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 811-8603 Name of Fund: Debt Strategies Fund, Inc. Fund Address: P.O. Box 9011 Princeton, NJ 08543-9011 Name and address of agent for service: Terry K. Glenn, President, Debt Strategies Fund, Inc., 800 Scudders Mill Road, Plainsboro, NJ 08536. Mailing address: P.O. Box 9011, Princeton, NJ 08543-9011 Registrant's telephone number, including area code: (609) 282-2800 Date of fiscal year end: 02/28/03 Date of reporting period: 03/01/02 - 2/28/03 Item 1 - Attach shareholder report [LOGO] Merrill Lynch Investment Managers Annual Report February 28, 2003 Debt Strategies Fund, Inc. www.mlim.ml.com DEBT STRATEGIES FUND, INC. The Benefits and Risks of Leveraging Debt Strategies Fund, Inc. utilizes leverage through borrowings or issuance of short-term debt securities or shares of Preferred Stock. The concept of leveraging is based on the premise that the cost of assets to be obtained from leverage will be based on short-term interest rates, which normally will be lower than the return earned by the Fund on its longer-term portfolio investments. To the extent that the total assets of the Fund (including the assets obtained from leverage) are invested in higher-yielding portfolio investments, the Fund's Common Stock shareholders will benefit from the incremental yield. Leverage creates risks for holders of Common Stock including the likelihood of greater net asset value and market price volatility. In addition, there is the risk that fluctuations in interest rates on borrowings (or in the dividend rates on any Preferred Stock, if the Fund were to issue Preferred Stock) may reduce the Common Stock's yield and negatively impact its market price. If the income derived from securities purchased with assets received from leverage exceeds the cost of leverage, the Fund's net income will be greater than if leverage had not been used. Conversely, if the income from the securities purchased is not sufficient to cover the cost of leverage, the Fund's net income will be less than if leverage had not been used, and therefore the amount available for distribution to Common Stock shareholders will be reduced. In this case, the Fund may nevertheless decide to maintain its leveraged position in order to avoid capital losses on securities purchased with leverage. However, the Fund will not generally utilize leverage if it anticipates that its leveraged capital structure would result in a lower rate of return for its Common Stock than would be obtained if the Common Stock were unleveraged for any significant amount of time. Portfolio Information As of February 28, 2003 (unaudited) Percent of Ten Largest Holdings Total Assets - -------------------------------------------------------------------------------- Wyndham International, Inc. ........................................ 1.9% Charter Communications Holdings LLC ................................ 1.9 CSC Holdings Inc. .................................................. 1.8 Radio Unica Corp. .................................................. 1.8 Coaxial LLC/Coaxial Finance ........................................ 1.7 Spectracite Communications ......................................... 1.6 Crown Castle International Corporation ............................. 1.5 Century Cable Holdings LLC ......................................... 1.5 Ainsworth Lumber Company ........................................... 1.5 Western Resources Inc. ............................................. 1.5 - -------------------------------------------------------------------------------- Percent of Five Largest Industries Total Assets - -------------------------------------------------------------------------------- Cable Television Services .................................. 12.8% Utilities .................................................. 6.7 Gaming ..................................................... 6.1 Wireless Telecommunications ................................ 5.8 Broadcasting ............................................... 5.0 - -------------------------------------------------------------------------------- Quality Ratings by Percent of S&P/Moody's Long-Term Investments - -------------------------------------------------------------------------------- BBB/Baa .................................................. 0.7% BB/Ba .................................................... 9.9 B/B ...................................................... 41.0 CCC/Caa or lower ......................................... 30.9 NR (Not Rated) ........................................... 17.5 - -------------------------------------------------------------------------------- Geographic Allocation Percent of By Country Long-Term Investments - -------------------------------------------------------------------------------- United States ........................................... 89.3% Canada .................................................. 8.4 Kyrgyzstan .............................................. 0.9 Australia ............................................... 0.5 Poland .................................................. 0.2 Bahamas ................................................. 0.2 United Kingdom .......................................... 0.2 Cayman Islands .......................................... 0.2 Netherlands ............................................. 0.1 - -------------------------------------------------------------------------------- Debt Strategies Fund, Inc., February 28, 2003 DEAR SHAREHOLDER Investment Approach Debt Strategies Fund, Inc. is comprised of high yield bonds and leveraged bank loans. The high yield bond and bank loan markets contain similar industry sectors and often have overlapping issuers. As a result, general economic events and trends tend to move the two markets in the same direction, although bonds typically experience greater volatility than bank loans. This can be attributed to two factors. First, bank loans are usually senior secured obligations, thus generally offering investors greater principal protection than unsecured bonds. Second, bank loans are typically floating rate instruments whose principal value generally does not move inversely with interest rate movements, as is the case with fixed income bonds. Market Review The continued high and unprecedented level of default rates in 2002 was the dominant factor impacting the high yield markets. Although the default rate for junk bond-rated companies fell from 10.6% to 8.3%, the actual dollar volume of defaults increased. Moody's Investors Service is forecasting a decline in the default rate to 6.9% for 2003. The high yield bond and leveraged loan markets' returns both crossed into negative territory in the second and third quarters, but this situation reversed sharply in the fourth quarter because of the emergence of solid retail and institutional demand in mid-October. Both markets had positive performance results for the fourth quarter of 2002 with +5.92% (bonds) and +1.93% (bank loans), as measured by their respective Credit Suisse First Boston (CSFB) Indexes. An important development in the high yield markets occurred in 2002 as we saw the importance of collateralized bond obligations (CBOs) abate significantly. The channel for collateralized loan obligations (CLOs) remains open, though somewhat constricted. The negative impact of high yield bond defaults on the subordinated investor tranches is the principal reason for the decline of CBO issues. With non-CBO investor demand channels currently playing a relatively more important role in the high yield markets, this may increase volatility as CBOs have a comparatively more stable and longer-term investment horizon than retail funds. Fund Performance For the year ended February 28, 2003, the Common Stock of Debt Strategies Fund, Inc. had a net annualized yield of 14.61%, based on a year-end per share net asset value of $5.35 and $.782 per share income dividends. Over the same period, the total investment return on the Fund's Common Stock was +2.04%, based on a change in per share net asset value from $6.03 to $5.35, and assuming reinvestment of $.789 per share ordinary income dividends. For the six-month period ended February 28, 2003, the total investment return on the Fund's Common Stock was +11.88%, based on a change in per share net asset value from $5.14 to $5.35, and assuming reinvestment of $.393 per share income dividends. For the one-year and six-month periods ended February 28, 2003, the Fund's benchmark, which is an equal blend of the CSFB High Yield Index and the CSFB Leveraged Loan Index, had total returns of +5.05% and +6.55%, respectively. For a description of the Fund's total investment return based on a change in the per share market value (as measured by the trading price of the Fund's shares on the New York Stock Exchange), and assuming reinvestment of dividends, please refer to the Financial Highlights section of the Financial Statements included in this report. As a closed-end fund, the Fund's shares may trade in the secondary market at a premium or discount to the Fund's net asset value. As a result, total investment returns based on changes in the Fund's market value can vary significantly from total investment return based on changes in the Fund's net asset value. There are both general and specific reasons for this performance. First, as we stated in previous shareholder reports, we maintained an overweighted position in bonds relative to bank loans in order to maintain the dividend yield and benefit from a potential rally in the high yield market. The Fund underperformed in the first half of the fiscal year, and outperformed in the second half, as the overweighted bond position caused the Fund to move in greater sympathy with the high yield bond market. Second, there were several specific investments that hurt performance during the year. Among them was Mission Energy Holdings, where we saw our $30 million bond position collapse in price from 101 to 28. Mission Energy is a holding company founded to own Edison International of California, which in turn bought the non-nuclear generating assets of Exelon Corporation (formerly Commonwealth Edison). Mission Energy was pressured by two factors. First, the decision by a major customer not to renew a long-term power purchase agreement, left Mission Energy more exposed to the vagaries of the spot market. Second, the downgrading of Edison to below investment grade inhibited its ability to upstream dividends to Mission Energy. Importantly, a combination of escrowed coupons and tax sharing arrangements would give the company sufficient debt service ability through 2004 and time to resolve these problems. Considering that the price of 28 at February 28, 2003 values these securities only slightly above the value of these payments, we believe these bonds are quite undervalued. Our bank loan and bond exposure in the cable television company Charter Communications Holdings LLC also hurt Fund performance. Our $11 million in bank loan positions weakened from 97 to 84, while $19.7 million in various bond holdings fell in price from the high 90s into the 40s. These positions began to weaken following the Adelphia Communications Corp. bankruptcy. This situation was further exacerbated by disclosure that Charter Communication's management had concealed the true level of subscriber disconnects. This issue has been addressed and relevant management replaced. Charter Communications is currently in compliance with its debt agreements but remains relatively highly leveraged. Nevertheless, we believe our positions are currently undervalued. Positive developments in the Fund included our holdings in Nextel Communications, Inc. Our confidence in this wireless provider was rewarded as we sold $23 million in bonds and bank debt around 80 and purchased 16,000 shares of Preferred Stock around 60. We subsequently liquidated most of the preferred position at prices ranging from 94 to par. Our 7,300 remaining shares at February 28, 2003 were trading above par. Radio Unica Corp. was another positive holding for the Fund as our $24 million bond position rallied from 41 to 60 during the year. This company is the only national Spanish language radio network in the United States. Paradoxically, the bond price strengthened on the prospect of the company missing its coupon payment (which was subsequently made during the 30-day grace period), highlighting the firm's excellent franchise value, and ample asset coverage. Investment Strategy With the three-month London InterBank Offering Rate near 1.3%, we plan to continue our high yield bond overweight at around 70% of total assets. We are maintaining leverage near 33%, and managing the duration of the bond portion of the Fund's portfolio approximately 3.1 years, compared to a high yield market duration of 4.0 years. By doing so, we are seeking to lessen the potential negative impact on high yield bond prices should a rising interest rate outlook prompt a rebalancing toward bank loans. In Conclusion The market is currently dominated by geopolitical risk. We are managing the Fund somewhat defensively (that is, through shorter duration and broad diversification), while maintaining the portfolio's yield in this low interest rate environment. However, we are confident that we will continue to see well-structured transactions and a declining default rate through 2003. We thank you for your interest in Debt Strategies Fund, Inc., and we look forward to serving your investment needs in the months and years ahead. Sincerely, /s/ Terry K. Glenn Terry K. Glenn President and Director /s/ Kevin J. Booth Kevin J. Booth Vice President and Portfolio Manager /s/ Joseph P. Matteo Joseph P. Matteo Vice President and Portfolio Manager March 31, 2003 2 & 3 Debt Strategies Fund, Inc., February 28, 2003 AUTOMATIC DIVIDEND REINVESTMENT PLAN The following description of the Fund's Automatic Dividend Reinvestment Plan (the "Plan") is sent to you annually as required by the Federal securities laws. Pursuant to the Fund's Plan, unless a holder of Common Stock otherwise elects, all dividend and capital gains distributions will be automatically reinvested by The Bank of New York, as agent for shareholders in administering the Plan (the "Plan Agent"), in additional shares of Common Stock of the Fund. Holders of Common Stock who elect not to participate in the Plan will receive all distributions in cash paid by check mailed directly to the shareholder of record (or, if the shares are held in street or other nominee name then to such nominee) by The Bank of New York, as dividend paying agent. Such participants may elect not to participate in the Plan and to receive all distributions of dividends and capital gains in cash by sending written instructions to The Bank of New York, as dividend paying agent, at the address set forth below. Participation in the Plan is completely voluntary and may be terminated or resumed at any time without penalty by written notice if received by the Plan Agent not less than ten days prior to any dividend record date; otherwise such termination will be effective with respect to any subsequently declared dividend or distribution. Whenever the Fund declares an income dividend or capital gains distribution (collectively referred to as "dividends") payable either in shares or in cash, non-participants in the Plan will receive cash and participants in the Plan will receive the equivalent in shares of Common Stock. The shares will be acquired by the Plan Agent for the participant's account, depending upon the circumstances described below, either (i) through receipt of additional unissued but authorized shares of Common Stock from the Fund ("newly issued shares") or (ii) by purchase of outstanding shares of Common Stock on the open market ("open-market purchases") on the New York Stock Exchange or elsewhere. If on the payment date for the dividend, the net asset value per share of the Common Stock is equal to or less than the market price per share of the Common Stock plus estimated brokerage commissions (such condition being referred to herein as "market premium"), the Plan Agent will invest the dividend amount in newly issued shares on behalf of the participant. The number of newly issued shares of Common Stock to be credited to the participant's account will be determined by dividing the dollar amount of the dividend by the net asset value per share on the date the shares are issued, provided that the maximum discount from the then current market price per share on the date of issuance may not exceed 5%. If on the dividend payment date the net asset value per share is greater than the market value (such condition being referred to herein as "market discount"), the Plan Agent will invest the dividend amount in shares acquired on behalf of the participant in open-market purchases. In the event of a market discount on the dividend payment date, the Plan Agent will have until the last business day before the next date on which the shares trade on an "ex-dividend" basis or in no event more than 30 days after the dividend payment date (the "last purchase date") to invest the dividend amount in shares acquired in open-market purchases. It is contemplated that the Fund will pay monthly income dividends. Therefore, the period during which open-market purchases can be made will exist only from the payment date on the dividend through the date before the next "ex-dividend" date which typically will be approximately ten days. If, before the Plan Agent has completed its open-market purchases, the market price of a share of Common Stock exceeds the net asset value per share, the average per share purchase price paid by the Plan Agent may exceed the net asset value of the Fund's shares, resulting in the acquisition of fewer shares than if the dividend had been paid in newly issued shares on the dividend payment date. Because of the foregoing difficulty with respect to open-market purchases, the Plan provides that if the Plan Agent is unable to invest the full dividend amount in open-market purchases during the purchase period or if the market discount shifts to a market premium during the purchase period, the Plan Agent will cease making open-market purchases and will invest the uninvested portion of the dividend amount in newly issued shares at the close of business on the last purchase date determined by dividing the uninvested portion of the dividend by the net asset value per share. The Plan Agent maintains all shareholders' accounts in the Plan and furnishes written confirmation of all transactions in the account, including information needed by shareholders for tax records. Shares in the account of each Plan participant will be held by the Plan Agent in non-certificated form in the name of the participant, and each shareholder's proxy will include those shares purchased or received pursuant to the Plan. The Plan Agent will forward all proxy solicitation materials to participants and vote proxies for shares held pursuant to the Plan in accordance with the instructions of the participants. In the case of shareholders such as banks, brokers or nominees that hold shares of others who are the beneficial owners, the Plan Agent will administer the Plan on the basis of the number of shares certified from time to time by the record shareholders as representing the total amount registered in the record shareholder's name and held for the account of beneficial owners who are to participate in the Plan. There will be no brokerage charges with respect to shares issued directly by the Fund as a result of dividends or capital gains distributions payable either in shares or in cash. However, each participant will pay a pro rata share of brokerage commissions incurred with respect to the Plan Agent's open-market purchases in connection with the reinvestment of dividends. The automatic reinvestment of dividends and distributions will not relieve participants of any Federal, state or local income tax that may be payable (or required to be withheld) on such dividends. Shareholders participating in the Plan may receive benefits not available to shareholders not participating in the Plan. If the market price plus commissions of the Fund's shares is above the net asset value, participants in the Plan will receive shares of the Fund at less than they could otherwise purchase them and will have shares with a cash value greater than the value of any cash distribution they would have received on their shares. If the market price plus commissions is below the net asset value, participants will receive distributions in shares with a net asset value greater than the value of any cash distribution they would have received on their shares. However, there may be insufficient shares available in the market to make distributions in shares at prices below the net asset value. Also, since the Fund does not redeem shares, the price on resale may be more or less than the net asset value. The value of shares acquired pursuant to the Plan will generally be excluded from gross income to the extent that the cash amount reinvested would be excluded from gross income. If, when the Fund's shares are trading at a premium over net asset value, the Fund issues shares pursuant to the Plan that have a greater fair market value than the amount of cash reinvested, it is possible that all or a portion of such discount (which may not exceed 5% of the fair market value of the Fund's shares) could be viewed as a taxable distribution. If the discount is viewed as a taxable distribution, it is also possible that the taxable character of this discount would be allocable to all the shareholders, including shareholders who do not participate in the Plan. Thus, shareholders who do not participate in the Plan might be required to report as ordinary income a portion of their distributions equal to their allocable share of the discount. Experience under the Plan may indicate that changes are desirable. Accordingly, the Fund reserves the right to amend or terminate the Plan. There is no direct service charge to participants in the Plan; however, the Fund reserves the right to amend the Plan to include a service charge payable by the participants. All correspondence concerning the Plan should be directed to the Plan Agent at The Bank of New York, Church Street Station, P.O. Box 11258, New York, NY 10286-1258, Telephone: 800-432-8224. 4 & 5 Debt Strategies Fund, Inc., February 28, 2003 SCHEDULE OF INVESTMENTS S&P Moody's Face INDUSTRIES Ratings++ Ratings++ Amount Corporate Debt Obligations Value ==================================================================================================================================== Aerospace & CCC+ Caa2 $ 1,250,000 Hexcel Corporation, 9.75% due 1/15/2009 $ 1,062,500 Defense--0.2% ==================================================================================================================================== Air Transportation B B3 10,251,725 American Airlines, 7.379% due 5/23/2016 2,155,548 Service--0.5% D Ca 2,795,000 +USAir Inc., 10.375% due 3/01/2013 614,900 ----------- 2,770,448 ==================================================================================================================================== Amusement & B+ B1 8,250,000 Intrawest Corporation, 10.50% due 2/01/2010 8,621,250 Recreational NR* NR* 1,800,000 +Loews Cineplex Entertainment, 8.875% due 8/01/2008 173,250 Services--1.8% B B2 1,225,000 Vail Resorts Inc., 8.75% due 5/15/2009 1,249,500 ----------- 10,044,000 ==================================================================================================================================== Apparel--0.5% Arena Brands, Inc.:** NR* NR* 16,916 Term A, due 6/01/2003 16,800 NR* NR* 2,802,219 Term B, due 6/01/2003 2,785,756 ----------- 2,802,556 ==================================================================================================================================== Automotive B+ NR* 3,326,637 Citation Corporation, Term B, due 12/01/2007** 2,927,441 Equipment--1.9% B B2 1,550,000 Dura Operating Corporation, 9% due 5/01/2009 1,325,250 CCC- Caa3 3,200,000 +Holley Performance Products, 12.25% due 9/15/2007 1,216,000 NR* NR* 3,850,000 +Key Plastics, Inc., 10.25% due 3/15/2007 385 B B3 2,500,000 Metaldyne Corporation, 11% due 6/15/2012 1,975,000 CCC+ Caa1 3,375,000 Tenneco Automotive Inc., 11.625% due 10/15/2009 2,531,250 +Venture Holdings Trust: D Caa1 1,800,000 9.50% due 7/01/2005 450,000 D Caa2 4,450,000 12% due 6/01/2009 178,000 ----------- 10,603,326 ==================================================================================================================================== Broadcasting--7.1% CCC+ B3 6,400,000 Acme Television/Finance, 10.875% due 9/30/2004 6,544,000 Cumulus Media Inc.: B- B3 2,000,000 10.375% due 7/01/2008 2,140,000 B+ Ba3 1,000,000 Term B, due 3/28/2010** 1,007,188 NR* NR* 6,471,568 Gocom Communications LLC, Term B, due 12/31/2007** 5,889,127 NR* NR* 2,916,667 Granite Broadcasting, Term A, due 4/15/2004** 2,843,750 B- B3 1,600,000 Nexstar Finance Inc. LLC, 12% due 4/01/2008 1,760,000 NR* Caa3 24,525,000 Radio Unica Corp., 11.75% due 8/01/2006 14,745,656 B- B3 4,650,000 Spanish Broadcasting System, 9.625% due 11/01/2009 4,766,250 ----------- 39,695,971 ==================================================================================================================================== Building & B B2 10,500,000 Champion Home Builders, 11.25% due 4/15/2007 9,030,000 Construction--1.6% ==================================================================================================================================== Building NR* NR* 5,850,000 +Formica Corporation, 10.875% due 3/01/2009 1,404,000 Materials--0.6% NR* NR* 2,293,267 Trussway Industries Inc., Term B, due 12/31/2006** 1,777,282 ----------- 3,181,282 ==================================================================================================================================== Cable Television BB- B1 3,450,000 CSC Holdings Inc., 7.25% due 7/15/2008 3,363,750 Services--16.2% Century Cable Holdings LLC:** D Caa1 10,000,000 Discretionary Term, due 6/30/2009 7,208,330 D Caa1 7,000,000 Term, due 12/31/2009 4,942,777 Charter Communications Holdings LLC: B+ B2 10,000,000 10% due 4/01/2009 4,800,000 CCC- Ca 2,000,000 0/11.75% due 1/15/2010 (c) 760,000 CCC- Ca 2,000,000 11.125% due 1/15/2011 980,000 CCC- Ca 2,700,000 0/9.92% due 4/01/2011 (c) 1,161,000 CCC- Ca 3,000,000 10% due 5/15/2011 1,440,000 Charter Communications Operating LLC: BB- B1 1,985,000 Incremental Term, due 9/18/2008** 1,662,713 BB- B1 4,962,500 Term B, due 3/18/2008** 4,178,648 B B3 4,500,000 Coaxial Communications, Phoenix, 10% due 8/15/2006 4,230,000 CCC+ Caa1 20,000,000 Coaxial LLC/Coaxial Finance, 0/12.875% due 8/15/2008 (c) 14,025,000 C Caa2 5,000,000 Comcast UK Cable Partners Ltd., 11.20% due 11/15/2007 3,675,000 B+ B1 6,950,000 Echostar DBS Corporation, 9.375% due 2/01/2009 7,401,750 Insight Midwest: B+ B2 2,500,000 9.75% due 10/01/2009 2,437,500 BB+ Ba3 8,000,000 Term B, due 12/31/2009** 7,727,000 NR* NR* 8,750,000 +Mallard Cablevision LLC & Sun Tel Comm., Term B, due 9/30/2008** 4,375,000 D B2 6,000,000 Olympus Cable Holdings LLC, Term B, due 9/30/2010** 4,866,816 B+ B1 3,920,000 Pegasus Media & Communications, Inc., Term, due 4/30/2005** 3,543,241 CCC+ Ca 7,500,000 Pegasus Satellite, 12.375% due 8/01/2006 5,943,750 C Ca 6,100,000 +Telewest Communications PLC, 9.875% due 2/01/2010 1,128,500 D Ca 5,500,000 +United Pan-Europe Communications NV, 11.25% due 2/01/2010 453,750 ----------- 90,304,525 ==================================================================================================================================== Chemicals--5.0% BB B1 4,000,000 Equistar Chemicals LP, 8.75% due 2/15/2009 3,420,000 B- B3 2,000,000 Geo Specialty Chemicals, 10.125% due 8/01/2008 1,100,000 B- Caa1 2,000,000 Huntsman ICI Chemicals, 10.125% due 7/01/2009 1,695,000 B- Caa2 11,000,000 Huntsman ICI Holdings, 0% due 12/31/2009 (c) 2,530,000 B B3 1,900,000 Huntsman International LLC, 9.875% due 3/01/2009 1,942,750 B+ B2 3,150,000 ISP Holdings, Inc., 10.625% due 12/15/2009 3,008,250 BB Ba3 3,550,000 Lyondell Chemical Company, 9.80% due 2/01/2020 2,733,500 BBB- Ba1 2,400,000 Millennium America Inc., 7.625% due 11/15/2026 2,100,000 NR* NR* 1,450,917 PCI Chemicals, 10% due 12/31/2008 1,102,697 NR* NR* 483,639 Pioneer Companies, Inc., 4.90% due 12/31/2006 357,893 B Caa3 9,125,000 Terra Industries, 10.50% due 6/15/2005 7,893,125 ----------- 27,883,215 ==================================================================================================================================== Computer-Related NR* NR* 2,230,423 +Bridge Information Systems, Term B, due 5/29/2005** 301,107 Products--0.1% ==================================================================================================================================== Consumer BB+ Ba3 3,500,000 American Greetings, 11.75% due 7/15/2008 3,893,750 Products--4.0% BB- Ba3 800,984 Burhmann NV, Term B, due 10/26/2007** 760,635 NR* Caa3 25,460,000 +Decora Industries Inc., 11% due 5/01/2005 2,546 D C 2,500,000 +Diamond Brands Inc., 0/12.875% due 4/15/2009 (c) 12,500 B- Caa2 2,000,000 Home Products International Inc., 9.625% due 5/15/2008 1,800,000 B- B2 1,475,000 Remington Arms Company, 10.50% due 2/01/2011 (d) 1,552,437 6 & 7 Debt Strategies Fund, Inc., February 28, 2003 SCHEDULE OF INVESTMENTS (continued) S&P Moody's Face INDUSTRIES Ratings++ Ratings++ Amount Corporate Debt Obligations Value ==================================================================================================================================== Consumer Products CCC Caa2 $ 5,500,000 Remington Product Company LLC, 11% due 5/15/2006 $ 5,060,000 (concluded) CCC Caa2 11,000,000 Samsonite Corporation, 10.75% due 6/15/2008 9,377,500 ----------- 22,459,368 ==================================================================================================================================== Electronics/Electrical NR* C 10,143,000 +Advanced Glassfiber Yarn, 9.875% due 1/15/2009 519,829 Components--4.1% Amkor Technology Inc.: B B1 3,500,000 9.25% due 5/01/2006 3,325,000 B B1 6,700,000 9.25% due 2/15/2008 6,298,000 NR* B1 1,661,397 DD Incorporated, Term B, due 4/22/2005** 1,204,513 CCC Caa2 10,145,000 High Voltage Engineering, 10.75% due 8/15/2004 2,942,050 BB Ba3 4,300,000 Mirant Americas Generation LLC, 7.625% due 5/01/2006 2,429,500 B Caa2 1,332,228 ON Semiconductor Corporation (Semiconductor Components), Term D, due 8/04/2007** 1,212,328 B Caa2 7,500,000 SCG Holdings Corporation, 12% due 8/01/2009 4,275,000 NR* B1 2,498,027 +Trend Technologies, Inc., Term, due 2/28/2007** 686,958 ----------- 22,893,178 ==================================================================================================================================== Energy--4.7% B+ Ba3 8,925,000 Citgo Petroleum Corporation, 11.375% due 2/01/2011 (d) 8,969,625 CCC+ Caa1 1,900,000 Continental Resources, 10.25% due 8/01/2008 1,776,500 BB- Ba3 2,092,024 Dresser Inc., Term B, due 4/10/2009** 2,097,440 El Paso Energy Partners: BB- B1 750,000 8.50% due 6/01/2011 723,750 NR* NR* 1,000,000 Term B, due 9/01/2009** 952,500 CCC+ Caa3 3,250,000 Energy Corp. of America, 9.50% due 5/15/2007 1,982,500 B+ Ba3 8,550,000 Fluor Corporation, 6.95% due 3/01/2007 6,669,000 B B2 2,925,000 Lone Star Technologies, 9% due 6/01/2011 2,837,250 ----------- 26,008,565 ==================================================================================================================================== Environmental D NR* 1,800,000 +IT Group Inc., 11.25% due 4/01/2009 18 Services--0.2% B B2 1,500,000 URS Corporation, 12.25% due 5/01/2009 1,177,500 ----------- 1,177,518 ==================================================================================================================================== Financial B B2 3,000,000 Ares Leveraged Fund II, Junior Subordinate Secured Note, Services--1.9% due 10/31/2005 (a)(d) 2,100,000 NR* NR* 8,000,000 Finova Group Inc., 7.50% due 11/15/2009 2,560,000 NR* NR* 1,500,000 Investcorp SA, Term, due 10/21/2008** 1,522,066 NR* Ba3 2,000,000 Pennant CBO Limited, 13.43% due 3/14/2011 (d)(f) 678,125 NR* NR* 3,500,000 Preferred Term Securities VI, 20% due 7/03/2032 (a)(d) 3,543,750 SKM-Libertyview CBO Limited (d)(f): AAA Ca3 1,500,000 8.71% due 4/10/2011 278,438 AAA Ca 1,000,000 11.91% due 4/10/2011 10,000 ----------- 10,692,379 ==================================================================================================================================== Food & Kindred NR* NR* 2,807,494 Archibald Candy Corporation, 10% due 11/01/2007 2,526,745 Products--6.1% BB+ Ba2 4,599,381 Dean Foods Company, Term B, due 7/15/2008** 4,604,270 B- B2 2,200,000 Doane Pet Care Company, 10.75% due 3/01/2010 (d) 2,222,000 NR* NR* 22,526,000 +Envirodyne Industries, 10.25% (h) 4,505,200 BB- Ba3 8,000,000 Luigino's Inc., 10% due 2/01/2006 8,160,000 BB- Ba3 3,927,800 Merisant Company, Term B, due 3/30/2007** 3,931,484 NR* Caa2 11,750,000 RAB Enterprises Inc., 10.50% due 5/01/2005 5,875,000 B+ Ba2 2,000,000 SC International Services, Inc., 9.25% due 9/01/2007 2,092,700 ----------- 33,917,399 ==================================================================================================================================== Forest Products--3.3% Ainsworth Lumber Company: B- B3 9,000,000 12.50% due 7/15/2007 (b) 9,675,000 B- B3 2,500,000 13.875% due 7/15/2007 2,725,000 B+ B3 6,000,000 Millar Western Forest, 9.875% due 5/15/2008 6,000,000 ----------- 18,400,000 ==================================================================================================================================== Gaming--8.8% +Aladdin Gaming LLC: NR* NR* 13,000,000 0/13.50% due 3/01/2010 (c) 146,250 NR* Caa1 2,968,421 Term B, due 2/26/2006** 2,463,789 NR* Caa1 4,455,000 Term C, due 2/26/2008** 3,697,650 Hollywood Park Inc.: CCC+ Caa1 4,300,000 9.25% due 2/15/2007 (d) 3,827,000 CCC+ Caa1 3,000,000 9.50% due 8/01/2007 2,670,000 B B2 2,000,000 Jacobs Entertainment, 11.875% due 2/01/2009 2,080,000 B+ B2 3,600,000 Marina District Finance Co. (Borgata), Term B, due 5/31/2007** 3,550,500 BB+ Ba2 7,000,000 Park Place Entertainment, 8.125% due 5/15/2011 7,035,000 B B2 2,150,000 Peninsula Gaming LLC, 12.25% due 7/01/2006 2,193,000 B- B3 7,000,000 Penn National Gaming Inc., 11.125% due 3/01/2008 7,420,000 B+ B2 1,800,000 Sun International Hotels, 8.875% due 8/15/2011 1,809,000 B- B3 4,000,000 Venetian Casino/LV Sands, 11% due 6/15/2010 4,080,000 CCC+ B3 8,000,000 Wynn Las Vegas LLC, 12% due 11/01/2010 8,040,000 ----------- 49,012,189 ==================================================================================================================================== Health Services--1.2% B+ B1 3,460,956 Medpointe, Term B, due 9/30/2008** 3,158,122 CCC+ B3 3,325,000 Vanguard Health Systems, 9.75% due 8/01/2011 3,233,563 ----------- 6,391,685 ==================================================================================================================================== Health Care BB- Ba2 5,000,000 Fresenius Medical Capital Trust IV, 7.875% due 6/15/2011 5,000,000 Providers--0.9% ==================================================================================================================================== Hotels & Motels--5.7% B B2 7,000,000 Extended Stay America, 9.15% due 3/15/2008 6,685,000 BB- Ba3 1,800,000 HMH Properties, Inc., 8.45% due 12/01/2008 1,692,000 B B2 1,650,000 John Q. Hammons Hotels, 8.875% due 5/15/2012 1,633,500 B B2 6,500,000 Majestic Star LLC, 10.875% due 7/01/2006 6,565,000 Wyndham Hotel Corporation:** B NR* 6,543,291 Increasing Rate Term, due 6/30/2004 4,962,681 B NR* 14,015,206 Term, due 6/30/2006 10,183,799 ----------- 31,721,980 ==================================================================================================================================== Industrial BB- Ba3 1,990,000 Johnson Divessey, Term B, due 9/15/2009** 2,001,817 Services--1.3% B- Caa3 9,375,000 Muzak Holdings LLC, 0/13% due 3/15/2010 (c) 5,074,219 ----------- 7,076,036 ==================================================================================================================================== 8 & 9 Debt Strategies Fund, Inc., February 28, 2003 SCHEDULE OF INVESTMENTS (continued) S&P Moody's Face INDUSTRIES Ratings++ Ratings++ Amount Corporate Debt Obligations Value ==================================================================================================================================== Leasing & Rental CCC+ Caa2 $ 3,750,000 Anthony Crane Rental LP, Term, due 7/22/2006** $ 1,125,000 Services--2.2% B Caa3 6,800,000 National Equipment Services, 10% due 11/30/2004 2,040,000 BB- B1 3,000,000 United Rentals Inc., 10.75% due 4/15/2008 (d) 2,962,500 B B3 6,400,000 Williams Scotsman, Inc., 9.875% due 6/01/2007 6,016,000 ----------- 12,143,500 ==================================================================================================================================== Manufacturing--5.6% NR* NR* 4,500,000 AquaChem Inc., 11.25% due 7/01/2008 3,465,000 CCC- NR* 8,350,000 International Utility Structures, 10.75% due 2/01/2008 4,175,000 BB+ Ba2 4,000,000 JLG Industries Inc., 8.375% due 6/15/2012 3,240,000 B- Caa3 5,000,000 Jordan Industries, 10.375% due 8/01/2007 2,506,250 B+ B1 3,749,701 Metokote, Term B, due 11/02/2005** 3,698,143 NR* NR* 8,980,000 +Moll Industries, 10.50% due 7/01/2008 1,077,600 B+ B3 600,000 NMHG Holding Company, 10% due 5/15/2009 624,000 B- B3 700,000 Rexnord Corporation, 10.125% due 12/15/2012 (d) 729,750 B B2 3,775,000 Terex Corporation, 9.25% due 7/15/2011 3,586,250 D Ca 6,000,000 +Thermadyne Manufacturing, 9.875% due 6/01/2008 1,627,500 B B3 1,300,000 Trimas Corporation, 9.875% due 6/15/2012 (d) 1,267,500 B+ B3 5,760,000 U.S. Industries, Inc., 11.25% due 12/31/2005 (d) 5,356,800 ----------- 31,353,793 ==================================================================================================================================== Metals & NR* NR* 8,185,176 +Acme Metals Inc., Term, due 12/01/2005** 1,227,777 Mining--3.7% BBB Ba2 4,000,000 Great Central Mines Ltd., 8.875% due 4/01/2008 3,830,000 B- B3 5,029,000 Great Lakes Carbon Corp., 10.25% due 5/15/2008 (b) 3,771,750 CCC+ Caa2 5,700,000 Haynes International Inc., 11.625% due 9/01/2004 2,793,000 Ispat Int'l:** B- Caa2 1,241,500 Term B, due 7/15/2006 806,975 B- Caa1 1,241,500 Term C, due 7/15/2005 806,975 CCC Caa3 5,375,000 Neenah Corporation, 11.125% due 5/01/2007 1,988,750 BB- B1 1,450,000 Oregon Steel Mills Inc., 10% due 7/15/2009 1,402,875 CCC Ca 3,000,000 Ormet Corporation, Term, due 8/15/2008** 1,440,000 NR* Ca 550,000 +Pen Holdings Inc., 9.875% due 6/15/2008 66,000 CCC+ Caa2 9,095,000 WCI Steel Inc., 10% due 12/01/2004 2,546,600 ----------- 20,680,702 ==================================================================================================================================== Natural Gas-- B+ B1 650,000 Southern Natural Gas, 8.875% due 3/15/2010 (d) 641,667 Pipelines--0.1% ==================================================================================================================================== Packaging--3.7% B+ B2 7,625,000 Anchor Glass Container Corporation, 11% due 2/15/2013 (d) 7,605,937 B- B3 1,575,000 Berry Plastics, 10.75% due 7/15/2012 1,673,437 B B2 4,400,000 Crown Euro Holdings SA, 10.875% due 3/01/2013 (d) 4,433,000 CCC+ NR* 5,700,000 Graham Packaging Company, 10.75% due 1/15/2009 5,500,500 B- Caa1 1,800,000 Pliant Corporation, 13% due 6/01/2010 1,422,000 NR* Ca 2,750,000 +Spinnaker Industries Inc., 10.75% due 10/15/2006 275 ----------- 20,635,149 ==================================================================================================================================== Paper--4.7% BB+ Ba2 7,250,000 Georgia Pacific Corporation, 9.375% due 2/01/2013 (d) 7,322,500 MDP Acquisitions PLC (d): B B3 283,563 15.50% due 10/01/2013 306,957 B B3 7,000,000 15.50% due 10/01/2013 (b) 7,577,500 Stone Container Corporation: B B2 3,600,000 8.375% due 7/01/2012 3,780,000 B+ Ba3 5,480,769 Term B, due 6/30/2009** 5,422,109 B+ Ba3 2,019,231 Term C, due 6/30/2009** 1,997,146 ----------- 26,406,212 ==================================================================================================================================== Petroleum B+ B3 9,000,000 Giant Industries, 11% due 5/15/2012 7,470,000 Refineries--3.1% Tesoro Petroleum Corp.: B+ B2 2,000,000 9% due 7/01/2008 1,660,000 BB Ba3 3,332,851 Term B, due 12/31/2007** 3,169,541 B- B3 6,600,000 United Refining Co., 10.75% due 6/15/2007 5,230,500 ----------- 17,530,041 ==================================================================================================================================== Pharmaceuticals-- B+ NR* 2,000,000 ICN Pharmaceuticals Inc., 6.50% due 7/15/2008 (Convertible) 1,685,000 0.3% ==================================================================================================================================== Printing & B B3 775,000 Houghton Mifflin Company, 9.875% due 2/01/2013 (d) 813,750 Publishing--0.6% NR* B3 2,635,000 Perry-Judd, 10.625% due 12/15/2007 2,569,125 ----------- 3,382,875 ==================================================================================================================================== Property NR* NR* 4,887,805 Buffington Harbor Parking Associates, LLC, Term B, Management--1.5% due 7/01/2011** 4,887,805 B- B2 3,200,000 Corrections Corporation of America, 9.875% due 5/01/2009 3,440,000 ----------- 8,327,805 ==================================================================================================================================== Restaurants--0.7% BB- Ba3 3,980,000 Domino's Pizza, Term B, due 7/30/2008** 3,992,438 ==================================================================================================================================== Retail & Retail BBB+ Ba1 4,963,235 Shoppers Drug Mart, Term F, due 2/04/2009** 4,975,023 Specialty--1.9% B B3 5,500,000 Star Gas Partners, LP, 10.25% due 2/15/2013 (d) 5,403,750 ----------- 10,378,773 ==================================================================================================================================== Shipping--0.1% BB- Ba3 500,000 Stena AB, 9.625% due 12/01/2012 517,500 ==================================================================================================================================== Textile Mill NR* NR* 7,900,000 +Galey & Lord, Inc., 9.125% due 3/01/2008 158,000 Products--0.0% ==================================================================================================================================== Tower Construction & CCC B3 1,325,000 American Tower Escrow, 0% due 8/01/2008 (c) 814,875 Leasing--4.3% American Tower Systems Corporation: B- Caa1 3,000,000 9.375% due 2/01/2009 2,385,000 BB- B2 4,169,966 Term B, due 12/31/2007** 3,951,260 Crown Castle International Corporation: B B3 1,100,000 9% due 5/15/2011 863,500 CCC B3 3,625,000 9.375% due 8/01/2011 2,936,250 CC B3 14,445,028 Spectrasite Communications, Term B, due 12/31/2007** 12,819,962 ----------- 23,770,847 ==================================================================================================================================== 10 & 11 Debt Strategies Fund, Inc., February 28, 2003 SCHEDULE OF INVESTMENTS (continued) S&P Moody's Face INDUSTRIES Ratings++ Ratings++ Amount Corporate Debt Obligations Value ==================================================================================================================================== Transportation CCC Caa2 $10,000,000 +American Commercial LLC, 11.25% due 1/01/2008 $ 2,600,000 Services--1.3% B+ B1 4,549,825 North American Van Lines, Inc., Term B, due 11/18/2007** 4,437,503 ----------- 7,037,503 ==================================================================================================================================== Utilities--9.7% B- Caa1 2,500,000 The AES Corporation, 8.50% due 11/01/2007 1,425,000 NR* NR* 5,185,072 AES Corporation (formerly AES EDC Funding II LLC), Term C, due 7/15/2005** 4,978,966 NR* Ba3 1,875,000 AES New York Funding, LLC, Term, due 2/28/2005** 1,765,626 BB- B3 6,000,000 CMS Energy Corporation, 8.50% due 4/15/2011 4,980,000 B+ B1 3,000,000 Calpine Canada Energy Finance, 8.50% due 5/01/2008 1,455,000 Calpine Corporation: B+ B1 2,700,000 8.50% due 2/15/2011 1,296,000 BBB- Ba3 3,798,260 Term B, due 5/31/2004** 3,470,185 Consumer Energy, Term:** NR* NR* 833,333 due 5/16/2003 836,979 NR* NR* 833,333 due 7/16/2003 836,979 NR* NR* 833,333 due 8/29/2003 836,979 BB+ Baa2 2,985,000 Michigan Electric Transmission Co., Term B, due 5/01/2007** 2,985,934 B- B3 30,000,000 Mission Energy Holdings, 13.50% due 7/15/2008 8,400,000 CCC+ Caa1 1,950,000 Mission Resources Corporation, 10.875% due 4/01/2007 1,189,500 BB Ba2 5,500,000 Southern California Edison, Term B, due 3/01/2005** 5,512,892 BB+ Ba2 2,228,125 TNP Enterprises, Inc., Term, due 3/30/2006** 2,214,199 Western Resources Inc.: BB- Ba2 10,100,000 9.75% due 5/01/2007 10,453,500 BBB- Ba1 1,497,436 Term N, due 6/05/2005** 1,482,462 ----------- 54,120,201 ==================================================================================================================================== Wired B- B3 6,800,000 Fairpoint Communications, 12.50% due 5/01/2010 5,746,000 Telecommunications-- NR* NR* 7,486,509 +Pacific Crossing Ltd., Term B-1, due 7/28/2006** 399,278 3.5% CCC+ Caa1 2,000,000 Qwest Communications International, 7.50% due 11/01/2008 1,680,000 B- B3 8,000,000 Time Warner Telecom LLC, 9.75% due 7/15/2008 5,640,000 B B2 8,200,000 U.S. West Capital Funding Inc., 6.875% due 7/15/2028 5,289,000 NR* Caa3 5,611,040 +WCI Capital (Winstar Communications), Debtor in Possession, due 12/31/2003** 981,932 ----------- 19,736,210 ==================================================================================================================================== Wireless Centennial Cellular:** Telecommunications-- B B3 5,144,157 Term B, due 5/30/2007 4,038,163 6.2% B B3 4,505,393 Term C, due 11/30/2007 3,531,908 CCC C 10,000,000 +Microcell Telecommunications, 0/12% due 6/01/2009 (c) 525,000 Nextel Communications, Inc.: B B3 425,000 9.50% due 2/01/2011 427,125 BB- Ba3 5,220,778 Term D, due 3/31/2009** 4,877,930 Nextel Partners Inc.: CCC+ B3 4,000,000 12.50% due 11/15/2009 3,880,000 CCC+ B3 7,100,000 11% due 3/15/2010 6,496,500 B+ B1 475,000 PTC International Finance II SA, 11.25% due 12/01/2009 517,750 B+ B1 605,000 PTC International Finance BV, 10.75% due 7/01/2007 638,275 Rural Cellular:** B+ Ba3 3,339,569 Term B, due 10/03/2008 2,891,111 B+ Ba3 3,339,569 Term C, due 4/03/2009 2,891,111 Telesystem International Wireless: B- NR* 3,773,000 14% due 12/30/2003 3,395,700 B- NR* 358,922 14% due 12/30/2003 (d) 323,030 ----------- 34,433,603 ==================================================================================================================================== Total Investments in Corporate Debt Obligations (Cost--$926,425,473)--130.9% 729,361,046 ==================================================================================================================================== Shares Held Common Stocks ==================================================================================================================================== Automotive 3,614,601 Cambridge Liquidating Trust 175,308 Equipment--0.0% ==================================================================================================================================== Chemicals--0.0% 93,826 +Pioneer Companies, Inc. 272,096 ==================================================================================================================================== Food & Kindred 15,252 +Archibald Candy Corporation 1,418,436 Products--0.3% ==================================================================================================================================== Hotels & Motels-- 83,363 +Lodgian, Inc. 275,932 0.1% ==================================================================================================================================== Metals & 91,399 +Geneva Steel Holdings Corp. 91 Mining--0.0% ==================================================================================================================================== Textile Mill 1,725,000 Global Manufacturing Liquidation Trust 17 Products--0.0% ==================================================================================================================================== Wired 57,455 +WilTel Communications, Inc. 795,177 Telecommunications-- 0.1% ==================================================================================================================================== Total Investments in Common Stocks (Cost--$11,974,381)--0.5% 2,937,057 ==================================================================================================================================== Preferred Stocks ==================================================================================================================================== Broadcasting--0.1% 77 Paxson Communications (b) 524,076 34 Paxson Communications (Convertible) (b)(d) 141,985 ----------- 666,061 ==================================================================================================================================== Cable Television 5,000 Adelphia Communications 2,500 Services--2.4% 22,500 CSC Holdings Inc. 2,317,500 89,100 CSC Holdings Inc. (b) 9,132,750 3,500 Pegasus Satellite 1,697,500 ----------- 13,150,250 ==================================================================================================================================== Financial Services-- 30,000 Sinclair Capital (Convertible) 3,180,000 0.6% ==================================================================================================================================== 12 & 13 Debt Strategies Fund, Inc., February 28, 2003 SCHEDULE OF INVESTMENTS (concluded) Shares INDUSTRIES Held Preferred Stocks Value =================================================================================================================================== Hotels & Motels-- 70,359 Lodgian, Inc. $ 1,329,785 0.2% =================================================================================================================================== Printing & 250,000 NewsCorp Overseas Ltd. 5,150,000 Publishing--1.4% 35,000 Primedia, Inc. 2,765,000 ------------- 7,915,000 =================================================================================================================================== Tower Construction 12,184 Crown Castle International Corporation (b) 8,437,420 & Leasing--1.5% =================================================================================================================================== Wireless 11,023 Dobson Communications (b) 7,275,081 Telecommunications-- 5,267 Nextel Communications, Inc. (b) 5,372,340 2.3% ------------- 12,647,421 =================================================================================================================================== Total Investments in Preferred Stocks (Cost--$51,633,748)--8.5% 47,325,937 =================================================================================================================================== Warrants & Rights =================================================================================================================================== Broadcasting--0.0% 704 Paxson Communications (Warrants) (d)(g) 1 15,000 Sirius Satellite (Warrants) (g) 150 ------------- 151 =================================================================================================================================== Gaming--0.0% 15,140 Peninsula Gaming LLC (Warrants) (g) 90,842 =================================================================================================================================== Metals & 28,660 Geneva Steel Holdings Corp. (Equity Rights) (e) 0 Mining--0.0% =================================================================================================================================== Paper--0.0% Cellu Tissue Holdings, Inc. (Warrants) (g): 30 Series A 0 15 Series B 0 ------------- 0 =================================================================================================================================== Total Investments in Warrants & Rights (Cost--$875,851)--0.0% 90,993 =================================================================================================================================== Beneficial Interest Short-Term Securities =================================================================================================================================== $ 361,669 Merrill Lynch Liquidity Series, LLC Cash Sweep Series I (i) 361,669 =================================================================================================================================== Total Investments in Short-Term Securities (Cost--$361,669)--0.1% 361,669 =================================================================================================================================== Total Investments (Cost--$991,271,122)--140.0% 780,076,702 Liabilities in Excess of Other Assets--(40.0%) (223,008,418) ------------- Net Assets--100.0% $ 557,068,284 ============= =================================================================================================================================== * Not Rated. ** Floating rate corporate debt in which the Fund invests generally pays interest at rates that are periodically redetermined by reference to a base lending rate plus a premium. These base lending rates are generally (i) the lending rate offered by one or more major European banks, such as LIBOR (London Inter-Bank Offered Rate), (ii) the prime rate offered by one or more major United States banks or (iii) the certificate of deposit rate. Floating rate corporate debt is generally considered to be restricted in that the Fund ordinarily is contractually obligated to receive approval from the agent bank and/or borrower prior to its disposition. Corporate loans represent 36.3% of the Fund's net assets. + Non-income producing security. ++ Ratings of issues shown are unaudited. (a) Floating rate note. (b) Represents a pay-in-kind security which may pay interest/dividends in additional face/shares. (c) Represents a zero coupon or step bond; the interest rate on a step bond will commence its accrual at a fixed rate of interest on a predetermined date until maturity. (d) The security may be offered and sold to "qualified institutional buyers" under Rule 144A of the Securities Act of 1933. (e) Each Equity Right entitles the Fund to purchase one share of new Preferred Stock at a price of $10.80 per Equity Right. (f) Mortgage-Backed Obligations are subject to principal paydowns as a result of prepayments or refinancing of the underlying mortgage instruments. As a result, the average life may be substantially less than the original maturity. (g) Warrants entitle the Fund to purchase a predetermined number of shares of common stock and are non-income producing. The purchase price and number of shares are subject to adjustment under certain conditions until the expiration date. (h) Maturity of this security is pending as a result of bankruptcy proceedings. (i) Investments in companies considered to be an affiliate of the Fund (such companies are defined as "Affiliated Companies" in Section 2(a)(3) of the Investment Company Act of 1940) are as follows: - -------------------------------------------------------------------------------- Net Interest Affiliate Activity Income - -------------------------------------------------------------------------------- Merrill Lynch Liquidity Series, LLC Cash Sweep Series I $361,669 $ 10,161 - -------------------------------------------------------------------------------- See Notes to Financial Statements. 14 & 15 Debt Strategies Fund, Inc., February 28, 2003 STATEMENT OF ASSETS, LIABILITIES AND CAPITAL As of February 28, 2003 ============================================================================================================== Assets: Investments, at value (identified cost--$991,271,122) ..... $ 780,076,702 Cash ...................................................... 27,599 Receivables: Interest ................................................ $ 17,584,821 Securities sold ......................................... 10,317,436 Dividends ............................................... 346,628 28,248,885 ------------ Prepaid expenses and other assets ......................... 15,591 --------------- Total assets .............................................. 808,368,777 --------------- ============================================================================================================== Liabilities: Loans ..................................................... 245,900,000 Payables: Securities purchased .................................... 4,839,303 Investment adviser ...................................... 365,822 Interest on loans ....................................... 60,412 Commitment fees ......................................... 5,417 5,270,954 ------------ Deferred income ........................................... 52,762 Accrued expenses .......................................... 76,777 --------------- Total liabilities ......................................... 251,300,493 --------------- ============================================================================================================== Net Assets: Net assets ................................................ $ 557,068,284 =============== ============================================================================================================== Capital: Common Stock, $.10 par value, 200,000,000 shares authorized $ 10,413,927 Paid-in capital in excess of par .......................... 1,054,989,649 Undistributed investment income--net ...................... $ 7,189,935 Accumulated realized capital losses on investments and foreign currency transactions--net ........................ (304,256,681) Unrealized depreciation on investments--net ............... (211,268,546) ------------ Total accumulated losses--net ............................. (508,335,292) --------------- Total Capital--Equivalent to $5.35 per share based on 104,139,273 shares of Capital Stock outstanding (market price--$5.99) ..................................... $ 557,068,284 =============== ============================================================================================================== See Notes to Financial Statements. STATEMENT OF OPERATIONS For the Year Ended February 28, 2003 ================================================================================================================ Investment Income: Interest ............................................ $ 88,211,396 Dividends ........................................... 3,438,146 Facility and other fees ............................. 755,457 ------------- Total income ........................................ 92,404,999 ------------- ================================================================================================================ Expenses: Investment advisory fees ............................ $ 4,851,140 Loan interest expense ............................... 4,767,895 Borrowing costs ..................................... 425,923 Professional fees ................................... 210,046 Accounting services ................................. 191,864 Transfer agent fees ................................. 103,658 Printing and shareholder reports .................... 74,159 Listing fees ........................................ 70,110 Directors' fees and expenses ........................ 56,051 Custodian fees ...................................... 51,270 Pricing services .................................... 14,978 Other ............................................... 51,145 ------------ Total expenses ...................................... 10,868,239 ------------- Investment income--net .............................. 81,536,760 ------------- ================================================================================================================ Realized & Unrealized Realized gain (loss) on: Gain (Loss) on Investments--net .................................. (60,908,014) Investments & Foreign currency transactions--net ................ 355 (60,907,659) Foreign Currency ------------ Transactions--Net: Change in unrealized appreciation/depreciation on investments--net .................................... (9,693,150) ------------- Total realized and unrealized loss on investments and foreign currency transactions--net .................. (70,600,809) ------------- Net Increase in Net Assets Resulting from Operations $ 10,935,951 ============= ================================================================================================================ See Notes to Financial Statements. 16 & 17 Debt Strategies Fund, Inc., February 28, 2003 STATEMENTS OF CHANGES IN NET ASSETS For the Year Ended February 28, ------------------------------- Increase (Decrease) in Net Assets: 2003 2002 ============================================================================================================================ Operations: Investment income--net ................................................ $ 81,536,760 $ 93,622,888 Realized loss on investments and foreign currency transactions--net ... (60,907,659) (116,592,237) Change in unrealized appreciation/depreciation on investments--net .... (9,693,150) (34,776,801) ------------- ------------- Net increase (decrease) in net assets resulting from operations ....... 10,935,951 (57,746,150) ------------- ------------- ============================================================================================================================ Dividends to Dividends to shareholders from investment income--net ................. (81,536,390) (94,977,575) Shareholders: ------------- ------------- ============================================================================================================================ Capital Share Write-off of offering costs resulting from the issuance of Common Stock -- 238,476 Transactions: Value of shares issued in reinvestment of dividends ................... 7,626,072 8,693,666 ------------- ------------- Net increase in net assets resulting from capital share transactions .. 7,626,072 8,932,142 ------------- ------------- ============================================================================================================================ Net Assets: Total decrease in net assets .......................................... (62,974,367) (143,791,583) Beginning of year ..................................................... 620,042,651 763,834,234 ------------- ------------- End of year* .......................................................... $ 557,068,284 $ 620,042,651 ============= ============= ============================================================================================================================ * Undistributed investment income--net .................................. $ 7,189,935 $ 6,798,047 ============= ============= ============================================================================================================================ See Notes to Financial Statements. STATEMENT OF CASH FLOWS For the Year Ended February 28, 2003 ============================================================================================== Cash Provided by Net increase in net assets resulting from operations $ 10,935,951 Operating Activities: Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by operating activities: Increase in receivables .......................... (123,687) Increase in other assets ......................... (6,765) Increase in other liabilities .................... 22,597 Realized and unrealized loss on investments and foreign currency transactions--net ............... 70,600,809 Amortization of premium .......................... (23,549,550) ------------- Net cash provided by operating activities .......... 57,879,355 ------------- ============================================================================================== Cash Provided by Proceeds from sales of long-term investments ....... 539,628,061 Investing Activities: Purchases of long-term investments ................. (503,690,247) Proceeds from sales and maturities of short-term investments--net ................................... 6,854,621 ------------- Net cash provided by investing activities .......... 42,792,435 ------------- ============================================================================================== Cash Used for Cash receipts from borrowings ...................... 196,800,000 Financing Activities: Cash payments on borrowings ........................ (224,500,000) Dividends paid to shareholders ..................... (73,910,318) ------------- Net cash used for financing activities ............. (101,610,318) ------------- ============================================================================================== Cash: Net decrease in cash ............................... (938,528) Cash at beginning of year .......................... 966,127 ------------- Cash at end of year ................................ $ 27,599 ============= ============================================================================================== Cash Flow Cash paid for interest ............................. $ 4,769,965 Information: ============= ============================================================================================== Non-Cash Capital shares issued in reinvestment of Financing Activities: dividends paid to shareholders ..................... $ 7,626,072 ============= ============================================================================================== See Notes to Financial Statements. 18 & 19 Debt Strategies Fund, Inc., February 28, 2003 FINANCIAL HIGHLIGHTS For the The following per share data and ratios have Period been derived from information provided in For the Year Ended For the March 27, the financial statements. February 28, Year Ended 1998+ to ----------------------------------- February 29, February 28, Increase (Decrease) in Net Asset Value: 2003 2002 2001 2000 1999 =================================================================================================================================== Per Share Net asset value, beginning of period ............ $ 6.03 $ 7.53 $ 8.60 $ 9.15 $ 10.00 Operating --------- --------- --------- --------- --------- Performance: Investment income--net .......................... .79++ .92++ .96++ .97 .76 Realized and unrealized loss on investments and foreign currency transactions--net .............. (.68) (1.49) (1.07) (.56) (.91) --------- --------- --------- --------- --------- Total from investment operations ................ .11 (.57) (.11) .41 (.15) --------- --------- --------- --------- --------- Less dividends from investment income--net ...... (.79) (.93) (.96) (.96) (.69) --------- --------- --------- --------- --------- Capital write-off (charge) resulting from the issuance of Common Stock ........................ -- --@@ -- -- (.01) --------- --------- --------- --------- --------- Net asset value, end of period .................. $ 5.35 $ 6.03 $ 7.53 $ 8.60 $ 9.15 ========= ========= ========= ========= ========= Market price per share, end of period ........... $ 5.99 $ 6.57 $ 7.15 $ 7.1875 $ 7.875 ========= ========= ========= ========= ========= ================================================================================================================================== Total Investment Based on market price per share ................. 4.85% 5.69% 13.97% 3.19% (14.87%)@ Return:** ========= ========= ========= ========= ========= Based on net asset value per share .............. 2.04% (7.89%) .31% 6.26% (1.09%)@ ========= ========= ========= ========= ========= ================================================================================================================================== Ratios to Average Expenses, net of reimbursement and excluding Net Assets: interest expense ................................ 1.07% 1.04% 1.20% .98% .54%* ========= ========= ========= ========= ========= Expenses, net of reimbursement .................. 1.91% 2.59% 3.87% 2.87% .93%* ========= ========= ========= ========= ========= Expenses ........................................ 1.91% 2.59% 3.87% 2.87% 1.20%* ========= ========= ========= ========= ========= Investment income--net .......................... 14.32% 13.69% 12.23% 10.88% 8.60%* ========= ========= ========= ========= ========= ================================================================================================================================== Leverage: Amount of borrowings, end of period (in thousands) .................................. $ 245,900 $ 273,600 $ 301,000 $ 161,000 $ 142,000 ========= ========= ========= ========= ========= Average amount of borrowings outstanding during the period (in thousands) ....................... $ 238,863 $ 280,460 $ 228,640 $ 182,404 $ 42,330 ========= ========= ========= ========= ========= Average amount of borrowings outstanding per share during the period ......................... $ 2.31 $ 2.75 $ 3.07 $ 2.91 $ .69 ========= ========= ========= ========= ========= ================================================================================================================================== Supplemental Net assets, end of period (in thousands) ........ $ 557,068 $ 620,043 $ 763,834 $ 538,343 $ 572,902 Data: ========= ========= ========= ========= ========= Portfolio turnover .............................. 64.54% 49.58% 36.86% 61.76% 89.76% ========= ========= ========= ========= ========= =================================================================================================================================== * Annualized. ** Total investment returns based on market value, which can be significantly greater or lesser than the net asset value, may result in substantially different returns. Total investment returns exclude the effects of sales charges. If applicable, the Fund's Investment Adviser waived a portion of its management fee. Without such waiver, the Fund's performance would have been lower. + Commencement of operations. ++ Based on average shares outstanding. @ Aggregate total investment return. @@ Amount is less than $.01 per share. See Notes to Financial Statements. NOTES TO FINANCIAL STATEMENTS 1. Significant Accounting Policies: Debt Strategies Fund, Inc. (the "Fund") is registered under the Investment Company Act of 1940 as a diversified, closed-end management investment company. The Fund's financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, which may require the use of management accruals and estimates. The Fund determines and makes available for publication the net asset value of its Common Stock on a weekly basis. The Fund's Common Stock is listed on the New York Stock Exchange under the symbol DSU. (a) Corporate debt obligations -- The Fund invests principally in debt obligations of companies, including Corporate Loans made by banks and other financial institutions and both privately and publicly offered corporate bonds and notes. Because agents and intermediaries are primarily commercial banks, the Fund's investment in Corporate Loans could be considered concentrated in financial institutions. (b) Valuation of investments -- Corporate Loans are valued in accordance with guidelines established by the Board of Directors. Corporate Loans are valued at the mean between the last available bid and asked prices from one or more brokers or dealers as obtained from Loan Pricing Corporation. For the limited number of Corporate Loans for which no reliable price quotes are available, such Corporate Loans will be valued by Loan Pricing Corporation through the use of pricing matrices to determine valuations. If the pricing service does not provide a value for the Corporate Loan, the Investment Adviser will value the loan at fair value, which is intended to approximate market value. Other portfolio securities may be valued on the basis of prices furnished by one or more pricing services, which determine prices for normal, institutional-size trading units of such securities using market information, transactions for comparable securities and various relationships between securities that are generally recognized by institutional traders. In certain circumstances, portfolio securities are valued at the last sale price on the exchange that is the primary market for such securities, or the last quoted bid price for those securities for which the over-the-counter market is the primary market or for listed securities in which there were no sales during the day. The value of interest rate swaps, caps and floors is determined in accordance with a formula and then confirmed periodically by obtaining a bank quotation. Financial futures contracts and options thereon, which are traded on exchanges, are valued at their closing prices as of the close of such exchanges. Options written or purchased are valued at the last sale price in the case of exchange-traded options. In the case of options traded in the over-the-counter market, valuation is the last asked price (options written) or the last bid price (options purchased). Short-term securities with remaining maturities of sixty days or less are valued at amortized cost, which approximates market value. Securities and assets for which market price quotations are not readily available are valued at fair value as determined in good faith by or under the direction of the Board of Directors of the Fund. Occasionally, events affecting the values of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the market on which such security trades) and the close of business on the NYSE. If events (for example, company announcement, natural disasters, market volatility) occur during such periods that are expected to materially affect the value for such securities, those securities may be valued at their fair market value as determined in good faith by the Fund's Board of Directors or by the investment adviser using a pricing service and/or procedures approved by the Board of Directors of the Fund. (c) Derivative financial instruments -- The Fund may engage in various portfolio investment strategies to increase or decrease the level of risk to which the Fund is exposed more quickly and efficiently than transactions in other types of instruments. Losses may arise due to changes in the value of the contract or if the counterparty does not perform under the contract. o Financial futures contracts -- The Fund may purchase or sell financial futures contracts and options on such futures contracts for the purpose of hedging the market risk on existing securities or for the intended purchase of securities. 20 & 21 Debt Strategies Fund, Inc., February 28, 2003 NOTES TO FINANCIAL STATEMENTS (continued) Futures contracts are contracts for delayed delivery of securities at a specific future date and at a specific price or yield. Upon entering into a contract, the Fund deposits and maintains as collateral such initial margin as required by the exchange on which the transaction is effected. 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 value of the contract. Such receipts or payments are known as variation margin and are recorded by the Fund as unrealized gains or losses. When the contract is closed, the Fund records a realized 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. o Forward foreign exchange contracts -- The Fund is authorized to enter into forward foreign exchange contracts as a hedge against either specific transactions or portfolio positions. The contract is marked-to-market daily and the change in market value is recorded by the Fund as an unrealized gain or loss. When the contract is closed, the Fund records a realized gain or loss equal to the difference between the value at the time it was opened and the value at the time it was closed. o Options -- The Fund is authorized to write covered call and put options and purchase call and put options. When the Fund writes an option, an amount equal to the premium received by the Fund is reflected as an asset and an equivalent liability. The amount of the liability is subsequently marked to market to reflect the current market value of the option written. When a security is purchased or sold through an exercise of an option, the related premium paid (or received) is added to (or deducted from) the basis of the security acquired or deducted from (or added to) the proceeds of the security sold. When an option expires (or the Fund enters into a closing transaction), the Fund realizes a gain or loss on the option to the extent of the premiums received or paid (or gain or loss to the extent the cost of the closing transaction exceeds the premium paid or received). Written and purchased options are non-income producing investments. o Interest rate swaps -- The Fund is authorized to enter into swap agreements for the purpose of hedging the market risk on existing securities. In a swap agreement, the Fund exchanges with the counterparty their respective commitments to pay or receive interest on a specified notional principal amount. If the counterparty defaults on its obligation, the Fund's ability to receive interest will be delayed or limited. Furthermore, if the Fund does not have sufficient income to pay its obligation under the swap agreement, the Fund would be in default and the counterparty would be able to terminate the swap agreement. When the swap agreement is closed, the Fund records a realized gain or loss equal to the difference between the value of the swap agreement at the time it was entered into and the value at the time it was closed. (d) Foreign currency transactions -- Transactions denominated in foreign currencies are recorded at the exchange rate prevailing when recognized. Assets and liabilities denominated in foreign currencies are valued at the exchange rate at the end of the period. Foreign currency transactions are the result of settling (realized) or valuing (unrealized) assets or liabilities expressed in foreign currencies into U.S. dollars. Realized and unrealized gains or losses from investments include the effects of foreign exchange rates on investments. (e) Income taxes -- 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. Therefore, no Federal income tax provision is required. Under the applicable foreign tax law, a withholding tax may be imposed on interest, dividends and capital gains at various rates. (f) Security transactions and investment income -- Security transactions are recorded on the dates the transactions are entered into (the trade dates). Realized gains and losses on security transactions are determined on the identified cost basis. Dividend income is recorded on the ex-dividend dates. Interest income is recognized on the accrual basis. The Fund amortizes all premiums and discounts on debt securities. (g) Dividends and distributions -- Dividends from net investment income are declared and paid monthly. Distributions of capital gains are recorded on the ex-dividend dates. (h) Offering expenses -- During the year ended February 28, 2002, overestimated offering expenses resulting from the issuance of Common Stock were written off to paid-in capital in excess of par. (i) Reclassification -- Accounting principles generally accepted in the United States of America require that certain components of net assets be adjusted to reflect permanent differences between financial and tax reporting. Accordingly, the current year's permanent book/tax difference of $391,518 have been reclassified between accumulated net realized capital losses and undistributed net investment income. This reclassification has no effect on net assets or net asset value per share. 2. Investment Advisory Agreement and Transactions with Affiliates: The Fund has entered into an Investment Advisory Agreement with Fund Asset Management, L.P. ("FAM"). The general partner of FAM is Princeton Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML & Co."), which is the limited partner. FAM has entered into a Sub-Advisory Agreement with Merrill Lynch Asset Management U.K. Limited ("MLAM U.K."), an affiliate of FAM, pursuant to which MLAM U.K. provides investment advisory services to FAM with respect to the Fund. There is no increase in the aggregate fees paid by the Fund for these services. FAM is responsible for the management of the Fund's portfolio and provides the necessary personnel, facilities, equipment and certain other services necessary to perform the investment advisory function. For such services, the Fund pays a monthly fee at an annual rate of .60% of the Fund's average weekly net assets plus the proceeds of any outstanding borrowings used for leverage. For the year ended February 28, 2003, the Fund paid Merrill Lynch Security Pricing Service, an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), $553 for security price quotations to compute the net asset value of the Fund. In addition, MLPF&S received $11,169 in commissions on the execution of portfolio security transactions for the Fund for the year ended February 28, 2003. For the year ended February 28, 2003, the Fund reimbursed FAM $14,049 for certain accounting services. Certain officers and/or directors of the Fund are officers and/or directors of FAM, MLAM U.K., PSI, and/or ML & Co. 3. Investments: Purchases and sales of investments, excluding short-term securities, for the year ended February 28, 2003 were $508,529,550 and $549,895,857, respectively. Net realized gains (losses) for the year ended February 28, 2003 and net unrealized losses as of February 28, 2003 were as follows: - -------------------------------------------------------------------------------- Realized Unrealized Gains (Losses) Losses - -------------------------------------------------------------------------------- Long-term investments ................ $ (60,908,014) $(211,194,420) Unfunded corporate loans ............. -- (74,126) Foreign currency transactions ........ 355 -- ------------- ------------- Total ................................ $ (60,907,659) $(211,268,546) ============= ============= - -------------------------------------------------------------------------------- As of February 28, 2003, net unrealized depreciation for Federal income tax purposes aggregated $210,812,783, of which $22,291,962 related to appreciated securities and $233,104,745 related to depreciated securities. The aggregate cost of investments at February 28, 2003 for Federal income tax purposes was $990,889,485. 4. Capital Share Transactions: The Fund is authorized to issue 200,000,000 shares of Common Stock, par value $.10 per share. Shares issued and outstanding during the years ended February 28, 2003 and February 28, 2002 increased by 1,356,882 and 1,332,057, respectively, as a result of dividend reinvestment. 5. Unfunded Loan Interests: As of February 28, 2003, the Fund had unfunded loan commitments of approximately $2,083,000, which would be extended at the option of the borrower, pursuant to the following loan agreement: - -------------------------------------------------------------------------------- Unfunded Commitment Borrower (in Thousands) - -------------------------------------------------------------------------------- Granite Broadcasting Corporation ............................ $2,083 - -------------------------------------------------------------------------------- 22 & 23 Debt Strategies Fund, Inc., February 28, 2003 NOTES TO FINANCIAL STATEMENTS (concluded) 6. Short-Term Borrowings: On May 30, 2002, the Fund renewed its one-year $325,000,000 revolving credit and security agreement with Citibank, N.A. and other lenders (the "Lenders"). Under the revolving credit and security agreement, the Fund may borrow money through (i) a line of credit from certain Lenders at the Eurodollar rate plus .75% or the highest of the Federal Funds rate plus .50%, a Base rate as determined by Citibank, N.A. and the latest three-week moving average of secondary market morning offering rates in the United States for three-month certificates of deposit of major United States money market banks plus .50%, or (ii) the issuance of commercial paper notes by certain Lenders at rates of interest derived from the weighted average of the per annum rates paid or payable by such Lenders in respect of those commercial paper notes. As security for its obligations to the Lenders under the revolving credit and security agreement, the Fund has granted a security interest in substantially all of its assets to and in favor of the Lenders. For the year ended February 28, 2003, the average amount borrowed was approximately $238,863,000 and the daily weighted average interest rate was 1.99%. For the year ended February 28, 2003, facility and commitment fees aggregated approximately $426,000. 7. Distributions to Shareholders: The Fund paid an ordinary income dividend in the amount of $.061464 per share on March 31, 2003 to shareholders of record on March 17, 2003. The tax character of distributions paid during the fiscal years ended February 28, 2003 and February 28, 2002 was as follows: - -------------------------------------------------------------------------------- 2/28/2003 2/28/2002 - -------------------------------------------------------------------------------- Distributions paid from: Ordinary income ........................ $81,536,390 $94,977,575 ----------- ----------- Total taxable distributions .............. $81,536,390 $94,977,575 =========== =========== - -------------------------------------------------------------------------------- As of February 28, 2003, the components of accumulated losses on a tax basis were as follows: - -------------------------------------------------------------------------------- Undistributed ordinary income--net ..................... $ 9,272,063 Undistributed long-term capital gains--net ............. -- ------------- Total undistributed earnings--net ...................... 9,272,063 Capital loss carryforward .............................. (288,233,985)* Unrealized losses--net ................................. (229,373,370)** ------------- Total accumulated losses--net .......................... $(508,335,292) ============= - -------------------------------------------------------------------------------- * On February 28, 2003, the Fund had a net capital loss carryforward of $288,233,985, of which $263,491 expires in 2005, $12,067,388 expires in 2006, $27,376,921 expires in 2007, $51,234,056 expires in 2008, $21,442,332 expires in 2009, $90,564,493 expires in 2010 and $85,285,304 expires in 2011. This amount will be available to offset like amounts of any future taxable gains. ** The difference between book-basis and tax-basis net unrealized losses is attributable primarily to the tax deferral of losses on wash sales, the book/tax differences in the accrual of income on securities in default, the difference between book and tax amortization methods for premiums and discounts on fixed income securities, the deferral of post-October capital losses for tax purposes and other book/tax temporary differences. INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders, Debt Strategies Fund, Inc.: We have audited the accompanying statement of assets, liabilities and capital, including the schedule of investments, of Debt Strategies Fund, Inc. as of February 28, 2003, and the related statements of operations and cash flows for the year then ended, the statements of changes in net assets for each of the years in the two-year period then ended, and the financial highlights for each of the respective periods then ended. These financial statements and the financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and the financial highlights based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and the financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned at February 28, 2003 by correspondence with the custodian and financial intermediaries; where replies were not received from financial intermediaries, we performed other auditing procedures. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements and financial highlights present fairly, in all material respects, the financial position of Debt Strategies Fund, Inc. as of February 28, 2003, the results of its operations and its cash flows, the changes in its net assets and the financial highlights for the respective stated periods in conformity with accounting principles generally accepted in the United States of America. Deloitte & Touche LLP Princeton, New Jersey April 24, 2003 IMPORTANT TAX INFORMATION (unaudited) Of the ordinary income distributions paid monthly by Debt Strategies Fund, Inc. during the fiscal year ended February 28, 2003, 3.85% qualifies for the dividends received deduction for corporations. Please retain this information for your records. 24 & 25 Debt Strategies Fund, Inc., February 28, 2003 OFFICERS AND DIRECTORS Number of Portfolios in Other Position(s) Length Fund Complex Directorships Held of Time Overseen by Held by Name Address & Age with Fund Served Principal Occupation(s) During Past 5 Years Director Director ==================================================================================================================================== Interested Director ==================================================================================================================================== Terry K. Glenn* P.O. Box 9011 President 1999 to President and Chairman of Merrill Lynch 120 Funds None Princeton, NJ and present Investment Managers, L.P. ("MLIM")/Fund Asset 162 Portfolios 08543-9011 Director and 1997 Management, L.P. ("FAM")--Advised Funds since Age: 62 to present 1999; Chairman (Americas Region) of MLIM from 2000 to 2002; Executive Vice President of MLIM and FAM (which terms as used herein include their corporate predecessors) from 1983 to 2002; President of FAM Distributors, Inc. ("FAMD") from 1986 to 2002 and Director thereof from 1991 to 2002; Executive Vice President and Director of Princeton Services, Inc. ("Princeton Services") from 1993 to 2002; President of Princeton Administrators, L.P. from 1988 to 2002; Director of Financial Data Services, Inc. from 1985 to 2002. ==================================================================================================================== * Mr. Glenn is a director, trustee or member of an advisory board of certain other investment companies for which FAM or MLIM acts as investment adviser. Mr. Glenn is an "interested person," as described in the Investment Company Act, of the Fund based on his former positions with FAM, MLIM, FAMD, Princeton Services, and Princeton Administrators, L.P. The Director's term is unlimited. As Fund President, Mr. Glenn serves at the pleasure of the Board of Directors. ==================================================================================================================================== Number of Portfolios in Other Position(s) Length Fund Complex Directorships Held of Time Overseen by Held by Name Address & Age with Fund Served* Principal Occupation(s) During Past 5 Years Director Director ==================================================================================================================================== Independent Directors ==================================================================================================================================== Ronald W. Forbes P.O. Box 9095 Director 1997 to Professor Emeritus of Finance, School of 47 Funds None Princeton, NJ present Business, State University of New York at 52 Portfolios 08543- 9095 Albany since 2000 and Professor thereof from Age: 62 1989 to 2000. ==================================================================================================================================== Cynthia A. P.O. Box 9095 Director 1997 to Professor, Harvard Business School since 1989; 47 Funds Unum Provi- Montgomery Princeton, NJ present Director, Unum Provident Corporation since 52 Portfolios dent Corp- 08543-9095 1990; Director, Newell Rubbermaid, Inc. oration; Age: 50 since 1995. Newell Rub- bermaid Inc. ==================================================================================================================================== Charles C. P.O. Box 9095 Director 1997 to Self-employed financial consultant since 1990. 47 Funds None Reilly Princeton, NJ present 52 Portfolios 08543-9095 Age: 71 ==================================================================================================================================== Kevin A. Ryan P.O. Box 9095 Director 1997 to Founder and Director Emeritus of The Boston 47 Funds None Princeton, NJ present University Center for the Advancement of 52 Portfolios 08543-9095 Ethics and Character; Professor of Education Age: 70 at Boston University from 1982 to 1999 and Professor Emeritus since 1999. ==================================================================================================================================== Roscoe S. P.O. Box 9095 Director 2000 to President, Middle East Institute from 1995 to 47 Funds None Suddarth Princeton, NJ present 2001; Foreign Service Officer, United States 52 Portfolios 08543-9095 Foreign Service from 1961 to 1995; Career Age: 67 Minister from 1989 to 1995; Deputy Inspector General, U.S. Department of State from 1991 to 1994; U.S. Ambassador to the Hashemite Kingdom of Jordan from 1987 to 1990. ==================================================================================================================================== Richard R. West P.O. Box 9095 Director 1997 to Dean Emeritus of New York University, Leonard 47 Funds Bowne & Princeton, NJ present N. Stern School of Business Administration 52 Portfolios Co., Inc.; 08543-9095 since 1994. Vornado Age: 65 Operating Company; Vornado Realty Trust; Alexander's Inc. ==================================================================================================================================== Edward D. P.O. Box 9095 Director 2000 to Self-employed financial consultant since 1994. 47 Funds None Zinbarg Princeton, NJ present 52 Portfolios 08543-9095 Age: 68 ==================================================================================================================== * The Director's term is unlimited. ==================================================================================================================================== Position(s) Length Held of Time Name Address & Age with Fund Served* Principal Occupation(s) During Past 5 Years ==================================================================================================================================== Fund Officers ==================================================================================================================================== Donald C. Burke P.O. Box 9011 Vice 1997 to First Vice President of FAM and MLIM since 1997 and the Princeton, NJ 08543-9011 President present Treasurer thereof since 1999; Senior Vice President and Age: 42 and and 1999 Treasurer of Princeton Services since 1999; Vice President of Treasurer to present FAMD since 1999; Director of MLIM Taxation since 1990. ==================================================================================================================================== Kevin J. Booth P.O. Box 9011 Vice 2001 to Director (Global Fixed Income) of MLIM since 2000; Vice Princeton, NJ 08543-9011 President present President of MLIM from 1994 to 2000. Age: 48 ==================================================================================================================================== Joseph P. Matteo P.O. Box 9011 Vice 2001 to Director (Global Fixed Income) of MLIM since 2001; Vice Princeton, NJ 08543-9011 President present President of MLIM from 1997 to 2001. Age: 39 ==================================================================================================================================== Bradley J. Lucido P.O. Box 9011 Secretary 1999 to Director (Legal Advisory) of MLIM since 2002; Vice President of Princeton, NJ 08543-9011 present MLIM from 1999 to 2002; Attorney associated with MLIM since Age: 37 1995. ==================================================================================================================== * Officers of the Fund serve at the pleasure of the Board of Directors. ==================================================================================================================================== Custodian The Bank of New York 100 Church Street New York, NY 10286 Transfer Agent The Bank of New York 101 Barclay Street New York, NY 10286 NYSE Symbol DSU 26 & 27 [LOGO] Merrill Lynch Investment Managers [GRAPHICS OMITTED] Debt Strategies Fund, Inc. seeks to provide current income by investing primarily in a diversified portfolio of U.S. companies' debt instruments, including corporate loans, that are rated in the lower rating categories of the established rating services (Baa or lower by Moody's Investors Service, Inc. or BBB or lower by Standard & Poor's) or unrated debt instruments of comparable quality. This report, including the financial information herein, is transmitted to shareholders of Debt Strategies Fund, Inc. for their information. It is not a prospectus. Past performance results shown in this report should not be considered a representation of future performance. The Fund leverages its Common Stock to provide Common Stock shareholders with a potentially higher rate of return. Leverage creates risk for Common Stock shareholders, including the likelihood of greater volatility of net asset value and market price of Common Stock shares, and the risk that fluctuations in short-term interest rates may reduce the Common Stock's yield. Statements and other information herein are as dated and are subject to change. Debt Strategies Fund, Inc. Box 9011 Princeton, NJ 08543-9011 [RECYCLED LOGO] Printed on post-consumer recycled paper #DEBT--2/03 Item 2 - Did registrant adopt a code of ethics, as of the end of the period covered by this report, that applies to the registrant's 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 registrant or a third party? If not, why not? Briefly describe any amendments or waivers that occurred during the period. State here if code of ethics/amendments/waivers are on website and give website address-. State here if fund will send code of ethics to shareholders without charge upon request-- N/A (not answered until July 15, 2003 and only annually for funds) Item 3 - Did the registrant's board of directors determine that the registrant either: (i) has at least one audit committee financial expert serving on its audit committee; or (ii) does not have an audit committee financial expert serving on its audit committee? If yes, disclose name of financial expert and whether he/she is "independent," (fund may, but is not required, to disclose name/independence of more than one financial expert) If no, explain why not. -N/A (not answered until July 15, 2003 and only annually for funds) Item 4 - Disclose annually only (not answered until December 15, 2003) (a) Audit Fees - Disclose aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit of the registrant's annual financial statements or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years. N/A. (b) Audit-Related Fees - Disclose aggregate fees billed in each of the last two fiscal years for assurance and related services by the principal accountant that are reasonably related to the performance of the audit of the registrant's financial statements and are not reported under paragraph (a) of this Item. Registrants shall describe the nature of the services comprising the fees disclosed under this category. N/A. (c) Tax Fees - Disclose aggregate fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning. Registrants shall describe the nature of the services comprising the fees disclosed under this category. N/A. (d) All Other Fees - Disclose aggregate fees billed in each of the last two fiscal years for products and services provided by the principal accountant, other than the services reported in paragraphs (a) through (c) of this Item. Registrants shall describe the nature of the services comprising the fees disclosed under this category. N/A. (e)(1) Disclose the audit committee's pre-approval policies and procedures described in paragraph (c)(7) of Rule 2-01 of Regulation S-X. N/A. (e)(2) Disclose the percentage of services described in each of paragraphs (b) through (d) of this Item that were approved by the audit committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X. N/A. (f) If greater than 50%, disclose the percentage of hours expended on the principal accountant's engagement to audit the registrant's financial statements for the most recent fiscal year that were attributed to work performed by persons other than the principal accountant's full-time, permanent employees. N/A. (g) Disclose the aggregate non-audit fees billed by the registrant's accountant for services rendered to the registrant, and rendered to the registrant's investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the adviser that provides ongoing services to the registrant for each of the last two fiscal years of the registrant. N/A. (h) Disclose whether the registrant's audit committee has considered whether the provision of non-audit services that were rendered to the registrant's investment adviser (not including any subadviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the registrant that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X is compatible with maintaining the principal accountant's independence. N/A. Items 5-6 - Reserved Item 7 - For closed-end funds that contain voting securities in their portfolio, describe the policies and procedures that it uses to determine how to vote proxies relating to those portfolio securities. N/A (not answered until July 1, 2003) Item 8 -- Reserved Item 9(a) - Disclose the conclusions of the registrant's principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, about the effectiveness of the registrant's disclosure controls and procedures (as defined in Rule 30a-2(c) under the Act (17 CFR 270.30a-2(c))) based on their evaluation of these controls and procedures as of a date within 90 days of the filing date of the report that includes the disclosure required by this paragraph. N/A (not answered until July 15, 2003 and only annually for funds) Item 9(b) -- There were no significant changes in the registrant's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Item 10 - Exhibits 10(a) - Attach code of ethics or amendments/waivers, unless code of ethics or amendments/waivers is on website or offered to shareholders upon request without charge. N/A. 10(b) - Attach certifications (4 in total pursuant to Sections 302 and 906 for CEO/CFO). Attached hereto. 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. Debt Strategies Fund, Inc. By: /s/ Terry K. Glenn ------------------------------ Terry K. Glenn, President of Debt Strategies Fund, Inc. Date: April 21, 2003 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Terry K. Glenn ------------------------------ Terry K. Glenn, President of Debt Strategies Fund, Inc. Date: April 21, 2003 By: /s/ Donald C. Burke ------------------------------ Donald C. Burke, Chief Financial Officer of Debt Strategies Fund, Inc. Date: April 21, 2003