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, 2007
Date of reporting period: September 30, 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 semiannual 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.
INCOME EARNED BY CERTAIN SECURITIES IN THE PORTFOLIO MAY BE SUBJECT TO THE
FEDERAL ALTERNATIVE MINIMUM TAX (AMT).
FUND REPORT
For the six months ended September 30, 2006
MARKET CONDITIONS
During the six months ended September 30, 2006, the market focused on the new
leadership at the Federal Reserve Board (the "Fed") and the conflicting
uncertainties created by inflationary pressures and forecasts of slower economic
growth. As consumer spending and housing weakened, the pace of U.S. economic
growth moderated and inflation remained within the range that the Fed was
apparently willing to tolerate. In its first two meetings during the period, the
Fed continued its tightening policy, raising the Fed funds target rate in 25
basis point increments, bringing it to 5.25 percent at the end of June. In July,
investors began to anticipate that the Fed would take a break from rate
increases and in August it did pause, ending a record two-year run of 17
consecutive rate increases. At its September meeting, the Fed again kept its
target rate unchanged as the housing market continued to weaken and oil prices
declined.
The municipal market reflected this improved outlook for bonds and tracked the
third calendar-quarter rally in Treasuries. Representative yields on 30-year
AAA-rated municipal bonds, which increased from 4.50 percent in March to 4.65
percent in June, dropped to 4.20 percent by the end of September. While yields
on longer maturities declined, interest rates on two-year AAA tax-exempt
municipal maturities remained unchanged. Accordingly, the spread between
short-term and long-term interest rates narrowed and the slope of the municipal
yield curve continued to flatten. Many investors continued to favor the
increased income of lower-quality bonds and as a result, credit spreads remained
tight. (Credit spreads measure the incremental yield investors are willing to
accept to assume additional credit risk. When credit spreads tighten,
lower-quality issues typically outperform high-grade issues).
Reinvestment of an estimated $100 billion of bond maturities, calls and coupons
in June, July and September supported demand for municipal bonds. However,
municipal bond issuance lagged last year's record pace by over 15 percent in the
first nine months of 2006. The overall decline was due in great part to a 50
percent slowdown of refunding activity. In California and New York, the drop in
new-issue volume exceeded national levels with declines of 20 percent and 35
percent, respectively. The volume of higher yielding, lower-rated and non-rated
municipal debt was also significantly lower.
Steady demand and lower supply helped municipal bond performance keep pace with
that of Treasuries. The municipal-to-Treasury yield ratio measures the relative
attractiveness of the two sectors. A decline in this ratio indicates that while
municipals outperformed Treasuries for the period measured, they also became
relatively richer (i.e. prices increased to a greater extent). During the
six-month reporting period, the 30-year municipal-to-Treasury yield ratio
declined from 92 to 87 percent. In comparison, the yield ratio reached a high of
102 percent in 2005.
PERFORMANCE ANALYSIS
For the six-month period ended September 30, 2006, Morgan Stanley Municipal
Income Opportunities Trust III's (OIC's) net asset value (NAV) increased from
$9.77 to $10.05 per share. Based on this change plus reinvestment of tax-free
dividends totaling $0.27 per share, the Fund's total NAV return was 5.67
percent. OIC's value on the New York Stock Exchange (NYSE) moved from $9.60 to
$9.86 per share during
2
the same period. Based on this change plus reinvestment of tax-free dividends,
the Fund's total market return was 5.61 percent. OIC's NYSE market price was at
a 1.89 percent discount to its NAV.
Monthly dividends for the fourth quarter of 2006, declared in September, 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 $0.122 per share on September 30, 2006, versus $0.124 per share six months
earlier.(1)
During the reporting period, the Fund's interest-rate posture continued to
reflect the anticipation of higher rates. As a result, at the end of September
the Fund's option-adjusted duration* was conservatively positioned at 6.5 years.
To implement this strategy, U.S. Treasury futures hedges were used to reduce the
portfolio's duration. This positioning helped total returns as interest rates
rose but tempered performance when rates declined in the third quarter. (The
Fund may enter into interest rate swaps in addition to shorting U.S. Treasury
futures to help preserve a return or spread on a particular investment or
portion of the portfolio).
Consistent with its focus on higher yielding securities, the Fund continued to
benefit from tighter credit-quality spreads as high-yield municipal bonds
outperformed investment grade issues during the period. The decline in
high-yield issuance, coupled with strong demand, served as catalysts to their
relative outperformance. During the reporting period, more than two-thirds of
the Fund's assets were below investment grade or non-rated issues. Another boost
to the Fund's performance was the fact that two holdings, representing over 2
percent of net assets, appreciated significantly when they were prerefunded.
Reflecting an ongoing commitment to diversification, the Fund's net assets of
more than $85 million were invested among 12 municipal sectors and 91 credits as
of the end of the period.
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 26.9%
Hospital 17.7
Tax Allocation 13.5
IDR/PCR** 10.9
Nursing & Health Related Facilities 7.8
LONG-TERM CREDIT ANALYSIS
Aaa/AAA 3.6%
Aa/AA 0.3
A/A 1.2
Baa/BBB 23.1
Ba/BB or Less 6.7
Non Rated 65.1
** Industrial Development/Pollution Control Revenue
Data as of September 30, 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 within 60 days of the end of the fund's second
and fourth fiscal quarters 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 September 30, 2006
WEIGHTED AVERAGE MATURITY: 23 YEARS(A)
0-5 7.00
6-10 2.00
11-15 6.00
16-20 11.00
21-25 33.00
26-30 30.00
30+ 11.00
(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%
Alaska.................... 1.2
Arizona................... 1.3
California................ 7.4
Colorado.................. 4.2
Connecticut............... 1.9
District of Columbia...... 1.1
Florida................... 9.3
Georgia................... 0.3
Hawaii.................... 2.0
Idaho..................... 1.2
Illinois.................. 5.1
Indiana................... 2.9
Iowa...................... 2.0
Kansas.................... 2.5
Maryland.................. 2.8
Massachusetts............. 3.8
Minnesota................. 2.1
Missouri.................. 5.8
Nevada.................... 4.8
New Hampshire............. 1.2
New Jersey................ 6.3
New York.................. 7.1
North Carolina............ 1.2
Oklahoma.................. 1.3
Pennsylvania.............. 3.3
South Carolina............ 1.0
Tennessee................. 3.3
Texas..................... 4.9
Virginia.................. 6.9
Washington................ 0.3
Wyoming................... 1.9
Joint exemptions*......... (1.1)
-----
Total+.................... 100.5%
=====
---------------
* Joint exemptions have been included in each geographic location.
+ Does not include open short future contracts with an underlying face value
amount of $4,271,563 with unrealized depreciation of $29,563.
5
CALL AND COST (BOOK) YIELD STRUCTURE
(Based on Long-Term Portfolio) As of September 30, 2006
YEARS BONDS CALLABLE -- WEIGHTED AVERAGE CALL PROTECTION: 6 YEARS(A)
2006(A) 1.00
2007 9.00
2008 7.00
2009 10.00
2010 7.00
2011 10.00
2012 10.00
2013 10.00
2014 8.00
2015 9.00
2016+ 19.00
COST (BOOK) YIELD(B) -- WEIGHTED AVERAGE BOOK YIELD: 6.4%
2006(A) 7.00
2007 6.40
2008 6.40
2009 6.30
2010 7.30
2011 7.40
2012 6.50
2013 6.60
2014 6.10
2015 5.50
2016+ 5.70
(a) May include issues 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 7.0% on 1% of the
long-term portfolio that is callable in 2006.
Portfolio structure is subject to change.
6
INVESTMENT ADVISORY AGREEMENT APPROVAL
NATURE, EXTENT AND QUALITY OF SERVICES
The Board reviewed and considered the nature and extent of the investment
advisory services provided by the Investment Adviser under the Advisory
Agreement, including portfolio management, investment research and fixed income
securities trading. The Board also reviewed and considered the nature and extent
of the non-advisory, administrative services provided by the Fund's
Administrator under the Administration Agreement, including accounting,
clerical, bookkeeping, compliance, business management and planning, and the
provision of supplies, office space and utilities at the Investment Adviser's
expense. (The Investment Adviser and the Administrator together are referred to
as the "Adviser" and the Advisory and Administration Agreements together are
referred to as the "Management Agreement.") The Board also compared the nature
of the services provided by the Adviser with similar services provided by
non-affiliated advisers as reported to the Board by Lipper Inc. ("Lipper").
The Board reviewed and considered the qualifications of the portfolio managers,
the senior administrative managers and other key personnel of the Adviser who
provide the advisory and administrative services to the Fund. The Board
determined that the Adviser's portfolio managers and key personnel are well
qualified by education and/or training and experience to perform the services in
an efficient and professional manner. The Board concluded that the nature and
extent of the advisory and administrative services provided were necessary and
appropriate for the conduct of the business and investment activities of the
Fund. The Board also concluded that the overall quality of the advisory and
administrative services was satisfactory.
PERFORMANCE RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS
On a regular basis, the Board reviews the performance of all funds in the Morgan
Stanley Fund Complex, including the Fund, compared to their peers, paying
specific attention to the underperforming funds. In addition, the Board
specifically reviewed the Fund's performance for the one-, three- and five-year
periods ended November 30, 2005, as shown in a report provided by Lipper (the
"Lipper Report"), compared to the performance of comparable funds selected by
Lipper. The Board considered that the Fund is unleveraged and that eight of the
fifteen funds comprising the performance peer group are leveraged funds. The
Board discussed with the Adviser the performance goals and the actual results
achieved in managing the Fund and concluded that the Fund's performance was
acceptable.
FEES RELATIVE TO OTHER PROPRIETARY FUNDS MANAGED BY THE ADVISER WITH COMPARABLE
INVESTMENT STRATEGIES
The Board reviewed the advisory and administrative fee (together, the
"management fee") rate paid by the Fund under the Management Agreement. The
Board noted that the management fee rate was comparable to
7
the management fee rates charged by the Adviser to other proprietary funds it
manages with investment strategies comparable to those of the Fund.
FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS
The Board reviewed the management fee rate and total expense ratio of the Fund
as compared to the average management fee rate and average total expense ratio
for funds, selected by Lipper (the "expense peer group"), managed by other
advisers with investment strategies comparable to those of the Fund, as shown in
the Lipper Report. The Board concluded that the Fund's management fee rate and
total expense ratio were competitive with those of its expense peer group.
BREAKPOINTS AND ECONOMIES OF SCALE
The Board reviewed the structure of the Fund's management fee schedule under the
Management Agreement and noted that it does not include any breakpoints. The
Board considered that the Fund is a closed-end fund and, therefore, that the
Fund's assets are not likely to grow with new sales or grow significantly as a
result of capital appreciation. The Board concluded that economies of scale for
the Fund were not a factor that needed to be considered at the present time.
PROFITABILITY OF THE ADVISER AND AFFILIATES
The Board considered information concerning the costs incurred and profits
realized by the Adviser and affiliates during the last year from their
relationship with the Fund and during the last two years from their relationship
with the Morgan Stanley Fund Complex and reviewed with the Adviser the cost
allocation methodology used to determine the profitability of the Adviser and
affiliates. Based on its review of the information it received, the Board
concluded that the profits earned by the Adviser and affiliates were not
excessive in light of the advisory, administrative and other services provided
to the Fund.
FALL-OUT BENEFITS
The Board considered so-called "fall-out benefits" derived by the Adviser and
affiliates from their relationship with the Fund and the Morgan Stanley Fund
Complex, such as commissions on the purchase and sale of Fund shares and "float"
benefits derived from handling of checks for purchases and sales of Fund shares,
through a broker-dealer affiliate of the Adviser. The Board concluded that the
commissions were competitive with those of other broker-dealers and the float
benefits were relatively small.
8
SOFT DOLLAR BENEFITS
The Board considered whether the Adviser realizes any benefits from commissions
paid to brokers who execute securities transactions for the Fund ("soft
dollars"). The Board noted that the Fund invests only in fixed income
securities, which do not generate soft dollars.
ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE FUNDS'S NEEDS
The Board considered whether the Adviser is financially sound and has the
resources necessary to perform its obligations under the Management Agreement.
The Board noted that the Adviser's operations remain profitable, although
increased expenses in recent years have reduced the Adviser's profitability. The
Board concluded that the Adviser has the financial resources necessary to
fulfill its obligations under the Management Agreement.
HISTORICAL RELATIONSHIP BETWEEN THE FUND AND THE ADVISER
The Board also reviewed and considered the historical relationship between the
Fund and the Adviser, including the organizational structure of the Adviser, the
policies and procedures formulated and adopted by the Adviser for managing the
Fund's operations and the Board's confidence in the competence and integrity of
the senior managers and key personnel of the Adviser. The Board concluded that
it is beneficial for the Fund to continue its relationship with the Adviser.
OTHER FACTORS AND CURRENT TRENDS
The Board considered the controls and procedures adopted and implemented by the
Adviser and monitored by the Fund's Chief Compliance Officer and concluded that
the conduct of business by the Adviser indicates a good faith effort on its part
to adhere to high ethical standards in the conduct of the Fund's business.
GENERAL CONCLUSION
After considering and weighing all of the above factors, the Board concluded
that it would be in the best interest of the Fund and its shareholders to
approve renewal of the Management Agreement for another year.
9
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2006 (UNAUDITED)
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
----------------------------------------------------------------------------------------------------------
Tax-Exempt Municipal Bonds (97.8%)
Educational Facilities Revenue (6.0%)
$ 1,000 Pima County Industrial Development Authority, Arizona, Noah
Webster Basic School Ser 2004 A.......................... 6.125% 12/15/34 $ 1,052,560
495 Bellalago Educational Facilities Benefits District,
Florida, Bellalago Charter School Ser 2004 B............. 5.80 05/01/34 515,008
500 Illinois Finance Authority, Fullerton Village Student
Housing Ser 2004 A....................................... 5.125 06/01/35 514,170
1,500 Upland, Indiana, Taylor University Ser 2002................ 6.25 09/01/28 1,654,575
420 Maryland Industrial Development Financing Authority, Our
Lady of Good Counsel High School Ser 2005 A.............. 5.50 05/01/20 443,348
1,000 Chattanooga Health Educational & Housing Facilities Board,
Tennessee, Student Housing Refg Ser 2005 A**............. 5.00 10/01/25 1,008,300
-----------
-------
5,187,961
4,915
-----------
-------
Hospital Revenue (17.7%)
1,000 Colbert County -- Northwest Health Care Authority, Alabama,
Helen Keller Hospital Ser 2003........................... 5.75 06/01/27 1,046,900
500 Salida, Hospital District, Colorado, Heart of the Rockies
Regional Medical Center Ser 2006 (WI).................... 5.25 10/01/36 497,380
750 University of Colorado Hospital Authority, Ser 2006 A...... 5.00 11/15/37 766,523
1,500 Hawaii Department of Budget & Finance, Wilcox Memorial
Hospital Ser 1998........................................ 5.50 07/01/28 1,542,570
1,000 Madison County Industrial Development Authority, Idaho,
Madison Memorial Hospital Ser 2006 COPs.................. 5.25 09/01/37 1,037,710
500 Indiana Health Facility Financing Authority, Riverview
Hospital Ser 2002........................................ 6.125 08/01/31 540,720
500 Washington County Hospital, Iowa, Ser 2006................. 5.375 07/01/26 515,465
1,250 Aitkin, Minnesota, Riverwood Healthcare Center Ser 2006.... 5.60 02/01/32 1,281,225
1,000 Nevada, Missouri, Nevada Regional Medical Center Ser
2001..................................................... 6.75 10/01/31 1,062,120
1,000 Henderson, Nevada, Catholic Health West Ser 1998 A......... 5.125 07/01/28 1,018,770
1,000 New Hampshire Higher Educational & Health Facilities
Authority, Littleton Hospital Association Ser 1998 A..... 6.00 05/01/28 1,025,830
1,000 New Jersey Health Care Facilities Financing Authority,
Raritan Bay Medical Center Ser 1994...................... 7.25 07/01/27 1,023,400
1,000 Oklahoma Development Finance Authority, Comanche County
Hospital 2000 Ser B...................................... 6.60 07/01/31 1,114,730
500 Knox County Health, Educational & Housing Facility Board,
Tennessee, Baptist Health of East Tennessee Ser 2002..... 6.50 04/15/31 551,835
See Notes to Financial Statements
10
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2006 (UNAUDITED) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
----------------------------------------------------------------------------------------------------------
$ 500 Decatur Hospital Authority, Texas, Wise Regional Health Ser
2004 A................................................... 7.125% 09/01/34 $ 548,725
1,500 Teton County Hospital District, Wyoming, St John's Medical
Center Ser 2002.......................................... 6.75 12/01/27 1,597,410
-----------
-------
15,171,313
14,500
-----------
-------
Industrial Development/Pollution Control Revenue (10.9%)
1,000 Northern Tobacco Securitization Corporation, Alaska, Ser
2006 A................................................... 5.00 06/01/46 1,002,770
1,000 California County Tobacco Securitization Agency, Gold
County Settlement Funding Corp Ser 2006.................. 0.00 06/01/33 216,330
905 Metropolitan Washington Airports Authority, District of
Columbia & Virginia, CaterAir International Corp Ser 1991
(AMT)+................................................... 10.125 09/01/11 906,348
200 Hawaii Department of Budget & Finance, Hawaiian Electric Co
Ser 1996 A (AMT) (MBIA).................................. 6.20 05/01/26 202,390
1,235 Maryland Industrial Development Financing Authority,
Medical Waste Associates LP 1989 Ser (AMT)............... 8.75 11/15/10 916,790
1,000 Nassau County Tobacco Settlement Corporation, New York, Ser
2006 A-3................................................. 5.125 06/01/46 1,017,480
New York City Industrial Development Agency, New York,
1,000 American Airlines Inc Ser 2005 (AMT)..................... 7.75 08/01/31 1,180,420
1,000 IAC/Interactive Corp Ser 2005............................ 5.00 09/01/35 1,018,340
1,000 7 World Trade Center LLC Ser 2005 A...................... 6.50 03/01/35 1,067,880
425 Carbon County Industrial Development Authority,
Pennsylvania, Panther Creek Partners Refg 2000 Ser
(AMT).................................................... 6.65 05/01/10 448,681
500 Pennsylvania Economic Development Financing Authority,
Reliant Energy Inc Ser 2001 A (AMT)...................... 6.75 12/01/36 537,310
100 Lexington County, South Carolina, Ellett Brothers Inc
Refg Ser 1988............................................ 7.50 09/01/08 99,423
700 Pittsylvania County Industrial Development Authority,
Virginia,
Multi-Trade LP Ser 1994 A (AMT).......................... 7.45 01/01/09 711,011
-----------
-------
9,325,173
10,065
-----------
-------
Mortgage Revenue - Multi-Family (0.3%)
290 Washington Housing Finance Commission, FNMA Collateralized
------- Refg Ser 1990 A.......................................... 7.50 07/01/23 290,580
-----------
Mortgage Revenue - Single Family (0.6%)
25 Maricopa County Industrial Development Authority, Arizona,
Ser 2000-1C (AMT)........................................ 6.25 12/01/30 25,533
205 Colorado Housing Finance Authority, 1998 Ser B-2 (AMT)..... 7.25 10/01/31 209,469
305 Chicago, Illinois, GNMA-Collateralized Ser 1998 A-1
(AMT).................................................... 6.45 09/01/29 312,402
-----------
-------
547,404
535
-----------
-------
See Notes to Financial Statements
11
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2006 (UNAUDITED) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
----------------------------------------------------------------------------------------------------------
Nursing & Health Related Facilities Revenue (7.8%)
$ 2,000 Orange County Health Facilities Authority, Florida,
Westminister Community Care Services Inc Ser 1999........ 6.75% 04/01/34 $ 2,079,640
1,000 Pinellas County Health Facilities Authority, Florida, Oaks
of Clearwater Ser 2004................................... 6.25 06/01/34 1,070,190
Massachusetts Development Finance Agency,
500 Evergreen Center Ser 2005................................ 5.50 01/01/35 511,775
1,205 Kennedy-Donovan Center Inc 1990 Issue.................... 7.50 06/01/10 1,251,597
710 New Jersey Health Care Facilities Financing Authority,
Spectrum for Living - FHA Insured Mortgage Refg Ser B.... 6.50 02/01/22 711,498
1,000 Mount Vernon Industrial Development Agency, New York,
Meadowview at the Wartburg Ser 1999...................... 6.20 06/01/29 1,026,870
-----------
-------
6,651,570
6,415
-----------
-------
Public Facilities Revenue (1.2%)
1,000 Kansas City Industrial Development Authority, Missouri,
------- Plaza Library Ser 2004................................... 5.90 03/01/24 1,008,060
-----------
Recreational Facilities Revenue (7.1%)
1,000 Sacramento Financing Authority, California, Convention
Center Hotel 1999 Ser A.................................. 6.25 01/01/30 1,045,080
1,300 San Diego County, California, San Diego Natural History
Museum COPs.............................................. 5.60 02/01/18 1,300,637
1,500 Mohegan Tribe of Indians of Connecticut, Ser 2001 (a)...... 6.25 01/01/31 1,599,720
1,000 Overland Park Development Corporation, Kansas, Convention
Center Hotel Ser 2000 A.................................. 7.375 01/01/32 1,096,420
1,000 Austin Convention Enterprises Inc, Texas, Convention Center
Hotel Ser 2000 A......................................... 6.70 01/01/32 1,059,830
-----------
-------
6,101,687
5,800
-----------
-------
Retirement & Life Care Facilities Revenue (26.9%)
1,100 Orange County Health Facilities Authority, Florida, Orlando
Lutheran Towers Inc Ser 2005............................. 5.375 07/01/20 1,114,465
1,000 Illinois Finance Authority, Friendship Village of
Schaumburg Ser 2005 A.................................... 5.625 02/15/37 1,028,500
750 Illinois Health Facilities Authority, Villa St Benedict Ser
2003 A-1................................................. 6.90 11/15/33 824,168
275 Saint Joseph County, Indiana, Holy Cross Village at Notre
Dame Ser 2006 A.......................................... 6.00 05/15/26 291,478
1,000 Olathe, Kansas, Catholic Care Ser 2006 A................... 6.00 11/15/38 1,052,960
500 Maryland Health & Higher Education Facilities Authority,
Edenwald Ser 2006 A...................................... 5.40 01/01/37 520,620
1,425 Massachusetts Development Finance Agency, Loomis
Communities Ser 1999 A................................... 5.625 07/01/15 1,468,847
500 Buffalo, Minnesota, Central Minnesota Senior Housing Ser
2006 A................................................... 5.50 09/01/33 500,925
See Notes to Financial Statements
12
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2006 (UNAUDITED) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
----------------------------------------------------------------------------------------------------------
$ 1,000 Kansas City Industrial Development Authority, Missouri,
Bishop Spencer 2004 Ser I................................ 6.25% 01/01/24 $ 1,051,160
New Jersey Economic Development Authority,
1,000 Cedar Crest Village Inc Ser 2001 A....................... 7.25 11/15/31 1,089,330
1,000 Franciscan Oaks Ser 1997................................. 5.70 10/01/17 1,024,780
1,000 Franciscan Oaks Ser 1997................................. 5.75 10/01/23 1,023,830
500 Lions Gate Ser 2005 A.................................... 5.875 01/01/37 516,715
750 Suffolk County Industrial Development Agency, New York,
Jefferson's Ferry Ser 2006............................... 5.00 11/01/28 774,270
1,000 North Carolina Medical Care Commission Health Care
Facilities, Presbyterian Homes Ser 2006.................. 5.50 10/01/31 1,035,800
750 Bucks County Industrial Development Authority,
Pennsylvania, Ann's Choice Ser 2005 A.................... 6.25 01/01/35 802,350
500 Montgomery County Industry Development Authority,
Pennsylvania, Whitemarsh Community Ser 2005.............. 6.25 02/01/35 532,330
750 South Carolina Jobs Economic Development Authority, Wesley
Commons Ser 2006 (WI).................................... 5.30 10/01/36 752,888
Shelby County Health, Educational & Housing Facilities
Board, Tennessee,
500 Trezevant Manor Ser 2006 A............................... 5.75 09/01/37 510,585
750 Village at Germantown Ser 2003 A......................... 7.25 12/01/34 801,113
1,000 Bexar County Health Facilities Development Corporation,
Texas, Army Retirement Residence Ser 2002................ 6.30 07/01/32 1,081,600
500 HFDC Central Texas Inc, Legacy at Willow Bend, Ser 2006 A
(WI)..................................................... 5.75 11/01/36 501,020
1,000 Lubbock Health Facilities Development Corporation, Texas,
Carillon Ser 2005 A...................................... 6.50 07/01/26 1,035,880
2,580 Chesterfield County Industrial Development Authority,
Virginia, Brandermill Woods Ser 1998..................... 6.50 01/01/28 2,671,432
1,000 Peninsula Ports Authority of Virginia, Virginia Baptist
Homes Ser 2006 C......................................... 5.40 12/01/33 1,024,300
-----------
-------
23,031,346
22,130
-----------
-------
Tax Allocation Revenue (13.5%)
475 Carlsbad Community Facility District # 3, California, Ser
2006..................................................... 5.30 09/01/36 487,702
1,500 Poway Unified School District Community Facilities District
# 14, California, Ser 2006............................... 5.25 09/01/36 1,534,290
1,000 San Marcos Community Facilities District # 2002-01,
California, University Commons Ser 2004.................. 5.90 09/01/28 1,046,900
700 Santa Ana Unified School District Community Facilities
District
# 2004-1, California, Ser 2005........................... 5.05 09/01/30 705,726
1,000 Copperleaf Metropolitan District # 2, Colorado, Ser 2006... 5.95 12/01/36 1,019,390
See Notes to Financial Statements
13
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2006 (UNAUDITED) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
----------------------------------------------------------------------------------------------------------
Elk Valley Public Improvement Corporation, Colorado
$ 500 Ser 2001 A............................................... 7.30% 09/01/22 $ 537,035
500 Ser 2001 A............................................... 7.35 09/01/31 533,665
1,000 Midtown Miami Community Development District, Florida,
Parking Garage Ser 2004 A................................ 6.25 05/01/37 1,094,260
500 Bolingbrook, Illinois, Sales Tax Ser 2005.................. 0.00++ 01/01/24 485,740
500 Chicago, Illinois, Lake Shore East Ser 2002................ 6.75 12/01/32 541,715
500 Pingree Grove Special Service Area # 7, Illinois, Cambridge
Lakes Ser 2006........................................... 6.00 03/01/36 511,345
500 Prince George's County, Maryland, National Harbor Ser
2004..................................................... 5.20 07/01/34 509,930
1,000 Des Peres, Missouri, West County Center Ser 2002........... 5.75 04/15/20 1,028,350
500 Clark County Special Improvement District # 142, Nevada,
Mountains Edge Ser 2003.................................. 6.375 08/01/23 518,190
500 Henderson, Nevada, Local Improvement District # T-18 Ser
2006..................................................... 5.30 09/01/35 509,325
500 Allegheny County Redevelopment Authority, Pennsylvania,
Pittsburgh Mills Ser 2004................................ 5.60 07/01/23 529,830
-----------
-------
11,593,393
11,175
-----------
-------
Transportation Facilities Revenue (1.2%)
1,000 Nevada Department of Business & Industry, Las Vegas
------- Monorail 2nd Tier Ser 2000............................... 7.375 01/01/40 1,045,960
-----------
Refunded (4.6%)
2,000 St Johns County Industrial Development Authority, Florida,
Glenmoor Ser 1999 A...................................... 8.00 01/01/10++ 2,143,280
940 Iowa Health Facilities Development Financing Authority,
Care Initiatives Ser 1996................................ 9.25 07/01/11++ 1,171,926
500 Peninsula Ports Authority of Virginia, Virginia Baptist
Homes Ser 2003 A......................................... 7.375 12/01/13++ 612,950
-----------
-------
3,928,156
3,440
-----------
-------
81,265 Total Tax-Exempt Municipal Bonds (Cost $79,406,155)............................ 83,882,603
-----------
-------
Taxable Convertible Bond (0.2%)
Airlines
190 UAL Corp. (Cost $189,924) (b).............................. 5.00 02/01/21 182,688
-----------
-------
NUMBER OF
SHARES
---------
Common Stock (0.0%)
Airlines
224 UAL Corp. (Cost $6,008) (c)................................ 5,952
-----------
-------
See Notes to Financial Statements
14
Morgan Stanley Municipal Income Opportunities Trust III
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 2006 (UNAUDITED) continued
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
---------------------------------------------------------------------------------------------------------
Short-Term Tax-Exempt Municipal Obligations (2.5%)
$ 300 Hapeville Development Authority, Georgia, Haperville Hotel
Ser 1985 (Demand 10/02/06)............................... 3.78*% 11/01/15 $ 300,000
800 Missouri Development Finance Board, Nelson-Atkins Museum of
Art Ser 2001 B (MBIA) (Demand 10/02/06).................. 3.89* 12/01/31 800,000
990 Reno, Nevada, St Mary's Medical Center 1998 Ser B (MBIA)
(Demand 10/02/06)........................................ 3.80* 05/15/23 990,000
------------
-------
2,090 Total Short-Term Tax-Exempt Municipal Obligations (Cost $2,090,000)........... 2,090,000
------------
-------
$83,545 Total Investments (Cost $81,692,087) (d) (e)......................... 100.5% 86,161,243
=======
Liabilities in Excess of Other Assets................................ (0.5) (400,390)
----- -----------
Net Assets........................................................... 100.0% $85,760,853
===== ============
---------------------
AMT Alternative Minimum Tax.
COPs Certificates of Participation.
WI Security purchased on a when-issued basis.
* Current coupon of variable rate demand obligation.
** A portion of this security has been physically segregated in
connection with open futures contracts in the amount of
$20,000.
+ Joint exemption in locations shown.
++ Prerefunded to call date 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) Common stock issued in reorganization.
(d) Securities have been designated as collateral in an amount
equal to $5,981,976 in connection with open futures
contracts and securities purchased on a when-issued basis.
(e) The aggregate cost for federal income tax purposes
approximates the aggregate cost for book purposes. The
aggregate gross unrealized appreciation is $4,866,794 and
the aggregate gross unrealized depreciation is $356,114,
resulting in net unrealized appreciation of $4,510,680.
Bond Insurance:
---------------
MBIA Municipal Bond Investors Assurance Corporation.
FUTURES CONTRACTS OPEN AT SEPTEMBER 30, 2006:
NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE UNREALIZED
CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE DEPRECIATION
------------------------------------------------------------------------------------------------
20 Short U.S. Treasury Notes 10 Year, $(2,110,313) $(10,758)
December 2006
20 Short U.S. Treasury Notes 5 Year, (2,161,250) (18,805)
December 2006
--------
Total Unrealized Depreciation......................... $(29,563)
========
See Notes to Financial Statements
15
Morgan Stanley Municipal Income Opportunities Trust III
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
September 30, 2006 (unaudited)
Assets:
Investments in securities, at value (cost $81,692,087)...... $86,161,243
Cash........................................................ 70,700
Receivable for:
Interest................................................ 1,295,650
Investments sold........................................ 140,665
Variation margin........................................ 3,125
Prepaid expenses and other assets........................... 9,179
-----------
Total Assets............................................ 87,680,562
-----------
Liabilities:
Payable for:
Investments purchased................................... 1,759,866
Investment advisory fee................................. 42,244
Administration fee...................................... 6,759
Transfer agent fee...................................... 3,167
Accrued expenses and other payables......................... 107,673
-----------
Total Liabilities....................................... 1,919,709
-----------
Net Assets.............................................. $85,760,853
===========
Composition of Net Assets:
Paid-in-capital............................................. $81,443,858
Net unrealized appreciation................................. 4,439,593
Accumulated undistributed net investment income............. 1,042,508
Accumulated net realized loss............................... (1,165,106)
-----------
Net Assets.............................................. $85,760,853
===========
Net Asset Value Per Share
8,537,057 shares outstanding (unlimited shares authorized of
$.01 par value)............................................. $10.05
===========
See Notes to Financial Statements
16
Morgan Stanley Municipal Income Opportunities Trust III
FINANCIAL STATEMENTS continued
Statement of Operations
For the six months ended September 30, 2006 (unaudited)
Net Investment Income:
Interest Income............................................. $2,614,087
----------
Expenses
Investment advisory fee..................................... 212,595
Administration fee.......................................... 34,015
Professional fees........................................... 31,719
Shareholder reports and notices............................. 16,859
Listing fees................................................ 10,914
Transfer agent fees and expenses............................ 6,738
Trustees' fees and expenses................................. 4,239
Custodian fees.............................................. 2,612
Other....................................................... 10,481
----------
Total Expenses.......................................... 330,172
Less: expense offset........................................ (2,572)
----------
Net Expenses............................................ 327,600
----------
Net Investment Income................................... 2,286,487
----------
Net Realized and Unrealized Gain (Loss):
Net Realized Gain (Loss) on:
Investments................................................. 219,313
Futures contracts........................................... (41,020)
----------
Net Realized Gain....................................... 178,293
----------
Net Change in Unrealized Appreciation/Depreciation on:
Investments................................................. 2,201,880
Futures contracts........................................... (29,563)
----------
Net Appreciation........................................ 2,172,317
----------
Net Gain................................................ 2,350,610
----------
Net Increase................................................ $4,637,097
==========
See Notes to Financial Statements
17
Morgan Stanley Municipal Income Opportunities Trust III
FINANCIAL STATEMENTS continued
Statements of Changes in Net Assets
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
SEPTEMBER 30, 2006 MARCH 31, 2006
------------------ --------------
(unaudited)
Increase (Decrease) in Net Assets:
Operations:
Net investment income....................................... $ 2,286,487 $ 4,834,759
Net realized gain........................................... 178,293 756,757
Net change in unrealized appreciation/depreciation.......... 2,172,317 1,140,280
----------- -----------
Net Increase............................................ 4,637,097 6,731,796
Dividends to shareholders from net investment income........ (2,307,873) (4,574,650)
Decrease from transactions in shares of beneficial
interest.................................................. (365,290) (2,740,265)
----------- -----------
Net Increase (Decrease)................................. 1,963,934 (583,119)
Net Assets:
Beginning of period......................................... 83,796,919 84,380,038
----------- -----------
End of Period
(Including accumulated undistributed net investment income
of $1,042,508 and $1,063,894, respectively)................. $85,760,853 $83,796,919
=========== ===========
See Notes to Financial Statements
18
Morgan Stanley Municipal Income Opportunities Trust III
NOTES TO FINANCIAL STATEMENTS - SEPTEMBER 30, 2006 (UNAUDITED)
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
19
Morgan Stanley Municipal Income Opportunities Trust III
NOTES TO FINANCIAL STATEMENTS - SEPTEMBER 30, 2006 (UNAUDITED) 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 six months ended September 30, 2006 aggregated
$13,863,642 and $12,712,957, respectively.
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 compensation. The
Trustees voted to close the plan to new participants and eliminate the future
20
Morgan Stanley Municipal Income Opportunities Trust III
NOTES TO FINANCIAL STATEMENTS - SEPTEMBER 30, 2006 (UNAUDITED) continued
benefits growth due to increases to compensation after July 31, 2003. Aggregate
pension costs for the six months ended September 30, 2006 included in Trustees'
fees and expenses in the Statement of Operations amounted to $3,633. At
September 30, 2006, the Fund had an accrued pension liability of $62,377 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 or she 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, 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
Treasury shares purchased and retired (weighted average
discount 4.03%)*.......................................... (38,700) (387) (364,903)
--------- ------- -----------
Balance, September 30, 2006................................. 8,537,057 $85,371 $81,358,487
========= ======= ===========
---------------------
* The Trustees have voted to retire the shares purchased.
5. Dividends
On September 26, 2006, the Fund declared the following dividends from net
investment income:
AMOUNT RECORD PAYABLE
PER SHARE DATE DATE
--------- ---------------- -----------------
0$.045... October 6, 2006 October 20, 2006
0$.045... November 3, 2006 November 17, 2006
0$.045... December 8, 2006 December 22, 2006
21
Morgan Stanley Municipal Income Opportunities Trust III
NOTES TO FINANCIAL STATEMENTS - SEPTEMBER 30, 2006 (UNAUDITED) continued
6. Expense Offset
The expense offset represents a reduction of the fees and expenses for interest
earned on cash balances maintained by the Fund with the transfer agent and
custodian.
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.
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.
9. New Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (FASB) issued
Interpretation 48, Accounting for Uncertainty in Income Taxes - an
interpretation of FASB Statement 109 (FIN 48). FIN 48 clarifies the accounting
for income taxes by prescribing the minimum recognition threshold a tax position
must meet before being recognized in the financial statements. FIN 48 is
effective for fiscal years
22
Morgan Stanley Municipal Income Opportunities Trust III
NOTES TO FINANCIAL STATEMENTS - SEPTEMBER 30, 2006 (UNAUDITED) continued
beginning after December 15, 2006. The Fund will adopt FIN 48 for the fiscal
year ending 2008 and the impact to the Fund's financial statements, if any, is
currently being assessed.
In addition, in September 2006, Statement of Financial Accounting Standards No.
157, Fair Value Measurements (SFAS 157), was issued and is effective for fiscal
years beginning after November 15, 2007. SFAS 157 defines fair value,
establishes a framework for measuring fair value and expands disclosures about
fair value measurements. Management is currently evaluating the impact the
adoption of SFAS 157 will have on the Fund's financial statement disclosures.
23
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 SIX FOR THE YEAR ENDED MARCH 31
MONTHS ENDED ----------------------------------------------------
SEPTEMBER 30, 2006 2006 2005 2004 2003 2002
------------------ -------- -------- -------- -------- --------
(unaudited)
Selected Per Share Data:
Net asset value, beginning of period........ $ 9.77 $ 9.51 $ 9.39 $ 9.33 $ 9.32 $ 9.48
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income*.................. 0.27 0.55 0.53 0.52 0.56 0.57
Net realized and unrealized gain
(loss).................................. 0.28 0.22 0.10 0.09 0.01 (0.12)
------ ------ ------ ------ ------ ------
Total income from investment operations..... 0.55 0.77 0.63 0.61 0.57 0.45
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income................... (0.27) (0.53) (0.53) (0.56) (0.57) (0.57)
Net realized gain....................... -- -- -- -- -- (0.05)
------ ------ ------ ------ ------ ------
Total dividends and distributions........... (0.27) (0.53) (0.53) (0.56) (0.57) (0.62)
------ ------ ------ ------ ------ ------
Anti-dilutive effect of acquiring treasury
shares*.................................... 0.00 0.02 0.02 0.01 0.01 0.01
------ ------ ------ ------ ------ ------
Net asset value, end of period.............. $10.05 $ 9.77 $ 9.51 $ 9.39 $ 9.33 $ 9.32
====== ====== ====== ====== ====== ======
Market value, end of period................. $ 9.86 $ 9.60 $ 8.27 $ 8.92 $ 8.63 $ 8.72
====== ====== ====== ====== ====== ======
Total Return+............................... 5.61%(1) 22.84% (1.27)% 10.00% 5.58% 5.56%
Ratios to Average Net Assets:
Total expenses (before expense offset)...... 0.78%(2)(3) 0.79%(3) 0.93 %(3) 1.02%(3) 0.98%(3) 0.99%(3)
Net investment income....................... 5.38%(2) 5.74% 5.68 % 5.59% 5.96% 6.02%
Supplemental Data:
Net assets, end of period, in thousands..... $85,761 $83,797 $84,380 $85,549 $86,567 $88,271
Portfolio turnover rate..................... 16%(1) 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) Not annualized.
(2) Annualized.
(3) Does not reflect the effect of expense offset of 0.01%.
See Notes to Financial Statements
24
Morgan Stanley Municipal Income Opportunities Trust III
REVISED INVESTMENT POLICY
INTEREST RATE TRANSACTIONS. The Fund may enter into interest rate swaps and may
purchase or sell interest rate caps, floors and collars. The Fund expects to
enter into these transactions primarily to manage interest rate risk, hedge
portfolio positions and preserve a return or spread on a particular investment
or portion of its portfolio. The Fund may also enter into these transactions to
protect against any increase in the price of securities the Fund anticipates
purchasing at a later date. The Fund does not intend to use these transactions
as speculative investments and will not enter into interest rate swaps or sell
interest rate caps or floors where it does not own or have the right to acquire
the underlying securities or other instruments providing the income stream the
Fund may be obligated to pay. Interest rate swaps involve the exchange by the
Fund with another party of their respective commitments to pay or receive
interest, e.g., an exchange of floating rate payments for fixed-rate payments.
The purchase of an interest rate cap entitles the purchaser, to the extent that
a specified index exceeds a predetermined interest rate, to receive payments of
interest on a contractually-based principal amount from the party selling the
interest rate cap. The purchase of an interest rate floor entitles the
purchaser, to the extent that a specified index falls below a predetermined
interest rate, to receive payments of interest on a contractually-based
principal amount from the party selling the interest rate floor. An interest
rate collar combines the elements of purchasing a cap and selling a floor. The
collar protects against an interest rate rise above the maximum amount but
foregoes the benefit of an interest rate decline below the minimum amount.
The Fund may enter into interest rate swaps, caps, floors and collars on either
an asset-based or liability-based basis, and will usually enter into interest
rate swaps on a net basis, i.e., the two payment streams are netted out, with
the Fund receiving or paying, as the case may be, only the net amount of the two
payments. The net amount of the excess, if any, of the Fund's obligations over
its entitlements with respect to each interest rate swap will be accrued on a
daily basis and the Fund segregates an amount of cash and/or liquid securities
having an aggregate net asset value at least equal to the accrued excess. If the
Fund enters into an interest rate swap on other than a net basis, the Fund would
segregate the full amount accrued on a daily basis of the Fund's obligations
with respect to the swap. Interest rate transactions do not constitute senior
securities under the 1940 Act when the Fund segregates assets to cover the
obligations under the transactions. The Fund will enter into interest rate swap,
cap or floor transactions only with counterparties approved by the Fund's Board
of Trustees. The Adviser will monitor the creditworthiness of counterparties to
the Fund's interest rate swap, cap, floor and collar transactions on an ongoing
basis. If there is a default by the other party to such a transaction, the Fund
will have contractual remedies pursuant to the agreements related to the
transaction. To the extent the Fund sells (i.e., writes) caps, floors and
collars, it will segregate cash and/or liquid securities having an aggregate net
asset value at least equal to the full amount, accrued on a daily basis, of the
Fund's net obligations with respect to the
25
caps, floors or collars. The use of interest rate swaps is a highly specialized
activity which involves investment techniques and risks different from those
associated with ordinary portfolio securities transactions. If the Adviser is
incorrect in its forecasts of the market values, interest rates and other
applicable factors, the investment performance of the Fund would diminish
compared with what it would have been if these investment techniques were not
used. The use of interest rate swaps, caps, collars and floors may also have the
effect of shifting the recognition of income between current and future periods.
These transactions do not involve the delivery of securities or other underlying
assets or principal. Accordingly, the risk of loss with respect to interest rate
swaps is limited to the net amount of interest payments that the Fund is
contractually obligated to make. If the other party to an interest rate swap
defaults, the Fund's risk of loss consists of the net amount of interest
payments that the Fund contractually is entitled to receive.
26
(This Page Intentionally Left Blank)
TRUSTEES
Frank L. Bowman
Michael Bozic
Kathleen A. Dennis
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Joseph J. Kearns
Michael F. Klein
Michael E. Nugent
W. Allen Reed
Fergus Reid
OFFICERS
Michael E. Nugent
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
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
The financial statements included herein have been taken from the records of the
Fund without examination by the independent auditors and accordingly they do not
express an opinion thereon.
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
Semiannual Report
September 30, 2006
[MORGAN STANLEY LOGO]
01CSAR-RA06-01036P-Y09/06
Item 2. Code of Ethics.
Not applicable for semiannual reports.
Item 3. Audit Committee Financial Expert.
Not applicable for semiannual reports.
Item 4. Principal Accountant Fees and Services
Not applicable for semiannual reports.
Item 5. Audit Committee of Listed Registrants.
Not applicable for semiannual reports.
Item 6.
Refer to Item 1.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies.
Not applicable for semiannual reports.
Item 8. Portfolio Managers of Closed-End Management Investment Companies
Applicable only to reports covering periods ending on or after December 31,
2005.
Item 9. Closed-End Fund Repurchases
REGISTRANT PURCHASE OF EQUITY SECURITIES
(d) Maximum
(c) Total Number (or
Number of Approximate
Shares Dollar Value)
(or Units) of Shares (or
Purchased Units) that
(a) Total as Part of May Yet Be
Number of (b) Average Publicly Purchased
Shares Price Paid Announced Under the
(or Units) per Share Plans or Plans or
Period Purchased (or Unit) Programs Programs
------ ---------- ----------- ---------- -------------
April 1, 2006-
April 30, 2006 19,100 $9.5028 N/A N/A
May 1, 2006-
May 31, 2006 6,400 9.4178 N/A N/A
June 1, 2006-
June 30, 2006 13,200 9.3481 N/A N/A
July 1, 2006-
July 31, 2006 -- -- N/A N/A
August 1, 2006-
August 31, 2006 -- -- N/A N/A
September 1, 2006-
September 30, 2006 -- -- N/A N/A
------ ------- --- ---
Total 38,700 $9.4229 N/A N/A
====== ======= === ===
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.
2
(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) Code of Ethics - Not applicable for semiannual reports.
(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.
3
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
November 21, 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
November 21, 2006
/s/ Francis Smith
-------------------------------------
Francis Smith
Principal Financial Officer
November 21, 2006
4