Calamos Convertible and High Income Fund posted strong gains in 2006. We asked the management team, led by Co-Chief Investment Officers, John P. Calamos, Sr. and Nick P. Calamos, to discuss how they invested the portfolio as well as their perspective on the economic and market climate.

Q. What is the Fund's investment strategy?

A. As you know, Calamos Convertible and High Income Fund (CHY) offers investors an enhanced fixed-income strategy focused on delivering an attractive income stream with the potential for capital gains. The types of bonds that the Fund typically holds (high yield corporate and convertible securities) have different characteristics than traditional bonds, providing an attractive complement to a standard fixed-income allocation. The NAV of the Fund typically performs well in periods marked by economic expansion, as convertible and high-yield bonds tend to be economically sensitive compared with high-quality bonds, which are often more sensitive to changes in interest rates.

Q. How did the Fund perform in 2006?

A. For the year ended December 31, 2006, high-yield and convertible securities provided positive returns, both finishing higher than investment-grade fixed-income issues. The Fund had a strong run for the 12-month period, returning 13.67% (NAV) and outperforming the CS High Yield Index* with its return of 11.93%. In addition, the Fund has maintained a stable distribution of at least $0.1219 since August 2003. As of December 31, 2006, his equated to an annualized distribution rate¹ of 8.46% based on market price.

*The CS High Yield Index is an unmanaged index of high yield debt securities. Investors cannot invest directly in an index. Source: Russell/Mellon Analytical Services LLC.

You can purchase or sell common shares daily. Like any other stock, market price will fluctuate with the market. Upon sale, your shares may have a market price that is above or below net asset value and may be worth more or less than your original investment. Shares of closed-end funds frequently trade at a market price that is below their net asset value.

View most recent month-end performance.

Q. What benefited the Fund in 2006?

A. Both of the Fund's main asset classes (high-yield corporates and convertible bonds) posted strong positive returns for the fiscal year. The portfolio benefited from our focus on more equity-sensitive convertible securities—which performed well—reflecting the positive returns in their underlying equities. The portfolio's convertible holdings got an added boost as valuations in the convertible market continued to improve over the period. At the end of December 2006, the Fund's allocation was 39% in convertibles and 58% in high-yield corporates.

In June, we completed a secondary offering of CHY. We were pleased to provide investors with another opportunity to invest in the Fund. The offering, which raised approximately $62 million (net), enabled the Fund to put fresh money to work at a point when we believed convertible valuations were exceptionally attractive.

From a sector standpoint, all of the portfolio's sector allocations delivered positive performance, with five of the 10 sectors providing double-digit returns. Relative to the CS High Yield Index, security selection in financials and utilities racked up the biggest gains. In general, selection among the securities of larger-cap companies also proved advantageous.

*Sector and portfolio asset allocation are based on net assets.

Q. What hampered the Fund's performance?

A. Relative to the index, security selection within the materials and industrials sectors, while positive, detracted from performance, as did an overweight and selection in Energy. In addition, the portfolio's higher credit quality relative to the index held back performance, as low-quality issues performed well. From a long-term risk/reward perspective, however, we believe that our rigorous credit research will benefit clients over the full course of a market cycle.

Q. The Fund uses swap agreements to limit the interest-rate risk of leverage³. What will you do as these swaps roll off?

A. As a matter of fact, one of the Fund's swaps rolled off (matured) in October 2006, and we elected not to lock back in at higher rates. When we entered into the swap arrangements, we carefully planned the timing of when these swaps would mature. In order to avoid a significant impact on the portfolio, the maturities of the swap agreements have been staggered over a two-year time period. While we will continue to actively evaluate the opportunity to use swaps, given the current economic environment and the low likelihood of near-term interest rate increases, it does not appear to be advantageous to lock in rates by entering into new swap agreements.

Q. What is your outlook in the coming year and how are you positioning the portfolio accordingly?

A. Although convertible securities saw their valuations improve in 2006, we believe this asset class can provide additional upside against the backdrop of a rising equity market. Moreover, we believe the current interest rate environment may give rise to additional issuance and more choices for convertible investors in 2007. Now that interest rates have risen from their historic lows, companies seeking access to capital may find it more affordable to issue convertible debt rather than "straight" (non-convertible) bonds.

We believe that convertible securities will continue to offer investors a valuable means of enhancing returns and managing risk—particularly when they are judiciously blended with other asset classes. Consistent with our overall view of the economy, we are favoring higher-quality, equity-sensitive convertibles of traditional growth companies with solid balance sheets and reduced cyclical exposure. We are avoiding "busted" convertibles, which trade essentially as straight bonds and offer little equity participation.

Over the past five years, we have been bullish on the high-yield market and justified the narrow yield spread based on the strength of the economy, excess liquidity, strength in corporate balance sheets and support from private markets and hedge funds. But things have changed. Most notably, the economy is slowing and complacency may have set in. We have seen remarkably low levels of corporate and equity market volatility, low inflation, low default risk and stable growth. The lack of negative surprises and the low volatility in asset classes has manifested itself in the form of more leverage, debt and tight credit spreads.

Despite this added caution, we believe in the merits of the asset class, particularly given our highly selective, rigorous bottom-up security selection process. We are favoring the higher-quality tiers of the high yield universe and avoiding truly distressed issues.

We have reduced our weightings in cyclicals such as energy, industrials and materials; we believe cyclical businesses that owe their growth to volatile commodity prices or to recovery-level growth in the GDP pose higher risk today than more stable growth issues.