.25 billion; 0.30% to the portion of
the daily net assets exceeding $1.25 billion but not exceeding $1.5 billion;
0.275% to the portion of the daily net assets exceeding $1.5 billion but not
exceeding $1.75 billion; 0.25% to the
12
<Page>
portion of the daily net assets exceeding $1.75 billion but not exceeding $2.25
billion; 0.225% to the portion of the daily net assets exceeding $2.25 billion
but not exceeding $2.75 billion; 0.20% to the portion of the daily net assets
exceeding $2.75 billion but not exceeding $15 billion; 0.199% to the portion of
the daily net assets exceeding $15 billion but not exceeding $17.5 billion;
0.198% to the portion of the daily net assets exceeding $17.5 billion but not
exceeding $25 billion; 0.197% to the portion of the daily net assets exceeding
$25 billion but not exceeding $30 billion; and 0.196% to the portion of the
daily net assets in excess of $30 billion.
Pursuant to an Administration Agreement with Morgan Stanley Services Company
Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Fund
pays an administration fee, accrued daily and payable monthly, by applying the
annual rate of 0.05% to the Fund's daily net assets.
3. PLAN OF DISTRIBUTION
Morgan Stanley Distributors Inc. (the "Distributor"), an affiliate of the
Investment Adviser and Administrator, is the distributor of the Fund's shares
and in accordance with a Plan of Distribution (the "Plan") pursuant to Rule
12b-1 under the Act, finances certain expenses in connection with the promotion
of sales of Fund shares.
Reimbursements for these expenses are made in monthly payments by the Fund to
the Distributor, which will in no event exceed an amount equal to a payment at
the annual rate of 0.15% of the Fund's average daily net assets during the
month. Expenses incurred by the Distributor pursuant to the Plan in any fiscal
year will not be reimbursed by the Fund through payments accrued in any
subsequent fiscal year. For the year ended August 31, 2006, the distribution fee
was accrued at the annual rate of 0.10%.
4. SECURITY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES
The cost of purchases and proceeds from sales/maturities of portfolio securities
for the year ended August 31, 2006, aggregated $87,008,854,673 and
$88,846,112,766, respectively.
Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and
Distributor, is the Fund's transfer agent.
The Fund has an unfunded noncontributory defined benefit pension plan covering
certain independent Directors of the Fund who will have served as independent
Directors for at least five years at the time of retirement. Benefits under this
plan are based on factors which include years of service and compensation. The
Directors voted to close the plan to new participants and eliminate the future
benefits growth due to increases to compensation after July 31, 2003. Aggregate
pension costs for the year ended August 31, 2006, included in Directors' fees
and expenses in the Statement of
13
<Page>
Operations amounted to $7,486. At August 31, 2006, the Fund had an accrued
pension liability of $64,471 which is included in accrued expenses in the
Statement of Assets and Liabilities.
The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan")
which allows each independent Director to defer payment of all, or a portion, of
the fees they receive for serving on the Board of Directors. Each eligible
Director generally may elect to have their deferred amounts credited with a
return equal to the total return on one or more of the Morgan Stanley funds that
are offered as investment options under the Compensation Plan.
Appreciation/depreciation and distributions received from these investments are
recorded with an offsetting increase/decrease in the deferred compensation
obligation and do not affect the net asset value of the Fund.
5. CAPITAL STOCK
Transactions in capital stock, at $1.00 per share, were as follows:
FOR THE YEAR FOR THE YEAR
ENDED ENDED
AUGUST 31, 2006 AUGUST 31, 2005
--------------- ---------------
Shares sold. 50,899,093,960 51,455,651,164
Shares issued in reinvestment of
dividends and distributions 688,878,298 380,704,220
-------------- --------------
51,587,972,258 51,836,355,384
Shares redeemed (52,773,725,126) (54,239,434,052)
-------------- --------------
Net decrease (1,185,752,868) (2,403,078,668)
============== ==============
6. EXPENSE OFFSET
The expense offset represents a reduction of the transfer agent fees and
expenses for earnings on cash balances maintained by the Fund.
7. LEGAL MATTERS
The Investment Adviser, certain affiliates of the Investment Adviser, certain
officers of such affiliates and certain investment companies advised by the
Investment Adviser or its affiliates, including the Fund, were named as
defendants in a consolidated class action. This consolidated action also named
as defendants certain individual Trustees and Directors of the Morgan Stanley
funds. The consolidated amended complaint, filed in the United States District
Court for the Southern District of New York on April 16, 2004, generally alleged
that defendants, including the Fund, violated their statutory disclosure
obligations and fiduciary duties by failing properly to disclose (i) that the
Investment Adviser and certain affiliates of the Investment Adviser allegedly
offered economic incentives to brokers and others to recommend the funds advised
by the Investment Adviser or its affiliates to investors rather than funds
14
<Page>
managed by other companies, and (ii) that the funds advised by the Investment
Adviser or its affiliates, including the Fund, allegedly paid excessive
commissions to brokers in return for their alleged efforts to recommend these
funds to investors. The complaint sought, among other things, unspecified
compensatory damages, rescissionary damages, fees and costs. On July 2, 2004,
defendants moved to dismiss the action. On March 9, 2005, plaintiffs filed a
Motion for Leave to File a Supplemental Pleading that would, among other things,
expand the allegations and alleged class. On April 14, 2006, the Court granted
defendants' motion to dismiss in its entirety, with prejudice. Additionally,
plaintiffs' Motion for Leave to File a Supplemental Pleading was denied. The
time for plaintiffs to appeal the orders granting defendants' motion to dismiss
and denying plaintiffs' motion for supplemental pleading has expired. This case
is now concluded.
8. NEW ACCOUNTING PRONOUNCEMENTS
In July 2006, the Financial Accounting Standards Board (FASB) issued
Interpretation 48, Accounting for Uncertainty in Income Taxes -- an
interpretation of FASB Statement 109 (FIN 48). FIN 48 clarifies the accounting
for income taxes by prescribing the minimum recognition threshold a tax position
must meet before being recognized in the financial statements. FIN 48 is
effective for fiscal years beginning after December 15, 2006. The Fund will
adopt FIN 48 during 2007 and the impact to the Fund's financial statements, if
any, is currently being assessed.
In addition, in September 2006, Statement of Financial Accounting Standards No.
157, Fair Value Measurements (SFAS 157), was issued and is effective for fiscal
years beginning after November 15, 2007. SFAS 157 defines fair value,
establishes a framework for measuring fair value and expands disclosures about
fair value measurements. Management is currently evaluating the impact the
adoption of SFAS 157 will have on the Fund's financial statement disclosures.
15
<Page>
MORGAN STANLEY LIQUID ASSET FUND INC.
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of capital stock outstanding
throughout each period:
<Table>
<Caption>
FOR THE YEAR ENDED AUGUST 31,
-------------------------------------------------
2006 2005 2004 2003 2002
------- ------- ------- ------- -------
Selected Per Share Data:
Net asset value, beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
------- ------- ------- ------- -------
Net income from investment operations 0.040 0.020 0.006 0.009 0.018
Less dividends from net investment income (0.040) (0.020)+ (0.006)+ (0.009) (0.018)+
------- ------- ------- ------- -------
Net asset value, end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======= ======= ======= ======= =======
Total Return 4.10% 2.03% 0.58% 0.86% 1.78%
Ratios to Average Net Assets:
Total expenses (before expense offset) 0.60% 0.59% 0.58% 0.56% 0.56%
Net investment income 3.99% 1.98% 0.57% 0.85% 1.76%
Supplemental Data:
Net assets, end of period, in millions $16,886 $18,072 $20,475 $23,081 $23,931
</Table>
- ----------
+ INCLUDES CAPITAL GAIN DISTRIBUTION OF LESS THAN $0.001.
SEE NOTES TO FINANCIAL STATEMENTS
16
<Page>
MORGAN STANLEY LIQUID ASSET FUND INC.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of
Morgan Stanley Liquid Asset Fund Inc.:
We have audited the accompanying statement of assets and liabilities of Morgan
Stanley Liquid Asset Fund Inc. (the "Fund"), including the portfolio of
investments, as of August 31, 2006, 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 the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. The Fund
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of August 31, 2006, by correspondence with the custodian.
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 Liquid Asset Fund Inc. as of August 31, 2006, 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 23, 2006
17
<Page>
MORGAN STANLEY LIQUID ASSET FUND INC.
RESULTS OF SPECIAL SHAREHOLDER MEETING
On August 1, 2006, a Special Meeting of Shareholders of the Fund was scheduled
in order to vote on the following proposals: (i) to elect Directors; (ii) to
eliminate certain fundamental investment restrictions; (iii) to modify certain
fundamental investment restrictions; and (iv) to reclassify certain fundamental
policies as non-fundamental policies. The proposals failed to obtain the quorum
necessary in order to hold the meeting and, therefore, the meeting was adjourned
until August 23, 2006. The August 23, 2006 meeting was further adjourned to
September 27, 2006, and later adjourned to October 30, 2006 to permit further
solicitation of proxies.
18
<Page>
MORGAN STANLEY LIQUID ASSET FUND INC.
DIRECTOR AND OFFICER INFORMATION
INDEPENDENT DIRECTORS:
<Table>
<Caption>
NUMBER OF
PORTFOLIOS
TERM OF IN FUND
POSITION(S) OFFICE AND COMPLEX
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) OVERSEEN OTHER DIRECTORSHIPS
INDEPENDENT DIRECTOR REGISTRANT TIME SERVED* DURING PAST 5 YEARS BY DIRECTOR** HELD BY DIRECTOR
- ----------------------------------------------------------------------------------------------------------------------------------
Michael Bozic (65) c/o Director Since Private investor; Chairperson 197 Director of various business
Kramer Levin Naftalis & April 1994 of the Valuation, Insurance organizations.
Frankel LLP Counsel to and Compliance Committee
the Independent Trustees (since October 2006); Director
1177 Avenue of the or Trustee of the Retail Funds
Americas New York, (since April 1994) and the
NY 10036 Institutional Funds (since
July 2003); formerly
Chairperson of the Insurance
Committee (July 2006-
September 2006); Vice Chairman
of Kmart 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); variously
Chairman, Chief Executive
Officer, President and Chief
Operating Officer (1987-1991)
of the Sears Merchandise Group
of Sears, Roebuck & Co.
Edwin J. Garn (73) Director Since Consultant; Director or 197 Director of Franklin Covey
1031 N. Chartwell Court January 1993 Trustee of the Retail Funds (time management systems), BMW
Salt Lake City, UT 84103 (since January 1993) and the Bank of North America, Inc.
Institutional Funds (since (industrial loan corporation),
July 2003); member of the Utah Escrow Bank USA (industrial
Regional Advisory Board of loan corporation), United
Pacific Corp. (utility Space Alliance (joint venture
company); formerly Managing between Lockheed Martin and
Director of Summit Ventures the Boeing Company) and Nuskin
LLC (2000-2004) (lobbying and Asia Pacific (multilevel
consulting firm); (2000-2004) marketing); member of the
United States Senator (R-Utah) board of various civic and
(1974-1992) and Chairman, charitable organizations.
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 (72) c/o Director Since Retired; Director or Trustee 197 Director of The PMI Group Inc.
Kramer Levin Naftalis & September of the Retail Funds (since (private mortgage insurance);
Frankel LLP Counsel to 1997 September 1997) and the Trustee and Vice Chairman of
the Independent Trustees Institutional Funds (since The Field Museum of Natural
1177 Avenue of the July 2003); formerly History; director of various
Americas New York, associated with the Allstate other business and charitable
NY 10036 Companies (1966-1994), most organizations.
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).
</Table>
19
<Page>
<Table>
<Caption>
NUMBER OF
PORTFOLIOS
TERM OF IN FUND
POSITION(S) OFFICE AND COMPLEX
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) OVERSEEN OTHER DIRECTORSHIPS
INDEPENDENT DIRECTOR REGISTRANT TIME SERVED* DURING PAST 5 YEARS BY DIRECTOR** HELD BY DIRECTOR
- ----------------------------------------------------------------------------------------------------------------------------------
Dr. Manuel H. Johnson Director Since Senior Partner, Johnson Smick 197 Director of NVR, Inc. (home
(57) c/o Johnson Smick July 1991 International, Inc., a construction); Director of KFX
Group, Inc. 888 16th consulting firm; Chairperson Energy; Director of RBS
Street, NW Suite 740 of the Investment Committee Greenwich Capital Holdings
Washington, D.C. 20006 (since October 2006) and (financial holding company).
Director or Trustee of the
Retail Funds (since July 1991)
and the Institutional Funds
(since July 2003); Co-Chairman
and a founder of the Group of
Seven Council (G7C), an
international economic
commission; formerly Chairman
of the Audit Committee (July
1991-September 2006); Vice
Chairman of the Board of
Governors of the Federal
Reserve System and Assistant
Secretary of the U.S.
Treasury.
Joseph J. Kearns (64) Director Since President, Kearns & Associates 198 Director of Electro Rent
c/o Kearns & Associates July 2003 LLC (investment consulting); Corporation (equipment
LLC PMB754 23852 Pacific Chairperson of the Audit leasing), The Ford Family
Coast Highway Malibu, CA Committee (since October 2006) Foundation, and the UCLA
90265 and Director or Trustee of the Foundation.
Retail Funds (since July 2003)
and the Institutional Funds
(since August 1994);
previously Deputy Chairperson
of the Audit Committee (July
2003-September 2006) and
Chairman of the Audit
Committee of the Institutional
Funds (October 2001-July
2003); formerly CFO of the J.
Paul Getty Trust.
Michael E. Nugent (70) Chairman Chairman of General Partner of Triumph 197 None.
c/o Triumph Capital, of the the Board Capital, L.P., a private
L.P. 445 Park Avenue Board since July investment partnership;
New York, NY 10022 and 2006 and Chairman of the Board of the
Director Director Retail Funds and Institutional
since July Funds (since July 2006) and
1991 Director or Trustee of the
Retail Funds (since July 1991)
and the Institutional Funds
(since July 2001); formerly
Chairman of the Insurance
Committee (July 1991-July
2006) Vice President, Bankers
Trust Company and BT Capital
Corporation (1984-1988).
Fergus Reid (74) Director Since Chairman of Lumelite Plastics 198 Trustee and Director of
c/o Lumelite Plastics July 2003 Corporation; Chairperson of certain investment companies
Corporation 85 Charles the Governance Committee and in the JPMorgan Funds complex
Colman Blvd. Pawling, Director or Trustee of the managed by J.P. Morgan
NY 12564 Retail Funds (since July 2003) Investment Management Inc.
and the Institutional Funds
(since June 1992).
</Table>
20
<Page>
INTERESTED DIRECTOR:
<Table>
<Caption>
NUMBER OF
PORTFOLIOS
IN FUND
TERM OF COMPLEX
POSITION(S) OFFICE AND OVERSEEN BY
NAME, AGE AND ADDRESS OF HELD WITH LENGTH OF PRINCIPAL OCCUPATION(S) INTERESTED OTHER DIRECTORSHIPS
INDEPENDENT DIRECTOR REGISTRANT TIME SERVED* DURING PAST 5 YEARS DIRECTOR** HELD BY DIRECTOR
- ----------------------------------------------------------------------------------------------------------------------------------
James F. Higgins (58) Director Since Director or Trustee of the 197 Director of AXA Financial,
c/o Morgan Stanley Trust June 2000 Retail Funds (since June 2000) Inc. and The Equitable Life
Harborside Financial and the Institutional Funds Assurance Society of the
Center Plaza Two (since July 2003); Senior United States (financial
Jersey City, NJ 07311 Advisor of Morgan Stanley services).
(since August 2000).
</Table>
- ----------
* THIS IS THE EARLIEST DATE THE DIRECTOR BEGAN SERVING THE FUNDS ADVISED BY
MORGAN STANLEY INVESTMENT ADVISORS INC. (THE "INVESTMENT ADVISER") (THE
"RETAIL FUNDS") OR THE FUNDS ADVISED BY MORGAN STANLEY INVESTMENT
MANAGEMENT INC. AND MORGAN STANLEY AIP GP LP (THE "INSTITUTIONAL FUNDS").
** THE FUND COMPLEX INCLUDES ALL OPEN-END AND CLOSED-END FUNDS (INCLUDING ALL
OF THEIR PORTFOLIOS) ADVISED BY THE INVESTMENT ADVISER AND ANY FUNDS THAT
HAVE AN INVESTMENT ADVISER THAT IS AN AFFILIATED PERSON OF THE INVESTMENT
ADVISER (INCLUDING, BUT NOT LIMITED TO, MORGAN STANLEY INVESTMENT
MANAGEMENT INC.) AS OF OCTOBER 2, 2006.
21
<Page>
EXECUTIVE OFFICERS:
<Table>
<Caption>
POSITION(S) TERM OF OFFICE
NAME, AGE AND ADDRESS OF HELD WITH AND LENGTH OF
EXECUTIVE OFFICER REGISTRANT TIME SERVED* PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
- --------------------------- -------------- ----------------- ------------------------------------------------------------
Ronald E. Robison (67) President and President since President (since September 2005) and Principal Executive
1221 Avenue of the Americas Principal September 2005 Officer (since May 2003) of funds in the Fund Complex;
New York, NY 10020 Executive and Principal President (since September 2005) and Principal Executive
Officer Executive Officer Officer (since May 2003) of the Van Kampen Funds; Managing
since May 2003 Director, Director and/or Officer of the Investment Adviser
and various entities affiliated with the Investment Adviser;
Director of Morgan Stanley SICAV (since May 2004). Formerly,
Executive Vice President (July 2003 to September 2005) of
funds in the Fund Complex and the Van Kampen Funds;
President and Director of the Institutional Funds (March
2001 to July 2003); Chief Global Operating Officer of Morgan
Stanley Investment Management Inc.; Chief Administrative
Officer of Morgan Stanley Investment Advisors Inc.; Chief
Administrative Officer of Morgan Stanley Services Company
Inc.
J. David Germany (52) Vice President Since Managing Director and (since December 2005) Chief Investment
Morgan Stanley February 2006 Officer - Global Fixed Income of Morgan Stanley Investment
Investment Management Ltd. Management; Managing Director and Director of Morgan Stanley
25 Cabot Square Investment Management Ltd.; Vice President (since February
Canary Wharf, London 2006) of the Retail and Institutional Funds.
United Kingdom E144QA
Dennis F. Shea (53) Vice President Since Managing Director and (since February 2006) Chief Investment
1221 Avenue of the Americas February 2006 Officer - Global Equity of Morgan Stanley Investment
New York, NY 10020 Management; Vice President (since February 2006) of the
Retail and Institutional Funds. Formerly, Managing Director
and Director of Global Equity Research at Morgan Stanley.
Barry Fink (51) Vice President Since Managing Director and General Counsel of Morgan Stanley
1221 Avenue of the Americas February 1997 Investment Management; Managing Director of the Investment
New York, NY 10020 Adviser and various entities affiliated with the Investment
Adviser; Vice President of the Retail Funds and (since July
2003) the Institutional Funds. Formerly, Secretary, General
Counsel and/or Director of the Investment Adviser and
various entities affiliated with the Investment Adviser;
Secretary and General Counsel of the Retail Funds.
Amy R. Doberman (44) Vice President Since July 2004 Managing Director and General Counsel, U.S. Investment
1221 Avenue of the Americas Management of Morgan Stanley Investment Management (since
New York, NY 10020 July 2004); Vice President of the Retail Funds and the
Institutional Funds (since July 2004); Vice President of the
Van Kampen Funds (since August 2004); Secretary (since
February 2006) and Managing Director (since July 2004) of
the Investment Adviser and various entities affiliated with
the Investment Adviser. Formerly, Managing Director and
General Counsel - Americas, UBS Global Asset Management
(July 2000 to July 2004).
Carsten Otto (42) Chief Since October Managing Director and U.S. Director of Compliance for Morgan
1221 Avenue of the Americas Compliance 2004 Stanley Investment Management (since October 2004); Managing
New York, NY 10020 Officer Director and Chief Compliance Officer of Morgan Stanley
Investment Management. Formerly, Assistant Secretary and
Assistant General Counsel of the Retail Funds.
</Table>
22
<Page>
<Table>
<Caption>
POSITION(S) TERM OF OFFICE
NAME, AGE AND ADDRESS OF HELD WITH AND LENGTH OF
EXECUTIVE OFFICER REGISTRANT TIME SERVED* PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
- --------------------------- -------------- ----------------- ------------------------------------------------------------
Stefanie V. Chang Yu (39) Vice President Since July 2003 Executive Director of the Investment Adviser and various
1221 Avenue of the Americas entities affiliated with the Investment Adviser; Vice
New York, NY 10020 President of the Retail Funds (since July 2002) and the
Institutional Funds (since December 1997). Formerly,
Secretary of various entities affiliated with the Investment
Adviser.
Francis J. Smith (41) Treasurer and Treasurer since Executive Director of the Investment Adviser and various
c/o Morgan Stanley Trust Chief Financial July 2003 and entities affiliated with the Investment Adviser; Treasurer
Harborside Financial Center Officer Chief Financial and Chief Financial Officer of the Retail Funds (since July
Plaza Two Officer since 2003). Formerly, Vice President of the Retail Funds
Jersey City, NJ 07311 September 2002 (September 2002 to July 2003).
Mary E. Mullin (39) Secretary Since July 2003 Executive Director of the Investment Adviser and various
1221 Avenue of the Americas entities affiliated with the Investment Adviser; Secretary
New York, NY 10020 of the Retail Funds (since July 2003) and the Institutional
Funds (since June 1999).
</Table>
- ----------
* THIS IS THE EARLIEST DATE THE OFFICER BEGAN SERVING THE RETAIL FUNDS OR THE
INSTITUTIONAL FUNDS.
2006 FEDERAL TAX NOTICE (UNAUDITED)
Of the Fund's ordinary dividends paid during the fiscal year ended August 31,
2006, 0.19% 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.
23
<Page>
DIRECTORS
Michael Bozic
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Joseph J. Kearns
Michael E. Nugent
Fergus Reid
OFFICERS
Michael E. Nugent
CHAIRMAN OF THE BOARD
Ronald E. Robison
PRESIDENT AND PRINCIPAL EXECUTIVE OFFICER
J. David Germany
VICE PRESIDENT
Dennis F. Shea
VICE PRESIDENT
Barry Fink
VICE PRESIDENT
Amy R. Doberman
VICE PRESIDENT
Carsten Otto
CHIEF COMPLIANCE OFFICER
Stefanie V. Chang Yu
VICE PRESIDENT
Francis J. Smith
TREASURER AND CHIEF FINANCIAL OFFICER
Mary E. Mullin
SECRETARY
TRANSFER AGENT
Morgan Stanley Trust
Harborside Financial Center, Plaza Two
Jersey City, New Jersey 07311
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
Two World Financial Center
New York, New York 10281
INVESTMENT ADVISER
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 directors. 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) 2006 Morgan Stanley
MORGAN STANLEY
MORGAN STANLEY FUNDS
MORGAN STANLEY LIQUID ASSET FUND
ANNUAL REPORT
AUGUST 31, 2006
ILAFRPT-37925RPT-RA06-00941P-T08/06
MORGAN STANLEY
<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) Not applicable.
(d) Not applicable.
(e) Not applicable.
(f)
(1) The Fund's Code of Ethics is attached hereto as Exhibit 12 A.
(2) Not applicable.
(3) Not applicable.
Item 3. Audit Committee Financial Expert.
The Fund's Board of Directors has determined that it has two "audit committee
financial experts" serving on its audit committee, each of whom are
"independent" Directors: 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 Directors
in the absence of such designation or identification.
<Page>
Item 4. Principal Accountant Fees and Services.
(a)(b)(c)(d) and (g). Based on fees billed for the periods shown:
2006
REGISTRANT COVERED ENTITIES(1)
AUDIT FEES $31,520 N/A
NON-AUDIT FEES
AUDIT-RELATED FEES $ 531(2) $5,328,768(2)
TAX FEES $ 5,000(3) $1,640,675(4)
ALL OTHER FEES $ -- $ --(5)
TOTAL NON-AUDIT FEES $ 5,531 $6,969,443
TOTAL $37,051 $6,969,443
2005
REGISTRANT COVERED ENTITIES(1)
AUDIT FEES $31,496 N/A
NON-AUDIT FEES
AUDIT-RELATED FEES $ 540(2) $3,215,745(2)
TAX FEES $ 5,483(3) $ 24,000(4)
ALL OTHER FEES $ -- $ --
TOTAL NON-AUDIT FEES $ 6,023 $3,239,745
TOTAL $37,519 $3,239,745
N/A- Not applicable, as not required by Item 4.
(1) Covered Entities include the Adviser (excluding sub-advisors) and any
entity controlling, controlled by or under common control with the Adviser
that provides ongoing services to the Registrant.
(2) Audit-Related Fees represent assurance and related services provided that
are reasonably related to the performance of the audit of the financial
statements of the Covered Entities' and funds advised by the Adviser or its
affiliates, specifically data verification and agreed-upon procedures
related to asset securitizations and agreed-upon procedures engagements.
(3) Tax Fees represent tax compliance, tax planning and tax advice services
provided in connection with the preparation and review of the Registrant's
tax returns.
(4) Tax Fees represent tax compliance, tax planning and tax advice services
provided in connection with the review of Covered Entities' tax returns.
(5) All other fees represent project management for future business
applications and improving business and operational processes.
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(e)(1) The audit committee's pre-approval policies and procedures are as
follows:
APPENDIX A
AUDIT COMMITTEE
AUDIT AND NON-AUDIT SERVICES
PRE-APPROVAL POLICY AND PROCEDURES
OF THE
MORGAN STANLEY RETAIL AND INSTITUTIONAL FUNDS
AS ADOPTED AND AMENDED JULY 23, 2004,(1)
1. STATEMENT OF PRINCIPLES
The Audit Committee of the Board is required to review and, in its sole
discretion, pre-approve all Covered Services to be provided by the Independent
Auditors to the Fund and Covered Entities in order to assure that services
performed by the Independent Auditors do not impair the auditor's independence
from the Fund.
The SEC has issued rules specifying the types of services that an independent
auditor may not provide to its audit client, as well as the audit committee's
administration of the engagement of the independent auditor. The SEC's rules
establish two different approaches to pre-approving services, which the SEC
considers to be equally valid. Proposed services either: may be pre-approved
without consideration of specific case-by-case services by the Audit Committee
("GENERAL PRE-APPROVAL"); or require the specific pre-approval of the Audit
Committee or its delegate ("SPECIFIC PRE-APPROVAL"). The Audit Committee
believes that the combination of these two approaches in this Policy will result
in an effective and efficient procedure to pre-approve services performed by the
Independent Auditors. As set forth in this Policy, unless a type of service has
received general pre-approval, it will require specific pre-approval by the
Audit Committee (or by any member of the Audit Committee to which pre-approval
authority has been delegated) if it is to be provided by the Independent
Auditors. Any proposed services exceeding pre-approved cost levels or budgeted
amounts will also require specific pre-approval by the Audit Committee.
The appendices to this Policy describe the Audit, Audit-related, Tax and All
Other services that have the general pre-approval of the Audit Committee. The
term of any general pre-approval is 12 months from the date of pre-approval,
unless the Audit Committee considers and provides a different period and states
otherwise. The Audit Committee will annually review and pre-approve the services
that may be provided by the Independent Auditors without obtaining specific
pre-approval from the Audit Committee. The Audit Committee will add to or
subtract from the list of general pre-approved services from time to time, based
on subsequent determinations.
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(1) This Audit Committee Audit and Non-Audit Services Pre-Approval Policy and
Procedures (the "POLICY"), adopted as of the date above, supersedes and
replaces all prior versions that may have been adopted from time to time.
<Page>
The purpose of this Policy is to set forth the policy and procedures by which
the Audit Committee intends to fulfill its responsibilities. It does not
delegate the Audit Committee's responsibilities to pre-approve services
performed by the Independent Auditors to management.
The Fund's Independent Auditors have reviewed this Policy and believes that
implementation of the Policy will not adversely affect the Independent Auditors'
independence.
2. DELEGATION
As provided in the Act and the SEC's rules, the Audit Committee may delegate
either type of pre-approval authority to one or more of its members. The member
to whom such authority is delegated must report, for informational purposes
only, any pre-approval decisions to the Audit Committee at its next scheduled
meeting.
3. AUDIT SERVICES
The annual Audit services engagement terms and fees are subject to the specific
pre-approval of the Audit Committee. Audit services include the annual financial
statement audit and other procedures required to be performed by the Independent
Auditors to be able to form an opinion on the Fund's financial statements. These
other procedures include information systems and procedural reviews and testing
performed in order to understand and place reliance on the systems of internal
control, and consultations relating to the audit. The Audit Committee will
approve, if necessary, any changes in terms, conditions and fees resulting from
changes in audit scope, Fund structure or other items.
In addition to the annual Audit services engagement approved by the Audit
Committee, the Audit Committee may grant general pre-approval to other Audit
services, which are those services that only the Independent Auditors reasonably
can provide. Other Audit services may include statutory audits and services
associated with SEC registration statements (on Forms N-1A, N-2, N-3, N-4,
etc.), periodic reports and other documents filed with the SEC or other
documents issued in connection with securities offerings.
The Audit Committee has pre-approved the Audit services in Appendix B.1. All
other Audit services not listed in Appendix B.1 must be specifically
pre-approved by the Audit Committee (or by any member of the Audit Committee to
which pre-approval has been delegated).
4. AUDIT-RELATED SERVICES
Audit-related services are assurance and related services that are reasonably
related to the performance of the audit or review of the Fund's financial
statements and, to the extent they are Covered Services, the Covered Entities or
that are traditionally performed by the Independent Auditors. Because the Audit
Committee believes that the provision of Audit-related services does not impair
the independence of the auditor and is consistent with the SEC's rules on
auditor independence, the Audit Committee may grant general pre-approval to
Audit-related services. Audit-related services include, among others, accounting
consultations related to accounting, financial reporting or disclosure matters
<Page>
not classified as "Audit services"; assistance with understanding and
implementing new accounting and financial reporting guidance from rulemaking
authorities; agreed-upon or expanded audit procedures related to accounting
and/or billing records required to respond to or comply with financial,
accounting or regulatory reporting matters; and assistance with internal control
reporting requirements under Forms N-SAR and/or N-CSR.
The Audit Committee has pre-approved the Audit-related services in Appendix B.2.
All other Audit-related services not listed in Appendix B.2 must be specifically
pre-approved by the Audit Committee (or by any member of the Audit Committee to
which pre-approval has been delegated).
5. TAX SERVICES
The Audit Committee believes that the Independent Auditors can provide Tax
services to the Fund and, to the extent they are Covered Services, the Covered
Entities, such as tax compliance, tax planning and tax advice without impairing
the auditor's independence, and the SEC has stated that the Independent Auditors
may provide such services.
Pursuant to the preceding paragraph, the Audit Committee has pre-approved the
Tax Services in Appendix B.3. All Tax services in Appendix B.3 must be
specifically pre-approved by the Audit Committee (or by any member of the Audit
Committee to which pre-approval has been delegated).
6. ALL OTHER SERVICES
The Audit Committee believes, based on the SEC's rules prohibiting the
Independent Auditors from providing specific non-audit services, that other
types of non-audit services are permitted. Accordingly, the Audit Committee
believes it may grant general pre-approval to those permissible non-audit
services classified as All Other services that it believes are routine and
recurring services, would not impair the independence of the auditor and are
consistent with the SEC's rules on auditor independence.
The Audit Committee has pre-approved the All Other services in Appendix B.4.
Permissible All Other services not listed in Appendix B.4 must be specifically
pre-approved by the Audit Committee (or by any member of the Audit Committee to
which pre-approval has been delegated).
7. PRE-APPROVAL FEE LEVELS OR BUDGETED AMOUNTS
Pre-approval fee levels or budgeted amounts for all services to be provided by
the Independent Auditors will be established annually by the Audit Committee.
Any proposed services exceeding these levels or amounts will require specific
pre-approval by the Audit Committee. The Audit Committee is mindful of the
overall relationship of fees for audit and non-audit services in determining
whether to pre-approve any such services.
8. PROCEDURES
All requests or applications for services to be provided by the Independent
Auditors that do not require specific approval by the Audit Committee will be
submitted to the Fund's Chief Financial Officer and must include a detailed
description of the services to be
<Page>
rendered. The Fund's Chief Financial Officer will determine whether such
services are included within the list of services that have received the general
pre-approval of the Audit Committee. The Audit Committee will be informed on a
timely basis of any such services rendered by the Independent Auditors. Requests
or applications to provide services that require specific approval by the Audit
Committee will be submitted to the Audit Committee by both the Independent
Auditors and the Fund's Chief Financial Officer, and must include a joint
statement as to whether, in their view, the request or application is consistent
with the SEC's rules on auditor independence.
The Audit Committee has designated the Fund's Chief Financial Officer to monitor
the performance of all services provided by the Independent Auditors and to
determine whether such services are in compliance with this Policy. The Fund's
Chief Financial Officer will report to the Audit Committee on a periodic basis
on the results of its monitoring. Both the Fund's Chief Financial Officer and
management will immediately report to the chairman of the Audit Committee any
breach of this Policy that comes to the attention of the Fund's Chief Financial
Officer or any member of management.
9. ADDITIONAL REQUIREMENTS
The Audit Committee has determined to take additional measures on an annual
basis to meet its responsibility to oversee the work of the Independent Auditors
and to assure the auditor's independence from the Fund, such as reviewing a
formal written statement from the Independent Auditors delineating all
relationships between the Independent Auditors and the Fund, consistent with
Independence Standards Board No. 1, and discussing with the Independent Auditors
its methods and procedures for ensuring independence.
10. COVERED ENTITIES
Covered Entities include the Fund's investment adviser(s) and any entity
controlling, controlled by or under common control with the Fund's investment
adviser(s) that provides ongoing services to the Fund(s). Beginning with
non-audit service contracts entered into on or after May 6, 2003, the Fund's
audit committee must pre-approve non-audit services provided not only to the
Fund but also to the Covered Entities if the engagements relate directly to the
operations and financial reporting of the Fund. This list of Covered Entities
would include:
MORGAN STANLEY RETAIL FUNDS
Morgan Stanley Investment Advisors Inc.
Morgan Stanley & Co. Incorporated
Morgan Stanley DW Inc.
Morgan Stanley Investment Management Inc.
Morgan Stanley Investment Management Limited
Morgan Stanley Investment Management Private Limited
Morgan Stanley Asset & Investment Trust Management Co., Limited
Morgan Stanley Investment Management Company
Van Kampen Asset Management
Morgan Stanley Services Company, Inc.
Morgan Stanley Distributors Inc.
Morgan Stanley Trust FSB
<Page>
MORGAN STANLEY INSTITUTIONAL FUNDS
Morgan Stanley Investment Management Inc.
Morgan Stanley Investment Advisors Inc.
Morgan Stanley Investment Management Limited
Morgan Stanley Investment Management Private Limited
Morgan Stanley Asset & Investment Trust Management Co., Limited
Morgan Stanley Investment Management Company
Morgan Stanley & Co. Incorporated
Morgan Stanley Distribution, Inc.
Morgan Stanley AIP GP LP
Morgan Stanley Alternative Investment Partners LP
(e)(2) Beginning with non-audit service contracts entered into on or after May
6, 2003, the audit committee also is required to pre-approve services to Covered
Entities to the extent that the services are determined to have a direct impact
on the operations or financial reporting of the Registrant. 100% of such
services were pre-approved by the audit committee pursuant to the Audit
Committee's pre-approval policies and procedures (attached hereto).
(f) Not applicable.
(g) See table above.
(h) The audit committee of the Board of Directors has considered whether the
provision of services other than audit services performed by the auditors to the
Registrant and Covered Entities is compatible with maintaining the auditors'
independence in performing audit services.
Item 5. Audit Committee of Listed Registrants.
(a) The Fund has a separately-designated standing audit committee established in
accordance with Section 3(a)(58)(A) of the Exchange Act whose members are:
Michael Bozic, Edwin J. Garn, Wayne E. Hedien, Manual H. Johnson, Joseph J.
Kearns, Michael Nugent and Fergus Reid.
(b) Not applicable.
Item 6. Schedule of Investments
Refer to Item 1.
<Page>
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies.
Applicable only to reports filed by closed-end funds.
Item 8. Portfolio Managers of Closed-End Management Investment Companies
Applicable only to reports filed by closed-end funds.
Item 9. Closed-End Fund Repurchases
Applicable only to reports filed by closed-end funds.
Item 10. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 11. Controls and Procedures
(a) The Fund's principal executive officer and principal financial officer have
concluded that the Fund's disclosure controls and procedures are sufficient to
ensure that information required to be disclosed by the Fund in this Form N-CSR
was recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, based
upon such officers' evaluation of these controls and procedures as of a date
within 90 days of the filing date of the report.
(b) There were no changes in the registrant's internal control over financial
reporting that occurred during the second fiscal quarter of the period covered
by this report that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial reporting.
Item 12. Exhibits
(a) 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.
<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 Liquid Asset Fund Inc.
/s/ Ronald E. Robison
- -------------------------------------
Ronald E. Robison
Principal Executive Officer
October 19, 2006
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
October 19, 2006
/s/ Francis Smith
- -------------------------------------
Francis Smith
Principal Financial Officer
October 19, 2006