UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSRS
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number 811-08603
Name of Fund: Debt Strategies Fund, Inc.
Fund Address: P.O. Box 9011
Princeton, NJ 08543-9011
Name and address of agent for service: Robert C. Doll, Jr., Chief Executive
Officer, Debt Strategies Fund, Inc., 800 Scudders Mill Road, Plainsboro,
NJ 08536. Mailing address: P.O. Box 9011, Princeton, NJ 08543-9011
Registrant's telephone number, including area code: (609) 282-2800
Date of fiscal year end: 02/28/06
Date of reporting period: 03/01/05 - 08/31/05
Item 1 - Report to Stockholders
Debt Strategies Fund, Inc.
Semi-Annual Report
August 31, 2005
Debt Strategies Fund, Inc.
The Benefits and Risks of Leveraging
Debt Strategies Fund, Inc. utilizes leveraging 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.
Portfolio Information as of August 31, 2005
Percent of
Ten Largest Holdings Net Assets
--------------------------------------------------------------------------------
Century Cable Holdings LLC* ............................................. 2.4%
Charter Communications Operating LLC .................................... 2.1
United Rentals North America, Inc. ...................................... 2.0
Commonwealth Brands, Inc.* .............................................. 1.8
XM Satellite Radio, Inc. ................................................ 1.8
PolyOne Corp. ........................................................... 1.8
FelCor Lodging LP ....................................................... 1.7
NewPage Corp.* .......................................................... 1.7
Intelsat Bermuda Ltd.* .................................................. 1.7
Sealy Mattress Co. ...................................................... 1.6
--------------------------------------------------------------------------------
* Includes combined holdings.
Percent of
Five Largest Industries Net Assets
--------------------------------------------------------------------------------
Cable -- U.S. ........................................................... 17.5%
Chemicals ............................................................... 14.3
Telecommunications ...................................................... 9.5
Paper ................................................................... 9.2
Information Technology .................................................. 7.0
--------------------------------------------------------------------------------
For Fund compliance purposes, the Fund's industry classifications refer to
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 industry sub-classifications for reporting
ease.
Quality Ratings by Percent of
S&P/Moody's Total Investments
--------------------------------------------------------------------------------
BBB/Baa ................................................................. 0.9%
BB/Ba ................................................................... 10.5
B/B ..................................................................... 59.4
CCC/Caa ................................................................. 14.3
CC/Ca ................................................................... 0.2
C/C ..................................................................... 0.1
D ....................................................................... 0.8
NR (Not Rated) .......................................................... 10.5
Other* .................................................................. 3.3
--------------------------------------------------------------------------------
* Includes portfolio holdings in common stocks, preferred stocks, warrants,
other interests and short-term investments.
2 DEBT STRATEGIES FUND, INC. AUGUST 31, 2005
A Letter From the President
Dear Shareholder
Amid what we've coined a "muddle through" year for the financial markets, the
major market benchmarks managed to post positive results for the current
reporting period:
Total Returns as of August 31, 2005 6-month 12-month
===============================================================================================
U.S. equities (Standard & Poor's 500 Index) +2.33% +12.56%
-----------------------------------------------------------------------------------------------
Small-cap U.S. equities (Russell 2000 Index) +5.75% +23.10%
-----------------------------------------------------------------------------------------------
International equities (MSCI Europe Australasia Far East Index) +1.98% +23.58%
-----------------------------------------------------------------------------------------------
Fixed income (Lehman Brothers Aggregate Bond Index) +2.85% + 4.15%
-----------------------------------------------------------------------------------------------
Tax-exempt fixed income (Lehman Brothers Municipal Bond Index) +2.85% + 5.31%
-----------------------------------------------------------------------------------------------
High yield bonds (Credit Suisse First Boston High Yield Index) +1.35% + 8.98%
-----------------------------------------------------------------------------------------------
Since June 2004, the Federal Reserve Board (the Fed) has tirelessly advanced its
interest rate-hiking program, bringing the federal funds rate to 3.5% by August
31 (and to 3.75% on September 20). Economists and investors have struggled to
project the Fed's future moves, vacillating from expectations for an impending
end to monetary tightening to fears that the central bank may increase interest
rates more than is necessary to moderate economic growth and keep inflation in
check. Most recently, the devastation of Hurricane Katrina added a new element
of ambiguity in terms of its impact on the economy and Fed sentiment. Many now
believe the Fed will suspend its interest rate-hiking campaign at some point
this year.
Equity market returns over the past several months have reflected a degree of
investor uncertainty. After a strong finish to 2004, the S&P 500 Index posted
gains in four of the first eight months of 2005. Up to this point, strong
corporate earnings reports and low long-term bond yields have worked in favor of
equities. Factors that pose the greatest risks to stocks include record-high oil
prices, continued interest rate hikes and the possibility for disappointing
earnings for the remainder of the year.
Fixed income markets have fared relatively well in the face of monetary
tightening. As the short end of the yield curve moved in concert with Fed
interest rate hikes, long-term bond yields remained low, perpetuating the yield
curve flattening trend. Because bond prices move in the opposite direction of
yields, the result has been that longer-term bonds have outperformed short-term
bonds. At period end, the spread between two-year and 10-year Treasury yields
was just 18 basis points (.18%).
Financial markets are likely to face continued crosscurrents for the remainder
of 2005, particularly as the economy digests the impact of Hurricane Katrina.
Nevertheless, opportunities do exist and we encourage you to work with your
financial advisor to diversify your portfolio among a variety of asset types.
This can help to diffuse risk while also tapping into the potential benefits of
a broader range of investment alternatives. As always, we thank you for trusting
Merrill Lynch Investment Managers with your investment assets.
Sincerely,
/s/ Robert C. Doll, Jr.
Robert C. Doll, Jr.
President and Director
DEBT STRATEGIES FUND, INC. AUGUST 31, 2005 3
A Discussion With Your Fund's Portfolio Manager
We continued our efforts to build a well-diversified portfolio and to
protect the Fund's underlying value in the case of rising long-term interest
rates.
How did the Fund perform during the period in light of the existing market
conditions?
For the six-month period ended August 31, 2005, the Common Stock of Debt
Strategies Fund, Inc. had net annualized yields of 9.29% and 9.42%, based on a
period-end per share net asset value of $6.79 and a per share market price of
$6.70, respectively, and $.318 per share income dividends. Over the same period,
the total investment return on the Fund's Common Stock was +0.93%, based on a
change in per share net asset value from $7.06 to $6.79, and assuming
reinvestment of all distributions. The Fund's total return for the period
trailed the +2.11% return of its benchmark, which is an equal blend of the
Credit Suisse First Boston (CSFB) High Yield Index and the CSFB Leveraged Loan
Index.
For a description of the Fund's total investment return based on a change in the
per share market value of the Fund's Common Stock (as measured by the trading
price of the Fund's shares on the New York Stock Exchange), and assuming
reinvestment of dividends, please refer to the Financial Highlights section of
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 returns based on
changes in the Fund's net asset value.
The high yield market was highly volatile during the six-month reporting period.
General Motors Corp. (GM) announced higher-than-expected losses on March 16.
This exacerbated concerns that both GM and Ford Motor Co. would be lowered to
junk bond status and exerted significant downward pressure on the entire high
yield market. Concurrent with this development, the 10-year Treasury rate shot
up to 4.6% in the last week of March, adding yet more downward price pressure on
the high yield market. The Merrill Lynch High Yield Index declined 2.72% in
March and 1.04% in April. The market subsequently gained some perspective on the
GM and Ford downgrades and staged a four-month rally totaling approximately 4.9%
by August 31. This high yield upturn was complemented by a rally in the 10-year
Treasury rate, which finished the period at 4.02%, 58 basis points (.58%) off
its peak for the reporting period. The later part of this Treasury rally was
fueled by an investor flight to quality in the aftermath of Hurricane Katrina.
Conditions in the leveraged loan market were much less unsettled than those in
the high yield bond market. Three primary factors account for this. First,
credit concerns have less of an impact on leveraged loans compared to high yield
bonds due to the senior secured status of most leveraged bank loans. Second,
leveraged bank loans are set off of the London InterBank Offered Rate (LIBOR),
and are less affected by moves in long-term interest rates. Third, demand for
bank loans has been greatly boosted by the influx of collateralized loan
obligations (CLOs) into the market. For the eight months ended August 31, 2005,
we saw $26.2 billion in CLO issuance. Generally speaking, bank loans lack call
protection, and corporate treasurers have exploited this robust demand to
refinance at increasingly tighter spreads to LIBOR.
Despite increasing leverage and greater high yield issuance at the lower end of
the credit rating spectrum, default rates continued to decline, reaching their
lowest levels since 1994 at .45% for leveraged loans and .91% for high yield
bonds, as of June 30, 2005, according to CSFB. While strong market liquidity and
gross domestic product growth projections in the 3% - 4% range have enabled
companies to stretch their credit parameters, it must be noted that default
rates are a lagging indicator. The average incubation period for a high yield
credit default is roughly 36 months. Consequently, current rates are more
reflective of the underwriting standards of 2002 - 2003 than those of today.
What factors most influenced Fund performance?
The Fund's underperformance of the benchmark reflects the portfolio's relatively
aggressive credit stance. In general, credits rated B and CCC fared worse than
those rated BB during the credit correction prompted by the GM downgrade. Price
weakness was amplified by the Fund's leverage lines, which were actively used
during the period. The Fund's maximum leverage amount is 33%; we maintained
leverage in the 25% - 30% range during this reporting period.
Specific credits that detracted from performance during the past six months
included Anchor Glass Container Corp., Pliant Corp. and GEO Specialty Chemicals,
Inc. A common theme among these three investments is the meaningful impact that
high energy prices are having on U.S. manufacturers.
4 DEBT STRATEGIES FUND, INC. AUGUST 31, 2005
In terms of Anchor Glass Container, we owned $9.625 million in bonds of this
glass bottle manufacturer priced at 101 as of February 28, 2005. We purchased
additional bonds on price weakness, leaving the Fund with an $11.9 million
position priced at 67 at period-end. Anchor Glass' financial performance
continued to weaken in the midst of high natural gas and soda ash prices,
culminating in a Chapter 11 filing on August 8, 2005.
The Fund's $12.3 million bond position in Pliant, a flexible plastic
manufacturing company, slid 25 points to 72 during the period. The company's
difficulty in passing along rising raw material costs, namely oil-based resins,
is a challenge facing the entire industry.
The price of our 339,340 share GEO equity position retreated from 15 per share
to 8.25 per share following weaker-than-expected profit margins. It appears that
the significantly higher raw material prices had not been fully reflected in
sales prices. GEO manufactures functional chemicals for a variety of markets,
including industrial water treatment, paints and coatings, construction and
electronics. We received this equity following the company's emergence from
Chapter 11 bankruptcy in November 2004.
Specific credits that made outsized contributions to performance during the
six-month reporting period included High Voltage Engineering Corporation (HVE),
Centerpoint Energy, Inc. and Loral Cyberstar, Inc. Our 501,000 shares of common
equity in HVE rallied from 1.50 per share to 9.00 per share during the period.
The price of this equity, which we received in 2004 via a Chapter 11
reorganization, had been under pressure as the company faced daunting liquidity
issues arising from overextended working capital positions. Subsequently, the
company's principal division, Robicon, was sold to Siemens AG at a surprisingly
strong multiple. This propelled the stock upward. We liquidated this position in
August.
The Fund's $7 million position in the convertible bonds of Centerpoint Energy
rallied from 113 to 120 during the period, as improving fundamentals drove the
common stock higher. Centerpoint is in the midst of a transition from an
integrated utility to a pure transmission and distribution company. During the
period, the stock also benefited from several favorable court rulings concerning
disposition of stranded asset costs.
At February 28, 2005, the Fund held a $2.5 million position in the bonds of
bankrupt satellite manufacturer Loral Cyberstar. The bonds were marked at 74. We
purchased another $4 million during the period at an average price of 74.52.
Since its emergence from Chapter 11, the company's operational prospects have
improved markedly and its bonds appreciated to 90.0 by period-end. We believe
the satellite market holds great promise.
What changes were made to the portfolio during the period?
We continued to increase the Fund's exposure to floating rate notes during the
period, culminating in a portfolio composition of 60% fixed rate/40% floating
rate at period-end. Our primary concern has been, and continues to be, the
potential for a negative price impact on the Fund's net asset value if long-term
interest rates rise. Long-term interest rates actually declined (with the
10-year Treasury yield falling from 4.38% at February 28, 2005 to 4.02% at
August 31, 2005), and the Fund has paid the cost for our defensive shift in the
form of foregone interest. This cost, however, has been reduced as the
underlying LIBOR base for the floating rate investments has risen in lockstep
with the federal funds interest rate increases. At August 31, 2005, three-month
LIBOR was 3.87% versus 2.92% at February 28, 2005, and it should continue to
rise with future Federal Reserve Board (the Fed) interest rate increases. Since
June 2004, the Fed has increased the target short-term interest rate 11
consecutive times, from 1% to 3.75% as of September 20, 2005.
How would you characterize the Fund's position at the close of the period?
Going forward, we plan to maintain the portfolio's 60% fixed rate/40% floating
rate composition, relying on floating rate notes as opposed to bank loans, where
we have seen further spread compression. Our investment approach will continue
to be credit-driven, with the aim of maintaining a well-diversified investment
portfolio. We also intend to maintain our use of leverage within a target range
of 25% - 30%.
Kevin J. Booth
Vice President and Portfolio Manager
September 20, 2005
DEBT STRATEGIES FUND, INC. AUGUST 31, 2005 5
Schedule of Investments (in U.S. dollars)
Face
Amount Corporate Bonds Value
======================================================================================================
Aerospace & Defense--3.0%
$ 5,000,000 Alliant Techsystems, Inc., 3%
due 8/15/2024 (d)(k) $ 5,725,000
7,500,000 L-3 Communications Corp.,
3% due 8/01/2035 (d)(k) 7,753,125
8,120,000 Vought Aircraft Industries, Inc., 8% due 7/15/2011 7,998,200
--------------
21,476,325
======================================================================================================
Airlines--0.6%
4,241,544 American Airlines, Inc. Series 2001-1, 7.379%
due 11/23/2017 3,161,282
5,875,000 Delta Air Lines, Inc., 2.875%
due 2/18/2024 (d)(k)(m) 962,031
--------------
4,123,313
======================================================================================================
Automotive--2.6%
700,000 Advanced Accessory Systems LLC,
10.75% due 6/15/2011 612,500
4,950,000 Cooper-Standard Automotive, Inc., 8.375%
due 12/15/2014 4,504,500
2,700,000 Delco Remy International, Inc.,
7.599% due 4/15/2009 (a) 2,673,000
1,550,000 Dura Operating Corp. Series D, 9% due 5/01/2009 1,240,000
4,900,000 Exide Technologies, 10.50% due 3/15/2013 (d) 3,773,000
6,050,000 Metaldyne Corp., 11% due 6/15/2012 4,658,500
925,000 Tenneco Automotive Inc., Series B,
10.25% due 7/15/2013 1,049,875
Venture Holdings Co. LLC (i):
4,450,000 12% due 6/01/2009 0
1,800,000 Series B, 9.50% due 7/01/2005 2,250
--------------
18,513,625
======================================================================================================
Broadcasting--5.0%
3,950,000 Emmis Communications Corp.,
9.745% due 6/15/2012 (a) 3,999,375
6,000,000 Granite Broadcasting Corp.,
9.75% due 12/01/2010 5,662,500
3,870,000 Sinclair Broadcast Group, Inc. Class A, 4.875%
due 7/15/2018 (k) 3,526,538
8,300,000 Sirius Satellite Radio, Inc.,
9.625% due 8/01/2013 (d) 8,154,750
12,625,000 XM Satellite Radio, Inc.,
9.193% due 5/01/2009 (a) 12,767,031
2,000,000 Young Broadcasting Inc., 10% due 3/01/2011 1,925,000
--------------
36,035,194
======================================================================================================
Cable--International--0.1%
750,000 NTL Cable Plc, 8.75% due 4/15/2014 791,250
======================================================================================================
Cable--U.S.--10.5%
7,500,000 Adelphia Communications Corp.,
6% due 2/15/2006 (i)(k) 356,250
2,000,000 Atlantic Broadband Finance LLC,
9.375% due 1/15/2014 (d) 1,940,000
3,450,000 CSC Holdings, Inc., 7.25% due 7/15/2008 3,488,812
4,225,000 Cablevision Systems Corp. Series B,
7.88% due 4/01/2009 (a) 4,362,312
Charter Communications Holdings LLC:
3,750,000 10% due 4/01/2009 (a) 3,210,937
2,000,000 11.75% due 1/15/2010 1,700,000
2,000,000 11.125% due 1/15/2011 1,535,000
2,700,000 9.92% due 4/01/2011 2,025,000
3,000,000 10% due 5/15/2011 2,242,500
2,500,000 Insight Midwest, LP, 9.75% due 10/01/2009 2,590,625
Intelsat Bermuda Ltd. (d):
3,825,000 8.695% due 1/15/2012 (a) 3,891,938
3,375,000 8.25% due 1/15/2013 3,434,063
4,800,000 8.625% due 1/15/2015 4,980,000
7,398,000 Loral Cyberstar, Inc., 10% due 7/15/2006 (i) 6,912,765
2,350,000 Mediacom Broadband LLC, 11% due 7/15/2013 2,564,438
3,875,000 Mediacom LLC, 9.50% due 1/15/2013 3,942,813
New Skies Satellites NV:
3,500,000 8.539% due 11/01/2011 (a) 3,631,250
3,700,000 9.125% due 11/01/2012 3,838,750
10,000,000 Rainbow National Services LLC,
10.375% due 9/01/2014 (d) 11,400,000
10,350,000 Zeus Special Subsidiary Ltd.,
9.25% due 2/01/2015 (c)(d) 6,986,250
--------------
75,033,703
======================================================================================================
Chemicals--10.6%
3,550,000 ArCo Chemical Co., 9.80% due 2/01/2020 4,011,500
2,320,000 BCP Caylux Holdings Luxembourg SCA,
9.625% due 6/15/2014 2,630,300
4,000,000 Compass Minerals International, Inc. Series B,
12% due 6/01/2013 (c) 3,420,000
9,783,000 GEO Specialty Chemicals, Inc.,
12.016% due 12/31/2009 (k) 10,272,150
Huntsman International, LLC:
1,900,000 9.875% due 3/01/2009 2,023,500
1,199,000 10.125% due 7/01/2009 1,234,970
3,150,000 ISP Holdings, Inc. Series B,
10.625% due 12/15/2009 3,339,000
1,500,000 Innophos, Inc., 8.875% due 8/15/2014 (d) 1,543,125
6,000,000 Invista B.V., 9.25% due 5/01/2012 (d) 6,600,000
2,400,000 Millennium America, Inc.,
7.625% due 11/15/2026 2,256,000
10,000,000 Omnova Solutions, Inc., 11.25% due 6/01/2010 10,650,000
7,575,917 PCI Chemicals Canada, Inc., 10% due 12/31/2008 8,068,352
11,700,000 PolyOne Corp., 10.625% due 5/15/2010 12,562,875
Rockwood Specialties Group, Inc.:
3,700,000 10.625% due 5/15/2011 4,070,000
450,000 7.50% due 11/15/2014 (d) 459,000
1,656,000 Terra Capital, Inc., 11.50% due 6/01/2010 1,896,120
691,000 United Agri Products, Inc., 8.25% due 12/15/2011 732,460
--------------
75,769,352
======================================================================================================
Consumer--Durables--2.4%
10,750,000 Sealy Mattress Co., 8.25% due 6/15/2014 11,475,625
10,000,000 Simmons Co., 10.207% due 12/15/2014 (c)(d) 5,750,000
--------------
17,225,625
======================================================================================================
Consumer--Non-Durables--3.2%
2,000,000 Ames True Temper, Inc., 7.599% due 1/15/2012 (a) 1,950,000
3,400,000 Chattem, Inc., 6.87% due 3/01/2010 (a) 3,425,500
2,000,000 General Binding Corp., 9.375% due 6/01/2008 2,035,000
3,000,000 Hines Nurseries, Inc., 10.25% due 10/01/2011 3,082,500
4,000,000 North Atlantic Holding Co., Inc., 12.25%
due 3/01/2014 (c) 1,060,000
10,500,000 Playtex Products, Inc., 9.375% due 6/01/2011 11,130,000
--------------
22,683,000
======================================================================================================
6 DEBT STRATEGIES FUND, INC. AUGUST 31, 2005
Schedule of Investments (continued) (in U.S. dollars)
Face
Amount Corporate Bonds Value
======================================================================================================
Diversified Media--3.5%
$ 2,000,000 Cadmus Communications Corp.,
8.375% due 6/15/2014 $ 2,077,500
Houghton Mifflin Co.:
775,000 9.875% due 2/01/2013 837,000
3,000,000 11.415% due 10/15/2013 (c) 2,336,250
7,500,000 Liberty Media Corp., 0.75% due 3/30/2023 (k) 8,278,125
1,800,000 Loews Cineplex Entertainment Corp.,
8.875% due 8/01/2008 (i) 0
2,675,000 Muzak Holdings, LLC, 13% due 3/15/2010 835,938
3,875,000 NBC Acquisition Corp., 11% due 3/15/2013 (c) 2,857,813
1,700,000 Nebraska Book Co., Inc., 8.625% due 3/15/2012 1,636,250
Universal City Florida Holding Co. I:
375,000 8.375% due 5/01/2010 394,688
5,300,000 8.443% due 5/01/2010 (a) 5,551,750
--------------
24,805,314
======================================================================================================
Energy--Other--3.7%
6,150,000 Aventine Renewable Energy Holdings, Inc.,
9.87% due 12/15/2011 (a)(d) 6,180,750
Dresser, Inc.:
1,000,000 9.375% due 4/15/2011 1,055,000
2,325,000 Dresser-Rand Group, Inc.,
7.375% due 11/01/2014 (d) 2,406,375
Giant Industries, Inc.:
6,480,000 11% due 5/15/2012 7,322,400
3,525,000 8% due 5/15/2014 3,701,250
6,250,000 Star Gas Partners LP, 10.25% due 2/15/2013 5,562,500
--------------
26,228,275
======================================================================================================
Financial--2.3%
5,777,222 Archimedes Funding III Ltd.,
5.50% due 11/29/2011 (a)(d) 4,477,347
1,500,000 Investcorp SA, 7.54% due 10/21/2008 1,520,182
2,000,000 Pennant CBO Ltd., 13.43% due 3/14/2011 1,540,000
7,625,000 Refco Finance Holdings LLC, 9% due 8/01/2012 8,311,250
SKM-LibertyView CBO Ltd. Series 1A (f)(i):
1,500,000 Class C1, 8.71% due 4/10/2011 525,000
1,000,000 Class D, 11.91% due 4/10/2011 15,000
--------------
16,388,779
======================================================================================================
Food & Drug--0.3%
2,750,000 Duane Reade, Inc., 9.75% due 8/01/2011 2,172,500
======================================================================================================
Food & Tobacco--3.0%
949,670 Archibald Candy Corp., 10% due 11/01/2007 (i) 284,207
Commonwealth Brands, Inc. (d):
4,550,000 9.75% due 4/15/2008 4,800,250
8,000,000 10.625% due 9/01/2008 8,440,000
1,175,000 Doane Pet Care Co., 10.75% due 3/01/2010 1,283,687
1,362,000 Dole Food Co., Inc., 8.875% due 3/15/2011 1,450,530
2,875,000 Gold Kist Inc., 10.25% due 3/15/2014 3,270,313
28,918,000 New World Pasta Co., 9.25% due 2/15/2009 (i) 2,024,260
--------------
21,553,247
======================================================================================================
Gaming--1.4%
4,000,000 Inn of the Mountain Gods Resort & Casino,
12% due 11/15/2010 4,590,000
2,000,000 Jacobs Entertainment, Inc.,
11.875% due 2/01/2009 2,145,000
1,825,000 Majestic Star Casino LLC, 9.50% due 10/15/2010 1,838,688
1,725,000 Penn National Gaming, Inc., 6.75% due 3/01/2015 1,707,750
--------------
10,281,438
======================================================================================================
Health Care--5.7%
6,000,000 CDRV Investors, Inc., 9.75% due 1/01/2015 (c) 3,480,000
5,000,000 Cinacalcet Royalty Corp., 8% due 3/30/2017 5,200,000
Elan Finance Plc (d):
3,525,000 7.75% due 11/15/2011 3,102,000
4,825,000 7.79% due 11/15/2011 (a) 4,270,125
HealthSouth Corp.:
2,500,000 8.50% due 2/01/2008 2,512,500
2,500,000 10.75% due 10/01/2008 2,587,500
3,000,000 7.625% due 6/01/2012 2,917,500
5,000,000 Risperdal Consta Pharma, 7% due 1/01/2018 4,350,000
6,000,000 Tenet Healthcare Corp., 7.375% due 2/01/2013 5,850,000
1,400,000 VWR International, Inc., 8% due 4/15/2014 1,389,500
Vanguard Health Holding Co., LLC:
4,100,000 I, 11.25% due 10/01/2015 3,044,250
2,325,000 II, 9% due 10/01/2014 2,528,438
--------------
41,231,813
======================================================================================================
Housing--2.8%
Compression Polymers Corp. (d):
2,000,000 10.46% due 7/01/2012 (a) 2,005,000
1,300,000 10.50% due 7/01/2013 1,313,000
421,312 Formica Holdings Corp., 8.76% due 6/10/2011 400,246
Goodman Global Holding Co., Inc. (d):
3,190,000 6.41% due 6/15/2012 (a) 3,174,050
8,200,000 7.875% due 12/15/2012 7,749,000
2,500,000 Nortek, Inc., 8.50% due 9/01/2014 2,431,250
2,250,000 Stanley-Martin Communities,
9.75% due 8/15/2015 (d) 2,272,500
1,000,000 US Concrete, Inc., 8.375% due 4/01/2014 1,000,000
--------------
20,345,046
======================================================================================================
Information Technology--6.1%
Amkor Technology, Inc.:
6,950,000 9.25% due 2/15/2008 6,533,000
1,000,000 10.50% due 5/01/2009 915,000
5,000,000 Cypress Semiconductor Corp.,
1.25% due 6/15/2008 (k) 5,962,500
4,725,000 Freescale Semiconductor, Inc.,
6.349% due 7/15/2009 (a) 4,878,562
MagnaChip Semiconductor SA:
1,375,000 7.12% due 12/15/2011 (a) 1,381,875
1,050,000 8% due 12/15/2014 987,000
Sungard Data Systems, Inc. (d):
3,825,000 8.525% due 8/15/2013 (a) 3,958,875
7,075,000 9.125% due 8/15/2013 7,428,750
4,100,000 10.25% due 8/15/2015 4,284,500
2,925,000 Telcordia Technologies Inc.,
10% due 3/15/2013 (d) 2,778,750
5,075,000 Viasystems, Inc., 10.50% due 1/15/2011 4,998,875
--------------
44,107,687
======================================================================================================
Leisure--2.0%
12,000,000 FelCor Lodging LP, 7.78% due 6/01/2011 (a) 12,510,000
2,000,000 True Temper Sports, Inc., 8.375% due 9/15/2011 1,940,000
--------------
14,450,000
======================================================================================================
DEBT STRATEGIES FUND, INC. AUGUST 31, 2005 7
Schedule of Investments (continued) (in U.S. dollars)
Face
Amount Corporate Bonds Value
======================================================================================================
Manufacturing--4.5%
$ 575,000 Aearo Co., 8.25% due 4/15/2012 $ 579,312
4,000,000 CPI Holdco, Inc., 9.672% due 2/01/2015 (a) 3,966,568
4,525,000 EaglePicher Inc., 9.75% due 9/01/2013 (i) 3,393,750
5,875,000 Invensys Plc, 9.875% due 3/15/2011 (d) 5,904,375
4,899,000 Medis Technologies Ltd.,
6% due 7/15/2010 (d)(k) 4,947,990
8,300,000 Mueller Group, Inc., 10% due 5/01/2012 8,891,375
600,000 NMHG Holding Co., 10% due 5/15/2009 642,000
4,000,000 Propex Fabrics, Inc., 10% due 12/01/2012 3,860,000
--------------
32,185,370
======================================================================================================
Metal--Other--1.0%
1,100,000 Aleris International, Inc., 9% due 11/15/2014 1,160,500
5,500,000 James River Coal Co., 9.375% due 6/01/2012 5,816,250
--------------
6,976,750
======================================================================================================
Packaging--4.9%
11,905,000 Anchor Glass Container Corp.,
11% due 2/15/2013 (i) 7,976,350
3,800,000 Consolidated Container Co. LLC,
10.75% due 6/15/2009 (c) 3,154,000
4,400,000 Crown European Holdings SA,
9.50% due 3/01/2011 4,851,000
1,100,000 Graham Packing Co., Inc.,
9.875% due 10/15/2014 1,138,500
12,300,000 Pliant Corp., 13% due 6/01/2010 8,856,000
Tekni-Plex, Inc.:
2,000,000 12.75% due 6/15/2010 1,420,000
1,000,000 10.875% due 8/15/2012 (d) 1,087,500
1,250,000 8.75% due 11/15/2013 (d) 1,093,750
6,575,000 Wise Metals Group LLC, 10.25% due 5/15/2012 5,407,938
--------------
34,985,038
======================================================================================================
Paper--9.1%
6,500,000 Abitibi-Consolidated, Inc.,
7.37% due 6/15/2011 (a) 6,500,000
6,025,000 Ainsworth Lumber Co. Ltd.,
7.24% due 10/01/2010 (a) 5,964,750
Boise Cascade LLC:
2,150,000 6.474% due 10/15/2012 (a) 2,166,125
900,000 7.125% due 10/15/2014 875,250
7,600,000 Bowater, Inc., 6.87% due 3/15/2010 (a) 7,676,000
3,775,000 Domtar, Inc., 7.125% due 8/15/2015 3,763,618
4,250,000 Georgia-Pacific Corp., 9.375% due 2/01/2013 4,749,375
2,000,000 Graphic Packaging International Corp.,
9.50% due 8/15/2013 2,050,000
JSG Funding Plc:
2,000,000 9.625% due 10/01/2012 2,045,000
6,125,000 7.75% due 4/01/2015 5,390,000
NewPage Corp. (d):
8,000,000 9.943% due 5/01/2012 (a) 7,960,000
4,725,000 12% due 5/01/2013 4,488,750
1,600,000 Smurfit-Stone Container Enterprises, Inc.,
8.375% due 7/01/2012 1,592,000
3,450,000 Tembec Industries, Inc., 8.625% due 6/30/2009 2,777,250
7,281,000 Western Forest Products, Inc.,
15% due 7/28/2009 (b)(d) 7,106,097
--------------
65,104,215
======================================================================================================
Service--5.0%
Allied Waste North America, Inc.:
1,440,000 7.875% due 4/15/2013 1,483,200
6,250,000 Series B, 7.375% due 4/15/2014 5,875,000
2,000,000 Buhrmann US, Inc., 7.875% due 3/01/2015 (d) 2,025,000
1,750,000 Cardtronics, Inc., 9.25% due 8/15/2013 (d) 1,780,625
7,500,000 HydroChem Industrial Services, Inc.,
9.25% due 2/15/2013 (d) 7,350,000
3,000,000 Neff Rental LLC, 11.25% due 6/15/2012 (d) 3,195,000
14,825,000 United Rentals North America, Inc.,
7.75% due 11/15/2013 14,491,438
--------------
36,200,263
======================================================================================================
Telecommunications--9.4%
5,000,000 ADC Telecommunications, Inc.,
3.996% due 6/15/2013 (a)(k) 5,006,250
3,265,000 Alaska Communications Systems Holdings, Inc.,
9.875% due 8/15/2011 3,575,175
7,500,000 Cincinnati Bell, Inc., 8.375% due 1/15/2014 7,575,000
6,000,000 LCI International, Inc., 7.25% due 6/15/2007 5,910,000
Qwest Capital Funding, Inc.:
2,000,000 6.375% due 7/15/2008 1,960,000
8,200,000 6.875% due 7/15/2028 6,806,000
7,900,000 Qwest Communications International, Inc.,
7.29% due 2/15/2009 (a) 7,860,500
2,675,000 Qwest Corp., 7.12% due 6/15/2013 (a)(d) 2,802,063
Terremark Worldwide Inc. (k):
4,475,000 9% due 6/15/2009 3,759,000
6,000,000 9% due 6/15/2009 (d) 5,040,000
Time Warner Telecom Holdings, Inc.:
7,000,000 7.79% due 2/15/2011 (a) 7,175,000
6,000,000 9.25% due 2/15/2014 6,090,000
4,000,000 Time Warner Telecom, Inc., 9.75% due 7/15/2008 4,060,000
--------------
67,618,988
======================================================================================================
Transportation--0.9%
3,000,000 Progress Rail Services Corp.,
7.75% due 4/01/2012 (d) 3,048,750
3,500,000 Titan Petrochemicals Group Ltd.,
8.50% due 3/18/2012 (d) 3,342,500
--------------
6,391,250
======================================================================================================
Utility--2.4%
7,000,000 Centerpoint Energy, Inc. Series B,
3.75% due 5/15/2023 (k) 8,942,500
6,000,000 Sierra Pacific Resources, 8.625% due 3/15/2014 6,630,000
1,425,000 Williams Cos., Inc., 8.625% due 6/01/2010 1,540,781
--------------
17,113,281
======================================================================================================
Wireless Communications--3.5%
5,500,000 Alamosa Delaware, Inc., 8.50% due 1/31/2012 5,967,500
267,000 American Tower Corp., 9.375% due 2/01/2009 280,016
Dobson Cellular Systems:
1,750,000 8.375% due 11/01/2011 1,855,000
4,675,000 8.443% due 11/01/2011 (a) 4,862,000
950,000 Horizon PCS, Inc., 11.375% due 7/15/2012 1,102,000
2,500,000 iPCS Escrow Co., 11.50% due 5/01/2012 2,887,500
1,600,000 Rural Cellular Corp., 8.37% due 3/15/2010 (a) 1,656,000
6,600,000 US Unwired, Inc., 7.66% due 6/15/2010 (a) 6,864,000
--------------
25,474,016
------------------------------------------------------------------------------------------------------
Total Corporate Bonds
(Cost--$800,350,166)--109.5% 785,264,657
======================================================================================================
8 DEBT STRATEGIES FUND, INC. AUGUST 31, 2005
Schedule of Investments (continued) (in U.S. dollars)
Face
Amount Floating Rate Loan Interests* Value
======================================================================================================
Automotive--1.9%
$ 6,000,000 Delphi Automotive Systems Corp. Term Loan,
10.30% due 6/14/2011 $ 6,165,534
4,501,182 Intermet Corp. Term Loan B, 8.25% due 3/31/2009 4,478,676
Tenneco Automotive, Inc.:
2,185,236 Term Loan B, 6.08% due 12/12/2010 2,223,478
959,936 Tranche B-1 Credit Linked Deposit,
5.76% due 12/12/2010 976,734
--------------
13,844,422
======================================================================================================
Cable--U.S.--6.7%
Century Cable Holdings LLC:
7,000,000 Discretionary Term Loan,
9.50% due 12/31/2009 6,957,125
10,000,000 Term Loan B, 8.50% due 6/30/2009 9,943,750
14,831,561 Charter Communications Operating LLC Tranche
B Term Loan, 6.83% - 6.93% due 4/07/2011 14,898,436
7,880,000 Insight Midwest Holdings LLC Term Loan C,
5.625% due 12/31/2009 7,996,727
993,739 New Skies Satellites, BV Term Loan,
5.688% - 5.875% due 5/04/2011 1,007,846
Olympus Cable Holdings LLC:
6,000,000 Term Loan B, 8.50% due 9/30/2010 5,967,324
1,500,000 Tranche 2 Term Loan A,
8.50% due 6/30/2010 1,487,946
--------------
48,259,154
======================================================================================================
Chemicals--3.0%
3,100,000 Huntsman International LLC Term Loan B,
5.323% due 8/16/2012 3,145,533
Invista B.V. New Tranche:
3,532,632 B-1 Term Loan, 5.75% due 4/29/2011 3,592,246
1,532,691 B-2 Term Loan, 5.75% due 4/29/2011 1,558,555
1,516,457 Pinnacle Polymers Term Loan,
6.109% due 12/15/2006 1,537,853
3,184,000 Rockwood Specialties Group, Inc., Tranche B
Term Loan, 5.93% due 12/10/2012 3,243,038
8,000,000 Wellman, Inc. Second Lien Term Loan,
10.46% - 10.71% due 2/10/2010 8,120,000
--------------
21,197,225
======================================================================================================
Consumer--Durables--0.7%
5,000,000 Simmons Co. Term Loan, 7% due 6/19/2012 5,077,085
======================================================================================================
Consumer--Non-Durables--1.4%
9,825,000 Levi Strauss & Co. Tranche A Term Loan,
10.434% - 10.635% due 9/29/2009 10,291,688
======================================================================================================
Energy--Exploration & Production--0.5%
Quest Cherokee LLC:
222,222 Line of Credit, 8.325% due 12/31/2008 222,222
1,500,000 Revolving Credit, 8.25% due 7/22/2009 1,451,250
1,764,444 Term Loan B, 8.61% - 10.25% due 7/22/2010 1,764,444
--------------
3,437,916
======================================================================================================
Energy--Other--0.8%
Dresser, Inc.:
1,148,861 Term Loan C, 5.99% due 4/10/2009 1,161,307
2,500,000 Term Loan Unsecured, 6.91% due 3/01/2010 2,543,750
2,000,000 EPCO Holdings, Inc. Term Loan B,
5.84% due 8/18/2010 2,035,312
--------------
5,740,369
======================================================================================================
Food & Tobacco--0.5%
3,693,700 Dr. Pepper/Seven Up Bottling Group, Inc. Term
Loan B, 5.339% - 5.609% due 12/19/2010 3,751,876
======================================================================================================
Gaming--0.6%
4,122,245 Buffington Harbor Parking Associates LLC Term
Loan B, 10.375% due 7/01/2011 4,122,245
======================================================================================================
Health Care--1.1%
4,500,000 HealthSouth Corp. Term Loan,
10.375% due 1/16/2011 4,668,750
3,399,153 Medpointe Healthcare Inc. Tranche B Term Loan,
8.89% - 8.99% due 9/30/2008 3,441,642
--------------
8,110,392
======================================================================================================
Housing--3.2%
4,627,970 General Growth Properties, Inc. Term Loan B,
5.67% due 11/12/2008 4,687,939
4,980,066 Headwaters, Inc. First Lien Term Loan,
5.87% - 7.75% due 4/30/2011 5,050,618
2,939,910 LNR Property Corp. Tranche B Term Loan,
6.53% - 6.71% due 2/03/2008 2,972,196
10,000,000 Stile U.S. Acquisition Corp. Bridge Loan,
9.384% due 4/06/2015 10,000,000
--------------
22,710,753
======================================================================================================
Information Technology--0.9%
3,097,500 Fidelity National Information Solutions, Inc. Term
Loan B, 5.321% due 3/09/2013 3,105,244
3,366,563 Telcordia Technologies Inc. Term Loan,
6.51 - 6.61% due 9/15/2012 3,366,563
--------------
6,471,807
======================================================================================================
Manufacturing--0.7%
5,000,000 Invensys International Holdings Ltd. Second Lien
Term Loan, 8.529% due 12/04/2009 5,125,000
======================================================================================================
Metal--Other--1.0%
Euramax International Plc:
3,000,000 First Lien Term Loan, 6.125% due 6/29/2012 3,023,124
4,000,000 Second Lien Term Loan,
10.55% due 6/29/2013 4,060,000
--------------
7,083,124
======================================================================================================
Packaging--1.3%
2,350,057 Anchor Glass Container Corp. Second Lien
Revolving Credit, 10.57% due 9/26/2005 2,355,932
6,774,814 Owens-Illinois Group, Inc. French Tranche C-1,
5.45% due 4/01/2008 6,846,797
--------------
9,202,729
======================================================================================================
Service--0.6%
3,950,000 Waste Services, Inc. Tranche B Term Loan,
7.87% - 8.53% due 3/31/2011 4,019,125
======================================================================================================
Steel--0.0%
Acme Metals, Inc. Term Loan (i):
7,000,072 11.75% due 12/01/2005 0
711,758 12% due 12/01/2005 0
--------------
0
======================================================================================================
DEBT STRATEGIES FUND, INC. AUGUST 31, 2005 9
Schedule of Investments (continued) (in U.S. dollars)
Face
Amount Floating Rate Loan Interests* Value
======================================================================================================
Utility--2.2%
$ 7,840,000 Calpine Corp. Second Lien Term Loan,
9.349% due 7/15/2007 $ 6,417,040
5,000,000 Covanta Energy Corp. Second Lien Term Loan,
8.96% - 9.141% due 6/24/2013 5,037,500
El Paso Corp.:
1,500,000 Deposit Account, 2.77% due 11/23/2009 1,520,105
2,470,000 Term Loan, 6.438% due 11/23/2009 2,509,794
--------------
15,484,439
======================================================================================================
Wireless Communications--0.8%
5,910,000 Centennial Cellular Operating Co. Term Loan,
5.63% - 6.11% due 2/09/2011 6,011,315
------------------------------------------------------------------------------------------------------
Total Floating Rate Loan Interests
(Cost--$201,782,631)--27.9% 199,940,664
======================================================================================================
Shares
Held Common Stocks
======================================================================================================
Chemicals--0.7%
339,340 GEO Specialty Chemicals, Inc. (j) 2,884,390
82,516 Pioneer Cos., Inc. (j) 1,825,254
--------------
4,709,644
======================================================================================================
Energy--Other--0.8%
239,975 Trico Marine Services, Inc. (j) 5,449,832
======================================================================================================
Financial--0.4%
35,000 Preferred Term Securities VI (d)(j) 2,686,250
======================================================================================================
Food & Tobacco--0.5%
1,428,423 Viskase Cos., Inc. 3,428,215
======================================================================================================
Leisure--0.0%
27,787 Lodgian, Inc. (j) 290,930
======================================================================================================
Manufacturing--0.2%
724,291 ACP Holding Co. (d)(j) 1,448,582
======================================================================================================
Paper--0.1%
211,149 Western Forest Products, Inc. (j) 462,072
======================================================================================================
Service--0.5%
90,876 Outsourcing Solutions Inc. (j) 3,816,782
======================================================================================================
Steel--0.0%
41,149 Acme Package Corp. Senior Holdings (j)(l) 113,160
======================================================================================================
Telecommunications--0.1%
59,534 IDT Corp. Class B (j) 787,635
------------------------------------------------------------------------------------------------------
Total Common Stocks
(Cost--$17,333,780)--3.3% 23,193,102
======================================================================================================
Preferred Stocks
======================================================================================================
Automotive--0.6%
200,000 General Motors Corp. Series C, 6.25% (d)(k) 4,284,000
======================================================================================================
Broadcasting--0.0%
2 Paxson Communications Corp., 9.75% (b)(d)(k) 6,720
======================================================================================================
Shares
Held Preferred Stocks Value
======================================================================================================
Cable--U.S.--0.0%
5,000 Adelphia Communications Corp.,
Series B, 13% 1,000
------------------------------------------------------------------------------------------------------
Total Preferred Stocks
(Cost--$5,357,155)--0.6% 4,291,720
======================================================================================================
Warrants (g)
======================================================================================================
Broadcasting--0.0%
15,000 Sirius Satellite Radio, Inc. (expires 5/15/2009) 7,500
======================================================================================================
Health Care--0.0%
126,761 HealthSouth Corp. (expires 1/16/2014) 316,903
======================================================================================================
Manufacturing--0.2%
652,739 ACP Holding Co. (expires 9/30/2013) 1,305,478
======================================================================================================
Paper--0.0%
18 Cellu Tissue Holdings, Inc.
Series A (expires 9/28/2011) 174,044
7,000 MDP Acquisitions Plc (expires 10/01/2013) 35,000
--------------
209,044
======================================================================================================
Wireless Communications--0.1%
1,325 American Tower Corp. (expires 8/01/2008) 446,736
------------------------------------------------------------------------------------------------------
Total Warrants
(Cost--$870,754)--0.3% 2,285,661
======================================================================================================
Beneficial
Interest Other Interests (e)
======================================================================================================
Airlines--0.2%
$ 2,641,443 US Airways Group, Inc. (Certificate of
Beneficial Interest) 1,109,406
======================================================================================================
Automotive--0.0%
3,614,601 Cambridge Industries, Inc. (Litigation
Trust Certificates) (j) 36,146
======================================================================================================
Cable--U.S.--0.3%
9,500,000 Pegasus Satellite Communications, Inc.
(Litigation Trust Certificates) (j) 2,458,125
------------------------------------------------------------------------------------------------------
Total Other Interests
(Cost--$3,530,676)--0.5% 3,603,677
======================================================================================================
Short-Term Securities
======================================================================================================
$ 332,089 Merrill Lynch Liquidity Series, LLC Cash Sweep
Series I (h) 332,089
------------------------------------------------------------------------------------------------------
Total Short-Term Securities
(Cost--$332,089)--0.0% 332,089
======================================================================================================
Total Investments (Cost--$1,029,557,251**)--142.1% 1,018,911,570
Liabilities in Excess of Other Assets--(42.1%) (301,642,467)
--------------
Net Assets--100.0% $ 717,269,103
==============
10 DEBT STRATEGIES FUND, INC. AUGUST 31, 2005
Schedule of Investments (concluded) (in U.S. dollars)
* Floating rate loan interests in which the Fund invests generally pay
interest at rates that are periodically redetermined by reference to a
base lending rate plus a premium. The base lending rates are generally (i)
the lending rate offered by one or more European banks, such as LIBOR
(London Interbank Offered Rate), (ii) the prime rate offered by one or
more U.S. banks or (iii) the certificate of deposit rate.
** The cost and unrealized appreciation (depreciation) of investments as of
August 31, 2005, as computed for federal income tax purposes, were as
follows:
Aggregate cost .......................................... $1,029,317,429
==============
Gross unrealized appreciation ........................... $ 51,330,406
Gross unrealized depreciation ........................... (61,736,265)
--------------
Net unrealized depreciation ............................. $ (10,405,859)
==============
(a) Floating rate note.
(b) Represents a pay-in-kind security which may pay interest/dividends in
additional face/shares.
(c) Represents a step bond; the interest rate shown reflects the effective
yield at the time of purchase by the Fund.
(d) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(e) Other interests represent beneficial interest in liquidation trusts and
other reorganization entities.
(f) Mortgage-Backed Securities 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, for
purposes of Section 2(a)(3) of the Investment Company Act of 1940, were as
follows:
--------------------------------------------------------------------------
Net Interest
Affiliate Activity Income
--------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC
Cash Sweep Series I $128,407 $17,274
--------------------------------------------------------------------------
(i) Non-income producing security; issuer filed for bankruptcy or is in
default of interest payments.
(j) Non-income producing security.
(k) Convertible security.
(l) Restricted securities as to resale, representing 0.02% of net assets, were
as follows:
--------------------------------------------------------------------------
Acquisition
Issue Date Cost Value
--------------------------------------------------------------------------
Acme Package Corp.
Senior Holdings 11/25/2002 -- $113,160
--------------------------------------------------------------------------
(m) Issuer filed for bankruptcy.
For Fund compliance purposes, the Fund's industry classifications refer to
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. Industries are shown as a percent of net assets.
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. AUGUST 31, 2005 11
Statement of Assets, Liabilities and Capital
As of August 31, 2005
============================================================================================================================
Assets
----------------------------------------------------------------------------------------------------------------------------
Investments in unaffiliated securities, at value (identified
cost--$1,029,225,162) ........................................ $ 1,018,579,481
Investments in affiliated securities, at value (identified
cost--$332,089) .............................................. 332,089
Cash .......................................................... 19,111
Receivables:
Interest (including $3,030 from affiliates) ................ $ 16,768,458
Commitment fees ............................................ 1,028 16,769,486
---------------
Prepaid expenses and other assets ............................. 83,126
---------------
Total assets .................................................. 1,035,783,293
---------------
============================================================================================================================
Liabilities
----------------------------------------------------------------------------------------------------------------------------
Loans ......................................................... 317,100,000
Unfunded loan commitment ...................................... 32,500
Payables:
Investment adviser ......................................... 402,171
Dividends to shareholders .................................. 322,856
Interest on loans .......................................... 228,947
Other affiliates ........................................... 6,257
Securities purchased ....................................... 6,066 966,297
---------------
Accrued expenses and other liabilities ........................ 415,393
---------------
Total liabilities ............................................. 318,514,190
---------------
============================================================================================================================
Net Assets
----------------------------------------------------------------------------------------------------------------------------
Net assets .................................................... $ 717,269,103
===============
============================================================================================================================
Capital
----------------------------------------------------------------------------------------------------------------------------
Common Stock, $.10 par value, 200,000,000 shares authorized.... $ 10,557,036
Paid-in capital in excess of par .............................. 1,063,890,539
Undistributed investment income--net .......................... $ 5,999,314
Accumulated realized capital losses--net ...................... (352,509,404)
Unrealized depreciation--net .................................. (10,668,382)
---------------
Total accumulated losses--net ................................. (357,178,472)
---------------
Total capital--Equivalent to $6.79 per share based on
105,570,363 shares of Capital Stock outstanding
(market price--$6.70) ........................................ $ 717,269,103
===============
See Notes to Financial Statements.
12 DEBT STRATEGIES FUND, INC. AUGUST 31, 2005
Statement of Operations
For the Six Months Ended August 31, 2005
============================================================================================================================
Investment Income
----------------------------------------------------------------------------------------------------------------------------
Interest (including $17,274 from affiliates) .................. $ 41,997,030
Dividends ..................................................... 600,671
Facility and other fees ....................................... 595,842
---------------
Total income .................................................. 43,193,543
---------------
============================================================================================================================
Expenses
----------------------------------------------------------------------------------------------------------------------------
Loan interest expense ......................................... $ 5,041,550
Investment advisory fees ...................................... 3,058,867
Borrowing costs ............................................... 195,353
Accounting services ........................................... 115,544
Professional fees ............................................. 64,098
Transfer agent fees ........................................... 56,741
Listing fees .................................................. 37,745
Printing and shareholder reports .............................. 31,653
Custodian fees ................................................ 27,288
Directors' fees and expenses .................................. 21,618
Pricing services .............................................. 13,175
Other ......................................................... 12,934
---------------
Total expenses ................................................ 8,676,566
---------------
Investment income--net ........................................ 34,516,977
---------------
============================================================================================================================
Realized & Unrealized Loss--Net
----------------------------------------------------------------------------------------------------------------------------
Realized loss on investments--net ............................. (11,800,781)
Change in unrealized appreciation/depreciation on:
Investments--net ........................................... (17,131,730)
Unfunded corporate loans--net .............................. (69) (17,131,799)
----------------------------------
Total realized and unrealized loss--net ....................... (28,932,580)
---------------
Net Increase in Net Assets Resulting from Operations .......... $ 5,584,397
===============
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. AUGUST 31, 2005 13
Statements of Changes in Net Assets
For the Six For the
Months Ended Year Ended
August 31, February 28,
Increase (Decrease) in Net Assets: 2005 2005
============================================================================================================================
Operations
----------------------------------------------------------------------------------------------------------------------------
Investment income--net ........................................ $ 34,516,977 $ 70,429,602
Realized loss--net ............................................ (11,800,781) (553,188)
Change in unrealized appreciation/depreciation--net ........... (17,131,799) 35,909,565
----------------------------------
Net increase in net assets resulting from operations .......... 5,584,397 105,785,979
----------------------------------
============================================================================================================================
Dividends to Shareholders
----------------------------------------------------------------------------------------------------------------------------
Dividends to shareholders from investment income--net ......... (33,571,375) (69,339,355)
----------------------------------
============================================================================================================================
Capital Share Transactions
----------------------------------------------------------------------------------------------------------------------------
Value of shares issued in reinvestment of dividends ........... -- 2,548,243
----------------------------------
Net increase in net assets resulting from capital share
transactions ................................................. -- 2,548,243
----------------------------------
============================================================================================================================
Net Assets
----------------------------------------------------------------------------------------------------------------------------
Total increase (decrease) in net assets ....................... (27,986,978) 38,994,867
Beginning of period ........................................... 745,256,081 706,261,214
----------------------------------
End of period* ................................................ $ 717,269,103 $ 745,256,081
==================================
* Undistributed investment income--net ..................... $ 5,999,314 $ 5,053,712
==================================
See Notes to Financial Statements.
14 DEBT STRATEGIES FUND, INC. AUGUST 31, 2005
Statement of Cash Flows
For the Six Months Ended August 31, 2005
=========================================================================================================
Cash Provided by Operating Activities
---------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations ............ $ 5,584,397
Adjustments to reconcile net increase in net assets resulting
from operations to net cash provided by operating activities:...
Increase in receivables ...................................... (1,780,908)
Decrease in prepaid expenses and other assets ................ 142,028
Increase in other liabilities ................................ 483,283
Realized and unrealized loss--net ............................ 28,932,580
Amortization of premium and discount ......................... (2,941,031)
Proceeds from sales and paydowns of long-term securities ........ 224,874,955
Proceeds on other investment related transactions ............... 2,930,572
Purchases of long-term securities ............................... (247,482,506)
Purchases of short-term investments--net ........................ (128,407)
-------------
Net cash provided by operating activities ....................... 10,614,963
-------------
=========================================================================================================
Cash Used for Financing Activities
---------------------------------------------------------------------------------------------------------
Cash receipts from borrowings ................................... 209,200,000
Cash payments on borrowings ..................................... (190,500,000)
Dividends paid to shareholders .................................. (33,591,785)
-------------
Net cash used for financing activities .......................... (14,891,785)
-------------
=========================================================================================================
Cash
---------------------------------------------------------------------------------------------------------
Net decrease in cash ............................................ (4,276,822)
Cash at beginning of period ..................................... 4,295,933
-------------
Cash at end of period ........................................... $ 19,111
=============
=========================================================================================================
Cash Flow Information
---------------------------------------------------------------------------------------------------------
Cash paid for interest .......................................... $ 4,904,725
=============
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. AUGUST 31, 2005 15
Financial Highlights
For the Six For the For the For the Year Ended
Months Ended Year Ended Year Ended February 28,
The following per share data and ratios have been derived August 31, February 28, February 29, ----------------------
from information provided in the financial statements. 2005 2005 2004 2003 2002
================================================================================================================================
Per Share Operating Performance
--------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period ..... $ 7.06 $ 6.71 $ 5.35 $ 6.03 $ 7.53
-----------------------------------------------------------------
Investment income--net*** ................ .33 .67 .75 .79 .92
Realized and unrealized gain (loss)--net . (.28) .34 1.40 (.68) (1.49)
-----------------------------------------------------------------
Total from investment operations ......... .05 1.01 2.15 .11 (.57)
-----------------------------------------------------------------
Less dividends from investment income--net (.32) (.66) (.79) (.79) (.93)
-----------------------------------------------------------------
Recovery of previously expensed offering
costs (capital write-off) resulting from
the issuance of Common Stock ........... -- -- --+ -- --+
-----------------------------------------------------------------
Net asset value, end of period ........... $ 6.79 $ 7.06 $ 6.71 $ 5.35 $ 6.03
=================================================================
Market price per share, end of period .... $ 6.70 $ 6.71 $ 6.69 $ 5.99 $ 6.57
=================================================================
================================================================================================================================
Total Investment Return**
--------------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share ....... .93%@ 15.95% 41.84% 2.04% (7.89%)
=================================================================
Based on market price per share .......... 4.78%@ 10.53% 26.31% 4.85% 5.69%
=================================================================
================================================================================================================================
Ratios to Average Net Assets
--------------------------------------------------------------------------------------------------------------------------------
Expenses, excluding interest expense ..... 1.01%* 1.02% 1.00% 1.07% 1.04%
=================================================================
Expenses ................................. 2.41%* 1.83% 1.53% 1.91% 2.59%
=================================================================
Investment income--net ................... 9.61%* 9.84% 12.22% 14.32% 13.69%
=================================================================
================================================================================================================================
Leverage
--------------------------------------------------------------------------------------------------------------------------------
Amount of borrowings, end of period (in
thousands) ............................. $317,100 $298,400 $269,075 $245,900 $273,600
=================================================================
Average amount of borrowings outstanding
during the period (in thousands) ....... $298,546 $304,549 $239,315 $238,863 $280,460
=================================================================
Average amount of borrowings outstanding
per share during the period*** ......... $ 2.83 $ 2.89 $ 2.29 $ 2.31 $ 2.75
=================================================================
================================================================================================================================
Supplemental Data
--------------------------------------------------------------------------------------------------------------------------------
Net assets, end of period (in thousands) . $717,269 $745,256 $706,261 $557,068 $620,043
=================================================================
Portfolio turnover ....................... 21.26% 60.11% 70.43% 64.54% 49.58%
=================================================================
* Annualized.
** Total investment returns based on market value, which can be significantly
greater or lesser than the net asset value, may result in substantially
different returns. Total investment returns exclude the effects of sales
charges.
*** Based on average shares outstanding.
+ Amount is less than $.01 per share.
@ Aggregate total investment return.
See Notes to Financial Statements.
16 DEBT STRATEGIES FUND, INC. AUGUST 31, 2005
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 U.S. generally accepted accounting principles, which may require the use of
management accruals and estimates. Actual results may differ from these
estimates. These unaudited financial statements reflect all adjustments, which
are, in the opinion of management, necessary to present a fair statement of the
results for the interim period. All such adjustments are of a normal, recurring
nature. The Fund determines and makes available for publication the net asset
value of its Common Stock on a daily basis. The Fund's Common Stock shares are
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 floating rate 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 floating rate loans could
be considered concentrated in financial institutions.
(b) Valuation of investments -- Floating rate loans are valued in accordance
with guidelines established by the Board of Directors. Floating rate 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 floating rate loans for which no reliable price quotes are
available, such floating rate loans will be valued by Loan Pricing Corporation
through the use of pricing matrixes to determine valuations. If the pricing
service does not provide a value for floating rate loans, the Investment Adviser
will value the floating rate loans 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 asked 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 Directors 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. Floating rate loan interests are valued at the
mean between the last available bid and asked prices from one or more brokers or
dealers as obtained from a pricing service. Short positions in securities traded
in the OTC market are valued at the last available asked 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 asked 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. Swap agreements are valued based upon quoted fair valuations
received daily by the Fund from a pricing service or counterparty. 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 Board of 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 Board of Directors. Such valuations and procedures
will be reviewed periodically by the Board of 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
DEBT STRATEGIES FUND, INC. AUGUST 31, 2005 17
Notes to Financial Statements (continued)
the times at which they are determined and the close of business on the NYSE
that may not be reflected in the computation of the Fund's net asset value. If
events (for example, a company announcement, market volatility or a natural
disaster) occur during such periods that are expected to materially affect the
value of such securities, those securities may be valued at their fair value as
determined in good faith by the Board of Directors or by the Investment Adviser
using a pricing service and/or procedures approved by the Board of Directors.
(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. These periodic payments received or made by the Fund are
recorded in the accompanying Statement of Operations as realized gains or
losses, respectively. Gains or losses are also realized upon termination
of the swap agreements. Swaps are marked-to-market daily and changes in
value are recorded as unrealized appreciation (depreciation). Risks
include changes in the returns of the underlying instruments, failure of
the counterparties to perform under the contracts' terms and the possible
lack of liquidity with respect to the swap agreements.
(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
18 DEBT STRATEGIES FUND, INC. AUGUST 31, 2005
Notes to Financial Statements (continued)
federal income tax provision is required. Under the applicable foreign tax law,
a withholding tax may be imposed on interest, dividends and capital gains at
various rates.
(f) Security transactions and investment income -- Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Interest income is recognized on the accrual basis. The Fund amortizes all
premiums and discounts on debt securities.
(g) Dividends and distributions -- Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates.
(h) Securities lending -- The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it collects a fee from the borrower. The Fund typically receives the income on
the loaned securities but does not receive the income on the collateral. Where
the Fund receives cash collateral, it may invest such collateral and retain the
amount earned on such investment, net of any amount rebated to the borrower.
Loans of securities are terminable at any time and the borrower, after notice,
is required to return borrowed securities within five business days. The Fund
may pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
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 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.
The Fund has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated, an affiliate of FAM, or its affiliates. Pursuant to
that order, the Fund also has retained Merrill Lynch Investment Managers, LLC
("MLIM, LLC"), an affiliate of FAM, as the securities lending agent for a fee
based on a share of the returns on investment of cash collateral. MLIM, LLC may,
on behalf of the Fund, invest cash collateral received by the Fund for such
loans, among other things, in a private investment company managed by MLIM, LLC
or in registered money market funds advised by FAM or its affiliates.
For the six months ended August 31, 2005, the Fund reimbursed FAM $8,050 for
certain accounting services.
Certain officers and/or directors of the Fund are officers and/or directors of
FAM, PSI, ML & Co., and/or MLIM, LLC.
3. Investments:
Purchases and sales (including paydowns) of investments, excluding short-term
securities, for the six months ended August 31, 2005 were $242,780,552 and
$213,410,682, respectively.
DEBT STRATEGIES FUND, INC. AUGUST 31, 2005 19
Notes to Financial Statements (concluded)
4. Capital Share Transactions:
The Fund is authorized to issue 200,000,000 shares of Common Stock, par value
$.10 per share. Shares issued and outstanding during the six months ended August
31, 2005 remained constant and during the year ended February 28, 2005 increased
by 374,356 as a result of dividend reinvestment.
5. Unfunded Loan Interests:
As of August 31, 2005, the Fund had unfunded loan commitments of approximately
$1,000,000, which would be extended at the option of the borrower, pursuant to
the following loan agreement:
--------------------------------------------------------------------------------
Unfunded
Commitment
Borrower (in Thousands)
--------------------------------------------------------------------------------
Quest Cherokee LLC .................................................... $1,000
--------------------------------------------------------------------------------
6. Short-Term Borrowings:
On May 24, 2005, the Fund renewed its revolving credit and security agreement
funded by a commercial paper asset securitization program with Citigroup North
America, Inc. ("Citigroup") as Agent, certain secondary backstop lenders, and
certain asset securitization conduits as lenders (the "Lenders"). The agreement
was renewed for one year and has a maximum limit of $370,000,000. Under the
Citigroup program, the conduits will fund advances to the Fund through the
issuance of highly rated commercial paper. As security for its obligations to
the Lenders under the revolving securitization facility, the Fund has granted a
security interest in substantially all of its assets to and in favor of the
Lenders. The interest rate on the Fund's borrowings is based on the interest
rate carried by the commercial paper plus a program fee. The Fund pays
additional borrowing costs including a backstop commitment fee.
The weighted average annual interest rate was 3.35% and the average borrowing
was approximately $298,546,000 for the six months ended August 31, 2005.
7. Capital Loss Carryforward:
On February 28, 2005, the Fund had a net capital loss carryforward of
$326,319,995, of which $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, $17,223,475 expires in 2012 and $21,126,025
expires in 2013. This amount will be available to offset like amounts of any
future taxable gains.
8. Subsequent Event:
The Fund paid an ordinary income dividend in the amount of $.053000 per share on
September 30, 2005 to shareholders of record on September 14, 2005.
20 DEBT STRATEGIES FUND, INC. AUGUST 31, 2005
Disclosure of Investment Advisory Agreement
Activities of and Composition of the Board of Directors
All but one member of the Board of Directors is an independent director whose
only affiliation with Fund Asset Management, L.P. (the "Investment Adviser") or
other Merrill Lynch affiliates is as a director of the Fund and certain other
funds advised by the Investment Adviser or its affiliates. The Chairman of the
Board is also an independent director. New director nominees are chosen as
nominees by a Nominating Committee comprised of independent directors. All
independent directors also are members of the Board's Audit Committee and the
independent directors meet in executive session at each in-person Board meeting.
The Board and the Audit Committee meet in person for at least two days each
quarter and conduct other in-person and telephone meetings throughout the year,
some of which are formal board meetings, and some of which are informational
meetings. The independent counsel to the independent directors attends all
in-person Board and Audit Committee meetings and other meetings at the
independent directors' request.
Investment Advisory Agreement -- Matters Considered by the Board
Every year, the Board considers approval of the Fund's investment advisory
agreement (the "Investment Advisory Agreement"). The Board assesses the nature,
scope and quality of the services provided to the Fund by the personnel of the
Investment Adviser and its affiliates, including administrative services,
shareholder services, oversight of fund accounting, marketing services and
assistance in meeting legal and regulatory requirements. The Board also receives
and assesses information regarding the services provided to the Fund by certain
unaffiliated service providers.
At various times throughout the year, the Board also considers a range of
information in connection with its oversight of the services provided by the
Investment Adviser and its affiliates. Among the matters considered are: (a)
fees (in addition to management fees) paid to the Investment Adviser and its
affiliates by the Fund, such as transfer agency fees; (b) Fund operating
expenses paid to third parties; (c) the resources devoted to and compliance
reports relating to the Fund's investment objective, policies and restrictions,
and its compliance with its Code of Ethics and the Investment Adviser's
compliance policies and procedures; and (d) the nature, cost and character of
non-investment management services provided by the Investment Adviser and its
affiliates.
The Board believes that the Investment Adviser is one of the most experienced
global asset management firms and considers the overall services provided by the
Investment Adviser to be generally of high quality. The Board also believes that
the Investment Adviser is financially sound and well managed and notes that the
Investment Adviser is affiliated with one of America's largest financial firms.
The Board works closely with the Investment Adviser in overseeing the Investment
Adviser's efforts to achieve good performance. As part of this effort, the Board
discusses portfolio manager effectiveness and, when performance is not
satisfactory, discusses with the Investment Adviser taking steps such as
changing investment personnel.
Annual Consideration of Approval by the Board of Directors
In the period prior to the Board meeting to consider renewal of the Investment
Advisory Agreement, the Board requested and received materials specifically
relating to the Fund's Investment Advisory Agreement. These materials included
(a) information compiled by Lipper Inc. ("Lipper") on the fees and expenses and
the investment performance of the Fund as compared to a comparable group of
funds as classified by Lipper; (b) information comparing the Fund's market price
with its net asset value per share; (c) a discussion by the Fund's portfolio
management team of investment strategies used by the Fund during its most recent
fiscal year; (d) information on the profitability to the Investment Adviser and
its affiliates of the Investment Advisory Agreement and other relationships with
the Fund; and (e) information provided by the Investment Adviser concerning
investment advisory fees charged to other clients, such as offshore funds under
similar investment mandates and generally to institutional clients. The Board
also considers other matters it deems important to the approval process such as
services related to the valuation and pricing of Fund portfolio holdings,
allocation of Fund brokerage fees (including the related benefits to the
Investment Adviser of "soft dollars"), the Fund's portfolio turnover statistics,
and direct and indirect benefits to the Investment Adviser and its affiliates
from their relationship with the Fund.
Certain Specific Renewal Data
In connection with the most recent renewal of the Fund's Investment Advisory
Agreement in August 2005, the independent directors' and Board's review included
the following:
DEBT STRATEGIES FUND, INC. AUGUST 31, 2005 21
Disclosure of Investment Advisory Agreement (concluded)
Services Provided by the Investment Adviser -- The Board reviewed the nature,
extent and quality of services provided by the Investment Adviser, including the
investment advisory services and the resulting performance of the Fund. The
Board focused primarily on the Investment Adviser's investment advisory services
and the Fund's investment performance, having concluded that the other services
provided to the Fund by the Investment Adviser were satisfactory. The Board
compared Fund performance -- both including and excluding the effects of the
Fund's fees and expenses -- to the performance of a comparable group of mutual
funds, and the performance of a relevant index or combination of indexes. While
the Board reviews performance data at least quarterly, consistent with the
Investment Adviser's investment goals, the Board attaches more importance to
performance over relatively long periods of time, typically three to five years.
The Fund's performance after fees and expenses ranked in the third quintile
compared to its peers for the one-year period ended May 31, 2005; in the first
quintile compared to its peers for the three-year period ended May 31, 2005; and
in the second quintile compared to its peers for the five-year period ended May
31, 2005. Considering these factors, the Board concluded that the Fund's
performance supported the continuation of the Investment Advisory Agreement.
The Investment Adviser's Personnel and Investment Process -- The Board reviewed
the Fund's investment objectives and strategies. The Board discussed with senior
management of the Investment Adviser responsible for investment operations and
the senior management of the Investment Adviser's taxable fixed-income investing
group the strategies being used to achieve the stated objectives. Among other
things, the Board considered the size, education and experience of the
Investment Adviser's investment staff, its use of technology, and the Investment
Adviser's approach to training and retaining portfolio managers and other
research, advisory and management personnel. The Board also reviewed the
Investment Adviser's compensation policies and practices with respect to the
Fund's portfolio manager. The Board also considered the experience of the Fund's
portfolio manager and noted that Mr. Booth has more than twenty years experience
in the financial industry. The Board noted that the Investment Adviser and its
investment staff have extensive experience in analyzing and managing the types
of investments used by the Fund. The Board concluded that the Fund benefits from
that expertise.
Management Fees and Other Expenses -- The Board reviewed the Fund's contractual
management fee rate and actual management fee rate as a percentage of total
assets at common asset levels -- the actual rate includes advisory and
administrative service fees and the effects of any fee waivers -- compared to
the other funds in its Lipper category. It also compared the Fund's total
expenses to those of other comparable funds. The Board considered the services
provided to and the fees charged by the Investment Adviser to other types of
clients, such as offshore funds, with similar investment mandates and noted that
the fees charged by the Investment Adviser in those cases typically exceeded
those being charged to the Fund. The Board also noted that, as a general matter,
fees charged to institutional clients were lower than the fees charged to the
Fund, but believed that less extensive services were being provided to such
clients. The Fund's contractual and actual management fee rates were lower than
the median fees charged by comparable funds, as determined by Lipper. The Board
has concluded that the Fund's management fee and fee rate and overall expense
ratio are acceptable compared to those of other comparable funds.
Profitability -- The Board considered the cost of the services provided to the
Fund by the Investment Adviser, and the Investment Adviser's and its affiliates'
profits in relating to the management of the Fund and the MLIM/FAM-advised
funds. As part of its analysis, the Board reviewed the Investment Adviser's
methodology in allocating its costs to the management of the Fund and concluded
that there was a reasonable basis for the allocation. The Board believes the
Investment Adviser's profits are acceptable in relation to the nature and
quality of services provided and given the level of fees and expenses overall.
Economies of Scale -- The Board considered whether there have been economies of
scale in respect of the management of MLIM/FAM-advised funds, whether the
MLIM/FAM-advised funds (including the Fund) have appropriately benefited from
any economies of scale, and whether there is potential for realization of any
further economies of scale. The Board considered economies of scale to the
extent applicable to the Fund's closed-end structure and determined that no
changes were currently necessary.
Conclusion
After the independent directors deliberated in executive session, the entire
Board, including all of the independent directors, approved the renewal of the
existing Investment Advisory Agreement, concluding that the advisory fee was
reasonable in relation to the services provided and that a contract renewal was
in the best interests of the shareholders.
22 DEBT STRATEGIES FUND, INC. AUGUST 31, 2005
Officers and Directors
Robert C. Doll, Jr., President and Director
Ronald Forbes, Director
Cynthia A. Montgomery, Director
Jean Margo Reid, Director
Roscoe S. Suddarth, Director
Richard R. West, Director
Edward D. Zinbarg, Director
Kevin J. Booth, Vice President
Donald C. Burke, Vice President and Treasurer
Jeffrey Hiller, Chief Compliance Officer
Alice A. Pellegrino, Secretary
Custodian
The Bank of New York
100 Church Street
New York, NY 10286
Transfer Agent
The Bank of New York
101 Barclay Street -- 11 East
New York, NY 10286
NYSE Symbol
DSU
Proxy Results
During the six-month period ended August 31, 2005, Debt Strategies Fund, Inc.`s
shareholders voted on the following proposal. The proposal was approved at a
shareholders' meeting on August 23, 2005. A description of the proposal and
number of shares voted are as follows:
-----------------------------------------------------------------------------------------------------------
Shares Voted Shares Withheld
For From Voting
-----------------------------------------------------------------------------------------------------------
1. To elect the Fund's Board of Directors: Robert C. Doll, Jr. 94,401,550 3,085,279
Ronald W. Forbes 94,495,122 2,991,707
Cynthia A. Montgomery 94,356,298 3,130,531
Jean Margo Reid 94,382,462 3,104,367
Roscoe S. Suddarth 94,439,957 3,046,872
Richard R. West 94,438,602 3,048,227
Edward D. Zinbarg 94,338,933 3,147,896
-----------------------------------------------------------------------------------------------------------
Availability of Quarterly Schedule of Investments
The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission ("SEC") for the first and third quarters of each fiscal
year on Form N-Q. The Fund's Forms N-Q are available on the SEC's Web site at
http://www.sec.gov. The Fund's Forms N-Q may also be reviewed and copied at the
SEC's Public Reference Room in Washington, DC. Information on the operation of
the Public Reference Room may be obtained by calling 1-800-SEC-0330.
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 Web
site at 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.
DEBT STRATEGIES FUND, INC. AUGUST 31, 2005 23
[LOGO] Merrill Lynch Investment Managers
www.mlim.ml.com
--------------------------------------------------------------------------------
Mercury Advisors
A Division of Merrill Lynch Investment Managers
www.mercury.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)
at www.mutualfunds.ml.com; and (3) on the Securities and Exchange Commission's
Web site at http://www.sec.gov. Information about how the Fund voted proxies
relating to securities held in the Fund's portfolio during the most recent
12-month period ended June 30 is available (1) at www.mutualfunds.ml.com and (2)
on the Securities and Exchange Commission's Web site at http://www.sec.gov.
Debt Strategies Fund, Inc.
Box 9011
Princeton, NJ 08543-9011
#DEBT -- 8/05
Item 2 - Code of Ethics - Not Applicable to this semi-annual report
Item 3 - Audit Committee Financial Expert - Not Applicable to this semi-annual
report
Item 4 - Principal Accountant Fees and Services - Not Applicable to this
semi-annual report
Item 5 - Audit Committee of Listed Registrants - Not Applicable to this
semi-annual report
Item 6 - Schedule of Investments - Not Applicable
Item 7 - Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies - Not Applicable to this semi-annual
report
Item 8 - Portfolio Managers of Closed-End Management Investment Companies - Not
Applicable to this semi-annual report
Item 9 - Purchases of Equity Securities by Closed-End Management Investment
Company and Affiliated Purchasers - Not Applicable
Item 10 - Submission of Matters to a Vote of Security Holders - Not Applicable
Item 11 - Controls and Procedures
11(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.
11(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 last 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 12 - Exhibits attached hereto
12(a)(1) - Code of Ethics - Not Applicable to this semi-annual report
12(a)(2) - Certifications - Attached hereto
12(a)(3) - Not Applicable
12(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/ Robert C. Doll, Jr.
---------------------------
Robert C. Doll, Jr.,
Chief Executive Officer of
Debt Strategies Fund, Inc.
Date: October 19, 2005
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/ Robert C. Doll, Jr.
---------------------------
Robert C. Doll, Jr.,
Chief Executive Officer of
Debt Strategies Fund, Inc.
Date: October 19, 2005
By: /s/ Donald C. Burke
---------------------------
Donald C. Burke,
Chief Financial Officer of
Debt Strategies Fund, Inc.
Date: October 19, 2005