UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number 811-21286
Name of Fund: Preferred Income Strategies Fund, Inc.
Fund Address: P.O. Box 9011
Princeton, NJ 08543-9011
Name and address of agent for service: Terry K. Glenn, President, Preferred
Income Strategies Fund, Inc., 800 Scudders Mill Road, Plainsboro, NJ
08536. Mailing address: P.O. Box 9011, Princeton, NJ 08543-9011
Registrant's telephone number, including area code: (609) 282-2800
Date of fiscal year end: 10/31/04
Date of reporting period: 11/01/03 - 10/31/04
Item 1 - Report to Stockholders
[LOGO] Merrill Lynch Investment Managers www.mlim.ml.com
Preferred Income
Strategies Fund, Inc.
Annual Report
October 31, 2004
[LOGO] Merrill Lynch Investment Managers
Preferred Income Strategies Fund, Inc.
The Benefits and Risks of Leveraging
Preferred Income Strategies Fund, Inc. utilizes leveraging through borrowings or
issuance of short-term debt securities or shares of Preferred Stock. The concept
of leveraging is based on the premise that the cost of assets to be obtained
from leverage will be based on short-term interest or dividend rates, which
normally will be lower than the income earned by the Fund on its longer-term
portfolio investments. To the extent that the total assets of the Fund
(including the assets obtained from leverage) are invested in higher-yielding
portfolio investments, the Fund's Common Stock shareholders are the
beneficiaries of the incremental yield.
Leverage creates risks for holders of Common Stock including the likelihood of
greater net asset value and market price volatility. In addition, there is the
risk that fluctuations in interest rates on borrowings (or in the dividend rates
on any Preferred Stock, if the Fund were to issue Preferred Stock) may reduce
the Common Stock's yield and negatively impact its net asset value and market
price. If the income derived from securities purchased with assets received from
leverage exceeds the cost of leverage, the Fund's net income will be greater
than if leverage had not been used. Conversely, if the income from the
securities purchased is not sufficient to cover the cost of leverage, the Fund's
net income will be less than if leverage had not been used, and therefore the
amount available for distribution to Common Stock shareholders will be reduced.
Portfolio Information (unaudited)
Asset Mix Percent of Total
As of October 31, 2004 Investments
--------------------------------------------------------------------------------
Capital Trusts .............................................. 35.8%
Preferred Stocks ............................................ 17.8
Real Estate Investment Trusts ............................... 18.0
Trust Preferred ............................................. 8.4
Corporate Bonds ............................................. 17.9
Options Purchased ........................................... 0.0
Other* ...................................................... 2.1
--------------------------------------------------------------------------------
* Includes portfolio holdings in short-term investments.
2 PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004
A Letter From the President
Dear Shareholder
As we ended the current reporting period, the financial markets were facing a
number of uncertainties. At the top of investors' minds were questions about
economic expansion, corporate earnings, interest rates and inflation, politics,
oil prices and terrorism.
After benefiting from aggressive monetary and fiscal policy stimulus, some fear
the U.S. economy has hit a "soft patch." In fact, economic expansion has slowed
somewhat in recent months, but we believe it is easing into a pace of growth
that is sustainable and healthy. The favorable economic environment has served
to benefit American corporations, which have continued to post strong earnings.
Although the most impressive earnings results were seen earlier in the year,
solid productivity, improved revenue growth and cost discipline all point to a
vital corporate sector.
In terms of inflation and interest rates, the Federal Reserve Board (the Fed)
has signaled its confidence in the economic recovery by increasing the Federal
Funds target rate four times in the past several months, from 1% to 2% as of the
November 10 Federal Open Market Committee meeting. Inflation, for its part, has
remained in check. Investors and economists are focused on how quickly Fed
policy will move from here.
With the presidential election now behind us, any politically provoked market
angst should subside to some extent. The effect of oil prices, however, is more
difficult to predict. At around $50 per barrel, the price of oil is clearly a
concern. However, on an inflation-adjusted basis and considering modern usage
levels, the situation is far from the crisis proportions we saw in the 1980s.
Finally, although terrorism and geopolitical tensions are realities we are
forced to live with today, history has shown us that the financial effects of
any single event tend to be short-lived.
Amid the uncertainty, fixed income markets provided positive results. For the
12-month period ended October 31, 2004, the Lehman Brothers Aggregate Bond Index
returned +5.53% and the Merrill Lynch U.S. Corporate and Government Master Index
returned +5.54%. In terms of yield, the 10-year Treasury recorded a yield of
4.05% at the end of October 2004, versus 4.33% at October 31, 2003. The
three-month Treasury yield was 1.91% at period-end, compared to .96% 12 months
earlier.
The key during uncertain times is to remain focused on the big picture.
Investment success comes not from reacting to short-term volatility, but from
maintaining a long-term perspective and adhering to the disciplines of asset
allocation, diversification and rebalancing. We encourage you to work with your
financial advisor to ensure these time-tested techniques are incorporated into
your investment plan. We thank you for trusting Merrill Lynch Investment
Managers with your investment assets, and we look forward to serving you in the
months and years ahead.
Sincerely,
/s/ Terry K. Glenn
Terry K. Glenn
President and Director
PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004 3
[LOGO] Merrill Lynch Investment Managers
A Discussion With Your Fund's Portfolio Managers
The Fund slightly underperformed its benchmark during the year because of
adverse security selection in the insurance sector and its relatively short
duration in a modestly declining interest rate environment.
How did the Fund perform during the fiscal year in light of the existing market
conditions?
For the 12-month period ended October 31, 2004, the Common Stock of Merrill
Lynch Preferred Income Strategies Fund, Inc. had net annualized yields of 9.08%
and 9.32%, based on a year-end per share net asset value of $23.48 and a per
share market price of $22.87, respectively, and $2.132 per share income
dividends. For the same period, the total investment return on the Fund's Common
Stock was +5.22%, based on a change in per share net asset value from $24.53 to
$23.48, and assuming reinvestment of ordinary income dividends and capital gains
distributions. For the same period, the unmanaged benchmark Merrill Lynch
Preferred Stock Fixed Rate Index returned +5.69%, while the unmanaged Merrill
Lynch U.S. Corporate Master Index and the Merrill Lynch U.S. Treasury/Agency
Master Index returned +6.92% and +4.75%, respectively.
For the six-month period ended October 31, 2004, the total investment return on
the Fund's Common Stock was +2.62%, based on a change in per share net asset
value from $23.91 to $23.48, and assuming reinvestment of ordinary income
dividends. For the same period, the unmanaged Merrill Lynch Preferred Stock
Fixed Rate Index returned +5.73%, while the unmanaged Merrill Lynch U.S.
Corporate Master Index and the Merrill Lynch U.S. Treasury/Agency Master Index
returned +4.94% and +3.91%, respectively.
For a description of the Fund's total investment return based on a change in the
per share market value of the Fund's Common Stock (as measured by the trading
price of the Fund's shares on the New York Stock Exchange), and assuming
reinvestment of dividends, please refer to the Financial Highlights section of
this report. As a closed-end fund, the Fund's shares may trade in the secondary
market at a premium or discount to the Fund's net asset value. As a result,
total investment returns based on changes in the market value of the Fund's
Common Stock can vary significantly from total investment returns based on
changes in the Fund's net asset value.
Security selection in the insurance sector and the Fund's relatively short
duration contributed to the underperformance for the year. After holding the
target Federal Funds rate steady at 1.0% for approximately one year, the Federal
Reserve Board (the Fed) began to raise short-term interest rates in June 2004.
The Fed followed up its initial .25% increase with two more interest rate hikes
of .25% in August and September. Throughout the period, the Fund was positioned
with a shorter duration than that of its benchmark, the Merrill Lynch Preferred
Stock Fixed Rate Index. We established this positioning in anticipation of
rising interest rates, as a shorter duration limits an investment's sensitivity
to rate increases, thereby preserving its net asset value. This strategy
initially proved successful, as the yield on the 10-year U.S. Treasury note rose
.30% between October 31, 2003 and June 30, 2004. However, the shorter duration
caused the Fund to underperform compared to the benchmark later in the period,
as the 10-year Treasury note gained 6.15% between June 30 and October 31, 2004,
while its yield fell from 4.58% to 4.03%. For the 12-month period ended October
31, 2004, the 10-year Treasury yield fell from 4.30% to 4.03%.
Our use of hedge strategies had an overall slightly negative effect on Fund
performance during the year. Like the short duration, the hedges were used in an
effort to reduce the risk of loss associated with rising interest rates. Among
the hedges we implemented during the period were interest rate swaps, U.S.
Treasury futures and options on Treasury futures. During the period, we swapped
some fixed rate securities for variable rate issues. When interest rates
increase, the value of a variable rate security does not fall as much as that of
a fixed rate issue because its interest payments would adjust periodically to
keep pace with rising interest rates. Therefore, these swaps had a positive
effect on the Fund's return as interest rates moved higher between April and
June. Conversely, a fixed rate security would generally outperform a variable
rate obligation in a declining interest rate environment.
4 PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004
What changes were made to the portfolio during the year?
As interest rates moved higher in April, we reduced the portfolio's duration --
which already was shorter than that of its benchmark -- by two years. At the
same time, we trimmed our holdings in preferred securities that trade on the New
York Stock Exchange and reinvested the proceeds in preferred securities that
trade in the over-the-counter market. Exchange-traded preferred securities are
more vulnerable to extended rises in interest rates and the reduction in
exposure contributed positively to performance in the rising interest rates
environment in the spring and early summer.
Additionally, we trimmed the Fund's exposure to the insurance sector, as we saw
this as an opportunity to realize profits on some of our holdings. We also
reduced our positions in floating rate preferred and $25 par retail preferred
securities later in the period.
How would you characterize the Fund's position at the close of the period?
We maintained the Fund's short duration relative to its benchmark, in keeping
with our view that the Fed will continue to gradually raise short-term interest
rates, eventually forcing long-term rates higher. The portfolio also has
extensive positive convexity. This means that, as interest rates move up, the
portfolio's duration will fall, and vice versa. Thus, the Fund's duration will
decrease further as interest rates rise.
The portfolio is well diversified among issuers, and we intend to maintain the
diversification of our holdings across issuers and sectors. At October 31, 2004,
the Fund was approximately 36% leveraged as a percent of total assets. (For a
more complete explanation of the benefits and risks of leveraging, see page 2 of
this report to shareholders.) Also at period-end, the portfolio carried an
average credit rating of Baa1 from Moody's Investors Service, down slightly from
the A2 rating at the beginning of the period.
John Burger
Vice President and Portfolio Manager
Thomas Musmanno
Vice President and Portfolio Manager
November 4, 2004
PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004 5
[LOGO] Merrill Lynch Investment Managers
Schedule of Investments (in U.S. dollars)
====================================================================================================================================
Preferred Securities
------------------------------------------------------------------------------------------------------------------------------------
S&P Moody's Face
Industry+ Ratings@ Ratings@ Amount Capital Trusts Value
====================================================================================================================================
Auto Components-- BB Baa3 $ 13,000,000 Delphi Trust II, 6.197% due 11/15/2033 (b) $ 13,025,740
1.4%
====================================================================================================================================
Capital Markets-- A- A1 11,300,000 Goldman Sachs Capital I, 6.345% due 2/15/2034 11,516,474
1.2%
====================================================================================================================================
Commercial A- A3 12,035,000 ABN AMRO North America Holding Preferred Capital
Banks--21.4% Repackaging Trust I, 6.523% (a)(b)(c) 13,350,931
A- A2 11,000,000 Abbey National Capital Trust I, 8.963% (b)(c) 15,156,284
A- A1 2,000,000 Bank One Capital III, 8.75% due 9/01/2030 2,702,446
A- A1 1,000,000 Chase Capital I, 7.67% due 12/01/2026 1,099,234
A- A1 16,455,000 Chase Capital II, 2.194% due 2/01/2027 (b) 15,421,264
A Aa3 7,225,000 Danske Bank A/S, 5.914% (a)(b)(c) 7,700,138
BBB+ A3 34,000,000 Dresdner Funding Trust I, 8.151% due 6/30/2031 (a) 41,500,638
BB Baa1 8,500,000 Fuji JGB Investment LLC, 9.87% (a)(b)(c) 9,982,162
A NR* 4,310,000 HBOS Capital Funding LP, 6.85% (c) 4,444,687
A- A1 2,000,000 HSBC Americas Capital Trust I, 7.808% due 12/15/2026 (a) 2,181,402
A- A1 15,835,000 HSBC Capital Funding LP, 10.176% (a)(b)(c) 24,595,429
NR* NR* 12,275,000 Hubco Capital Trust II, 7.65% due 6/15/2028 12,581,875
A- A1 998,000 JPM Capital Trust I, 7.54% due 1/15/2027 1,094,616
A+ Aa2 2,000,000 Lloyds TSB Bank PLC, 6.90% (c) 2,080,200
A- Aa3 18,470,000 NB Capital Trust III, 2.15% due 1/15/2027 (b) 17,658,871
A A1 970,000 RBS Capital Trust I, 4.709% (b)(c) 949,029
A- A1 2,000,000 Republic New York Capital II, 7.53% due 12/04/2026 2,178,806
BB Baa3 5,000,000 SB Treasury Company LLC, 9.40% (a)(b)(c) 5,810,095
NR* Baa1 4,500,000 St. George Bank Funding Company, LLC, 8.485% (a)(c) 5,207,387
AA- Aa3 8,000,000 Swedish Export Credit Corporation, 6.375% (a)(c) 8,110,752
A- A2 10,000,000 Westpac Capital Trust III, 5.819% (a)(b)(c) 10,509,100
--------------
204,315,346
====================================================================================================================================
Consumer Finance-- BB+ Baa3 1,000,000 MBNA Capital A, 8.278% due 12/01/2026 1,101,089
0.1%
====================================================================================================================================
Diversified Financial NR* NR* 15,000,000 AgFirst Farm Credit Bank, 8.393% due 12/15/2016 (b) 17,497,920
Services--4.2% BBB+ A3 10,000,000 CIT Capital Trust I, 7.70% due 2/15/2027 11,128,630
A+ A1 10,000,000 Sun Life of Canada (U.S.) Capital Trust I, 8.526% (a)(c) 11,633,330
--------------
40,259,880
====================================================================================================================================
Electric Utilities--2.6% BB+ Ba3 14,950,000 REI Capital Trust II, 8.257% due 2/01/2037 15,576,854
BB+ Baa2 9,500,000 SWEPCO Capital Trust I, 5.25% due 10/01/2043 (b) 9,674,097
--------------
25,250,951
====================================================================================================================================
Gas Utilities--0.6% BBB Baa2 5,000,000 AGL Capital Trust, 8.17% due 6/01/2037 5,575,065
====================================================================================================================================
Insurance--16.9% BBB- Baa1 22,100,000 ACE Capital Trust II, 9.70% due 4/01/2030 28,831,704
BBB- Baa3 24,175,000 AON Capital Trust, 8.205% due 1/01/2027 24,821,173
AA Aa1 2,000,000 American General Institutional Capital, 8.125%
due 3/15/2046 (a) 2,629,352
BBB+ A3 23,725,000 Axa, 8.60% due 12/15/2030 30,948,171
BBB+ Baa3 15,000,000 Farmers Exchange Capital, 7.05% due 7/15/2028 (a) 15,190,875
BBB+ A3 1,000,000 GenAmerica Capital I, 8.525% due 6/30/2027 (a) 1,123,155
A- A2 6,066,000 ING Capital Funding Trust III, 8.439% (b)(c) 7,356,353
BB Ba1 1,000,000 Markel Capital Trust I, 8.71% due 1/01/2046 1,054,178
A- A2 10,000,000 Oil Insurance Limited, 5.15% due 8/15/2033 (a)(b) 10,209,170
A+ A1 6,325,000 Principal Life Insurance Company, 8% due 3/01/2044
(Surplus Notes) (a) 6,942,984
BBB Baa1 14,000,000 QBE Insurance Group Limited, 5.647% due 7/01/2023 (a)(b) 13,874,224
A- Baa1 6,225,000 Transamerica Capital III, 7.625% due 11/15/2037 6,813,599
A- Baa2 10,000,000 Zurich Capital Trust I, 8.376% due 6/01/2037 (a) 11,337,280
--------------
161,132,218
====================================================================================================================================
Multi-Utilities & BBB- Baa2 10,000,000 Dominion Resources Capital Trust I, 7.83% due 12/01/2027 11,009,770
Unregulated BBB- Baa2 15,000,000 Dominion Resources Capital Trust III, 8.40%
Power--3.2% due 1/15/2031 18,684,180
--------------
29,693,950
6 PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004
Schedule of Investments (continued) (in U.S. dollars)
====================================================================================================================================
Preferred Securities (continued)
------------------------------------------------------------------------------------------------------------------------------------
S&P Moody's Face
Industry+ Ratings@ Ratings@ Amount Capital Trusts Value
====================================================================================================================================
Oil & Gas--2.0% BBB Baa2 $ 9,850,000 ConocoPhillips Capital Trust II, 8% due 1/15/2037 $ 11,320,162
BB+ Baa3 5,000,000 KN Capital Trust I, 8.56% due 4/15/2027 5,633,050
BB+ Baa3 1,750,000 KN Capital Trust III, 7.63% due 4/15/2028 1,942,129
--------------
18,895,341
====================================================================================================================================
Thrifts & Mortgage Astoria Capital Trust I:
Finance--3.7% BB Baa2 5,000,000 9.75% due 11/01/2029 6,067,500
BB Baa2 1,000,000 9.75% due 11/01/2029 (a) 1,194,500
BBB Baa1 5,760,000 Dime Capital Trust I, 9.33% due 5/06/2027 6,691,317
BBB- A3 12,765,000 GreenPoint Capital Trust I, 9.10% due 6/01/2027 14,746,473
BB NR* 5,775,000 Webster Capital Trust I, 9.36% due 1/29/2027 (a) 6,707,853
--------------
35,407,643
----------------------------------------------------------------------------------------------------------
Total Investments in Capital Trusts
(Cost--$518,725,088)--57.3% 546,173,697
==========================================================================================================
Shares
Held Preferred Stocks
====================================================================================================================================
Capital Markets--2.2% 100,000 Lehman Brothers Holdings, Inc., 5.94% 5,100,000
600,000 Lehman Brothers Holdings, Inc., 6.50% 15,930,000
--------------
21,030,000
====================================================================================================================================
Commercial Banks--7.9% 150 BBVA Privanza International (Gibraltar) Ltd., 7.764% (a) 15,900,000
435,200 Banco Santander Central Hispano SA, 6.41% (a) 10,660,659
1,000,000 Royal Bank of Scotland Group PLC, 5.75% 23,920,000
23,000 SG Preferred Capital II, 6.302% 24,656,000
--------------
75,136,659
====================================================================================================================================
Diversified Financial 320,000 CoBank, ACB, 7% (a) 16,969,600
Services--2.7% 9,000,000 Farm Credit Bank of Texas, 7.561% (b)(c) 9,378,090
--------------
26,347,690
====================================================================================================================================
Electric Utilities--3.1% 14,000 Alabama Power Company, 5.83% 352,660
8,200 Delmarva Power & Light Company, 4.56% 724,419
80,000 Duquesne Light Company, 6.50% 4,112,000
80,000 Interstate Power and Light Company, 8.375% 2,560,000
17,372 South Carolina Electric & Gas Company, 4.60% 877,830
200,000 TXU Corporation, 7.24% (b) 20,680,000
--------------
29,306,909
====================================================================================================================================
Gas Utilities--1.8% 626,000 Southern Union Company, 7.55% 17,089,800
====================================================================================================================================
Insurance--5.4% 880,000 ACE Limited, 7.80% 23,337,600
17,340 Zurich RegCaPS Funding Trust I, 6.01% (a)(b) 17,825,520
9,800 Zurich RegCaPS Funding Trust II, 6.58% (a)(b) 10,192,000
--------------
51,355,120
====================================================================================================================================
Thrifts & Mortgage 264,650 Federal National Mortgage Association, 5.125% 11,882,785
Finance--1.2%
====================================================================================================================================
Wireless 30,423 Centaur Funding Corporation, 9.08% (a) 39,873,144
Telecommunication
Services--4.2%
----------------------------------------------------------------------------------------------------------
Total Investments in Preferred Stocks
(Cost--$259,997,559)--28.5% 272,022,107
==========================================================================================================
PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004 7
[LOGO] Merrill Lynch Investment Managers
Schedule of Investments (continued) (in U.S. dollars)
====================================================================================================================================
Preferred Securities (continued)
------------------------------------------------------------------------------------------------------------------------------------
Shares
Industry+ Held Real Estate Investment Trusts Value
====================================================================================================================================
Real Estate 196,000 AMB Property Corporation, 6.50% $ 4,906,135
Investment Trusts 124,000 AMB Property Corporation, 6.75% 3,081,400
251,400 Alexandria Real Estate Equities, Inc., 8.375% 6,724,950
290,000 BRE Properties, Inc., 6.75% 7,244,200
400,000 CBL & Associates Properties, Inc., 7.75% 10,808,000
600,000 CarrAmerica Realty Corporation, 7.50% 15,636,000
200,000 Cousins Properties, Inc., 7.75% 5,237,500
780,000 Developers Diversified Realty Corporation, 7.375% 20,514,000
280,000 Developers Diversified Realty Corporation, 8% 7,120,400
100,000 Duke Realty Corporation, 6.50% 2,540,630
270,000 Duke Realty Corporation, 6.625% 6,750,000
787,000 Equity Residential Properties Trust, 6.48% 19,556,950
2,390 First Industrial Realty Trust, Inc., 6.236% (b) 2,397,170
4,000 Firstar Realty LLC, 8.875% (a) 5,172,400
768,000 Health Care Property Investors, Inc., 7.10% 19,576,320
172,800 Health Care REIT, Inc., 7.625% 4,325,409
686,000 Kimco Realty Corporation, 6.65% 18,041,800
1,600,000 New Plan Excel Realty Trust, 7.625% 42,656,000
161,400 PS Business Parks, Inc., 7% 3,999,492
72,000 PS Business Parks, Inc., 7.95% 1,872,000
320,000 Public Storage, Inc., 6.45% 7,939,200
58,000 Regency Centers Corporation, 7.25% 1,488,065
607,550 Regency Centers Corporation, 7.45% 15,978,565
11,857 Sovereign Real Estate Investment Trust, 12% (a) 17,785,500
145,000 Vornado Realty Trust, 7% 3,810,789
130,000 Wachovia Preferred Funding Corporation, 7.25% 3,606,200
600,000 Weingarten Realty Investors, Inc., 6.75% 16,260,000
----------------------------------------------------------------------------------------------------------
Total Investments in Real Estate Investment Trusts
(Cost--$264,542,085)--28.9% 275,029,075
==========================================================================================================
S&P Moody's Face
Ratings@ Ratings@ Amount Trust Preferred
====================================================================================================================================
Aerospace & NR* NR* $ 27,450,000 RC Trust I, 7% due 5/15/2006 28,976,934
Defense--3.0%
====================================================================================================================================
Auto Components-- BB Baa3 10,000,000 Delphi Trust I, 8.25% due 10/15/2033 10,106,019
1.1%
====================================================================================================================================
Capital Markets--0.1% BBB+ A3 875,000 Lehman Brothers Holdings Capital Trust III, 6.375%
due 3/15/2052 880,841
====================================================================================================================================
Commercial Banks-- A- A2 3,625,000 J.P. Morgan Chase Capital XI, 5.875% due 6/15/2033 3,528,899
0.4%
====================================================================================================================================
Communications BBB Baa2 2,000,000 Corporate-Backed Trust Certificates, Motorola
Equipment--0.2% Debenture-Backed, Series 2002-14, Class A-1, 8.375%
due 11/15/2028 2,192,815
====================================================================================================================================
Diversified Financial NR* NR* 4,000,000 Principal Protected PreTSL IX, Ltd., 14.50% due 4/03/2033 3,764,000
Services--0.4%
====================================================================================================================================
Electric Utilities--1.8% A A2 6,750,000 Georgia Power Company, 5.90% due 4/15/2033 6,714,287
BBB- Baa2 3,000,000 HECO Capital Trust III, 6.50% due 3/18/2034 3,158,053
BBB+ A3 5,000,000 Natural Rural Utilities Cooperative Finance Corporation,
6.75% due 2/15/2043 5,289,713
BB+ Baa3 397,425 PSEG Funding Trust II, 8.75% due 12/31/2032 438,724
BBB Baa1 950,000 Virginia Power Capital Trust II, 7.375% due 7/30/2042 1,015,738
--------------
16,616,515
==========================================================================================================
8 PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004
Schedule of Investments (continued) (in U.S. dollars)
====================================================================================================================================
Preferred Securities (concluded)
------------------------------------------------------------------------------------------------------------------------------------
S&P Moody's Face
Industry+ Ratings@ Ratings@ Amount Trust Preferred Value
====================================================================================================================================
Gas Utilities--0.7% BBB- Baa1 $ 500,000 Dominion-CNG Capital Trust I, 7.80% due 10/31/2041 $ 531,376
BB Baa3 5,750,000 Southwest Gas Capital II, 7.70% due 9/15/2043 6,136,471
--------------
6,667,847
====================================================================================================================================
Insurance--2.3% A A3 16,000,000 ABN AMRO North America Capital Funding Trust II,
1.935% (a)(b)(c) 15,660,000
BBB Baa1 1,000,000 Everest Re Capital Trust, 7.85% due 11/15/2032 1,099,147
BBB Baa1 5,000,000 Lincoln National Capital VI, 6.75% due 9/11/2052 5,312,818
--------------
22,071,965
====================================================================================================================================
Thrifts & Mortgage BBB+ Baa1 27,000,000 Countrywide Capital IV, 6.75% due 4/01/2033 27,592,569
Finance--3.5% NR* NR* 6,000,000 Dime Community Capital I, 7% due 4/14/2034 (a) 5,880,000
--------------
33,472,569
----------------------------------------------------------------------------------------------------------
Total Investments in Trust Preferred
(Cost--$125,985,120)--13.5% 128,278,404
==========================================================================================================
Total Investments in Preferred Securities
(Cost--$1,169,249,852)--128.2% 1,221,503,283
==========================================================================================================
Corporate Bonds
====================================================================================================================================
Automobiles--1.0% BBB- Baa1 10,000,000 Ford Motor Company, 7.45% due 7/16/2031 9,738,860
====================================================================================================================================
Diversified BBB- Baa1 29,000,000 General Motors Acceptance Corporation, 8% due 11/01/2031 30,016,334
Financial AAA Aaa 15,000,000 Sigma Finance Corporation, 4.281% due 8/15/2011 15,000,000
Services--4.7% --------------
45,016,334
====================================================================================================================================
Diversified BBB+ Baa2 28,000,000 France Telecom, 9.25% due 3/01/2031 37,798,292
Telecommunication Sprint Capital Corporation:
Services--7.5% BBB- Baa3 2,000,000 6.90% due 5/01/2019 2,239,022
BBB- Baa3 24,000,000 8.75% due 3/15/2032 31,447,488
--------------
71,484,802
====================================================================================================================================
Electric Utilities--1.2% BB+ Baa3 10,000,000 FirstEnergy Corp., 6.45% due 11/15/2011 10,956,760
====================================================================================================================================
Food Products--0.6% BBB Baa3 4,800,000 Tyson Foods, Inc., 7% due 1/15/2028 5,149,805
====================================================================================================================================
Insurance--1.6% A- A1 10,000,000 GE Global Insurance Holding Corporation, 7.75%
due 6/15/2030 11,845,050
BBB NR* 3,605,000 Oil Casualty Insurance, Ltd., 8% due 9/15/2034 (a) 3,622,037
--------------
15,467,087
====================================================================================================================================
Media--5.1% BBB Baa3 10,000,000 Comcast Corporation, 7.05% due 3/15/2033 11,295,230
BBB- Baa3 10,000,000 Liberty Media Corporation, 5.70% due 5/15/2013 10,101,300
Time Warner Inc.:
BBB+ Baa1 5,000,000 7.625% due 4/15/2031 5,924,050
BBB+ Baa1 18,000,000 7.70% due 5/01/2032 21,555,684
--------------
48,876,264
====================================================================================================================================
Multi-Utilities & BBB Baa2 16,575,000 Duke Energy Field Services, LLC, 8.125% due 8/16/2030 21,125,583
Unregulated Power--
2.2%
==========================================================================================================
PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004 9
[LOGO] Merrill Lynch Investment Managers
Schedule of Investments (continued) (in U.S. dollars)
S&P Moody's Face
Industry+ Ratings@ Ratings@ Amount Corporate Bonds Value
====================================================================================================================================
Thrifts & Mortgage NR* NR* $ 8,000,000 Roslyn Real Estate Asset Corporation, 5.236% (b)(c) $ 8,607,504
Finance--0.9%
====================================================================================================================================
Wireless A Baa2 28,000,000 AT&T Wireless Services, Inc., 8.75% due 3/01/2031 37,590,504
Telecommunication
Services--3.9%
====================================================================================================================================
Total Investments in Corporate Bonds
(Cost--$252,206,763)--28.7% 274,013,503
==========================================================================================================
Short-Term Securities
==========================================================================================================
16,100,000 Federal Home Loan Mortgage Corporation, 1.75%
due 11/02/2004 (d) 16,099,217
16,100,000 Federal National Mortgage Association, 1.83%
due 11/24/2004 (d)(e) 16,081,995
----------------------------------------------------------------------------------------------------------
Total Investments in Short-Term Securities
(Cost--$32,181,212)--3.4% 32,181,212
==========================================================================================================
Number of
Contracts Put Options Purchased
==========================================================================================================
400 U.S. Treasury Bonds, expiring November 2004 at $109,
Broker Credit Suisse First Boston 12,500
----------------------------------------------------------------------------------------------------------
Total Put Options Purchased
(Premiums Paid--$107,750)--0.0% 12,500
==========================================================================================================
Total Investments (Cost--$1,453,745,577**)--160.3% 1,527,710,498
Liabilities in Excess of Other Assets--(2.6%) (24,687,582)
Preferred Stock, at Redemption Value--(57.7%) (550,050,344)
---------------
Net Assets Applicable to Common Stock--100.0% $ 952,972,572
===============
* Not Rated.
** The cost and unrealized appreciation/depreciation of investments as of
October 31, 2004, as computed for federal income tax purposes, were as
follows:
--------------------------------------------------------------------------
Aggregate cost ............................. $ 1,460,051,539
===============
Gross unrealized appreciation .............. $ 83,293,811
Gross unrealized depreciation .............. (15,634,852)
---------------
Net unrealized appreciation ................ $ 67,658,959
===============
+ For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management.
These industry sub-classifications are unaudited. This definition may not
apply for purposes of this report, which may combine such industry
sub-classifications for reporting ease. These industry classifications are
unaudited.
@ Ratings of issues shown are unaudited.
(a) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(b) Floating rate note.
(c) The security is a perpetual bond and has no definite maturity date.
(d) Certain U.S. Government Obligations are traded on a discount basis; the
interest rate shown reflects the discount rate paid at the time of
purchase.
(e) All or a portion of security held as collateral in connection with open
Financial Futures.
Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) were as follows:
----------------------------------------------------------------------------------------
Net Interest
Affiliate Activity Income
----------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Cash Sweep Series I $(21,767,413) $ 70,767
----------------------------------------------------------------------------------------
10 PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004
Schedule of Investments (concluded) (in U.S. dollars)
Swaps outstanding as of October 31, 2004 were as follows:
------------------------------------------------------------------------------------------------------------------------------
Unrealized
Notional Appreciation/
Amount Depreciation
------------------------------------------------------------------------------------------------------------------------------
Bought credit default protection on Aon Corp. and receive 2.55% interest
Broker, Lehman Brothers Special Finance
Expires December 2009 $ 3,990,000 $ (211,470)
Bought credit default protection on Aon Corp. and receive 2.65% interest
Broker, J.P. Morgan Chase Bank
Expires December 2009 $ 3,990,000 (208,538)
Bought credit default protection on Aon Corp. and receive 2.45% interest
Broker, J.P. Morgan Chase Bank
Expires December 2009 $ 3,990,000 (172,571)
Bought credit default protection on Aon Corp. and receive 1.48% interest
Broker, J.P. Morgan Chase Bank
Expires December 2009 $ 3,990,000 --
Receive a variable rate equal to 1-month USD LIBOR and pay a fixed rate of 1.32% interest
Broker, UBS Warburg
Expires June 2005 $ 25,000,000 175,992
Receive a variable rate equal to 1-month USD LIBOR and pay a fixed rate of 1.3275% interest
Broker, J.P. Morgan Chase Bank
Expires June 2005 $ 125,000,000 868,865
Receive a variable rate equal to 1-month USD LIBOR and pay a fixed rate of 1.33% interest
Broker, Morgan Stanley Capital Services Inc.
Expires June 2005 $ 125,000,000 866,458
Receive a variable rate equal to 1-month USD LIBOR and pay a fixed rate of 1.31% interest
Broker, UBS Warburg
Expires June 2005 $ 150,000,000 1,042,198
Receive a variable rate equal to 3-month USD LIBOR and pay a fixed rate of 5.4975% interest
Broker, Morgan Stanley Capital Services Inc.
Expires February 2015 $ 300,000,000 (22,548,900)
------------------------------------------------------------------------------------------------------------------------------
Total $ (20,187,966)
==============
Financial futures contracts sold as of October 31, 2004 were as follows:
-------------------------------------------------------------------------------------------------
Number of Face Unrealized
Contracts Issue Expiration Date Value Depreciation
-------------------------------------------------------------------------------------------------
7,307 10-Year U.S. Treasury Notes December 2004 $ 817,321,247 $(12,479,941)
800 30-Year U.S. Treasury Bonds December 2004 $ 89,110,260 (1,964,740)
-------------------------------------------------------------------------------------------------
Total $(14,444,681)
=============
See Notes to Financial Statements.
PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004 11
[LOGO] Merrill Lynch Investment Managers
Statement of Net Assets
As of October 31, 2004
=====================================================================================================================
Assets
---------------------------------------------------------------------------------------------------------------------
Investments in unaffiliated securities, at value
(identified cost--$1,453,637,827) ........................ $1,527,697,998
Options purchased, at value (premiums paid--$107,750) ..... 12,500
Unrealized appreciation on swaps--net ..................... 1,705,946
Receivables:
Interest ............................................... $ 17,889,899
Securities sold ........................................ 6,017,859
Dividends .............................................. 808,295 24,716,053
-------------
Prepaid expenses and other assets ......................... 106,637
-------------
Total assets .............................................. 1,554,239,134
-------------
=====================================================================================================================
Liabilities
---------------------------------------------------------------------------------------------------------------------
Unrealized depreciation on swaps--net ..................... 21,893,912
Payables:
Securities purchased ................................... 16,081,995
Dividends to Common Stock shareholders ................. 6,765,525
Variation margin ....................................... 3,290,125
Swaps .................................................. 1,846,512
Investment adviser ..................................... 864,041
Custodian bank ......................................... 350,498
Other affiliates ....................................... 10,601 29,209,297
-------------
Accrued expenses .......................................... 113,009
-------------
Total liabilities ......................................... 51,216,218
-------------
=====================================================================================================================
Preferred Stock
---------------------------------------------------------------------------------------------------------------------
Preferred Stock, at redemption value, par value $.10 per
share (2,800 Series M7 Shares, 2,800 Series T7 Shares,
2,800 Series W7 Shares, 2,800 Series TH7 Shares, 2,800
Series F7 Shares, 4,000 Series W28 Shares and 4,000
Series TH28 Shares of AMPS* authorized, issued and
outstanding at $25,000 per share liquidation preference) . 550,050,344
-------------
=====================================================================================================================
Net Assets Applicable to Common Stock
---------------------------------------------------------------------------------------------------------------------
Net assets applicable to Common Stock ..................... $ 952,972,572
=============
=====================================================================================================================
Analysis of Net Assets Applicable to Common Stock
---------------------------------------------------------------------------------------------------------------------
Common Stock, par value $.10 per share (40,593,070 shares
issued and outstanding) .................................. $ 4,059,307
Paid-in capital in excess of par .......................... 958,513,227
Undistributed investment income--net ...................... $ 1,937,813
Accumulated realized capital losses--net .................. (50,870,049)
Unrealized appreciation--net .............................. 39,332,274
-------------
Total accumulated losses--net ............................. (9,599,962)
-------------
Total--Equivalent to $23.48 net asset value per share of
Common Stock (market price--$22.87) ...................... $ 952,972,572
=============
* Auction Market Preferred Stock.
See Notes to Financial Statements.
12 PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004
Statement of Operations
For the Year Ended October 31, 2004
=====================================================================================================================
Investment Income
---------------------------------------------------------------------------------------------------------------------
Interest (including $70,767 from affiliates) .............. $ 63,077,630
Dividends ................................................. 35,503,569
-------------
Total income .............................................. 98,581,199
-------------
=====================================================================================================================
Expenses
---------------------------------------------------------------------------------------------------------------------
Investment advisory fees .................................. $ 9,110,010
Commission fees ........................................... 1,369,756
Accounting services ....................................... 459,964
Transfer agent fees ....................................... 155,978
Directors' fees and expenses .............................. 94,534
Professional fees ......................................... 89,070
Custodian fees ............................................ 82,668
Printing and shareholder reports .......................... 59,021
Listing fees .............................................. 47,486
Pricing fees .............................................. 11,254
Other ..................................................... 118,020
-------------
Total expenses ............................................ 11,597,761
-------------
Investment income--net .................................... 86,983,438
-------------
=====================================================================================================================
Realized & Unrealized Gain (Loss)--Net
---------------------------------------------------------------------------------------------------------------------
Realized gain (loss) on:
Investments--net ....................................... (36,027,652)
Futures contracts and swaps--net ....................... (39,116,475)
Options written--net ................................... 10,413,025 (64,731,102)
-------------
Change in unrealized appreciation/depreciation on:
Investments--net ....................................... 67,926,503
Futures contracts and swaps--net ....................... (33,739,481)
Options written--net ................................... (1,544,087) 32,642,935
-------------------------------
Total realized and unrealized loss--net ................... (32,088,167)
=====================================================================================================================
Dividends & Distributions to Preferred Stock Shareholders
---------------------------------------------------------------------------------------------------------------------
Investment income--net .................................... (7,213,974)
Realized gain--net ........................................ (259,790)
-------------
Total dividends and distributions to Preferred Stock
shareholders ............................................. (7,473,764)
-------------
Net Increase in Net Assets Resulting from Operations ...... $ 47,421,507
=============
See Notes to Financial Statements.
PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004 13
[LOGO] Merrill Lynch Investment Managers
Statements of Changes in Net Assets
For the Period
For the March 28,
Year Ended 2003+ to
October 31, October 31,
Increase (Decrease) in Net Assets: 2004 2003
=====================================================================================================================
Operations
---------------------------------------------------------------------------------------------------------------------
Investment income--net .................................... $ 86,983,438 $ 46,111,517
Realized gain (loss)--net ................................. (64,731,102) 18,173,984
Change in unrealized appreciation/depreciation--net ....... 32,642,935 6,689,339
Dividends and distributions to Preferred Stock shareholders (7,473,764) (2,706,868)
-------------------------------
Net increase in net assets resulting from operations ...... 47,421,507 68,267,972
-------------------------------
=====================================================================================================================
Dividends and Distributions to Common Stock Shareholders
---------------------------------------------------------------------------------------------------------------------
Investment income--net .................................... (86,340,486) (35,192,379)
Realized gain--net ........................................ (3,830,687) --
-------------------------------
Net decrease in net assets resulting from dividends and
distributions to Common Stock shareholders ............... (90,171,173) (35,192,379)
-------------------------------
=====================================================================================================================
Stock Transactions
---------------------------------------------------------------------------------------------------------------------
Net proceeds from issuance of Common Stock ................ -- 968,131,250
Value of shares issued to Common Stock shareholders in
reinvestment to dividends ................................ -- 965,500
Offering costs resulting from the issuance of Common Stock -- (570,622)
Offering and underwriting costs resulting from the
issuance of Preferred Stock .............................. -- (5,979,495)
-------------------------------
Net increase in net assets derived from stock transactions -- 962,546,633
-------------------------------
=====================================================================================================================
Net Assets Applicable to Common Stock
---------------------------------------------------------------------------------------------------------------------
Total increase (decrease) in net assets applicable to
Common Stock ............................................. (42,749,666) 995,622,226
Beginning of period ....................................... 995,722,238 100,012
-------------------------------
End of period* ............................................ $ 952,972,572 $ 995,722,238
===============================
* Undistributed investment income--net ................. $ 1,937,813 $ 8,345,285
===============================
+ Commencement of operations.
See Notes to Financial Statements.
14 PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004
Financial Highlights
For the Period
The following per share data and ratios have been derived For the March 28,
from information provided in the financial statements. Year Ended 2003+ to
October 31, October 31,
Increase (Decrease) in Net Asset Value: 2004 2003
===========================================================================================================================
Per Share Operating Performance
---------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period .............................. $ 24.53 $ 23.88
---------------------------
Investment income--net ............................................ 2.14@@ 1.14
Realized and unrealized gain (loss)--net .......................... (.78) .61
Dividends and distributions to Preferred Stock shareholders from:
Investment income--net ......................................... (.18) (.07)
Realized gain--net ............................................. (.01) --
---------------------------
Total from investment operations .................................. 1.17 1.68
---------------------------
Less dividends and distributions to Common Stock shareholders from:
Investment income--net ......................................... (2.13) (.87)
Realized gain--net ............................................. (.09) --
---------------------------
Total dividends and distributions to Common Stock shareholders .... (2.22) (.87)
---------------------------
Offering costs resulting from the issuance of Common Stock ........ -- (.01)
---------------------------
Offering and underwriting costs resulting from the issuance of
Preferred Stock .................................................. -- (.15)
---------------------------
Net asset value, end of period .................................... $ 23.48 $ 24.53
===========================
Market price per share, end of period ............................. $ 22.87 $ 23.69
===========================
===========================================================================================================================
Total Investment Return**
---------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share ................................ 5.22% 6.47%@
===========================
Based on market price per share ................................... 6.12% (1.80%)@
===========================
===========================================================================================================================
Ratios Based on Average Net Assets of Common Stock
---------------------------------------------------------------------------------------------------------------------------
Total expenses, net of waiver*** .................................. 1.19% .79%*
===========================
Total expenses*** ................................................. 1.19% 1.05%*
===========================
Total investment income--net*** ................................... 8.93% 8.31%*
===========================
Amount of dividends to Preferred Stock shareholders ............... .74% .49%*
===========================
Investment income--net, to Common Stock shareholders .............. 8.19% 7.82%*
===========================
===========================================================================================================================
Ratios Based on Average Net Assets of Common & Preferred Stock***
---------------------------------------------------------------------------------------------------------------------------
Total expenses, net of waiver ..................................... .76% .54%*
===========================
Total expenses .................................................... .76% .72%*
===========================
Total investment income--net ...................................... 5.71% 5.67%*
===========================
===========================================================================================================================
Ratios Based on Average Net Assets of Preferred Stock
---------------------------------------------------------------------------------------------------------------------------
Dividends to Preferred Stock shareholders ......................... 1.32% 1.05%*
===========================
PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004 15
[LOGO] Merrill Lynch Investment Managers
Financial Highlights (concluded)
For the Period
For the March 28,
Year Ended 2003+ to
The following per share data and ratios have been derived October 31, October 31,
from information provided in the financial statements. 2004 2003
===========================================================================================================================
Supplemental Data
---------------------------------------------------------------------------------------------------------------------------
Net assets applicable to Common Stock, end of period (in thousands) $952,973 $995,722
===========================
Preferred Stock outstanding, end of period (in thousands) ......... $550,000 $550,000
===========================
Portfolio turnover ................................................ 22.56% 27.31%
===========================
===========================================================================================================================
Leverage
---------------------------------------------------------------------------------------------------------------------------
Asset coverage per $1,000 ......................................... $ 2,733 $ 2,810
===========================
===========================================================================================================================
Dividends Per Share on Preferred Stock Outstanding++
---------------------------------------------------------------------------------------------------------------------------
Series M7--Investment income--net ................................. $ 330 $ 127
===========================
Series T7--Investment income--net ................................. $ 329 $ 122
===========================
Series W7--Investment income--net ................................. $ 327 $ 122
===========================
Series TH7--Investment income--net ................................ $ 320 $ 184
===========================
Series F7--Investment income--net ................................. $ 326 $ 125
===========================
Series W28--Investment income--net ................................ $ 338 $ 105
===========================
Series TH28--Investment income--net ............................... $ 324 $ 95
===========================
* Annualized.
** Total investment returns based on market value, which can be significantly
greater or lesser than the net asset value, may result in substantially
different returns. Total investment returns exclude the effects of sales
charges. If applicable, the Fund's Investment Adviser voluntarily waived a
portion of its management fee. Without such waiver, the Fund's performance
would have been lower.
*** Do not reflect the effect of dividends to Preferred Stock shareholders.
+ Commencement of operations.
++ The Fund's Preferred Stock was issued on May 16, 2003.
@ Aggregate total investment return.
@@ Based on average shares outstanding.
See Notes to Financial Statements.
16 PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004
Notes to Financial Statements
1. Significant Accounting Policies:
Preferred Income Strategies Fund, Inc. (the "Fund") is registered under the
Investment Company Act of 1940, as amended, as a diversified, closed-end
management investment company. The Fund's financial statements are prepared in
conformity with U.S. generally accepted accounting principles, which may require
the use of management accruals and estimates. Actual results may differ from
these estimates. The Fund's Common Stock is listed on the New York Stock
Exchange ("NYSE") under the symbol PSY. The following is a summary of
significant accounting policies followed by the Fund.
(a) Valuation of investments -- Debt securities are traded primarily in the
over-the-counter markets and are valued at the last available bid price in the
over-the-counter market or on the basis of values obtained by a pricing service.
Pricing services use valuation matrixes that incorporate both dealer-supplied
valuations and valuation models. The procedures of the pricing service and its
valuations are reviewed by the officers of the Fund under the general direction
of the Board of Directors. Such valuations and procedures will be reviewed
periodically by the Board of Directors of the Fund. Financial futures contracts
and options thereon, which are traded on exchanges, are valued at their closing
prices as of the close of such exchanges. Options written or purchased are
valued at the last sales price in the case of exchange-traded options. In the
case of options traded in the over-the-counter ("OTC") market, valuation is the
last asked price (options written) or the last bid price (options purchased).
Swap agreements are valued by quoted fair valuations received daily by the Fund
from the counterparty. Short-term investments with a remaining maturity of 60
days or less are valued at amortized cost, which approximates market value,
under which method the investment is valued at cost and any premium or discount
is amortized on a straight line basis to maturity. Repurchase agreements are
valued at cost plus accrued interest. Investments in open-end investment
companies are valued at their net asset value each business day. Securities and
other assets for which market quotations are not readily available are valued at
fair value as determined in good faith by or under the direction of the Board of
Directors of the Fund.
Equity securities that are held by the Fund, which are traded on stock exchanges
or the Nasdaq National Market, are valued at the last sale price or official
close price on the exchange, as of the close of business on the day the
securities are being valued or, lacking any sales, at the last available bid
price for long positions, and at the last available ask price for short
positions. In cases where equity securities are traded on more than one
exchange, the securities are valued on the exchange designated as the primary
market by or under the authority of the Board of Directors of the Fund. Long
positions traded in the OTC market, Nasdaq Small Cap or Bulletin Board are
valued at the last available bid price obtained from one or more dealers or
pricing services approved by the Board of Directors of the Fund. Short positions
traded in the OTC market are valued at the last available asked price. Portfolio
securities that are traded both in the OTC market and on a stock exchange are
valued according to the broadest and most representative market.
Generally, trading in foreign securities is substantially completed each day at
various times prior to the close of business on the NYSE. The values of such
securities used in computing the net asset value of the Fund's shares are
determined as of such times. Foreign currency exchange rates also are generally
determined prior to the close of business on the NYSE. Occasionally, events
affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of business on the
NYSE that may not be reflected in the computation of the Fund's net asset value.
If events (for example, a company announcement, market volatility or a natural
disaster) occur during such periods that are expected to materially affect the
value of such securities, those securities may be valued at their fair value as
determined in good faith by the Fund's Board of Directors or by the Investment
Adviser using a pricing service and/or procedures approved by the Fund's Board
of Directors.
(b) Derivative financial instruments -- The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
o Options -- The Fund may write and purchase call and put options. When the
Fund writes an option, an amount equal to the premium received by the Fund
is reflected as an asset and an equivalent liability. The amount of the
liability is subsequently marked-to-market to reflect the current market
value of the option written.
PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004 17
[LOGO] Merrill Lynch Investment Managers
Notes to Financial Statements (continued)
When a security is purchased or sold through an exercise of an option, the
related premium paid (or received) is added to (or deducted from) the
basis of the security acquired or deducted from (or added to) the proceeds
of the security sold. When an option expires (or the Fund enters into a
closing transaction), the Fund realizes a gain or loss on the option to
the extent of the premiums received or paid (or gain or loss to the extent
the cost of the closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
o Financial futures contracts -- The Fund may purchase or sell financial
futures contracts and options on such futures contracts. Futures contracts
are contracts for delayed delivery of securities at a specific future date
and at a specific price or yield. Upon entering into a contract, the Fund
deposits and maintains as collateral such initial margin as required by
the exchange on which the transaction is effected. Pursuant to the
contract, the Fund agrees to receive from or pay to the broker an amount
of cash equal to the daily fluctuation in value of the contract. Such
receipts or payments are known as variation margin and are recorded by the
Fund as unrealized gains or losses. When the contract is closed, the Fund
records a realized gain or loss equal to the difference between the value
of the contract at the time it was opened and the value at the time it was
closed.
o Swaps -- The Fund may enter into swap agreements, which are
over-the-counter contracts in which the Fund and a counterparty agree to
make periodic net payments on a specified notional amount. The net
payments can be made for a set period of time or may be triggered by a
pre-determined credit event. The net periodic payments may be based on a
fixed or variable interest rate; the change in market value of a specified
security, basket of securities, or index; or the return generated by a
security.
(c) Income taxes -- It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no federal income tax provision is required.
(d) Security transactions and investment income -- Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Interest income is recognized on the accrual basis. The Fund amortizes all
premiums and discounts on debt securities.
(e) Offering expenses -- Direct expenses relating to the public offering of the
Fund's Common Stock were charged to capital at the time of issuance of the
shares.
(f) Dividends and distributions -- Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates.
(g) Custodian bank -- The Fund recorded an amount payable to the custodian bank
resulting from a timing difference of security transaction settlements.
(h) Securities lending -- The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it collects a fee from the borrower. The Fund typically receives the income on
the loaned securities but does not receive the income on the collateral. Where
the Fund receives cash collateral, it may invest such collateral and retain the
amount earned on such investment, net of any amount rebated to the borrower.
Loans of securities are terminable at any time and the borrower, after notice,
is required to return borrowed securities within five business days. The Fund
may pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
(i) Reclassifications -- U.S. generally accepted accounting principles require
that certain components of net assets be
18 PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004
Notes to Financial Statements (continued)
adjusted to reflect permanent differences between financial and tax reporting.
Accordingly, during the current year, $89,439 has been reclassified between
accumulated net realized capital losses and undistributed net investment income
and $74,111 has been reclassified between paid-in capital in excess of par and
undistributed net investment income as a result of permanent differences
attributable to swap transactions, the classification of investments, passive
foreign investment companies, and non-deductible expenses. These
reclassifications have no effect on net assets or net asset values per share.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund Asset
Management L.P. ("FAM"). The general partner of FAM is Princeton Services, Inc.
("PSI"), an indirect, wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML
& Co."), which is the limited partner.
FAM is responsible for the management of the Fund's portfolio and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
an annual rate of .60% of the Fund's average weekly net assets including
proceeds from the issuance of Preferred Stock, plus the proceeds of any
outstanding borrowings used for leverage.
The Fund has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated, a subsidiary of ML & Co., or its affiliates.
Pursuant to that order, the Fund also has retained Merrill Lynch Investment
Managers, LLC ("MLIM, LLC"), an affiliate of FAM, as the securities lending
agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Fund, invest cash collateral
received by the Fund for such loans, among other things, in a private investment
company managed by MLIM, LLC or in registered money market funds advised by FAM
or its affiliates.
For the year ended October 31, 2004, the Fund reimbursed FAM $70,096 for certain
accounting services.
Certain officers and/or directors of the Fund are officers and/or directors of
FAM, PSI, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities, for the
year ended October 31, 2004 were $340,747,642 and $415,271,737, respectively.
Transactions in options written for the year ended October 31, 2004 were as
follows:
--------------------------------------------------------------------------------
Number of Premiums
Put Options Written Contracts Received
--------------------------------------------------------------------------------
Outstanding put options written,
beginning of year ...................... 675 $ 10,528,750
Options written .......................... 1,650 964,125
Options closed ........................... (175) (10,311,875)
Options expired .......................... (2,150) (1,181,000)
--------------------------
Outstanding put options written,
end of year ............................ -- $ --
==========================
--------------------------------------------------------------------------------
Number of Premiums
Call Options Written Contracts Received
--------------------------------------------------------------------------------
Outstanding call options written,
beginning of year ...................... -- --
Options written .......................... 7,310 $ 4,133,728
Options closed ........................... (1,225) (1,067,281)
Options expired .......................... (6,085) (3,066,447)
--------------------------
Outstanding call options written,
end of year ............................ -- $ --
==========================
4. Stock Transactions:
The Fund is authorized to issue 200,000,000 shares of stock, including Preferred
Stock, par value $.10 per share, all of which were initially classified as
Common Stock. The Board of Directors is authorized, however, to reclassify any
unissued shares of stock without approval of holders of Common Stock.
Common Stock
Shares issued and outstanding during the year ended October 31, 2004 remained
constant and during the period March 28, 2003 to October 31, 2003 increased by
40,550,000 from shares sold and 38,881 from reinvestment.
Preferred Stock
Auction Market Preferred Stock are redeemable shares of Preferred Stock of the
Fund, with a par value of $.10 per share and liquidation preference of $25,000
per share, plus accrued and unpaid dividends, that entitle their holders to
receive cash dividends at an annual rate that may vary for the successive
dividend periods. The yields in effect at October 31, 2004 were as follows:
Series M7, 1.85%; Series T7, 1.87%; Series W7, 1.87%; Series TH7, 1.84%; Series
F7, 1.85%; Series W28, 2.00% and Series TH28, 1.90%.
PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004 19
[LOGO] Merrill Lynch Investment Managers
Notes to Financial Statements (concluded)
The Fund pays commissions to certain broker-dealers at the end of each auction
at an annual rate ranging from .25% to .375%, calculated on the proceeds of each
auction. For the year ended October 31, 2004, Merrill Lynch, Pierce, Fenner &
Smith Incorporated, an affiliate of FAM, earned $549,948 as commissions.
5. Distributions to Shareholders:
The Fund paid an ordinary income dividend in the amount of $.166667 per share on
November 30, 2004 to shareholders of record on November 12, 2004.
The tax character of distributions paid during the fiscal year ended October 31,
2004 and during the period March 28, 2003 to October 31, 2003 was as follows:
--------------------------------------------------------------------------------
3/28/2003+ to
10/31/2004 10/31/2003
--------------------------------------------------------------------------------
Distributions paid from:
Ordinary income ........................ $93,554,460 $37,899,247
Net long-term capital gains ............ 4,090,477 --
------------------------------
Total taxable distributions .............. $97,644,937 $37,899,247
==============================
+ Commencement of operations.
As of October 31, 2004, the components of accumulated losses on a tax basis were
as follows:
--------------------------------------------------------------------------------
Undistributed ordinary income--net ...................... $ --
Undistributed long-term capital gains--net .............. --
------------
Total undistributed earnings--net ....................... --
Capital loss carryforward ............................... (62,733,648)*
Unrealized gains--net ................................... 53,133,686**
------------
Total accumulated losses--net ........................... $ (9,599,962)
============
* On October 31, 2004, the Fund had a net capital loss carryforward of
$62,733,648, all of which expires in 2012. This amount will be available
to offset like amounts of any future taxable gains.
** The difference between book-basis and tax-basis net unrealized gains is
attributable primarily to the tax deferral of losses on wash sales, the
realization for tax purposes of unrealized gains on certain futures and
forward foreign currency contracts, the realization for tax purposes of
unrealized gains on investments in passive foreign investment companies
and other book/tax temporary differences.
20 PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of
Preferred Income Strategies Fund, Inc.:
We have audited the accompanying statement of net assets, including the schedule
of investments, of Preferred Income Strategies Fund, Inc. as of October 31,
2004, the related statement of operations for the year then ended, the statement
of changes in net assets and financial highlights for the year then ended and
for the period March 28, 2003 to October 31, 2003. These financial statements
and financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. Our procedures included confirmation of
securities owned as of October 31, 2004, by correspondence with the custodian
and others. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Preferred Income Strategies Fund, Inc. at October 31, 2004, the results of its
operations for the year then ended, the changes in its net assets and its
financial highlights for the year then ended and for the period March 28, 2003
through October 31, 2003, in conformity with U.S. generally accepted accounting
principles.
/s/ Ernst & Young LLP
Philadelphia, Pennsylvania
December 16, 2004
Important Tax Information (unaudited)
The following information is provided with respect to the ordinary income
distributions paid by Preferred Income Strategies Fund, Inc. during the fiscal
year ended October 31, 2004:
-------------------------------------------------------------------------------------
Qualified Dividend Income for Individuals:
November 2003 ........................................................... 18.51%
December 2003 ........................................................... 25.73%
January 2004 - October 2004 ............................................. 24.80%
Dividends Qualifying for the Dividends Received Deduction for Corporations:
November 2003 ........................................................... 9.69%
December 2003 - October 2004 ............................................ 13.49%
-------------------------------------------------------------------------------------
Additionally, the following table summarizes the per share long-term capital
gain distributions paid by the Fund during the year:
-----------------------------------------------------------------------------------
Payable Long Term
Date Capital Gains
-----------------------------------------------------------------------------------
Common Stock Shareholders .......................... 1/13/2004 $0.094368
Preferred Stock Shareholders: Series M-7 ........... 3/23/2004 $ 12.17
Series T-7 ........... 3/24/2004 $ 11.69
Series W-7 ........... 3/18/2004 $ 11.74
Series TH-7 .......... 3/19/2004 $ 17.69
Series F-7 ........... 3/22/2004 $ 12.01
Series W-28 .......... 4/15/2004 $ 10.09
Series TH-28 ......... 4/30/2004 $ 9.15
-----------------------------------------------------------------------------------
Please retain this information for your records.
PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004 21
[LOGO] Merrill Lynch Investment Managers
Proxy Results
During the six-month period ended October 31, 2004, Preferred Income Strategies
Fund, Inc.'s Common Stock shareholders voted on the following proposal. The
proposal was approved at a shareholders' meeting on August 25, 2004. A
description of the proposal and number of shares voted are as follows:
---------------------------------------------------------------------------------------------
Shares Voted Shares Withheld
For From Voting
---------------------------------------------------------------------------------------------
1. To elect the Fund's Directors: David O. Beim 38,255,769 865,946
James T. Flynn 39,257,504 864,211
Karen P. Robards 39,254,038 867,677
---------------------------------------------------------------------------------------------
During the six-month period ended October 31, 2004, Preferred Income Strategies
Fund, Inc.'s Preferred Stock (Series A & B) shareholders voted on the following
proposal. The proposal was approved at a shareholders' meeting on August 25,
2004. A description of the proposal and number of shares voted are as follows:
--------------------------------------------------------------------------------------------------------------
Shares Voted Shares Withheld
For From Voting
--------------------------------------------------------------------------------------------------------------
1. To elect the Fund's Board of Directors: Terry K. Glenn, David O. Beim,
James T. Flynn, W. Carl Kester and Karen P. Robards 13,767 0
--------------------------------------------------------------------------------------------------------------
22 PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004
Automatic Dividend Reinvestment Plan (unaudited)
The following description of the Fund's Automatic Dividend Reinvestment Plan
(the "Plan") is sent to you annually as required by federal securities laws.
Pursuant to the Fund's Plan, unless a holder of Common Stock otherwise elects,
all dividend and capital gains distributions will be automatically reinvested by
EquiServe (the "Plan Agent"), as agent for shareholders in administering the
Plan, in additional shares of Common Stock of the Fund. Holders of Common Stock
who elect not to participate in the Plan will receive all distributions in cash
paid by check mailed directly to the shareholder of record (or, if the shares
are held in street or other nominee name then to such nominee) by EquiServe, as
dividend paying agent. Such participants may elect not to participate in the
Plan and to receive all distributions of dividends and capital gains in cash by
sending written instructions to EquiServe, as dividend paying agent, at the
address set forth below. Participation in the Plan is completely voluntary and
may be terminated or resumed at any time without penalty by written notice if
received by the Plan Agent not less than ten days prior to any dividend record
date; otherwise such termination will be effective with respect to any
subsequently declared dividend or distribution.
Whenever the Fund declares an income dividend or capital gains distribution
(collectively referred to as "dividends") payable either in shares or in cash,
non-participants in the Plan will receive cash and participants in the Plan will
receive the equivalent in shares of Common Stock. The shares will be acquired by
the Plan Agent for the participant's account, depending upon the circumstances
described below, either (i) through receipt of additional unissued but
authorized shares of Common Stock from the Fund ("newly issued shares") or (ii)
by purchase of outstanding shares of Common Stock on the open market
("open-market purchases") on the New York Stock Exchange or elsewhere. If, on
the payment date for the dividend, the net asset value per share of the Common
Stock is equal to or less than the market price per share of the Common Stock
plus estimated brokerage commissions (such conditions being referred to herein
as "market premium"), the Plan Agent will invest the dividend amount in newly
issued shares on behalf of the participant. The number of newly issued shares of
Common Stock to be credited to the participant's account will be determined by
dividing the dollar amount of the dividend by the net asset value per share on
the date the shares are issued, provided that the maximum discount from the then
current market price per share on the date of issuance may not exceed 5%. If, on
the dividend payment date, the net asset value per share is greater than the
market value (such condition being referred to herein as "market discount"), the
Plan Agent will invest the dividend amount in shares acquired on behalf of the
participant in open-market purchases.
In the event of a market discount on the dividend payment date, the Plan Agent
will have until the last business day before the next date on which the shares
trade on an "ex-dividend" basis or in no event more than 30 days after the
dividend payment date (the "last purchase date") to invest the dividend amount
in shares acquired in open-market purchases. It is contemplated that the Fund
will pay monthly income dividends. Therefore, the period during which
open-market purchases can be made will exist only from the payment date on the
dividend through the date before the next "ex-dividend" date, which typically
will be approximately ten days. If, before the Plan Agent has completed its
open-market purchases, the market price of a share of Common Stock exceeds the
net asset value per share, the average per share purchase price paid by the Plan
Agent may exceed the net asset value of the Fund's shares, resulting in the
acquisitions of fewer shares than if the dividend had been paid in newly issued
shares on the dividend payment date. Because of the foregoing difficulty with
respect to open-market purchases, the Plan provides that if the Plan Agent is
unable to invest the full dividend amount in open-market purchases during the
purchase period or if the market discount shifts to a market premium during the
purchase period, the Plan Agent will cease making open-market purchases and will
invest the uninvested portion of the dividend amount in newly issued shares at
the close of business on the last purchase date determined by dividing the
uninvested portion of the dividend by the net asset value per share.
The Plan Agent maintains all shareholders' accounts in the Plan and furnishes
written confirmation of all transactions in the account, including information
needed by shareholders for tax records. Shares in the account of each Plan
participant will be held by the Plan Agent in non-certificated form in the name
of the participant, and each shareholder's proxy will include those shares
purchased or received pursuant to the Plan. The Plan Agent will forward all
proxy solicitation materials to participants and vote proxies for shares held
pursuant to the Plan in accordance with the instructions of the participants.
In the case of shareholders such as banks, brokers or nominees which hold shares
of others who are the beneficial owners, the Plan Agent will administer the Plan
on the basis of the number of shares certified from time to time by the record
PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004 23
[LOGO] Merrill Lynch Investment Managers
Automatic Dividend Reinvestment Plan (unaudited) (concluded)
shareholders as representing the total amount registered in the record
shareholder's name and held for the account of beneficial owners who are to
participate in the Plan.
There will be no brokerage charges with respect to shares issued directly by the
Fund as a result of dividends or capital gains distributions payable either in
shares or in cash. However, each participant will pay a pro rata share of
brokerage commissions incurred with respect to the Plan Agent's open-market
purchases in connection with the reinvestment of dividends.
The automatic reinvestment of dividends and distributions will not relieve
participants of any federal, state or local income tax that may be payable (or
required to be withheld) on such dividends.
Shareholders participating in the Plan may receive benefits not available to
shareholders not participating in the Plan. If the market price plus commissions
of the Fund's shares is above the net asset value, participants in the Plan will
receive shares of the Fund at less than they could otherwise purchase them and
will have shares with a cash value greater than the value of any cash
distribution they would have received on their shares. If the market price plus
commissions is below the net asset value, participants will receive
distributions in shares with a net asset value greater than the value of any
cash distribution they would have received on their shares. However, there may
be insufficient shares available in the market to make distributions in shares
at prices below the net asset value. Also, since the Fund does not redeem
shares, the price on resale may be more or less than the net asset value.
The value of shares acquired pursuant to the Plan will generally be excluded
from gross income to the extent that the cash amount reinvested would be
excluded from gross income. If, when the Fund's shares are trading at a premium
over net asset value, the Fund issues shares pursuant to the Plan that have a
greater fair market value than the amount of cash reinvested, it is possible
that all or a portion of such discount (which may not exceed 5% of the fair
market value of the Fund's shares) could be viewed as a taxable distribution. If
the discount is viewed as a taxable distribution, it is also possible that the
taxable character of this discount would be allocable to all the shareholders,
including shareholders who do not participate in the Plan. Thus, shareholders
who do not participate in the Plan might be required to report as ordinary
income a portion of their distributions equal to their allocable share of the
discount.
Experience under the Plan may indicate that changes are desirable. Accordingly,
the Fund reserves the right to amend or terminate the Plan. There is no direct
service charge to participants in the Plan; however, the Fund reserves the right
to amend the Plan to include a service charge payable by the participants.
All correspondence concerning the Plan should be directed to the Plan Agent at
EquiServe, P.O. Box 43010, Providence, RI 02940-3010, Telephone: 800-426-5523.
24 PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004
[LOGO] Merrill Lynch Investment Managers
Officers and Directors (unaudited)
Number of
Portfolios in Other Public
Position(s) Length of Fund Complex Directorships
Held with Time Overseen by Held by
Name Address & Age Fund Served Principal Occupation(s) During Past 5 Years Director Director
====================================================================================================================================
Interested Director
------------------------------------------------------------------------------------------------------------------------------------
Terry K. P.O. Box 9011 President 2003 to President of the Merrill Lynch Investment Managers, 124 Funds None
Glenn* Princeton, NJ and present L.P. ("MLIM")/Fund Asset Management, L.P. 157 Portfolios
08543-9011 Director ("FAM")-advised funds since 1999; Chairman
Age: 64 (Americas Region) of MLIM from 2000 to 2002;
Executive Vice President of MLIM and FAM (which
terms as used herein include their corporate
predecessors) from 1983 to 2002; President of
FAM Distributors, Inc. ("FAMD") from 1986 to 2002
and Director thereof from 1991 to 2002; Executive
Vice President and Director of Princeton Services,
Inc. ("Princeton Services") from 1993 to 2002;
President of Princeton Administrators, L.P. from
1989 to 2002; Director of Financial Data Services,
Inc. since 1985.
------------------------------------------------------------------------------------------------------------------------
* Mr. Glenn is a director, trustee or member of an advisory board of certain other investment companies for which MLIM
or FAM act as investment adviser. Mr. Glenn is an "interested person," as described in the Investment Company Act, of
the Fund based on his present and former positions with MLIM, FAM, FAMD, Princeton Services and Princeton
Administrators, L.P. The Director's term is unlimited. Directors serve until their resignation, removal or death, or
until December 31 of the year in which they turn 72. As Fund President, Mr. Glenn serves at the pleasure of the Board
of Directors.
====================================================================================================================================
Independent Directors*
------------------------------------------------------------------------------------------------------------------------------------
David O. P.O. Box 9095 Director 2003 to Professor of Finance and Economics at the Columbia 14 Funds None
Beim Princeton, NJ present University Graduate School of Business since 1991; 17 Portfolios
08543-9095 Chairman of Outward Bound U.S.A. from 1997 to
Age: 64 2002; Chairman of Wave Hill, Inc. since 1990.
------------------------------------------------------------------------------------------------------------------------------------
James T. P.O. Box 9095 Director 2003 to Chief Financial Officer of J.P. Morgan & Co., Inc. 14 Funds None
Flynn Princeton, NJ present from 1990 to 1995 and an employee of J.P. Morgan in 17 Portfolios
08543-9095 various capacities from 1967 to 1995.
Age: 65
------------------------------------------------------------------------------------------------------------------------------------
W. Carl P.O. Box 9095 Director 2003 to Mizuho Financial Group Professor of Finance; Senior 14 Funds None
Kester Princeton, NJ present Associate Dean and Chairman of the MBA Program 17 Portfolios
08543-9095 of Harvard University Graduate School of Business
Age: 52 Administration since 1999; James R. Williston
Professor of Business Administration of Harvard
University Graduate School of Business from 1997
to 1999; MBA Class of 1977, Professor of Business
Administration of Harvard University Graduate School
of Business Administration from 1981 to 1997;
Independent Consultant since 1978.
------------------------------------------------------------------------------------------------------------------------------------
Karen P. P.O. Box 9095 Director 2003 to President of Robards & Company, a financial advisory 14 Funds None
Robards Princeton, NJ present since 1987; formerly an investment banker with 17 Portfolios
08543-9095 Morgan Stanley for more than ten years; Director of
Age: 54 Enable Medical Corp. since 1996; Director of Atricure,
Inc. since 2000; Director of CineMuse Inc. from 1996
to 2000; Director of the Cooke Center for Learning and
Development, a not-for-profit organization, since 1987.
------------------------------------------------------------------------------------------------------------------------
* The Director's term is unlimited. Directors serve until their resignation, removal or death, or until December 31 of
the year in which they turn 72.
PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004 25
[LOGO] Merrill Lynch Investment Managers
Officers and Directors (unaudited) (concluded)
Position(s) Length of
Held with Time
Name Address & Age Fund Served Principal Occupation(s) During Past 5 Years
====================================================================================================================================
Fund Officers*
------------------------------------------------------------------------------------------------------------------------------------
Donald C. P.O. Box 9011 Vice 2003 to First Vice President of MLIM and FAM since 1997 and Treasurer thereof since 1999;
Burke Princeton, NJ President present Senior Vice President and Treasurer of Princeton Services since 1999 and Director
08543-9011 and since 2004; Vice President of FAMD since 1999; Vice President of MLIM and FAM from
Age: 44 Treasurer 1990 to 1997; Director of MLIM Taxation since 1990.
------------------------------------------------------------------------------------------------------------------------------------
John D. P.O. Box 9011 Vice 2003 to Director (Global Fixed Income) of MLIM since 2000; Vice President of MLIM from
Burger Princeton, NJ President present 1998 to 2000.
08543-9011
Age: 42
------------------------------------------------------------------------------------------------------------------------------------
Thomas P.O. Box 9011 Vice 2003 to Vice President of MLIM since 1997.
Musmanno Princeton, NJ President present
08543-9011
Age: 35
------------------------------------------------------------------------------------------------------------------------------------
Jeffrey P.O. Box 9011 Chief 2004 to Chief Compliance Officer of the MLIM/FAM-advised funds and First Vice President and
Hiller Princeton, NJ Compliance present Chief Compliance Officer of MLIM since 2004; Global Director of Compliance at
08543-9011 Officer Morgan Stanley Investment Management from 2002 to 2004; Managing Director and
Age: 53 Global Director of Compliance at Citigroup Asset Management from 2000 to 2002;
Chief Compliance Officer at Soros Fund Management in 2000; Chief Compliance Officer
at Prudential Financial from 1995 to 2000.
------------------------------------------------------------------------------------------------------------------------------------
Alice A. P.O. Box 9011 Secretary 2004 to Director (Legal Advisory) of MLIM since 2002; Vice President of MLIM from 1999 to
Pellegrino Princeton, NJ present 2002; Attorney associated with MLIM since 1997.
08543-9011
Age: 44
------------------------------------------------------------------------------------------------------------------------
* Officers of the Fund serve at the pleasure of the Board of Directors.
------------------------------------------------------------------------------------------------------------------------------------
Custodian
State Street Bank and Trust Company
P.O. Box 351
Boston, MA 02101
Transfer Agents
Common Stock:
EquiServe
P.O. Box 43010
Providence, RI 02940-3010
Preferred Stock:
The Bank of New York
101 Barclay Street - 7 West
New York, NY 10286
NYSE Symbol
PSY
26 PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004
Availability of Quarterly Schedule of Investments
The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission ("SEC") for the first and third quarters of each fiscal
year on Form N-Q. The Fund's Forms N-Q are available on the SEC's Web site at
http://www.sec.gov. The Fund's Forms N-Q may also be reviewed and copied at the
SEC's Public Reference Room in Washington, DC. Information on the operation of
the Public Reference Room may be obtained by calling 1-800-SEC-0330.
Electronic Delivery
The Fund offers electronic delivery of communications to its shareholders. In
order to receive this service, you must register your account and provide us
with e-mail information. To sign up for this service, simply access this Web
site http://www.icsdelivery.com/live and follow the instructions. When you visit
this site, you will obtain a personal identification number (PIN). You will need
this PIN should you wish to update your e-mail address, choose to discontinue
this service and/or make any other changes to the service. This service is not
available for certain retirement accounts at this time.
PREFERRED INCOME STRATEGIES FUND, INC. OCTOBER 31, 2004 27
[LOGO] Merrill Lynch Investment Managers www.mlim.ml.com
Preferred Income Strategies Fund, Inc. seeks to provide shareholders with
current income. The secondary objective of the Fund is to seek to provide
shareholders with capital appreciation. The Fund seeks to achieve its objectives
by investing primarily in a portfolio of preferred securities, including
convertible preferred securities that may be converted into common stock or
other securities of the same or a different issuer.
This report, including the financial information herein, is transmitted to
shareholders of Preferred Income Strategies Fund, Inc. for their information. It
is not a prospectus. The Fund leverages its Common Stock to provide Common Stock
shareholders with a potentially higher rate of return. Leverage creates risk for
Common Stock shareholders, including the likelihood of greater volatility of net
asset value and market price of Common Stock shares, and the risk that
fluctuations in short-term interest rates may reduce the Common Stock's yield.
Past performance results shown in this report should not be considered a
representation of future performance. Statements and other information herein
are as dated and are subject to change.
A description of the policies and procedures that the Fund uses to determine how
to vote proxies relating to portfolio securities is available (1) without
charge, upon request, by calling toll-free 1-800-MER-FUND (1-800-637-3863); (2)
at www.mutualfunds.ml.com; and (3) on the Securities and Exchange Commission's
Web site at http://www.sec.gov. Information about how the Fund voted proxies
relating to securities held in the Fund's portfolio during the most recent
12-month period ended June 30 is available (1) at www.mutualfunds.ml.com and (2)
on the Securities and Exchange Commission's Web site at http://www.sec.gov.
Preferred Income Strategies Fund, Inc.
Box 9011
Princeton, NJ 08543-9011
#PIS -- 10/04
Item 2 - Code of Ethics - The registrant has adopted a code of ethics, as of the
end of the period covered by this report, that applies to the
registrant's principal executive officer, principal financial officer
and principal accounting officer, or persons performing similar
functions. A copy of the code of ethics is available without charge
upon request by calling toll-free 1-800-MER-FUND (1-800-637-3863).
Item 3 - Audit Committee Financial Expert - The registrant's board of directors
has determined that (i) the registrant has the following audit
committee financial experts serving on its audit committee and (ii)
each audit committee financial expert is independent: (1) David O.
Beim, (2) W. Carl Kester, (3) James T. Flynn and (4) Karen P. Robards.
The registrant's board of directors has determined that David O. Beim,
W. Carl Kester and Karen P. Robards qualify as financial experts
pursuant to Item 3(c)(4) of Form N-CSR.
Mr. Beim has a thorough understanding of generally accepted accounting
principles, financial statements and internal control over financial
reporting as well as audit committee functions. For 25 years, Mr. Beim
was an investment banker actively engaged in financial analysis for
securities transactions and mergers. These transactions presented a
breadth and level of complexity of accounting issues that are generally
comparable to the breadth and complexity of issues that can reasonably
be expected to be raised by the Registrant's financial statements. Mr.
Beim has also been a professor of finance and economics at the Columbia
University Graduate School of Business for the past 11 years.
Prof. Kester has a thorough understanding of generally accepted
accounting principles, financial statements and internal control over
financial reporting as well as audit committee functions. Prof. Kester
has been involved in providing valuation and other financial consulting
services to corporate clients since 1978. Prof. Kester's financial
consulting services present a breadth and level of complexity of
accounting issues that are generally comparable to the breadth and
complexity of issues that can reasonably be expected to be raised by
the Registrant's financial statements.
Ms. Robards has a thorough understanding of generally accepted
accounting principles, financial statements and internal control over
financial reporting as well as audit committee functions. Ms. Robards
has been President of Robards & Company, a financial advisory firm,
since 1987. Ms. Robards was formerly an investment banker for more than
10 years where she was responsible for evaluating and assessing the
performance of companies based on their financial results. Ms. Robards
has over 30 years of experience analyzing financial statements. She
also is the member of the Audit Committees of two privately held
companies and a non-profit organization.
Item 4 - Principal Accountant Fees and Services
(a) Audit Fees - Fiscal Year Ending October 31, 2004 - $38,000
Fiscal Year Ending October 31, 2003 - $35,550
(b) Audit-Related Fees - Fiscal Year Ending October 31, 2004 - $3,000
Fiscal Year Ending October 31, 2003 - $3,000
The nature of the services include assurance and related services
reasonably related to the performance of the audit of financial
statements not included in Audit Fees.
(c) Tax Fees - Fiscal Year Ending October 31, 2004 - $5,200
Fiscal Year Ending October 31, 2003 - $5,000
The nature of the services include tax compliance, tax advice and tax
planning.
(d) All Other Fees - Fiscal Year Ending October 31, 2004 - $0
Fiscal Year Ending October 31, 2003 - $0
(e)(1) The registrant's audit committee (the "Committee") has adopted
policies and procedures with regard to the pre-approval of services.
Audit, audit-related and tax compliance services provided to the
registrant on an annual basis require specific pre-approval by the
Committee. The Committee also must approve other non-audit services
provided to the registrant and those non-audit services provided to the
registrant's affiliated service providers that relate directly to the
operations and the financial reporting of the registrant. Certain of
these non-audit services that the Committee believes are a) consistent
with the SEC's auditor independence rules and b) routine and recurring
services that will not impair the independence of the independent
accountants may be approved by the Committee without consideration on a
specific case-by-case basis ("general pre-approval"). However, such
services will only be deemed pre-approved provided that any individual
project does not exceed $5,000 attributable to the registrant or
$50,000 for all of the registrants the Committee oversees. Any proposed
services exceeding the pre-approved cost levels will require specific
pre-approval by the Committee, as will any other services not subject
to general pre-approval (e.g., unanticipated but permissible services).
The Committee is informed of each service approved subject to general
pre-approval at the next regularly scheduled in-person board meeting.
(e)(2) 0%
(f) Not Applicable
(g) Fiscal Year Ending October 31, 2004 - $8,200
Fiscal Year Ending October 31, 2003 - $8,000
(h) The registrant's audit committee has considered and determined that
the provision of non-audit services that were rendered to the
registrant's investment adviser and any entity controlling, controlled
by, or under common control with the investment adviser that provides
ongoing services to the registrant that were not pre-approved pursuant
to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X is compatible
with maintaining the principal accountant's independence.
Regulation S-X Rule 2-01(c)(7)(ii) - $945,000, 0%
Item 5 - Audit Committee of Listed Registrants - The following individuals are
members of the registrant's separately-designated standing audit
committee established in accordance with Section 3(a)(58)(A) of the
Exchange Act (15 U.S.C. 78c(a)(58)(A)):
David O. Beim
James T. Flynn
Todd Goodwin (retired as of December 31, 2003)
George W. Holbrook, Jr. (retired as of December 31, 2003)
W. Carl Kester
Karen P. Robards
Item 6 - Schedule of Investments - Not Applicable
Item 7 - Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies - Proxy Voting Policies and Procedures
Each Fund's Board of Directors/Trustees has delegated to Merrill Lynch
Investment Managers, L.P. and/or Fund Asset Management, L.P. (the
"Investment Adviser") authority to vote all proxies relating to the
Fund's portfolio securities. The Investment Adviser has adopted
policies and procedures ("Proxy Voting Procedures") with respect to the
voting of proxies related to the portfolio securities held in the
account of one or more of its clients, including a Fund. Pursuant to
these Proxy Voting Procedures, the Investment Adviser's primary
objective when voting proxies is to make proxy voting decisions solely
in the best interests of each Fund and its shareholders, and to act in
a manner that the Investment Adviser believes is most likely to enhance
the economic value of the securities held by the Fund. The Proxy Voting
Procedures are designed to ensure that that the Investment Adviser
considers the interests of its clients, including the Funds, and not
the interests of the Investment Adviser, when voting proxies and that
real (or perceived) material conflicts that may arise between the
Investment Adviser's interest and those of the Investment Adviser's
clients are properly addressed and resolved.
In order to implement the Proxy Voting Procedures, the Investment
Adviser has formed a Proxy Voting Committee (the "Committee"). The
Committee is comprised of the Investment Adviser's Chief Investment
Officer (the "CIO"), one or more other senior investment professionals
appointed by the CIO, portfolio managers and investment analysts
appointed by the CIO and any other personnel the CIO deems appropriate.
The Committee will also include two non-voting representatives from the
Investment Adviser's Legal department appointed by the Investment
Adviser's General Counsel. The Committee's membership shall be limited
to full-time employees of the Investment Adviser. No person with any
investment banking, trading, retail brokerage or research
responsibilities for the Investment Adviser's affiliates may serve as a
member of the Committee or participate in its decision making (except
to the extent such person is asked by the Committee to present
information to the Committee, on the same basis as other interested
knowledgeable parties not affiliated with the Investment Adviser might
be asked to do so). The Committee determines how to vote the proxies of
all clients, including a Fund, that have delegated proxy voting
authority to the Investment Adviser and seeks to ensure that all votes
are consistent with the best interests of those clients and are free
from unwarranted and inappropriate influences. The Committee
establishes general proxy voting policies for the Investment Adviser
and is responsible for determining how those policies are applied to
specific proxy votes, in light of each issuer's unique structure,
management, strategic options and, in certain circumstances, probable
economic and other anticipated consequences of alternate actions. In so
doing, the Committee may determine to vote a particular proxy in a
manner contrary to its generally stated policies. In addition, the
Committee will be responsible for ensuring that all reporting and
recordkeeping requirements related to proxy voting are fulfilled.
The Committee may determine that the subject matter of a recurring
proxy issue is not suitable for general voting policies and requires a
case-by-case determination. In such cases, the Committee may elect not
to adopt a specific voting policy applicable to that issue. The
Investment Adviser believes that certain proxy voting issues require
investment analysis - such as approval of mergers and other significant
corporate transactions - akin to investment decisions, and are,
therefore, not suitable for general guidelines. The Committee may elect
to adopt a common position for the Investment Adviser on certain proxy
votes that are akin to investment decisions, or determine to permit the
portfolio manager to make individual decisions on how best to maximize
economic value for a Fund (similar to normal buy/sell investment
decisions made by such portfolio managers). While it is expected that
the Investment Adviser will generally seek to vote proxies over which
the Investment Adviser exercises voting authority in a uniform manner
for all the Investment Adviser's clients, the Committee, in conjunction
with a Fund's portfolio manager, may determine that the Fund's specific
circumstances require that its proxies be voted differently.
To assist the Investment Adviser in voting proxies, the Committee has
retained Institutional Shareholder Services ("ISS"). ISS is an
independent adviser that specializes in providing a variety of
fiduciary-level proxy-related services to institutional investment
managers, plan sponsors, custodians, consultants, and other
institutional investors. The services provided to the Investment
Adviser by ISS include in-depth research, voting recommendations
(although the Investment Adviser is not obligated to follow such
recommendations), vote execution, and recordkeeping. ISS will also
assist the Fund in fulfilling its reporting and recordkeeping
obligations under the Investment Company Act.
The Investment Adviser's Proxy Voting Procedures also address special
circumstances that can arise in connection with proxy voting. For
instance, under the Proxy Voting Procedures, the Investment Adviser
generally will not seek to vote proxies related to portfolio securities
that are on loan, although it may do so under certain circumstances. In
addition, the Investment Adviser will vote proxies related to
securities of foreign issuers only on a best efforts basis and may
elect not to vote at all in certain countries where the Committee
determines that the costs associated with voting generally outweigh the
benefits. The Committee may at any time override these general policies
if it determines that such action is in the best interests of a Fund.
From time to time, the Investment Adviser may be required to vote proxies in
respect of an issuer where an affiliate of the Investment Adviser (each, an
"Affiliate"), or a money management or other client of the Investment Adviser
(each, a "Client") is involved. The Proxy Voting Procedures and the Investment
Adviser's adherence to those procedures are designed to address such conflicts
of interest. The Committee intends to strictly adhere to the Proxy Voting
Procedures in all proxy matters, including matters involving Affiliates and
Clients. If, however, an issue representing a non-routine matter that is
material to an Affiliate or a widely known Client is involved such that the
Committee does not reasonably believe it is able to follow its guidelines (or if
the particular proxy matter is not addressed by the guidelines) and vote
impartially, the Committee may, in its discretion for the purposes of ensuring
that an independent determination is reached, retain an independent fiduciary to
advise the Committee on how to vote or to cast votes on behalf of the Investment
Adviser's clients.
In the event that the Committee determines not to retain an independent
fiduciary, or it does not follow the advice of such an independent
fiduciary, the powers of the Committee shall pass to a subcommittee,
appointed by the CIO (with advice from the Secretary of the Committee),
consisting solely of Committee members selected by the CIO. The CIO
shall appoint to the subcommittee, where appropriate, only persons
whose job responsibilities do not include contact with the Client and
whose job evaluations would not be affected by the Investment Adviser's
relationship with the Client (or failure to retain such relationship).
The subcommittee shall determine whether and how to vote all proxies on
behalf of the Investment Adviser's clients or, if the proxy matter is,
in their judgment, akin to an investment decision, to defer to the
applicable portfolio managers, provided that, if the subcommittee
determines to alter the Investment Adviser's normal voting guidelines
or, on matters where the Investment Adviser's policy is case-by-case,
does not follow the voting recommendation of any proxy voting service
or other independent fiduciary that may be retained to provide research
or advice to the Investment Adviser on that matter, no proxies relating
to the Client may be voted unless the Secretary, or in the Secretary's
absence, the Assistant Secretary of the Committee concurs that the
subcommittee's determination is consistent with the Investment
Adviser's fiduciary duties
In addition to the general principles outlined above, the Investment
Adviser has adopted voting guidelines with respect to certain recurring
proxy issues that are not expected to involve unusual circumstances.
These policies are guidelines only, and the Investment Adviser may
elect to vote differently from the recommendation set forth in a voting
guideline if the Committee determines that it is in a Fund's best
interest to do so. In addition, the guidelines may be reviewed at any
time upon the request of a Committee member and may be amended or
deleted upon the vote of a majority of Committee members present at a
Committee meeting at which there is a quorum.
The Investment Adviser has adopted specific voting guidelines with
respect to the following proxy issues:
o Proposals related to the composition of the Board of Directors of issuers
other than investment companies. As a general matter, the Committee
believes that a company's Board of Directors (rather than shareholders) is
most likely to have access to important, nonpublic information regarding a
company's business and prospects, and is therefore best-positioned to set
corporate policy and oversee management. The Committee, therefore,
believes that the foundation of good corporate governance is the election
of qualified, independent corporate directors who are likely to diligently
represent the interests of shareholders and oversee management of the
corporation in a manner that will seek to maximize shareholder value over
time. In individual cases, the Committee may look at a nominee's history
of representing shareholder interests as a director of other companies or
other factors, to the extent the Committee deems relevant.
o Proposals related to the selection of an issuer's independent auditors. As
a general matter, the Committee believes that corporate auditors have a
responsibility to represent the interests of shareholders and provide an
independent view on the propriety of financial reporting decisions of
corporate management. While the Committee will generally defer to a
corporation's choice of auditor, in individual cases, the Committee may
look at an auditors' history of representing shareholder interests as
auditor of other companies, to the extent the Committee deems relevant.
o Proposals related to management compensation and employee benefits. As a
general matter, the Committee favors disclosure of an issuer's
compensation and benefit policies and opposes excessive compensation, but
believes that compensation matters are normally best determined by an
issuer's board of directors, rather than shareholders. Proposals to
"micro-manage" an issuer's compensation practices or to set arbitrary
restrictions on compensation or benefits will, therefore, generally not be
supported.
o Proposals related to requests, principally from management, for approval
of amendments that would alter an issuer's capital structure. As a general
matter, the Committee will support requests that enhance the rights of
common shareholders and oppose requests that appear to be unreasonably
dilutive.
o Proposals related to requests for approval of amendments to an issuer's
charter or by-laws. As a general matter, the Committee opposes poison pill
provisions.
o Routine proposals related to requests regarding the formalities of
corporate meetings.
o Proposals related to proxy issues associated solely with holdings of
investment company shares. As with other types of companies, the Committee
believes that a fund's Board of Directors (rather than its shareholders)
is best-positioned to set fund policy and oversee management. However, the
Committee opposes granting Boards of Directors authority over certain
matters, such as changes to a fund's investment objective, that the
Investment Company Act envisions will be approved directly by
shareholders.
o Proposals related to limiting corporate conduct in some manner that
relates to the shareholder's environmental or social concerns. The
Committee generally believes that annual shareholder meetings are
inappropriate forums for discussion of larger social issues, and opposes
shareholder resolutions "micromanaging" corporate conduct or requesting
release of information that would not help a shareholder evaluate an
investment in the corporation as an economic matter. While the Committee
is generally supportive of proposals to require corporate disclosure of
matters that seem relevant and material to the economic interests of
shareholders, the Committee is generally not supportive of proposals to
require disclosure of corporate matters for other purposes.
Item 8 - Purchases of Equity Securities by Closed-End Management Investment
Company and Affiliated Purchasers - Not Applicable
Item 9 - Submission of Matters to a Vote of Security Holders - Not Applicable
Item 10 - Controls and Procedures
10(a) - The registrant's certifying officers have reasonably designed such
disclosure controls and procedures to ensure material information
relating to the registrant is made known to us by others particularly
during the period in which this report is being prepared. The
registrant's certifying officers have determined that the registrant's
disclosure controls and procedures are effective based on our evaluation
of these controls and procedures as of a date within 90 days prior to
the filing date of this report.
10(b) - There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the Act (17 CFR
270.30a-3(d)) that occurred during the second fiscal half-year of the
period covered by this report that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting.
Item 11 - Exhibits attached hereto
11(a)(1) - Code of Ethics - See Item 2
11(a)(2) - Certifications - Attached hereto
11(a)(3) - Not Applicable
11(b) - Certifications - Attached hereto
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Preferred Income Strategies Fund, Inc.
By: /s/ Terry K. Glenn
----------------------
Terry K. Glenn,
President of
Preferred Income Strategies Fund, Inc.
Date: December 13, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By: /s/ Terry K. Glenn
----------------------
Terry K. Glenn,
President of
Preferred Income Strategies Fund, Inc.
Date: December 13, 2004
By: /s/ Donald C. Burke
----------------------
Donald C. Burke,
Chief Financial Officer of
Preferred Income Strategies Fund, Inc.
Date: December 13, 2004