N-CSR 1 y19708nvcsr.txt FORM N-CSR 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: 811-06052 Morgan Stanley Municipal Income Opportunities Trust III (Exact name of registrant as specified in charter) 1221 Avenue of the Americas, New York, New York 10020 (Address of principal executive offices) (Zip code)
Ronald E. Robison 1221 Avenue of the Americas, New York, New York 10020 (Name and address of agent for service) Registrant's telephone number, including area code: 212-762-4000 Date of fiscal year end: March 31, 2006 Date of reporting period: March 31, 2006 Item 1 - Report to Shareholders Welcome, Shareholder: In this report, you'll learn about how your investment in Morgan Stanley Municipal Income Opportunities Trust III performed during the annual period. We will provide an overview of the market conditions, and discuss some of the factors that affected performance during the reporting period. In addition, this report includes the Fund's financial statements and a list of Fund investments. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE FUND IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE FUND WILL DECLINE AND, THEREFORE, THE VALUE OF THE FUND'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS FUND. FUND REPORT For the year ended March 31, 2006 MARKET CONDITIONS Over the 12-month period ending March 31, 2006, events ranging from the Gulf Coast hurricanes to soaring oil prices raised market concern about the sustainability of economic growth. Some observers initially believed the economy would suffer significant adverse after-effects from Hurricane Katrina. However, as time progressed, it became apparent that the impact on the economy would be smaller and more temporary than anticipated. Even the sharply higher energy prices failed to interrupt the positive economic momentum, and real gross domestic product growth continued at a favorable pace throughout the period. Given the economy's solid growth and relatively low inflation, the Federal Open Market Committee (the "Fed") continued with its targeting policy, raising the federal funds target rate from 2.75 percent to 4.75 percent through eight increases of 25 basis points each. Moreover, as the reporting period came to a close, comments by the Fed suggested that the current tightening cycle was not over. Yields on short-term municipal bonds followed the target rate and rose steadily. In contrast, the yields of long-term bonds declined for the period overall, reflecting strong demand for longer maturities and the market's perception that inflation was under control. Accordingly, the slope of the yield curve flattened as the difference between short-term and long-term interest rates narrowed substantially. Representative yields on 30-year AAA rated municipal bonds began at 4.60 percent and ended at 4.50 percent during the period, having ranged from a low of 4.20 percent in June to a high of 4.65 percent in November. Investors' quest for yield favored lower-quality bonds over high-grade issues and kept credit spreads relatively tight. (Credit spreads measure the incremental yield investors require to assume additional credit risk. When credit spreads tighten, lower-rated issues typically outperform high-grade issues.) Long-term municipal volume increased 13 percent to a record $408 billion in 2005. The flatter yield curve and low long-term interest rates encouraged municipalities to refinance their debt. Refundings accounted for 30 percent of annual volume, a nearly 50 percent increase over 2004. In the first three months of calendar year 2006, volume dropped 30 percent compared to the same period in 2005. The municipal-to-Treasury yield ratio, which gauges the performance between the two markets, remained attractive for tax-exempt bonds. As a result, institutional investors--such as hedge funds and arbitrage accounts--that normally focus on taxable bond sectors "crossed-over" to purchase municipal bonds. Demand from individual investors was less robust, given the low absolute level of yields. 2 PERFORMANCE ANALYSIS For the 12-month period ended March 31, 2006, Morgan Stanley Municipal Income Opportunities Trust III's (OIC's) net asset value (NAV) increased from $9.51 to $9.77 per share. Based on this change plus reinvestment of tax-free dividends totaling $0.525 per share, the Fund's total NAV return was 8.72 percent. OIC's value on the New York Stock Exchange (NYSE) moved from $8.27 to $9.60 per share during the same period. Based on this change plus reinvestment of tax-free dividends, the Fund's total market return was 22.84 percent. OIC's NYSE market price was at a 1.74 percent discount to its NAV. During the fiscal year, the Fund purchased and retired 300,621 shares of common stock at a weighted average market discount of 5.68 percent. Monthly dividends for the first quarter of 2006, declared in December, were unchanged at $0.045 per share. The dividend reflects the current level of the Fund's net investment income. OIC's level of undistributed net investment income was $0.13 per share on March 31, 2006, versus $0.10 per share 12 months earlier(1). All holdings were accruing interest at the end of the fiscal year. The Fund maintained a conservative interest rate strategy in anticipation of continued Fed tightening and generally higher interest rates. At the end of March, the Fund's option-adjusted duration(*) was 6.5 years. Overall, the Fund's duration positioning tempered total returns when rates declined, but helped total returns when rates rose. As discussed in previous reports, the Fund invests primarily in higher yielding municipal bonds. Consistent with its focus on higher yielding securities, the Fund's exposure to below investment grade or non-rated issues was gradually increased to more than two-thirds of assets by the close of the period. This security mix had a positive impact on performance as lower rated bonds outperformed the high-grade municipal bond market. Reflecting a commitment to diversification, the Fund's net assets of $83.8 million were invested among 11 long-term sectors and 84 credits. OIC's procedure for reinvesting all dividends and distributions in common shares is through purchases in the open market. This method helps support the market value of the Fund's shares. In addition, we would like to remind you that the Trustees have approved a procedure whereby the Fund may, when appropriate, purchase shares in the open market or in privately negotiated transactions at a price not above market value or net asset value, whichever is lower at the time of purchase. ------------------- PERFORMANCE DATA QUOTED REPRESENTS PAST PERFORMANCE, WHICH IS NO GUARANTEE OF FUTURE RESULTS, AND CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THE FIGURES SHOWN. INVESTMENT RETURN, NET ASSET VALUE AND COMMON SHARE MARKET PRICE WILL FLUCTUATE AND FUND SHARES, WHEN SOLD, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. There is no guarantee that any sectors mentioned will continue to perform as discussed herein or that securities in such sectors will be held by the Fund in the future. 1 Income earned by certain securities in the portfolio may be subject to the federal alternative minimum tax (AMT). * A measure of the sensitivity of a bond's price to changes in interest rates, expressed in years. Each year of duration represents an expected 1 percent change in the price of a bond for every 1 percent change in interest rates. The longer a bond's duration, the greater the effect of interest-rate movements on its price. Typically, funds with shorter durations perform better in rising-interest-rate environments, while funds with longer durations perform better when rates decline. 3
TOP FIVE SECTORS Retirement & Life Care Facilities 24.1% Hospital 14.4 IDR/PCR* 12.4 Recreational Facilities 11.5 Nursing & Health Related Facilities 11.0
LONG-TERM CREDIT ANALYSIS Aaa/AAA 1.6% Aa/AA 0.3 A/A 1.2 Baa/BBB 19.6 Ba/BB or Less 9.9 NR 67.4
* Industrial Development/Pollution Control Revenue Data as of March 31, 2006. Subject to change daily. All percentages for top five sectors are as a percentage of net assets and all percentages for long-term credit analysis are as a percentage of total long-term investments. These data are provided for informational purposes only and should not be deemed a recommendation to buy or sell the securities mentioned. Morgan Stanley is a full-service securities firm engaged in securities trading and brokerage activities, investment banking, research and analysis, financing and financial advisory services. FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS Each Morgan Stanley fund provides a complete schedule of portfolio holdings in its semiannual and annual reports by filing the schedule electronically with the Securities and Exchange Commission (SEC). The semiannual reports are filed on Form N-CSRS and the annual reports are filed on Form N-CSR. Morgan Stanley also delivers the semiannual and annual reports to fund shareholders and makes these reports available on its public Web site, www.morganstanley.com. Each Morgan Stanley fund also files a complete schedule of portfolio holdings with the SEC for the fund's first and third fiscal quarters on Form N-Q. Morgan Stanley does not deliver the reports for the first and third fiscal quarters to shareholders, nor are the reports posted to the Morgan Stanley public Web site. You may, however, obtain the Form N-Q filings (as well as the Form N-CSR and N-CSRS filings) by accessing the SEC's Web site, http://www.sec.gov. You may also review and copy them at the SEC's Public Reference Room in Washington, DC. Information on the operation of the SEC's Public Reference Room may be obtained by calling the SEC at (800) SEC-0330. You can also request copies of these materials, upon payment of a duplicating fee, by electronic request at the SEC's e-mail address (publicinfo@sec.gov) or by writing the Public Reference section of the SEC, Washington, DC 20549-0102. 4 DISTRIBUTION BY MATURITY (% of Long-Term Portfolio) As of March 31, 2006 WEIGHTED AVERAGE MATURITY: 21 YEARS(a) 0-5 9 6-10 8 11-15 9 16-20 12 21-25 32 26-30 21 30+ 9
(a) Where applicable maturities reflect mandatory tenders, puts and call dates. Portfolio structure is subject to change. Geographic Summary of Investments Based on Market Value as a Percent of Net Assets Alabama................. 1.2% Arizona................. 1.3 California.............. 5.5 Colorado................ 1.5 Connecticut............. 2.5 District of Columbia.... 1.2 Florida................. 9.5 Hawaii.................. 2.0 Idaho................... 2.0 Illinois................ 5.6 Indiana................. 2.9 Iowa.................... 2.6 Kansas.................. 2.5 Louisiana............... 1.5 Maryland................ 2.2 Massachusetts........... 4.1 Missouri................ 8.5 Nevada.................. 3.1 New Hampshire........... 1.2 New Jersey.............. 7.7 New York................ 8.1 Ohio.................... 0.7 Oklahoma................ 1.3 Pennsylvania............ 3.4 South Carolina.......... 0.6 Tennessee............... 3.4 Texas................... 4.4 Virginia................ 8.9 Washington.............. 0.3 Wyoming................. 1.9 Joint exemptions*....... (1.2) ----- Total................... 100.4% =====
-------------------------- * Joint exemptions have been included in each geographic location. 5 CALL AND COST (BOOK) YIELD STRUCTURE (Based on Long-Term Portfolio) As of March 31, 2006 YEARS BONDS CALLABLE -- WEIGHTED AVERAGE CALL PROTECTION: 5 YEARS(a) 2006(a) 14 2007 4 2008 8 2009 10 2010 8 2011 10 2012 11 2013 10 2014 7 2015 9 2016+ 9
COST (BOOK) YIELD(b) -- WEIGHTED AVERAGE BOOK YIELD: 6.7% 2006(a) 7.1 2007 7.4 2008 6.4 2009 6.3 2010 7.2 2011 7.4 2012 6.7 2013 6.6 2014 6.2 2015 5.6 2016+ 6.8
(a) May include issues initially callable in previous years. (b) Cost or "book" yield is the annual income earned on a portfolio investment based on its original purchase price before the Fund's operating expenses. For example, the Fund is earning a book yield of 7.1% on 14% of the long-term portfolio that is callable in 2006. Portfolio structure is subject to change. 6 Morgan Stanley Municipal Income Opportunities Trust III PORTFOLIO OF INVESTMENTS - MARCH 31, 2006
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE --------------------------------------------------------------------------------------------------------- Tax-Exempt Municipal Bonds (95.8%) Educational Facilities Revenue (6.8%) $ 1,000 Pima County Industrial Development Authority, Arizona, Noah Webster Basic School Ser 2004 A.......................... 6.125% 12/15/34 $ 1,019,470 600 ABAG Finance Authority for Nonprofit Corporations, California, National Center for International Schools COPs..................................................... 7.50 05/01/11 613,434 500 Bellalago Educational Facilities Benefits District, Florida, Bellalago Charter School Ser 2004 B............. 5.80 05/01/34 516,605 500 Illinois Finance Authority, Fullerton Village Student Housing Ser 2004 A....................................... 5.125 06/01/35 503,280 1,500 Upland, Indiana, Taylor University Ser 2002................ 6.25 09/01/28 1,638,345 420 Maryland Industrial Development Financing Authority, Our Lady of Good Counsel High School Ser 2005 A.............. 5.50 05/01/20 438,749 1,000 Chattanooga Health Educational & Housing Facilities Board, Tennessee, Student Housing Refg Ser 2005 A............... 5.00 10/01/25 983,490 ----------- ------- 5,713,373 5,520 ----------- ------- Hospital Revenue (14.4%) 1,000 Colbert County -- Northwest Health Care Authority, Alabama, Helen Keller Hospital Ser 2003........................... 5.75 06/01/27 1,021,790 1,500 Hawaii Department of Budget & Finance, Wilcox Memorial Hospital Ser 1998........................................ 5.50 07/01/28 1,502,385 1,000 Madison County Industrial Development Authority, Idaho, Madison Memorial Hospital Ser 2006 COPS (WI)............. 5.25 09/01/37 1,013,170 500 Indiana Health Facility Financing Authority, Riverview Hospital Ser 2002........................................ 6.125 08/01/31 532,990 1,000 Nevada, Missouri, Nevada Regional Medical Center Ser 2001..................................................... 6.75 10/01/31 1,059,230 1,000 Henderson, Nevada, Catholic Health West Ser 1998 A......... 5.125 07/01/28 1,010,180 1,000 New Hampshire Higher Educational & Health Facilities Authority, Littleton Hospital Association Ser 1998 A..... 6.00 05/01/28 1,022,770 1,000 New Jersey Health Care Facilities Financing Authority, Raritan Bay Medical Center Ser 1994...................... 7.25 07/01/27 1,025,200 1,000 Oklahoma Development Finance Authority, Comanche County Hospital 2000 Ser B...................................... 6.60 07/01/31 1,100,530 120 South Carolina Jobs Economic Development Authority, Palmetto Health Ser 2003 C............................... 6.875 08/01/27 138,231 500 Knox County Health, Educational & Housing Facility Board, Tennessee, Baptist Health of East Tennessee Ser 2002..... 6.50 04/15/31 531,235 500 Decatur Hospital Authority, Texas, Wise Regional Health Ser 2004 A................................................... 7.125 09/01/34 542,695 1,500 Teton County Hospital District, Wyoming, St John's Medical Center Ser 2002.......................................... 6.75 12/01/27 1,590,555 ----------- ------- 12,090,961 11,620 ----------- -------
7 See Notes to Financial Statements Morgan Stanley Municipal Income Opportunities Trust III PORTFOLIO OF INVESTMENTS - MARCH 31, 2006 continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE --------------------------------------------------------------------------------------------------------- Industrial Development/Pollution Control Revenue (12.4%) $ 1,005 Metropolitan Washington Airports Authority, District of Columbia & Virginia, CaterAir International Corp Ser 1991 (AMT)+................................................... 10.125% 09/01/11 $ 1,006,377 200 Hawaii Department of Budget & Finance, Hawaiian Electric Co Ser 1996 A (AMT) (MBIA).................................. 6.20 05/01/26 202,402 1,000 Iowa Finance Authority, IPSCO Inc Ser 1997 (AMT) (Mandatory Tender 06/01/07)......................................... 6.00 06/01/27 1,012,480 1,235 Maryland Industrial Development Financing Authority, Medical Waste Associates LP 1989 Ser (AMT)............... 8.75 11/15/10 895,363 1,000 New Jersey Economic Development Authority, Continental Airlines Inc Ser 1999 (AMT).............................. 6.625 09/15/12 1,031,390 1,000 Nassau County Tobacco Settlement Corporation, New York, Ser 2006 (WI)................................................ 5.125 06/01/46 971,750 New York City Industrial Development Agency, New York, 1,000 American Airlines Inc Ser 2005 (AMT)..................... 7.75 08/01/31 1,108,410 1,000 IAC/Interactive Corp Ser 2005............................ 5.00 09/01/35 1,007,430 1,000 7 World Trade Center LLC Ser 2005 A...................... 6.50 03/01/35 1,056,900 425 Carbon County Industrial Development Authority, Pennsylvania, Panther Creek Partners Refg 2000 Ser (AMT).................................................... 6.65 05/01/10 448,490 500 Pennsylvania Economic Development Financing Authority, Reliant Energy Inc Ser 2001 A (AMT)...................... 6.75 12/01/36 533,970 375 Lexington County, South Carolina, Ellett Brothers Inc Refg Ser 1988................................................. 7.50 09/01/08 371,325 700 Pittsylvania County Industrial Development Authority, Virginia, Multi-Trade Ser 1994 A (AMT)............................. 7.45 01/01/09 710,143 ----------- ------- 10,356,430 10,440 ----------- ------- Mortgage Revenue - Multi-Family (3.5%) Alexandria Redevelopment & Housing Authority, Virginia, 1,760 Courthouse Commons Apts Ser 1990 A (AMT)................. 10.00 01/01/21 1,601,002 8,791 Courthouse Commons Apts Ser 1990 B (AMT)................. 0.00 01/01/21 1,056,293 290 Washington Housing Finance Commission, FNMA Collateralized Refg Ser 1990 A.......................................... 7.50 07/01/23 290,545 ----------- ------- 2,947,840 10,841 ----------- ------- Mortgage Revenue - Single Family (0.7%) 45 Maricopa County Industrial Development Authority, Arizona, Ser 2000-1C (AMT)........................................ 6.25 12/01/30 45,170 205 Colorado Housing Finance Authority, 1998 Ser B-2 (AMT)..... 7.25 10/01/31 211,968 320 Chicago, Illinois, GNMA-Collateralized Ser 1998 A-1 (AMT).................................................... 6.45 09/01/29 330,605 ----------- ------- 587,743 570 ----------- -------
8 See Notes to Financial Statements Morgan Stanley Municipal Income Opportunities Trust III PORTFOLIO OF INVESTMENTS - MARCH 31, 2006 continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE --------------------------------------------------------------------------------------------------------- Nursing & Health Related Facilities Revenue (11.0%) $ 2,000 Orange County Health Facilities Authority, Florida, Westminister Community Care Services Inc Ser 1999........ 6.75% 04/01/34 $ 2,068,480 1,000 Pinellas County Health Facilities Authority, Florida, Oaks of Clearwater Ser 2004................................... 6.25 06/01/34 1,051,610 960 Iowa Health Facilities Development Financing Authority, Care Initiatives Ser 1996................................ 9.25 07/01/25 1,148,640 1,200 Westside Habilitation Center, Louisiana, Intermediate Care Facility for the Mentally Retarded Refg Ser 1993......... 8.375 10/01/13 1,224,648 Massachusetts Development Finance Agency, 500 Evergreen Center Ser 2005................................ 5.50 01/01/35 501,675 1,455 Kennedy-Donovan Center Inc 1990 Issue.................... 7.50 06/01/10 1,502,899 730 New Jersey Health Care Facilities Financing Authority, Spectrum for Living - FHA Insured Mortgage Refg Ser B.... 6.50 02/01/22 731,387 1,000 Mount Vernon Industrial Development Agency, New York, Meadowview at the Wartburg Ser 1999...................... 6.20 06/01/29 1,022,140 ----------- ------- 9,251,479 8,845 ----------- ------- Public Facilities Revenue (1.2%) 1,000 Kansas City Industrial Development Authority, Missouri, ------- Plaza Library Ser 2004................................... 5.90 03/01/24 999,500 ----------- Recreational Facilities Revenue (11.5%) 1,000 Sacramento Financing Authority, California, Convention Center Hotel 1999 Ser A.................................. 6.25 01/01/30 1,039,140 1,300 San Diego County, California, San Diego Natural History Museum COPs.............................................. 5.60 02/01/18 1,245,764 500 Mashantucket (Western) Pequot Tribe, Connecticut, 1996 Ser A (a).................................................... 6.40 09/01/11 514,450 1,500 Mohegan Tribe of Indians, Connecticut, Gaming Authority Ser 2001..................................................... 6.25 01/01/31 1,605,225 1,000 Overland Park Development Corporation, Kansas, Convention Center Hotel Ser 2000 A.................................. 7.375 01/01/32 1,098,010 3,000 St Louis Industrial Development Authority, Missouri, Kiel Center Refg Ser 1992 (AMT)...................................... 7.75 12/01/13 3,029,400 1,000 Austin Convention Enterprises Inc, Texas, Convention Center Hotel Ser 2000 A......................................... 6.70 01/01/32 1,058,870 ----------- ------- 9,590,859 9,300 ----------- ------- Retirement & Life Care Facilities Revenue (24.1%) 1,100 Orange County Health Facilities Authority, Florida, Orlando Lutheran Towers Inc Ser 2005............................. 5.375 07/01/20 1,092,333 2,000 St Johns County Industrial Development Authority, Florida, Glenmoor Ser 1999 A...................................... 8.00 01/01/30 2,146,160 1,000 Illinois Finance Authority, Friendship Village of Schaumburg Ser 2005 A.................................... 5.625 02/15/37 1,014,570
9 See Notes to Financial Statements Morgan Stanley Municipal Income Opportunities Trust III PORTFOLIO OF INVESTMENTS - MARCH 31, 2006 continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE --------------------------------------------------------------------------------------------------------- $ 750 Illinois Health Facilities Authority, Villa St Benedict Ser 2003 A-1................................................. 6.90% 11/15/33 $ 814,680 275 Saint Joseph County, Indiana, Holy Cross Village at Notre Dame Ser 2006 A.......................................... 6.00 05/15/26 287,936 1,000 Olathe, Kansas, Catholic Care Ser 2006 A................... 6.00 11/15/38 1,030,010 1,425 Massachusetts Development Finance Agency, Loomis Communities Ser 1999 A................................... 5.625 07/01/15 1,438,708 1,000 Kansas City Industrial Development Authority, Missouri, Bishop Spencer 2004 Ser I................................ 6.25 01/01/24 1,042,270 New Jersey Economic Development Authority, 1,000 Cedar Crest Village Inc Ser 2001 A....................... 7.25 11/15/31 1,083,280 1,000 Franciscan Oaks Ser 1997................................. 5.70 10/01/17 1,016,260 1,000 Franciscan Oaks Ser 1997................................. 5.75 10/01/23 1,013,520 500 Lions Gate Ser 2005 A.................................... 5.875 01/01/37 512,415 750 Bucks County Industrial Development Authority, Pennsylvania, Ann's Choice Ser 2005 A.................... 6.25 01/01/35 775,470 500 Montgomery County Industry Development Authority, Pennsylvania, Whitemarsh Community Ser 2005.............. 6.25 02/01/35 531,305 Shelby County Health, Educational & Housing Facilities Board, Tennessee, 500 Trezevant Manor Ser 2006 A............................... 5.75 09/01/37 501,370 750 Village at Germantown Ser 2003 A......................... 7.25 12/01/34 794,947 1,000 Bexar County Health Facilities Development Corporation, Texas, Army Retirement Residence Ser 2002................ 6.30 07/01/32 1,065,160 1,000 Lubbock Health Facilities Development Corporation, Texas, Carillon Ser 2005 A...................................... 6.50 07/01/26 986,590 2,580 Chesterfield County Industrial Development Authority, Virginia, Brandermill Woods Ser 1998..................... 6.50 01/01/28 2,500,464 500 Peninsula Ports Authority of Virginia, Virginia Baptist Homes Ser 2003 A......................................... 7.375 12/01/32 556,000 ----------- ------- 20,203,448 19,630 ----------- ------- Tax Allocation Revenue (8.9%) 1,000 San Marcos Community Facilities District No 2002-01, California, University Commons Ser 2004.................. 5.90 09/01/28 1,048,560 700 Santa Ana Unified School District, California, Community Facilities District No 2004-1 Ser 2005................... 5.05 09/01/30 692,895 Elk Valley Public Improvement Corporation, Colorado, 500 Ser 2001 A............................................... 7.30 09/01/22 536,270 500 Ser 2001 A............................................... 7.35 09/01/31 532,395 1,000 Midtown Miami Community Development District, Florida, Parking Garage Ser 2004 A................................ 6.25 05/01/37 1,088,330 500 Bolingbrook, Illinois, Sales Tax Ser 2005.................. 0.00++ 01/01/24 448,420 500 Chicago, Illinois, Lake Shore East Ser 2002................ 6.75 12/01/32 540,325
10 See Notes to Financial Statements Morgan Stanley Municipal Income Opportunities Trust III PORTFOLIO OF INVESTMENTS - MARCH 31, 2006 continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE --------------------------------------------------------------------------------------------------------- $ 500 Prince George's County, Maryland, National Harbor Ser 2004..................................................... 5.20% 07/01/34 $ 504,160 1,000 Des Peres, Missouri, West County Center Ser 2002........... 5.75 04/15/20 1,021,160 500 Clark County Special Improvement District 142, Nevada, Mountains Edge Ser 2003.................................. 6.375 08/01/23 518,225 500 Allegheny County Redevelopment Authority, Pennsylvania, Pittsburgh Mills Ser 2004................................ 5.60 07/01/23 526,455 ----------- ------- 7,457,195 7,200 ----------- ------- Transportation Facilities Revenue (1.3%) 1,000 Nevada Department of Business & Industry, Las Vegas Monorail 2nd Tier Ser 2000............................... 7.375 01/01/40 1,045,030 ----------- ------- 85,966 Total Tax-Exempt Municipal Bonds (Cost $77,994,625)........................... 80,243,858 ----------- ------- Taxable Convertible Bond (0.2%) Airlines 190 UAL Corp. (Cost $189,924) (b).............................. 5.00 02/01/21 207,967 ----------- ------- Short-Term Tax-Exempt Municipal Obligations (4.4%) 700 Idaho Health Facilities Authority, St Luke's Regional Medical Center Ser 2000 (FSA) (Demand 04/03/06).......... 3.15* 07/01/35 700,000 800 Illinois Financing Authority, Resurrection Health Ser 2005 B (Demand 04/03/06)...................................... 3.18* 05/15/35 800,000 1,600 New York City Municipal Water Finance Authority, New York, 2000 Ser C (Demand 04/03/06)............................. 3.14* 06/15/33 1,600,000 600 Cuyahoga County, Ohio, University Hospital of Cleveland Ser 1985 (Demand 04/03/06)................................... 3.15* 01/01/16 600,000 ----------- ------- 3,700 Total Short-Term Tax-Exempt Municipal Obligations (Cost $3,700,000)........... 3,700,000 ----------- ------- $89,856 Total Investments (Cost $81,884,549) (c)............................ 100.4% 84,151,825 ======= Liabilities in Excess of Other Assets............................... (0.4) (354,906) ----- ----------- Net Assets.......................................................... 100.0% $83,796,919 ===== ===========
11 See Notes to Financial Statements Morgan Stanley Municipal Income Opportunities Trust III PORTFOLIO OF INVESTMENTS - MARCH 31, 2006 continued --------------------- AMT Alternative Minimum Tax. COPs Certificates of Participation. WI Security purchased on a when-issued basis. * Current coupon of variable rate demand obligation. + Joint exemption in locations shown. ++ Security is a "step-up" bond where the coupon increases on a predetermined future date. (a) Resale is restricted to qualified institutional investors. (b) Taxable convertible bond issued in reorganization. (c) The aggregate cost for federal income tax purposes is $81,803,287. The aggregate gross unrealized appreciation is $3,912,378 and the aggregate gross unrealized depreciation is $1,563,840, resulting in net unrealized appreciation of $2,348,538. Bond Insurance: --------------- MBIA Municipal Bond Investors Assurance Corporation. FSA Financial Security Assurance Inc.
12 See Notes to Financial Statements Morgan Stanley Municipal Income Opportunities Trust III FINANCIAL STATEMENTS Statement of Assets and Liabilities March 31, 2006 Assets: Investments in securities, at value (cost $81,884,549)...... $84,151,825 Cash........................................................ 93,025 Receivable for: Interest................................................ 1,373,240 Investments sold........................................ 325,000 Prepaid expenses and other assets........................... 692 ----------- Total Assets............................................ 85,943,782 ----------- Liabilities: Payable for: Investments purchased................................... 1,981,240 Investment advisory fee................................. 40,236 Administration fee...................................... 6,438 Transfer agent fee...................................... 4,319 Accrued expenses and other payables......................... 114,630 ----------- Total Liabilities....................................... 2,146,863 ----------- Net Assets.............................................. $83,796,919 =========== Composition of Net Assets: Paid-in-capital............................................. $81,809,148 Net unrealized appreciation................................. 2,267,276 Accumulated undistributed net investment income............. 1,063,894 Accumulated net realized loss............................... (1,343,399) ----------- Net Assets.............................................. $83,796,919 =========== Net Asset Value Per Share 8,575,757 shares outstanding (unlimited shares authorized of $.01 par value)............................................. $9.77 ===========
13 See Notes to Financial Statements Morgan Stanley Municipal Income Opportunities Trust III FINANCIAL STATEMENTS continued Statement of Operations For the year ended March 31, 2006 Net Investment Income: Interest Income............................................. $5,491,734 ---------- Expenses Investment advisory fee..................................... 422,271 Professional fees........................................... 68,932 Administration fee.......................................... 67,563 Shareholder reports and notices............................. 31,921 Transfer agent fees and expenses............................ 19,759 Registration fees........................................... 16,130 Trustees' fees and expenses................................. 8,232 Custodian fees.............................................. 5,244 Other....................................................... 21,882 ---------- Total Expenses.......................................... 661,934 Less: expense offset........................................ (4,959) ---------- Net Expenses............................................ 656,975 ---------- Net Investment Income................................... 4,834,759 ---------- Net Realized and Unrealized Gain: Net realized gain........................................... 756,757 Net change in unrealized appreciation....................... 1,140,280 ---------- Net Gain................................................ 1,897,037 ---------- Net Increase................................................ $6,731,796 ==========
14 See Notes to Financial Statements Morgan Stanley Municipal Income Opportunities Trust III FINANCIAL STATEMENTS continued Statements of Changes in Net Assets
FOR THE YEAR FOR THE YEAR ENDED ENDED MARCH 31, 2006 MARCH 31, 2005 -------------- -------------- Increase (Decrease) in Net Assets: Operations: Net investment income....................................... $ 4,834,759 $ 4,778,236 Net realized gain (loss).................................... 756,757 (891,137) Net change in unrealized appreciation/depreciation.......... 1,140,280 1,695,270 ----------- ----------- Net Increase............................................ 6,731,796 5,582,369 Dividends to shareholders from net investment income........ (4,574,650) (4,789,919) Net decrease from transactions in shares of beneficial interest.................................................. (2,740,265) (1,961,269) ----------- ----------- Net Decrease............................................ (583,119) (1,168,819) Net Assets: Beginning of period......................................... 84,380,038 85,548,857 ----------- ----------- End of Period (Including accumulated undistributed net investment income of $1,063,894 and $865,557, respectively)................... $83,796,919 $84,380,038 =========== ===========
15 See Notes to Financial Statements Morgan Stanley Municipal Income Opportunities Trust III NOTES TO FINANCIAL STATEMENTS - MARCH 31, 2006 1. Organization and Accounting Policies Morgan Stanley Municipal Income Opportunities Trust III (the "Fund"), is registered under the Investment Company Act of 1940, as amended, as a diversified, closed-end management investment company. The Fund's investment objective is to provide a high level of current income which is exempt from federal income tax. The Fund was organized as a Massachusetts business trust on February 20, 1990 and commenced operations on April 30, 1990. The following is a summary of significant accounting policies: A. Valuation of Investments -- (1) portfolio securities are valued by an outside independent pricing service approved by the Trustees. The pricing service uses both a computerized grid matrix of tax-exempt securities and evaluations by its staff, in each case based on information concerning market transactions and quotations from dealers which reflect the mean between the last reported bid and asked price. The portfolio securities are thus valued by reference to a combination of transactions and quotations for the same or other securities believed to be comparable in quality, coupon, maturity, type of issue, call provisions, trading characteristics and other features deemed to be relevant. The Trustees believe that timely and reliable market quotations are generally not readily available for purposes of valuing tax-exempt securities and that the valuations supplied by the pricing service are more likely to approximate the fair value of such securities; (2) futures are valued at the latest sale price on the commodities exchange on which they trade unless it is determined that such price does not reflect their market value, in which case they will be valued at their fair value as determined in good faith under procedures established by and under the supervision of the Trustees; and (3) short-term debt securities having a maturity date of more than sixty days at time of purchase are valued on a mark-to-market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. Short-term debt securities having a maturity date of sixty days or less at the time of purchase are valued at amortized cost. B. Accounting for Investments -- Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined by the identified cost method. Discounts are accreted and premiums are amortized over the life of the respective securities. Interest income is accrued daily except where collection is not expected. C. Futures Contracts -- A futures contract is an agreement between two parties to buy and sell financial instruments or contracts based on financial indices at a set price on a future date. Upon entering into such a contract, the Fund is required to pledge to the broker cash, U.S. Government securities or other liquid portfolio securities equal to the minimum initial margin requirements of the applicable futures exchange. Pursuant to the contract, the Fund agrees to receive from or pay to the 16 Morgan Stanley Municipal Income Opportunities Trust III NOTES TO FINANCIAL STATEMENTS - MARCH 31, 2006 continued broker an amount of cash equal to the daily fluctuation in the value of the contract. Such receipts or payments known as variation margin are recorded by the Fund as unrealized gains and losses. Upon closing of the contract, the Fund realizes a 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. D. Federal Income Tax Policy -- 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 and nontaxable income to its shareholders. Accordingly, no federal income tax provision is required. E. Dividends and Distributions to Shareholders -- Dividends and distributions to shareholders are recorded on the ex-dividend date. F. Use of Estimates -- The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and disclosures. Actual results could differ from those estimates. 2. Investment Advisory/Administration Agreements Pursuant to an Investment Advisory Agreement with Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") the Fund pays the Investment Adviser an advisory fee, calculated weekly and payable monthly, by applying the annual rate of 0.50% to the Fund's weekly net assets. Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Fund pays an administration fee, calculated weekly and payable monthly, by applying the annual rate of 0.08% to the Fund's weekly net assets. 3. Security Transactions and Transactions with Affiliates The cost of purchases and proceeds from sales of portfolio securities, excluding short-term investments, for the year ended March 31, 2006 aggregated $16,312,094 and $20,204,736, respectively. Included in the aforementioned transactions is a purchase of $999,250 with Morgan Stanley Quality Municipal Investment Trust. Morgan Stanley Trust, an affiliate of the Investment Adviser and Administrator, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and 17 Morgan Stanley Municipal Income Opportunities Trust III NOTES TO FINANCIAL STATEMENTS - MARCH 31, 2006 continued compensation. The Trustees voted to close the plan to new participants and eliminate the future benefits growth due to increases to compensation after July 31, 2003. Aggregate pension costs for the year ended March 31, 2006 included in Trustees' fees and expenses in the Statement of Operations amounted to $7,245. At March 31, 2006, the Fund had an accrued pension liability of $62,816 which is included in accrued expenses in the Statement of Assets and Liabilities. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 4. Shares of Beneficial Interest Transactions in shares of beneficial interest were as follows:
CAPITAL PAID IN PAR VALUE EXCESS OF SHARES OF SHARES PAR VALUE --------- --------- ----------- Balance, March 31, 2004..................................... 9,109,873 $91,099 $86,421,820 Treasury shares purchased and retired (weighted average discount 10.25%)*......................................... (233,495) (2,335) (1,958,934) Reclassification due to permanent book/tax differences...... -- -- (60) --------- ------- ----------- Balance, March 31, 2005..................................... 8,876,378 88,764 84,462,826 Treasury shares purchased and retired (weighted average discount 5.68%)*.......................................... (300,621) (3,006) (2,737,259) Reclassification due to permanent book/tax differences...... -- -- (2,177) --------- ------- ----------- Balance, March 31, 2006..................................... 8,575,757 $85,758 $81,723,390 ========= ======= ===========
--------------------- * The Trustees have voted to retire the shares purchased. 5. Dividends On March 28, 2006, the Fund declared the following dividends from net investment income:
AMOUNT PER SHARE RECORD DATE PAYABLE DATE --------- ---------------- ---------------- $0.045 April 7, 2006 April 21, 2006 $0.045 May 5, 2006 May 19, 2006 $0.045 June 9, 2006 June 23, 2006
18 Morgan Stanley Municipal Income Opportunities Trust III NOTES TO FINANCIAL STATEMENTS - MARCH 31, 2006 continued 6. Expense Offset The expense offset represents a reduction of the custodian fees for earnings on cash balances maintained by the Fund. 7. Risks Relating to Certain Financial Instruments The Fund may invest a portion of its assets in residual interest bonds, which are inverse floating rate municipal obligations. The prices of these securities are subject to greater market fluctuations during periods of changing prevailing interest rates than are comparable fixed rate obligations. To hedge against adverse interest rate changes, the Fund may invest in financial futures contracts or municipal bond index futures contracts ("futures contracts"). These futures contracts involve elements of market risk in excess of the amount reflected in the Statement of Assets and Liabilities. The Fund bears the risk of an unfavorable change in the value of the underlying securities. Risks may also arise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts. 8. Federal Income Tax Status The amount of dividends and distributions from net investment income and net realized capital gains are determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income and net realized capital gains for tax purposes are reported as distributions of paid-in-capital. The tax character of distributions paid was as follows:
FOR THE YEAR FOR THE YEAR ENDED ENDED MARCH 31, 2006 MARCH 31, 2005 -------------- -------------- Tax-exempt income........................................... $4,574,650 $4,731,105 Ordinary income............................................. -- 58,814 ---------- ---------- Total distributions......................................... $4,574,650 $4,789,919 ========== ==========
19 Morgan Stanley Municipal Income Opportunities Trust III NOTES TO FINANCIAL STATEMENTS - MARCH 31, 2006 continued As of March 31, 2006, the tax-basis components of accumulated earnings were as follows: Undistributed tax-exempt income............................. $ 1,010,915 Undistributed ordinary income............................... 53,555 Undistributed long-term gains............................... -- ----------- Net accumulated earnings.................................... 1,064,470 Capital loss carryforward*.................................. (1,343,391) Temporary differences....................................... (81,846) Net unrealized appreciation................................. 2,348,538 ----------- Total accumulated earnings.................................. $ 1,987,771 ===========
--------------------- * During the year ended March 31, 2006, the Fund utilized $813,673 of its net capital loss carryforward. As of March 31, 2006, the Fund had a net capital loss carryforward of $1,343,391 of which $375,070 will expire on March 31, 2011 and $968,321 will expire on March 31, 2013 to offset future capital gains to the extent provided by regulations. As of March 31, 2006, the Fund had temporary book/tax differences primarily attributable to book amortization of discounts on debt securities and permanent book/tax differences primarily attributable to tax adjustments on debt securities sold by the Fund. To reflect reclassifications arising from the permanent differences, paid-in-capital was charged $2,177, accumulated undistributed net investment income was charged $61,772 and accumulated net realized loss was credited $63,949. 20 Morgan Stanley Municipal Income Opportunities Trust III FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE YEAR ENDED MARCH 31 ---------------------------------------------------------------- 2006 2005 2004 2003 2002 -------- -------- -------- -------- -------- Selected Per Share Data: Net asset value, beginning of period........... $9.51 $9.39 $9.33 $9.32 $9.48 ----- ----- ----- ----- ----- Income (loss) from investment operations: Net investment income*..................... 0.55 0.53 0.52 0.56 0.57 Net realized and unrealized gain (loss).... 0.22 0.10 0.09 0.01 (0.12) ----- ----- ----- ----- ----- Total income from investment operations........ 0.77 0.63 0.61 0.57 0.45 ----- ----- ----- ----- ----- Less dividends and distributions from: Net investment income...................... (0.53) (0.53) (0.56) (0.57) (0.57) Net realized gain.......................... -- -- -- -- (0.05) ----- ----- ----- ----- ----- Total dividends and distributions.............. (0.53) (0.53) (0.56) (0.57) (0.62) ----- ----- ----- ----- ----- Anti-dilutive effect of acquiring treasury shares*....................................... 0.02 0.02 0.01 0.01 0.01 ----- ----- ----- ----- ----- Net asset value, end of period................. $9.77 $9.51 $9.39 $9.33 $9.32 ===== ===== ===== ===== ===== Market value, end of period.................... $9.60 $8.27 $8.92 $8.63 $8.72 ===== ===== ===== ===== ===== Total Return+.................................. 22.84% (1.27)% 10.00% 5.58% 5.56% Ratios to Average Net Assets: Expenses....................................... 0.79%(1) 0.93%(1) 1.02%(1) 0.98%(1) 0.99%(1) Net investment income.......................... 5.74% 5.68% 5.59% 5.96% 6.02% Supplemental Data: Net assets, end of period, in thousands........ $83,797 $84,380 $85,549 $86,567 $88,271 Portfolio turnover rate........................ 20% 17% 12% 8% 18%
--------------------- * The per share amounts were computed using an average number of shares outstanding during the period. + Total return is based upon the current market value on the last day of each period reported. Dividends and distributions are assumed to be reinvested at the prices obtained under the Fund's dividend reinvestment plan. Total return does not reflect brokerage commissions. (1) Does not reflect the effect of expense offset of 0.01%.
21 See Notes to Financial Statements Morgan Stanley Municipal Income Opportunities Trust III REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and Board of Trustees of Morgan Stanley Municipal Income Opportunities Trust III: We have audited the accompanying statement of assets and liabilities of Morgan Stanley Municipal Income Opportunities Trust III (the "Fund"), including the portfolio of investments, as of March 31, 2006, and the related statements of operations for the year then ended and changes in net assets for each of the two years in the period then ended, and the financial highlights for each of the five years in the period then ended. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with 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. The Fund is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of March 31, 2006, by correspondence with the custodian and brokers. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Morgan Stanley Municipal Income Opportunities Trust III as of March 31, 2006, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. Deloitte & Touche LLP New York, New York May 19, 2006 22 Morgan Stanley Municipal Income Opportunities Trust III REVISED INVESTMENT POLICY (UNAUDITED) On August 24, 2005, the Trustees of Morgan Stanley Municipal Income Opportunities Trust III (the "Fund") approved a change to the Fund's investment policy with respect to inverse floating rate municipal obligations whereby the Fund now would be permitted to invest up to 15% of its assets in inverse floating rate municipal obligations. The inverse floating rate municipal obligations in which the Fund will invest are typically created through a division of a fixed rate municipal obligation into two separate instruments, a short-term obligation and a long-term obligation. The interest rate on the short-term obligation is set at periodic auctions. The interest rate on the long-term obligation is the rate the issuer would have paid on the fixed income obligation: (i) plus the difference between such fixed rate and the rate on the short-term obligation, if the short-term rate is lower than the fixed rate; or (ii) minus such difference if the interest rate on the short-term obligation is higher than the fixed rate. The interest rates on these obligations generally move in the reverse direction of market interest rates. If market interest rates fall, the interest rate on the obligation will increase and if market interest rates increase, the interest rate on the obligation will fall. Inverse floating rate municipal obligations offer the potential for higher income than is available from fixed rate obligations of comparable maturity and credit rating. They also carry greater risks. In particular, the prices of inverse floating rate municipal obligations are more volatile, i.e., they increase and decrease in response to changes in interest rates to a greater extent than comparable fixed rate obligations. 23 Morgan Stanley Municipal Income Opportunities Trust III RESULTS OF ANNUAL SHAREHOLDER MEETING (UNAUDITED) On October 26, 2005, an annual meeting of the Fund's shareholders was held for the purpose of voting on the following matter, the results of which were as follows: Election of Trustees:
FOR WITHHELD ----------------------------- Wayne E. Hedien............................................. 7,576,870 110,646 Dr. Manuel H. Johnson....................................... 7,579,100 108,416 Joseph J. Kearns............................................ 7,579,061 108,455 Fergus Reid................................................. 7,585,301 102,215
The following Trustees were not standing for reelection at this meeting: Michael Bozic, Edwin J. Garn, Michael E. Nugent, Charles A. Fiumefreddo and James F. Higgins. 24 Morgan Stanley Municipal Income Opportunities Trust III TRUSTEE AND OFFICER INFORMATION Independent Trustees:
Number of Portfolios in Position(s) Term of Office Fund Complex Name, Age and Address of Held with and Length of Principal Occupation(s) During Overseen by Independent Trustee Registrant Time Served* Past 5 Years** Trustee*** --------------------------------------- ----------- -------------- ------------------------------ ------------- Michael Bozic (65) Trustee Since April Private Investor; Director or 197 c/o Kramer Levin Naftalis & Frankel LLP 1994 Trustee of the Retail Funds Counsel to the Independent Trustees (since April 1994) and the 1177 Avenue of the Americas Institutional Funds (since New York, NY 10036 July 2003); formerly Vice Chairman of Kmart Corporation (December 1998-October 2000), Chairman and Chief Executive Officer of Levitz Furniture Corporation (November 1995-November 1998) and President and Chief Executive Officer of Hills Department Stores (May 1991-July 1995); formerly variously Chairman, Chief Executive Officer, President and Chief Operating Officer (1987-1991) of the Sears Merchandise Group of Sears, Roebuck & Co. Edwin J. Garn (73) Trustee Since January Consultant; Director or 197 1031 N. Chartwell Court 1993 Trustee of the Retail Funds Salt Lake City, UT 84103 (since January 1993) and the Institutional Funds (since July 2003); member of the Utah Regional Advisory Board of Pacific Corp. (utility company); formerly Managing Director of Summit Ventures LLC (2000-2004) (lobbying and consulting firm); United States Senator (R-Utah) (1974-1992) and Chairman, Senate Banking Committee (1980-1986), Mayor of Salt Lake City, Utah (1971-1974), Astronaut, Space Shuttle Discovery (April 12-19, 1985), and Vice Chairman, Huntsman Corporation (chemical company). Name, Age and Address of Independent Trustee Other Directorships Held by Trustee --------------------------------------- ----------------------------------- Michael Bozic (65) Director of various business c/o Kramer Levin Naftalis & Frankel LLP organizations. Counsel to the Independent Trustees 1177 Avenue of the Americas New York, NY 10036 Edwin J. Garn (73) Director of Franklin Covey (time 1031 N. Chartwell Court management systems), BMW Bank of Salt Lake City, UT 84103 North America, Inc. (industrial loan corporation), Escrow Bank USA (industrial loan corporation); United Space Alliance (joint venture between Lockheed Martin and the Boeing Company) and Nuskin Asia Pacific (multilevel marketing); member of the board of various civic and charitable organizations.
25 Morgan Stanley Municipal Income Opportunities Trust III TRUSTEE AND OFFICER INFORMATION continued
Number of Portfolios in Position(s) Term of Office Fund Complex Name, Age and Address of Held with and Length of Principal Occupation(s) During Overseen by Independent Trustee Registrant Time Served* Past 5 Years** Trustee*** --------------------------------------- ----------- -------------- ------------------------------ ------------- Wayne E. Hedien (72) Trustee Since Retired; Director or Trustee 197 c/o Kramer Levin Naftalis & Frankel LLP September 1997 of the Retail Funds (since Counsel to the Independent Trustees September 1997) and the 1177 Avenue of the Americas Institutional Funds (since New York, NY 10036 July 2003); formerly associated with the Allstate Companies (1966-1994), most recently as Chairman of The Allstate Corporation (March 1993-December 1994) and Chairman and Chief Executive Officer of its wholly-owned subsidiary, Allstate Insurance Company (July 1989-December 1994). Dr. Manuel H. Johnson (57) Trustee Since July Senior Partner, Johnson Smick 197 c/o Johnson Smick Group, Inc. 1991 International, Inc., a 888 16th Street, NW consulting firm; Chairman of Suite 740 the Audit Committee and Washington, D.C. 20006 Director or Trustee of the Retail Funds (since July 1991) and the Institutional Funds (since July 2003); Co- Chairman and a founder of the Group of Seven Council (G7C), an international economic commission; formerly Vice Chairman of the Board of Governors of the Federal Reserve System and Assistant Secretary of the U.S. Treasury. Joseph J. Kearns (63) Trustee Since July President, Kearns & Associates 198 c/o Kearns & Associates LLC 2003 LLC (investment consulting); PMB754 Deputy Chairman of the Audit 23852 Pacific Coast Highway Committee and Director or Malibu, CA 90265 Trustee of the Retail Funds (since July 2003) and the Institutional Funds (since August 1994); previously Chairman of the Audit Committee of the Institutional Funds (October 2001-July 2003); formerly CFO of the J. Paul Getty Trust. Name, Age and Address of Independent Trustee Other Directorships Held by Trustee --------------------------------------- ----------------------------------- Wayne E. Hedien (72) Director of The PMI Group Inc. c/o Kramer Levin Naftalis & Frankel LLP (private mortgage insurance); Counsel to the Independent Trustees Trustee and Vice Chairman of The 1177 Avenue of the Americas Field Museum of Natural History; New York, NY 10036 director of various other business and charitable organizations. Dr. Manuel H. Johnson (57) Director of NVR, Inc. (home c/o Johnson Smick Group, Inc. construction); Director of KFX 888 16th Street, NW Energy; Director of RBS Greenwich Suite 740 Capital Holdings (financial holding Washington, D.C. 20006 company). Joseph J. Kearns (63) Director of Electro Rent c/o Kearns & Associates LLC Corporation (equipment leasing), PMB754 The Ford Family Foundation, and the 23852 Pacific Coast Highway UCLA Foundation. Malibu, CA 90265
26 Morgan Stanley Municipal Income Opportunities Trust III TRUSTEE AND OFFICER INFORMATION continued
Number of Portfolios in Position(s) Term of Office Fund Complex Name, Age and Address of Held with and Length of Principal Occupation(s) During Overseen by Independent Trustee Registrant Time Served* Past 5 Years** Trustee*** --------------------------------------- ----------- -------------- ------------------------------ ------------- Michael E. Nugent (69) Trustee Since July General Partner of Triumph 197 c/o Triumph Capital, L.P. 1991 Capital, L.P., a private 445 Park Avenue investment partnership; New York, NY 10022 Chairman of the Insurance Committee and Director or Trustee of the Retail Funds (since July 1991) and the Institutional Funds (since July 2001); formerly Vice President, Bankers Trust Company and BT Capital Corporation (1984-1988). Fergus Reid (73) Trustee Since July Chairman of Lumelite Plastics 198 c/o Lumelite Plastics Corporation 2003 Corporation; Chairman of the 85 Charles Colman Blvd. Governance Committee and Pawling, NY 12564 Director or Trustee of the Retail Funds (since July 2003) and the Institutional Funds (since June 1992). Name, Age and Address of Independent Trustee Other Directorships Held by Trustee --------------------------------------- ----------------------------------- Michael E. Nugent (69) None. c/o Triumph Capital, L.P. 445 Park Avenue New York, NY 10022 Fergus Reid (73) Trustee and Director of certain c/o Lumelite Plastics Corporation investment companies in the 85 Charles Colman Blvd. JPMorgan Funds complex managed by Pawling, NY 12564 J.P. Morgan Investment Management Inc.
27 Morgan Stanley Municipal Income Opportunities Trust III TRUSTEE AND OFFICER INFORMATION continued Interested Trustees:
Number of Portfolios in Position(s) Term of Office Fund Complex Name, Age and Address of Held with and Length of Principal Occupation(s) During Overseen by Interested Trustee Registrant Time Served* Past 5 Years** Trustee*** ------------------------------------- ----------- -------------- ------------------------------ ------------- Charles A. Fiumefreddo (72) Chairman of Since July Chairman and Director or 197 c/o Morgan Stanley Trust the Board 1991 Trustee of the Retail Funds Harborside Financial Center, and Trustee (since July 1991) and the Plaza Two, Institutional Funds (since Jersey City, NJ 07311 July 2003); formerly Chief Executive Officer of the Retail Funds (until September 2002). James F. Higgins (58) Trustee Since June Director or Trustee of the 197 c/o Morgan Stanley Trust 2000 Retail Funds (since June 2000) Harborside Financial Center, and the Institutional Funds Plaza Two, (since July 2003); Senior Jersey City, NJ 07311 Advisor of Morgan Stanley; Director of Dean Witter Realty Inc. Name, Age and Address of Interested Trustee Other Directorships Held by Trustee ------------------------------------- ----------------------------------- Charles A. Fiumefreddo (72) None. c/o Morgan Stanley Trust Harborside Financial Center, Plaza Two, Jersey City, NJ 07311 James F. Higgins (58) Director of AXA Financial, Inc. and c/o Morgan Stanley Trust The Equitable Life Assurance Harborside Financial Center, Society of the United States Plaza Two, (financial services). Jersey City, NJ 07311
--------------------- * This is the earliest date the Trustee began serving the funds advised by Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") (the "Retail Funds"). ** The dates referenced below indicating commencement of services as Director/Trustee for the Retail Funds and the funds advised by Morgan Stanley Investment Management Inc. and Morgan Stanley AIP GP LP (the "Institutional Funds") reflect the earliest date the Director/Trustee began serving the Retail or Institutional Funds, as applicable. *** The Fund Complex includes all open-end and closed-end funds (including all of their portfolios) advised by the Investment Adviser and any funds that have an investment adviser that is an affiliated person of the Investment Adviser (including, but not limited to, Morgan Stanley Investment Management Inc.). 28 Morgan Stanley Municipal Income Opportunities Trust III TRUSTEE AND OFFICER INFORMATION continued Officers:
Term of Position(s) Office and Name, Age and Address of Held with Length of Executive Officer Registrant Time Served* Principal Occupation(s) During Past 5 Years** ----------------------------- --------------- -------------- ------------------------------------------------------------ Ronald E. Robison (67) President and Since May 2003 President (since September 2005) and Principal Executive 1221 Avenue of the Americas Principal Officer (since May 2003) of funds in the Fund Complex; New York, NY 10020 Executive President (since September 2005) and Principal Executive Officer Officer (since May 2003) of the Van Kampen Funds; Managing Director, Director and/or Officer of the Investment Adviser and various entities affiliated with the Investment Adviser; Director of Morgan Stanley SICAV (since May 2004). Formerly, Executive Vice President (July 2003 to September 2005) of funds in the Fund Complex and the Van Kampen Funds; President and Director of the Institutional Funds (March 2001 to July 2003); Chief Global Operating Officer of Morgan Stanley Investment Management Inc.; Chief Administrative Officer of Morgan Stanley Investment Advisors Inc.; Chief Administrative Officer of Morgan Stanley Services Company Inc. J. David Germany (51) Vice President Since February Managing Director and (since December 2005) Chief Investment 25 Cabot Square, 2006 Officer -- Global Fixed Income of Morgan Stanley Investment Canary Wharf, London, Management; Managing Director and Director of Morgan Stanley United Kingdom E144QA Investment Management Ltd.; Vice President (since February 2006) of the Retail and Institutional Funds. Dennis F. Shea (52) Vice President Since February Managing Director and (since February 2006) Chief Investment 1221 Avenue of the Americas 2006 Officer -- Global Equity of Morgan Stanley Investment New York, NY 10020 Management; Vice President (since February 2006) of the Retail and Institutional Funds. Formerly, Managing Director and Director of Global Equity Research at Morgan Stanley. Barry Fink (51) Vice President Since February Managing Director and General Counsel of Morgan Stanley 1221 Avenue of the Americas 1997 Investment Management; Managing Director of the Investment New York, NY 10020 Adviser and various entities affiliated with the Investment Adviser; Vice President of the Retail Funds and (since July 2003) the Institutional Funds. Formerly, Secretary, General Counsel and/or Director of the Investment Adviser and various entities affiliated with the Investment Adviser; Secretary and General Counsel of the Retail Funds. Amy R. Doberman (44) Vice President Since July Managing Director and General Counsel, U.S. Investment 1221 Avenue of the Americas 2004 Management of Morgan Stanley Investment Management (since New York, NY 10020 July 2004); Vice President of the Retail Funds and the Institutional Funds (since July 2004); Vice President of the Van Kampen Funds (since August 2004); Secretary (since February 2006) and Managing Director (since July 2004) of the Investment Adviser and various entities affiliated with the Investment Adviser. Formerly, Managing Director and General Counsel -- Americas, UBS Global Asset Management (July 2000 to July 2004). Carsten Otto (42) Chief Since October Managing Director and U.S. Director of Compliance for Morgan 1221 Avenue of the Americas Compliance 2004 Stanley Investment Management (since October 2004); Managing New York, NY 10020 Officer Director and Chief Compliance Officer of Morgan Stanley Investment Management. Formerly, Assistant Secretary and Assistant General Counsel of the Retail Funds. Stefanie V. Chang Yu (39) Vice President Since July Executive Director of the Investment Adviser and various 1221 Avenue of the Americas 2003 entities affiliated with the Investment Adviser; Vice New York, NY 10020 President of the Retail Funds (since July 2002) and the Institutional Funds (since December 1997). Formerly, Secretary of various entities affiliated with the Investment Adviser.
29 Morgan Stanley Municipal Income Opportunities Trust III TRUSTEE AND OFFICER INFORMATION continued
Term of Position(s) Office and Name, Age and Address of Held with Length of Executive Officer Registrant Time Served* Principal Occupation(s) During Past 5 Years** ----------------------------- --------------- -------------- ------------------------------------------------------------ Francis J. Smith (40) Treasurer and Treasurer Executive Director of the Investment Adviser and various c/o Morgan Stanley Trust Chief Financial (since July entities affiliated with the Investment Adviser; Treasurer Harborside Financial Center, Officer 2003) and and Chief Financial Officer of the Retail Funds (since July Plaza Two, Chief 2003). Formerly, Vice President of the Retail Funds Jersey City, NJ 07311 Financial (September 2002 to July 2003). Officer (since September 2002) Thomas F. Caloia (60) Vice President Since July Executive Director of the Investment Adviser and various c/o Morgan Stanley Trust 2003 entities affiliated with the Investment Adviser; Vice Harborside Financial Center, President of the Retail Funds. Formerly, Treasurer of the Plaza Two, Retail Funds (April 1989 to July 2003). Jersey City, NJ 07311 Mary E. Mullin (39) Secretary Since July Executive Director of the Investment Adviser and various 1221 Avenue of the Americas 2003 entities affiliated with the Investment Adviser; Secretary New York, NY 10020 of the Retail Funds (since July 2003) and the Institutional Funds (since June 1999).
--------------------- * This is the earliest date the Officer began serving the Retail Funds. Each Officer serves an indefinite term, until his or her successor is elected. ** The dates referenced below indicating commencement of service as an Officer for the Retail and Institutional Funds reflect the earliest date the Officer began serving the Retail or Institutional Funds, as applicable. In accordance with Section 303A.12(a) of the New York Stock Exchange Listed Company Manual, the Fund's Annual CEO Certification certifying as to compliance with NYSE's Corporate Governance Listing Standards was submitted to the Exchange on December 5, 2005. The Fund's Principal Executive Officer and Principal Financial Officer Certifications required by Section 302 of the Sarbanes-Oxley Act of 2002 were filed with the Fund's N-CSR and are available on the Securities and Exchange Commission's Web site at http://www.sec.gov. 2006 FEDERAL TAX NOTICE (UNAUDITED) For the year ended March 31, 2006, all of the Fund's dividends from net investment income were exempt interest dividends, excludable from gross income for Federal income tax purposes. 30 (This Page Intentionally Left Blank) TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo Chairman of the Board Ronald E. Robison President and Principal Executive Officer J. David Germany Vice President Dennis F. Shea Vice President Barry Fink Vice President Amy R. Doberman Vice President Carsten Otto Chief Compliance Officer Stefanie V. Chang Yu Vice President Francis J. Smith Treasurer and Chief Financial Officer Thomas F. Caloia Vice President Mary E. Mullin Secretary TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT ADVISER Morgan Stanley Investment Advisors Inc. 1221 Avenue of the Americas New York, New York 10020 Investments and services offered through Morgan Stanley DW Inc., member SIPC. (c) 2006 Morgan Stanley [MORGAN STANLEY LOGO] MORGAN STANLEY FUNDS Morgan Stanley Municipal Income Opportunities Trust III Annual Report March 31, 2006 [MORGAN STANLEY LOGO] 38513RPT-RA06-00393P-Y03/06 Item 2. Code of Ethics. (a) The Fund has adopted a code of ethics (the "Code of Ethics") that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the Fund or a third party. (b) No information need be disclosed pursuant to this paragraph. (c) Not applicable. (d) Not applicable. (e) Not applicable. (f) (1) The Fund's Code of Ethics is attached hereto as Exhibit 12 A. (2) Not applicable. (3) Not applicable. Item 3. Audit Committee Financial Expert. The Fund's Board of Trustees has determined that it has two "audit committee financial experts" serving on its audit committee, each of whom are "independent" Trustees: Dr. Manuel H. Johnson and Joseph J. Kearns. Under applicable securities laws, a person who is determined to be an audit committee financial expert will not be deemed an "expert" for any purpose, including without limitation for the purposes of Section 11 of the Securities Act of 1933, as a result of being designated or identified as an audit committee financial expert. The designation or identification of a person as an audit committee financial expert does not impose on such person any duties, obligations, or liabilities that are greater than the duties, obligations, and liabilities imposed on such person as a member of the audit committee and Board of Trustees in the absence of such designation or identification. 2 Item 4. Principal Accountant Fees and Services. (a)(b)(c)(d) and (g). Based on fees billed for the periods shown: 2006
REGISTRANT COVERED ENTITIES(1) ---------- ------------------- AUDIT FEES.............. $30,446 N/A NON-AUDIT FEES AUDIT-RELATED FEES... $ 540(2) $5,190,300(2) TAX FEES............. $ 4,448(3) $2,044,491(4) ALL OTHER FEES....... $ -- $ -- TOTAL NON-AUDIT FEES.... $ 4,988 $7,234,791 TOTAL................... $35,434 $7,234,791
2005
REGISTRANT COVERED ENTITIES(1) ---------- ------------------- AUDIT FEES.............. $29,002 N/A NON-AUDIT FEES AUDIT-RELATED FEES... $ 452(2) $3,215,745(2) TAX FEES............. $ 4,585(3) $ 24,000(4) ALL OTHER FEES....... $ -- $ -- TOTAL NON-AUDIT FEES.... $ 5,037 $3,239,745 TOTAL................... $34,039 $3,239,745
N/A- Not applicable, as not required by Item 4. (1) Covered Entities include the Adviser (excluding sub-advisors) and any entity controlling, controlled by or under common control with the Adviser that provides ongoing services to the Registrant. (2) Audit-Related Fees represent assurance and related services provided that are reasonably related to the performance of the audit of the financial statements of the Covered Entities' and funds advised by the Adviser or its affiliates, specifically data verification and agreed-upon procedures related to asset securitizations and agreed-upon procedures engagements. (3) Tax Fees represent tax compliance, tax planning and tax advice services provided in connection with the preparation and review of the Registrant's tax returns. (4) Tax Fees represent tax compliance, tax planning and tax advice services provided in connection with the review of Covered Entities' tax returns. (5) All other fees represent project management for future business applications and improving business and operational processes. 3 (e)(1) The audit committee's pre-approval policies and procedures are as follows: APPENDIX A AUDIT COMMITTEE AUDIT AND NON-AUDIT SERVICES PRE-APPROVAL POLICY AND PROCEDURES OF THE MORGAN STANLEY RETAIL AND INSTITUTIONAL FUNDS AS ADOPTED AND AMENDED JULY 23, 2004,(1) 1. STATEMENT OF PRINCIPLES The Audit Committee of the Board is required to review and, in its sole discretion, pre-approve all Covered Services to be provided by the Independent Auditors to the Fund and Covered Entities in order to assure that services performed by the Independent Auditors do not impair the auditor's independence from the Fund. The SEC has issued rules specifying the types of services that an independent auditor may not provide to its audit client, as well as the audit committee's administration of the engagement of the independent auditor. The SEC's rules establish two different approaches to pre-approving services, which the SEC considers to be equally valid. Proposed services either: may be pre-approved without consideration of specific case-by-case services by the Audit Committee ("general pre-approval"); or require the specific pre-approval of the Audit Committee or its delegate ("specific pre-approval"). The Audit Committee believes that the combination of these two approaches in this Policy will result in an effective and efficient procedure to pre-approve services performed by the Independent Auditors. As set forth in this Policy, unless a type of service has received general pre-approval, it will require specific pre-approval by the Audit Committee (or by any member of the Audit Committee to which pre-approval authority has been delegated) if it is to be provided by the Independent Auditors. Any proposed services exceeding pre-approved cost levels or budgeted amounts will also require specific pre-approval by the Audit Committee. The appendices to this Policy describe the Audit, Audit-related, Tax and All Other services that have the general pre-approval of the Audit Committee. The term of any general pre-approval is 12 months from the date of pre-approval, unless the Audit Committee considers and provides a different period and states otherwise. The Audit Committee will annually review and pre-approve the services that may be provided by the Independent Auditors without obtaining specific pre-approval from the Audit Committee. The Audit Committee will add to or subtract from the list of general pre-approved services from time to time, based on subsequent determinations. ---------- (1) This Audit Committee Audit and Non-Audit Services Pre-Approval Policy and Procedures (the "Policy"), adopted as of the date above, supersedes and replaces all prior versions that may have been adopted from time to time. 4 The purpose of this Policy is to set forth the policy and procedures by which the Audit Committee intends to fulfill its responsibilities. It does not delegate the Audit Committee's responsibilities to pre-approve services performed by the Independent Auditors to management. The Fund's Independent Auditors have reviewed this Policy and believes that implementation of the Policy will not adversely affect the Independent Auditors' independence. 2. DELEGATION As provided in the Act and the SEC's rules, the Audit Committee may delegate either type of pre-approval authority to one or more of its members. The member to whom such authority is delegated must report, for informational purposes only, any pre-approval decisions to the Audit Committee at its next scheduled meeting. 3. AUDIT SERVICES The annual Audit services engagement terms and fees are subject to the specific pre-approval of the Audit Committee. Audit services include the annual financial statement audit and other procedures required to be performed by the Independent Auditors to be able to form an opinion on the Fund's financial statements. These other procedures include information systems and procedural reviews and testing performed in order to understand and place reliance on the systems of internal control, and consultations relating to the audit. The Audit Committee will approve, if necessary, any changes in terms, conditions and fees resulting from changes in audit scope, Fund structure or other items. In addition to the annual Audit services engagement approved by the Audit Committee, the Audit Committee may grant general pre-approval to other Audit services, which are those services that only the Independent Auditors reasonably can provide. Other Audit services may include statutory audits and services associated with SEC registration statements (on Forms N-1A, N-2, N-3, N-4, etc.), periodic reports and other documents filed with the SEC or other documents issued in connection with securities offerings. The Audit Committee has pre-approved the Audit services in Appendix B.1. All other Audit services not listed in Appendix B.1 must be specifically pre-approved by the Audit Committee (or by any member of the Audit Committee to which pre-approval has been delegated). 4. AUDIT-RELATED SERVICES Audit-related services are assurance and related services that are reasonably related to the performance of the audit or review of the Fund's financial statements and, to the extent they are Covered Services, the Covered Entities or that are traditionally performed by the Independent Auditors. Because the Audit Committee believes that the provision of Audit-related services does not impair the independence of the auditor and is consistent with the SEC's rules on auditor independence, the Audit Committee may grant general pre-approval to Audit-related services. Audit-related services include, among others, accounting consultations related to accounting, financial reporting or disclosure matters 5 not classified as "Audit services"; assistance with understanding and implementing new accounting and financial reporting guidance from rulemaking authorities; agreed-upon or expanded audit procedures related to accounting and/or billing records required to respond to or comply with financial, accounting or regulatory reporting matters; and assistance with internal control reporting requirements under Forms N-SAR and/or N-CSR. The Audit Committee has pre-approved the Audit-related services in Appendix B.2. All other Audit-related services not listed in Appendix B.2 must be specifically pre-approved by the Audit Committee (or by any member of the Audit Committee to which pre-approval has been delegated). 5. TAX SERVICES The Audit Committee believes that the Independent Auditors can provide Tax services to the Fund and, to the extent they are Covered Services, the Covered Entities, such as tax compliance, tax planning and tax advice without impairing the auditor's independence, and the SEC has stated that the Independent Auditors may provide such services. Pursuant to the preceding paragraph, the Audit Committee has pre-approved the Tax Services in Appendix B.3. All Tax services in Appendix B.3 must be specifically pre-approved by the Audit Committee (or by any member of the Audit Committee to which pre-approval has been delegated). 6. ALL OTHER SERVICES The Audit Committee believes, based on the SEC's rules prohibiting the Independent Auditors from providing specific non-audit services, that other types of non-audit services are permitted. Accordingly, the Audit Committee believes it may grant general pre-approval to those permissible non-audit services classified as All Other services that it believes are routine and recurring services, would not impair the independence of the auditor and are consistent with the SEC's rules on auditor independence. The Audit Committee has pre-approved the All Other services in Appendix B.4. Permissible All Other services not listed in Appendix B.4 must be specifically pre-approved by the Audit Committee (or by any member of the Audit Committee to which pre-approval has been delegated). 7. PRE-APPROVAL FEE LEVELS OR BUDGETED AMOUNTS Pre-approval fee levels or budgeted amounts for all services to be provided by the Independent Auditors will be established annually by the Audit Committee. Any proposed services exceeding these levels or amounts will require specific pre-approval by the Audit Committee. The Audit Committee is mindful of the overall relationship of fees for audit and non-audit services in determining whether to pre-approve any such services. 8. PROCEDURES All requests or applications for services to be provided by the Independent Auditors that do not require specific approval by the Audit Committee will be submitted to the Fund's Chief Financial Officer and must include a detailed description of the services to be 6 rendered. The Fund's Chief Financial Officer will determine whether such services are included within the list of services that have received the general pre-approval of the Audit Committee. The Audit Committee will be informed on a timely basis of any such services rendered by the Independent Auditors. Requests or applications to provide services that require specific approval by the Audit Committee will be submitted to the Audit Committee by both the Independent Auditors and the Fund's Chief Financial Officer, and must include a joint statement as to whether, in their view, the request or application is consistent with the SEC's rules on auditor independence. The Audit Committee has designated the Fund's Chief Financial Officer to monitor the performance of all services provided by the Independent Auditors and to determine whether such services are in compliance with this Policy. The Fund's Chief Financial Officer will report to the Audit Committee on a periodic basis on the results of its monitoring. Both the Fund's Chief Financial Officer and management will immediately report to the chairman of the Audit Committee any breach of this Policy that comes to the attention of the Fund's Chief Financial Officer or any member of management. 9. ADDITIONAL REQUIREMENTS The Audit Committee has determined to take additional measures on an annual basis to meet its responsibility to oversee the work of the Independent Auditors and to assure the auditor's independence from the Fund, such as reviewing a formal written statement from the Independent Auditors delineating all relationships between the Independent Auditors and the Fund, consistent with Independence Standards Board No. 1, and discussing with the Independent Auditors its methods and procedures for ensuring independence. 10. COVERED ENTITIES Covered Entities include the Fund's investment adviser(s) and any entity controlling, controlled by or under common control with the Fund's investment adviser(s) that provides ongoing services to the Fund(s). Beginning with non-audit service contracts entered into on or after May 6, 2003, the Fund's audit committee must pre-approve non-audit services provided not only to the Fund but also to the Covered Entities if the engagements relate directly to the operations and financial reporting of the Fund. This list of Covered Entities would include: Morgan Stanley Retail Funds Morgan Stanley Investment Advisors Inc. Morgan Stanley & Co. Incorporated Morgan Stanley DW Inc. Morgan Stanley Investment Management Inc. Morgan Stanley Investment Management Limited Morgan Stanley Investment Management Private Limited Morgan Stanley Asset & Investment Trust Management Co., Limited Morgan Stanley Investment Management Company Van Kampen Asset Management Morgan Stanley Services Company, Inc. Morgan Stanley Distributors Inc. Morgan Stanley Trust FSB 7 Morgan Stanley Institutional Funds Morgan Stanley Investment Management Inc. Morgan Stanley Investment Advisors Inc. Morgan Stanley Investment Management Limited Morgan Stanley Investment Management Private Limited Morgan Stanley Asset & Investment Trust Management Co., Limited Morgan Stanley Investment Management Company Morgan Stanley & Co. Incorporated Morgan Stanley Distribution, Inc. Morgan Stanley AIP GP LP Morgan Stanley Alternative Investment Partners LP (e)(2) Beginning with non-audit service contracts entered into on or after May 6, 2003, the audit committee also is required to pre-approve services to Covered Entities to the extent that the services are determined to have a direct impact on the operations or financial reporting of the Registrant. 100% of such services were pre-approved by the audit committee pursuant to the Audit Committee's pre-approval policies and procedures (attached hereto). (f) Not applicable. (g) See table above. (h) The audit committee of the Board of Trustees has considered whether the provision of services other than audit services performed by the auditors to the Registrant and Covered Entities is compatible with maintaining the auditors' independence in performing audit services. Item 5. Audit Committee of Listed Registrants. (a) The Fund has a separately-designated standing audit committee established in accordance with Section 3(a)(58)(A) of the Exchange Act whose members are: Michael Bozic, Edwin J. Garn, Wayne E. Hedien, Manual H. Johnson, Joseph J. Kearns, Michael Nugent and Fergus Reid. (b) Not applicable. Item 6. See Item 1. 8 Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies. The Fund invests in exclusively non-voting securities and therefore this item is not applicable. Item 8. Portfolio Managers of Closed-End Management Investment Companies FUND MANAGEMENT PORTFOLIO MANAGEMENT. As of the date of this report, the Fund is managed by members of the Municipal Fixed Income team. The team consists of portfolio managers and analysts. Current members of the team jointly and primarily responsible for the day-to-day management of the Fund's portfolio are James F. Willison and Wayne D. Godlin, Managing Directors of the Investment Adviser and Gerard J. Lian, an Executive Director of the Investment Adviser. Mr. Willison has been associated with the Investment Adviser in an investment management capacity since January 1980 and began managing the Fund at inception. Mr. Godlin has been associated with the Investment Adviser in an investment management capacity since May 1988 and began managing the Fund in October 2001. Mr. Lian has been associated with the Investment Adviser in an investment management capacity since December 1991 and began managing the Fund in February 2003. The composition of the team may change without notice from time to time. OTHER ACCOUNTS MANAGED BY THE PORTFOLIO MANAGERS The following information is as of March 31, 2006. As of March 31, 2006, Mr. Willison managed 21 mutual funds with a total of approximately $6.9 billion in assets; no pooled investment vehicles other than mutual funds; and no other accounts. As of March 31, 2006, Mr. Godlin managed five mutual funds with a total of approximately $6.5 billion in assets; no pooled investment vehicles other than mutual funds; and no other accounts. As of March 31, 2006, Mr. Lian managed three mutual funds with a total of approximately $388.8 million in assets; no pooled investment vehicles other than mutual funds; and no other accounts. Because the portfolio managers may manage assets for other investment companies, pooled investment vehicles, and/or other accounts (including institutional clients, pension 9 plans and certain high net worth individuals), there may be an incentive to favor one client over another resulting in conflicts of interest. For instance, the Investment Adviser may receive fees from certain accounts that are higher than the fee it receives from the Fund, or it may receive a performance-based fee on certain accounts. In those instances, the portfolio managers may have an incentive to favor the higher and/or performance-based fee accounts over the Fund. The Investment Adviser has adopted trade allocation and other policies and procedures that it believes are reasonably designed to address these and other conflicts of interest. PORTFOLIO MANAGER COMPENSATION STRUCTURE Portfolio managers receive a combination of base compensation and discretionary compensation, comprising a cash bonus and several deferred compensation programs described below. The methodology used to determine portfolio manager compensation is applied across all funds/accounts managed by the portfolio manager. BASE SALARY COMPENSATION. Generally, portfolio managers receive base salary compensation based on the level of their position with the Investment Adviser. DISCRETIONARY COMPENSATION. In addition to base compensation, portfolio managers may receive discretionary compensation. Discretionary compensation can include: - Cash Bonus; - Morgan Stanley's Equity Incentive Compensation Program (EICP) awards -- a mandatory program that defers a portion of discretionary year-end compensation into restricted stock units or other awards based on Morgan Stanley common stock that are subject to vesting and other conditions; - Investment Management Deferred Compensation Plan (IMDCP) awards -- a mandatory program that defers a portion of discretionary year-end compensation and notionally invests it in designated funds advised by the Investment Adviser or its affiliates. The award is subject to vesting and other conditions. Portfolio managers must notionally invest a minimum of 25% to a maximum of 75% of the IMDCP deferral into a combination of the designated funds they manage that are included in the IMDCP fund menu, which may or may not include the Fund; - Voluntary Deferred Compensation Plans -- voluntary programs that permit certain employees to elect to defer a portion of their discretionary year-end compensation and directly or notionally invest the deferred amount: (1) across a range of designated investment funds, including funds advised by the adviser or its affiliates; and/or (2) in Morgan Stanley stock units. 10 Several factors determine discretionary compensation, which can vary by portfolio management team and circumstances. In order of relative importance, these factors include: - Investment performance. A portfolio manager's compensation is linked to the pre-tax investment performance of the funds/accounts managed by the portfolio manager. Investment performance is calculated for one-, three- and five-year periods measured against a fund's/account's primary benchmark (as set forth in the fund's prospectus), indices and/or peer groups where applicable. Generally, the greatest weight is placed on the three- and five-year periods. - Revenues generated by the investment companies, pooled investment vehicles and other accounts managed by the portfolio manager. - Contribution to the business objectives of the Investment Adviser. - The dollar amount of assets managed by the portfolio manager. - Market compensation survey research by independent third parties. - Other qualitative factors, such as contributions to client objectives. - Performance of Morgan Stanley and Morgan Stanley Investment Management, and the overall performance of the Global Investor Group, a department within Morgan Stanley Investment Management that includes all investment professionals. SECURITIES OWNERSHIP OF PORTFOLIO MANAGERS As of March 31, 2006, the dollar range of securities beneficially owned by each portfolio manager in the Fund is shown below: James F. Willison: None Wayne D. Godlin: None Gerard J. Lian: None 11 Item 9. Closed-End Fund Repurchases REGISTRANT PURCHASE OF EQUITY SECURITIES
(d) Maximum Number (or Approximate (c) Total Number of Dollar Value) of Shares (or Units) Shares (or Units) Purchased as Part that May Yet Be (a) Total Number (b) Average of Publicly Purchased Under of Shares (or Price Paid per Announced Plans or the Plans or Period Units) Purchased Share (or Unit) Programs Programs ------ ---------------- --------------- ------------------- ------------------ April 1, 2005 -- April 30, 2005 29,300 $8.5181 N/A N/A May 1, 2005 --- May 31, 2005 33,521 $8.6715 N/A N/A June 1, 2005 --- June 30, 2005 27,500 $8.9030 N/A N/A July 1, 2005 --- July 31, 2005 28,800 $9.0776 N/A N/A August 1, 2005 --- August 31, 2005 31,800 $9.1024 N/A N/A September 1, 2005 -- September 30, 2005 31,800 $9.1981 N/A N/A October 1, 2005 -- October 31, 2005 27,500 $9.3517 N/A N/A November 1, 2005 -- November 30, 2005 21,200 $9.3956 N/A N/A December 1, 2005 -- December 31, 2005 18,700 $9.2698 N/A N/A January 1, 2006 -- January 31, 2006 27,200 $9.5187 N/A N/A February 1, 2006 -- February 28, 2006 13,500 $9.5083 N/A N/A March 1, 2006 -- March 31, 2006 9,800 $9.5899 N/A N/A ------- ------- --- --- Total 300,621 $9.1754 N/A N/A ======= ======= === ===
12 Item 10. Submission of Matters to a Vote of Security Holders Not applicable. Item 11. Controls and Procedures (a) The Fund's principal executive officer and principal financial officer have concluded that the Fund's disclosure controls and procedures are sufficient to ensure that information required to be disclosed by the Fund in this Form N-CSR was recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, based upon such officers' evaluation of these controls and procedures as of a date within 90 days of the filing date of the report. (b) There were no changes in the registrant's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. Item 12. Exhibits (a) The Code of Ethics for Principal Executive and Senior Financial Officers is attached hereto. (b) A separate certification for each principal executive officer and principal financial officer of the registrant are attached hereto as part of EX-99.CERT. 13 SIGNATURES 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. Morgan Stanley Municipal Income Opportunities Trust III /s/ Ronald E. Robison ------------------------------------- Ronald E. Robison Principal Executive Officer May 18, 2006 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ Ronald E. Robison ------------------------------------- Ronald E. Robison Principal Executive Officer May 18, 2006 /s/ Francis Smith ------------------------------------- Francis Smith Principal Financial Officer May 18, 2006 14