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: 02/29/04
Date of reporting period: 03/01/03 - 08/31/03
Item 1 - Attach shareholder report
[LOGO] Merrill Lynch Investment Managers www.mlim.ml.com
Debt Strategies Fund, Inc.
Semi-Annual Report
August 31, 2003
[LOGO] Merrill Lynch Investment Managers
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 income 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 net asset value and 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.
Proxy Results
During the six-month period ended August 31, 2003, Debt Strategies Fund, Inc.'s
shareholders voted on the following proposal. The proposal was approved at a
shareholders' meeting on August 25, 2003. A description of the proposal and
number of shares voted are as follows:
- -----------------------------------------------------------------------------------------------------------------
Shares Voted Shares Withheld
For From Voting
- -----------------------------------------------------------------------------------------------------------------
1. To elect the Fund's Board of Directors: Terry K. Glenn 94,609,979 3,439,739
Ronald W. Forbes 94,679,007 3,370,711
Cynthia A. Montgomery 94,619,211 3,430,507
Charles C. Reilly 94,565,259 3,484,459
Kevin A. Ryan 94,564,294 3,485,424
Roscoe S. Suddarth 94,595,674 3,454,044
Richard R. West 94,610,410 3,439,308
Edward D. Zinbarg 94,618,656 3,431,062
- -----------------------------------------------------------------------------------------------------------------
2 DEBT STRATEGIES FUND, INC. AUGUST 31, 2003
A Letter From the President
Dear Shareholder
Now more than half behind us, 2003 has been a meaningful year in many respects.
After one of the most significant equity market downturns in many investors'
memories, this year finally brought hopeful signs for a sustainable economic
recovery. With that bit of good news, fixed income investments, which had become
the asset class of choice during the long equity market decline, were left to
perform on a new playing field.
The Federal Reserve Board continued its accommodative monetary policy into June
2003, when it brought the Federal Funds rate down to 1%, its lowest level since
1958. With this move, long-term interest rates continued to be volatile, as
investors began to anticipate the impact of future Federal Reserve Board moves
and economic revitalization. As of August 31, 2003, the ten-year Treasury bond
was yielding 4.47%. This compared to a yield of 3.69% six months earlier and
4.14% one year ago.
Against this backdrop, our portfolio managers continued to work diligently to
deliver on our commitment to provide superior performance within reasonable
expectations for risk and return. With that said, remember also that the advice
and guidance of a skilled financial advisor often can mean the difference
between fruitful and fruitless investing. A financial professional can help you
choose those investments that will best serve you as you plan for your financial
future.
Finally, I am proud to premiere a new look to our shareholder communications.
Our portfolio manager commentaries have been trimmed and organized in such a way
that you can get the information you need at a glance, in plain language.
Today's markets are confusing enough. We want to help you put it all in
perspective. The report's new size also allows us certain mailing efficiencies.
Any cost savings in production or postage are passed on to the Fund and,
ultimately, to Fund shareholders.
We thank you for trusting Merrill Lynch Investment Managers with your investment
assets, and we look forward to serving you in the months and years ahead.
Sincerely,
/s/ Terry K. Glenn
Terry K. Glenn
President and Director
DEBT STRATEGIES FUND, INC. AUGUST 31, 2003 3
[LOGO] Merrill Lynch Investment Managers
A Discussion With Your Fund's Portfolio Managers
The high yield market continued its rally throughout the period, and Fund
performance benefited from a significant overweighting in this market.
How did the Fund perform in light of the existing market conditions?
During the period, the high yield market rallied as investors moved into
lower-rated securities in search of yield in the low interest rate environment.
Good supply, especially from the new-issue calendar, also attracted investors to
the market. Our significant allocation to high yield issues generated strong
returns for the Fund as a result.
For the six-month period ended August 31, 2003, the Common Stock of Debt
Strategies Fund, Inc. had a net annualized yield of 13.97%, based on a
period-end per share net asset value of $6.07 and $.427 per share income
dividends. Over the same period, the total return on the Fund's Common Stock was
+21.36%, based on a change in per share net asset value from $5.35 to $6.07, and
assuming reinvestment of $.420 per share ordinary income dividends. The Fund's
benchmark, which is an equal blend of the Credit Suisse First Boston (CSFB) High
Yield II Index and the CSFB Leveraged Loan Index, returned +9.16% for the same
period.
For a description of the Fund's total investment return based on a change in the
per share market value of the Fund's Common Stock (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 market value of the Fund's Common Stock can vary significantly from total
investment return based on changes in the Fund's net asset value.
Top-performing portfolio holdings included Mission Energy Holdings, one of the
Fund's largest positions. Mission rallied in price from 28 to 55 as investors
favorably reassessed the company's coal-fired generation capacity, especially in
light of rising natural gas prices and the fact that nearly all U.S. electrical
generating capacity additions over the past four years have been gas-fired
turbines. Charter Communications Holdings also performed strongly during the
period. A combination of factors have improved Charter's prospects, including a
favorable reappraisal of cable subscription valuations, which increases the
potential for a deleveraging event, and enhanced liquidity through a $300
million line of credit from Charter's owner, Paul Allen. We held several bond
positions and bank debt issued by Coaxial Communications, which also benefited
from the positive reappraisal of cable subscription valuations and a management
tender announcement in August.
Investments that detracted from performance during the period included
International Utility Structures (IUS), a manufacturer of overhead street
lighting and power line and tension support structures. IUS was subject to a
sharp price decline following a missed interest payment on August 1, 2003. These
notes will likely be exchanged following a financial restructuring of the
company. Archibald Candy Corporation, which manufactures and retails the Fannie
May and Fanny Farmer chocolate brands, also fell in price. Business results
following the company's emergence from Chapter 11 last January have been weak.
Vectura Group, a barge transportation company, continued to weaken during the
period because of depressed rates and an adverse working environment in the
inland waterways.
4 DEBT STRATEGIES FUND, INC. AUGUST 31, 2003
What changes did you make to the portfolio during the period?
We maintained our portfolio allocation of approximately 80% high yield bonds and
20% leveraged bank loans. During the period, we attempted to take advantage of
the recent updraft in the high yield market, exit or lighten up on those names
that reached 12-month highs or had, in our opinion, greater downside risk than
upside potential. In doing so, we created the liquidity to redeploy proceeds in
an attractive new-issue market.
We also maintained a below-market duration of less than four years during the
period. The goal was to lower the portfolio's sensitivity to a possible rise in
interest rates.
How would you characterize the portfolio's position at the close of the period?
We expect to maintain our allocation to high yield bonds at approximately 80%.
While the high yield market has rallied sharply over the last year, we believe
that conditions there remain positive. Low interest rates should prompt
investors to continue to seek yield in non-investment grade securities. At the
same time, access to relatively inexpensive capital for corporations will likely
result in a robust new-issue calendar. Leveraged buyouts, which typically
include a high yield bond component, are likely to pick up. Most importantly,
default rates, which had reached approximately 20% during 2001-2002, have
significantly decreased. This is due to the stronger economy, improving
underwriting standards and greater availability of capital, which has enabled
issuers to push out approaching debt maturities.
That being said, the Fund's structure provides the flexibility to shift
investments from the high yield market into the bank loan market should we
experience an unexpected inflationary shock. As such, we intend to maintain our
20% allocation to the bank loan market, increasing that allocation should the
inflation outlook deteriorate. We also expect to maintain the Fund's use of
leverage at approximately 30% of total assets. While leverage can potentially
hinder total return in a weak market, the converse also is true. A leverage
strategy adds to incremental yield, but increases volatility in both weak and
strong markets. (For a more complete explanation of the benefits and risks of
leveraging, see page 2 of this report to shareholders.)
Kevin J. Booth
Vice President and Portfolio Manager
Joseph P. Matteo
Vice President and Portfolio Manager
September 11, 2003
DEBT STRATEGIES FUND, INC. AUGUST 31, 2003 5
[LOGO] Merrill Lynch Investment Managers
Schedule of Investments (in U.S. dollars)
S&P Moody's Face
Industries++ Ratings Ratings Amount Corporate Debt Obligations Value
- -----------------------------------------------------------------------------------------------------------------------------------
Aerospace & Defense-- B+ B1 $ 3,750,000 Armor Holdings, Inc., 8.25% due 8/15/2013 (d) $ 3,881,250
1.5% B+ B1 525,000 Esterline Technologies, 7.75% due 6/15/2013 (d) 542,062
B B3 325,000 Hexcel Corporation, 9.875% due 10/01/2008 (d) 355,875
B- B3 775,000 TD Funding Corporation, 8.375% due 7/15/2011 (d) 809,875
B B2 3,920,000 Vought Aircraft Industries Inc., 8% due 7/15/2011 (d) 3,978,800
------------
9,567,862
- -----------------------------------------------------------------------------------------------------------------------------------
Air Transportation B B3 9,785,505 American Airlines, 7.379% due 5/23/2016 4,900,578
Service--1.5% CC Caa3 3,400,000 Amtran Inc., 10.50% due 8/01/2004 2,333,250
B- B3 1,800,000 Evergreen International Aviation, 12% due 5/15/2010 (d) 1,737,000
NR* Ca 2,641,443 + USAir Inc., 10.375% due 3/01/2013 818,847
------------
9,789,675
- -----------------------------------------------------------------------------------------------------------------------------------
Amusement & B+ B1 8,250,000 Intrawest Corporation, 10.50% due 2/01/2010 8,868,750
Recreational NR* NR* 1,800,000 + Loews Cineplex Entertainment, 8.875% due 8/01/2008 22,320
Services--1.6% B B2 1,225,000 Vail Resorts Inc., 8.75% due 5/15/2009 1,255,625
------------
10,146,695
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Automotive B+ B1 3,318,304 Citation Corporation, Term B, due 12/01/2007** 2,638,052
Equipment--2.1% B B2 1,550,000 Dura Operating Corporation, 9% due 5/01/2009 1,426,000
CCC- Caa3 3,200,000 + Holley Performance Products, 12.25% due 9/15/2007 1,216,000
B Caa1 1,000,000 Metaldyne Corporation, 11% due 6/15/2012 870,000
Tenneco Automotive Inc.:
CCC+ Caa1 6,375,000 11.625% due 10/15/2009 5,833,125
CCC+ B2 925,000 10.25% due 7/15/2013 (d) 957,375
+ Venture Holdings Trust:
NR* NR* 1,800,000 9.50% due 7/01/2005 360,000
NR* NR* 4,450,000 12% due 6/01/2009 27,813
------------
13,328,365
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Broadcasting--5.2% NR* NR* 6,471,568 Gocom Communications LLC, Term B, due 12/31/2007** 6,439,210
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 1,792,000
NR* Caa3 24,525,000 Radio Unica Corp., 11.75% due 8/01/2006 16,983,563
B- B3 4,650,000 Spanish Broadcasting System, 9.625% due 11/01/2009 4,917,375
------------
32,975,898
- -----------------------------------------------------------------------------------------------------------------------------------
Building & B- B2 10,500,000 Champion Home Builders, 11.25% due 4/15/2007 10,185,000
Construction--1.6%
- -----------------------------------------------------------------------------------------------------------------------------------
Building Materials-- NR* NR* 5,850,000 + Formica Corporation, 10.875% due 3/01/2009 1,462,500
2.4% BB Ba1 4,000,000 Lone Star Industries Inc., 8.85% due 6/15/2005 (d) 4,155,000
BB- B1 7,625,000 Texas Industries Inc., 10.25% due 6/15/2011 (d) 8,273,125
NR* NR* 2,284,168 Trussway Industries Inc., Term B, due 12/31/2006** 1,541,814
------------
15,432,439
- -----------------------------------------------------------------------------------------------------------------------------------
Cable Television BB- B1 3,450,000 CSC Holdings Inc., 7.25% due 7/15/2008 3,450,000
Services--15.8% Century Cable Holdings LLC**:
NR* NR* 10,000,000 Term (PR), due 6/30/2009 8,389,290
D Caa1 7,000,000 Term (TD), due 12/31/2009 5,761,000
Charter Communications Holdings LLC:
CCC- Ca 10,000,000 10% due 4/01/2009 7,800,000
CCC- Ca 2,000,000 0/11.75% due 1/15/2010 (c) 1,260,000
CCC- Ca 2,000,000 11.125% due 1/15/2011 1,600,000
CCC- Ca 2,700,000 0/9.92% due 4/01/2011 (c) 1,809,000
CCC- Ca 3,000,000 10% due 5/15/2011 2,265,000
Charter Communications Operating LLC**:
B B2 1,975,000 Incremental Term, due 9/18/2008 1,840,179
B B2 4,937,500 Term B, due 3/18/2008 4,640,944
B NR* 4,500,000 Coaxial Communications, Phoenix, 10% due 8/15/2006 4,685,625
NR* NR* 20,000,000 Coaxial LLC/Coaxial Finance, 12.875% due 8/15/2008 21,050,000
C Caa2 5,000,000 Comcast UK Cable Partners Ltd., 11.20% due 11/15/2007 4,962,500
BB+ Ba3 8,000,000 Insight Midway, Term B, due 12/31/2009** 8,015,000
B+ B2 2,500,000 Insight Midwest, 9.75% due 10/01/2009 2,562,500
NR* NR* 8,750,000 + Mallard Cablevision LLC & Sun Tel Communications, Term B,
due 9/30/2008** 3,062,500
6 DEBT STRATEGIES FUND, INC. AUGUST 31, 2003
Schedule of Investments (continued) (in U.S. dollars)
S&P Moody's Face
Industries++ Ratings Ratings Amount Corporate Debt Obligations Value
- -----------------------------------------------------------------------------------------------------------------------------------
Cable Television D B2 $ 6,000,000 Olympus Cable Holdings LLC, Term B, due 9/30/2010** $ 5,242,500
Services B- B3 3,871,897 Pegasus Media & Communications Inc., Term, due 4/30/2005** 3,639,584
(concluded) CCC- C 9,500,000 Pegasus Satellite, 0/13.50% due 3/01/2007 (c) 6,127,500
C Ca 6,100,000 + Telewest Communications PLC, 9.875% due 2/01/2010 2,501,000
------------
100,664,122
- -----------------------------------------------------------------------------------------------------------------------------------
Chemicals--8.9% B B2 1,858,904 Ethyl Corporation, Term, due 4/30/2009** 1,875,170
CCC- Caa3 7,200,000 Geo Specialty Chemicals, 10.125% due 8/01/2008 3,240,000
B- NR* 825,000 HMP Equity Holdings Corporation, 0% due 5/15/2008 (c)(h) 400,125
B- Caa1 2,000,000 Huntsman ICI Chemicals, 10.125% due 7/01/2009 1,890,000
B- Caa2 11,000,000 Huntsman ICI Holdings, 0% due 12/31/2009 (c) 4,235,000
B B3 1,900,000 Huntsman International LLC, 9.875% due 3/01/2009 1,957,000
B+ B2 3,150,000 ISP Holdings, Inc., 10.625% due 12/15/2009 3,283,875
BB- Ba3 3,550,000 Lyondell Chemical Company, 9.80% due 2/01/2020 3,088,500
BB Ba3 2,400,000 Millennium America Inc., 7.625% due 11/15/2026 2,016,000
NR* NR* 5,500,000 Noveon International Inc., 13% due 8/31/2011 (b) 5,665,000
BB B2 6,000,000 Omnova Solutions Inc., 11.25% due 6/01/2010 6,270,000
NR* NR* 1,450,917 PCI Chemicals, 10% due 12/31/2008 1,240,534
NR* NR* 459,457 Pioneer Companies, Inc., 4.60% due 12/31/2006 390,538
BB- B2 7,500,000 Polyone Corporation, 10.625% due 5/15/2010 6,337,500
Resolution Performance:
B+ B2 2,400,000 9.50% due 4/15/2010 2,376,000
B- Caa1 3,000,000 13.50% due 11/15/2010 2,595,000
BB- Ba3 1,500,000 Rhodia SA, 8.875% due 6/01/2011 (d) 1,507,500
B- B3 3,700,000 Rockwood Specialties Corporation, 10.625% due 5/15/2011 (d) 3,857,250
B- NR* 4,000,000 Salt Holdings Corporation Inc., 0/12% due 6/01/2013 (c)(d) 2,300,000
B- Caa1 2,450,000 Terra Capital Inc., 11.50% due 6/01/2010 2,082,500
------------
56,607,492
- -----------------------------------------------------------------------------------------------------------------------------------
Computer-Related NR* NR* 2,184,394 + Bridge Information Systems, Term B, due 7/7/2005** 240,283
Products--0.0%
- -----------------------------------------------------------------------------------------------------------------------------------
Consumer BB+ Ba3 3,500,000 American Greetings, 11.75% due 7/15/2008 3,955,000
Products--2.9% D NR* 2,500,000 + Diamond Brands Inc., 12.875% due 4/15/2009 250
B- Caa1 2,000,000 General Binding Corporation, 9.375% due 6/01/2008 1,930,000
CCC+ Caa2 2,000,000 Home Products International Inc., 9.625% due 5/15/2008 1,500,000
B- B2 1,475,000 Remington Arms Company, 10.50% due 2/01/2011 1,489,750
CCC Caa2 5,500,000 Remington Product Company LLC, 11% due 5/15/2006 5,500,000
CCC+ Caa2 4,000,000 Samsonite Corporation, 10.75% due 6/15/2008 4,130,000
------------
18,505,000
- -----------------------------------------------------------------------------------------------------------------------------------
Electronics/Electrical NR* NR* 10,143,000 + Advanced Glassfiber Yarn, 9.875% due 1/15/2009 519,829
Components--1.8% Amkor Technology Inc.:
B Ba3 3,800,000 9.25% due 2/15/2008 4,075,500
B B1 2,000,000 7.75% due 5/15/2013 (d) 1,945,000
NR* B3 1,657,971 DD Incorporated, Term B, due 4/22/2005** 911,884
D Caa2 10,145,000 High Voltage Engineering, 10.75% due 8/15/2004 2,029,000
D NR* 2,300,000 Mirant Americas Generation LLC, 7.625% due 5/01/2006 1,690,500
NR* B1 2,473,729 + Trend Technologies, Inc., Term, due 2/28/2007** 24,737
------------
11,196,450
- -----------------------------------------------------------------------------------------------------------------------------------
Energy--4.8% BB Ba3 8,925,000 Citgo Petroleum Corporation, 11.375% due 2/01/2011 (d) 9,951,375
CCC+ Caa1 1,900,000 Continental Resources, 10.25% due 8/01/2008 1,866,750
Dresser Inc.:
B B2 1,000,000 9.375% due 4/15/2011 1,020,000
BB- Ba3 2,092,024 Term B, due 4/10/2009** 2,104,724
El Paso Energy Partners:
BB- B1 750,000 8.50% due 6/01/2011 796,875
BB+ Ba1 984,375 Term B, due 9/01/2009** 984,375
CCC- Caa3 3,250,000 Energy Corp. of America, 9.50% due 5/15/2007 2,307,500
B B2 2,925,000 Lone Star Technologies, 9% due 6/01/2011 2,822,625
B+ Ba3 8,550,000 Massey Energy Company, 6.95% due 3/01/2007 8,357,625
------------
30,211,849
DEBT STRATEGIES FUND, INC. AUGUST 31, 2003 7
[LOGO] Merrill Lynch Investment Managers
Schedule of Investments (continued) (in U.S. dollars)
S&P Moody's Face
Industries++ Ratings Ratings Amount Corporate Debt Obligations Value
- -----------------------------------------------------------------------------------------------------------------------------------
Environmental D Caa1 $ 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 1,485,000
------------
1,485,018
- -----------------------------------------------------------------------------------------------------------------------------------
Financial B B2 3,000,000 Ares Leveraged Fund II, Junior Subordinate Secured Note,
Services--1.4% due 10/31/2005 (a)(d) 1,350,000
NR* Ba1 1,500,000 Investcorp SA, Term, due 10/21/2008** 1,522,131
NR* B2 11,476,563 + Outsourcing Solutions, Inc., Term B, due 6/01/2006** 5,279,219
NR* Ba3 2,000,000 Pennant CBO Limited, 13.43% due 3/14/2011 (d)(f) 440,000
+ SKM-Libertyview CBO Limited (d)(f):
NR* Ba2 1,500,000 8.71% due 4/10/2011 210,000
NR* Ba3 1,000,000 11.91% due 4/10/2011 10,000
------------
8,811,350
- -----------------------------------------------------------------------------------------------------------------------------------
Food & Kindred NR* NR* 2,947,868 Archibald Candy Corporation, 10% due 11/01/2007 972,796
Products--3.0% BB+ Ba1 4,576,269 Dean Foods Company, Term B, due 7/15/2008** 4,590,789
CCC+ B2 2,200,000 Doane Pet Care Company, 10.75% due 3/01/2010 2,354,000
B- B3 8,000,000 Luigino's Inc., 10% due 2/01/2006 8,200,000
NR* Caa3 6,000,000 RAB Enterprises Inc., 10.50% due 5/01/2005 2,700,000
------------
18,817,585
- -----------------------------------------------------------------------------------------------------------------------------------
Food/Tobacco--4.7% Commonwealth Brands, Inc. (d):
NR* NR* 4,550,000 9.75% due 4/15/2008 4,891,250
B- B3 8,000,000 10.625% due 9/01/2008 8,240,000
Dole Foods Company (d):
BB- B2 8,000,000 7.25% due 6/15/2010 7,780,000
BB- B2 3,825,000 8.875% due 3/15/2011 4,016,250
NR* NR* 9,338,661 Viskase Companies Inc., 8% due 12/01/2008 (b) 4,669,331
------------
29,596,831
- -----------------------------------------------------------------------------------------------------------------------------------
Forest Products--3.0% Ainsworth Lumber Company:
B- B3 9,000,000 12.50% due 7/15/2007 (b) 10,080,000
B- B3 2,500,000 13.875% due 7/15/2007 2,812,500
B+ B3 6,000,000 Millar Western Forest, 9.875% due 5/15/2008 6,150,000
------------
19,042,500
- -----------------------------------------------------------------------------------------------------------------------------------
Gaming--8.2% + Aladdin Gaming LLC:
NR* NR* 13,000,000 13.50% due 3/01/2010 65,000
NR* Caa1 2,968,421 Term B, due 2/26/2006** 2,411,842
NR* Caa1 4,455,000 Term C, due 2/26/2008** 3,619,688
Hollywood Park Inc.:
CCC+ Caa1 4,300,000 9.25% due 2/15/2007 (d) 4,343,000
CCC+ Caa1 3,000,000 9.50% due 8/01/2007 3,030,000
B B2 2,000,000 Jacobs Entertainment, 11.875% due 2/01/2009 2,140,000
B+ B2 3,600,000 Marina District Finance Co. (Borgata), Term B,
due 7/15/2007** 3,622,500
BB+ Ba2 7,000,000 Park Place Entertainment, 8.125% due 5/15/2011 7,560,000
B B2 2,150,000 Peninsula Gaming LLC, 12.25% due 7/01/2006 2,227,938
B- B3 7,000,000 Penn National Gaming Inc., 11.125% due 3/01/2008 7,805,000
B+ B2 1,800,000 Sun International Hotels, 8.875% due 8/15/2011 1,939,500
B- B3 4,000,000 Venetian Casino/LV Sands, 11% due 6/15/2010 4,550,000
CCC+ B3 8,000,000 Wynn Las Vegas LLC, 12% due 11/01/2010 9,080,000
------------
52,394,468
- -----------------------------------------------------------------------------------------------------------------------------------
Health Care Providers-- BB- Ba2 5,000,000 Fresenius Medial Capital Trust IV, 7.875% due 6/15/2011 5,200,000
0.8%
- -----------------------------------------------------------------------------------------------------------------------------------
Health Services--1.1% B B1 3,460,956 Medpointe, Term B, due 9/30/2008** 3,279,255
CCC+ B3 3,325,000 Vanguard Health Systems, 9.75% due 8/01/2011 3,391,500
------------
6,670,755
- -----------------------------------------------------------------------------------------------------------------------------------
8 DEBT STRATEGIES FUND, INC. AUGUST 31, 2003
Schedule of Investments (continued) (in U.S. dollars)
S&P Moody's Face
Industries++ Ratings Ratings Amount Corporate Debt Obligations Value
- -----------------------------------------------------------------------------------------------------------------------------------
Hotels & Motels--3.4% B B2 $ 7,000,000 Extended Stay America, 9.15% due 3/15/2008 $ 7,210,000
B+ Ba3 1,800,000 HMH Properties, Inc., 8.45% due 12/01/2008 1,838,250
B B2 1,650,000 John Q. Hammons Hotels, 8.875% due 5/15/2012 1,724,250
B B2 6,500,000 Majestic Star LLC, 10.875% due 7/01/2006 6,853,470
Wyndham Hotel Corporation**:
BB- B1 1,299,270 Increasing Rate Term, due 6/30/2004 1,109,658
B- B1 3,684,573 Term, due 6/30/2006 3,078,461
------------
21,814,089
- -----------------------------------------------------------------------------------------------------------------------------------
Industrial Services-- BB- Ba3 1,907,005 Johnson Divessey, Term B, due 9/15/2009** 1,917,732
1.5% B- Caa3 9,375,000 Muzak Holdings LLC, 0/13% due 3/15/2010 (c) 7,406,250
------------
9,323,982
- -----------------------------------------------------------------------------------------------------------------------------------
Leasing & Rental CCC+ Caa2 3,750,000 + Anthony Crane Rental LP, Term, due 7/22/2006** 562,500
Services--1.3% United Rentals Inc.:
BB B1 3,000,000 10.75% due 4/15/2008 3,300,000
BB B1 1,440,000 10.75% due 4/15/2008 (d) 1,584,000
B B3 2,500,000 Williams Scotsman, Inc., 9.875% due 6/01/2007 2,450,000
------------
7,896,500
- -----------------------------------------------------------------------------------------------------------------------------------
Manufacturing--3.9% CCC+ Caa2 4,500,000 AquaChem Inc., 11.25% due 7/01/2008 3,690,000
B- B3 4,000,000 Eagle-Picher, Inc., 9.75% due 9/01/2013 (d) 4,100,000
CC Caa2 3,876,431 Gentek Inc., Term C, due 10/31/2007** 2,459,596
NR* NR* 8,350,000 International Utility Structures, 10.75% due 2/01/2008 2,421,500
B B3 4,000,000 JLG Industries Inc., 8.375% due 6/15/2012 3,820,000
CCC- Caa3 5,000,000 Jordan Industries, 10.375% due 8/01/2007 2,250,000
B+ B1 3,643,801 Metokote, Term B, due 11/02/2005** 3,586,866
NR* NR* 8,980,000 + Moll Industries, 10.50% due 7/01/2008 1
B+ B3 600,000 NMHG Holding Company, 10% due 5/15/2009 642,000
B- B3 700,000 Rexnord Corporation, 10.125% due 12/15/2012 752,500
B B3 1,300,000 Trimas Corporation, 9.875% due 6/15/2012 1,274,000
------------
24,996,463
- -----------------------------------------------------------------------------------------------------------------------------------
Metals & Mining--1.9% NR* NR* 7,866,978 + Acme Metals Inc., Term, due 12/01/2005** 629,359
CCC- Caa2 7,700,000 Haynes International Inc., 11.625% due 9/01/2004 3,696,000
Ispat International**:
B- Caa 237,625 Term B, due 7/15/2006 166,337
B- Caa1 237,625 Term C, due 7/15/2005 166,337
D C 5,375,000 + Neenah Corporation, 11.125% due 5/01/2007 2,795,000
NR* B2 1,450,000 Oregon Steel Mills Inc., 10% due 7/15/2009 1,152,750
CCC+ Caa2 3,000,000 + Ormet Corporation, Term, due 8/15/2008** 735,000
NR* Ca 550,000 + Pen Holdings Inc., 9.875% due 6/15/2008 55,000
NR* Ca 9,095,000 + WCI Steel Inc., 10% due 12/01/2004 2,637,550
------------
12,033,333
- -----------------------------------------------------------------------------------------------------------------------------------
Multimedia--0.5% B+ B1 3,250,000 Vivendi Universal SA, 6.25% due 7/15/2008 (d) 3,250,000
- -----------------------------------------------------------------------------------------------------------------------------------
Natural Gas-- B+ B1 650,000 Southern Natural Gas, 8.875% due 3/15/2010 685,750
Pipelines--0.1%
- -----------------------------------------------------------------------------------------------------------------------------------
Packaging--7.4% Anchor Glass Container:
B+ B2 7,625,000 11% due 2/15/2013 8,368,437
B+ B2 2,000,000 11% due 2/15/2013 (d) 2,195,000
B- B3 1,575,000 Berry Plastics, 10.75% due 7/15/2012 1,728,562
B B2 4,400,000 Crown Euro Holdings SA, 10.875% due 3/01/2013 (d) 4,862,000
Graham Packaging Company:
CCC+ Caa1 5,000,000 4.735% due 1/15/2008 4,350,000
CCC+ Caa1 2,000,000 8.75% due 1/15/2008 (d) 1,970,000
CCC+ Caa2 5,700,000 10.75% due 1/15/2009 5,842,500
B- Caa1 6,400,000 Pliant Corporation, 13% due 6/01/2010 5,568,000
B+ B2 7,250,000 Owens--Brockway Glass Container, 8.25% due 5/15/2013 (d) 7,322,500
B- Caa1 3,400,000 Pliant Corporation, 13% due 6/01/2010 2,958,000
B B2 2,500,000 Radnor Holdings Inc., 11% due 3/15/2010 (d) 2,000,000
------------
47,164,999
DEBT STRATEGIES FUND, INC. AUGUST 31, 2003 9
[LOGO] Merrill Lynch Investment Managers
Schedule of Investments (continued) (in U.S. dollars)
S&P Moody's Face
Industries++ Ratings Ratings Amount Corporate Debt Obligations Value
- -----------------------------------------------------------------------------------------------------------------------------------
Paper--4.6% BB+ Ba2 $ 8,250,000 Georgia Pacific Corporation, 9.375% due 2/01/2013 (d) $ 8,848,125
B- B3 2,000,000 Graphic Packaging International, 9.50% due 8/15/2013 (d) 2,100,000
B B2 1,525,000 Jefferson Smurfit Corporation, 7.50% due 6/01/2013 1,544,063
B B3 7,858,975 MDP Acquisitions PLC, 15.50% due 10/01/2013 (b) 9,116,411
Stone Container Corporation:
B B2 3,600,000 8.375% due 7/01/2012 3,708,000
B+ Ba3 3,607,107 Term B, due 6/30/2009** 3,623,789
B+ Ba3 611,164 Term C, due 6/30/2009** 613,990
------------
29,554,378
- -----------------------------------------------------------------------------------------------------------------------------------
Petroleum Refineries-- Giant Industries, Inc.:
4.0% B- B3 2,000,000 9% due 9/01/2007 1,880,000
B- B3 9,000,000 11% due 5/15/2012 8,730,000
B+ B3 7,680,000 Tesoro Petroleum Corp., 9% due 7/01/2008 7,526,400
B- Caa1 9,050,000 United Refining Co., 10.75% due 6/15/2007 7,149,500
------------
25,285,900
- -----------------------------------------------------------------------------------------------------------------------------------
Pharmaceuticals--0.3% B NR* 2,000,000 ICN Pharmaceuticals Inc., 6.50% due 7/15/2008 (Convertible) 1,955,000
- -----------------------------------------------------------------------------------------------------------------------------------
Printing & Publishing-- B B3 775,000 Houghton Mifflin Company, 9.875% due 2/01/2013 (d) 844,750
0.1%
- -----------------------------------------------------------------------------------------------------------------------------------
Property Management-- NR* B3 4,887,805 Buffington Harbor Parking Associates, LLC, Term B,
1.3% due 7/01/2011** 4,887,805
B B1 3,200,000 Corrections Corporation of America, 9.875% due 5/01/2009 3,528,000
------------
8,415,805
- -----------------------------------------------------------------------------------------------------------------------------------
Retail & Retail BBB+ Ba1 4,566,176 Shoppers Drug Mart, Term F, due 2/04/2009** 4,578,067
Specialty--1.6% B B3 5,500,000 Star Gas Partners LP, 10.25% due 2/15/2013 5,747,500
------------
10,325,567
- -----------------------------------------------------------------------------------------------------------------------------------
Shipping--0.1% BB Ba3 500,000 Stena AB, 9.625% due 12/01/2012 543,125
- -----------------------------------------------------------------------------------------------------------------------------------
Textile Mill Products-- NR* NR* 7,900,000 + Galey & Lord, Inc., 9.125% due 3/01/2008 59,250
0.0%
- -----------------------------------------------------------------------------------------------------------------------------------
Tower Construction & CCC B3 1,325,000 American Tower Escrow, 0% due 8/01/2008 (c) 874,500
Leasing--3.3% American Tower Systems Corporation:
CCC Caa1 3,000,000 9.375% due 2/01/2009 3,037,500
BB- B2 4,149,116 Term B, due 12/31/2007** 4,171,040
Crown Castle International Corporation:
CCC B3 1,100,000 9% due 5/15/2011 1,116,500
CCC B3 3,625,000 9.375% due 8/01/2011 3,779,063
CCC+ B3 7,400,000 Spectrasite Inc., 8.25% due 5/15/2010 (d) 7,696,000
------------
20,674,603
- -----------------------------------------------------------------------------------------------------------------------------------
Transportation B- B3 6,400,000 Accuride Corporation, Term B, due 6/30/2007** 6,408,000
Services--2.4% CC Ca2 10,000,000 + American Commercial LLC, 11.25% due 1/01/2008 925,000
B+ B2 2,950,000 Laidlaw International Inc., 10.75% due 6/15/2011 (d) 3,097,500
B+ B1 4,526,372 North American Van Lines Inc., Term B, due 11/18/2007** 4,466,257
------------
14,896,757
- -----------------------------------------------------------------------------------------------------------------------------------
Utilities--10.1% B- Caa1 1,250,000 The AES Corporation, 8.50% due 11/01/2007 1,181,250
B+ B3 6,000,000 CMS Energy Corporation, 8.50% due 4/15/2011 5,872,500
CCC+ B1 3,000,000 Calpine Canada Energy Finance, 8.50% due 5/01/2008 2,280,000
Calpine Corporation:
CCC+ B1 2,700,000 8.50% due 2/15/2011 2,011,500
B Ba3 8,000,000 Term, due 7/15/2007** 7,580,000
BB+ Baa2 2,970,000 Michigan Electric Transmission Co., Term B, due 3/31/2007** 2,979,899
B- Caa2 30,000,000 Mission Energy Holdings, 13.50% due 7/15/2008 16,800,000
NR* Ca 1,950,000 Mission Resources Corporation, 10.875% due 4/01/2007 1,335,750
Reliant Resources Inc. (d):
B B1 2,000,000 9.25% due 7/15/2010 1,860,000
B B1 3,500,000 9.50% due 7/15/2013 3,220,000
10 DEBT STRATEGIES FUND, INC. AUGUST 31, 2003
Schedule of Investments (continued) (in U.S. dollars)
S&P Moody's Face
Industries++ Ratings Ratings Amount Corporate Debt Obligations Value
- -----------------------------------------------------------------------------------------------------------------------------------
Utilities BB Ba2 $ 5,500,000 Southern California Edison, Term B, due 3/01/2005** $ 5,519,767
(concluded) Western Resources Inc.:
BB- Ba2 10,100,000 9.75% due 5/01/2007 11,198,375
BB+ Ba1 1,009,882 Term N, due 6/05/2005** 1,014,932
B+ B3 1,425,000 Williams Companies, Inc., 8.625% due 6/01/2010 1,482,000
------------
64,335,973
- -----------------------------------------------------------------------------------------------------------------------------------
Waste Management-- BB- Ba3 1,440,000 Allied Waste North America, 7.875% due 4/15/2013 1,468,800
0.2%
- -----------------------------------------------------------------------------------------------------------------------------------
Wired B- Caa1 11,025,000 Fairpoint Communications, 12.50% due 5/01/2010 11,686,500
Telecommunications-- NR* NR* 7,486,509 + Pacific Crossing Ltd., Term B-1, due 7/28/2006** 524,056
5.3% CCC+ Caa2 6,000,000 Qwest Capital Funding, 7.25% due 2/15/2011 5,070,000
CCC+ B3 8,000,000 Time Warner Telecom LLC, 9.75% due 7/15/2008 7,520,000
US West Capital Funding Inc.:
CCC+ Caa2 2,000,000 6.375% due 7/15/2008 1,665,000
CCC+ Caa2 8,200,000 6.875% due 7/15/2028 6,068,000
NR* NR* 5,611,041 + WCI Capital (Winstar Communications), Debtor in
Possession, due 12/31/2003** 981,932
------------
33,515,488
- -----------------------------------------------------------------------------------------------------------------------------------
Wireless Centennial Cellular**:
Telecommunications-- B B3 3,400,898 Term B, due 5/30/2007 3,294,620
3.5% B B3 2,978,568 Term C, due 11/30/2007 2,881,765
CCC+ B3 3,775,000 Mobifon Holdings BV, 12.50% due 7/31/2010 (d) 4,001,500
Nextel Communications, Inc.:
B+ B2 425,000 9.50% due 2/01/2011 465,375
BB- Ba2 5,194,674 Term D, due 3/31/2009** 5,171,947
Nextel Partners Inc.:
CCC+ Caa1 1,450,000 12.50% due 11/15/2009 1,631,250
CCC+ Caa1 4,100,000 11% due 3/15/2010 4,407,500
BB- Ba3 475,000 PTC International Finance II SA, 11.25% due 12/01/2009 513,000
------------
22,366,957
---------------------------------------------------------------------------------------------------------
Total Investments in Corporate Debt Obligations
(Cost--$940,035,950)--129.3% 822,277,106
=========================================================================================================
Shares
Held Common Stocks
- -----------------------------------------------------------------------------------------------------------------------------------
Automotive 3,614,601 Cambridge Liquidating Trust 175,308
Equipment--0.0%
- -----------------------------------------------------------------------------------------------------------------------------------
Chemicals--0.1% 93,826 + Pioneer Companies, Inc. 342,465
- -----------------------------------------------------------------------------------------------------------------------------------
Communications--0.0% 3,500,000 + LTC--Williams Communications 35
2,000,000 + LTC--Williams Communications 20
------------
55
- -----------------------------------------------------------------------------------------------------------------------------------
Financial Services--0.6% 35,000 Preferred Term Securities VI (d) 3,543,750
- -----------------------------------------------------------------------------------------------------------------------------------
Food & Kindred 15,252 + Archibald Candy Corporation 153
Products--0.0%
- -----------------------------------------------------------------------------------------------------------------------------------
Food/Tobacco--0.0% 1,428,423 + Viskase Companies, Inc. 78,319
- -----------------------------------------------------------------------------------------------------------------------------------
Hotels & Motels--0.1% 83,363 + Lodgian, Inc. 433,488
- -----------------------------------------------------------------------------------------------------------------------------------
Manufacturing--0.0% 21,203 + Thermadyne Holdings Corporation 248,075
- -----------------------------------------------------------------------------------------------------------------------------------
Metals & Mining--0.2% 41,149 Acme Package Corp Senior Holdings 987,576
91,399 + Geneva Steel Holdings Corp. 91
------------
987,667
- -----------------------------------------------------------------------------------------------------------------------------------
DEBT STRATEGIES FUND, INC. AUGUST 31, 2003 11
[LOGO] Merrill Lynch Investment Managers
Schedule of Investments (continued) (in U.S. dollars)
Shares
Industries++ Held Common Stocks Value
- -----------------------------------------------------------------------------------------------------------------------------------
Wireless + Microcell Telecommunications Inc.:
Telecommunications-- 259 (Class A) $ 2,474
0.0% 30,841 (Class B) 303,485
------------
305,959
---------------------------------------------------------------------------------------------------------
Total Investments in Common Stocks
(Cost--$17,250,795)--1.0% 6,115,239
=========================================================================================================
Preferred Stocks
- -----------------------------------------------------------------------------------------------------------------------------------
Automotive 200,000 General Motors Corp. (Convertible) 5,246,000
Equipment--0.8%
- -----------------------------------------------------------------------------------------------------------------------------------
Broadcasting--0.2% 82 Paxson Communications (b) 731,135
34 Paxson Communications (Convertible) (b)(d) 261,592
------------
992,727
- -----------------------------------------------------------------------------------------------------------------------------------
Cable Television 5,000 Adelphia Communications 25,000
Services--2.2% 22,500 CSC Holdings Inc. 2,362,500
89,100 CSC Holdings Inc. (b) 9,310,950
3,500 Pegasus Satellite 2,485,000
------------
14,183,450
- -----------------------------------------------------------------------------------------------------------------------------------
Hotels & Motels-- 70,359 Lodgian, Inc. 1,442,360
0.2%
- -----------------------------------------------------------------------------------------------------------------------------------
Printing & 250,000 NewsCorp Overseas Ltd. 5,900,000
Publishing--1.8% 55,000 Primedia, Inc. (Series D) 5,170,000
------------
11,070,000
- -----------------------------------------------------------------------------------------------------------------------------------
Wireless 11,754 Dobson Communications (b) 11,812,619
Telecommunications-- 31,026 Microcell Telecommunications Inc. (Series B) (Convertible) 303,069
1.9% ------------
12,115,688
---------------------------------------------------------------------------------------------------------
Total Investments in Preferred Stocks
(Cost--$43,326,738)--7.1% 45,050,225
=========================================================================================================
Warrants & Rights
- -----------------------------------------------------------------------------------------------------------------------------------
Broadcasting--0.0% 15,000 Sirius Satellite (Warrants) (g) 150
- -----------------------------------------------------------------------------------------------------------------------------------
Gaming--0.0% 15,140 Peninsula Gaming LLC (Warrants) (g) 90,842
- -----------------------------------------------------------------------------------------------------------------------------------
Manufacturing--0.0% Thermadyne Holdings Corporation (Warrants) (g):
33,536 Series A 0
20,290 Series B 0
------------
0
- -----------------------------------------------------------------------------------------------------------------------------------
Metals & Mining-- 28,660 Geneva Steel Holdings Corp. (Equity Rights) (e) 0
0.0%
- -----------------------------------------------------------------------------------------------------------------------------------
Paper--0.0% 7,000 MDP Acquisitions PLC (Warrants) (g) 70
- -----------------------------------------------------------------------------------------------------------------------------------
Tower Construction 1,325 American Tower Corporation (Warrants) (g) 175,563
& Leasing--0.0%
- -----------------------------------------------------------------------------------------------------------------------------------
Wireless 11,456 Microcell Telecommunications Inc. (Warrants) (g) 6,524
Telecommunications-- 19,093 Microcell Telecommunications Inc. (Warrants) (g) 16,104
0.0% ------------
22,628
---------------------------------------------------------------------------------------------------------
Total Investments in Warrants & Rights
(Cost--$1,396,295)--0.0% 289,253
=========================================================================================================
12 DEBT STRATEGIES FUND, INC. AUGUST 31, 2003
Schedule of Investments (concluded) (in U.S. dollars)
Beneficial
Interest Short-Term Securities Value
- -----------------------------------------------------------------------------------------------------------------------------------
$ 3,389,219 Merrill Lynch Liquidity Series, LLC Cash Sweep
Series I (i) $ 3,389,219
---------------------------------------------------------------------------------------------------------
Total Investments in Short-Term Securities
(Cost--$3,389,219)--0.5% 3,389,219
- -----------------------------------------------------------------------------------------------------------------------------------
Total Investments (Cost--$1,005,398,997)--137.9% 877,121,042
Liabilities in Excess of Other Assets--(37.9%) (241,162,055)
------------
Net Assets--100.0% $635,958,987
============
* 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. Corporate loans represent 24.8% of the Fund's net assets.
+ Non-income producing security.
++ For Fund compliance purposes, "Industries" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management.
This definition may not apply for purposes of this report, which may
combine such industry sub-classifications for reporting ease.
(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) Restricted securities as to resale. The value of the Fund's investments in
restricted securities was approximately $400,000, representing 0.1% of net
assets.
--------------------------------------------------------------------------
Acquisition
Issue Date Cost Value
--------------------------------------------------------------------------
HMP Equity Holdings
Corporation,
0% due 5/15/2008 4/30/2003 $409,965 $400,125
--------------------------------------------------------------------------
Total $409,965 $400,125
=======================
(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 $3,027,550 $15,287
--------------------------------------------------------------------------
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. AUGUST 31, 2003 13
[LOGO] Merrill Lynch Investment Managers
Statement of Assets, Liabilities and Capital
As of August 31, 2003
- ------------------------------------------------------------------------------------------------------------------------------
Assets
- ------------------------------------------------------------------------------------------------------------------------------
Investments, at value (identified cost--$1,005,398,997) ................ $ 877,121,042
Cash ................................................................... 712,246
Interest receivable .................................................... 19,121,188
Deferred facility fees ................................................. 3,539
Prepaid expenses ....................................................... 7,800
---------------
Total assets ........................................................... 896,965,815
---------------
- ------------------------------------------------------------------------------------------------------------------------------
Liabilities
- ------------------------------------------------------------------------------------------------------------------------------
Loans .................................................................. 260,400,000
Payables:
Investment adviser .................................................. $ 421,031
Interest on loans ................................................... 77,379
Commitment fees ..................................................... 7,066
Other affiliates .................................................... 6,005 511,481
------------
Deferred income ........................................................ 52,867
Accrued expenses and other liabilities ................................. 42,480
---------------
Total liabilities ...................................................... 261,006,828
---------------
- ------------------------------------------------------------------------------------------------------------------------------
Net Assets
- ------------------------------------------------------------------------------------------------------------------------------
Net assets ............................................................. $ 635,958,987
===============
- ------------------------------------------------------------------------------------------------------------------------------
Capital
- ------------------------------------------------------------------------------------------------------------------------------
Common Stock, $.10 par value, 200,000,000 shares authorized ............ $ 10,472,770
Paid-in capital in excess of par ....................................... 1,058,583,220
Undistributed investment income--net ................................... $ 6,753,338
Accumulated realized capital losses on investments--net ................ (311,507,715)
Unrealized depreciation on investments--net ............................ (128,342,626)
------------
Total accumulated losses--net .......................................... (433,097,003)
---------------
Total Capital--Equivalent to $6.07 per share based on 104,727,702 shares
of Capital Stock outstanding (market price--$6.60) ................... $ 635,958,987
===============
See Notes to Financial Statements.
14 DEBT STRATEGIES FUND, INC. AUGUST 31, 2003
Statement of Operations
For the Six Months Ended August 31, 2003
- ------------------------------------------------------------------------------------------------------------------------------
Investment Income
- ------------------------------------------------------------------------------------------------------------------------------
Interest ............................................................... $ 45,987,187
Dividends .............................................................. 2,135,933
Facility and other fees ................................................ 391,518
---------------
Total income ........................................................... 48,514,638
---------------
- ------------------------------------------------------------------------------------------------------------------------------
Expenses
- ------------------------------------------------------------------------------------------------------------------------------
Investment advisory fees ............................................... $ 2,616,858
Loan interest expense .................................................. 1,865,098
Borrowing costs ........................................................ 175,141
Accounting services .................................................... 104,397
Professional fees ...................................................... 99,522
Transfer agent fees .................................................... 50,986
Listing fees ........................................................... 38,209
Printing and shareholder reports ....................................... 34,511
Custodian fees ......................................................... 27,820
Directors' fees and expenses ........................................... 24,784
Pricing services ....................................................... 10,332
Other .................................................................. 9,402
------------
Total expenses ......................................................... 5,057,060
---------------
Investment income--net ................................................. 43,457,578
---------------
- ------------------------------------------------------------------------------------------------------------------------------
Realized & Unrealized Gain (Loss) on Investments--Net
- ------------------------------------------------------------------------------------------------------------------------------
Realized loss on investments--net ...................................... (7,251,034)
Change in unrealized depreciation on investments--net .................. 82,925,920
---------------
Total realized and unrealized gain on investments--net ................. 75,674,886
---------------
Net Increase in Net Assets Resulting from Operations ................... $ 119,132,464
===============
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. AUGUST 31, 2003 15
[LOGO] Merrill Lynch Investment Managers
Statements of Changes in Net Assets
For the Six For the
Months Ended Year Ended
August 31, February 28,
Increase (Decrease) in Net Assets: 2003 2003
- ---------------------------------------------------------------------------------------------------------------------------
Operations
- ---------------------------------------------------------------------------------------------------------------------------
Investment income--net ................................................. $ 43,457,578 $ 81,536,760
Realized loss on investments and foreign currency transactions--net .... (7,251,034) (60,907,659)
Change in unrealized depreciation on investments--net .................. 82,925,920 (9,693,150)
----------------------------
Net increase in net assets resulting from operations ................... 119,132,464 10,935,951
----------------------------
- ---------------------------------------------------------------------------------------------------------------------------
Dividends to Shareholders
- ---------------------------------------------------------------------------------------------------------------------------
Dividends to shareholders from investment income--net .................. (43,894,175) (81,536,390)
----------------------------
- ---------------------------------------------------------------------------------------------------------------------------
Capital Share Transactions
- ---------------------------------------------------------------------------------------------------------------------------
Value of shares issued in reinvestment of dividends .................... 3,652,414 7,626,072
----------------------------
Net increase in net assets resulting from capital share transactions ... 3,652,414 7,626,072
----------------------------
- ---------------------------------------------------------------------------------------------------------------------------
Net Assets
- ---------------------------------------------------------------------------------------------------------------------------
Total increase (decrease) in net assets ................................ 78,890,703 (62,974,367)
Beginning of period .................................................... 557,068,284 620,042,651
----------------------------
End of period* ......................................................... $635,958,987 $557,068,284
============================
* Undistributed investment income--net .............................. $ 6,753,338 $ 7,189,935
============================
See Notes to Financial Statements.
16 DEBT STRATEGIES FUND, INC. AUGUST 31, 2003
Statement of Cash Flows
For the Six Months Ended August 31, 2003
- -----------------------------------------------------------------------------------------------------------------------------
Cash Provided by Operating Activities
- -----------------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations .................................... $ 119,132,464
Adjustments to reconcile net increase in net assets resulting from operations to net cash
provided by operating activities:
Increase in receivables .............................................................. (1,189,739)
Decrease in other assets ............................................................. 4,252
Increase in other liabilities ........................................................ 45,638
Realized and unrealized gain on investments and foreign currency transactions--net ... (75,674,886)
Amortization of premium .............................................................. (9,280,795)
-------------
Net cash provided by operating activities ............................................... 33,036,934
-------------
- -----------------------------------------------------------------------------------------------------------------------------
Cash Used for Investing Activities
- -----------------------------------------------------------------------------------------------------------------------------
Proceeds from sales of long-term investments ............................................ 296,984,538
Purchases of long-term investments ...................................................... (300,567,514)
Proceeds from sales and maturities of short-term investments--net ....................... (3,027,550)
-------------
Net cash provided by investing activities ............................................... (6,610,526)
-------------
- -----------------------------------------------------------------------------------------------------------------------------
Cash Used for Financing Activities
- -----------------------------------------------------------------------------------------------------------------------------
Cash receipts from borrowings ........................................................... 143,500,000
Cash payments on borrowings ............................................................. (129,000,000)
Dividends paid to shareholders .......................................................... (40,241,761)
-------------
Net cash used for financing activities .................................................. (25,741,761)
-------------
- -----------------------------------------------------------------------------------------------------------------------------
Cash
- -----------------------------------------------------------------------------------------------------------------------------
Net increase in cash .................................................................... 684,647
Cash at beginning of period ............................................................. 27,599
-------------
Cash at end of period ................................................................... $ 712,246
=============
- -----------------------------------------------------------------------------------------------------------------------------
Cash Flow Information
- -----------------------------------------------------------------------------------------------------------------------------
Cash paid for interest .................................................................. $ 1,848,131
=============
- -----------------------------------------------------------------------------------------------------------------------------
Non-Cash Financing Activities
- -----------------------------------------------------------------------------------------------------------------------------
Capital shares issued in reinvestment of dividends paid to shareholders ................. $ 3,652,414
=============
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. AUGUST 31, 2003 17
[LOGO] Merrill Lynch Investment Managers
Financial Highlights
The following per share data and ratios have been derived For the For the Year Ended For the Six
from information provided in the financial statements. Months Ended February 28, Year Ended
August 31, ------------------------------ February 29,
Increase (Decrease) in Net Asset Value: 2003 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Per Share Operating Performance
- ------------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period ..................... $ 5.35 $ 6.03 $ 7.53 $ 8.60 $ 9.15
-----------------------------------------------------
Investment income--net ................................... .42+ .79+ .92+ .96+ .97
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net ..................... .72 (.68) (1.49) (1.07) (.56)
-----------------------------------------------------
Total from investment operations ......................... 1.14 .11 (.57) (.11) .41
-----------------------------------------------------
Less dividends from investment income--net ............... (.42) (.79) (.93) (.96) (.96)
-----------------------------------------------------
Offering costs resulting from the issuance of Common Stock -- -- --@@ -- --
-----------------------------------------------------
Net asset value, end of period ........................... $ 6.07 $ 5.35 $ 6.03 $ 7.53 $ 8.60
=====================================================
Market price per share, end of period .................... $ 6.60 $ 5.99 $ 6.57 $ 7.15 $ 7.1875
=====================================================
- ------------------------------------------------------------------------------------------------------------------------------------
Total Investment Return**
- ------------------------------------------------------------------------------------------------------------------------------------
Based on market price per share .......................... 17.86%@ 4.85% 5.69% 13.97% 3.19%
=====================================================
Based on net asset value per share ....................... 21.36%@ 2.04% (7.89%) .31% 6.26%
=====================================================
- ------------------------------------------------------------------------------------------------------------------------------------
Ratio to Average Net Assets
- ------------------------------------------------------------------------------------------------------------------------------------
Expenses, net of reimbursement and excluding interest
expense ................................................ 1.03%* 1.07% 1.04% 1.20% .98%
=====================================================
Expenses, net of reimbursement ........................... 1.63%* 1.91% 2.59% 3.87% 2.87%
=====================================================
Expenses ................................................. 1.63%* 1.91% 2.59% 3.87% 2.87%
=====================================================
Investment income--net ................................... 14.02%* 14.32% 13.69% 12.23% 10.88%
=====================================================
- ------------------------------------------------------------------------------------------------------------------------------------
Leverage
- ------------------------------------------------------------------------------------------------------------------------------------
Amount of borrowings, end of period (in thousands) ....... $260,400 $245,900 $273,600 $301,000 $161,000
=====================================================
Average amount of borrowings outstanding during the
period (in thousands) .................................. $251,044 $238,863 $280,460 $228,640 $182,404
=====================================================
Average amount of borrowings outstanding per share
during the period ...................................... $ 2.41 $ 2.31 $ 2.75 $ 3.07 $ 2.91
=====================================================
- ------------------------------------------------------------------------------------------------------------------------------------
Supplemental Data
- ------------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period (in thousands) ................. $635,959 $557,068 $620,043 $763,834 $538,343
=====================================================
Portfolio turnover ....................................... 33.59% 64.54% 49.58% 36.86% 61.76%
=====================================================
* 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. Total investment returns include any waiver, if applicable, by
the Fund's Investment Adviser or any portion of its management fee.
Without such waiver, the Fund's performance would have been lower.
+ Based on average shares outstanding.
@ Aggregate total investment return.
@@ Amount is less than $.01 per share.
See Notes to Financial Statements.
18 DEBT STRATEGIES FUND, INC. AUGUST 31, 2003
Notes to Financial Statements
1. Significant Accounting Policies:
Debt Strategies Fund, Inc. (the "Fund") is registered under the Investment
Company Act of 1940, as amended, 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. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to a fair statement of the results for the interim period
presented. All such adjustments are of a normal, recurring nature. 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 ("NYSE") 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 and other
financial institutions, 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.
Securities that are held by the Fund that are traded on stock exchanges or the
NASDAQ National Market are valued at the last sale price or official close price
on the exchange on which such securities are traded, as of the close of business
on the day the securities are being valued or, lacking any sales, at the last
available bid price for long positions, and at the last available ask price for
short positions. In cases where securities are traded on more than one exchange,
the securities are valued on the exchange designated as the primary market by or
under the authority of the Board of the Fund. Long positions in securities
traded in the over-the-counter ("OTC") market, NASDAQ Small Cap or Bulletin
Board are valued at the last available bid price or yield equivalent obtained
from one or more dealers or pricing services approved by the Board of the Fund.
Short positions in securities traded in the OTC market are valued at the last
available ask price. Portfolio securities that are traded both in the OTC market
and on a stock exchange are valued according to the broadest and most
representative market. When the Fund writes an option, the amount of the premium
received is recorded on the books of the Fund as an asset and an equivalent
liability. The amount of the liability is subsequently valued to reflect the
current market value of the option written, based on the last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last ask price. Options purchased by the Fund are valued at their
last sale price in the case of exchange-traded options or, in the case of
options traded in the OTC market, the last bid price. The value of swaps,
including interest rate swaps, caps and floors, will be determined by obtaining
dealer quotations. Other investments, including futures contracts and related
options, are stated at market value. Obligations with remaining maturities of 60
days or less are valued at amortized cost unless the Investment Adviser believes
that this method no longer produces fair valuations. Repurchase agreements will
be valued at cost plus accrued interest. The Fund employs certain pricing
services to provide securities prices for the Fund. Securities and assets for
which market quotations are not readily available are valued at fair value as
determined in good faith by or under the direction of the Directors of the Fund,
including valuations furnished by the pricing services retained by the Fund,
which may use a matrix system for valuations. The procedures of a pricing
service and its valuations are reviewed by the officers of the Fund under the
general supervision of the Directors. Such valuations and procedures will be
reviewed periodically by the Directors.
Generally, trading in foreign securities, as well as U.S. Government securities
and money market instruments, is substantially completed each day at various
times prior to the close of business on the NYSE. The values of such securities
used in computing the net asset value of the Fund's shares are determined as of
such times. Foreign currency exchange rates also are generally determined prior
to the close of business on the NYSE. Occasionally, events affecting the values
of such securities and such exchange rates may occur between the times at which
they are determined and the close of business on the NYSE that may not be
reflected in the computation of the Fund's net asset value. If events (for
example, a company announcement, market volatility or a natural disaster) occur
during such periods that are expected to materially affect the value of such
securities, those securities may be valued at their fair value as determined in
good faith by the Board of Directors or by the Investment Adviser using a
pricing service and/or procedures approved by the Board of Directors.
DEBT STRATEGIES FUND, INC. AUGUST 31, 2003 19
[LOGO] Merrill Lynch Investment Managers
Notes to Financial Statements (continued)
(c) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movement and movements in the securities
markets. 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. 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 may 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 may 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 Swaps--The Fund may enter into swap agreements, which are over-the-counter
contracts in which the Fund and a counterparty agree to make periodic net
payments on a specified notional amount. The net payments can be made for
a set period of time or may be triggered by a pre-determined credit event.
The net periodic payments may be based on a fixed or variable interest
rate; the change in market value of a specified security, basket of
securities, or index; or the return generated by a security.
(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.
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
20 DEBT STRATEGIES FUND, INC. AUGUST 31, 2003
Notes to Financial Statements (concluded)
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.
In addition, Merrill Lynch, Pierce, Fenner & Smith Incorporated, a subsidiary of
ML & Co., received $4,500 in commissions on the execution of portfolio security
transactions for the Fund for the six months ended August 31, 2003.
For the six months ended August 31, 2003, the Fund reimbursed FAM $7,403 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 six
months ended August 31, 2003 were $295,728,211 and $286,667,102, respectively.
Net realized losses for the six months ended August 31, 2003 and net unrealized
losses as of August 31, 2003 were as follows:
- -------------------------------------------------------------------------------
Realized Unrealized
Losses Losses
- -------------------------------------------------------------------------------
Long-term investments .............. $ (7,251,034) $(128,277,955)
Unfunded corporate loans ........... -- (64,671)
-----------------------------------
Total .............................. $ (7,251,034) $(128,342,626)
===================================
As of August 31, 2003, net unrealized depreciation for Federal income tax
purposes aggregated $127,863,529, of which $51,153,004 related to appreciated
securities and $179,016,533 related to depreciated securities. The aggregate
cost of investments at August 31, 2003 for Federal income tax purposes was
$1,004,984,571.
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 six months ended August
31, 2003 and the year ended February 28, 2003 increased by 588,429 and
1,356,882, respectively, as a result of dividend reinvestment.
5. Unfunded Loan Interests:
As of August 31, 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
===========
6. Short-Term Borrowings:
On May 28, 2003, the Fund entered into its $318,000,000 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/or 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 based
upon 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 six months ended August 31, 2003, the average amount borrowed was
approximately $251,044,000 and the daily weighted average interest rate was
1.48%.
7. Capital Loss Carryforward:
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.
8. Subsequent Event:
The Fund paid an ordinary income dividend in the amount of $.068419 per share on
September 30, 2003 to shareholders of record on September 16, 2003.
DEBT STRATEGIES FUND, INC. AUGUST 31, 2003 21
[LOGO] Merrill Lynch Investment Managers
Portfolio Information
As of August 31, 2003
Percent of
Ten Largest Holdings Total Assets
- --------------------------------------------------------------------------------
Coaxial LLC/Coaxial Finance .......................................... 2.3%
Radio Unica Corp. .................................................... 1.9
Mission Energy Holdings .............................................. 1.9
CSC Holdings Inc. .................................................... 1.7
Charter Communications Holdings LLC .................................. 1.6
Century Cable Holdings LLC ........................................... 1.6
Commonwealth Brands, Inc. ............................................ 1.5
Ainsworth Lumber Company ............................................. 1.4
Western Resources Inc. ............................................... 1.4
Graham Packaging Company ............................................. 1.4
- --------------------------------------------------------------------------------
Percent of
Five Largest Industries++ Total Assets
- --------------------------------------------------------------------------------
Cable Television Services ............................................ 12.8%
Utilities ............................................................ 7.2
Chemicals ............................................................ 6.3
Gaming ............................................................... 5.9
Packaging ............................................................ 5.3
- --------------------------------------------------------------------------------
++ For Fund compliance purposes, "Industries" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management.
This definition may not apply for purposes of this report, which may
combine such industry sub-classifications for reporting ease.
Quality Ratings by Percent of
S&P/Moody's Long-Term Investments
- --------------------------------------------------------------------------------
BBB/Baa .............................................................. 0.3%
BB/Ba ................................................................ 18.9
B/B .................................................................. 47.5
CCC/Caa or lower ..................................................... 19.6
NR (Not Rated) ....................................................... 13.7
- --------------------------------------------------------------------------------
Geographic Allocation Percent of
By Country Long-Term Investments
- --------------------------------------------------------------------------------
United States ........................................................ 77.8%
Canada ............................................................... 14.5
Ireland .............................................................. 3.1
Kyrguzstan ........................................................... 2.0
France ............................................................... 1.6
Bahamas .............................................................. 0.6
Poland ............................................................... 0.2
Cayman Islands ....................................................... 0.2
- --------------------------------------------------------------------------------
22 DEBT STRATEGIES FUND, INC. AUGUST 31, 2003
Electronic Delivery
The Fund is now offering electronic delivery of communications to its
shareholders. In order to receive this service, you must register your account
and provide us with e-mail information. To sign up for this service, simply
access this website http://www.icsdelivery.com/live and follow the instructions.
When you visit this site, you will obtain a personal identification number
(PIN). You will need this PIN should you wish to update your e-mail address,
choose to discontinue this service and/or make any other changes to the service.
This service is not available for certain retirement accounts at this time.
Officers and Directors
Terry K. Glenn, President and Director
Ronald Forbes, Director
Cynthia A. Montgomery, Director
Charles C. Reilly, Director
Kevin A. Ryan, Director
Roscoe S. Suddarth, Director
Richard R. West, Director
Edward D. Zinbarg, Director
Kevin J. Booth, Vice President
Joseph Matteo, Vice President
Donald C. Burke, Vice President and Treasurer
Bradley J. Lucido, Secretary
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
DEBT STRATEGIES FUND, INC. AUGUST 31, 2003 23
[LOGO] Merrill Lynch Investment Managers www.mlim.ml.com
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.
A description of the policies and procedures that the Fund uses to determine how
to vote proxies relating to portfolio securities is available (1) without
charge, upon request, by calling toll-free 1-800-MER-FUND (1-800-637-3863); (2)
on www.mutualfunds.ml.com; and (3) on the Securities and Exchange Commission's
website at http://www.sec.gov.
Debt Strategies Fund, Inc.
Box 9011
Princeton, NJ
08543-9011
#DEBT -- 8/03
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 (annual requirement only)
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 (annual requirement
only)
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.
Item 5 - If the registrant is a listed issuer as defined in Rule 10A-3 under the
Exchange Act, state whether or not the registrant has a
separately-designated standing audit committee established in
accordance with Section 3(a)(58)(A) of the Exchange Act. If the
registrant has such a committee, however designated, identify each
committee member. If the entire board of directors is acting as the
registrant's audit committee in Section 3(a)(58)(B) of the Exchange
Act, so state.
If applicable, provide the disclosure required by Rule 10A-3(d) under
the Exchange Act regarding an exemption from the listing standards for
audit committees. N/A
(Listed issuers must be in compliance with the new listing rules by the
earlier of their first annual shareholders meeting after January 2004,
or October 31, 2004 (annual requirement))
Item 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.
Proxy Voting Policies and Procedures
Each Fund's Board of Directors/Trustees has delegated to Merrill Lynch
Investment Managers, L.P. and/or Fund Asset Management, L.P. (the
"Investment Adviser") authority to vote all proxies relating to the
Fund's portfolio securities. The Investment Adviser has adopted
policies and procedures ("Proxy Voting Procedures") with respect to the
voting of proxies related to the portfolio securities held in the
account of one or more of its clients, including a Fund. Pursuant to
these Proxy Voting Procedures, the Investment Adviser's primary
objective when voting proxies is to make proxy voting decisions solely
in the best interests of each Fund and its shareholders, and to act in
a manner that the Investment Adviser believes is most likely to enhance
the economic value of the securities held by the Fund. The Proxy Voting
Procedures are designed to ensure that the Investment Adviser considers
the interests of its clients, including the Funds, and not the
interests of the Investment Adviser, when voting proxies and that real
(or perceived) material conflicts that may arise between the Investment
Adviser's interest and those of the Investment Adviser's clients are
properly addressed and resolved.
In order to implement the Proxy Voting Procedures, the Investment
Adviser has formed a Proxy Voting Committee (the "Committee"). The
Committee is comprised of the Investment Adviser's Chief Investment
Officer (the "CIO"), one or more other senior investment professionals
appointed by the CIO, portfolio managers and investment analysts
appointed by the CIO and any other personnel the CIO deems appropriate.
The Committee will also include two non-voting representatives from the
Investment Adviser's Legal department appointed by the Investment
Adviser's General Counsel. The Committee's membership shall be limited
to full-time employees of the Investment Adviser. No person with any
investment banking, trading, retail brokerage or research
responsibilities for the Investment Adviser's affiliates may serve as a
member of the Committee or participate in its decision making (except
to the extent such person is asked by the Committee to present
information to the Committee, on the same basis as other interested
knowledgeable parties not affiliated with the Investment Adviser might
be asked to do so). The Committee determines how to vote the proxies of
all clients, including a Fund, that have delegated proxy voting
authority to the Investment Adviser and seeks to ensure that all votes
are consistent with the best interests of those clients and are free
from unwarranted and inappropriate influences. The Committee
establishes general proxy voting policies for the Investment Adviser
and is responsible for determining how those policies are applied to
specific proxy votes, in light of each issuer's unique structure,
management, strategic options and, in certain circumstances, probable
economic and other anticipated consequences of alternate actions. In so
doing, the Committee may determine to vote a particular proxy in a
manner contrary to its generally stated policies. In addition, the
Committee will be responsible for ensuring that all reporting and
recordkeeping requirements related to proxy voting are fulfilled.
The Committee may determine that the subject matter of a recurring
proxy issue is not suitable for general voting policies and requires a
case-by-case determination. In such cases, the Committee may elect not
to adopt a specific voting policy applicable to that issue. The
Investment Adviser believes that certain proxy voting issues require
investment analysis - such as approval of mergers and other significant
corporate transactions - akin to investment decisions, and are,
therefore, not suitable for general guidelines. The Committee may elect
to adopt a common position for the Investment Adviser on certain proxy
votes that are akin to investment decisions, or determine to permit the
portfolio manager to make individual decisions on how best to maximize
economic value for a Fund (similar to normal buy/sell investment
decisions made by such portfolio managers). While it is expected that
the Investment Adviser will generally seek to vote proxies over which
the Investment Adviser exercises voting authority in a uniform manner
for all the Investment Adviser's clients, the Committee, in conjunction
with a Fund's portfolio manager, may determine that the Fund's specific
circumstances require that its proxies be voted differently.
To assist the Investment Adviser in voting proxies, the Committee has
retained Institutional Shareholder Services ("ISS"). ISS is an
independent adviser that specializes in providing a variety of
fiduciary-level proxy-related services to institutional investment
managers, plan sponsors, custodians, consultants, and other
institutional investors. The services provided to the Investment
Adviser by ISS include in-depth research, voting recommendations
(although the Investment Adviser is not obligated to follow such
recommendations), vote execution, and recordkeeping. ISS will also
assist the Fund in fulfilling its reporting and recordkeeping
obligations under the Investment Company Act.
The Investment Adviser's Proxy Voting Procedures also address special
circumstances that can arise in connection with proxy voting. For
instance, under the Proxy Voting Procedures, the Investment Adviser
generally will not seek to vote proxies related to portfolio securities
that are on loan, although it may do so under certain circumstances. In
addition, the Investment Adviser will vote proxies related to
securities of foreign issuers only on a best efforts basis and may
elect not to vote at all in certain countries where the Committee
determines that the costs associated with voting generally outweigh the
benefits. The Committee may at any time override these general policies
if it determines that such action is in the best interests of a Fund.
From time to time, the Investment Adviser may be required to vote proxies in
respect of an issuer where an affiliate of the Investment Adviser (each, an
"Affiliate"), or a money management or other client of the Investment Adviser
(each, a "Client") is involved. The Proxy Voting Procedures and the Investment
Adviser's adherence to those procedures are designed to address such conflicts
of interest. The Committee intends to strictly adhere to the Proxy Voting
Procedures in all proxy matters, including matters involving Affiliates and
Clients. If, however, an issue representing a non-routine matter that is
material to an Affiliate or a widely known Client is involved such that the
Committee does not reasonably believe it is able to follow its guidelines (or if
the particular proxy matter is not addressed by the guidelines) and vote
impartially, the Committee may, in its discretion for the purposes of ensuring
that an independent determination is reached, retain an independent fiduciary to
advise the Committee on how to vote or to cast votes on behalf of the Investment
Adviser's clients.
In the event that the Committee determines not to retain an independent
fiduciary, or it does not follow the advice of such an independent
fiduciary, the powers of the Committee shall pass to a subcommittee,
appointed by the CIO (with advice from the Secretary of the Committee),
consisting solely of Committee members selected by the CIO. The CIO
shall appoint to the subcommittee, where appropriate, only persons
whose job responsibilities do not include contact with the Client and
whose job evaluations would not be affected by the Investment Adviser's
relationship with the Client (or failure to retain such relationship).
The subcommittee shall determine whether and how to vote all proxies on
behalf of the Investment Adviser's clients or, if the proxy matter is,
in their judgment, akin to an investment decision, to defer to the
applicable portfolio managers, provided that, if the subcommittee
determines to alter the Investment Adviser's normal voting guidelines
or, on matters where the Investment Adviser's policy is case-by-case,
does not follow the voting recommendation of any proxy voting service
or other independent fiduciary that may be retained to provide research
or advice to the Investment Adviser on that matter, no proxies relating
to the Client may be voted unless the Secretary, or in the Secretary's
absence, the Assistant Secretary of the Committee concurs that the
subcommittee's determination is consistent with the Investment
Adviser's fiduciary duties
In addition to the general principles outlined above, the Investment
Adviser has adopted voting guidelines with respect to certain recurring
proxy issues that are not expected to involve unusual circumstances.
These policies are guidelines only, and the Investment Adviser may
elect to vote differently from the recommendation set forth in a voting
guideline if the Committee determines that it is in a Fund's best
interest to do so. In addition, the guidelines may be reviewed at any
time upon the request of a Committee member and may be amended or
deleted upon the vote of a majority of Committee members present at a
Committee meeting at which there is a quorum.
The Investment Adviser has adopted specific voting guidelines with
respect to the following proxy issues:
o Proposals related to the composition of the Board of Directors of issuers
other than investment companies. As a general matter, the Committee
believes that a company's Board of Directors (rather than shareholders) is
most likely to have access to important, nonpublic information regarding a
company's business and prospects, and is therefore best-positioned to set
corporate policy and oversee management. The Committee, therefore,
believes that the foundation of good corporate governance is the election
of qualified, independent corporate directors who are likely to diligently
represent the interests of shareholders and oversee management of the
corporation in a manner that will seek to maximize shareholder value over
time. In individual cases, the Committee may look at a nominee's history
of representing shareholder interests as a director of other companies or
other factors, to the extent the Committee deems relevant.
o Proposals related to the selection of an issuer's independent auditors. As
a general matter, the Committee believes that corporate auditors have a
responsibility to represent the interests of shareholders and provide an
independent view on the propriety of financial reporting decisions of
corporate management. While the Committee will generally defer to a
corporation's choice of auditor, in individual cases, the Committee may
look at an auditors' history of representing shareholder interests as
auditor of other companies, to the extent the Committee deems relevant.
o Proposals related to management compensation and employee benefits. As a
general matter, the Committee favors disclosure of an issuer's
compensation and benefit policies and opposes excessive compensation, but
believes that compensation matters are normally best determined by an
issuer's board of directors, rather than shareholders. Proposals to
"micro-manage" an issuer's compensation practices or to set arbitrary
restrictions on compensation or benefits will, therefore, generally not be
supported.
o Proposals related to requests, principally from management, for approval
of amendments that would alter an issuer's capital structure. As a general
matter, the Committee will support requests that enhance the rights of
common shareholders and oppose requests that appear to be unreasonably
dilutive.
o Proposals related to requests for approval of amendments to an issuer's
charter or by-laws. As a general matter, the Committee opposes poison pill
provisions.
o Routine proposals related to requests regarding the formalities of
corporate meetings.
o Proposals related to proxy issues associated solely with holdings of
investment company shares. As with other types of companies, the Committee
believes that a fund's Board of Directors (rather than its shareholders)
is best-positioned to set fund policy and oversee management. However, the
Committee opposes granting Boards of Directors authority over certain
matters, such as changes to a fund's investment objective, that the
Investment Company Act envisions will be approved directly by
shareholders.
o Proposals related to limiting corporate conduct in some manner that
relates to the shareholder's environmental or social concerns. The
Committee generally believes that annual shareholder meetings are
inappropriate forums for discussion of larger social issues, and opposes
shareholder resolutions "micromanaging" corporate conduct or requesting
release of information that would not help a shareholder evaluate an
investment in the corporation as an economic matter. While the Committee
is generally supportive of proposals to require corporate disclosure of
matters that seem relevant and material to the economic interests of
shareholders, the Committee is generally not supportive of proposals to
require disclosure of corporate matters for other purposes.
Item 8 -- Reserved
Item 9(a) - The registrant's certifying officers have reasonably designed such
disclosure controls and procedures to ensure material information
relating to the registrant is made known to us by others
particularly during the period in which this report is being
prepared. The registrant's certifying officers have determined that
the registrant's disclosure controls and procedures are effective
based on our evaluation of these controls and procedures as of a
date within 90 days prior to the filing date of this report.
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 pursuant to Section 302 of the Sarbanes-Oxley Act.
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: October 24, 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: October 24, 2003
By: /s/ Donald C. Burke
--------------------------
Donald C. Burke,
Chief Financial Officer of
Debt Strategies Fund, Inc.
Date: October 24, 2003
Attached hereto as a furnished exhibit are the certifications pursuant
to Section 906 of the Sarbanes-Oxley Act.