Deans Knight Income Corporation Releases Annual Management Report of Fund Performance and Financial Statements for the year ended December 31, 2011


VANCOUVER, BRITISH COLUMBIA--(Marketwire - March 9, 2012) - Deans Knight Income Corporation (the "Company") (TSX:DNC) is pleased to release its annual Management Report of Fund Performance and Financial Statements for the year ended December 31, 2011.

These documents can be found on SEDAR at www.sedar.com or the Company's website: www.dkincomecorp.com.

Forward-Looking Statements

This press release contains forward-looking statements. More particularly, this press release contains forward-looking statements concerning the Company's corporate objectives, the investment of the Company's proceeds from the sale of investments previously made, availability of tax losses and deductions, the anticipated total return to the Company's shareholders and the Company's intention to pay out earned income in the form of monthly dividends. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable, undue reliance should not be placed on them because the Company can give no assurance that they will prove to be correct since forward-looking statements address future events and conditions and by their very nature, involve inherent risks and uncertainties. The forward-looking statements contained in this press release are made as of the date hereof and the Company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise, unless so required by applicable securities laws.

Deans Knight Income Corporation
Annual Management Report
of Fund Performance For 2011

This annual management report of fund performance (the "Report") contains financial highlights of Deans Knight Income Corporation (the "Company"). This Report should be read in conjunction with the annual financial statements of the Company for the year ended December 31, 2011 (the "Financial Statements"), which, if not included with this Report, can be obtained at your request, at no cost by emailing info@dkincomecorp.com, visiting our website at www.dkincomecorp.com for contact details or on SEDAR at www.sedar.com. Readers may also contact us to request a free copy of the Company's proxy voting policies and procedures, proxy voting disclosure record or quarterly portfolio disclosure.

A NOTE ON FORWARD-LOOKING STATEMENTS

This Report contains certain forward-looking statements. In particular, this Report contains forward-looking statements in respect of the Company's targeted dividend payout, investment strategy, behaviour of financial markets and reflects the Company's expectations regarding the growth, results of operations, performance and business prospects and opportunities of the Company and its investments. In some cases, forward-looking statements can be identified by terminology such as "may", "will", "should", "expect", "plan", "anticipate", "believe", "estimate", "predict", "potential", "continue" or the negative of these terms or other comparable terminology. Such forward-looking statements reflect the Company's current beliefs and are based on information currently available to the Company. With respect to such forward-looking statements, the Company has made assumptions regarding, among other things, what type of debt securities will be included in its investment portfolio, currency, exchange and interest rates. A number of factors could cause actual events or results to differ materially from the results discussed in the forward-looking statements. In evaluating these statements, prospective investors should specifically consider various factors, including global equity and capital markets, business competition, technological change, changes in government regulations, unexpected judicial or regulatory proceedings, and catastrophic events and the risks outlined under "Risk Factors" in the AIF (as defined herein), which may cause actual results to differ materially from any forward-looking statement. Although the forward-looking statements contained in this Report are based upon what the Company believes to be reasonable assumptions, the Company cannot assure investors that actual results will be consistent with these forward-looking statements. Forward-looking statements are made as of the date of this Report and, other than as required by applicable law, the Company assumes no obligation to update or revise them to reflect new events or circumstances.

This Report also contains certain financial and operational information obtained from public sources in respect of certain companies included in the Company's investment portfolio. While management believes this data to be reliable, such information is subject to variations and may not be able to be verified due to limits on the availability and reliability of data inputs, the nature of the data gathering process and other limitations and uncertainties inherent in such information. Accordingly, the accuracy, currency and completeness of this information cannot be guaranteed. The Company has not independently verified any of the data from third party sources referred to in this Report or ascertained the underlying assumptions relied upon by such sources.

Investment Objectives and Strategies

The Company is a closed-end, non-redeemable investment company focused on investing in corporate debt securities. The Company's assets are actively managed by Deans Knight Capital Management Ltd. ("Deans Knight"), a respected British Columbia-based investment firm focused on managing high income and growth mandates for high net worth individuals. Deans Knight, formed in 1992, has an experienced management team and a long history of successful investing in corporate debt securities.

The Company's investment objectives are to: (i) maximize the total return for shareholders, consisting of dividend income and capital appreciation; and (ii) provide shareholders with monthly dividends, which to date have been set at $0.0583 per share per month. The Company intends to achieve these objectives by investing primarily in corporate debt securities rated BBB or below by Standard & Poor's Rating Services ("S&P") or an equivalent rating by another nationally recognized statistical rating organization. The Company may also invest in investment grade debt securities rated above BBB and non-rated debt securities from time to time. Examples of investments made during the period are detailed below in the Results from Operations.

The Company believes there are attractive investment opportunities today in owning corporate debt of businesses with tangible assets, strong cash flows and reasonable leverage.

When evaluating securities to purchase for the Company, Deans Knight focuses on the following:

  • amount of security or collateral within a business to support the value of the securities;
  • the position of the debt in the capital structure;
  • covenants;
  • liquidity;
  • the business' ability to reduce or refinance the debt; and
  • the overall term of the debt and yield to bondholders.

Deans Knight intends to employ the above credit-based analysis to identify corporate debt for inclusion in the Company's investment portfolio with attractive valuations in order to maintain its targeted dividend payment.

Risk

The overall risks of the Company are as described in its annual information form of the Company dated March 9, 2012 (the "AIF").

Prior to the reorganization and change in business as discussed in Note 1 of the Financial Statements, the Company generated significant tax losses and other tax attributes as a result of its prior businesses and research activities. The Company has recorded, as a tax asset, the full amount of the potential tax benefit of such items to the extent of its projected taxable income. There is uncertainty as to whether the tax authorities will allow the Company to deduct some or all of the tax losses and other attributes. Should the Company be denied the deductions in full, the recorded amount of the tax assets as well as such amounts claimed to date would be recorded as a charge to income. The total tax assets recognized and tax losses and other attributes claimed to date, which are subject to uncertainty, amount to $21,024,806 (2010 - $20,747,249), representing $2.00 per common share at December 31, 2011 (2010 - $1.97).

There were no significant changes during the year ending December 31, 2011 that affected the overall risk of investing in the Company. Given the type of investments made by the Company, an investment in the Company may be considered to be speculative. An investment in the Company is generally suitable for investors who are looking to receive income, yet are willing to tolerate volatility in the value of their investment.

Results of Operations

The net assets of the Company at December 31, 2011 were $141,539,920 or $13.43 per common share (2010 - $143,343,361 or $13.60 per common share). The net assets of the Company consisted of the following components:

December 31, 2011

$
Per common share(1)
%
Investments(2)129,918,543 12.33 91.8
Cash and short-term deposits4,997,715 0.47 3.5
Accrued income2,339,751 0.22 1.7
Prepaid expenses73,151 0.01 0.0
Future income tax asset(3)4,920,000 0.47 3.5
Accounts payable and accrued liabilities(709,240) (0.07) (0.5)
141,539,920 13.43 100.0
(1)Based on 10,537,263 common shares, including 10,191,592 voting common shares and 345,671 non-voting common shares, as outlined in the notes to the Financial Statements.
(2)The details of the investments are outlined in the Summary of Investment Portfolio below.
(3)Refer to the Taxation note to the Financial Statements for more detail.
December 31, 2010

$
Per common share(1)
%
Investments(2)128,449,450 12.19 89.6
Cash and short-term deposits7,137,967 0.68 5.0
Accrued income1,808,756 0.17 1.2
Prepaid expenses89,662 0.01 0.1
Future income tax asset(3)6,550,000 0.62 4.6
Accounts payable and accrued liabilities(692,474) (0.07) (0.5)
143,343,361 13.60 100.0
(1)Based on 10,537,263 common shares, including 10,191,592 voting common shares and 345,671 non-voting common shares, as outlined in the notes to the Financial Statements.
(2)The details of the investments are outlined in the Summary of Investment Portfolio below.
(3)Refer to the Taxation note to the Financial Statements for more detail.

The majority of the decline in net assets of the Company, from $13.60 per share to $13.43 was the result of the $1,630,000, or $0.15 per share, decrease in the value of the future income tax asset recorded by the Company. This asset decreased as the Company realized the benefits of the assets sheltering the current year's taxable income.

Net investment income for the year ended December 31, 2011 was $8,837,650 or $0.84 per share (2010- $7,376,571, or $0.70 per share). The increase in net investment income of $1,461,079 was predominantly from the Company's investment portfolio having more capital invested in 2011 than 2010, and from redeploying capital into higher yielding income generating securities upon the sale of a portion of Whitecap Resource Inc. common shares held by the Company. At December 31, 2011, the Company still owned 1,254,167 shares of Whitecap (7.3% of the Net Asset Value at December 31, 2011).

During 2011, the Company made monthly dividend payments totalling $7,371,869, or $0.70 per share (2010 - $7,371,869, or $0.70 per share). This represented approximately 83.4% of Net investment income (2010 - 99.9%). On January 9, 2012, the Company announced it will maintain monthly cash dividends at $0.0583 per share for each of the first three months of 2012.

As we outlined in our Q3-2011 press release, high yield bond prices were volatile for the first 9 months of the year with spreads peaking around September 30, 2011. High yield bond prices improved in the fourth quarter and, despite the volatility, the net assets of the Company remained relatively flat in 2011, excluding the decrease in the future income tax asset. As you will see from the graph below, although spreads have declined since September 30th, they are still above the long term average, and as such the Company is still seeing attractive investment opportunities.

A graph of the Credit Spread History is available at the following address: http://media3.marketwire.com/docs/creditspreadhistory.pdf

Will the volatility in high yield bond prices continue in 2012? The honest answer is we don't know. What we do know is as a bondholder, the most important consideration is the borrowers' ability to meet their coupon payments and pay us back our principal at maturity. A secondary consideration is whether or not we are being compensated for the risk that they fail to meet these obligations. We own corporate debt of businesses with tangible assets as collateral, strong cash flows and reasonable leverage. There are currently no defaults in our portfolio and all of our holdings are servicing their debt while, in most cases, continuing to reduce leverage. Although bonds could get cheaper, the Company believes current prices offer investors attractive returns; especially given their position in the capital structure.

At December 31, 2011, the Company is paying a monthly dividend equal to $0.70 per share per annum, or 5.2% of the net asset value at December 31, 2011. Further, the investment portfolio provides a yield to maturity of 8.4%. We believe this offers a strong incentive for investors to move out of treasury securities and investment grade bonds and into higher yielding corporate bonds.

A graph of bond ratings is available at the following address: http://media3.marketwire.com/docs/5yearcanadian.pdf

In addition to corporate bonds, we will also opportunistically invest in private debt financings with equity incentives that provide equity-like returns.

During the fourth quarter, Deans Knight Capital Management designed and the Company participated in a $12 million Secured Note with Conifex Timber Inc. ($3.0 million or 2.1% of the Net Asset Value at December 31, 2011). The proceeds from the note will be used for general corporate purposes. Conifex is a lumber producer with sawmills in the northern interior of BC. It owns sawmills in two British Columbia locations, Fort St. James and Mackenzie, with a combined capacity of approximately 745 million foot board measure. Conifex holds forest licences with average allowable cut of 1.573 million m3 of timber in the Prince George and Mackenzie Timber Supply Areas, providing them with ample supply of sawlogs.

In the last three years, Conifex has invested $80 million into its sawmills and current operations are generating positive EBITDA despite depressed lumber prices. A recent sale of assets in British Columbia, by Tembec, for $60 million provides further evidence that the debt of Conifex is secured by the assets. They have almost double the capacity and 50% more allowable cut which would value the assets at approximately $100 million. Including our facility, Conifex can have up to $24.5 million in debt.

The notes mature on December 31, 2012 and bear interest at 10% for the first six months and 12% for the remaining term of the loan. In addition to the coupon, the Company received a commitment fee of 2% and warrants to purchase 81,250 common shares at a price of $9.50 per share, which mature on December 31, 2014. At year end, the common stock closed at $7.25.

As reported in our Q3-2011 operational update, the Company participated in an $18 million Secured Subordinated Revenue Note with RapidEye Canada Ltd. The proceeds from the financing were used to acquire the assets of RapidEye AG, a global provider of high-resolution imagery and geospatial solutions, out of bankruptcy. On December 7, 2011, RapidEye Canada repaid $5 million of the Notes, at Par, leaving $13 million outstanding. At December 31, 2011, the Company held $5,281,250 of these Notes, equaling 4.1% of the Net Asset Value.

Recent Developments

Comparison of net asset value and net assets

National Instrument 81-106 ("NI 81-106") permits investment companies to have two different net asset values: (i) one for financial statements, which will be prepared in accordance with Canadian Generally Accepted Accounting Principles ("GAAP") including Section 3855 (and referred to as "net assets") and (ii) another for all other purposes, including unit pricing for investor transactions (referred to as "net asset value"). The main difference in calculating net assets and net asset value is that GAAP requires bid price to be used in valuing securities traded in an active market where quoted prices are readily and regularly available, rather than the use of a price between the bid and the ask price currently used for determining net asset value. This difference results in an insignificant difference of approximately $0.06 per common share at December 31, 2011 (2010 - $0.05 per common share), as outlined in the notes to the Financial Statements.

International Financial Reporting Standards

The Company will be required to adopt international financial reporting standards ("IFRS"). The Canadian Accounting Standards Board (AcSB) previously announced January 1, 2011 as the date international financial reporting standards (IFRS) would replace current Canadian standards and interpretations as GAAP for publicly accountable enterprises, which include investment companies.

In December 2011, the AcSB issued a decision to defer adoption of IFRS for investment companies currently applying Accounting Guideline 18 - Investment Companies until years beginning on or after January 1, 2014.

Under the above noted decision, the Company's first set of financial statements to be reported on under IFRS would be for the semi-annual period ending June 30, 2014. These statements would include corresponding comparative financial information for 2013, including an opening statement of net assets as at January 1, 2013. However, the Company has a termination date of April 30, 2014, and as such will not be required to issue statements reported on under IFRS. The Company will continue to monitor any further AcSB decisions that may affect the Company's requirement to adopt IFRS.

Harmonized Sales Tax

The Corporation is subject to non-recoverable Harmonized Sales Tax on its expenses. The BC Government has announced that the Harmonized Sales Tax will be replaced by the Federal Goods and Services Tax and a Provincial Sales Tax in 2013; however, the legislation has not yet been announced. Accordingly, until further information becomes available the impact cannot be quantified

Related Party Transactions

The officers, and certain directors, of the Company are also employees of Deans Knight, the Company's investment advisor. These officers, and directors, are not paid by the Company. Deans Knight provides investment management services to the Company, as well as administration, financial reporting and other ancillary services required by a publicly listed company. Management fees, for the services outlined above, are computed and paid quarterly, at an annual rate of 1.5% of the net asset value plus applicable taxes, and adjusted for certain non-investment related assets.

For the year ended December 31, 2011, management fees totaled $2,283,158 (2010 - $2,110,657). At December 31, 2011, $575,224 (December 2010- $599,474) was owed to Deans Knight, which was included in accounts payable and accrued liabilities in the statement of net assets, and is payable immediately. In calculating the management fee, the net asset value was reduced by the value of the future income tax asset included in the statement of net assets.

A director of the Company is a partner at a law firm that provides legal services to the Company. During the year ended December 31, 2011, the Company incurred $42,750 (2010 - $30,195) in legal services and disbursements received from this related party. At December 31, 2011, accounts payable and accrued liabilities include $4,185 (2010 - $1,355) due to the law firm for legal fees and disbursements.

Financial Highlights

The following tables show selected key financial information about the Company and are intended to help you understand the Company's financial performance since it began operating its new business of investing in corporate debt in March 2009.

The Company's Net Assets per Common Share (1)

2011
$
2010
$
Net assets, beginning of year (2)13.60 12.21
Increase from operations
Total revenue1.10 0.94
Total expenses(0.26)(0.24)
Realized gains0.36 1.82
Unrealized losses(0.52)(0.27)
Future income taxes(0.15)(0.16)
Total increase from operations (2)0.53 2.09
Dividends (2)(3)
From income(0.70)(0.70)
Net assets at end of year (4)13.43 13.60
(1)The information is derived from the Company's audited annual financial statements. Common shares outstanding are 10,537,263, including 10,191,592 voting common shares and 345,671 non-voting common shares.
(2)Net assets and dividends are based on the actual number of shares outstanding at the relevant time. The increase/decrease from operations is based on the weighted average number of shares outstanding over the year.
(3)Dividends were paid in cash.
(4)The net assets per share presented in the financial statements differs from the net asset value per share calculated for fund pricing purposes due to the provisions of CICA Handbook Section 3855. An explanation of the differences can be found in the notes to the financial statements.
Ratios and Supplemental Data (1)
2011

2010
Net asset value (000's)$142,178 $143,880
Number of common shares outstanding (000's)10,537 10,537
Management expense ratio (2)1.90%1.91%
Portfolio turnover rate (3)79.90%86.60%
Trading expense ratio (4)0.00%0.01%
Net asset value per common share$13.49 $13.65
Closing market price - common share$11.84 $12.54
(1)This information is provided as at December 31 of the years shown.
(2)Management expense ratio is based on total expenses for the period and is expressed as an percentage of weekly average net asset values over the year.
(3)The Company's portfolio turnover rate indicates how actively the Company manages its portfolio investments. A portfolio turnover rate of 100% is equivalent to the Company buying and selling all of the securities in its portfolio once in the course of the year. The higher a portfolio turnover-rate in a year, the greater the trading costs payable by the Company in the year. There is not necessarily a relationship between a high turnover rate and the performance of the investment portfolio.
(4)The trading expense ratio represents total commissions and other portfolio transaction costs expressed as an annualized percentage of daily average net asset value during the period. This expense is $nil for 2011 (2010- $13,500), as the purchasing and selling of bonds do not attract a commission from the buying or selling party.

Management Fees

Deans Knight provides investment management services to the Company, as well as administration, financial reporting and other ancillary services required by a publicly listed company. Management fees are computed and paid quarterly, at an annual rate of 1.5% of the net asset value plus applicable taxes, and adjusted for certain non-investment related assets.

Past Performance

This section shows the Company's past performance, since it began operating its business as an investment fund. The past performance information includes changes in net asset value and assumes the reinvestment of all dividends paid to common shareholders. It is important to note that the past performance will not necessarily indicate what performance in the future will be.

Year-by-year Returns

The accompanying bar chart shows the Company's performance for the years shown and illustrates how the Company's performance has changed from year to year. The bar chart shows, in percentage terms, how much an investment made from when the Company began its operation as an investment fund on March 17, 2009 to December 31, 2009, and how much an investment made for the years ending December 31, 2010 and 2011.

A bar chart is available at the following address: http://media3.marketwire.com/docs/inception.pdf

Annual Compound Returns

The table below summarizes the Company's annual compound total returns for the periods ended December 31 as indicated. As a basis for comparison, we have provided the performance of the Merrill Lynch Canada High Yield Bond Index ("Index"). The Index is a broad based index that tracks the performance of the Canadian high-yield bond market. As the criteria for determining the constituents of the Company's investment portfolio and the Index differ, it is not expected that the Company's performance will mirror that of the Index. Further, the return of the Index is calculated without the deduction of management fees and fund expenses whereas the performance of the Company is calculated after deducting fees and expenses.

Annual Compound ReturnsCompany Index
1 Year4.4%3.1%
2 Years10.3%8.2%
Since Inception16.7%24.4%

Summary of Investment Portfolio

The following is a summary of the Company's investment portfolio as at December 31, 2011. This is a summary only and will change due to ongoing portfolio transactions of the Company. A quarterly update is available at www.dkincomecorp.com.

A table of the investment portfolio is available at the following address: http://media3.marketwire.com/docs/summaryofinvestment.pdf

Deans Knight Income Corporation

Financial Statements

December 31, 2011

Deans Knight Income Corporation

Statement of Net Assets

As at December 31, 2011


2011
$
2010
$
Assets
Current
Investments - at fair value (cost - $125,475,983; 2010 - $118,563,957)129,918,543
128,449,450
Cash and cash equivalents4,997,7157,137,967
Accrued interest receivable2,339,7511,808,756
Prepaid expenses73,15189,662
Future income tax benefits (note 7)2,180,0002,150,000
139,509,160139,635,835
Non-current
Future income tax benefits (note 7)2,740,0004,400,000
142,249,160144,035,835
Liabilities
Accounts payable and accrued liabilities (note 5)709,240692,474
Net assets141,539,920143,343,361
Shareholders' equity
Common shares (note 3)99,366,42999,366,429
Contributed surplus (note 3)9,904,5049,904,504
Retained earnings (note 4)32,268,98734,072,428
141,539,920143,343,361
Number of common shares outstanding (note 3)10,537,26310,537,263
Net assets per common share (notes 7 and 10)13.4313.60
Contingencies (notes 1 and 7)
Commitment (note 9)
Subsequent events (note 11)

Approved by the Board of Directors

(signed) Craig Langdon, Director

(signed) Wayne Deans, Director

The accompanying notes are an integral part of these financial statements.

Deans Knight Income Corporation

Statement of Operations

For the year ended December 31, 2011

2011
$
2010
$
Investment income
Interest and other11,607,293 9,985,529
Expenses
Management fees (note 5)2,283,158 2,110,657
Directors' fees and expenses157,681 136,347
Public company reporting costs141,111 127,949
Audit, accounting and tax fees87,003 142,515
Custodial fees51,354 35,795
Legal fees (note 5)37,336 30,195
Independent Review Committee fees12,000 12,000
Transaction costs- 13,500
2,769,643 2,608,958
Net investment income8,837,650 7,376,571
Realized and unrealized gains (losses) on investments
Net realized gain on investments sold (note 6)4,695,889 15,928,417
Net realized (loss) gain on settlement of foreign currency contracts (note 6)(892,178)3,227,698
Change in unrealized appreciation on investments(5,832,280)(3,674,974)
Unrealized appreciation on foreign currency contracts389,347 825,824
Net (loss) gain on investments(1,639,222)16,306,965
Increase in net assets from operations before tax7,198,428 23,683,536
Provision for future income tax (note 7)(1,630,000)(1,650,000)
Increase in net assets from operations5,568,428 22,033,536
Increase in net assets from operations per weighted average common share (note 2)0.53 2.09

The accompanying notes are an integral part of these financial statements.

Deans Knight Income Corporation

Statement of Changes in Net Assets

Year ended December 31

2011
$
2010
$
Increase in net assets from operations5,568,428 22,033,536
Dividends to common shareholders (notes 4 and 9)(7,371,869)(7,371,869)
(Decrease) increase in net assets during the year(1,803,441)14,661,667
Net assets - Beginning of year143,343,361 128,681,694
Net assets - End of year141,539,920 143,343,361
The accompanying notes are an integral part of these financial statements.
Deans Knight Income Corporation
Statement of Cash Flows
For the year ended December 31, 2011
2011
$
2010
$
Cash flows from operating activities
Increase in net assets from operations5,568,428 22,033,536
Items not affecting cash
Net realized gain on investments sold(4,695,889)(15,928,417)
Net realized loss (gain) on settlement of foreign currency contracts892,178 (3,227,698)
Change in unrealized appreciation on investments5,832,280 3,674,974
Unrealized appreciation on foreign currency contracts(389,347)(825,824)
Future income tax provision1,630,000 1,650,000
8,837,650 7,376,571
Cost of investments purchased (note 6)(62,743,948)(106,283,479)
Proceeds from investments sold (note 6)59,635,633 107,386,034
Net change in non-cash balances related to operations
Accrued interest receivable(530,995)(138,508)
Prepaid expenses16,511 178
Accounts payable and accrued liabilities16,766 126,284
5,231,617 8,467,080
Cash flows from financing activities
Dividends paid to common shareholders (note 4 and 9)(7,371,869)(7,371,869)
Net (decrease) increase in cash and cash equivalents during the year(2,140,252)1,095,211
Cash and cash equivalents - Beginning of year7,137,967 6,042,756
Cash and cash equivalents - End of year4,997,715 7,137,967
Cash and cash equivalents comprise
Cash2,402,631 5,340,955
Short-term deposits2,595,084 1,797,012
4,997,715 7,137,967
The accompanying notes are an integral part of these financial statements.
Deans Knight Income Corporation
Statement of Investments
As at December 31, 2011


Par value 1
$


Average cost ²
$


Fair value ²
$
Percentage of total fair
value
3
%
Fixed income - Canadian
Denominated in Canadian dollars
Air Canada 10.13% 08-01-20151,500,0001,485,690 1,342,5001.0
Black Press Group 10.00% 02-04-20142,7502,750,000 2,701,8752.1
Cara Operations Ltd. 9.13% 12-01-20153,500,0003,500,000 3,473,7502.7
Conifex Timber Inc. 10.00% 12-31-2012 53,000,0003,000,000 3,000,0002.3
Flint Energy Services 7.50% 06-15-20191,250,0001,237,500 1,225,0000.9
Garda World Security 9.75% 03-15-20172,500,0002,472,105 2,525,0001.9
Gateway Casinos 8.88% 11-15-20172,750,0002,816,875 2,791,2502.1
Mercator Minerals 6.50% 01-03-2013 54,500,0004,500,000 4,500,0003.5
North American Energy Partners Inc. 9.13%8,750,0008,793,125 8,487,5006.5
04-07-2017 4
Paramount Resources 8.25% 12-13-20179,250,0009,250,000 9,562,1887.4
Perpetual Energy Inc. 8.75% 03-15-20185,000,0005,000,000 4,625,0003.6
RapidEye Canada 5.00% 08-31-2014 55,281,2505,281,250 5,281,2504.1
Sherritt International Corp. 7.75% 10-15-2015196,000152,233 203,8400.2
Sherritt International Corp. 8.00% 11-15-20183,750,0003,750,000 3,834,3753.0
Skylink Aviation Inc. 12.25% 03-15-20165,350,0005,277,250 4,333,5003.3
Sure Energy 6.25% 01-21-2014 52,500,0002,500,000 2,500,0001.9
Trident Exploration 8.25% 04-13-20181,650,0001,650,000 1,468,5001.1
63,416,028 61,855,52847.6
Denominated in United States dollars
CCS Inc. 11.00% 11-15-20157,750,0003,879,423 7,684,7065.9
CHC Helicopter 9.25% 10-15-2020250,000253,623 228,8250.2
Mirabela Nickel Ltd. 8.75% 04-15-20187,850,0007,512,897 7,145,1885.5
National Money Mart 10.38% 12-15-20163,750,0004,091,114 4,071,1783.2
Pacific Rubiales Energy Corp. 7.25%2,300,0002,365,780 2,339,1001.8
12-12-2021
Southern Pacific Resources Libor+8.5% 07-01-20165,940,0005,868,031 6,010,7754.6
Tembec Industries 11.25% 12-15-20185,000,0005,287,975 5,237,5504.0
29,258,843 32,717,32225.2
Total Canadian fixed income 92,674,871 94,572,85072.8
1 Par values are presented in their source currency
2 All amounts are shown in Canadian dollars
3 Percentages are shown as a percentage of total investments
4These investments share a common director with the Company
5 These investments represent loans receivable
The accompanying notes are an integral part of these financial statements.


Par value 1
$


Average cost 2
$


Fair value 2
$
Percentage of total fair
value
3
%
Fixed income - United States
Denominated in United States dollars
ABI Escrow Corp. 10.25% 10-15-20181,390,0001,433,0901,551,4591.2
Beazer Homes USA, Inc. 9.13% 06-15-20183,250,0003,327,0562,264,0961.7
Calfrac Holdings LP 7.5% 12-01-20206,000,0006,130,3295,949,4504.6
McMoRan Exploration Co. 11.88% 11-15-20142,000,0002,114,4712,156,0401.7
Number Merger Sub 11.00% 12-15-20191,850,0001,926,5841,890,8571.5
Stone Energy Corp. 8.63% 2-01-20178,750,0008,821,6388,987,7386.9
Total United States fixed income 23,753,16822,799,64017.5
Total fixed income 116,428,039117,372,49090.3
Convertible debentures - Australian
Denominated Australian dollars
Western Areas NL 8.0% 07-02-20121,500,0001,322,2761,554,2181.2
1,322,2761,554,2181.2
Equities
Conifex Timber Inc.- purchase warrants81,250-32,1290.0
Sure Energy Inc.- purchase warrants625,000-173,3150.1
Whitecap Resources Inc.- common shares1,254,1677,725,66810,397,0448.1
7,725,66810,602,4888.2
Investments subtotal 125,475,983129,529,19699.7
Hedges
Denominated in United States and
Australian dollars
Foreign currency exchange contracts (note 8)55,500,000-389,3470.3
125,475,983129,918,543100.0
1 Par values are presented in their source currency
2 All amounts are shown in Canadian dollars
3 Percentages are shown as a percentage of total investments
4These investments share a common director with the Company
5 These investments represent loans receivable
The accompanying notes are an integral part of these financial statements.

Deans Knight Income Corporation

Notes to Financial Statements

December 31, 2011

1 Nature of operations and basis of presentation

Deans Knight Income Corporation (the "Company") is a corporation continued under the laws of Canada on April 11, 2001. The Company is a closed-end, non-redeemable investment company. It invests, primarily, in corporate debt rated BBB or below by recognized credit rating organizations.

Prior to its reorganization in May 2008, the Company was a life sciences company involved in the research, development and commercialization of innovative products for the prevention and treatment of life-threatening diseases. Forbes Medi-Tech Inc ("Forbes"), who now carries on the prior business of the Company, has provided an indemnity to the Company with respect to liabilities relating to the Company's assets transferred to Forbes and the Company's prior business. In addition, Forbes obtained, on behalf of the Company, product liability insurance for certain claims that may arise in the future in connection with the Company's prior business. To date, no such claims or potential claims have arisen. There can be no assurance that the above noted guarantee will be sufficient to cover any future claims. In March 2009, the Company completed an initial public offering, whereby it raised gross proceeds of $100,368,900 and began operating its new business of investing in corporate debt.

The common shares of the Company will be redeemed on, or around, April 30, 2014, for a cash amount equal to 100% of the net asset value per share.

The accompanying financial statements are prepared in accordance with Part V of the Canadian Institute of Chartered Accountants Handbook, Pre-Changeover Accounting Standards (GAAP). All amounts are presented in Canadian dollars, unless otherwise noted.

2 Summary of significant accounting policies

The following is a summary of significant accounting policies followed by the Company:

Financial instruments

Investments

Investments are held for trading and are recorded at fair values determined as follows:

Fixed income investments

Fixed income investments traded on a public securities exchange or traded on an over-the-counter market are valued at the closing bid price. Where no closing bid price is available, the last sale or close price is used where, in management's opinion, this provides the best estimate of fair value.

Unlisted or non-exchange traded investments, or investments where a last bid, sale or close price is unavailable, or investments for which market quotations are, in the Company's opinion, inaccurate, unreliable, or not reflective of all available material information, are valued at their fair value as determined by the Company using appropriate and accepted industry valuation techniques including valuation models. The fair value determined using valuation models requires the use of inputs and assumptions based on observable market data including volatility and other applicable rates or prices. In certain circumstances, the fair value may be determined using valuation techniques that are not supported by observable market data.

The resulting values for investments not traded in an active market may differ from values that would be determined had a ready market existed, and the difference could be significant.

Forward currency contracts

Forward currency contracts are recorded at fair value. The proceeds (payments) on contracts settled during the year are included in the net realized gain on settlement of foreign currency contracts (note 6). The Company's policy is to hedge 95% - 105% of the fair value of foreign denominated investments with foreign exchange forward sell contracts.

Public company equities

Publicly traded equities are recorded at bid prices as quoted on recognized stock exchanges.

The amounts at which the Company's publicly-traded investments could be disposed of currently may differ from the carrying value based on market quotes, as the value at which significant ownership positions are sold is often different than the quoted market price due to a variety of factors such as premiums paid for large blocks or discounts due to illiquidity.

Warrants

Warrants are recorded at their estimated fair value using appropriate and accepted industry valuation techniques.

The impact of changes in fair value on net income of the Company arising from changes in estimated fair value of investments is recorded in the statement of operations.

Cash and cash equivalents

Cash and cash equivalents are accounted for at amortized cost. They consist of cash and deposits with maturities, at the time of purchase, of three months or less and are held with a Canadian chartered bank.

Accrued interest receivable

Accrued interest is designated as loans and receivables and is accounted for at amortized cost. Due to the immediate and short-term nature, the carrying value approximates fair value.

Financial liabilities

Financial liabilities, consisting of accounts payable and accrued liabilities, are designated as other financial liabilities and are accounted for at amortized cost. Due to the immediate and short-term nature, the carrying value approximates fair value.

Investment transactions

Investment transactions are recorded on the trade date. Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of an investment, which include fees and commissions paid to agents, advisors, brokers and dealers, levies by regulatory agencies and securities exchanges, and transfer taxes and duties. These costs are expensed and are included in the statement of operations.

Income recognition

Income from investments is recognized on an accrual basis. Interest income is accrued based on the number of days the investment is held during the year. Royalty income is recognized on an accrual basis as earned. Gains or losses on the sale of investments, including foreign exchange gain or loss on such investments, are calculated on an average cost basis.

Forward foreign currency contracts

Forward foreign currency contracts (note 8) entered into by the Company are valued at an amount that is equal to the gain or loss that would be realized if the position were to be closed out, which is equivalent to the difference between the deliverable asset and the value of the asset to be received. Changes in the value of a forward contract or the assets deliverable under such a contract are included as unrealized appreciation/depreciation of foreign currency contracts in the statement of operations.

Foreign exchange

Assets and liabilities denominated in foreign currencies are translated into Canadian dollars at the exchange rate applicable on the valuation date. Purchases and sales of investments, investment income and expenses are calculated at the exchange rates prevailing on the dates of the transactions.

Fair value measurement

Financial instruments are classified in a hierarchy that prioritizes the inputs to fair value measurement. Each level is based on the transparency of the inputs used to measure the fair values of assets and liabilities. The three levels of the fair value hierarchy are:

Level 1 - inputs that reflect unadjusted quoted prices in active markets for identical assets or liabilities;

Level 2 - inputs that reflect other than quoted prices that are observable for the assets or liabilities either directly or indirectly;

Level 3 - inputs that are not based on observable market data.

Income taxes

The Company follows the asset and liability method of accounting for income taxes. Future income tax assets and liabilities are measured using rates expected to apply to the taxable income in the years in which the temporary differences are expected to be settled. The Company accounts for uncertain tax positions using the contingent liability model, whereby a provision is established only where it is likely that a payment will be required to be made.

A valuation allowance is recognized to the extent it is more likely than not that future income tax assets will not be realized. Management has estimated the income tax provision and future income tax balances taking into account its expectation of future income and an interpretation of the various income tax laws and regulations. It is possible, due to the complexity inherent in estimating income taxes, that the tax provision and future tax balances could change (note 7), and the change could be significant.

Use of estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses. Actual results could differ from those reported and such differences could be material. Significant areas involving the use of estimates include determining the estimated fair value of investments and future income tax assets.

Comparative figures

Certain of the comparative figures have been reclassified to conform with the current year presentation.

Net assets per common share

The net assets per common share is computed by dividing the net assets of the Company by the total number of common shares outstanding on the Statement of net assets date.

Increase in net assets from operations per weighted average common share

The increase in net assets from operations per common share represents the increase in net assets from operations divided by the weighted average number of common shares outstanding during the period.
The weighted average number of shares outstanding during the year ended December 31, 2011 was 10,537,263 (December 31, 2010 - 10,537,263). This weighted average includes both the voting common shares and non-voting common shares of the Company.

3 Capital stock

The Company is authorized to issue an unlimited number of voting common shares without par value, and an unlimited number of non-voting common shares without par value.

There have been no changes in the number of voting and non-voting common shares for the periods ended December 31, 2010 and December 31, 2011.

The total shares outstanding at December 31 are summarized as follows:

December 31, 2011December 31, 2010
Number of SharesAmount
$
Number of SharesAmount
$
Voting common shares10,191,59296,273,34310,191,59296,273,343
Non-voting common shares345,6713,093,086345,6713,093,086
Total common shares outstanding10,537,26399,366,42910,537,26399,366,429

Contributed surplus

The contributed surplus balance did not change during the year, and consists of:

December 31,
2011
$
December 31,
2010
$
Surplus related to stock compensation, warrants and options associated with common shares8,030,2958,030,295
Surplus relating to warrants associated with previously issued preferred shares1,874,2091,874,209
9,904,5049,904,504

4 Retained earnings

The changes in retained earnings for the year were as follows:

2011
$
2010
$
Retained earnings - Opening balance34,072,428 19,410,761
Increase in net assets from operations5,568,428 22,033,536
Dividends paid from net investment income(7,371,869)(7,371,869)
Retained earnings - closing balance32,268,987 34,072,428

5 Related party transactions and balances

Management fees are paid quarterly to Deans Knight Capital Management Ltd. (the Investment Advisor), a corporation with certain common directors and officers of the Company, for services received in connection with the management of the investment portfolio and financial accounts, among other services provided. Management fees are computed quarterly at an annual rate of 1.5% of net asset value, adjusted for certain non-investment related assets. For the year ended December 31, 2011, management fees totalled $2,283,158 (December 31, 2010 - $2,110,657). At December 31, 2011, $575,224 (December 31, 2010 - $599,474) was owed to the Investment Advisor, which was included in accounts payable and accrued liabilities in the statement of net assets at December 31, 2011, and is payable immediately.

A director of the Company is a partner at a law firm that provides legal services to the Company. During the year ended December 31, 2011, the Company incurred $42,750 (December 31, 2010 - $ 30,195) in legal services and disbursements received from this related party. At December 31, 2011, accounts payable and accrued liabilities include $4,185 (December 31, 2010 - $1,355) due to the law firm for legal fees and disbursements.

6 Net realized gains on investments sold and foreign currency contracts

The net realized gain on sale of investments for the year ended December 31 was as follows:

2011
$
2010
$
Proceeds from investments sold59,635,633 107,386,034
Investments at cost - Beginning of year118,563,957 100,510,397
Add: Cost of investments purchased62,743,948 106,283,479
181,307,905 206,793,876
Less: Investments at cost - End of year(125,475,983)(118,563,957)
Cost of investments sold55,831,922 88,229,919
Net realized gain on investments sold3,803,711 19,156,115

Net realized gains on investments sold consist of:

2011
$
2010
$
Realized gain on securities sold4,695,889 15,928,417
Realized (loss) gain on settlement of foreign currency contracts(892,178)3,227,698
3,803,711 19,156,115

7 Taxation

Uncertainty of deductibility of tax losses

Prior to the reorganization and change in business as discussed in note 1, the Company had generated significant tax losses and other tax attributes as a result of its prior businesses and research activities. The Company has recorded, as a tax asset, the full amount of the potential tax benefit of such items to the extent of its projected taxable income. There is no guarantee that the tax authorities will allow the Company to deduct some, or all, of the tax losses and other attributes. Should the Company be denied the deductions, the recognized amount of the tax assets, as well as such amounts claimed to date, would be recorded as a charge to income. The total tax assets recognized and tax losses and other attributes claimed to date, which are subject to uncertainty, amount to $21,024,806 (December 31, 2010 - $20,747,249), representing $2.00 per common share at December 31, 2011 (December 31, 2010 - $1.97 per common share).

Future tax asset

Canadian GAAP requires a valuation allowance to be recognized against any future tax asset to the extent that it is more likely than not that the future income tax asset will not be realized. This is also the Company's stated accounting policy.

As the Company's investments in debt securities are generating interest income, but are not expected to generate sufficient taxable income in order to fully utilize the available tax credits during the years of operations through to April 30, 2014, the Company has recorded a valuation allowance. The difference between the total value of these tax benefits less the valuation allowance, being $4,920,000 (December 31, 2010 - $6,550,000), is the amount of the future income tax asset that has been recorded by the Company in the statement of net assets. The valuation allowance is reviewed periodically, based on updated projections of taxable income, and adjusted accordingly by a credit or charge to the statement of operations in that period.

The tax effects of temporary differences and tax credits that give rise to significant components of the future income tax assets at the statutory enacted rates, when such benefits are expected to be realized are as follows:

December 31,
2011
$
December 31,
2010
$
Future tax assets
Research and development expenditures6,879,250 8,467,000
Investment tax credits6,032,450 6,032,450
Share issuance costs626,880 959,100
Total gross future tax assets13,538,580 15,458,550
Valuation allowance(8,618,580)(8,908,550)
Net future tax asset4,920,000 6,550,000
Less: current portion(2,180,000)(2,150,000)
2,740,000 4,400,000

The tax balances and income tax expense recognized by the Company are based on management's interpretation of the tax laws. Due to the complexity inherent in tax interpretations, regulations and legislation, there are significant estimates required to compute income tax balances. It is possible that some or all of the Company's significant components of the future income tax assets may not be deductible for tax purposes and, accordingly, the amount of future income taxes and provision for income taxes recorded in the financial statements could change by a material amount.

In determining the amount of future income tax assets recognized, management assessed the projected taxable income of the Company. Inherent in all forward looking information is uncertainty and actual amounts could differ from these estimates and the difference could be material. In developing the projection, management has assumed full payment of all contractual interest, that investments maturing prior to April 30, 2014 will be redeemed for par value, that reinvested funds will achieve an 8% yield, and that investments maturing after April 30, 2014 will be sold at their current value.

Tax pools available to offset future tax expense and payable

The operations of the Company and related tax interpretations, regulations and legislation are continually changing. As a result, significant estimates are required to compute income tax balances. As at December 31, 2011, the Company has accumulated scientific research and experimental development expenditures in the amount of $27,500,000 available for carry-forward indefinitely. The Company also has accumulated approximately $7,097,000 of unclaimed federal investment tax credits, which expire as follows:

Investment
tax credits
$
Year of expiry
2018265,000
2019990,000
20201,872,000
20212,483,000
2022298,000
2023187,000
2024496,000
2025506,000
7,097,000

Reconciliation of income tax expense

The reconciliation of income tax computed at the statutory tax rate to income tax expense, using a 26.5% statutory tax rate (2010 - 28.5%), is:

December 31,
2011
$
December 31,
2010
$
Increase in net assets from operations before taxes7,198,428 23,683,536
Statutory tax rate26.5%28.5%
Income tax expense at statutory rates1,907,583 6,749,808
Use of prior year losses- (6,124,935)
Use of scientific research and experimental development expenditures(1,575,337)(267,551)
Recognition of future tax asset1,630,000 1,650,000
Current tax deductions for offering costs(332,246)(357,322)
Provision for future income tax1,630,000 1,650,000

8 Financial instruments

The following tables illustrate the classification of the Company's financial instruments within the fair value hierarchy:

Financial assets at fair value - December 31, 2011

Level 1
$

Level 2
$

Level 3
$

Total
$
Corporate debt-94,406,53422,965,956117,372,490
Convertible debentures--1,554,2181,554,218
Equities10,397,044-205,44410,602,488
Foreign currency forward contracts-389,347-389,347
10,397,04494,795,88124,725,618129,918,543
Financial assets at fair value - December 31, 2010

Level 1
$

Level 2
$

Level 3
$

Total
$
Corporate debt-91,969,70314,475,875106,445,578
Convertible debentures-9,334,3693,617,67712,952,046
Equities7,826,002-400,0008,226,002
Foreign currency forward contracts-
825,824
-
825,824
7,826,002102,129,89618,493,552128,449,450

All investments remained at their respective levels within the fair value hierarchy during the year.

The following table reconciles the Company's Level 3 fair value measurements:

Fair value measurements of Level 3 inputs
Corporate
debt
$
Convertible
debentures
$

Equities
$

Total
$
Balance - December 31, 200911,616,418 10,561,008 - 22,177,426
Purchases7,500,000 1,879,862 - 9,379,862
Sales(6,061,608)(17,921,531)- (23,983,139)
Unrealized appreciation included in net gain on investments
1,421,065

9,098,338

400,000

10,919,403
Balance - December 31, 201014,475,875 3,617,677 400,000 18,493,552
Purchases14,812,500 - - 14,812,500
Sales(7,031,250)(2,148,120)- (9,179,370)
Unrealized appreciation (depreciation) included in net gain on investments708,831 84,661 (194,556)598,936
Balance - December 31, 201122,965,956 1,554,218 205,444 24,725,618

Level 3 fair value measurements have predominantly been valued by considering data inputs such as the last price the security was traded at, most recent bid/ask information, prices of similar securities with available prices, and comparison of yields of comparable investments. Accordingly it is not practicable to provide a sensitivity analysis.

Management of financial risks

In the normal course of business, the Company is exposed to various financial risks, including credit risk, liquidity risk and market risk (consisting of interest rate risk, currency risk and other price risk). The Company's overall risk management program seeks to minimize potentially adverse effects of these risks on the Company's financial performance by employing a professional, experienced portfolio adviser, monitoring daily the Company's positions and market events, diversifying the investment portfolio within the constraints of the investment guidelines and periodically using derivatives to hedge certain risk exposures. Further, the Company monitors the portfolio to ensure compliance with its investment strategy, investment guidelines and securities regulations.

Fair value risk

The Company's investments are exposed to market price risk and this risk affects the fair value of the investments. All fixed income investments have an inherent risk of loss of capital. Except for foreign currency forward contracts, the maximum risk resulting from investments is determined by their fair value. The Company seeks to manage valuation risks by careful selection of fixed income investments prior to making an investment and by regular ongoing monitoring of the investment performance of the individual investee companies.

Credit risk

Credit risk is the risk that a counterparty to a financial instrument will fail to discharge an obligation or commitment that it has entered into with the Company.

All transactions executed by the Company in listed securities are settled/paid for upon delivery using approved brokers. The risk of this settlement not occurring is considered minimal, as delivery of securities sold is only made once the broker has received payment. Payment is made on a purchase once the securities have been received by the broker. The trade will fail if either party fails to meet its obligation. Since the Company invests in high-yield debt instruments and derivatives, this represents the main concentration of credit risk. The fair value of debt securities includes consideration of the creditworthiness of the debt issuer. The maximum credit exposure of these assets is represented by their carrying amounts. This maximum exposure may be offset to varying degrees in each investment, based on the collateral held, if any. Collateral may include such things as a general security agreement over all assets, or specific security over specific assets. It may also entitle the debt holder to take over the overall business through restructuring of the investment.

The Company's credit risk exposure by credit ratings on its investments is listed as follows:

As a % of net assets
December 31,
2011
December 31,
2010
Credit rating
BB1.710.7
B37.336.0
CCC23.021.3
CC-1.0
Not rated*29.320.0
91.389.0

* Unrated securities consist primarily of equity securities, convertible debentures and promissory notes in publicly traded companies

Credit ratings are obtained from various credit rating agencies and sources. Where one or more rating is obtained for a security, the lowest rating has been used.

The Company's credit risk exposure by sector on its investments is as follows:

As a % of net assets
December 31,
2011
December 31,
2010
Sector
Energy50.457.1
Materials and metals12.26.0
Consumer goods7.59.4
Services4.23.6
Chemicals-3.4
Financial services2.93.0
Industrial/manufacturing3.52.2
Forestry6.94.3
Technology3.7-
91.389.0

Interest rate risk

Interest rate risk arises from the possibility that changes in interest rates will affect future cash flows or fair values of financial instruments.

The Company invests primarily in interest-bearing financial instruments. As such, the Company is exposed to the risk that the value of such financial instruments will fluctuate due to changes in the prevailing levels of market interest rates. The table below summarizes the Company's exposure to interest rate risk by term to maturity:

Fair value
December 31,
2011
$
December 31,
2010
$
Maturity
Less than 1 year1,943,5655,825,824
1 - 3 years20,139,16516,154,645
3 - 5 years27,120,25027,443,442
Greater than 5 years70,113,07570,799,537
119,316,055120,223,448

As at December 31, 2011, if the prevailing interest rates had been raised or lowered by 1%, assuming a parallel shift in the yield curve, with all other factors remaining constant, net assets could possibly have decreased or increased, respectively, by approximately $5,000,000, or approximately 3.5% of net assets (December 31, 2010 - $4,900,000, or approximately 3.4% of net assets).

Liquidity risk

As the Company is a publicly traded, closed-end investment company with a fixed number of common shares outstanding, unlike an open-ended mutual fund, it is not exposed to the liquidity risk associated with daily cash redemptions of securities.

Investments in fixed income investments may not be able to be liquidated quickly at an amount close to their fair value to respond to specific events such as deterioration in the creditworthiness of any particular issuer. Fixed income investments purchased by the Company may be subject to resale restrictions such as hold periods. The resulting values for fixed income investments may differ from values that would be realized had a ready market existed.

The Company actively reviews its investment portfolio, and the fixed income market, to assess liquidity risk on its holdings.

Currency risk

Currency risk is the risk that the value of a financial instrument will fluctuate due to changes in foreign exchange rates. The Company invests a portion of its assets in securities that are denominated in a currency other than the Canadian dollar, which represents the functional currency of the Company. Consequently, the Company is exposed to currency risk as the value of the portfolio securities denominated in currencies other than the Canadian dollar will vary due to changes in foreign currency exchange rates.

The Company enters into foreign currency contracts with financial institutions to hedge the value of foreign currency denominated investments. The fair value of these contracts is reflected in investments. Gains or losses arising from these contracts offset the gains or losses from the underlying investments. The unrealized gains or losses are reflected in unrealized appreciation/depreciation on foreign currency contracts on the statement of operations. The potential impact to net assets of a 5% change in foreign currency rates against the Canadian dollar, assuming all other variables remain constant, would be $160,000 (2010 - $180,000).

At December 31, 2011, the Company had outstanding foreign exchange contracts to sell US$54,000,000 and AUS$1,500,000 against future commitments at exchange rates ranging between 1.01745 and 1.03175 for US dollar foreign exchange contracts and 1.03000 for the AUS dollar foreign exchange contract. Those contracts had maturities ranging up to January 25, 2012 and are with AAA rated Canadian banks and counterparties.

9 Capital management

The capital of the Company is divided into voting and non-voting common shares, each having an unlimited authorized amount. The number of voting and non-voting shares outstanding, and changes thereto, are outlined in note 3.

The Company manages its capital in accordance with the Company's investment objectives. The Company's investment objectives are to: (i) maximize the total return for common shareholders, consisting of dividend income and capital appreciation; and (ii) provide shareholders with monthly dividends targeted to payout a minimum of 75% of net investment income annually. Net investment income, in reference to the Company's dividend payments to shareholders, excludes any realized and unrealized capital gains and losses from debt securities in the portfolio and any income or loss not derived from debt securities in the portfolio. The Company commenced its dividend payments on June 30, 2009, making monthly payments of $0.0583 per voting and non-voting common share, or $614,322. During the year ended December 31, 2011, the Company made dividend payments of $7,371,869 (December 31, 2010 - $7,371,869).

The Company intends to continue paying a monthly dividend of $0.0583 per voting and non-voting common share for the three months ending March 31, 2012, totalling $1,842,966 (note 11).

10 Comparison of net asset value per share and net assets per share

In accordance with Section 3.6(1) of National Instrument 81-106, the Company's net asset value per share, the net assets per share calculated in accordance with Canadian GAAP for financial reporting purposes, and an explanation of the differences between such amounts, are required disclosures in the notes to the financial statements. For investments that are traded in an active market, Canadian GAAP requires that bid prices be used in the fair value of instruments, rather than the use of the last traded price, as currently used for the purpose of determining net asset value. This change accounts for the difference between the net asset value and the net assets.

December 31,
2011
$
December 31,
2010
$
Net asset value per share13.49 13.65
Canadian GAAP adjustments(0.06)(0.05)
Net assets per common share13.43 13.60

11 Subsequent events

On January 9, 2012, the Company announced a monthly dividend of $614,322, or $0.0583 per common share, payable on each of January 31, 2012, February 29, 2012 and March 30, 2012.

Contact Information:

Deans Knight Income Corporation
Craig Langdon
Chief Executive Officer and Director
(604) 669-0212

Deans Knight Income Corporation
Mark Myles
Chief Financial Officer
(604) 669-0212
www.dkincomecorp.com