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<SEC-DOCUMENT>0000927405-97-000015.txt : 19970120
<SEC-HEADER>0000927405-97-000015.hdr.sgml : 19970120
ACCESSION NUMBER:		0000927405-97-000015
CONFORMED SUBMISSION TYPE:	N-30D
PUBLIC DOCUMENT COUNT:		1
CONFORMED PERIOD OF REPORT:	19961130
FILED AS OF DATE:		19970117
SROS:			NYSE
SROS:			PSE

FILER:

	COMPANY DATA:	
		COMPANY CONFORMED NAME:			PREFERRED INCOME OPPORTUNITY FUND INC
		CENTRAL INDEX KEY:			0000882071
		STANDARD INDUSTRIAL CLASSIFICATION:	 []
		IRS NUMBER:				954355600
		STATE OF INCORPORATION:			MD
		FISCAL YEAR END:			1130

	FILING VALUES:
		FORM TYPE:		N-30D
		SEC ACT:		1940 Act
		SEC FILE NUMBER:	811-06495
		FILM NUMBER:		97507202

	BUSINESS ADDRESS:	
		STREET 1:		301 E COLORADO BLVD STE 720
		STREET 2:		C/O FLAHERTY & CRUMRINE INC
		CITY:			PASADENA
		STATE:			CA
		ZIP:			91101
		BUSINESS PHONE:		8187957300

	MAIL ADDRESS:	
		STREET 1:		301 COLORADO BLVD
		STREET 2:		STE 720
		CITY:			PASADENA
		STATE:			CA
		ZIP:			91101
</SEC-HEADER>
<DOCUMENT>
<TYPE>N-30D
<SEQUENCE>1
<TEXT>


<PAGE>
 
     The WIDE SWINGS IN LONG TERM INTEREST RATES IN FISCAL 1996 TURNED OUT TO BE
AN OPPORTUNITY for the Fund, although we had to make some mid-course
adjustments. The yields of 30 year Treasury bonds rose, from around 6% at the
start of the year to a high of close to 7 1/4% by early summer, only to tumble
to roughly 6 3/8% by November 30. The Fund's hedges served it well as interest
rates rose, helping to offset much of the decline in the value of the Fund's
preferred stock portfolio. As rates later declined, we gave back part of the
gains on our hedges, but the accompanying rise in the value of our preferred
stocks more than made up for it. When the smoke cleared, the NAV was up and the
Fund had a win-win result with net appreciation for the year on both its hedges
and its preferred stocks.
 
     There were also CROSSCURRENTS WITHIN THE PREFERRED STOCK MARKET IN FISCAL
1996. In the heat of the budget battle in December, 1995, the Clinton
Administration proposed some tax law changes that would have reduced the
benefits of the Dividends Received Deduction ("DRD") for corporate investors,
with negative overtones for traditional preferred stocks eligible for the DRD.
As the year wore on investors' concern about adverse tax changes faded, and the
market for traditional preferred stocks strengthened significantly. The market
now seems to be focusing almost exclusively on the shrinking supply of
traditional preferreds. Such traditional preferreds are being steadily replaced
by newer forms of "hybrid" preferreds that do not qualify for the DRD, but may
offer greater tax advantages to issuers. The growing recognition of what we have
previously called the "creeping scarcity" of traditional preferreds has
benefited the Fund's portfolio significantly.
 
     The following "pie charts" illustrate the SHIFTS DURING THE YEAR IN THE
PORTIONS OF THE PORTFOLIO ALLOCATED TO VARIOUS SECTORS OF THE PREFERRED MARKET.
The increase in adjustable rate preferreds ("ARPs") from 25% to 31%, in round
numbers, was especially helpful to the Fund's performance. For most of the year,
ARPs dawdled along, becoming increasingly undervalued in our opinion, until they
caught fire in the last quarter. We also ventured, to the extent of 6% of the
portfolio, into "hybrid" preferreds that are not eligible for the DRD. The
latter purchases reflected specific opportunities uncovered in a market sector
that we previously considered to be generally overpriced.
 
<TABLE>
[Pie Charts]
<CAPTION>

                              11/30/95        11/30/96
                              --------        --------
<S>                             <C>             <C>
Adjustable Rates                25.4%           31.3%
Traditional Fixed Rates         73.2%           57.9%
Non-DRD Preferreds               0.0%            6.3%
Common Stock                     0.0%            2.2%
Cash & Other                     1.4%            2.3%
</TABLE>

 
     THE FISCAL 1996 RETURN OF 15.4% BASED ON THE MARKET PRICE OF THE FUND'S
SHARES WAS HELPED BY A NARROWING OF THE DISCOUNT OF THE MARKET PRICE FROM NAV
DURING THE YEAR, as shown by the chart on the following page. The narrowing may
reflect the market scarcity of preferreds eligible for the DRD, which make up
most of the Fund's portfolio, and fading concern over the risk of tax changes.
The purchase of
 
                                        2

<PAGE>
 
over 20% of the shares of the Preferred Income Management Fund, a sister fund,
by Horesji Enterprises, Inc. may have had a market impact also.
 

<TABLE>
           [Graph Showing Premium/Discount of Market Price to NAV]
<CAPTION>

                      Preferred Income Opportunity Fund
        Premium/Discount of Market Price to NAV through November 1996

             Premium/
  Date       Discount
  ----       --------
<S>          <C>
02/21/92       7.26%
02/28/92       8.05%
03/06/92       8.74%
03/13/92       9.80%
03/20/92       8.19%
03/27/92       5.56%
04/03/92       5.38%
04/10/92       7.05%
04/17/92       5.47%
04/24/92       5.90%
05/01/92       5.46%
05/08/92       5.36%
05/15/92       3.06%
05/22/92       2.48%
05/29/92       3.07%
06/05/92       2.82%
06/12/92       4.00%
06/19/92       3.57%
06/26/92       4.42%
07/03/92       4.75%
07/10/92       6.26%
07/17/92       8.00%
07/24/92       5.92%
07/31/92       6.47%
08/07/92       6.13%
08/14/92       6.28%
08/21/92       5.14%
08/28/92       5.39%
09/04/92       5.06%
09/11/92       6.48%
09/18/92       4.74%
09/25/92       4.41%
10/02/92       6.20%
10/09/92       6.75%
10/16/92       4.90%
10/23/92       1.88%
10/30/92       2.78%
11/06/92       1.80%
11/13/92       1.88%
11/20/92       4.08%
11/27/92       8.44%
12/04/92       6.30%
12/11/92       6.13%
12/18/92       6.91%
12/25/92       5.36%
01/01/93       6.21%
01/08/93       6.79%
01/15/93       5.95%
01/22/93       4.34%
01/29/93       5.76%
02/05/93       4.83%
02/12/93       2.84%
02/19/93       2.02%
02/26/93       3.10%
03/05/93       4.73%
03/12/93       6.51%
03/19/93       3.03%
03/26/93       4.57%
04/02/93       5.14%
04/09/93       5.78%
04/16/93       5.70%
04/23/93       6.59%
04/30/93       6.51%
05/07/93       5.13%
05/14/93       6.10%
05/21/93       5.70%
05/28/93       4.41%
06/04/93       4.97%
06/11/93       5.61%
06/18/93       4.97%
06/25/93       4.17%
07/02/93       4.72%
07/09/93       4.25%
07/16/93       3.62%
07/23/93       1.63%
07/30/93       3.06%
08/06/93       2.12%
08/13/93       1.81%
08/20/93       0.08%
08/27/93       3.70%
09/03/93       3.31%
09/10/93       4.01%
09/17/93       3.38%
09/24/93       2.44%
10/01/93       2.14%
10/08/93       2.61%
10/15/93       2.63%
10/22/93       2.46%
10/29/93       0.90%
11/05/93       0.00%
11/12/93      -1.07%
11/19/93      -2.82%
11/26/93      -1.79%
12/03/93      -0.76%
12/10/93      -3.34%
12/17/93      -3.38%
12/24/93      -4.31%
12/31/93      -1.53%
01/07/94      -0.36%
01/14/94       1.57%
01/21/94      -1.29%
01/28/94      -3.77%
02/04/94      -3.92%
02/11/94      -4.62%
02/18/94      -8.63%
02/25/94      -5.00%
03/04/94      -3.92%
03/11/94      -3.15%
03/18/94      -5.85%
03/25/94      -5.62%
04/01/94      -5.52%
04/08/94      -5.10%
04/15/94      -9.76%
04/22/94     -10.12%
04/29/94     -10.42%
05/06/94      -7.75%
05/13/94      -7.73%
05/20/94      -6.36%
05/27/94      -3.12%
06/03/94      -6.83%
06/10/94      -2.88%
06/17/94      -4.57%
06/24/94      -3.93%
07/01/94      -4.09%
07/08/94      -3.44%
07/15/94      -4.90%
07/22/94      -2.94%
07/29/94      -3.27%
08/05/94      -2.21%
08/12/94      -2.98%
08/19/94      -3.76%
08/26/94      -2.94%
09/02/94      -2.04%
09/09/94      -3.18%
09/16/94      -4.09%
09/23/94      -6.28%
09/30/94      -5.10%
10/07/94     -13.22%
10/14/94     -13.68%
10/21/94     -14.10%
10/28/94     -10.40%
11/04/94      -7.86%
11/11/94     -10.87%
11/18/94      -9.90%
11/23/94      -7.70%
12/02/94      -4.02%
12/09/94      -8.68%
12/16/94      -7.32%
12/23/94      -6.04%
12/30/94      -8.51%
01/06/95      -0.10%
01/13/95      -1.41%
01/20/95      -4.21%
01/27/95      -6.19%
02/03/95      -2.34%
02/10/95      -3.14%
02/17/95      -5.88%
02/24/95      -3.76%
03/03/95      -2.97%
03/10/95      -5.85%
03/17/95      -5.23%
03/24/95      -5.34%
03/31/95      -3.93%
04/07/95      -3.41%
04/14/95      -3.93%
04/21/95      -6.90%
04/28/95      -3.41%
05/05/95      -5.76%
05/12/95      -3.93%
05/19/95      -9.33%
05/26/95      -7.53%
06/02/95      -4.81%
06/09/95      -7.29%
06/16/95      -8.07%
06/23/95      -7.49%
06/30/95      -6.86%
07/07/95      -6.90%
07/14/95      -7.64%
07/21/95     -10.87%
07/28/95      -9.11%
08/04/95      -9.73%
08/11/95     -10.18%
08/18/95     -10.11%
08/25/95      -7.80%
09/01/95      -7.06%
09/08/95      -8.33%
09/15/95      -8.13%
09/22/95      -7.49%
09/29/95      -6.41%
10/06/95      -7.18%
10/13/95     -10.06%
10/20/95      -9.09%
10/27/95     -10.12%
11/03/95     -12.32%
11/10/95     -11.15%
11/17/95     -10.71%
11/24/95      -9.91%
12/01/95     -10.14%
12/08/95     -11.74%
12/15/95     -12.33%
12/22/95     -12.65%
12/29/95     -14.54%
01/05/96     -11.97%
01/12/96     -12.79%
01/19/96     -13.12%
01/26/96     -11.46%
02/02/96     -12.33%
02/09/96     -12.33%
02/16/96     -12.79%
02/23/96     -13.03%
03/01/96     -11.24%
03/08/96     -14.65%
03/15/96     -15.08%
03/22/96     -14.87%
03/29/96     -15.15%
04/05/96     -13.15%
04/12/96     -12.86%
04/19/96     -12.79%
04/26/96     -13.83%
05/03/96     -11.53%
05/10/96     -11.30%
05/17/96     -14.08%
05/24/96     -13.86%
05/31/96     -13.86%
06/07/96     -12.55%
06/14/96     -13.37%
06/21/96     -13.01%
06/28/96      -9.18%
07/05/96     -10.79%
07/12/96     -10.13%
07/19/96     -11.22%
07/26/96      -9.39%
08/02/96      -8.76%
08/09/96      -6.88%
08/16/96      -6.73%
08/23/96      -7.79%
08/30/96      -8.36%
09/06/96      -8.36%
09/13/96      -6.61%
09/20/96      -9.91%
09/27/96      -9.91%
10/04/96      -8.76%
10/11/96      -8.76%
10/18/96      -9.35%
10/25/96      -8.34%
11/01/96      -7.81%
11/08/96      -9.32%
11/15/96      -6.30%
11/22/96      -5.86%
11/29/96      -6.08%
12/06/96      -7.92%
12/13/96      -8.13%
12/20/96     -10.09%
</TABLE>


     On December 31, 1996, the Fund paid A SPECIAL DISTRIBUTION TO SHAREHOLDERS
OF $0.28 PER SHARE. Information on the tax status of that distribution appears
on page 23 of this report.
 
     The Fund's income is doing well. We raised the dividend rate once during
the fiscal year after the run-up in interest rates in early Spring. Following
the year-end distributions, THE FUND WILL RESUME REGULAR MONTHLY DISTRIBUTIONS
IN JANUARY, 1997 AT THE NEW RATE OF $0.073 PER SHARE. That rate is below the
previous rate due to the reduction of earning assets in the Fund's portfolio
caused by the year-end distribution. Those shareholders that participate in the
Fund's Dividend Reinvestment Plan will see little change in their monthly
income. Other shareholders have, in effect, had part of their principal returned
to them.
 
     We are also watching the nickels and dimes closely. The management of the
Fund conducted an EXTENSIVE REVIEW OF GENERAL AND ADMINISTRATIVE COSTS during
the year in light of an increasingly competitive market for such services.
Meaningful reductions have been achieved in several areas, which will generally
come into effect in fiscal 1997. Additional information appears in Footnote No.
2 to the financial statements in this report.
 
                                        3

<PAGE>
 
     The Fund's Board of Directors recently ELIMINATED THE POLICY THAT THE
FUND'S PORTFOLIO BE MANAGED WITH A VIEW TO MAXIMIZING DISTRIBUTIONS THAT ARE
ELIGIBLE FOR THE DRD. This change is intended to create future flexibility
rather than to signal any significant near term shift in the Fund's portfolio.
It is very difficult to pinpoint what the situation will be several years down
the road given the tax factors mentioned above and recent changes in bank
regulation that could contribute to the shrinkage of the supply of preferred
stocks eligible for the DRD. We simply want to be prepared for whatever may
come.
 
     The Question and Answer section that follows is recommended reading. It
provides additional information on such matters as the Fund's income and
performance, the discount from NAV and the situation surrounding the DRD.
                                         Sincerely,
 

                                         /s/ Robert T. Flaherty
                                         Robert T. Flaherty
                                         Chairman of the Board
 
December 31, 1996
 


                   QUESTIONS AND ANSWERS CONCERNING THE FUND
 
HAS THE FUND'S INCOME STRATEGY WORKED AS EXPECTED?
 
     Yes, our income strategy has worked very well. Just to remind everyone, we
expect income to rise and fall with long term interest rates. However, we would
like it to go up more when rates are on the upswing and fall less when rates go
down.
 
     The chart on the following page, which is one of our favorites, is a rerun
from last year's annual report. It shows the history of the Fund's income (on
the left hand scale) against the level of interest rates on long term Treasury
bonds (on the right hand scale). Over the life of the Fund, income has increased
when interest rates were rising and given ground only begrudgingly when rates
were falling. That is what we set out to do.
 
     The chart is based on a hypothetical investment in 1,000 shares ($12,500)
initial investment of the Fund's common stock at the inception of the Fund. We
have assumed that the shareholder took the regular dividend in cash each month
and used only the amount by which the year-end distributions were above and
beyond the regular dividends to buy additional shares at net asset value. The
Fund's income has been projected into January, 1997 to reflect the year-end
distribution and the dividend rate that will be effective afterwards.
 
                                        4

<PAGE>
<TABLE>
Graph showing the history of the Funds income against the level of interest
rates on long term Treasury bonds on a 1,000 shares ($12,500) initial investment
<CAPTION>

              Income
             w/Reinv.     UST 30 YR
 Date       Cap Gains        YTM
- ------      ---------     ---------

<S>           <C>           <C>
Feb-92                      7.79%
Feb-92                      7.96%
Mar-92                      8.03%
Apr-92                      7.84%
May-92        $82.50        7.84%
Jun-92        $82.50        7.78%
Jul-92        $82.50        7.46%
Aug-92        $82.50        7.41%
Sep-92        $82.50        7.38%
Oct-92        $82.50        7.62%
Nov-92        $82.50        7.60%
Dec-92        $83.14        7.39%
Jan-93        $83.14        7.19%
Feb-93        $83.14        6.90%
Mar-93        $83.14        6.92%
Apr-93        $83.14        6.93%
May-93        $83.14        6.98%
Jun-93        $83.14        6.67%
Jul-93        $83.14        6.56%
Aug-93        $83.14        6.09%
Sep-93        $83.14        6.02%
Oct-93        $83.14        5.97%
Nov-93        $83.14        6.30%
Dec-93        $79.87        6.35%
Jan-94        $79.87        6.24%
Feb-94        $79.87        6.66%
Mar-94        $79.87        7.09%
Apr-94        $79.87        7.26%
May-94        $85.89        7.34%
Jun-94        $85.89        7.61%
Jul-94        $85.89        7.39%
Aug-94        $85.89        7.48%
Sep-94        $85.89        7.82%
Oct-94        $85.89        7.96%
Nov-94        $89.17        7.94%
Dec-94        $88.36        7.88%
Jan-95        $88.36        7.73%
Feb-95        $88.36        7.55%
Mar-95        $88.36        7.43%
Apr-95        $88.36        7.33%
May-95        $88.36        6.63%
Jun-95        $88.83        6.54%
Jul-95        $88.83        6.90%
Aug-95        $88.83        6.61%
Sep-95        $88.83        6.50%
Oct-95        $88.83        6.36%
Nov-95        $88.83        6.08%
Dec-95        $78.73        5.95%
Jan-96        $78.73        6.05%
Feb-96        $78.73        6.36%
Mar-96        $78.73        6.67%
Apr-96        $78.73        6.83%
May-96        $83.83        7.00%
Jun-96        $83.83        6.95%
Jul-96        $83.83        7.01%
Aug-96        $83.83        7.12%
Sep-96        $83.83        6.90%
Oct-96        $83.83        6.81%
Nov-96        $83.83        6.51%
Nov-96        $84.03        6.60%
</TABLE>

 
HOW HAS THE FUND'S NAV RETURN BEEN ABLE TO OUTPERFORM THE PREVIOUSLY MENTIONED
GROUP OF INVESTMENT QUALITY BOND FUNDS IN BOTH GOOD AND BAD MARKETS?
 
     The rather remarkable record shown in the chart on the first page of this
report is actually just the flip side of the success of our income strategy
discussed above.
 
     It is not too surprising that we have done well relative to the group of
bond funds when long term interest rates have increased. Our hedging strategies
have generally been profitable when that has happened, giving us a source of
funds to add to our portfolio and increase income. Such hedging gains have also
cushioned the decline in the value of our preferred stock holdings and helped
support the Fund's NAV. The key has been keeping overall principal declines
small enough to get a good result even after the magnifying effect of the Fund's
leverage. So far, we have been able to do just that.
 
     Beating the bond funds when interest rates were falling was a good trick.
We do not expect the Fund's portfolio to keep up with a sharply rising bond
market, since it will have to absorb some hedging losses. If we can stay close,
however, the Fund's leverage should do the rest. Our success in limiting hedge
losses was due, in part, to hedging by buying put options (on Treasury bond
futures contracts) where the risk can not exceed the purchase price. The hedge
losses we did incur were covered by selling
 
                                        5

<PAGE>
 
some of the preferred stocks in the Fund's portfolio. Income declined as we did
that, of course, which is expected when rates fall.
 
     The Fund's returns also reflect successful execution "in the trenches" of
hundreds of market and credit decisions designed to take advantage of the
inefficient nature of the preferred market. Active management in a relatively
illiquid market may seem like a contradiction in terms, but it is an important
source of added value.
 
HAS THE RETURN ON THE MARKET PRICE OF FUND'S SHARES KEPT UP WITH THE STRONG
PERFORMANCE OF NAV
 
     The following chart shows the cumulative market value and NAV of an
investment of $1,000 in the Fund at its inception. Recently, the market value
has done even better than NAV as the discount from NAV has narrowed. Previously,
particularly in fiscal 1993 and 1994, the opposite was true as the market price
of the Fund's shares went from a premium to a discount.
 
<TABLE>
Graph showing NAV and Market Performance on a $1,000 investment
<CAPTION>

             Total NAV   Total Market
              Value of     Value of
 Date       Shares Held   Shares Held
            -----------  ------------

<S>           <C>           <C>
Feb-92        $  930        $1,000
Feb-92        $  944        $1,000
Mar-92        $  961        $1,000
Apr-92        $  967        $1,010
May-92        $  996        $1,007
Jun-92        $1,001        $1,034
Jul-92        $1,035        $1,051
Aug-92        $1,052        $1,109
Sep-92        $1,060        $1,105
Oct-92        $1,062        $1,113
Nov-92        $1,063        $1,130
Dec-92        $1,072        $1,138
Jan-93        $1,094        $1,145
Feb-93        $1,129        $1,152
Mar-93        $1,144        $1,204
Apr-93        $1,159        $1,234
May-93        $1,168        $1,219
Jun-93        $1,195        $1,238
Jul-93        $1,209        $1,245
Aug-93        $1,222        $1,253
Sep-93        $1,234        $1,248
Oct-93        $1,246        $1,279
Nov-93        $1,233        $1,228
Dec-93        $1,233        $1,177
Jan-94        $1,243        $1,184
Feb-94        $1,251        $1,191
Mar-94        $1,242        $1,173
Apr-94        $1,232        $1,105
May-94        $1,217        $1,163
Jun-94        $1,221        $1,171
Jul-94        $1,218        $1,179
Aug-94        $1,226        $1,187
Sep-94        $1,203        $1,130
Oct-94        $1,191        $1,126
Nov-94        $1,163        $1,081
Dec-94        $1,168        $1,072
Jan-95        $1,204        $1,178
Feb-95        $1,233        $1,200
Mar-95        $1,240        $1,195
Apr-95        $1,271        $1,232
May-95        $1,359        $1,255
Jun-95        $1,367        $1,278
Jul-95        $1,368        $1,243
Aug-95        $1,394        $1,310
Sep-95        $1,417        $1,334
Oct-95        $1,442        $1,298
Nov-95        $1,473        $1,337
Dec-95        $1,457        $1,255
Jan-96        $1,470        $1,308
Feb-96        $1,450        $1,286
Mar-96        $1,475        $1,264
Apr-96        $1,478        $1,319
May-96        $1,506        $1,313
Jun-96        $1,522        $1,400
Jul-96        $1,523        $1,410
Aug-96        $1,527        $1,419
Sep-96        $1,543        $1,444
Oct-96        $1,605        $1,486
Nov-96       $1,653        $1,560
</TABLE>


 
     The chart sends a very strong message. Swings in premiums and discounts can
cause distortions between market and NAV performance over shorter periods. Over
longer periods, it is much more difficult
 

<PAGE>
 
for the market to take leave of the reality of NAV, which is the value actually
standing behind each share of the Fund.
 
     The most important point is that returns have been very good on both NAV
and market price. The table below sets forth the total returns on NAV and Market
per year for the last fiscal year, the last two fiscal years and since the
inception of the Fund, assuming all dividends were reinvested at the Dividend
Reinvestment Plan price.
 
<TABLE>
<CAPTION>
                                                                  TOTAL RETURN PER YEAR
                                                                 ------------------------
                                                                                ON MARKET
                                                                 ON NAV           PRICE
                                                                 ------         ---------
          <S>                                                     <C>              <C>
          Fiscal 1996..........................................   13.1%            15.4%
          Last 2 Fiscal Years, 1995 and 1996...................   20.0             20.1
          Inception Through Fiscal 1996........................   13.1              9.7
</TABLE>
 
     One last thought on the Fund's performance is worth noting. On the
ex-dividend date for the year-end distribution, the market price and the NAV of
the Fund's shares must decline to reflect the assets being paid out of the Fund
to shareholders. Once the checks have been cashed and spent (except by those who
participate in the Fund's Dividend Reinvestment Plan), the memory of the
distribution will fade. Next, we will get questions from shareholders about why
the performance of the Fund is down, even if things are going great. Please tie
a string around your finger to remind yourself of your year-end check from the
Preferred Income Opportunity Fund.
 
WHAT CAN BE DONE ABOUT SHARE PRICE DISCOUNTS?
 
     This is a tough question. The easy answers that often come up in connection
with reducing discounts do not offer much promise for the Preferred Income
Opportunity Fund. As discussed previously in these letters, converting to an
open-end format would require the Fund to give up its leverage, which is an
important element in its strategy. Furthermore, we believe that a closed-end
fund is better able to take advantage of periods when the preferred market is
relatively illiquid. Stock repurchase offers have not demonstrated any lasting
effect on narrowing discounts.
 
IS THE FUND STILL APPROPRIATE FOR CORPORATE INVESTORS GIVEN THE PREVIOUSLY
MENTIONED CHANGE IN POLICY REGARDING MAXIMIZING THE DIVIDENDS RECEIVED
DEDUCTION?
 
     We think it is very appropriate. Remember, this is still a preferred fund.
Traditional preferred stocks that qualify for the DRD account for the lion's
share of its portfolio. Subject to future market developments, we do not see
that changing significantly in the near future.
 
     It is very difficult to predict the future course of tax policy. The
Clinton Administration has previously proposed restricting the tax "loophole"
that is stimulating the replacement of DRD-eligible preferreds by new hybrid
preferreds. However, the Administration has also proposed reducing the DRD
percentage from 70% to 50%. As things are going now, the DRD could continue at
70% but be available only to a much smaller, and probably higher priced, supply
of traditional preferreds.
 
     We do not want to make this change in the Fund's policy regarding the DRD
into any more or less than it really is. Some new development will probably come
along well before traditional preferreds become high-priced buggy whips, largely
replaced by hybrid preferreds. It is in the best interests of all shareholders,
corporate or not, for the Fund to be as flexible as possible in dealing with
whatever develops.
 
                                        7

<PAGE>
 
- --------------------------------------------------------------------------------
Preferred Income Opportunity Fund Incorporated
FINANCIAL DATA
PER SHARE OF COMMON STOCK (UNAUDITED)
- ---------------------------------------------------
 
<TABLE>
<CAPTION>
                                                                                                  DIVIDEND
                                                     DIVIDEND     NET ASSET         NYSE        REINVESTMENT
                                                       PAID         VALUE       CLOSING PRICE     PRICE(1)
                                                     --------     ----------    -------------   ------------
<S>                                                   <C>           <C>            <C>              <C>
December 29, 1995..................................   $0.0695       $12.14         $10.375          $10.47
January 31, 1996...................................    0.0695        12.18          10.750           10.73
February 29, 1996..................................    0.0695        11.95          10.500           10.58
March 29, 1996.....................................    0.0695        12.08          10.250           10.28
April 30, 1996.....................................    0.0695        12.04          10.625           10.56
May 31, 1996.......................................    0.0740        12.19          10.500           10.52
June 28, 1996......................................    0.0740        12.25          11.125           10.99
July 31, 1996......................................    0.0740        12.18          11.000           11.13
August 30, 1996....................................    0.0740        12.14          11.125           11.12
September 30, 1996.................................    0.0740        12.19          11.125           11.25
October 31, 1996...................................    0.0740        12.61          11.500           11.66
November 29, 1996..................................    0.0740        12.91          12.000           12.13
</TABLE>
 
- ---------------
 
(1) See ADDITIONAL INFORMATION; Dividend Reinvestment and Cash Purchase Plan on
    pages 26 and 27 of this report.
 
                                        8

<PAGE>
 
- --------------------------------------------------------------------------------
                                  Preferred Income Opportunity Fund Incorporated
                                                        PORTFOLIO OF INVESTMENTS
                                                               NOVEMBER 30, 1996
                 ---------------------------------------------------------------
<TABLE>
<CAPTION>
                                                   VALUE
 SHARES                                           (NOTE 1)
 -------                                        -----------
PREFERRED STOCKS AND SECURITIES -- 95.5% 
  ADJUSTABLE RATE PREFERRED STOCKS -- 31.3% 
        UTILITIES -- 10.0% 
 <S>       <C>                                  <C>
   8,000   Alabama Power Company,
             Series 1993, Adj. Rate Pfd. .....  $   178,000
  22,470   Arizona Public Service Company,       
             Series Q, Adj. Rate Pfd. ........    2,089,710
  41,700   ENSERCH Corporation,                  
             Series F, Adj. Rate Pfd. ........      964,312
   4,899   Entergy Gulf States Utilities Inc.,   
             Series A, Adj. Rate Pfd. ........      485,001
           Georgia Power Company:                
   7,500     Series 1993 K, Adj. Rate Pfd. ...      182,344
  43,600     Series 1993-2 L, Adj. Rate Pfd...      986,450
   9,000   Gulf Power Company,                   
             Adj. Rate Pfd. ..................      199,125
  81,415   Illinois Power Company,               
             Series A, Adj. Rate Pfd. ........    3,780,709
  94,504   New York State Electric & Gas         
             Corporation,                        
             Series B, Adj. Rate Pfd. ........    2,220,844
           Niagara Mohawk Power Corporation:     
  95,275     Series A, Adj. Rate Pfd. ........    1,601,811
 195,918     Series B, Adj. Rate Pfd. ........    3,967,340
  25,000     Series C, Adj. Rate Pfd. ........      478,125
  12,300   Northern Indiana Public Service       
             Company, Series A, Adj. Rate        
             Pfd. ............................      575,025
           Northern States Power Company:        
  11,520     Series A, Adj. Rate Pfd. ........    1,108,800
  13,935     Series B, Adj. Rate Pfd. ........    1,342,986
  39,600   Puget Sound Power & Light Company,    
             Series B, Adj. Rate Pfd. ........      898,425
   3,900   Texas Utilities Electric Company,     
             Series B, Adj. Rate Pfd. ........      392,437
                                                -----------
           TOTAL UTILITY ADJUSTABLE RATE         
             PREFERRED STOCKS.................   21,451,444
                                                -----------
        BANKING -- 21.3%                         
           Bank of Boston Corporation:           
   9,800     Series A, Adj. Rate Pfd. ........      462,437
  60,600     Series B, Adj. Rate Pfd. ........    2,848,200
  33,700     Series C, Adj. Rate Pfd. ........    2,881,350
           BankAmerica Corporation:
   9,050     Series A, Adj. Rate Pfd. ........      447,975
  69,200     Series B, Adj. Rate Pfd. ........    6,487,500
           Bankers Trust New York Corporation:   
 204,000     Series Q, Adj. Rate Pfd. ........    4,615,500
   6,500     Series R, Adj. Rate Pfd. ........      147,875
           Chase Manhattan Corporation:          
  10,900     Series L, Adj. Rate Pfd. ........    1,024,600
  20,400     Series N, Adj. Rate Pfd. ........      484,500
           Citicorp:                             
  96,948     Second Series, Adj. Rate Pfd. ...    9,100,994
   1,500     Third Series, Adj. Rate Pfd. ....      149,156
           First Chicago NBD:                    
  46,211     Series B, Adj. Rate Pfd. ........    4,387,157
  20,000     Series C, Adj. Rate Pfd. ........    1,980,000
   8,800   Fleet Financial Group, Inc.,          
             Adj. Rate Pfd. ..................      411,400
  32,500   HSBC Americas Inc.,                   
             Series A, Adj. Rate Pfd. ........    1,519,375
 131,200   MBNA Corporation,                     
             Series B, Adj. Rate Pfd. ........    3,386,600
  35,750   Morgan (J.P.) & Company Inc.,         
             Series A, Adj. Rate Pfd. ........    2,868,938
  65,000   Republic New York Corporation,        
             Series D, Adj. Rate Pfd. ........    1,519,375
  20,000   Wells Fargo & Company,                
             Series B, Adj. Rate Pfd. ........      920,000
                                                -----------
           TOTAL BANKING ADJUSTABLE RATE         
             PREFERRED STOCKS.................   45,642,932
                                                -----------
           TOTAL ADJUSTABLE RATE                 
             PREFERRED STOCKS.................   67,094,376
                                                -----------
  FIXED RATE PREFERRED STOCKS AND SECURITIES -- 64.2%
        UTILITIES -- 45.1% 
           Alabama Power Company:
 159,700     Class A, 6.40% Pfd. .............    3,972,538
  24,500     Series 1992-1, 7.60% Pfd. .......      620,156
  39,400     Series 1992-2, 7.60% Pfd. .......      992,388
</TABLE>
 
                       See Notes to Financial Statements.
 
                                        9

<PAGE>
 
- --------------------------------------------------------------------------------
Preferred Income Opportunity Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 1996
- ---------------------------------------------------------------
 
<TABLE>
<CAPTION>
                                                    VALUE
 SHARES                                            (NOTE 1)
 -------                                          ----------
PREFERRED STOCKS AND SECURITIES (CONTINUED)
  FIXED RATE PREFERRED STOCKS AND SECURITIES (CONTINUED)
        UTILITIES (CONTINUED)

 <S>       <C>                                    <C>
  21,800   Appalachian Power Company,
             Series A, 8.25% TOPRS............    $  547,725
 196,246   Arizona Public Service Company,
             Series W, 7.25% Pfd. ............     4,955,211
           Baltimore Gas & Electric Company:
  27,650     Series 1993, 6.70% Pfd. .........     2,958,550
   3,585     Series 1993, 7.125% Pfd. ........       392,558
  48,800     Series 1995, 6.99% Pfd. .........     5,349,700
   7,500   Boston Edison Company,
             4.78% Pfd. ......................       526,875
     100   Central Hudson Gas & Electric
             Corporation,
             Series D, 4.35% Pfd. ............         6,625
   7,500   Commonwealth Edison Company,
             $8.40 Pfd. ......................       772,500
           Consumers Power Company:
 127,533     Class A, 8.32% Pfd. .............     3,268,033
   3,170     Series D, $7.45 Pfd. ............       305,509
   2,850     Series G, $7.76 Pfd. ............       285,712
  42,400   Detroit Edison Company,
             7.75% Pfd. ......................     1,097,100
           Duke Power Company:
   8,900     Series 1993 A, 6.375% Pfd. ......       228,062
   3,500     Series C, 4.50% Pfd. ............       259,875
   4,000     Series E, 6.72% Pfd. ............       408,000
  20,700     Series S, 7.85% Pfd. ............     2,310,637
  46,935     Series W, 7.00% Pfd. ............     5,051,379
  18,755     Series Y, 7.04% Pfd. ............     2,023,196
  43,750   Duquesne Capital,
             Series A, 8.375% MIPS ...........     1,094,844
   3,125   Entergy Gulf States Utilities Inc.,
             $9.96 Pfd. ......................       322,656
   6,000   Entergy Mississippi Inc.,
             8.36% Pfd. ......................       616,500
           Florida Power & Light Company:
   4,000     4.50% Pfd. ......................       295,500
   4,000     Series E, 4.35% Pfd. ............       277,000
  38,850     Series S, 6.98% Pfd. ............     4,195,800
  36,400     Series T, 7.05% Pfd. ............     3,949,400
   7,000     Series U, 6.75% Pfd. ............       746,375
           Georgia Power Company:
   1,246     $6.48 Pfd. ......................       126,157
   2,639     $6.60 Pfd. ......................       274,456
  16,000     Series P, $1.90 Pfd. ............       405,000
  21,000     Series Q, $1.9875 Pfd. ..........       536,813
  12,500     Series S, $1.925 Pfd. ...........       319,531
   8,000   Gulf Power Company,
             Series A, 7.00% Pfd. ............       203,000
  10,000   Jersey Central Power & Light
             Company, Series K, 7.52% Sinking
             Fund Pfd. .......................     1,052,500
   4,000   Massachusetts Electric Company,
             6.84% Pfd. ......................       105,000
  62,000   Mississippi Power Company,
             7.25% Pfd. ......................     1,581,000
  20,000   Monongahela Power Company,
             Series L, $7.73 Pfd. ............     2,202,500
  30,000   Montana Power Capital,
             Series A, 8.45% QUIPS............       765,000
   3,900   Montana Power Company,
             $6.875 Pfd. .....................       416,813
           New York State Electric & Gas
             Corporation:
   5,000     6.30% Sinking Fund Pfd. .........       515,625
   9,696     6.48% Pfd. ......................       927,180
           Niagara Mohawk Power Corporation:
   6,250     4.10% Pfd. ......................       272,656
  44,605     7.85% Sinking Fund Pfd. .........     1,103,974
  62,000     9.50% Pfd. ......................     1,486,450
           Northern States Power Company:
   2,380     $4.10 Pfd. ......................       159,757
   2,420     $4.16 Pfd. ......................       164,863
   4,000     Series H, $6.80 Pfd. ............       416,000
   5,600     Series I, $7.00 Pfd. ............       583,800
   2,150   Pacific Enterprises,
             $4.50 Pfd. ......................       157,219
   9,000   Pacificorp,
             7.48% Sinking Fund Pfd. .........       983,250
</TABLE>
 
                       See Notes to Financial Statements.
 
                                       10

<PAGE>
 
- --------------------------------------------------------------------------------
                                  Preferred Income Opportunity Fund Incorporated
                                            PORTFOLIO OF INVESTMENTS (CONTINUED)
                                                               NOVEMBER 30, 1996
                 ---------------------------------------------------------------
 
<TABLE>
<CAPTION>

                                                    VALUE
 SHARES                                            (NOTE 1)
 -------                                         -----------
PREFERRED STOCKS AND SECURITIES (CONTINUED)
  FIXED RATE PREFERRED STOCKS AND SECURITIES (CONTINUED)
        UTILITIES (CONTINUED)
 <S>       <C>                                   <C>
  17,800   Pennsylvania Power Company,
             7.75% Pfd. ......................   $ 1,726,600
  15,800   Pennsylvania Power & Light Company,
             $6.75 Pfd. ......................     1,690,600
   1,273   Potomac Electric Power Company,
             Series 1957, $2.44 Pfd. .........        50,124
           PSI Energy, Inc.:
   4,850     6.875% Pfd. .....................       518,344
 167,582     7.44% Pfd. ......................     4,262,867
   5,283   Public Service Company of Colorado,
             4.64% Pfd. ......................       394,904
           Puget Sound Power & Light Company:
  19,100     7.75% Sinking Fund Pfd. .........     2,028,181
  77,135     7.875% Pfd. .....................     1,966,942
   4,030   Rochester Gas & Electric
             Corporation, Series I, 4.75%
             Pfd. ............................       290,664
 146,800   San Diego Gas & Electric Company,
             6.80% Pfd. ......................     3,991,125
  26,000   Sierra Pacific Capital,
             8.60% TOPRS......................       680,875
  26,000   Southern California Gas Company,
             7.75% Pfd. ......................       669,500
   4,000   Southern Indiana Gas & Electric,
             4.75% Pfd. ......................       293,000
  19,850   Texas Utilities Electric Company,
             $7.98 Pfd. ......................     2,176,056
           TU Capital:
  60,220     Series M, 8.25% TOPRS............     1,510,017
   9,000     Series N, 9.00% TOPRS............       235,125
           Union Electric Company:
   3,000     $7.64 Pfd. ......................       332,250
  10,000     Series G, $6.40 Pfd. ............     1,001,250
           Virginia Electric & Power Company:
   1,136     $4.04 Pfd. ......................        74,408
   1,420     $4.20 Pfd. ......................        96,560
  39,800     $6.98 Pfd. ......................     4,283,475
  16,900     $7.05 Pfd. ......................     1,818,862
 128,500   Washington Natural Gas Company,
             Series II, 7.45% Pfd. ...........     3,453,438
   5,500   Wisconsin Power & Light Company,
             6.20% Pfd. ......................       552,750
                                                 -----------
           TOTAL UTILITY FIXED RATE
             PREFERRED STOCKS
             AND SECURITIES...................    96,686,865
                                                 -----------
        BANKING -- 2.9% 
  21,000   Bankers Trust New York Corporation,
             Series O, 7.625% Pfd. ...........       536,813
           Chase Manhattan Corporation:
 101,050     Series C, 10.84% Pfd. ...........     3,113,603
  12,700     Series K, 7.50% Pfd. ............       329,406
           Fleet Financial Group, Inc.:
  12,300     Series VI, 6.75% Pfd. ...........       652,669
  35,000     Series E, 9.35% Pfd. ............       984,375
  10,000   Morgan (J.P.) & Company Inc.,
             Series H, 6.625% Pfd. ...........       521,250
                                                 -----------
           TOTAL BANKING FIXED RATE
           PREFERRED STOCKS...................     6,138,116
                                                 -----------
        FINANCIAL SERVICES -- 7.3% 
 174,950   Household Capital,
             8.70% TOPRS......................     4,548,700
 106,785   Household International Inc.,
             Series 1993 A, 7.35% Pfd. .......     2,763,062
  86,500   Lehman Brothers Holdings Inc.,
             5.00% Conv. Pfd. ................     2,270,625
 104,200   Merrill Lynch & Company, Inc.,
             Series A, 9.00% Pfd. ............     3,119,487
  56,000   Morgan Stanley Group Inc.,
             7.75% Pfd. ......................     3,031,000
                                                 -----------
           TOTAL FINANCIAL SERVICES
             FIXED RATE PREFERRED STOCKS
             AND SECURITIES...................    15,732,874
                                                 -----------
</TABLE>
 
                       See Notes to Financial Statements.
 
                                       11

<PAGE>
 
- --------------------------------------------------------------------------------
Preferred Income Opportunity Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 1996
- ---------------------------------------------------------------
<TABLE>
<CAPTION>
                                                   VALUE
 SHARES                                           (NOTE 1)
 -------                                        ------------
PREFERRED STOCKS AND SECURITIES (CONTINUED)
  FIXED RATE PREFERRED STOCKS AND SECURITIES (CONTINUED)
 <S>       <C>                                  <C>
        INDUSTRIAL -- 5.9%     
  67,319   Coastal Corporation,
             Series H, $2.125 Pfd. ...........  $  1,737,672
 103,570   Ford Motor Company,
             Series B, 8.25% Pfd. ............     2,880,541
  85,800   James River Corporation,
             Series O, 8.25% Pfd. ............     2,198,625
  56,200   Tenneco Inc.,
             Series A, 8.25% Pfd. ............     2,845,125
  92,893   Transcanada Pipeline Ltd.,
             8.50% COPRS......................     2,386,189
   9,520   Viad Corporation,
             $4.75 Sinking Fund Pfd. .........       523,600
                                                ------------
           TOTAL INDUSTRIAL FIXED RATE
             PREFERRED STOCKS
             AND SECURITIES...................    12,571,752
                                                ------------
        INSURANCE -- 3.0% 
 124,750   AON Corporation,
             8.00% Pfd. ......................     3,220,109
  50,000   Berkley (W.R.) Corporation,
             Series A, 7.375% Pfd. ...........     1,287,500
  70,681   Hartford Capital
             Series B, 8.35% QUIPS............     1,820,036
                                                ------------
           TOTAL INSURANCE FIXED RATE
             PREFERRED STOCKS
             AND SECURITIES...................     6,327,645
                                                ------------
           TOTAL FIXED RATE
             PREFERRED STOCKS
             AND SECURITIES...................   137,457,252
                                                ------------
           TOTAL PREFERRED STOCKS
             AND SECURITIES
           (Cost $191,559,209)................   204,551,628
                                                ------------
 COMMON STOCKS -- 2.2% 
        UTILITIES -- 2.2% 
  11,000   Consolidated Edison Company of
             New York, Inc. ..................  $    320,375
 220,800   Nevada Power Company...............     4,526,400
                                                ------------
           TOTAL UTILITY COMMON STOCKS
           (Cost $5,066,257)..................     4,846,775
                                                ------------
MISCELLANEOUS SECURITIES -- 0.3%  (Cost $1,425,460)
           Put Options on U.S. Treasury
             Bond Futures.....................       617,704
                                                ------------
</TABLE>
 
<TABLE>
<CAPTION>
 PRINCIPAL
  AMOUNT
- -----------
 <S>                                    <C>     <C>
REPURCHASE AGREEMENT -- 1.4% (Cost $2,954,000)
 $2,954,000   Agreement with UBS Securities
                Inc., 5.60% dated 11/29/96, to
                be repurchased at $2,955,379
                on 12/2/96, collateralized by
                $2,962,000 U.S. Treasury Note,
                6.125% due 3/31/98
                (value $3,090,353)............     2,954,000
                                                ------------
TOTAL INVESTMENTS (Cost $201,004,926*)...99.4%   212,970,107
                                                
OTHER ASSETS AND LIABILITIES (Net)........ 0.6     1,224,599
                                        ------  ------------
NET ASSETS..............................100.0%  $214,194,706
                                        =====   ============
</TABLE>
 
- ---------------
 
* Aggregate cost for Federal tax purposes is $200,455,151.
 
<TABLE>
<S>    <C>
ABBREVIATIONS:
TOPRS  -- Trust Originated Preferred Securities (Note 7)
MIPS   -- Monthly Income Preferred Securities (Note 7)
QUIPS  -- Quarterly Income Preferred Securities (Note 7)
COPRS  -- Canadian Originated Preferred Securities (Note 7)
</TABLE>
 
                       See Notes to Financial Statements.
 
                                       12

<PAGE>
 
- --------------------------------------------------------------------------------
                                  Preferred Income Opportunity Fund Incorporated
                                             STATEMENT OF ASSETS AND LIABILITIES
                                                               NOVEMBER 30, 1996
                                  ----------------------------------------------
 
<TABLE>
<S>                                                                <C>                <C>
ASSETS:
  Investments, at value (Cost $201,004,926) (Note 1)
     See accompanying schedule..................................                      $212,970,107
  Cash..........................................................                               189
  Dividends and interest receivable.............................                         1,728,821
  Receivable for securities sold................................                         1,009,491
  Prepaid expenses..............................................                            21,397
  Unamortized organization costs (Note 6).......................                             3,333
                                                                                      ------------
          Total Assets..........................................                       215,733,338
LIABILITIES:
     Payable for securities purchased...........................   $ 1,013,766
     Dividends payable..........................................       280,797
     Investment advisory fee payable (Note 2)...................        97,662
     Accrued expenses and other payables........................       146,407
                                                                   -----------
          Total Liabilities.....................................                         1,538,632
                                                                                      ------------
NET ASSETS......................................................                      $214,194,706
                                                                                      ============
NET ASSETS consist of:
  Undistributed net investment income (Note 1)..................                      $  1,001,239
  Accumulated net realized gain on investments sold (Note 1)....                         2,293,783
  Unrealized appreciation of investments (Note 3)...............                        11,965,181
  Par value of Common Stock.....................................                           111,513
  Paid-in capital in excess of par value of Common Stock........                       128,822,990
  Money Market Cumulative Preferred[Trademark] Stock (Note 5)...                        70,000,000
                                                                                      ------------
          Total Net Assets......................................                      $214,194,706
                                                                                      ============
                                                                    PER SHARE
                                                                   -----------
NET ASSETS AVAILABLE TO:
     Money Market Cumulative Preferred[Trademark] Stock 
       (700 shares outstanding) redemption value................   $100,000.00        $ 70,000,000
     Accumulated undeclared dividends on Money Market Cumulative
       Preferred[Trademark] Stock...............................        260.00             182,000
                                                                   -----------        ------------
                                                                   $100,260.00          70,182,000
                                                                   ===========
     Common Stock (11,151,287 shares outstanding)...............        $12.91         144,012,706
                                                                        ======        ------------
TOTAL NET ASSETS................................................                      $214,194,706
                                                                                      ============
</TABLE>
 
                       See Notes to Financial Statements.
 
                                       13

<PAGE>
 
- --------------------------------------------------------------------------------
Preferred Income Opportunity Fund Incorporated
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED NOVEMBER 30, 1996
- ----------------------------------------------
 
<TABLE>
<S>                                                                  <C>               <C>
INVESTMENT INCOME:
     Dividends....................................................                     $15,041,334
     Interest.....................................................                         204,701
                                                                                       -----------
          Total Investment Income.................................                      15,246,035
EXPENSES:
     Investment advisory fee (Note 2).............................   $1,156,891
     Administration fee (Note 2)..................................      392,108
     Money Market Cumulative Preferred[Trademark] broker 
       commissions and Auction Agent fees.........................      177,928
     Shareholder servicing agent fees (Note 2)....................      135,859
     Insurance expense............................................       97,620
     Economic consulting fee (Note 2).............................       64,561
     Custodian fees (Note 2)......................................       63,761
     Legal and audit fees.........................................       63,685
     Directors' fees and expenses (Note 2)........................       43,109
     Amortization of deferred organization costs (Note 6).........       14,000
     Other........................................................      121,856
                                                                     ----------
          Total Expenses..........................................                       2,331,378
                                                                                       -----------
NET INVESTMENT INCOME.............................................                      12,914,657
                                                                                       -----------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS
  (Notes 1 and 3):
     Net realized gain on investments sold during the year........                       6,552,224
     Change in net unrealized appreciation/(depreciation) of
       investments during the year................................                        (630,710)
                                                                                       -----------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS...................                       5,921,514
                                                                                       -----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS..............                     $18,836,171
                                                                                       ===========
</TABLE>
 
                       See Notes to Financial Statements.
 
                                       14

<PAGE>
 
- --------------------------------------------------------------------------------
                                  Preferred Income Opportunity Fund Incorporated
                                              STATEMENT OF CHANGES IN NET ASSETS
                                  ----------------------------------------------
 
<TABLE>
<CAPTION>
                                                                       YEAR ENDED            YEAR ENDED
                                                                    NOVEMBER 30, 1996     NOVEMBER 30, 1995
                                                                    -----------------     -----------------
<S>                                                                    <C>                   <C>
OPERATIONS:
     Net investment income.......................................      $ 12,914,657          $ 14,179,582
     Net realized gain/(loss) on investments sold during 
       the year...................................................        6,552,224            (5,097,206)
     Change in net unrealized appreciation/(depreciation) of
       investments during the year...............................          (630,710)           24,429,567
                                                                       ------------          ------------
     Net increase in net assets resulting from operations........        18,836,171            33,511,943
DISTRIBUTIONS:
     Dividends paid from net investment income to Money Market
       Cumulative Preferred[Trademark] Stock Shareholders 
       (Note 5)..................................................        (2,326,879)           (3,498,611)
     Distributions paid from net realized capital gains to Money
       Market Cumulative Preferred[Trademark] Stock Shareholders 
       (Note 5)..................................................          (383,206)              (12,001)
     Dividends paid from net investment income to Common Stock
       Shareholders..............................................        (9,651,475)          (12,414,321)
     Distributions paid from net realized capital gains to Common
       Stock Shareholders (Note 9)...............................                --            (1,894,269)
FUND SHARE TRANSACTIONS:
     Increase from Common Stock transactions (Note 4)............                --               230,242
                                                                       ------------          ------------
NET INCREASE IN NET ASSETS FOR THE YEAR..........................         6,474,611            15,922,983
NET ASSETS:
Beginning of year................................................       207,720,095           191,797,112
                                                                       ------------          ------------
End of year (including undistributed net investment income of
  $1,001,239 and $44,550, respectively)..........................      $214,194,706          $207,720,095
                                                                       ============          ============
</TABLE>
 
                       See Notes to Financial Statements.
 
                                       15

<PAGE>
 
- --------------------------------------------------------------------------------
Preferred Income Opportunity Fund Incorporated
FINANCIAL HIGHLIGHTS
FOR A COMMON SHARE OUTSTANDING THROUGHOUT EACH YEAR.
- ----------------------------------------------------
 
     Contained below is per share operating performance data, total investment
returns, ratios to average net assets and other supplemental data. This
information has been derived from information provided in the financial
statements and market price data for the Fund's shares.
 
<TABLE>
<CAPTION>
                                                  YEAR ENDED       YEAR ENDED       YEAR ENDED       YEAR ENDED      PERIOD ENDED
                                                 NOVEMBER 30,     NOVEMBER 30,     NOVEMBER 30,     NOVEMBER 30,     NOVEMBER 30,
                                                     1996             1995             1994             1993            1992*
                                                 ------------     ------------     ------------     ------------     ------------
<S>                                                <C>              <C>               <C>             <C>              <C>
OPERATING PERFORMANCE:
Net asset value, beginning of year.............    $  12.35         $  10.92          $  13.17        $  12.69         $  11.63
                                                   --------         --------          --------        --------         --------
Net investment income..........................        1.16             1.27              1.19            1.19             0.88
Net realized and unrealized gain/(loss) on
 investments...................................        0.53             1.73             (1.64)           0.92             1.09
                                                   --------         --------          --------        --------         --------
Net increase/(decrease) in net asset value
 resulting from investment operations..........        1.69             3.00             (0.45)           2.11             1.97
Offering costs and Money Market Cumulative
 Preferred[Trademark] Stock underwriting 
 commissions charged to paid-in capital........          --               --                --              --            (0.19)
DISTRIBUTIONS:
Dividends paid from net investment income to
 Money Market Cumulative Preferred[Trademark]
 Stock Shareholders............................       (0.21)           (0.31)            (0.18)          (0.15)           (0.10)
Distributions paid from net realized capital
 gains to Money Market Cumulative Preferred
 [Trademark] Stock Shareholders................       (0.03)           (0.00)            (0.03)          (0.05)           (0.02)
Dividends paid from net investment income to
 Common Stock Shareholders.....................       (0.87)           (1.11)            (0.86)          (1.18)           (0.58)
Distributions paid from net realized capital
 gains to Common Stock Shareholders............          --            (0.17)            (0.72)          (0.26)              --
Change in accumulated undeclared dividends on
 Money Market Cumulative Preferred[Trademark]
 Stock.........................................       (0.02)            0.02             (0.01)           0.01            (0.02)
                                                   --------         --------          --------        --------         --------
Total distributions............................       (1.13)           (1.57)            (1.80)          (1.63)           (0.72)
                                                   --------         --------          --------        --------         --------
Net asset value, end of year...................    $  12.91         $  12.35          $  10.92        $  13.17         $  12.69
                                                   ========         ========          ========        ========         ========
Market value, end of year......................    $ 12.000         $ 11.250          $ 10.125        $ 13.250         $ 13.625
                                                   ========         ========          ========        ========         ========
Total investment return based on net asset
 value***......................................       13.11%           27.25%            (5.44)%         16.04%           14.18%
                                                   ========         ========          ========        ========         ========
Total investment return based on market
 value***......................................       15.42%           25.02%           (12.83)%          8.70%           14.10%
                                                   ========         ========          ========        ========         ========
Net assets, end of year (in 000's).............    $214,195         $207,720          $191,797        $213,569         $200,469
                                                   ========         ========          ========        ========         ========
RATIOS TO AVERAGE NET ASSETS
 AVAILABLE TO COMMON STOCK
 SHAREHOLDERS/SUPPLEMENTAL DATA:
   Net investment income.......................        7.36%            8.47%             8.31%           7.65%            7.46%**
   Operating expenses..........................        1.71%            1.78%             1.69%           1.72%            1.73%**
   Portfolio turnover rate.....................          87%              94%              116%            129%              77%
EXPENSE RATIO TO TOTAL AVERAGE NET ASSETS
 (WHICH INCLUDES MONEY MARKET CUMULATIVE
 PREFERRED[TRADEMARK] STOCK):
   Operating expenses..........................        1.13%            1.13%             1.11%           1.14%            1.19%**
</TABLE>
 
- ---------------
 
   * The Fund commenced operations on February 13, 1992.
  ** Annualized.
 *** Assumes reinvestment of distributions.
 
                       See Notes to Financial Statements.
 
                                       16

<PAGE>
 
- --------------------------------------------------------------------------------
                                  Preferred Income Opportunity Fund Incorporated
                                                FINANCIAL HIGHLIGHTS (CONTINUED)
                                  ----------------------------------------------
 
     The table below sets out information with respect to Money Market
Cumulative Preferred[Trademark] Stock currently outstanding.
 
<TABLE>
<CAPTION>
                                             INVOLUNTARY           AVERAGE
                                 ASSET       LIQUIDATING            MARKET
              TOTAL SHARES     COVERAGE       PREFERENCE            VALUE
              OUTSTANDING      PER SHARE     PER SHARE(1)     PER SHARE(1) & (2)
              ------------     ---------     ------------     ------------------
<S>                <C>          <C>            <C>                 <C>
11/30/96           700          $305,992       $100,000            $100,000
11/30/95           700           296,743        100,000             100,000
11/30/94           700           273,996        100,000             100,000
11/30/93           700           305,099        100,000             100,000
11/30/92           700           286,384        100,000             100,000
</TABLE>
 
- ---------------
(1) Excludes accumulated undeclared dividends.
(2) See Note 5.
 


                       See Notes to Financial Statements.
 
                                       17

<PAGE>
 
- --------------------------------------------------------------------------------
Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS
- ----------------------------------------------
 
1.   SIGNIFICANT ACCOUNTING POLICIES
 
     Preferred Income Opportunity Fund Incorporated (the "Fund") is a
diversified, closed-end management investment company organized as a Maryland
corporation on December 10, 1991 and is registered with the Securities and
Exchange Commission ("SEC") under the Investment Company Act of 1940, as
amended. The Fund commenced operations on February 13, 1992. The policies
described below are followed consistently by the Fund in the preparation of its
financial statements in conformity with generally accepted accounting
principles.
 
     Portfolio valuation:  The net asset value of the Fund's Common Stock is
determined by the Fund's administrator no less frequently than on the last
business day of each week and month. It is determined by dividing the value of
the Fund's net assets attributable to common shares by the number of shares of
Common Stock outstanding. The value of the Fund's net assets attributable to
common shares is deemed to equal the value of the Fund's total assets less (i)
the Fund's liabilities, (ii) the aggregate liquidation value of the outstanding
Money Market Cumulative Preferred[Trademark] Stock and (iii) accumulated and
unpaid dividends on the outstanding Money Market Cumulative Preferred[Trademark]
Stock. Securities listed on a national securities exchange are valued on the
basis of the last sale on such exchange on the day of valuation. In the absence
of sales of listed securities and with respect to securities for which the most
recent sale prices are not deemed to represent fair market value and unlisted
securities (other than money market instruments), securities are valued at the
mean between the closing bid and asked prices when quoted prices for
investments are readily available. Investments for which market quotations are
not readily available are valued at fair value as determined in good faith by
or under the direction of the Board of Directors of the Fund, including
reference to valuations of other securities which are considered comparable in
quality, maturity and type. Investments in money market instruments, which
mature in 60 days or less, are valued at amortized cost.
 
     Securities transactions and investment income:  Securities transactions are
recorded as of the trade date. Realized gains and losses from securities sold
are recorded on the identified cost basis. Dividend income is recorded on
ex-dividend dates. Interest income is recorded on the accrual basis.
 
     Option accounting principles:  Upon the purchase of a put option by the
Fund, the total purchase price paid is recorded as an investment. The market
valuation is determined as set forth in the second preceding paragraph. When the
Fund enters into a closing sale transaction, the Fund will record a gain or loss
depending on the difference between the purchase and sale price. The risks
associated with purchasing options and the maximum loss the Fund would incur are
limited to the purchase price originally paid.
 
     Repurchase Agreements:  The Fund may engage in repurchase agreement
transactions. The Fund's Board of Directors reviews and approves periodically
the eligibility of the banks and dealers with which the Fund enters into
repurchase agreement transactions. The value of the collateral underlying such
transactions is at least equal at all times to the total amount of the
repurchase obligations, including interest. The Fund maintains possession of the
collateral and, in the event of counterparty default, the
 
                                       18

<PAGE>
 
- --------------------------------------------------------------------------------
                                  Preferred Income Opportunity Fund Incorporated
                                       NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                                  ----------------------------------------------
 
Fund has the right to use the collateral to offset losses incurred. There is the
possibility of loss to the Fund in the event the Fund is delayed or prevented
from exercising its rights to dispose of the collateral securities.
 
     Dividends and distributions to shareholders:  The Fund expects to declare
dividends on a monthly basis to shareholders of Common Stock. The shareholders
of Money Market Cumulative Preferred[Trademark] Stock are entitled to receive
cumulative cash dividends as declared by the Fund's Board of Directors.
Distributions to shareholders are recorded on the ex-dividend date. Any net
realized short-term capital gains will be distributed to shareholders at least
annually. Any net realized long-term capital gains may be distributed to
shareholders at least annually or may be retained by the Fund as determined by
the Fund's Board of Directors. Capital gains retained by the Fund are subject to
tax at the corporate tax rate. Any taxes paid by the Fund on such net realized
long-term gains may be used by the Fund's Common Stock Shareholders as a credit
against their own tax liabilities subject to the Fund qualifying as a regulated
investment company as described in the following paragraph.
 
     Federal income taxes:  The Fund intends to qualify as a regulated
investment company by complying with the requirements under subchapter M of the
Internal Revenue Code of 1986, as amended, applicable to regulated investment
companies and intends to distribute substantially all of its taxable net
investment income to its shareholders. Therefore, no Federal income tax
provision is required.
 
     Income distributions and capital gain distributions are determined in
accordance with income tax regulations which may differ from generally accepted
accounting principles. These differences are primarily due to differing
treatments of income and gains on various investment securities held by the
Fund, timing differences and the differing characterization of distributions
made by the Fund.
 
     The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts and disclosures in the financial
statements. Actual results could differ from those estimates.
 
2.   INVESTMENT ADVISORY FEE, DIRECTORS' FEES, ECONOMIC CONSULTING FEE,
     ADMINISTRATION FEE AND TRANSFER AGENT FEE
 
     Flaherty & Crumrine Incorporated (the "Adviser") serves as the Fund's
Investment Adviser. The Fund pays the Adviser a monthly fee at an annual rate of
0.625% of the value of the Fund's average monthly net assets up to $100 million
and 0.50% of the value of the Fund's average monthly net assets in excess of
$100 million.
 
     The Fund currently pays each Director who is not a director, officer or
employee of the Adviser a fee of $9,000 per annum, plus $500 for each in-person
meeting of the Board of Directors or any committee and $100 for each telephone
meeting. In addition, the Fund will reimburse all Directors for travel and out-
of-pocket expenses incurred in connection with such meetings.
 
                                       19

<PAGE>
 
- --------------------------------------------------------------------------------
Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- ----------------------------------------------
 
     Prior to September 9, 1996, Lehman Brothers Global Economics ("Global
Economics") (formerly Economic Advisors, Inc.), a department of Lehman Brothers
Inc., served as the Fund's Economic Consultant. The Fund paid Global Economics
at an annual rate equal to $75,000 for services provided. Allen Sinai served as
the chief economist at Global Economics. On September 9, 1996, Mr. Sinai, along
with other key economists, left Global Economics to join Primark Decision
Economics Inc. ("Primark"). As of October 18, 1996, Primark serves as the Fund's
Economic Consultant. The Fund pays Primark an annual fee equal to $45,333 for
services provided.
 
     First Data Investor Services Group, Inc. ("FDISG"), a wholly owned
subsidiary of First Data Corporation, serves as the Fund's Administrator and
Transfer Agent. As Administrator, FDISG calculates the net asset value of the
Fund's shares and generally assists in all aspects of the Fund's administration
and operation. As compensation for FDISG's services as Administrator, the Fund
pays FDISG a monthly fee at an annual rate of 0.19% of the Fund's average
monthly net assets. Boston Safe Deposit and Trust Company ("Boston Safe"), a
wholly owned subsidiary of Mellon Bank Corporation, serves as the Fund's
Custodian. As compensation for Boston Safe's services as Custodian, the Fund
pays Boston Safe a monthly fee at an annual rate of 0.02% of the Fund's average
monthly net assets. FDISG also serves as the Fund's common stock servicing agent
(transfer agent), dividend-paying agent and registrar, and as compensation for
FDISG's services as transfer agent, the Fund pays FDISG a fee at an annual rate
of 0.04% of the Fund's average monthly net assets plus certain out-of-pocket
expenses.
 
     As of December 1, 1996, the fees paid by the Fund to its administrator,
custodian and transfer agent have been revised as follows. The Fund will pay
FDISG for administration services a monthly fee at an annual rate of 0.12% of
the Fund's average monthly net assets. As compensation for Boston Safe's
services as custodian, the Fund will pay Boston Safe a monthly fee at an annual
rate of 0.01% of the Fund's average monthly net assets. The Fund will pay FDISG
for transfer agency services a monthly fee at an annual rate of 0.02% of the
Fund's average monthly net assets plus certain out-of-pocket expenses.
 
     Chase Manhattan Bank ("Auction Agent") serves as the Fund's Money Market
Cumulative Preferred[Trademark] Stock transfer agent, registrar, dividend 
disbursing agent and redemption agent.
 
3.   PURCHASES AND SALES OF SECURITIES
 
     Cost of purchases and proceeds from sales of securities for the year ended
November 30, 1996, excluding short-term investments, aggregated $174,860,691 and
$174,302,936, respectively.
 
     At November 30, 1996, aggregate gross unrealized appreciation for all
securities in which there is an excess of value over tax cost was $14,158,122
and aggregate gross unrealized depreciation for all securities in which there is
an excess of tax cost over value was $1,643,166.
 
                                       20

<PAGE>
 
- --------------------------------------------------------------------------------
                                  Preferred Income Opportunity Fund Incorporated
                                       NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                                  ----------------------------------------------
 
4.   COMMON STOCK
 
     At November 30, 1996, 240,000,000 shares of $0.01 par value Common Stock
were authorized.
 
     Common Stock transactions were as follows:
 
<TABLE>
<CAPTION>
                                                             YEAR ENDED               YEAR ENDED
                                                              11/30/96                 11/30/95
                                                         ------------------      --------------------
                                                         SHARES      AMOUNT      SHARES       AMOUNT
                                                         ------      ------      ------      --------
<S>                                                      <C>         <C>         <C>         <C>
Issued as reinvestment of dividends under the Dividend
  Reinvestment and Cash Purchase Plan.................        0      $    0      21,619      $230,242
                                                         ======      ======      ======      ========
</TABLE>
 
5.   MONEY MARKET CUMULATIVE PREFERRED[TRADEMARK] STOCK
 
     The Fund's Articles of Incorporation authorize the issuance of up to
10,000,000 shares of $0.01 par value preferred stock. On April 9, 1992, the Fund
received proceeds from the public offering of 700 shares of Money Market
Cumulative Preferred[Trademark] Stock of $70,000,000 before offering costs of
$144,375 and underwriting discounts and commissions paid directly to Lehman
Brothers Inc. of $1,225,000. The Money Market Cumulative Preferred[Trademark]
Stock is senior to the Common Stock and results in the financial leveraging of
the Common Stock. Such leveraging tends to magnify both the risks and
opportunities to Common Stock Shareholders. Dividends on shares of Money Market
Cumulative Preferred[Trademark] Stock are cumulative.
 
     The Fund is required to meet certain asset coverage tests with respect to
the Money Market Cumulative Preferred[Trademark] Stock. If the Fund fails to    
meet these requirements and does not correct such failure, the Fund may be
required to redeem, in part or in full, Money Market Cumulative Preferred 
[Trademark] Stock at a redemption price of $100,000 per share plus an amount
equal to the accumulated and unpaid dividends on such shares in order to meet
these requirements. Additionally, failure to meet the foregoing asset
requirements could restrict the Fund's ability to pay dividends to Common Stock
Shareholders and could lead to sales of portfolio securities at inopportune
times.
 
     If the Fund allocates any net gains or income ineligible for the Dividends
Received Deduction to shares of the Money Market Cumulative Preferred[Trademark]
Stock, the Fund may be required to make additional distributions to Money Market
Cumulative Preferred[Trademark] Stock Shareholders or to pay a higher dividend
rate in amounts needed to provide a return, net of tax, equal to the return had
such originally paid distributions been eligible for the Dividends Received
Deduction.
 
     An auction of the Money Market Cumulative Preferred[Trademark] Stock is 
[Trademark] generally held every 49 days. Existing shareholders may submit an
order to hold, bid or sell such shares at par value on each auction date. Money
Market Cumulative Preferred[Trademark] Stock Shareholders may also trade shares
in the secondary market between auction dates.
 
     At November 30, 1996, 700 shares of Money Market Cumulative 
Preferred[Trademark] Stock were outstanding at the annual rate of 3.900%. The
dividend rate, as set by the auction process, is generally expected to
 
                                       21

<PAGE>
 
- --------------------------------------------------------------------------------
Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- ----------------------------------------------
 
vary with short-term interest rates. These rates may vary in a manner unrelated
to the income received on the Fund's assets, which could have either a
beneficial or detrimental impact on net investment income and gains available to
Common Stock Shareholders. While the Fund expects to structure the portfolio
holdings and hedging transactions to lessen such risks to Common Stock
Shareholders, there can be no assurance that such results will be attained.
 
6.   ORGANIZATION COSTS
 
     Costs incurred by the Fund in connection with its organization and
initial public offering of Common Stock and Money Market Cumulative
Preferred[Trademark] Stock were $40,000 and $30,000, respectively, and are
being amortized on a straight-line basis over a five year period beginning
February 13, 1992 (the date of the Fund's commencement of investment
operations) and April 9, 1992 (the date of the issuance of the Fund's Money
Market Cumulative Preferred[Trademark] Stock), respectively.
 
7.   PORTFOLIO INVESTMENTS, CONCENTRATION AND INVESTMENT QUALITY
 
     The Fund invests primarily in adjustable and fixed rate preferred stocks.
Under normal market conditions, the Fund invests at least 25% of its assets in
securities issued by utilities and may invest a significant portion of its
assets, but less than 25% of its assets, in companies in the banking industry.
The Fund's portfolio may therefore be subject to greater risk and market
fluctuation than a portfolio of securities representing a broader range of
investment alternatives. Because of the Fund's concentration of investments in
the utility industry and significant holdings in the banking industry, the
ability of the Fund to maintain its dividend and the value of the Fund's
investments could be adversely affected by the possible inability of companies
in these industries to pay dividends and interest on their securities and the
ability of holders of securities of such companies to realize any value from the
assets of the issuer upon liquidation or bankruptcy. The Fund may invest up to
15% of its assets at the time of purchase in securities rated below investment
grade, provided that no such investment may be rated below both "Ba" by Moody's
Investors Service, Inc. and "BB" by Standard & Poor's Ratings Group or judged to
be comparable in quality at the time of purchase; however, any such securities
must be issued by an issuer having an outstanding class of senior debt rated
investment grade. The Fund may also invest up to 15% of its assets in common
stock. The Fund's investment policy regarding debt securities was amended by the
Board of Directors on July 21, 1995. The amended policy allows the Fund to
invest up to 35% of its assets collectively in the following securities: Trust
Originated Preferred Securities ("TOPRS"), Monthly Income Preferred Securities
("MIPS"), Quarterly Income Debt Securities ("QUIDS"), Quarterly Income Preferred
Securities ("QUIPS"), Canadian Originated Preferred Securities ("COPRS"), and
similarly-structured instruments, subject to the quality standards set forth
above.
 
8.   SPECIAL INVESTMENT TECHNIQUES
 
     The Fund may employ certain investment techniques in accordance with its
fundamental investment policies. These may include the use of when-issued and
delayed delivery transactions. Securities purchased or sold on a when-issued or
delayed delivery basis may be settled within 45 days after the
 
                                       22

<PAGE>
 
- --------------------------------------------------------------------------------
                                  Preferred Income Opportunity Fund Incorporated
                                       NOTES TO FINANCIAL STATEMENTS (CONTINUED)
                                  ----------------------------------------------
 
date of the transaction. Such transactions may expose the Fund to credit and
market valuation risk greater than that associated with regular trade
settlement procedures. The Fund may also enter into transactions, in accordance 
with its fundamental investment policies, involving any or all of the
following: lending of portfolio securities, short sales of securities, futures
contracts, options on futures contracts, and options on securities. With the
exception of purchasing securities on a when-issued or delayed delivery basis
or lending portfolio securities, these transactions are used for hedging or
other appropriate risk-management purposes or, under certain other
circumstances, to increase income. As of November 30, 1996, the Fund owned put
options on U.S. Treasury bond futures contracts. No assurance can be given that
such transactions will achieve their desired purposes or will result in an
overall reduction of risk to the Fund.
 
9.   SUBSEQUENT EVENTS
 
     On December 16, 1996, the Fund declared a dividend of $0.280 per share (of
which for tax purposes $0.125 per share represents a dividend from net
investment income and $0.155 per share represents a dividend from realized long
term capital gains) to Common Stock Shareholders of record December 26, 1996,
payable December 31, 1996.
 
     As a result of the gains realized by the Fund, a portion of the    
distributions paid to the Fund's Money Market Cumulative Preferred[Trademark]
Stock Shareholders from January 1, 1996 through November 30, 1996 has been
designated as being from long term capital gains, as required by ruling 89-81
of the  Internal Revenue Service Code. Therefore, on December 16, 1996, the
Fund declared an additional distribution of $109,135 payable December 18, 1996
to Money Market Cumulative Preferred[Trademark] Stock Shareholders as required
by the Fund's Articles Supplementary. This additional distribution is required
to reflect the fact that the original distributions did not qualify 100% for
the corporate Dividends Received Deduction.
 
                                       23

<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Shareholders and Board of Directors
  of Preferred Income Opportunity Fund Incorporated:
 
     We have audited the accompanying statement of assets and liabilities of the
Preferred Income Opportunity Fund Incorporated, including the portfolio of
investments, as of November 30, 1996 and the related statement of operations for
the year then ended, the statement of changes in net assets for each of the two
years in the period then ended and the financial highlights for each of the four
years in the period then ended and for the period from February 13, 1992
(commencement of operations) to November 30, 1992. These financial statements
and financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
November 30, 1996 by correspondence with the custodian and brokers. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
 
     In our opinion, the financial statements and the financial highlights
referred to above present fairly, in all material respects, the financial
position of the Preferred Income Opportunity Fund Incorporated as of November
30, 1996, the results of its operations for the year then ended, the changes in
its net assets for each of the two years in the period then ended and the
financial highlights for each of the four years in the period then ended and for
the period from February 13, 1992 (commencement of operations) to November 30,
1992, in conformity with generally accepted accounting principles.
 
Boston, Massachusetts                               Coopers & Lybrand L.L.P.
January 3, 1997
 
                                       24

<PAGE>
 
- --------------------------------------------------------------------------------
                                  Preferred Income Opportunity Fund Incorporated
                                                     TAX INFORMATION (UNAUDITED)
                                  ----------------------------------------------
 
     For the fiscal year ended November 30, 1996, the Fund realized, and by
December 31, 1996, had distributed long term capital gains to both Common Stock
Shareholders and Money Market Cumulative Preferred[Trademark] Stock
Shareholders of $2,127,113. The Fund, in doing so, has utilized all capital
losses carried forward from the prior year. The amount may differ from those
shown elsewhere in this annual report due to differences in the calculation of
long term gains for tax purposes as compared with SEC financial reporting
requirements. Of the total distributions attributable to the fiscal year ended
November 30, 1996, including the Additional Distribution to Money Market
Cumulative Preferred[Trademark] Stock Shareholders, 85.86% qualifies for the
Dividends Received Deduction for eligible corporate investors. (See Note 9).
 
     For the calendar year ended December 31, 1996, 85.59% of all dividends paid
to Common Stock Shareholders qualifies for the Dividends Received Deduction for
eligible corporate investors. Shareholders should refer to Form 1099 when
preparing their tax returns to determine the appropriate tax treatment of the
distributions they received from the Fund in calendar year 1996.
 
- --------------------------------------------------------------------------------
                                  Preferred Income Opportunity Fund Incorporated
                           QUARTERLY RESULTS OF INVESTMENT OPERATION (UNAUDITED)
                           -----------------------------------------------------
 
<TABLE>
<CAPTION>
                                                  AVAILABLE TO COMMON STOCK SHAREHOLDERS
                                     ---------------------------------------------------------------
                                                              NET REALIZED          NET INCREASE/
                                                             AND UNREALIZED         (DECREASE) IN
                                       NET INVESTMENT          GAIN/(LOSS)         NET ASSETS FROM
                 INVESTMENT INCOME         INCOME            ON INVESTMENTS           OPERATIONS
                ------------------   ------------------   --------------------   -------------------
 QUARTER                     PER                  PER                    PER                   PER
  ENDED           TOTAL     SHARE*     TOTAL     SHARE*      TOTAL      SHARE*      TOTAL     SHARE*
- --------        ----------  ------   ----------  ------   -----------   ------   -----------  ------
<S>             <C>          <C>     <C>          <C>     <C>           <C>      <C>          <C>
02/28/95        $3,861,014   $0.35   $2,420,831   $0.22   $ 4,639,812   $ 0.41   $ 7,060,643  $ 0.63
05/31/95         4,149,620    0.37    2,769,492    0.25     9,552,841     0.86    12,322,333    1.11
08/31/95         4,225,009    0.38    2,843,183    0.25       518,935     0.05     3,362,118    0.30
11/30/95         4,181,057    0.37    2,849,065    0.26     4,620,773     0.41     7,469,838    0.67
02/29/96         3,672,584    0.33    2,333,543    0.21    (4,454,117)   (0.40)   (2,120,574)  (0.19) 
05/31/96         3,868,154    0.35    2,573,570    0.23     2,444,402     0.22     5,017,972    0.45
08/31/96         3,961,160    0.35    2,661,602    0.24      (716,135)   (0.06)    1,945,467    0.18
11/30/96         3,744,137    0.34    2,845,619    0.25     8,647,364     0.77    11,492,983    1.02
</TABLE>
 
- ---------------
 
* Per share of common stock.
 
                                       25

<PAGE>
 
- --------------------------------------------------------------------------------
Preferred Income Opportunity Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED)
- ----------------------------------------------
 
DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN
 
     Under the Fund's Dividend Reinvestment and Cash Purchase Plan (the "Plan"),
a shareholder whose Common Stock is registered in his own name will have all
distributions reinvested automatically by FDISG as agent under the Plan, unless
the shareholder elects to receive cash. Distributions with respect to shares
registered in the name of a broker-dealer or other nominee (that is, in "street
name") may be reinvested by the broker or nominee in additional shares under the
Plan, but only if the service is provided by the broker or nominee, unless the
shareholder elects to receive distributions in cash. A shareholder who holds
Common Stock registered in the name of a broker or other nominee may not be able
to transfer the Common Stock to another broker or nominee and continue to
participate in the Plan. Investors who own Common Stock registered in street
name should consult their broker or nominee for details regarding reinvestment.
 
     The number of shares of Common Stock distributed to participants in the
Plan in lieu of a cash dividend is determined in the following manner. Whenever
the market price per share of the Fund's Common Stock is equal to or exceeds the
net asset value per share on the valuation date, participants in the Plan will
be issued new shares valued at the higher of net asset value or 95% of the then
current market value. Otherwise, FDISG will buy shares of the Fund's Common
Stock in the open market, on the New York Stock Exchange or elsewhere, on or
shortly after the payment date of the dividend or distribution and continuing
until the ex-dividend date of the Fund's next distribution to holders of the
Common Stock or until it has expended for such purchases all of the cash that
would otherwise be payable to the participants. The number of purchased shares
that will then be credited to the participants' accounts will be based on the
average per share purchase price of the shares so purchased, including brokerage
commissions. If FDISG commences purchases in the open market and the then
current market price of the shares (plus any estimated brokerage commissions)
subsequently exceeds their net asset value most recently determined before the
completion of the purchases, FDISG will attempt to terminate purchases in the
open market and cause the Fund to issue the remaining dividend or distribution
in shares. In this case, the number of shares received by the participant will
be based on the weighted average of prices paid for shares purchased in the open
market and the price at which the Fund issues the remaining shares. These
remaining shares will be issued by the Fund at the higher of net asset value or
95% of the then current market value.
 
     Plan participants are not subject to any charge for reinvesting dividends
or capital gains distributions. Each Plan participant will, however, bear a
proportionate share of brokerage commissions incurred with respect to FDISG's
open market purchases in connection with the reinvestment of dividends or
capital gains distributions. For the year ended November 30, 1996, $9,224 in
brokerage commissions were incurred.
 
     The automatic reinvestment of dividends and capital gains distributions
will not relieve Plan participants of any income tax that may be payable on the
dividends or capital gains distributions. A participant in the Plan will be
treated for Federal income tax purposes as having received, on the dividend
 
                                       26

<PAGE>
 
- --------------------------------------------------------------------------------
                                  Preferred Income Opportunity Fund Incorporated
                                  ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
                                  ----------------------------------------------
 
payment date, a dividend or distribution in an amount equal to the cash that the
participant could have received instead of shares.
 
     In addition to acquiring shares of Common Stock through the reinvestment of
cash dividends and distributions, a shareholder may invest any further amounts
from $100 to $3,000 semi-annually at the then current market price in shares
purchased through the Plan. Such semi-annual investments are subject to any
brokerage commission charges incurred.
 
     A shareholder whose Common Stock is registered in his or her own name may
terminate participation in the Plan at any time by notifying FDISG in writing,
by completing the form on the back of the Plan account statement and forwarding
it to FDISG or by calling FDISG directly. A termination will be effective
immediately if notice is received by FDISG not less than 10 days before any
dividend or distribution record date. Otherwise, the termination will be
effective, and only with respect to any subsequent dividends or distributions,
on the first day after the dividend or distribution has been credited to the
participant's account in additional shares of the Fund. Upon termination and
according to a participant's instructions, FDISG will either (a) issue
certificates for the whole shares credited to the shareholder's Plan account and
a check representing any fractional shares or (b) sell the shares in the market.
Shareholders who hold common stock registered in the name of a broker or other
nominee should consult their broker or nominee to terminate participation.
 
     The Plan is described in more detail in the Fund's Plan brochure.
Information concerning the Plan may be obtained from FDISG at 1-800-331-1710.
 
MEETING OF SHAREHOLDERS
 
     On July 19, 1996, the Fund held its Annual Meeting of Shareholders to (1)
elect two Directors of the Fund, and (2) ratify the selection of Coopers &
Lybrand L.L.P. as independent accountants for the Fund for the fiscal year
ending November 30, 1996. The results of each proposal are as follows:
 
PROPOSAL 1:  ELECTION OF DIRECTORS.
 
<TABLE>
<CAPTION>
                          NAME                                  FOR        AGAINST
                          ----                               ---------     -------
<S>                                                          <C>           <C>       
Common Stock
       Robert T. Flaherty................................    9,754,650     155,447
Preferred Stock
       Morgan Gust.......................................          461           0
</TABLE>
 
PROPOSAL 2:  RATIFY THE SELECTION OF COOPERS & LYBRAND L.L.P. AS INDEPENDENT
             ACCOUNTANTS.
 
<TABLE>
<CAPTION>
                                                                 FOR        AGAINST    ABSTAINED
                                                              ---------     -------    ---------
    <S>                                                       <C>            <C>        <C>
    Voted.................................................    9,727,633      42,273     140,652
</TABLE>
 
                                       27

<PAGE>
 
     DIRECTORS
       Martin Brody
       Donald F. Crumrine, CFA
       Robert T. Flaherty, CFA
       Morgan Gust
       Robert F. Wulf
 
     OFFICERS
       Robert T. Flaherty, CFA
          Chairman of the Board
          and President
       Donald F. Crumrine, CFA
          Vice President
          and Secretary
       Robert M. Ettinger, CFA
          Vice President
       Peter C. Stimes, CFA
          Vice President
          and Treasurer
       Carl D. Johns
          Assistant Treasurer
 
     INVESTMENT ADVISER
       Flaherty & Crumrine Incorporated
 
     QUESTIONS CONCERNING YOUR SHARES OF PREFERRED
       INCOME OPPORTUNITY FUND?
       - If your shares are held in a Brokerage
         Account, contact your Broker.
       - If you have physical possession of your shares
         in certificate form, contact the Fund's Transfer
         Agent & Shareholder Servicing Agent --
                 First Data Investor Services Group, Inc.
                   (FDISG)
                       P.O. Box 1376
                       Boston, MA 02104
                       1-800-331-1710
 
     THIS REPORT IS SENT TO SHAREHOLDERS OF PREFERRED INCOME OPPORTUNITY
     FUND INCORPORATED FOR THEIR INFORMATION. IT IS NOT A PROSPECTUS,
     CIRCULAR OR REPRESENTATION INTENDED FOR USE IN THE PURCHASE OR SALE OF
     SHARES OF THE FUND OR OF ANY SECURITIES MENTIONED IN THIS REPORT.
 
                   [PREFERRED INCOME OPPORTUNITY FUND LOGO]
 

                                    Annual
                                    Report
 





                              November 30, 1996

</TEXT>
</DOCUMENT>
</SEC-DOCUMENT>
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