As Filed Electronically with the Securities and Exchange Commission on March 3, 2009

Registration No. 333-156464

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM N-14

REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933 o

Pre-Effective Amendment No. 2 þ Post-Effective Amendment No. __ o

HIGHLAND CREDIT STRATEGIES FUND

NexBank Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240
(Address of Principal Executive Offices) (Zip Code)

877-665-1287
(Registrant’s Area Code and Telephone Number)

With copies to:

Approximate date of proposed public offering: As soon as practicable after the effective date of this Registration Statement.

Calculation of Registration Fee Under the Securities Act of 1933:

Proposed Maximum

Proposed Maximum

Title of Securities

Amount Being

Offering Price Per

Aggregate Offering

Amount of

Being Registered

Registered (1)

Unit (1)

Price (1)

Registration Fee

Common Stock (par value $0.001)

9,750,000

$6.83

(2)

$66,592,500

$2,617.09

(3)

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission acting pursuant to said section 8(a), may determine.

 

 

Highland Distressed Opportunities, Inc.
NexBank Tower
13455 Noel Road, Suite 800
Dallas, Texas 75240

Special Meeting of Stockholders to be held April 9, 2009

March 5, 2009

Dear Stockholder:

     You are being asked to vote on a proposed merger of Highland Distressed Opportunities, Inc. (“Acquired Fund”) into Highland Credit Strategies Fund (“Acquiring Fund” and together with the Acquired Fund, the “Funds”), as further described below. As a result of the merger, your common shares in the Acquired Fund will be converted to common shares of the Acquiring Fund (and cash in lieu of any fractional shares). The conversion will be done on the basis of the relative net asset values of the two Funds.

     The Board of Directors of the Acquired Fund has called a special meeting of stockholders of the Acquired Fund (the “Meeting”) to be held at The Westin Galleria Dallas, 13340 Dallas Parkway, Dallas, TX 75240 — Austin I Conference Room, 2nd Floor, on April 9, 2009, at 8:00 a.m. Central Time, so that stockholders can vote on an Agreement and Plan of Merger and Liquidation (“Agreement”). The Agreement provides for the merger of Acquired Fund with and into HCF Acquisition LLC (“Merger Sub”), a Delaware limited liability company to be organized as a wholly owned subsidiary of the Acquiring Fund (the “Merger”), with Merger Sub being the surviving entity (although it will exist only for a short period of time, as noted below) and pursuant to which common stockholders of Acquired Fund will receive shares of beneficial interest of Acquiring Fund (and cash in lieu of any fractional shares). Immediately after the Merger, Merger Sub will distribute its assets to Acquiring Fund, and Acquiring Fund will assume the liabilities of Merger Sub, in complete liquidation and dissolution of Merger Sub (collectively with the Merger, the “Reorganization”). It is expected that the liquidation and dissolution of Merger Sub will occur shortly after the effective time of the Merger. As a result of the Reorganization, each common stockholder of the Acquired Fund will become a common shareholder of the Acquiring Fund. The attached combined Proxy Statement and Prospectus includes detailed information about the proposed Reorganization and Agreement. After careful consideration, the Board of the Acquired Fund unanimously recommends that you support the Reorganization and vote “FOR” the proposed Agreement.

     The investment objective of the Acquired Fund is similar to that of the Acquiring Fund in that both emphasize capital appreciation and current income, although current income may be relatively more important for the Acquiring Fund and capital appreciation relatively more important for the Acquired Fund. In addition the Funds’ investment policies, strategies and risks are similar in that both invest a substantial portion of their assets in senior loans and below investment grade bonds. Highland Capital Management, L.P. is the investment adviser to each Fund.

     Your vote is very important to us regardless of the number of shares you own. Whether or not you plan to attend the Meeting in person, please read the Proxy Statement and Prospectus and cast your vote promptly. To vote, simply date, sign and return the proxy card in the enclosed postage-paid envelope or follow the instructions on the proxy card for voting by touch-tone telephone or on the Internet.

     It is important that your vote be received no later than the time of the Meeting.

Sincerely,

R. Joseph Dougherty
Chairman of the Board
Highland Distressed Opportunities, Inc.

IMPORTANT NOTICE

TO STOCKHOLDERS OF
HIGHLAND DISTRESSED OPPORTUNITIES, INC.

QUESTIONS & ANSWERS

Although we recommend that you read the complete Proxy Statement and Prospectus (“Proxy Statement/Prospectus”), we have provided for your convenience a brief overview of the proposals to be voted on at the special meeting of stockholders.

APPROVAL OF REORGANIZATION OF THE ACQUIRED FUND

Q: WHAT IS BEING PROPOSED AT THE STOCKHOLDER MEETING?

A: You are being asked to vote on a proposed merger of Highland Distressed Opportunities, Inc. (“Acquired Fund”) into Highland Credit Strategies Fund (“Acquiring Fund” and together with the Acquired Fund, the “Funds”), as further described below. As a result of the merger, your common shares in Acquired Fund will be converted to common shares of the Acquiring Fund (and cash in lieu of any fractional shares). The conversion will be done on the basis of the relative net asset values of the two Funds. The proposed Reorganization involves the merger of Acquired Fund with and into HCF Acquisition LLC (“Merger Sub”), a Delaware limited liability company to be organized as a wholly owned subsidiary of Acquiring Fund, followed by the subsequent liquidation and dissolution of Merger Sub. This type of transaction is sometimes referred to as a “triangular merger”. The proposed Reorganization is structured as a triangular merger in order to address the requirements of provisions in the Acquired Fund’s charter documents that are intended to deter “hostile takeovers” and other transactions which the Board of the Acquired Fund may not consider to be in the best interests of Acquired Fund’s shareholders. Acquired Fund is a closed-end company that has elected to be regulated as a business development company under the 1940 Act. Acquiring Fund is a closed-end registered investment company that pursues similar (although not identical) investment strategies to those of the Acquired Fund and is managed by Highland Capital Management, L.P. (“Highland”), the same investment adviser as that of the Acquired Fund. The Acquiring Fund does not expect any material changes in its portfolio holdings after the proposed Reorganization, other than changes made in the ordinary course.

Unlike the Acquired Fund, the Acquiring Fund is not subject to the requirements applicable to business development companies, although it is subject to the requirements applicable to registered investment companies. For example, the Acquiring Fund has more flexibility in the types of instruments and issuers in which it can invest. The Acquired Fund is required to invest at least 70% of its total assets in certain “qualifying assets,” including securities of “eligible portfolio companies” as defined in the 1940 Act and the rules thereunder, while the Acquiring Fund is not subject to these requirements. In addition, unlike the Acquired Fund, the Acquiring Fund is not required to offer “significant managerial assistance” (within the meaning of the 1940 Act) to its portfolio companies. Restrictions on issuance of senior securities also differ between the Funds: while under the 1940 Act the Acquired Fund is permitted to issue senior securities representing indebtedness if such securities have an asset coverage of at least 200%, the Acquiring Fund may only issue such senior securities if they have an asset coverage of at least 300%. This means that under the 1940 Act the Acquiring Fund is generally not permitted to borrow as much as the Acquired Fund.

Q: WHY IS THE REORGANIZATION BEING RECOMMENDED?

A: The Board of Directors of the Acquired Fund has determined that the Reorganization should benefit its common stockholders. The Board of Trustees of the Acquiring Fund has determined that the Reorganization should benefit its common shareholders. The investment objective of the Acquired Fund and the Acquiring Fund are similar in that both emphasize capital appreciation and current income, although current income may be relatively more important for the Acquiring Fund and capital appreciation relatively more important for the Acquired Fund. Also the Funds seek to achieve their objectives in similar ways by investing a substantial portion of their assets in senior loans and below investment grade bonds. Each Fund is managed by the same investment adviser and has the same members on its Board. The Acquired Fund does not intend to make any material changes in its portfolio before the Reorganization, other than selling portfolio securities, when appropriate, to reduce Acquired Fund’s outstanding borrowings and in connection with normal portfolio management activities.

In reaching this determination, the Board of Directors of the Acquired Fund also considered that if stockholders approve the Reorganization, the annual operating expenses of the combined Fund are expected to be lower than the Acquired Fund’s current annual operating expenses. This is primarily due to the Acquiring Fund’s lower advisory and administration fees and lack of an incentive fee. As of each Fund’s twelve months ended December 31, 2008, the total annual operating expenses, including costs of leverage, as a percentage of average net assets, of the Acquired Fund and the Acquiring Fund were 9.18% and 3.94%, respectively. Assuming the Reorganization is approved, the estimated total annual operating expenses of the combined Fund would be 3.87% of average net assets and, with the contractual fee waivers currently in place, the estimated net annual operating expenses of the combined Fund would be 3.80% of average net assets.

The Proxy Statement/Prospectus contains further explanation of the reasons that the Boards of Directors/Trustees of the Funds unanimously recommend the Reorganization.

Q: HOW DOES THE ACQUIRING FUND’S INVESTMENT OBJECTIVE AND INVESTMENT STRATEGY DIFFER FROM MY FUND’S?

A: The Acquiring Fund is registered as a non-diversified, closed-end management investment company under the Investment Company Act of 1940, as amended (the “1940 Act”). The Acquiring Fund’s investment objective is to provide both current income and capital appreciation. The Acquiring Fund invests at least 80% of its assets in the

following categories of securities and instruments of corporations and other business entities: (i) secured and unsecured floating and fixed rate loans; (ii) bonds and other debt obligations; (iii) debt obligations of stressed, distressed and bankrupt issuers; (iv) structured products, including but not limited to, mortgage-backed and other asset-backed securities and collateralized debt obligations; and (v) equities. A significant portion of the Acquiring Fund’s assets may be invested in securities rated below investment grade (Ba/BB or lower), which are commonly referred to as “junk securities.” Both Funds have broad investment mandates that allow them to invest in many types of securities. The Acquiring Fund may also engage in short sales, while the Acquired Fund currently does not. See “Risk Factors and Special Considerations” for more information.

The Acquired Fund is a closed-end company under the 1940 Act that has elected to be regulated as a business development company under the 1940 Act. The Acquired Fund’s investment objective is to provide total return generated by both capital appreciation and current income. The Acquired Fund invests primarily in financially-troubled or distressed companies that are either middle-market companies or unlisted companies. The Acquired Fund seeks to achieve its objective by investing in senior secured debt, mezzanine debt and unsecured debt, each of which may include an equity component, and in equity investments. Generally, distressed companies are those that (i) are facing financial or other difficulties and (ii) are or have been operating under the provisions of the U.S. Bankruptcy Code or other similar laws or, in the near future, may become subject to such provisions or otherwise be involved in a restructuring of their capital structure. The term “middle-market” refers to companies with annual revenues between $50 million and $1 billion. The term “unlisted” refers to companies not listed on a national securities exchange (for example, companies whose securities are quoted on the over-the-counter bulletin board or through Pink Sheets LLC would not be “listed” on a national securities exchange, although they may be considered “public” companies).

Both Funds invest a substantial portion of their assets in senior loans and below investment grade bonds. As of December 31, 2008, the Acquired Fund and the Acquiring Fund invested 75.25% and 91.44% of their assets, respectively, in senior loans and below investment grade bonds. In addition, as of December 31, 2008, 78.21% of the assets in the Acquired Fund’s portfolio represented issuers whose securities were also owned by the Acquiring Fund.

Q: HOW WILL THE REORGANIZATION AFFECT ME?

A: If stockholders approve the Reorganization and you are a holder of common stock of the Acquired Fund, you will receive newly issued common shares of the Acquiring Fund (and cash for any fractional common shares), the aggregate net asset value of which will equal the aggregate net asset value, taking into account the Acquired Fund’s proportionate share of the costs of the Reorganization, of the common stock you held immediately prior to the Reorganization. The Acquiring Fund common shares received by Acquired Fund common stockholders will trade on New York Stock Exchange and will likely trade at a discount from net asset value, which might be greater or less than the trading discount of the Acquired Fund’s common stock at the time of the closing of the Reorganization.

Q: WILL I HAVE TO PAY ANY SALES LOAD, COMMISSION OR OTHER SIMILAR FEE IN CONNECTION WITH THE REORGANIZATION?

A: You will pay no sales loads or commissions in connection with the Reorganization. However, part of the costs associated with the Reorganization will be borne by the Acquired Fund and thus indirectly by its common stockholders.

Q: WILL MY DIVIDENDS BE AFFECTED BY THE PROPOSED REORGANIZATION?

A: If you are a common stockholder of the Acquired Fund, you receive distributions, which may contain returns of capital, on a quarterly basis. As shareholders of the Acquiring Fund, you will receive distributions, which may contain returns of capital, on a monthly basis. The rate of a Fund’s distribution may vary from one distribution to another. The distribution is not guaranteed and maybe reduced or eliminated. The Acquiring Fund’s current yield as of December 31, 2008 on a net asset value basis is higher than that of the Acquired Fund. There is no guarantee that the Acquiring Fund’s yield will continue at its current levels, and may decline.

The Acquiring Fund will not permit any holder of certificated common stock of the Acquired Fund at the time of the Reorganization to reinvest dividends or other distributions, transfer shares of the Acquiring Fund or pledge shares of

the Acquiring Fund until the certificates for stock of the Acquired Fund have been surrendered to PNC Global Investment Servicing (U.S.) Inc. (“PNC”), the Acquiring Fund’s transfer agent, or, in the case of lost certificates, until an adequate surety bond has been posted. To obtain information on how to return your stock certificates for the Acquired Fund if and when the Reorganization is completed, please call PNC at 877-247-1888.

If a shareholder is not, for the reasons above, permitted to reinvest dividends or other distributions on shares of the Acquiring Fund, the Acquiring Fund will pay all such dividends and other distributions in cash, notwithstanding any election the shareholder may have made previously to reinvest dividends and other distributions on stock of the Acquired Fund.

Q: WILL I HAVE TO PAY ANY FEDERAL INCOME TAXES AS A RESULT OF THE REORGANIZATION?

A: The Reorganization is intended to qualify as a “reorganization” within the meaning of Section 368(a)(1) of the Internal Revenue Code of 1986, as amended. If the Reorganization so qualifies, in general, stockholders of the Acquired Fund will not recognize gain or loss upon the conversion of their Acquired Fund shares solely into shares of the Acquiring Fund in connection with the Reorganization. However, stockholders of the Acquired Fund generally will recognize gain or loss with respect to any cash such holders receive pursuant to the Reorganization in lieu of the conversion of their Acquired Fund shares into fractional shares of Acquiring Fund to the extent any such cash received is greater or less (as the case may be) than the tax basis allocable to the fractional shares. Additionally, if the Reorganization so qualifies, the Acquired Fund will not recognize gain or loss directly as a result of the Reorganization. It is expected that a distribution or distributions of net income and net short-term and long-term capital gain will be made by the Acquired Fund shortly prior to the closing of the Reorganization, which generally will be taxable to Acquired Fund shareholders and neither the Acquiring Fund nor its shareholders will recognize any gain or loss directly in connection with the Reorganization. Should the Board decide to consummate the Reorganization even if it does not qualify as a “reorganization” within the meaning of Section 368(a)(1), it will notify Acquired Fund stockholders and re-solicit proxies. See “Federal Income Tax Consequences of the Reorganization” beginning on page 64.

Q: DO I HAVE THE RIGHT TO SEEK APPRAISAL OF THE “FAIR CASH VALUE” OF MY SHARES OF COMMON STOCK IF THE MERGER IS COMPLETED?

A: Yes. But, if you wish to exercise your appraisal rights, you must not vote in favor of adoption of the Agreement and Plan of Merger and Liquidation and approval of the Reorganization, and you must strictly follow all of the other requirements under Section 262 of the Delaware General Corporation Law (the “DGCL”), governing appraisal rights. In addition, you should note that it is a condition to closing of the Reorganization that there have been no demands for appraisal made or that the Board of both the Acquired Fund and Acquiring Fund in its sole discretion has determined to continue the Reorganization notwithstanding such demands. However, the Board may choose not to continue the Reorganization. If you comply with these requirements and if the Board chooses to continue the Reorganization notwithstanding the demands for appraisal rights, you will have the right to receive the “fair cash value” of your shares, as determined under the DGCL, instead of the consideration provided in the Agreement and Plan of Merger and Liquidation. The amount you will receive if you exercise your appraisal rights may be less than, equal to or more than the amount that you would otherwise receive under the Agreement and Plan of Merger and Liquidation. See “Appraisal Rights” beginning on page 66 and Appendix D hereto.

Q: HOW DOES THE BOARD OF DIRECTORS OF THE ACQUIRED FUND SUGGEST THAT I VOTE?

A: After careful consideration, the Board of Directors of the Acquired Fund unanimously recommends that you vote “FOR” the proposed Reorganization.

GENERAL

Q: HOW DO I VOTE MY PROXY?

A: You may use the enclosed postage-paid envelope to mail your proxy card or you may attend the meeting in person. You may also vote by phone by calling the proxy solicitor at (866) 387-9392.

Q: WHO DO I CALL IF I HAVE QUESTIONS?

A: We will be pleased to answer your questions about this proxy solicitation. Please call (866) 387-9392 with any questions.

HIGHLAND DISTRESSED OPPORTUNITIES INC.
(the “Acquired Fund”)

NOTICE OF SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD APRIL 9, 2009

This is the formal agenda for the Acquired Fund’s stockholder meeting. It tells you what matters will be voted on and the time and place of the meeting in case you want to attend in person.

To the stockholders of the Acquired Fund:

A stockholder meeting for the Acquired Fund will be held at The Westin Galleria Dallas, 13340 Dallas Parkway, Dallas, TX 75240 — Austin I Conference Room, 2nd Floor, on April 9, 2009, at 8:00 a.m. Central Time, to consider the following:

	1.		A proposal to approve an Agreement and Plan of Merger and Liquidation among Highland Distressed Opportunities, Inc. (the “Acquired Fund”), Highland Credit Strategies Fund (the “Acquiring Fund”) and HCF Acquisition LLC, a wholly owned subsidiary of the Acquiring Fund (“Merger Sub”), pursuant to which the Acquired Fund will merge with and into Merger Sub (the “Merger”) with Merger Sub being the surviving entity and the common stockholders of Acquired Fund receiving shares of beneficial interest of Acquiring Fund (and cash in lieu of any fractional shares); immediately after the Merger, Merger Sub will distribute its assets to Acquiring Fund and Acquiring Fund will assume the liabilities of Merger Sub, in complete liquidation and dissolution of Merger Sub (collectively with the Merger, the “Reorganization”). Immediately after the Reorganization, the Acquired Fund will withdraw its election to be regulated as a business development company (by approving the Reorganization, a stockholder is also approving this withdrawal).
	2.		Any other business that may properly come before the meeting or any adjournment thereof.

Stockholders of record as of the close of business on February 6, 2009, are entitled to vote at the meeting or any adjournment thereof. Stockholders of to the Acquired Fund are entitled to appraisal rights under Section 262 of the Delaware General Corporation Law in connection with the Reorganization. However, it is a condition to closing that there have been no demands for appraisal made or that the Board of both the Acquired Fund and Acquiring Fund in its sole discretion has determined to continue the Reorganization notwithstanding such demands.

Your attention is called to the accompanying Proxy Statement and Prospectus. Regardless of whether you plan to attend the meeting, PLEASE COMPLETE, SIGN, DATE AND RETURN THE ENCLOSED PROXY CARD PROMPTLY so that a quorum will be present and your shares may be voted. You may also vote by calling the proxy solicitor at (866) 387-9392. If you are present at the meeting, you may change your vote, if desired, at that time.

YOUR VOTE IS IMPORTANT, REGARDLESS OF THE NUMBER OF SHARES YOU OWN. YOU CAN VOTE EASILY AND QUICKLY BY MAIL OR BY TELEPHONE. A SELF-ADDRESSED, POSTAGE-PAID ENVELOPE HAS BEEN ENCLOSED FOR YOUR CONVENIENCE. YOU MAY ALSO VOTE BY CALLING THE NUMBER ON THE PROXY CARD. PLEASE HELP AVOID THE EXPENSE OF A FOLLOW-UP MAILING BY VOTING TODAY.

Dated: March 5, 2009

PROXY STATEMENT of
Highland Distressed Opportunities, Inc.
(the “Acquired Fund”)

And

PROSPECTUS for
Common Shares of
Highland Credit Strategies Fund
(the “Acquiring Fund”)

The address of the Acquired Fund and the Acquiring Fund (each, a “Fund”) is NexBank Tower, 13455 Noel Road, Suite 800, Dallas, Texas 75240. The telephone number of the Acquired Fund is 1-877-247-1888 and the Acquiring Fund is 1-877-665-1287.

This Proxy Statement and Prospectus (“Proxy Statement/Prospectus”) contains the information stockholders of the Acquired Fund should know before voting on the proposed Reorganization. Please read it carefully and retain it for future reference. For ease of reading, “shares” and “shareholders” has been used in certain places in the Proxy Statement/Prospectus to describe, respectively, the stock of the Acquired Fund and holders of stock of the Acquired Fund.

The Acquired Fund is a closed-end company under the 1940 Act and has elected to be regulated as a business development company under the 1940 Act. The Acquiring Fund is registered as a non-diversified, closed-end management investment company under the 1940 Act. The Acquired Fund’s investment objective is to provide total return generated by both capital appreciation and current income. The Acquiring Fund’s investment objective is to provide both current income and capital appreciation.

How the Reorganization Will Work

	§		The Reorganization, which was structured based on advice of counsel will work as follows. Pursuant to the Reorganization, Acquired Fund will merge with and into HCF Acquisition LLC (“Merger Sub”), a wholly owned subsidiary of the Acquiring Fund (the “Merger”), with Merger Sub being the surviving entity and the separate corporate existence of Acquired Fund shall thereupon cease. Common stockholders of Acquired Fund will receive shares of beneficial interest, with $0.001 par value, of Acquiring Fund (the “Merger Shares”) (and cash in lieu of any fractional shares) having an aggregate net asset value equal to the value of assets of Acquired Fund on the Valuation Date less the value of the liabilities of Acquired Fund on such Valuation Date.
	§		Immediately after the Merger and as part of the Reorganization, Merger Sub will distribute its assets to Acquiring Fund, and Acquiring Fund will assume the liabilities of Merger Sub, in complete liquidation and dissolution of Merger Sub.
	§		Before the Reorganization, Merger Sub will elect to be regulated as a business development company by filing the requisite forms with the Securities and Exchange Commission (the “SEC”) and, after the Reorganization, it will file the forms necessary to withdraw its election.
	§		In connection with the Reorganization, the Acquired Fund will withdraw its election to be regulated as a business development company under the 1940 Act, and by approving the Reorganization shareholders are also approving such withdrawal.
	§		Prior to the Merger, Acquired Fund will declare and pay to its stockholders a dividend or dividends and/or other distribution in an amount such that it will have distributed all of its net investment income and net long-term and short-term capital gains (if any), as described in Section 8(l) of the Agreement.
	§		The Reorganization is conditioned upon the approval of its shareholders. If the Reorganization is not approved by the Acquired Fund’s shareholders, the Fund will continue to exist and its Board of Directors will consider what additional action, if any, to take.
	§		It is intended that the Reorganization will be a tax-free reorganization for U.S. federal income tax purposes. This means that no gain or loss is expected to be recognized by the Acquired Fund or its shareholders directly as a result of the Reorganization, except, however, that shareholders of the Acquired Fund may recognize gain or loss with respect to cash such holders receive pursuant to the Reorganization in lieu of

			fractional shares of Acquiring Fund. Since the Reorganization will end the tax year of the Acquired Fund, it will accelerate distributions of any dividends from the Acquired Fund to its stockholders. Specifically, the Acquired Fund will recognize any net investment company taxable income and any net capital gains in the short taxable year ending on the date of the Reorganization, and will declare and pay a distribution or distributions of such income and such gains to its shareholders on or before that date. Any such distribution or distributions generally will be taxable to stockholders receiving such distribution or distributions. As of December 31, 2008, the amount of undistributed income was approximately $1,067,487, or $0.06 per share. There is no guarantee that any distributions will be made to shareholders prior to the date of the Reorganization or that such distributions will be equal to the amounts listed above. For more information about the U.S. federal income tax consequences of the Reorganization, see “Federal Income Tax Consequences of the Reorganization.”

Rationale for the Reorganization

The Board of Directors of the Acquired Fund and the Board of Trustees of the Acquiring Fund (each a “Board”) believes that the Reorganization of the Acquired Fund into the Acquiring Fund, a fund with a similar investment objective and having a combined portfolio with greater assets, offers you potential benefits. These potential benefits and Board considerations include:

	•		Economies of Scale in Expenses. A combined Fund offers economies of scale that may lead to a reduction in operating expenses. Due to the combined Fund’s lower management fee, lower administration fee, no incentive fee, lower interest expense due to lower leverage and elimination of overlapping expenses, the estimated annual operating expenses of the combined Fund are expected to be lower than the current annual operating expenses of the Acquired Fund. Each Fund incurs New York Stock Exchange (“NYSE”) listing fees, costs for legal, auditing, and custodial services, and miscellaneous fees. Additionally, the Acquired Fund incurs expenses related to Sarbanes-Oxley implementation that the Acquiring Fund does not and that the combined Fund would not incur. Many of these expenses overlap and there may be an opportunity to reduce them over time if the Funds are combined.
	•		Exchange of Common Shares at Net Asset Value (“NAV”). On its closing date, the Reorganization will result in the Acquired Fund shareholders receiving shares of beneficial interest the Acquiring Fund and cash (in lieu of fractional shares) based on the Acquired Fund’s NAV (i.e., the shareholder of Acquired Fund will receive its common shares of the Acquiring Fund and cash (in lieu of fractional shares) with an aggregate NAV equal to the value of the Acquired Fund shares held immediately before the Valuation Time for the Merger). Because the Acquiring Fund historically has traded at a greater premium or narrower discount than the Acquired Fund since inception of the Acquired Fund, Acquired Fund stockholders would receive shares of the Acquiring Fund, which based on historical trading, may potentially trade at a narrower discount than shares of the Acquired Fund.
	•		Enhanced Common Share Liquidity. Following the Reorganization, the substantially larger trading market in the common shares of the Acquiring Fund, as compared to that of the Acquired Fund prior to the Reorganization, may provide Acquired Fund shareholders with enhanced market liquidity. Trading discounts can result from many different factors, however, and there is no assurance that the Acquiring Fund will continue to trade at a smaller discount to NAV.
	•		Increased Asset Size. The Acquiring Fund will obtain additional assets without incurring underwriting expenses and other transaction expenses associated with offering new shares. In addition, the Acquiring Fund is obtaining the additional portfolio securities of the Acquired Fund without the commensurate brokerage costs, dealer spreads or other trading expenses. It is also obtaining these securities in a manner that is likely to minimize the market impact of such acquisition on the short-term prices of these securities. However, the increase in Acquiring Fund shares as a result of the Reorganization may also cause Acquiring Fund shares to trade at a larger discount from NAV. Because shareholders of the Acquired Fund will receive Acquiring Fund shares, Acquired Fund shareholders may share in these potential benefits.
	•		Portfolio Management Efficiencies. The Reorganization would permit Acquired Fund shareholders to pursue similar investment goals in a larger fund. The greater asset size of the combined Fund may allow the combined Fund, relative to the Acquired Fund, to obtain better net prices on securities trades and achieve greater diversification of portfolio holdings. Although 78.21% of the Acquired Fund’s assets represented issuers of securities owned by the Acquiring Fund at December 31, 2008, such issuers made up only 22.91% of the Acquiring Fund’s assets.
	•		Shareholders’ Ability to Margin. Stocks that trade below $5.00 are not currently marginable. Since the Acquired Fund currently trades well below $5.00 per share, and the Acquiring Fund has recently been trading at around $5.00 per share, if the Reorganization is approved, Acquired Fund shareholders would receive shares of the Acquiring Fund that would be more likely to be marginable (based on current market prices). Additionally, marginable securities may be more liquid that those that are not marginable because many institutional/large investors are believed to avoid stocks that are not marginable. However, if the price per share of the Acquiring Fund trades below $5.00 (which it has recently done), the shares of the Acquiring Fund would no longer be marginable. It is possible that the Reorganization will exert downward pressure on the price per share of the Acquiring Fund.

The Board of the Acquired Fund unanimously recommends that you vote FOR the Reorganization into the Acquiring Fund. Please see “Reasons for the Proposed Reorganization” for a description of the factors considered by the Board in deciding to approve the Reorganization and recommend its approval by shareholders.

Who Bears the Expenses Associated with the Proxy Statement/Prospectus

The costs associated with the Reorganization will be borne by each of the Acquired Fund and the Acquiring Fund in proportion to their respective net assets determined at the close of regular trading on the NYSE on the date of the Reorganization’s closing.

Who is Eligible to Vote

Shareholders of record on February 6, 2009 are entitled to attend and vote at the meeting or any adjourned meeting. Each share is entitled to one vote. Shares represented by properly executed proxy cards, unless revoked before or at the meeting, will be voted according to shareholders’ instructions. If you sign a proxy card but do not fill in a vote, your shares will be voted for the Reorganization. If any other business comes before the meeting, your shares will be voted at the discretion of the persons named as proxies.

The common shares of the Acquiring Fund are listed on the NYSE under the ticker symbol “HCF” and will continue to be so listed subsequent to the Reorganization. The common shares of the Acquiring Fund are listed on the NYSE under the ticker symbol “HCD”.

Where to Get More Information

A Statement of Additional Information dated March 5, 2009, which relates to this Proxy Statement/Prospectus and the Reorganization, has been filed with the SEC and contains additional information about the Acquired Fund and the Acquiring Fund		On file with the SEC or available at no charge by calling our toll free number: 877-247-1888 for the Acquired Fund and 877-665-1287 for the Acquiring Fund. The statement of additional information is incorporated by reference into (and therefore legally part of) this Proxy Statement/Prospectus or by writing to either Fund at NexBank Tower, 13455 Noel Road, Suite 800, Dallas, TX 75240.
To ask questions about this Proxy Statement/Prospectus		Call the proxy solicitor at (866) 387-9392.

The date of this Proxy Statement/Prospectus is March 5, 2009.

Shares of the Acquiring Fund have not been approved or disapproved by the SEC. The SEC has not passed upon the accuracy or adequacy of this Proxy Statement/Prospectus. Any representation to the contrary is a criminal offense.

Shares of the Acquiring Fund are not deposits or obligations of, or guaranteed or endorsed by, any bank or other depository institution. These shares are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other government agency.

TABLE OF CONTENTS

		Page
INTRODUCTION			6
SUMMARY OF INFORMATION RELATED TO PROPOSAL			6
RISK FACTORS AND SPECIAL CONSIDERATIONS RELATED TO PROPOSAL			9
DESCRIPTION OF THE REORGANIZATION			23
Reasons for the Proposed Reorganization			24
Comparative Fees and Expense Ratios			25
Board’s Evaluation and Recommendation			27
Required Vote			27
ADDITIONAL INFORMATION RELATED TO THE REORGANIZATION OF THE ACQUIRED FUND			28
Comparison of the Funds: Investment Objectives and Policies			28
Information About the Funds			33
Outstanding Securities			33
Common Share Price Data			33
Asset Coverage of Senior Securities			34
Share Repurchases			34
Dividends and Other Distributions			35
Dividend Reinvestment Plan			35
Description of Capital Structure			38
Acquired Fund			38
Acquiring Fund			40
Comparison of Charters and By-laws			43
Federal Income Tax Matters			44
Anti-Takeover Provisions			46
Acquired Fund			46
Acquiring Fund			47
Past Performance of Each Fund			48
Financial Highlights			49
Selected Financial Data			52
Acquired Fund Selected Quarterly Financial Data			53
Management’s Discussion and Analysis of Financial Condition and Results of Operations of Acquired Fund			53
Acquired Fund’s Portfolio Companies			62
Further Information on the Reorganization			64
Federal Income Tax Consequences of the Reorganization			64
Additional Terms of the Agreement and Plan of Merger and Liquidation			65

		Page
Payment of Undistributed Income in Advance of Reorganization			66
Appraisal Rights			66
Capitalization			70
Management of the Funds			71
Trustees/Directors and Officers			71
Investment Adviser			71
Comparison Of Investment Advisory Agreements			74
Administrator/Sub-Administrator/Accounting Services Agent			74
Portfolio Management			75
Portfolio Transactions with Affiliates			76
Other Service Providers			77
Expenses			77
VOTING INFORMATION AND REQUIRED VOTE			77
INFORMATION CONCERNING THE MEETING			79
Expenses and Methods of Solicitation			79
Revoking Proxies			79
Outstanding Shares			79
Other Business			79
Shareholders’ Proposals and Communications			79
Proxy Statement/Prospectus Delivery			79
OWNERSHIP OF SHARES OF THE FUNDS			80
EXPERTS			80
AVAILABLE INFORMATION			80
APPENDIX A — FORM OF AGREEMENT AND PLAN OF MERGER AND LIQUIDATION			A-1
APPENDIX B — DESCRIPTION OF INVESTMENT TYPES			B-1
APPENDIX C — OWNERSHIP OF SHARES OF THE FUNDS			C-1
APPENDIX D — SECTION 262 OF THE DELAWARE GENERAL CORPORATION LAW			D-1

INTRODUCTION

This Proxy Statement/Prospectus is being used by the Acquired Fund’s Board to solicit proxies to be voted at the special meeting of the Acquired Fund’s shareholders (“Meeting”). The Meeting will be held at The Westin Galleria Dallas, 13340 Dallas Parkway, Dallas, TX 75240 — Austin I Conference Room, 2nd Floor, on April 9, 2009, at 8:00 a.m. Central Time. At the Meeting, the Acquired Fund will consider a proposal to approve an Agreement and Plan of Merger and Liquidation providing for the Reorganization of the Acquired Fund into the Acquiring Fund. This Proxy Statement/Prospectus is being mailed to you on or about March 5, 2009.

This Proxy Statement/Prospectus includes information about the proposal. A comparison summary is provided with respect to the proposal. You should read carefully the proxy statement, as well as the Appendices and the enclosed materials, because they contain details that are not in the summary.

SUMMARY OF INFORMATION RELATED TO PROPOSAL

The following is a summary of certain information regarding the proposal contained elsewhere in this Proxy Statement/Prospectus and is qualified in its entirety by reference to the more complete information contained in this Proxy Statement/Prospectus and in the Statement of Additional Information. Shareholders should read the entire Proxy Statement/Prospectus carefully.

PROPOSAL: REORGANIZATION OF THE ACQUIRED FUND

The Proposed Reorganization. The Board of the Acquired Fund, including the Directors who are not “interested persons” (as defined in the Investment Company Act of 1940, as amended (the “1940 Act”)) of the Acquired Fund, has unanimously approved the Agreement and Plan of Merger and Liquidation. If quorum is present at the Meeting and a majority of the outstanding voting securities of the Acquired Fund (as defined in the 1940 Act) approve the Agreement and Plan of Merger and Liquidation, then the Acquired Fund will merge with and into Merger Sub (the “Merger”) with Merger Sub being the surviving entity and common stockholders of the Acquired Fund receiving shares of beneficial interest of the Acquiring Fund (the “Merger Shares”) (and cash in lieu of any fractional shares) having an aggregate net asset value equal to the value of the assets of Acquired Fund on the Valuation Date less then value of the liabilities of Acquired Fund on such Valuation Date. Merger Sub will elect to be regulated as a business development company by filing the requisite forms with the SEC. Immediately after the Merger, Merger Sub will distribute its assets to Acquiring Fund, and Acquiring Fund will assume the liabilities of Merger Sub, in complete liquidation of Merger Sub. The Acquired Fund and Merger Sub will then withdraw their elections to be regulated as a business development companies. By approving the Reorganization, shareholders of the Acquired Fund are also approving such withdrawal of its election to be treated as a business development company. The aggregate value of Acquiring Fund common shares and any cash you receive in the Reorganization will equal the aggregate net asset value, taking into account your Fund’s proportionate share of the costs of the Reorganization, of your Acquired Fund common shares held immediately prior to the Reorganization.

Summary of Fund Comparisons

Investment Objectives and Policies. The Acquired Fund is a closed-end company under the 1940 Act and has elected to be regulated as a business development company under the 1940 Act. The Acquiring Fund is registered as a non-diversified, closed-end management investment company under the 1940 Act. The Acquired Fund seeks total return generated by both capital appreciation and current income. The Acquiring Fund seeks to provide both current income and capital appreciation. The investment objective of the Acquired Fund and the Acquiring Fund are similar in that both emphasize capital appreciation and current income, although current income may be relatively more important for the Acquiring Fund and capital appreciation relatively more important for the Acquired Fund. Also the Funds seek to achieve their objectives in similar ways by investing a substantial portion of their assets in senior loans and below investment grade bonds. Highland is the investment adviser to each Fund.

The Acquiring Fund invests at least 80% of its assets in the following categories of securities and instruments of corporations and other business entities: (i) secured and unsecured floating and fixed rate loans; (ii) bonds and other debt obligations; (iii) debt obligations of stressed, distressed and bankrupt issuers; (iv) structured products, including but not limited to, mortgage-backed and other asset-backed securities and collateralized debt obligations; and (v)

equities. A significant portion of the Acquiring Fund’s assets may be invested in securities rated below investment grade (Ba/BB or lower), which are commonly referred to as “junk securities” or “high-yield securities.”

The Acquired Fund invests primarily in financially-troubled or distressed companies that are either middle-market companies or unlisted companies. The Acquired Fund seeks to achieve its objective by investing in senior secured debt, mezzanine debt and unsecured debt, each of which may include an equity component, and in equity investments. Generally, distressed companies are those that (i) are facing financial or other difficulties and (ii) are or have been operating under the provisions of the U.S. Bankruptcy Code or other similar laws or, in the near future, may become subject to such provisions or otherwise be involved in a restructuring of their capital structure. The term “middle-market” refers to companies with annual revenues between $50 million and $1 billion. The term “unlisted” refers to companies not listed on a national securities exchange (for example, companies whose securities are quoted on the over-the-counter bulletin board or through Pink Sheets LLC would not be “listed” on a national securities exchange, although they may be considered “public” companies).

Dividends and other Distributions. The Acquired Fund intends to make distributions, which may contain returns of capital, to holders of common shares on a quarterly basis. The Acquiring Fund intends to make distributions, which may contain returns of capital, to holders of common shares of the Acquiring Fund on a monthly basis. The rate of a Fund’s distribution may vary from one distribution to another. The Acquiring Fund’s current yield as of December 31, 2008 on a net asset value basis is higher than that of the Acquired Fund. However, since November 2008, the Acquiring Fund’s monthly distribution rate was lower than the monthly distribution rate during the previous twelve months.

Purchase and Sale. Purchase and sale procedures for the common shares of the Funds are similar. Investors typically purchase and sell common shares of the Funds on the NYSE through a broker-dealer.

Redemptions. The common shares of each Fund have no redemption rights. However, the Board of each Fund may consider open market share repurchases of, or tendering for, common shares to seek to reduce or eliminate any discount in the market place of the common shares from the NAV thereof, although neither Fund has ever engaged in any such purchases. Each Fund’s ability to repurchase, or tender for, its common shares may be limited by the 1940 Act asset coverage requirements and the terms of the credit facility to which it is a party. The Board of each Fund has no present intention of authorizing the repurchase of its common shares or conducting a tender offer for such common shares.

Expenses. Due to the Acquiring Fund’s lower management fee, lower administration fee, no incentive fee, lower interest expense due to lower leverage and elimination of overlapping expenses, the estimated annual operating expenses of the Acquiring Fund should be lower than the current annual operating expenses the Acquired Fund.

Leverage. Both Funds employ leverage through borrowings through a credit facility. As of December 31, 2008, leverage as a percentage of total assets of the Acquired Fund and the Acquiring Fund was 20.4% and 28.1%, respectively.

Performance and Premium/Discount Profile. The Acquired Fund and the Acquiring Fund commenced investment operations and public trading in February 2007 and June 2006, respectively, and have a limited operating history and history of public trading.

The Acquiring Fund’s 1-year performance as of December 31, 2008 on a net asset value basis and market value basis is better than that of the Acquired Fund. Please see “Additional Information Related to the Reorganization of the Acquired Fund — Past Performance of Each Fund” and “Additional Information Related to the Reorganization of the Acquired Fund — Information About the Funds — Common Share Price Data” for further information. There is no guarantee or assurance as to the future performance of the Acquiring Fund.

Background and Reasons for the Proposed Reorganization. The Board of the Acquired Fund considered that the Acquired Fund has been trading at a larger discount from net asset value than the Acquiring Fund. In addition, the Board considered that there are limited prospects for growth of the Acquired Fund, given the discount, current market conditions and its performance history. For the reasons set forth below under “Reasons for the Proposed

Reorganization” and based upon its evaluation of relevant information the Board of the Acquired Fund anticipates that the common shareholders of the Acquired Fund should benefit from the Reorganization.

The Board of the Acquired Fund has also determined that participation in the Reorganization, which is being effected at the Funds’ respective net asset values per share, is in the best interests of the Acquired Fund and that the interests of its stockholders will not be diluted as a result of the Reorganization. Although the Board of each Fund determined that the Reorganization would not result in dilution of the interests of the shareholders of such Fund, the Board also considered the fact that the net asset value (“NAV”) per share of the combined Acquiring Fund will decrease by the expenses related to the Reorganization, estimated to be 1 cent per share. However, as a result of the Reorganization, stockholders of the Acquired Fund will have a smaller percentage of ownership in the combined Fund than they did in any of the separate Funds.

Expenses Associated with the Reorganization. The costs associated with the Reorganization generally will be borne by each of the Acquired Fund and the Acquiring Fund in proportion to their respective net assets determined at the close of regular trading on the NYSE on the date of the Reorganization’s closing. As a result, part of the costs associated with the Reorganization will be indirectly borne by the shareholders of each of the Acquired Fund and the Acquiring Fund based on the number of shares owned.

Tax Consequences. The Reorganization is intended to qualify as a “reorganization” within the meaning of Section 368(a)(1) of the Internal Revenue Code of 1986, as amended (“Code”). If the Reorganization so qualifies, in general, shareholders of the Acquired Fund will not recognize gain or loss upon the conversion of their Acquired Fund shares into shares of the Acquiring Fund in connection with the Reorganization. However, shareholders of the Acquired Fund generally will recognize gain or loss with respect to any cash they receive pursuant to the Reorganization in lieu of the conversion of their Acquired Fund shares into fractional shares of Acquiring Fund to the extent any such cash received is greater or less (as the case may be) than the tax basis allocable to the fractional shares. Additionally, if the Reorganization so qualifies, the Acquired Fund will not recognize gain or loss directly as a result of the Reorganization and neither the Acquiring Fund nor its shareholders will recognize any gain or loss directly in connection with the Reorganization. Should the Board decide to consummate the Reorganization even if it does not qualify as a “reorganization” within the meaning of Section 368(a)(1), it will notify Acquired Fund shareholders and re-solicit proxies. See “Federal Income Tax Consequences of the Reorganization” beginning on page 64.

Required Vote. Shareholder approval of the Reorganization requires, if a quorum is present at the Meeting, the affirmative vote of a majority of the outstanding voting securities of the Acquired Fund, which is defined in the 1940 Act as the lesser of (a) 67% or more of the voting securities present at the Meeting, if the holders of more than 50% of the outstanding voting securities of the Acquired Fund are present or represented by proxy, or (b) more than 50% of the outstanding voting securities of the Acquired Fund. The presence in person or by proxy of shareholders of the Acquired Fund entitled to cast at least a majority of the votes entitled to be cast shall constitute a quorum for the Meeting

The Board of the Acquired Fund unanimously recommends that you vote FOR the Acquired Fund’s proposed Reorganization.

RISK FACTORS AND SPECIAL CONSIDERATIONS RELATED TO PROPOSAL

Because each of the Acquiring Fund and the Acquired Fund, under normal market conditions, invest a substantial amount of its assets in below investment grade securities, any general risks inherent in such investments are applicable to both the Acquiring Fund and the Acquired Fund and will apply to the Acquiring Fund after the Reorganization. The general risks of investing in the Acquiring Fund are described below, including comparisons to certain risks of investing in the Acquired Fund. The Reorganization itself is not expected to adversely affect the right of common shareholders of either of the Funds. For information regarding the percentage limitations, if any, of an investment described in the risks listed below, see “Comparison of the Funds: Investment Objectives and Policies.”

Limited Operating History. The Acquiring Fund and the Acquired Fund are both recently organized. They commenced investment operations and public trading in June 2006 and February 2007, respectively, and have a limited operating history and history of public trading that investors can use to evaluate their investment performance and volatility.

Asset Allocation Risk. Because the Funds invests in a broad array of asset classes, they are subject to asset allocation risk. When deciding on which investments to make for a Fund, Highland relies on its expectations regarding particular securities or interest rates. Highland may be incorrect in its expectations and allocate assets to an asset class that underperforms other asset classes.

Investment and Market Discount Risk. An investment in the Acquiring Fund’s common shares is subject to investment risk, including the possible loss of the entire amount that you invest. As with any stock, the price of the Acquiring Fund’s shares will fluctuate with market conditions and other factors. If common shares are sold, the price received may be more or less than the original investment. Common shares are designed for long-term investors and should not be treated as trading vehicles. Shares of closed-end management investment companies frequently trade at a discount to their NAV.

Risks of Non-Diversification and Other Focused Strategies. While the Adviser invests in a number of fixed-income and equity instruments issued by different issuers and employs multiple investment strategies with respect to the Acquiring Fund’s portfolio, it is possible that a significant amount of the Acquiring Fund’s investments could be invested in the instruments of only a few companies or other issuers or that at any particular point in time one investment strategy could be more heavily weighted than the others. The focus of the Acquiring Fund’s portfolio in any one issuer would subject the Acquiring Fund to a greater degree of risk with respect to defaults by such issuer or other adverse events affecting that issuer, and the focus of the portfolio in any one industry or group of industries would subject the Acquiring Fund to a greater degree of risk with respect to economic downturns relating to such industry or industries. The focus of the Acquiring Fund’s portfolio in any one investment strategy would subject the Acquiring Fund to a greater degree of risk than if the Acquiring Fund’s portfolio were varied in its investments with respect to several investment strategies.

Illiquidity of Investments. The investments made by the Acquiring Fund may be very illiquid, and consequently, the Acquiring Fund may not be able to sell such investments at prices that reflect the Adviser’s assessment of their fair value or the amount paid for such investments by the Acquiring Fund. Illiquidity may result from the absence of an established market for the investments as well as legal, contractual or other restrictions on their resale by the Acquiring Fund and other factors. Furthermore, the nature of the Acquiring Fund’s investments, especially those in financially stressed and distressed companies, may require a long holding period prior to being able to determine whether the investment will be profitable or not. There is no limit on the amount of the Acquiring Fund’s portfolio that can be invested in illiquid securities.

Risks of Investing in Senior Loans. Senior loans, such as bank loans, are typically at the most senior level of the capital structure, and are sometimes secured by specific collateral, including, but not limited to, trademarks, patents, accounts receivable, inventory, equipment, buildings, real estate, franchises and common and preferred stock of the obligor or its affiliates. A portion of the Acquiring Fund’s investments may consist of loans and participations therein originated by banks and other financial institutions, typically referred to as “bank loans.” The Acquiring Fund’s investments may include loans of a type generally incurred by borrowers in connection with highly leveraged transactions, often to finance internal growth, acquisitions, mergers or stock purchases, or for other

reasons. As a result of the additional debt incurred by the borrower in the course of the transaction, the borrower’s creditworthiness is often judged by the rating agencies to be below investment grade. Such loans are typically private corporate loans which are negotiated by one or more commercial banks or financial institutions and syndicated among a group of commercial banks and financial institutions. In order to induce the lenders to extend credit and to offer a favorable interest rate, the borrower often provides the lenders with extensive information about its business which is not generally available to the public. To the extent the Acquiring Fund receives material non-public information, it may be prohibited from trading in certain securities, even when it might otherwise be beneficial to do so.

Bank loans often, but not always, contain restrictive covenants designed to limit the activities of the borrower in an effort to protect the right of lenders to receive timely payments of principal and interest. Such covenants may include restrictions on distribution payments, specific mandatory minimum financial ratios, limits on total debt and other financial tests. Bank loans usually have shorter terms than subordinated obligations and may require mandatory prepayments from excess cash flow, asset dispositions and offerings of debt and/or equity securities. The bank loans and other debt obligations to be acquired by the Acquiring Fund are likely to be below investment grade.

The Acquiring Fund may acquire interests in bank loans and other debt obligations either directly (by way of sale or assignment) or indirectly (by way of participation). The purchaser of an assignment typically succeeds to all the rights and obligations of the assigning institution and becomes a lender under the credit agreement with respect to the debt obligation; however, its rights can be more restricted than those of the assigning institution, and, in any event, the Acquiring Fund may not be able unilaterally to enforce all rights and remedies under the loan and any associated collateral. A participation interest in a portion of a debt obligation typically results in a contractual relationship only with the institution participating out the interest, not with the borrower. In purchasing participations, the Acquiring Fund generally will have no right to enforce compliance by the borrower with the terms of the loan agreement or any rights of setoff against the borrower, and the Acquiring Fund may not directly benefit from the collateral supporting the debt obligation in which it has purchased the participation. As a result, the Acquiring Fund will be exposed to the credit risk of both the borrower and the institution selling the participation.

Purchasers of bank loans are predominantly commercial banks, investment funds and investment banks. As secondary market trading volumes increase, new bank loans frequently adopt standardized documentation to facilitate loan trading, which the Adviser believes should improve market liquidity. There can be no assurance, however, that future levels of supply and demand in bank loan trading will provide an adequate degree of liquidity or that the current level of liquidity will continue. Because of the provision to holders of such loans of confidential information relating to the borrower, the unique and customized nature of the loan agreement, the limited universe of eligible purchasers and the private syndication of the loan, bank loans are not as easily purchased or sold as a publicly traded-security.

Second Lien Loans Risk. Second lien loans are subject to the same risks associated with investment in senior loans and non-investment grade securities. However, second lien loans are second in right of payment to senior loans and therefore are subject to additional risk that the cash flow of the borrower and any property securing the loan may be insufficient to meet scheduled payments after giving effect to the senior secured obligations of the borrower. Second lien loans are expected to have greater price volatility than senior loans and may be less liquid. There is also a possibility that originators will not be able to sell participations in second lien loans, which would create greater credit risk exposure.

Other Secured Loans Risk. Secured loans other than senior loans and second lien loans are subject to the same risks associated with investment in senior loans, second lien loans and non-investment grade securities. However, such loans may rank lower in right of payment than any outstanding senior loans and second lien loans of the borrower and therefore are subject to additional risk that the cash flow of the borrower and any property securing the loan may be insufficient to meet scheduled payments after giving effect to the higher ranking secured obligations of the borrower. Lower ranking secured loans are expected to have greater price volatility than senior loans and second lien loans and may be less liquid. There is also a possibility that originators will not be able to sell participations in lower ranking secured loans, which would create greater credit risk exposure.

Unsecured Loans Risk. Unsecured loans are subject to the same risks associated with investment in senior loans, second lien loans, other secured loans and non-investment grade securities. However, because unsecured loans have

lower priority in right of payment to any higher ranking obligations of the borrower and are not backed by a security interest in any specific collateral, they are subject to additional risk that the cash flow of the borrower and available assets may be insufficient to meet scheduled payments after giving effect to any higher ranking obligations of the borrower. Unsecured loans are expected to have greater price volatility than senior loans, second lien loans and other secured loans and may be less liquid. There is also a possibility that originators will not be able to sell participations in unsecured loans, which would create greater credit risk exposure.

Loans other than senior loans may not be acceptable collateral under the Acquired Fund’s current credit facility or under any future credit facilities, or may require a higher collateral-to-loan ratio, and therefore to the extent the Acquired Fund invests in such loans its ability to borrow may be reduced.

Risks of Investing in Obligations of Stressed, Distressed and Bankrupt Issuers. The Acquiring Fund is authorized to invest in the securities and other obligations of stressed, distressed and bankrupt issuers, including debt obligations that are in covenant or payment default. There is no limit on the amount of the Acquiring Fund’s portfolio that can be invested in stressed, distressed or bankrupt issuers, and the Acquiring Fund may invest for purposes of control. Such investments generally trade significantly below par and are considered speculative. The repayment of defaulted obligations is subject to significant uncertainties. Defaulted obligations might be repaid only after lengthy workout or bankruptcy proceedings, during which the issuer might not make any interest or other payments. Typically such workout or bankruptcy proceedings result in only partial recoveries, which may be in the form of cash payments or an exchange of the defaulted obligation for other debt or equity securities of the issuer or its affiliates, which may in turn be illiquid or speculative. It is also possible that there could be limited or no recovery for creditors in a bankruptcy or workout.

There are a number of significant risks inherent in the bankruptcy process, including, without limitation, those set forth in this paragraph. First, many events in a bankruptcy are the product of contested matters and adversary proceedings and are beyond the control of the creditors. While creditors are generally given an opportunity to object to significant actions, there can be no assurance that a bankruptcy court in the exercise of its broad powers would not approve actions that would be contrary to the interests of the Acquiring Fund. Second, a bankruptcy filing by an issuer may adversely and permanently affect the issuer. The issuer may lose its market position and key employees and otherwise become incapable of restoring itself as a viable entity. If for this or any other reason the proceeding is converted to a liquidation, the value of the issuer may not equal the liquidation value that was believed to exist at the time of the investment. Third, the duration of a bankruptcy proceeding is difficult to predict. A creditor’s return on investment can be adversely affected by delays while the plan of reorganization is being negotiated, approved by the creditors and confirmed by the bankruptcy court and until it ultimately becomes effective. Fourth, the administrative costs in connection with a bankruptcy proceeding are frequently high and would be paid out of the debtor’s estate prior to any return to creditors. For example, if a proceeding involves protracted or difficult litigation, or turns into a liquidation, substantial assets may be devoted to administrative costs. Fifth, bankruptcy law permits the classification of “substantially similar” claims in determining the classification of claims in a reorganization. Because the standard for classification is vague, there exists the risk that the Acquiring Fund’s influence with respect to the class of securities or other obligations it owns can be lost by increases in the number and amount of claims in that class or by different classification and treatment. Sixth, in the early stages of the bankruptcy process it is often difficult to estimate the extent of, or even to identify, any contingent claims that might be made. Seventh, especially in the case of investments made prior to the commencement of bankruptcy proceedings, creditors can lose their ranking and priority if they exercise “domination and control” over a debtor and other creditors can demonstrate that they have been harmed by such actions. Eighth, certain claims that have priority by law (for example, claims for taxes) may be substantial.

In any investment involving stressed and distressed debt obligations, there exists the risk that the transaction involving such debt obligations will be unsuccessful, take considerable time or will result in a distribution of cash or a new security or obligation in exchange for the stressed and distressed debt obligations, the value of which may be less than the Acquiring Fund’s purchase price of such debt obligations. Furthermore, if an anticipated transaction does not occur, the Acquiring Fund may be required to sell its investment at a loss. Given the substantial uncertainties concerning transactions involving stressed and distressed debt obligations in which the Acquiring Fund invests, there is a potential risk of loss by the Acquiring Fund of its entire investment in any particular investment.

Investments in companies operating in workout modes or under Chapter 11 of the Bankruptcy Code are also, in certain circumstances, subject to certain additional liabilities which may exceed the value of the Acquiring Fund’s original investment in a company. For example, under certain circumstances, creditors who have inappropriately exercised control over the management and policies of a debtor may have their claims subordinated or disallowed or may be found liable for damages suffered by parties as a result of such actions. The Adviser’s active management style may present a greater risk in this area than would a more passive approach. In addition, under certain circumstances, payments to the Acquiring Fund and distributions by the Acquiring Fund or payments on the debt may be reclaimed if any such payment is later determined to have been a fraudulent conveyance or a preferential payment.

The Adviser, on behalf of the Acquiring Fund (and its other clients), may participate on committees formed by creditors to negotiate with the management of financially troubled companies that may or may not be in bankruptcy or may negotiate directly with debtors with respect to restructuring issues. If the Acquiring Fund does choose to join a committee, the Acquiring Fund would likely be only one of many participants, all of whom would be interested in obtaining an outcome that is in their individual best interests. There can be no assurance that the Acquiring Fund would be successful in obtaining results most favorable to it in such proceedings, although the Acquiring Fund may incur significant legal and other expenses in attempting to do so. As a result of participation by the Acquiring Fund on such committees, the Acquiring Fund may be deemed to have duties to other creditors represented by the committees, which might thereby expose the Acquiring Fund to liability to such other creditors who disagree with the Acquiring Fund’s actions. Participation by the Acquiring Fund on such committees may cause the Acquiring Fund to be subject to certain restrictions on its ability to trade in a particular investment and may also make the Acquiring Fund an “insider” or an “underwriter” for purposes of the federal securities laws. Either circumstance will restrict the Acquiring Fund’s ability to trade in or acquire additional positions in a particular investment when it might otherwise desire to do so.

Distressed debt obligations that are at risk of or in default present special tax issues for the Acquiring Fund because the U.S. federal income tax rules relating to those obligations are currently unclear. For instance, tax rules are unclear as to whether the Acquiring Fund should recognize market discount on certain distressed debt obligations and, if so, the amount of market discount the Acquiring Fund should recognize and when the Acquiring Fund may cease to accrue interest, original issue discount or market discount. These and other related issues will be addressed by the Acquiring Fund when, as and if it invests in such securities, in order to seek to ensure that it distributes sufficient income to preserve its status as a regulated investment company (“RIC”) and that it does not become subject to Fund -level U.S. federal income and/or excise taxes.

Risks of Investing in High-Yield Securities. A portion of the Acquiring Fund’s investments will consist of investments that may generally be characterized as “high-yield securities” or “junk securities.” Such securities are typically rated below investment grade by one or more nationally recognized statistical rating organizations or are unrated but of comparable credit quality to obligations rated below investment grade, and have greater credit and liquidity risk than more highly rated obligations. High-yield securities are generally unsecured and may be subordinate to other obligations of the obligor. The lower rating of high-yield securities reflects a greater possibility that adverse changes in the financial condition of the issuer or in general economic conditions (including, for example, a substantial period of rising interest rates or declining earnings) or both may impair the ability of the issuer to make payment of principal and interest. Many issuers of high-yield securities are highly leveraged, and their relatively high debt to equity ratios create increased risks that their operations might not generate sufficient cash flow to service their obligations. Overall declines in the below investment grade bond and other markets may adversely affect such issuers by inhibiting their ability to refinance their obligations at maturity.

High-yield securities are often issued in connection with leveraged acquisitions or recapitalizations in which the issuers incur a substantially higher amount of indebtedness than the level at which they had previously operated. High-yield securities that are debt instruments have historically experienced greater default rates than has been the case for investment grade securities. The Acquiring Fund may also invest in equity securities issued by entities whose obligations are unrated or are rated below investment grade.

The Acquiring Fund is authorized to invest in obligations of issuers which are generally trading at significantly higher yields than had been historically typical of the applicable issuer’s obligations. Such investments may include debt obligations that have a heightened probability of being in covenant or payment default in the future. Such

investments generally are considered speculative. The repayment of defaulted obligations is subject to significant uncertainties. Defaulted obligations might be repaid only after lengthy workout or bankruptcy proceedings, during which the issuer might not make any interest or other payments. Typically such workout or bankruptcy proceedings result in only partial recovery of cash payments or an exchange of the defaulted security for other debt or equity securities of the issuer or its affiliates, which may in turn be illiquid or speculative.

High-yield securities purchased by the Acquiring Fund are subject to certain additional risks to the extent that such obligations may be unsecured and subordinated to substantial amounts of senior indebtedness, all or a significant portion of which may be secured. Moreover, such obligations purchased by the Acquiring Fund may not be protected by financial covenants or limitations upon additional indebtedness and are unlikely to be secured by collateral.

Insolvency Considerations with Respect to Issuers of Debt Obligations. Various laws enacted for the protection of creditors may apply to the debt obligations held by the Acquiring Fund. The information in this paragraph is applicable with respect to U.S. issuers subject to United States bankruptcy laws. Insolvency considerations may differ with respect to other issuers. If a court in a lawsuit brought by an unpaid creditor or representative of creditors of an issuer of a debt obligation, such as a trustee in bankruptcy or a creditors’ committee, were to find that the issuer did not receive fair consideration or reasonably equivalent value for incurring the indebtedness constituting the debt obligation and, after giving effect to such indebtedness, the issuer (i) was insolvent, (ii) was engaged in a business for which the remaining assets of such issuer constituted unreasonably small capital or (iii) intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature, such court could determine to invalidate, in whole or in part, such indebtedness as a fraudulent conveyance, to subordinate such indebtedness to existing or future creditors of such issuer, or to recover amounts previously paid by such issuer in satisfaction of such indebtedness.

The measure of insolvency for purposes of the foregoing will vary. Generally, an issuer would be considered insolvent at a particular time if the sum of its debts were then greater than all of its property at a fair valuation, or if the present fair saleable value of its assets was then less than the amount that would be required to pay its probable liabilities on its existing debts as they became absolute and matured. There can be no assurance as to what standard a court would apply in order to determine whether the issuer was “insolvent” after giving effect to the incurrence of the indebtedness constituting the debt obligation or that, regardless of the method of valuation, a court would not determine that the issuer was “insolvent” upon giving effect to such incurrence. In addition, in the event of the insolvency of an issuer of a debt obligation, payments made on such debt obligation could be subject to avoidance as a “preference” if made within a certain period of time (which may be as long as one year) before insolvency. Similarly, a court might apply the doctrine of equitable subordination to subordinate the claim of a lending institution against an issuer, to claims of other creditors of the borrower, when the lending institution, another investor, or any of their transferees, is found to have engaged in unfair, inequitable, or fraudulent conduct. In general, if payments on a debt obligation are avoidable, whether as fraudulent conveyances or preferences, such payments can be recaptured either from the initial recipient (such as the Fund) or from subsequent transferees of such payments (such as the investors in the Acquiring Fund). To the extent that any such payments are recaptured from the Acquiring Fund the resulting loss will be borne by the investors. However, a court in a bankruptcy or insolvency proceeding would be able to direct the recapture of any such payment from such a recipient or transferee only to the extent that such court has jurisdiction over such recipient or transferee or its assets. Moreover, it is likely that avoidable payments could not be recaptured directly from any such recipient or transferee that has given value in exchange for its note, in good faith and without knowledge that the payments were avoidable. Although the Adviser will seek to avoid conduct that would form the basis for a successful cause of action based upon fraudulent conveyance, preference or equitable subordination, these determinations are made in hindsight and a court could disagree with the Acquiring Fund’s position, and, in any event, there can be no assurance as to whether any lending institution or other investor from which the Acquiring Fund acquired the debt obligations engaged in any such conduct (or any other conduct that would subject the debt obligations and the issuer to insolvency laws) and, if it did, as to whether such creditor claims could be asserted in a U.S. court (or in the courts of any other country) against the Acquiring Fund.

Leverage Risk. The Acquiring Fund has the ability to use leverage through the issuance of preferred shares, borrowings from a credit facility or both. The Acquiring Fund currently leverages through borrowings from a credit facility and has no present intention of issuing preferred shares. The use of leverage, which can be described as

exposure to changes in price at a ratio greater than the amount of equity invested, either through the issuance of preferred shares, borrowings or other forms of market exposure, magnifies both the favorable and unfavorable effects of price movements in the investments made by the Acquiring Fund. Insofar as the Acquiring Fund continues to employ leverage in its investment operations, the Acquiring Fund will be subject to substantial risks of loss.

The Acquiring Fund currently leverages through borrowings from a credit facility. The Acquiring Fund has entered into a revolving credit agreement with The Bank of Nova Scotia (“Scotia”) to borrow up to $380,000,000 (the “Loan Agreement”). Such borrowings constitute financial leverage. The Loan Agreement contains customary covenant, negative covenant and default provisions, including covenants that limit the Acquiring Fund’s ability to, without the prior consent of Scotia: (i) pay dividends in certain circumstances, (ii) incur additional debt or (iii) adopt or carry out any plan of liquidation, reorganization, incorporation, recapitalization, merger or consolidation or sell, transfer or otherwise dispose of all or a substantial part of its assets. In addition, the Acquiring Fund agreed not to purchase assets not contemplated by the investment policies and restrictions in effect when the Loan Agreement became effective. The prohibition on the payment of dividends or distributions might impair the ability of the Acquiring Fund to meet the RIC distribution requirements and to avoid Acquiring Fund-level U.S. federal income and/or excise taxes. Furthermore, the Acquiring Fund may not incur additional debt from any other party, except for in limited circumstances (e.g., in the ordinary course of business). In addition, the Loan Agreement contains a covenant requiring asset coverage ratios that may be more stringent than those required by the 1940 Act. Such restrictions shall apply only so long as the Loan Agreement remains in effect. Any senior security representing indebtedness, as defined in Section 18(g) of the 1940 Act, must have asset coverage of at least 300%. Debt incurred under the Loan Agreement will be considered a senior security for this purpose. The Acquiring Fund has notified Scotia regarding the proposed Reorganization and expects to receive Scotia’s consent prior to the time of closing.

Indebtedness issued under the Loan Agreement is not convertible into any other securities of the Acquiring Fund. Outstanding amounts would be payable at maturity or such earlier times as required by the Loan Agreement. The Acquiring Fund may be required to prepay outstanding amounts under the Loan Agreement or incur a penalty rate of interest in the event of the occurrence of certain events of default. The Acquiring Fund is expected to indemnify the lenders under the Loan Agreement against certain liabilities they may incur in connection with the credit facility. The Acquiring Fund is required to pay commitment fees under the terms of the Loan Agreement. With the use of borrowings, there is a risk that the interest rates paid by the Acquiring Fund on the amount it borrows will be higher than the return on the Acquiring Fund’s investments. The credit facility with Scotia may in the future be replaced or refinanced by one or more credit facilities having substantially different terms or by the issuance of preferred shares, or the Acquiring Fund may be unable to renew or replace its credit facility upon the termination of the current facility. Any of these situations could adversely impact income or total return to shareholders.

In order to obtain and maintain the required ratings of loans made under the Loan Agreement or another credit facility, the Acquiring Fund must comply with investment quality, diversification and other guidelines established by Moody’s and/or S&P and the credit facility, respectively. The Acquiring Fund does not anticipate that such guidelines will have a material adverse effect on the Acquiring Fund’s common shareholders or its ability to achieve its investment objectives. Moody’s and S&P receive fees in connection with their ratings issuances.

The Acquired Fund also has the ability to use leverage through the issuance of preferred shares, borrowings from a credit facility or both. The Acquired Fund is allowed to borrow amounts such that its asset coverage, as defined in the 1940 Act, is at least 200% after such borrowing. The Acquired Fund currently leverages through borrowings from a credit facility. The credit facility imposes stricter limitations than the 1940 Act, requiring generally that asset coverage be at least 300% after a borrowing. Please see “Additional Information Related to the Reorganization of the Acquired Fund — Description of Capital Stock — Acquired Fund — Credit Facility” for a description of the credit facility.

Preferred Share Risk. Preferred share risk is the risk associated with the issuance of the preferred shares by the Acquiring Fund to leverage the common shares. If preferred shares are issued, the NAV and market value of the common shares will be more volatile, and the yield to the holders of common shares will tend to fluctuate with changes in the shorter-term dividend rates on the preferred shares. The Acquiring Fund will pay (and the holders of common shares will bear) all costs and expenses relating to the issuance and ongoing maintenance of the preferred shares, including higher advisory fees. Accordingly, the Acquiring Fund cannot assure common shareholders that the issuance of preferred shares will result in a higher yield or return to the holders of the common shares. If the dividend rate and other costs of the preferred shares approach the net rate of return on the Acquiring Fund’s investment portfolio, the benefit of

leverage to the holders of the common shares would be reduced. If the dividend rate and other costs of the preferred shares exceed the net rate of return on the Acquiring Fund’s portfolio, the leverage will result in a lower rate of return to the holders of common shares than if the Acquiring Fund had not issued preferred shares.

Similarly, any decline in the NAV of the Acquiring Fund’s investments will be borne entirely by the holders of common shares. Therefore, if the market value of the Acquiring Fund’s portfolio declines, the leverage will result in a greater decrease in NAV to the holders of common shares than if the Acquiring Fund were not leveraged. This greater NAV decrease will also tend to cause a greater decline in the market price for the common shares. The Acquiring Fund might be in danger of failing to maintain the required asset coverage of the preferred shares or of losing its ratings on the preferred shares or, in an extreme case, the Acquiring Fund’s current investment income might not be sufficient to meet the dividend requirements on the preferred shares. In order to counteract such an event, the Acquiring Fund might need to liquidate investments in order to fund a redemption of some or all of the preferred shares. Liquidation at times of low prices may result in capital loss and may reduce returns to the holders of common shares.

If preferred shares are issued, holders of preferred shares may have differing interests than holders of common shares and holders of preferred shares may at times have disproportionate influence over the Acquiring Fund’s affairs. If preferred shares are issued, holders of preferred shares, voting separately as a single class, would have the right to elect two members of the board of trustees at all times. The remaining members of the board of trustees would be elected by holders of common shares and preferred shares, voting as a single class. The 1940 Act also requires that, in addition to any approval by shareholders that might otherwise be required, the approval of the holders of a majority of any outstanding preferred shares, voting separately as a class, would be required to (i) adopt any plan of reorganization that would adversely affect the preferred shares and (ii) take any action requiring a vote of security holders under Section 13(a) of the 1940 Act, including, among other things, changes in the Acquiring Fund’s subclassification as a closed-end investment company or changes in its fundamental investment restrictions.

The Acquiring Fund anticipates that any preferred shares that it issues would be initially given the highest ratings by Moody’s (“Aaa”) or by S&P (“AAA”), but no assurance can be given that such ratings will be obtained. No minimum rating is required for the issuance of preferred shares by the Acquiring Fund.

Common Stock Risk. The Acquiring Fund will have exposure to common stocks. Although common stocks have historically generated higher average total returns than fixed income securities over the long-term, common stocks also have historically experienced significantly more volatility in those returns. Therefore, the Acquiring Fund’s exposure to common stocks could result in worse performance than would be the case had the Acquiring Fund been invested solely in debt securities. An adverse event, such as an unfavorable earnings report, may depress the value of a particular common stock held by the Acquiring Fund. Also, the price of common stock is sensitive to general movements in the stock market and a drop in the stock market may depress the price of a common stock to which the Acquiring Fund has exposure. Common stock prices fluctuate for several reasons, including changes in investors’ perceptions of the financial condition of an issuer or the general condition of the relevant stock market, or when political or economic events affecting an issuer occur. In addition, common stock prices may be particularly sensitive to rising interest rates, as the cost of capital rises and borrowing costs increase.

Dividend Risk. Dividends on common stock are not fixed but are declared at the discretion of an issuer’s board of directors. There is no guarantee that the issuers of the common stocks in which the Acquiring Fund invests will declare dividends in the future or that, if declared, the dividends will remain at current levels or increase over time.

Small and Mid-Cap Securities Risk. The Acquiring Fund may invest in companies with small or medium-sized capitalizations. Securities issued by small and medium-sized companies can be more volatile than, and perform differently from, larger company securities. There may be less trading in a small or medium-sized company’s securities, which means that buy and sell transactions in those securities could have a larger impact on the security’s price than is the case with larger company securities. Small or medium-sized companies may have fewer business lines; changes in any one line of business, therefore, may have a greater impact on a small or medium-sized company’s security price than is the case for a larger company. In addition, small or medium-sized company securities may not be well known to the investing public.

Non-U.S. Securities Risk. Both the Acquired Fund and the Acquiring Fund may invest up to 20% of its total assets in non-U.S. securities, including emerging market securities. Investing in non-U.S. securities involves certain risks not involved in domestic investments, including, but not limited to: (i) fluctuations in foreign exchange rates; (ii) future foreign economic, financial, political and social developments; (iii) different legal systems; (iv) the possible imposition of exchange controls or other foreign governmental laws or restrictions; (v) lower trading volume; (vi) much greater price volatility and illiquidity of certain non-U.S. securities markets; (vii) different trading and settlement practices; (viii) less governmental supervision; (ix) changes in currency exchange rates; (x) high and volatile rates of inflation; (xi) fluctuating interest rates; (xii) less publicly available information; and (xiii) different accounting, auditing and financial recordkeeping standards and requirements.

Certain countries in which the Acquiring Fund may invest, especially emerging market countries, historically have experienced, and may continue to experience, high rates of inflation, high interest rates, exchange rate fluctuations, large amounts of external debt, balance of payments and trade difficulties and extreme poverty and unemployment. Many of these countries are also characterized by political uncertainty and instability. These risks are especially evident in the Middle East and Africa. The cost of servicing external debt will generally be adversely affected by rising international interest rates because many external debt obligations bear interest at rates which are adjusted based upon international interest rates. In addition, with respect to certain foreign countries, there is a risk of: (i) the possibility of expropriation or nationalization of assets; (ii) confiscatory taxation; (iii) difficulty in obtaining or enforcing a court judgment; (iv) economic, political or social instability; and (v) diplomatic developments that could affect investments in those countries. In addition, individual foreign economies may differ favorably or unfavorably from the U.S. economy in such respects as: (i) growth of gross domestic product; (ii) rates of inflation; (iii) capital reinvestment; (iv) resources; (v) self-sufficiency; and (vi) balance of payments position.

As a result of these potential risks, Highland may determine that, notwithstanding otherwise favorable investment criteria, it may not be practicable or appropriate to invest in a particular country. The Acquiring Fund may invest in countries in which foreign investors, including Highland, have had no or limited prior experience.

Emerging Markets Risk. Both the Acquired Fund and the Acquiring Fund may invest up to 20% of its total assets in securities of issuers based in emerging markets. Investing in securities of issuers based in emerging markets entails all of the risks of investing in securities of non-U.S. issuers, but to a heightened degree. Emerging market countries generally include every nation in the world except the United States, Canada, Japan, Australia, New Zealand and most countries located in Western Europe. These heightened risks include: (i) greater risks of expropriation, confiscatory taxation, nationalization, and less social, political and economic stability; (ii) the smaller size of the markets for such securities and a lower volume of trading, resulting in lack of liquidity and in price volatility; and (iii) certain national policies which may restrict the Acquiring Fund’s investment opportunities including restrictions on investing in issuers or industries deemed sensitive to relevant national interests.

Foreign Currency Risk. Because the Acquiring Fund may invest in securities denominated or quoted in currencies other than the U.S. dollar, changes in foreign currency exchange rates may affect the value of securities owned by the Acquiring Fund, the unrealized appreciation or depreciation of investments and gains on and income from investments. Currencies of certain countries may be volatile and therefore may affect the value of securities denominated in such currencies, which means that the Acquiring Fund’s NAV could decline as a result of changes in the exchange rates between foreign currencies and the U.S. dollar. These risks often are heightened for investments in smaller or emerging capital markets. In addition, the Acquiring Fund may enter into foreign currency transactions in an attempt to enhance total return which may further expose the Acquiring Fund to the risks of foreign currency movements and other risks. The use of foreign currency transactions can result in the Acquiring Fund incurring losses as a result of the imposition of exchange controls, suspension of settlements or the inability of the Acquiring Fund to deliver or receive a specified currency.

Investments in Unseasoned Companies. The Acquiring Fund may invest in the securities of less seasoned companies. These investments may present greater opportunities for growth, but also involve greater risks than customarily are associated with investments in securities of more established companies. Some of the companies in which the Acquiring Fund may invest will be start-up companies which may have insubstantial operational or earnings history or may have limited products, markets, financial resources or management depth. Some may also be emerging companies at the research and development stage with no products or technologies to market or approved for marketing. Securities of emerging companies may lack an active secondary market and may be subject to more

abrupt or erratic price movements than securities of larger, more established companies or stock market averages in general. Competitors of certain companies may have substantially greater financial resources than many of the companies in which the Acquiring Fund may invest.

Initial Public Offerings Risk. The Acquiring Fund may invest in shares of companies through initial public offerings (“IPOs”). IPOs and companies that have recently gone public have the potential to produce substantial gains for the Acquiring Fund. However, there is no assurance that the Acquiring Fund will have access to profitable IPOs. The investment performance of the Acquiring Fund during periods when it is unable to invest significantly or at all in IPOs may be lower than during periods when the Acquiring Fund is able to do so. Securities issued in IPOs are subject to many of the same risks as investing in companies with smaller market capitalizations. Securities issued in IPOs have no trading history, and information about the companies may be available for limited periods of time. In addition, the prices of securities sold in IPOs may be highly volatile or may decline shortly after the IPO.

Securities Lending Risk. The Acquiring Fund may lend its portfolio securities (up to a maximum of one-third of its total assets) to banks or dealers which are determined by the Adviser to present acceptable credit risk to the Acquiring Fund. Securities lending is subject to the risk that loaned securities may not be available to the Acquiring Fund on a timely basis and the Acquiring Fund may, therefore, lose the opportunity to sell the securities at a desirable price. Any loss in the market price of securities loaned by the Acquiring Fund that occurs during the term of the loan would be borne by the Acquiring Fund and would adversely affect the Acquiring Fund’s performance. Also, there may be delays in recovery, or no recovery, of securities loaned should the borrower of the securities fail financially while the loan is outstanding. Although the Acquiring Fund generally has the ability to recall loaned securities pursuant to a securities lending arrangement in the event that a shareholder vote is held, there is a risk that any delay in recovery of such security will result in the holder of such security being unable to vote. All of the aforementioned risks may be greater for non-U.S. securities.

These lending transactions must be fully collateralized at all times, but involve some credit risk to the Acquiring Fund if the borrower or the party (if any) guaranteeing the loan should default on its obligation and the Acquiring Fund is delayed in or prevented from recovering the collateral. In addition, any income or gains and losses from investing and reinvesting any cash collateral delivered by a borrower pursuant to a loan are generally at the Acquiring Fund’s risk, and to the extent any such losses reduce the amount of cash below the amount required to be returned to the borrower upon the termination of any loan, the Acquiring Fund may be required to pay or cause to be paid to such borrower or another entity an amount equal to such shortfall in cash.

Risks Associated with Options on Securities. There are several risks associated with transactions in options on securities, such as exchange-listed, over-the-counter and index options. For example, there are significant differences between the securities and options markets that could result in an imperfect correlation between these markets, causing a given transaction not to achieve its objectives. A decision as to whether, when and how to use options involves the exercise of skill and judgment, and even a well conceived transaction may be unsuccessful to some degree because of market behavior or unexpected events.

As the writer of a covered call option, the Acquiring Fund forgoes, during the option’s life, the opportunity to profit from increases in the market value of the security covering the call option above the sum of the premium and the strike price of the call, but has retained the risk of loss should the price of the underlying security decline. As the Acquiring Fund writes covered calls over more of its portfolio, its ability to benefit from capital appreciation becomes more limited. The writer of an option has no control over the time when it may be required to fulfill its obligation as a writer of the option. Once an option writer has received an exercise notice, it cannot effect a closing purchase transaction in order to terminate its obligation under the option and must deliver the underlying security at the exercise price.

When the Acquiring Fund writes covered put options, it bears the risk of loss if the value of the underlying stock declines below the exercise price minus the put premium. If the option is exercised, the Acquiring Fund could incur a loss if it is required to purchase the stock underlying the put option at a price greater than the market price of the stock at the time of exercise plus the put premium the Acquiring Fund received when it wrote the option. While the Acquiring Fund’s potential gain in writing a covered put option is limited to distributions earned on the liquid assets securing the put option plus the premium received from the purchaser of the put option, the Acquiring Fund risks a loss equal to the entire exercise price of the option minus the put premium.

Exchange-Listed Option Risks. There can be no assurance that a liquid market will exist when the Acquiring Fund seeks to close out an option position on an options exchange. Reasons for the absence of a liquid secondary market on an exchange include the following: (i) there may be insufficient trading interest in certain options; (ii) restrictions may be imposed by an exchange on opening transactions or closing transactions or both; (iii) trading halts, suspensions or other restrictions may be imposed with respect to particular classes or series of options; (iv) unusual or unforeseen circumstances may interrupt normal operations on an exchange; (v) the facilities of an exchange or the Options Clearing Corporation may not at all times be adequate to handle current trading volume; or (vi) one or more exchanges could, for economic or other reasons, decide or be compelled at some future date to discontinue the trading of options (or a particular class or series of options). If trading were discontinued, the secondary market on that exchange (or in that class or series of options) would cease to exist. However, outstanding options on that exchange that had been issued by the Options Clearing Corporation as a result of trades on that exchange would continue to be exercisable in accordance with their terms. If the Acquiring Fund were unable to close out a covered call option that it had written on a security, it would not be able to sell the underlying security unless the option expired without exercise.

The hours of trading for options on an exchange may not conform to the hours during which the underlying securities are traded. To the extent that the options markets close before the markets for the underlying securities, significant price and rate movements can take place in the underlying markets that cannot be reflected in the options markets. Call options are marked to market daily and their value will be affected by changes in the value and dividend rates of the underlying common stocks, an increase in interest rates, changes in the actual or perceived volatility of the stock market and the underlying common stocks and the remaining time to the options’ expiration. Additionally, the exercise price of an option may be adjusted downward before the option’s expiration as a result of the occurrence of certain corporate events affecting the underlying equity security, such as extraordinary dividends, stock splits, merger or other extraordinary distributions or events. A reduction in the exercise price of a call option would written by the Acquiring Fund reduce the Acquiring Fund’s capital appreciation potential on the underlying security.

Over-the-Counter Option Risk. The Acquiring Fund may write (sell) unlisted (“OTC” or “over-the-counter”) options. Options written by the Acquiring Fund with respect to non-U.S. securities, indices or sectors generally will be OTC options. OTC options differ from exchange-listed options in that they are two-party contracts, with exercise price, premium and other terms negotiated between buyer and seller, and generally do not have as much market liquidity as exchange-listed options. The counterparties to these transactions typically will be major international banks, broker-dealers and financial institutions. The Acquiring Fund may be required to treat as illiquid those securities being used to cover certain written OTC options. The OTC options written by the Acquiring Fund will not be issued, guaranteed or cleared by the Options Clearing Corporation. In addition, the Acquiring Fund’s ability to terminate the OTC options may be more limited than with exchange-traded options. Banks, broker-dealers or other financial institutions participating in such transactions may fail to settle a transaction in accordance with the terms of the option as written. In the event of default or insolvency of the counterparty, the Acquiring Fund may be unable to liquidate an OTC option position.

Index Option Risk. The Acquiring Fund may sell index put and call options from time to time. The purchaser of an index put option has the right to any depreciation in the value of the index below the exercise price of the option on or before the expiration date. The purchaser of an index call option has the right to any appreciation in the value of the index over the exercise price of the option on or before the expiration date. Because the exercise of an index option is settled in cash, sellers of index call options, such as the Acquiring Fund, cannot provide in advance for their potential settlement obligations by acquiring and holding the underlying securities. The Acquiring Fund will lose money if it is required to pay the purchaser of an index option the difference between the cash value of the index on which the option was written and the exercise price and such difference is greater than the premium received by the Acquiring Fund for writing the option. The value of index options written by the Acquiring Fund, which will be priced daily, will be affected by changes in the value and dividend rates of the underlying common stocks in the respective index, changes in the actual or perceived volatility of the stock market and the remaining time to the options’ expiration. The value of the index options also may be adversely affected if the market for the index options becomes less liquid or smaller. Distributions paid by the Acquiring Fund on its common shares may be derived in part from the net index option premiums it receives from selling index put and call options, less the cost of paying settlement amounts to purchasers of the options that exercise their options. Net index option premiums can vary widely over the short term and long term.

Interest Rate Risk. Interest rate risk is the risk that debt securities, and the Acquiring Fund’s net assets, may decline in value because of changes in interest rates. Generally, fixed rate debt securities will decrease in value when interest rates rise and increase in value when interest rates decline. This means that the NAV of the common shares will fluctuate with interest rate changes and the corresponding changes in the value of the Acquiring Fund’s debt security holdings.

Prepayment Risk. If interest rates fall, the principal on bonds and loans held by the Acquiring Fund may be paid earlier than expected. If this happens, the proceeds from a prepaid security may be reinvested by the Acquiring Fund in securities bearing lower interest rates, resulting in a possible decline in the Acquiring Fund’s income and distributions to shareholders. The Acquiring Fund may invest in pools of mortgages or other assets issued or guaranteed by private issuers or U.S. government agencies and instrumentalities.

Asset-Backed Securities Risk. Payment of interest and repayment of principal on asset-backed securities may be largely dependent upon the cash flows generated by the assets backing the securities and, in certain cases, supported by letters of credit, surety bonds or other credit enhancements. Asset-backed security values may also be affected by the creditworthiness of the servicing agent for the pool, the originator of the loans or receivables or the entities providing the credit enhancement. In addition, the underlying assets are subject to prepayments that shorten the securities’ weighted average maturity and may lower their return.

Mortgage-Backed Securities Risk. A mortgage-backed security, which represents an interest in a pool of assets such as mortgage loans, will mature when all the mortgages in the pool mature or are prepaid. Therefore, mortgage-backed securities do not have a fixed maturity, and their expected maturities may vary when interest rates rise or fall.

When interest rates fall, homeowners are more likely to prepay their mortgage loans. An increased rate of prepayments on the Acquiring Fund’s mortgage-backed securities will result in an unforeseen loss of interest income to the Acquiring Fund as the Acquiring Fund may be required to reinvest assets at a lower interest rate. Because prepayments increase when interest rates fall, the price of mortgage-backed securities does not increase as much as that of other fixed income securities when interest rates fall.

When interest rates rise, homeowners are less likely to prepay their mortgage loans. A decreased rate of prepayments lengthens the expected maturity of a mortgage-backed security. Therefore, the prices of mortgage-backed securities may decrease more than prices of other fixed income securities when interest rates rise.

Timely payment of interest and principal of mortgage backed securities may be supported by various forms of private insurance or guarantees, including individual loan, title, pool and hazard insurance purchased by the issuer. There can be no assurance that the private insurers can meet their obligations under the policies. An unexpectedly high rate of defaults on the mortgages held by a mortgage pool may adversely affect the value of a mortgage backed security and could result in losses to the Acquiring Fund. The risk of such defaults is generally higher in the case of mortgage pools that include sub-prime or “Alt-A” mortgages. These types of mortgages are made to borrowers with weakened credit histories or with a lower capacity to make timely payments on their mortgages. Market factors adversely affecting mortgage loan repayments may include a general economic downturn, high unemployment, a general slowdown in the real estate market, a drop in the market prices of real estate, or an increase in interest rates resulting in higher mortgage payments by holders of adjustable rate mortgages.

The market for mortgage-backed and asset-backed securities has recently experienced high volatility and a lack of liquidity. As a result, the value of many of these securities has significantly declined. There can be no assurance that these markets will become more liquid or less volatile, and it is possible that the value of these securities could decline further.

Repurchase Agreement Risk. The Acquiring Fund may enter into repurchase agreements up to a maximum of 33 1/3% of its total assets. Repurchase agreements may be considered loans to the seller, collateralized by the underlying securities. The risk to the Acquiring Fund is limited to the ability of the seller to pay the agreed-upon sum on the repurchase date; in the event of default, the repurchase agreement provides that the Acquiring Fund is entitled to sell the underlying collateral. If the value of the collateral declines after the agreement is entered into, and if the seller defaults under a repurchase agreement when the value of the underlying collateral is less than the repurchase price, the Acquiring Fund could incur a loss of both principal and interest. If the seller were to be subject to a federal bankruptcy proceeding, the ability of the Acquiring Fund to liquidate the collateral could be delayed or impaired because of certain provisions of the bankruptcy laws.

Credit Default Swaps Risk. Credit default swaps involve greater risks than if the Acquiring Fund had invested in the reference obligation directly. In addition to general market risks, credit default swaps are subject to illiquidity risk, counterparty risk and credit risks. The Acquiring Fund will enter into swap agreements only with counterparties which the Adviser believes to be creditworthy. A buyer also will lose its investment and recover nothing should no event of default occur. If an event of default were to occur, the value of the reference obligation received by the seller, coupled with the periodic payments previously received, may be less than the full notional value it pays to the buyer, resulting in a loss of value to the seller. When the Acquiring Fund acts as a seller of a credit default swap agreement it is exposed to many of the same risks of leverage described under “Leverage Risk” since if an event of default occurs the seller generally must pay the buyer the full notional value of the reference obligation. There is no percentage limitation on the Acquiring Fund’s investments in credit default swaps.

Derivatives Risk. Derivative transactions in which the Acquiring Fund may engage for hedging and speculative purposes or to enhance total return, including engaging in transactions such as options, futures, swaps, foreign currency transactions, forward foreign currency contracts, currency swaps or options on currency futures and other derivatives transactions (collectively, “Derivative Transactions”), involve certain risks and special considerations. Derivative Transactions have risks, including the imperfect correlation between the value of such instruments and the underlying assets, the possible default of the other party to the transaction or illiquidity of the derivative

instruments. Furthermore, the ability to successfully use Derivative Transactions depends on the Adviser’s ability to predict pertinent market movements, which cannot be assured. Because many derivatives are “leveraged,” and thus provide significantly more market exposure than the money paid or deposited when the transaction is entered into, a relatively small adverse market movement can not only result in the loss of the entire investment, but may also expose the Acquiring Fund to the possibility of a loss exceeding the original amount invested. Thus, the use of Derivative Transactions may result in losses greater than if they had not been used, may require the Acquiring Fund to sell or purchase portfolio securities at inopportune times or for prices other than current market values, may limit the amount of appreciation the Acquiring Fund can realize on an investment or may cause the Acquiring Fund to hold a security that it might otherwise sell. The use of foreign currency transactions can result in the Acquiring Fund’s incurring losses as a result of the imposition of exchange controls, the suspension of settlements or the inability of the Acquiring Fund to deliver or receive a specified currency. Additionally, amounts paid by the Acquiring Fund as premiums and cash or other assets held in margin accounts with respect to Derivative Transactions are not otherwise available to the Acquiring Fund for investment purposes. In addition, the Acquiring Fund’s Derivative Transactions are generally subject to numerous special and complex tax rules. Because the tax rules applicable to such transactions may be uncertain under current law, an adverse determination or future Internal Revenue Service (“IRS”) guidance with respect to these rules may affect whether the Acquiring Fund has made sufficient distributions, and otherwise satisfied the relevant requirements, to maintain its qualification as a RIC and avoid Fund-level U.S. federal income and/or excise taxes. Therefore, the Acquiring Fund’s investments in derivative instruments may be limited by these or other U.S. federal income tax considerations.

If a put or call option purchased by the Acquiring Fund is not sold when it has remaining value, and if the market price of the underlying security remains equal to or greater than the exercise price (in the case of a put), or remains less than or equal to the exercise price (in the case of a call), the Acquiring Fund will lose its entire investment in the option.

Also, where a put or call option on a particular security is purchased to hedge against price movements in a related security, the price of the put or call option may move more or less than the price of the related security. If restrictions on exercise were imposed, the Acquiring Fund might be unable to exercise an option it had purchased. If the Acquiring Fund were unable to close out an option that it had purchased on a security, it would have to exercise the option in order to realize any profit or the option may expire worthless.

Counterparty Risk. The Acquiring Fund will be subject to credit risk with respect to the counterparties to the derivative contracts purchased or sold by the Acquiring Fund. If a counterparty becomes bankrupt, or otherwise fails to perform its obligations under a derivative contract due to financial difficulties, the Acquiring Fund may experience significant delays in obtaining any recovery under the derivative contract in a bankruptcy or other reorganization proceeding. The Acquiring Fund may obtain only a limited recovery or may obtain no recovery in such circumstances.

Market Risk Generally. The profitability of a significant portion of the Acquiring Fund’s investment program depends to a great extent upon correctly assessing the future course of the price movements of securities and other investments and the movements of interest rates. There can be no assurance that the Adviser will be able to predict accurately these price and interest rate movements. With respect to certain investment strategies the Acquiring Fund utilizes, there is a high degree of market risk.

Reinvestment Risk. The Acquiring Fund reinvests the cash flows received from a security. The additional income from such reinvestment, sometimes called interest-on-interest, is reliant on the prevailing interest rate levels at the time of reinvestment. There is a risk that the interest rate at which interim cash flows can be reinvested will fall. Reinvestment risk is greater for longer holding periods and for securities with large, early cash flows such as high-coupon bonds. Reinvestment risk also applies generally to the reinvestment of the proceeds the Acquiring Fund receives upon the maturity or sale of a portfolio security.

Timing Risk. Many agency, corporate and municipal bonds, and most mortgage-backed securities, contain a provision that allows the issuer to “call” all or part of the issue before the bond’s maturity date — often after 5 or 10 years. The issuer usually retains the right to refinance the bond in the future if market interest rates decline below the coupon rate. There are three disadvantages to the call provision. First, the cash flow pattern of a callable bond is not known with certainty. Second, because an issuer is more likely to call the bonds when interest rates have dropped,

the Acquiring Fund is exposed to reinvestment risk, i.e., the Acquiring Fund may have to reinvest at lower interest rates the proceeds received when the bond is called. Finally, the capital appreciation potential of a bond will be reduced because the price of a callable bond may not rise much above the price at which the issuer may call the bond.

Inflation Risk. Inflation risk results from the variation in the value of cash flows from a security due to inflation, as measured in terms of purchasing power. For example, if the Acquiring Fund purchases a bond in which it can realize a coupon rate of 5%, but the rate of inflation increases from 2% to 6%, then the purchasing power of the cash flow has declined. For all but adjustable bonds or floating rate bonds, the Acquiring Fund is exposed to inflation risk because the interest rate the issuer promises to make is fixed for the life of the security. To the extent that interest rates reflect the expected inflation rate, floating rate bonds have a lower level of inflation risk. In addition, during any periods of rising inflation, dividend rates of any variable rate preferred shares issued by the Fund would likely increase, which would tend to further reduce returns to common shareholders.

Arbitrage Risks. The Acquiring Fund engages in capital structure arbitrage and other arbitrage strategies. Arbitrage strategies entail various risks including the risk that external events, regulatory approvals and other factors will impact the consummation of announced corporate events and/or the prices of certain positions. In addition, hedging is an important feature of capital structure arbitrage. There is no guarantee that the Adviser will be able to hedge the Acquiring Fund’s portfolio in the manner necessary to employ successfully the Acquiring Fund’s strategy. The general risks of using arbitrage strategies do not apply to the Acquired Fund since it generally does not use arbitrage strategies.

Short Sales Risk. Short selling involves selling securities which may or may not be owned and borrowing the same securities for delivery to the purchaser, with an obligation to replace the borrowed securities at a later date. Short selling allows the Acquiring Fund to profit from declines in market prices to the extent such decline exceeds the transaction costs and the costs of borrowing the securities. However, since the borrowed securities must be replaced by purchases at market prices in order to close out the short position, any appreciation in the price of the borrowed securities would result in a loss. There can be no assurance that the securities necessary to cover a short position will be available for purchase. Purchasing securities to close out the short position can itself cause the price of the securities to rise further, thereby exacerbating the loss. The Acquiring Fund may mitigate such losses by replacing the securities sold short before the market price has increased significantly. Under adverse market conditions, the Acquiring Fund might have difficulty purchasing securities to meet its short sale delivery obligations, and might have to sell portfolio securities to raise the capital necessary to meet its short sale obligations at a time when fundamental investment considerations would not favor such sales. Short sales by the Acquiring Fund that are not made “against the box” theoretically involve unlimited loss potential since the market price of securities sold short may continuously increase. The general risks of using short sales do not apply to the Acquired Fund since it generally does not use short sales.

Risks of Investing in Structured Finance Securities. A portion of the Acquiring Fund’s investments may consist of collateralized mortgage obligations, collateralized bond obligations, collateralized loan obligations or similar instruments. Structured finance securities may present risks similar to those of the other types of debt obligations in which the Acquiring Fund may invest and, in fact, such risks may be of greater significance in the case of structured finance securities. Moreover, investing in structured finance securities may entail a variety of unique risks. Among other risks, structured finance securities may be subject to prepayment risk. In addition, the performance of a structured finance security will be affected by a variety of factors, including the security’s priority in the capital structure of the issuer thereof, the availability of any credit enhancement, the level and timing of payments and recoveries on and the characteristics of the underlying receivables, loans or other assets that are being securitized, remoteness of those assets from the originator or transferor, the adequacy of and ability to realize upon any related collateral and the capability of the servicer of the securitized assets. In addition, the complex structure of the security may not be fully understood at the time of investment and may produce unexpected investment results. Investments in structured finance securities may also be subject to illiquidity risk. Collateralized mortgage obligations may have risks similar to those of mortgage-backed securities. See “Mortgage-Backed Securities Risk” for more information.

Risks of Investing in Preferred Securities. There are special risks associated with investing in preferred securities, including:

	•		Deferral. Preferred securities may include provisions that permit the issuer, at its discretion, to defer distributions for a stated period without any adverse consequences to the issuer. If the Acquiring Fund owns a preferred security that is deferring the payment of its distributions, the Acquiring Fund may be required to report income for U.S. federal income tax purposes to the extent of any such deferred distribution even though the Acquiring Fund has not yet received such income. In order to receive the special treatment accorded to RICs and their shareholders under the Code and to avoid U.S. federal income and/or excise taxes at the Acquiring Fund level, the Acquiring Fund may be required to distribute this reported income to shareholders in the tax year in which the income is reported (without a corresponding receipt of cash). Therefore, the Acquiring Fund may be required to pay out as an income distribution in any such tax year an amount greater than the total amount of income the Acquiring Fund actually received, and to sell portfolio securities to obtain cash needed for these income distributions.
	•		Subordination. Preferred securities are subordinated to bonds and other debt instruments in a company’s capital structure in terms of priority to corporate income and liquidation payments, and therefore will be subject to greater credit risk than more senior debt instruments.
	•		Liquidity. Preferred securities may be substantially less liquid than many other securities, such as common stock or U.S. government securities.
	•		Limited Voting Rights. Generally, preferred security holders have no voting rights with respect to the issuing company unless preferred dividends have been in arrears for a specified number of periods, at which time the preferred security holders may elect a number of directors to the issuer’s board. Generally, once all the arrearages have been paid, the preferred security holders no longer have voting rights.

Risks of Investing in Synthetic Securities. In addition to credit risks associated with holding non-investment grade loans and high-yield debt securities, with respect to synthetic securities the Acquiring Fund will usually have a contractual relationship only with the counterparty of such synthetic securities, and not the Reference Obligor (as defined below) on the Reference Obligation (as defined below). The Acquiring Fund generally will have no right to enforce directly compliance by the Reference Obligor with the terms of the Reference Obligation nor any rights of setoff against the Reference Obligor, nor have any voting rights with respect to the Reference Obligation. The Acquiring Fund will not benefit directly from any collateral supporting the Reference Obligation or have the benefit of the remedies on default that would normally be available to a holder of such Reference Obligation. In addition, in the event of insolvency of its counterparty, the Acquiring Fund will be treated as a general creditor of such counterparty and will not have any claim with respect to the credit risk of the counterparty as well as that of the Reference Obligor. As a result, investments in synthetic securities are subject to an additional degree of risk because they are subject to the credit risk of the counterparty as well as that of the Reference Obligor. The Adviser may not perform independent credit analyses of any particular counterparty, or any entity guaranteeing the obligations of such counterparty. A “Reference Obligation” is the debt security or other obligation upon which the synthetic security is based. A “Reference Obligor” is the obligor on a Reference Obligation. There is no maximum amount of the Acquiring Fund’s assets that may be invested in these securities.

Valuation Risk. Fair value is defined as the amount for which assets could be sold in an orderly disposition over a reasonable period of time, taking into account the nature of the asset. Fair value pricing, however, involves judgments that are inherently subjective and inexact, since fair valuation procedures are used only when it is not possible to be sure what value should be attributed to a particular asset or when an event will affect the market price of an asset and to what extent. Currently, the Acquiring Fund does not utilize Sterling Valuation Group, Inc. for its quarterly valuation. Instead it relies upon the Adviser for fair value pricing. There can be no assurance that fair value pricing will reflect actual market value and it is possible that the fair value determined for a security will be materially different from the value that actually could be or is realized upon the sale of that asset. Although the valuation policies of the Acquired Fund and Acquiring Fund are substantially similar, the valuation policy of the Acquired Fund requires its Board and the Fund’s Valuation Committee to consider both the fair value assigned by the Acquired Fund’s investment adviser and that supplied by an independent valuation firm (currently, Sterling Valuation Group, Inc., as indicated above) the Board has engaged for the valuation of securities for which market quotations are not readily available. The Acquiring Fund’s Board is not required to consider valuation provided by independent valuation firm. It is possible that the fair value pricing of a security could differ under the two policies; however, Highland expects the values of Acquired Fund assets that are fair valued will not change as a result of the application of the Acquiring Fund’s fair valuation policies.

Market Disruption and Geopolitical Risk. The aftermath of the war in Iraq and the continuing occupation of Iraq, instability in the Middle East and terrorist attacks in the United States and around the world may result in market volatility and may have long-term effects on the U.S. and worldwide financial markets and may cause further economic uncertainties in the United States and worldwide. The Adviser does not know how long the securities markets may be affected by these events and cannot predict the effects of the occupation or similar events in the future on the U.S. economy and securities markets.

Risks of Investing in a Fund with Anti-Takeover Provisions. The Acquiring Fund’s Agreement and Declaration of Trust includes provisions that could limit the ability of other entities or persons to acquire control of the Acquiring Fund or convert the Acquiring Fund to open-end status. These provisions could deprive the holders of common shares of opportunities to sell their common shares at a premium over the then current market price of the common shares or at NAV.

Key Adviser Personnel Risk. The Acquiring Fund’s ability to identify and invest in attractive opportunities is dependent upon Highland, its investment adviser. If one or more key individuals leaves Highland, Highland may not be able to hire qualified replacements or may require an extended time to do so. This situation could prevent the Acquiring Fund from achieving its investment objectives.

Given the risks described above, an investment in the common shares of the Acquiring Fund may not be appropriate for all investors. You should carefully consider your ability to assume these risks before making an investment in the Acquiring Fund.

There are no restrictions on the Acquiring Fund’s ability to pay dividends with respect to any class of securities. See “Information About the Funds: Dividends and Other Distributions” for more information.

DESCRIPTION OF THE REORGANIZATION

You are being asked to approve an Agreement and Plan of Merger and Liquidation to which your Fund is a party, a form of which is attached to this Proxy Statement/Prospectus as Appendix A (the “Agreement”). Additional information about the Reorganization and Agreement is set forth below under “Further Information on the Reorganization.” The Agreement provides for Reorganization on the following terms:

	•		Pursuant to the Reorganization, Acquired Fund will merge with and into HCF Acquisition LLC, a wholly owned subsidiary of Acquiring Fund (the “Merger”), with Merger Sub being the surviving entity and the separate corporate existence of Acquired Fund shall thereupon cease. Common stockholders of Acquired Fund will receive shares of beneficial interest, with $0.001 par value, of Acquiring Fund (the “Merger Shares”) (and cash in lieu of any fractional shares) having an aggregate net asset value equal to the value of assets of Acquired Fund on the Valuation Date less the value of the liabilities of Acquired Fund on such Valuation Date. Immediately after the Merger, Merger Sub will distribute its assets to Acquiring Fund, and Acquiring Fund will assume the liabilities of Merger Sub, in complete liquidation and dissolution of Merger Sub.
	•		The Acquiring Fund will issue and cause to be listed on the NYSE newly issued Merger Shares (and cash in lieu of any fractional shares) in an amount equal to the value of the Acquired Fund’s net assets attributable to its common shares (taking into account the Acquired Fund’s proportionate share of the costs of the Reorganization). Common shareholders of record of the Acquired Fund will have their shares of the Acquired Fund converted into Merger Shares in proportion to their holdings of the Acquired Fund’s shares immediately prior to the Merger. Acquired Fund common shareholders will receive cash for any Acquiring Fund fractional shares they otherwise would be entitled to receive other than with respect to shares held in a Dividend Reinvestment Plan account. As a result, common shareholders of the Acquired Fund will end up as common shareholders of the Acquiring Fund.
	•		Before the Reorganization, Merger Sub will elect to be regulated as a business development company by filing the requisite forms with the Securities and Exchange Commission (the “SEC”) and, after the Reorganization, it will file the forms necessary to withdraw its election.
	•		After the Reorganization, the Acquired Fund will then (1) withdraw its election to be regulated as a business development company and de-register with the SEC and (2) de-list from the NYSE.

The distribution of Merger Shares pursuant to the Reorganization will be accomplished by opening new accounts on the books of the Acquiring Fund in the names of the Acquired Fund’s common shareholders of record as of the closing date of the Reorganization and transferring the Merger Shares to those accounts. Each such account for a former common shareholder of the Acquired Fund will be credited with the pro rata number of Merger Shares (rounded down, in the case of fractional shares held other than in a Dividend Reinvestment Plan account, to the next largest number of whole shares) due such shareholder. If fractional Merger Shares otherwise would have been credited to an account, the Acquiring Fund will issue cash for such fractional shares (except for shares held in a

Dividend Reinvestment Plan account). See “Further Information on the Reorganization — Additional Terms of the Agreement and Plan of Merger and Liquidation” below for a description of the procedures to be followed by the Acquired Fund’s shareholders to obtain Merger Shares (and cash in lieu of any fractional shares).

REASONS FOR THE PROPOSED REORGANIZATION

The Boards of the Funds considered the Reorganization at meetings held on October 24, November 6 and December 18-19, 2008. At the December 18-19 meeting, the Board of each Fund, including the Trustees/Directors who are not “interested persons” (as defined in the 1940 Act) of each Fund, unanimously approved the Agreement.

The Board of the Acquired Fund has determined that participation in the Reorganization is in the best interests of the Fund and that the interests of its shareholders will not be diluted as a result of that Reorganization. Similarly, the Acquiring Fund’s Board has determined that participation in the Reorganization is in the best interests of its common shareholders and that the interests of such shareholders will not be diluted as a result of the Reorganization. Although the Board of each Fund determined that the Reorganization would not result in dilution of the interests of the shareholders of such Fund, the Board also considered the fact that the net asset value (“NAV”) per share of the combined Acquiring Fund will decrease by the expenses related to the Reorganization, estimated to be 1 cent per share. In addition, as a result of the Reorganization, shareholders of each Fund, particularly the shareholders of the Acquired Fund, will have a smaller percentage of ownership in the larger combined Fund than they did in any of the separate Funds.

The Board of the Acquired Fund believes that reorganizing the Acquired Fund into the Acquiring Fund, a fund with a similar investment objective and policies, and having a combined portfolio with greater assets, offers you potential benefits. In determining whether or not to approve the Agreement, the Board of the Acquired Fund reviewed a number of factors and various information about the Funds and the proposed Reorganization, and considered, among other things:

	•		the terms and conditions of the Agreement and the Reorganization;
	•		the fact that the Reorganization would not result in the dilution of shareholders’ interests;
	•		the compatibility of and differences between the Funds’ investment goals, policies, risks and principal investment strategies;
	•		the Funds’ relative asset sizes;
	•		the fact that the Reorganization is expected to be tax-free for federal income tax purposes;
	•		the fact that no gain or loss is expected to be recognized by Acquired Fund stockholders for federal income tax purposes as a result of the Reorganization (except to the extent of cash received in lieu of any fractional share of Acquiring Fund);
	•		the respective tax positions of each Fund;
	•		the historic operating expenses for each Fund; and
	•		the historic performance of each Fund for the past one-year period ended October 31, 2008, the year-to-date period ended October 31, 2008 and for the period February 26, 2007 (inception of the Acquired Fund) through October 31, 2008.

More specifically, with respect to the proposed Reorganization, the Board of the Acquired Fund made the following determinations, among others:

	•		Economies of Scale in Expenses. A combined Fund offers economies of scale that may lead to a reduction in operating expenses. Due to the combined Fund’s lower management fee, lower administration fee, no incentive fee, lower interest expense due to lower leverage and elimination of overlapping expenses, the estimated annual operating expenses of the combined Fund are expected to be lower than the current annual operating expenses of the Acquired Fund. Each Fund incurs New York Stock Exchange (“NYSE”) listing fees, costs for legal, auditing, and custodial services, and miscellaneous fees. Additionally, the Acquired Fund incurs expenses related to Sarbanes-Oxley implementation that the Acquiring Fund does not and that the combined Fund would not incur. Many of these expenses overlap and there may be an opportunity to reduce them over time if the Funds are combined.
	•		Exchange of Common Shares at Net Asset Value (“NAV”). On its closing date, the Reorganization will result in the Acquired Fund shareholders receiving shares of beneficial interest the Acquiring Fund and cash (in lieu of fractional shares) based on the Acquired Fund’s NAV (i.e., the shareholder of Acquired Fund will receive common shares of the Acquiring Fund and cash (in lieu of fractional shares) with an aggregate NAV equal to the value of the Acquired Fund shares held immediately before the Valuation Time for the Merger). Because the Acquiring Fund historically has traded at a greater premium or narrower discount than the Acquired Fund since inception of the Acquired Fund, Acquired Fund stockholders would receive shares of the Acquiring Fund, which based on historical trading, may potentially trade at a narrower discount than shares of the Acquired Fund.
	•		Enhanced Common Share Liquidity. Following the Reorganization, the substantially larger trading market in the common shares of the Acquiring Fund, as compared to that of the Acquired Fund prior to the Reorganization, may provide Acquired Fund shareholders with enhanced market liquidity. Trading discounts can result from many different factors, however, and there is no assurance that the Acquiring Fund will continue to trade at a smaller discount to NAV.
	•		Increased Asset Size. The Acquiring Fund will obtain additional assets without incurring underwriting expenses and other transaction expenses associated with offering new shares. In addition, the Acquiring Fund is obtaining the additional portfolio securities of the Acquired Fund without the commensurate brokerage costs, dealer spreads or other trading expenses. It is also obtaining these securities in a manner that is likely to minimize the market impact of such acquisition on the short-term prices of these securities. However, the increase in Acquiring Fund shares as a result of the Reorganization may also cause Acquiring

			Fund shares to trade at a larger discount from NAV. Because shareholders of the Acquired Fund will receive Acquiring Fund shares, Acquired Fund shareholders may share in these potential benefits.
	•		Portfolio Management Efficiencies. The Reorganization would permit Acquired Fund shareholders to pursue similar investment goals in a larger fund. The greater asset size of the combined Fund may allow the combined Fund, relative to the Acquired Fund, to obtain better net prices on securities trades and achieve greater diversification of portfolio holdings. Although 78.21% of the Acquired Fund’s assets represented issuers of securities owned by the Acquiring Fund at December 31, 2008, such issuers made up only 22.91% of the Acquiring Fund’s assets.
	•		Shareholders’ Ability to Margin. Stocks that trade below $5.00 are not currently marginable. Since the Acquired Fund currently trades well below $5.00 per share, and the Acquiring Fund has recently been trading at around $5.00 per share, if the Reorganization is approved, Acquired Fund shareholders would receive shares of the Acquiring Fund that would be more likely to be marginable (based on current market prices). Additionally, marginable securities may be more liquid that those that are not marginable because many institutional/large investors are believed to avoid stocks that are not marginable. However, if the price per share of the Acquiring Fund trades below $5.00 (which it has recently done), the shares of the Acquiring Fund would no longer be marginable. It is possible that the Reorganization will exert downward pressure on the price per share of the Acquiring Fund.

Accordingly, for the reasons noted above, together with other factors and information considered relevant, and recognizing that there can be no assurance that any economies of scale or other benefits will be realized, the Board of the Acquired Fund concluded that the Reorganization would be in the best interests of the Acquired Fund and its shareholders. The Board of the Acquired Fund unanimously recommends that you vote FOR the Reorganization of the Acquired Fund into the Acquiring Fund.

COMPARATIVE FEES AND EXPENSE RATIOS

As the tables below indicate, the pro forma annual operating expenses of the Acquiring Fund are lower than the annual operating expenses of the Acquired Fund.

The Funds’ Expenses

The tables below illustrate the change in operating expenses expected as a result of the Reorganization. The tables set forth (i) the fees, expenses and interest payments on borrowed funds paid by the Acquired Fund for the twelve-month period ended December 31, 2008; (ii) the fees, expenses, and interest payments on borrowed funds paid by the Acquiring Fund for the twelve-month period ended December 31, 2008; and (iii) the pro forma fees, expenses and interest payments on borrowed funds for the Acquiring Fund for the twelve-month period ended December 31, 2008, assuming the Reorganization had been completed at the beginning of such period. The following tables show each Fund’s expenses as a percentage of net assets attributable to common shares and borrowing in an amount equal to 37.68% of the Acquired Fund’s total assets and 28.5% of the Acquiring Fund’s total assets and 28.5% of the combined Fund’s total assets after the Reorganization is completed.

PRO FORMA

ACTUAL

COMBINED(1)

Acquired

Acquiring

Fund

Fund

Acquiring Fund

Common Shareholder Transaction Expenses

Sales Load (as a percentage of offering price)

None(1)

None(1)

None(1)

Dividend Reinvestment Plan Fees

None(2)

None(3)

None(3)

		ACTUAL
		Percentage of Net Assets
		Attributable to Common
		Shares (Twelve Months ended								PRO FORMA
		December 31, 2008)								COMBINED(1)
		Acquired				Acquiring
		Fund				Fund				Acquiring Fund
Management Fee			3.21	%			1.40	%			1.40	%
Incentive Fee			1.29	%			0.00	%			0.00	%
Interest Payments on Borrowed Funds			2.43	%			1.63	%			1.63	%
Other Expenses
Dividend Expense For Short Positions			0.00	%			0.17	%			0.17	%
Other Expenses(4)			2.26	%			0.75	%			0.70	%
Total Other Expenses			2.26	%			0.92	%			0.87	%
Total Annual Expenses			9.18	%			3.94	%			3.90	%
Minus: Management Fee Waivers(5)			0.00	%			0.09	%			0.07	%
Net Expenses			9.18	%(6)			3.86	%			3.83	%

The purpose of the tables in this section is to assist you in understanding the various costs and expenses that a shareholder will bear directly or indirectly by investing in a Fund’s common shares and the Acquiring Fund’s costs and expenses that are expected to be incurred in the first year following the Reorganization.

Example

The following example is intended to help you compare the costs of investing in the Acquiring Fund pro forma after the Reorganization with the costs of investing in the Acquired Fund and the Acquiring Fund without the Reorganization. An investor would pay the following expenses on a $1,000 investment in common shares, assuming (i) the operating expense ratio for each Fund (as a percentage of net assets attributable to common shares) set forth in the table above for years 1 through 10, (ii) average borrowings under the Acquired Fund’s credit facility of $79 million and the Acquiring Fund’s credit facility of $257 million prior to the Reorganization, (iii) borrowings under the Acquiring Fund’s credit facility of $309 million after the Reorganization, (iv) a 5% annual return throughout the period, and (v) the contractual fee waivers noted above after the Reorganization, but only for the period of such contractual waivers.

(Unaudited)

		1 Year				3 Years				5 Years				10 Years
Acquired Fund		$	90			$	259			$	413			$	747
Acquiring Fund		$	39			$	119			$	201			$	418
Pro Forma Combined — Acquiring Fund (1)		$	39			$	118			$	199			$	412

The example set forth above assumes the reinvestment of all dividends and other distributions at NAV and that the percentage of the Acquiring Fund’s assets represented by leverage of the Acquiring Fund will remain the same pre-and post-Reorganization. The example set forth above should not be considered a representation of past or future expenses or annual rates of return. Actual expenses or annual rates of return may be more or less than those assumed for purposes of the example.

BOARD’S EVALUATION AND RECOMMENDATION

After careful consideration of all factors deemed relevant, including the reasons described herein, the Board of the Acquired Fund, including the Directors who are not “interested persons” (as defined in the 1940 Act) of the Fund, the Acquiring Fund or the Adviser, approved the Reorganization. In particular, the Directors determined that participation in the Reorganization involving the Fund is in its best interests and that the interests of its stockholders would not be diluted as a result of the Reorganization. Similarly, the Board of the Acquiring Fund, including the Trustees who are not “interested persons” (as defined in the 1940 Act) of any Fund or the Adviser, approved the Reorganization. They also determined that participation in the Reorganization is in the Acquiring Fund’s best interests and that the interests of its stockholders would not be diluted as a result of the Reorganization. Although the Board of each Fund determined that the Reorganization would not result in dilution of the interests of the shareholders of such Fund, the Board also considered the fact that the net asset value (“NAV”) per share of the combined Acquiring Fund will decrease by the expenses related to the Reorganization, estimated to be 1 cent per share.

REQUIRED VOTE

Approval of the Reorganization requires, if a quorum is present at the Meeting, the affirmative vote of a majority of the outstanding voting securities of the Acquired Fund, which is defined in the 1940 Act as the lesser of (a) 67% or more of the voting securities present at the Meeting, if the holders of more than 50% of the outstanding voting securities of the Acquired Fund are present or represented by proxy, or (b) more than 50% of the outstanding voting securities of the Acquired Fund.

ADDITIONAL INFORMATION RELATED TO THE REORGANIZATION OF THE ACQUIRED FUND

COMPARISON OF THE FUNDS: INVESTMENT OBJECTIVES AND POLICIES

The following tables compare the investment objectives and policies of the Acquired Fund to the Acquiring Fund and summarize the types of investments that each may engage in. For a more complete description of the types of investments, please refer to Appendix B.

		Acquired Fund		Acquiring Fund
Business		The Fund is a closed-end company, organized as a Delaware corporation on August 22, 2006, that has elected to be regulated as a business development company under the 1940 Act.		The Fund is a non-diversified, closed-end management investment company organized as a Delaware statutory trust on March 10, 2006.
Net Assets (December 31, 2008)		$60.6 million		$361.2 million
Listing (Common Shares)		NYSE under the ticker symbol “HCD”		NYSE under the ticker symbol “HCF”
Fiscal Year End		12/31		12/31
Investment Adviser		Highland Capital Management, L.P.		Highland Capital Management, L.P.
Portfolio Managers		Brad Borud Greg Stuecheli		Brad Borud Brad Means
Investment Objective(s)		The Fund’s investment objective is to provide total return generated by both capital appreciation and current income. The investment objective may be changed without shareholder approval.		The Fund’s investment objective is to provide both current income and capital appreciation. The investment objective may be changed without shareholder approval.
Primary Investment Strategies		The Fund pursues its objectives by investing in senior secured debt, mezzanine debt and unsecured debt, each of which may include an equity component, and in equity investments. The Fund has filed an election to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940 (the “1940 Act”). While the Fund’s primary focus will be to generate capital appreciation and current income through investments in senior secured debt, mezzanine debt, unsecured debt and equity investments, the Fund may invest up to 30% of the portfolio in opportunistic investments that the research platform of the Investment Adviser identifies during the investment process in order to seek to enhance returns to stockholders. Such investments may include, for example, investments in the senior secured debt, mezzanine debt, unsecured debt, equity investments, other debt obligations, options, structured products and		The Fund pursues its objectives by investing primarily in the following categories of securities and instruments of corporations and other business entities: (i) secured and unsecured floating and fixed rate loans; (ii) bonds and other debt obligations; (iii) debt obligations of stressed, distressed and bankrupt issuers; (iv) structured products, including but not limited to, mortgage-backed and other asset-backed securities and collateralized debt obligations; and (v) equities. Additionally, within the categories of obligations and securities in which the Fund may invest, Highland may employ various trading strategies, including but not limited to, capital structure arbitrage, pair trades, and shorting. The Fund may also invest in these categories of obligations and securities through the use of derivatives. Highland will seek to achieve its capital appreciation objective by investing in category (iii) and (v) obligations and securities, and to a lesser extent, in category (i), (ii), and (iv)

		Acquired Fund		Acquiring Fund
		other derivatives of middle-market or unlisted companies operating in the financial sector or foreign and/or larger, listed companies. The Fund expects that these companies generally will have debt securities that are non-investment grade.		obligations. Under normal market conditions, at least 80% of the Fund’s assets will be invested in one or more of these principal investment categories. Subject only to this general guideline, the Adviser has broad discretion to allocate the Fund’s assets among these investment categories and to change allocations as conditions warrant. The Adviser has full discretion regarding the capital markets from which it can access investment opportunities in accordance with the investment limitations set forth in this prospectus. A significant portion of the Fund’s assets may be invested in securities rated below investment grade, which are commonly referred to as “junk securities.”
Leverage and Borrowing		The Fund employs leverage through borrowings through a credit facility and, as of December 31, 2008, the Fund had borrowings of approximately $15.5 million.		The Fund employs leverage through borrowings through a credit facility and, as of December 31, 2008, the Fund had borrowings of approximately $141 million.
Diversification		The Fund is non-diversified.		The Fund is non-diversified.
Concentration		There is no limit on the amount of the Fund’s portfolio that can be concentrated in one industry.		The Fund may not invest 25% or more of its assets in the securities of issuers in one industry.
Illiquid Securities		There is no limit on the amount of the Fund’s portfolio that can be invested in illiquid securities.		There is no limit on the amount of the Fund’s portfolio that can be invested in illiquid securities.
Portfolio Turnover		The Fund’s portfolio turnover rate may exceed 100% per year.		The Fund’s portfolio turnover rate may exceed 100% per year.
Senior Loans, Unsecured Loans, Second Lien Loans and Other Secured Loans		There is no limit on the amount of the Fund’s portfolio that can be invested in senior loans, including bank loans, unsecured loans, second lien loans and other secured loans.		There is no limit on the amount of the Fund’s portfolio that can be invested in senior loans, including bank loans, unsecured loans, second lien loans and other secured loans.
Investment Grade Securities		There is no limit on the amount of the Fund’s portfolio that can be invested in investment grade securities, however, a significant portion of the Fund’s assets may be invested in securities rated below investment grade, which are commonly referred to as “junk securities.”		There is no limit on the amount of the Fund’s portfolio that can be invested in investment grade securities, however, a significant portion of the Fund’s assets may be invested in securities rated below investment grade, which are commonly referred to as “junk securities.”
Non-Investment Grade Securities		There is no limit on the amount of the Fund’s portfolio that can be invested in non-investment grade securities and a significant portion of the Fund’s assets may be invested in securities rated below investment grade, which are commonly referred to as “junk securities.”		There is no limit on the amount of the Fund’s portfolio that can be invested in non-investment grade securities and a significant portion of the Fund’s assets may be invested in securities rated below investment grade, which are commonly referred to as “junk securities.”
Asset-Backed Securities and Mortgaged-Backed Securities		The Fund may invest in asset-backed securities and mortgage-backed securities.		The Fund may invest in asset-backed securities and mortgage-backed securities.

		Acquired Fund		Acquiring Fund
Collateralized Loan Obligations and Bond Obligations		The Fund may invest in collateralized loan obligations and bond obligations. The Fund invests in the lower tranches of collateralized bond obligations.		The Fund may invest in collateralized loan obligations and bond obligations. The Fund invests in the lower tranches of collateralized bond obligations.
Distressed Debt and Stressed Debt		The Fund may invest in the securities and other obligations of stressed, distressed and bankrupt issuers, including debt obligations that are in covenant or payment default.		The Fund may invest in the securities and other obligations of stressed, distressed and bankrupt issuers, including debt obligations that are in covenant or payment default.
Equity Securities		There is no limit on the amount of the Fund’s portfolio that can be invested in equity securities including common and preferred stocks.		There is no limit on the amount of the Fund’s portfolio that can be invested in equity securities including common stock, preferred stocks, convertible securities, warrants and depository receipts.
Money Market Instruments and U.S. Government Securities		The Fund may invest in money market instruments and U.S. government securities.		The Fund may invest in money market instruments and U.S. government securities.
Other Investment Companies		The Fund may invest in the securities of other investment companies (including exchange traded funds (“ETFs”)) to the extent that such investments are consistent with the Fund’s investment objectives and principal investment strategies and permissible under the 1940 Act.		The Fund may invest in the securities of other investment companies (including exchange traded funds (“ETFs”)) to the extent that such investments are consistent with the Fund’s investment objectives and principal investment strategies and permissible under the 1940 Act.
Zero-Coupon Securities and Deferred Payment Obligations		The Fund may invest in zero-coupon bonds and deferred payment obligations and there is no limit on the amount of the Fund’s portfolio that can be invested in these securities.		The Fund may invest in zero-coupon bonds and deferred payment obligations and there is no limit on the amount of the Fund’s portfolio that can be invested in these securities.
Derivatives		The Fund may purchase and sell derivative instruments such as exchange-listed and over-the-counter put and call options on securities, financial futures, equity, fixed-income and interest rate indices, and other financial instruments, purchase and sell financial futures contracts and options thereon, enter into various interest rate transactions such as swaps, caps, floors or collars and enter into various currency transactions such as currency forward contracts, currency futures contracts, currency swaps or options on currency or currency futures or credit transactions and credit default swaps. The Fund also may purchase derivative instruments that combine features of these instruments. Apart from senior loan based derivatives, derivatives are not a significant part of the Fund’s investments. However, the Fund has no limit on the amount of its total assets that may be invested in derivative instruments.		The Fund may purchase and sell derivative instruments such as exchange-listed and over-the-counter put and call options on securities, financial futures, equity, fixed-income and interest rate indices, and other financial instruments, purchase and sell financial futures contracts and options thereon, enter into various interest rate transactions such as swaps, caps, floors or collars and enter into various currency transactions such as currency forward contracts, currency futures contracts, currency swaps or options on currency or currency futures or credit transactions and credit default swaps. The Fund also may purchase derivative instruments that combine features of these instruments. Apart from senior loan based derivatives, derivatives are not a significant part of the Fund’s investments. However, the Fund has no limit on the amount of its total assets that may be invested in derivative instruments.
Senior Loan Based Derivatives		The Fund may obtain exposure to senior loans and baskets of senior loans through the use of derivative instruments.		The Fund may obtain exposure to senior loans and baskets of senior loans through the use of derivative instruments.

		Acquired Fund		Acquiring Fund
Swaps		The Fund may invest in swaps including credit default swaps, interest rate swaps, total return swaps and currency swaps. The Fund may use swaps for risk management purposes and as a speculative investment.		The Fund may invest in swaps including credit default swaps, interest rate swaps, total return swaps and currency swaps. The Fund may use swaps for risk management purposes and as a speculative investment.
Credit Linked Notes		The Fund may invest in CLNs for risk management purposes and to vary its portfolio. A CLN is a derivative instrument.		The Fund may invest in CLNs for risk management purposes and to vary its portfolio. A CLN is a derivative instrument.
Options		The Fund may purchase and sell put and call options on securities and indices.		The Fund may purchase and sell put and call options on securities and indices.
Futures Contracts and Options on Futures Contracts		The Fund may enter into contracts for the purchase or sale for future delivery (“futures contracts”) of securities, aggregates of securities or indices or prices thereof. The Fund will engage in such transactions only for bona fide risk management and other portfolio management purposes.		The Fund may enter into futures contracts of securities, aggregates of securities or indices or prices thereof, other financial indices and U.S. government debt securities or options on the above. The Fund will engage in such transactions only for bona fide risk management and other portfolio management purposes.
Foreign Currency and Forward Foreign Currency Contracts		The Fund may buy or sell foreign currencies or deal in forward foreign currency contracts for hedging and speculative purposes or to enhance total return,		The Fund may enter into foreign currency transactions in an attempt to enhance total return. The Fund may enter into forward currency contracts to purchase or sell foreign currencies for a fixed amount of U.S. dollars or another foreign currency.
Short Sales		The Fund does not engage in short sales.		The Fund may engage in short sales against the box and not against the box. Subject to the requirements of the 1940 Act and the Code, the Fund will not make a short sale if, after giving effect to such sale, the market value of all securities sold short by the Fund exceeds 25% of the value of its total assets. The Fund may make short sales against the box without respect to such limitations.
Repurchase Agreements		The Fund may enter into repurchase agreements.		The Fund may enter into repurchase agreements up to a maximum 33 1/3% of its total assets.
Reverse Repurchase Agreements		The Fund does not enter into reverse repurchase agreements.		The Fund may enter into reverse repurchase agreements. Reverse repurchase agreements will be considered borrowings by the Fund and would be subject to any restrictions on borrowing.
Inverse Floaters		The Fund may invest in inverse floaters.		The Fund may invest in inverse floaters.
Pay-in-kind (“PIK”) Bonds		The Fund may invest in PIK bonds.		The Fund may invest in PIK bonds.
When-Issued, Delayed-Delivery and Forward Commitment Purchases		The Fund may purchase securities on a when-issued basis and may purchase or sell securities on a “forward commitment” basis.		The Fund may purchase securities on a when-issued basis and may purchase or sell securities on a “forward commitment” basis.
Securities Lending		The Fund may lend its portfolio securities in an amount up to a maximum of 33 1/3% of its total assets.		The Fund may lend its portfolio securities in an amount up to a maximum of 33 1/3% of its total assets.

		Acquired Fund		Acquiring Fund
Foreign Securities		The Fund may invest up to 20% of its total assets in non-U.S. securities.		The Fund may invest up to 20% of its total assets in non-U.S. securities.
Temporary Defensive Position		Under certain market conditions, the Fund may adopt a temporary defensive position to invest its assets in cash or cash equivalents.		Under certain market conditions, the Fund may adopt a temporary defensive position to invest its assets in cash or cash equivalents.

Under the 1940 Act, the Acquired Fund, as a business development company, generally may not acquire any assets other than assets of the type listed in Section 55(a) of the 1940 Act, which are sometimes referred to as “qualifying assets”, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. The Acquiring Fund, which is not a business development company, is not subject to this restriction.

The Statement of Additional Information sets forth the Acquiring Fund’s fundamental investment restrictions, which may not be changed without the vote of a majority of the outstanding voting securities.

INFORMATION ABOUT THE FUNDS

OUTSTANDING SECURITIES

Set forth below is information about each Fund’s common shares as of December 31, 2008.

Acquiring Fund

Title of Class		Amount Authorized		Amount Held by Fund		Amount Outstanding
Common Shares		Unlimited		—		55,526,190

Acquired Fund

Title of Class		Amount Authorized		Amount Held by Fund		Amount Outstanding
Common Shares		550,000,000		—		17,716,771

COMMON SHARE PRICE DATA

The following table sets forth the high and low sales prices for common shares of each Fund on the NYSE for each full quarterly period within the two most recent fiscal years or since inception and each full quarter since the beginning of the current fiscal year, along with the NAV and discount or premium to NAV for each quotation.

The Acquiring Fund only makes public its net asset value on a weekly basis, and the Acquired Fund only makes public its net asset value on a quarterly basis. Accordingly, the net asset value and the premium and discount from net asset value in the table below are based on the publicly available net asset values for the week or quarter, as applicable, in which the high and low sales price occurred. Since the net asset value and the premium and discount from net asset value is based on the publicly available net asset values for the week, which may not fall on the same date as the high and low sales prices, the range of net asset values and the premium and discount from net asset value for the common shares during the periods shown may be broader or more narrow than what is shown in this table.

ACQUIRING FUND

																		Premium/(Discount) as a %
		Market price								Net asset value per share								of net asset value
Quarter		High				Low				High				Low				High				Low
2nd Quarter 2006*			20.60				20.18				19.07				19.06				8.0	%			5.9	%
3rd Quarter 2006			21.00				19.91				19.13				19.18				9.8	%			3.8	%
4th Quarter 2006			21.20				20.31				19.97				19.44				6.2	%			4.5	%
1st Quarter 2007			21.46				20.41				20.29				20.37				5.8	%			0.2	%
2nd Quarter 2007			21.12				19.80				20.51				20.45				3.0	%			-3.2	%
3rd Quarter 2007			20.04				17.31				20.60				19.33				-2.7	%			-10.4	%
4th Quarter 2007			18.35				15.73				19.63				17.99				-6.5	%			-12.6	%
1st Quarter 2008			15.54				12.95				17.85				14.53				-12.9	%			-10.9	%
2nd Quarter 2008			14.29				13.44				15.20				14.63				-6.0	%			-8.1	%
3rd Quarter 2008			13.20				9.47				14.41				12.64				-8.4	%			-25.1	%
4th Quarter 2008			9.22				5.13				12.13				7.01				-24.0	%			-26.8	%

ACQUIRED FUND

														Premium/(Discount) as a %
		Market price												of net asset value
		High				Low								High				Low
Quarter		Net asset value per share(1)
1st Quarter 2007*			15.15				14.13			$	14.05				7.8	%			0.6	%
2nd Quarter 2007			15.04				14.03			$	14.08				6.8	%			-0.2	%
3rd Quarter 2007			14.41				10.45			$	12.34				16.8	%			-15.3	%
4th Quarter 2007			13.07				8.51			$	10.27				27.3	%			-17.1	%
1st Quarter 2008			9.21				6.15			$	8.26				11.5	%			-25.5	%
2nd Quarter 2008			8.58				5.74			$	7.24				18.5	%			-20.7	%
3rd Quarter 2008			5.98				2.97			$	6.69				-10.6	%			-55.6	%
4th Quarter 2008			3.29				0.96			$	3.42				-3.8	%			-71.9	%

As of December 31, 2008, (i) the net value per share for common shares of the Acquiring Fund was $6.51 and the market price per share was $5.70, representing a discount to NAV of 12.4%, and (ii) the NAV per share for common shares of the Acquired Fund was $3.42 and the market price per share was $2.15, representing a discount to NAV of 37.1%.

The NAV per share and market price per share of the common shares of each Fund may fluctuate prior to the closing date of the Reorganization. Depending on market conditions immediately prior to the closing date of the Reorganization, Acquiring Fund common shares may trade at a larger or smaller discount to NAV than the Acquired Fund’s common shares. This could result in the Acquiring Fund common shares having a market value that is greater or less than the market value of the Acquired Fund’s common shares on the closing date of the Reorganization.

ASSET COVERAGE OF SENIOR SECURITIES

The following tables provide information about senior securities of each of Acquiring Fund and Acquired Fund as of the dates below (which are the ends of each fiscal year). Both Funds employ leverage through borrowings through a credit facility. Asset coverage is calculated by subtracting the Fund’s total liabilities, not including any amount representing bank loans and senior securities, from the Fund’s total assets and dividing the result by the principal amount of the borrowings outstanding.

Acquiring Fund

Date			Total Amount Outstanding				Asset Coverage per $1000
December 31, 2008			$141,000,000				$3,562
December 31, 2007			$248,000,000				$3,504
December 31, 2006			$285,000,000				$3,429

Acquired Fund

Date			Total Amount Outstanding				Asset Coverage per $1000
December 31, 2008			$15,500,000				$4,907
December 31, 2007			$142,000,000				$2,282

In light of the broader unprecedented market dislocation that began in 2007, continued into 2008 and accelerated in the fourth quarter, the Acquired Fund and Acquiring Fund have reduced their leverage over the year ended December 31, 2008 by using excess funds generated in the course of each Fund’s operations to pay down each such Fund’s credit facility.

SHARE REPURCHASES

Common shares of each of the Acquiring Fund and the Acquired Fund have traded at a premium to NAV at certain times and at a discount to NAV at certain times.

Each Fund may from time to time take action to attempt to reduce or eliminate a market value discount from NAV by repurchasing their common shares in the open market or by tendering for their common shares at NAV.

Subject to its investment restrictions, a Fund may borrow to finance the repurchase of shares or to make a tender offer. Interest on any borrowings to finance share repurchase transactions or the accumulation of cash by a Fund in anticipation of share repurchases or tenders will reduce the Fund’s net income. The Fund will comply with the Securities Exchange Act of 1934, as amended (the “1934 Act”), the 1940 Act and the rules and regulations thereunder in connection with any share repurchase, tender offer or borrowing that might be approved by the Fund’s Board. Any such borrowings will be subject to the limitations imposed by the 1940 Act and the Rating Agency Guidelines.

The repurchase by a Fund of its common shares at prices below NAV will result in an increase in the NAV of those common shares that remain outstanding. However, there can be no assurance that common share repurchases or tender offers at or below NAV will result in the Fund’s common shares trading at a price equal to their NAV. Nevertheless, the fact that a Fund’s common shares may be the subject of repurchase or tender offers from time to time, or that the Fund may be converted to an open-end investment company, may reduce any spread between market price and NAV that might otherwise exist.

In addition, a purchase by the Fund of its common shares will decrease the Fund’s total assets which would likely have the effect of increasing the Fund’s expense ratio. Any purchase by the Fund of its common shares at a time when preferred shares are outstanding will increase the leverage applicable to the outstanding common shares then remaining.

Before deciding whether to take any action if the common shares trade below NAV, a Fund’s Board would likely consider all relevant factors, including the extent and duration of the discount, the liquidity of the Fund’s portfolio, the impact of any action that might be taken on the Fund or its shareholders and market considerations. Based on these considerations, even if a Fund’s shares should trade at a discount, the Fund’s Board may determine that, in the interest of the Fund and its shareholders, no action should be taken.

DIVIDENDS AND OTHER DISTRIBUTIONS

Both Funds.

Distributions, which may contain returns of capital, on each Fund’s common shares are declared based on annual projections of net investment income (defined as dividends and interest income received on underlying portfolio securities, net of Fund expenses). The Acquiring Fund pays monthly distributions to common shareholders. The Acquired Fund pays quarterly distributions to common shareholders. As a result of market conditions or investment decisions, the amount of distributions may exceed net investment income earned at certain times throughout the period. It is anticipated that, on an annual basis, the amount of distributions to common shareholders will not exceed net investment income (as defined above) allocated to common shareholders for income tax purposes. Each Fund generally intends to pay any net long-term and short-term capital gain distributions annually. However, from time to time, the Acquiring Fund may determine to retain net long-term capital gains for reinvestment and pay a Fund-level tax on those retained amounts, in which case shareholders may be required to include in income for U.S. federal income tax purposes, as long-term capital gain, their shares of such undistributed amounts, and entitled to a credit and/or refund on their U.S. income tax returns on their proportionate shares of the tax paid by the Fund on undistributed amounts. See the Statement of Additional Information under “Tax Matters.”

Various factors will affect the level of each Fund’s current income and current gains, such as its asset mix, and each Fund’s use of options. To permit each Fund to maintain more stable dividends and annual distributions, each Fund may from time to time distribute less than the entire amount of income and gains earned in the relevant month, quarter or year, as applicable. The undistributed income and gains would be available to supplement future distributions. As a result, the distributions paid by each Fund for any particular period may be more or less than the amount of income and gains actually earned by each Fund during the applicable period. Undistributed income and gains will add to each Fund’s NAV and, correspondingly, distributions from undistributed income and gains and from capital, if any, will be deducted from each Fund’s NAV. Shareholders will automatically have all dividends and other distributions reinvested in common shares of each Fund issued by each Fund or purchased in the open market in accordance with each Fund’s Dividend Reinvestment Plan unless an election is made to receive cash. Each participant in each Fund’s Dividend Reinvestment Plan will pay a pro rata portion of brokerage commissions incurred in connection with open market purchases, and participants requesting a sale of securities through the plan agent of the Dividend Reinvestment Plan of the Acquiring Fund are subject to a sales fee and a brokerage commission.

DIVIDEND REINVESTMENT PLAN

Each Fund offers its shareholders a Dividend Reinvestment Plan (the “Plan”), which offers the opportunity to earn compounded yields. The terms of each Plan is set forth below.

Acquired Fund. Unless the registered owner of your shares elects to receive cash by contacting the Plan Agent, the agent for stockholders that is administering the Acquired Fund’s Plan, all dividends declared for your shares will be automatically reinvested by the Plan Agent in additional Shares. If the registered owner of your shares elects not to participate in the Plan, you will receive all dividends in cash paid by check mailed directly to you (or, if the shares are held in street or other nominee name, then to such nominee) by PNC, as the dividend disbursing agent. You may elect not to participate in the Plan and to receive all dividends in cash by sending written instructions or by contacting PNC, as the dividend disbursing agent.

The Plan Agent will open an account for each common stockholder under the Plan in the same name in which such common stockholder’s shares are registered. Whenever the Acquired Fund declares a dividend or other distribution (together, a “dividend”) payable in cash, non-participants in the Plan will receive cash and participants in the Plan

will receive the equivalent in shares. The shares will be acquired by the Plan Agent for the participants’ accounts, depending upon the circumstances described below, either (i) through receipt of additional unissued but authorized shares (“newly-issued shares”) or (ii) by purchase of outstanding shares on the open market (“open-market purchases”) on the NYSE or elsewhere.

If, on the payment date for any dividend, the market price per share plus estimated brokerage commissions is greater than the net asset value per share (such condition being referred to herein as “market premium”), the Plan Agent will invest the dividend amount in newly-issued shares, including fractions, on behalf of the Plan participants. The number of newly-issued shares to be credited to each participant’s account will be determined by dividing the dollar amount of the dividend by the net asset value per share on the payment date; provided that, if the net asset value per share is less than 95% of the market price per share on the payment date, the dollar amount of the dividend will be divided by 95% of the market price per share on the payment date.

If, on the payment date for any dividend, the net asset value per share is greater than the market value per share plus estimated brokerage commissions (such condition being referred to herein as “market discount”), the Plan Agent will invest the dividend amount in shares acquired on behalf of the participants in open-market purchases.

In the event of a market discount on the payment date for any dividend, the Plan Agent will have until the last business day before the next date on which the shares trade on an “ex-dividend” basis or 120 days after the payment date for such dividend, whichever is sooner (the “last purchase date”), to invest the dividend amount in shares acquired in open-market purchases. It is contemplated that the Acquired Fund will pay quarterly dividends. Therefore, the period during which open-market purchases can be made will exist only from the payment date of each dividend through the date before the “ex-dividend” date of the third month of the quarter. If, before the Plan Agent has completed its open-market purchases, the market price of a share exceeds the net asset value per share, the average per share purchase price paid by the Plan Agent may exceed the net asset value of the shares, resulting in the acquisition of fewer shares than if the dividend had been paid in newly-issued shares on the dividend payment date. Because of the foregoing difficulty with respect to open market purchases, if the Plan Agent is unable to invest the full dividend amount in open market purchases during the purchase period or if the market discount shifts to a market premium during the purchase period, the Plan Agent may cease making open-market purchases and may invest the uninvested portion of the dividend amount in newly-issued shares at the net asset value per share at the close of business on the last purchase date; provided that, if the net asset value per share is less than 95% of the market price per share on the payment date, the dollar amount of the dividend will be divided by 95% of the market price per share on the payment date.

The Plan Agent maintains all stockholders’ accounts in the Plan and furnishes written confirmation of all transactions in the accounts, including information needed by stockholders for tax records. shares in the account of each Plan participant will be held by the Plan Agent on behalf of the Plan participant, and each stockholder proxy will include those shares purchased or received pursuant to the Plan. The Plan Agent will forward all proxy solicitation materials to participants and vote proxies for shares held under the Plan in accordance with the instructions of the participants. In the case of stockholders such as banks, brokers or nominees that hold shares for others who are the beneficial owners, the Plan Agent will administer the Plan on the basis of the number of shares certified from time to time by the record stockholder’s name and held for the account of beneficial owners who participate in the Plan.

There will be no brokerage charges with respect to Shares issued directly by the Acquired Fund. However, each participant will pay a pro rata share of brokerage commissions incurred in connection with open-market purchases.

The automatic reinvestment of dividends will not relieve participants of any federal, state or local income tax that may be payable (or required to be withheld) on such dividends. Participants that request a sale of Shares through the Plan Agent are subject to a $2.50 sales fee and a brokerage commission of $0.05 per Share sold.

The Fund reserves the right to amend or terminate the Plan. There is no direct service charge to participants in the Plan; however, the Acquired Fund reserves the right to amend the Plan to include a service charge payable by the participants. All correspondence concerning the Plan should be directed to the Plan Agent at PNC, 301 Bellevue Parkway, Wilmington, Delaware 19809; telephone 877-247-1888 for the Acquired Fund and 877-665-1287 for the Acquiring Fund.

Acquiring Fund. Unless the registered owner of common shares elects to receive cash by contacting the Plan Agent, all dividends declared for the common shares of the Acquiring Fund will be automatically paid in the form of, or reinvested by the Plan Agent (agent for shareholders in administering the Acquiring Fund’s Plan) in, additional common shares of the Acquiring Fund. If you are a registered owner of common shares and elect not to participate in the Plan, you will receive all dividends in cash paid by check mailed directly to you (or, if the shares are held in street or other nominee name, then to such nominee) by PNC, as dividend disbursing agent. You may elect not to participate in the Plan and to receive all dividends in cash by sending written instructions or by contacting PNC, as dividend disbursing agent, at the address set forth below. Participation in the Plan is completely voluntary and may be terminated or resumed at any time without penalty by contacting the Plan Agent before the dividend record date; otherwise such termination or resumption will be effective with respect to any subsequently declared dividend or other distribution. Some brokers may automatically elect to receive cash on your behalf and may re-invest that cash in additional shares of the Acquiring Fund for you.

The Plan Agent will open an account for each shareholder under the Plan in the same name in which such shareholder’s shares are registered. Whenever the Acquiring Fund declares a dividend or other distribution (together, a “dividend”) payable in cash, non-participants in the Plan will receive cash and participants in the Plan will receive the equivalent in common shares. The common shares will be acquired by the Plan Agent for the participants’ accounts, depending upon the circumstances described below, either (i) through receipt of additional unissued but authorized shares from the Acquiring Fund (“newly issued shares”) or (ii) by purchase of outstanding common shares on the open market (“open-market purchases”) on the NYSE or elsewhere.

If, on the payment date for any dividend, the market price per common share plus estimated brokerage commissions is greater than the NAV per common share (such condition being referred to herein as “market premium”), the Fund will issue common shares, including fractions, to the participants in the amount of the dividend. The number of newly issued common shares to be credited to each participant’s account will be determined by dividing the dollar amount of the dividend by the NAV per common share on the payment date; provided that, if the NAV per common share is less than 95% of the market price per common share on the payment date, the dollar amount of the dividend will be divided by 95% of the market price per common share on the payment date.

If, on the payment date for any dividend, the NAV per common share is greater than the market value per common share plus estimated brokerage commissions (such condition being referred to herein as “market discount”), the Plan Agent will invest the dividend amount in common shares acquired on behalf of the participants in open-market purchases.

In the event of a market discount on the payment date for any dividend, the Plan Agent will have until the last business day before the next date on which the common shares trade on an “ex-dividend” basis or 120 days after the payment date for such dividend, whichever is sooner (the “last purchase date”), to invest the dividend amount in common shares acquired in open-market purchases. It is contemplated that the Acquiring Fund will pay monthly dividends. Therefore, the period during which open-market purchases can be made will exist only from the payment date of each dividend through the date before the “ex-dividend” date of the third month of the quarter. If, before the Plan Agent has completed its open-market purchases, the market price of a common share exceeds the NAV per common share, the average per common share purchase price paid by the Plan Agent may exceed the NAV of the common shares, resulting in the acquisition of fewer common shares than if the dividend had been paid in newly issued common shares on the dividend payment date. Because of the foregoing difficulty with respect to open market purchases, if the Plan Agent is unable to invest the full dividend amount in open market purchases during the purchase period or if the market discount shifts to a market premium during the purchase period, the Plan Agent may cease making open-market purchases and may invest the uninvested portion of the dividend amount in newly issued common shares at the NAV per common share at the close of business on the last purchase date; provided that, if the NAV per common share is less than 95% of the market price per common share on the payment date, the dollar amount of the dividend will be divided by 95% of the market price per common share on the payment date.

The Plan Agent maintains all shareholders’ accounts in the Plan and furnishes written confirmation of all transactions in the accounts, including information needed by shareholders for tax records. Common shares in the account of each Plan participant will be held by the Plan Agent on behalf of the Plan participant, and each shareholder proxy will include those shares purchased or received pursuant to the Plan. The Plan Agent will forward

all proxy solicitation materials to participants and vote proxies for shares held under the Plan in accordance with the instructions of the participants.

In the case of shareholders such as banks, brokers or nominees which hold shares for others who are the beneficial owners, the Plan Agent will administer the Plan on the basis of the number of common shares certified from time to time by the record shareholder’s name and held for the account of beneficial owners who participate in the Plan.

There will be no brokerage charges with respect to common shares issued directly by the Acquiring Fund. However, each participant will pay a pro rata share of brokerage commissions incurred in connection with open-market purchases. The automatic reinvestment of dividends will not relieve participants of any federal, state or local income tax that may be payable (or required to be withheld) on such dividends. Accordingly, any taxable dividend received by a participant that is reinvested in additional common shares will be subject to federal (and possibly state and local) income tax even though such participant will not receive a corresponding amount of cash with which to pay such taxes. See “Tax Matters.” Participants who request a sale of shares through the Plan Agent are subject to a $2.50 sales fee and pay a brokerage commission of $0.05 per share sold.

The Acquiring Fund reserves the right to amend or terminate the Plan. There is no direct service charge to participants in the Plan; however, the Acquiring Fund reserves the right to amend the Plan to include a service charge payable by the participants.

All correspondence concerning the Plan should be directed to the Plan Agent at PNC, 301 Bellevue Parkway, Wilmington, Delaware 19809; telephone 877-247-1888 for the Acquired Fund and 877-665-1287 for the Acquiring Fund.

DESCRIPTION OF CAPITAL STRUCTURE

ACQUIRED FUND

Common Stock

The Acquired Fund is a corporation organized under the laws of Delaware pursuant to a certificate of incorporation dated as of August 22, 2006. The Acquired Fund is authorized to issue 550,000,000 Shares, par value $0.001 per Share. Each Share has one vote and, when issued and paid for, is fully paid and non-assessable, except that the Board shall have the power to cause stockholders to pay expenses of the Acquired Fund by setting off charges due from stockholders from declared but unpaid dividends or distributions owed the stockholders and/or by reducing the number of Shares owned by each respective stockholder. All Shares are equal as to dividends, assets and voting privileges and have no conversion, preemptive or other subscription rights. The Acquired Fund will send annual reports, including financial statements, to all holders of its Shares.

Any additional offerings of Shares will require approval by the Board. Any additional offering of Shares will be subject to the requirements of the 1940 Act, which provides that Shares may not be issued at a price below the then current net asset value, exclusive of sales load, except in connection with an offering to existing holders of Shares or with the consent of a majority of the Acquired Fund’s outstanding voting securities.

Preferred Stock

The Acquired Fund’s Certificate of Incorporation and By-laws provide that the Board may authorize and issue preferred stock (the “Preferred Stock”) with rights as determined by the Board, by action of the Board without the approval of the holders of the Shares. Holders of Shares have no preemptive right to purchase any Preferred Stock that might be issued. Whenever Preferred Stock is outstanding, the holders of Shares will not be entitled to receive any distributions from the Acquired Fund unless all accrued dividends on Preferred Stock have been paid, unless asset coverage (as defined in the 1940 Act) with respect to Preferred Stock would be at least 200% after giving effect to the distributions and unless certain other requirements imposed by any rating agencies rating the Preferred Stock have been met.

Liquidation Preference. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Acquired Fund, the holders of Preferred Stock will be entitled to receive a preferential liquidating distribution, which is expected to equal the original purchase price per share of Preferred Stock plus accrued and unpaid dividends, whether or not declared, before any distribution of assets is made to holders of Shares. After payment of the full amount of the liquidating distribution to which they are entitled, the holders of Preferred Stock will not be entitled to any further participation in any distribution of assets by the Acquired Fund.

Voting Rights. The 1940 Act requires that the holders of any Preferred Stock, voting separately as a single class, have the right to elect at least two directors on the Board at all times. The remaining directors on the Board will be elected by holders of Shares and Preferred Stock, voting together as a single class. In addition, subject to the prior rights, if any, of the holders of any other class of senior securities outstanding, the holders of any Preferred Stock have the right to elect a majority of the directors on the Board at any time two years’ dividends on any Preferred Stock are unpaid. The 1940 Act also requires that, in addition to any approval by stockholders that might otherwise be required, the approval of the holders of a majority of any outstanding Preferred Stock, voting separately as a class, would be required to (i) adopt any plan of reorganization that would adversely affect the Preferred Stock, and (ii) take any action requiring a vote of security holders under Section 13(a) of the 1940 Act. As a result of these voting rights, the Acquired Fund’s ability to take any such actions may be impeded to the extent that there is any Preferred Stock outstanding. The Board presently intends that, except as otherwise indicated in this prospectus and except as otherwise required by applicable law, holders of Preferred Stock will have equal voting rights with holders of Shares (one vote per share, unless otherwise required by the 1940 Act) and will vote together with holders of Shares as a single class.

The affirmative vote of the holders of a majority of the outstanding Preferred Stock, voting as a separate class, will be required to amend, alter or repeal any of the preferences, rights or powers of holders of Preferred Stock so as to affect materially and adversely such preferences, rights or powers, or to increase or decrease the authorized number of shares of Preferred Stock. The class vote of holders of Preferred Stock described above will in each case be in addition to any other vote required to authorize the action in question.

Redemption, Purchase and Sale of Preferred Stock by the Acquired Fund. The terms of any Preferred Stock would typically provide that (i) they are redeemable by the Acquired Fund in whole or in part at the original purchase price per share plus accrued dividends per share, (ii) the Acquired Fund may tender for or purchase Preferred Stock and (iii) the Acquired Fund may subsequently resell any shares so tendered for or purchased. Any redemption or purchase of Preferred Stock by the Acquired Fund will reduce the leverage applicable to the shares, while any resale of shares by the Acquired Fund will increase that leverage.

The discussion above describes the possible offering of Preferred Stock by the Acquired Fund. If the Board determines to proceed with such an offering, the terms of the Preferred Stock may be the same as, or different from, the terms described above, subject to applicable law and the Acquired Fund’s Certificate of Incorporation and By-laws. The Board, without the approval of the holders of Shares, may authorize an offering of Preferred Stock or may determine not to authorize such an offering, and may fix the terms of the Preferred Stock to be offered.

The Acquired Fund may apply for ratings for any Preferred Stock from Moody’s, S&P or Fitch. In order to obtain and maintain the required ratings, the Acquired Fund will be required to comply with investment quality, diversification and other guidelines established by Moody’s, S&P and/or Fitch. Such guidelines will likely be more restrictive than the restrictions set forth above. The Acquired Fund does not anticipate that such guidelines would have a material adverse effect on the holders of Shares or the Acquired Fund’s ability to achieve its investment objective.

Under the 1940 Act, the Acquired Fund is not permitted to issue senior securities unless after such issuance the value of the Acquired Fund’s total assets, less certain ordinary course liabilities, is at least 200% of the amount of any debt outstanding and 200% of the liquidation preference of any Preferred Stock outstanding. In addition, the Acquired Fund is not permitted to declare any cash distributions on its Shares unless, at the time of such declaration, the value of the Acquired Fund’s total assets is at least 200% of the liquidation preference of the Acquired Fund’s outstanding Preferred Stock and 200% of the amount of the Acquired Fund’s outstanding senior securities representing debt. If senior securities are issued, the Acquired Fund intends, to the extent possible, to purchase or redeem senior securities from time to time to the extent necessary in order to maintain coverage of any senior

securities of at least 200%. In addition, as a condition to obtaining ratings on the senior securities, the terms of any senior securities issued are expected to include asset coverage maintenance provisions which will require the redemption of the senior securities in the event of non-compliance by the Acquired Fund and may also prohibit distributions on the Shares in such circumstances.

The Acquired Fund may also borrow money as a temporary measure for liquidity and extraordinary or emergency purposes, including the payment of dividends and the settlement of securities transactions which otherwise might require untimely dispositions of Acquired Fund securities.

Credit Facility

The Acquired Fund currently leverages through borrowings from a credit facility, which borrowings are expected to be paid down prior to the closing of the Reorganization.

In accordance with the 1940 Act, with certain limited exceptions, the Acquired Fund is only allowed to borrow amounts such that its asset coverage, as defined in the 1940 Act, is at least 200% after such borrowing. The Acquired Fund entered into a Revolving Credit and Security Agreement with Liberty Street Funding LLC, as conduit lender, and The Bank of Nova Scotia, acting through its New York agency, as secondary lender and agent (the “Agent”) on June 27, 2008, as amended November 25, 2008 (the “Credit Agreement”). Under the Credit Agreement, the Acquired Fund may borrow on a revolving basis up to $60 million, subject to the satisfaction of certain conditions including compliance with borrowing base tests and asset coverage limits. The Credit Agreement imposes stricter limitations than the 1940 Act, requiring generally that asset coverage be at least 350% after a borrowing. The Credit Agreement expires in May 2009 and borrowings thereunder are secured by substantially all of the assets in the Acquired Fund’s portfolio, including cash and cash equivalents. The interest rate charged is based on prevailing commercial paper rates if the conduit lender makes the advance, other than through participations, plus commitment and utilization fees. However, if the conduit lender does not make the advance, other than through participations, the interest rate is based on the prevailing Eurodollar rate, Federal Funds rate or the agent’s reference rate, in each case plus an applicable spread and commitment and utilization fees. The Acquired Fund pays a commitment fee at the annual rate of 1.25% on the total commitment amount, and a utilization fee at the annual rate of 0.75% on outstanding borrowings. The Credit Agreement contains customary events of default (with grace periods where customary) including, among other things, failure to pay interest or principal when due and failure to comply with certain asset coverage and borrowing base tests.

ACQUIRING FUND

Common Stock

The Acquiring Fund is a statutory trust organized under the laws of Delaware pursuant to an Agreement and Declaration of Trust dated as of March 10, 2006 (“Declaration of Trust”). The Acquiring Fund is authorized to issue an unlimited number of common shares of beneficial interest, par value $0.001 per share. Each common share has one vote and, when issued and paid for is fully paid and non-assessable, except that the trustees shall have the power to cause shareholders to pay expenses of the Acquiring Fund by setting off charges due from shareholders from declared but unpaid dividends or distributions owed the shareholders and/or by reducing the number of common shares owned by each respective shareholder. The Acquiring Fund currently is not aware of any expenses that will be paid pursuant to this provision, except to the extent fees payable under its Dividend Reinvestment Plan are deemed to be paid pursuant to this provision.

The Acquiring Fund intends to hold annual meetings of shareholders so long as the common shares are listed on a national securities exchange and such meetings are required as a condition to such listing. All common shares are equal as to dividends, assets and voting privileges and have no conversion, preemptive or other subscription rights. The Acquiring Fund will send annual and semi-annual reports, including financial statements, to all holders of its shares.

While the Acquiring Fund has filed a registration statement to permit it to offer additional shares from time to time, such registration statement has not been declared effective and the Acquiring Fund has no present intention of offering any additional shares on that registration statement. Any additional offerings of shares will require approval

by the Acquiring Fund’s Board. Any additional offering of common shares will be subject to the requirements of the 1940 Act, which provides that shares may not be issued at a price below the then current NAV, exclusive of sales load, except in connection with an offering to existing holders of common shares or with the consent of a majority of the Acquiring Fund’s common shareholders. The Acquiring Fund currently issues additional shares under its Dividend Reinvestment Plan and, if approved, the Acquiring Fund will issue additional shares pursuant to the Reorganization.

Any additional offerings of common shares would result in current shareholders owning a smaller proportionate interest in the Acquiring Fund than they owned prior to such offering to the extent that shareholders do not purchase sufficient shares in such offering to maintain their percentage interest. The Acquiring Fund’s net asset value would be reduced immediately following an offering of the shares due to the costs of such offering, which will be borne entirely by the Acquiring Fund. The sale of shares by the Acquiring Fund (or the perception that such sales may occur) may have an adverse effect on prices of shares in the secondary market. An increase in the number of shares available may put downward pressure on the market price for shares. If the Acquiring Fund were unable to invest the proceeds of an additional offering of shares as intended, the Acquiring Fund’s per share distribution may decrease and the Acquiring Fund may not participate in market advances to the same extent as if such proceeds were fully invested as planned.

Unlike open-end funds, closed-end funds like the Acquiring Fund do not continuously offer shares and do not provide daily redemptions. Rather, if a shareholder determines to buy additional common shares or sell shares already held, the shareholder may do so by trading through a broker on the NYSE or otherwise. Shares of closed-end investment companies frequently trade on an exchange at prices lower than NAV. Because the market value of the common shares may be influenced by such factors as dividend levels (which are in turn affected by expenses), dividend stability, NAV, relative demand for and supply of such shares in the market, general market and economic conditions and other factors beyond the control of the Acquiring Fund, the Acquiring Fund cannot assure you that common shares will trade at a price equal to or higher than NAV in the future. The common shares are designed primarily for long-term investors and you should not purchase the common shares if you intend to sell them soon after purchase. See the Statement of Additional Information under “Repurchase of Common Shares.”

Preferred Shares

The Declaration of Trust provides that the Acquiring Fund’s Board may authorize and issue preferred shares with rights as determined by the Board, by action of the Board without the approval of the holders of the common shares. Holders of common shares have no preemptive right to purchase any preferred shares that might be issued. Whenever preferred shares are outstanding, the holders of common shares will not be entitled to receive any distributions from the Acquiring Fund unless all accrued dividends on preferred shares have been paid, unless asset coverage (as defined in the 1940 Act) with respect to preferred shares would be at least 200% after giving effect to the distributions and unless certain other requirements imposed by any rating agencies rating the preferred shares have been met.

The Acquiring Fund may issue preferred shares as part of its leverage strategy. We cannot assure you, however, that any preferred shares will be issued. Although the terms of any preferred shares, including dividend rate, liquidation preference and redemption provisions, will be determined by the Board, subject to applicable law and the Declaration of Trust, it is likely that the preferred shares will be structured to carry a relatively short-term dividend rate reflecting interest rates on short-term bonds, by providing for the periodic redetermination of the dividend rate at relatively short intervals through an auction, remarketing or other procedure. The Acquiring Fund also believes that it is likely that the liquidation preference, voting rights and redemption provisions of the preferred shares will be similar to those stated below.

Liquidation Preference. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Acquiring Fund, the holders of preferred shares will be entitled to receive a preferential liquidating distribution, which is expected to equal the original purchase price per preferred share plus accrued and unpaid dividends, whether or not declared, before any distribution of assets is made to holders of common shares. After payment of the full amount of the liquidating distribution to which they are entitled, the holders of preferred shares will not be entitled to any further participation in any distribution of assets by the Acquiring Fund.

Voting Rights. The 1940 Act requires that the holders of any preferred shares, voting separately as a single class, have the right to elect at least two trustees at all times. The remaining trustees will be elected by holders of common shares and preferred shares, voting together as a single class. In addition, subject to the prior rights, if any, of the holders of any other class of senior securities outstanding, the holders of any preferred shares have the right to elect a majority of the trustees of the Acquiring Fund at any time two years’ dividends on any preferred shares are unpaid. The 1940 Act also requires that, in addition to any approval by shareholders that might otherwise be required, the approval of the holders of a majority of any outstanding preferred shares, voting separately as a class, would be required to (i) adopt any plan of reorganization that would adversely affect the preferred shares, and (ii) take any action requiring a vote of security holders under Section 13(a) of the 1940 Act, including, among other things, changes in the Acquiring Fund’s subclassification as a closed-end investment company or changes in its fundamental investment restrictions. As a result of these voting rights, the Acquiring Fund’s ability to take any such actions may be impeded to the extent that there are any preferred shares outstanding. The board of trustees presently intends that, except as otherwise indicated in this prospectus and except as otherwise required by applicable law, holders of preferred shares will have equal voting rights with holders of common shares (one vote per share, unless otherwise required by the 1940 Act) and will vote together with holders of common shares as a single class.

The affirmative vote of the holders of a majority of the outstanding preferred shares, voting as a separate class, will be required to amend, alter or repeal any of the preferences, rights or powers of holders of preferred shares so as to affect materially and adversely such preferences, rights or powers, or to increase or decrease the authorized number of preferred shares. The class vote of holders of preferred shares described above will in each case be in addition to any other vote required to authorize the action in question.

Redemption, Purchase and Sale of Preferred Shares by the Acquiring Fund. The terms of the preferred shares are expected to provide that (i) they are redeemable by the Acquiring Fund in whole or in part at the original purchase price per share plus accrued dividends per share, (ii) the Acquiring Fund may tender for or purchase preferred shares and (iii) the Acquiring Fund may subsequently resell any shares so tendered for or purchased. Any redemption or purchase of preferred shares by the Acquiring Fund will reduce the leverage applicable to the common shares, while any resale of shares by the Acquiring Fund will increase that leverage.

The discussion above describes the possible offering of Preferred Shares by the Acquiring Fund. If the Board determines to proceed with such an offering, the terms of the preferred shares may be the same as, or different from, the terms described above, subject to applicable law and the Declaration of Trust. The board of trustees, without the approval of the holders of common shares, may authorize an offering of preferred shares or may determine not to authorize such an offering and may fix the terms of the preferred shares to be offered.

Other Shares

The Board (subject to applicable law and the Declaration of Trust) may authorize an offering, without the approval of the holders of common shares, of other classes of shares, or other classes or series of shares, as they determine to be necessary, desirable or appropriate, having such terms, rights, preferences, privileges, limitations and restrictions as the board of trustees see fit. The Acquiring Fund currently does not expect to issue any other classes of shares, or series of shares, except for the common shares.

Credit Facility

The Acquiring Fund currently leverages through borrowings from a credit facility.

The Acquiring Fund has entered into a revolving credit agreement with The Bank of Nova Scotia (“Scotia”) to borrow up to $380,000,000 (the “Loan Agreement”). At December 31, 2008, the Acquiring Fund had outstanding borrowings totaling $141,000,000. Such borrowings constitute financial leverage. The Loan Agreement contains covenants that limit the Acquiring Fund’s ability to, without the prior consent of Scotia: (i) pay dividends in certain circumstances, (ii) incur additional debt, or (iii) adopt or carry out any plan of liquidation, reorganization, incorporation, recapitalization, merger or consolidation or sell, transfer or otherwise dispose of all or a substantial part of its assets. The Acquiring Fund has notified Scotia regarding the proposed Reorganization and expects to receive Scotia’s consent prior to the time of closing. For instance, the Acquiring Fund agreed not to purchase assets not contemplated by the investment policies and restrictions in effect when the Loan Agreement became effective. Furthermore, the Acquiring Fund may not incur additional debt from any other party, except for in limited circumstances (e.g., in the ordinary course of business). In addition, the Loan Agreement contains a covenant requiring asset coverage ratios

that may be more stringent than those required by the 1940 Act. Such restrictions shall apply only so long as the Loan Agreement remains in effect. Any senior security representing indebtedness, as defined in Section 18(g) of the 1940 Act, must have asset coverage of at least 300%. Debt incurred under the Loan Agreement will be considered a senior security for this purpose. The Acquiring Fund will have 300% asset coverage immediately following the Reorganization. For information about the Loan Agreement, see “Risk Factors and Special Considerations Related to Proposal — Leverage Risk.”

COMPARISON OF CHARTERS AND BY-LAWS

The Acquired Fund is governed by an Amended and Restated Certificate of Incorporation (the “Certificate”). The Acquiring Fund is governed by an Agreement and Declaration of Trust (the “Declaration of Trust” and together with the Certificate, the “Charters”).

Powers and Liabilities Relating to Shares. The Certificate permits Directors of the Acquired Fund, without shareholder approval, to provide for the issuance of all or any of the preferred shares in one or more classes or series, and to fix for each such class or series such voting powers, full or limited, or no voting powers, and such distinctive designations, preferences and relative, participating, optional or other special rights and such qualifications, limitations or restrictions as shall be stated in the resolution adopted by the Board of Directors providing for the issuance of such class or series. The Declaration of Trust permits the Trustees of the Acquiring Fund, without shareholder approval, to issue, sell, repurchase, redeem, retire, cancel, acquire, hold, resell, reissue, dispose of, transfer and otherwise deal in, Shares including Shares in fractional denominations.

The Declaration of Trust limits the personal liability of any shareholder in connection with Acquiring Fund property or the acts, obligations or affairs of the Acquiring Fund. Shareholders have the same limitation of personal liability as is extended to stockholders of a private corporation for profit incorporated under the Delaware General Corporation Law. The Certificate does not have a similar provision, though stockholders have limited personal liability under the Delaware General Corporation Law.

Shareholder Voting Requirements — Generally.

Holders of record of Common Shares of the Acquired Fund shall have one vote in respect of each share of stock held by such holder of record on the books of the Acquired Fund for the election of directors and on all other matters submitted to a vote of stockholders of the Acquired Fund. The affirmative vote of the holders of at least seventy-five percent (75%) of the then outstanding shares of the Acquired Fund’s capital stock entitled to vote generally in the election of directors, voting together as a single class, shall be required to amend in any respect or repeal the article relating to Amendments. In the Acquiring Fund’s Declaration of Trust, no amendment may be made to the By-laws or the Declaration of Trust except after a majority of the trustees have approved a resolution therefor, by the affirmative vote of the holders of not less than 75% of the shares of each affected class or series outstanding, voting as separate classes or series, unless such amendment has been approved by 80% of the Trustees, in which case approval by a Majority Shareholder Vote (as defined below) is required. “Majority Shareholder Vote” means the vote, at the annual or a special meeting of the security holders of such company duly called: (A) of 67% of more of the voting securities present at such meeting, if the holders of more than 50% of the outstanding voting securities of such company are present or represented by proxy; or (B) of more than 50% of the outstanding voting securities of such company, whichever is the less.

Shareholders of the Acquiring Fund shall have no power to vote on any matter except matters on which a vote of Shareholders is required by applicable law, the Declaration of Trust or resolution of the Trustees. The Declaration of Trust expressly provides that no matter for which voting is required by the Statutory Trust Act in the absence of the contrary provision in the Declaration of Trust shall require any vote. Except as otherwise provided herein, any matter required to be submitted to Shareholders and affecting one or more classes or series of shares shall require approval by the required vote of all the affected classes and series of shares voting together as a single class; provided, however, that as to any matter with respect to which a separate vote of any class or series of shares is required by the 1940 Act, such requirement as to a separate vote by that class or series of shares shall apply in addition to a vote of all the affected classes and series voting together as a single class. Shareholders or a particular class or series of shares shall not be entitled to vote on any matter that affects only one or more other classes or series of shares. There shall be no cumulative voting in the election or removal of trustees.

In the Acquired Fund’s Certificate, any director may be removed for cause from office by the action of the holders of at least 75% of the then outstanding shares of the Acquired Fund’s capital stock entitled to vote for the election of the respective director. In the Acquiring Fund’s Declaration of Trust, any of the trustees may be removed for cause and only by action taken by a majority of the remaining trustees followed by the holders of at least 75% of the Shares then entitled to vote in an election of such trustee.

In the Acquired Fund’s Certificate, the affirmative vote of the holders of at least 75% of the then outstanding shares of the Acquired Fund’s capital stock entitled to vote generally in the election of directors, voting together as a single class, is required to amend Article VI relating to Directors, Article VIII relating to Stockholders and Article IX relating to the amendment or repeal of By-laws. However, the Board of Directors is empowered to adopt, amend of repeal the By-laws of the Acquired Fund, provided however, that any adoption, amendment or repeal of the By-laws by the Board of Directors requires the approval of at least 66 2/3% of the total number of all authorized directors (whether or not there exists any vacancies in previously authorized directorships at the time any resolution providing for adoption, amendment or repeal is presented to the Board of Directors).

Shareholder Voting Requirements — Merger and Consolidation. The Acquired Fund’s Certificate states that the conversion of the Acquired Fund from a business development company to an investment company, the liquidation and dissolution of the Acquired Fund, the merger or consolidation of the Acquired Fund with any entity in a transaction as a result of which the governing documents of the surviving entity do not contain substantially the same anti-takeover provisions as described in the Certificate, and any amendment to the provision relating to merger and consolidation — requires the approval of (i) the holders of at least eighty percent (80%) of the then outstanding shares of the Acquired Fund’s capital stock, voting together as a single class, or (ii) at least (A) a majority of the “continuing directors” and (B) the holders of at least seventy-five percent (75%) of the then outstanding shares of the Acquired Fund’s capital stock entitled to vote generally in the election of directors, voting together as a single class.

The Acquiring Fund’s Declaration of Trust states that the Acquiring Fund may merge or consolidate with any other corporation, association, trust or other organization or may sell, lease or exchange all or substantially all of the Acquired Fund’s property or the property, including its good will, upon such terms and conditions and for such consideration when and as authorized by two-thirds of the trustees and approved by a majority shareholder vote and any such merger, consolidation, sale, lease or exchange shall be determined for all purposes to have been accomplished under and pursuant to the statutes of the State of Delaware.

Governing Law. The Acquired Fund is governed by the Delaware General Corporations Law. The Acquiring Fund is governed by the Delaware Statutory Trust Act.

FEDERAL INCOME TAX MATTERS

The following discussion summarizes certain U.S. federal income tax considerations affecting the Funds and their shareholders that are “U.S. persons” as defined for U.S. federal income tax purposes. It reflects provisions of the Code, existing Treasury regulations, rulings published by the IRS, and other applicable authorities, as of the date of this prospectus. These authorities may be changed, possibly with retroactive effect, or subject to new legislative, administrative, or judicial interpretations. Your investment in the Funds may have other tax implications. Please consult your tax advisor about federal, state, local, foreign or other tax laws applicable to you. For more information, including information about the tax consequences to foreign persons of investing in the Funds, please see the Statement of Additional Information under “Tax Matters.”

Each Fund intends to qualify each year as a RIC under the Code. A RIC is not subject to tax at the company level on income and gains from investments that are distributed to shareholders. However, a Fund’s failure to qualify as a RIC would result in Fund-level taxation and consequently a reduction in income available for distribution to shareholders.

Amounts not distributed on a timely basis in accordance with a calendar year distribution requirement are subject to a nondeductible 4% federal excise tax at the Fund level. To avoid the tax, a Fund must distribute during each calendar year an amount at least equal to the sum of (i) 98% of its ordinary income (not taking into account any capital gains or losses) for the calendar year, (ii) 98% of its capital gains in excess of its capital losses (adjusted for

certain ordinary losses) for a one-year period generally ending on October 31 of the calendar year (unless an election is made to use the Fund’s taxable year) and (iii) certain undistributed amounts from previous years on which the Fund paid no U.S. federal income tax. Each Fund reserves the right to pay the excise tax when circumstances warrant.

Certain of the Fund’s investment practices may be subject to special and complex U.S. federal income tax provisions that may, among other things: (i) disallow, suspend or otherwise limit the allowance of certain losses or deductions, (ii) convert lower taxed long-term capital gain or “qualified dividend income” into higher taxed short-term capital gain or ordinary income, (iii) accelerate income, (iv) convert short-term losses into long-term losses, (v) cause the Trust to recognize income or gain without a corresponding receipt of cash, (vi) adversely affect the time a purchase or sale of stock or securities is deemed to occur, (vii) cause adjustments in the holding periods of the Fund’s securities, and (viii) adversely alter the characterization of certain complex financial transactions. These U.S. federal income tax provisions could therefore affect the amount, timing and character of distributions to shareholders. Each Fund intends to monitor its transactions and may make certain tax elections. In addition, a Fund may be required to borrow money or dispose of securities to mitigate the effect of certain of these provisions, prevent the Fund’s disqualification as a RIC, and avoid incurring Fund-level U.S. federal income and/or excise taxes.

Special tax rules may change the treatment of gains and losses recognized by a Fund when the Fund invests in certain foreign securities or currencies. The application of these special rules may also affect the timing, amount and character of distributions made by a Fund. In addition, dividend, interest and other income received by a Fund from investments outside the United States may be subject to withholding and other taxes imposed by foreign countries. Tax treaties between the United States and other countries may reduce or eliminate such taxes. The Funds do not expect that they will be eligible to elect to treat any foreign taxes they pay as paid by their shareholders, and therefore shareholders will not be entitled to claim a credit or deduction for such taxes on their own tax returns. Foreign taxes paid by a Fund will reduce the return from the Fund’s underlying investments.

Distributions paid to shareholders by a Fund from its net realized long-term capital gains (that is, the excess of any net long-term capital gain over net short-term capital loss) that the Fund designates as capital gain dividends (“capital gain dividends”) are taxable to shareholders as long-term capital gains, regardless of how long shareholders have held their shares. Long-term capital gain rates applicable to individuals have been temporarily reduced—in general, to 15% with lower rates applying to taxpayers in the 10% and 15% rate brackets—for taxable years beginning before January 1, 2011. All other dividends paid to shareholders by a Fund (including dividends from net investment income and from short-term capital gains (that is, the excess of any net short-term capital gain over any net long-term capital loss)) from its earnings and profits are generally subject to tax as ordinary income. For taxable years beginning before January 1, 2011, distributions of investment income designated by a Fund as derived from “qualified dividend income” will be taxed in the hands of individuals at the rates applicable to long-term capital gains, provided holding periods and other requirements are met at both the shareholder and Fund levels. It is not generally expected that a significant portion of either Fund’s distributions will qualify for favorable tax treatment as “qualified dividend income” for individual shareholders or as income eligible for the dividend-received deduction for corporate shareholders.

Dividends and other taxable distributions are taxable to shareholders even if they are reinvested in additional common shares of the Funds. Dividends and other distributions paid by the Funds are generally treated as received by shareholders at the time the dividend or distribution is made. If, however, a Fund pays you a dividend in January that was declared in the previous October, November or December and a shareholder was the owner of record on a specified date in one of such months, then such dividend will be treated for tax purposes as being paid by the Fund and received by the shareholder on December 31 of the year in which the dividend was declared.

The price of common shares purchased at any time may reflect the amount of a forthcoming distribution. If you purchase common shares just prior to a distribution, you will receive a distribution that will be taxable to you even though it represents in part a return of your invested capital.

The Funds will send you information after the end of each year setting forth the amount and tax status of any distributions paid to you by the Funds.

If you sell or otherwise dispose of common shares of a Fund, you will generally recognize a gain or loss in an amount equal to the difference between your tax basis in such shares of the Fund and the amount you receive in exchange for such shares. If you hold your common shares as capital assets, any such gain or loss generally will be long-term capital gain or loss if you have held (or are treated as having held) such shares for more than one year at the time of sale.

A Fund may be required to withhold, for U.S. federal backup withholding tax purposes, a portion of the dividends, distributions and redemption proceeds payable to a non-corporate shareholder who fails to provide the Trust (or its agent) with the shareholder’s correct taxpayer identification number (in the case of an individual, generally, such individual’s social security number) or to make the required certification, or who has been notified by the IRS that such shareholder is subject to backup withholding. Certain shareholders are exempt from backup withholding. Backup withholding is not an additional tax and any amount withheld may be refunded or credited against your U.S. federal income tax liability, if any, provided that you furnish the required information to the IRS.

The discussions set forth herein and in the Statement of Additional Information do not constitute tax advice, and you are urged to consult your own tax advisor to determine the specific U.S. federal, state, local and foreign tax consequences to you of investing in the Funds.

ANTI-TAKEOVER PROVISIONS

ACQUIRED FUND

The Acquired Fund’s Certificate and By-laws include provisions that could have the effect of limiting the ability of other entities or persons to acquire control of the Acquired Fund or to change the composition of its Board. This could have the effect of depriving stockholders of an opportunity to sell their stock at a premium over prevailing market prices by discouraging a third party from seeking to obtain control over the Acquired Fund. Such attempts could have the effect of increasing the expenses of the Acquired Fund and disrupting the normal operation of the Acquired Fund. The Board is divided into three classes, with the term of one class expiring at each annual meeting of stockholders. At each annual meeting, one class of Board members is elected to a three-year term. This provision could delay for up to two years the replacement of a majority of the Board. A Board member may be removed from office for cause by the action of a majority of the remaining Board members followed by a vote of the holders of at least 75% of the stock then entitled to vote for the election of the respective Board member.

In addition, the Acquired Fund’s Certificate and By-laws require the favorable vote of a majority of the Directors followed by the favorable vote of the holders of at least 75% of the outstanding stock of each affected class or series of the Acquired Fund, voting separately as a class or series, to approve, adopt or authorize certain transactions with Principal Stockholders (as defined below), unless 80% of the Directors have by resolution approved a memorandum of understanding with the Principal Stockholder with respect to and substantially consistent with such transaction, in which case approval by “a majority of the outstanding voting securities” (as defined in the 1940 Act) of the Acquired Fund, with each class and series of shares voting together as a single class, unless otherwise required, will be required. For purposes of these provisions, a Principal Stockholder refers to any person (as defined in the Acquired Fund’s Certificate) who, whether directly or indirectly and whether alone or together with its affiliates and associates, beneficially owns 10% or more of the outstanding stock of the voting securities of the Acquired Fund.

The Principal Stockholder transactions subject to these special approval requirements are: the merger or consolidation of the Acquired Fund or any subsidiary of the Acquired Fund with or into any Principal Stockholder; the issuance of any securities of the Acquired Fund to any Principal Stockholder for cash, except pursuant to any automatic dividend reinvestment plan; the sale, lease or exchange of all or any substantial part of the assets of the Acquired Fund to any Principal Stockholder, except assets having an aggregate fair market value of less than 5% of the total assets of the Acquired Fund, aggregating for the purpose of such computation all assets sold, leased or exchanged in any series of similar transactions within a twelve-month period; or the sale, lease or exchange to the Acquired Fund or any subsidiary of the Acquired Fund, in exchange for securities of the Acquired Fund, of any assets of any Principal Stockholder, except assets having an aggregate fair market value of less than 5% of the total assets of the Acquired Fund, aggregating for purposes of such computation all assets sold, leased or exchanged in any series of similar transactions within a twelve-month period.

To convert the Acquired Fund to an investment company, to liquidate and dissolve the Acquired Fund, to merge or consolidate the Acquired Fund with any entity in a transaction as a result of which the governing documents of the surviving entity do not contain substantially the same anti-takeover provisions as described in this prospectus or to amend any of the provisions discussed herein, the Acquired Fund’s Certificate and By-laws require the approval of (i) the holders of at least 80% of the then outstanding shares of the Acquired Fund’s capital stock, voting together as a single class, or (ii) at least (A) a majority of the “continuing directors” (as defined in the Certificate) and (B) the holders of at least 75% of the then outstanding shares of the Acquired Fund’s capital stock entitled to vote generally in the election of directors, voting together as a single class. You should assume that it is not likely that the Board would vote to convert the Acquired Fund to an investment company.

For purposes of calculating “a majority of the outstanding voting securities” under the Acquired Fund’s certificate of incorporation and bylaws, each class and series of stock of the Acquired Fund will vote together as a single class, except to the extent required by the 1940 Act or the Acquired Fund’s certificate of incorporation and bylaws, with respect to any class or series of shares. If a separate class vote is required, the applicable proportion of stock of the class or series, voting as a separate class or series, also will be required.

The Board has determined that provisions with respect to the Board and the stockholder voting requirements described above, which voting requirements are greater than the minimum requirements under Delaware law or the 1940 Act, are in the best interest of stockholders generally. Reference should be made to the Acquired Fund’s Certificate and By-laws on file with the SEC for the full text of these provisions.

ACQUIRING FUND

Similar to the Acquired Fund, the Acquiring Fund’s Declaration of Trust includes provisions that could have the effect of limiting the ability of other entities or persons to acquire control of the Fund or to change the composition of its board of trustees. These provisions are similar to, but not identical to those of the Acquired Fund. This could have the effect of depriving shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging a third party from seeking to obtain control over the Fund. Such attempts could have the effect of increasing the expenses of the Fund and disrupting the normal operation of the Fund. The board of trustees is divided into three classes, with the terms of one class expiring at each annual meeting of shareholders. At each annual meeting, one class of trustees is elected to a three-year term. This provision could delay for up to two years the replacement of a majority of the board of trustees. A trustee may be removed from office (for cause, and not without cause) by the action of a majority of the remaining trustees followed by a vote of the holders of at least 75% of the shares then entitled to vote for the election of the respective trustee.

In addition, the Declaration of Trust requires the favorable vote of a majority of the Fund’s board of trustees followed by the favorable vote of the holders of at least 75% of the outstanding shares of each affected class or series of the Fund, voting separately as a class or series, to approve, adopt or authorize certain transactions with Principal Shareholders (as defined below), unless the transaction has been approved by at least 80% of the trustees, in which case “a majority of the outstanding voting securities” (as defined in the 1940 Act) of the Fund shall be required. For purposes of these provisions, a “Principal Shareholder” refers to any person who, whether directly or indirectly and whether alone or together with its affiliates and associates, beneficially owns 5% or more of the outstanding shares of all outstanding classes or series of shares of beneficial interest of the Fund.

The Principal Shareholder transactions subject to these special approval requirements are: the merger or consolidation of the Fund or any subsidiary of the Fund with or into any Principal Shareholder; the issuance of any securities of the Fund to any Principal Shareholder for cash, except pursuant to any automatic dividend reinvestment plan; the sale, lease or exchange of all or any substantial part of the assets of the Fund to any Principal Shareholder, except assets having an aggregate fair market value of less than 2% of the total assets of the Fund, aggregating for the purpose of such computation all assets sold, leased or exchanged in any series of similar transactions within a twelve-month period; or the sale, lease or exchange to the Fund or any subsidiary of the Fund, in exchange for securities of the Fund, of any assets of any Principal Shareholder, except assets having an aggregate fair market value of less than 2% of the total assets of the Fund, aggregating for purposes of such computation all assets sold, leased or exchanged in any series of similar transactions within a twelve-month period.

To convert the Fund to an open-end investment company, the Declaration of Trust requires the favorable vote of a majority of the board of the trustees followed by the favorable vote of the holders of at least 75% of the outstanding

shares of each affected class or series of shares of the Fund, voting separately as a class or series, unless such amendment has been approved by at least 80% of the trustees, in which case “a majority of the outstanding voting securities” (as defined in the 1940 Act) of the Fund shall be required. The foregoing vote would satisfy a separate requirement in the 1940 Act that any conversion of the Fund to an open-end investment company be approved by the shareholders. If approved in the foregoing manner, conversion of the Fund to an open-end investment company could not occur until 90 days after the shareholders’ meeting at which such conversion was approved and would also require at least 30 days’ prior notice to all shareholders. Following any such conversion, it is possible that certain of the Fund’s investment policies and strategies would have to be modified to assure sufficient portfolio liquidity. In the event of conversion, the common shares would cease to be listed on the NYSE or other national securities exchanges or market systems. Shareholders of an open-end investment company may require the company to redeem their shares at any time, except in certain circumstances as authorized by or under the 1940 Act, at their NAV, less such redemption charge, if any, as might be in effect at the time of a redemption. The Fund expects to pay all such redemption requests in cash, but reserves the right to pay redemption requests in a combination of cash or securities. If such partial payment in securities were made, investors may incur brokerage costs in converting such securities to cash. If the Fund were converted to an open-end fund, it is likely that new shares would be sold at NAV plus a sales load. The board of trustees believes, however, that the closed-end structure is desirable in light of the Fund’s investment objectives and policies. Therefore, you should assume that it is not likely that the board of trustees would vote to convert the Fund to an open-end fund.

For the purposes of calculating “a majority of the outstanding voting securities” under the Declaration of Trust, each class and series of the Fund shall vote together as a single class, except to the extent required by the 1940 Act or the Declaration of Trust, with respect to any class or series of shares. If a separate class vote is required, the applicable proportion of shares of the class or series, voting as a separate class or series, also will be required.

The Declaration of Trust also provides that the Fund may be liquidated upon the approval of 80% of the trustees.

The board of trustees has determined that provisions with respect to the board of trustees and the shareholder voting requirements described above, which voting requirements are greater than the minimum requirements under Delaware law or the 1940 Act, are in the best interest of shareholders generally. Reference should be made to the Declaration of Trust, on file with the SEC for the full text of these provisions.

PAST PERFORMANCE OF EACH FUND

As shown in the table below, the performance of the Acquiring Fund on a net asset value basis and market value basis has exceeded that of the Acquired Fund for the one-year period ended December 31, 2008. However, there is no guarantee or assurance as to the future performance of the Acquiring Fund. Each Fund’s performance at market price may differ from its results at NAV. Although market price performance generally reflects investment results, it may also be influenced by several factors, including changes in investor perceptions of each Fund or its investment adviser, market conditions, fluctuations in supply and demand for each Fund’s shares and changes in each Fund’s distributions.

TOTAL RETURNS AS OF DECEMBER 31, 2008

		Acquired Fund*								Acquiring Fund**
						Market								Market
		NAV				Price				NAV				Price
1 year			-61.24	%			-70.80	%			-57.68	%			-57.84	%
3 years			N/A				N/A				N/A				N/A
5 years			N/A				N/A				N/A				N/A
10 years/ Since Inception			-46.23	%			-58.66	%			-26.82	%			-31.92	%

FINANCIAL HIGHLIGHTS

The following Financial Highlights tables are intended to help you understand each Fund’s financial performance since inception. This information for each period presented, derived from each Fund’s Financial Statements, has been audited (except where noted) by PricewaterhouseCoopers LLP, whose report is included in the Acquiring Fund’s Annual Report and the Acquired Fund’s Annual Report on Form 10-K, which are incorporated by reference into the Statement of Additional Information and available upon request.

Highland Distressed Opportunities, Inc.

		Year Ended				Year Ended
		12/31/08				12/31/07 (a)
Net Asset Value, Beginning of Period			$    10.27				$    14.33	(b	)
Income from Investment Operations
Net investment income			0.61				0.97
Net realized and unrealized gain on investments			-6.71				-4.43
Total from investment operations applicable to common shareholders			-6.10				-3.46
Common Stock Offering Cost			0.00				-0.07
Capital Contribution			0.00				0.26	(c	)
Less Distributions Declared to Common Shareholders
From net investment income			-0.75				-0.79
From net realized gains			0.00				0.00
Total Distributions Declared			-0.75				-0.79
Net Asset Value, End of Period			$      3.42				$    10.27
Market Value, End of Period			$      2.15				$      8.57
Market Value Total Return (d)(e)			-70.80	%			-38.85	%
Ratios to Average Net Assets/Supplemental Data
Common Share Information at End of Period (g):
Ratios based on average net assets
Net assets, end of period (in 000’s) (f)			$60,556				$182,015
Net operating expenses (excluding interest expense)			6.75	%			5.74	%
Interest expenses			2.43	%			3.80	%
Dividend expense from short positions			0.00	%			0.00	%
Waiver/reimbursement			0.62	%			2.24	%
Net expenses (h)			8.56	%			7.30	%
Net investment income			8.25	%			8.77	%
Portfolio turnover rate (e)			49	%			224	%

Highland Credit Strategies Fund

		Year Ended								Year Ended				Year Ended
		12/31/08								12/31/07				12/31/06 (a)
Net Asset Value, Beginning of Period			$    17.99								$    20.08				$    19.06
Income from Investment Operations
Net investment income			1.35								1.71				0.71
Net realized and unrealized gain on investments			-9.79								-1.85				0.91
Total from investment operations applicable to common shareholders			-8.44								-0.14				1.62
Less Distributions Declared to Common Shareholders
From net investment income			-1.46								-1.65				-0.60
From net realized gains			-0.26								-0.30				0.00
Total Distributions Declared			-1.72								-1.95				-0.60
Dilutive impact of rights offering			-1.32								0.00				0.00
Net Asset Value, End of Period			$      6.51								$    17.99				$    20.08
Market Value, End of Period			$      5.70								$    15.82				$    21.66
Market Value Total Return (b)			-57.84	%			(c	)			-17.05	%			9.06	%			(c	)
Ratios to Average Net Assets/Supplemental Data
Common Share Information at End of Period (g):
Ratios based on average net assets
Net assets, end of period (in 000’s) (d)			$361,210								$621,078				$692,964
Net operating expenses (excluding interest expense)			2.15	%							1.87	%			1.53	%
Interest expenses			1.63	%							2.16	%			1.03	%
Dividend expense from short positions			0.17	%							0.03	%			0.00	%
Waiver/reimbursement			0.09	%							0.00	%			0.00	%
Net expenses			3.86	%							4.06	%			2.56	%
Net investment income			11.36	%							8.64	%			7.37	%
Portfolio turnover rate			78	%			(c	) (e)			66	%			46	%			(c	)

SELECTED FINANCIAL DATA

The following table sets forth selected historical financial and operating data for Acquiring Fund, as of and for the dates and period indicated. The selected historical financial data are derived from the Acquiring Fund’s December 31, 2008 and December 31, 2007 financial statements, which have been audited by PricewaterhouseCoopers LLP, Acquiring Fund’s independent registered public accounting firm. This selected financial data should be read in conjunction with Acquiring Fund’s financial statements.

		Year Ended December 31,				Year Ended December 31,
		2008				2007
Total Investment Income		$	97,893,590			$	86,865,105
Net Expenses		$	24,817,494			$	27,760,416
Net Investment Income		$	73,076,096			$	59,104,689
Net realized and unrealized gain/(loss) on investments		$	(558,938,817	)		$	17,716,313
Net increase/(decrease) in stockholders equity resulting from operations		$	(485,862,721	)		$	(4,761,752	)
Balance Sheet Data:
Total Assets		$	529,859,897			$	916,967,476
Borrowing Outstanding		$	141,000,000			$	248,000,000
Stockholders Equity		$	361,210,505			$	621,078,161

The following table sets forth selected historical financial and operating data for Acquired Fund, as of and for the dates and period indicated. The selected historical financial data are derived from Acquired Fund’s December 31, 2008 and December 31, 2007 financial statements, which have been audited by PricewaterhouseCoopers LLP, Acquired Fund’s independent registered public accounting firm. This selected financial data should be read in conjunction with Acquired Fund’s financial statements.

		Year Ended December 31, 2008				Period Ended December 31, 2007 (a)
Total investment income		$	21,978,674			$	31,329,721
Net expenses		$	11,188,738			$	14,240,203
Net investment income		$	10,789,936			$	17,089,518
Net realized and unrealized gain/(loss) on investments		$	(84,535,832	)		$	(74,340,032	)
Net increase/(decrease) in stockholders’ equity (net assets) resulting from operations		$	(108,171,046	)		$	(57,250,514	)
Balance Sheet Data:
Total assets		$	87,162,000			$	346,923,924
Borrowings outstanding		$	15,500,000			$	142,000,000
Stockholders’ equity (net assets)		$	60,556,428			$	182,015,052

ACQUIRED FUND SELECTED QUARTERLY FINANCIAL DATA

(Unaudited) (in thousands, except per share amounts)

		2007
		Q1 *				Q2				Q3				Q4				Total
Total investment income		$	1,653			$	9,577			$	9,521			$	10,578			$	31,330
Total investment income per share		$	0.09			$	0.54			$	0.54			$	0.60			$	1.77
Net investment income		$	1,290			$	6,173			$	4,266			$	5,361			$	17,090
Net investment income per share		$	0.07			$	0.35			$	0.24			$	0.30			$	0.97
Net realized and unrealized gain/(loss)		$	(934	)		$	(5,729	)		$	(30,386	)		$	(37,291	)		$	(74,340	)
Net realized and unrealized gain/(loss) per share		$	(0.05	)		$	(0.32	)		$	(1.72	)		$	(2.10	)		$	(4.20	)
Net increase/(decrease) in stockholders’ equity (net assets) resulting from operations		$	356			$	443			$	(26,120	)		$	(31,929	)		$	(57,251	)
Net increase/(decrease) in stockholders’ equity (net assets) resulting from operations per share		$	0.02			$	0.03			$	(1.47	)		$	(1.80	)		$	(3.23	)

		2008
		Q1				Q2				Q3				Q4				Total
Total investment income		$	7,893			$	6,479			$	4,086			$	3,520			$	21,979
Total investment income per share		$	0.45			$	0.37			$	0.23			$	0.20			$	1.24
Net investment income		$	3,481			$	4,050			$	1,972			$	1,286			$	10,790
Net investment income per share		$	0.20			$	0.23			$	0.11			$	0.07			$	0.61
Net realized and unrealized gain/(loss)		$	(34,511	)		$	(17,433	)		$	(9,076	)		$	(57,971	)		$	(118,961	)
Net realized and unrealized gain/(loss) per share		$	(1.95	)		$	(0.98	)		$	(0.51	)		$	(3.27	)		$	(6.71	)
Net increase/(decrease) in stockholders’ equity (net assets) resulting from operations		$	(31,030	)		$	(13,383	)		$	(7,103	)		$	(56,655	)		$	(108,171	)
Net increase/(decrease) in stockholders’ equity (net assets) resulting from operations per share		$	(1.75	)		$	(0.76	)		$	(0.40	)		$	(3.20	)		$	(6.11	)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF ACQUIRED FUND

Some of the statements in this report constitute forward-looking statements, which relate to future events or the future performance or financial condition of Highland Distressed Opportunities, Inc. (the “Acquired Fund,” “we,” “us” and “our”). The forward-looking statements contained in this report involve risks and uncertainties, including statements as to:

Ÿ		our future operating results;
Ÿ		the benefits of the proposed reorganization of the Acquired Fund into the Acquiring Fund, announced on December 19, 2008;
Ÿ		our business prospects and the prospects of our portfolio companies;
Ÿ		the impact of investments that we expect to make;
Ÿ		our contractual arrangements and relationships with third parties;
Ÿ		the dependence of our future success on the general economy and its impact on the industries in which we invest;
Ÿ		our expected financings and investments;
Ÿ		the adequacy of our cash resources and working capital, including our ability to obtain continued financing on favorable terms;
Ÿ		the timing of cash flows, if any from the operations of our portfolio companies; and
Ÿ		the ability of our investment adviser to locate suitable investments for us and to monitor and administer our investments.

We have generally identified such statements by using words such as “anticipates,” “believes,” “expects,” “intends,” “will,” “should,” “may” and similar expressions to identify forward-looking statements. Our actual results could differ materially from those projected in the forward-looking statements for any reason. We have based the forward-looking statements included in this report on information available to us on the date of this report, and we assume no obligation to update any such forward-looking statements. Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports and other information that we in the future may file with the Securities and Exchange Commission (“SEC”), including proxy statements, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. The public may read and copy any materials filed by the Acquired Fund with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically. Information about the Acquired Fund is also available at http://www.HighlandHCD.com.

Overview

This discussion is as of December 31, 2008. We were incorporated in Delaware on August 22, 2006 and initially funded on January 18, 2007. We commenced material operations on February 27, 2007. Our investment objective is total return generated by both capital appreciation and current income. We will seek to achieve this objective by investing in financially-troubled or distressed companies that are either middle-market companies or unlisted companies by investing in senior secured debt, mezzanine debt and unsecured debt, each of which may include an equity component, and in equity investments.

Generally, distressed companies are those that (i) are facing financial or other difficulties and (ii) are or have been operating under the provisions of the U.S. Bankruptcy Code or other similar laws or, in the near future, may become subject to such provisions or otherwise be involved in a restructuring of their capital structure. We use the term “middle-market” to refer to companies with annual revenues between $50 million and $1 billion. We use the term “unlisted” to refer to companies not listed on a national securities exchange (for example, companies whose securities are quoted on the over-the-counter bulletin board or through Pink Sheets LLC would not be “listed” on a national securities exchange, although they may be considered “public” companies).

We have elected to be treated as a business development company (a “BDC”) under the Investment Company Act of 1940 (the “1940 Act”). As a BDC, we are required to comply with certain regulatory requirements. For instance, we are generally prohibited from acquiring assets other than “qualifying assets” unless, after giving effect to the acquisition, at least 70% of our total assets are qualifying assets. Qualifying assets generally include securities of “eligible portfolio companies” (as defined in the 1940 Act), cash, cash equivalents, U.S. government securities and high-quality debt instruments maturing in one year or less from the time of investment. Additionally, we have elected to be treated as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986 (the “Code”).

On February 26, 2007, the Acquired Fund closed its initial public offering (“IPO” or the “Offering”) and sold 17,000,000 shares of its common stock at a price of $15.00 per share, less an underwriting discount and commissions totaling $0.675 per share. We commenced material operations on February 27, 2007 as we received $243,525,000 in total net proceeds from the IPO. On March 23, 2007 the Acquired Fund issued 284,300 shares of common stock to cover the underwriters’ partial exercise of the over-allotment option on the Offering and received approximately $4,072,698 in net proceeds after deducting underwriting discounts and commissions.

On December 19, 2008, the Board of Directors of the Acquired Fund approved an agreement and plan of merger and liquidation (“Agreement”). The Agreement provides for the merger of the Acquired Fund with and into HCF Acquisition LLC (“Merger Sub”), a Delaware limited liability company to be organized as a wholly owned subsidiary of Highland Credit Strategies Fund (the “Acquiring Fund”), a non-diversified, closed-end management investment company also managed by the Highland Capital Management, L.P. (the “Merger”), with Merger Sub being the surviving entity and pursuant to which common stockholders of the Acquired Fund will receive shares of beneficial interest of the Acquiring Fund (and cash in lieu of any fractional shares). Immediately after the Merger, Merger Sub will distribute its assets to the Acquiring Fund, and the Acquiring Fund will assume the liabilities of Merger Sub, in complete liquidation and dissolution of Merger Sub (collectively with the Merger, the “Reorganization”). As a result of the Reorganization, each common stockholder of the Acquired Fund will become a common shareholder of the Acquiring Fund.

The closing of the Reorganization is subject to several conditions, including the approval of the Acquired Fund’s stockholders. If stockholders of the Acquired Fund do not approve the reorganization or, if such other conditions are not satisfied or waived, the Acquired Fund will continue its current operations. There is no assurance that the requisite stockholder approval will be obtained for the Reorganization or such other conditions will be satisfied.

On December 24, 2008, the Acquiring Fund filed with the Securities and Exchange Commission a proxy statement/prospectus with respect to the Reorganization. The Acquired Fund expects to mail the proxy statement/prospectus to its stockholders and to solicit approval of the reorganization in March 2009. The Acquired Fund and the Acquiring Fund will bear the costs of the reorganization. It is currently expected that the Reorganization will qualify as a tax-free reorganization for federal income tax purposes. The number of shares of the Acquiring Fund (and cash for fractional shares) that stockholders of the Acquired Fund will receive in the Reorganization will be based on the relative net asset values of the Acquired Fund and the Acquiring Fund as of the close of business on the valuation date for the Reorganization. Subject to stockholder approval and the satisfaction or waiver of certain conditions, the Reorganization is currently expected to occur in the 2nd quarter of 2009.

Until the date of the stockholder meeting to consider the Reorganization and, if approved, during the period between the stockholder meeting and the closing of the Reorganization, the Acquired Fund may determine to use funds received from interest payments or the sale of investments to pay down the Acquired Fund’s credit facility and may maintain a larger cash position than under normal circumstances pending the Reorganization.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Changes in the economic environment, financial markets and any other parameters used in determining such estimates could cause actual results to differ materially. In addition to the discussion below, our significant accounting policies are further described in the notes to the financial statements.

Valuation of Investments

We use the following valuation methods to determine either current market value for investments for which market quotations are available, or if not available, then fair value, as determined in good faith pursuant to policies and procedures approved by the Acquired Fund’s Board:

Market Quotations Available

The market value of each security listed or traded on any recognized securities exchange or automated quotation system will be the last reported sale price at the relevant valuation date on the composite tape or on the principal exchange on which such security is traded. If no sale is reported on that date, the Acquired Fund utilizes, when available, pricing quotations from principal market makers. Such quotations may be obtained from third-party pricing services or directly from investment brokers and dealers in the secondary market. Generally, the Acquired Fund’s loan and bond positions are not traded on exchanges and consequently are valued based on market prices received from third-party pricing services or broker-dealer sources. The Acquired Fund obtains multiple broker-dealer quotes when available, but places greater reliance on quotes from broker-dealers that serve as underwriters for the issuer. In order to validate market quotations, the Acquired Fund evaluates information, as available and as applicable, to determine if the quotations are representative of fair value, including, but not limited to, the source and nature of the quotations, qualitative analysis of the issuer and internally developed expectations and models. The valuation of certain securities for which there is little to no market activity may take into account appraisal reports obtained by management from independent valuation firms. Short-term debt securities having a remaining maturity of 60 days or less when purchased and debt securities originally purchased with maturities in excess of 60 days but which currently have maturities of 60 days or less may be valued at cost adjusted for amortization of premiums and accretion of discounts.

Market Quotations Not Available

Securities for which market quotations are not readily available, or for which the Acquired Fund has determined the price received from a pricing service or broker-dealer is “stale” or otherwise does not represent fair value, are valued by the Acquired Fund at fair value, taking into account factors reasonably determined to be relevant, including: (i) the fundamental analytical data relating to the investment; (ii) the nature and duration of restrictions on disposition of the securities; and (iii) an evaluation of the forces that influence the market in which these securities are purchased and sold. The Acquired Fund takes the following steps each time it determines its net asset value in order to determine the value of its securities for which market quotations are not readily available, as determined in good faith pursuant to policies and procedures approved by the Board:

	1.		The valuation process begins with each portfolio company or investment being initially valued by the investment professionals responsible for the portfolio investment.
	2.		Preliminary valuation conclusions will then be documented and discussed with Highland Capital Management, L.P.’s (the “Investment Adviser”) senior management.
	3.		The Acquired Fund’s valuation committee, comprised of the Investment Adviser’s investment professionals and other senior management, will then review these preliminary valuations. An independent valuation firm engaged by the Acquired Fund’s Board reviews all of these preliminary valuations each quarter.
	4.		Finally, the Board discusses valuations and reviews the fair value of each investment in the Acquired Fund’s portfolio in good faith, pursuant to policies and procedures approved by the Board, based on the input of the valuation committee and an independent valuation firm.

As part of the valuation process, management takes into account the following types of factors, if relevant, in determining the fair value of our investments: the enterprise value of a portfolio company (an estimate of the total fair value of the portfolio company’s debt and equity), the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, comparison to publicly traded securities, changes in the interest rate environment and the credit markets generally that may affect the price at which similar investments may be made in the future and other relevant factors. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we use the pricing indicated by the external event to corroborate our valuation.

Revenue Recognition

We record interest income, adjusted for amortization of premium and accretion of discount, on an accrual basis. Origination, closing and/or commitment fees associated with investments in portfolio companies are accreted into interest income over the respective terms of the applicable loans. Upon the prepayment of a loan or debt security, any prepayment penalties and unamortized loan origination, closing and commitment fees are recorded as interest income. Payment-in-kind (“PIK”) interest, computed at the contractual rate specified in each loan agreement, is added to the principal balance of the loan and recorded as interest income. To maintain the Acquired Fund’s status as a RIC, this non-cash source of income must be paid out to stockholders in the form of distributions, even though the Acquired Fund has not yet collected cash. We do not accrue as a receivable interest on loans and debt securities if we have reason to doubt our ability to collect such interest.

Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation

We measure realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized, but considering unamortized upfront fees. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized.

Within the context of these critical accounting policies, we are not currently aware of any reasonably likely events or circumstances that would result in materially different amounts being reported.

Portfolio and Investment Activity

The following table summarizes the historical composition of our investment portfolio, exclusive of cash and cash equivalents, as a percentage of total investments.

						Corporate
		Senior Loans				Notes and Bonds				Claims				Equity Interests
December 31, 2008			47.4	%			27.8	%			0.1	%			24.7	%
September 30, 2008			60.5	%			24.9	%			0.7	%			13.9	%
June 30, 2008			68.1	%			27.0	%			0.2	%			4.7	%
March 31, 2008			49.7	%			40.4	%			0.5	%			9.4	%
December 31, 2007			48.4	%			34.8	%			0.5	%			16.3	%
September 30, 2007			50.3	%			34.4	%			1.2	%			14.1	%
June 30, 2007			45.9	%			35.4	%			0.8	%			17.9	%
March 31, 2007			76.7	%			21.1	%			0.8	%			1.4	%

Our equity investments increased as a percentage of total investments during the fourth quarter. This was caused primarily by a decline in our loan and bond investments while the equity investments maintained their value in large part. However, during the fourth quarter we did not increase our equity holdings through additional investments.

Bank debt typically accrues interest at variable rates determined by reference to a base lending rate, such as LIBOR or prime rate, and typically will have maturities of 3 to 5 years. Corporate notes and bonds will typically accrue interest at fixed rates and have stated maturities at origination that range from 5 to 10 years. At December 31, 2008, the weighted average yield of our portfolio investments, exclusive of cash and cash equivalents, was approximately 5.7%. At December 31, 2008, the weighted average yield of our investments in senior loans and corporate notes and bonds was approximately 6.0%. Yields are computed assuming a fully settled portfolio; using interest rates as of the report date and include amortization of senior loan discount points, original issue discount and market premium or discount; weighted by their respective costs when averaged.

As of December 31, 2008, approximately 85.3% of our portfolio consisted of investments in 10 issuers. This is a material increase from prior quarters as we have sought to consolidate our holdings into fewer core positions. We accomplished this consolidation by liquidating smaller, non-core positions and using the proceeds to pay down the credit facility. Additional information regarding these specific investments has been outlined below. This additional information is limited to publicly available information, and does not address the creditworthiness or financial viability of the issuer, or the future plans of the Acquired Fund as it relates to a specific investment. Furthermore, while the objective of the Acquired Fund is to invest primarily in financially-troubled or distressed companies, the Acquired Fund can and does invest in issuers that are not financially-troubled or distressed at the time of investment. The Acquired Fund may have sold some, or all, of the positions outlined below subsequent to December 31, 2008.

Argatroban Royalty Sub, LLC

Argatroban Royalty Sub, LLC, a wholly-owned subsidiary of Encysive Pharmaceuticals, was established to issue senior secured bonds backed by the royalty cash stream from the sales of Argatroban, a branded pharmaceutical marketed by GlaxoSmithKline plc. Argatroban is a synthetic direct thrombin inhibitor indicated as an anticoagulant for prophylaxis or treatment of thrombosis in patients with heparin-induced thrombocytopenia, or HIT, which is a profound allergic reaction to anticoagulation therapy with heparin. More information can be found at www.argatroban.com.

Azithromycin Royalty Sub, LLC

Azithromycin Royalty Sub, LLC, a wholly-owned subsidiary of InSite Vision Inc., was established to issue senior secured bonds backed by the royalty cash stream from the sales of azithromycin ophthalmic solution, a branded pharmaceutical sold under the brand name AzaSite^® and marketed by Inspire Pharmaceuticals, Inc. The solution is used to treat conjunctivitis. More information can be found at www.azasite.com.

Baker & Taylor, Inc.

Baker & Taylor, Inc. (“B&T”) is engaged in the distribution of books, music, video and game products. In addition, unique information services built around the B&T’s proprietary databases as well as specialized consulting and outsourcing services are provided to customers. Customers include retailers (including Internet retailers), public, academic and school libraries and various departments of federal and local governments. B&T distributes its products throughout the United States and worldwide.

Celtic Pharma Phinco B.V.

Celtic Pharmaceuticals Phinco B.V. (“Celtic Pharma”) is a private investment fund with a mandate to purchase a diversified portfolio of novel pharmaceutical products in the later stages of development that have already demonstrated initial proof of principle efficacy in human clinical trials. Celtic Pharma has $250 million of equity commitments in addition to raising $156 million of high-yield bonds. Celtic Pharma has invested in nine drug programs since its 2004 inception. More information can be found at www.celticpharma.com.

Comcorp Broadcasting, Inc.

Comcorp Broadcasting, Inc. (“ComCorp”) is a privately-held regional broadcasting company based in Lafayette, LA. ComCorp operates 23 TV stations in 10 markets in Texas, Louisiana, and Indiana. ComCorp filed for bankruptcy in June 2006 after it was unable to meet its ongoing debt obligations. ComCorp, and its direct and indirect subsidiaries, exited bankruptcy with an effective date of October 4, 2007 under reorganization plans filed (“Plans”) with the United States Bankruptcy Court in the Western District of Louisiana (Case No. 06-50410). Copies of the Plans and the Confirmation Orders may be downloaded, without cost, at www.kccllc.net/cca, or be requested free of charge by calling Kurtzman Carson Consultants LLC at 1-866-381-9100.

Fontainebleau Florida Hotel, LLC

Fontainebleau Florida Hotel, LLC is the owner of the Fontainebleau Miami Beach, an 825 room luxury hotel redevelopment in Miami Beach, Florida. The parent company of Fontainebleau Florida Hotel, LLC and developer of the resort is Fontainebleau Resorts, LLC (“Fontainebleau”). Fontainebleau is led by Chairman Jeffrey Soffer, who also serves as Chief Executive Officer of Turnberry, Ltd., a creator of luxury condominium and condominium-hotel developments, and President and Chief Financial Officer Glenn Schaeffer, a former Chief Executive Officer of Mandalay Resort Group. The Fontainebleau Miami was renovated and expanded into a 22-acre destination resort, which opened in the fall of 2008. More information can be found at www.bleaumiamibeach.com.

Genesys Ventures IA, LP

Genesys Ventures IA, LP, a limited partnership with Genesys Capital Partners of Toronto, Ontario, was established to hold the preferred equity of three late-stage venture healthcare companies.

Kepler Holdings Limited

Kepler Holdings Limited is a Bermuda-based special purpose vehicle with a portfolio comprised of pre-defined segments of Hannover Re’s natural catastrophe property reinsurance business.

LVI Services, Inc.

LVI Services, Inc. (“LVI”) is a remediation and facility services firm serving commercial, industrial, retail, government, healthcare and education end markets. From a nationwide branch network, LVI provides asbestos abatement, soft and structural demolition, mold remediation, emergency response, fireproofing, decontamination and decommissioning, lead-based paint abatement and infection control. More information can be found at www.lviservices.com.

Penhall Holding Company

Penhall Holding Company is the parent company of Penhall International Corporation (“Penhall”), one of the largest providers of concrete cutting, breaking and highway grinding services in the United States. Penhall’s business model is centered on utilizing a nationwide network of approximately 800 skilled operators and an extensive fleet of specialized construction equipment to perform primarily non-residential and infrastructure-related construction work. The Acquired Fund operates 41 locations in the United States and Canada, and has a customer base that includes construction contractors, industrial companies, manufacturers, government agencies and municipalities.

Results of Operations

Results comparisons are for the year ended December 31, 2008 (“Fiscal 2008”) and the period from January 18, 2007 (commencement of operations) through December 31, 2007 (“Fiscal 2007”). These comparisons between current and prior periods may not necessarily be meaningful as we were incorporated in Delaware on August 22, 2006, initially funded on January 18, 2007, and commenced material operations on February 27, 2007.