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The chart that follows shows the allocation of the Fund’s holdings by asset category as of May 31, 2006.

THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.

*	As a percentage of total investments.

1

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Dear Shareholder:

We welcome this opportunity to provide you with information about The Hyperion Strategic Mortgage Income Fund, Inc. (the “Fund”), for the semi-annual period ended May 31, 2006. The Fund is a closed-end bond fund whose shares are traded on the New York Stock Exchange (“NYSE”) under the symbol “HSM”.

Description of the Fund

The Fund is a diversified closed-end management investment company. The Fund’s primary investment objective is to provide a high level of current income by investing primarily in mortgage-backed securities that offer an attractive combination of credit quality, yield and maturity. The Fund’s secondary investment objective is to provide capital appreciation. Under normal market conditions, the Fund will invest at least 80% of its total assets in investment-grade mortgage-backed securities (“MBS”) including Agency MBS, Non-Agency Residential MBS (“RMBS”), and Commercial MBS (“CMBS”), and may invest up to 20% of its total assets in U.S. Government securities, cash or other short-term instruments.

Portfolio Performance

For the six month period ended May 31, 2006, shareholders realized a total investment return of 2.01%, which assumes the reinvestment of dividends and is exclusive of brokerage commissions. Based on the NYSE closing price of $12.42 on May 31, 2006, the Fund’s shares had a current yield of 8.70%.

As of May 31, 2006, the Fund, inclusive of the effect of leverage, was managed with an average duration (a bond’s duration is the weighted average number of years until maturity of all its cash flows, including coupon payments and principal) of 4.6 years, as measured on a net asset basis.

Market Environment

The economy has continued to drift sideways. Business indicators (ISM and the Chicago Purchasing Managers reports) indicate growth, hard commodity prices have soared (although they appear to have peaked), and consumer confidence remains above 100. However, new home sales have dipped, home inventories have risen, oil prices remain high, and interest rates continue to climb. Stocks are about unchanged for 2006.

The Fed raised the Fed Funds target rate four times during the last six months, most recently to 5.00% at the May 10 meeting (16 meetings in a row!). The market anticipates another 25 basis point hike at the upcoming August meeting but we expect that the Fed is towards the end of this tightening cycle.

Our sense is that Fed Chairman Bernanke is looking to demonstrate his resolve in fighting inflation (and to make sure that any U.S dollar weakness is moderate), so these last two tightening moves may be typical of the Fed overshooting on Fed Funds targeting.

We expect the impact of higher mortgage rates and energy prices to eventually have a negative impact on the consumer sector, which at 75% of GDP, would have a profound impact on the economy. We look for the economy to slow toward the end of third quarter, and expect the Fed to begin easing in the first quarter of 2007. (The average time between the last tightening of an interest rate cycle and the first ease of the next cycle has been nine months.)

The yield curve has shifted higher across all maturities throughout the last six months as the Fed tightened. Additionally, interest rates (and stock markets) have been rising around the globe as other central banks have raised funding rates. This has led to yield curve flattening in many markets. While increased geo-political issues (Iran, Venezuela) have increased the risk of longer maturity bonds, the global appetite for longer duration securities should keep longer dated Treasury yields from rising much further.

2

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Portfolio Strategy

Credit spreads tightened in three key sectors (residential, commercial and corporate credit) during 2006 despite signals of economic weakness, reflecting the huge global pool of funds that may be invested. Foreign buyers have continued to recycle U.S. dollars (from our large trade deficit) back into the financial markets (thereby keeping our interest rates relatively low).

The most significant yield spread tightening occurred in the commercial mortgage backed securities (CMBS) market. We had increased our CMBS allocation in February, with the idea that the strength in the business sector (versus some anticipated weakness in the consumer sector) would increase demand for office space, hotels and industrial space, which are some of the core components of the CMBS market. That view proved correct and BBB- rated CMBS bonds are 60 basis points tighter than at year-end. We remain fans of CMBS as those bonds are better insulated from many of the “shareholder friendly” corporate actions (e.g. MBO, share-buybacks, increase in leverage) that plagues the corporate credit sector.

We continue to position the Fund with an “up-in-credit” bias. Our AAA rated exposure remains in excess of 53%.

The Fund remains nearly fully leveraged (with a maximum of 50% of net assets by charter) to take advantage of the yield premium afforded by some of the mortgage-related credit sectors. We have kept some buying power in reserve should credit spreads widen.

The Fund’s exposure to increases in financing costs had been almost fully hedged (either through buying floaters or by using interest rate swaps) for the last year. In anticipation that the Fed is near the end of this tightening cycle, we have begun to leave some portion of the funding cost unhedged.

Similarly, given our view that longer maturity U.S Treasury interest rates are not likely to head much higher, we have extended the duration of the Fund slightly to about 4.6 years. Over time, higher interest rates will cause some extension in duration of the underlying assets, although much less than what we expect in the Agency MBS market. Our intention is to manage the duration toward a target of 4.5 to 5.0 years during the summer.

3

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Conclusion

We remain committed to the Fund and its shareholders. As always, we will continue to actively seek investment opportunities in the market and act on them in a timely fashion in an effort to achieve the Fund’s objectives. We welcome your questions and comments, and encourage you to contact our Shareholder Services Representatives at 1-800-HYPERION.

We appreciate the opportunity to serve your investment needs.

Sincerely,
CLIFFOR E. LAI President, The Hyperion Strategic Mortgage Income Fund, Inc. President and Chief Executive Officer, Hyperion Brookfield Asset Management, Inc.
JOHN H. DOLAN Vice President, The Hyperion Strategic Mortgage Income Fund, Inc. Chief Investment Officer, Hyperion Brookfield Asset Management, Inc.

4

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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Portfolio of Investments – (Unaudited)
											Principal
May 31, 2006					Interest						Amount				Value
					Rate				Maturity		(000s)				(Note 2)
U.S. GOVERNMENT & AGENCY OBLIGATIONS – 73.9%
U.S. Government Agency Pass-Through Certificates – 56.1%
	Federal Home Loan Mortgage Corporation
		Pool A14559				6.50	%		09/01/33		$	1,935			$	1,959,595
		Pool C68878				7.00			06/01/32			462				474,063
		Pool C69047				7.00			06/01/32			1,051				1,077,929
		Pool G01466				9.50			12/01/22			1,185				1,287,282
		Pool 555559				10.00			03/01/21			1,251				1,371,412
																6,170,281
	Federal National Mortgage Association
		TBA				5.50			07/01/33			5,000				4,810,940
		TBA				6.00			07/01/26			5,000				4,932,810
		Pool 694391				5.50			03/01/33			3,363				3,251,186
		Pool 753914				5.50			12/01/33			7,911	@			7,648,039
		Pool 754355				6.00			12/01/33			4,151				4,111,831
		Pool 761836				6.00			06/01/33			3,147				3,118,261
		Pool 763643				6.00			01/01/34			6,991	@			6,919,465
		Pool 255413				6.50			10/01/34			8,105	@			8,180,973
		Pool 323982				6.50			10/01/06			160				160,096
		Pool 795367				6.50			09/01/34			3,715				3,749,609
		Pool 809989				6.50			03/01/35			3,748	@			3,782,629
		Pool 626299				7.00			06/01/32			408				418,800
		Pool 635095				7.00			06/01/32			849				871,080
		Pool 641575				7.00			04/01/32			278				285,487
		Pool 645399				7.00			05/01/32			2,329				2,389,782
		Pool 645466				7.00			05/01/32			2,388				2,450,115
		Pool 650131				7.00			07/01/32			1,416				1,453,246
		Pool 819251				7.50			05/01/35			3,290				3,411,828
		Pool 398800				8.00			06/01/12			600				622,424
		Pool 827854				8.00			10/01/29			2,223				2,365,130
		Pool 636449				8.50			04/01/32			1,880				2,025,503
		Pool 823757				8.50			10/01/29			3,254				3,503,277
		Pool 458132				9.45			03/15/31			1,620				1,771,990
																72,234,501
Total U.S. Government Agency Pass-Through Certificates
			(Cost – $80,590,111)													78,404,782
U.S. Treasury Obligations – 17.8%           United States Treasury Notes
			(Cost – $25,698,400)			4.50			02/15/16			26,100	@			24,840,884
Total U.S. Government & Agency Obligations
			(Cost – $106,288,511)													103,245,666
ASSET-BACKED SECURITIES – 18.5%
Housing Related Asset-Backed Securities – 16.8%
	Asset Backed Funding Certificates
		Series 2005-AQ1, Class B1* (b)				5.75/6.25			06/25/35			993				838,125
		Series 2005-AQ1, Class B2* (b)				5.75/6.25			06/25/35			1,050				871,964
																1,710,089

See notes to financial statements.

5

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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Portfolio of Investments – (Unaudited)
											Principal
May 31, 2006					Interest						Amount				Value
					Rate				Maturity		(000s)				(Note 2)
ASSET-BACKED SECURITIES (continued)
	Bank of America Funding Corp.
		Series 2005-2, Class B4				5.66	%†		04/25/35		$	869			$	719,284
		Series 2005-2, Class B5				5.66	†		04/25/35			695				448,610
		Series 2005-2, Class B6				5.66	†		04/25/35			522				177,573
																1,345,467
	First Franklin Mortgage Loan Asset Backed Certificates
		Series 2004-FF8, Class B4*(a)				8.58	†		10/25/34			1,250				1,170,029
		Series 2004-FFH2C, Class B1*(a)				8.58	†		06/25/34			1,250				1,207,236
																2,377,265
	Green Tree Financial Corp.
		Series 1997-3, Class M1				7.53			03/15/28			2,000				1,250,000
		Series 1995-6, Class M1				8.10			09/15/26			4,325				4,411,889
																5,661,889
	Harborview Mortgage Loan Trust
		Series 2005-14, Class B4*				5.52	†		12/19/35			394				325,588
		Series 2005-1, Class B4*(a)				6.83	†		03/19/35			629				536,721
		Series 2005-1, Class B5*(a)				6.83	†		03/19/35			914				632,912
		Series 2005-1, Class B6*(a)				6.83	†		03/19/35			1,144				228,738
		Series 2005-2, Class B4*(a)				6.34	†		05/19/35			1,488				1,243,762
																2,967,721
	Mid-State Trust
		Series 2004-1, Class M2				8.11			08/15/37			1,450				1,470,864
	Option One Mortgage Loan Trust
		Series 2006-1, Class M7				6.23	†		01/25/36			3,000				3,026,280
	Structured Asset Investment Loan Trust
		Series 2004-11, Class M9(b)				5.00/5.50			01/25/35			1,900				1,787,792
		Series 2004-4, Class B*(b)				5.00/5.50			04/25/34			1,500				1,356,797
		Series 2004-8, Class B1(a)				7.58	†		09/25/34			1,000				956,127
																4,100,716
	Structured Asset Securities Corporation
		Series 2005-6, Class B5				5.34	†		05/25/35			493				384,182
		Series 2005-6, Class B6				5.34	†		05/25/35			494				303,412
		Series 2005-6, Class B7				5.34	†		05/25/35			345				103,569
																791,163
Total Housing Related Asset-Backed Securities
			(Cost – $24,182,146)													23,451,454
Non-Housing Related Asset-Backed Securities – 1.7%
	Airplanes Pass Through Trust
			Series 1R, Class A8
			(Cost – $2,099,032)			5.46	†		03/15/19			2,490				2,384,333
Total Asset-Backed Securities
			(Cost – $26,281,178)													25,835,787
COMMERCIAL MORTGAGE BACKED SECURITIES – 23.0%
	Banc America Commercial Mortgage, Inc.
		Series 2006-1, Class J*				5.78			09/10/45			1,000				931,583

See notes to financial statements.

6

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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Portfolio of Investments – (Unaudited)
											Principal
May 31, 2006					Interest						Amount				Value
					Rate				Maturity		(000s)				(Note 2)
COMMERCIAL MORTGAGE BACKED SECURITIES (continued)
	Bear Stearns Commercial Mortgage Securities
		Series 2006-PWR11, Class H*				5.63	%		03/11/39		$	1,100			$	1,009,637
		Series 1999-C1, Class D				6.53			02/14/31			2,500				2,541,275
		Series 2000-WF1, Class E				7.90	†		02/15/32			2,000				2,119,860
																5,670,772
	CD 2006 CD2
		Series 2006-CD2, Class J*				5.48			01/11/46			1,000				915,732
	Credit Suisse Mortgage Capital Certificates
		Series 2006-C1, Class K*				5.56	†		02/15/16			2,358				2,179,704
	GE Capital Commercial Mortgage Corp.
		Series 2002-2A, Class G*				6.04			08/11/36			3,000				3,025,419
		Series 2000-1, Class G*				6.13			01/15/33			1,000				574,200
		Series 2002-2A, Class H*				6.31			08/11/36			2,000				2,050,462
																5,650,081
	GMAC Commercial Mortgage Securities
		Series 2006-CICTF, Class G*				5.44			01/24/45			2,500				2,350,775
	JP Morgan Chase Commercial Mortgage Securities
		Series 2003-LN1, Class G*				5.48	†		10/15/37			1,600				1,539,413
		Series 2006-CIBC14, Class H*				5.54	†		12/12/44			1,211				1,117,282
																2,656,695
	Morgan Stanley Capital I
		Series 2004-HQ4, Class G*				5.53			09/14/14			1,000				948,157
		Series 1999-FNV1, Class E				7.44	†		03/15/31			2,000				2,091,880
																3,040,037
	Nationslink Funding Corp.
		Series 1998-2, Class E				7.11			08/20/30			4,000				4,147,028
	UBS 400 Atlantic Street Mortgage Trust
		Series 2002-C1A, Class B3*				7.19			01/11/22			2,000				2,066,200
	Wachovia Bank Commercial Mortgage Trust
		Series 2005-C16, Class H*				5.30	†		10/15/41			2,000				1,847,032
		Series 2004-WL4A, Class H*				5.93	†		10/15/15			700				700,181
																2,547,213
Total Commercial Mortgage Backed Securities
			(Cost – $32,767,554)													32,155,820
NON-AGENCY RESIDENTIAL MORTGAGE BACKED SECURITIES – 25.6%
Subordinated Collateralized Mortgage Obligations – 25.6%
	Bank of America Alternative Loan Trust
		Series 2004-3, Class 30B4*				5.50			04/25/34			988				801,339
		Series 2004-3, Class 30B5				5.50			04/25/34			692				436,542
																1,237,881
	Bank of America Mortgage Securities, Inc.
		Series 2004-A, Class B4				3.91	†		02/25/34			2,032				1,887,625
		Series 2003-10, Class 1B4				5.50			01/25/34			554				488,071
		Series 2002-10, Class 1B3				6.00			11/25/32			1,431				1,381,527
																3,757,223

See notes to financial statements.

7

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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Portfolio of Investments – (Unaudited)
										Principal
May 31, 2006				Interest						Amount				Value
				Rate				Maturity		(000s)				(Note 2)
NON-AGENCY RESIDENTIAL MORTGAGE BACKED SECURITIES (continued)
	Cendant Mortgage Corp.
		Series 2002-4, Class B1			6.50	%		07/25/32		$	2,565			$	2,542,804
		Series 2002-4, Class B2			6.50			07/25/32			1,026				1,017,122
		Series 2002-4, Class B3			6.50			07/25/32			598				592,418
		Series 2002-4, Class B4			6.50			07/25/32			342				334,605
		Series 2002-4, Class B5			6.50			07/25/32			256				232,216
		Series 2002-4, Class B6*			6.50			07/25/32			342				273,550
															4,992,715
	First Horizon Alternative Mortgage Securities
		Series 2005-AA6, Class B4			5.46	†		08/25/35			849				696,614
		Series 2005-AA6, Class B5			5.46	†		08/25/35			799				529,301
		Series 2005-AA6, Class B6			5.46	†		08/25/35			499				124,788
															1,350,703
	First Horizon Mortgage Pass-Through Trust
		Series 2005-4, Class B4*			5.45	†		07/25/35			423				342,152
		Series 2005-5, Class B4*			5.46	†		10/25/35			723				582,863
		Series 2005-5, Class B5*			5.46	†		10/25/35			542				332,030
		Series 2005-5, Class B6*			5.46	†		10/25/35			543				160,303
		Series 2005-3, Class B4			5.50			06/25/35			453				367,123
															1,784,471
	G3 Mortgage Reinsurance Ltd.
		Series 1, Class E*			25.08	†		05/25/08			4,157				4,525,708
	JP Morgan Mortgage Trust
		Series 2003-A1, Class B4			4.48	†		10/25/33			534				456,753
	Residential Finance Limited Partnership
		Series 2002-A, Class B7			10.78	†		10/10/34			1,900				1,909,363
	Residential Funding Mortgage Securities I, Inc.
		Series 2004-S1, Class B2			5.25			02/25/34			448				289,071
		Series 2003-S7, Class B2			5.50			05/25/33			523				201,194
		Series 2003-S7, Class B3			5.50			05/25/33			317				210,628
		Series 2006-SA1, Class B2*			5.67			02/25/36			825				618,513
		Series 2006-SA1, Class B3*			5.67			02/25/36			687				250,741
															1,570,147
	Resix Finance Limited Credit-Linked Note
		Series 2005-C, Class B7*			8.18	†		09/10/37			1,982				1,974,655
		Series 2004-C, Class B7*			8.58	†		09/10/36			977				986,819
		Series 2004-B, Class B8*			9.83	†		02/10/36			791				803,345
		Series 2003-CB1, Class B8*			11.83	†		06/10/35			952				982,465
		Series 2004-B, Class B9*			13.33	†		02/10/36			1,212				1,245,669
		Series 2004-A, Class B10*			16.58	†		02/10/36			484				498,374
															6,491,327
	Structured Asset Mortgage Investments, Inc.
		Series 2002-AR1, Class B4			6.06	†		03/25/32			480				470,814
	Washington Mutual Mortgage Securities Corp.
		Series 2002-AR12, Class B4			4.67	†		10/25/32			834				806,970
		Series 2002-AR12, Class B5			4.67	†		10/25/32			626				612,612
		Series 2002-AR12, Class B6			4.67	†		10/25/32			1,044				772,217
		Series 2002-AR10, Class B4*			4.95	†		10/25/32			804				779,420

See notes to financial statements.

8

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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Portfolio of Investments – (Unaudited)
										Principal
May 31, 2006				Interest						Amount				Value
				Rate				Maturity		(000s)				(Note 2)
NON-AGENCY RESIDENTIAL MORTGAGE BACKED SECURITIES (continued)
		Series 2002-AR10, Class B5*			4.95	%†		10/25/32		$	603			$	568,334
		Series 2002-AR10, Class B6*			4.95	†		10/25/32			1,006				744,805
		Series 2002-AR11, Class B5			5.12	†		10/25/32			516				504,235
		Series 2002-AR11, Class B6			5.12	†		10/25/32			692				595,361
		Series 2005-AR2, Class B10(a)			5.91	†		01/25/45			1,789				1,494,908
															6,878,862
	Wells Fargo Mortgage Backed Securities Trust
		Series 2002, Class B5			6.00			06/25/32			356				343,038
Total Subordinated Collateralized Mortgage Obligations
		(Cost – $35,006,585)													35,769,005
Total Non-Agency Residential Mortgage Backed Securities
		(Cost – $35,006,585)													35,769,005
SHORT TERM INVESTMENTS – 0.8%
	Federal Home Loan Bank Discount Notes				4.93			06/02/06			1,000				999,863
	United States Treasury Bills				0			06/15/06			50	#			49,908
Total Short Term Investments
		(Cost – $1,049,777)													1,049,771
Total Investments – 141.8%
		(Cost – $201,393,605)													198,056,049
Liabilities in Excess of Other Assets – (41.8)%															(58,352,408	)
NET ASSETS – 100.0%														$	139,703,641

@		—		Portion or entire principal amount delivered as collateral for reverse repurchase agreements. (Note 5)
†		—		Variable Rate Security: Interest rate is the rate in effect as of May 31, 2006.
*		—		Security exempt from registration under Rule 144A of the Securities Act of 1933. These securities may only be resold in transactions exempt from registration, normally to qualified institutional buyers.
(a)		—		Security is a “step up” bond where coupon increases or steps up at a predetermined date. At that date these coupons increase to LIBOR plus a predetermined margin.
(b)		—		Security is a “step up” bond where coupon increases or steps up at a predetermined date. Rates shown are current coupon and next coupon rate when security steps up.
#		—		Portion or entire principal amount is held as collateral for open futures contracts.
TBA		—		Settlement is on a delayed delivery or when-issued basis with a final maturity To Be Announced.

See notes to financial statements.

9

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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Statement of Assets and Liabilities – (Unaudited)
May 31, 2006
Assets:
	Investments in securities, at market (cost $201,393,605) (Note 2)			$	198,056,049
	Cash				150,953
	Interest receivable				1,203,268
	Receivable for investments sold				9,694,362
	Principal paydowns receivable				28,992
	Unrealized appreciation on swap contracts (Note 7)				1,316,109
	Prepaid expenses and other assets				50,186
		Total assets			210,499,919
Liabilities:
	Reverse repurchase agreements (Note 5)				50,906,125
	Interest payable for reverse repurchase agreements (Note 5)				73,820
	Payable for investments purchased				19,575,833
	Investment advisory fee payable (Note 3)				77,319
	Payable for variation margin				20,625
	Administration fee payable (Note 3)				19,130
	Directors’ fee payable				127
	Accrued expenses and other liabilities				123,299
		Total liabilities			70,796,278
Net Assets (equivalent to $13.77 per share based on 10,144,002 shares issued and outstanding)				$	139,703,641
Composition of Net Assets:
	Capital stock, at par value ($.01) (Note 6)			$	101,440
	Additional paid-in capital (Note 6)				144,148,737
	Accumulated undistributed net investment income				1,520,888
	Accumulated net realized loss				(4,012,317	)
	Net unrealized depreciation on investments, swap contracts and futures				(2,055,107	)
	Net assets applicable to capital stock outstanding			$	139,703,641

See notes to financial statements.

10

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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Statement of Operations – (Unaudited)
For the Six Months Ended May 31, 2006
Investment Income (Note 2):
	Interest				$	6,958,113
Expenses:
	Investment advisory fee (Note 3)					458,028
	Administration fee (Note 3)					140,932
	Insurance					77,633
	Custodian					36,031
	Accounting and tax services					35,515
	Reports to shareholders					36,426
	Transfer agency					18,331
	Directors’ fees					39,226
	Legal					9,351
	Registration fees					17,833
	Miscellaneous					7,334
		Total operating expenses				876,640
			Interest expense on reverse repurchase agreements (Note 5)			1,297,391
		Total expenses				2,174,031
	Net investment income					4,784,082
Realized and Unrealized Gain (Loss) on Investments (Notes 2 and 7):
Net realized loss on:
	Investment transactions					(717,966	)
	Futures transactions					(189,754	)
	Swap contracts					(52,687	)
Net realized loss on investment transactions, futures transactions and swap contracts						(960,407	)
Net change in unrealized appreciation/depreciation on:
	Investments					(2,069,467	)
	Futures					(33,660	)
	Swap contracts					930,261
Net change in unrealized appreciation/depreciation on investments, futures and swap contracts						(1,172,866	)
Net realized and unrealized loss on investments, futures and swap contracts						(2,133,273	)
Net increase in net assets resulting from operations					$	2,650,809

See notes to financial statements.

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				For the Six Months
				Ended				For the Year
				May 31, 2006				Ended
				(Unaudited)				November 30, 2005
Increase (Decrease) in Net Assets Resulting from Operations:
	Net investment income			$	4,784,082			$	11,748,542
	Net realized loss on investment transactions, futures transactions and swap contracts				(960,407	)			(290,021	)
	Net change in unrealized appreciation/depreciation on investments, futures and swap contracts				(1,172,866	)			(4,359,745	)
	Net increase in net assets resulting from operations				2,650,809				7,098,776
Dividends to Shareholders (Note 2):
	Net investment income				(5,477,761	)			(12,233,207	)
Capital Stock Transactions (Note 6):
	Net asset value of shares issued through dividend reinvestment (0 and 1,366 shares, respectively)				—				19,808
	Net increase from capital stock transactions				—				19,808
		Total decrease in net assets			(2,826,952	)			(5,114,623	)
Net Assets:
	Beginning of period				142,530,593				147,645,216
	End of period (including undistributed net investment income of $1,520,888 and $1,739,109, respectively)			$	139,703,641			$	142,530,593

See notes to financial statements.

12

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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Statement of Cash Flows – (Unaudited)
For the Six Months Ended May 31, 2006
Increase (Decrease) in Cash:
	Cash flows provided by (used for) operating activities:
		Net increase in net assets resulting from operations			$	2,650,809
		Adjustments to reconcile net increase in net assets from operations to net cash provided by operating activities:
			Purchases of long-term portfolio investments			(97,416,434	)
			Proceeds from disposition of long-term portfolio investments, principal paydowns, and securities sold short			104,715,599
			Purchases of short-term portfolio investments, net			(999,864	)
			Increase in interest receivable			(248,237	)
			Increase in receivable for investments sold			(7,979,857	)
			Increase in prepaid expenses and other assets			(35,759	)
			Increase in variation margin payable			20,625
			Increase in interest payable for reverse repurchase agreements			1,549
			Increase in payable for investments purchased			14,619,205
			Increase in investment advisory fee payable			1,130
			Increase in administration fee payable			347
			Decrease in accrued expenses and other liabilities			(30,367	)
			Net accretion on investments			(299,648	)
			Unrealized depreciation on investments			2,069,467
			Unrealized appreciation on swaps			(930,261	)
			Net realized loss on investment transactions			717,966
		Net cash provided by operating activities				16,856,270
	Cash flows used for financing activities:
		Net cash used for reverse repurchase agreements				(11,898,875	)
		Dividends paid to shareholders, net of reinvestments				(5,477,761	)
		Net cash used for financing activities				(17,376,636	)
	Net decrease in cash					(520,366	)
	Cash at beginning of period					671,319
	Cash at end of period				$	150,953

Interest payments for the six months ended May 31, 2006, totaled $1,290,842.

See notes to financial statements.

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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Financial Highlights
			For the
			Six Months
			Ended				For the Year Ended November 30,
			May 31, 2006
			(Unaudited)				2005				2004				2003				2002@
Per Share Operating Performance:
Net asset value, beginning of period			$	14.05			$	14.56			$	14.41			$	14.10			$	14.25	*
Net investment income				0.47				1.16				1.20				1.22				0.37
Net realized and unrealized gain (loss) on investments, short sales, futures transactions and swap contracts				(0.21	)			(0.46	)			0.25				0.39				(0.17	)
Net increase in net asset value resulting from operations				0.26				0.70				1.45				1.61				0.20
Dividends from net investment income				(0.54	)			(1.21	)			(1.30	)			(1.30	)			(0.32	)
Offering costs charged to additional paid-in-capital				—				—				—				—				(0.03	)
Net asset value, end of period			$	13.77			$	14.05			$	14.56			$	14.41			$	14.10
Market price, end of period			$	12.4200			$	12.7000			$	14.6100			$	14.6700			$	13.6800
Total Investment Return+				1.98%	(1)			(5.20)%				9.10%				17.55%				(6.66	)%(1)
Ratios to Average Net Assets/ Supplementary Data:
Net assets, end of period (000’s)			$	139,704			$	142,531			$	147,645			$	146,180			$	142,921
Operating expenses				1.24%	(2)			1.24%				1.25%				1.28%				1.23%	(2)
Interest expense				1.84%	(2)			1.45%				0.58%				0.51%				0.99%	(2)
	Total expenses			3.08%	(2)			2.69%				1.83%				1.79%				2.22%	(2)
Net expenses				3.08%	(2)			2.69%				1.83%				1.79%				2.19%	(2)
Net investment income				6.79%	(2)			8.05%				8.23%				8.54%				7.48%	(2)
Portfolio turnover rate				48%	(1)			46%				65%				78%				70%	(1)

+	Total investment return is calculated assuming a purchase of common stock at the current market price on the first day and a sale at the current market price on the last day of the period reported. For the period ended November 30, 2002, total investment return is based on a beginning period price of $15.00 (initial offering price). Total investment return for subsequent periods is computed based upon the New York Stock Exchange market price of the Fund’s shares. Dividends and distributions, if any, are assumed for purposes of this calculation, to be reinvested at the prices obtained under the Fund’s dividend reinvestment plan. Total investment return does not reflect brokerage commissions and is not annualized.
(1)	Not Annualized
(2)	Annualized
@	Commenced operations on July 26, 2002
*	Initial public offering of $15.00 per share less underwriting discount of $0.75 per share.

See notes to financial statements.

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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Notes to Financial Statements – (Unaudited)
May 31, 2006

The Hyperion Strategic Mortgage Income Fund, Inc. (the “Fund”), which was incorporated under the laws of the State of Maryland on May 17, 2002, is registered under the Investment Company Act of 1940 (the “1940 Act”) as a diversified, closed-end management investment company. The Fund commenced operations on July 26, 2002. Prior to July 26, 2002, the Fund had no operations other than the sale of 7,018 shares for $100,000 to Hyperion Brookfield Asset Management, Inc. (formerly Hyperion Capital Management, Inc.) (the “Advisor”).

The Fund’s investment objective is to provide a high level of current income by investing primarily in mortgage-backed securities. No assurance can be given that the Fund’s investment objective will be achieved.

2.     Significant Accounting Policies

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Valuation of Investments: Where market quotations are readily available, securities held by the Fund are valued based upon the current bid price, except preferred stocks, which are valued based upon the closing price. Securities may be valued by independent pricing services that have been approved by the Board of Directors. The prices provided by a pricing service take into account broker dealer market price quotations for institutional size trading in similar groups of securities, security quality, maturity, coupon and other security characteristics as well as any developments related to the specific securities. The Fund values mortgage-backed securities (“MBS”) and other debt securities for which market quotations are not readily available (approximately 28% of the investments in securities held by the Fund at May 31, 2006) at their fair value as determined in good faith, utilizing procedures approved by the Board of Directors of the Fund, on the basis of information provided by dealers in such securities. Some of the general factors which may be considered in determining fair value include the fundamental analytic data relating to the investment and an evaluation of the forces which influence the market in which these securities are purchased and sold. Determination of fair value involves subjective judgment, as the actual market value of a particular security can be established only by negotiations between the parties in a sales transaction. Debt securities having a remaining maturity of sixty days or less when purchased and debt securities originally purchased with maturities in excess of sixty days but which currently have maturities of sixty days or less are valued at amortized cost.

The ability of issuers of debt securities held by the Fund to meet their obligations may be affected by economic developments in a specific industry or region. The values of MBS can be significantly affected by changes in interest rates or in the financial condition of an issuer or market.

Options Written or Purchased: The Fund may write or purchase options as a method of hedging potential declines in similar underlying securities. When the Fund writes or purchases an option, an amount equal to the premium received or paid by the Fund is recorded as a liability or an asset and is subsequently adjusted to the current market value of the option written or purchased. Premiums received or paid from writing or purchasing options which expire unexercised are treated by the Fund on the expiration date as realized gains or losses. The difference between the premium and the amount paid or received on effecting a closing purchase or sale transaction, including brokerage commissions, also is treated as a realized gain or loss. If an option is exercised, the premium paid or received is added to the proceeds from the sale or cost of the purchase in determining whether the Fund has realized a gain or a loss on the investment transaction.

The Fund, as writer of an option, may have no control over whether the underlying securities may be sold (call) or purchased (put) and as a result bears the market risk of an unfavorable change in the price of the security underlying the written option.

The Fund purchases or writes options to hedge against adverse market movements or fluctuations in value caused by changes in interest rates. The Fund bears the risk in purchasing an option, to the extent of the premium paid, that it will expire without being exercised. If this occurs, the option expires worthless and the premium paid for the option is recognized as a realized loss. The risk associated with writing call options is that the Fund may forego the opportunity for a profit if the market value of the underlying position increases and the option is exercised. The Fund will only write call options on positions held in its portfolio. The risk in writing a put option is that the Fund may incur a loss if the market value of the

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underlying position decreases and the option is exercised. In addition, the Fund bears the risk of not being able to enter into a closing transaction for written options as a result of an illiquid market.

Short Sales: The Fund may make short sales of securities as a method of hedging potential declines in similar securities owned. The Fund may have to pay a fee to borrow the particular securities and may be obligated to pay to the lender an amount equal to any payments received on such borrowed securities. A gain, limited to the amount at which the Fund sold the security short, or a loss, unlimited as to dollar amount, will be realized upon the termination of a short sale if the market price is less or greater than the proceeds originally received.

Financial Futures Contracts: A futures contract is an agreement between two parties to buy and sell a financial instrument for a set price on a future date. Initial margin deposits are made upon entering into futures contracts and can be either cash or securities. During the period the futures contract is open, changes in the value of the contract are recognized as unrealized gains or losses by “marking-to-market” on a daily basis to reflect the market value of the contract at the end of each day’s trading. Variation margin payments are made or received, depending upon whether unrealized gains or losses are incurred. When the contract is closed, the Fund records a realized gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Fund’s basis in the contract.

The Fund invests in financial futures contracts to hedge against fluctuations in the value of portfolio securities caused by changes in prevailing market interest rates. Should interest rates move unexpectedly, the Fund may not achieve the anticipated benefits of the financial futures contracts and may realize a loss. The use of futures transactions involves the risk of imperfect correlation in movements in the price of futures contracts, interest rates and the underlying hedged assets. The Fund is at risk that it may not be able to close out a transaction because of an illiquid market.

Swap agreements: The Fund may enter into interest rate swap agreements to manage its exposure to interest rates. Interest rate swap agreements involve the exchange by the Fund with another party of their respective commitments to pay or receive interest, e.g., an exchange of floating rate payments for fixed rate payments with respect to a notional amount of principal. The Fund will usually enter into interest rate swaps on a net basis, i.e., the two payment streams are netted out, with the Fund receiving or paying, as the case may be, only the net amount of the two payments. Swaps are marked to market based upon quotations from market makers and the change, if any, along with an accrual for periodic payments due or owed is recorded as unrealized gain or loss in the Statement of Operations. Net payments of interest on interest rate swap agreements are included as part of realized gain/loss in the Statement of Operations. Entering into these agreements involves, to varying degrees, elements of credit and market risk in excess of the amounts recognized on the Statement of Assets and Liabilities. Such risks involve the possibility that there will be no liquid market for these agreements, that the counterparty to the agreements may default on its obligation to perform or that there may be unfavorable changes in the fluctuation of interest rates. See Note 7 for a summary of all open swap agreements as of May 31, 2006.

When-Issued Purchases and Forward Commitments: The Fund may purchase securities on a “when-issued” basis and may purchase or sell securities on a “forward commitment” basis in order to hedge against anticipated changes in interest rates and prices and secure a favorable rate of return. When such transactions are negotiated, the price, which is generally expressed in yield terms, is fixed at the time the commitment is made, but delivery and payment for the securities take place at a later date, which can be a month or more after the date of the transaction. At the time the Fund makes the commitment to purchase securities on a when-issued or forward commitment basis it will record the transaction and thereafter reflect the value of such securities in determining its net asset value. At the time the Fund enters into a transaction on a when-issued or forward commitment basis, the Advisor will identify collateral consisting of cash or liquid securities equal to the value of the when-issued or forward commitment securities and will monitor the adequacy of such collateral on a daily basis. On the delivery date, the Fund will meet its obligations from securities that are then maturing or sales of the securities identified as collateral by the Advisor and/or from then available cash flow. When-issued securities and forward commitments may be sold prior to the settlement date. If the Fund disposes of the right to acquire a when-issued security prior to its acquisition or disposes of its right to deliver or receive against a forward commitment, it can incur a gain or loss due to market fluctuation. There is always a risk that the securities may not be delivered and that the Fund may incur a loss. Settlements in the ordinary course are not treated by the Fund as when-issued or forward commitment transactions and, accordingly, are not subject to the foregoing limitations even though some of the risks described above may be present in such transactions.

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Securities Transactions and Investment Income: Securities transactions are recorded on the trade date. Realized gains and losses from securities transactions are calculated on the identified cost basis. Interest income is recorded on the accrual basis. Discounts and premiums on securities are accreted and amortized, respectively, using the effective yield to maturity method.

Taxes: It is the Fund’s intention to continue to meet the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute substantially all of its taxable income to its shareholders. Therefore, no federal income or excise tax provision is required.

Dividends and Distributions: The Fund declares and pays dividends monthly from net investment income. Distributions of realized capital gains in excess of capital loss carryforwards are distributed at least annually. Dividends and distributions are recorded on the ex-dividend date. Dividends from net investment income and distributions from realized gains from investment transactions have been determined in accordance with Federal income tax regulations and may differ from net investment income and realized gains recorded by the Fund for financial reporting purposes. These differences, which could be temporary or permanent in nature, may result in reclassification of distributions; however, net investment income, net realized gains and net assets are not affected.

Cash Flow Information: The Fund invests in securities and distributes dividends and distributions which are paid in cash or are reinvested at the discretion of shareholders. These activities are reported in the Statement of Changes in Net Assets. Additional information on cash receipts and cash payments is presented in the Statement of Cash Flows. Cash, as used in the Statement of Cash Flows, is the amount reported as “Cash” in the Statement of Assets and Liabilities, and does not include short-term investments.

Accounting practices that do not affect reporting activities on a cash basis include carrying investments at value and accreting discounts and amortizing premiums on debt obligations.

Repurchase Agreements: The Fund, through its custodian, receives delivery of the underlying collateral, the market value of which at the time of purchase is required to be in an amount at least equal to the resale price, including accrued interest. The Advisor is responsible for determining that the value of these underlying securities is sufficient at all times. If the seller defaults and the value of the collateral declines or if bankruptcy proceedings commence with respect to the seller of the security, realization of the collateral by the Fund may be delayed or limited.

3.     Investment Advisory Agreements and Affiliated Transactions

Pursuant to a transaction whereby Brascan Financial (U.S.) Corporation purchased all stock ownership of the holding company indirectly owning the Advisor as described in the Proxy Statement to Stockholders dated March 18, 2005 (the “Transaction”) the Fund entered into an Investment Advisory Agreement (the “New Investment Advisory Agreement”) with the Advisor on April 28, 2005. The Advisor is responsible for the management of the Fund’s portfolio and provides the necessary personnel, facilities, equipment and certain other services necessary to the operations of the Fund. For such services, the Fund pays a monthly fee at an annual rate of 0.65% of the Fund’s average weekly net assets. During the six months ended May 31, 2006, the Advisor earned $458,028 in investment advisory fees.

The Fund has entered into an Administration Agreement with Hyperion Brookfield Asset Management, Inc. (formerly Hyperion Capital Management, Inc.) (the “Administrator”). The Administrator entered into a sub-administration agreement with State Street Bank and Trust Company (the “Sub-Administrator”). The Administrator and Sub-Administrator perform administrative services necessary for the operation of the Fund, including maintaining certain books and records of the Fund and preparing reports and other documents required by federal, state, and other applicable laws and regulations, and providing the Fund with administrative office facilities. For these services, the Fund pays to the Administrator a monthly fee at an annual rate of 0.20% of the Fund’s average weekly net assets. During the six months ended May 31, 2006 the Administrator earned $140,932 in administration fees. The Administrator is responsible for any fees due the Sub-Administrator.

Certain officers and/or directors of the Fund are officers and/or directors of the Advisor and/or Administrator.

4.     Purchases and Sales of Investments

Purchases and sales of investments, excluding short-term securities, U.S. Government securities and reverse repurchase agreements, for the six months ended May 31, 2006, were $13,666,986 and $17,431,941, respectively. Purchases and sales of

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U.S. Government securities, for the six months ended May 31, 2006, were $83,749,448 and $87,067,452, respectively. For purposes of this footnote, U.S. Government securities may include securities issued by the U.S. Treasury, Federal Home Loan Mortgage Corporation, and the Federal National Mortgage Association.

5.     Borrowings

The Fund may enter into reverse repurchase agreements with the same parties with whom it may enter into repurchase agreements. Under a reverse repurchase agreement, the Fund sells securities and agrees to repurchase them at a mutually agreed upon date and price. Under the 1940 Act, reverse repurchase agreements will be regarded as a form of borrowing by the Fund unless, at the time it enters into a reverse repurchase agreement, it establishes and maintains a segregated account with its custodian containing securities from its portfolio having a value not less than the repurchase price (including accrued interest). The Fund has established and maintained such an account for each of its reverse repurchase agreements.

Reverse repurchase agreements involve the risk that the market value of the securities retained in lieu of sale by the Fund may decline below the price of the securities the Fund has sold but is obligated to repurchase. In the event the buyer of securities under a reverse repurchase agreement files for bankruptcy or becomes insolvent, such buyer or its trustee or receiver may receive an extension of time to determine whether to enforce the Fund’s obligation to repurchase the securities, and the Fund’s use of the proceeds of the reverse repurchase agreement may effectively be restricted pending such decision.

At May 31, 2006, the Fund had the following reverse repurchase agreements outstanding:

							Maturity
Face Value				Description			Amount
$	7,958,000			Goldman Sachs 5.06%, dated 05/11/06, maturity date 06/15/06			$	7,997,149
	22,204,875			Lehman Brothers 4.55%, dated 05/22/06, maturity date 06/05/06				22,244,165
	2,876,250			Lehman Brothers 4.65%, dated 05/25/06, maturity date 06/05/06				2,880,337
	7,427,000			Lehman Brothers 5.07%, dated 05/23/06, maturity date 06/22/06				7,458,379
	3,694,000			Morgan Stanley 5.05%, dated 05/25/06, maturity date 06/27/06				3,711,100
	6,746,000			Morgan Stanley 5.05%, dated 05/25/06, maturity date 06/13/06				6,763,980
$	50,906,125
					Maturity Amount, Including Interest Payable		$	51,055,110
					Market Value of Assets Sold Under Agreements		$	51,371,989
					Weighted Average Interest Rate			4.81	%

The average daily balance of reverse repurchase agreements outstanding during the six months ended May 31, 2006, was approximately $59,572,005 at a weighted average interest rate of 4.36%. The maximum amount of reverse repurchase agreements outstanding at any time during the period was $66,455,044 as of December 23, 2005, which was 32.09% of total assets.

6.     Capital Stock

There are 50 million shares of $0.01 par value common stock authorized. Of the 10,144,002 shares outstanding at May 31, 2006, the Advisor owned 7,018 shares.

In connection with the initial public offering of the Fund’s Shares, the Advisor made an undertaking to pay any offering costs in excess of $0.03 per common share. The Advisor has advised the Fund that such excess amounted to $482,964.

7.     Financial Instruments

The Fund regularly trades in financial instruments with off-balance sheet risk in the normal course of its investing activities to assist in managing exposure to various market risks. These financial instruments include written options, futures contracts and swap agreements and may involve, to a varying degree, elements of risk in excess of the amounts recognized for financial statement purposes. The notional or contractual amounts of these instruments represent the investment the Fund has in particular classes of financial instruments and does not necessarily represent the amounts potentially subject to risk. The measurement of the risks associated with these instruments is meaningful only when all related and offsetting transactions

18

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are considered. During the period, the Fund had segregated sufficient cash and/or securities to cover any commitments under these contracts.

There was no written option activity for the six months ended May 31, 2006.

As of May 31, 2006, the following swap agreements were outstanding:

				Expiration						Net Unrealized
Notional Amount				Date				Description		Appreciation
$	20,000,000				10/11/10			Agreement with Morgan Stanley Capital Services, Inc., dated 10/07/05 to pay semi-annually the notional amount multiplied by 4.716% and to receive quarterly the notional amount multiplied by 3 month USD-LIBOR-BBA.		$	627,693
	11,000,000				12/15/14			Agreement with Morgan Stanley Capital Services, Inc., dated 12/13/04 to pay semi-annually the notional amount multiplied by 4.555% and to receive quarterly the notional amount multiplied by 3 month USD-LIBOR-BBA.			688,416
										$	1,316,109

As of May 31, 2006, the following futures contract was outstanding:

Long:

Notional										Cost at				Value at				Unrealized
Amount				Type				Expiration Date		Trade Date				May 31, 2006				Depreciation
$	8,800,000			5 Yr. U.S. Treasury Note				September 2006		$	9,151,285			$	9,117,625			$	(33,660	)

8.     Federal Income Tax Information

The below information is based upon financial data and book/tax differences as of May 31, 2006. As a result, the amounts provided may change based upon year-end information.

Income and capital gain distributions are determined in accordance with federal income tax regulations, which may differ from generally accepted accounting principles.

At May 31, 2006, the tax character of the $5,477,761 of distributions paid was entirely from ordinary income. During the year ended November 30, 2005, the tax character of the $12,233,207 of distributions paid was also entirely from ordinary income.

At May 31, 2006, the components of net assets (excluding paid-in-capital) on a tax basis were as follows:

Undistributed Tax ordinary Income			$	1,418,333
	Accumulated capital loss			(4,045,979	)
Tax basis unrealized depreciation				(1,918,890	)
	Total		$	(4,546,536	)

The differences between book and tax basis unrealized appreciation/(depreciation) is primarily attributable to the mark-to-market of futures and differing treatment of swap interest income (expense) for tax purposes.

Capital Account Reclassification: At May 31, 2006, the Funds undistributed net investment income was increased by $271,464 with an offsetting increase in accumulated net realized loss. These adjustments were primarily the result of current period paydown reclassifications and swap interest income (expense) reclassifications.

Federal Income Tax Basis: The federal income tax basis of the Fund’s investments at May 31, 2006 was $201,393,605. Net unrealized depreciation was $3,337,556 (gross unrealized appreciation — $1,987,224; gross unrealized depreciation — $5,324,780. At May 31, 2006, the Fund had a capital loss carryforward of $4,045,979, of which $1,070,268 expires as of

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November 30, 2011, $1,336,845 expires as of November 30, 2013 and $1,638,866 expires as of November 30, 2014, available to offset any future gains, to the extent provided by regulations.

9.     Subsequent Events

Dividend: The Fund’s Board of Directors declared the following regular monthly dividends:

Dividend				Record				Payable
Per Share				Date				Date
$	0.090				06/13/06				06/29/06
$	0.090				07/18/06				07/27/06

10.     Contractual Obligations

The Fund enters into contracts that contain a variety of indemnification. The Fund’s maximum exposure under these arrangements is unknown. However, the Fund has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote.

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During the six months ended May 31, 2006, The Hyperion Strategic Mortgage Income Fund, Inc. shareholders voted on the following proposals at a shareholders’ meeting on April 18, 2006. The description of each proposal and number of shares voted are as follows:

Shares Voted

Shares Voted

Shares Voted

For

Against

Abstain

1. To elect to the Fund’s Board of Directors

Robert F. Birch:

9,806,582

0

103,679

Shares Voted

Shares Voted

Shares Voted

for

Against

Abstain

2. To elect to the Fund’s Board of Directors

Stuart A. McFarland:

9,798,016

0

112,245

Shares Voted

Shares Voted

Shares Voted

For

Against

Abstain

3. To elect to the Fund’s Board of Directors

Louis P. Salvatore:

9,806,755

0

103,506

21

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On May 17, 2006, the Fund submitted a CEO annual certification to the New York Stock Exchange (“NYSE”) on which the Fund’s principal executive officer certified that he was not aware, as of that date, of any violation by the Fund of the NYSE’s Corporate Governance listing standards. In addition, as required by Section 302 of the Sarbanes-Oxley Act of 2002 and related SEC rules, the Fund’s principal executive and principal financial officers have made quarterly certifications, included in filings with the SEC on Forms N-CSR and N-Q relating to, among other things, the Fund’s disclosure controls and procedures and internal control over financial reporting, as applicable.

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		Position(s) Held with				Number of
		Fund and Term of				Portfolios in Fund
Name, Address		Office and Length of		Principal Occupation(s) During Past 5 Years		Complex Overseen
and Age		Time Served		and Other Directorships Held by Director		by Director
Disinterested Director
Class II Director to serve until 2007 Annual Meeting of Stockholders:
Rodman L. Drake c/o Three World Financial Center, 200 Vesey Street, 10th Floor, New York, New York 10281-1010 Age 63		Chairman Elected December 2003 Director since June 2002, Member of the Audit Committee, Chairman of Nominating and Compensation Committee Elected for Three Year Term		Chairman (since 2003) and Director of several investment companies advised by the Advisor or by its affiliates (1989-Present); Director of Crystal River Capital, Inc. (2005-Present); Director of Celgene Corporation (“CELG”) (April 2006-Present); Director of Student Loan Corporation (“STU”) (2005-Present); General Partner of Resource Capital Fund I, II & III CIP L.P. (1998-Present); Co-founder of Baringo Capital LLC (2002-Present); Director of Jackson Hewitt Tax Services Inc. (“JTX”) (2004-Present); Director of Animal Medical Center (2002-Present); Director and/or Lead Director of Parsons Brinckerhoff, Inc. (1995- Present); Trustee of Excelsior Funds (33) (1994-Present).			4
Disinterested Directors
Class I Directors to serve until 2009 Annual Meeting of Stockholders:
Robert F. Birch c/o Three World Financial Center, 200 Vesey Street, 10th Floor, New York, New York 10281-1010 Age 70		Director since June 2002, Member of the Audit Committee, Member of Nominating and Compensation Committee, Member of Executive Committee Elected for Three Year Term		Director of several investment companies advised by the Advisor or by its affiliates (1998- Present); Director and President of New America High Income Fund (1992-Present); Director of Brandywine Funds (3) (2001 to Present).			4
Stuart A. McFarland c/o Three World Financial Center, 200 Vesey Street, 10th Floor, New York, New York 10281-1010 Age 59		Director since April 2006, Member of the Audit Committee, Member of Nominating and Compensation Committee Elected for Three Year Term		Director of Brandywine Funds (2003-Present); Director of New Castle Investment Corp. (2000-Present); Chairman and Chief Executive Officer of Federal City Bancorp, Inc. (2005- Present); Managing Partner of Federal City Capital Advisors (1997-Present).			2
Interested Director
Class III Director to serve until 2008 Annual Meeting of Stockholders:
Clifford E. Lai* c/o Three World Financial Center, 200 Vesey Street, 10th Floor, New York, New York 10281-1010 Age 53		Director since December 2003, Member of Executive Committee Elected for Three Year Term		Managing Partner (2005-Present), President (1998-Present) and Chief Investment Officer (1993-2002) of the Advisor; President and Director of Crystal River Capital, Inc. (2005- Present); President and Director of several investment companies advised by the Advisor (1995-Present); Co-Chairman (2003-2006) and Board of Managers (1995-2006) of Hyperion-GMAC Capital Advisors, LLC (formerly Lend Lease Hyperion Capital, LLC).			4

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		Position(s) Held with				Number of
		Fund and Term of				Portfolios in Fund
Name, Address		Office and Length of		Principal Occupation(s) During Past 5 Years		Complex Overseen
and Age		Time Served		and Other Directorships Held by Director		by Director
Disinterested Director
Class III Director to serve until 2008 Annual Meeting of Stockholders:
Louis P. Salvatore c/o Three World Financial Center, 200 Vesey Street, 10th Floor, New York, New York 10281-1010 Age 59		Director since September 2005, Chairman of the Audit Committee, Member of Compensation and Nominating Committee Elected for Two Year Term		Director of several investment companies advised by the Advisor or by its affiliates (2005- Present); Director of Crystal River Capital, Inc. (2005-Present); Director of Turner Corp. (2003-Present); Director of Jackson Hewitt Tax Services, Inc. (“JTX”) (2004-Present); Director of Professional Services Insurance Company Limited (2002-Present); Employee of Arthur Andersen LLP (2002-Present); Partner of Arthur Andersen LLP (1977-2002).			2

*	Interested person as defined by the Investment Company Act of 1940 (the “1940 Act”) because of affiliations with Hyperion Brookfield Asset Management, Inc., the Fund’s Advisor.

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Officers of the Fund

		Position(s)		Term of Office and		Principal Occupation(s)
Name, Address and Age		Held with Fund		Length of Time Served		During Past 5 Years
Clifford E. Lai* c/o Three World Financial Center, 200 Vesey Street, 10th floor, New York, New York 10281-1010 Age 53		President		Elected Annually Since June 2002		Please see “Information Concerning Directors.”
John Dolan* c/o Three World Financial Center, 200 Vesey Street, 10th floor, New York, New York 10281-1010 Age 52		Vice President		Elected Annually Since June 2002		Managing Partner (2005-Present), Chief Investment Strategist (1998-Present) and Chief Investment Officer (2002-Present) of the Advisor; Chief Investment Officer of Crystal River Capital, Inc. (2005-Present); Board of Managers (1995-2006) of Hyperion-GMAC Capital Advisors, LLC (formerly Lend Lease Hyperion Capital, LLC).
Daniel S. Kim* c/o Three World Financial Center, 200 Vesey Street, 10th floor, New York, New York 10281-1010 Age 38		Chief Compliance Officer (“CCO”) & Secretary		Elected Annually CCO Since September 2004 and Secretary Since January 2005		Director, General Counsel and CCO (2004- Present), and Secretary (2005-Present) of the Adviser; Secretary (2005-Present) and CCO (2004-Present) of several investment companies advised by the Advisor; Assistant Secretary of Crystal River Capital, Inc. (2005-Present); Secretary (2005-2006) and CCO (2004-2006) of Hyperion GMAC Capital Advisors, LLC; Vice President, Assistant General Counsel and CCO of Oak Hill Capital Management, Inc. (2001-2004) and Assistant General Counsel of Oak Hill Advisors, LP (2000-2004).
Thomas F. Doodian* c/o Three World Financial Center, 200 Vesey Street, 10th floor, New York, New York 10281-1010 Age 47		Treasurer		Elected Annually Since June 2002		Managing Director, Chief Operating Officer (1998-Present) and Chief Financial Officer (2000-Present) of the Advisor (1995-Present); Treasurer of several investment companies advised by the Advisor (1996-Present); Treasurer of Hyperion GMAC Capital Advisors, LLC (formerly, Lend Lease Hyperion Capital Advisors, LLC) (1996-2006).

*	Interested person as defined by the Investment Company Act of 1940 (the “1940 Act”) because of affiliations with Hyperion Brookfield Asset Management, Inc., the Fund’s Advisor.

The Fund’s Statement of Additional Information includes additional information about the directors and is available, without charge, upon request by calling 1-800-497-3746

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A Dividend Reinvestment Plan (the “Plan”) is available to shareholders of the Fund pursuant to which they may elect to have all distributions of dividends and capital gains automatically reinvested by American Stock Transfer & Trust Company (the “Plan Agent”) in additional Fund shares. Shareholders who do not participate in the Plan will receive all distributions in cash paid by check mailed directly to the shareholder of record (or if the shares are held in street or other nominee name, then to the nominee) by the Fund’s Custodian, as Dividend Disbursing Agent.

The Plan Agent serves as agent for the shareholders in administering the Plan. After the Fund declares a dividend or determines to make a capital gain distribution, payable in cash, if (1) the market price is lower than net asset value, the participants in the Plan will receive the equivalent in Fund shares valued at the market price determined as of the time of purchase (generally, the payment date of the dividend or distribution); or if (2) the market price of the shares on the payment date of the dividend or distribution is equal to or exceeds their net asset value, participants will be issued Fund shares at the higher of net asset value or 95% of the market price. This discount reflects savings in underwriting and other costs that the Fund otherwise will be required to incur to raise additional capital. If net asset value exceeds the market price of the Fund shares on the payment date or the Fund declares a dividend or other distribution payable only in cash (i.e., if the Board of Directors precludes reinvestment in Fund shares for that purpose), the Plan Agent will, as agent for the participants, receive the cash payment and use it to buy Fund shares in the open market, on the New York Stock Exchange or elsewhere, for the participants’ accounts. If, before the Plan Agent has completed its purchases, the market price exceeds the net asset value of the Fund’s shares, the average per share purchase price paid by the Plan Agent may exceed the net asset value of the Fund’s shares, resulting in the acquisition of fewer shares than if the dividend or distribution had been paid in shares issued by the Fund. The Fund will not issue shares under the Plan below net asset value.

Participants in the Plan may withdraw from the Plan upon written notice to the Plan Agent. When a participant withdraws from the Plan or upon termination of the Plan by the Fund, certificates for whole shares credited to his or her account under the Plan will be issued and a cash payment will be made for any fraction of a share credited to such account.

There is no charge to participants for reinvesting dividends or capital gain distributions, except for certain brokerage commissions, as described below. The Plan Agent’s fees for handling the reinvestment of dividends and distributions are paid by the Fund. There are no brokerage commissions charged with respect to shares issued directly by the Fund. However, each participant will pay a pro rata share of brokerage commissions incurred with respect to the Plan Agent’s open market purchases in connection with the reinvestment of dividends and distributions.

The automatic reinvestment of dividends and distributions will not relieve participants of any federal income tax that may be payable on such dividends or distributions.

A brochure describing the Plan is available from the Plan Agent, by calling 1-212-936-5100.

If you wish to participate in the Plan and your shares are held in your name, you may simply complete and mail the enrollment form in the brochure. If your shares are held in the name of your brokerage firm, bank or other nominee, you should ask them whether or how you can participate in the Plan. Shareholders whose shares are held in the name of a brokerage firm, bank or other nominee and are participating in the Plan may not be able to continue participating in the Plan if they transfer their shares to a different brokerage firm, bank or other nominee, since such shareholders may participate only if permitted by the brokerage firm, bank or other nominee to which their shares are transferred.

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SUB-ADMINISTRATOR


STATE STREET BANK and TRUST COMPANY
2 Avenue De Lafayette
Lafayette Corporate Center
Boston, Massachusetts 02116

CUSTODIAN AND FUND ACCOUNTING AGENT


STATE STREET BANK and TRUST COMPANY
2 Avenue De Lafayette
Lafayette Corporate Center
Boston, Massachusetts 02116

TRANSFER AGENT


AMERICAN STOCK TRANSFER & TRUST
COMPANY
Investor Relations Department
59 Maiden Lane
New York, NY 10038
For Shareholder Services:
1 (800) 937-5449

INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM


BRIGGS, BUNTING & DOUGHERTY, LLP
Two Penn Center, Suite 820
Philadelphia, Pennsylvania 19102

LEGAL COUNSEL


SULLIVAN & WORCESTER LLP
1666 K Street, NW
Washington, D.C. 20006

Notice is hereby given in accordance with Section 23(c) of the Investment Company Act of 1940 that periodically the Fund may purchase its shares in the open market at prevailing market prices.

Quarterly Portfolio Schedule: The Fund will file Form N-Q with the Securities and Exchange Commission for the first and third quarters of each fiscal year. The Fund’s Forms N-Q will be available on the Securities and Exchange Commission’s website at http://www.sec.gov. The Fund’s Forms N-Q may be reviewed and copied at the Securities and Exchange Commission’s Public Reference Room in Washington, D.C. and information on the operation of the Public Reference Room may be obtained by calling 1 (800) SEC-0330. Once filed, the most recent Form N-Q will be available without charge, upon request, by calling 1 (800) HYPERION or on the Fund’s website at http://www.hyperionbrookfield.com.

Proxy Voting Policies and Procedures

A description of the policies and procedures that the Fund uses to determine how to vote proxies relating to portfolio securities is available without charge, upon request, by calling 1 (800) 497-3746 and on the Securities and Exchange Commission’s website at http://www.sec.gov.

Proxy Voting Record

The Fund has filed with the Securities and Exchange Commission its proxy voting record for the 12-month period ending June 30 on Form N-PX. Once filed, the most recent Form N-PX will be available without charge, upon request, by calling 1 (800) 497-3746 or on the Securities and Exchange Commission’s website at http://www.sec.gov.

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	Rodman L. Drake* Chairman Robert F. Birch* Director Stuart A. McFarland* Director Louis P. Salvatore* Director Clifford E. Lai Director and President John Dolan Vice President Thomas F. Doodian Treasurer Daniel Kim CCO and Secretary
	* Audit Committee Members
	The financial information included herein is taken from records of the Fund without audit by the Fund’s independent auditors, who do not express an opinion thereon.

This report is for shareholder information. This is not a prospectus intended for use in the purchase or sale of Fund shares.

The Hyperion Strategic Mortgage Income Fund, Inc.

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