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 - 02/29/04
Item 1 - Report to Stockholders
[LOGO] Merrill Lynch Investment Managers www.mlim.ml.com
Debt Strategies Fund, Inc.
Annual Report
February 29, 2004
[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.
2 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
A Letter From the President
Dear Shareholder
As I write to you at February month-end, fixed income markets in the United
States continued to reward those investors willing to accept greater risk. The
high yield market, as measured by the Credit Suisse First Boston High Yield
Index, provided a return of +10.88% over the past six months and +25.17% for the
12-month period ended February 29, 2004. In other areas of fixed income,
investment grade corporate bonds, as measured by the Merrill Lynch Corporate
Master Index, returned +6.59% and +8.11% for the six-month and 12-month periods
ended February 29, 2004, respectively. Treasury issues, as measured by the
Merrill Lynch U.S. Treasuries 1 - 10 Years Index, returned +3.16% and +2.73% for
the six-month and 12-month periods ended February 29, 2004, respectively.
At the same time, equity markets maintained their positive momentum from
year-end 2003. For the six-month and 12-month periods ended February 29, 2004,
the Standard & Poor's (S&P) 500 Index returned +14.59% and +38.52%,
respectively. Much of the boost came from improving economic conditions in the
United States.
The major signposts as we enter 2004 indicate that we are seeing a shift from
economic growth fueled primarily by fiscal and monetary stimulus to a
broader-based, self-sustaining economic expansion. Gross domestic product
growth, which peaked at an annualized rate of 8.2% in the third quarter of 2003,
was 4.1% in the fourth quarter. A similar level of growth is expected in the
first quarter of 2004. For its part, the Federal Reserve Board has reiterated
its willingness to keep short-term interest rates at current low levels to
ensure the economy's strength.
Accompanying the increase in economic activity was an improvement in corporate
earnings. By February 10, 2004, 392 of the S&P 500 companies had reported their
fourth-quarter 2003 results, and 67.6% of those exceeded expectations. In the
meantime, the American consumer, who continued to spend despite the faltering
economy, may get further incentive from another round of federal tax refunds
this year.
At Merrill Lynch Investment Managers, we believe the events and efforts of 2003
leave us with a much stronger economy and that recent optimism suggests it is
time for investors to consider what can go right in 2004. We encourage you to
revisit your portfolio and your asset allocation strategy to ensure you are well
positioned to take advantage of the opportunities that lie ahead.
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. FEBRUARY 29, 2004 3
[LOGO] Merrill Lynch Investment Managers
A Discussion With Your Fund's Portfolio Managers
The Fund provided superior returns during the fiscal year, significantly
outperforming its blended benchmark, primarily from its overweight bond position
in the robust high yield market.
How did the Fund perform during the fiscal year?
For the 12-month period ended February 29, 2004, the Common Stock of Debt
Strategies Fund, Inc. had net annualized yields of 11.72% and 11.75%, based on a
year-end per share net asset value of $6.71 and a per share market price of
$6.69, respectively, and $.786 per share income dividends. Over the same period,
the total return on the Fund's Common Stock was +41.84%, based on a change in
per share net asset value from $5.35 to $6.71, and assuming reinvestment of
$.791 per share ordinary income dividends. The Fund's benchmark, which is an
equal blend of the Credit Suisse First Boston (CSFB) High Yield Index and the
CSFB Leveraged Loan Index, returned +17.62% for the same period.
For the six-month period ended February 29, 2004, the total investment return on
the Fund's Common Stock was +16.88%, based on a change in per share net asset
value from $6.07 to $6.71, and assuming reinvestment of $.370 per share income
dividends. The blended benchmark returned +7.75% for the same six-month 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
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.
What were the reasons for the Fund's significant outperformance of its
benchmark?
The strong performance is primarily attributed to two factors. First, we
maintained an overweight bond position throughout the year -- specifically, 80%
bonds and 20% bank loans. We initiated this strategy a couple of years ago as
short-term interest rates declined, given that lower rates would have a negative
effect on bank loan yields. The portfolio benefited particularly from its
wireless and cable positions as issues rated CCC and low-B outperformed the rest
of the index during this high yield market boom during the Fund's fiscal year.
Taken together, we had an overweight bond position that was supercharged by our
investment in the lower end of the spectrum, and this allowed the Fund to
outperform. The second strategy that had a positive effect on performance was
our decision to make fairly full use of our leverage facilities. Leverage was
maintained at around 30% of total assets throughout the fiscal year. (For a
complete discussion of the benefits and risks of leverage, see page 2 of this
report to shareholders.)
In terms of specific investments, the largest positive contributor this year was
Mission Energy. Although Mission disappointed last year, we maintained our
confidence in the company's coal-fired capacity. We started the period with $30
million in Mission bonds priced at $28. These bonds rallied close to par by the
end of the fiscal year. We took advantage of the rally and reduced our position
to $12.6 million bonds. The second-largest positive contributor was Coaxial
Communications. We began the year with a $20 million bond position marked at
$70. By August, this position had rallied in price to $106.4, the call price at
which the company redeemed this debt. Coaxial's ability to refinance its debt
resulted from a favorable financial market and a positive reassessment of cable
valuations. This constructive reassessment also benefited the portfolio's
third-best performer, Charter Communications. The Fund owns nearly $25 million
in Charter bond and bank loan positions, which rallied an average of 20 points
during the year.
The three positions that detracted the most from performance this year all fell
into the distressed investments bucket that we use in the Fund. Overall, the
negative impact of these positions was modest in relation to the significant
outperformance afforded by the Fund's top performers. The first, Viskase
Companies, Inc. is a maker of casings used in preparing and packaging processed
meat products. Viskase emerged from bankruptcy protection in April 2003, but
overcapacity in the industry continued to put downward pressure on the company's
financial results and on the value of its debt and equity securities. Following
the bankruptcy reorganization, we received $9.2 million in new bonds and an
equity interest in exchange for our $22 million bond position. We subsequently
sold the new bonds at a price of approxi-
4 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
mately $67 and retained the equity interest. The second, International Utility
Structures Inc. (IUS), is a Canadian holding company that owns equity in two
utility pole manufacturing operations in France and the United States. In August
2003, IUS failed to pay its coupon and shortly thereafter filed for the Canadian
equivalent of Chapter 11. As we ended the period, our $8.35 million bond
position had declined in price from $50 to $22, reflecting the company's efforts
to reduce cash burn in North America and stabilize French operations. Finally,
Archibald Candy, manufacturer of Fannie Farmer chocolates filed for bankruptcy
again in January 2004 and is conducting an orderly liquidation of its assets.
Our $3.1 million bond position was marked at $38 as of period-end.
Describe the market conditions that impacted the portfolio during the year.
The high yield rally continued to perform well through the end of the Fund's
fiscal year. This was primarily a spread compression rally as opposed to an
interest rate rally. The CSFB High Yield Index spread declined from 947 basis
points (9.47%) to 486 basis points during calendar year 2003. At the same time,
the yield on the 10-year Treasury note rose from 3.83% to 4.25%. Treasury note
yields worked against the rally, but were more than offset by high yield spread
compression.
Perhaps the most important factor affecting high yield returns was the sharp
decline in the payment default rate. According to CSFB, the 12-month rolling
default rate declined from 14.9% at December 31, 2002 to 4.05% a year later. We
expect a continuation of lower default rates in 2004. Moody's is projecting a
default rate of 3% - 3.5% for the year.
Increased investor risk appetites accompanied the declining default rates. This
was the main catalyst for the $26.2 billion in high yield market inflows in
2003. (This represents actual new money entering the market for purchase of
existing or new high yield bonds.) The year 2003 also brought $133 billion in
new-issue volume -- that is, the transactions put together and brought to market
for the first time. At first glance, the figures appear to reflect a
supply/demand imbalance. However, the wide disparity between the two is
explained by the fact that nearly 80% of new issuance is attributed to
refinancing. Corporate treasurers took advantage of lower interest rates to
refinance and lengthen the maturity of their obligations.
Dynamics in the leveraged loan market mirrored those of the high yield market,
and we experienced spread compression in our bank loan portfolio. For BB-rated
loans, the spreads over LIBOR (London InterBank Offered Rate) narrowed from 371
basis points in the fourth quarter of 2002 to 247 basis points a year later.
Despite this, loan demand remained strong given rising interest rate fears and
investors' inclination to be defensively positioned.
What changes were made to the portfolio during the period?
We trimmed or eliminated a number of positions that were lowest in the capital
structure, as these had the greatest run during the high yield rally. Many of
these were CCC-rated positions.
During the last quarter of the year, we initiated a shift toward bank loans. We
are most concerned about the potential impact of a rising 10-year Treasury note
yield. During August 2003, we saw the 10-year Treasury note yield whipsaw from
under 4% to 4.60%. At the same time, bonds that traded tight to the Treasury
declined several points. Such a scenario could happen again -- quickly. Our
strategy is to lower the duration of the portfolio, hence the shift toward bank
loans. We are also purchasing floating rate bonds. The aim is to lower the
negative impact on the portfolio's value that would result from rising interest
rates.
How would you characterize the portfolio's position at the close of the period?
We ended the period with an allocation close to 80% bonds and 20% bank loans.
Our target is a more defensive 70% bond/30% bank loan allocation during 2004.
Therefore, we would characterize our position as defensive while still focused
on maintaining the Fund's attractive yield. We plan to maintain leverage within
a target range of 25% - 30% of assets for the foreseeable future. We also
continue to be cautious and selective in adding new positions.
Kevin J. Booth
Vice President and Portfolio Manager
Joseph P. Matteo
Vice President and Portfolio Manager
March 10, 2004
DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004 5
[LOGO] Merrill Lynch Investment Managers
Schedule of Investments (in U.S. dollars)
S&P Moody's Face
Industry++ Ratings@ Ratings@ Amount Corporate Debt Obligations Value
===================================================================================================================================
Aerospace & Defense-- B B2 $ 5,000,000 Alliant Techsystems Inc., 2.75% due 2/15/2024
2.0% (Convertible) (d) $ 5,137,500
B+ B1 3,750,000 Armor Holdings, Inc., 8.25% due 8/15/2013 (d) 4,096,875
B B2 4,920,000 Vought Aircraft Industries, Inc., 8%
due 7/15/2011 (d) 5,092,200
-------------
14,326,575
===================================================================================================================================
Airlines--0.8% BB B3 5,387,254 American Airlines, Inc., 7.379% due 5/23/2016 4,322,323
CCC+ B3 1,800,000 Evergreen International Aviation, Inc., 12%
due 5/15/2010 (d) 1,242,000
-------------
5,564,323
===================================================================================================================================
Automotive B- B3 6,400,000 Accuride Corporation, Term B, due 6/30/2007** 6,546,003
Equipment--2.9% B B2 1,550,000 Dura Operating Corporation, 9% due 5/01/2009 1,584,875
B Caa1 1,000,000 Metaldyne Corporation, 11% due 6/15/2012 937,500
Tenneco Automotive Inc.:
CCC+ Caa1 6,375,000 11.625% due 10/15/2009 6,885,000
CCC+ B2 925,000 10.25% due 7/15/2013 1,077,625
B B1 2,482,759 Tranche B, due 12/12/2010** 2,528,275
B B1 1,117,241 Tranche B-1, Credit Link due 12/12/2010** 1,137,724
+ Venture Holdings Company LLC:
NR* NR* 1,800,000 9.50% due 7/01/2005 63,000
NR* NR* 4,450,000 12% due 6/01/2009 445
-------------
20,760,447
===================================================================================================================================
Broadcasting--0.7% CCC+ Caa1 4,650,000 Spanish Broadcasting System, Inc., 9.625%
due 11/01/2009 4,917,375
===================================================================================================================================
Cable-- C Caa2 500,000 Diamond Holdings PLC, 9.125% due 2/01/2008 515,625
International--3.1% C Caa2 5,000,000 NTL Incorporated, 11.20% due 11/15/2007 5,031,250
Telewest Communications PLC:
C Ca 6,100,000 + 9.875% due 2/01/2010 3,873,500
NR* NR* 7,000,000 Term, due 1/16/2006** 12,876,936
-------------
22,297,311
===================================================================================================================================
Cable--U.S.--13.1% CCC+ Caa1 2,000,000 Atlantic Broadband Finance, LLC, 9.375%
due 1/15/2014 (d) 2,005,000
NR* NR* 7,500,000 + Adelphia Communications Corporation, 6%
due 2/15/2006 (Convertible) 2,925,000
BB- B1 3,450,000 CSC Holdings, Inc., 7.25% due 7/15/2008 3,674,250
Century Cable Holdings LLC**:
NR* Caa1 7,000,000 Discretionary Term Loan, due 12/31/2009 6,647,816
NR* NR* 10,000,000 Term, due 6/30/2009 9,589,580
Charter Communications Holdings, LLC:
CCC- Ca 10,000,000 10% due 4/01/2009 8,700,000
CCC- Ca 2,000,000 0/11.75% due 1/15/2010 (c) 1,630,000
CCC- Ca 2,000,000 11.125% due 1/15/2011 1,775,000
CCC- Ca 2,700,000 0/9.92% due 4/01/2011 (c) 2,234,250
CCC- Ca 3,000,000 10% due 5/15/2011 2,535,000
NR* NR* 1,965,000 Incremental Term, due 9/18/2008** 1,913,965
NR* NR* 4,912,500 Term B, due 3/18/2008** 4,790,370
Inmarsat Investments Limited**:
BB- Ba3 5,000,000 Term B, due 1/23/2012 5,022,915
BB- Ba3 5,000,000 Term C, due 1/23/2012 5,022,915
BB+ Ba3 8,000,000 Insight Midwest, Term B, due 12/31/2009** 8,054,448
B+ B2 2,500,000 Insight Midwest, LP, 9.75% due 10/01/2009 2,631,250
NR* NR* 2,500,000 + Loral Cyberstar, Inc., 10% due 7/15/2006 1,937,500
NR* NR* 5,721,814 + Mallard Cablevision LLC & Sun Tel Communications,
Term B, due 9/30/2008** 171,654
B+ B2 5,500,000 Mediacom Broadband LLC, 11% due 7/15/2013 5,967,500
D B2 6,000,000 Olympus Cable Holdings LLC, Term B, due 9/30/2010** 5,716,878
NR* B3 1,100,080 Pegasus Media & Communications Inc., Term B,
due 4/30/2005** 1,081,745
CCC- Ca 9,500,000 Pegasus Satellite Communications, Inc., 11.25%
due 1/15/2010 8,455,000
-------------
92,482,036
6 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
Schedule of Investments (continued) (in U.S. dollars)
S&P Moody's Face
Industry++ Ratings@ Ratings@ Amount Corporate Debt Obligations Value
===================================================================================================================================
Chemicals--10.9% B+ B1 $ 3,550,000 Arco Chemical, 9.80% due 2/01/2020 $ 3,487,875
B+ Ba3 869,565 Ethyl Corporation, Term, due 4/30/2009** 876,811
D C 8,700,000 GEO Specialty Chemicals, Inc., 10.125% due 8/01/2008 2,610,000
CCC+ Caa2 16,000,000 Huntsman ICI Holdings, 0% due 12/31/2009 (c) 7,520,000
Huntsman International LLC:
B- B3 1,900,000 9.875% due 3/01/2009 2,090,000
CCC+ Caa1 2,000,000 10.125% due 7/01/2009 2,040,000
B+ B1 3,000,000 IMC Global Inc., 10.875% due 8/01/2013 (d) 3,720,000
B+ B2 3,150,000 ISP Holdings, Inc., 10.625% due 12/15/2009 3,480,750
BB- B1 2,400,000 Millennium America Inc., 7.625% due 11/15/2026 2,280,000
NR* NR* 6,238,237 Noveon International, Inc., 13% due 8/31/2011 (b) 6,612,531
BB- B2 7,000,000 Omnova Solutions Inc., 11.25% due 6/01/2010 7,805,000
NR* NR* 1,450,917 PCI Chemicals, 10% due 12/31/2008 1,414,644
NR* NR* 4,000,000 Pinnacle Polymers, Term, due 12/15/2006** 4,008,640
NR* NR* 459,457 Pioneer Companies, Inc., 4.663% due 12/31/2006 (a) 447,971
BB- B3 9,500,000 PolyOne Corporation, 10.625% due 5/15/2010 9,785,000
CCC+ Caa1 2,150,000 Rhodia SA, 8.875% due 6/01/2011 (d) 1,924,250
B- B3 3,700,000 Rockwood Specialties Group, Inc., 10.625%
due 5/15/2011 4,107,000
B- NR* 4,000,000 Salt Holdings Corporation, Inc., 0/12%
due 6/01/2013 (c)(d) 3,040,000
B- Caa1 2,450,000 Terra Capital, Inc., 11.50% due 6/01/2010 2,682,750
B B3 750,000 United Agri Products, Inc., 8.25% due 12/15/2011 (d) 776,250
B- B1 6,500,000 Wellman, Inc., Second Lien Term, due 2/10/2009** 6,383,540
-------------
77,093,012
===================================================================================================================================
Consumer Durables-- Simmons Company:
1.5% B- Caa1 4,975,000 7.875% due 1/15/2014 5,012,313
B+ B3 5,000,000 Term B, due 6/19/2012** 5,065,105
-------------
10,077,418
===================================================================================================================================
Consumer Non BB+ Ba3 3,500,000 American Greetings Corporation, 11.75% due 7/15/2008 3,998,750
Durables--5.3% B+ Ba3 2,600,000 Chattem, Inc., 4.12% due 3/01/2010 (a)(d) 2,626,000
B- B3 300,000 Elizabeth Arden, Inc., 7.75% due 1/15/2014 (d) 309,750
NR* NR* 7,900,000 + Galey & Lord, Inc., 9.125% due 03/01/2008 59,250
B- Caa1 2,000,000 General Binding Corporation, 9.375% due 6/01/2008 2,017,500
CCC- Caa2 2,000,000 Home Products International, Inc., 9.625%
due 5/15/2008 1,450,000
NR* Caa2 9,975,000 Levi Strauss & Co., Term A, due 9/29/2009** 10,357,342
B- Caa1 4,000,000 North Atlantic Holding Company, 0/12.25%
due 3/01/2014 (c)(d) 2,440,000
CCC+ Caa2 10,500,000 Playtex Products, Inc., 9.375% due 6/01/2011 9,738,750
CCC+ Caa1 4,000,000 Samsonite Corporation, 10.75% due 6/15/2008 4,170,000
-------------
37,167,342
===================================================================================================================================
Diversified Media-- Houghton Mifflin Company:
4.7% B B3 775,000 9.875% due 2/01/2013 848,625
B Caa1 8,525,000 0/11.50% due 10/15/2013 (c)(d) 5,157,625
BBB- Baa3 7,500,000 Liberty Media Corporation, 0.75% due 3/30/2023
(Convertible) 8,559,375
NR* NR* 1,800,000 + Loews Cineplex Entertainment Corporation, 8.875%
due 8/01/2008 22,320
CCC+ Caa3 9,375,000 Muzak Holdings, LLC, 0/13% due 3/15/2010 (c) 9,000,000
CCC+ Caa2 3,875,000 NBC Acquisition Corp., 0/11% due 3/15/2013 (c)(d) 2,516,696
CCC+ Caa1 1,700,000 Nebraska Book Co., 8.625% due 3/15/2012 (d) 1,700,000
B B2 2,000,000 TransWestern Publishing Company, LLC, Term 2,
due 2/25/2012** 2,024,376
BB B1 3,250,000 Vivendi Universal SA, 6.25% due 7/15/2008 3,485,625
-------------
33,314,642
DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004 7
[LOGO] Merrill Lynch Investment Managers
Schedule of Investments (continued) (in U.S. dollars)
S&P Moody's Face
Industry++ Ratings@ Ratings@ Amount Corporate Debt Obligations Value
===================================================================================================================================
Energy, Exploration & CCC+ Caa1 $ 8,900,000 Continental Resources, Inc., 10.25% due 8/01/2008 $ 9,167,000
Production--1.4% B B2 975,000 EXCO Resources, Inc., 7.25% due 1/15/2011 (d) 1,001,813
-------------
10,168,813
===================================================================================================================================
Energy-Other--9.2% BB Ba3 8,925,000 CITGO Petroleum Corporation, 11.375% due 2/01/2011 10,620,750
Dresser, Inc.:
B B2 1,000,000 9.375% due 4/15/2011 1,080,000
BB- Ba3 2,012,903 Term B, due 4/10/2009** 2,035,967
C Caa3 3,250,000 Energy Corporation of America, 9.50% due 5/15/2007 3,087,500
Giant Industries, Inc.:
B- B3 2,000,000 9% due 9/01/2007 2,057,500
B- B3 12,000,000 11% due 5/15/2012 13,380,000
BB- B1 520,000 GulfTerra Energy Partners, LP, 8.50% due 6/01/2011 579,800
BBB Baa2 7,500,000 Halliburton Company, 3.125% due 7/15/2023
(Convertible) (d) 8,475,000
B B3 5,500,000 Star Gas Partners, LP, 10.25% due 2/15/2013 6,105,000
B B1 575,000 Suburban Propane Partners, LP, 6.875%
due 12/15/2013 (d) 589,375
B B3 8,180,000 Tesoro Petroleum Corporation, 9% due 7/01/2008 8,486,750
B- Caa1 9,050,000 United Refining Company, 10.75% due 6/15/2007 8,416,500
-------------
64,914,142
===================================================================================================================================
Finance--1.1% NR* B2 3,000,000 Ares Leveraged Investment Fund II, Junior
Subordinate Secured Note,
due 10/31/2005 (a)(d) 1,080,000
NR* NR* 1,500,000 Investcorp SA, 7.54% due 10/21/2008 1,521,375
BBB- Ba1 4,000,000 Leucadia National Corporation, 7% due 8/15/2013 (d) 4,120,000
NR* Ca 2,134,300 Pennant CBO Limited, 13.43% due 3/14/2011 (b)(d)(f) 853,720
+ SKM-Libertyview CBO I Limited (d)(f):
NR* Ca 1,500,000 8.71% due 4/10/2011 255,000
NR* C 1,000,000 11.91% due 4/10/2011 50,000
-------------
7,880,095
===================================================================================================================================
Food/Tobacco--7.7% NR* NR* 3,095,261+ Archibald Candy Corporation, 10% due 11/01/2007 1,176,199
Atkins Nutritionals, Inc.**:
NR* NR* 2,500,000 First Lien, due 11/26/2009 2,509,375
NR* NR* 2,500,000 Second Lien, due 11/26/2009 2,515,625
Commonwealth Brands, Inc. (d):
NR* NR* 4,550,000 9.75% due 4/15/2008 4,982,250
NR* NR* 8,000,000 10.625% due 9/01/2008 8,760,000
CCC B2 2,200,000 Doane Pet Care Company, 10.75% due 3/01/2010 2,282,500
Dole Food Company, Inc.:
BB- B2 8,000,000 7.25% due 6/15/2010 (d) 8,160,000
BB- B2 3,825,000 8.875% due 3/15/2011 4,102,313
NR* NR* 4,241,096 Dr. Pepper Bottling, Term B, due 12/19/2010** 4,307,363
B- B3 8,000,000 Luigino's Inc., 10% due 2/01/2006 8,180,000
NR* NR* 8,000,000 + New World Pasta Company, 9.25% due 2/15/2009 1,360,000
NR* Caa3 6,000,000 R.A.B. Enterprises, Inc., 10.50% due 5/01/2005 3,120,000
B- Caa1 4,800,000 Tabletop Holdings, Inc., 0/12.25%
due 5/15/2014 (c)(d) 2,640,000
-------------
54,095,625
===================================================================================================================================
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 8/26/2006** 2,686,421
NR* Caa1 4,455,000 Term C, due 2/26/2008** 4,031,775
NR* NR* 4,887,805 Buffington Harbor Parking Associates LLC, Term B,
due 7/01/2011** 4,900,025
CCC+ Caa1 4,300,000 Hollywood Park, 9.25% due 2/15/2007 (d) 4,439,750
B Caa1 4,000,000 Inn of the Mountain Gods Resort and Casino, 12%
due 11/15/2010 (d) 4,350,000
B B2 2,000,000 Jacobs Entertainment, Inc., 11.875% due 2/01/2009 2,140,000
B B2 1,825,000 The Majestic Star Casino, LLC, 9.50% due 10/15/2010 1,911,688
B+ B2 3,591,000 Marina District Finance Co. (Borgata), Term B,
due 7/15/2007** 3,644,416
BB- Ba2 7,000,000 Park Place Entertainment Corporation, 8.125%
due 5/15/2011 7,910,000
B B2 2,150,000 Peninsula Gaming Company, LLC, 12.25% due 7/01/2006 2,322,000
8 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
Schedule of Investments (continued) (in U.S. dollars)
S&P Moody's Face
Industry++ Ratings@ Ratings@ Amount Corporate Debt Obligations Value
===================================================================================================================================
Gaming B B3 $ 7,000,000 Penn National Gaming, Inc., 11.125% due 3/01/2008 $ 7,857,500
(concluded) B B2 300,000 Poster Financial Group Inc., 8.75%
due 12/01/2011 (d) 311,250
B+ B2 1,800,000 Sun International Hotels, 8.875% due 8/15/2011 1,989,000
B- B3 4,000,000 Venetian Casino Resort, LLC, 11% due 6/15/2010 4,600,000
CCC+ B3 4,000,000 Wynn Las Vegas, LLC, 12% due 11/01/2010 4,800,000
-------------
57,958,825
===================================================================================================================================
Health Care--5.7% BB- Ba2 5,000,000 Fresenius Medical Care Capital Trust IV, 7.875%
due 6/15/2011 5,431,250
HealthSouth Corporation:
NR* NR* 2,500,000 8.50% due 2/01/2008 2,468,750
NR* NR* 2,500,000 10.75% due 10/01/2008 2,443,750
NR* NR* 5,000,000 7.625% due 6/01/2012 4,787,500
NR* NR* 4,500,000 Term, due 1/16/2011** 4,477,500
B+ B1 3,452,127 MedPointe Inc., Term B, due 9/30/2008** 3,473,702
B+ B1 6,000,000 Tenet Healthcare Corporation, 7.375% due 2/01/2013 5,550,000
BB- B3 8,000,000 Triad Hospitals, Inc., 7% due 11/15/2013 (d) 8,280,000
CCC+ B3 3,325,000 Vanguard Health Systems, Inc., 9.75% due 8/01/2011 3,632,563
-------------
40,545,015
===================================================================================================================================
Housing--3.0% NR* NR* 5,850,000 + Formica Corporation, 10.875% due 3/01/2009 1,023,750
BB Ba1 4,000,000 Lone Star Industries Inc., 8.85% due 6/15/2005 (d) 4,175,000
B+ B1 5,975,000 Nortek Holdings, Inc., 4.17% due 12/31/2010 (a)(d) 5,989,938
BB- B1 7,625,000 Texas Industries, Inc., 10.25% due 6/15/2011 8,654,375
NR* NR* 2,226,853 Trussway Industries Inc., Term B, due 12/31/2006** 1,647,871
-------------
21,490,934
===================================================================================================================================
Information Technology NR* B1 2,435,874 + Trend Technologies, Inc., Term, due 2/28/2007** 0
- --0.0%
===================================================================================================================================
Leisure--2.7% B B2 7,000,000 Extended Stay America, Inc., 9.15% due 3/15/2008 7,227,500
B+ B1 8,250,000 Intrawest Corporation, 10.50% due 2/01/2010 9,075,000
Wyndham International Corporation**:
NR* NR* 1,198,087 Increasing Rate Term II, due 4/01/2006 1,169,418
NR* NR* 1,750,151 Term I, due 6/30/2006 1,725,617
-------------
19,197,535
===================================================================================================================================
Manufacturing--4.4% B- B3 4,000,000 EaglePicher Incorporated, 9.75% due 9/01/2013 4,400,000
NR* NR* 1,231,968 GenTek Inc., Term, due 11/10/2008** 1,240,284
NR* Caa2 10,145,000 + High Voltage Engineering Corporation, 10.75%
due 8/15/2004 2,536,250
NR* Caa3 8,350,000 + International Utility Structures Inc., 10.75%
due 2/01/2008 1,837,000
B- B3 5,875,000 Invensys plc, 9.875% due 3/15/2011 (d) 5,766,136
B B3 4,000,000 JLG Industries, Inc., 8.375% due 6/15/2012 4,180,000
B+ B3 600,000 NMHG Holding Company, 10% due 5/15/2009 660,000
BBB- Ba2 7,500,000 Tyco International Group SA, 2.75% due 1/15/2018
(Convertible) 10,106,250
-------------
30,725,920
===================================================================================================================================
Metal--Other--1.8% B- NR* 3,325,130 Citation Corporation, Term B, due 12/01/2007** 2,948,974
B+ B1 8,550,000 Massey Energy Company, 6.95% due 3/01/2007 8,806,500
NR* NR* 3,000,000 + Ormet Corporation, Term, due 8/15/2008** 1,215,000
-------------
12,970,474
DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004 9
[LOGO] Merrill Lynch Investment Managers
Schedule of Investments (continued) (in U.S. dollars)
S&P Moody's Face
Industry++ Ratings@ Ratings@ Amount Corporate Debt Obligations Value
===================================================================================================================================
Packaging--7.5% B+ B2 $ 9,625,000 Anchor Glass Container Corporation, 11%
due 2/15/2013 $ 11,165,000
B- B3 1,575,000 Berry Plastics Corporation, 10.75% due 7/15/2012 1,827,000
CCC+ B2 4,400,000 Crown Euro Holdings SA, 10.875% due 3/01/2013 5,126,000
Graham Packaging Company:
CCC+ Caa1 2,000,000 8.75% due 1/15/2008 2,020,000
CCC+ Caa1 5,000,000 4.795% due 1/15/2008 (a) 4,650,000
CCC+ Caa2 5,700,000 Graham Packaging Holdings Company, 10.75%
due 1/15/2009 5,871,000
B B3 7,250,000 Owens-Brockway Glass Container, Inc., 8.25%
due 5/15/2013 7,630,625
B- Caa2 9,800,000 Pliant Corporation, 13% due 6/01/2010 8,330,000
B- B2 325,000 Portola Packaging, Inc., 8.25% due 2/01/2012 (d) 334,750
B B2 2,500,000 Radnor Holdings Corporation, 11% due 3/15/2010 2,262,500
Tekni-Plex, Inc.:
B- B3 2,000,000 12.75% due 6/15/2010 2,160,000
B- B2 1,250,000 8.75% due 11/15/2013 (d) 1,303,125
-------------
52,680,000
===================================================================================================================================
Paper--7.7% Ainsworth Lumber Co. Ltd.:
B+ B3 9,000,000 12.50% due 7/15/2007 11,610,000
B+ B3 2,500,000 13.875% due 7/15/2007 2,925,000
BB Ba2 2,425,000 Boise Cascade Corporation, 6.50% due 11/01/2010 2,553,467
BB+ Ba2 8,250,000 Georgia-Pacific Corporation, 9.375% due 2/01/2013 9,508,125
B- B3 2,000,000 Graphic Packaging International Inc., 9.50%
due 8/15/2013 2,250,000
B Caa1 8,479,846 MDP Acquisitions PLC, 15.50% due 10/01/2013 10,006,218
B+ B3 630,000 Millar Western Forest Products Ltd., 7.75%
due 11/15/2013 (d) 663,075
B+ B2 850,000 Riverside Forest Products Ltd., 7.875%
due 3/01/2014 (d) 877,625
B+ B1 2,500,000 SP Newsprint Co., Term B, due 1/09/2010** 2,534,375
Stone Container Corporation:
B B2 3,600,000 8.375% due 7/01/2012 3,910,500
NR* NR* 3,573,252 Term B, due 6/30/2009** 3,620,894
NR* NR* 605,427 Term C, due 6/30/2009** 611,103
BB- Ba3 3,000,000 Tembec Industries, Inc., 8.625% due 6/30/2009 2,955,000
-------------
54,025,382
===================================================================================================================================
Services--2.9% BB- Ba3 1,440,000 Allied Waste North America, Inc., 7.875%
due 4/15/2013 1,562,400
NR* Caa2 3,750,000 Anthony Crane Rental, Term, due 7/20/2006** 712,500
B B1 3,200,000 Corrections Corporation of America, 9.875%
due 5/01/2009 3,576,000
B- B3 350,000 Great Lakes Dredge & Dock Corporation, 7.75%
due 12/15/2013 (d) 365,750
D NR* 1,800,000 + IT Group Inc., 11.25% due 4/01/2009 18
Outsourcing Solutions Inc.**:
NR* NR* 66,714 Revolving Credit, due 12/09/2008 65,046
NR* NR* 4,064,544 Term, due 12/09/2008 3,962,930
B+ B2 7,525,000 United Rentals North America Inc., 7.75%
due 11/15/2013 (d) 7,468,563
B- B3 2,500,000 Williams Scotsman, Inc., 9.875% due 6/01/2007 2,456,250
-------------
20,169,457
===================================================================================================================================
Steel--0.1% + Acme Metals Incorporated**:
NR* NR* 2,123,599 Post-Petition, due 12/01/2005 100,871
NR* NR* 183,854 Pre-Petition, due 12/01/2005 8,733
NR* NR* 5,254,254 Term, due 12/01/2005 249,578
-------------
359,182
===================================================================================================================================
Telecommunications-- NR* NR* 5,000,000 ADC Telecommunications, Inc., 1.605% due 6/15/2013
8.9% (Convertible) (a) 5,500,000
B- B2 5,000,000 Alaska Communications System Holdings, Inc., 9.875%
due 8/15/2011 5,275,000
B- B3 1,200,000 Cincinnati Bell Inc., 8.375% due 1/15/2014 1,263,000
B- Caa1 11,025,000 FairPoint Communications, Inc., 12.50% due 5/01/2010 11,907,000
Qwest Capital Funding, Inc.:
CCC+ Caa2 2,000,000 6.375% due 7/15/2008 1,810,000
CCC+ Caa2 6,000,000 7.25% due 2/15/2011 5,370,000
CCC+ Caa2 8,200,000 6.875% due 7/15/2028 6,314,000
CCC+ B3 7,900,000 Qwest Communications International Inc., 4.63%
due 2/15/2009 (a)(d) 7,465,500
10 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
Schedule of Investments (continued) (in U.S. dollars)
S&P Moody's Face
Industry++ Ratings@ Ratings@ Amount Corporate Debt Obligations Value
===================================================================================================================================
Telecommunications B B1 $ 7,000,000 Time Warner Telecom Holdings, Inc., 5.12%
(Concluded) due 2/15/2011 (a)(d) $ 6,947,500
CCC+ B3 8,000,000 Time Warner Telecom, Inc., 9.75% due 7/15/2008 7,560,000
NR* NR* 3,454,305 WilTel Communications Group, Inc., Term,
due 9/08/2006** 3,449,987
-------------
62,861,987
===================================================================================================================================
Transportation NR* B+ 2,950,000 Laidlaw International Inc., 10.75% due 6/15/2011 (d) 3,385,125
Services--1.1% B+ B1 1,200,000 OMI Corporation, 7.625% due 12/01/2013 1,251,000
NR* NR* 10,000,000 + Vectura Group, 11.25% due 1/01/2008 2,812,500
-------------
7,448,625
===================================================================================================================================
Utilities--5.9% B- Caa1 1,250,000 The AES Corporation, 8.50% due 11/01/2007 1,278,125
CCC+ Caa1 3,000,000 Calpine Canada Energy Finance ULC, 8.50%
due 5/01/2008 2,317,500
Calpine Corporation:
CCC+ Caa1 2,700,000 8.50% due 2/15/2011 2,065,500
B NR* 7,960,000 Term B, due 7/15/2007** 7,596,825
D NR* 2,300,000 + Mirant Americas Generation LLC, 7.625% due 5/01/2006 1,851,500
Mission Energy Holding Company:
CCC Caa2 12,600,000 13.50% due 7/15/2008 13,072,500
NR* NR* 3,000,000 Term, due 12/11/2006** 3,030,000
NRG Energy, Inc.:
B+ B2 2,275,000 8% due 12/15/2013 (d) 2,348,938
BB B1 437,500 Credit Link Deposit, due 6/23/2010** 450,693
BB B1 781,375 Term, due 6/23/2010** 804,938
B- B2 3,200,000 Sierra Pacific Resources, 8.75% due 5/15/2005 3,312,000
B- B1 650,000 Southern Natural Gas Company, 8.875% due 3/15/2010 715,000
BB+ Ba2 1,592,000 TNP Enterprises, Inc., Term, due 12/31/2006** 1,606,925
B+ B3 1,425,000 The Williams Companies, Inc., 8.625% due 6/01/2010 1,556,813
-------------
42,007,257
===================================================================================================================================
Wireless CCC Caa1 5,500,000 Alamosa (Delaware), Inc., 8.50% due 1/31/2012 (d) 5,252,500
Communications--8.4% American Tower Corporation:
CCC Caa1 3,000,000 9.375% due 2/01/2009 3,180,000
CCC Caa1 5,000,000 5% due 2/15/2010 (Convertible) 4,931,250
CCC B3 1,325,000 American Tower Escrow Corporation, 0%
due 8/01/2008 (c) 927,500
B B1 2,672,175 American Tower Systems Corp., Term C,
due 12/31/2007** 2,705,021
B- B2 6,000,000 Centennial Cellular, Term, due 2/09/2011** 6,033,126
Crown Castle International Corp. (d):
CCC B3 3,625,000 9.375% due 8/01/2011 3,987,500
CCC B3 13,000,000 7.50% due 12/01/2013 13,032,500
B- B1 2,394,000 Dobson Cellular Systems, Inc., Term, due 3/31/2010** 2,417,085
CCC+ B3 3,775,000 MobiFon Holdings B.V., 12.50% due 7/31/2010 4,416,750
CCC+ B2 425,000 Nextel Communications, Inc., 9.50% due 2/01/2011 477,063
CCC+ Caa1 984,000 Nextel Partners, Inc., 12.50% due 11/15/2009 1,146,360
CC Caa2 2,150,000 SBA Communications Corporation, 10.25% due 2/01/2009 2,155,375
CC Caa1 1,425,000 SBA Telecommunications, Inc., 0/9.75%
due 12/15/2011 (c)(d) 983,250
CCC+ B3 7,400,000 SpectraSite, Inc., 8.25% due 5/15/2010 7,788,500
-------------
59,433,780
---------------------------------------------------------------------------------------------------------
Total Investments in Corporate Debt Obligations
(Cost--$961,305,163)--132.7% 936,933,529
=========================================================================================================
Shares
Held Common Stocks
===================================================================================================================================
Chemicals--0.1% 93,826 + Pioneer Companies, Inc. 609,869
===================================================================================================================================
Finance--0.5% 35,000 Preferred Term Securities VI (d) 3,258,500
===================================================================================================================================
Food/Tobacco--0.1% 15,252 + Archibald Candy Corporation 153
1,428,423 + Viskase Companies, Inc. 585,653
-------------
585,806
===================================================================================================================================
DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004 11
[LOGO] Merrill Lynch Investment Managers
Schedule of Investments (continued) (in U.S. dollars)
Shares
Industry++ Held Common Stocks Value
===================================================================================================================================
Leisure--0.1% 83,363 + Lodgian, Inc. $ 663,569
===================================================================================================================================
Manufacturing--0.2% 724,291 + ACP Holding Company (d) 1,086,437
21,203 + Thermadyne Holdings Corporation 296,842
-------------
1,383,279
===================================================================================================================================
Services--0.4% 89,027 + Outsourcing Solutions Inc 3,115,945
===================================================================================================================================
Steel--0.0% 41,149 Acme Package Corp. Senior Holdings 205,745
91,399 + Geneva Steel Holdings Corp. 9
-------------
205,754
===================================================================================================================================
Telecommunications--0.2% 26,457 IDT Corporation 466,635
33,077 + IDT Corporation (Class B) 686,348
-------------
1,152,983
===================================================================================================================================
Wireless + Microcell Telecommunications Inc:
Telecommunications--0.1% 259 (Class A) 4,828
30,841 (Class B) 574,641
-------------
579,469
---------------------------------------------------------------------------------------------------------
Total Investments in Common Stocks
(Cost--$20,213,288)--1.7% 11,555,174
=========================================================================================================
Preferred Stocks
===================================================================================================================================
Automotive 200,000 General Motors Corporation (Convertible) 6,128,000
Equipment--0.8%
===================================================================================================================================
Broadcasting--0.0% 36 Paxson Communications Corporation
(Convertible) (b)(d) 288,960
===================================================================================================================================
Cable-U.S.--1.8% 5,000 Adelphia Communications Corporation 45,000
22,500 CSC Holdings, Inc. 2,379,375
69,100 CSC Holdings, Inc. 7,290,050
3,500 Pegasus Satellite Communications, Inc. 2,870,000
-------------
12,584,425
===================================================================================================================================
Diversified 250,000 Newscorp Overseas Limited 6,305,000
Media--0.9%
===================================================================================================================================
Leisure--0.3% 78,977 Lodgian, Inc. 1,974,425
===================================================================================================================================
Wireless 1 Dobson Communications Corporation (b) 714
Communications--0.1% 31,026 Microcell Telecommunications Inc. (Convertible)
(Class B) 547,796
-------------
548,510
---------------------------------------------------------------------------------------------------------
Total Investments in Preferred Stocks
(Cost--$24,731,567)--3.9% 27,829,320
=========================================================================================================
Warrants & Rights
===================================================================================================================================
Broadcasting--0.0% 15,000 Sirius Satellite Radio Inc. (Warrants) (g) 150
===================================================================================================================================
Gaming--0.0% 15,140 Peninsula Gaming Company, LLC (Warrants) (g) 90,842
===================================================================================================================================
Health Care--0.1% 126,760 HealthSouth Corporation (Warrants) (g) 285,211
===================================================================================================================================
Manufacturing--0.1% 652,739 ACP Holding Company (Warrants) (g) 979,109
Thermadyne Holdings Corporation (Warrants) (g):
33,536 (Series A) 5,030
20,290 (Series B) 0
-------------
984,139
===================================================================================================================================
Paper--0.0% 7,000 MDP Acquisitions PLC (Warrants) (g) 84,000
===================================================================================================================================
12 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
Schedule of Investments (concluded) (in U.S. dollars)
Shares
Industry++ Held Warrants & Rights Value
===================================================================================================================================
Services--0.0% Anthony Crane Rental Holdings LP (Warrants) (g):
4,768 (Class A) $ 0
530 (Class L) 0
-------------
0
===================================================================================================================================
Steel--0.0% 28,660 Geneva Steel Holdings Corp. (Equity Rights) (e) 0
===================================================================================================================================
Wireless 1,325 American Tower Escrow Corporation (Warrants) (g) 180,200
Communications--0.1% 11,456 Microcell Telecommunications Inc. (Warrants) (g) 47,813
19,093 Microcell Telecommunications Inc. (Warrants) (g) 94,629
-------------
322,642
---------------------------------------------------------------------------------------------------------
Total Investments in Warrants & Rights
(Cost--$1,396,295)--0.3% 1,766,984
=========================================================================================================
Beneficial
Interest Other Interests (i)
=========================================================================================================
3,614,601 Cambridge Industries, Inc. (Litigation Trust
Certificates) 175,308
2,641,443 US Airways, Inc.--Certificate of Beneficial Interest 739,604
3,500,000 WilTel Communications Group, Inc. (Litigation Trust
Certificates) 35
2,000,000 WilTel Communications Group, Inc. (Litigation Trust
Certificates) 20
5,611,040 WinStar Communications, Inc. (Litigation Trust
Certificates) 63,180
---------------------------------------------------------------------------------------------------------
Total Investments in Other Interests
(Cost--$855,617)--0.1% 978,147
=========================================================================================================
Short-Term Securities
=========================================================================================================
$ 939,431 Merrill Lynch Liquidity Series, LLC Cash Sweep
Series I (h) 939,431
---------------------------------------------------------------------------------------------------------
Total Investments in Short-Term Securities
(Cost--$939,431)--0.1% 939,431
=========================================================================================================
Total Investments (Cost--$1,009,441,361)--138.8% 980,002,585
Liabilities in Excess of Other Assets--(38.8%) (273,741,371)
-------------
Net Assets--100.0% $ 706,261,214
=============
* 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 26.3% of the Fund's net assets.
+ Non-income producing security.
++ For Fund compliance purposes, "Industry" 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. These
industry classifications are unaudited.
@ Ratings of issues shown are unaudited.
(a) Floating rate note.
(b) Represents a pay-in-kind security which may pay interest/dividends in
additional face/shares.
(c) Represents a zero coupon or step bond; the interest rate on a step bond
will commence its accrual at a fixed rate of interest on a predetermined
date until maturity.
(d) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(e) Each Equity Right entitles the Fund to purchase one share of new Preferred
Stock at a price of $10.80 per Equity Right and is non-income producing.
(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) 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 $577,762 $ 54,596
--------------------------------------------------------------------------
(i) Other interests represent beneficial interest in liquidation trusts and
other reorganization entities and are non-income producing.
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004 13
[LOGO] Merrill Lynch Investment Managers
Statement of Assets, Liabilities and Capital
As of February 29, 2004
===================================================================================================================================
Assets
- -----------------------------------------------------------------------------------------------------------------------------------
Investments, at value (identified cost--$1,009,441,361) ............... $ 980,002,585
Cash .................................................................. 30,094
Receivables:
Interest (including $26 from affiliates) ........................... $ 14,817,339
Securities sold .................................................... 279,641 15,096,980
------------
Deferred facility fees ................................................ 5,540
Prepaid expenses and other assets ..................................... 149,919
---------------
Total assets .......................................................... 995,285,118
---------------
===================================================================================================================================
Liabilities
- -----------------------------------------------------------------------------------------------------------------------------------
Loans ................................................................. 269,075,000
Payables:
Securities purchased ............................................... 19,381,480
Investment adviser ................................................. 442,770
Interest on loans .................................................. 48,425
Commitment fees .................................................... 4,417
Other affiliates ................................................... 2,372 19,879,464
------------
Deferred income ....................................................... 6,891
Accrued expenses and other liabilities ................................ 62,549
---------------
Total liabilities ..................................................... 289,023,904
---------------
===================================================================================================================================
Net Assets
- -----------------------------------------------------------------------------------------------------------------------------------
Net assets ............................................................ $ 706,261,214
===============
===================================================================================================================================
Capital
- -----------------------------------------------------------------------------------------------------------------------------------
Common Stock, $.10 par value, 200,000,000 shares authorized ........... $ 10,519,601
Paid-in capital in excess of par ...................................... 1,061,643,222
Undistributed investment income--net .................................. $ 2,758,783
Accumulated realized capital losses on investments and foreign
currency transactions--net ........................................... (339,214,244)
Unrealized depreciation on investments and foreign currency
transactions--net .................................................... (29,446,148)
------------
Total accumulated losses--net ......................................... (365,901,609)
---------------
Total capital--Equivalent to $6.71 per share based on 105,196,007
shares of Capital Stock outstanding (market price--$6.69) ............ $ 706,261,214
===============
See Notes to Financial Statements.
14 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
Statement of Operations
For the Year Ended February 29, 2004
===================================================================================================================================
Investment Income
- -----------------------------------------------------------------------------------------------------------------------------------
Interest (including $54,596 from affiliates) ......................... $ 85,003,143
Dividends ............................................................ 3,221,201
Facility and other fees .............................................. 658,576
-------------
Total income ......................................................... 88,882,920
-------------
===================================================================================================================================
Expenses
- -----------------------------------------------------------------------------------------------------------------------------------
Investment advisory fees ............................................. $ 5,313,524
Loan interest expense ................................................ 3,397,080
Borrowing costs ...................................................... 340,378
Accounting services .................................................. 213,246
Professional fees .................................................... 198,635
Transfer agent fees .................................................. 123,585
Listing fees ......................................................... 77,582
Printing and shareholder reports ..................................... 62,817
Custodian fees ....................................................... 52,600
Directors' fees and expenses ......................................... 49,861
Pricing services ..................................................... 26,743
Other ................................................................ 31,293
-------------
Total expenses ....................................................... 9,887,344
-------------
Investment income--net ............................................... 78,995,576
-------------
===================================================================================================================================
Realized & Unrealized Gain (Loss) on Investments and Foreign Currency Transactions--Net
- -----------------------------------------------------------------------------------------------------------------------------------
Realized gain (loss) on:
Investments--net .................................................. (35,690,641)
Foreign currency transactions--net ................................ 68,110 (35,622,531)
-------------
Changes in unrealized depreciation on:
Investments--net .................................................. 181,822,649
Foreign currency transactions--net ................................ (251) 181,822,398
--------------------------------
Total realized and unrealized gain on investments and foreign
currency transactions--net .......................................... 146,199,867
-------------
Net Increase in Net Assets Resulting from Operations ................. $ 225,195,443
=============
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004 15
[LOGO] Merrill Lynch Investment Managers
Statements of Changes in Net Assets
For the For the
Year Ended Year Ended
February 29, February 28,
Increase (Decrease) in Net Assets: 2004 2003
===================================================================================================================================
Operations
- -----------------------------------------------------------------------------------------------------------------------------------
Investment income--net .................................................. $ 78,995,576 $ 81,536,760
Realized loss on investments and foreign currency transactions--net ..... (35,622,531) (60,907,659)
Change in unrealized depreciation on investments and foreign
currency transactions--net ............................................. 181,822,398 (9,693,150)
-------------------------------
Net increase in net assets resulting from operations .................... 225,195,443 10,935,951
-------------------------------
===================================================================================================================================
Dividends to Shareholders
- -----------------------------------------------------------------------------------------------------------------------------------
Dividends to shareholders from investment income--net ................... (82,761,761) (81,536,390)
-------------------------------
===================================================================================================================================
Capital Share Transactions
- -----------------------------------------------------------------------------------------------------------------------------------
Value of shares issued in reinvestment of dividends ..................... 6,747,816 7,626,072
Recovery of previously expensed Common Stock offering costs ............. 11,432 --
-------------------------------
Net increase in net assets resulting from capital share transactions .... 6,759,248 7,626,072
-------------------------------
===================================================================================================================================
Net Assets
- -----------------------------------------------------------------------------------------------------------------------------------
Total increase (decrease) in net assets ................................. 149,192,930 (62,974,367)
Beginning of year ....................................................... 557,068,284 620,042,651
-------------------------------
End of year* ............................................................ $ 706,261,214 $ 557,068,284
===============================
* Undistributed investment income--net ............................... $ 2,758,783 $ 7,189,935
===============================
See Notes to Financial Statements.
16 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
Statement of Cash Flows
For the Year Ended February 29, 2004
===================================================================================================================================
Cash Provided by Operating Activities
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations ................................. $ 225,195,443
Adjustments to reconcile net increase in net assets resulting from
operations to net cash provided by operating activities:
Decrease in receivables ........................................................... 3,114,110
Increase in other assets .......................................................... (139,868)
Increase in other liabilities ..................................................... 6,234
Realized and unrealized gain on investments--net .................................. (146,199,867)
Amortization of premium and discount .............................................. (16,608,587)
Proceeds from sales and paydowns of long-term securities .......................... 628,390,513
Purchases of long-term securities ................................................. (640,350,208)
Purchases of short-term investments--net .......................................... (577,762)
-------------
Net cash provided by operating activities ............................................ 52,830,008
-------------
===================================================================================================================================
Cash Used for Financing Activities
- -----------------------------------------------------------------------------------------------------------------------------------
Cash receipts from borrowings ........................................................ 281,175,000
Cash payments on borrowings .......................................................... (258,000,000)
Write-off of offering costs resulting from the issuance of common stock .............. 11,432
Dividends paid to shareholders ....................................................... (76,013,945)
-------------
Net cash used for financing activities ............................................... (52,827,513)
-------------
===================================================================================================================================
Cash
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase in cash ................................................................. 2,495
Cash at beginning of year ............................................................ 27,599
-------------
Cash at end of year .................................................................. $ 30,094
=============
===================================================================================================================================
Cash Flow Information
- -----------------------------------------------------------------------------------------------------------------------------------
Cash paid for interest ............................................................... $ 3,409,067
=============
===================================================================================================================================
Non-Cash Financing Activities
- -----------------------------------------------------------------------------------------------------------------------------------
Capital shares issued in reinvestment of dividends paid to shareholders .............. $ 6,747,816
=============
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004 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
from information provided in the financial statements. Year Ended February 28, Year Ended
February 29, ------------------------------------- February 29,
Increase (Decrease) in Net Asset Value: 2004 2003 2002 2001 2000
===================================================================================================================================
Per Share Operating Performance
- -----------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of year ................ $ 5.35 $ 6.03 $ 7.53 $ 8.60 $ 9.15
---------------------------------------------------------------
Investment income--net ............................ .75+ .79+ .92+ .96+ .97
Realized and unrealized gain (loss) on investments
and foreign currency transactions--net ........... 1.40 (.68) (1.49) (1.07) (.56)
---------------------------------------------------------------
Total from investment operations .................. 2.15 .11 (.57) (.11) .41
---------------------------------------------------------------
Less dividends from investment income--net ........ (.79) (.79) (.93) (.96) (.96)
---------------------------------------------------------------
Recovery of previously expensed offering costs
(capital write-off) resulting from the issuance of
Common Stock ..................................... --@ -- --@ -- --
---------------------------------------------------------------
Net asset value, end of year ...................... $ 6.71 $ 5.35 $ 6.03 $ 7.53 $ 8.60
===============================================================
Market price per share, end of year ............... $ 6.69 $ 5.99 $ 6.57 $ 7.15 $ 7.1875
===============================================================
===================================================================================================================================
Total Investment Return*
- -----------------------------------------------------------------------------------------------------------------------------------
Based on market price per share ................... 26.31% 4.85% 5.69% 13.97% 3.19%
===============================================================
Based on net asset value per share ................ 41.84% 2.04% (7.89%) .31% 6.26%
===============================================================
===================================================================================================================================
Ratio to Average Net Assets
- -----------------------------------------------------------------------------------------------------------------------------------
Expenses, excluding interest expense .............. 1.00% 1.07% 1.04% 1.20% .98%
===============================================================
Expenses .......................................... 1.53% 1.91% 2.59% 3.87% 2.87%
===============================================================
Investment income--net ............................ 12.22% 14.32% 13.69% 12.23% 10.88%
===============================================================
===================================================================================================================================
Leverage
- -----------------------------------------------------------------------------------------------------------------------------------
Amount of borrowings, end of year (in thousands) .. $ 269,075 $ 245,900 $ 273,600 $ 301,000 $ 161,000
===============================================================
Average amount of borrowings outstanding during the
year (in thousands) .............................. $ 239,315 $ 238,863 $ 280,460 $ 228,640 $ 182,404
===============================================================
Average amount of borrowings outstanding per share
during the year .................................. $ 2.29 $ 2.31 $ 2.75 $ 3.07 $ 2.91
===============================================================
===================================================================================================================================
Supplemental Data
- -----------------------------------------------------------------------------------------------------------------------------------
Net assets, end of year (in thousands) ............ $ 706,261 $ 557,068 $ 620,043 $ 763,834 $ 538,343
===============================================================
Portfolio turnover ................................ 70.43% 64.54% 49.58% 36.86% 61.76%
===============================================================
* 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.
+ Based on average shares outstanding.
@ Amount is less than $.01 per share.
See Notes to Financial Statements.
18 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
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. 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 Directors
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 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
DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004 19
[LOGO] Merrill Lynch Investment Managers
Notes to Financial Statements (continued)
Board of Directors or by the Investment Adviser using a pricing service and/or
procedures approved by the Board of Directors.
(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 movements 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.
20 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
Notes to Financial Statements (continued)
(h) Reclassification -- Accounting principles generally accepted in the United
States of America require that certain components of net assets be adjusted to
reflect permanent differences between financial and tax reporting. Accordingly,
the current year's permanent book/tax difference of $664,968 has been
reclassified between undistributed net investment income and accumulated net
realized capital losses. This reclassification has no effect on net assets or
net asset value per share.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund Asset
Management, L.P. ("FAM"). The general partner of FAM is Princeton Services, Inc.
("PSI"), an indirect, wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML
& Co."), which is the limited partner. FAM has entered into a Sub-Advisory
Agreement with Merrill Lynch Asset Management U.K. Limited ("MLAM U.K."), an
affiliate of FAM, pursuant to which MLAM U.K. provides investment advisory
services to FAM with respect to the Fund. There is no increase in the aggregate
fees paid by the Fund for these services.
FAM is responsible for the management of the Fund's portfolio and provides the
necessary personnel, facilities, equipment and certain other services necessary
to perform the investment advisory function. For such services, the Fund pays a
monthly fee at an annual rate of .60% of the Fund's average weekly net assets
plus the proceeds of any outstanding borrowings used for leverage.
In addition, Merrill Lynch, Pierce, Fenner, & Smith Incorporated, a subsidiary
of ML & Co., received $5,094 in commissions on the execution of portfolio
security transactions for the Fund for the year ended February 29, 2004.
For the year ended February 29, 2004, the Fund reimbursed FAM $13,759 for
certain accounting services.
Certain officers and/or directors of the Fund are officers and/or directors of
FAM, MLAM U.K., PSI, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities, for the
year ended February 29, 2004 were $654,892,385 and $618,352,718, respectively.
Net realized gains (losses) for the year ended February 29, 2004 and net
unrealized gains (losses) as of February 29, 2004 were as follows:
- --------------------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains (Losses)
- --------------------------------------------------------------------------------
Long-term investments .................. $(35,690,641) $(29,438,776)
Unfunded corporate loans ............... -- (7,121)
Foreign currency transactions .......... 68,110 (251)
--------------------------------
Total .................................. $(35,622,531) $(29,446,148)
================================
As of February 29, 2004, net unrealized depreciation for Federal income tax
purposes aggregated $29,627,650, of which $74,959,682 related to appreciated
securities and $104,587,332 related to depreciated securities. The aggregate
cost of investments at February 29, 2004 for Federal income tax purposes was
$1,009,630,235.
4. Capital Share Transactions:
The Fund is authorized to issue 200,000,000 shares of Common Stock, par value
$.10 per share. Shares issued and outstanding during the years ended February
29, 2004 and February 28, 2003 increased by 1,056,734 and 1,356,882,
respectively, as a result of dividend reinvestment.
5. Unfunded Corporate Loans:
As of February 29, 2004, the Fund had unfunded loan commitments of $142,425,
which would be extended at the option of the borrower, pursuant to the following
loan agreement:
- --------------------------------------------------------------------------------
Unfunded
Commitment
Borrower (in Thousands)
- --------------------------------------------------------------------------------
Outsourcing Solutions Inc. .................................. $ 142
=============
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 U.S. 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
DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004 21
[LOGO] Merrill Lynch Investment Managers
Notes to Financial Statements (concluded)
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. The Fund also pays additional borrowing costs which
include a commitment fee for this facility at the annual rate of .10% and a
program fee of .24% on the borrowings outstanding.
For the year ended February 29, 2004, the average amount borrowed was
approximately $239,315,000 and the daily weighted average interest rate was
1.42%.
7. Distributions to Shareholders:
The Fund paid an ordinary income dividend in the amount of $.057000 per share on
March 31, 2004 to shareholders of record on March 15, 2004.
The tax character of distributions paid during the fiscal years ended February
29, 2004 and February 28, 2003 was as follows:
- --------------------------------------------------------------------------------
2/29/2004 2/28/2003
- --------------------------------------------------------------------------------
Distributions paid from:
Ordinary income ....................... $82,761,761 $81,536,390
------------------------------
Total taxable distributions .............. $82,761,761 $81,536,390
==============================
As of February 29, 2004, the components of accumulated losses on a tax basis
were as follows:
- -----------------------------------------------------------------------------
Undistributed ordinary income--net ..................... $ 4,613,248
Undistributed long-term capital gains--net ............. --
-------------
Total undistributed earnings--net ...................... 4,613,248
Capital loss carryforward .............................. (305,457,461)*
Unrealized losses--net ................................. (65,057,396)**
-------------
Total accumulated losses--net .......................... $(365,901,609)
=============
* On February 29, 2004, the Fund had a net capital loss carryforward of
$305,457,461, 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, $85,285,305
expires in 2011 and $17,223,475 expires in 2012. This amount will be
available to offset like amounts of any future taxable gains.
** The difference between book-basis and tax-basis net unrealized losses is
attributable primarily to the tax deferral of losses on wash sales,
book/tax differences in the accrual of income on securities in default,
the difference between book and tax amortization methods for premiums and
discounts on fixed income securities, the deferral of post-October capital
losses for tax purposes and other book/tax temporary differences.
22 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
Independent Auditors' Report
To the Shareholders and Board of Directors of
Debt Strategies Fund, Inc.:
We have audited the accompanying statement of assets, liabilities and capital,
including the schedule of investments, of Debt Strategies Fund, Inc. as of
February 29, 2004, and the related statements of operations and cash flows for
the year then ended, the statements of changes in net assets for each of the two
years in the period then ended, and the financial highlights for each of the
five years in the period then ended. These financial statements and financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and financial highlights
based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. Our procedures included confirmation of
securities owned as of February 29, 2004, by correspondence with the custodian
and financial intermediaries; where replies were not received from financial
intermediaries, we performed other auditing procedures. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Debt
Strategies Fund, Inc. as of February 29, 2004, the results of its operations and
its cash flows for the year then ended, the changes in its net assets for each
of the two years in the period then ended, and its financial highlights for the
five years in the period then ended, in conformity with accounting principles
generally accepted in the United States of America.
Deloitte & Touche LLP
Princeton, New Jersey
April 22, 2004
DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004 23
[LOGO] Merrill Lynch Investment Managers
Portfolio Information (unaudited)
As of February 29, 2004
Percent of
Ten Largest Holdings Total Assets
- --------------------------------------------------------------------------------
Crown Castle International Corp. ....................................... 1.7%
Charter Communications Holdings, LLC ................................... 1.7
Telewest Communications PLC ............................................ 1.7
Century Cable Holdings PLC ............................................. 1.6
Mission Energy Holding Company ......................................... 1.6
Giant Industries, Inc. ................................................. 1.6
Ainsworth Lumber Co. Ltd. .............................................. 1.5
HealthSouth Corporation ................................................ 1.4
Commonwealth Brands Inc. ............................................... 1.4
Quest Capital Funding, Inc. ............................................ 1.4
- --------------------------------------------------------------------------------
Percent of
Five Largest Industries* Total Assets
- --------------------------------------------------------------------------------
Cable-U.S ................................................. 10.6%
Chemicals ................................................. 7.8
Energy--Other ............................................. 6.5
Telecommunications ........................................ 6.4
Wireless Communications ................................... 6.1
- --------------------------------------------------------------------------------
* 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. These
industry classifications are unaudited.
Percent of
Quality Ratings by S&P/Moody's Long-Term Investments
- --------------------------------------------------------------------------------
BBB/Baa .................................................. 3.2%
BB/Ba .................................................... 13.9
B/B ...................................................... 44.9
CCC/Caa or lower ......................................... 21.0
NR (Not Rated) ........................................... 17.0
- --------------------------------------------------------------------------------
Geographic Allocation Percent of
By Country Long-Term Investments
- --------------------------------------------------------------------------------
United States ........................................... 91.4%
Canada .................................................. 3.6
France .................................................. 1.1
Luxembourg .............................................. 1.0
Ireland ................................................. 1.0
Australia ............................................... 0.7
Bermuda ................................................. 0.5
Netherlands ............................................. 0.5
Bahamas ................................................. 0.2
Cayman Islands .......................................... 0.0*
- --------------------------------------------------------------------------------
* Amount is less than 0.1%.
24 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
Automatic Dividend Reinvestment Plan
The following description of the Fund's Automatic Dividend Reinvestment Plan
(the "Plan") is sent to you annually as required by Federal securities laws.
Pursuant to the Fund's Plan, unless a holder of Common Stock otherwise elects,
all dividend and capital gains distributions will be automatically reinvested by
The Bank of New York (the "Plan Agent"), as agent for shareholders in
administering the Plan, in additional shares of Common Stock of the Fund.
Holders of Common Stock who elect not to participate in the Plan will receive
all distributions in cash paid by check mailed directly to the shareholder of
record (or, if the shares are held in street or other nominee name then to such
nominee) by The Bank of New York, as dividend paying agent. Such participants
may elect not to participate in the Plan and to receive all distributions of
dividends and capital gains in cash by sending written instructions to The Bank
of New York, as dividend paying agent, at the address set forth below.
Participation in the Plan is completely voluntary and may be terminated or
resumed at any time without penalty by written notice if received by the Plan
Agent not less than ten days prior to any dividend record date; otherwise such
termination will be effective with respect to any subsequently declared dividend
or distribution.
Whenever the Fund declares an income dividend or capital gains distribution
(collectively referred to as "dividends") payable either in shares or in cash,
non-participants in the Plan will receive cash and participants in the Plan will
receive the equivalent in shares of Common Stock. The shares will be acquired by
the Plan Agent for the participant's account, depending upon the circumstances
described below, either (i) through receipt of additional unissued but
authorized shares of Common Stock from the Fund ("newly issued shares") or (ii)
by purchase of outstanding shares of Common Stock on the open market
("open-market purchases") on the New York Stock Exchange or elsewhere. If on the
payment date for the dividend, the net asset value per share of the Common Stock
is equal to or less than the market price per share of the Common Stock plus
estimated brokerage commissions (such conditions being referred to herein as
"market premium"), the Plan Agent will invest the dividend amount in newly
issued shares on behalf of the participant. The number of newly issued shares of
Common Stock to be credited to the participant's account will be determined by
dividing the dollar amount of the dividend by the net asset value per share on
the date the shares are issued, provided that the maximum discount from the then
current market price per share on the date of issuance may not exceed 5%. If on
the dividend payment date the net asset value per share is greater than the
market value (such condition being referred to herein as "market discount"), the
Plan Agent will invest the dividend amount in shares acquired on behalf of the
participant in open-market purchases.
In the event of a market discount on the dividend payment date, the Plan Agent
will have until the last business day before the next date on which the shares
trade on an "ex-dividend" basis or in no event more than 30 days after the
dividend payment date (the "last purchase date") to invest the dividend amount
in shares acquired in open-market purchases. It is contemplated that the Fund
will pay monthly income dividends. Therefore, the period during which
open-market purchases can be made will exist only from the payment date on the
dividend through the date before the next "ex-dividend" date, which typically
will be approximately ten days. If, before the Plan Agent has completed its
open-market purchases, the market price of a share of Common Stock exceeds the
net asset value per share, the average per share purchase price paid by the Plan
Agent may exceed the net asset value of the Fund's shares, resulting in the
acquisitions of fewer shares than if the dividend had been paid in newly issued
shares on the dividend payment date. Because of the foregoing difficulty with
respect to open-market purchases, the Plan provides that if the Plan Agent is
unable to invest the full dividend amount in open-market purchases during the
purchase period or if the market discount shifts to a market premium during the
purchase period, the Plan Agent will cease making open-market purchases and will
invest the uninvested portion of the dividend amount in newly issued shares at
the close of business on the last purchase date determined by dividing the
uninvested portion of the dividend by the net asset value per share.
The Plan Agent maintains all shareholders' accounts in the Plan and furnishes
written confirmation of all transactions in the account, including information
needed by shareholders for tax records. Shares in the account of each Plan
participant will be held by the Plan Agent in non-certificated form in the name
of the participant, and each shareholder's proxy will include those shares
purchased or received pursuant to the Plan. The Plan Agent will forward all
proxy solicitation materials to participants and vote proxies for shares held
pursuant to the Plan in accordance with the instructions of the participants.
DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004 25
[LOGO] Merrill Lynch Investment Managers
Automatic Dividend Reinvestment Plan (concluded)
In the case of shareholders such as banks, brokers or nominees which hold shares
of others who are the beneficial owners, the Plan Agent will administer the Plan
on the basis of the number of shares certified from time to time by the record
shareholders as representing the total amount registered in the record
shareholder's name and held for the account of beneficial owners who are to
participate in the Plan.
There will be no brokerage charges with respect to shares issued directly by the
Fund as a result of dividends or capital gains distributions payable either in
shares or in cash. However, each participant will pay a pro rata share of
brokerage commissions incurred with respect to the Plan Agent's open-market
purchases in connection with the reinvestment of dividends.
The automatic reinvestment of dividends and distributions will not relieve
participants of any Federal, state or local income tax that may be payable (or
required to be withheld) on such dividends.
Shareholders participating in the Plan may receive benefits not available to
shareholders not participating in the Plan. If the market price plus commissions
of the Fund's shares is above the net asset value, participants in the Plan will
receive shares of the Fund at less than they could otherwise purchase them and
will have shares with a cash value greater than the value of any cash
distribution they would have received on their shares. If the market price plus
commissions is below the net asset value, participants will receive
distributions in shares with a net asset value greater than the value of any
cash distribution they would have received on their shares. However, there may
be insufficient shares available in the market to make distributions in shares
at prices below the net asset value. Also, since the Fund does not redeem
shares, the price on resale may be more or less than the net asset value.
The value of shares acquired pursuant to the Plan will generally be excluded
from gross income to the extent that the cash amount reinvested would be
excluded from gross income. If, when the Fund's shares are trading at a premium
over net asset value, the Fund issues shares pursuant to the Plan that have a
greater fair market value than the amount of cash reinvested, it is possible
that all or a portion of such discount (which may not exceed 5% of the fair
market value of the Fund's shares) could be viewed as a taxable distribution. If
the discount is viewed as a taxable distribution, it is also possible that the
taxable character of this discount would be allocable to all the shareholders,
including shareholders who do not participate in the Plan. Thus, shareholders
who do not participate in the Plan might be required to report as ordinary
income a portion of their distributions equal to their allocable share of the
discount.
Experience under the Plan may indicate that changes are desirable. Accordingly,
the Fund reserves the right to amend or terminate the Plan. There is no direct
service charge to participants in the Plan; however, the Fund reserves the right
to amend the Plan to include a service charge payable by the participants.
All correspondence concerning the Plan should be directed to the Plan Agent at
The Bank of New York, Church Street Station, P.O. Box 11258, New York, NY
10286-1258, Telephone: 800-432-8224.
26 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
Important Tax Information (unaudited)
Of the ordinary income distributions paid monthly by Debt Strategies Fund, Inc.
during the fiscal year ended February 29, 2004, 3.95% qualifies for the
dividends received deduction for corporations and 3.89% qualifies for dividend
income for individuals.
Please retain this information for your records.
DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004 27
[LOGO] Merrill Lynch Investment Managers
Officers and Directors (unaudited)
Number of
Portfolios in Other Public
Position(s) Length Fund Complex Directorships
Held with of Time Overseen by Held by
Name Address & Age Fund Served Principal Occupation(s) During Past 5 Years Director Director
====================================================================================================================================
Interested Director
- ------------------------------------------------------------------------------------------------------------------------------------
Terry K. P.O. Box 9011 President 1999 to President and Chairman of the Merrill Lynch 123 Funds None
Glenn* Princeton, NJ and present Investment Managers, L.P. ("MLIM")/Fund Asset 159 Portfolios
08543-9011 Director and Management, L.P. ("FAM")--Advised Funds since
Age: 63 1997 to 1999; Chairman (Americas Region) of MLIM from 2000
present to 2002; Executive Vice President of FAM and MLIM
(which terms as used herein include their corporate
predecessors) from 1983 to 2002; President of
FAM Distributors, Inc. ("FAMD") from 1986 to 2002
and Director thereof from 1991 to 2002; Executive
Vice President and Director of Princeton Services,
Inc. ("Princeton Services") from 1993 to 2002;
President of Princeton Administrators, L.P. from
1989 to 2002; Director of Financial Data Services,
Inc. since 1985.
------------------------------------------------------------------------------------------------------------------------
* Mr. Glenn is a director, trustee or member of an advisory board of certain other investment companies for which FAM or
MLIM acts as investment adviser. Mr. Glenn is an "interested person," as described in the Investment Company Act, of
the Fund based on his former positions with FAM, MLIM, FAMD, Princeton Services and Princeton Administrators, L.P. The
Director's term is unlimited. Directors serve until their resignation, removal or death, or until December 31 of the
year in which they turn 72. As Fund President, Mr. Glenn serves at the pleasure of the Board of Directors.
====================================================================================================================================
Independent Directors*
- ------------------------------------------------------------------------------------------------------------------------------------
Ronald W. P.O. Box 9095 Director 1997 to Professor Emeritus of Finance, School of Business, 51 Funds None
Forbes Princeton, NJ present State University of New York at Albany since 2000 50 Portfolios
08543-9095 and Professor thereof from 1989 to 2000;
Age: 63 International Consultant at the Urban Institute
from 1995 to 1999.
- ------------------------------------------------------------------------------------------------------------------------------------
Cynthia A. P.O. Box 9095 Director 1997 to Professor of Harvard Business School since 1989. 51 Funds Newell
Montgomery Princeton, NJ present 50 Portfolios Rubbermaid,
08543-9095 Inc.
Age: 51
- ------------------------------------------------------------------------------------------------------------------------------------
Kevin A. P.O. Box 9095 Director 1997 to Director Emeritus of The Boston University Center 51 Funds None
Ryan Princeton, NJ present for the Advancement of Ethics and Character from 50 Portfolios
08543-9095 1989 to 1999; Professor of Education at Boston
Age: 71 University from 1982 to 1999 and Professor Emeritus
thereof since 1999.
- ------------------------------------------------------------------------------------------------------------------------------------
Roscoe S. P.O. Box 9095 Director 2000 to President of Middle East Institute from 1995 to 51 Funds None
Suddarth Princeton, NJ present 2001; Foreign Service Officer of United States 50 Portfolios
08543-9095 Foreign Service from 1961 to 1995 and Career
Age: 68 Minister from 1989 to 1995; Deputy Inspector
General of U.S. Department of State from 1991
to 1994; U.S. Ambassador to the Hashemite
Kingdom of Jordan from 1987 to 1990.
- ------------------------------------------------------------------------------------------------------------------------------------
Richard R. P.O. Box 9095 Director 1997 to Professor of Finance, New York University, Leonard 51 Funds Bowne &
West Princeton, NJ present N. Stern School of Business Administration from 50 Portfolios Co., Inc.;
08543-9095 1982 to 1994 and Dean Emeritus thereof since 1994. Vornado
Age: 66 Operating
Company;
Vornado
Realty Trust;
Alexander's,
Inc.
- ------------------------------------------------------------------------------------------------------------------------------------
28 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
Officers and Directors (unaudited) (concluded)
Number of
Portfolios in Other Public
Position(s) Length Fund Complex Directorships
Held with of Time Overseen by Held by
Name Address & Age Fund Served Principal Occupation(s) During Past 5 Years Director Director
====================================================================================================================================
Independent Directors* (concluded)
- ------------------------------------------------------------------------------------------------------------------------------------
Edward D. P.O. Box 9095 Director 2000 to Self-employed financial consultant since 1994; 51 Funds None
Zinbarg Princeton, NJ present Executive Vice President of The Prudential 50 Portfolios
08543-9095 Insurance Company of America from 1988 to
Age: 69 1994; Former Director of Prudential Reinsurance
Company and former Trustee of The Prudential
Foundation.
------------------------------------------------------------------------------------------------------------------------
* The Director's term is unlimited. Directors serve until their resignation, removal or death, or until December 31 of
the year in which they turn 72.
- ------------------------------------------------------------------------------------------------------------------------------------
Position(s) Length
Held with of Time
Name Address & Age Fund Served* Principal Occupation(s) During Past 5 Years
====================================================================================================================================
Fund Officers
- ------------------------------------------------------------------------------------------------------------------------------------
Donald C. P.O. Box 9011 Vice 1997 to First Vice President of FAM and MLIM since 1997 and Treasurer thereof since 1999;
Burke Princeton, NJ President present Senior Vice President and Treasurer of Princeton Services since 1999; Vice
08543-9011 and and President of FAMD since 1999; Director of MLIM Taxation since 1990.
Age: 43 Treasurer 1999 to
present
- ------------------------------------------------------------------------------------------------------------------------------------
Kevin J. P.O. Box 9011 Vice 2001 to Director (Global Fixed Income) of MLIM since 2000; Vice President of MLIM from
Booth Princeton, NJ President present 1994 to 2000.
08543-9011
Age: 49
- ------------------------------------------------------------------------------------------------------------------------------------
Joseph P. P.O. Box 9011 Vice 2001 to Director (Global Fixed Income) of MLIM since 2001; Vice President of MLIM from
Matteo Princeton, NJ President present 1997 to 2001.
08543-9011
Age: 40
- ------------------------------------------------------------------------------------------------------------------------------------
Phillip S. P.O. Box 9011 Secretary 2004 to First Vice President of MLIM since 2001; Director (Legal Advisory) from 2000 to
Gillespie Princeton, NJ present 2001; Vice President from 1999 to 2000; Attorney associated with MLIM since 1998.
08543-9011
Age: 39
------------------------------------------------------------------------------------------------------------------------
* Officers of the Fund serve at the pleasure of the Board of Directors.
- ------------------------------------------------------------------------------------------------------------------------------------
Custodian
The Bank of New York
100 Church Street
New York, NY 10286
Transfer Agent
The Bank of New York
101 Barclay Street
New York, NY 10286
NYSE Symbol
DSU
- --------------------------------------------------------------------------------
Charles C. Reilly, Director of Debt Strategies Fund, Inc., has recently retired.
The Fund's Board of Directors wishes Mr. Reilly well in his retirement.
- --------------------------------------------------------------------------------
DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004 29
[LOGO] Merrill Lynch Investment Managers
Electronic Delivery
The Fund offers 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.
30 DEBT STRATEGIES FUND, INC. FEBRUARY 29, 2004
[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 -- 2/04
Item 2 - Code of Ethics - The registrant has adopted 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
and principal accounting officer, or persons performing similar
functions. A copy of the code of ethics is available without charge
upon request by calling toll-free 1-800-MER-FUND (1-800-637-3863).
Item 3 - Audit Committee Financial Expert - The registrant's board of directors
has determined that (i) the registrant has the following audit
committee financial experts serving on its audit committee and (ii)
each audit committee financial expert is independent: (1) Ronald W.
Forbes, (2) Richard R. West, and (3) Edward D. Zinbarg.
Item 4 - Principal Accountant Fees and Services
(a) Audit Fees - Fiscal Year Ending February 29, 2004 - $38,900
Fiscal Year Ending February 28, 2003 - $38,000
(b) Audit-Related Fees - Fiscal Year Ending February 29, 2004 - $7,500
Fiscal Year Ending February 28, 2003 - $30,000
The nature of the services include assurance and related services
reasonably related to the performance of the audit of financial
statements not included in Audit Fees above.
(c) Tax Fees - Fiscal Year Ending February 29, 2004 - $5,200
Fiscal Year Ending February 28, 2003 - $4,800
The nature of the services include tax compliance, tax advice and tax
planning.
(d) All Other Fees - Fiscal Year Ending February 29, 2004 - $0
Fiscal Year Ending February 28, 2003 - $0
(e)(1) The registrant's audit committee (the "Committee") has adopted
policies and procedures with regard to the pre-approval of services.
Audit, audit-related and tax compliance services provided to the
registrant on an annual basis require specific pre-approval by the
Committee. The Committee also must approve other non-audit services
provided to the registrant and those non-audit services provided to the
registrant's affiliated service providers that relate directly to the
operations and the financial reporting of the registrant. Certain of
these non-audit services that the Committee believes are a) consistent
with the SEC's auditor independence rules and b) routine and recurring
services that will not impair the independence of the independent
accountants may be approved by the Committee without consideration on a
specific case-by-case basis ("general pre-approval"). However, such
services will only be deemed pre-approved provided that any individual
project does not exceed $5,000 attributable to the registrant or
$50,000 for the project as a whole. Any proposed services exceeding the
pre-approved cost levels will require specific pre-approval by the
Committee, as will any other services not subject to general
pre-approval (e.g., unanticipated but permissible services). The
Committee is informed of each service approved subject to general
pre-approval at the next regularly scheduled in-person board meeting.
(e)(2) 0%
(f) Not Applicable
(g) Fiscal Year Ending February 29, 2004 - $17,838,364
Fiscal Year Ending February 28, 2003 - $17,256,337
(h) The registrant's audit committee has considered and determined that
the provision of non-audit services that were rendered to the
registrant's 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.
Regulation S-X Rule 2-01(c)(7)(ii) - $541,640, 0%
Item 5 - Audit Committee of Listed Registrants - The following individuals are
members of the registrant's separately-designated standing audit
committee established in accordance with Section 3(a)(58)(A) of the
Exchange Act (15 U.S.C. 78c(a)(58)(A)):
Ronald W. Forbes
Cynthia A. Montgomery
Charles C. Reilly (retiring as of December 31, 2003)
Kevin A. Ryan
Roscoe S. Suddarth
Richard R. West
Edward D. Zinbarg
Item 6 - Schedule of Investments - Not Applicable
Item 7 - Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies -
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 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 - Purchases of Equity Securities by Closed-End Management Investment
Company and Affiliated Purchasers - Not Applicable
Item 9 - Submission of Matters to a Vote of Security Holders - Not Applicable
Item 10 - Controls and Procedures
10(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.
10(b) - There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the Act (17 CFR
270.30a-3(d)) that occurred during the second fiscal half-year of the
period covered by this report that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting.
Item 11 - Exhibits attached hereto
11(a)(1) - Code of Ethics - See Item 2
11(a)(2) - Certifications - Attached hereto
11(a)(3) - Not Applicable
11(b) - Certifications - Attached hereto
Pursuant to the requirements of the Securities Exchange Act of 1934 and
the Investment Company Act of 1940, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Debt Strategies Fund, Inc.
By: /s/ Terry K. Glenn
---------------------------
Terry K. Glenn,
President of
Debt Strategies Fund, Inc.
Date: April 16, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934 and
the Investment Company Act of 1940, this report has been signed below by
the following persons on behalf of the registrant and in the capacities
and on the dates indicated.
By: /s/ Terry K. Glenn
---------------------------
Terry K. Glenn,
President of
Debt Strategies Fund, Inc.
Date: April 16, 2004
By: /s/ Donald C. Burke
---------------------------
Donald C. Burke,
Chief Financial Officer of
Debt Strategies Fund, Inc.
Date: April 16, 2004