Investment Commentary and Annual Report to ... - Western Asset

Annual Report to Shareholders(1) If the Fund is a seller of protection and a credit event occurs, as defined under the terms of that particular swap agreement, the Fund will either (i)pay to the buyer of protection an amount equal to the notional amount of the swap and take delivery of the referenced obligation or underlyingsecurities comprising the referenced index or (ii) pay a net settlement amount in the form of cash or securities equal to the notional amount of theswap less the recovery value of the referenced obligation or underlying securities comprising the referenced index.(2) The maximum potential amount the Fund could be required to make as a seller of credit protection or receive as a buyer of credit protection if acredit event occurs as defined under the terms of that particular swap agreement.(3) The quoted market prices and resulting values for credit default swap agreements on asset-backed securities and credit indices serve as anindicator of the current status of the payment/performance risk and represent the likelihood of an expected liability (or profit) for the creditderivative should the notional amount of the swap agreement have been closed/sold as of the period end. Decreasing market values whencompared to the notional amount of the swap, represent a deterioration of the referenced entity’s credit soundness and a greater likelihood or riskof default or other credit event occurring as defined under the terms of the agreement.(4) If the Fund is a buyer of protection and a credit event occurs, as defined under the terms of that particular swap agreement, the Fund will either(i) receive from the seller of protection an amount equal to the notional amount of the swap and deliver the underlying securities comprising thereferenced index or (ii) receive a net settlement amount in the form of cash or securities equal to the notional amount of the swap less the recoveryvalue of the underlying securities comprising the referenced index.‡ Percentage shown is an annual percentage rate.4. Common Shares:Of the 11,474,540 shares of common stock outstanding at December 31, 2008, Western Asset owns 11,975 shares.5. Preferred Shares:There are 2,880 shares of Auction Market Preferred Shares (“Preferred Shares”) authorized. The Preferred Shares have rights asset forth in the Fund’s Agreement and Declaration of Trust, as amended to date, and its Bylaws, as amended to date (the“Bylaws”), or as otherwise determined by the Trustees. The 2,880 Preferred Shares outstanding consist of two series, 1,440 sharesof Series M and 1,440 shares of Series W. The Preferred Shares have a liquidation value of $25,000 per share, plus any accumulatedbut unpaid dividends whether or not earned or declared.Dividends on the Series M and Series W Preferred Shares are cumulative and are paid at a rate typically reset every seven andtwenty-eight days, respectively, based on the results of an auction. Dividend rates ranged from 0.15% to 5.60% between January 1,2008 to December 31, 2008. Under the Investment Company Act of 1940, the Fund may not declare dividends or make other distributionson common shares or purchase any such shares if, at the time of the declaration, distribution or purchase, asset coveragewith respect to the outstanding Preferred Shares would be less than 200%.The Preferred Shares are redeemable at the option of the Fund, in whole or in part, on the second business day precedingany dividend payment date at $25,000 per share plus any accumulated but unpaid dividends. The Preferred Shares are also subjectto mandatory redemption at $25,000 per share plus any accumulated but unpaid dividends, whether or not earned or declared, ifcertain requirements relating to the composition of the assets and liabilities of the Fund as set forth in the Bylaws are not satisfied.Preferred shareholders, who are entitled to one vote per Preferred Share, generally vote as a single class with the commonshareholders, but will vote separately as a class (and, in certain circumstances, vote separately by series) with respect to certainmatters set forth in the Bylaws. The preferred shareholders are entitled to elect two Trustees of the Fund.6. Transactions with Affiliates:The Fund has a management agreement with Western Asset Management Company (“Western Asset”). Pursuant to the termsof the management agreement, the Fund pays Western Asset an annual fee, payable monthly, in an amount equal to 0.55% of theaverage weekly value of the Fund’s total managed assets. “Total managed assets” means the total assets of the Fund (including anyassets attributable to leverage) minus accrued liabilities. The liquidation preference of any Preferred Shares outstanding is not considereda liability. Pursuant to a Portfolio Management Agreement between Western Asset and Western Asset ManagementCompany Limited (“WAML”), Western Asset pays a portion of the fees it receives from the Fund to WAML at an annual rate of0.425% of the average weekly value of the Fund’s total managed assets that WAML manages. Western Asset and WAML are whollyowned subsidiaries of Legg Mason, Inc.41