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: 811-07096 ---------------------------------------------- Investment Grade Municipal Income Fund Inc. ------------------------------------------------------------------------------ (Exact name of registrant as specified in charter) 51 West 52nd Street, New York, New York 10019-6114 ------------------------------------------------------------------------------ (Address of principal executive offices) (Zip code) Mark F. Kemper, Esq. UBS Global Asset Management (US) Inc. 51 West 52nd Street New York, NY 10019-6114 (Name and address of agent for service) Copy to: Jack W. Murphy, Esq. Dechert LLP 1775 I Street, N.W. Washington, DC 20006-2401 Registrant's telephone number, including area code: 212-882 5000 Date of fiscal year end: September 30 Date of reporting period: September 30, 2004 ITEM 1. REPORTS TO STOCKHOLDERS. --------------------------------- [UBS GLOBAL ASSET MANAGEMENT LOGO] INVESTMENT GRADE MUNICIPAL INCOME FUND INC. Annual Report September 30, 2004 Investment Grade Municipal Income Fund Inc. November 15, 2004 INVESTMENT GRADE MUNICIPAL INCOME FUND INC. Dear Shareholder, INVESTMENT GOAL: We present you with the annual report for High level of current income Investment Grade Municipal Income Fund Inc. exempt from federal (the "Fund") for the fiscal year ended income tax, consistent with September 30, 2004. preservation of capital. Performance PORTFOLIO MANAGER: William Veronda Over the 12-month period, the Fund's net UBS Global Asset asset value return was 6.02%. On a market Management (US) Inc. price basis, the Fund's return was 5.57%. Over the same period, the Lipper General COMMENCEMENT: Municipal Debt Funds (Leveraged) median's November 6, 1992 net asset value and market price returns were 7.50% and 8.00%, respectively. NYSE SYMBOL: (For more performance information, please PPM refer to "Performance At A Glance" on page 5.) DIVIDEND PAYMENTS: Monthly The Fund used leverage during the fiscal year, which was 39.4% of total assets as of September 30, 2004. Leverage can magnify returns on the upside and on the downside, and can create wider dispersions of returns within the Fund's peer group. An Interview with Portfolio Manager William Veronda Q. CAN YOU DESCRIBE THE ECONOMIC ENVIRONMENT DURING THE FISCAL YEAR? A. During the period, gross domestic product (GDP) figures confirmed that the US economy was growing, fueled by the combined effects of solid consumer and business spending, an increase in exports and ongoing military spending. Third quarter 2003 GDP came in at 8.2%, up from 3.3% over the prior three months. This number was far higher than anticipated, and the sharpest recorded advance of GDP since 1984. Fourth quarter 2003 and first quarter 2004 numbers were solid at 4.1% and 4.5%, respectively, followed by a more muted second quarter GDP of 3.3%. -------------------------------------------------------------------------------- 1 Investment Grade Municipal Income Fund Inc. Q. HOW DID THE FEDERAL RESERVE BOARD (THE "FED") REACT TO THESE ECONOMIC CONDITIONS? A. The Fed maintained its accommodative monetary policy through much of the fiscal year. As late as the end of March 2004, many market participants believed the Fed would hold rates steady until after the November presidential election, or until early 2005. However, this abruptly changed as improvements in the labor market became apparent. During March, April and May, a total of nearly one million new jobs were created. This, in turn, prompted the Fed to begin laying the groundwork for higher rates. After many months of speculation, the Fed raised the federal funds rate (or "fed funds" rate)-the rate that banks charge one another for funds they borrow on an overnight basis-from 1.00% to 1.25% on June 30, 2004. The Fed raised rates again at its subsequent meetings on August 10, 2004 and September 21, 2004, to 1.50% and 1.75%, respectively. In doing so, it noted that, "Even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity." Market perception grew that the Fed, through its statements and in its actions, was paving the way to continue raising rates in the future. Q. HOW DID YOU POSITION THE FUND'S PORTFOLIO DURING THE REPORTING PERIOD? A. As the fiscal year began, the Fund's duration was similar to that of the Lehman Municipal Bond Index. Given expectations for a continuation of the economic recovery and rising interest rates, in early 2004 we moved the Fund's duration modestly lower than that of the Index. This initially detracted from results when, surprisingly, yields fell during the first quarter of 2004. However, as fears of a "jobless economic recovery" abated in the second quarter, this positioning enhanced performance. The economy then appeared to weaken in the third quarter of the year, due in large part to record high oil prices. This caused yields to again decline, and the Fund's short duration hurt relative performance. Fortunately, astute yield curve positioning in the third quarter helped to offset some of the losses, as our expectations for a flattening yield curve were met (the curve flattens when the gap between short- and long-term yields narrows). In particular, in recent months we emphasized securities in the 5- to 10-year and 20- to 30-year portions of the curve, while holding underweight positions in the 1- to 5-year and 10- to 15-year ranges of the curve. -------------------------------------------------------------------------------- 2 Investment Grade Municipal Income Fund Inc. Q. WHICH SECTORS OF THE MARKET DID YOU FIND TO BE ATTRACTIVE DURING THE FISCAL YEAR? A. The Fund is highly diversified, and we seek compelling opportunities in a wide variety of sectors and subsectors. For example, because of declining government reimbursements, we remain negative on the healthcare sector as a whole. However, using our extensive research capabilities, we identified a number of securities that we believe offer attractive yields and, in our opinion, more than compensate investors for the potential risks. During the fiscal year, we purchased Kaiser Permanente (1.1%),* a California-based health maintenance organization. We also purchased a block of bonds issued by St. Francis Healthcare Center in Minnesota (0.9%).* Q. WHAT HAS BEEN YOUR APPROACH IN TERMS OF THE CALIFORNIA MUNICIPAL MARKET? A. California was one of a number of states that saw its fiscal situation improve during the 12-month period; thus, we added a number of California issues to our portfolio. At period end, the Fund's California holdings had enhanced results. Another state that shored up its balance sheet in the latter months of the period was Massachusetts, and we are therefore looking to increase the Fund's exposure to this state's municipal securities. Q. THE TROUBLES IN THE AIRLINE SECTOR HAVE BEEN WELL-DOCUMENTED. DOES THE FUND HAVE ANY EXPOSURE TO THIS AREA? A. While the airline industry is experiencing high-profile issues, we continue to find attractive opportunities in the airport sector. Over the last year, both business and consumer flight trends have improved. Given the expectations for a continuation of an economic expansion, we expect airfreight usage will remain strong. Q. WHAT OTHER STRATEGIES DID YOU IMPLEMENT DURING THE PERIOD? A. As we mentioned in our last report to you, we increased the Fund's leverage from approximately 33% to 40% at the end of December 2003, through the Fund's issuance of an additional series of Auction Preferred Shares. Although leverage can cause the Fund's short-term volatility to increase, it also can better position the Fund to seek preservation of capital. Additionally, it has the * As a percentage of net assets applicable to common shareholders as of September 30, 2004. -------------------------------------------------------------------------------- 3 Investment Grade Municipal Income Fund Inc. potential to allow us to generate additional dividend income. We, therefore, maintained the Fund's leverage at roughly 40% over most of the period. Q. HOW DO YOU ANTICIPATE POSITIONING THE FUND'S PORTFOLIO GOING FORWARD? A. Although the US economy experienced a "soft patch" during the third quarter, it now appears that this may have been overstated. Final second-quarter gross domestic product was revised upward from 2.8% to 3.3%. In addition, aside from stubbornly high oil prices, inflation remains low. We believe the Fed will continue to raise interest rates, and, as such, we expect to retain our short duration position. We also anticipate remaining focused on the 5- to 10-year and 20- to 30-year portions of the yield curve. We will continue to look for opportunities in the general obligation market, in particular issues from the state of California. Having said that, we expect to avoid securities in the 1- to 5-year range, as we do not believe they are attractive given the underlying risks. On a national level, we will seek higher yielding securities that appear attractive given their risk/reward characteristics. We thank you for your continued support and welcome any comments or questions you may have. For additional information on the UBS Funds,* please contact your financial advisor or visit us at www.ubs.com. Sincerely, /s/ Joseph A. Varnas /s/ William Veronda Joseph A. Varnas William Veronda President Portfolio Manager Investment Grade Municipal Income Fund Inc. Investment Grade Municipal Income Fund Inc. Managing Director Executive Director UBS Global Asset Management (US) Inc. UBS Global Asset Management (US) Inc. This letter is intended to assist shareholders in understanding how the Fund performed during the fiscal year ended September 30, 2004, and reflects our views at the time of its writing. Of course, these views may change in response to changing circumstances, and they do not guarantee the future performance of the markets or the Fund. We encourage you to consult your financial advisor regarding your personal investment program. * Mutual funds are sold by prospectus only. A prospectus contains more complete information regarding investment objectives, risks, charges and expenses, and should be read carefully before investing. -------------------------------------------------------------------------------- 4 Investment Grade Municipal Income Fund Inc. Performance At A Glance Average Annual Total Returns For Periods Ended 9/30/04 NET ASSET VALUE RETURNS 6 MONTHS 1 YEAR 5 YEARS 10 YEARS --------------------------------------------------------------------------------------- Investment Grade Municipal Income Fund Inc. 2.43% 6.02% 6.78% 7.19% --------------------------------------------------------------------------------------- Lipper General Municipal Debt Funds (Leveraged) Median 1.94 7.50 8.05 7.46 --------------------------------------------------------------------------------------- MARKET PRICE RETURNS --------------------------------------------------------------------------------------- Investment Grade Municipal Income Fund Inc. -4.53 5.57 8.40 8.70 --------------------------------------------------------------------------------------- Lipper General Municipal Debt Funds (Leveraged) Median -1.45 8.00 9.05 8.14 --------------------------------------------------------------------------------------- Past performance does not predict future performance. The return and principal value of an investment will fluctuate, so that an investor's shares, when sold, may be worth more or less than their original cost. NAV return assumes, for illustration only, that dividends were reinvested at the net asset value on the payable dates. NAV and market price returns for periods less than one year are cumulative. Returns do not reflect the deduction of taxes that a shareholder could pay on Fund distributions. Lipper peer group data calculated by Lipper Inc.; used with permission. The Lipper Median is the return of the fund that places in the middle of the peer group. SHARE PRICE, DIVIDEND AND YIELDS AS OF 9/30/04 ----------------------------------------------------------------------- Market Price $14.25 ----------------------------------------------------------------------- Net Asset Value (per share applicable to common shareholders) $15.81 ----------------------------------------------------------------------- 12-Month Net Investment Income Dividend (ended 9/30/04) $0.93 ----------------------------------------------------------------------- September 2004 Dividend $0.075 ----------------------------------------------------------------------- Market Yield* 6.32% ----------------------------------------------------------------------- NAV Yield* 5.69% ----------------------------------------------------------------------- IPO Yield* 6.00% ----------------------------------------------------------------------- * Market yield is calculated by multiplying the September dividend by 12 and dividing by the month-end market price. NAV yield is calculated by multiplying the September dividend by 12 and dividing by the month-end net asset value. IPO yield is calculated by multiplying the September dividend by 12 and dividing by the initial public offering price. Prices and yields will vary. -------------------------------------------------------------------------------- 5 Investment Grade Municipal Income Fund Inc. Portfolio Statistics CHARACTERISTICS 9/30/04 3/31/04 9/30/03 -------------------------------------------------------------------------------------------------------------- Net Assets Applicable to Common Shareholders (mm) $163.7 $164.5 $168.9 -------------------------------------------------------------------------------------------------------------- Weighted Average Maturity* 11.7 yrs 11.2 yrs 13.0 yrs -------------------------------------------------------------------------------------------------------------- Weighted Average Duration* 5.1 yrs 5.1 yrs 6.3 yrs -------------------------------------------------------------------------------------------------------------- Weighted Average Coupon* 5.5% 5.3% 5.4% -------------------------------------------------------------------------------------------------------------- Leverage** 39.4% 40.0% 32.1% -------------------------------------------------------------------------------------------------------------- Callable/Maturing Within 5 Years* 9.1% 6.0% 5.8% -------------------------------------------------------------------------------------------------------------- Callable/Maturing Beyond 5 Years* 90.9% 94.0% 94.2% -------------------------------------------------------------------------------------------------------------- PORTFOLIO COMPOSITION*** 9/30/04 3/31/04 9/30/03 -------------------------------------------------------------------------------------------------------------- Long-Term Municipal Bonds 160.2% 155.1% 135.8% -------------------------------------------------------------------------------------------------------------- Short-Term Municipal Notes 6.4 9.6 7.8 -------------------------------------------------------------------------------------------------------------- Futures (0.0)**** (0.1) - -------------------------------------------------------------------------------------------------------------- Other Assets Less Liabilities 0.6 2.3 3.8 -------------------------------------------------------------------------------------------------------------- Liquidation Value of Auction Preferred Shares (67.2) (66.9) (47.4) -------------------------------------------------------------------------------------------------------------- TOTAL 100.0% 100.0% 100.0% -------------------------------------------------------------------------------------------------------------- CREDIT QUALITY*** 9/30/04 3/31/04 9/30/03 -------------------------------------------------------------------------------------------------------------- AAA/Aaa 59.2% 47.0% 50.8% -------------------------------------------------------------------------------------------------------------- AA/Aa 40.3 46.4 37.3 -------------------------------------------------------------------------------------------------------------- A/A 29.4 27.6 16.0 -------------------------------------------------------------------------------------------------------------- BBB/Baa 18.0 20.7 18.8 -------------------------------------------------------------------------------------------------------------- BB/Ba - - 0.9 -------------------------------------------------------------------------------------------------------------- A1/P1/SP-1/VMIG-1 6.4 9.6 6.9 -------------------------------------------------------------------------------------------------------------- Nonrated 13.3 13.4 12.9 -------------------------------------------------------------------------------------------------------------- Other Assets Less Liabilities 0.6 2.2 3.8 -------------------------------------------------------------------------------------------------------------- Liquidation Value of Auction Preferred Shares (67.2) (66.9) (47.4) -------------------------------------------------------------------------------------------------------------- TOTAL 100.0% 100.0% 100.0% -------------------------------------------------------------------------------------------------------------- TOP FIVE STATES*** 9/30/04 3/31/04 9/30/03 -------------------------------------------------------------------------------------------------------------- California 29.4% New York 26.3% Texas 23.0% -------------------------------------------------------------------------------------------------------------- New York 19.0 California 20.9 California 16.2 -------------------------------------------------------------------------------------------------------------- Texas 17.9 Texas 19.1 New York 11.8 -------------------------------------------------------------------------------------------------------------- Florida 10.6 Indiana 10.3 Illinois 10.4 -------------------------------------------------------------------------------------------------------------- Indiana 9.7 Illinois 8.3 Indiana 10.1 -------------------------------------------------------------------------------------------------------------- TOTAL 86.6% 84.9% 71.5% -------------------------------------------------------------------------------------------------------------- TOP FIVE SECTORS*** 9/30/04 3/31/04 9/30/03 -------------------------------------------------------------------------------------------------------------- Power 36.6% Power 39.3% Power 36.3% -------------------------------------------------------------------------------------------------------------- Lease 20.7 Water & Sewer 26.2 Water & Sewer 25.6 -------------------------------------------------------------------------------------------------------------- Water & Sewer 15.7 Lease 21.2 Lease 21.3 -------------------------------------------------------------------------------------------------------------- Hospital 11.3 Escrowed to Maturity 11.2 Hospital 6.6 -------------------------------------------------------------------------------------------------------------- Escrowed to Maturity 10.2 Pre-refunded 8.9 Tolls 6.3 -------------------------------------------------------------------------------------------------------------- TOTAL 94.5% 106.8% 96.1% -------------------------------------------------------------------------------------------------------------- * Weightings represent percentages of portfolio assets as of the dates indicated. The Fund's portfolio is actively managed and its composition will vary over time. ** As a percentage of total assets as of the dates indicated. *** As a percentage of net assets applicable to common shareholders as of the dates indicated. Credit quality ratings designated by Standard & Poor's Rating Group and Moody's Investor Services, Inc. Both are independent rating agencies. **** Represents less than 0.05% of net assets applicable to common shareholders. -------------------------------------------------------------------------------- 6 Investment Grade Municipal Income Fund Inc. PORTFOLIO OF INVESTMENTS-SEPTEMBER 30, 2004 PRINCIPAL MOODY'S S&P AMOUNT RATING RATING MATURITY INTEREST (000) (UNAUDITED) (UNAUDITED) DATES RATES VALUE -------------------------------------------------------------------------------------------------------------- Long-Term Municipal Bonds - 160.21% -------------------------------------------------------------------------------------------------------------- Arizona - 1.60% $2,380 Arizona State Transportation Board Highway Revenue- Series B Aa1 AAA 07/01/18 5.250% $2,625,783 -------------------------------------------------------------------------------------------------------------- Arkansas - 1.09% 1,705 Little Rock Capital Improvement Revenue Parks & Recreation Projects-Series A NR NR 01/01/18 5.700 1,781,316 -------------------------------------------------------------------------------------------------------------- California - 29.41% 5,000 California State Department Water Resources Revenue- Series A A2 BBB+ 05/01/16 5.875 5,703,200 -------------------------------------------------------------------------------------------------------------- 5,000 California State Economic Recovery General Obligation- Series A (FGIC Insured) Aaa AAA 07/01/14 5.250 5,684,200 -------------------------------------------------------------------------------------------------------------- 4,000 California State Economic Recovery General Obligation- Series A (MBIA Insured) Aaa AAA 07/01/12 5.000 4,458,720 -------------------------------------------------------------------------------------------------------------- 2,290 California State Variable Purpose General Obligation A3 A 04/01/11 5.000 2,517,580 -------------------------------------------------------------------------------------------------------------- 3,000 California Statewide Communities Development Authority Irvine Apartment Communities-Series A-3 Baa2 BBB 05/15/25+ 5.100 3,167,340 -------------------------------------------------------------------------------------------------------------- 1,750 California Statewide Communities Development Authority Revenue Kaiser Permanente-Series H NR A 04/01/34+ 2.625 1,744,628 -------------------------------------------------------------------------------------------------------------- 2,150 Fontana Redevelopment Agency Tax Allocation Jurupa Hills Redevelopment Project A NR A- 10/01/17 5.500 2,292,394 -------------------------------------------------------------------------------------------------------------- 5,000 Los Angeles County Sanitation Funding Authority Revenue- Series A (FSA Insured) Aaa AAA 10/01/18 5.000 5,402,350 -------------------------------------------------------------------------------------------------------------- 3,000 Los Angeles Water & Power Revenue Power Systems- Series A (MBIA Insured) Aaa AAA 07/01/16 5.000 3,272,760 -------------------------------------------------------------------------------------------------------------- 3,200 Los Angeles Water & Power Revenue Power Systems- Series A-A-1 (FSA Insured) Aaa AAA 07/01/21 5.250 3,464,288 -------------------------------------------------------------------------------------------------------------- 6,000 Los Angeles Water & Power Revenue Power Systems- Series A-A-1 (MBIA Insured) Aaa AAA 07/01/14 5.000 6,637,440 -------------------------------------------------------------------------------------------------------------- 3,500 Metropolitan Water District of Southern California Waterworks-Series A Aaa AAA 03/01/18 5.250 3,811,990 -------------------------------------------------------------------------------------------------------------- 48,156,890 -------------------------------------------------------------------------------------------------------------- Colorado - 1.15% 1,742 University of Colorado Participation Interests NR A- 12/01/13 6.000 1,884,983 -------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 7 Investment Grade Municipal Income Fund Inc. PORTFOLIO OF INVESTMENTS-SEPTEMBER 30, 2004 PRINCIPAL MOODY'S S&P AMOUNT RATING RATING MATURITY INTEREST (000) (UNAUDITED) (UNAUDITED) DATES RATES VALUE -------------------------------------------------------------------------------------------------------------- Long-Term Municipal Bonds - (continued) -------------------------------------------------------------------------------------------------------------- Florida - 10.57% $6,495 Broward County Parks & Land Preservation Project Aa1 AA+ 01/01/22 5.000% $6,869,112 -------------------------------------------------------------------------------------------------------------- 1,175 Gainesville Utilities Systems Revenue-Series A Aa2 AA 10/01/20 5.250 1,282,336 -------------------------------------------------------------------------------------------------------------- 2,000 Orlando Utilities Commission Water & Electric Revenue- Series A Aa1 AA 10/01/19 5.000 2,138,500 -------------------------------------------------------------------------------------------------------------- 6,425 Orlando Utilities Commission Water & Electric Revenue- Series C # Aa1 AA 10/01/18 5.250 7,020,983 -------------------------------------------------------------------------------------------------------------- 17,310,931 -------------------------------------------------------------------------------------------------------------- Illinois - 4.46% 5,000 Chicago Parking District Parking Facility Revenue (Pre-refunded with U.S. Government Securities to 01/01/2010) Baa1 A 01/01/14 6.250 5,794,550 -------------------------------------------------------------------------------------------------------------- 1,200 Illinois Educational Facilities Authority Revenue Augustana College-Series A Baa1 NR 10/01/22 5.625 1,257,024 -------------------------------------------------------------------------------------------------------------- 250 Metropolitan Pier & Exposition Authority A1 NR 06/15/27 6.500 252,963 -------------------------------------------------------------------------------------------------------------- 7,304,537 -------------------------------------------------------------------------------------------------------------- Indiana - 9.66% 1,000 Clark Pleasant Community School Building Corp. First Mortgage (AMBAC Insured) Aaa AAA 07/15/17 5.500 1,122,200 -------------------------------------------------------------------------------------------------------------- 3,305 Indiana Transportation Financing Authority Airport Facilities Lease Revenue-Series A A1 AA 11/01/12 5.500 3,429,004 -------------------------------------------------------------------------------------------------------------- 1,430 Indiana Transportation Financing Authority Airport Facilities Lease Revenue-Series A A1 AA- 11/01/16 6.250 1,434,833 -------------------------------------------------------------------------------------------------------------- 2,000 Indiana Transportation Financing Authority Airport Facilities Lease Revenue-Series A A1 AA 11/01/17 5.500 2,066,120 -------------------------------------------------------------------------------------------------------------- 3,400 Marion County Convention & Recreational Facilities Authority Excise Tax Revenue-Series A (MBIA Insured) Aaa AAA 06/01/17 5.500 3,801,200 -------------------------------------------------------------------------------------------------------------- 1,865 Wayne Township Marion County School Building Corp.- First Mortgage NR A+ 01/15/15 5.250 1,951,909 -------------------------------------------------------------------------------------------------------------- 1,915 Wayne Township Marion County School Building Corp.- First Mortgage NR A+ 07/15/15 5.250 2,004,239 -------------------------------------------------------------------------------------------------------------- 15,809,505 -------------------------------------------------------------------------------------------------------------- Iowa - 3.21% 4,880 Polk County-Series A # Aa1 AA+ 06/01/19 5.000 5,259,566 -------------------------------------------------------------------------------------------------------------- Kentucky - 4.89% 7,750 Boone County Pollution Control Revenue Dayton Power & Light Co.-Series A Baa3 BBB- 11/15/22 6.500 8,004,200 -------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 8 Investment Grade Municipal Income Fund Inc. PORTFOLIO OF INVESTMENTS-SEPTEMBER 30, 2004 PRINCIPAL MOODY'S S&P AMOUNT RATING RATING MATURITY INTEREST (000) (UNAUDITED) (UNAUDITED) DATES RATES VALUE -------------------------------------------------------------------------------------------------------------- Long-Term Municipal Bonds - (continued) -------------------------------------------------------------------------------------------------------------- Louisiana - 2.18% $ 3,280 New Orleans Sewage Service Revenue Aaa AAA 06/01/16 5.000% $3,563,195 -------------------------------------------------------------------------------------------------------------- Massachusetts - 7.65% 5,865 Massachusetts State Consolidated Loan-Series A Aa2 AA- 08/01/16 5.000 6,498,772 -------------------------------------------------------------------------------------------------------------- 2,000 Massachusetts State Water Pollution Abatement-Series A Aaa AAA 08/01/20 5.250 2,155,480 -------------------------------------------------------------------------------------------------------------- 1,305 University of Massachusetts Building Authority Revenue Refunding-Series 05-1 (AMBAC Insured) (a) Aaa AAA 05/01/12 5.000 1,423,833 -------------------------------------------------------------------------------------------------------------- 1,235 University of Massachusetts Building Authority Revenue Refunding-Series 05-1 (AMBAC Insured) (a) Aaa AAA 05/01/13 5.000 1,348,991 -------------------------------------------------------------------------------------------------------------- 1,000 University of Massachusetts Building Authority Revenue Refunding-Series 05-1 (AMBAC Insured) (a) Aaa AAA 05/01/14 5.000 1,091,100 -------------------------------------------------------------------------------------------------------------- 12,518,176 -------------------------------------------------------------------------------------------------------------- Michigan - 4.82% 3,425 Michigan State Building Authority Revenue Program-Series III Aa2 AA 10/15/16 5.375 3,853,776 -------------------------------------------------------------------------------------------------------------- 2,000 Michigan State Strategic Fund Limited Obligation Revenue-Ford Motor Co. Project-Series A Baa1 BBB- 02/01/06 7.100 2,115,680 -------------------------------------------------------------------------------------------------------------- 1,750 Michigan Municipal Bond Authority Clear Water Revenue Aaa AAA 10/01/19 5.250 1,928,325 -------------------------------------------------------------------------------------------------------------- 7,897,781 -------------------------------------------------------------------------------------------------------------- Minnesota - 0.93% 1,500 Shakopee Health Care Facilities Saint Francis Regional Medical Center Revenue Refunding NR BBB 09/01/17 5.000 1,530,885 -------------------------------------------------------------------------------------------------------------- Nevada - 4.19% 6,750 Clark County Pollution Control Revenue Nevada Power Co. Project-Series B (FGIC Insured) Aaa AAA 06/01/19 6.600 6,856,380 -------------------------------------------------------------------------------------------------------------- New Mexico - 0.68% 1,000 University of New Mexico Revenues Sub Lien-Series A Aa3 AA 06/01/16 5.250 1,109,670 -------------------------------------------------------------------------------------------------------------- New York - 19.05% 4,030 Long Island Power Authority Electric Systems Revenue- Series C Baa1 A- 09/01/17 5.500 4,438,319 -------------------------------------------------------------------------------------------------------------- 1,765 Metropolitan Transportation Authority New York Dedicated Tax Fund-Series A (FSA Insured) Aaa AAA 11/15/24 5.250 1,878,878 -------------------------------------------------------------------------------------------------------------- 5,000 New York City General Obligation-Series G A2 A 08/01/09 5.000 5,451,550 -------------------------------------------------------------------------------------------------------------- 2,500 New York City General Obligation-Series G A2 A 08/01/13 5.000 2,736,025 -------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 9 Investment Grade Municipal Income Fund Inc. PORTFOLIO OF INVESTMENTS-SEPTEMBER 30, 2004 PRINCIPAL MOODY'S S&P AMOUNT RATING RATING MATURITY INTEREST (000) (UNAUDITED) (UNAUDITED) DATES RATES VALUE ---------------------------------------------------------------------------------------------------------- Long-Term Municipal Bonds - (continued) ---------------------------------------------------------------------------------------------------------- New York - (concluded) ---------------------------------------------------------------------------------------------------------- $ 2,000 New York City Municipal Water Finance Authority Revenue- Water & Sewer Systems- Series D Aa2 AA+ 06/15/17 5.250% $2,182,320 ---------------------------------------------------------------------------------------------------------- 1,625 Triborough Bridge & Tunnel Authority Revenue-Series B Aa3 AA- 11/15/18 5.250 1,774,061 ---------------------------------------------------------------------------------------------------------- 8,155 Triborough Bridge & Tunnel Authority Revenue-Series B # Aa3 AA- 11/15/19 5.250 8,873,537 ---------------------------------------------------------------------------------------------------------- 3,350 Triborough Bridge & Tunnel Authority Revenue-Series Y Aa3 AAA 01/01/12 6.000 3,851,998 ---------------------------------------------------------------------------------------------------------- 31,186,688 ---------------------------------------------------------------------------------------------------------- North Carolina - 7.02% 5,000 North Carolina Eastern Municipal Power Agency-Series A (Escrowed to Maturity) Baa2 BBB 01/01/11 5.500 5,463,000 ---------------------------------------------------------------------------------------------------------- 2,000 North Carolina Eastern Municipal Power Agency-Series A (Escrowed to Maturity) Baa2 BBB 01/01/12 5.500 2,191,080 ---------------------------------------------------------------------------------------------------------- 3,065 North Carolina Eastern Municipal Power Agency-Series A (Escrowed to Maturity) Baa2 AAA 01/01/21 6.400 3,847,617 ---------------------------------------------------------------------------------------------------------- 11,501,697 ---------------------------------------------------------------------------------------------------------- Ohio - 6.60% 2,185 Ohio State Higher Education- Series B Aa1 AA+ 11/01/17 5.250 2,425,722 ---------------------------------------------------------------------------------------------------------- 8,000 Ohio State Water Development Authority Water Quality Pollution Control Aaa AAA 06/01/24 5.000 8,387,120 ---------------------------------------------------------------------------------------------------------- 10,812,842 ---------------------------------------------------------------------------------------------------------- Oregon - 0.67% 1,000 Portland Sewer Systems Revenue-Series A Aaa AAA 06/01/18 5.250 1,098,440 ---------------------------------------------------------------------------------------------------------- Pennsylvania - 5.01% 5,000 Northumberland County Authority-Guaranteed Lease Revenue-Mountain View Manor Project NR NR 10/01/20 7.000 5,140,600 ---------------------------------------------------------------------------------------------------------- 3,000 Susquehanna Area Regional Airport Authority Airport Systems Revenue-Sub Series D Baa2 NR 01/01/18 5.375 3,054,750 ---------------------------------------------------------------------------------------------------------- 8,195,350 ---------------------------------------------------------------------------------------------------------- Puerto Rico - 8.91% 8,010 Puerto Rico Commonwealth Refunding-Public Improvement-Series C Baa1 A- 07/01/18 5.000 8,621,403 ---------------------------------------------------------------------------------------------------------- 3,000 Puerto Rico Housing Finance Authority-Capital Funding Program (HUD Insured) Aa3 AA 12/01/18 5.000 3,204,480 ---------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10 Investment Grade Municipal Income Fund Inc. PORTFOLIO OF INVESTMENTS-SEPTEMBER 30, 2004 PRINCIPAL MOODY'S S&P AMOUNT RATING RATING MATURITY INTEREST (000) (UNAUDITED) (UNAUDITED) DATES RATES VALUE ---------------------------------------------------------------------------------------------------------- Long-Term Municipal Bonds - (continued) ---------------------------------------------------------------------------------------------------------- Puerto Rico - (concluded) $ 2,425 Puerto Rico Public Buildings Authority Revenue-Guaranteed Government Facilities-Series D (Pre-refunded with U.S. Government Securities to 07/01/2012 @ 100) Baa1 A- 07/01/13 5.375% $2,766,610 ---------------------------------------------------------------------------------------------------------- 14,592,493 ---------------------------------------------------------------------------------------------------------- Rhode Island - 0.09% 145 Rhode Island Housing & Mortgage Finance Corp. Homeownership Opportunity-Series 10-A Aa2 AA+ 04/01/27 6.500 145,171 ---------------------------------------------------------------------------------------------------------- South Carolina - 0.66% 1,000 Greenville Waterworks Revenue Aa1 AAA 02/01/20 5.250 1,087,810 ---------------------------------------------------------------------------------------------------------- South Dakota - 2.95% 3,441 Lower Brule Sioux Tribe++ NR NR 08/15/15 6.000 3,471,762 ---------------------------------------------------------------------------------------------------------- 1,323 Standing Rock South Dakota New Public Housing++ NR NR 08/07/13 6.000 1,356,579 ---------------------------------------------------------------------------------------------------------- 4,828,341 ---------------------------------------------------------------------------------------------------------- Tennessee - 1.64% 2,500 Memphis-Shelby County Airport Authority Special Facilities Revenue-Federal Express Corp. Baa2 BBB 09/01/09 5.000 2,678,550 ---------------------------------------------------------------------------------------------------------- Texas - 16.49% 2,475 Alvin Independent School District School House-Series A Aaa AAA 02/15/17 5.375 2,755,838 ---------------------------------------------------------------------------------------------------------- 4,000 Coastal Bend Health Facilities Development-Incarnate Word Health System (Escrowed to Maturity) (AMBAC Insured) Aaa AAA 01/01/17 6.300 4,690,000 ---------------------------------------------------------------------------------------------------------- 1,335 Eagle Mountain & Saginaw Independent School District Unlimited Tax-School Building Aaa AAA 08/15/14 5.375 1,499,085 ---------------------------------------------------------------------------------------------------------- 2,825 Fort Worth Water & Sewer Revenue Aa2 AA 02/15/16 5.625 3,198,380 ---------------------------------------------------------------------------------------------------------- 7,051 Harris County Texas Lease|P^ NR NR 05/01/20 6.750 6,864,493 ---------------------------------------------------------------------------------------------------------- 3,007 Houston Community College System Certificates of Participation++ NR NR 06/15/25 7.875 3,136,551 ---------------------------------------------------------------------------------------------------------- 1,485 Lower Colorado River Authority Transmission Contract Revenue Aaa AAA 05/15/20 5.250 1,608,938 ---------------------------------------------------------------------------------------------------------- 3,000 San Antonio Electric & Gas Revenue Aa1 AA+ 02/01/20 5.375 3,247,950 ---------------------------------------------------------------------------------------------------------- 27,001,235 ---------------------------------------------------------------------------------------------------------- Washington - 4.63% 1,920 Metropolitan Park District Tacoma (AMBAC Insured) Aaa AAA 12/01/14 6.000 2,235,014 ---------------------------------------------------------------------------------------------------------- 1,115 Metropolitan Park District Tacoma (AMBAC Insured) Aaa AAA 12/01/16 6.000 1,297,247 ---------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 11 Investment Grade Municipal Income Fund Inc. PORTFOLIO OF INVESTMENTS-SEPTEMBER 30, 2004 PRINCIPAL MOODY'S S&P AMOUNT RATING RATING MATURITY INTEREST (000) (UNAUDITED) (UNAUDITED) DATES RATES VALUE ------------------------------------------------------------------------------------------------------------------- Long-Term Municipal Bonds - (concluded) ------------------------------------------------------------------------------------------------------------------- Washington - (concluded) $ 3,555 Washington State Public Power Supply Systems Nuclear Project No. 1-Series B Aaa AA- 07/01/09 7.250% $4,056,468 ------------------------------------------------------------------------------------------------------------------- 7,588,729 ------------------------------------------------------------------------------------------------------------------- Total Long-Term Municipal Bonds (cost-$253,260,708) 262,331,144 ------------------------------------------------------------------------------------------------------------------- Short-Term Municipal Notes - 6.37% ------------------------------------------------------------------------------------------------------------------- Michigan - 1.95% 3,200 University of Michigan Revenues Refunding-Medical Service Plan-Series A-1 VMIG-1 A1+ 10/01/04 1.720* 3,200,000 ------------------------------------------------------------------------------------------------------------------- Missouri - 0.31% 500 Missouri State Health & Educational Facilities Authority Educational Facilities Revenue- Washington University-Series B VMIG-1 A1+ 10/01/04 1.700* 500,000 ------------------------------------------------------------------------------------------------------------------- Oklahoma - 0.02% 25 Tulsa County Industrial Authority Revenue First Mortgage- Series A NR A1+ 10/01/04 1.740* 25,000 ------------------------------------------------------------------------------------------------------------------- Texas - 1.40% 2,200 Harris County Health Facilities Development Corp. Revenue- Methodist Hospital NR A1+ 10/01/04 1.720* 2,200,000 ------------------------------------------------------------------------------------------------------------------- 100 North Central Health Facility Development Corp. Revenue- Methodist Hospitals Dallas- Series B (MBIA Insured) Aaa A1+ 10/01/04 1.740* 100,000 ------------------------------------------------------------------------------------------------------------------- 2,300,000 ------------------------------------------------------------------------------------------------------------------- Virginia - 2.69% 4,400 Loudoun County Industrial Development Authority Revenue-Howard Hughes Medical Institute-Series C VMIG-1 A1+ 10/01/04 1.800* 4,400,000 ------------------------------------------------------------------------------------------------------------------- Total Short-Term Municipal Notes (cost-$10,425,000) 10,425,000 ------------------------------------------------------------------------------------------------------------------- Total Investments (cost-$263,685,708)-166.58% 272,756,144 ------------------------------------------------------------------------------------------------------------------- Other assets in excess of liabilities-0.60% 980,880 ------------------------------------------------------------------------------------------------------------------- Liquidation value of auction preferred shares-(67.18)% (110,000,000) ------------------------------------------------------------------------------------------------------------------- Net Assets applicable to common shareholders-100.00% $163,737,024 ------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 12 Investment Grade Municipal Income Fund Inc. PORTFOLIO OF INVESTMENTS-SEPTEMBER 30, 2004 + The maturity date reflects the mandatory date bond will be put back to issuer. ++ Illiquid securities representing 9.06% of net assets. * Variable rate demand note is payable on demand. The maturity dates shown are the next interest rate reset dates. The interest rates shown are the current rates as of September 30, 2004. # Entire or partial amount pledged as collateral for future transactions. (a) Security purchased on a when-issued basis. When issued refers to a transaction made conditionally because a security, although authorized, has not yet been issued. NR - Not Rated AMBAC - American Municipal Bond Assurance Corporation FGIC - Financial Guaranty Insurance Company FSA - Financial Security Assurance HUD - Housing and Urban Development MBIA - Municipal Bond Investors Assurance NUMBER OF IN EXPIRATION UNREALIZED CONTRACTS CONTRACT TO RECEIVE EXCHANGE FOR DATE DEPRECIATION -------------------------------------------------------------------------------------- Futures Contracts 100 U.S. Treasury Note 10 Year Futures $11,262,500 December 2004 $ (61,325) -------------------------------------------------------------------------------------- See accompanying notes to financial statements -------------------------------------------------------------------------------- 13 Investment Grade Municipal Income Fund Inc. STATEMENT OF ASSETS AND LIABILITIES - SEPTEMBER 30, 2004 Assets: Investments in securities, at value (cost-$263,685,708) $272,756,144 --------------------------------------------------------------------------------------- Cash 2,092,579 --------------------------------------------------------------------------------------- Interest receivable 4,102,107 --------------------------------------------------------------------------------------- Receivable for investments sold 109,415 --------------------------------------------------------------------------------------- Receivable for variation margin 15,623 --------------------------------------------------------------------------------------- Other assets 15,255 --------------------------------------------------------------------------------------- Total assets 279,091,123 --------------------------------------------------------------------------------------- Liabilities: --------------------------------------------------------------------------------------- Payable for investments purchased 5,149,899 --------------------------------------------------------------------------------------- Payable to investment advisor and administrator 156,973 --------------------------------------------------------------------------------------- Dividends payable to auction preferred shareholders 6,250 --------------------------------------------------------------------------------------- Accrued expenses and other liabilities 40,977 --------------------------------------------------------------------------------------- Total liabilities 5,354,099 --------------------------------------------------------------------------------------- Auction Preferred Shares Series A, B and C-2,200 non-participating shares authorized, issued and outstanding; $0.001 par value; $50,000 liquidation value per share 110,000,000 --------------------------------------------------------------------------------------- Net assets applicable to common shareholders $163,737,024 --------------------------------------------------------------------------------------- Net assets applicable to common shareholders: Common Stock-$0.001 par value; 199,998,400 shares authorized; 10,356,667 shares issued and outstanding 153,239,012 --------------------------------------------------------------------------------------- Undistributed net investment income 211,405 --------------------------------------------------------------------------------------- Accumulated net realized gain from investment activities and futures 1,277,496 --------------------------------------------------------------------------------------- Net unrealized appreciation of investments and futures 9,009,111 --------------------------------------------------------------------------------------- Net assets applicable to common shareholders $163,737,024 --------------------------------------------------------------------------------------- Net asset value per common share ($163,737,024 applicable to 10,356,667 common shares outstanding) $15.81 --------------------------------------------------------------------------------------- See accompanying notes to financial statements -------------------------------------------------------------------------------- 14 Investment Grade Municipal Income Fund Inc. STATEMENT OF OPERATIONS For the Year Ended September 30, 2004 --------------------------------------------------------------------------------------- Investment income: Interest $ 12,142,124 --------------------------------------------------------------------------------------- Expenses: Investment advisory and administration fees 2,399,549 --------------------------------------------------------------------------------------- Auction Preferred Shares expenses 302,594 --------------------------------------------------------------------------------------- Custody and accounting 159,970 --------------------------------------------------------------------------------------- Professional fees 47,278 --------------------------------------------------------------------------------------- Reports and notices to shareholders 33,764 --------------------------------------------------------------------------------------- Transfer agency fees 12,491 --------------------------------------------------------------------------------------- Directors' fees 12,283 --------------------------------------------------------------------------------------- Other expenses 65,579 --------------------------------------------------------------------------------------- 3,033,508 --------------------------------------------------------------------------------------- Less: Fee waivers from investment advisor and administrator (533,233) --------------------------------------------------------------------------------------- Net expenses 2,500,275 --------------------------------------------------------------------------------------- Net investment income 9,641,849 --------------------------------------------------------------------------------------- Realized and unrealized gains (losses) from investment activities: Net realized gains from: --------------------------------------------------------------------------------------- Investments 1,713,606 --------------------------------------------------------------------------------------- Futures 176,070 --------------------------------------------------------------------------------------- Net change in unrealized appreciation/depreciation of: --------------------------------------------------------------------------------------- Investments (255,367) --------------------------------------------------------------------------------------- Futures (61,325) --------------------------------------------------------------------------------------- Net realized and unrealized gain from investment activities 1,572,984 --------------------------------------------------------------------------------------- Dividends and distributions to auction preferred shareholders from: Net investment income (863,818) --------------------------------------------------------------------------------------- Net realized gain from investment activities (318,688) --------------------------------------------------------------------------------------- Total dividends and distributions to auction preferred shareholders (1,182,506) --------------------------------------------------------------------------------------- Net increase in net assets applicable to common shareholders resulting from operations $10,032,327 --------------------------------------------------------------------------------------- See accompanying notes to financial statements -------------------------------------------------------------------------------- 15 Investment Grade Municipal Income Fund Inc. STATEMENT OF CHANGES IN NET ASSETS APPLICABLE TO COMMON SHAREHOLDERS For the Years Ended September 30, ------------------------------- 2004 2003 --------------------------------------------------------------------------------------------- From operations: Net investment income $9,641,849 $9,881,410 --------------------------------------------------------------------------------------------- Net realized gains from investment activities and futures 1,889,676 4,823,139 --------------------------------------------------------------------------------------------- Net change in unrealized appreciation/depreciation of investments and futures (316,692) (3,488,907) --------------------------------------------------------------------------------------------- Common share equivalent of dividends and distributions to auction preferred shareholders from: Net investment income (863,818) (946,455) --------------------------------------------------------------------------------------------- Net realized gains from investment activities (318,688) - --------------------------------------------------------------------------------------------- Total dividends and distributions paid to auction preferred shareholders (1,182,506) (946,455) --------------------------------------------------------------------------------------------- Net increase in net assets applicable to common shareholders resulting from operations 10,032,327 10,269,187 --------------------------------------------------------------------------------------------- Dividends and distributions to common shareholders from: Net investment income (9,631,721) (9,942,400) --------------------------------------------------------------------------------------------- Net realized gains from investment activities (5,116,194) (1,893,199) --------------------------------------------------------------------------------------------- Total dividends and distributions to common shareholders (14,747,915) (11,835,599) --------------------------------------------------------------------------------------------- Auction Preferred Shares offering expenses (435,135) - --------------------------------------------------------------------------------------------- Net decrease in net assets applicable to common shareholders (5,150,723) (1,566,412) --------------------------------------------------------------------------------------------- Net assets applicable to common shareholders: Beginning of year 168,887,747 170,454,159 --------------------------------------------------------------------------------------------- End of year $163,737,024 $168,887,747 --------------------------------------------------------------------------------------------- Accumulated undistributed net investment income $211,405 $1,065,095 --------------------------------------------------------------------------------------------- See accompanying notes to financial statements -------------------------------------------------------------------------------- 16 Investment Grade Municipal Income Fund Inc. NOTES TO FINANCIAL STATEMENTS ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Investment Grade Municipal Income Fund Inc. (the "Fund") was incorporated in Maryland on August 6, 1992, and is registered with the Securities and Exchange Commission under the Investment Company Act of 1940, as amended, as a closed-end diversified management investment company. The Fund's investment objective is to achieve a high level of current income that is exempt from federal income tax, consistent with the preservation of capital. In the normal course of business the Fund may enter into contracts that contain a variety of representations or that provide indemnification for certain liabilities. The Fund's maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Fund that have not yet occurred. However, the Fund has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote. The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires the Fund's management to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements. Actual results could differ from those estimates. The following is a summary of significant accounting policies: VALUATION OF INVESTMENTS--The Fund calculates net asset values based on the current market value for its portfolio's securities. The Fund normally obtains market values for its securities from independent pricing sources and broker-dealers. Independent pricing sources may use last reported sale prices, current market quotations or valuations from computerized "matrix" systems that derive values based on comparable securities. A matrix system incorporates parameters such as security quality, maturity and coupon, and/or research and evaluations by its staff, including review of broker-dealer market price quotations, if available, in determining the valuation of the portfolio securities. If a market value is not available from an independent pricing source for a particular security, that security is valued at fair value as determined in good faith by or under the direction of the Fund's Board of Directors (the "Board"). The amortized cost method of valuation, which approximates market value, generally is used to value short-term debt instruments with sixty days or less remaining to maturity, unless the Board determines that this does not represent fair value. Securities traded in the over-the-counter ("OTC") market are valued at the last bid price available on the valuation date prior to valuation. INVESTMENT TRANSACTIONS AND INVESTMENT INCOME--Investment transactions are recorded on the trade date. Realized gains and losses from investment transactions are calculated using the identified cost method. Interest income is recorded on an accrual basis. Discounts are accreted and premiums are amortized as adjustments to interest income and the identified cost of investments. -------------------------------------------------------------------------------- 17 Investment Grade Municipal Income Fund Inc. NOTES TO FINANCIAL STATEMENTS FUTURES CONTRACTS--Upon entering into a financial futures contract, the Fund is required to deposit in a segregated account with its custodian, in the name of the futures broker through which the transaction was effected, an amount of cash and/or municipal obligations equal to a certain percentage of the contract amount. This amount is known as the "initial margin." Subsequent payments, known as "variation margin" are made or received by the Fund each day, depending on the daily fluctuations in the value of the underlying financial futures contracts. Such variation margin is recorded for financial statement purposes on a daily basis as unrealized gain or loss until the financial futures contract is closed, at which time the net gain or loss is reclassified to realized gain or loss on futures. Variation margin calls could be substantial in the event of adverse price movements. Using financial futures contracts involves various market risks. If the Fund was unable to liquidate a futures position due to the absence of a liquid secondary market or the imposition of price limits, it could incur substantial losses. The Fund would continue to be subject to market risk with respect to the position. In addition, the Fund would continue to be required to make variation margin payments and might be required to maintain the position being hedged or to maintain cash or securities in a segregated account. Furthermore, certain characteristics of the futures market might increase the risk that movements in the prices of the financial futures contracts might not correlate perfectly with movements in the prices of the investments being hedged, including temporary price distortion. DIVIDENDS AND DISTRIBUTIONS--The Fund intends to pay monthly dividends to common shareholders at a level rate that over time will result in the distribution of all of the Fund's net investment income remaining after the payment of dividends on any outstanding auction preferred shares. The dividend rate on the common stock is adjusted as necessary to reflect the earnings rate of the Fund. Dividends and distributions to common shareholders are recorded on the ex-dividend date. Dividends to auction preferred shareholders are accrued daily. The amount of dividends from net investment income and distributions from net realized capital gains is determined in accordance with federal income tax regulations, which may differ from U.S. 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. CONCENTRATION OF RISK The Fund follows an investment policy of investing primarily in municipal obligations of various states. Economic changes affecting those states and certain of their public bodies and municipalities may affect the ability of the issuers within those -------------------------------------------------------------------------------- 18 Investment Grade Municipal Income Fund Inc. NOTES TO FINANCIAL STATEMENTS states to pay interest on, or repay principal of, municipal obligations held by the Fund. INVESTMENT ADVISOR AND ADMINISTRATOR The Board has approved an investment advisory and administration contract ("Advisory Contract") with UBS Global Asset Management (US) Inc. ("UBS Global AM"), under which UBS Global AM serves as investment advisor and administrator of the Fund. UBS Global AM is an indirect wholly owned asset management subsidiary of UBS AG, an internationally diversified organization with headquarters in Zurich, Switzerland and operations in many areas of the financial services industry. In accordance with the Advisory Contract, the Fund pays UBS Global AM an investment advisory and administration fee, which is accrued weekly and paid monthly, at the annual rate of 0.90% of the Fund's average weekly net assets applicable to holders of common and Auction Preferred Shares. UBS Global AM has agreed to waive 0.20% of the advisory and administration fee, so that the Fund's effective fee is 0.70% of average weekly net assets applicable to holders of common and Auction Preferred Shares. This waiver will continue indefinitely unless the Board agrees to any change. At September 30, 2004, the Fund owed UBS Global AM $156,973, which is $201,825 investment advisory and administration fees less fees waived of $44,852. For the year ended September 30, 2004, UBS Global AM waived $533,233 in investment advisory and administration fees from the Fund. AUCTION PREFERRED SHARES The Fund has issued 800 shares of Auction Preferred Shares Series A, 800 shares of Auction Preferred Shares Series B, and 600 shares of Auction Preferred Shares Series C, which are referred to herein collectively as the "APS." (Auction Preferred Shares Series C were issued on December 22, 2003). All shares of each series of APS have a liquidation preference of $50,000 per share plus an amount equal to accumulated but unpaid dividends upon liquidation. Dividends, which are cumulative, are generally reset every 7 days for each Series of APS. Dividend rates ranged from 0.750% to 2.050% for the year ended September 30, 2004. The Fund is subject to certain restrictions relating to the APS. Failure to comply with these restrictions could preclude the Fund from declaring any distributions to common shareholders or repurchasing common shares and/or could trigger the mandatory redemption of APS at liquidation value. The APS are entitled to one vote per share and, unless otherwise required by law, will vote with holders of common stock as a single class, except that the APS will vote separately as a class on certain matters, as required by law. The holders of the APS -------------------------------------------------------------------------------- 19 Investment Grade Municipal Income Fund Inc. NOTES TO FINANCIAL STATEMENTS have the right to elect two directors of the Fund. The redemption of the Fund's APS is outside of the control of the Fund because it is redeemable upon the occurrence of an event that is not solely within the control of the Fund. Offering expenses of $435,135 were charged to paid-in-capital of the Fund in connection with the offering of APS during the year ended September 30, 2004. PURCHASES AND SALES OF SECURITIES For the year ended September 30, 2004, aggregate purchases and sales of portfolio securities, excluding short-term securities, were $148,190,358 and $115,591,941, respectively. FEDERAL TAX STATUS The Fund intends to distribute substantially all of its tax-exempt income and any taxable income and to comply with the other requirements of the Internal Revenue Code applicable to regulated investment companies. Accordingly, no provision for federal income taxes is required. In addition, by distributing during each calendar year substantially all of its net investment income, net realized capital gains and certain other amounts, if any, the Fund intends not to be subject to a federal excise tax. The tax character of distributions paid during the fiscal years ended September 30, 2004 and September 30, 2003 were as follows: DISTRIBUTIONS PAID FROM: 2004 2003 ------------------------------------------------------------ Tax-exempt income $10,491,297 $10,662,658 ------------------------------------------------------------ Ordinary income 4,242 22,485 ------------------------------------------------------------ Net long-term capital gains 5,434,882 2,096,911 ------------------------------------------------------------ Total distributions paid $15,930,421 $12,782,054 ------------------------------------------------------------ -------------------------------------------------------------------------------- 20 Investment Grade Municipal Income Fund Inc. NOTES TO FINANCIAL STATEMENTS At September 30, 2004, the components of accumulated earnings on a tax basis were as follows: Undistributed tax exempt income $217,655 ---------------------------------------------------------- Undistributed ordinary income 19,083 ---------------------------------------------------------- Undistributed long-term capital gains 1,197,088 ---------------------------------------------------------- Net unrealized appreciation of investments 9,070,436 ---------------------------------------------------------- Total accumulated earnings $10,504,262 ---------------------------------------------------------- For federal income tax purposes, the tax cost of investments and the components of net unrealized appreciation of investments at September 30, 2004 were as follows: Tax cost of investments $263,685,708 --------------------------------------------- Gross unrealized appreciation 9,481,886 --------------------------------------------- Gross unrealized depreciation (411,450) --------------------------------------------- Net unrealized appreciation $9,070,436 --------------------------------------------- -------------------------------------------------------------------------------- 21 Investment Grade Municipal Income Fund Inc. FINANCIAL HIGHLIGHTS Selected data for a share of common stock outstanding throughout each year is presented below: ------------------------------------------------------------------------------------------------------------------------------------ FOR THE YEARS ENDED SEPTEMBER 30, ------------------------------------------------------------------------------------------------------------------------------------ 2004 2003 2002 2001 2000 ------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF YEAR $16.31 $16.46 $16.15 $15.91 $16.09 ------------------------------------------------------------------------------------------------------------------------------------ Net investment income 0.93 0.95 1.11 1.17 1.18 ------------------------------------------------------------------------------------------------------------------------------------ Net realized and unrealized gains (losses) from investment activities 0.14 0.13 0.29 0.46 (0.13) ------------------------------------------------------------------------------------------------------------------------------------ Common share equivalent of dividends and distributions paid to auction preferred shareholders from: Net investment income (0.08) (0.07) (0.12) (0.23) (0.31) ------------------------------------------------------------------------------------------------------------------------------------ Net realized gains from investment activities (0.03) (0.02) (0.01) (0.07) (0.00)(1) ------------------------------------------------------------------------------------------------------------------------------------ Total dividends and distributions paid to auction preferred shareholders (0.11) (0.09) (0.13) (0.30) (0.31) ------------------------------------------------------------------------------------------------------------------------------------ Net increase from operations 0.96 0.99 1.27 1.33 0.74 ------------------------------------------------------------------------------------------------------------------------------------ Dividends and distributions paid to common shareholders from: Net investment income (0.93) (0.96) (0.93) (0.90) (0.90) ------------------------------------------------------------------------------------------------------------------------------------ Net realized gains from investment activities (0.49) (0.18) (0.03) (0.19) (0.02) ------------------------------------------------------------------------------------------------------------------------------------ Total dividends and distributions to common shareholders (1.42) (1.14) (0.96) (1.09) (0.92) ------------------------------------------------------------------------------------------------------------------------------------ Auction Preferred Shares offering expenses (0.04) -- -- -- -- ------------------------------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, END OF YEAR $15.81 $16.31 $16.46 $16.15 $15.91 ------------------------------------------------------------------------------------------------------------------------------------ MARKET VALUE, END OF YEAR $14.25 $14.86 $15.60 $15.39 $13.75 ------------------------------------------------------------------------------------------------------------------------------------ TOTAL INVESTMENT RETURN (2) 5.57% 2.76% 7.96% 20.59% 5.90% ------------------------------------------------------------------------------------------------------------------------------------ RATIO TO AVERAGE NET ASSETS ATTRIBUTABLE TO COMMON SHARES: Total expenses, net of fee waivers by advisor 1.53% 1.45% 1.48% 1.49% 1.52% ------------------------------------------------------------------------------------------------------------------------------------ Total expenses, before fee waivers by advisor 1.86% 1.66% 1.67% 1.68% 1.71% ------------------------------------------------------------------------------------------------------------------------------------ Net investment income before Auction Preferred Shares dividends 5.91% 5.89% 6.89% 7.30% 7.48% ------------------------------------------------------------------------------------------------------------------------------------ Auction Preferred Shares dividends from net investment income 0.53% 0.44% 0.73% 1.42% 1.99% ------------------------------------------------------------------------------------------------------------------------------------ Net investment income available to common shareholders, net of fee waivers by advisor 5.38% 5.45% 6.16% 5.88% 5.49% ------------------------------------------------------------------------------------------------------------------------------------ Net investment income available to common shareholders, before fee waivers by advisor 5.05% 5.24% 5.97% 5.69% 5.30% ------------------------------------------------------------------------------------------------------------------------------------ SUPPLEMENTAL DATA: Net assets applicable to common shareholders, end of year (000's) $163,737 $168,888 $170,454 $167,295 $164,769 ------------------------------------------------------------------------------------------------------------------------------------ Portfolio turnover 45% 51% 21% 8% 14% ------------------------------------------------------------------------------------------------------------------------------------ Asset coverage per share of Auction Preferred Shares, end of year $124,426 $155,555 $156,534 $154,559 $152,980 ------------------------------------------------------------------------------------------------------------------------------------ (1) Distribution equal to $0.0042 per share. (2) Total investment return is calculated assuming a $10,000 purchase of common stock at the current market price on the first day of each year reported and a sale at the current market price on the last day of each year reported, and assuming reinvestment of dividends and other distributions to common shareholders at prices obtained under the Fund's Dividend Reinvestment Plan. Total investment return does not reflect brokerage commissions. Returns do not reflect the deduction of taxes that a shareholder could pay on Fund distributions. -------------------------------------------------------------------------------- 22 Investment Grade Municipal Income Fund Inc. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Shareholders Investment Grade Municipal Income Fund Inc. We have audited the accompanying statement of assets and liabilities of Investment Grade Municipal Income Fund Inc. (the "Fund"), including the portfolio of investments, as of September 30, 2004, and the related statement of operations for the year then ended, the statements of changes in net assets applicable to common shareholders for each of the two years in the period then ended, and the financial highlights for each of the four 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. The financial highlights for the year ended September 30, 2000, was audited by other auditors whose report dated November 22, 2000, expressed an unqualified opinion on those financial highlights. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights. Our procedures included confirmation of investments owned as of September 30, 2004, by correspondence with the custodian and brokers. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Investment Grade Municipal Income Fund Inc. at September 30, 2004, the results of its operations for the year then ended, the changes in its net assets applicable to common shareholders for each of the two years in the period then ended, and the financial highlights for each of the four years in the period then ended, in conformity with U.S. generally accepted accounting principles. /s/ Ernst & Young LLP New York, New York November 2, 2004 -------------------------------------------------------------------------------- 23 Investment Grade Municipal Income Fund Inc. GENERAL INFORMATION (UNAUDITED) THE FUND Investment Grade Municipal Income Fund Inc. (the "Fund") is a diversified, closed-end management investment company whose shares trade on the New York Stock Exchange ("NYSE"). The Fund's investment objective is to achieve a high level of current income that is exempt from federal income tax, consistent with the preservation of capital. The Fund's investment advisor and administrator is UBS Global Asset Management (US) Inc. ("UBS Global AM"), an indirect wholly owned asset management subsidiary of UBS AG, which had over $49.5 billion in assets under management as of September 30, 2004. SHAREHOLDER INFORMATION The Fund's NYSE trading symbol is "PPM." Comparative net asset value and market price information about the Fund is published weekly in The Wall Street Journal, The New York Times and Barron's, as well as in numerous other publications. PROXY VOTING POLICIES AND PROCEDURES AND RECORD You may obtain a description of the Fund's proxy voting policies and procedures, and its proxy voting record without charge, upon request by contacting the Fund directly at 1-800-647-1568, online on the Fund's Web site: www.ubs.com/ubsglobalam-proxy, or on the EDGAR Database on the SEC's website (http://www.sec.gov). QUARTERLY FORM N-Q PORTFOLIO SCHEDULE The Fund will file its complete schedule of portfolio holdings with the Securities and Exchange Commission ("SEC") for the first and third quarters of each fiscal year on Form N-Q. The Fund's Forms N-Q are available on the SEC's website at http://www.sec.gov. The Fund's Forms N-Q may be reviewed and copied at the SEC's Public Reference Room in Washington, D.C. Information on the operation of the SEC's Public Reference Room may be obtained by calling 1-800-SEC-0330. Additionally, you may obtain copies of Forms N-Q from the Fund upon request by calling 1-800-647-1568. DIVIDEND REINVESTMENT PLAN The Fund's Board has established a Dividend Reinvestment Plan (the "Plan") under which all common shareholders whose shares are registered in their own names, or in the name of UBS Financial Services Inc. or its nominee, will have all dividends and other distributions on their shares of common stock automatically reinvested -------------------------------------------------------------------------------- 24 Investment Grade Municipal Income Fund Inc. GENERAL INFORMATION (UNAUDITED) DIVIDEND REINVESTMENT PLAN (CONTINUED) in additional shares of common stock, unless such common shareholders elect to receive cash. Common shareholders who elect to hold their shares in the name of another broker or nominee should contact such broker or nominee to determine whether, or how, they may participate in the Plan. The ability of such shareholders to participate in the Plan may change if their shares are transferred into the name of another broker or nominee. A common shareholder may elect not to participate in the Plan or may terminate participation in the Plan at any time without penalty, and common shareholders who have previously terminated participation in the Plan may rejoin it at any time. Changes in elections must be made in writing to the Fund's transfer agent and should include the shareholder's name and address as they appear on the share certificate or in the transfer agent's records. An election to terminate participation in the Plan, until such election is changed, will be deemed an election by a common shareholder to take all subsequent distributions in cash. An election will be effective only for distributions declared and having a record date at least ten days after the date on which the election is received. Additional shares of common stock acquired under the Plan will be purchased in the open market, on the NYSE or otherwise, at prices that may be higher or lower than the net asset value per share of the common stock at the time of the purchase. The number of shares of common stock purchased with each dividend will be equal to the result obtained by dividing the amount of the dividend payable to a particular shareholder by the average price per share (including applicable brokerage commissions) that the transfer agent was able to obtain in the open market. The Fund will not issue any new shares of common stock in connection with the Plan. There currently is no charge to participants for reinvesting dividends or other distributions. The transfer agent's fees for handling the reinvestment of distributions will be paid by the Fund. However, each participant pays a pro rata share of brokerage commissions incurred with respect to the transfer agent's open market purchases of common stock in connection with the reinvestment of distributions. The automatic reinvestment of dividends and other distributions in shares of common stock does not relieve participants of any income tax that may be payable on such distributions. Experience under the Plan may indicate that changes are desirable. Accordingly, the Fund reserves the right to amend or terminate the Plan with respect to any dividend or other distribution if notice of the change is sent to Plan participants at least 30 days before the record date for such distribution. The Plan also may be amended or terminated by the transfer agent by at least 30 days' written notice to all Plan -------------------------------------------------------------------------------- 25 Investment Grade Municipal Income Fund Inc. GENERAL INFORMATION (UNAUDITED) DIVIDEND REINVESTMENT PLAN (CONCLUDED) participants. Additional information regarding the Plan may be obtained from, and all correspondence concerning the Plan should be directed to, the transfer agent at PFPC Inc., P.O. Box 43027, Providence, Rhode Island 02940-3027. For further information regarding the Plan, you may also contact the transfer agent directly at 1-800-331-1710. -------------------------------------------------------------------------------- 26 (This page has been left blank intentionally) -------------------------------------------------------------------------------- 27 Investment Grade Municipal Income Fund Inc. SUPPLEMENTAL INFORMATION (UNAUDITED) BOARD OF DIRECTORS & OFFICERS The Fund is governed by a Board of Directors which oversees the Fund's operations. Each Director serves until the next annual meeting of shareholders or until his or her successor is elected and qualified or until he or she resigns or is otherwise removed. Officers are appointed by the Directors and serve at the pleasure of the Board. The table below shows, for each Director and Officer, his or her name, address and age, the position held with the Fund, the length of time served as a Director and Officer of the Fund, the Director's or Officer's principal occupations during the last five years, the number of funds in the UBS Fund complex overseen by the Director or for which a person served as an Officer, and other directorships held by the Director. INTERESTED DIRECTOR Term of Position(s) Office and Name, Address, Held with Length of Principal Occupation(s) and Age Fund Time Served During Past 5 Years -------------------------------------------------------------------------------------------------------- Margo N. Alexander+; 57 Director Since 1996 Mrs. Alexander is retired. She was an c/o UBS Global Asset executive vice president of UBS Financial Management Services Inc. (from March 1984 to 51 West 52nd Street December 2002). She was chief executive New York, NY 10019 officer (from January 1995 to October 2000), a director (from January 1995 to September 2001) and chairman (from March 1999 to September 2001) of UBS Global AM (formerly known as Mitchell Hutchins Asset Management Inc.). -------------------------------------------------------------------------------- 28 Investment Grade Municipal Income Fund Inc. SUPPLEMENTAL INFORMATION (UNAUDITED) Number of Portfolios in Fund Complex Other Directorships Overseen by Director Held by Director ------------------------------------------------------------------------ Mrs. Alexander is a director or trustee of 16 None investment companies (consisting of 33 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. -------------------------------------------------------------------------------- 29 Investment Grade Municipal Income Fund Inc. SUPPLEMENTAL INFORMATION (UNAUDITED) INDEPENDENT DIRECTORS Term of Position(s) Office and Name, Address, Held with Length of Principal Occupation(s) and Age Fund Time Served During Past 5 Years ----------------------------------------------------------------------------------------------------------------- Richard Q. Armstrong; 69 Director and Since 1996 Mr. Armstrong is chairman and principal of c/o Willkie Farr & Chairman R.Q.A. Enterprises (management consulting Gallagher LLP of the Board of firm) (since April 1991 and principal 787 Seventh Avenue Directors occupation since March 1995). New York, NY 10019-6099 David J. Beaubien; 70 Director Since 2001 Mr. Beaubien is retired (since 2003). He was 84 Doane Road chairman of Yankee Environmental Ware, MA 01082 Systems, Inc., a manufacturer of meteorological measuring systems (since 1991). Richard R. Burt; 57 Director Since 1996 Mr. Burt is chairman of Diligence LLC 1275 Pennsylvania Avenue, (international information and security firm) N.W. and IEP Advisors (international investments Washington, D.C. 20004 and consulting firm). Meyer Feldberg; 62 Director Since 1992 Professor Feldberg is Dean Emeritus and Columbia Business School Sanford Bernstein Professor of Leadership 33 West 60th Street and Ethics at Columbia Business School. 7th Floor Prior to July 2004, he was Dean and New York, NY 10023-7905 Professor of Management of the Graduate School of Business at Columbia University (since 1989). Carl W. Schafer; 68 Director Since 1996 Mr. Schafer is president of the Atlantic 66 Witherspoon Street Foundation (charitable foundation) (since #1100 1990). Princeton, NJ 08542 William D. White; 70 Director Since 2001 Mr. White is retired (since 1994). P.O. Box 199 Upper Black Eddy, PA 18972 -------------------------------------------------------------------------------- 30 Investment Grade Municipal Income Fund Inc. SUPPLEMENTAL INFORMATION (UNAUDITED) Number of Portfolios in Fund Complex Other Directorships Overseen by Director Held by Director ------------------------------------------------------------------------------------------------------------------------- Mr. Armstrong is a director or trustee of 16 None investment companies (consisting of 33 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. Mr. Beaubien is a director or trustee of 16 Mr. Beaubien is also a director of IEC Electronics, Inc., a investment companies (consisting of 33 portfolios) manufacturer of electronic assemblies. for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. Mr. Burt is a director or trustee of 16 investment Mr. Burt is also a director of Hollinger International Inc. companies (consisting of 33 portfolios) for which (publishing), HCL Technologies, Ltd., (software and UBS Global AM or one of its affiliates serves as information technologies), The Central European Fund, Inc., investment advisor, sub-advisor or manager. The Germany Fund, Inc., IGT, Inc. (provides technology to gaming and wagering industry) and chairman of Weirton Steel Corp. (makes and finishes steel products). He is also a director or trustee of funds in the Scudder Mutual Funds Family (consisting of 47 portfolios). Professor Feldberg is a director or trustee of 30 Professor Feldberg is also a director of Primedia Inc. investment companies (consisting of 47 portfolios) (publishing), Federated Department Stores, Inc. (operator of for which UBS Global AM or one of its affiliates department stores), Revlon, Inc. (cosmetics), Select Medical serves as investment advisor, sub-advisor or Inc. (healthcare services) and SAPPI, Ltd. (producer of paper). manager. Mr. Schafer is a director or trustee of 16 investment Mr. Schafer is also a director of Labor Ready, Inc. (temporary companies (consisting of 33 portfolios) for which employment). Guardian Life Insurance Company Mutual UBS Global AM or one of its affiliates serves as Funds (consisting of 25 portfolios), the Harding, Loevner investment advisor, sub-advisor or manager. Funds (consisting of three portfolios), E.I.I. Realty Securities Trust (consisting of two portfolios) and Frontier Oil Corporation. Mr. White is a director or trustee of 16 investment None companies (consisting of 33 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. -------------------------------------------------------------------------------- 31 Investment Grade Municipal Income Fund Inc. SUPPLEMENTAL INFORMATION (UNAUDITED) OFFICERS Term of Principal Occupation(s) Position(s) Office and During Past 5 Years; Name, Address, Held With Length of Number of Portfolios in Fund Complex and Age Fund Time Served For Which Person Serves as Officer ----------------------------------------------------------------------------------------------------------------------- W. Douglas Beck*; 37 Vice President Since 2003 Mr. Beck is an executive director and head of mutual fund product management of UBS Global AM (since 2002). From March 1998 to November 2002, he held various positions at Merrill Lynch, the most recent being first vice president and co-manager of the managed solutions group. Mr. Beck is vice president of 20 investment companies (consisting of 75 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. James Capezzuto*; 40 Vice President Since 2004 Mr. Capezzuto is director and assistant and Assistant general counsel at UBS Global AM (since Secretary 2004). Prior to joining UBS Global AM he was senior vice president, senior compliance manager at Bank of America (from 2003-2004) prior to that he was general counsel at Steinberg Priest & Sloane and prior to that he was director and senior counsel at Deutsche Asset Management (from 1996 - 2002.) Mr. Capezzuto is a vice president and assistant secretary of 20 investment companies (consisting of 75 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. Thomas Disbrow*; 38 Vice President Since 2000 Mr. Disbrow is a director and co-head of the and Treasurer (Vice President) mutual fund finance department of UBS since 2004 Global AM. Prior to November 1999, he (Treasurer) was a vice president of Zweig/Glaser Advisers. Mr. Disbrow is a vice president and treasurer of 16 investment companies (consisting of 33 portfolios) and assistant treasurer of four investment companies (consisting of 42 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. Elbridge T. Gerry III*; 47 Vice President Since 1996 Mr. Gerry is a managing director-municipal fixed income of UBS Global AM. Mr. Gerry is a vice president of six investment companies (consisting of 10 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. -------------------------------------------------------------------------------- 32 Investment Grade Municipal Income Fund Inc. SUPPLEMENTAL INFORMATION (UNAUDITED) OFFICERS (CONTINUED) Term of Principal Occupation(s) Position(s) Office and During Past 5 Years; Name, Address, Held With Length of Number of Portfolios in Fund Complex and Age Fund Time Served For Which Person Serves as Officer --------------------------------------------------------------------------------------------------------------- Mark F. Kemper**; 46 Vice President Since 2004 Mr. Kemper is general counsel of UBS and Secretary Global Asset Management-Americas region (since July 2004). Mr. Kemper also is an executive director of UBS Global Asset Management (Americas) Inc. ("UBS Global AM (Americas)") and was its deputy general counsel from July 2001 to July 2004. He has been secretary of UBS Global AM (Americas) since 1999 and assistant secretary of UBS Global Asset Management Trust Company since 1993. Mr. Kemper is secretary of UBS Global AM (since 2004). Mr. Kemper is vice president and secretary of 20 investment companies (consisting of 75 portfolios) for which UBS Global AM (Americas) or one of its affiliates serves as investment advisor, sub-advisor or manager. Joanne M. Kilkeary*; 36 Vice President Since 2004 Ms. Kilkeary is an associate director and a and Assistant senior manager of the mutual fund finance Treasurer department of UBS Global AM. Ms. Kilkeary is a vice president and assistant treasurer of 16 investment companies (consisting of 33 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. Joseph T. Malone*; 36 Vice President Since 2004 Mr. Malone is a director and co-head of the and Assistant mutual fund finance department of UBS Treasurer Global AM. From August 2000 through June 2001, he was the controller at AEA Investors Inc. From March 1998 to August 2000, Mr. Malone was a manager within investment management services of PricewaterhouseCoopers LLC. Mr. Malone is vice president and assistant treasurer of 16 investment companies (consisting of 33 portfolios) and vice president, treasurer and principal accounting officer of four investment companies (consisting of 42 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. -------------------------------------------------------------------------------- 33 Investment Grade Municipal Income Fund Inc. SUPPLEMENTAL INFORMATION (UNAUDITED) OFFICERS (CONCLUDED) Term of Principal Occupation(s) Position(s) Office and During Past 5 Years; Name, Address, Held With Length of Number of Portfolios in Fund Complex and Age Fund Time Served For Which Person Serves as Officer ------------------------------------------------------------------------------------------------------------- Joseph McGill*; 42 Vice President Since 2004 Mr. McGill is executive director and chief and Chief compliance officer at UBS Global AM (since Compliance 2003). Prior to joining UBS Global AM he Officer was Assistant General Counsel, J.P. Morgan Investment Management (from 1999-2003). Mr. McGill is a vice president and chief compliance officer of 20 investment companies (consisting of 75 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. Joseph A. Varnas*; 36 President Since 2003 Mr. Varnas is a managing director (since March 2003), global head of information technology and operations (since March 2004) and head of product management- Americas (since November 2002) of UBS Global AM. He was head of technology of UBS Global AM from November 2002 to March 2004. From 2000 to 2001, he was manager of product development in Investment Consulting Services at UBS Financial Services Inc. Mr. Varnas was a senior analyst in the Global Securities Research and Economics Group at Merrill Lynch from 1995 to 1999. Mr. Varnas is president of 20 investment companies (consisting of 75 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. William Veronda*; 58 Vice President Since 2004 Mr. Veronda is an executive director-fixed income of UBS Global AM (since 1995). Mr. Veronda is a vice president of two investment companies (consisting of two portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. Keith A. Weller*; 43 Vice President Since 1995 Mr. Weller is a director and associate and Assistant general counsel of UBS Global AM. Mr. Secretary Weller is a vice president and assistant secretary of 20 investment companies (consisting of 75 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. * This person's business address is 51 West 52nd Street, New York, New York 10019-6114. ** This person's business address is One North Wacker Drive, Chicago, Illinois 60606. + Mrs. Alexander is an "interested person" of the Fund as defined in the Investment Company Act by virtue of her former positions with UBS Global AM and/or any of its affiliates. -------------------------------------------------------------------------------- 34 Investment Grade Municipal Income Fund Inc. NEW YORK STOCK EXCHANGE CERTIFICATIONS (UNAUDITED) Investment Grade Municipal Income Fund Inc. (the "Fund") is listed on the New York Stock Exchange ("NYSE"). As a result, it is subject to certain corporate governance rules and related interpretations issued by the exchange. Pursuant to those requirements, the Fund must include information in this report regarding certain certifications. The Fund's president and treasurer have filed certifications with the SEC regarding the quality of the Fund's public disclosure. Those certifications were made pursuant to Section 302 of the Sarbanes-Oxley Act ("Section 302 Certifications"). The Section 302 Certifications were filed as exhibits to the Fund's annual report on Form N-CSR, which included a copy of this annual report along with other information about the Fund. After the Fund's 2005 annual meeting of shareholders, it will be required to file a certification with the NYSE stating whether its president is aware of any violation of the NYSE's Corporate Governance listing standards. The Fund will be required to include certain additional information in subsequent annual reports relating to the NYSE certification. -------------------------------------------------------------------------------- 35 (This page has been left blank intentionally) Directors Richard Q. Armstrong Meyer Feldberg Chairman Carl W. Schafer Margo N. Alexander William D. White David J. Beaubien Richard R. Burt Principal Officers Joseph A. Varnas Elbridge T. Gerry III President Vice President Mark F. Kemper W. Douglas Beck Vice President and Secretary Vice President Thomas Disbrow Vice President and Treasurer Investment Advisor and Administrator UBS Global Asset Management (US) Inc. 51 West 52nd Street New York, New York 10019-6114 Notice is hereby given in accordance with Section 23(c) of the Investment Company Act of 1940 that from time to time the Fund may purchase shares of its common stock in the open market at market prices. This report is sent to the shareholders of the Fund for their information. It is not a prospectus, circular or representation intended for use in the purchase or sale of shares of the Fund or of any securities mentioned in this report. (copyright) 2004 UBS Global Asset Management (US) Inc. All rights reserved. ---------------- (UBS LOGO) Presorted Standard UBS GLOBAL ASSET MANAGEMENT (US) INC. US Postage 51 West 52nd Street PAID New York, NY 10019-6114 Smithtown, NY Permit 700 ---------------- ITEM 2. CODE OF ETHICS. ------------------------ The registrant has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions pursuant to Section 406 of the Sarbanes-Oxley Act of 2002. (The registrant has designated the code of ethics adopted pursuant to Sarbanes-Oxley as a "Code of Conduct" to lessen the risk of confusion with its separate code of ethics adopted pursuant to Rule 17j-1 under the Investment Company Act of 1940, as amended.) ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT. ------------------------------------------ The registrant's Board has determined that the following person serving on the registrant's Audit Committee is an "audit committee financial expert" as defined in item 3 of Form N-CSR: Richard Q. Armstrong. Mr. Armstrong is independent as defined in item 3 of Form N-CSR. ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES. ------------------------------------------------ (a) Audit Fees: ----------- For the fiscal years ended September 30, 2004 and September 30, 2003, the aggregate Ernst & Young LLP (E&Y) audit fees for professional services rendered to the registrant were approximately $36,750 and $13,600, respectively. Fees included in the audit fees category are those associated with the annual audits of financial statements and services that are normally provided in connection with statutory and regulatory filings. (b) Audit-Related Fees: ------------------- In each of the fiscal years ended September 30, 2004 and September 30, 2003, the aggregate audit-related fees billed by E&Y for services rendered to the registrant that are reasonably related to the performance of the audits of the financial statements, but not reported as audit fees, were approximately $12,693 and $21,300, respectively, which includes amounts related to non-audit services prior to May 6, 2003 that would have been subject to pre-approval if the SEC rules relating to the pre-approval of non-audit services had been in effect at that time. Fees included in the audit-related category are those associated with (1) the reading and providing of comments on the 2004 and 2003 semiannual financial statements, (2) review of portions of the registrant's semiannual 2003 Form N-SAR filing (3) review of the consolidated 2003 and 2002 report on UBS Funds' profitability of UBS Global Asset Management (US) Inc. ("UBS Global AM") to assist the board members in their annual advisory/administration contract reviews and (4) auction preferred shares testing for the registrant's fiscal years ended 2004 and 2003. There were no audit-related fees required to be approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X during the fiscal years indicated above. (c) Tax Fees: --------- In each of the fiscal years ended September 30, 2004 and September 30, 2003, the aggregate tax fees billed by E&Y for professional services rendered to the registrant were approximately $11,400 and $8,100, respectively, which includes amounts related to tax services prior to May 6, 2003 that would have been subject to pre-approval if the SEC rules relating to the pre-approval of non-audit services had been in effect at that time. Fees included in the tax fees category comprise all services performed by professional staff in the independent accountant's tax division except those services related to the audits. This category comprises fees for review of tax compliance, tax return preparation and excise tax calculations. There were no tax fees required to be approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X during the fiscal years indicated above. (d) All Other Fees: --------------- In each of the fiscal years ended September 30, 2004 and September 30, 2003, there were no fees billed by E&Y for products and services, other than the services reported in Item 4(a)-(c) above, rendered to the registrant. Fees included in the all other fees category would consist of services related to internal control reviews, strategy and other consulting, financial information systems design and implementation, consulting on other information systems, and other tax services unrelated to the registrant. There were no "all other fees" required to be approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X during the fiscal years indicated above. (e) (1) Audit Committee Pre-Approval Policies and Procedures: ----------------------------------------------------- The registrant's Audit Committee ("audit committee") has adopted an "Audit Committee Charter (Amended and Restated as of May 12, 2004)" (the "charter"). The charter contains the audit committee's pre-approval policies and procedures. Reproduced below is an excerpt from the charter regarding pre-approval policies and procedures: The [audit ]Committee shall: ... 2. Pre-approve (a) all audit and permissible non-audit services(1) to be provided to the Fund and (b) all permissible non-audit services to be provided by the Fund's independent auditors to UBS Global [AM] and any Covered Service Providers, if the engagement relates directly to the operations and financial reporting of the Fund. In carrying out this responsibility, the Committee shall seek periodically from UBS Global [AM] and from the independent auditors a list of such audit and permissible non-audit services that can be expected to be rendered to the Fund, UBS Global [AM] or any Covered Service Providers by the Fund's independent auditors, and an estimate of the fees sought to be paid in connection with such services. The Committee may delegate its responsibility to pre-approve any such audit and permissible non-audit services to a sub-committee consisting of the Chairperson of the Committee and two other members of the Committee as the Chairperson, from time to time, may determine and appoint, and such sub-committee shall report to the Committee, at its next regularly scheduled meeting after the sub-committee's meeting, its decision(s). From year to year, the Committee shall report to the Board whether this system of pre-approval has been effective and efficient or whether this Charter should be amended to allow for pre-approval pursuant to such policies and procedures as the Committee shall approve, including the delegation of some or all of the Committee's pre-approval responsibilities to other persons (other than UBS Global [AM] or the Fund's officers). --------------- (1) The Committee will not approve non-audit services that the Committee believes may taint the independence of the auditors. Currently, permissible non-audit services include any professional services (including tax services) that are not prohibited services as described below, provided to the Fund by the independent auditors, other than those provided to the Fund in connection with an audit or a review of the financial statements of the Fund. Permissible non-audit services may not include: (i) bookkeeping or other services related to the accounting records or financial statements of the Fund; (ii) financial information systems design and implementation; (iii) appraisal or valuation services, fairness opinions or contribution-in-kind reports; (iv) actuarial services; (v) internal audit outsourcing services; (vi) management functions or human resources; (vii) broker or dealer, investment adviser or investment banking services; (viii) legal services and expert services unrelated to the audit; and (ix) any other service the Public Company Accounting Oversight Board determines, by regulation, is impermissible. Pre-approval by the Committee of any permissible non-audit services is not required so long as: (i) the aggregate amount of all such permissible non-audit services provided to the Fund, UBS Global [AM] and any service providers controlling, controlled by or under common control with UBS Global [AM] that provide ongoing services to the Fund ("Covered Service Providers") constitutes not more than 5% of the total amount of revenues paid to the independent auditors (during the fiscal year in which the permissible non-audit services are provided) by (a) the Fund, (b) its investment adviser and (c) any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the Fund during the fiscal year in which the services are provided that would have to be approved by the Committee; (ii) the permissible non-audit services were not recognized by the Fund at the time of the engagement to be non-audit services; and (iii) such services are promptly brought to the attention of the Committee and approved by the Committee (or its delegate(s)) prior to the completion of the audit. (e) (2) Services approved pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X: Audit-Related Fees: ------------------- There were no amounts that were approved by the audit committee pursuant to the de minimis exception for the fiscal years ended September 30, 2004 and September 30, 2003 on behalf of the registrant. There were no amounts that were required to be approved by the audit committee pursuant to the de minimis exception for the fiscal years ended September 30, 2004 and September 30, 2003 on behalf of the registrant's service providers that relate directly to the operations and financial reporting of the registrant. Tax Fees: --------- There were no amounts that were approved by the audit committee pursuant to the de minimis exception for the fiscal years ended September 30, 2004 and September 30, 2003 on behalf of the registrant. There were no amounts that were required to be approved by the audit committee pursuant to the de minimis exception for the fiscal years ended September 30, 2004 and September 30, 2003 on behalf of the registrant's service providers that relate directly to the operations and financial reporting of the registrant. All Other Fees: --------------- There were no amounts that were approved by the audit committee pursuant to the de minimis exception for the fiscal years ended September 30, 2004 and September 30, 2003 on behalf of the registrant. There were no amounts that were required to be approved by the audit committee pursuant to the de minimis exception for the fiscal years ended September 30, 2004 and September 30, 2003 on behalf of the registrant's service providers that relate directly to the operations and financial reporting of the registrant. (f) According to E&Y, for the fiscal year ended September 30, 2004, the percentage of hours spent on the audit of the registrant's financial statements for the most recent fiscal year that were attributed to work performed by persons who are not full-time, permanent employees of E&Y was 0%. (g) For the fiscal years ended September 30, 2004 and September 30, 2003, the aggregate fees billed by E&Y of $3,661,972 and $3,178,679, respectively, for non-audit services rendered on behalf of the registrant ("covered"), its investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser) and any entity controlling, controlled by, or under common control with the adviser ("non-covered") that provides ongoing services to the registrant for each of the last two fiscal years of the registrant is shown in the table below: 2004 2003 ---- ---- Covered Services $24,093 $29,400 Non-Covered Services 3,637,879 3,149,279 (h) The registrant's audit committee was not required to consider whether the provision of non-audit services that were rendered to the registrant's investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the registrant that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X is compatible with maintaining the principal accountant's independence. ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS. ---------------------------------------------- The registrant has a separately designated standing audit committee (the "Audit Committee") established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. The Audit Committee is comprised of the following board members: Mr. Armstrong, Mr. Beaubien, Mr. Burt, Mr. Feldberg and Mr. White. ITEM 6. SCHEDULE OF INVESTMENTS. --------------------------------- Included as part of the report to shareholders filed under Item 1 of this form. ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END -------------------------------------------------------------------------- MANAGEMENT INVESTMENT COMPANIES. -------------------------------- The registrant's Board of Directors believes that the voting of proxies on securities held by the registrant is an important element of the overall investment process. As such, the Board has delegated the responsibility to vote such proxies to the registrant's advisor. Following is a summary of the proxy voting policy of the advisor. CORPORATE GOVERNANCE PHILOSOPHY, VOTING GUIDELINES AND POLICY SUMMARY The proxy voting policy of UBS Global AM is based on its belief that voting rights have economic value and must be treated accordingly. Generally, UBS Global AM expects the boards of directors of companies issuing securities held by its clients to act as stewards of the financial assets of the company, to exercise good judgment and practice diligent oversight with the management of the company. While there is no absolute set of rules that determines appropriate corporate governance under all circumstances and no set of rules will guarantee ethical behavior, there are certain benchmarks, which, if substantial progress is made toward, give evidence of good corporate governance. UBS Global AM may delegate to an independent proxy voting and research service the authority to exercise the voting rights associated with certain client holdings. Any such delegation shall be made with the direction that the votes be exercised in accordance with UBS Global AM's proxy voting policy. When UBS Global AM's view of a company's management is favorable, UBS Global AM generally supports current management initiatives. When UBS Global AM's view is that changes to the management structure would probably increase shareholder value, UBS Global AM may not support existing management proposals. In general, UBS Global AM (1) opposes proposals which act to entrench management; (2) believes that boards should be independent of company management and composed of persons with requisite skills, knowledge and experience; (3) opposes structures which impose financial constraints on changes in control; (4) believes remuneration should be commensurate with responsibilities and performance; and (5) believes that appropriate steps should be taken to ensure the independence of auditors. UBS Global AM has implemented procedures designed to identify whether it has a conflict of interest in voting a particular proxy proposal, which may arise as a result of its or its affiliates' client relationships, marketing efforts or banking and broker/dealer activities. To address such conflicts, UBS Global AM has imposed information barriers between it and its affiliates who conduct banking, investment banking and broker/dealer activities and has implemented procedures to prevent business, sales and marketing issues from influencing our proxy votes. Whenever UBS Global AM is aware of a conflict with respect to a particular proxy, its appropriate local corporate governance committee is required to review and agree to the manner in which such proxy is voted. ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES. -------------------------------------------------------------------------- Form N-CSR disclosure requirement not yet effective with respect to the registrant. ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT --------------------------------------------------------------------------- COMPANY AND AFFILIATED PURCHASERS. ---------------------------------- There were no purchases made by or on behalf of the registrant or any "affiliated purchaser," as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934, as amended, of shares of the registrant's equity securities made in the period covered by this report. ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. -------------------------------------------------------------- The registrant's Board has established a Nominating and Corporate Governance Committee. The Nominating and Corporate Governance Committee will consider nominees recommended by shareholders if a vacancy occurs among those board members who are not "interested persons" as defined in Section 2(a)(19) of the Investment Company Act of 1940, as amended. In order to recommend a nominee, a shareholder should send a letter to the chairperson of the Nominating and Corporate Governance Committee, Mr. Meyer Feldberg, care of the Secretary of the registrant at UBS Global Asset Management (US) Inc., 51 West 52nd Street, New York, New York 10019-6114, and indicate on the envelope "Nominating and Corporate Governance Committee." The shareholder's letter should state the nominee's name and should include the nominee's resume or curriculum vitae, and must be accompanied by a written consent of the individual to stand for election if nominated for the Board and to serve if elected by shareholders. ITEM 11. CONTROLS AND PROCEDURES. ---------------------------------- (a) The registrant's principal executive officer and principal financial officer have concluded that the registrant's disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940, as amended) are effective based on their evaluation of these controls and procedures as of a date within 90 days of the filing date of this document. (b) The registrant's principal executive officer and principal financial officer are aware of no changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal half-year that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. ITEM 12. EXHIBITS. ------------------- (a) (1) Code of Ethics as required pursuant to Section 406 of the Sarbanes-Oxley Act of 2002 (and designated by registrant as a "Code of Conduct") is attached hereto as Exhibit EX-99.CODE ETH. (a) (2) Certifications of principal executive officer and principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 is attached hereto as Exhibit EX-99.CERT. (b) Certifications of principal executive officer and principal financial officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 is attached hereto as Exhibit EX-99.906CERT. 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. Investment Grade Municipal Income Fund Inc. By: /s/ Joseph A. Varnas --------------------- Joseph A. Varnas President Date: November 24, 2004 ----------------- Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Joseph A. Varnas --------------------- Joseph A. Varnas President Date: November 24, 2004 ----------------- By: /s/ Thomas Disbrow ------------------ Thomas Disbrow Treasurer Date: November 24, 2004 -----------------