Subject to Completion

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

Preliminary Prospectus dated            , 2010

PROSPECTUS

Shares

Western Asset Mortgage
Defined Opportunity Fund Inc.

Common Stock

$20.00 per Share

The Fund. Western Asset Mortgage Defined Opportunity Fund Inc. (the "Fund") is a newly organized, non-diversified, limited-term, closed-end management investment company.

Investment Objectives. The Fund's primary investment objective is to provide current income. As a secondary investment objective, the Fund will seek capital appreciation. There can be no assurance the Fund will achieve its investment objectives.

Investment Strategies. The Fund seeks to achieve its investment objectives by investing primarily in a diverse portfolio of mortgage-backed securities ("MBS"), consisting primarily of non-agency residential mortgage-backed securities ("RMBS") and commercial mortgage-backed securities ("CMBS"). The Fund intends to invest in MBS directly, and indirectly through a separate investment in a public-private investment fund formed in connection with the Legacy Securities Public-Private Investment Program ("PPIP") established by the U.S. Department of the Treasury (the "Treasury").

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No Prior Trading History.   Because the Fund is newly organized, its common stock has no history of public trading. The shares of closed-end investment companies frequently trade at a discount from their net asset value which may increase investor risk of loss. This risk may be greater for investors expecting to sell their shares in a relatively short period after completion of the initial public offering.

The Fund's common stock has been approved for listing on the New York Stock Exchange (the "NYSE"), subject to notice of issuance. The trading or "ticker" symbol is "DMO."

Investing in the Fund's common stock involves certain risks. You could lose some or all of your investment. See "Risks" beginning on page 52 of this prospectus.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The Treasury has not participated in the preparation of this prospectus or made any representation regarding, and expressly disclaims any liability or responsibility to any investor in the Fund for, the accuracy, completeness or correctness of any of the materials contained herein. Without limitation of the foregoing, the Treasury does not approve or disapprove of any tax disclosure or advice set forth herein.

(1)  Legg Mason Partners Fund Advisor, LLC ("LMPFA") (and not the Fund) may pay from its own assets certain qualifying underwriters a structuring fee, additional compensation, or a sales incentive fee in connection with the offering. See "Underwriting." The total compensation received by the underwriters (including the sales load and additional compensation) will not exceed 9.0 % of the total public offering price of the common stock sold in this offering.

(2)  Total offering expenses to be paid by the Fund (other than the sales load) are estimated to be approximately $          , which represents $.04 per share. After payment of such expenses, proceeds to the Fund will be $19.06 per share. LMPFA has agreed to pay (i) all of the Fund's organizational expenses, which are estimated to be $25,000, and (ii) the Fund's offering expenses (other than the sales load) to the extent offering expenses are in excess of $.04 per share which are estimated to be $          .

(3)  The underwriters named in this prospectus may purchase up to              additional shares at the public offering price, less the sales load, solely to cover overallotments, if any. If this option is exercised in full, the total public offering price, sales load, estimated offering expenses and proceeds, after expenses, to the Fund will be approximately $          , $          , $           and $          , respectively.

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Portfolio Contents. Under normal circumstances, the Fund will invest at least 80 % of its Managed Assets (as defined below) in MBS directly, and indirectly by investing in a private feeder fund (the "Feeder Fund") which invests substantially all of its assets, alongside the Treasury, in a master fund (the "Master Fund") that has been organized to invest directly in MBS and other assets eligible for purchase under PPIP. The Fund also may invest up to 20 % of its Managed Assets directly in other permitted investments as described in this prospectus. Based upon current market conditions, the Fund anticipates it will have initial portfolio allocations (including its direct and indirect investments) of approximately 80 % to 100 % of Managed Assets in RMBS, 0 % to 10 % of Managed Assets in CMBS, and 0 % to 10 % of Managed Assets in other permitted investments. It is expected that these allocations will change over the life of the Fund. The Fund is not limited in its ability to invest in below investment grade ("junk" securities) or illiquid securities.

Allocation of Proceeds. Based on current market conditions, the Allocation Subadviser (as defined below) anticipates that the Fund will invest 60 % to 70 % of the net proceeds of this offering directly in MBS and other permitted investments and approximately 30 % to 40 % of the net proceeds of this offering in the Feeder Fund. Under no circumstances will the Fund invest more than 40 % of the net proceeds of this offering in the Feeder Fund.

Leverage. The Fund may seek to enhance the level of its current distributions to holders of common stock through the use of leverage. The Fund may use leverage directly at the Fund level through borrowings, including loans from certain financial institutions or through a qualified government sponsored program, the use of reverse repurchase agreements and/or the issuance of debt securities (collectively, "Borrowings"), and possibly through the issuance of preferred stock ("Preferred Stock"), in an aggregate amount of up to approximately 33 ¹ / ₃ % of the Fund's Total Assets immediately after such Borrowings and/or issuances of Preferred Stock. "Total Assets" means net assets of the Fund plus the amount of any Borrowings and assets attributable to Preferred Stock that may be outstanding. Currently, the Fund has no intention to issue notes or debt securities or Preferred Stock. In addition, the Fund may enter into additional reverse repurchase agreements and/or use similar investment management techniques that may provide leverage, but which are not subject to the foregoing 33 ¹ / ₃ % limitation so long as the Fund has covered its commitment with respect to such techniques by segregating liquid assets, entering into offsetting transactions or owning positions covering related obligations. See "Leverage," "Description of Shares—Preferred Stock" and "Risks—Risks Related to the Fund—Leverage Risk."

The Master Fund is expected to borrow money from the Treasury for investment purposes in an amount equal to approximately 50 % of the Master Fund's total assets immediately after giving effect to the borrowing (the "Treasury Debt Financing"). The Master Fund will bear the interest expense and other financing costs arising out of its use of the Treasury Debt Financing. To the extent the Fund invests in the Master Fund, through its investment in the Feeder Fund, the Fund will be subject to the implicit risks (and potential benefits) of such leverage. The Fund will also bear its allocable share of the Master Fund's cost of leverage. While such implicit leverage will not constitute actual borrowing of the Fund for purposes of the Investment Company Act of 1940, as amended (the "1940 Act"), in an effort to mitigate the overall risk of leverage, the Fund does not intend to incur additional direct leverage at the Fund level to the extent that its existing direct leverage at the Fund level and its implicit leverage through its investment in the Master Fund exceeds 33 ¹ / ₃ % of the Fund's Managed Assets immediately after Borrowings and/or issuances Preferred Stock at the Fund level. "Managed Assets" means the Total Assets of the Fund plus any implicit leverage at the Master Fund level attributable to the Fund's investment in the Feeder Fund.

Assuming the Fund invests 40% of the net proceeds of this offering in the Feeder Fund, it is expected that leverage at the Master Fund will constitute implicit leverage for the Fund of approximately        % of the Fund's Managed Assets after giving effect to the Treasury Debt Financing.

For more information on the Fund's investment strategies, see "The Fund's Investments" and "Risks."

Manager and Subadvisers. Legg Mason Partners Fund Advisor, LLC ("LMPFA"), the Fund's investment manager, will provide administrative and management services to the Fund. As of December 31, 2009, LMPFA's total assets under management were approximately $189 billion.

Western Asset Management Company (the "Subadviser") will have day-to-day responsibility for managing the Fund's direct investments in MBS and other permitted investments, subject to the supervision of the Fund's Board of Directors (the "Board of Directors") and LMPFA. At the direction of the Allocation Subadviser, the Subadviser may manage assets that the Allocation Subadviser has determined to commit to the Feeder Fund, but have not yet been called by the Feeder Fund. Assets, including investment income, that are distributed from the Feeder Fund to the Fund but are not distributed to holders of the Fund's common stock will be managed by the Subadviser. The Subadviser is also the investment adviser to the Feeder Fund and Master Fund (in that capacity, "Western Asset"). As of December 31, 2009, Western Asset and its supervised affiliates had approximately $482 billion in assets under management.

In connection with the Subadviser's service to the Fund, Western Asset Management Company Limited ("Western Asset Limited") will be responsible, generally, for managing investments denominated in currencies other than the U.S. dollar. LMPFA, the Subadviser and Western Asset Limited are subsidiaries of Legg Mason, Inc.

Wilshire Associates Incorporated, a registered investment adviser unaffiliated with Legg Mason, LMPFA or Western Asset (the "Allocation Subadviser"), will determine whether and to what extent the Fund will invest in the Feeder Fund, subject to the supervision of the Fund's Board of Directors and LMPFA. Assets not allocated by the Allocation Subadviser to the Feeder Fund will be managed directly by the Subadviser. In addition, during the invest-up period of the Feeder Fund, the Allocation Subadviser may direct the Subadviser to manage assets that have been committed to the Feeder Fund by the Allocation Subadviser, but have not yet been called by the Feeder Fund.

Limited Term. As a fundamental policy, the Fund intends to liquidate and distribute substantially all of the Fund's net assets to stockholders, after making appropriate provision for any liabilities of the Fund, on or about March 1, 2022. The Fund does not seek to return $20.00 per share upon termination. As the assets of the Fund will be liquidated in connection with its termination, the Fund may be required to sell portfolio securities when it otherwise would not, including at times when market conditions are not favorable, which may cause the Fund to lose money. Upon termination, the final distribution of net assets may be more than, equal to or less than $20.00 per share.

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(continued from previous page)

You should read this prospectus, which contains important information about the Fund that you should know before deciding whether to invest, and retain it for future reference. A Statement of Additional Information, dated       , as it may be amended (the "SAI"), containing additional information about the Fund, has been filed with the Securities and Exchange Commission (the "SEC") and is incorporated by reference in its entirety into this prospectus. You may request a free copy of the SAI (the table of contents of which is on page 105 of this prospectus), annual and semi-annual reports to stockholders (when available) and additional information about the Fund and make stockholders' inquiries by calling (888) 777-0102, by writing to the Fund or by visiting the Fund's website (http://www.leggmason.com/cef). The information contained in, or accessed through, the Fund's website is not part of this prospectus. You may also obtain a copy of the SAI (and other information regarding the Fund) from the SEC's Public Reference Room in Washington, D.C. Information relating to the Public Reference Room may be obtained by calling the SEC at (202) 551-8090. Such materials, as well as the Fund's annual and semi-annual reports (when available) and other information regarding the Fund are also available on the SEC's website (http://www.sec.gov). You may also e-mail requests for these documents to publicinfo@sec.gov or make a request in writing to the SEC's Public Reference Section, 100 F Street, N.E., Washington, D.C. 20549-0102.

The Fund's common stock does not represent a deposit or obligation of, and is not guaranteed or endorsed by, any bank or other insured depository institution, and is not federally insured by the Federal Deposit Insurance Corporation, the Board of Governors of the United States Federal Reserve or any other governmental agency.

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TABLE OF CONTENTS

You should rely only on the information contained in or incorporated by reference into this prospectus. The Fund has not, and the underwriters have not, authorized anyone to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. The Fund is not, and the underwriters are not, making an offer of these securities in any jurisdiction where the offer is not permitted.

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SUMMARY OF FUND EXPENSES

The purpose of the following table and the example below is to help you understand all fees and expenses that you, as a holder of Common Stock, would bear directly or indirectly. The expenses shown in the table under "Estimated Annual Expenses" are based on estimated amounts for the Fund's first full year of operations and assume that the Fund issues approximately 12,500,000 shares of Common Stock. If the Fund issues fewer shares of Common Stock, all other things being equal, these expenses would increase as a percentage of net assets attributable to Common Stock. The expenses shown in the table under "Other Expenses" and "Total Annual Expenses" also assume the Fund incurs no direct leverage at the Fund level and leverage of approximately 50% at the Master Fund level, which at the Fund level would be equal to approximately 25.9 % of the Fund's Managed Assets. The Fund's actual expenses may vary from the estimated expenses shown in the table. See "Management of the Fund." The "Other Expenses" shown in the table and related footnotes are based on estimated amounts.

(1)  LMPFA has agreed to pay (i) all of the Fund's organizational expenses and (ii) the Fund's offering expenses (other than sales load) to the extent offering expenses are in excess of $.04 per share of Common Stock. Assuming an offering of 12,500,000 shares of Common Stock for $20.00 per share, the total offering expenses are estimated to be $1,247,000, $500,000 of which would be borne by the Fund and $747,000 of which would be paid by LMPFA.

(2)  You will pay service charges and brokerage charges if you direct the Plan Agent (defined below) to sell your Common Stock held in a dividend reinvestment account. See "Dividend Reinvestment Plan."

(3)  This is an estimate of management fees payable by Common Stockholders with respect to the Managed Assets of the Fund. "Managed Assets" means the Total Assets of the Fund plus any implicit leverage at the Master Fund level attributable to the Fund's investment in the Feeder Fund. LMPFA will receive an annual fee, payable monthly, in an amount equal to 1.00 % of the Fund's average daily Managed Assets. The Allocation Subadviser will receive an annual fee, payable monthly, in an amount equal to .05% of the Fund's average daily Managed Assets, subject to a minimum compensation guarantee between the Allocation Subadviser and LMPFA.

(4)  If the Fund utilizes leverage in the form of bank loan facilities, reverse repurchase agreements and/or inverse floating rate securities, then there are no offering expenses associated with their use, although there may be legal and other expenses incurred in establishing bank loan facilities. Although the Fund has no current intention to do so, if the Fund elects to use other forms of leverage, including the issuance of notes or debt securities or Preferred Stock, there may be offering expenses associated with such issuance, which expenses would be borne immediately by the Common Stockholders and result in a reduction of the net asset value of the Common Stock. The Fund has no present intention to issue notes or debt securities or Preferred Stock in the next 12 months.

(5)  This is an estimate of annual management fees and expenses borne by Common Stockholders with respect to the Fund's investment in the Feeder Fund, and indirect investment in the Master Fund. This estimate includes: (i) the annual administrative fee to the General Partner which will ultimately be collected by RLJ, and not Western Asset, in an amount equal to .15 % of the capital commitment of the Fund in the Feeder Fund, (ii) the Fund's pro rata share of annual operating expenses of the Feeder Fund and the Master Fund, including the Fund's allocable share of expenses associated with the Treasury Debt Financing and (iii) the Fund's pro rata share of the organizational expenses of the Feeder Fund and the Master Fund in connection with such investment. The Fund's actual operating expenses will vary based upon the size of the Fund's investment in the Feeder Fund, the actual expenses of the Feeder Fund and the Master Fund, the actual amount of borrowings by the Master Fund and any fluctuations in interest rates or actions taken by the Master Fund to manage its interest rate exposure. This estimate assumes an investment of 35% of the Fund's net assets in the Master Fund, implicit leverage at the Master Fund level equal to approximately 25.9 % of the Fund's Managed Assets due to borrowings at the Master Fund level and an annual interest rate on such borrowings of 1.25 % .

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Example

The following example illustrates the expenses (including (i) the sales load of $45 and (ii) estimated offering expenses of this offering of $2) that you would pay on a $1,000 investment in Common Stock, assuming (1) total annual expenses of 2.23 % and (2) a 5 % annual return: ⁽¹⁾

(1)   The example above should not be considered a representation of future expenses. Actual expenses may be higher or lower than those shown. The example assumes that all dividends and distributions are reinvested at net asset value. Actual expenses may be greater or less than those assumed. Moreover, the Fund's actual rate of return may be greater or less than the hypothetical 5 % return shown in the example.

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THE FUND

The Fund is a newly organized, non-diversified, limited-term closed-end management investment company registered under the 1940 Act. The Fund was incorporated as a Maryland corporation on December 11, 2009, pursuant to the Articles. As a newly organized entity, the Fund has no operating history. The Fund's principal executive office is located at 55 Water Street, New York, New York 10041, and its telephone number is (888) 777-0102.

USE OF PROCEEDS

The net proceeds of the offering of Common Stock will be approximately $ if the underwriters exercise the overallotment option in full) after payment of the estimated offering expenses. The Fund will pay all of its offering expenses up to $.04 per share of Common Stock, and LMPFA has agreed to pay (i) all of the Fund's organizational expenses, which are estimated to be $25,000, and (ii) the Fund's offering expenses (other than sales load) to the extent offering expenses are in excess of $.04 per share.

The Fund will invest the net proceeds of the offering in accordance with the Fund's investment objectives and policies as stated below. It is currently anticipated that the Fund will be able to invest substantially all of the net proceeds in accordance with its investment objectives and policies within two to four months after the completion of the offering. Western Asset anticipates, based on current market conditions, that the Fund's indirect investment in the Master Fund will be invested within 12 months. Western Asset believes that the flexibility of investing over this period may permit the Master Fund to purchase securities at more favorable prices, although no assurance can be given in this regard. Pending such investment, it is anticipated that the proceeds of this offering will be invested in Treasury securities or other mortgage-related short-term investments, such as U.S. agency CMOs, CMBS, reverse repurchase agreements and other high quality securities, until such time as the Feeder Fund issues capital calls for portions of the Fund's capital commitment to the Feeder Fund for investment in the Feeder Fund and, subsequently, in the Master Fund.

THE FUND'S INVESTMENTS

Investment Objectives

The Fund's primary investment objective is to provide current income. As a secondary investment objective, the Fund will seek capital appreciation. There can be no assurance the Fund will achieve its investment objectives.

This section provides additional information about the Fund's investments and certain portfolio management techniques the Fund may use. More information about the Fund's investments and portfolio management techniques and the associated risks is included in the SAI.

Investment Strategies

The Fund seeks to achieve its investment objectives by investing primarily in a diverse portfolio of MBS, consisting primarily of non-agency RMBS and CMBS. MBS represent interests in diversified pools of residential or commercial mortgage loans, and typically take the form of pass-through securities or CMOs. MBS include, but are not limited to, the following: non-agency RMBS; CMBS; U.S. agency mortgage-backed pass-through securities issued by Ginnie Mae, Fannie Mae, Freddie Mac, and other federal agencies, or issues guaranteed by them; delegated underwriting and servicing bonds, including pools of multi-family housing loans issued by Fannie Mae and Freddie Mac; CMOs, including IO, PO and other mortgage securities backed by U.S. agency or non-agency pass-through securities; mortgage-related ABS, such as HEQ securities; MBS credit default swaps (including on the CMBX, TRX and ABX indices) and other derivative instruments related to MBS; inverse floating rate securities; non-dollar RMBS; and repurchase agreements supported by agency MBS. The Fund may invest in MBS of any type and of any credit quality, without limitation.

Under normal circumstances, the Fund will invest at least 80 % of its Managed Assets in MBS directly, and indirectly through a separate investment as a limited partner in the Feeder Fund. The Feeder Fund invests substantially all of its assets available for investment, alongside the Treasury, in the Master Fund. The Master Fund is organized to invest directly in MBS and other assets eligible for purchase under PPIP. Based on current market conditions, the Allocation Subadviser anticipates that the Fund will invest 60 % to 70 % of the net proceeds of this offering directly in MBS and other permitted investments and approximately 30 % to 40 % of the net proceeds of this offering in the Feeder Fund. Under no circumstances will the Fund invest more than 40 % of the net proceeds of this offering in the Feeder Fund.

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The Fund also may invest up to 20 % of its Managed Assets in other permitted investments, including cash and cash equivalents; Treasury securities; non-mortgage related ABS backed by various asset classes including, but not limited to, small balance commercial mortgages, aircrafts, automobiles, credit cards, equipment, manufactured housing, franchises, recreational vehicles and student loans; and investment grade and below investment grade fixed income securities including bonds, debentures, notes, commercial paper and other similar types of debt instruments including hybrid securities. The Fund also may invest in any newly developed mortgage-related derivatives that may hereafter become available for mortgage investing.

Based upon current market conditions, the Fund anticipates it will have initial portfolio allocations (including its direct investments and indirect investment in the Master Fund) of approximately 80 % to 100 % of Managed Assets in RMBS, 0 % to 10 % of Managed Assets in CMBS, and 0 % to 10 % of Managed Assets in other permitted investments. It is expected that these allocations will change over the life of the Fund.

The Fund may invest in derivative instruments, such as options contracts, futures contracts, options on futures contracts, indexed securities, credit linked notes, credit default swaps and other swap agreements for investment, hedging and risk management purposes; provided that the Fund's use of derivative instruments, as measured by the total notional amount of all such instruments, will not exceed 20 % of its Managed Assets. With respect to this limitation, the Fund may net derivatives with opposite exposure to the same underlying instrument. Notwithstanding the foregoing, the Fund may invest without limitation in Treasury futures, Eurodollar futures, interest rate swaps, swaptions or similar instruments and combinations thereof. To the extent that the security or index underlying the derivative or synthetic instrument is or is composed of MBS, the Fund will include such derivative and synthetic instruments for the purposes of the Fund's policy to invest at least 80 % of its Managed Assets in MBS. The use of derivatives by the Master Fund will be excluded from the calculation of the foregoing limitation. The Fund may sell certain equities or fixed income securities short including, but not limited to, Treasury securities, for investing or hedging purposes.

The Fund is not limited in its ability to invest in below investment grade or illiquid securities. Below investment grade fixed income securities are rated below "BBB-" by S&P or Fitch, below "Baa3" by Moody's or comparably rated by another NRSRO or, if unrated, determined by the Subadviser to be of comparable quality. Below investment grade fixed income securities are commonly referred to as "high yield" or "junk" bonds and are regarded as having predominantly speculative characteristics with respect to the issuer's capacity to pay interest and repay principal. In the event that a security receives different ratings from different NRSROs, the Fund will treat the security as being rated in the highest rating category received from an NRSRO. "Illiquid securities" are securities which cannot be sold within seven days in the ordinary course of business at approximately the value at which the Fund has valued the securities.

Credit Ratings and Unrated Securities

Rating agencies are private services that provide ratings of the credit quality of debt obligations, including convertible securities. Appendix A to the SAI describes the various ratings assigned to debt obligations by S&P, Moody's and Fitch. Ratings assigned by a rating agency are not absolute standards of credit quality and do not evaluate market risks or the liquidity of securities. Rating agencies may fail to make timely changes in credit ratings and an issuer's current financial condition may be better or worse than a rating indicates. To the extent that the issuer of a security pays a rating agency for the analysis of its security, an inherent conflict of interest may exist that could affect the reliability of the rating. S&P, Moody's and Fitch monitor and evaluate the ratings assigned to securities on an ongoing basis. The ratings of a debt security may change over time. As a result, debt instruments held by the Fund could receive a higher rating or a lower rating during the period in which they are held. The Fund will not necessarily sell a security when its rating is reduced below its rating at the time of purchase.

Western Asset does not rely solely on credit ratings, and develops its own analysis of issuer credit quality. The Fund may purchase unrated securities if Western Asset determines that the securities are of comparable quality to rated securities that the Fund may purchase. Unrated securities may be less liquid than comparable rated securities and involve the risk that Western Asset may not accurately evaluate the security's comparative credit rating. Analysis of the creditworthiness of issuers of high yield securities may be more complex than for issuers of higher-quality debt obligations. To the extent that the Fund invests in high yield and/or unrated securities, the Fund's success in achieving its investment objectives may depend more heavily on Western Asset's creditworthiness analysis than if the Fund invested exclusively in higher-quality and rated securities.

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Selection of Investments

Western Asset employs an actively managed investment approach which utilizes the expertise of its large and experienced team of credit analysts, risk analysts and portfolio managers. Western Asset believes that the ability to integrate superior fundamental credit research with relative value analysis will drive performance in the Fund's MBS portfolio. A team of investment professionals at Western Asset will have daily responsibility for the management of the portfolio and for the implementation of the investment process.

The Subadviser has extensive experience analyzing the relative value of securities within various sectors of the mortgage markets, including undervalued distressed assets. The Subadviser intends to seek to maximize returns on the Fund's investments in distressed assets by evaluating market opportunities based on the condition of the various sectors of the mortgage markets, the relative value of the specific asset within such markets and an internal risk/return analysis. In making investment decisions on behalf of the Fund, the Subadviser will incorporate its views on the economic environment and the outlook for the mortgage markets, including relative valuation, supply and demand trends, the level of interest rates, the shape of the yield curve, prepayment rates, financing and liquidity, commercial and residential real estate prices, delinquencies, default rates, recovery of various segments of the economy and vintage of collateral.

Percentage Limitations

Percentage limitations described in this prospectus are as of the time of investment by the Fund and may be exceeded on a going-forward basis as a result of credit rating downgrades or market value fluctuations of the Fund's portfolio securities.

Segregation and Cover Requirements

Certain portfolio management techniques, such as reverse repurchase agreements, purchasing securities on a when-issued or delayed delivery basis, writing credit default swaps or futures contracts, engaging in short sales or writing options on portfolio securities, may be considered senior securities under the 1940 Act unless appropriate steps are taken to segregate the Fund's assets or otherwise cover its obligations. If the Fund utilizes these portfolio management techniques, it may segregate liquid assets, enter into offsetting transactions or own positions covering related obligations. Although under no obligation to do so, the Subadviser intends to cover the Fund's commitment with respect to such techniques should the Fund enter into or engage in one or more of such management techniques. To the extent the Fund covers its commitment under such portfolio management techniques, such instrument will not be considered a senior security for the purposes of the 1940 Act. The Fund may cover such transactions using other methods currently or in the future permitted under the 1940 Act, the rules and regulations thereunder, or orders issued by the SEC thereunder. For these purposes, interpretations and guidance provided by the SEC staff may be taken into account when deemed appropriate by the Fund. These segregation and coverage requirements could result in the Fund maintaining securities positions that it would otherwise liquidate, segregating assets at a time when it might be disadvantageous to do so or otherwise restricting portfolio management. Such segregation and cover requirements will not limit or offset losses on related positions. See "Investment Policies and Techniques—Portfolio Composition—Derivatives—Use of Segregated and Other Special Accounts" in the SAI.

Portfolio Composition

The Fund's portfolio will be composed principally of the following investments. A more detailed description of the Fund's investment policies and restrictions and more detailed information about the Fund's portfolio investments are contained in the SAI.

MBS

MBS are structured debt obligations collateralized by pools of commercial or residential mortgages. Pools of mortgage loans and mortgage-related loans, such as mezzanine loans, are assembled into pools of assets that secure or back securities sold to investors by various governmental, government-related and private organizations. MBS in which the Fund may invest include those with fixed, floating or variable interest rates, those with interest rates that change based on a specified index of interest rates and those with interest rates that change inversely to changes in interest rates, as well as those that do not bear interest. The Fund may invest in RMBS and CMBS, including residual interests, issued by private issuers, including subordinated mortgage-related securities. The Fund may invest in subprime mortgages or MBS that are backed by subprime mortgages. Other mortgage-related securities in which the Fund may invest are described below.

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Non-Agency RMBS

Non-agency RMBS are residential MBS that are collateralized by pools of mortgage loans assembled for sale to investors by non-government entities such as commercial banks, savings and loan associations and specialty finance companies. Non-Agency RMBS are not issued or guaranteed by a U.S. government agency or federally chartered corporation. Like agency RMBS, non-agency RMBS represent interests in pools of mortgage loans secured by residential real property.

The mortgage loan collateral for non-agency RMBS consists of residential mortgage loans that do not generally conform to underwriting guidelines issued by a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the U.S. government, such as Ginnie Mae, due to certain factors, including mortgage balances in excess of agency underwriting guidelines, borrower characteristics, loan characteristics and level of documentation, and therefore are not issued or guaranteed by an agency. Senior RMBS typically are rated by at least one NRSRO, such as Moody's, S&P, or Fitch, and are or were at the time of issuance normally AAA-rated by at least one of these rating agencies, although such ratings may have been subsequently downgraded.

The non-agency and agency RMBS acquired by the Fund could be secured by fixed-rate mortgages ("FRMs"), adjustable rate mortgages ("ARMs"), or hybrid adjustable-rate mortgages ("hybrid ARMs"). FRMs have interest rates that are fixed for the term of the loan and do not adjust. The interest rates on ARMs generally adjust annually (although some may adjust more frequently) to an increment over a specified interest rate index. Hybrid ARMs have interest rates that are fixed for a specified period of time (typically three, five, seven or ten years) and, thereafter, adjust to an increment over a specified interest rate index. ARMs and hybrid ARMs generally have periodic and lifetime constraints on how much the loan interest rate can change on any predetermined interest rate reset date. Relative value analysis, including consideration of current market conditions, will determine the Fund's allocation to FRMs, ARMs and hybrid ARMs.

The Fund's allocation of non-agency RMBS collateralized by FRMs, ARMs or hybrid ARMs will depend on various factors including, but not limited to, relative value, expected future prepayment trends, home price appreciation trends, supply and demand, availability of financing, expected future interest rate volatility and the overall state of the non-agency RMBS secondary market. Borrowers of the underlying loans that secure the non-agency RMBS assets which the Fund may purchase can be divided into prime, Alternative-A and subprime borrowers based on their credit rating.

CMBS

CMBS are securities backed by obligations (including certificates of participation in obligations) that are principally secured by commercial mortgages on real property or interests therein having a multifamily or commercial use, such as regional malls, other retail space, office buildings, industrial or warehouse properties, hotels, apartments, nursing homes and senior living facilities. The Fund's emphasis will be on securities that when originally issued were rated in the highest rating category by one or more of the NRSROs, however, the Fund has not established a minimum current rating requirement.

CMBS are typically issued in multiple tranches whereby the more senior classes are entitled to priority distributions from the trust's income to make specified interest and principal payments on such tranches. Losses and other shortfalls from expected amounts to be received on the mortgage pool are borne by the most subordinate classes, which receive principal payments only after the more senior classes have received all principal payments to which they are entitled. The credit quality of CMBS depends on the credit quality of the underlying mortgage loans, which is a function of factors such as the principal amount of loans relative to the value of the related properties; the cash flow produced by the property; the mortgage loan terms, such as amortization; market assessment and geographic location; construction quality of the property; and the creditworthiness of the borrowers.

Agency RMBS

Agency RMBS are residential MBS for which a U.S. government agency such as Ginnie Mae, or a federally chartered corporation such as Fannie Mae or Freddie Mac guarantees payments of principal and interest on the securities. Although the U.S. government guarantees principal and interest payments on securities issued by the U.S. government and some of its agencies, such as securities issued by Ginnie Mae, this guarantee does not apply to losses resulting from declines in the market value of these securities. Some agency RMBS that the Fund may hold are not guaranteed or backed by the full faith and credit of the U.S. government, such as those issued by Fannie Mae and Freddie Mac. Although the U.S. government has recently provided financial

31

support to Fannie Mae and Freddie Mac, there can be no assurance that it will support these or other government-sponsored enterprises in the future.

Agency RMBS differ from other forms of traditional debt securities, which normally provide for periodic payments of interest in fixed amounts with principal payments at maturity or on specified call dates. Instead, agency RMBS provide for monthly payments, which consist of both principal and interest. In effect, these payments are a "pass-through" of scheduled and prepaid principal payments and the monthly interest made by the individual borrowers on the mortgage loans, net of any fees paid to the issuers, servicers or guarantors of the securities. The principal may be prepaid at any time due to prepayments on the underlying mortgage loans or other assets. These differences can result in significantly greater price and yield volatility than is the case with traditional fixed-income securities.

The Fund's allocation of agency RMBS collateralized by FRMs, ARMs or hybrid ARMs will depend on various factors including, but not limited to, relative value, expected future prepayment trends, supply and demand, costs of hedging, costs of financing, expected future interest rate volatility and the overall shape of the Treasury and interest rate swap yield curves. The Subadviser intends to take these factors into account when making investments. In the future, the Fund's residential portfolio may extend to debentures that are issued and guaranteed by Freddie Mac or Fannie Mae or MBS the collateral of which is guaranteed by Ginnie Mae, Freddie Mac, Fannie Mae or another federally chartered corporation.

Stripped Mortgage-Backed Securities

The Fund also may invest in stripped mortgage-backed securities ("Stripped MBS"). Stripped MBS are created by segregating the cash flows from underlying mortgage loans or mortgage securities to create two or more new securities, each with a specified percentage of the underlying security's principal or interest payments. Mortgage securities may be partially stripped so that each investor class receives some interest and some principal. When securities are completely stripped, however, all of the interest is distributed to holders of one type of security, known as an "IO," and all of the principal is distributed to holders of another type of security known as a "PO." Strips can be created in a pass-through structure or as tranches of a CMO. The yields to maturity on IOs and POs are very sensitive to the rate of principal payments (including prepayments) on the related underlying mortgage assets. If the underlying mortgage assets experience greater than anticipated prepayments of principal, the Fund may not fully recoup its initial investment in IOs. Conversely, if the underlying mortgage assets experience less than anticipated prepayments of principal, the yield on POs could be materially and adversely affected.

Inverse Floating Rate Securities and Tender Option Bonds

The Fund may invest in inverse floating rate securities (sometimes referred to as "inverse floaters"), which are derivative interests in MBS and participate in the creation of tender option bonds. Although volatile, these residual interests typically offer the potential for yields exceeding the yields available on fixed-rate MBS with comparable credit quality, coupon, call provisions and maturity.

Generally, inverse floating rate securities represent beneficial interests in a special purpose trust, which is sometimes referred to as a tender option bond trust, formed by a third party sponsor for the purpose of holding MBS. The special purpose trust typically sells two classes of beneficial interests or securities: short-term floating rate MBS (sometimes referred to as short-term floaters or tender option bonds), which are sold to third party investors, and inverse floating rate MBS, which the Fund would purchase. The short-term floating rate securities have first priority on the cash flow from the MBS held by the special purpose trust. For its inverse floating rate investment, the Fund receives the residual cash flow from the special purpose trust. If the Fund is the initial seller of the MBS to the special purpose trust, it receives the proceeds from the sale of the floating rate interests in the special purpose trust, less certain transaction costs. These proceeds generally would be used by the Fund to purchase additional MBS or other investments permitted by the Fund's investment policies. If the Fund ever purchases all or a portion of the short-term floating rate securities sold by the special purpose trust, it may surrender those short-term floating rate securities together with a proportionate amount of residual interests to the trustee of the special purpose trust in exchange for a proportionate amount of the MBS owned by the special purpose trust. In addition, all voting rights and decisions to be made with respect to any other rights relating to the MBS held in the special purpose trust are passed through to the Fund, as the holder of the residual interests. The Fund will recognize taxable capital gains (or losses) upon any sale of MBS to the special purpose trust.

Typically, a third party, such as a bank, broker dealer or other financial institution, grants the floating rate security holders the option, at periodic intervals, to tender their securities to the institution and receive the face

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value thereof. As consideration for providing the option, the financial institution receives periodic fees. The holder of the short-term floater effectively holds a demand obligation that bears interest at the prevailing short-term, tax-exempt rate. However, an institution will not be obligated to accept tendered short-term floaters in the event of certain defaults or a significant downgrade in the credit rating assigned to the bond issuer or certain events that indicate the issuer of the bonds may be entering bankruptcy. If the liquidity provider acquires the floating rate interests upon the occurrence of an event described above, the liquidity provider generally will be entitled to an in-kind distribution of the MBS owned by the special purpose trust or to cause the special purpose trust to sell the bonds and distribute the proceeds to the liquidity provider. The liquidity provider generally will enter into an agreement with the Fund that will require the Fund to make a payment to the liquidity provider in an amount equal to any loss suffered by the liquidity provider in connection with the foregoing transactions. Under these agreements, the Fund's potential exposure to losses related to or on inverse floaters may increase beyond the value of the Fund's inverse floater investments as the Fund may potentially be liable to fulfill all amounts owed to holders of the floating rate certificates.

In order to cover any potential obligation of the Fund to the liquidity provider pursuant to this agreement, the Fund may designate on its books and records liquid instruments having a value not less than the amount, if any, by which the original purchase price of the floating rate interests issued by the related special purpose trust exceeds the market value of the MBS owned by the special purpose trust.

Although regular inverse floating rate securities are derivative securities with economic leverage embedded in them, they will not constitute senior securities of the Fund (and will not be subject to the Fund's limitations on borrowings), because the Fund has no ongoing obligations to any party in connection with its ownership of such interests. With respect to highly leveraged inverse floating rate securities, if the Fund establishes and maintains a segregated account to cover any potential obligation to the liquidity provider, the Fund's obligation to the liquidity provider pursuant to the agreement will not be considered a borrowing by the Fund; however, under circumstances in which the Fund does not establish and maintain such a segregated account, such obligation will be considered a borrowing for the purpose of the Fund's limitation on borrowings.

ABS

ABS are securities that are primarily serviced by the cash flows of a discrete pool of receivables or other financial assets, either fixed or revolving, that by their terms convert into cash within a finite time period. Asset-backed securitization is a financing technique in which financial assets, in many cases themselves less liquid, are pooled and converted into instruments that may be offered and sold in the capital markets. In a basic securitization structure, an entity, often a financial institution, originates or otherwise acquires a pool of financial assets, either directly or through an affiliate. It then sells the financial assets, again either directly or through an affiliate, to a specially created investment vehicle that issues securities "backed" or supported by those financial assets, which securities are ABS. Payment on the ABS depends primarily on the cash flows generated by the assets in the underlying pool and other rights designed to assure timely payment, such as liquidity facilities, guarantees or other features generally known as credit enhancements. While residential mortgages were the first financial assets to be securitized in the form of MBS, non-mortgage related securitizations have grown to include many other types of financial assets, including, but not limited to, small balance commercial mortgages, aircrafts, automobiles, credit cards, equipment, manufactured housing, franchises, recreational vehicles and student loans.

Below Investment Grade ("High Yield" or "Junk") Securities

A significant portion of the Fund's portfolio (including both direct and indirect investments) may consist of below investment grade securities (commonly referred to as "high yield" or "junk" securities). Although all PPIP Eligible Assets must have originally been rated AAA or an equivalent rating by at least two NRSROs, many may currently be rated below investment grade. These high yield securities may be rated as low as C by Moody's, CCC or lower by S&P or CC or lower by Fitch. The issuers of high yield securities may be highly leveraged and have difficulty servicing their debt, especially during prolonged economic recessions or periods of rising interest rates. The prices of lower quality securities are volatile and may go down due to market perceptions of deteriorating issuer creditworthiness or economic conditions. Lower quality securities may become illiquid and hard to value in down markets. Securities rated below investment grade are considered speculative and, compared to investment grade securities, tend to have more volatile prices, increased price sensitivity to changing interest rates and to adverse economic and business developments, greater risk of loss due to default or declining credit quality, greater likelihood that adverse economic or issuer specific events will make the issuer unable to make interest and/or principal payments and greater susceptibility to negative market

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sentiments leading to depressed prices and decrease in liquidity. See "Risks—Risks Related to the Fund—Below Investment Grade ("High Yield" or "Junk") Securities Risk."

If a fixed income security is considered investment grade at the time of investment and is subsequently downgraded below that rating, the Fund will not be required to dispose of the security. With respect to securities that are downgraded, the Subadviser will consider what action, including the sale of the security, is in the best interests of the Fund and its stockholders.

Corporate Bonds

The Fund may invest in a wide variety of bonds of varying maturities issued by U.S. and foreign corporations and other business entities. Bonds are fixed or variable rate debt obligations, including bills, notes, debentures, money market instruments and similar instruments and securities. Corporate bonds are generally used by corporations to borrow money from investors. The issuer pays the investor a fixed or variable rate of interest and normally must repay the amount borrowed on or before maturity. Certain bonds are "perpetual" in that they have no maturity date. The investment return of corporate bonds reflects interest on the security and changes in the market value of the security. The market value of a corporate bond generally may be expected to rise and fall inversely with interest rates, and may also be affected by the credit rating of the corporation, the corporation's performance, perceptions of the corporation in the marketplace and general market liquidity. The value of the intermediate- and longer-term corporate bonds in which the Fund generally will invest normally fluctuates more in response to changes in interest rates than does the value of shorter-term corporate bonds. There is a risk that the issuers of corporate bonds may not be able to meet their obligations on interest or principal payments at the time called for by a bond.

Government Debt Securities

The Fund may invest in government debt securities, including those of emerging market issuers or of other non-U.S. issuers. Government debt securities include: debt securities issued or guaranteed by governments, governmental agencies or instrumentalities and political subdivisions; debt securities issued by government owned, controlled or sponsored entities; interests in entities organized and operated for the purpose of restructuring the investment characteristics of instruments issued by the above-noted issuers; or debt securities issued by supranational entities such as the World Bank or the European Union. Emerging market debt securities generally are rated in the lower rating categories by recognized credit rating agencies or are unrated and considered to be of comparable quality to lower rated debt securities. A non-U.S. issuer of debt or the non-U.S. governmental authorities that control the repayment of the debt may be unable or unwilling to repay principal or interest when due, and the Fund may have limited recourse in the event of a default. Some of these risks do not apply to issuers in larger, more developed countries. These risks are more pronounced in investments in issuers in emerging markets or if the Fund invests significantly in one country.

Derivatives

Generally, derivatives are financial contracts whose value depends upon, or are derived from, the value of an underlying asset, reference rate or index, and may relate to individual debt or equity instruments, interest rates, currencies or currency exchange rates and related indexes. The Fund may invest in derivative instruments, such as options contracts, futures contracts, options on futures contracts, indexed securities, credit linked notes, credit default swaps and other swap agreements for investment, hedging and risk management purposes; provided that the Fund's exposure to derivative instruments, as measured by the total notional amount of all such instruments, will not exceed 20 % of its Managed Assets. With respect to this limitation, the Fund may net derivatives with opposite exposure to the same underlying instrument. Notwithstanding the foregoing, the Fund may invest without limitation in Treasury futures, Eurodollar futures, interest rate swaps, swaptions or similar instruments and combinations thereof. To the extent that the security or index underlying the derivative or synthetic instrument is or is composed of MBS, the Fund will include such derivative and synthetic instruments for the purposes of the Fund's policy to invest at least 80 % of its Managed Assets in MBS. The Fund may sell certain equities or fixed income securities short including, but not limited to, Treasury securities, for investment and/or hedging purposes. See "Risks—Risks Related to the Fund—Derivatives Risk." The Fund may use any or all of these techniques at any time, and the use of any particular derivative transaction will depend on market conditions. The Fund's ability to pursue certain of these strategies may be limited by applicable regulations of the Commodity Futures Trading Commission ("CFTC") and the federal income tax requirements applicable to regulated investment companies.

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Due to restrictions imposed on the Master Fund, the Master Fund may use interest rate derivatives solely for the purpose of hedging interest rate mismatches between the Treasury Debt Financing and PPIP Eligible Assets, or as otherwise designed to reduce the Master Fund's exposure to prevailing interest rates. The Master Fund's ability to use derivative contracts and engage in other strategic transactions for other hedging and risk management purposes generally will require the consent of the Treasury. The use of derivatives by the Master Fund will be excluded from the calculation of the Fund's limitation on the use of derivatives.

The Fund's use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investment directly in securities and other more traditional investments. In particular, the variable degree of correlation between price movements of instruments the Fund has purchased or sold and price movements in the position being hedged creates the possibility that losses on the hedge may be greater than gains in the value of the Fund's position. In addition, certain derivative instruments and markets may not be liquid in all circumstances. As a result, in volatile markets, the Fund may not be able to close out a transaction without incurring losses substantially greater than the initial deposit. Although the contemplated use of these instruments should tend to minimize the risk of loss due to a decline in the value of the hedged position, at the same time they may tend to limit any potential gain which might result from an increase in the value of such position.

The successful use of derivative transactions by the Fund is subject to the ability of the Subadviser to correctly predict movements in the direction of interest rates and other factors affecting markets for securities. These skills are different from those needed to select portfolio securities. If the Subadviser's expectations are not met, the Fund would be in a worse position than if a derivative transaction had not been pursued. For example, if the Fund hedged against the possibility of an increase in interest rates which would adversely affect the price of securities in its portfolio and the price of such securities increased instead, the Fund would lose part or all of the benefit of the increased value of its securities because it would have offsetting losses in its derivatives positions. Losses due to derivative transactions will reduce net asset value of the Fund. See "Risks—Risks Related to the Fund—Derivatives Risk."

The Fund will engage in derivative transactions only to the extent such transactions are consistent with the requirements of the Code for maintaining its qualification as a regulated investment company for federal income tax purposes. See "Tax Matters."

Credit Default Swaps

Credit default swaps are agreements between two counterparties that allow one counterparty (the "seller") to purchase or be "long" a third party's credit risk and the other party (the "buyer") to sell or be "short" the credit risk. Typically, the buyer agrees to make regular fixed payments to the seller with the same frequency as the underlying reference bond. In exchange, the buyer typically has the right upon default of the underlying bond to put the bond to the seller in exchange for the bond's par value plus interest. Credit default swaps can be used as a substitute for purchasing or selling a credit security and are sometimes preferable to actually purchasing the security. A purchaser of a credit default swap is subject to counterparty risk.

Credit default swap agreements may have as reference obligations one or more securities that are not currently held by the Fund. The protection buyer in a credit default contract is generally obligated to pay the protection seller an upfront or a periodic stream of payments over the term of the contract provided that no credit event, such as a default, on a reference obligation has occurred. These payments are based on the difference between an interest rate applicable to the relevant issuer less a benchmark interest rate for a given maturity. If a credit event occurs, the seller generally must pay the buyer the "par value" (full notional value) of the swap in exchange for an equal face amount of deliverable obligations of the reference entity described in the swap, or the seller may be required to deliver the related net cash amount, if the swap is cash settled. The Fund may be either the buyer or seller in the transaction.

As the seller, the Fund would effectively add leverage to its portfolio because, in addition to its assets, the Fund would be subject to investment exposure on the notional amount of the swap. In connection with credit default swaps in which the Fund is the seller, the Fund will segregate cash or assets determined to be liquid by the Subadviser in accordance with procedures established by the Board of Directors, owning positions covering its obligations or enter into offsetting positions, with a value at least equal to the full notional amount of the swap (minus any amounts owed to the Fund). Such segregation will ensure that the Fund has assets available to satisfy its obligations with respect to the transaction and will limit any potential leveraging of the Fund's portfolio. To the extent assets are segregated, these instruments will not be considered "leverage" by the Fund for the purposes of the 1940 Act.

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The Fund may also purchase credit default swaps for hedging or investment purposes. If the Fund is a buyer and no credit event occurs, the Fund may recover nothing if the swap is held through its termination date. However, if a credit event occurs, the buyer generally may elect to receive the full notional value of the swap in exchange for an equal face amount of deliverable obligations of the reference entity whose value may have significantly decreased. In connection with credit default swaps in which a Fund is the buyer, the Fund will segregate cash or assets determined to be liquid by the Subadviser in accordance with procedures established by the Board of Directors, or enter into certain offsetting positions, with a value at least equal to the Fund's exposure (any accrued but unpaid net amounts owed by the Fund to any counterparty), on a marked-to-market basis.

The Fund may also enter into CDXs. A CDX index is an equally-weighted credit default swap index. This family of indexes is comprised of baskets of credit derivatives that are representative of certain market segments such as North American investment grade, high volatility investment grade, below investment grade, as well as emerging markets. Credit default swaps of individual reference entities are selected for inclusion in the indexes based on rating requirements and liquidity requirements. A CDX index tranche provides access to customized risk, exposing each investor to losses at different levels of subordination. The lowest part of the capital structure is called the "equity tranche" as it has exposure to the first losses experienced in the basket. The mezzanine and senior tranches are higher in the capital structure but can also be exposed to loss in value.

Commercial Paper

Commercial paper represents short-term unsecured promissory notes issued in bearer form by corporations such as banks or bank holding companies and finance companies. The rate of return on commercial paper may be linked or indexed to the level of exchange rates between the U.S. dollar and a foreign currency or currencies.

Certificates of Deposit

Certificates of deposit are negotiable certificates that are issued against funds deposited in a commercial bank for a definite period of time and that earn a specified return and are normally negotiable. The issuer of a certificate of deposit agrees to pay the amount deposited plus interest to the bearer of the certificate on the date specified thereon. Certificates of deposit purchased by the Fund may not be fully insured by the Federal Deposit Insurance Corporation.

Fixed Time Deposits

Fixed time deposits are bank obligations payable at a stated maturity date and bearing interest at a fixed rate. Fixed time deposits may be withdrawn on demand by the investor, but may be subject to early withdrawal penalties which vary depending upon market conditions and the remaining maturity of the obligation. There are generally no contractual restrictions on the right to transfer a beneficial interest in a fixed time deposit to a third party, although there is no market for such deposits. The Fund may also hold funds on deposit with its custodian bank in an interest-bearing account for temporary purposes.

Bankers' Acceptances

Bankers' acceptances are negotiable drafts or bills of exchange, normally drawn by an importer or exporter to pay for specific merchandise, which are "accepted" by a bank, meaning, in effect, that the bank unconditionally agrees to pay the face value of the instrument on maturity.

Zero Coupon Securities and Payment-In-Kind Securities

The Fund may invest in zero coupon securities and payment-in-kind securities. Zero coupon securities are debt securities that pay no cash income and are sold at substantial discounts from their value at maturity. When a zero coupon security is held to maturity, its entire return, which consists of the amortization discount, comes from the difference between its purchase price and its maturity value. This difference is known at the time of purchase, so that investors holding zero coupon securities until maturity know at the time of their investment what the expected return on their investment will be, assuming full repayment of the bond. The Fund also may purchase payment-in-kind securities. Payment-in-kind securities pay all or a portion of their interest in the form of debt or equity securities rather than cash.

Zero coupon securities and payment-in-kind securities tend to be subject to greater price fluctuations in response to changes in interest rates than are ordinary interest-paying debt securities with similar maturities. The value of zero coupon securities appreciates more during periods of declining interest rates and depreciates more during periods of rising interest rates than ordinary interest-paying debt securities with similar maturities. Zero

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coupon securities and payment-in-kind securities may be issued by a wide variety of corporate and governmental issuers.

Other Investment Companies

The Fund may invest in securities of other closed-end or open-end investment companies that invest primarily in MBS or other securities and instruments of the types in which the Fund may invest directly to the extent permitted by the 1940 Act. The Fund may invest in other investment companies during periods when it has large amounts of uninvested cash, such as the period shortly after the Fund receives the proceeds of the offering of its Common Stock, during periods when there is a shortage of attractive bonds available in the market, or when the Subadviser believes share prices of other investment companies offer attractive values. The Fund may invest in investment companies that are advised by the Subadviser or its affiliates to the extent permitted by applicable law and/or pursuant to exemptive relief from the SEC. As a stockholder in an investment company, the Fund will bear its ratable share of that investment company's expenses, and would remain subject to payment of the Fund's management fees and other expenses with respect to assets so invested. Common Stockholders would therefore be subject to duplicative expenses to the extent the Fund invests in other investment companies. The Subadviser will take expenses into account when evaluating the investment merits of an investment in an investment company relative to available bond investments. In addition, the securities of other investment companies may also be leveraged and will therefore be subject to the same leverage risks described herein. As described in the sections entitled "Risks—Risks Related to the Fund—Leverage Risk," the net asset value and market value of leveraged shares will be more volatile and the yield to stockholders will tend to fluctuate more than the yield generated by unleveraged shares. Other investment companies may have investment policies that differ from those of the Fund. In addition, to the extent the Fund invests in other investment companies, the Fund will be dependent upon the investment and research abilities of persons other than the Subadviser.

Temporary Defensive Strategies

At times the Subadviser may judge that conditions in the markets for MBS make pursuing the Fund's primary investment strategy inconsistent with the best interests of its stockholders. During temporary defensive periods or in order to keep the Fund's cash fully invested, including during the period when the net proceeds of the offering of Common Stock are being invested, the Fund may deviate from its investment policies and objectives. At such times the Subadviser may, temporarily, use alternative strategies, primarily designed to reduce fluctuations in the value of the Fund's assets. If the Fund takes a temporary defensive position, it may be unable to achieve its investment objectives.

In implementing these "defensive" strategies, the Fund may invest all or a portion of assets not invested in the Feeder Fund in non-U.S. government securities which have received the highest investment grade credit rating and U.S. government securities, including bills, notes and bonds differing as to maturity and rates of interest that are either issued or guaranteed by the Treasury or by U.S. government agencies or instrumentalities; certificates of deposit issued against funds deposited in a bank or a savings and loan association; commercial paper; bankers' acceptances; bank time deposits; shares of money market funds; repurchase agreements with respect to any of the foregoing; or any other fixed income securities that the Subadviser considers consistent with this strategy. It is impossible to predict when, or for how long, the Fund will use these alternative strategies. There can be no assurance that such strategies will be successful.

Investment Practices

Certain Interest Rate Transactions

The Fund may enter into various interest rate transactions, such as interest rate swaps and the purchase or sale of interest rate caps and floors. Interest rate swaps involve the exchange by the Fund with a counterparty of their respective commitments to pay either a fixed or floating rate denominated in a particular currency. The Fund may enter into, among other things, fixed-for-floating rate swaps in the same currency, fixed-for-floating rate swaps in different currencies, floating-for-floating rate swaps in the same currency, floating-for-floating rate swaps in different currencies, or fixed-for-fixed rate swaps in different currencies. Fixed-for-floating rate swaps may involve the Fund agreeing with the swap counterparty to pay a fixed rate payment in exchange for the counterparty paying the Fund a variable rate payment that is intended to approximate the Fund's variable rate payment obligation. Alternatively, fixed-for-floating rate swaps may involve the Fund agreeing with the swap counterparty to pay a floating rate payment in exchange for the counterparty paying the Fund a fixed rate payment. The payment obligation would be based on the notional amount of the swap. The Fund may enter into

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these transactions to hedge the value of the Fund's portfolio to seek to increase its return, to preserve a return or spread on a particular investment or portion of its portfolio, or for investment purposes.

The Fund may purchase an interest rate cap, which would require it to pay a premium to the cap counterparty and would entitle the Fund, to the extent that a specified variable rate index exceeds a predetermined fixed rate, to receive from the counterparty payment of the difference based on the notional amount. Alternatively, the Fund may sell an interest rate cap, which would require the cap counterparty to pay a premium to the Fund and would entitle the cap counterparty, to the extent that a specified variable rate index exceeds a predetermined fixed rate, to receive from the Fund payment of the difference based on the notional amount.

The Fund may use interest rate swaps or caps for hedging or investment purposes.

Total Return Swaps

The Fund may enter into total return swaps. In a total return swap, the Fund exchanges with another party their respective commitments to pay or receive the total return of an underlying debt or equity security and a floating local short-term interest rate. The payment obligation would be based on the notional amount of the swap. The Fund may use total return swaps for hedging or investment purposes.

Repurchase Agreements

The Fund may enter into repurchase agreements, in which the Fund purchases a security from a bank or broker-dealer and the bank or broker-dealer agrees to repurchase the security at the Fund's cost plus interest within a specified time. If the party agreeing to repurchase should default, the Fund will seek to sell the securities which it holds. This could involve transaction costs or delays in addition to a loss on the securities if their value should fall below their repurchase price. Repurchase agreements maturing in more than seven days are considered to be illiquid securities.

Reverse Repurchase Agreements

The Fund may enter into reverse repurchase agreements, under which the Fund will effectively pledge its assets as collateral to secure a short-term loan. Generally, the other party to the agreement makes the loan in an amount equal to a percentage of the market value of the pledged collateral. At the maturity of the reverse repurchase agreement, the Fund will be required to repay the loan and correspondingly receive back its collateral. While used as collateral, the assets continue to pay principal and interest which are for the benefit of the Fund.

When-Issued, Delayed Delivery and Forward Commitment Transactions

The Fund may purchase securities on a when-issued or delayed delivery basis. Securities purchased on a when-issued or delayed delivery basis are purchased for delivery beyond the normal settlement date at a stated price and yield. No income accrues to the purchaser of a security on a when-issued or delayed delivery basis prior to delivery. Such securities are recorded as an asset and are subject to changes in value based upon changes in the general level of interest rates. The Fund will make commitments to purchase securities on a when-issued or delayed delivery basis only with the intention of actually acquiring the securities but may sell them before the settlement date if it is deemed advisable. Purchasing a security on a when-issued or delayed delivery basis can involve a risk that the market price at the time of delivery may be lower than the agreed-upon purchase price, in which case there could be an unrealized loss at the time of delivery. If the Fund purchases securities on a when-issued or delayed delivery basis, it will segregate liquid assets, own positions covering its obligations or enter into offsetting transactions. To the extent the Fund covers its commitment under such portfolio management technique, such instrument will not be considered a senior security for the purposes of the 1940 Act. See "The Fund's Investments—Investment Strategies—Segregation and Cover Requirements."

New Securities and Other Investment Techniques

New types of securities and other investment and hedging practices are developed from time to time. The Subadviser expects, consistent with the Fund's investment objectives and policies, to invest in such new types of securities and to engage in such new types of investment practices if the Subadviser believes that these investments and investment techniques may assist the Fund in achieving its investment objectives. In addition, the Subadviser may use investment techniques and instruments that are not specifically described herein.

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Portfolio Turnover

The Fund does not have a formal portfolio turnover policy and does not intend to adopt one. Although the Fund generally intends to hold most of its RMBS and CMBS until maturity, it may, from time to time, sell any of its RMBS and CMBS as part of its overall management of its investment portfolio. When investments are realized, the Subadviser will reinvest proceeds therefrom in the Fund's target assets. Depending on market conditions, the Subadviser will also make opportunistic dispositions of the Fund's investments in its target assets. Frequent trading also increases transaction costs, which could detract from the Fund's performance.

Limited Term

As a fundamental policy, the Fund intends to liquidate and distribute substantially all of the Fund's net assets to stockholders, after making appropriate provision for any liabilities of the Fund, on or about March 1, 2022. Absent stockholder approval to shorten or extend the life of the Fund, the Fund's Articles provide that the Fund will terminate its existence on March 1, 2022, except for the purpose of satisfying any existing debts or obligations, collecting and distributing its assets and doing all other acts required to liquidate and wind up its business and affairs. If the Fund has not liquidated and wound up its business and affairs by the close of business on March 1, 2022, the Directors shall become trustees of the Fund's assets for purposes of liquidation. The term of the Fund may be shortened or altered if it is acquired by another fund or the Fund fails financially.

Upon its termination, the Fund will distribute substantially all of its net assets to stockholders, after making appropriate provision for any liabilities of the Fund. The Fund does not seek to return $20.00 per share upon termination. The final distribution of net assets upon termination may be more than, equal to or less than $20.00 per share. The Fund expects to complete its final distribution on or about March 1, 2022, but the liquidation process could be extended depending on market conditions at that time.

Prior to such termination, the Board of Directors will consider whether it is in the best interests of stockholders to terminate and liquidate the Fund. If the Board of Directors determines that under the circumstances, termination and liquidation of the Fund on or about March 1, 2022 would not be in the best interests of stockholders, the Board of Directors will present an appropriate amendment to the Articles at a regular or special meeting of stockholders. The Articles require either (i) the affirmative vote of at least 75 % of the Board of Directors and at least 75 % of the votes entitled to be cast by stockholders (including Preferred Stockholders, if any) or (ii) the affirmative vote of 75 % of the Continuing Directors and the approval of the holders of a majority of the votes entitled to be cast thereon by stockholders (including Preferred Stockholders, if any). Unless the termination date is amended by stockholders in accordance with the Articles, the Fund will be terminated on or about March 1, 2022 (regardless of any change in state law affecting the ability of the Board of Directors to amend the Articles). See "Certain Provisions in the Articles of Incorporation and By-Laws" and "Risks—Risks Related to the Fund—Limited Term Risk."

The Master Fund will continue for eight years following the Master Fund Closing Date (unless terminated earlier pursuant to certain conditions), subject to extension at the discretion of the General Partner with the written consent of the Treasury for consecutive periods of up to one year each up to a maximum of two years. Upon its termination, it is anticipated that the Master Fund (and in turn the Feeder Fund) will distribute substantially all of its net assets to its partners on a pro-rata basis. The Fund, in turn, will reinvest the proceeds received from the Feeder Fund or distribute such proceeds to Common Stockholders. See "Risks—Risks Related to the Fund—Limited Term Risk."

Initial Portfolio Composition

It is currently anticipated that the Fund will be able to invest substantially all of the net proceeds in accordance with its investment objectives and policies within two to four months after the completion of the offering. Western Asset anticipates, based on current market conditions, that the Fund's indirect investment in the Master Fund will be invested within 12 months. Based upon current market conditions, the Fund anticipates that, after the invest-up period, it will have initial portfolio allocations (including its direct and indirect investments) of approximately 80 % to 100 % of Managed Assets in RMBS, 0 % to 10 % of Managed Assets in CMBS, and 0 % to 10 % of Managed Assets in other permitted investments. It is expected that these allocations will change over the life of the Fund.

Fundamental Investment Policies

The Fund's (i) investment objectives, (ii) intention to liquidate and distribute substantially all of the Fund's net assets to stockholders, after making appropriate provision for any liabilities of the Fund, on or about

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March 1, 2022 and (iii) the investment restrictions listed in the SAI, are considered fundamental and may not be changed without the approval of the holders of a majority of the outstanding Common Stock (or Preferred Stock, if any). A "majority of the outstanding" shares means (i) 67 % or more of the shares present at a meeting, if the holders of more than 50 % of the shares outstanding are present or represented by proxy or (ii) more than 50 % of the shares outstanding, whichever of (i) or (ii) is less. See "Investment Restrictions" in the SAI for a complete list of the fundamental and non-fundamental investment policies of the Fund.

THE LEGACY SECURITIES PUBLIC-PRIVATE INVESTMENT PROGRAM

PPIP

On March 23, 2009, the Treasury, in conjunction with the Federal Deposit Insurance Corporation and the Federal Reserve, announced the creation of PPIP. PPIP is one component of a broader array of measures being taken by the Treasury to target legacy assets of financial institutions in order to encourage new credit formation. PPIP seeks to contribute to that effort by improving the health of financial institutions through the removal of "legacy securities" from their balance sheets and by helping to increase the liquidity and functioning of markets for these securities. The term "legacy assets" generally refers to real estate-related loans and securities that remain on banks' balance sheets that have lost value but are difficult to price due to the recent market disruption. The program is designed to bring private capital to these markets by providing matching equity capital from the Treasury and debt financing from the Federal Reserve and the Treasury, subject to certain maximum amounts. PPIP calls for the creation of public-private investment funds, such as the Master Fund, through which privately raised capital and Treasury capital are pooled together to facilitate the purchase of PPIP Eligible Assets.

PPIP Eligible Assets are those assets determined by the Treasury, from time to time, to be eligible for investment by the Master Fund. PPIP Eligible Assets currently include RMBS and CMBS issued prior to 2009 that were originally rated AAA or that received an equivalent rating by two or more NRSROs without ratings enhancement and that are secured directly by actual mortgage loans, leases or other assets and not other securities (other than certain swap positions, as determined by the Treasury). A rating issued by an NRSRO is only the opinion of the entity issuing the rating, and is not a guarantee as to quality, or an assurance of the performance, of the rated security. In addition, the manner in which NRSROs obtain and process information about a particular security may affect the NRSRO's ability to timely react to changes in an issuer's circumstances that could influence a particular rating. Currently, the Treasury requires that at least 90 % of the assets underlying any PPIP Eligible Asset must be situated in the United States. PPIP Eligible Assets can only be purchased from Financial Institutions from which the Secretary of the Treasury may purchase assets pursuant to Section 101(a)(1) of EESA. For these purposes, the term "Financial Institution" currently means any institution, including, but are not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company, established and regulated under the laws of the United States or any state, territory, or possession of the United States, the District of Columbia, Commonwealth of Puerto Rico, Commonwealth of Northern Mariana Islands, Guam, American Samoa, or the United States Virgin Islands, and having significant operations in the United States, but excluding any central bank of, or institution owned by, a foreign government. However, PPIP Eligible Assets currently may also be purchased from a foreign government if such foreign government's ownership of PPIP Eligible Assets resulted from extending financing to Financial Institutions that then failed or defaulted on such financing. The final determination of what constitutes PPIP Eligible Assets is made by the Treasury and may be subject to change. In the event the Treasury expands PPIP at a later date to include other permissible investments in addition to those currently defined as PPIP Eligible Assets, the Master Fund may invest in such investments at such time without any prior notice to or consent from the Fund.

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The Feeder Fund and Master Fund

The Fund's investment in the Feeder Fund will be governed by the terms and conditions of the partnership agreement for the Feeder Fund and the Feeder Fund's investment in the Master Fund will be governed by the terms and conditions of the partnership agreement for the Master Fund (collectively, the "Partnership Agreements"). The Partnership Agreements regulate the investment and financial operations, distributions of income, gains (if any) and returns of capital to the partners, governance and management of the Feeder Fund and the Master Fund, respectively. Western Asset is the investment adviser to, and the General Partner is general partner of, each of the Feeder Fund and the Master Fund. RLJ PPIP Administration, LLC, an affiliate of RLJ, performs certain functions in connection with the Feeder Fund and the Master Fund, including assisting with the (i) offering of interests in the Feeder Fund, (ii) structuring of the Feeder Fund and the Master Fund, (iii) ongoing operations of the Feeder Fund and the Master Fund and (iv) compliance oversight of the Feeder Fund and the Master Fund.

Neither the Feeder Fund nor the Master Fund is registered with the Securities and Exchange Commission as an investment company under the 1940 Act, and neither of these fund's interests are registered under the Securities Act.

The Feeder Fund

The Feeder Fund is a Delaware limited partnership formed to participate in PPIP by investing all or substantially all of its assets available for investment, alongside the Treasury, in the Master Fund. The Feeder Fund's investment objective is to generate attractive returns for investors through long-term opportunistic investments in PPIP Eligible Assets. The Master Fund has an investment objective that is consistent with the Feeder Fund. The Fund's interests in the Feeder Fund will be substantially identical to those of the other investors in the Feeder Fund in all material respects except with respect to fees payable in connection with PPIP. Private investors pay a management fee and performance allocation to the General Partner. This fee covers all aspects of the PPIP arrangement, including both administration and portfolio management. The Fund will only pay a reduced administration fee which will be allocated exclusively to RLJ and not Western Asset. The Feeder Fund is a private partnership organized to provide certain qualified institutional investors with access to PPIP. Western Asset is the investment adviser to the Feeder Fund. The General Partner serves as the general partner to the Feeder Fund. The Allocation Subadviser will determine whether and to what extent the Fund invests in the Feeder Fund. RLJ, through an affiliate, will provide certain administrative services to the Feeder Fund.

The Feeder Fund is accepting investors through several separate closings, and there have been one or more prior closings in which the Fund did not invest. If the Allocation Subadviser decides that the Fund will make an

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investment in the Feeder Fund, the Fund will do so in a subsequent closing. The Fund, as a new investor in the Feeder Fund, would be required to pay the interest equivalent on a portion of its investment in the Feeder Fund at an annual rate equal to the prime rate plus 2 % . The size of the interest equivalent or "equalization" payment will vary depending on the percentage of commitments called from prior investors and would be paid in addition to the Fund's capital contribution. The Fund's interest equivalent payment would be credited by the Master Fund on a pro rata basis to the prior investors' capital accounts and is designed to compensate prior investors for the use of their funds between prior and subsequent closings and to therefore ensure the equitable treatment of all investors. This interest payment will be in addition to the Fund's capital commitment and will affect the Fund's net asset value on the date of the Fund's investment in the Feeder Fund. In addition, the Fund will be deemed to have invested at the same time as the initial investors, meaning that to the extent the Master Fund experiences losses or gains before the date of the Fund's investment, the Fund will participate in such losses or gains to the extent of its pro rata share of the Master Fund's capital commitment. Notwithstanding the foregoing, upon the General Partner's determination that a pro rata payment by the Fund would not appropriately reflect a material change in the value of an investment then held by the Feeder Fund, the General Partner may either (i) adjust the payment required to be made by the Fund to appropriately reflect such change in value or (ii) exclude the Fund from participation in such investment.

The amount of the actual losses or gains allocated to the Fund would vary depending on the performance of the Feeder Fund's investment in the Master Fund for the period from the inception of the Feeder Fund up to the date on which the Fund's capital commitment for its initial investment in the Feeder Fund is accepted. The equalization payment, together with the gain or loss adjustment, may result in a material change to the Fund's net asset value on the date of the Fund's investment in the Feeder Fund which in turn may have a material impact on the market price of the Fund's Common Stock.

The Allocation Subadviser will consider the amount of such equalization payment and gain or loss adjustment in deciding whether and to what extent the Fund will invest in the Feeder Fund. If the Master Fund's losses are sufficiently large, the Allocation Subadviser may determine not to invest in the Feeder Fund, in which case the Fund would not be able to access PPIP or the Treasury debt financing provided through PPIP. If the Allocation Subadviser determines not to invest the Fund's assets in the Feeder Fund, those assets will be invested primarily in MBS and other permitted investments, and the Fund may seek to employ leverage directly at the Fund level in the form of borrowings through a qualified government sponsored program or from banks, the issuance of preferred shares, reverse repurchase agreements or other leverage financing.

The Feeder Fund may require any investor to return distributions it previously received to the Feeder Fund or the General Partner, as the case may be, including after dissolution of the Feeder Fund (in which case the General Partner would require such distributions to be returned to the General Partner or another party designated by the General Partner), (i) to the extent required by law and (ii) to the extent necessary to satisfy the Feeder Fund's expenses and obligations (including, without limitation, the Feeder Fund's portion of management fees payable to the General Partner, indemnification and similar obligations); provided, however, that, in the case of clause (ii) above, the amount of such contribution obligation shall not exceed an amount that is equal to 25 % of the amount of such investor's total capital commitment to the Feeder Fund; provided, further, that, in the case of clause (ii) above, no investor will have any such liability after the termination of the Feeder Fund except (a) with respect to liabilities or losses attributable to a particular Feeder Fund investment of which the General Partner has given such investor notice within the later of (x) three years after the date on which the Feeder Fund disposed of such investment and (y) one year after the termination of the Feeder Fund and (b) with respect to any other liabilities or losses of which the General Partner has given such investor notice within one year after the termination of the Feeder Fund.

The General Partner may terminate an investor's interest in the Feeder Fund in whole or in part at any time if (i) in the reasonable judgment of the General Partner the removal of an investor in the Feeder Fund is necessary to ensure compliance with the United States Employee Retirement Income Security Act of 1974, as amended ("ERISA"), or the United States Bank Holding Company Act of 1956, as amended, (ii) a material adverse effect on any of the Feeder Fund, the Master Fund, other investors in the Feeder Fund, the General Partner, Western Asset or any of their respective affiliates is likely to result by virtue of an investor's investment in the Feeder Fund, or (iii) if by its continuing participation as an investor in the Feeder Fund, (x) there is a substantial likelihood that an investor or its fiduciary is or would be violating a law, regulation or rule of whatever nature applicable to, or any action taken by any governmental authority as to, such investor, its fiduciary, the Master Fund or the Feeder Fund with respect to such investor in a manner that materially and adversely affects such investor or its fiduciary, (y) if such Limited Partner were to cease being an investor in the Feeder Fund, such violation would not occur or would thereafter cease to exist, and (z) there is no other action

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such investor or its fiduciary can take to eliminate such violation without incurring significant cost or adverse effect. In the event of any such termination by the General Partner, the General Partner will have the option of (i) causing such investor to be issued a note in the aggregate principal amount equal to such investor's capital account balance as of such withdrawal date, which is payable only out of funds available for distribution to Feeder Fund investors, or (ii) transferring such investor's interest in the Feeder Fund to another person or entity for an amount not less than such investor's capital account balance as of the termination date.

The obligation of investors in the Feeder Fund to fund commitments required to make new investments will expire on the third anniversary of the initial closing of the Feeder Fund. The term of the Feeder Fund will be eight years from the date of its initial closing; provided, however, that the General Partner may, in its sole discretion, extend such term for consecutive periods of up to one year each up to a maximum of two years. The Fund is also subject to earlier termination pursuant to law or upon the occurrence of certain events, including any of the following:

•   the dissolution of the Master Fund;

•   the election of the general partner of the Feeder Fund following its determination that a change in any applicable law or regulation would materially adversely impact the continuation of the Feeder Fund; or

•   the election of the general partner of the Feeder Fund following its determination, upon written advice of counsel, that dissolution is required by applicable law or regulation.

Based on current market conditions, the Allocation Subadviser anticipates that the Fund will invest 60 % to 70 % of the net proceeds of this offering directly in MBS and other permitted investments and approximately 25 % to 40 % of the net proceeds of this offering in the Feeder Fund. Under no circumstances will the Fund invest more than 40 % of the net proceeds of this offering in the Feeder Fund. The Feeder Fund invests substantially all of its assets available for investment in the Master Fund. The Fund generally may not withdraw from the Feeder Fund and the Fund may not, directly or indirectly, sell, assign, pledge, exchange or otherwise transfer its interest in the Feeder Fund, in whole or in part, without the prior written consent of the General Partner. As a result, the Fund's investment in the Feeder Fund will be illiquid.

The Master Fund

The Master Fund is a Delaware limited partnership that invests directly in a portfolio of PPIP Eligible Assets and borrows from the Treasury through Treasury Debt Financing. The Treasury invests directly in the Master Fund, and its capital commitment to the Master Fund equals the aggregate capital commitment of the limited partners of the Master Fund other than the Treasury. Western Asset serves as the investment adviser of the Master Fund. The General Partner serves as the general partner to the Master Fund. RLJ, through an affiliate, will provide certain administrative services to the Master Fund.

The General Partner, its members and/or their affiliates have, in the aggregate, committed more than $20 million directly to the Master Fund or indirectly to the Master Fund through the Feeder Fund or other feeder funds sponsored by the General Partner. Western Asset will not invest directly in the Master Fund.

The Treasury will make an investment in the Master Fund in an amount at all times equal to the aggregate capital commitments of the investors in the Master Fund other than the Treasury; provided that the Capital Commitment of the Treasury may not exceed $1,111,111,111.00 without the consent of the Treasury and the General Partner. The Treasury will also provide Treasury Debt Financing to the Master Fund to provide leverage and to fund its purchase of additional PPIP Eligible Assets. The Fund's investment in the Feeder Fund (and in turn the Feeder Fund's investment in the Master Fund) will not occur immediately, but rather the Fund's capital will be drawn down during a reasonable time period after the closing of this offering through a series of capital calls.

As described above, new investors in the Feeder Fund will be required to pay an interest equivalent and may be required to pay an interest equivalent and may be subject to a gain or loss adjustment at the time of making their investment. Any such payments or adjustments at the Feeder Fund level will be transferred to, and credited by, the Master Fund on a pro rata basis to its prior investors' capital accounts.

The Master Fund invests substantially all of its assets available for investment in PPIP Eligible Assets, including non-agency RMBS and CMBS. The Master Fund also may invest in Temporary Investments. The Master Fund will leverage its investments with Treasury Debt Financing, which generally will be non-recourse to the investors in the Master Fund, subject to certain exceptions. See "Leverage."

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As a result of the Treasury providing equity capital and the Treasury Debt Financing to the Master Fund, the Treasury has certain rights and powers in regard to the Master Fund, which will indirectly subject the Fund to various risks not typically associated with an investment in a registered closed-end investment company. For example, the Treasury has the right to unilaterally remove the general partner of the Master Fund in certain circumstances and to remove the general partner with the consent of a certain percentage of partnership units in other circumstances. See "Risks—Special Risks Related to PPIP—Risks Related to the Role of the Treasury in the Master Fund." In addition, the Master Fund has granted warrants to the Treasury in connection with the Treasury providing the Treasury Debt Financing. See "—Master Fund Warrants."

The Master Fund will not, without the written consent of the Treasury and notice to the Fund:

•   acquire directly or indirectly through a flow-through entity a residual interest in a real estate mortgage investment conduit;

•   invest in any securities or assets other than PPIP Eligible Assets, Temporary Investments, permitted interest rate hedges and other investments described herein;

•   enter into any derivative contract unless such contract is intended solely to hedge the Master Fund's interest rate exposure with respect to any debt obligation;

•   hedge any credit risks arising from investments made by the Master Fund;

•   directly or indirectly lend PPIP Eligible Assets, Temporary Investments or any economic interest therein for any purpose (including to facilitate delivery of a short sale);

•   invest more than 5 % of the Master Fund's aggregate capital commitments in any particular issuance of PPIP Eligible Assets (as measured by CUSIP number);

•   invest more than 25 % of the Master Fund's aggregate capital commitments in PPIP Eligible Assets that were originally issued AAA but were subordinate in the capital structure at the time of purchase;

•   invest more than 60 % of the Master Fund's aggregate capital commitments in PPIP Eligible Assets that have Alternative-A collateral;

•   invest more than 60 % of the Master Fund's aggregate capital commitments in CMBS; or

•   notwithstanding the withdrawal of a direct investor in the Feeder Fund or any other fund sponsored by the General Partner or the default of a direct investor in the Feeder Fund or a fund sponsored by the General Partner or the failure of any partner in the Master Fund to make, when due, any portion of a capital contribution required to be contributed by such partner, make any investment unless the partners of the Master Fund other than the Treasury have, in the aggregate, contributed an amount equal to the sum of their respective pro rata shares of the capital contributions required for such investment.

Due to restrictions imposed on the Master Fund, the Master Fund may use interest rate derivatives solely for the purpose of hedging interest rate mismatches between the Treasury Debt Financing and PPIP Eligible Assets, or as otherwise designed to reduce the Master Fund's exposure to prevailing interest rates. The Master Fund's ability to use derivative contracts and engage in other strategic transactions for other hedging and risk management purposes generally will require the consent of the Treasury. As a result, circumstances could arise in which Western Asset believes a particular derivative contract or other strategic transaction would be in the best interests of its investors but would be precluded from entering into such transaction without the consent of Treasury.

Western Asset, as investment adviser to the Master Fund has agreed, subject to the overall objective of maximizing the value of the Master Fund's investments and its fiduciary duties to the Master Fund, (i) to consent, on behalf of the Master Fund, to reasonable requests from servicers or trustees for approval to participate in Treasury's Making Home Affordable Program, or for approval to implement other reasonable loss mitigation measures (including but not limited to, term extensions, rate reductions, principal write-downs, or removal of caps on the percentage of loans that may be modified within the securitization structure) and (ii) where the Master Fund acquires 100 % of the RMBS that are backed by a particular pool of residential mortgage loans, to instruct the servicer or trustee of such securities, if such servicer or trustee is participating in the Making Home Affordable Program, to include such pool of residential mortgage loans in the Making Home Affordable Program. Although the Master Fund is eligible to receive its share of any standard investor subsidies payable to it under the Making Home Affordable Program and the Treasury's Home Affordable Modification Program, such agreements could reduce returns of the Master Fund and, therefore, the returns of the Fund.

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The Master Fund maintains a capital account for its partners. The Master Fund's partners (other than the Treasury) will pay their pro rata share, based on the amount each invests in the Master Fund, of all legal, accounting, filing and other expenses incurred by the Master Fund (and its affiliates) in connection with organizing and establishing the Master Fund. Western Asset (and its affiliates) will be responsible for the expenses of providing their services to the Master Fund, including overhead expenses (including systems and technology), office expenses and compensation of their employees. Except as noted above, the Master Fund will pay all reasonable expenses related to the operation of the Master Fund, including fees, costs and expenses related to the investigation, development, purchase, holding and sale of PPIP Eligible Assets (including PPIP Eligible Asset transactions that are not ultimately consummated or closed), fees, costs and expenses of any administrators, custodians, attorneys, accountants and other professionals, fees, costs and expenses incurred in connection with borrowings by the Master Fund through the Treasury Debt Financing or otherwise, certain taxes, the costs of any litigation (but not, for the avoidance of doubt, any losses incurred by the General Partner, certain of its affiliates, or any of their respective officers, directors, employees, shareholders, members or partners), directors' and officers' liability or other insurance (provided that the Master Fund shall not bear the cost of any incremental premium associated with the purchase of insurance designed to insure the General Partner or any other party for any liability resulting from fraud, bad faith, willful misconduct, breach of fiduciary duty, gross negligence, a violation of applicable securities laws, conduct that is the subject of a criminal proceeding where the insured party had no reasonable basis to believe that such conduct was lawful or a willful and material breach of the governing documents of the Master Fund), expenses incurred with respect to liquidation of the Master Fund and any fees or other governmental charges levied against the Master Fund. For the avoidance of doubt, these expenses shall not include any fees, costs or expenses of any unaffiliated third party engaged to monitor, or provide investment advice with respect to, the Master Fund's investments. Except as described above, all items of income, gain, loss and deduction will be allocated to the respective capital account of the Master Fund's partners, consistent with the distribution policies of the Master Fund. See "Distributions."

The obligation of investors in the Master Fund to fund commitments required to make new investments will expire on the third anniversary of the Master Fund Closing Date. The Master Fund may re-invest proceeds otherwise distributable to its partners, on a pro rata basis, in PPIP Eligible Assets during the Master Fund Investment Period. Subject to limitations imposed by PPIP, the Master Fund will distribute, on a pro rata basis, all distributable proceeds received after the third anniversary of the Master Fund Closing Date.

The Treasury may terminate the investment period of the Master Fund at any time on or after the one-year anniversary of the Master Fund Closing Date; provided that such termination shall not take effect solely in the case of any investment with respect to which the Master Fund or the General Partner has entered into a legally binding obligation to invest prior to such termination. The General Partner may terminate the investment period of the Master Fund (i) any time on or after the 18-month anniversary of the Master Fund Closing Date if it delivers a sworn officer's certificate to the limited partners of the Master Fund that it has determined in good faith that (x) there have been permanent changes in the market for PPIP Eligible Assets and (y) such permanent changes are such that it is no longer in the best interests of the partners of the Master Fund for the Master Fund to continue to acquire PPIP Eligible Assets or (ii) if the Treasury defaults on certain of its obligations under the partnership agreement governing the Master Fund, upon the written notice from the General Partner to the Treasury stating that it has elected to terminate the investment period of the Master Fund.

The term of the Master Fund will be eight years from the Master Fund Closing Date; provided, however, that the General Partner may extend such term, upon the written consent of the Treasury, for consecutive periods of up to one year each up to a maximum of two years. The Master Fund is subject to earlier dissolution and termination upon the occurrence of certain events, including any of the following:

•   following the expiration or termination of the Master Fund's investment period, upon the liquidation of all of the Master Fund's portfolio investments;

•   the bankruptcy, dissolution or any similar event of withdrawal of the General Partner (unless the Treasury agrees in writing to continue the business of the Master Fund and to the appointment of another general partner); or

•   the General Partner's good faith determination that a change in any law, regulation, rule or governmental order (or change in judicial or regulatory interpretation of any law, regulation or governmental order) would materially adversely impact the General Partner, at least a majority in interest of investors in the Feeder Fund (including, but not limited to, the Fund), or the affiliates of such investors as a result of their management of, or participation in, the Master Fund.

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The annual management fee payable to Western Asset with respect to its management of the Master Fund shall cease to accrue upon dissolution of the Master Fund.

The Treasury has the right to remove the General Partner without cause at any time with the consent of a majority of the Master Fund's shareholders or, following the occurrence of certain events related to key personnel at Western Asset, with the consent of one third of the Master Fund's shareholders. For example, the Treasury may remove the General Partner with the consent of one-third of the investors' interests in the Master Fund in certain circumstances in which management of the Master Fund changes, including in the event that certain key investment professionals of the General Partner cease to be actively involved in the business of the Master Fund and no qualified replacement deemed suitable by the Treasury can be found. The Treasury has the right to unilaterally remove the General Partner upon the occurrence certain events including (i) a breach of the General Partner's obligation to make capital contributions or to bear its expenses in accordance with the partnership agreement governing the Master Fund if the breach is not cured within five calendar days, (ii) a failure to obtain the Treasury's consent to certain amendments to the Master Fund's compliance and execution policies, (iii) a finding by any court or governmental body of competent jurisdiction or an admission by the General Partner or any person that has the power to direct or cause the direction of the management and policies of the General Partner, whether by ownership of voting shares, by contract or otherwise, and their respective senior officers and senior executives (each a "Relevant Person") (a) of fraud, gross negligence, bad faith or willful misconduct by any Relevant Person, (b) of a material violation of applicable securities laws by any Relevant Person or (c) that the General Partner has otherwise committed a material breach of the partnership agreement governing the Master Fund, including the representations and warranties contained in the agreement, (iv) a finding by any court or governmental body of competent jurisdiction or an admission by Western Asset that is has committed a material breach of the partnership agreement governing the Master Fund or (v) a conviction of, or plea of guilty or nolo contendere by any Relevant Person in respect of a felony. In addition, subject to the General Partner's right to take corrective action, the Treasury has the right to unilaterally remove the General Partner upon the occurrence of certain events outlined above with respect to other employees of the General Partner, Western Asset or its affiliates if such events relate to the activities of the Master Fund and have a material adverse effect on the Master Fund.

Master Fund Warrants. The Master Fund has granted warrants to the Treasury in connection with Treasury's provision of equity capital and Treasury Debt Financing to the Master Fund. The warrants provide for preferential payments by the Master Fund to the Treasury after the Master Fund has returned all of the capital invested in the Master Fund by its partners. After the Master Fund has paid to each partner distributions equal to each partner's capital contributions, for every $100 that would otherwise be distributed to the Feeder Fund (and thus indirectly to the Fund) and the other partners in the Master Fund, including Treasury, $2.50 would be allocated to an escrow account and $97.50 would be distributed to the Feeder Fund and other partners of the Master Fund, including Treasury, on a pro rata basis. Upon liquidation of the Master Fund, the amount, if any, by which cumulative warrant payments exceed 2.5 % of the cumulative net profits earned by the partners other than the Treasury will be returned to such other partners, including the Feeder Fund (assuming no event of default by the Feeder Fund). See "Risks—Risks Related to the Fund—Leverage Risk," and "—Special Risks Related to PPIP—Risks Related to the Role of the Treasury in the Master Fund."

Potential Conflicts of Interest

In connection with its management of the Master Fund, Western Asset will adopt a conflict of interest mitigation plan and a code of ethics reasonably satisfactory to the Treasury that will require Western Asset to (i) comply with the 1940 Act, (ii) adhere to specified allocation and valuation policies with respect to investment opportunities for the funds it manages participating in PPIP, (ii) invest a minimum amount set forth by the Treasury of its own firm capital in the Feeder Fund and the Master Fund, (iv) acknowledge fiduciary duties to the Treasury and private investors in the Feeder Fund and the Master Fund, (v) provide access to the Feeder Fund's and the Master Fund's records to the Office of the Special Inspector General for the TARP and the U.S. Government Accountability Office, to cause key persons to be available to discuss the Feeder Fund and the Master Fund with the Treasury and others, to provide access to the Treasury and its representatives to the books of the private vehicles that invest in the Feeder Fund and the Master Fund and to retain those documents for at least three years after the termination of the Feeder Fund and the Master Fund, (vi) permit the U.S. Trustee to review its compliance with these plans, (vii) maintain a PPIP Eligible Assets securities watch list and to employ a compliance officer to monitor compliance with allocation policies and other applicable rules, (viii) identify and disclose all conflicts of interest with the Feeder Fund and the Master Fund, (ix) disclose to the U.S. Trustee all information in its possession or in the possession of certain affiliates regarding the beneficial owners of

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equity in the Feeder Fund, (x) disclose the 10 largest investment positions of the Master Fund, (xi) comply with "know your customer" regulations, Office of Foreign Asset Control statutes and regulations and all relevant federal securities screening laws and anti-money laundering obligations with respect to new investors and transferees, (xii) consent to annual audits of its internal controls by an independent auditor and the delivery of such internal audit to the Treasury, (xiii) implement conflicts of interest policies that will provide that Western Asset may not acquire PPIP Eligible Assets from or sell PPIP Eligible Assets to certain affiliates that are major participants in the market for PPIP Eligible Assets, any other public-private investment fund or any investor that has invested 9.9 % or more of the private capital raised by the Master Fund, (xiv) require that all transactions of the Master Fund be conducted on an arm's length and commercially reasonable basis, (xv) disclose all instances where certain affiliates service or invest in PPIP Eligible Assets, and (xvi) represent that fees paid by the Feeder Fund to any servicer are arm's length and perform diligence on a regular basis to determine that such fees are at market rates. The plan and code will also prohibit any broker-dealer affiliate of Western Asset from executing trades for the Feeder Fund and address conflicts of interest with Western Asset's employees and certain of their family members. The Treasury requires that Western Asset implement policies requiring best price and best execution on all Master Fund transactions, no crossing of Master Fund trades, no purchase of PPIP Eligible Assets with the intention to resell within one week and no resale of PPIP Eligible Assets within 24 hours of purchasing such assets. The Treasury can require Western Asset to take corrective action if its participation in any other governmental program could create a conflict of interest.

LEVERAGE

The Fund may seek to enhance the level of its current distributions to Common Stockholders through the use of leverage. The Fund may use leverage directly at the Fund level or have exposure to leverage indirectly through its investment in the leveraged Master Fund. While such implicit leverage will not constitute actual borrowing of the Fund for purposes of the 1940 Act, in an effort to mitigate the overall risk of leverage, the Fund does not intend to incur additional direct leverage at the Fund level to the extent that its existing direct leverage at the Fund level and its implicit leverage through its investment in the Master Fund exceeds 33 ¹ / ₃ % of the Fund's Managed Assets immediately after Borrowings and/or issuances of Preferred Stock. at the Fund level.

Fund Leverage

The Fund may use leverage at the Fund level through Borrowings, including loans from certain financial institutions or through a qualified government sponsored program (including the Term Asset-Backed Securities Loan Facility ("TALF"), to the extent available to the Fund), the use of reverse repurchase agreements and/or the issuance of debt securities and possibly through the issuance of Preferred Stock, in an aggregate amount of up to approximately 33 ¹ / ₃ % of the Fund's Total Assets immediately after such Borrowings and/or issuances of Preferred Stock. In addition, the Fund may enter into additional reverse repurchase agreements and use similar investment management techniques that may provide leverage, but which are not subject to the foregoing 33 ¹ / ₃ % limitation so long as the Fund has covered its commitment with respect to such techniques by segregating liquid assets, entering into offsetting transactions or owning positions covering its obligations. The Fund may not use leverage at all times and the amount of leverage may vary depending upon a number of factors, including LMPFA's and the Subadviser's outlook for the market and the costs that the Fund would incur as a result of such leverage.

Currently, the Fund has no intention to offer notes or debt securities or Preferred Stock, but circumstances may arise such that the Fund may choose to issue Preferred Stock. Borrowings (and any Preferred Stock) will have seniority over Common Stock. Any Borrowings and Preferred Stock (if issued) will leverage your investment in Common Stock. Holders of Common Stock will bear the costs associated with any Borrowings, and if the Fund issues Preferred Stock, Common Stockholders will bear the offering costs of the Preferred Stock issuance. The Board of Directors of the Fund may authorize the use of leverage through Borrowings and Preferred Stock without the approval of the Common Stockholders.

Changes in the value of the Fund's portfolio securities, including costs attributable to Borrowings or Preferred Stock, will be borne entirely by the holders of the Common Stock. If there is a net decrease (or increase) in the value of the Fund's investment portfolio, the leverage will decrease (or increase) the net asset value per Common Stock to a greater extent than if the Fund were not leveraged. During periods when the Fund is using leverage through Borrowings or the issuance of Preferred Stock or has implicit leverage through its indirect investment in the Master Fund by reason of the Master Fund's use of the Treasury Debt Financing or other leverage, the fees paid to LMPFA, the Subadviser, the Allocation Subadviser and Western Asset Limited for advisory services will be higher than if the Fund did not use leverage because the fees paid will be calculated on the basis of the Fund's Managed Assets, which includes the principal amount of the Borrowings and any

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assets attributable to the issuance of Preferred Stock, as well as implicit leverage attributable to the Fund's indirect investment in the Master Fund. This means that LMPFA, the Subadviser, the Allocation Subadviser and Western Asset Limited may have a financial incentive to increase the Fund's use of leverage.

Under the 1940 Act, the Fund generally is not permitted to issue commercial paper or notes or borrow unless immediately after the borrowing or commercial paper or note issuance the value of the Fund's total assets less liabilities other than the principal amount represented by commercial paper, notes or borrowings is at least 300 % of such principal amount. In addition, the Fund is not permitted to declare any cash dividend or other distribution on its Common Stock unless, at the time of such declaration, the value of the Fund's total assets, less liabilities other than the principal amount represented by commercial paper, notes or borrowings, is at least 300 % of such principal amount after deducting the amount of such dividend or distribution. If the Fund borrows, the Fund intends, to the extent possible, to prepay all or a portion of the principal amount of any outstanding commercial paper, notes or borrowing to the extent necessary to maintain the required asset coverage. Failure to maintain certain asset coverage requirements could result in an event of default and entitle the debt holders to elect a majority of the Board of Directors.

Utilization of leverage is a speculative investment technique and involves certain risks to the holders of Common Stock. These include the possibility of higher volatility of the net asset value of the Common Stock and potentially more volatility in the market value of, and distributions on, the Common Stock. So long as the Fund is able to realize a higher net return on its investment portfolio than the then-current cost of any leverage together with other related expenses, the effect of the leverage will be to cause holders of Common Stock to realize a higher rate of return than if the Fund were not so leveraged. On the other hand, to the extent that the then-current cost of any leverage, together with other related expenses, approaches the net return on the Fund's investment portfolio, the benefit of leverage to holders of Common Stock will be reduced, and if the then-current cost of any leverage together with related expenses were to exceed the net return on the Fund's portfolio, the Fund's leveraged capital structure would result in a lower rate of return to holders of Common Stock than if the Fund were not so leveraged. There can be no assurance that the Fund's leveraging strategy will be successful.

Under the 1940 Act, the Fund is not permitted to issue Preferred Stock unless immediately after such issuance the value of the Fund's asset coverage is at least 200 % of the liquidation value of the outstanding Preferred Stock (i.e., such liquidation value may not exceed 50 % of the Fund's asset coverage less all liabilities other than borrowings).

In addition, the Fund is not permitted to declare any cash dividend or other distribution on its Common Stock unless, at the time of such declaration, the value of the Fund's asset coverage less liabilities other than borrowings satisfies the above-referenced 200 % coverage requirement. If Preferred Stock is issued, the Fund intends, to the extent possible, to purchase or redeem Preferred Stock from time to time to the extent necessary in order to maintain coverage of at least 200 % .

If Preferred Stock is outstanding, two of the Fund's Directors will be elected by the holders of Preferred Stock, voting separately as a class. The remaining Directors of the Fund will be elected by holders of Common Stock and Preferred Stock voting together as a single class. In the unlikely event that the Fund fails to pay dividends on the Preferred Stock for two years, holders of Preferred Stock would be entitled to elect a majority of the Directors of the Fund. The failure to pay dividends or make distributions could result in the Fund ceasing to qualify as a regulated investment company under the Code, which could have a material adverse effect on the value of the Common Stock.

The Fund may be subject to certain restrictions imposed either by guidelines of a lender, if the Fund borrows from a lender, or by one or more rating agencies which may issue ratings for Preferred Stock or debt securities. These guidelines may impose asset coverage or portfolio composition requirements that are more stringent than those imposed on the Fund by the 1940 Act. It is not anticipated that these covenants or guidelines will impede LMPFA, the Subadviser, the Allocation Subadviser and Western Asset Limited from managing the Fund's portfolio in accordance with the Fund's investment objectives and policies. In addition to other considerations, to the extent that the Fund believes that the covenants and guidelines required by the rating agencies would impede its ability to meet its investment objectives, or if the Fund is unable to obtain its desired rating on Preferred Stock or debt securities, the Fund will not issue Preferred Stock or debt securities.

Master Fund Leverage

Subject to certain limitations, the General Partner will have the right, at its option, to cause the Master Fund to incur indebtedness. It is expected that the Master Fund will enter into the Treasury Debt Financing, a senior secured multi-draw term loan facility, in an amount equal to approximately 50 % of the Master Fund's total assets

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immediately after giving effect to the borrowing (i.e., a Full Turn Election, as defined below), with availability at any time limited to the Master Fund's aggregate drawn capital commitments. The Master Fund will bear the interest expense and other financing costs arising out of its use of the Treasury Debt Financing. Although the Master Fund's Treasury Debt Financing will not constitute actual borrowing of the Fund and will be non-recourse to the Fund, assuming the Fund invests 40% of the net proceeds of this offering in the Feeder Fund, it will constitute implicit leverage for the Fund of approximately % of Managed Assets, depending on the size of the Fund's investment in the Feeder Fund.

The Master Fund may draw down on the Treasury Debt Financing from the initial closing of the Master Fund through and including the last day of the investment period of the Master Fund. Drawdowns are subject to the Master Fund's satisfaction of the requirements set forth in the Treasury Debt Financing documents including, among others, the Treasury satisfactorily completing all legal, compliance and business due diligence in connection with the financing, all representations and warranties of the Master Fund being true in all material respects (or, in the case of representations and warranties qualified by materiality, in all respects) , no default or event of default being in existence, the asset coverage ratio of the assets of the Master Fund over the outstanding principal of and interest on the loans being not lower than 150 % and the Master Fund having complied with all affirmative and negative covenants and conditions included in the Treasury Debt Financing documentation.

The Master Fund will also be required to make certain representations and warranties and to comply with certain conditions that are consistent with those typically seen with a commercial loan, as well as others specific to PPIP, in order to make use of the Treasury Debt Financing. Such conditions include, but are not limited to, that:

•   there must not be any incipient or matured event of default at the time of, or after giving effect to, the borrowing;

•   the amount of loans made on any borrowing date must not exceed the amount of the Treasury Debt Financing then available for borrowing;

•   assuming that the Master Fund has made a Full Turn Election, the Master Fund must have an asset coverage ratio of 200 % on a pro forma basis both before and after accounting for the borrowing;

•   the Treasury will have received a certificate from the Master Fund setting forth in reasonable detail calculations supporting certain determinations and certifying that the Master Fund owns only PPIP Eligible Assets and Temporary Investments; and

•   the deposit of a required amount must be have been made into an interest reserve account.

The Master Fund will also be required to comply with EESA, implement a conflict of interests mitigation plan and a code of ethics reasonably satisfactory to the Treasury and allow the Treasury, the Special Inspector General of TARP, the Government Accountability Office and their respective advisors and representatives to inspect property and books and records and meet with the General Partner.

As a result of receiving the Treasury Debt Financing, the Master Fund will be required to make interest and principal payments to the Treasury. Interest payments generally will be payable at a rate of one-month LIBOR (i.e., the rate for eurodollar deposits for a period equal to one month appearing on Reuters Screen LIBOR01 Page or if such rate ceases to appear on Reuters Screen LIBOR01 Page, on any other service providing comparable rate quotations at approximately 11:00 a.m., London time on the date of determination) plus 1 % per annum if the Master Fund is not then in default (one-month LIBOR plus 3 % per annum if the Master Fund is then in default). However, if LIBOR cannot be determined, then interest payments generally will be payable at the Prime Rate (i.e., the rate of interest per annum published by The Wall Street Journal from time to time as the prime rate) per annum if the Master Fund is not then in default (Prime Rate plus 2 % per annum if the Master Fund is then in default). Loans provided by Treasury will become due and payable on the earlier of (i) ten years from the Master Fund Closing Date, (ii) the expiration, termination or dissolution of the Master Fund and (iii) the date to which the loans made by the Treasury have been accelerated. The Master Fund can choose to optionally prepay the loan at any time in whole or in part without any premium or penalty, provided that any amounts repaid or prepaid may not be re-borrowed and will reduce the amount of the Treasury Debt Financing available to the Master Fund. The Master Fund will also be required to pay all reasonable out-of-pockets expenses of the agent and custodian in connection with the creation, implementation and maintenance of the Treasury Debt Financing. In addition, the Master Fund's use of the Treasury Debt Financing will require it to use and pay for a third-party valuation agent, Bank of New York Mellon Corporation (the "Valuation Agent"), to value its assets. The Valuation Agent will be the same for all public-private investment funds formed under PPIP.

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Under the terms of the Treasury Debt Financing, all investment proceeds of the Master Fund will be held and maintained in a custodial account until such time as they are allocated and distributed in accordance with a priority of payments schedule (the "Priority of Payments"). Pursuant to the Priority of Payments, the Master Fund will be required to make payments to other parties prior to, among other things, making distributions to its partners. The Priority of Payments will vary based upon whether the Master Fund is in default on the Treasury Debt Financing. Generally speaking, so long as the Master Fund has not defaulted on the Treasury Debt Financing, the Priority of Payments requires that the Master Fund distribute investment proceeds in the following order:

1.  to payments of taxes imposed on the Master Fund and, without duplication, administrative expenses of the Master Fund;

2.  to payments then due on interest rate hedges that the Master Fund is permitted to make (other than early termination payments attributable to counterparty default);

3.  to payment of current interest and any other amounts (other than principal amounts) due to the Treasury as lender;

4.  to set aside certain future interest payments in the interest reserve account;

5.  assuming that the Master Fund has made a Full Turn Election, if asset coverage with respect to the Treasury Debt Financing is less than 150 % , to the repayment of principal to the extent necessary to cause the asset coverage to be in excess of 150 % or until the Treasury Debt Financing has been repaid in full;

6.  to early termination payments under interest rate hedges the Master Fund is permitted to make attributable to counterparty default;

7.  at the option of Western Asset, for investments in Temporary Investments, for optional prepayment of the Treasury Debt Financing or, during the Master Fund's investment period and so long as no incipient or matured event of default is then continuing, for investments in PPIP Eligible Assets;

8.  commencing with the Treasury Debt Financing payment date occurring in January 2010, for distributions to the partners in the Master Fund; provided that, after giving effect to the distribution, asset coverage with respect to the Treasury Debt Financing is greater than 200 % . Distributions to the partners pursuant to this clause 8 in any period of 12 months (or, if shorter, the period commencing on the commencement of investment operations and ending on the last day of the month immediately preceding such loan payment date) may not exceed the lesser of (x) 8 % of the funded capital commitments to the Master Fund and (y) the cumulative net interest income of the Master Fund for the preceding period of 12 months (or, if shorter, the period commencing on the commencement of investment operations and ending on the last day of the month immediately preceding such loan payment date);

9.  to the repayment of principal in an amount equal to the lesser of (i) the product of (x) an applicable prepayment percentage multiplied by (y) the amount remaining on deposit in the custodial account available to be distributed and (ii) an amount which reduces the principal amount to zero (minus any amount paid on such loan payment date as provided in clauses 5 and 7 above; and

10.  so long as no incipient event of default is then continuing, to distributions to the Master Fund's partners or the repayment of principal under the Treasury Debt Financing.

The Master Fund would be limited in the amount of distributions it can make to its partners for so long as its asset coverage ratio is below 200 % . In addition, if the Master Fund's asset coverage ratio falls below 150 % , it will not be able to make distributions to any of its partners until such time as the asset coverage ratio is in excess of 150 % .

Generally speaking, if the Master Fund has defaulted on the Treasury Debt Financing, the Priority of Payments requires that the Master Fund distribute investment proceeds in the following order:

1.  to payments on permitted administrative expenses of the Master Fund;

2.  to payments on permitted interest rate hedges secured by PPIP Eligible Assets or other collateral of the Master Fund (other than early termination payments attributable to counterparty default);

3.  to payments of interest and principal and any other amounts due to the Treasury as the lender; and

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4.  to early termination payments under any permitted interest rate hedges secured by collateral attributable to counterparty default.

Events of default under the Treasury Debt Financing documents include, without limitation: non-payment of principal on the loans at maturity; non-payment of interest or other amounts owing on the loans after a specified grace period for curing any such non-payment; inaccuracy of representations and warranties in the credit documentation in any material respect (or, in the case of representations and warranties qualified by materiality, in any respect); violation of certain negative and affirmative covenants in the Treasury Debt Financing documentation (subject, in the case of certain affirmative covenants, to a grace period for curing any such violation); cross-default to the material debt of the Master Fund as described in the Treasury Debt Financing documentation; bankruptcy events of the Master Fund and the general partner of the Master Fund; certain ERISA events; any material judgment as described in the Treasury Debt Financing documentation; actual or asserted invalidity of any security document or security interest; the withdrawal, or the removal of, the general partner of the Master Fund; and the Master Fund becoming an "investment company" required to be registered under the Investment Company Act. An event of default can occur in certain cases that are unrelated to the performance of the Master Fund's portfolio, including a vote to remove the General Partner and the removal of the General Partner for cause or the happening of a certain events relating to the investment team.

Full-Turn versus Half-Turn Treasury Leverage. Investment proceeds distributed from the Master Fund to the Treasury are subject to an additional amount, calculated on the basis of an applicable "Warrant Percentage." The Warrant Percentage is, in turn, dependent on whether the Master Fund elects Treasury leverage of up to 100 % of the Master Fund's aggregate capital commitments (a "Full Turn Election") or up to 50 % of the Master Fund's aggregate capital commitments (a "Half Turn Election"). Because the Master Fund has elected a Full Turn Election, the Warrant Percentage will equal 2.5 % and no additional debt other than Treasury leverage is permitted. The Master Fund may change its Full Turn Election to a Half Turn Election at any time after the initial closing of the Master Fund during the investment period of the Master Fund if certain conditions are met. If such change is made, however, the Warrant Percentage will remain at the Full Turn Election rate. A Full Turn Election will not subsequently be available if the Master Fund switches to a Half Turn Election.

If a Half Turn Election is in effect, subject to compliance with the covenants in the Treasury Debt Financing documents (which include an incurrence-based leverage test and an asset coverage test), the Master Fund may also finance the purchase of PPIP Eligible Assets using proceeds from borrowings under TALF and, subject to the prior written consent of the Treasury, proceeds from borrowings from third parties (collectively, "Third Party Debt"). PPIP Eligible Assets acquired through Third Party Debt must be financed, acquired and held through wholly owned financing subsidiaries of the borrower. In connection with incurrence of permitted Third Party Debt, PPIP Eligible Assets may be contributed to financing subsidiaries or may be acquired by financing subsidiaries and will not constitute collateral for the Treasury Debt Financing and will be available to secure such Third Party Debt.

Effects of Leverage

The following table is designed to illustrate the effect of leverage on Common Stock total return, assuming investment portfolio total returns (comprised of income and changes in the value of securities held in the Fund's portfolio) of -10 % , -5 % , 0 % , 5 % and 10 % . These assumed investment portfolio returns are hypothetical figures and are not necessarily indicative of the investment portfolio returns experienced or expected to be experienced by the Fund. See "Risks."

The table further reflects the issuance of leverage representing 33 ¹ / ₃ % of the Fund's Managed Assets, net of expenses, the Fund's currently projected annual dividend and interest on its leverage of 2 % .

Common Stock Total Return is composed of two elements: the Common Stock dividends paid by the Fund (the amount of which is largely determined by the net investment income of the Fund after paying dividends or interest on its leverage) and gains or losses on the value of the securities the Fund owns. As required by SEC rules, the table above assumes that the Fund is more likely to suffer capital losses than to enjoy capital appreciation. For example, to assume a total return of 0 % the Fund must assume that the interest it receives on its debt security investments is entirely offset by losses in the value of those investments.

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RISKS

The Fund is a newly organized, non-diversified, limited-term, closed-end management investment company designed primarily as a long-term investment and not as a trading vehicle. The Fund is not intended to be a complete investment program and, due to the uncertainty inherent in all investments, there can be no assurance that the Fund will achieve its investment objective. The Fund's performance and the value of its investments will vary in response to changes in interest rates, inflation, the financial condition of a security's issuer, ratings on a security and other market factors. Your Common Stock at any point in time may be worth less than your original investment, even after taking into account the reinvestment of Fund dividends and distributions.

Risks Related to the Fund

No History of Operations

The Fund is a newly organized, non-diversified, limited-term, closed-end management investment company with no history of operations or public trading. The Feeder Fund and Master Fund are newly organized investment funds with no history of operations. As a result, prospective investors have no track record or history on which to base their investment decision. The Fund will be the first investment fund advised by LMPFA (and sub-advised by the Subadviser, Western Asset Limited and the Allocation Subadviser) that seeks to take advantage of PPIP. The Fund's shares of Common Stock have no history of public trading. If the Fund is unable to qualify for listing on a securities exchange, you may be unable to sell your shares of Common Stock or may be able to sell your shares only at a substantial discount from net asset value.

Investment and Market Risk

An investment in the Fund is subject to investment risk, including the possible loss of the entire amount that you invest. Your investment in Common Stock represents an indirect investment in the MBS and other assets owned by the Fund. The value of the Fund's portfolio securities may move up or down, sometimes rapidly and unpredictably. The Fund intends to take advantage of current market dislocations by buying MBS and other securities at depressed prices, but if such dislocations do not persist during the period when the Fund is investing the net proceeds of this offering, the Fund's returns may be adversely affected. In addition, if the current global economic downturn continues or deteriorates further, the ability of borrowers to service their obligations could be materially and adversely affected. At any point in time, your Common Stock may be worth less than your original investment, even after taking into account the reinvestment of Fund dividends and distributions.

Market Price Discount from Net Asset Value Risk

Shares of closed-end investment companies frequently trade at a discount from their net asset value. This risk is separate and distinct from the risk that the Fund's net asset value could decrease as a result of its investment activities and may be a greater risk to investors expecting to sell their Common Stock in a relatively short period following completion of this offering. Whether investors will realize gains or losses upon the sale of the Common Stock will depend not upon the Fund's net asset value but upon whether the market price of the Common Stock at the time of sale is above or below the investor's purchase price for the Common Stock. Because the market price of the Common Stock will be determined by factors such as relative supply of and demand for the Common Stock in the market, general market and economic conditions and other factors beyond the control of the Fund, the Fund cannot predict whether the Common Stock will trade at, above or below net asset value or at, above or below the initial public offering price. The Fund's Common Stock is designed primarily for long term investors and you should not view the Fund as a vehicle for trading purposes.

Risks Related to Investments in MBS

Investing in MBS (including PPIP Eligible Assets) entails various risks: credit risks, liquidity risks, interest rate risks, market risks, operations risks, structural risks, geographical concentration risks, basis risks and legal risks. Most MBS are subject to the significant credit risks inherent in the underlying collateral and to the risk that the servicer fails to perform. MBS are subject to risks associated with their structure and execution, including the process by which principal and interest payments are allocated and distributed to investors, how credit losses affect the issuing vehicle and the return to investors in such MBS, whether the collateral represents a fixed set of specific assets or accounts, whether the underlying collateral assets are revolving or closed-end, under what terms (including maturity of the MBS) any remaining balance in the accounts may revert to the issuing entity and the extent to which the entity that is the actual source of the collateral assets is obligated to provide support to the issuing vehicle or to the investors in such MBS. In addition, concentrations of MBS of a particular type, as well as concentrations of MBS issued or guaranteed by affiliated obligors, serviced by the

52

same servicer or backed by underlying collateral located in a specific geographic region, may subject the MBS to additional risk.

The risks associated with MBS include: (1) credit risk associated with the performance of the underlying mortgage properties and of the borrowers owning these properties; (2) adverse changes in economic conditions and circumstances, which are more likely to have an adverse impact on MBS secured by loans on certain types of commercial properties than on those secured by loans on residential properties; (3) prepayment risk, which can lead to significant fluctuations in value of the MBS; (4) loss of all or part of the premium, if any, paid; and (5) decline in the market value of the security, whether resulting from changes in interest rates, prepayments on the underlying mortgage collateral or perceptions of the credit risk associated with the underlying mortgage collateral.

MBS represent an interest in a pool of mortgages. When market interest rates decline, more mortgages are refinanced and the securities are paid off earlier than expected. Prepayments may also occur on a scheduled basis or due to foreclosure. When market interest rates increase, the market values of MBS decline. At the same time, however, mortgage refinancings and prepayments slow, lengthening the effective maturities of these securities. As a result, the negative effect of the rate increase on the market value of MBS is usually more pronounced than it is for other types of debt securities. In addition, due to increased instability in the credit markets, the market for some MBS has experienced reduced liquidity and greater volatility with respect to the value of such securities, making it more difficult to value such securities.

Moreover, the relationship between borrower prepayments and changes in interest rates may mean some high-yielding mortgage-related and asset-backed securities have less potential for increases in value if market interest rates were to fall than conventional bonds with comparable maturities. In addition, in periods of falling interest rates, the rate of prepayments tends to increase. During such periods, the reinvestment of prepayment proceeds by the Fund will generally be at lower rates than the rates that were carried by the obligations that have been prepaid. Because of these and other reasons, mortgage-related and asset-backed security's total return and maturity may be difficult to predict precisely. To the extent that the Fund purchases mortgage-related securities at a premium, prepayments (which may be made without penalty) may result in loss of the Fund's principal investment to the extent of premium paid.

The Fund's success depends on the Subadviser's ability to analyze the relationship of changing interest rates on prepayments of the mortgage loans that underlie the Fund's MBS. Changes in interest rates and prepayments affect the market price of the target assets that the Fund intends to purchase and any target assets that the Fund holds at a given time. As part of the Fund's overall portfolio risk management, the Subadviser will analyze interest rate changes and prepayment trends separately and collectively to assess their effects on the Fund's investment portfolio. In conducting its analysis, the Subadviser will depend on certain assumptions based upon historical trends with respect to the relationship between interest rates and prepayments under normal market conditions. If the recent dislocations in the mortgage market or other developments change the way that prepayment trends have historically responded to interest rate changes, the Subadviser's ability to (1) assess the market value of the Fund's investment portfolio, (2) implement any hedging strategies and (3) implement techniques to reduce prepayment rate volatility would be significantly affected, which could materially adversely affect the Fund's financial position and results of operations.

In general, losses on a mortgaged property securing a mortgage loan included in a securitization will be borne first by the equity holder of the property, then by a cash reserve fund or letter of credit, if any, then by the holder of a mezzanine loan or B-Note, if any, then by the "first loss" subordinated security holder (generally, the "B-Piece" buyer) and then by the holder of a higher-rated security. In the event of default and the exhaustion of any equity support, reserve fund, letter of credit, mezzanine loans or B-Notes, and any classes of securities junior to those in which the Fund invests, the Fund will not be able to recover all of its investment in the MBS it purchases. MBS in which the Fund invests may not contain reserve funds, letters of credit, mezzanine loans and/or junior classes of securities. The prices of lower credit quality securities are generally less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual issuer developments.

MBS generally are classified as either CMBS or RMBS, each of which are subject to certain specific risks as further described below. See "—Non-Agency RMBS Risk" and "—CMBS Risk."

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Non-Agency RMBS Risk

Non-agency RMBS are securities issued by non-governmental issuers, the payments on which depend (except for rights or other assets designed to assure the servicing or timely distribution of proceeds to holders of such securities) primarily on the cash flow from residential mortgage loans made to borrowers that are secured (on a first priority basis or second priority basis, subject to permitted liens, easements and other encumbrances) by residential real estate (one- to four- family properties) the proceeds of which are used to purchase real estate and purchase or construct dwellings thereon (or to refinance indebtedness previously so used). Non-agency RMBS have no direct or indirect government guarantees of payment and are subject to various risks as described herein.

Credit-Related Risk Associated with Borrowers on Non-Agency RMBS. Credit-related risk on non-agency RMBS arises from losses due to delinquencies and defaults by the borrowers in payments on the underlying mortgage loans and breaches by originators and servicers of their obligations under the underlying documentation pursuant to which the non-agency RMBS are issued. Residential mortgage loans are obligations of the borrowers thereunder only and are not typically insured or guaranteed by any other person or entity. The rate of delinquencies and defaults on residential mortgage loans and the aggregate amount of the resulting losses will be affected by a number of factors, including general economic conditions, particularly those in the area where the related mortgaged property is located, the level of the borrower's equity in the mortgaged property and the individual financial circumstances of the borrower. If a residential mortgage loan is in default, foreclosure on the related residential property may be a lengthy and difficult process involving significant legal and other expenses. The net proceeds obtained by the holder on a residential mortgage loan following the foreclosure on the related property may be less than the total amount that remains due on the loan. The prospect of incurring a loss upon the foreclosure of the related property may lead the holder of the residential mortgage loan to restructure the residential mortgage loan or otherwise delay the foreclosure process.

Impact of Real Estate and Mortgage Loan Markets on Non-Agency RMBS. In addition to the foregoing considerations, the market for defaulted residential mortgage loans and foreclosed real estate properties may be very limited. In particular, the economic conditions that lead to a higher rate of delinquencies and defaults on a portfolio of real estate mortgage loans may also lead to a reduction in the value of the related real estate properties, which in turn will result in greater losses upon a foreclosure of the real estate properties. At any one time, a portfolio of non-agency RMBS may be backed by residential mortgage loans that are highly concentrated in only a few states or regions. As a result, the performance of such residential mortgage loans may be more susceptible to a downturn in the economy, including in particular industries that are highly represented in such states or regions, natural calamities and other adverse conditions affecting such areas. In addition, the residential mortgage loans underlying non-agency RMBS may include so-called "jumbo" residential mortgage loans, having original principal balances that are significantly higher than is generally the case for residential mortgage loans. If the portfolio of residential mortgage loans underlying a non-agency RMBS includes a high concentration of "jumbo" residential mortgage loans, the performance of the non-agency RMBS will be more susceptible to the performance of individual borrowers and adverse economic conditions in general than would otherwise be the case.

Beginning in 2007, delinquencies and defaults on residential mortgage loans increased significantly and may continue to increase, particularly in the case of subprime and adjustable-rate mortgage loans that support or secure certain types of non-agency RMBS. In addition, in recent months, residential property values in many states and geographic areas have declined, after extended periods during which those values appreciated. A continued lack of increase or decline in those values may result in additional increases in delinquencies and defaults on residential mortgage loans generally, especially with respect to second homes and properties held for investment purposes, and with respect to any residential mortgage loans where the aggregate loan amounts (including any subordinate loans) are close to or greater than the related property values, which may make it difficult to refinance or sell the related property. The recent economic downturn experienced at the national level and the more serious economic downturn experienced in certain geographic areas of the United States, including in particular areas of the United States where rates of delinquencies and defaults on residential mortgage loans have already accelerated, may further contribute to the higher rates of delinquencies and defaults on the residential mortgage loans underlying the non-agency RMBS. There also can be no assurance that areas of the United States that have mostly avoided higher rates of delinquencies and defaults on residential mortgage loans will continue to do so if an economic downturn in the economy continues at the national level.

Another factor that may contribute to, and may in the future result in, higher delinquency and default rates is the increase in monthly payments on adjustable-rate mortgage loans. Any increase in prevailing market interest

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rates may result in increased payments for borrowers who have adjustable-rate mortgage loans. Moreover, with respect to hybrid mortgage loans after their initial fixed-rate period or other so-called adjustable-rate mortgage loans, interest-only products or products having a lower rate, and with respect to mortgage loans with a negative amortization feature which reach their negative amortization cap, borrowers may experience a substantial increase in their monthly payment even without an increase in prevailing market interest rates. Increases in payments for borrowers may result in increased rates of delinquencies and defaults on residential mortgage loans underlying the non-agency RMBS. The past performance of the market for non-agency RMBS is not a reliable indicator of future performance because of the unprecedented and unpredictable performance of the residential mortgage loan market.

As a result of rising concerns about increases in delinquencies and defaults on residential mortgage loans (particularly on subprime and adjustable-rate mortgage loans) and as a result of increasing concerns about the financial strength of originators and servicers and their ability to perform their obligations with respect to non-agency RMBS, there may be an adverse change in the market sentiments of investors about the market values and volatility and the degree of risk of non-agency RMBS generally. Some or all of the underlying residential mortgage loans in an issue of non-agency RMBS may have balloon payments due on their respective maturity dates. Balloon residential mortgage loans involve a greater risk to a lender than fully amortizing loans, because the ability of a borrower to pay such amount will normally depend on its ability to obtain refinancing of the related mortgage loan or sell the related mortgaged property at a price sufficient to permit the borrower to make the balloon payment, which will depend on a number of factors prevailing at the time such refinancing or sale is required, including, without limitation, the strength of the local or national residential real estate markets, interest rates and general economic conditions and the financial condition of the borrower. If borrowers are unable to make such balloon payments, the related issue of non-agency RMBS may experience losses.

Prepayment Risk Associated with Non-Agency RMBS. Non-agency RMBS are susceptible to prepayment risks. Except in the case of certain types of non-agency RMBS, the mortgage loans underlying non-agency RMBS generally do not contain prepayment penalties and a reduction in market interest rates will increase the likelihood of prepayments on the related non-agency RMBS, resulting in a reduction in yield to maturity for most holders of such securities. In the case of certain home equity loan securities and certain types of non-agency RMBS, even though the underlying mortgage loans often contain prepayment premiums, such prepayment premiums may not be sufficient to discourage borrowers from prepaying their mortgage loans in the event of a reduction in market interest rates, resulting in a reduction in the yield to maturity for holders of the related non-agency RMBS. In addition to reductions in the level of market interest rates and the prepayment provisions of the mortgage loans, repayments on the residential mortgage loans underlying an issue of non-agency RMBS may also be affected by a variety of economic, geographic and other factors, including the size difference between the interest rates on the underlying residential mortgage loans (giving consideration to the cost of refinancing) and prevailing mortgage rates and the availability of refinancing. In general, if prevailing interest rates fall significantly below the interest rates on the related residential mortgage loans, the rate of prepayment on the underlying residential mortgage loans would be expected to increase. Conversely, if prevailing interest rates rise to a level significantly above the interest rates on the related mortgage loans, the rate of prepayment would be expected to decrease. Prepayments could reduce the yield received on the related issue of non-agency RMBS.

Non-agency RMBS typically contain provisions that require repurchase of mortgage loans by the originator or other seller in the event of a breach of a representation or warranty regarding loan quality and characteristics of such loan. Any repurchase of a mortgage loan as a result of a breach has the same effect on the yield received on the related issue of non-agency RMBS as a prepayment of such mortgage loan. Any increase in breaches of representations and the consequent repurchases of mortgage loans that result from inadequate underwriting procedures and policies and protections against fraud will have the same effect on the yield on the related non-agency RMBS as an increase in prepayment rates. CMBS are also subject to prepayment risk, as described above. Risk of prepayment may be reduced for commercial real estate property loans containing significant prepayment penalties or prohibitions on principal payments for a period of time following origination.

The Fund may also invest in MBS which are IO securities and PO securities. An IO security receives some or all of the interest portion of the underlying collateral and little or no principal. A reference principal value called a notional value is used to calculate the amount of interest due. IO securities are sold at a deep discount to their notional principal amount. A PO security does not receive any interest, is priced at a deep discount to its redemption value and ultimately receives the redemption value. Generally speaking, when interest rates are falling and prepayment rates are increasing, the value of a PO security will rise and the value of an IO security

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will fall. Conversely, when interest rates are rising and prepayment rates are decreasing, generally the value of a PO security will fall and the value of an IO security will rise.

Legislation and Government Plans Potentially Affecting the Value of Non-Agency RMBS The significance of the mortgage crisis and loan defaults in residential mortgage loan sectors led to the enactment in July 2008 of the Housing and Economic Recovery Act of 2008, a wide-ranging housing rescue bill that offers up to $300 billion in assistance to troubled homeowners and emergency assistance to Freddie Mac and Fannie Mae, companies that operate under federal charter and play a vital role in providing financing for the housing markets. The above-mentioned housing bill could potentially have a material adverse effect on the Fund's investment program as the bill, among other things, (1) allows approximately 400,000 homeowners to refinance into affordable, government-backed loans through a program run by the Federal Housing Administration (the "FHA"), a division of the U.S. Housing and Urban Development ("HUD") and (2) provides approximately $180 million for "pre-foreclosure" housing counseling and legal services for distressed borrowers. In addition, the mortgage crisis has led public advocacy groups to demand, and governmental officials to propose and consider, a variety of other "bailout" and "rescue" plans that could potentially have a material adverse effect on the Fund's investment program. Some members of the U.S. Congress are concerned that the downturn in the housing market has played a role in the rise of late mortgage payments and foreclosures and expect that these conditions will lead to increased filings for bankruptcy. In 2007, U.S. Treasury then-Secretary Henry Paulson and HUD then-Secretary Alphonso Jackson and the mortgage industry worked to develop HOPE NOW, an alliance of participants in the mortgage industry intended to work with borrowers with subprime mortgages facing interest rate increases and increasing payments. The Congressional Research Service reports that HOPE NOW has undertaken an initiative to provide homeowners with free telephone consultations with HUD-approved credit counselors, who can help homeowners contact their lenders and credit counselors to work out a plan to avoid foreclosure. Certain borrowers may also seek relief through the "FHA Secure" refinancing option that gives homeowners with non-FHA adjustable rate mortgages, current or delinquent and regardless of reset status, the ability to refinance into a FHA-insured mortgage. The Helping Families Save Their Homes Act of 2009, which was enacted on May 20, 2009, provides a safe harbor for servicers entering into "qualified loss mitigation plans" with respect to residential mortgages originated before the act was enacted. By protecting servicers from certain liabilities, this safe harbor may encourage loan modifications and reduce the likelihood that investors in securitizations will be paid on a timely basis or will be paid in full. In addition to the above, a variety of other plans and proposals from federal and state regulatory agencies have been presented. The terms of other proposed legislation or other plans may include, by way of example and not limitation, the following:

•   moratoriums on interest rate increases for certain mortgage loans and on foreclosure proceedings;

•   conversions of adjustable rate mortgages to fixed-rate mortgages (including in connection with government-backed refinancings of individual mortgage loans), with potential workouts to provide borrowers with equity stakes in their homes;

•   increased scrutiny of mortgage originations (including mortgage loans in which the Fund may own an interest through non-agency RMBS) and foreclosure proceedings;

•   additional registration and licensing requirements for mortgage brokers, lenders and others involved in the mortgage industry; and

•   greater relief to homeowners under the U.S. Bankruptcy Code or other federal or state laws, including relief to stay or delay the foreclosure of residential mortgage loans or to modify payment terms, including interest rates and repayment periods, of residential mortgage loans, over a lender's objections, as the result of a "cramdown," which decreases the debt's value to as low as the collateral's fair market value.

A significant number of loan modifications could result in a significant reduction in cash flows to the holders of the mortgage securities on an ongoing basis. These loan modification programs, as well as future legislative or regulatory actions, including amendments to the bankruptcy laws, that result in the modification of outstanding mortgage loans may adversely affect the value of, and the returns on, the target assets in which the Fund intends to invest.

Law, legislation or other government regulation, including that which is promulgated in furtherance of a "bailout" or "rescue" plan to address the crisis and distress in the residential mortgage loan sector, may result in a reduction of available transactional opportunities for the Fund, or an increase in the cost associated with such transactions. Any such law, legislation or regulation may adversely affect the market value of non-agency RMBS.

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Legal Risks Associated with Non-Agency RMBS. Legal risks can arise as a result of the procedures followed in connection with the origination of the mortgage loans or the servicing thereof which may be subject to various federal and state laws (including, without limitation, predatory lending laws), public policies and principles of equity regulating interest rates and other charges, require certain disclosures, require licensing of originators, prohibit discriminatory lending practices, regulate the use of consumer credit information and debt collection practices and may limit the servicer's ability to collect all or part of the principal of or interest on a residential mortgage loan, entitle the borrower to a refund of amounts previously paid by it or subject the servicer to damages and sanctions. Specifically, provisions of federal predatory lending laws, such as the federal Truth-in-Lending Act (as supplemented by the Home Ownership and Equity Protection Act of 1994) and Regulation Z, and various recently enacted state predatory lending laws provide that a purchaser or assignee of specified types of residential mortgage loans (including an issuer of non-agency RMBS) may be held liable for violations by the originator of such mortgage loans. Under such assignee liability provisions, a borrower is generally given the right to assert against a purchaser of its mortgage loan any affirmative claims and defenses to payment such borrower could assert against the originator of the loan or, where applicable, the home improvement contractor that arranged the loan. Liability under such assignee liability provisions could, therefore, result in a disruption of cash flows allocated to the holders of non-agency RMBS where either the issuer of such non-agency RMBS is liable in damages or is unable to enforce payment by the borrower. In most but not all cases, the amount recoverable against a purchaser or assignee under such assignee liability provisions is limited to amounts previously paid and still owed by the borrower. Moreover, sellers of residential mortgage loans to an issuer of non-agency RMBS typically represent that the loans have been originated in accordance with all applicable laws and in the event such representation is breached, the seller typically must repurchase the offending loan.

Notwithstanding these protections, an issuer of non-agency RMBS may be exposed to an unquantifiable amount of potential assignee liability because, first, the amount of potential assignee liability under certain predatory lending laws is unclear and has yet to be litigated, and, second, in the event a predatory lending law does not prohibit class action lawsuits, it is possible that an issuer of non-agency RMBS could be liable in damages for more than the original principal amount of the offending loans held by it. In such circumstances the issuer of non-agency RMBS may be forced to seek contribution from other parties, who may no longer exist or have adequate funds available to fund such contribution.

In addition, structural and legal risks of non-agency RMBS include the possibility that, in a bankruptcy or similar proceeding involving the originator or the servicer (often the same entity or affiliates), the assets of the issuer could be treated as never having been truly sold by the originator to the issuer and could be substantively consolidated with those of the originator, or the transfer of such assets to the issuer could be voided as a fraudulent transfer. Challenges based on such doctrines could result also in cash flow delays and losses on the related issue of non-agency RMBS.

In some cases, servicers of non-agency RMBS have been the subject of legal proceedings involving the origination and/or servicing practices of such servicers. Large groups of private litigants and states attorneys general have brought such proceedings. Because of the large volume of mortgage loans originated and serviced by such servicers, such litigation can cause heightened financial strain on servicers. In other cases, origination and servicing practices may cause or contribute to such strain, because of representation and warranty repurchase liability arising in MBS and mortgage loan sale transactions. Any such financial strain could cause servicers to service below required standards, causing delinquencies and losses in any related MBS transaction to rise, and in extreme cases could cause the servicer to seek the protection of any applicable bankruptcy or insolvency law. In any such proceeding, it is unclear whether the fees that the servicer charges in such transactions would be sufficient to permit that servicer or a successor servicer to service the mortgage loans in such transaction adequately. If such fees had to be increased, it is likely that the most subordinated security holders in such transactions would be effectively required to pay such increased fees. Finally, these entities may be the subject of future laws designed to protect consumers from defaulting on their mortgage loans. Such laws may have an adverse effect on the cash flows paid under such non-agency RMBS.

In the past year, a number of lenders specializing in residential mortgages have sought bankruptcy protection, shut down or been refused further financings from their lenders. In addition, certain lenders who service and/or issue non-agency RMBS have recently announced that they are being investigated by or have received information requests from U.S. federal and/or state authorities, including the Securities and Exchange Commission. As a result of such investigations and other similar investigations and general concerns about the adequacy or accuracy of disclosure of risks to borrowers and their understanding of such risks, U.S. financial regulators have recently indicated that they may propose new guidelines for the mortgage industry. Guidelines, if

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introduced, together with the other factors described herein, may make it more difficult for borrowers with weaker credit to refinance, which may lead to further increases in delinquencies, extensions in duration and losses in mortgage-related assets. Furthermore, because some mortgage loans have high recoveries, and as property values decline, increasing loan-to-value ratios, recoveries on some defaulted mortgage loans are more likely to be less than the amounts owed under such mortgage loans, resulting in higher net losses than would have been the case had property values remained the same or increased.

CMBS Risk

CMBS are, generally, securities backed by obligations (including certificates of participation in obligations) that are principally secured by mortgages on real property or interests therein having a multifamily or commercial use, such as regional malls, other retail space, office buildings, industrial or warehouse properties, hotels, nursing homes and senior living centers. The market for CMBS developed more recently and, in terms of total outstanding principal amount of issues, is relatively small compared to the market for residential single-family mortgage-related securities. CMBS are subject to particular risks, including lack of standardized terms, shorter maturities than residential mortgage loans and payment of all or substantially all of the principal only at maturity rather than regular amortization of principal. Additional risks may be presented by the type and use of a particular commercial property. Special risks are presented by hospitals, nursing homes, hospitality properties and certain other property types. Commercial property values and net operating income are subject to volatility, which may result in net operating income becoming insufficient to cover debt service on the related mortgage loan. The repayment of loans secured by income-producing properties is typically dependent upon the successful operation of the related real estate project rather than upon the liquidation value of the underlying real estate. Furthermore, the net operating income from and value of any commercial property is subject to various risks, including changes in general or local economic conditions and/or specific industry segments; the solvency of the related tenants; declines in real estate values; declines in rental or occupancy rates; increases in interest rates, real estate tax rates and other operating expenses; changes in governmental rules, regulations and fiscal policies; acts of God; terrorist threats and attacks and social unrest and civil disturbances. Consequently, adverse changes in economic conditions and circumstances are more likely to have an adverse impact on mortgage-related securities secured by loans on commercial properties than on those secured by loans on residential properties. In addition, commercial lending generally is viewed as exposing the lender to a greater risk of loss than one- to four- family residential lending. Commercial lending, for example, typically involves larger loans to single borrowers or groups of related borrowers than residential one- to four- family mortgage loans. In addition, the repayment of loans secured by income producing properties typically is dependent upon the successful operation of the related real estate project and the cash flow generated therefrom.

The exercise of remedies and successful realization of liquidation proceeds relating to CMBS is also highly dependent on the performance of the servicer or special servicer. In many cases, overall control over the special servicing of related underlying mortgage loans will be held by a "directing certificateholder" or a "controlling class representative," which is appointed by the holders of the most subordinate class of CMBS in such series. The Fund may not have the right to appoint the directing certificateholder. In connection with the servicing of the specially serviced mortgage loans, the related special servicer may, at the direction of the directing certificateholder, take actions with respect to the specially serviced mortgage loans that could adversely affect the Fund's interests. There may be a limited number of special servicers available, particularly those that do not have conflicts of interest.

The Subadviser will value the Fund's potential CMBS investments based on loss-adjusted yields, taking into account estimated future losses on the mortgage loans included in the securitization's pool of loans, and the estimated impact of these losses on expected future cash flows. The Subadviser's loss estimates may not prove accurate, as actual results may vary from estimates. In the event that the Subadviser overestimates the pool level losses relative to the price the Fund pays for a particular CMBS investment, the Fund may experience losses with respect to such investment.

Interest Rate Risk Associated with Non-Agency RMBS and CMBS

The rate of interest payable on certain non-agency RMBS and CMBS may be set or effectively capped at the weighted average net coupon of the underlying mortgage loans themselves, often referred to as an "available funds cap." As a result of this cap, the return to the holder of such non-agency RMBS and CMBS is dependent on the relative timing and rate of delinquencies and prepayments of mortgage loans bearing a higher rate of interest. In general, early prepayments will have a greater negative impact on the yield to the holder of such non-agency RMBS and CMBS.

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The value of fixed rate debt securities can be expected to vary inversely with changes in prevailing interest rates. Fixed rate debt securities with longer maturities, which tend to produce higher yields, are subject to potentially greater capital appreciation and depreciation than securities with shorter maturities. The Master Fund is not restricted to any maximum or minimum time to maturity in purchasing PPIP Eligible Assets subject to the restrictions imposed by PPIP if applicable, and the average maturity of the assets of the Master Fund may vary.

Structural Risks Associated with Non-Agency RMBS and CMBS

Because non-agency RMBS generally are ownership or participation interests in pools of mortgage loans secured by a pool of one- to four-family residential properties underlying the mortgage loan pool, the non-agency RMBS are entitled to payments provided for in the underlying agreement only when and if funds are generated by the underlying mortgage loan pool. This likelihood of the return of interest and principal may be assessed as a credit matter. However, the holders of non-agency RMBS do not have the legal status of secured creditors, and cannot accelerate a claim for payment on their securities, or force a sale of the mortgage loan pool in the event that insufficient funds exist to pay such amounts on any date designated for such payment. The holders of non-agency RMBS do not typically have any right to remove a servicer solely as a result of a failure of the mortgage pool to perform as expected. A similar risk is associated with CMBS.

Subordination Risk Associated with Non-Agency RMBS and CMBS

The non-agency RMBS and CMBS may be subordinated to one or more other senior classes of securities of the same series for purposes of, among other things, offsetting losses and other shortfalls with respect to the related underlying mortgage loans. For example, in the case of certain non-agency RMBS and CMBS, no distributions of principal will generally be made with respect to any class until the aggregate principal balances of the corresponding senior classes of securities have been reduced to zero. As a result, non-agency RMBS and CMBS may be more sensitive to risk of loss, writedowns, the non-fulfillment of repurchase obligations, overadvancing on a pool of loans and the costs of transferring servicing than senior classes of securities.

Credit Risk

Credit risk is the risk that one or more MBS or other securities in the Fund's portfolio will decline in price, or the issuer thereof will fail to pay interest or principal when due, because the issuer experiences a decline in its financial status. Credit risk is increased when a portfolio security is downgraded or the perceived creditworthiness of the issuer deteriorates. In general, lower-rated securities carry a greater degree of risk that the issuer will lose its ability to make interest and principal payments, which could have a negative impact on the Fund's net asset value or dividends and on the market price of the Common Stock. Ratings may not accurately reflect the actual credit risk associated with a security. If a security satisfies the rating requirements described above at the time of investment and is subsequently downgraded below that rating, the Fund will not be required to dispose of the security. If a downgrade occurs, LMPFA and the Subadviser will consider what action, including the sale of the security, is in the best interests of the Fund and its stockholders. There can be no assurance that any action that may be taken by LMPFA or the Subadviser will be implemented in a timely manner or that such actions will preserve the value of your investment in the Fund. Securities of below investment grade quality, commonly referred to as junk bonds, are regarded as having predominately speculative characteristics with respect to the issuer's capacity to pay interest and repay principal when due, and are more susceptible to default or decline in market value due to adverse economic and business developments than investment grade securities. Also, to the extent that the rating assigned to a security in the Fund's portfolio is downgraded by any NRSRO, the market price and liquidity of such security may be adversely affected. The market values for securities of below investment grade quality tend to be volatile, and these securities are less liquid than investment grade securities, potentially making them difficult to value. Issuers of below investment grade securities are more vulnerable to financial setbacks and recession than more creditworthy issuers, which may impair their ability to make interest and principal payments. It is likely that the current economic recession may severely disrupt the market for such securities and have an adverse impact on the value of such securities. In addition, it is likely that continued economic deterioration may adversely affect the ability of such issuers to repay principal and pay interest on these securities and increase the incidence of default for such securities. For these reasons, an investment in the Fund, compared with a portfolio consisting solely of investment grade securities, may experience the following:

•   increased price sensitivity resulting from a deteriorating economic environment and changing interest rates;

•   greater risk of loss due to default or declining credit quality;

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•   adverse issuer specific events that are more likely to render the issuer unable to make interest and/or principal payments; and

•   the possibility that a negative perception of the below investment grade market develops, resulting in the price and liquidity of below investment grade securities becoming depressed, and this negative perception could last for a significant period of time.

Adverse changes in economic conditions are more likely to lead to a weakened capacity of a below investment grade issuer to make principal payments and interest payments compared to an investment grade issuer. The principal amount of below investment grade securities outstanding has proliferated in the past decade as an increasing number of issuers have used below investment grade securities for financing. The current economic downturn may severely affect the ability of highly leveraged issuers to service their debt obligations or to repay their obligations upon maturity. If the current economic downturn continues or worsens, or in the event interest rates rise sharply, increasing the interest cost on variable rate instruments and negatively impacting economic activity, the number of defaults by below investment grade issuers is likely to increase. Similarly, down-turns in profitability in specific industries could adversely affect private activity bonds. The market values of lower quality debt securities tend to reflect the individual circumstances of the issuer to a greater extent than do higher quality securities, which react primarily to fluctuations in the general level of interest rates. Factors having an adverse impact on the market value of lower quality securities may have an adverse impact on the Fund's net asset value and the market value of its Common Stock. In addition, the Fund may incur additional expenses to the extent it is required to seek recovery upon a default in payment of principal or interest on its portfolio holdings. In certain circumstances, the Fund may be required to foreclose on an issuer's assets and take possession of its property or operations. In such circumstances, the Fund would incur additional costs in disposing of such assets and potential liabilities from operating any business acquired.

The secondary market for below investment grade securities may not be as liquid as the secondary market for more highly rated securities, a factor that may have an adverse effect on the Fund's ability to dispose of a particular security. There are fewer dealers in the market for below investment grade securities than in the market for investment grade securities. The prices quoted by different dealers for below investment grade securities may vary significantly, and the spread between the bid and ask price is generally much larger for below investment grade securities than for higher quality instruments. Under adverse market or economic conditions, the secondary market for below investment grade securities could contract further, independent of any specific adverse changes in the condition of a particular issuer, and these instruments may become illiquid. As a result, the Fund could find it more difficult to sell these securities or may be able to sell the securities only at prices lower than if such securities were widely traded. Prices realized upon the sale of such lower rated or unrated securities, under such circumstances, may be less than the prices used in calculating the Fund's net asset value.

Issuers of below investment grade securities are highly leveraged and may not have available to them more traditional methods of financing. Therefore, the risk associated with acquiring the securities of such issuers generally is greater than is the case with higher rated securities. For example, during an economic downturn or a sustained period of rising interest rates, highly leveraged issuers of below investment grade securities may experience financial stress. During such periods, such issuers may not have sufficient revenues to meet their interest payment obligations. An issuer's ability to service its debt obligations also may be adversely affected by adverse developments in its business or affairs, the issuer's inability to meet specific projected forecasts or the unavailability of additional financing. The risk of loss from default by the issuer is significantly greater for the holders of below investment grade securities because such securities are generally unsecured and are often subordinated to other creditors of the issuer. Prices and yields of below investment grade securities will fluctuate over time and, during periods of economic uncertainty, volatility of below investment grade securities may adversely affect the Fund's net asset value. In addition, investments in below investment grade zero coupon bonds rather than income-bearing below investment grade securities, may be more speculative and may be subject to greater fluctuations in value due to changes in interest rates.

Investments in lower rated or unrated securities may present special tax issues for the Fund to the extent that the issuers of these securities default on their obligations pertaining thereto, and the federal income tax consequences to the Fund as a holder of such securities may not be clear.

Interest Rate Risk

Interest rate risk is the risk that the debt securities in the Fund's portfolio will decline in value because of increases in market interest rates. As interest rates decline, issuers of securities may prepay principal earlier than scheduled, forcing the Fund to reinvest in lower-yielding securities and potentially reducing the Fund's income.

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As interest rates increase, slower than expected principal payments may extend the average life of securities, potentially locking in a below-market interest rate and reducing the Fund's value. In typical market interest rate environments, the prices of longer-term debt securities generally fluctuate more than the prices of shorter-term debt securities as interest rates change. To the extent the Fund invests in debt securities that may be prepaid at the option of the obligor, the sensitivity of such securities to changes in interest rates may increase (to the detriment of the Fund) when interest rates rise. Interest rates are currently low relative to historic levels. Moreover, because rates on certain floating rate debt securities in which the Fund may invest typically reset only periodically, changes in prevailing interest rates (and particularly sudden and significant changes) can be expected to cause some fluctuations in the Fund's net asset value. The Fund may utilize certain strategies, including taking positions in futures or interest rate swaps, for the purpose of reducing the interest rate sensitivity of the Fund's debt securities and decreasing the Fund's exposure to interest rate risk. The Fund is not required to hedge its exposure to interest rate risk and may choose not to do so. In addition, there is no assurance that any attempts by the Fund to reduce interest rate risk will be successful.

An increase in the interest payments on the Fund's borrowings relative to the interest it earns on its investment securities may adversely affect the Fund's profitability. The Fund earns money based upon the spread between the interest payments it earns on its investment securities and the interest payments it must make on its borrowings.

The Fund relies primarily on short-term borrowings to acquire investment securities with long-term maturities. Accordingly, if short-term interest rates increase, this may adversely affect its profitability. Some of the investment securities the Fund may acquire are adjustable-rate securities. This means that their interest rates may vary over time based upon changes in an objective index, such as:

•    LIBOR. The interest rate that banks in London offer for deposits in London of U.S. dollars.

•    Treasury Rate. A monthly or weekly average yield of benchmark Treasury securities, as published by the Board of Governors of the United States Federal Reserve.

•    CD Rate. The weekly average of secondary market interest rates on six-month negotiable certificates of deposit, as published by the Board of Governors of the United States Federal Reserve.

These indices generally reflect short-term interest rates.

The interest rates on the Fund's borrowings similarly vary with changes in an objective index. Nevertheless, the interest rates on the Fund's borrowings generally adjust more frequently than the interest rates on its adjustable-rate investment securities. In a period of rising interest rates, the Fund could experience a decrease in net income or a net loss because the interest rates on its borrowings adjust faster than the interest rates on its adjustable-rate investment securities.

In a period of rising interest rates, the Fund's interest and dividend payments could increase while the interest it earns on its fixed-rate MBS would not change. This would adversely affect the Fund's profitability.

Rising interest rates generally reduce the demand for mortgage loans due to the higher cost of borrowing. A reduction in the volume of mortgage loans originated may affect the volume of target assets available to the Fund, which could adversely affect the Fund's ability to acquire assets that satisfy its investment objectives. Rising interest rates may also cause target assets that were issued prior to an interest rate increase to provide yields that are below prevailing market interest rates. If rising interest rates cause the Fund to be unable to acquire a sufficient volume of target assets with a yield that is above the Fund's borrowing cost, its ability to satisfy its investment objectives and to generate income and make distributions may be materially and adversely affected.

The relationship between short-term and longer-term interest rates is often referred to as the "yield curve." Ordinarily, short-term interest rates are lower than longer-term interest rates. If short-term interest rates rise disproportionately relative to longer-term interest rates (a flattening of the yield curve), the Fund's borrowing costs may increase more rapidly than the interest income earned on the Fund's assets. Because the Fund expects that its investments, on average, generally will bear interest based on longer-term rates than its borrowings, a flattening of the yield curve would tend to decrease the Fund's net income and the market value of its net assets. Additionally, to the extent cash flows from investments that return scheduled and unscheduled principal are reinvested, the spread between the yields on the new investments and available borrowing rates may decline, which would likely decrease the Fund's net income. It is also possible that short-term interest rates may exceed longer-term interest rates (a yield curve inversion) in which event the Fund's borrowing costs may exceed its interest income and the Fund could incur operating losses.

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Leverage Risk

The Fund may seek to enhance the level of its current distributions to holders of Common Stock through the use of leverage. The Fund may use leverage directly at the Fund level or have exposure to leverage indirectly through its investment in the leveraged Master Fund. While such implicit leverage will not constitute actual borrowing of the Fund for purposes of the 1940 Act, to seek to mitigate the overall risk of leverage, the Fund does not intend to incur additional direct leverage at the Fund level to the extent that its existing direct leverage at the Fund level and its implicit leverage through its investment in the Master Fund exceeds 33 ¹ / ₃ % of the Fund's Managed Assets immediately after such Borrowings and/or issuances of Preferred Stock at the Fund level.

The Fund also may establish a standby credit facility in an amount up to 5 % of Managed Assets as a temporary measure for purposes of making distributions to stockholders in order to maintain its favorable tax status as a regulated investment company. In addition, the Fund may borrow for temporary, emergency or other purposes as permitted under the 1940 Act. Any such indebtedness would be in addition to the combined direct and implicit leverage ratio of up to 33 ¹ / ₃ % of the Fund's Managed Assets.

The Fund will pay (and Common Stockholders will bear) any costs and expenses relating to the use of leverage by the Fund and by the Master Fund, to the extent the Fund bears such costs, which will result in a reduction in the net asset value of the Common Stock.

Leverage may result in greater volatility of the net asset value and market price of, and distributions on, the Common Stock because changes in the value of the Fund's portfolio investments, including investments purchased with the proceeds from Borrowings or the issuance of Preferred Stock, if any, are borne entirely by Common Stockholders. Common Stock income may fall if the interest rate on Borrowings or the dividend rate on Preferred Stock rises, and may fluctuate as the interest rate on Borrowings or the dividend rate on Preferred Stock varies. So long as the Fund is able to realize a higher net return on its investment portfolio than the then-current cost of any leverage together with other related expenses, the effect of the leverage will be to cause Common Stockholders to realize higher current net investment income than if the Fund were not so leveraged. On the other hand, the Fund's use of leverage will result in increased operating costs. Thus, to the extent that the then-current cost of any leverage, together with other related expenses, approaches the net return on the Fund's investment portfolio, the benefit of leverage to Common Stockholders will be reduced, and if the then-current cost of any leverage together with related expenses were to exceed the net return on the Fund's portfolio, the Fund's leveraged capital structure would result in a lower rate of return to Common Stockholders than if the Fund were not so leveraged. There can be no assurance that the Fund's leveraging strategy will be successful.

During periods when the Fund is using leverage through Borrowings or the issuance of Preferred Stock, or has implicit leverage through its indirect investment in the Master Fund by reason of the Master Fund's use of the Treasury Debt Financing or other leverage, the fees paid to LMPFA, the Subadviser, the Allocation Subadviser and Western Asset Limited for advisory services will be higher than if the Fund did not use leverage because the fees paid will be calculated on the basis of the Fund's Managed Assets, which includes the amount of Borrowings and any assets attributable to Preferred Stock, as well as implicit leverage attributable to the Fund's indirect investment in the Master Fund. This means that LMPFA, the Subadviser, the Allocation Subadviser and Western Asset Limited may have a financial incentive to increase the Fund's use of leverage.

Any decline in the net asset value of the Fund will be borne entirely by Common Stockholders. Therefore, if the market value of the Fund's portfolio declines, the Fund's use of leverage will result in a greater decrease in net asset value to Common Stockholders than if the Fund were not leveraged. Such greater net asset value decrease will also tend to cause a greater decline in the market price for the Common Stock.

Certain types of Borrowings may result in the Fund being subject to covenants in credit agreements relating to asset coverage or portfolio composition or otherwise. In addition, the terms of the credit agreements may also require that the Fund pledge some or all of its assets as collateral. In addition, the Fund may be subject to certain restrictions imposed by guidelines of one or more rating agencies which may issue ratings for commercial paper or notes issued by the Fund. Such restrictions may be more stringent than those imposed by the 1940 Act.

The current weakness in the financial markets, the residential and commercial mortgage markets and the economy could adversely affect one or more of the Fund's potential lenders and could cause one or more of the Fund's potential lenders to be unwilling or unable to provide the Fund with financing or to increase the costs of that financing. Current market conditions have affected different types of financing for mortgage-related assets to varying degrees, with some sources generally being unavailable, others being available but at a higher cost, while others are largely unaffected. For example, in the repurchase agreement market, non-agency RMBS have

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been more difficult to finance than agency RMBS. Repurchase agreement counterparties have generally increased haircuts, which are the percentages that represent how much the amount of the loan is less than the value of the collateral securing the loan. Repurchase agreement counterparties have taken these steps in order to compensate themselves for a perceived increased risk due to the illiquidity of the underlying collateral. In some cases, margin calls have forced borrowers to liquidate collateral in order to meet the capital requirements of these margin calls, resulting in losses.

The return on the Fund's assets and cash available for distribution to Common Stockholders may be reduced to the extent that market conditions prevent the Fund from leveraging assets or cause the cost of the Fund's financing to increase relative to the income that can be derived from the assets acquired. The Fund's financing costs will reduce cash available for distributions to Common Stockholders. The Fund may not be able to meet its financing obligations and, to the extent that it cannot, it risks the loss of some or all of its assets to liquidation or sale to satisfy the obligations under its repurchase agreements. A decrease in the value of these assets may lead to margin calls which the Fund will have to satisfy. The Fund may not have the funds available to satisfy any such margin calls and may be forced to sell assets at significantly depressed prices due to market conditions or otherwise, which may result in losses. The satisfaction of such margin calls may reduce cash flow available for distribution to Common Stockholders. Any reduction in distributions to Common Stockholders may cause the value of the Fund's Common Stock to decline.

ABS Risk

The Fund may invest up to 20 % of its Managed Assets in non-mortgage related ABS. Investing in ABS entails various risks, including credit risks, liquidity risks, interest rate risks, market risks and legal risks. Credit risk is an important issue in ABS because of the significant credit risks inherent in the underlying collateral and because issuers are primarily private entities. The structure of an ABS and the terms of the investors' interest in the collateral can vary widely depending on the type of collateral, the desires of investors and the use of credit enhancements. Although the basic elements of all ABS are similar, individual transactions can differ markedly in both structure and execution. Important determinants of the risk associated with issuing or holding the securities include the process by which principal and interest payments are allocated and distributed to investors, how credit losses affect the issuing vehicle and the return to investors in such ABS, whether collateral represents a fixed set of specific assets or accounts, whether the underlying collateral assets are revolving or closed-end, under what terms (including the maturity of the ABS itself) any remaining balance in the accounts may revert to the issuing entity and the extent to which the entity that is the actual source of the collateral assets is obligated to provide support to the issuing vehicle or to the investors in such ABS. The Fund may invest in ABS that are subordinate in right of payment and rank junior to other securities that are secured by or represent an ownership interest in the same pool of assets. In addition, many of the transactions in which such securities are issued have structural features that divert payments of interest and/or principal to more senior classes when the delinquency or loss experience of the pool exceeds certain levels. As a result, such securities have a higher risk of loss as a result of delinquencies or losses on the underlying assets.

Below Investment Grade ("High Yield" or "Junk") Securities Risk

A significant portion of the Fund's portfolio (including both direct and indirect investments) may consist of below investment grade securities. The Fund will invest a substantial portion of its assets in MBS that were originally rated AAA, but subsequently have been downgraded to below investment grade. As a result of being downgraded to below investment grade, these assets will be regarded as predominately speculative with respect to the issuer's capacity to pay interest and repay principal. Lower grade securities may be particularly susceptible to economic downturns. It is likely that the current economic recession could further disrupt the market for such securities and may have an adverse impact on the value of such securities. In addition, it is likely that any such economic downturn could adversely affect the ability of the issuers of such securities to repay principal and pay interest thereon and increase the incidence of default for such securities.

Lower grade securities, though high yielding, are characterized by high risk. They may be subject to certain risks with respect to the issuing entity and to greater market fluctuations than certain lower yielding, higher rated securities. The retail secondary market for lower grade securities may be less liquid than that for higher rated securities. Adverse conditions could make it difficult at times to sell certain securities or could result in lower prices than those used in calculating the Fund's net asset value. Because of the substantial risks associated with investments in lower grade securities, you could lose money on your investment in Common Stock, both in the short-term and the long-term.

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Distressed Investments

The Fund will invest in distressed securities, which are securities and obligations of companies that are experiencing financial or business difficulties. Distressed investments may result in significant returns to the Fund, but also involve a substantial degree of risk. Among the risks inherent in distressed situations is the fact that it frequently may be difficult to obtain information as to the true condition of the securities being purchased. The market prices of distressed securities are also subject to abrupt and erratic market movements and above average price volatility, and the spread between the bid and asked prices of such securities may be greater than normally experienced. Certain categories of PPIP Eligible Assets have been referred to by the financial media as "toxic assets." If the market continues to view such assets as impaired over the life of the Fund, the Fund may not be able to dispose of such assets or dispose of them at a good return.

The Fund intends to invest in distressed investments including non-performing and sub-performing RMBS and CMBS, many of which are not publicly traded and which may involve a substantial degree of risk. In certain periods, there may be little or no liquidity in the markets for these securities or instruments. In addition, the prices of such securities or instruments may be subject to periods of abrupt and erratic market movements and above-average price volatility. It may be more difficult to value such securities and the spread between the bid and asked prices of such securities may be greater than normally expected. If the Subadviser's evaluation of the risks and anticipated outcome of an investment in a distressed security should prove incorrect, the Fund may lose a substantial portion or all of its investment.

Furthermore, investments in assets operating in workout modes or under Chapter 11 of the United States Bankruptcy Code, as amended, and other comparable bankruptcy laws may, in certain circumstances, be subject to certain additional potential liabilities that may exceed the value of the Fund's original investment. For example, under certain circumstances, lenders who have inappropriately exercised control of the management and policies of a debtor may have their claims subordinated or disallowed or counterclaims may be filed and lenders may be found liable for damages suffered by various parties as a result of such actions. In addition, under certain circumstances, payments to the Fund and distributions by the Fund to its investors may be reclaimed if any such payment or distribution is later determined to have been a fraudulent conveyance or a preferential payment.

Up to 10 % of the loans and other assets underlying any PPIP Eligible Asset may be situated outside the United States. Such investments are subject to additional risks and uncertainties related to litigation, bankruptcy, and other laws and regulations affecting the rights and remedies of the Fund with respect to these assets that can create additional financial risks to the Fund.

The Fund is not limited in its ability to invest in distressed investments.

Credit Risk Associated with Originators and Servicers of Residential and Commercial Mortgage Loans

A number of originators and servicers of residential and commercial mortgage loans, including some of the largest originators and servicers in the residential and commercial mortgage loan market, have experienced serious financial difficulties, including some that are now subject to federal insolvency proceedings. These difficulties have resulted from many factors, including increased competition among originators for borrowers, decreased originations by such originators of mortgage loans and increased delinquencies and defaults on such mortgage loans, as well as from increases in claims for repurchases of mortgage loans previously sold by them under agreements that require repurchase in the event of breaches of representations regarding loan quality and characteristics. Such difficulties may affect the performance of non-agency RMBS and CMBS backed by mortgage loans. Furthermore, the inability of the originator to repurchase such mortgage loans in the event of loan representation breaches or the servicer to repurchase such mortgage loans upon a breach of its servicing obligations also may affect the performance of related non-agency RMBS and CMBS. Delinquencies and losses on, and, in some cases, claims for repurchase by the originator of, mortgage loans originated by some mortgage lenders have recently increased as a result of inadequate underwriting procedures and policies, including inadequate due diligence, failure to comply with predatory and other lending laws and, particularly in the case of any "no documentation" or "limited documentation" mortgage loans that may support non-agency RMBS, inadequate verification of income and employment history. Delinquencies and losses on, and claims for repurchase of, mortgage loans originated by some mortgage lenders have also resulted from fraudulent activities of borrowers, lenders, appraisers, and other residential mortgage industry participants such as mortgage brokers, including misstatements of income and employment history, identity theft and overstatements of the appraised value of mortgaged properties. Many of these originators and servicers are very highly leveraged. These difficulties may also increase the chances that these entities may default on their warehousing or other credit

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lines or become insolvent or bankrupt and thereby increase the likelihood that repurchase obligations will not be fulfilled and the potential for loss to holders of non-agency RMBS, CMBS and subordinated security holders.

The servicers of non-agency RMBS and CMBS are often the same entities as, or affiliates of, the originators of these mortgage loans. Accordingly, the financial risks relating to originators of non-agency RMBS and CMBS described immediately above also may affect the servicing of non-agency RMBS and CMBS. In the case of such servicers, and other servicers, financial difficulties may have a negative effect on the ability of servicers to pursue collection on mortgage loans that are experiencing increased delinquencies and defaults and to maximize recoveries on sale of underlying properties following foreclosure.

Non-agency RMBS and CMBS typically provide that the servicer is required to make advances in respect of delinquent mortgage loans. However, servicers experiencing financial difficulties may not be able to perform these obligations or obligations that they may have to other parties of transactions involving these securities. Like originators, these entities are typically very highly leveraged. Such difficulties may cause servicers to default under their financing arrangements. In certain cases, such entities may be forced to seek bankruptcy protection. Due to the application of the provisions of bankruptcy law, servicers who have sought bankruptcy protection may not be required to advance such amounts. Even if a servicer were able to advance amounts in respect of delinquent mortgage loans, its obligation to make such advances may be limited to the extent that it does not expect to recover such advances due to the deteriorating credit of the delinquent mortgage loans or declining value of the related mortgaged properties. Moreover, servicers may overadvance against a particular mortgage loan or charge too many costs of resolution or foreclosure of a mortgage loan to a securitization, which could increase the potential losses to holders of non-agency RMBS and CMBS. In such transactions, a servicer's obligation to make such advances may also be limited to the amount of its servicing fee. In addition, if an issue of non-agency RMBS and CMBS provides for interest on advances made by the servicer, in the event that foreclosure proceeds or payments by borrowers are not sufficient to cover such interest, such interest will be paid to the servicer from available collections or other mortgage income, thereby reducing distributions made on the non-agency RMBS and CMBS and, in the case of senior-subordinated non-agency RMBS and CMBS described below, first from distributions that would otherwise be made on the most subordinated non-agency RMBS and CMBS of such issue. Any such financial difficulties may increase the possibility of a servicer termination and the need for a transfer of servicing and any such liabilities or inability to assess such liabilities may increase the difficulties and costs in affecting such transfer and the potential loss, through the allocation of such increased cost of such transfer, to subordinated security holders.

There can be no assurance that originators and servicers of mortgage loans will not continue to experience serious financial difficulties or experience such difficulties in the future, including becoming subject to bankruptcy or insolvency proceedings, or that underwriting procedures and policies and protections against fraud will be sufficient in the future to prevent such financial difficulties or significant levels of default or delinquency on mortgage loans. Because the recent financial difficulties experienced by such originators and services is unprecedented and unpredictable, the past performance of the residential and commercial mortgage loans originated and serviced by them (and the corresponding performance of the related non-agency RMBS and CMBS) is not a reliable indicator of the future performance of such residential mortgage loans (or the related non-agency RMBS and CMBS).

Subprime Mortgage Market Risk

The residential mortgage market in the United States recently has experienced difficulties that may adversely affect the performance and market value of certain mortgages and mortgage-related securities. Delinquencies and losses on residential mortgage loans (especially subprime and second-line mortgage loans) generally have increased recently and may continue to increase, and a decline in or flattening of housing values (as has recently been experienced and may continue to be experienced in many housing markets) may exacerbate such delinquencies and losses. Borrowers with adjustable rate mortgage loans are more sensitive to changes in interest rates, which affect their monthly mortgage payments, and may be unable to secure replacement mortgages at comparably low interest rates. Also, a number of residential mortgage loan originators have recently experienced serious financial difficulties or bankruptcy. Largely due to the foregoing, reduced investor demand for mortgage loans and mortgage-related securities and increased investor yield requirements have caused limited liquidity in the secondary market for mortgage-related securities, which can adversely affect the market value of mortgage-related securities. It is possible that such limited liquidity in such secondary markets could continue or worsen.

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Certain categories of PPIP Eligible Assets, such as RMBS involving adjustable rate mortgages offering different payment options ("Option ARM RMBS") and certain RMBS involving mortgages made with borrowers with limited credit history or made with limited documentation ("Subprime RMBS"), have been referred to by the financial media as "toxic assets." The Fund intends to invest in Option ARM RMBS and select Subprime RMBS.

The Fund may acquire non-agency RMBS backed by collateral pools of mortgage loans that have been originated using underwriting standards that are less restrictive than those used in underwriting "prime mortgage loans" and "Alt-A mortgage loans." These lower standards include mortgage loans made to borrowers having imperfect or impaired credit histories, mortgage loans where the amount of the loan at origination is 80 % or more of the value of the mortgage property, mortgage loans made to borrowers with low credit scores, mortgage loans made to borrowers who have other debt that represents a large portion of their income and mortgage loans made to borrowers whose income is not required to be disclosed or verified. Due to economic conditions, including increased interest rates and lower home prices, as well as aggressive lending practices, subprime mortgage loans have in recent periods experienced increased rates of delinquency, foreclosure, bankruptcy and loss, and they are likely to continue to experience delinquency, foreclosure, bankruptcy and loss rates that are higher, and that may be substantially higher, than those experienced by mortgage loans underwritten in a more traditional manner. Thus, because of the higher delinquency rates and losses associated with subprime mortgage loans, the performance of non-agency RMBS backed by subprime mortgage loans that the Fund may acquire could be correspondingly adversely affected, which could adversely impact the Fund's results of operations, financial condition and business.

If the economy of the United States further deteriorates, the incidence of mortgage foreclosures, especially subprime mortgages, may continue to increase, which may adversely affect the value of any MBS owned by the Fund. The U.S. Congress and various government regulatory authorities have discussed the possibility of restructuring mortgages and imposing forbearance requirements on defaulted mortgages. Neither LMPFA nor the Subadviser can predict the form any such modifications, forbearance or related regulations might take, and these regulations may adversely affect the value of MBS owned by the Fund.

Tax Risks

To qualify for the favorable U.S. federal income tax treatment generally accorded to regulated investment companies, among other things, the Fund must derive in each taxable year at least 90 % of its gross income from certain prescribed sources and satisfy certain distribution and asset diversification requirements. If for any taxable year the Fund does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) would be subject to tax at regular corporate rates without any deduction for distributions to stockholders, and such distributions would be taxable as ordinary dividends to the extent of the Fund's current and accumulated earnings and profits.

Risk of Taxable Income in Excess of Economic Income. The Fund expects to acquire debt instruments in the secondary market for less than their stated redemption price at maturity. The discount at which such debt instruments are acquired may reflect doubts about their ultimate collectability rather than current market interest rates. The amount of such discount will nevertheless generally be treated as "market discount" for U.S. federal income tax purposes. Market discount on a debt instrument accrues ratably on a daily basis, unless an election is made to accrue market discount on the basis of the constant yield to maturity of the debt instrument, based generally on the assumption that all future payments on the debt instrument will be made. Absent an election to accrue currently, accrued market discount is reported as income when, and to the extent that, any payment of principal of the debt instrument is made. Payments on residential mortgage loans are ordinarily made monthly, and include both principal and interest, and consequently accrued market discount may have to be included in income each month as if the debt instrument were assured of ultimately being collected in full.

Similarly, many of the debt instruments (including MBS) that the Fund purchases will likely have been issued with original issue discount ("OID"), which discount might reflect doubt as to whether the entire principal amount of such debt instruments will ultimately prove to be collectible. The Fund will be required to report such OID based on a constant yield method and income will be accrued and be currently taxable based on the assumption that all future projected payments due on such debt instruments will be made.

Finally, in the event that any debt instruments (including MBS) acquired by the Fund are delinquent as to mandatory principal and interest payments, or in the event payments with respect to a particular debt instrument are not made when due, the Fund may nonetheless be required to continue to recognize the unpaid interest as taxable income as it accrues, despite doubt as to its ultimate collectability. Similarly, the Fund may be required

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to accrue interest income with respect to subordinate MBS at its stated rate regardless of whether corresponding cash payments are received or are ultimately collectible.

Status as Regulated Investment Company. As described under the heading "Tax Matters" in the SAI, the Fund must satisfy, among other requirements, an asset diversification test in order to qualify as a regulated investment company under Subchapter M of the Code. Under that test, the Fund must diversify its holdings so that, at the end of each quarter of each taxable year, (i) at least 50 % of the value of the Fund's assets is represented by cash and cash items (including receivables), U.S. government securities, the securities of other regulated investment companies and other securities, with such other securities of any one issuer limited for the purposes of this calculation to an amount not greater than 5 % of the value of the Fund's total assets and not greater than 10 % of the outstanding voting securities of such issuer, and (ii) not more than 25 % of the value of its total assets is invested in the securities (other than U.S. government securities or the securities of other regulated investment companies) of a single issuer, or two or more issuers that the Fund controls and are engaged in the same, similar or related trades or businesses, or the securities of one or more qualified publicly traded partnerships.

In applying the asset diversification test described in the preceding sentence, the Fund will look through to the assets of the Master Fund, relying in part on an opinion from Simpson Thacher & Bartlett LLP that for purposes of Section 851(b)(3) of the Code, the Fund should be treated as though it directly invested in the assets held by the Master Fund. The opinion is based on analogous provisions in the tax law, on general principles of partnership taxation, and on the purpose and intention of the tax laws governing regulated investment companies. While it reflects the administrative practice of the IRS in rulings that have been issued to other taxpayers and in generally applicable revenue procedures, such administrative interpretations do not constitute official precedent. The opinion notes that there is no specific authority directly on point dealing with the application of Code Section 851(b)(3) to partnership interests held by regulated investment companies and it states that there can be no assurance that the IRS will not successfully challenge the conclusions therein.

If the Fund fails to satisfy as of the close of any quarter the asset diversification test referred to in the preceding paragraphs, it will have 30 days to cure the failure by, for example, selling securities that are the source of the violation. However, because the Feeder Fund may effect withdrawals from the Master Fund only upon written consent of the Treasury, and the Fund may effect withdrawals from the Feeder Fund only upon written consent of the General Partner, the Fund may not be able to withdraw its investment promptly after it has made a decision to do so. As a result, it will be more difficult for the Fund to cure a violation within the 30-day period.

If the Fund fails to cure a violation within 30 days, it may lose its status as a regulated investment company under the Code. In that case, all of its taxable income would be subject to U.S. federal income tax at regular corporate rates without any deduction for distributions to stockholders. In addition, all distributions (including distributions of net capital gain) would be taxed to the Fund's Common Stockholders as ordinary dividend income to the extent of the Fund's current and accumulated earnings and profits. Accordingly, disqualification as a regulated investment company could have a material adverse effect on the value of the Fund's Common Stock and the amount of Fund distributions.

Risks Associated with the Fund's Ability To Satisfy Regulated Investment Company Distribution Requirements. The Fund generally must distribute annually at least 90 % of its taxable income, excluding any net capital gain, in order to maintain its qualification as a regulated investment company for U.S. federal income tax purposes. To the extent that the Fund satisfies this distribution requirement, but distributes less than 100 % of its taxable income and net capital gain, the Fund will be subject to U.S. federal corporate income tax on the Fund's undistributed taxable income. In addition, the Fund will be subject to a 4 % nondeductible excise tax if the actual amount that the Fund distributes to its Common Stockholders in a calendar year is less than a minimum amount specified under U.S. federal income tax laws. The Fund intends to make distributions to its Common Stockholders to comply with the requirements of the Code and to avoid paying U.S. federal income taxes and, if practicable, excise taxes, on undistributed taxable income. However, differences in timing between the recognition of taxable income and the actual receipt of cash could require the Fund to sell assets (including Temporary Investments) or borrow funds on a short-term or long-term basis or issue cash-stock dividends (described below) to meet the distribution requirements of the Code.

The Fund may find it difficult or impossible to meet distribution requirements in certain circumstances. Due to the nature of the assets in which the Fund intends to invest, the Fund's taxable income may exceed the Fund's net income as determined based on GAAP because, for example, realized capital losses will be deducted in determining the Fund's GAAP net income but may not be deductible in computing the Fund's taxable income.

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In addition, the Fund may invest in assets, including debt instruments requiring the Fund to accrue OID, that generate taxable income (referred to as "phantom income") in excess of economic income or in advance of the corresponding cash flow from the assets. In addition, if the debt instruments provide for "payment-in-kind" or PIK interest, the Fund may recognize OID for federal income tax purposes. Moreover, the Fund may acquire distressed debt investments that are subsequently modified by agreement with the borrower. If the amendments to the outstanding debt are "significant modifications" under the applicable Treasury regulations, the modified debt may be considered to have been reissued to the Fund in a debt-for-debt exchange with the borrower. In that event, if the debt is considered to be "publicly traded" for federal income tax purposes, the modified debt in the hands of the Fund may be considered to have been issued with OID to the extent the fair-market value of the modified debt is less than the principal amount of the outstanding debt. Also, certain previously modified debt that the Fund acquires in the secondary market may be considered to have been issued with OID at the time it was modified. In general, the Fund will be required to accrue OID on a debt instrument as taxable income in accordance with applicable federal income tax rules even though no cash payments may be received on such debt instrument. In the event a borrower with respect to a particular debt instrument encounters financial difficulty rendering it unable to pay stated interest as due, the Fund may nonetheless be required to continue to recognize the unpaid interest as taxable income. Similarly, the Fund may be required to accrue interest income with respect to subordinate MBS at the stated rate regardless of when their corresponding cash payments are received. Further, the Fund may invest in assets that accrue market discount income, which may result in the recognition of taxable income in excess of the Fund's economic gain in certain situations or the deferral of a portion of the Fund's interest deduction paid on debt to incur such assets.

Due to each of these potential timing differences between income recognition or expense deduction and cash receipts or disbursements, there is a significant risk that the Fund may have substantial taxable income in excess of cash available for distribution. To satisfy its distribution requirements, the Fund may borrow on unfavorable terms or distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt. In addition, the Fund may make distributions in its Common Stock to satisfy the distribution requirements necessary to maintain the Fund's status as a regulated investment company for U.S. federal income tax purposes and to avoid U.S. federal income and excise taxes, but no assurances can be given in this regard. Moreover, if the Fund's only feasible alternative were to make a taxable distribution of the Fund's Common Stock to comply with the regulated investment company distribution requirements for any taxable year and the value of the Fund's Common Stock was not sufficient at such time to make a distribution to its Common Stockholders in an amount at least equal to the minimum amount required to comply with such regulated investment company distribution requirements, the Fund would generally fail to qualify as a regulated investment company for such taxable year.

Despite undertaking the efforts mentioned in the previous paragraph, the Fund may not be able to distribute the amounts necessary to satisfy the distribution requirements necessary to meet its regulated investment company status for U.S. federal income taxes and to avoid U.S. federal income and excise taxes. If the Fund were unable to satisfy the 90 % distribution requirement or otherwise were to fail to qualify as a regulated investment company in any year, material adverse tax consequences would result to investors. The Fund would be taxed in the same manner as an ordinary corporation and distributions to the Fund's Common Stockholders would not be deductible by the Fund in computing its taxable income. To qualify again to be taxed as a regulated investment company in a subsequent year, the Fund would be required to distribute to its Common Stockholders its earnings and profits attributable to non-regulated investment company years reduced by an interest charge on 50 % of such earnings and profits payable by the Fund to the IRS. In addition, if the Fund failed to qualify as a regulated investment company for a period greater than two taxable years, then the Fund would be required to elect to recognize and pay tax on any net built-in gain (the excess of aggregate gain, including items of income, over aggregate loss that would have been realized if the Fund had been liquidated) or, alternatively, be subject to taxation on such built-in gain recognized for a period of 10 years, in order to qualify as a regulated investment company in a subsequent year.

Finally, the Master Fund is required to satisfy certain asset coverage ratios according to the terms of financing provided to the Master Fund by the Treasury Debt Financing. If the Master Fund fails to satisfy those asset coverage ratios, it may not be able to make distributions to the Fund, which may adversely affect the Fund's ability to make cash distributions to its stockholders. See "—Risks Associated with Asset Coverage Requirements and Regulated Investment Company Distribution Requirements."

Risks Associated with Asset Coverage Requirements and Regulated Investment Company Distribution Requirements. The Master Fund must satisfy an asset coverage test before distributing its investment proceeds to its investors (including the Feeder Fund and, indirectly, the Fund), which may limit the Fund's ability to make

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cash distributions to its stockholders. During the term of any Treasury loan received through the PPIP, the Master Fund is subject to an asset coverage test calculated by dividing (a) the sum of the aggregate market value of all PPIP Eligible Assets and Temporary Investments held by the Master Fund, by (b) the sum of the outstanding principal amount of the Treasury Debt Financing and accrued and unpaid interest due thereon. If a Half Turn Election is in effect, the asset coverage test is satisfied if the asset coverage ratio is equal to or exceeds 225 % . If a Full Turn Election is in effect, the asset coverage test is satisfied if the asset coverage ratio is equal to or exceeds 150 % . In the event the Master Fund is unable, on any date of determination, to achieve the required asset coverage ratio, it is required to pay down the Treasury Debt Financing until such time as it achieves the required asset coverage ratio. The Master Fund cannot make distributions of its investment proceeds until it satisfies the asset coverage test. In addition, pursuant to the terms of the Treasury Debt Financing, the Master Fund is limited in the amount of distributions it can make if the asset coverage ratio falls below 200 % for a Full Turn Election and 300 % for a Half Turn Election. There can be no assurance that the Master Fund will achieve the required asset coverage ratio. The Fund's ability to satisfy the distribution requirements necessary to maintain the Fund's status as a regulated investment company for U.S. federal income tax purposes and to avoid U.S. federal income and excise taxes may be adversely affected by these debt pay down requirements. Commencing on the loan payment date occurring in January 2010 and continuing on each loan payment date thereafter, in the event the Master Fund achieves an asset coverage ratio of 200 % , it may make a distribution (after making certain other payments) to its investors (including the Feeder Fund) in an amount not to exceed in any 12-month period the lesser of (1) 8 % of its funded capital commitments, and (2) the cumulative net interest income of the Master Fund for the preceding 12-month period. If the Master Fund is restricted in its ability to make cash distributions to the Feeder Fund, the Fund may be unable to satisfy the cash distribution requirements for regulated investment company purposes. The Fund intends to hold MBS and other permitted investments directly and not through the Master Fund to endeavor to satisfy the distribution requirements necessary to maintain the Fund's status as a regulated investment company for U.S. federal income tax purposes and to avoid U.S. federal income and excise taxes, but no assurances can be given in this regard. Further, to satisfy its distribution requirements, the Fund may borrow on unfavorable terms or distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt. In addition, the Fund may make distribution in its Common Stock to satisfy the distribution requirements necessary to maintain the Fund's status as a regulated investment company for U.S. federal income tax purposes and to avoid U.S. federal income and excise taxes, but no assurances can be given in this regard.

Cash/Stock Dividend Risks. The Fund may distribute taxable dividends that are payable in cash and Common Stock at the election of each Common Stockholder. Under IRS Revenue Procedure 2010-12, up to 90 % of any such taxable dividend for any Fund taxable year ending on or before December 31, 2011 could be payable in the Fund's Common Stock with the 10 % or greater balance paid in cash. The IRS has also issued (and where Revenue Procedure 2010-12 is not currently applicable, the IRS continues to issue) private letter rulings on cash/stock dividends paid by regulated investment companies and real estate investment trusts using a 20 % cash standard (instead of the 10 % cash standard of Revenue Procedure 2010-12) if certain requirements are satisfied. While such private letter rulings are not official precedent, they may reveal the IRS's interpretation of the tax laws. Common Stockholders receiving such dividends will be required to include the full amount of the dividend as taxable income to the extent of the Fund's current and accumulated earnings and profits for federal income tax purposes. As a result, Common Stockholders may be required to pay federal income taxes with respect to such dividends in excess of the cash dividends received. If a U.S. Common Stockholder sells the Common Stock that it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of the Fund's Common Stock at the time of the sale. Furthermore, with respect to non-U.S. Common Stockholders, the Fund may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in Common Stock. In addition, if a significant number of the Fund's Common Stockholders determine to sell shares of the Fund's Common Stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of the Fund's Common Stock. It is unclear whether and to what extent the Fund will be able to pay taxable dividends in cash and Common Stock (whether pursuant to Revenue Procedure 2010-12 or otherwise).

Government Intervention in Financial Markets

The recent instability in the financial markets discussed above has led the U.S. government to take a number of unprecedented actions (including the creation of PPIP) designed to support certain financial institutions and segments of the financial markets that have experienced extreme volatility, and in some cases a lack of liquidity. Federal, state, and other governments, their regulatory agencies, or self-regulatory organizations

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may take actions that affect the regulation of the instruments in which the Fund invests, or the issuers of such instruments, in ways that are unforeseeable. Legislation or regulation may also change the way in which the Fund itself is regulated. Such legislation or regulation could limit or preclude the Fund's ability to achieve its investment objective.

Governments or their agencies may also acquire distressed assets from financial institutions and acquire ownership interests in those institutions. The implications of government ownership and disposition of these assets are unclear, and such a program may have positive or negative effects on the liquidity, valuation and performance of the Fund's portfolio holdings.

TARP and the Financial Stability Plan. On October 3, 2008, the U.S. Congress enacted EESA, which included TARP, a $700 billion program which permits the U.S. Secretary of the Treasury (the "Treasury Secretary") to buy certain troubled assets. Financial institutions eligible to participate in TARP include, but are not necessarily limited to, depository institutions, brokers and dealers and insurance companies that are established and regulated under U.S. laws and have significant operations in the U.S. The announced initial focus of EESA was commercial and residential mortgages and mortgage-related securities, however, the Treasury Secretary is authorized to purchase any other type of financial instrument if the Treasury Secretary determines that such purchase is necessary to promote financial market stability. In mid-November 2008, the Treasury Secretary announced revisions to TARP including a shifted focus towards strengthening financial institution balance sheets through direct purchases of equity in financial institutions rather than on purchasing troubled assets and additional changes may be made to TARP over time. Other governments may enact similar legislation. In early 2009, the Treasury Secretary announced the Financial Stability Plan ("FSP"), which is aimed at restoring stability to the American financial system. The implications of EESA, TARP and FSP, and of government ownership and disposition of assets and equity stakes, are unclear at this time, and such programs may have positive or negative effects on the liquidity, valuation and performance of the Fund's investments.

There can be no assurance that EESA, TARP, FSP, PPIP or other recent U.S. government, Federal Reserve, Treasury and other governmental and regulatory actions will have a beneficial impact on the financial markets, including on current extreme levels of volatility. To the extent the market does not respond favorably to these initiatives or these initiatives do not function as intended, the Fund may not receive the anticipated positive impact from the legislation. There can also be no assurance that the Fund will be eligible to participate in any programs established by the U.S. government or, if the Fund is eligible, that it will be able to utilize them successfully or at all. In addition, because the programs are designed, in part, to restart the market for certain of the Fund's target assets, the establishment of these programs may result in increased competition for attractive opportunities in target assets. It is also possible that the Fund's competitors may utilize the programs which would provide them with attractive debt and equity capital funding from the U.S. government. In addition, the U.S. government, the Federal Reserve, the Treasury and other governmental and regulatory bodies have taken or are considering taking other actions to address the financial crisis. The Fund cannot predict whether or when such actions may occur, and such actions could have a dramatic impact on its business, results of operations and financial condition.

Currency Risks

If the Fund invests directly in foreign (non-U.S.) currencies or in securities that trade in, and receive revenues in, foreign (non-U.S.) currencies, or in derivatives that provide exposure to foreign (non-U.S.) currencies, it will be subject to the risk that those currencies will decline in value relative to the U.S. dollar, or, in the case of hedging positions intended to protect the Fund from decline in the value of foreign (non-U.S.) currencies, that the U.S. dollar will decline in value relative to the currency being hedged. Currency rates in foreign countries may fluctuate significantly over short periods of time for a number of reasons, including changes in interest rates, intervention (or the failure to intervene) by U.S. or foreign governments, central banks or supranational entities such as the International Monetary Fund, or by the imposition of currency controls or other political developments in the United States or abroad. As a result, the Fund's investments in foreign currency denominated securities may reduce the returns of the Fund. While certain of the Fund's non-U.S. dollar-denominated securities may be hedged into U.S. dollars, hedging may not alleviate all currency risks. See "—Derivatives Risk."

Expedited Transactions

Investment analyses and decisions by LMPFA and the Subadviser may frequently be required to be undertaken on an expedited basis to take advantage of investment opportunities. In such cases, the information available to LMPFA or the Subadviser at the time of an investment decision may be limited, and LMPFA and the Subadviser may not have access to detailed information regarding the investment opportunity. Therefore, no

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assurance can be given that LMPFA or the Subadviser will have knowledge of all circumstances that may adversely affect an investment.

Extension Risk

Extension, or slower prepayments of the underlying mortgage loans, would extend the time it would take to receive cash flows and would generally compress the yield on non-agency RMBS and CMBS. Rising interest rates can cause the average maturity of the Fund to lengthen due to a drop in mortgage prepayments. This will increase both the sensitivity to rising interest rates and the potential for price declines of the Fund.

"Widening" Risk

The prices of non-agency RMBS or CMBS may decline substantially, for reasons that may not be attributable to any of the other risks described in this prospectus. In particular, purchasing assets at what may appear to be "undervalued" levels is no guarantee that these assets will not be trading at even more "undervalued" levels at a time of valuation or at the time of sale. It may not be possible to predict, or to protect against, such "spread widening" risk.

Management Risk

The Fund is subject to management risk because it is an actively managed portfolio. LMPFA, the Subadviser and Western Asset Limited may not be successful in selecting the best performing securities or investment techniques, and the Fund's performance may lag behind that of similar funds. LMPFA, the Subadviser and Western Asset Limited will apply investment techniques and risk analyses in making investment decisions for the Fund, but there can be no assurance that these will produce the desired results. The Fund will invest in MBS and other PPIP Eligible Assets that the portfolio management team believes are undervalued or mispriced as a result of recent economic events, such as market dislocations, an inability of other investors to evaluate risk and forced selling. If their valuation of a security is incorrect, a Common Stockholder's investment in the Fund may lose value.

Current Economic Conditions—Credit Crisis Liquidity and Volatility Risk

The markets for credit instruments, including MBS, have experienced periods of extreme illiquidity and volatility since the latter half of 2007. General market uncertainty and consequent repricing risk have led to market imbalances of sellers and buyers, which in turn have resulted in significant valuation uncertainties in a variety of MBS. These conditions resulted, and in many cases continue to result in, greater volatility, less liquidity, widening credit spreads and a lack of price transparency, with many MBS remaining illiquid and of uncertain value. These market conditions may make valuation of some of the Fund's MBS uncertain and/or result in sudden and significant valuation increases or declines in its holdings. A significant decline in the value of the Fund's portfolio would likely result in a significant decline in the value of your investment in Common Stock.

The debt and equity capital markets in the United States have been negatively impacted by significant write-offs in the financial services sector relating to subprime mortgages and the re-pricing of credit risk in the broadly syndicated market, among other things. These events, along with the deterioration of the housing market and the failure of major financial institutions, have led to worsening general economic conditions, which have materially and adversely impacted the broader financial and credit markets and have reduced the availability of debt and equity capital for the market as a whole and financial firms in particular. These developments may increase the volatility of the value of securities owned by the Fund and also may make it more difficult for the Fund to accurately value securities or to sell securities on a timely basis. These developments have adversely affected the broader economy, and may continue to do so, which in turn may adversely affect the ability of issuers of securities owned by the Fund to make payments of principal and interest when due, lead to lower credit ratings and increase defaults. Such developments could, in turn, reduce the value of securities owned by the Fund and adversely affect the net asset value of the Fund. In addition, the prolonged continuation or further deterioration of current market conditions could adversely impact the Fund's portfolio.

New Program Risk

PPIP is a recently-commenced program with a limited operating history. PPIP is without precedent and its effects are impossible to predict with certainty. Such uncertainties of the program may result in challenges for the Fund that make achievement of its investment objectives more difficult than would otherwise be the case with more established methods of investing and financing.

The risk factors described herein relating to PPIP and the Fund are based on information available from the Treasury as of the date of this prospectus. The Treasury and/or the U.S. Congress may change the terms of

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PPIP at any time and such changes may adversely affect the Fund and its ability to achieve its investment objectives and change the risks involved in participating in PPIP.

Investment Focus

The Fund intends to invest, both directly and indirectly in the Master Fund, a substantial portion of its assets in MBS, including leveraged PPIP Eligible Assets. As a result, the Fund will be affected to a greater degree by events affecting the MBS market, and more specifically, the markets for PPIP Eligible Assets, than if it invested in a broader array of securities, and such impact could be considerably greater than if it did not focus its investments to such an extent, particularly as a result of the leveraged nature of its investments. Such restrictions on the type of securities in which the Fund may invest may adversely affect the Fund's ability to achieve its investment objective.

The Fund is expected to employ a variety of proprietary risk analytics and risk management tools in connection with making and monitoring portfolio investments. Prospective investors should be aware that no risk management or portfolio analytics system is fail-safe, and no assurance can be given that risk frameworks employed by either LMPFA and/or the Subadviser (e.g., stop-win, stop-loss, Sharpe Ratios, loss limits, value-at-risk or any other methodology now known or later developed) will achieve their objectives and prevent or otherwise limit substantial losses. No assurance can be given that the risk management systems and techniques or pricing models will accurately predict future trading patterns or the manner in which investments are priced in financial markets in the future. In addition, certain risk management tools may rely on certain assumptions (e.g., historical interest rates, anticipated rate trends) and such assumptions may prove incorrect.

Competition for Investment Opportunities

Identifying, completing and realizing attractive portfolio investments is competitive and involves a high degree of uncertainty. The Fund's profitability depends, in large part, on its ability to acquire target assets at attractive prices. In acquiring its target assets, the Fund will compete with a variety of institutional investors, including specialty finance companies, public and private funds (including other funds managed by LMPFA or the Subadviser), commercial and investment banks, commercial finance and insurance companies and other financial institutions. Many of the Fund's competitors are substantially larger and have considerably greater financial, technical, marketing and other resources than does the Fund. Some competitors may have a lower cost of funds and access to funding sources that may not be available to the Fund, such as funding from the U.S. government, if the Fund is not eligible to participate in certain programs established by the U.S. government. In addition, some of the Fund's competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than the Fund. Furthermore, competition for investments in the Fund's target assets may lead to the price of such assets increasing, which may further limit the Fund's ability to generate desired returns. The Fund cannot assure you that the competitive pressures it faces will not have a material adverse effect on its business, financial condition and results of operations. Also, as a result of this competition, desirable investments in the Fund's target assets may be limited in the future and the Fund may not be able to take advantage of attractive investment opportunities from time to time, as the Fund can provide no assurance that it will be able to identify and make investments that are consistent with its investment objectives. Additional third-party managed investment funds with similar objectives may be formed in the future. Given the foregoing, it is possible that competition for appropriate portfolio investments may increase, thus reducing the number of attractive portfolio investment opportunities available to the Fund and may adversely affect the terms upon which investments can be made. There can be no assurance that the Fund will be able to locate, consummate and exit investments that satisfy its investment objective, or that it will be able to invest the net proceeds from this offering in MBS and PPIP Eligible Assets to the extent necessary to achieve its investment objective. The Master Fund is subject to similar competitive risks with respect to its investments.

Inflation/Deflation Risk

Inflation risk is the risk that the value of certain assets or income from the Fund's investments will be worth less in the future as inflation decreases the value of money. As inflation increases, the real value of the Common Stock and distributions on the Common Stock can decline. In addition, during any periods of rising inflation, the dividend rates or borrowing costs associated with the Fund's use of leverage would likely increase, which would tend to further reduce returns to stockholders. Deflation risk is the risk that prices throughout the economy decline over time—the opposite of inflation. Deflation may have an adverse affect on the creditworthiness of issuers and may make issuer defaults more likely, which may result in a decline in the value of the Fund's portfolio.

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Reinvestment Risk

Reinvestment risk is the risk that income from the Fund's portfolio will decline if and when the Fund invests the proceeds from matured, traded or called bonds at market interest rates that are below the portfolio's current earnings rate. A decline in income could affect the market price of Common Stock or your overall returns. In addition, in the event certain PPIP Eligible Assets are prepaid, the Fund may be forced to reinvest the proceeds of such prepaid PPIP Eligible Assets in lower yielding securities, which may reduce the Fund's income. See "—Interest Rate Risk."

Reverse Repurchase Agreements Risk

The Fund's use of reverse repurchase agreements involves many of the same risks involved in the Fund's use of leverage, as the proceeds from reverse repurchase agreements generally will be invested in additional securities. There is a risk that the market value of the securities acquired in the reverse repurchase agreement may decline below the price of the securities that the Fund has sold but remains obligated to repurchase. In addition, there is a risk that the market value of the securities retained by the Fund may decline. If the buyer of securities under a reverse repurchase agreement were to file for bankruptcy or experience insolvency, the Fund may be adversely affected. Also, in entering into reverse repurchase agreements, the Fund would bear the risk of loss to the extent that the proceeds of the reverse repurchase agreement are less than the value of the underlying securities. In addition, due to the interest costs associated with reverse repurchase agreements transactions, the Fund's net asset value will decline, and, in some cases, the Fund may be worse off than if it had not used such instruments.

Repurchase Agreements Risk

Subject to its investment objectives and policies, the Fund may invest in repurchase agreements for investment purposes. Repurchase agreements typically involve the acquisition by the Fund of debt securities from a selling financial institution such as a bank, savings and loan association or broker-dealer. The agreement provides that the Fund will sell the securities back to the institution at a fixed time in the future. The Fund does not bear the risk of a decline in the value of the underlying security unless the seller defaults under its repurchase obligation. In the event of the bankruptcy or other default of a seller of a repurchase agreement, the Fund could experience both delays in liquidating the underlying securities and losses, including (1) possible decline in the value of the underlying security during the period in which the Fund seeks to enforce its rights thereto; (2) possible lack of access to income on the underlying security during this period; and (3) expenses of enforcing its rights. While repurchase agreements involve certain risks not associated with direct investments in debt securities, the Fund follows procedures approved by the Fund's Board of Directors that are designed to minimize such risks. These procedures include effecting repurchase transactions only with large, well-capitalized and well-established financial institutions whose financial condition will be continually monitored by the Subadviser. In addition, as described above, the value of the collateral underlying the repurchase agreement will be at least equal to the repurchase price, including any accrued interest earned on the repurchase agreement. In the event of a default or bankruptcy by a selling financial institution, the Fund generally will seek to liquidate such collateral. However, the exercise of the Fund's right to liquidate such collateral could involve certain costs or delays and, to the extent that proceeds from any sale upon a default of the obligation to repurchase were less than the repurchase price, the Fund could suffer a loss.

Variable Debt Risk

The absence of an active secondary market with respect to particular variable and floating rate instruments could make it difficult for the Fund to dispose of a variable or floating rate note if the issuer defaulted on its payment obligation or during periods that the Fund is not entitled to exercise its demand rights, and the Fund could, for these or other reasons, suffer a loss with respect to such instruments.

Credit Default Swap Risk

The Fund may invest in credit default swap transactions for hedging or investment purposes. Credit default swap agreements involve greater risks than if the Fund had invested in the reference obligation directly since, in addition to general market risks, credit default swaps are subject to illiquidity risk, counterparty risk and credit risk. The "buyer" in a credit default contract is obligated to pay the "seller" a periodic stream of payments over the term of the contract, provided that no event of default on an underlying reference obligation has occurred. If an event of default occurs, the seller must pay the buyer the full notional value, or "par value," of the reference obligation through either physical settlement or cash settlement. The Fund may be either the buyer or seller in a credit default swap transaction. If the Fund is a buyer and no event of default occurs, the Fund will have made a

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series of periodic payments and recover nothing of monetary value. However, if an event of default occurs, the Fund (if the buyer) will receive the full notional value of the reference obligation either through a cash payment in exchange for the asset or a cash payment in addition to owning the reference assets. As a seller, the Fund receives a fixed rate of income throughout the term of the contract, which typically is between six months and five years, provided that there is no event of default. The Fund currently intends to segregate assets on the Fund's records in the form of cash, cash equivalents or liquid securities in an amount equal to the notional value of the credit default swaps of which it is the seller. If such assets are not fully segregated by the Fund, the use of credit default swap transactions could then be considered leverage for purposes of the 1940 Act and the Fund's limits on leverage. Credit default swap transactions involve greater risks than if the Fund had invested in the reference obligation directly.

Structured Notes and Related Instruments Risk

The Fund may invest in "structured" notes and other related instruments, which are privately negotiated debt obligations where the principal and/or interest is determined by reference to the performance of a benchmark asset, market or interest rate (an "embedded index"), such as selected securities, an index of securities or specified interest rates, or the differential performance of two assets or markets, such as indexes reflecting bonds. Structured instruments may be issued by corporations, including banks, as well as by governmental agencies. Structured instruments frequently are assembled in the form of medium-term notes, but a variety of forms are available and may be used in particular circumstances. The terms of such structured instruments normally provide that their principal and/or interest payments are to be adjusted upwards or downwards (but ordinarily not below zero) to reflect changes in the embedded index while the structured instruments are outstanding. As a result, the interest and/or principal payments that may be made on a structured product may vary widely, depending on a variety of factors, including the volatility of the embedded index and the effect of changes in the embedded index on principal and/or interest payments. The rate of return on structured notes may be determined by applying a multiplier to the performance or differential performance of the referenced index(es) or other asset(s). Application of a multiplier involves leverage that will serve to magnify the potential for gain and the risk of loss.

Insolvency Considerations with Respect to Issuers of Indebtedness

Various laws enacted for the protection of U.S. creditors may apply to MBS in which the Fund invests. If a court in a lawsuit brought by an unpaid creditor or representative of the creditors of an issuer of MBS, such as a trustee in bankruptcy, were to find that the issuer did not receive fair consideration or reasonably equivalent value for incurring the indebtedness, and after giving effect to such indebtedness, the issuer (i) was insolvent, (ii) was engaged in a business for which the remaining assets of such issuer constituted unreasonably small capital or (iii) intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature, such court could determine to invalidate, in whole or in part, such indebtedness as a fraudulent conveyance, to subordinate such indebtedness to existing or future creditors of such issuer, or to recover amounts previously paid by such issuer in satisfaction of such indebtedness. The measure of insolvency for purposes of the foregoing will vary. Generally, an issuer would be considered insolvent at a particular time if the sum of its debts were then greater than all of its property at a fair valuation, or if the present fair saleable value of its assets was then less than the amount that would be required to pay its probable liabilities on its existing debts as they became absolute and matured. There can be no assurance as to what standard a court would apply in order to determine whether the issuer was "insolvent" after giving effect to the incurrence of the indebtedness in which the Fund invested or that, regardless of the method of valuation, a court would not determine that the issuer was "insolvent" upon giving effect to such incurrence. In addition, in the event of the insolvency of an issuer of indebtedness in which the Fund invests, payments made on such indebtedness could be subject to avoidance as a "preference" if made within a certain period of time (which may be as long as one year) before insolvency. In general, if payments on indebtedness are avoidable, whether as fraudulent conveyances or preferences, such payments can be recaptured from the Fund.

Portfolio Valuation for Financial Accounting and Other Reporting Purposes

Valuations of the portfolio investments may involve uncertainties and judgment determinations. Third-party pricing information can vary considerably from one dealer or pricing service to another, and may at times not be available regarding certain of the investments of the Fund. A disruption in the secondary markets for the investments of the Fund may make it difficult to obtain accurate market quotations for purposes of valuing portfolio investments for financial accounting, borrowing and other reporting purposes. Further, because of the overall size and concentrations in particular markets and maturities of positions that may be held by the Fund

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from time to time, the liquidation values of portfolio investments may differ significantly from the valuations of such portfolio investments derived from the valuation methods described herein.

Some of the Fund's portfolio investments will be in the form of securities that are not publicly traded. The fair value of securities and other investments that are not publicly traded may not be readily determinable. The Fund will value these investments quarterly at fair value, as determined in accordance with Statement of Financial Accounting Standards, or SFAS, No. 157, "Fair Value Measurements," which may include unobservable inputs. Because such valuations are subjective, the fair value of certain of the Fund's assets may fluctuate over short periods of time and the Fund's determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. The value of the Fund's Common Stock could be adversely affected if the Fund's determinations regarding the fair value of these investments were materially higher than the values that it ultimately realizes upon their disposal.

Inverse Floating Rate Securities and Tender Option Bonds Risk

Subject to certain limitations, the Fund may invest in inverse floating rate securities. Typically, inverse floating rate securities represent beneficial interests in a special purpose trust (sometimes called a "tender option bond trust") formed by a third party sponsor for the purpose of holding MBS purchased from the Fund or from another third party. An investment in an inverse floating rate security may involve greater risk than an investment in a fixed-rate bond. Because changes in the interest rate on the underlying security or index inversely affect the residual interest paid on the inverse floating rate security, the value of an inverse floating rate security is generally more volatile than that of a fixed-rate bond.

Inverse floating rate securities have interest rate adjustment formulas which generally reduce or, in the extreme, eliminate the interest paid to the Fund when short-term interest rates rise, and increase the interest paid to the Fund when short-term interest rates fall. Inverse floating rate securities have varying degrees of liquidity, and the market for these securities is relatively volatile. These securities tend to underperform the market for fixed-rate bonds in a rising interest rate environment, but tend to outperform the market for fixed-rate bonds when interest rates decline. Shifts in long-term interest rates may, however, alter this tendency.

During times of reduced market liquidity, such as at the present, the Fund may not be able to sell MBS readily at prices reflecting the values at which the securities are carried on the Fund's books. Sales of large blocks of MBS by market participants, such as the Fund, that are seeking liquidity can further reduce MBS prices in an illiquid market. The Fund may seek to make sales of large blocks of MBS as part of its investment strategy or it may be required to raise cash to re-collateralize, unwind or "collapse" tender option bond trusts that issued inverse floating rate securities to the Fund or to make payments to such trusts to enable them to pay for tenders of the short-term securities they have issued if the remarketing agents for those MBS are unable to sell the short-term securities in the marketplace to other buyers. The Fund's potential exposure to losses related to or on inverse floating rate securities may increase beyond the value of the Fund's inverse floater investments as the Fund may potentially be liable to fulfill all amounts owed to holders of the floating rate certificates.

Although volatile, inverse floating rate securities typically offer the potential for yields exceeding the yields available on fixed-rate bonds with comparable credit quality, coupon, call provisions and maturity. These securities usually permit the investor to convert the floating rate to a fixed rate (normally adjusted downward), and this optional conversion feature may provide a partial hedge against rising rates if exercised at an opportune time.

Investment in inverse floating rate securities may amplify the effects of the Fund's use of leverage. Any economic effect of leverage through the Fund's purchase of inverse floating rate securities will create an opportunity for increased Common Stock net income and returns, but may also result in losses if the cost of leverage exceeds the value of the securities underlying the tender option bond trust or the return on the inverse floating rate securities purchased by the Fund.

Other Investment Companies Risk

The Fund may invest in the securities of other investment companies. Such securities may be leveraged. As a result, the Fund may be indirectly exposed to leverage through an investment in such securities. Utilization of leverage is a speculative investment technique and involves certain risks. An investment in securities of other investment companies that are leveraged may expose the Fund to higher volatility in the market value of such securities and the possibility that the Fund's long-term returns on such securities (and, indirectly, the long-term returns of the Common Stock) will be diminished.

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Risks Related to Fund Distributions

Limited liquidity in the MBS market may affect the market price of MBS securities, thereby adversely affecting the net asset values of the Fund and the Master Fund and their ability to make dividend distributions. Additionally, the terms of PPIP may limit the Master Fund's ability to distribute cash under certain circumstances, and therefore the Fund may make distributions in cash from a credit facility, liquidate assets at inopportune times, or may make distributions in Common Stock. This risk may be exacerbated by rules under PPIP which will prohibit the Master Fund from selling PPIP Eligible Assets to other public-private investment funds or certain other private investors. Upon its termination, it is anticipated that the Master Fund will distribute substantially all of its net assets to its partners, including to the Fund through its holdings in the Feeder Fund. The Fund, in turn, will distribute the proceeds received indirectly from the Master Fund and the proceeds from any PPIP Eligible Assets it holds to the Common Stockholders.

Derivatives Risk

The Fund may invest in derivative instruments, such as options contracts, futures contracts, options on futures contracts, indexed securities, credit linked notes, credit default swaps and other swap agreements for investment, hedging and risk management purposes; provided that the Fund's use of derivative instruments, as measured by the total notional amount of all such instruments, will not exceed 20% of its Managed Assets. With respect to this limitation, the Fund may net derivatives with opposite exposure to the same underlying instrument. Notwithstanding the foregoing, the Fund may invest without limitation in Treasury futures, Eurodollar futures, interest rate swaps, swaptions or similar instruments and combinations thereof. A derivative is a financial contract whose value depends on changes in the value of one or more underlying assets or reference rates. Derivatives are subject to a number of risks described elsewhere in this prospectus, such as liquidity risk, interest rate risk, credit risk and management risk. Derivatives are also subject to counterparty risk, which is the risk that the other party in the transaction will not fulfill its contractual obligation. Changes in the credit quality of the companies that serve as the Fund's counterparties with respect to its derivative transactions will affect the value of those instruments. By using derivatives that expose the Fund to counterparties, the Fund assumes the risk that its counterparties could experience financial hardships that could call into question their continued ability to perform their obligations. In addition, in the event of the insolvency of a counterparty to a derivative transaction, the derivative transaction would typically be terminated at its fair market value. If the Fund is owed this fair market value in the termination of the derivative transaction and its claim is unsecured, the Fund will be treated as a general creditor of such counterparty, and will not have any claim with respect to the underlying security. As a result, concentrations of such derivatives in any one counterparty would subject the Fund to an additional degree of risk with respect to defaults by such counterparty. Derivatives also involve the risk of mispricing or improper valuation and the risk that changes in the value of a derivative may not correlate perfectly with an underlying asset, interest rate or index. Suitable derivative transactions may not be available in all circumstances and there can be no assurance that the Fund will engage in these transactions to reduce exposure to other risks when that would be beneficial. If the Fund invests in a derivative instrument, it could lose more than the principal amount invested.

Derivative instruments can be illiquid, may disproportionately increase losses, and may have a potentially large impact on Fund performance.

Short Sales Risk

To the extent the Fund makes use of short sales for investment and/or risk management purposes, the Fund may be subject to risks associated with selling short. Short sales are transactions in which the Fund sells securities or other instruments that the Fund does not own. Short sales expose the Fund to the risk that it will be required to cover its short position at a time when the securities have appreciated in value, thus resulting in a loss to the Fund. The Fund may engage in short sales where it does not own or have the right to acquire the security sold short at no additional cost. The Fund's loss on a short sale theoretically could be unlimited in a case where the Fund is unable, for whatever reason, to close out its short position. In addition, the Fund's short selling strategies may limit its ability to benefit from increases in the markets. If the Fund engages in short sales, it will segregate liquid assets, enter into offsetting transactions or own positions covering its obligations; however, such segregation and cover requirements will not limit or offset losses on related positions. Short selling also involves a form of financial leverage that may exaggerate any losses realized by the Fund. Also, there is the risk that the counterparty to a short sale may fail to honor its contractual terms, causing a loss to the Fund.

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Risks of Short Economic Exposure Through Derivatives

The use by the Fund of derivatives such as options, forwards or futures contracts for investment and/or risk management purposes may subject the Fund to risks associated with short economic exposure through such derivatives. Taking a short economic position through derivatives exposes the Fund to the risk that it will be obligated to make payments to its counterparty if the underlying asset appreciates in value, thus resulting in a loss to the Fund. The Fund's loss on a short position using derivatives theoretically could be unlimited.

Risks of Futures and Options on Futures

The use by the Fund of futures contracts and options on futures contracts to hedge interest rate risks involves special considerations and risks, as described below.

•   Successful use of hedging transactions depends upon the Subadviser's ability to correctly predict the direction of changes in interest rates. There can be no assurance that any particular hedging strategy will succeed.

•   There might be imperfect correlation, or even no correlation, between the price movements of a futures or option contract and the movements of the interest rates being hedged. Such a lack of correlation might occur due to factors unrelated to the interest rates being hedged, such as market liquidity and speculative or other pressures on the markets in which the hedging instrument is traded.

•   Hedging strategies, if successful, can reduce risk of loss by wholly or partially offsetting the negative effect of unfavorable movements in the interest rates being hedged. However, hedging strategies can also reduce opportunity for gain by offsetting the positive effect of favorable movements in the hedged interest rates.

•   There is no assurance that a liquid secondary market will exist for any particular futures contract or option thereon at any particular time. If the Fund were unable to liquidate a futures contract or an option on a futures contract 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.

•   There is no assurance that the Fund will use hedging transactions. For example, if the Fund determines that the cost of hedging will exceed the potential benefit to the Fund, the Fund will not enter into such transactions.

Liquidity Risk

The Fund, both directly and indirectly through its investment through the Feeder Fund in the Master Fund, may invest in MBS, including PPIP Eligible Assets, for which there is no readily available trading market or which are otherwise illiquid. Liquidity risk exists when particular investments are difficult to sell. Securities may become illiquid after purchase by the Fund, particularly during periods of market turmoil. When the Fund holds illiquid investments, the portfolio may be harder to value, especially in changing markets, and if the Fund is forced to sell these investments in order to segregate assets or for other cash needs, the Fund may suffer a loss. The prices of securities with limited liquidity may be more volatile than prices of more liquid securities. Limited liquidity can also affect the market price of securities, thereby adversely affecting the Fund's net asset value and its ability to make dividend distributions. These risks may be exacerbated by rules under PPIP which will prohibit the Master Fund from selling PPIP Eligible Assets to other public-private investment funds or certain other private investors. In addition, the Fund generally may not withdraw from the Feeder Fund and the Fund may not, directly or indirectly, sell, assign, pledge, exchange or otherwise transfer its interest in the Feeder Fund, in whole or in part, without the prior written consent of the General Partner. As a result, any amount invested by the Fund in the Feeder Fund will be illiquid.

When-Issued and Delayed-Delivery Transactions Risk

The Fund may purchase fixed income securities on a when-issued basis, and may purchase or sell those securities for delayed delivery. When-issued and delayed-delivery transactions occur when securities are purchased or sold by the Fund with payment and delivery taking place in the future to secure an advantageous yield or price. Securities purchased on a when-issued or delayed-delivery basis may expose the Fund to counterparty risk of default as well as the risk that securities may experience fluctuations in value prior to their actual delivery. The Fund will not accrue income with respect to a when-issued or delayed-delivery security prior to its stated delivery date. Purchasing securities on a when-issued or delayed-delivery basis can involve the

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additional risk that the price or yield available in the market when the delivery takes place may not be as favorable as that obtained in the transaction itself.

Non-Diversification Risk

The Fund is classified as "non-diversified" under the 1940 Act. As a result, it can invest a greater portion of its assets in obligations of a single issuer than a "diversified" fund. The Fund may therefore be more susceptible than a diversified fund to being adversely affected by any single corporate, economic, political or regulatory occurrence. See "The Fund's Investments." The Fund intends to qualify for the special tax treatment available to "regulated investment companies" under Subchapter M of the Code, and thus intends to satisfy the diversification requirements of Subchapter M, including the less stringent diversification requirement that applies to the percent of its total assets that are represented by cash and cash items (including receivables), U.S. government securities, the securities of other regulated investment companies and certain other securities.

Risks Related to Potential Conflicts of Interest

LMPFA and the Subadviser manage other registered investment companies, separate accounts, private investment funds and other investment funds, which may raise potential conflicts of interest, including those associated with allocating management time, services and functions, and there can be no assurance that any actual or potential conflicts of interest will not result in the Fund receiving less favorable investment terms in certain investments than if such conflicts of interest did not exist. Western Asset has adopted procedures to address these requirements, including policies and procedures to require the fair allocation of portfolio transactions and investment opportunities across multiple client accounts on a fair and equitable basis over time. All eligible accounts that can participate in a trade share the same price on an equitable basis in an attempt to mitigate any conflict of interest. Trades are allocated among similarly managed accounts to maintain consistency of portfolio strategy, taking into account cash availability, investment restrictions and guidelines, and portfolio composition versus strategy. Western Asset also maintains policies and procedures to address potential personal trading conflicts, approved broker requirements, holding period requirements and such other requirements as mandated by the Treasury.

Counterparty Risk

Changes in the credit quality of the companies that serve as the Fund's counterparties with respect to derivatives or other transactions supported by another party's credit will affect the value of those instruments. Certain entities that have served as counterparties in the markets for these transactions have recently incurred significant financial hardships including bankruptcy and losses as a result of exposure to sub-prime mortgages and other lower quality credit investments that have experienced recent defaults or otherwise suffered extreme credit deterioration. If a counterparty becomes bankrupt or otherwise fails to perform its obligations under a derivative contract due to financial difficulties, the Fund may experience significant delays in obtaining any recovery under the derivative contract in a bankruptcy or other reorganization proceeding. The Fund may obtain only a limited recovery or may obtain no recovery in such circumstances.

Portfolio Turnover Risk

Changes to the investments of the Fund may be made regardless of the length of time particular investments have been held. A high portfolio turnover rate may result in increased transaction costs for the Fund in the form of increased dealer spreads and other transactional costs, which may have an adverse impact on the Fund's performance. In addition, high portfolio turnover may result in the realization of net short-term capital gains by the Fund which, when distributed to stockholders, will be taxable as ordinary income. A high portfolio turnover may increase the Fund's current and accumulated earnings and profits, resulting in a greater portion of the Fund's distributions being treated as a dividend to the Fund's stockholders. The portfolio turnover rate of the Fund will vary from year to year, as well as within a given year.

Temporary Defensive Strategies Risk

When the Subadviser anticipates unusual market or other conditions, the Fund may temporarily depart from its principal investment strategies as a defensive measure and invest all or a portion of its assets non-U.S. government securities which have received the highest investment grade credit rating and U.S. government securities, including bills, notes and bonds differing as to maturity and rates of interest that are either issued or guaranteed by the Treasury or by U.S. government agencies or instrumentalities; certificates of deposit issued against funds deposited in a bank or a savings and loan association; commercial paper; bankers' acceptances; bank time deposits; shares of money market funds; repurchase agreements with respect to any of the foregoing;

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or any other fixed income securities that the Subadviser considers consistent with this strategy. To the extent that the Fund invests defensively, it may not achieve its investment objectives.

Anti-Takeover Provisions

The Fund's Articles and By-Laws include provisions that could limit the ability of other entities or persons to acquire control of the Fund or convert the Fund to an open-end fund. These provisions could have the effect of depriving Common Stockholders of opportunities to sell their Common Stock at a premium over the then-current market price of the Common Stock.

Limited Term Risk

As a fundamental policy, the Fund intends to liquidate and distribute substantially all of the Fund's net assets to stockholders, after making appropriate provision for any liabilities of the Fund, on or about March 1, 2022. Because the assets of the Fund, the Feeder Fund and the Master Fund will be liquidated in connection with their respective terminations, each may be required to sell portfolio securities when they otherwise would not, including at times when market conditions are not favorable, which may cause them to lose money. As they approach their respective termination dates, their respective portfolio composition may change as more of their original PPIP Eligible Assets mature or are called or sold, which may cause their returns to decrease and the net asset value of the Common Stock to fall. Rather than reinvesting the proceeds of matured, called or sold PPIP Eligible Assets, each may distribute the proceeds in one or more liquidating distributions prior to the final liquidation, which may cause fixed expenses to increase when expressed as a percentage of assets under management, or they may invest the proceeds in lower yielding securities or hold the proceeds in cash, which may adversely affect their performance.

The Feeder Fund and Master Fund will continue until the eighth anniversary of the Master Fund Closing Date, subject to extension at the discretion of the General Partner with the written consent of the Treasury for up to two consecutive one-year periods. The Feeder Fund and Master Fund are subject to earlier dissolution and termination upon the occurrence of certain events, including any of the following:

•   following the expiration or termination of the Master Fund's investment period, upon the liquidation of all of the Master Fund's portfolio investments;

•   the bankruptcy, dissolution or any similar event of withdrawal of the General Partner (unless the Treasury agrees in writing to continue the business of the Feeder Fund and Master Fund and to the appointment of another general partner); or

•   the General Partner's good faith determination that a change in any law, regulation, rule or governmental order (or change in judicial or regulatory interpretation of any law, regulation or governmental order) would materially adversely impact the General Partner, at least a majority in interest of investors in the Master Fund or the investors in the Feeder Fund (including, but not limited to, the Fund), or the affiliates of such investors as a result of their management of, or participation in, the Feeder Fund or the Master Fund.

The Fund's investment objective and policies are not designed to seek to return to investors that purchase Common Stock in this offering their initial investment on the termination date, and such initial investors and any investors that purchase Common Stock after the completion of this offering may receive more or less than their original investment upon termination.

Market Disruption and Geopolitical Risk

The aftermath of the war with Iraq, instability in the Middle East and terrorist attacks in the United States and around the world may have a substantial impact on the U.S. and world economies and securities markets. The nature, scope and duration of the occupation of Iraq cannot be predicted with any certainty. Terrorist attacks closed some of the U.S. securities markets in 2001, and similar events cannot be ruled out in the future. The war and occupation, terrorism and related geopolitical risks have led, and may in the future lead to, increased short-term market volatility and may have adverse long-term effects on U.S. and world economies and markets generally. These risks may adversely affect individual issuers and securities markets, interest rates, secondary trading, ratings, investor psychology, credit risk, inflation and other factors relating to the Common Stock. High-yield securities tend to be more volatile than higher rated securities so that these events and any actions resulting from them may have a greater impact on the prices and volatility of high yield securities than on higher rated securities.

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Managed Distribution Risk

Under a managed distribution policy, the Fund would intend to make monthly distributions to stockholders at a fixed rate per share of Common Stock or a fixed percentage of net asset value that may include periodic distributions of long-term capital gains. Under a managed distribution policy, if, for any monthly distribution, ordinary income (that is, net investment income and any net short-term capital gain) and net realized capital gains were less than the amount of the distribution, the difference would be distributed from the Fund's previously accumulated earnings and profits or cash generated from the sale of Fund assets. If, for any fiscal year, the total distributions exceeded ordinary income and net realized capital gains (the "Excess"), the Excess would decrease the Fund's total assets and, as a result, would have the likely effect of increasing the Fund's expense ratio. There is a risk that the Fund would not eventually realize capital gains in an amount corresponding to a distribution of the Excess. In addition, in order to make such distributions, the Fund may have to sell a portion of its investment portfolio at a time when independent investment judgment might not dictate such action. If the Fund were to issue senior securities and not be in compliance with the asset coverage requirements of the 1940 Act, the Fund would be required to suspend the managed distribution policy. Pursuant to the requirements of the 1940 Act and other applicable laws, a notice will accompany each monthly distribution disclosing the sources of the distribution.

Personnel Turnover Risk

As a result of current deteriorating market conditions or other reasons, LMPFA and the Subadviser may need to implement cost reductions in the future which could make the retention of qualified and experienced personnel more difficult and could lead to personnel turnover. Loss of significant personnel, whether in terms of number or role in managing the Fund or an inability to hire qualified replacements in a timely manner, could adversely affect the operation of the Fund and its ability to achieve its investment objectives and pursue its anticipated strategies.

Special Risks Related to PPIP

The risk factors described herein relating to PPIP and the Fund are based on information available from the Treasury as of the date of this prospectus. The Treasury and/or the U.S. Congress may change the terms of PPIP at any time and such changes may adversely affect the Fund and its ability to achieve its investment objective and change the risks involved in participating in PPIP.

Risks Related to Investments in PPIP Eligible Assets

The Master Fund invests substantially all of its assets in PPIP Eligible Assets. PPIP Eligible Assets generally are debt securities that entitle the holders thereof to receive payments of interest and principal that depend primarily on the cash flow from or sale proceeds of a specified pool of assets, either fixed or revolving, that by their terms convert into cash within a finite time period, together with rights or other assets designed to assure the servicing or timely distribution of proceeds to holders of such securities. Investments in these securities may be speculative. Investing in PPIP Eligible Assets entails various risks: credit risks, liquidity risks, interest rate risks, market risks, operations risks, structural risks, geographical concentration risks, basis risks and legal risks. PPIP Eligible Assets are subject to the significant credit risks inherent in the underlying collateral and to the risk that the servicer fails to perform. PPIP Eligible Assets are subject to risks associated with their structure and execution, including the process by which principal and interest payments are allocated and distributed to investors, how credit losses affect the issuing vehicle and the return to investors in such PPIP Eligible Assets, whether the collateral represents a fixed set of specific assets or accounts, whether the underlying collateral assets are revolving or closed-end, under what terms (including maturity of the PPIP Eligible Asset) any remaining balance in the accounts may revert to the issuing entity and the extent to which the entity that is the actual source of the collateral assets is obligated to provide support to the issuing vehicle or to the investors in such PPIP Eligible Asset. In addition, concentrations of PPIP Eligible Assets of a particular type, as well as concentrations of PPIP Eligible Assets issued or guaranteed by affiliated obligors, serviced by the same servicer or backed by underlying collateral located in a specific geographic region, may subject the PPIP Eligible Assets to additional risk.

Up to 10 % of the loans and other assets underlying any PPIP Eligible Asset may be situated outside the United States. Non-U.S. investments are generally denominated in non-U.S. currencies and involve certain risks not typically associated with investments in the United States. These considerations include changes in exchange rates and exchange control regulations, political and social instability, expropriation, imposition of foreign taxes, less liquid markets and less available information than is generally the case in the United States, higher transaction costs, less governmental supervision of exchanges, brokers and issuers, greater risks associated with

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counterparties and settlement, difficulty in enforcing contractual obligations, lack of uniform accounting and auditing standards and greater price volatility. Furthermore, restrictions imposed to prevent capital flight may make it difficult or impossible to exchange or repatriate foreign currency.

Risks Related to the Role of the Treasury in the Master Fund

As a result of the Treasury providing equity capital and the Treasury Debt Financing to the Master Fund, the Treasury will be able to exercise certain rights and powers in regard to the Master Fund. The Treasury has no fiduciary duty to the Common Stockholders and may exercise these rights in its own interest and not in the interests of the Fund or the Common Stockholders. The Treasury's exercise of these rights and powers in its own interest may adversely affect the Fund and its ability to achieve its investment objective. Specifically:

•   The Treasury has the sole right to waive the Master Fund's investment limitations. Included in the investment limitations are restrictions on the Master Fund's ability to enter into derivative contracts, to hedge credit risks, to lend PPIP Eligible Assets for any purpose and various restrictions providing limitations on investments that have "subprime" collateral, that were subordinate in the capital structure at the time of purchase, that have Alt-A collateral or that are CMBS. A waiver of one or more of these restrictions could allow the Master Fund to make (and therefore cause the Fund to be exposed to) types of investments or investments in aggregate amounts that were unanticipated by investors at the time of their purchase of Common Stock and may ultimately prove detrimental to the Fund or adversely affect its profitability.

•   The Treasury may, in its sole discretion, terminate the investment period of the Master Fund (which would terminate the investment period of the Feeder Fund) at any time on or after the one year anniversary of the Master Fund Closing Date, regardless of the prior performance of the Master Fund (and therefore the Fund) and its investments.

•   The Treasury has reserved the right to terminate its commitment to provide Treasury Debt Financing to the Master Fund at any time after the one-year anniversary of the Master Fund Closing Date, in its sole discretion. The Master Fund may be unable to obtain debt financing on similar terms and such actions may adversely affect its ability to purchase PPIP Eligible Assets and may otherwise affect expected returns on its investments. In addition, the definitive documentation evidencing the Treasury Debt Financing contains various covenants restricting the activities of the Master Fund. Failure to comply with these covenants will limit the Master Fund's ability to borrow from the Treasury and make distributions through the Feeder Fund to the Fund, which will adversely affect the Fund's returns and may result in negative tax consequences to the Fund. To the extent that Treasury Debt Financing results in a claim on the assets of the Master Fund securing such loan, such claim would be senior to the rights of an investor in the Master Fund, including the Feeder Fund, and ultimately the Fund. As a result, if the losses of the Master Fund were to exceed the amount of capital invested, an investor such as the Feeder Fund, and ultimately the Fund, could lose its entire investment.

•   The Treasury will receive warrants in the Master Fund. These warrants will be structured as preferential payments to be made to the Treasury after the Master Fund has made distributions to the Feeder Fund and the other partners equal to the capital the Feeder Fund and other partners have invested in the Master Fund. Payments under the warrants would reduce the amount of distributions that would otherwise be payable to Common Stockholders and could pose adverse tax consequences to them.

•   The Feeder Fund may not, directly or indirectly, sell, assign, pledge, exchange or otherwise transfer its interest in the Master Fund, in whole or in part, without the prior written consent of the Treasury and the Feeder Fund generally may not withdraw from the Feeder Fund.

•   The consequences of failure of Western Asset or certain affiliates to comply with the conflict of interest and code of ethics requirements in any respect are not certain, but could include the imposition of additional requirements and the removal of the General Partner by the Treasury, as described below.

•   The Treasury will have the right to remove the General Partner of the Master Fund in its sole discretion in certain circumstances and with the consent of the Feeder Fund and other partners. For example, the Treasury will also have the right to remove the General Partner without cause at any time with the vote of a majority of the investors' interests in the Master Fund. Additionally, under circumstances related to changes in the management of the Master Fund, including if certain key personnel cease to be actively involved with the General Partner, the Treasury will have the right to remove the General Partner with

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the consent of one-third of the investors' interests in the Master Fund. In addition, if the Treasury were to remove the General Partner, a replacement general partner would have to be selected. The Treasury will be required to consent to any replacement general partner for the Master Fund. Any refusal to grant this consent would deny investors in the Master Fund their choice for a replacement general partner. Any delay in granting this consent would cause the Master Fund to miss investment opportunities. During the replacement process, the General Partner will be prohibited from causing the Master Fund to make any new investments and may cause the Master Fund to sell an investment only if the General Partner determines in good faith that the disposition is necessary to avoid a material loss to the Master Fund. The Master Fund, as a result, may miss attractive investment opportunities during this time period. In addition, there can be no assurance that a suitable replacement will be found in a timely manner or at all. Consequently, removal of the General Partner may adversely affect the ability of the Master Fund, the Feeder Fund and the Fund to achieve their respective investment objectives.

Equalization Payment Risk.

The Feeder Fund is accepting investors through several separate closings, and there have been one or more prior closings in which the Fund did not invest. If the Allocation Subadviser decides that the Fund will make an investment in the Feeder Fund, the Fund will do so in a subsequent closing. The Fund, as a new investor in the Feeder Fund, would be required to pay the interest equivalent on a portion of its investment in the Feeder Fund at an annual rate equal to the prime rate plus 2 % . The size of the interest equivalent or "equalization" payment will vary depending on the percentage of commitments called from prior investors and would be paid in addition to the Fund's capital contribution. The Fund's interest equivalent payment would be credited by the Master Fund on a pro rata basis to the prior investors' capital accounts and is designed to compensate prior investors for the use of their funds between prior and subsequent closings and to therefore ensure the equitable treatment of all investors. This interest payment will be in addition to the Fund's capital commitment and will affect the Fund's net asset value on the date of the Fund's investment in the Feeder Fund. In addition, the Fund will be deemed to have invested at the same time as the initial investors, meaning that to the extent the Master Fund experiences losses or gains before the date of the Fund's investment, the Fund will participate in such losses or gains to the extent of its pro rata share of the Master Fund's capital commitment. The amount of the actual losses or gains allocated to the Fund would vary depending on the performance of the Feeder Fund's investment in the Master Fund for the period from the inception of the Feeder Fund up to the date on which the Fund's capital commitment for its initial investment in the Feeder Fund is accepted. The equalization payment, together with the gain or loss adjustment, may result in a material change to the Fund's net asset value on the date of the Fund's investment in the Feeder Fund which in turn may have a material impact on the market price of the Fund's Common Stock.

The Allocation Subadviser will consider the amount of such equalization payment and gain or loss adjustment in deciding whether and to what extent the Fund will invest in the Feeder Fund. If the Master Fund's losses are sufficiently large, the Allocation Subadviser may determine not to invest in the Feeder Fund, in which case the Fund would not be able to access PPIP or the Treasury Debt Financing. If the Allocation Subadviser determines not to invest the Fund's assets in the Feeder Fund, those assets will be invested primarily in MBS and other permitted investments, and the Fund may seek to employ leverage directly at the Fund level in the form of borrowings through a qualified government sponsored program or from banks, the issuance of preferred shares, reverse repurchase agreements or other leverage financing.

PPIP Amendment Risk

PPIP could be amended pursuant to new legislation or altered through administrative or judicial action. Such amendments or alterations could be retroactive, which could have the effect of preventing the Fund from benefiting from its investment in the Feeder Fund. While the Treasury may deem such revisions to the PPIP beneficial to the program and the U.S. government and/or U.S. economy as a whole, there can be no assurance that such revisions will prove to be beneficial as anticipated by the Treasury or that such revisions will not be viewed by individual investors as detrimental to their interests. Examples of the PPIP's currently existing provisions and guidelines, the manner in which they may be revised, and a discussion of how such revisions could prove detrimental to the Fund or its investors is provided below.

•   The Treasury has currently released a definition of "Eligible Assets" which are those assets that participating funds (such as the Master Fund) are entitled to invest in (currently non-agency RMBS and CMBS issued prior to 2009 that were originally rated AAA or an equivalent rating by two or more NRSROs without ratings enhancement and that are secured directly by the actual mortgage loans, leases

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or other assets and not other securities, other than certain swap positions, as determined by the Treasury). However, there are no restrictions on the Treasury's ability to broaden the definition of Eligible Assets and accordingly the scope of the investment program to be undertaken by the Master Fund (and therefore, indirectly, the Fund). There is no guarantee that these additional asset classes will not present unanticipated risks that are not currently associated with the current Eligible Assets (e.g., the Treasury could, if it so chooses, allow the funds in the program to invest in RMBS and CMBS that were originally rated lower than AAA or it could broaden the scope of the program to include higher risk investments in other assets).

•   In addition to the Treasury's equity commitment to the funds participating in PPIP, the Treasury has also offered such funds the right to enter into a loan facility with the Treasury and the Fund expects that the Master Fund's Treasury Debt Financing will be in the amount of 100 % of the Master Fund's aggregate capital commitments. There can be no guarantee that the Treasury will not revise or modify the terms of the Treasury Debt Financing in a manner that is adverse to the Master Fund and, indirectly, the Fund.

•   While the Treasury has initially pre-qualified only a limited number of fund managers, including Western Asset, to participate in PPIP, any potential expansion by the Treasury of the number of funds and fund managers that are participating in the program will further increase competition for investments in Eligible Assets and could adversely affect the Fund if the Master Fund is unable to participate in enough suitable investments to invest the capital committed to the Master Fund.

Loan Modification Risk

The General Partner, subject to certain conditions, will be required under the terms of PPIP to (i) consent on behalf of the Master Fund to reasonable requests from servicers or trustees for approval to participate in the Treasury's Making Home Affordable Program, or for approval to implement other reasonable loss mitigation measures (including but not limited to, term extensions, rate reductions, principal write downs, or removal of caps on the percentage of loans that may be modified within the securitization structure), and (ii) where the Master Fund acquires 100 % of the RMBS that are backed by a particular pool of residential mortgage loans, instruct the servicer or trustee of such securities, if such servicer or trustee is participating in the Making Home Affordable Program, to include such pool of residential mortgage loans in the Making Home Affordable Program. Although the General Partner will only be required to so consent or instruct if it receives reasonably requested information from the servicer or the trustee and access to appropriate individuals at the servicer or the trustee which allows the General Partner to make an independent analysis that the consent or instruction is consistent with its duties as general partner of the Master Fund, any such consent or instruction nevertheless may have a negative effect on the Master Fund's investment performance, and consequently on the performance on the Fund and the value of the Common Stock.

Feeder and Master Funds Not Registered

The Feeder Fund and Master Fund are not registered under the 1940 Act, and their interests are not registered under the Securities Act. The 1940 Act provides certain protections to investors that generally will not apply to investors in the Fund or the Master Fund. The 1940 Act, among other things, (i) imposes limitations on certain types of investments; (ii) requires that a fund's board of directors (including in certain instances disinterested directors) approve certain of the fund's activities and contractual obligations; (iii) requires securities held in custody for a fund at all times to be individually segregated from the securities of any other person and marked to clearly identify such securities as the property of the fund; (iv) prohibits a fund from engaging in certain transactions with its affiliates; (v) requires shareholders to vote on certain matters; and (vi) regulates the relationship between an adviser and a fund. The Securities Act provides certain protections to investors, none of which will be applicable to the Feeder Fund or Master Fund.

New Financing Program Risk

The Feeder Fund and the Master Fund were formed to take advantage of PPIP, a recently-commenced program with a limited operating history. PPIP is designed to encourage the transfer of certain illiquid legacy real estate-related assets off of the balance sheets of financial institutions, restarting the market for these assets and supporting the flow of credit and other capital into the broader economy. PPIP is without precedent and its effects are impossible to predict with certainty. Such uncertainties of the program may result in challenges for the Fund, the Feeder Fund and the Master Fund that make achievement of the Fund's investment objectives more difficult than would otherwise be the case with more established methods of investing and financing.

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Risks Relating to PPIP Distributions; Asset Coverage Requirement and Leverage Ratio Risk

During the term of any Treasury Debt Financing received through PPIP, the Master Fund is subject to an asset coverage test and a leverage ratio test, each which must be satisfied on a pro forma basis to use the Treasury Debt Financing. In addition, failure to satisfy the asset coverage test at specified levels restricts the ability of the Master Fund (and consequently the Fund) to make distributions. The asset coverage test is calculated by dividing (a) the sum of the aggregate market value of all PPIP Eligible Assets and Temporary Investments held by the Master Fund, by (b) the sum of the outstanding principal amount of the Treasury Debt Financing and accrued and unpaid interest due thereon. If a Half Turn Election is in effect, the asset coverage test is satisfied if the asset coverage ratio is equal to or exceeds 225 % . If a Full Turn Election is in effect, the asset coverage test is satisfied if the asset coverage ratio is equal to or exceeds 150 % . In the event the Master Fund is unable, on any date of determination, to achieve the required asset coverage ratio, it is required to pay down the Treasury Debt Financing until such time as it achieves the required asset coverage ratio. Pursuant to the terms of the Treasury Debt Financing, the Master Fund is limited in the amount of distributions it can make if the asset coverage ratio falls below 200 % for the Full Turn Election and 300 % for the Half Turn Election. There can be no assurance that the Master Fund will achieve the required asset coverage ratio. The Fund's ability to satisfy the distribution requirements necessary to maintain the Fund's status as a regulated investment company for U.S. federal income tax purposes and to avoid U.S. federal income and excise taxes may be adversely affected by these debt pay down requirements imposed on distributions by PPIP. See also "—Tax Risks—Risks Associated with Asset Coverage Requirements and Regulated Investment Company Distribution Requirements."

Leverage Recourse Risk

The Fund's investment through the Feeder Fund in the Master Fund does not create recourse liability to the Fund from the Treasury, the Feeder Fund or the other investors in the Master Fund. However, the Treasury Debt Financing provided to the Master Fund is subject to certain terms and conditions, which, if violated by the Master Fund, may under certain limited circumstances lead to the Treasury having recourse to the assets of the Master Fund. For example, upon the occurrence of certain events of default, including, but not limited to, material inaccuracies in the Master Fund's credit documentation, violation of negative covenants made by the Master Fund, or the asserted invalidity of the Master Fund's security documents, payments of principal owed to the Treasury will be prioritized over distributions to the Master Fund's investors, which include the Feeder Fund and therefore the Fund. The Fund has little or no ability to ensure that the Master Fund adheres to the terms and conditions of the Treasury Debt Financing, and there can be no assurance that the Treasury will not have recourse to the assets of the Master Fund as a result.

Limited Recourse to the General Partner and Western Asset

The General Partner has been formed by Western Asset for the purpose of serving as the general partner of the Feeder Fund and the Master Fund. The organizational documents of the Feeder Fund and Master Fund seek to limit the circumstances under which the General Partner or Western Asset can be held liable to the Feeder Fund, the Master Fund or their investors (including the Fund). The General Partner generally will not be held liable with respect to its actions or inactions unless they constitute fraud, willful misconduct, bad faith, or gross negligence.

Limited Recourse to the Treasury

Pursuant to the terms of the partnership agreement governing the Master Fund, the Treasury has reserved all immunities, defenses, rights or actions arising out of either the Treasury's status as an instrumentality of a sovereign state or entity or under the United States Constitution, and no waiver of any of such immunities, defenses, rights or actions shall be implied or otherwise deemed to exist by Treasury's entry into such partnership agreement. As a result, to the extent the Treasury breaches any of its obligations under the partnership agreement governing the Master Fund or the Treasury Debt Financing documents, the Master Fund and the General Partner may have limited, if any, recourse against the Treasury either to require the Treasury to fulfill its obligations under the terms of such agreements or to receive a monetary award for damages. Any such breach by the Treasury could adversely affect the performance of the Master Fund and, therefore, the Fund.

Master-Feeder Structure

As noted above, investors will invest indirectly in the Master Fund through the Feeder Fund. The "master-feeder" fund structure, and in particular the existence of multiple investment vehicles investing in the same portfolio, presents certain unique risks to investors. Each investment vehicle that invests in the Master

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Fund may have differing and conflicting tax interests. Accordingly, the investment decisions of Western Asset may not always be consistent with the tax interests of the Feeder Fund or the other investment vehicles that invest in the Master Fund, or the investors in those investment vehicles (including the Fund).

By investing the Fund's assets in the Feeder Fund, which in turn invests indirectly in the Master Fund, investors may incur certain duplicative fees and expenses. For more information concerning fees and expenses, please refer to "Summary of Fund Expenses." Investors will have no power to vote directly on matters relating to the Feeder Fund or the Master Fund. In addition, amendments may be made to the governing documents of the Feeder Fund or the Master Fund without the consent of, or notice to, investors in the Fund.

Default

If an investor defaults on its obligation to make required capital contributions, it may be difficult for the Feeder Fund or the Master Fund to make up the shortfall from other sources. The other investors may be required to make additional contributions to replace such shortfall, thereby reducing the diversification of their investments. Under current economic conditions, it has been reported that certain investors in other investment vehicles have suspended, or have threatened to suspend, making capital contributions due to their own financial condition. Any default by one or more investors could have an extremely deleterious effect on the Feeder Fund and the Master Fund, their assets, and the interests of the other investors, including the Fund.

Removal of an Investor

If, in the reasonable judgment of the General Partner, (i) the removal of an investor in the Feeder Fund is necessary to ensure compliance with ERISA, as amended, the United States Bank Holding Company Act of 1956, as amended, or the terms of the Master Fund or (ii) a material adverse effect on any of the Feeder Fund, the Master Fund, other investors in the Feeder Fund, the General Partner, or any of their respective affiliates is likely to result by virtue of an investor's investment in the Feeder Fund, the Feeder Fund will redeem the entire interest in the Feeder Fund held by such investor by issuing a preferential promissory note payable to the order of the investor in the amount of the fair market value of such interest, as determined by the General Partner in its sole discretion. There can be no certainty that the General Partner's determination of the fair market value of such interest will be equal to or greater than the valuation that an independent appraiser would determine for the interest. If the Feeder Fund, and indirectly, the Fund, were to be so removed, they may be adversely affected by their exclusion from a portion of the Master Fund's investment program.

Market Value Calculation May Not Reflect Liquidation Value of PPIP Eligible Assets; Effect on Asset Coverage Test and Leverage Ratio Test

The market value of PPIP Eligible Assets held by the Master Fund is calculated by the Valuation Agent using a specific Treasury-approved pricing process. This process may not produce prices that accurately reflect the liquidation value of PPIP Eligible Assets or their value on a hold-to-maturity basis.

Both the asset coverage test and the leverage ratio test are calculated using the market value of PPIP Eligible Assets. If the market value for a PPIP Eligible Asset decreases, the asset coverage ratio will also decrease, while the leverage ratio will increase. If the asset coverage ratio falls below the level required by the asset coverage test or if the leverage ratio exceeds the level required by the leverage ratio test, the Master Fund will be prohibited from drawing additional Treasury Debt Financing, thus restricting its ability to invest in additional PPIP Eligible Assets and reducing the aggregate investment proceeds generated and distributed by the Master Fund.

Master Fund Hedging Risk

PPIP imposes restrictions on the ability of the Master Fund to hedge its portfolio. Specifically, without the Treasury's consent, the Master Fund may only use interest rate swaps, caps and collars solely for the purpose of hedging interest rate mismatches between the Treasury Debt Financing and PPIP Eligible Assets. The Master Fund's ability to in engage in any other hedging strategy will require the consent of the Treasury. There can be no assurance that the Treasury will allow the Master Fund to engage in any other hedging strategy, which could result in the Master Fund suffering losses it otherwise would not have had it been allowed to engage in such hedging strategy.

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Restrictions on Acquiring and Selling PPIP Eligible Assets Risk; Risks Relating to Conflict of Interest and Code of Ethics Restrictions

The Master Fund must implement a conflict of interest mitigation plan and a code of ethics reasonably satisfactory to the Treasury that will provide that Western Asset may not, without the Treasury's consent, acquire PPIP Eligible Assets from, or sell PPIP Eligible Assets to, certain affiliates, any other public-private investment fund or any investor that owns 9.9 % or more of the Master Fund. Such restrictions on the type of persons from whom the Master Fund may purchase securities may adversely affect the Master Fund's (and consequently the Fund's) ability to achieve its investment objective. In addition, the Master Fund will be prohibited from using any broker-dealer affiliate of Western Asset for executing trades for the Master Fund, purchasing PPIP Eligible Assets with the intention to resell within one week and reselling PPIP Eligible Assets within 24 hours of purchasing such assets. These restrictions may limit the ability of the Master Fund to acquire certain PPIP Eligible Assets that it would otherwise desire to purchase and the ability to sell PPIP Eligible Assets at a time it would otherwise desire to sell PPIP Eligible Assets.

Risks Relating to Affiliates

Section 17(d) of the 1940 Act and Rule 17d-1 thereunder limit the ability of affiliates of registered investment companies from acting as principal to effect any transactions in which the registered investment company is a joint or joint and several participant with the affiliate. If the Fund's investment in the Feeder Fund were determined to be a prohibited joint transaction under Section 17(d), there could be adverse consequences to the Fund, including the inability to gain exposure to PPIP through an indirect investment in the Master Fund.

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MANAGEMENT OF THE FUND

Directors and Officers

The overall management of the business and affairs of the Fund is vested in the Board of Directors. The Board of Directors approves all significant agreements between the Fund and persons or companies furnishing services to the Fund. The day-to-day operation of the Fund is delegated to the officers of the Fund, LMPFA, the Subadviser, the Allocation Subadviser and Western Asset Limited, subject always to the investment objectives, restrictions and policies of the Fund and to the general supervision of the Board of Directors. Certain Directors and officers of the Fund are affiliated with Legg Mason, the parent corporation of LMPFA, the Subadviser and Western Asset Limited. All of the Fund's executive officers hold similar offices with some or all of the other funds advised by LMPFA.

Manager

Legg Mason Partners Fund Advisor, LLC, located at 620 Eighth Avenue, New York, New York 10018, serves as the Fund's investment manager. LMPFA is a registered investment adviser and will provide administrative and management services to the Fund. As of December 31, 2009, LMPFA's total assets under management were approximately $189 billion. LMPFA is a wholly-owned subsidiary of Legg Mason. Legg Mason is a global asset management firm. As of December 31, 2009, Legg Mason's asset management operation had aggregate assets under management of approximately $682 billion.

The Subadviser

Western Asset Management Company, located at 385 East Colorado Boulevard, Pasadena, California 91101, serves as the Fund's Subadviser. The Subadviser, a wholly-owned subsidiary of Legg Mason, is a registered investment adviser and will have day-to-day responsibility for managing the Fund's direct investments in MBS and other permitted investments, subject to the supervision of the Fund's Board of Directors and LMPFA. At the direction of the Allocation Subadviser, the Subadviser may manage assets that the Allocation Subadviser has determined to commit to the Feeder Fund, but have not yet been called by the Feeder Fund. Assets, including investment income, that are distributed from the Feeder Fund to the Fund but are not distributed to Common Stockholders will be managed by the Subadviser.

As of December 31, 2009, the Subadviser and its investment advisory affiliates over which the Subadviser has operational responsibility, or its supervised affiliates, had approximately $482 billion in assets under management. As of December 31, 2009, Western Asset had a total of $46.8 billion in MBS, of which $17.1 billion was invested in non-agency RMBS, $2.6 billion in CMBS, and $27.1 billion in agency RMBS.

On July 8, 2009, the U.S. Department of the Treasury publicly announced that the Western Asset, in a joint venture with The RLJ Companies, was selected as one of nine pre-qualified asset managers under the PPIP. The joint venture will serve as general partner of the Feeder Fund and the Master Fund and will be responsible for the administrative affairs of each, but will not make any investment decisions. Western Asset will serve as the investment manager of the Feeder Fund and the Master Fund and will be solely responsible for managing all aspects of the Master Fund's investment and borrowing activities.

The RLJ Companies, founded by Robert L. Johnson, owner of the NBA Charlotte Bobcats and founder of Black Entertainment Television, is a diverse portfolio of companies in the financial services, asset management, real estate, hospitality, professional sports, film production and gaming industries. Headquartered in Bethesda, Maryland, The RLJ Companies also has operations in Charlotte, North Carolina; Los Angeles, California; Orlando, Florida; Little Rock, Arkansas; and San Juan, Puerto Rico.

RLJ Western Asset Management, LLC, an affiliate of Western Asset, is the general partner to the Feeder Fund and the Master Fund.

However, investors should be aware that the investments made by the Fund and the results achieved by the Fund at any given time are not expected to be the same as those made by other funds for which Western Asset acts as investment adviser, including funds with names, investment objectives and policies similar to the Fund.

Non-U.S. Subadviser

In connection with the Subadviser's service to the Fund, Western Asset Limited will provide certain subadvisory services pursuant to the Western Limited Subadvisory Agreement. Western Asset Limited was founded in 1984 and has offices at 10 Exchange Square, Primrose Street, London EC2A2EN.

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Western Asset Limited is a corporation organized under the laws of England and is registered under the Investment Advisers Act of 1940, as amended, and has irrevocably designated the Secretary of the SEC, as its agent to accept service of process in any suit, action or proceeding to enforce the provisions of U.S. securities laws. There can be no assurance that Western Asset Limited will have any assets in the United States that could be attached in connection with any action, suit or proceeding. In addition, it may not be possible to enforce judgments of U.S. courts or liabilities in original actions predicated upon civil liability provisions of U.S. law in foreign courts against Western Asset Limited. Furthermore, there can be no assurance that such foreign courts would enforce, in original actions, liabilities against Western Asset Limited predicated solely upon the federal securities laws.

Western Asset Limited is generally responsible for managing investments denominated in currencies other than U.S. dollars, including the related portions of the Subadviser' broader portfolios, as well as servicing these relationships. Western Asset Limited undertakes investment-related activities including investment management, research and analysis and securities settlement.

While the Subadviser will remain ultimately responsible for investment decisions relating to the Fund's portfolio, Western Asset Limited will provide certain subadvisory services to the Fund relating to currency transactions and investments in non-U.S. dollar-denominated securities and related foreign currency instruments.

Western Asset Limited is a registered investment adviser and is an affiliate of Legg Mason, LMPFA and the Subadviser.

The Allocation Subadviser

Wilshire Associates Incorporated, located at 1299 Ocean Avenue, Suite 700, Santa Monica, California, 90401, serves as the Fund's Allocation Subadviser. The Allocation Subadviser is a registered investment adviser and will be responsible for determining whether and to what extent the Fund will invest in the Feeder Fund and to provide certain ongoing monitoring and reporting services with respect to such investment, subject to the supervision of the Fund's Board of Directors.

Investment Management Agreement and Subadvisory Agreements

Investment Management Agreement

Under the Fund's management agreement with LMPFA (the "Investment Management Agreement"), subject to the supervision and direction of the Fund's Board, LMPFA is delegated the responsibility of managing the Fund's portfolio in accordance with the Fund's stated investment objectives and policies, making investment decisions for the Fund and placing orders to purchase and sell securities. LMPFA performs administrative and management services necessary for the operation of the Fund, such as (1) supervising the overall administration of the Fund, including negotiation of contracts and fees with and the monitoring of performance and billings of the Fund's transfer agent, stockholder servicing agents, custodian and other independent contractors or agents; (2) providing certain compliance, Fund accounting, regulatory reporting and tax reporting services; (3) preparing or participating in the preparation of materials for the Fund's Board of Directors, registration statements, proxy statements and reports and other communications to stockholders; (4) maintaining the Fund's existence and (5) maintaining the registration and qualification of the Fund's shares under federal and (if required) state laws.

LMPFA also provides the office space, facilities, equipment and personnel necessary to perform the following services for the Fund: SEC compliance, including record keeping, reporting requirements and registration statements and proxies; supervision of Fund operations, including coordination of functions of the transfer agent, custodian, accountants, counsel and other parties performing services or operational functions for the Fund; and certain administrative and clerical services, including certain accounting services and maintenance of certain books and records.

The Investment Management Agreement continue in effect, unless otherwise terminated, until , 2012, and then will continue from year to year provided such continuance is specifically approved at least annually (a) by the Fund's Board of Directors or by a majority of the outstanding voting securities of the Fund (as defined in the 1940 Act) and (b) in either event, by a majority of the Directors of the Fund who are not "interested persons" of the Fund within the meaning of Section 2(a)(19) of the 1940 Act (the "Independent Directors") with such Independent Directors casting votes in person at a meeting called for such purpose. The Investment Management Agreement provides that LMPFA may render services to others. The Investment Management Agreement is terminable without penalty on not more than 60 days' nor less than 30 days' written notice by the Fund when authorized either by a vote of holders of shares representing a majority of the voting power of the

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outstanding voting securities of the Fund (as defined in the 1940 Act) or by a vote of a majority of the Fund's Directors, or by LMPFA on not less than 90 days' written notice, and will automatically terminate in the event of its assignment. The Investment Management Agreement provides that neither LMPFA nor its personnel or affiliates shall be liable for any error of judgment or mistake of law or for any loss arising out of any investment or for any act or omission in the execution of security transactions for the Fund, except for willful misfeasance, bad faith or gross negligence or reckless disregard of its or their obligations and duties.

Other than the cash management services it provides for certain equity funds, LMPFA does not provide day-to-day portfolio management services. Rather, portfolio management for the Fund is provided by the Subadviser.

Western Asset Subadvisory Agreement

The Subadviser provides services to the Fund pursuant to a subadvisory agreement between LMPFA and the Subadviser (the "Subadvisory Agreement"). Under the Subadvisory Agreement, subject to the supervision and direction of the Fund's Board of Directors and LMPFA, the Subadviser will manage the Fund's portfolio in accordance with the Fund's investment objectives and policies, make investment decisions for the Fund, place orders to purchase and sell securities, and employ professional portfolio managers and securities analysts who provide research services to the Fund.

The Subadvisory Agreement will continue in effect, unless otherwise terminated, until , 2012 and then will continue from year to year provided such continuance is specifically approved at least annually (a) by the Board of Directors or by a majority of the outstanding voting securities of the Fund (as defined in the 1940 Act), and (b) in either event, by a majority of the Independent Directors with such Independent Directors casting votes in person at a meeting called for such purpose. The Board of Directors or a majority of the outstanding voting securities of the Fund (as defined in the 1940 Act) may terminate the Subadvisory Agreement without penalty, in each case on not more than 60 days' nor less than 30 days' written notice to the Subadviser. The Subadviser may terminate the subadvisory agreement on 90 days' written notice to the Fund and LMPFA. LMPFA and the Subadviser may terminate the Subadvisory Agreement upon their mutual written consent. The Subadvisory Agreement will terminate automatically in the event of its assignment.

Western Limited Subadvisory Agreement

Western Asset Limited provides services to the Fund pursuant to a subadvisory agreement between Western Asset Limited and the Subadviser. The Western Limited Subadvisory Agreement provides that, subject to the supervision and direction of the Fund's Board of Directors and LMPFA, Western Asset Limited will manage the Fund's portfolio in accordance with the Fund's investment objectives and policies, make investment decisions for the Fund, place orders to purchase and sell securities and employ professional portfolio managers and securities analysts who provide research services to the Fund.

The Western Limited Subadvisory Agreement will continue in effect, unless otherwise terminated, until , 2012, and then will continue from year to year provided such continuance is specifically approved at least annually (a) by the Board of Directors or by a majority of the outstanding voting securities of the Fund (as defined in the 1940 Act), and (b) in either event, by a majority of the Independent Directors with such Independent Directors casting votes in person at a meeting called for such purpose. The Board of Directors or a majority of the outstanding voting securities of the Fund (as defined in the 1940 Act) may terminate the Western Limited Subadvisory Agreement without penalty, in each case on not more than 60 days' nor less than 30 days' written notice to Western Asset Limited. Western Asset Limited may terminate the Western Limited Subadvisory Agreement on 90 days' written notice to the Fund and the Subadviser. The Subadviser and Western Asset Limited may terminate the Western Limited Subadvisory Agreement upon their mutual written consent. The Western Limited Subadvisory Agreement will terminate automatically in the event of its assignment.

The Allocation Subadvisory Agreement

The Allocation Subadviser provides services to the Fund pursuant to a subadvisory agreement between Wilshire Associates Incorporated and the Fund (the "Allocation Subadvisory Agreement"). The Allocation Subadvisory Agreement provides that, subject to the supervision and direction of the Fund's Board of Directors, the Allocation Subadviser will determine whether and to what extent the Fund will invest in the Feeder Fund and to provide certain ongoing monitoring and reporting services with respect to such investment.

The Allocation Subadvisory Agreement will continue in effect, unless otherwise terminated, until November 30, 2011. Thereafter, if not terminated, the Allocation Subadvisory Agreement will continue in effect

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so long as such continuance is specifically approved (i) by the Fund's Board of Directors or (ii) by a vote of a majority of the outstanding voting securities of the Fund (as defined in the 1940 Act), provided that in either event the continuance is also approved by a majority of the Independent Directors, by vote cast in person at a meeting called for the purpose of voting on such approval. Thereafter, unless sooner terminated, the Allocation Subadvisory Agreement shall continue in effect until November 30, 2012 so long as the Allocation Subadvisory Agreement has been approved by the Fund's Board of Directors and by the voting securities of the Fund (as defined in the 1940 Act) in accordance with the requirements of the 1940 Act. Notwithstanding any of the foregoing, if the Fund's Board of Directors, in accordance with the requirements of the 1940 Act, should determine to approve the continuance of the Allocation Subadvisory Agreement past November 30, 2012, the term of the Allocation Subadvisory Agreement will be extended in accordance with such determination.

The Board of Directors or a majority of the outstanding voting securities of the Fund (as defined in the 1940 Act) may terminate the Allocation Subadvisory Agreement without penalty, in each case on not more than 60 days' nor less than 30 days' written notice to the Allocation Subadviser. The Allocation Subadviser may terminate the Allocation Subadvisory Agreement on 90 days' written notice to the Fund. The Fund and the Allocation Subadviser may terminate the Allocation Subadvisory Agreement upon their mutual written consent. The Allocation Subadvisory Agreement will terminate automatically in the event of its assignment.

Advisory Fees

For its services, the Fund has agreed to pay LMPFA an annual fee, payable monthly, in an amount equal to 1.0 % of the Fund's average daily Managed Assets. The Fund will pay all of its offering expenses up to and including $.04 per share of Common Stock. LMPFA has also agreed to pay (i) all of the Fund's organizational expenses and (ii) offering expenses of the Fund (other than the sales load) to the extent offering expenses exceed $.04 per share. The Fund's management fee and other expenses are borne by the stockholders.

The Subadviser will receive an annual subadvisory fee from LMPFA, payable monthly, in an amount equal to 70 % of the management fee paid to LMPFA. No advisory fee will be paid by the Fund directly to the Subadviser.

The Subadviser will pay Western Asset Limited a fee for its services at no additional expense to the Fund. Western Asset Limited will receive a fee from Western Asset, payable monthly, in an amount equal to an annual rate of .70 % of the Fund's daily Managed Assets related to the Fund's assets that the Subadviser allocates to Western Asset Limited to manage.

The Allocation Subadviser will receive an annual fee, payable monthly, in an amount equal to .05 % of the Fund's average daily Managed Assets (the "Allocation Subadvisory Fee"). Pursuant to a separate compensation agreement between LMPFA and the Allocation Subadviser, LMPFA has agreed to ensure that the Allocation Subadvisory Fee payable to the Allocation Subadviser will be no less than a minimum amount of $100,000 per year for each year during which the Allocation Subadvisory Agreement remains in effect. Any difference between the Allocation Subadvisory Fee otherwise payable and such minimum amount will be paid to the Allocation Subadviser by LMPFA (and not the Fund).

The basis for the Board of Directors' initial approval of the Investment Management Agreement, Subadvisory Agreement, Western Limited Subadvisory Agreement and Allocation Subadvisory Agreement will be provided in the Fund's initial stockholder report. The basis for subsequent continuations of such agreements will be provided in annual or semi-annual reports to stockholders for the periods during which such continuations occur.

Subadviser Philosophy

In recent years, adverse changes in financial market conditions have required a deleveraging of the entire global financial system and caused the forced sale of large quantities of mortgage-related and other financial assets, resulting in a significant contraction in market liquidity for mortgages and mortgage-related assets. This illiquidity has negatively affected both the terms and availability of financing for most mortgage-related assets, including non-agency RMBS and CMBS, and has generally resulted in mortgage-related assets trading at significantly lower prices compared to prior periods. The recent period has also been characterized by an almost across the board downward movement in non-agency RMBS, CMBS and ABS valuations and correspondingly higher yields to compensate investors for the higher risks associated with owning these assets. The Fund believes that the current distressed conditions in the financial markets present attractive investment opportunities.

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The Subadviser's objective for fixed income management is to provide clients with diversified, tightly controlled, value-oriented portfolios. The Subadviser's management style emphasizes the use of multiple strategies and active sector rotation and issue selection. This philosophy is implemented through uniform application of the following key strategic points:

Integrated Team Approach

The Subadviser's fixed income discipline emphasizes a team approach that unites groups of specialists dedicated to different market sectors. A team of investment professionals at the Subadviser will have daily responsibility for the management of the portfolio and for the implementation of the investment process. The investment responsibilities of each sector group are distinct, yet results are derived from the constant interaction that unites the specialty groups into a cohesive investment management team. The sector teams are comprised of the Subadviser's senior portfolio managers, research analysts, and an in-house economist who are highly skilled and experienced in all major areas of the fixed income market. They exchange views on a daily basis and meet more formally twice each month to review the Subadviser's economic outlook and investment strategy. This structure seeks to ensure that client portfolios benefit from a consensus that draws on the expertise of all team members.

Subadviser Investment Process

The strategic goal at the Subadviser is to add value to client portfolios while adhering to a disciplined risk control process. The portfolio construction process begins with the Subadviser's view regarding the global macroeconomic environment as determined by the firm's senior portfolio managers. The Fund's investment management team, who have daily responsibility for the management of the portfolio, exercise their investment discretion with the benefit of this macroeconomic viewpoint. The Subadviser's investment philosophy combines traditional analysis with innovative technology applied to all sectors of the market. The Subadviser believes inefficiencies exist in the fixed income markets and attempts to add incremental value by exploiting these inefficiencies across all eligible market sectors. The Subadviser's non-agency MBS and CMBS investment processes are described below.

A key element of the non-agency RMBS investment process is the forecast of expected losses due to defaults on the underlying non-agency RMBS loan collateral. The level of losses is dependent on the quantity of loans which default and the loss severity upon liquidation of defaulted loans. The Subadviser has developed a number of proprietary tools to analyze residential mortgage loan defaults and loss severities that combine loan level characteristics with zip-code level data, such as unemployment rates, and growth rates for incomes, house prices, populations, and housing supply, to project home price levels and loan and security performance. These tools encompass home price models, default models, and loan loss severity models. When projecting future performance, many assumptions have to be made. The Subadviser uses in-house quantitative research from loan level data to project mortgage pool cash flows, analyze security structures, and ultimately assess the risk in its RMBS positions. The Subadviser also makes qualitative adjustments to reflect the current state of the housing market, securities market liquidity, and potential implications of policy changes and macroeconomic conditions.

The Subadviser's CMBS investment process is enhanced and supported by proprietary performance models that combine property level data with commercial real estate market factors, including metropolitan specific economic growth rates, property lease trends and property usage trends, to project loan and security performance. The Subadviser invests across the capital structure in large diverse conduit deals, single borrower and single property deals as well one-off deals such as credit tenant lease transactions. The level of analysis for different securities will vary based on the risk profile of the investment being evaluated. To manage risk appropriately for troubled CMBS, the Subadviser evaluates the potential for losses based on both the structure of the security or loan, as well as how the cash flows and values of the underlying properties will contribute to potential defaults and ultimate recoveries.

These non-agency RMBS and CMBS models are continuously back-tested and updated to reflect current economic and real estate market data. The non-agency MBS and CMBS investment processes will help the Subadviser identify securities with attractive relative value across the various sectors of the mortgage markets, including undervalued distressed assets. On a monthly basis, multiple stress analyses will be run to monitor collateral performance, evaluate relative value and serve as the basis for asset dispositions. In making investment decisions, the Subadviser will incorporate its views on the economic environment and the outlook for the mortgage markets, including relative valuation, supply and demand trends, the level of interest rates, the

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shape of the yield curve, prepayment rates, financing and liquidity, commercial and residential real estate prices, delinquencies, default rates, loss severities, and the recovery of various segments of the economy.

Additional information about the portfolio managers' compensation, other accounts managed by them and other information is provided in the SAI.

Control Persons

Prior to the public offering of shares of Common Stock, Legg Mason will purchase shares of Common Stock from the Fund in an amount satisfying the net worth requirements of Section 14(a) of the 1940 Act. Legg Mason may be deemed to control the Fund until such time as it owns less than 25 % of the outstanding shares of Common Stock, which is expected to occur as of the completion of the offering of Common Stock.

NET ASSET VALUE

The Fund determines the net asset value of its Common Stock on each day the NYSE is open for business, as of the close of the customary trading session (normally 4:00 p.m. Eastern Time), or any earlier closing time that day. The Fund determines the net asset value per share of Common Stock by dividing the value of the Fund's securities, cash and other assets (including interest accrued but not collected) less all its liabilities (including accrued expenses, the liquidation preference of any outstanding preferred stock and dividends payable) by the total number of shares of Common Stock outstanding. Securities are valued at the mean between the last quoted bid and asked prices provided by an independent pricing service that are based on transactions in corporate obligations, quotations from corporate bond dealers, market transactions in comparable securities and various other relationships between securities. The Fund values portfolio securities for which market quotations are readily available at the last reported sales price or official closing price on the primary market or exchange on which they trade. Under the Fund's valuation policies and procedures, which were adopted by the Board, the Fund's short-term investments are valued at amortized cost when the security has 60 days or less to maturity. Determination of the Common Stock's net asset value is made in accordance with GAAP.

The Fund values all other securities and assets at their fair value. If events occur that materially affect the value of a security between the time trading ends on the security and the close of the customary trading session of the NYSE, the Fund may value the security at its fair value as determined in good faith by or under the

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supervision of the Board of Directors of the Fund. The effect of using fair value pricing is that the Common Stock's net asset value will be subject to the judgment of the Board of Directors or its designee instead of being determined by the market.

Any swap transaction that the Fund enters into may, depending on the applicable interest rate environment, have a positive or negative value for purposes of calculating net asset value. Any cap transaction that the Fund enters into may, depending on the applicable interest rate environment, have no value or a positive value. In addition, accrued payments to the Fund under such transactions will be assets of the Fund and accrued payments by the Fund will be liabilities of the Fund.

Based on current market conditions, the Allocation Subadviser anticipates that the Fund will invest approximately 25% to 40% of the net proceeds of this offering in the Feeder Fund, which will in turn invest in the Master Fund. The Treasury has mandated that MBS held in any public-private investment fund, including the Master Fund, be valued pursuant to a specific Treasury-approved pricing process. This process is substantially similar to the process used to value the Fund's direct investments, described above. Accordingly, the Fund does not anticipate material differences between the values determined by the Fund's valuation process and the valuation process employed by the Master Fund. On a regular basis, the Fund will obtain information from the Valuation Agent and Western Asset to enable the Fund to monitor any price differences and to take appropriate actions if any material price differences are detected.

DISTRIBUTIONS

The Fund expects to make monthly distributions in cash to Common Stockholders, commencing in approximately 90 days after the completion of this offering, depending on market conditions. The Fund's distributions are expected to be composed of net investment income. In addition, the Fund may distribute, at least annually, any net realized capital gains to Common Stockholders.

The Fund may employ a managed distribution policy in order to provide Common Stockholders an opportunity to receive potential realized capital gains and/or principal repayments on its RMBS and CMBS portfolio over time through monthly distributions rather than in potentially large lump sum payments. While the major portion of the Fund's distributions are projected to be sourced from the Fund's net investment income, the Fund believes there is a potential for substantial, additional capital appreciation in addition to the Fund's net investment income over the term of the Fund. Such potential additional returns will depend on a variety of factors, including, among others: the discount pricing obtained in acquiring portfolio securities, the recoveries from the underlying mortgages and the securities currently in default, the actual default losses and prepayment rates of the underlying mortgage pools going forward, the cost of leverage, and the payments on the warrants made by the Master Fund to the Treasury.

If, for any monthly distribution, net investment income and net realized capital gains were less than the amount of the distribution, the difference may be distributed from the Fund's assets in the form of a return of capital which is applied against and reduces the stockholder's basis in his or her shares of Common Stock. A "return of capital" merely represents a partial return of your original investment and does not represent a gain on the Fund's investments. When you sell your shares in the Fund, the amount, if any, by which your sales price exceeds your basis in the Fund's shares is gain subject to tax. Because a return of capital reduces your basis in the shares, it will increase the amount of your gain or decrease the amount of your loss when you sell the shares, all other things being equal. To the extent that the amount of any such distribution exceeds the stockholder's basis in his or her shares, the excess will be treated by the stockholder as gain from a sale or exchange of the Common Stock. In addition, in order to make such distributions, the Fund might have to sell a portion of its investment portfolio at a time when independent investment judgment might not dictate such action. The Fund's final distribution for each calendar year may include any remaining net investment income and net realized capital gains undistributed during the year. The Fund's actual financial performance will likely vary significantly from month-to-month and from year-to-year, and there may be extended periods of up to several years when the distribution rate will exceed the Fund's actual total returns. The Fund's projected or actual distribution rate is not a prediction of what the Fund's actual total returns will be over any specific future period.

As portfolio and market conditions change, the rate of distributions on the Common Stock and the Fund's distribution policy could change. To the extent that the total return of the Fund's overall strategy exceeds the distribution rate for an extended period, the Fund may be in a position to increase the distribution rate or distribute supplemental amounts to Common Stockholders. Conversely, if the total return of the Fund's overall strategy is less than the distribution rate for an extended period of time, the Fund will effectively be drawing upon its net asset value to meet payments prescribed by its distribution policy. For tax purposes, such

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distributions by the Fund may consist in part of a return of capital to Common Stockholders. The exact tax characteristics of the Fund's distributions will not be known until after the Fund's fiscal year-end. Common Stockholders should not confuse a return of capital distribution with "dividend yield" or "total return."

The ability of the Fund to make distributions to Common Stockholders is dependent, in part, upon the distributions the Master Fund makes to the Feeder Fund and the distributions the Feeder Fund in turn makes to the Fund.

During the Master Fund Investment Period, proceeds otherwise distributable to the Master Fund's partners (including, indirectly, the Fund) may be retained and re-invested by the General Partner of the Master Fund. Subject to the Master Fund's distribution restrictions (including required prepayments of principal on Treasury Debt Financing), the Master Fund is required to distribute any income earned from its investments, including principal paydowns, interest and dividend income and any net proceeds realized from dispositions of investments, no later than 30 calendar days following the end of each fiscal quarter in which such income is received by the Master Fund. However, the General Partner will be allowed to withhold from any distributions amounts necessary to (i) create reasonable reserves for Master Fund expenses, (ii) create reasonable reserves for repayment of indebtedness and (iii) make investments as permitted by PPIP (including with respect to re-investment of investment proceeds during the Master Fund Investment Period). Generally, distribution of income by the Master Fund will initially be made to the partners in the Master Fund, which include the Treasury and the Feeder Fund, in proportion to each of their respective percentage interests in the Master Fund.

The General Partner of the Feeder Fund will determine the amount of funds available for distribution to its investors, including the Fund, after applying any funds needed to pay expenses of the Feeder Fund (including the Feeder Fund's share of certain expenses of the Master Fund) or for any reserves established by the Feeder Fund. During the term of any Treasury Debt Financing loan received through PPIP, the Master Fund will be subject to an asset coverage test (and, under certain circumstances, a leverage ratio test), each of which must be satisfied on a pro forma basis. Failure to satisfy the asset coverage test at specified levels restricts the ability of the Master Fund (and consequently the Fund) to make distributions. See "Risks—Special Risks Relating to PPIP—Risks Related to PPIP Distributions; Asset Coverage Requirement and Leverage Ratio Risk."

At the same time that it pays a monthly distribution, the Fund will send written notices to Common Stockholders of the estimated sources and tax characteristics of the Fund's distributions (i.e., what percentage of the distributions is estimated to constitute ordinary income, short-term capital gains, long-term capital gains, and/or a non-taxable return of capital) on a year-to-date basis, in compliance with a federal securities law requirement that any fund paying a distribution from sources other than net investment income disclose to Common Stockholders the respective portion attributable to such other sources. These estimates may be based on certain assumptions about the Fund's expected investment returns and the realization of net gains, if any, over the remaining course of the year. These estimates may, and likely will, vary over time based on the activities of the Fund and changes in the value of portfolio investments. The Fund expects that it will provide this type of information primarily on a tax basis, instead of on a GAAP basis, because experience has shown that fund stockholders are most concerned about the tax character of their distributions, and because the Fund expects that the distributions' tax characteristics will fairly reflect the economic basis of the Fund's distributions and returns. The final determination of the source and tax characteristics of all distributions will be made after December 31 in each year, and reported to Common Stockholders on Form 1099-DIV early the following year.

As explained more fully below in "Tax Matters," the Fund intends to make distributions to comply with the requirements of the Code and to avoid paying U.S. federal income taxes and, if practicable, excise taxes, on undistributed taxable income. However, in response to differences in the timing between the recognition of taxable income and the actual receipt of cash, as well as limits imposed by the Treasury Debt Financing on the Master Fund's ability to make distributions to the Feeder Fund and in turn the ability of the Feeder Fund to make distributions to the Fund, the Fund may elect to meet the distribution requirements under the Code by selling assets or drawing on a standby credit facility or by issuing a portion of dividends in the form of Common Stock in lieu of cash. See "Risks—Risks Related to the Fund—Tax Risks" and "—Special Risks Related to PPIP— Risks Relating to PPIP Distributions; Asset Coverage Requirement and Leverage Ratio Risk."

The Fund may distribute taxable dividends that are payable in cash and the Fund's Common Stock at the election of each Common Stockholder. On December 23, 2009, the IRS issued IRS Revenue Procedure 2010-12 that temporarily allows a regulated investment company that is traded on an established securities market to distribute its own stock as a dividend for the purpose of fulfilling its distribution requirements. Pursuant to this revenue procedure, a regulated investment company may treat a distribution of its own shares as fulfilling its

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distribution requirements if (i) the distribution is declared with respect to a taxable year ending on or before December 31, 2011 and (ii) each Common Stockholder may elect to receive his or her entire distribution in either cash or shares of the regulated investment company subject to a limitation on the aggregate amount of cash to be distributed to all Common Stockholders, which must be at least 10 % of the aggregate declared distribution. If too many Common Stockholders elect to receive cash, each Common Stockholder electing to receive cash will receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any Common Stockholder electing to receive cash receive less than 10 % of his or her entire distribution in cash. In such case, for U.S. federal income tax purposes, the amount of the dividend paid in stock (i) will be equal to the amount of cash that could have been received instead of stock, unless the regulated investment company issues new shares that are trading at or above net asset value, and (ii) will be equal to the amount of the fair market value of the distributed shares if the regulated investment company issues new shares that are trading at or above net asset value. See "Tax Matters" for tax consequences to Common Stockholders upon receipt of such dividends.

Revenue Procedure 2010-12 is temporary in that it does not apply to dividends declared with respect to taxable years ending after December 31, 2011. It is uncertain whether, and no assurances can be given that, the IRS will extend such guidance for taxable years ending after December 31, 2011. The IRS has also issued (and where Revenue Procedure 2010-12 is not currently applicable, the IRS continues to issue) private letter rulings on cash/stock dividends paid by regulated investment companies and real estate investment trusts using a 20 % cash standard (instead of the 10 % cash standard of Revenue Procedure 2010-12) if certain requirements are satisfied. While such private letter rulings are not official precedent, they may reveal the IRS's interpretation of the tax laws. No assurances can be given that the IRS will not discontinue or adversely alter such ruling policy. The Fund has not yet decided whether to pay a portion of any future dividend in its Common Stock (whether pursuant to Revenue Procedure 2010-12 or otherwise). Moreover, no assurances can be given that the Fund will be able to pay any such dividend in cash and Common Stock.

At least annually, the Fund may elect to retain rather than distribute all or a portion of any net capital gain (which is the excess of net long-term capital gain over net short-term capital loss) otherwise allocable to Common Stockholders and pay U.S. federal income tax on the retained gain. As provided under federal tax law, Common Stockholders of record as of the end of the Fund's taxable year will include their attributable share of the retained gain in their income for the year as a long-term capital gain, and will be entitled to an income tax credit or refund for the tax deemed paid on their behalf by the Fund. The Fund may treat the cash value of tax credit and refund amounts in connection with retained capital gains as a substitute for equivalent cash distributions.

The Fund reserves the right to change its distribution policy and the basis for establishing the rate of its monthly distributions at any time and may do so without prior notice to Common Stockholders.

DIVIDEND REINVESTMENT PLAN

Unless you elect to receive distributions in cash (i.e., opt-out), all dividends, including any capital gain dividends, on your Common Stock will be automatically reinvested by American Stock Transfer & Trust Company LLC, as agent for the stockholders (the "Plan Agent"), in additional shares of Common Stock under the Fund's Dividend Reinvestment Plan (the "Plan"). You may elect not to participate in the Plan by contacting the Plan Agent. If you do not participate, you will receive all cash distributions paid by check mailed directly to you by American Stock Transfer & Trust Company LLC, as dividend paying agent.

If you participate in the Plan, the number of shares of Common Stock you will receive will be determined as follows:

(1)  If the market price of the Common Stock on the record date (or, if the record date is not a NYSE trading day, the immediately preceding trading day) for determining stockholders eligible to receive the relevant dividend or distribution (the "determination date") is equal to or exceeds 98 % of the net asset value per share of the Common Stock, the Fund will issue new Common Stock at a price equal to the greater of

(a)  98 % of the net asset value per share at the close of trading on the NYSE on the determination date or

(b)  95 % of the market price per share of the Common Stock on the determination date.

(2)  If 98 % of the net asset value per share of the Common Stock exceeds the market price of the Common Stock on the determination date, the Plan Agent will receive the dividend or distribution in cash and

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will buy Common Stock in the open market, on the NYSE or elsewhere, for your account as soon as practicable commencing on the trading day following the determination date and terminating no later than the earlier of (a) 30 days after the dividend or distribution payment date, or (b) the record date for the next succeeding dividend or distribution to be made to the stockholders; except when necessary to comply with applicable provisions of the federal securities laws. If during this period: (i) the market price rises so that it equals or exceeds 98 % of the net asset value per share of the Common Stock at the close of trading on the NYSE on the determination date before the Plan Agent has completed the open market purchases or (ii) if the Plan Agent is unable to invest the full amount eligible to be reinvested in open market purchases, the Plan Agent will cease purchasing Common Stock in the open market and the Fund shall issue the remaining Common Stock at a price per share equal to the greater of (a) 98 % of the net asset value per share at the close of trading on the NYSE on the determination date or (b) 95 % of the then current market price per share.

Common Stock in your account will be held by the Plan Agent in non-certificated form. Any proxy you receive will include all shares of Common Stock you have received under the Plan.

You may withdraw from the Plan (i.e., opt-out) by notifying the Plan Agent in writing at P.O. Box 922, Wall Street Station, New York, NY 10269-0560 or by calling the Plan Agent at 877-366-6441. Such withdrawal will be effective immediately if notice is received by the Plan Agent not less than ten business days prior to any dividend or distribution record date; otherwise such withdrawal will be effective as soon as practicable after the Plan Agent's investment of the most recently declared dividend or distribution on the Common Stock.

Upon any termination, you will be sent a certificate or certificates for the full number of shares of Common Stock held for you under the Plan and cash for any fractional share of Common Stock. You may elect to notify the Plan Agent in advance of such termination to have the Plan Agent sell part or all of your Common Stock on your behalf. You will be charged a service charge and the Plan Agent is authorized to deduct brokerage charges actually incurred for this transaction from the proceeds.

There is no service charge for reinvestment of your dividends or distributions in Common Stock. However, all participants will pay a pro rata share of brokerage commissions incurred by the Plan Agent when it makes open market purchases. Because all dividends and distributions will be automatically reinvested in additional shares of Common Stock, this allows you to add to your investment through dollar cost averaging, which may lower the average cost of your Common Stock over time. Dollar cost averaging is a technique for lowering the average cost per share over time if the Fund's net asset value declines. While dollar cost averaging has definite advantages, it cannot assure profit or protect against loss in declining markets.

Automatically reinvesting dividends and distributions does not mean that you do not have to pay income taxes due upon receiving dividends and distributions. Investors will be subject to income tax on amounts reinvested under the Plan.

The Fund reserves the right to amend or terminate the Plan if, in the judgment of the Board of Directors, the change is warranted. There is no direct service charge to participants in the Plan; however, the Fund reserves the right to amend the Plan to include a service charge payable by the participants. The Plan may be amended or supplemented by the Fund upon notice in writing mailed to stockholders at least 30 days prior to the record date for the payment of any dividend or distribution by the Fund for which the amendment or supplement is to be effective. Additional information about the Plan and your account may be obtained from the Plan Agent at 6201 15th Avenue, Brooklyn, New York 11219 or by calling the Plan Agent at 877-366-6441.

DESCRIPTION OF SHARES

Common Stock

The Articles authorize the issuance of 100,000,000 shares of Common Stock, par value $.001 per share. All shares of Common Stock have equal rights to the payment of dividends and the distribution of assets upon liquidation. Common Stock will, when issued, be fully paid and non-assessable, and will have no pre-emptive or conversion rights or rights to cumulative voting. The Board of Directors, without stockholder vote, can increase or decrease the aggregate number of shares of Common Stock outstanding and can reclassify any authorized but unissued shares.

The Fund's Common Stock has been approved for listing on the NYSE, subject to notice of issuance. The trading or "ticker" symbol is "DMO." The Fund intends to hold annual meetings of stockholders so long as the

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Common Stock is listed on a national securities exchange and such meetings are required as a condition to such listing. The Fund must continue to meet the NYSE requirements in order for the Common Stock to remain listed.

Net asset value will be reduced immediately following the offering by the amount of the sales load and the offering expenses paid by the Fund up to and including $.04 per share of Common Stock.

Unlike open-end funds, closed-end funds, like the Fund, do not continuously offer shares and do not provide daily redemptions. Rather, if a stockholder determines to buy additional shares of Common Stock or sell shares of Common Stock already held, the stockholder may do so by trading on the NYSE through a broker or otherwise. Shares of closed-end funds may frequently trade on an exchange at prices lower than net asset value.

The market value of the Common Stock may be influenced by such factors as dividend levels (which are in turn affected by expenses), call protection, dividend stability, portfolio credit quality, net asset value, relative demand for and supply of such Common Stock in the market, general market and economic conditions, and other factors beyond the control of the Fund. The Fund cannot assure you that Common Stock will trade at a price equal to or higher than net asset value in the future. The Fund's Common Stock is designed primarily for long-term investors, and investors in Common Stock should not view the Fund as a vehicle for trading purposes. See "Repurchase of Fund Shares."

The Articles provide that the Fund will terminate on or about March 1, 2022. Upon its termination, the Fund will distribute substantially all of its Managed Assets to stockholders, after making appropriate provision for any liabilities of the Fund. Prior to such termination, the Board of Directors of the Fund will consider whether it is in the best interests of stockholders to terminate and liquidate the Fund. If the Board of Directors determines that under the circumstances, termination and liquidation of the Fund on or about March 1, 2022 would not be in the best interests of stockholders, the Board of Directors will call a special meeting of stockholders to consider an appropriate amendment to the Articles. To approve such an amendment, the Articles require either (i) the affirmative vote of at least 75 % of the Board of Directors and at least 75 % of the votes entitled to be cast by stockholders (including Preferred Stockholders, if any) or (ii) the affirmative vote of 75 % of the Continuing Directors and the approval of the holders of a majority of the votes entitled to be cast thereon by stockholders (including Preferred Stockholders, if any).

Each outstanding share of Common Stock entitles the holder to one vote on all matters submitted to a vote of Common Stockholders, including the election of Directors. Except as provided with respect to any other class or series, the Common Stockholders will possess the exclusive voting power. There is no cumulative voting in the election of Directors, which means that the holders of a majority of the outstanding shares of Common Stock can elect all of the Directors then standing for election, and the holders of the remaining shares of Common Stock will not be able to elect any Directors.

Preferred Stock

The Articles provide that the Fund's Board of Directors may classify and issue Preferred Stock with rights as determined by the Board of Directors, by action of the Board of Directors without the approval of the Common Stockholders. Common Stockholders have no preemptive right to purchase any Preferred Stock that might be issued.

The Fund may elect to issue Preferred Stock as part of its leverage strategy. The Fund currently has the ability to issue leverage, which may include Preferred Stock, representing up to 33 ¹ / ₃ % of the Fund's Managed Assets immediately after the leverage is issued. The Board of Directors also reserves the right to authorize the Fund to issue Preferred Stock to the extent permitted by the 1940 Act, which currently limits the aggregate liquidation preference of all outstanding Preferred Stock plus the principal amount of any outstanding leverage consisting of debt to 50 % of the value of the Fund's total assets less liabilities and indebtedness of the Fund (other than leverage consisting of Preferred Stock). However, under current conditions it is unlikely that the Fund will issue Preferred Stock given that most auctions have failed, and the auction market has been largely frozen. Although the terms of any Preferred Stock, including dividend rate, liquidation preference and redemption provisions, will be set forth in the certificate of designation, the Fund believes that it is likely that the liquidation preference, voting rights and redemption provisions of the Preferred Stock may be similar to those stated below.

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Liquidation Preference

In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Fund, the holders of Preferred Stock will be entitled to receive a preferential liquidating distribution, which is expected to equal the original purchase price per Preferred Stock plus accrued and unpaid dividends, whether or not declared, before any distribution of assets is made to Common Stockholders. After payment of the full amount of the liquidating distribution to which they are entitled, the holders of Preferred Stock will not be entitled to any further participation in any distribution of assets by the Fund.

Voting Rights

The 1940 Act requires that the holders of any Preferred Stock, voting separately as a single class, have the right to elect at least two directors at all times. The remaining directors will be elected by holders of Common Stock and Preferred Stock, voting together as a single class. In addition, subject to the prior rights, if any, of the holders of any other class of senior securities outstanding, the holders of any Preferred Stock have the right to elect a majority of the directors of the Fund at any time that two years of dividends on any Preferred Stock are unpaid. The 1940 Act also requires that, in addition to any approval by the stockholders that might otherwise be required, the approval of the holders of a majority of any outstanding Preferred Stock, voting separately as a class, would be required to: (i) adopt any plan of reorganization that would adversely affect the Preferred Stock and (ii) take any action requiring a vote of security holders under Section 13(a) of the 1940 Act, including, among other things, changes in the Fund's subclassification as a closed-end investment company or changes in its fundamental investment restrictions. See "Certain Provisions in the Articles of Incorporation and By-Laws." As a result of these voting rights, the Fund's ability to take any such actions may be impeded to the extent that there are any shares of Preferred Stock outstanding. The Board of Directors presently intends that, except as otherwise indicated in this prospectus and except as otherwise required by applicable law or the Articles, holders of Preferred Stock will have equal voting rights with Common Stockholders (one vote per share, unless otherwise required by the 1940 Act) and will vote together with Common Stockholders as a single class.

The affirmative vote of the holders of a majority of the outstanding Preferred Stock, voting as a separate class, will be required to amend, alter or repeal any of the preferences, rights or powers of holders of Preferred Stock so as to affect materially and adversely such preferences, rights or powers, or to increase or decrease the authorized number of Preferred Stock. The class vote holders of Preferred Stock described above will in each case be in addition to any other vote required to authorize the action in question.

Redemption, Purchase and Sale of Preferred Stock by the Fund

The terms of any Preferred Stock issued are expected to provide that: (i) they are redeemable by the Fund in whole or in part at the original purchase price per share plus accrued dividends per share; (ii) the Fund may tender for or purchase Preferred Stock; and (iii) the Fund may subsequently resell any shares so tendered for or purchased. Any redemption or purchase of Preferred Stock by the Fund will reduce any leverage applicable to the Common Stock, while any resale of shares by the Fund will increase that leverage.

The discussion above describes the possible offering of Preferred Stock by the Fund. If the Board of Directors determines to proceed with such an offering, the terms of the Preferred Stock may be the same as, or different from, the terms described above, subject to applicable law and the Fund's Articles. The Board of Directors, without the approval of the Common Stockholders, may authorize an offering of Preferred Stock or may determine not to authorize such an offering, and may fix the terms of the Preferred Stock to be offered.

CERTAIN PROVISIONS IN THE ARTICLES OF INCORPORATION AND BY-LAWS

The Fund has provisions in its Articles and By-Laws that could have the effect of limiting the ability of other entities or persons to acquire control of the Fund, to cause it to engage in certain transactions or to modify its structure. Commencing with the first annual meeting of stockholders, if there are three or more Directors at that time, the Board of Directors will be divided into three classes, having initial terms of one, two and three years, respectively. At the annual meeting of stockholders in each year thereafter, the term of one class will expire and Directors will be elected to serve in that class for terms of three years. This provision could delay for up to two years the replacement of a majority of the Board of Directors. A Director may be removed from office only for cause and then only by a vote of the holders of at least 75 % of the outstanding Common Stock of the Fund entitled to be cast for the election of Directors.

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The Fund's By-Laws provide that with respect to any annual or special meeting of the stockholders, only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before an annual meeting, the business must be specified in the notice of meeting, brought by or at the direction of the Board of Directors or brought by a stockholder who is entitled to vote at the meeting and who complied with the advance notice procedures of the By-Laws, and it must be a proper subject under applicable law for stockholder action. To be properly brought before a special meeting, the business must be specified in the notice of meeting, brought by or at the direction of the Board of Directors, and it must be a proper subject under applicable law for stockholder action.

The affirmative vote of at least 75 % of the entire Board of Directors is required to authorize the conversion of the Fund from a closed-end to an open-end investment company. Such conversion also requires the affirmative vote of the holders of at least 75 % of the votes entitled to be cast thereon by the stockholders of the Fund unless it is approved by a vote of at least 75 % of the Continuing Directors, in which event such conversion requires the approval of the holders of a majority of the votes entitled to be cast thereon by the stockholders of the Fund. A "Continuing Director" is any member of the Board of Directors of the Fund who (i) is not a person or affiliate of a person, other than an investment company advised by LMPFA, who enters or proposes to enter into a Business Combination (as defined below) with the Fund (an "Interested Party") and (ii) who has been a member of the Board of Directors of the Fund for a period of at least 12 months, or has been a member of the Board of Directors since December 11, 2009, or is a successor of a Continuing Director who is unaffiliated with an Interested Party and is recommended to succeed a Continuing Director by a majority of the Continuing Directors then on the Board of Directors of the Fund. To amend the Articles to change any of the provisions of the first paragraph under this heading, this paragraph or the following paragraph, the Articles require either (i) the affirmative vote of at least 75 % of the entire Board of Directors and at least 75 % of the votes entitled to be cast by stockholders or (ii) the affirmative vote of 75 % of the Continuing Directors and the approval of the holders of a majority of the votes entitled to be cast thereon by stockholders.

The affirmative votes of at least 75 % of the entire Board of Directors and the holders of at least (i) 80 % of the votes entitled to be cast thereon by the stockholders of the Fund and (ii) in the case of a Business Combination (as defined below), 66 ² / ₃ % of the votes entitled to be cast thereon by the stockholders of the Fund other than votes held by an Interested Party who is (or whose affiliate is) a party to a Business Combination or an affiliate or associate of the Interested Party, are required to advise, approve, adopt or authorize any of the following transactions:

(i)  a merger, consolidation or statutory share exchange of the Fund with or into any other person;

(ii)  issuance or transfer by the Fund (in one or a series of transactions in any 12-month period) of any securities of the Fund to any person or entity for cash, securities or other property (or combination thereof) having an aggregate fair market value of $1,000,000 or more, excluding issuances or transfers of debt securities of the Fund, sales of securities of the Fund in connection with a public offering, issuances of securities of the Fund pursuant to a dividend reinvestment plan adopted by the Fund, issuance of securities of the Fund upon the exercise of any stock subscription rights distributed by the Fund and portfolio transactions effected by the Fund in the ordinary course of business;

(iii)  sale, lease, exchange, mortgage, pledge, transfer or other disposition by the Fund (in one or a series of transactions in any 12-month period) to or with any person or entity of any assets of the Fund having an aggregate fair market value of $1,000,000 or more except for portfolio transactions (including pledges of portfolio securities in connection with borrowings) effected by the Fund in the ordinary course of its business (each of the transactions within clauses (i), (ii) and (iii) above being known individually as a "Business Combination");

(iv)  the voluntary liquidation or dissolution of the Fund or an amendment to the Articles to terminate the Fund's existence; or

(v)  unless the 1940 Act or federal law requires a lesser vote, any stockholder proposal as to specific investment decisions made or to be made with respect to the Fund's assets as to which stockholder approval is required under federal or Maryland law.

However, the stockholder vote described above will not be required with respect to the foregoing transactions (other than those set forth in (v) above) if they are approved by a vote of at least 75 % of the Continuing Directors. In that case, if Maryland law requires stockholder approval, the affirmative vote of a majority of votes entitled to be cast thereon shall be required.

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The Articles and By-Laws contain provisions the effect of which is to prevent matters, including nominations of Directors, from being considered at a stockholders' meeting where the Fund has not received notice of the matters generally at least 60 but no more than 90 days prior to the first anniversary of the preceding year's annual meeting.

The Fund has provisions in its Articles and By-Laws that authorize the Fund, to the maximum extent permitted by Maryland law, to indemnify any present or former Director or officer from and against any claim or liability to which that person may become subject or which that person may incur by reason of his or her status as a present or former Director or officer of the Fund and to pay or reimburse their reasonable expenses in advance of final disposition of a proceeding. Pursuant to the By-Laws, absent a court determination that an officer or Director seeking indemnification was not liable on the merits or guilty of willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of his office, the decision by the Fund to indemnify such person will be based upon the reasonable determination of independent counsel or nonparty Independent Directors, after review of the facts, that such officer or director is not guilty of willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of his office.

Reference is made to the Articles and By-Laws of the Fund, on file with the SEC, for the full text of these provisions. These provisions could have the effect of depriving stockholders of an opportunity to sell their Common Stock at a premium over prevailing market prices by discouraging a third party from seeking to obtain control of the Fund in a tender offer or similar transaction. These provisions, however, offer several possible advantages. They may require persons seeking control of the Fund to negotiate with its management regarding the price to be paid for the Common Stock required to obtain such control, they promote continuity and stability and they enhance the Fund's ability to pursue long-term strategies that are consistent with its investment objectives.

Under Maryland law, "business combinations" between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. An interested stockholder is defined as:

•   any person who beneficially owns ten percent or more of the voting power of the corporation's shares; or

•   an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of ten percent or more of the voting power of the then outstanding voting stock of the corporation.

A person is not an interested stockholder under the statute if the board of directors of a corporation approved in advance the transaction by which he otherwise would have become an interested stockholder.

After the five-year prohibition, any business combination between the Maryland corporation and an interested stockholder generally must be recommended by the board of directors of the corporation and approved by the affirmative vote of at least:

•   80 % of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation; and

•   66 ² / ₃ % of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder.

These super-majority vote requirements do not apply if the corporation's common stockholders receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares. The statute permits various exemptions from its provisions, including business combinations that are exempted by the board of directors prior to the time that the interested stockholder becomes an interested stockholder.

The business combination statute may discourage others from trying to acquire control of the Fund and increase the difficulty of consummating any offer.

Maryland law provides that control shares of a Maryland corporation acquired in a control share acquisition have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the

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matter. Shares owned by the acquiror, by officers or by directors who are employees of the corporation are excluded from shares entitled to vote on the matter. Control shares are voting shares of stock which, if aggregated with all other shares of stock owned by the acquiror or in respect of which the acquiror is able to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), would entitle the acquiror to exercise voting power in electing directors within one of the following ranges of voting power:

•   one-tenth or more but less than one-third,

•   one-third or more but less than a majority, or

•   a majority or more of all voting power.

Control shares do not include shares the acquiring person is then entitled to vote as a result of having previously obtained stockholder approval. A control share acquisition means the acquisition of control shares, subject to certain exceptions.

A person who has made or proposes to make a control share acquisition may compel the board of directors of the corporation to call a special meeting of stockholders to be held within 50 days of demand to consider the voting rights of the shares. The right to compel the calling of a special meeting is subject to the satisfaction of certain conditions, including an undertaking to pay the expenses of the meeting. If no request for a meeting is made, the corporation may itself present the question at any stockholders meeting.

If voting rights are not approved at the meeting or if the acquiring person does not deliver an acquiring person statement as required by the statute, then the corporation may redeem for fair value any or all of the control shares, except those for which voting rights have previously been approved. The right of the corporation to redeem control shares is subject to certain conditions and limitations. Fair value is determined, without regard to the absence of voting rights for the control shares, as of the date of the last control share acquisition by the acquiror or of any meeting of stockholders at which the voting rights of the shares are considered and not approved. If voting rights for control shares are approved at a stockholders meeting and the acquiror becomes entitled to vote a majority of the shares entitled to vote, all other stockholders may exercise appraisal rights. The fair value of the shares as determined for purposes of appraisal rights may not be less than the highest price per share paid by the acquiror in the control share acquisition.

The control share acquisition statute does not apply (a) to shares acquired in a merger, consolidation or share exchange if the corporation is a party to the transaction, or (b) to acquisitions approved or exempted by the charter or by-laws of the corporation.

The control share acquisition statute may discourage others from trying to acquire control of the Fund and increase the difficulty of consummating any offer.

REPURCHASE OF FUND SHARES

The Fund is a closed-end investment company, and as such the Common Stockholders will not have the right to cause the Fund to redeem their Common Stock. Instead, liquidity will be provided through trading in the open market. Notice is hereby given in accordance with Section 23(c) of the 1940 Act that the Fund may purchase at market prices from time to time shares of its Common Stock in the open market but is under no obligation to do so.

TAX MATTERS

The discussion below and certain disclosure in the SAI provide general tax information related to an investment in the Fund's Common Stock. Because tax laws are complex and often change, Common Stockholders should consult their tax advisors about the tax consequences of an investment in the Fund. Unless otherwise noted, the following tax discussion applies only to U.S. stockholders that hold the Common Stock as a capital asset. A U.S. stockholder is an individual who is a citizen or resident of the United States, a U.S. domestic corporation, or any other person that is subject to U.S. federal income tax on a net income basis in respect of an investment in the Common Stock. No private letter ruling has been sought from the IRS regarding any matter discussed herein. Except for the opinion described below concerning the asset diversification test, counsel to the Fund has not rendered and will not render any legal opinion to the Fund regarding any tax consequences relating to the Fund or an investment in the Fund. No assurance can be given that the IRS would not assert, or that a court would not sustain, a position contrary to any of the tax aspects set forth below.

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The Fund intends to elect to be treated and to qualify each taxable year as a regulated investment company (a "RIC") under Subchapter M of the Code. To qualify under Subchapter M for the favorable tax treatment accorded to RICs, the Fund must, among other things: (1) distribute to its stockholders in each taxable year at least 90 % of its investment company taxable income (as that term is defined in the Code, but without regard to the deduction for dividends paid); (2) derive in each taxable year at least 90 % of its gross income from (a) dividends, interest, payments with respect to certain securities loans, and gains from the sale or other disposition of stock, securities or foreign currencies, or other income (including but not limited to gain from options, futures and forward contracts) derived with respect to its business of investing in such stock, securities or foreign currencies; and (b) net income derived from interests in certain publicly traded partnerships that are treated as partnerships for U.S. federal income tax purposes and that derive less than 90 % of their gross income from the items described in (a) above (each a "Qualified Publicly Traded Partnership"); and (3) diversify its holdings so that, at the end of each quarter of each taxable year of the Fund (a) at least 50 % of the value of the Fund's total assets is represented by cash, cash items, U.S. government securities and securities of other RICs, and other securities, with these other securities limited, with respect to any one issuer, to an amount not greater in value than 5 % of the value of the Fund's total assets, and to not more than 10 % of the outstanding voting securities of such issuer, and (b) not more than 25 % of the value of the Fund's total assets is invested in the securities (other than U.S. government securities or securities of other RICs) of (I) any one issuer, (II) any two or more issuers that the Fund controls and that are determined to be engaged in the same or similar trades or businesses or related trades or businesses or (III) any one or more Qualified Publicly Traded Partnerships. As a RIC, the Fund generally will not be subject to U.S. federal income tax on its investment company taxable income and net capital gain (the excess of net long-term capital gain over net short-term capital loss), if any, that it distributes in each taxable year to its stockholders. The Fund intends to distribute to its stockholders, at least annually, substantially all of its investment company taxable income and net capital gain.

A RIC that fails to distribute, by the close of each calendar year, at least 98 % of its ordinary taxable income and at least 98 % of its capital gain net income, plus any shortfalls from any prior year's required distribution, is liable for a 4 % excise tax on the portion of the undistributed amounts of such income that are less than the required percentages of such distributions. For these purposes, the Fund will be deemed to have distributed any income on which it paid U.S. federal income tax. To avoid the imposition of this excise tax, the Fund intends to make the required distributions of its ordinary taxable income and its capital gain net income, to the extent possible, by the close of each calendar year.

Based on current market conditions, the Allocation Subadviser anticipates that the Fund will invest approximately 25% to 40% of the net proceeds of this offering indirectly through the Feeder Fund in the Master Fund, each of which is treated as a partnership for U.S. federal income tax purposes. Consequently, with respect to its indirect investment in the Master Fund, the Fund's income, gains, losses, deductions and expenses will depend upon the corresponding items recognized by the Master Fund. For purposes of satisfying the income and asset diversification tests applicable to a RIC under the Code, the Fund intends to look through to the assets of the Master Fund, relying in part on an opinion from Simpson Thacher & Bartlett LLP that for the purposes of the asset diversification test of Section 851(b)(3) of the Code, the Fund should be treated as if it directly invested in the assets that are held by the Master Fund. The opinion is based on analogous provisions in the tax law, on general principles of partnership taxation, and on the purpose and intention of the tax laws governing RICs. While it reflects the administrative practice of the IRS in rulings that have been issued to other taxpayers and in generally applicable revenue procedures, such administrative interpretations do not constitute official precedent. The opinion notes that there is no specific authority directly on point dealing with the application of Code Section 851(b)(3) to partnership interests held by RICs and it states that there can be no assurance that the IRS will not successfully challenge the conclusions therein.

If the Fund fails to satisfy this asset diversification test as of the close of any quarter, it will have 30 days to cure the failure by, for example, selling securities that are the source of the violation. However, because the Feeder Fund may effect withdrawals from the Master Fund only upon written consent of the Treasury, and the Fund may effect withdrawals from the Feeder Fund only upon written consent of the General Partner, the Fund may not be able to withdraw its investment promptly after it has made a decision to do so. As a result, it will be more difficult for the Fund to cure a violation within the 30-day period.

If the Fund fails to cure a violation within 30 days, it may lose its status as a RIC under the Code. In that case, all of its taxable income would be subject to U.S. federal income tax at regular corporate rates without any deduction for distributions to stockholders. In addition, all distributions (including distributions of net capital gain) would be taxed to the Fund's Common Stockholders as ordinary dividend income to the extent of the

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Fund's current and accumulated earnings and profits. Accordingly, disqualification as a RIC could have a material adverse effect on the value of the Fund's shares and the amount of Fund distributions.

Distributions to Common Stockholders by the Fund of ordinary income (including "market discount" realized by the Fund on the sale of debt instruments (included MBS)), and of net short-term capital gains, if any, realized by the Fund will be taxable to Common Stockholders as ordinary income to the extent such distributions are paid out of the Fund's current or accumulated earnings and profits. Distributions, if any, of net capital gains will be taxable as long-term capital gains, regardless of the length of time the Common Stockholder has owned Common Stock of the Fund. A "return of capital" merely represents a partial return of your original investment and does not represent a gain on the Fund's investments. When you sell your shares in the Fund, the amount, if any, by which your sales price exceeds your basis in the Fund's shares is gain subject to tax. Because a return of capital reduces your basis in the shares, it will increase the amount of your gain or decrease the amount of your loss when you sell the shares, all other things being equal. Distributions paid by the Fund generally will not be eligible for the dividends received deduction allowed to corporations or for the reduced rates applicable to certain qualified dividend income received by non-corporate stockholders before January 1, 2011.

Distributions will be treated in the manner described above regardless of whether such distributions are paid in cash or invested in additional Common Stock of the Fund. Common Stockholders receiving distributions in the form of additional Common Stock of the Fund (i) will be treated as receiving a distribution in the amount of cash that they would have received if they had elected to receive the distribution in cash, unless the Fund issues new shares of Common Stock that are trading at or above net asset value, and (ii) will be treated as receiving a distribution in the amount of the fair market value of the distributed Common Stock if the Fund issues new shares of Common Stock that are trading at or above net asset value.

As described in "Distributions" above, the Fund may elect to retain its net capital gain or a portion thereof for investment and be taxed at corporate rates on the amount retained. In such case, it may designate the retained amount as undistributed capital gains in a notice to its Common Stockholders, who will be treated as if each received a distribution of his pro rata share of such gain, with the result that each Common Stockholder will (i) be required to report his pro rata share of such gain on his tax return as long-term capital gain, (ii) receive a refundable tax credit for his pro rata share of tax paid by the Fund on the gain and (iii) increase the tax basis for his shares by an amount equal to the deemed distribution less the tax credit.

Common Stockholders will be notified annually as to the U.S. federal tax status of distributions, and Common Stockholders receiving distributions in the form of additional shares will receive a report as to the net asset value of those shares.

The IRS currently requires that a RIC that has two or more classes of stock allocate to each such class proportionate amounts of each type of its income (such as ordinary income and capital gains) based upon the percentage of total dividends paid out of earnings or profits to each class for the tax year. Accordingly, if the Fund issues a class of preferred shares, then the Fund intends each year to allocate ordinary income dividends and distributions of net capital gain, if any, between its Common Stock and preferred shares in proportion to the total dividends paid out of earnings or profits to each class with respect to such tax year.

Although dividends generally will be treated as distributed when paid or reinvested in additional Common Stock, dividends declared in October, November or December, payable to Common Stockholders of record on a specified date in one of those months, and paid during the following January, will be treated as having been distributed by the Fund (and received by Common Stockholders) on December 31 of the year in which declared.

In general, the sale or other disposition of Common Stock will result in capital gain or loss to Common Stockholders. A Common Stockholder's gain or loss generally will be a long-term gain or loss if the Common Stock has been held for more than one year. Present law taxes both long- and short-term capital gains of corporations at the rates applicable to ordinary income. For non-corporate taxpayers, however, under current law net capital gains will be taxed at a maximum rate of 15 % for taxable years beginning on or before December 31, 2010 (and thereafter, the maximum rate will increase to 20 % , unless Congress enacts legislation providing otherwise), while short-term capital gains and other ordinary income will be taxed at a maximum rate of 35 % . Because of the limitations on itemized deductions and the deduction for personal exemptions applicable to higher income taxpayers, the effective rate of tax may be higher in certain circumstances. Losses realized by a Common Stockholder on the sale or exchange of Common Stock held for six months or less are treated as long-term capital losses to the extent of any distribution of long-term capital gain received (or amounts designated as undistributed capital gains) with respect to such Common Stock. In addition, no loss will be

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allowed on the sale or other disposition of Common Stock if the owner acquires or enters into a contract or option to acquire securities that are substantially identical to such Common Stock within 30 days before or after the disposition. In such case, the basis of the securities acquired will be adjusted to reflect the disallowed loss.

If a Common Stockholder is neither a citizen nor a resident of the United States, certain dividends received by such Common Stockholder from the Fund may be subject to U.S. federal withholding tax. To the extent that Fund distributions consist of ordinary dividends or other payments that are subject to withholding, the Fund will withhold U.S. federal income tax at the rate of 30 % (or such lower rate as may be determined in accordance with any applicable treaty). However, ordinary dividends that are designated by the Fund as "interest-related dividends" or "short-term capital gain dividends" are generally exempt from such withholding for taxable years of the Fund beginning before January 1, 2010. Recently proposed legislation (which was passed by the House of Representatives) would extend this exemption from withholding for taxable years beginning before January 1, 2011. However, there can be no assurance as to whether or not this proposed legislation will be enacted.

If a Common Stockholder does not provide the Fund with its correct taxpayer identification number and any required certifications, such Common Stockholder may be subject to backup withholding at the rate of 28 % on its taxable distributions, dividends, and redemption proceeds. Backup withholding will not, however, be applied to payments that have been subject to the 30 % withholding tax applicable to Common Stockholders who are neither citizens nor residents of the United States.

Recently proposed legislation (which was passed by the House of Representatives) would generally impose, effective for payments made after December 31, 2012, a withholding tax of 30 % on dividends from, and the gross proceeds of a disposition of, Common Stock paid to certain foreign entities unless various information reporting requirements are satisfied. There can be no assurance as to whether or not this proposed legislation will be enacted, and, if it is enacted, what form it will take or when it will be effective. Foreign Common Stockholders are encouraged to consult their own tax advisors regarding the possible implications of this proposed legislation on their investment in Common Stock.

Certain of the Fund's investment practices are subject to special and complex U.S. federal income tax provisions that may, among other things, (i) disallow, suspend or otherwise limit the allowance of certain losses or deductions, (ii) convert lower taxed long-term capital gain into higher taxed short-term capital gain or ordinary income, (iii) convert an ordinary loss or a deduction into a capital loss (the deductibility of which is more limited), (iv) cause the Fund to recognize income or gain without a corresponding receipt of cash, (v) adversely affect the time as to when a purchase or sale of stock or securities is deemed to occur, (vi) adversely alter the characterization of certain complex financial transactions and (vii) produce income that will not qualify as good income under the RIC rules. These rules could therefore affect the character, amount and timing of distributions to Common Stockholders. The Fund will monitor its transactions and may make certain tax elections in order to mitigate the effect of these provisions.

The foregoing tax discussion is for general information only. The provisions of the Code and regulations thereunder presently in effect as they directly govern the taxation of the Fund and its Common Stockholders are subject to change by legislative or administrative action, and any such change may be retroactive with respect to the Fund's transactions. The foregoing does not represent a detailed description of the U.S. federal income tax considerations relevant to special classes of taxpayers including, without limitation, financial institutions, insurance companies, investors in pass-through entities, U.S. stockholders whose "functional currency" is not the U.S. dollar, tax-exempt organizations, dealers in securities or currencies, traders in securities or commodities that elect mark to market treatment, or persons that will hold Common Stock as a position in a "straddle," "hedge" or as part of a "constructive sale" for U.S. federal income tax purposes. In addition, this discussion does not address the application of the U.S. federal alternative minimum tax. Common Stockholders are advised to consult with their own tax advisors for more detailed information concerning U.S. federal income tax matters.

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UNDERWRITING

Subject to the terms and conditions stated in the underwriting agreement dated , each underwriter named below, for which ____ and ____ are acting as representatives, has severally agreed to purchase, and the Fund has agreed to sell to such underwriter, the number of Common Stock set forth opposite such underwriter.

The underwriting agreement provides that the obligations of the underwriters to purchase the shares of Common Stock included in this offering are subject to approval of certain legal matters by counsel and certain other conditions. The underwriters are obligated, severally and not jointly, to purchase all the shares of Common Stock sold under the underwriting agreement if any of the shares of Common Stock are purchased.

In the underwriting agreement, the Fund, LMPFA and the Subadviser have agreed to indemnify the underwriters against certain liabilities, including liabilities arising under the Securities Act or to contribute to payments the underwriters may be required to make for any of these liabilities.

Commissions and Discounts

The underwriters propose to initially offer some of the shares of Common Stock directly to the public at the public offering price set forth on the cover page of this prospectus and some of the shares of Common Stock to certain dealers at the public offering price less a concession not in excess of $ per share of Common Stock. The sales load investors in the Fund will pay of $.90 per share of Common Stock is equal to 4.5 % of the initial offering price. The underwriters may allow, and dealers may reallow, a discount not in excess of $ per share of Common Stock on sales to other dealers. After the initial public offering the concession and discount may be changed. Investors must pay for any shares of Common Stock purchased on or before , 2010.

The following table shows the public offering price, estimated offering expenses, sales load and proceeds, to the Fund. The information assumes either no exercise or full exercise by the underwriters of their overallotment option.

The expenses of the offering are estimated at $.04 per share of Common Stock and are payable by the Fund. The Fund has agreed to pay the underwriters $ per share of Common Stock for each share of Common Stock purchased by the underwriters, as a partial reimbursement of expenses incurred in connection with the offering. The amount paid by the Fund for the partial reimbursement to the underwriters will not exceed % of the total price to the public of the Common Stock sold in this offering. Offering expenses paid by the Fund may include reimbursement to LMPFA, the Subadviser or their affiliates for expenses incurred in connection with the offering, including compensation to sales personnel for (i) coordinating the road show, (ii) designing and coordinating the printing of marketing materials and (iii) participating in the road show by giving presentations at branch offices of the underwriters. LMPFA has agreed to pay all organizational expenses and offering costs of the Fund (other than sales load) that exceed $.04 per share of Common Stock.

Overallotment Option

The Fund has granted the underwriters an option to purchase up to ____ additional shares of Common Stock at the public offering price, less the sales load, within 45 days from the date of this prospectus solely to cover any overallotments. If the underwriters exercise this option, each will be obligated, subject to conditions contained in the underwriting agreement, to purchase a number of additional shares of Common Stock proportionate to that underwriter's initial amount reflected in the preceding table.

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Price Stabilization, Short Positions and Penalty Bids

Until the distribution of the Common Stock is complete, SEC rules may limit underwriters and selling group members from bidding for and purchasing shares of Common Stock. However, the representatives may engage in transactions that stabilize the price of the Common Stock, such as bids or purchases to peg, fix or maintain that price.

If the underwriters create a short position in the Common Stock in connection with the offering (i.e., if they sell more shares of Common Stock than are listed on the cover of this prospectus), the representatives may reduce that short position by purchasing shares of Common Stock in the open market. The representatives may also elect to reduce any short position by exercising all or part of the overallotment option described above. The underwriters may also impose a penalty bid, whereby selling concessions allowed to syndicate members or other broker-dealers in respect the shares of Common Stock sold in this offering for their account may be reclaimed by the syndicate if such shares of Common Stock are repurchased by the syndicate in stabilizing or covering transactions. Purchases of the Common Stock to stabilize its price or to reduce a short position may cause the price of the Common Stock to be higher than it might be in the absence of such purchases.

Neither the Fund nor any of the underwriters makes any representation or prediction as to the direction or magnitude of any effect that the transactions described above may have on the price of the Common Stock. In addition, neither the Fund nor any of the underwriters makes any representation that the representatives will engage in these transactions or that these transactions, once commenced, will not be discontinued without notice.

The Fund has agreed not to offer or sell any additional shares of Common Stock for a period of 180 days after the date of the underwriting agreement without the prior written consent of the underwriters, except for the sale of the Common Stock to the underwriters pursuant to the underwriting agreement.

The Fund anticipates that the underwriters may from time to time act as brokers or dealers in executing the Fund's portfolio transactions after they have ceased to be underwriters, and may also act as placement agent for issuers whose securities the Fund purchases in direct placement transactions. The underwriters are active underwriters of, and dealers in, securities and act as market makers in a number of such securities, and therefore can be expected to engage in portfolio transactions with the Fund.

Shares of Common Stock will be sold so as to ensure that the NYSE distribution standards (i.e., round lots, public shares and aggregate market value) will be met.

Additional Compensation to be Paid by LMPFA

LMPFA (and not the Fund) may also pay certain qualifying underwriters a marketing and structuring fee, a sales incentive fee or, alternatively, additional compensation in connection with the offering. The total amounts of these payments will not exceed % of the total price of the Common Stock sold in this offering.

CUSTODIAN AND TRANSFER AGENT

The custodian of the assets of the Fund is State Street Bank and Trust Company LLC. The Custodian performs custodial, fund accounting and portfolio accounting services. The Fund's transfer, stockholder services and dividend paying agent is American Stock Transfer & Trust Company LLC.

LEGAL OPINIONS

Certain legal matters in connection with the Common Stock will be passed upon for the Fund by Simpson Thacher & Bartlett LLP, New York, New York and for the underwriters by                                       . Simpson Thacher & Bartlett LLP may rely as to certain matters of Maryland law on the opinion of DLA Piper LLP (US).

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Until (25 days after the date of this prospectus), all dealers that buy, sell or trade the Common Stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers' obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

Shares

Western Asset Mortgage
Defined Opportunity Fund Inc.

Common Stock
$20.00 per Share

PROSPECTUS

, 2010