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PRUDENTIAL HIGH YIELD FUND, INC.
Supplement dated November 18, 1996 to
Prospectus dated March 1, 1996
The following information supplements "How the Fund Invests - Investment
Objectives and Policies".
On October 30, 1996, shareholders voted to approve the changes to the
Fund's fundamental restrictions and policies summarized below.
Investments in Securities of Other Investment Companies
The Fund's investment restrictions regarding the purchase of shares of
investment companies is modified to permit the Fund to invest up to 10% of its
total assets in shares of other investment companies. To the extent that the
Fund does invest in securities of other investment companies, shareholders of
the Fund may be subject to duplicate management and advisory fees.
Investment in Equity Securities
The Fund's investment restriction No. 1 is eliminated. Restriction No. 1 had
prohibited the Fund from investing in any non-fixed income equity securities,
including warrants, except when attached to or included as a unit with
fixed-income securities. Accordingly, the Fund is now permitted to invest in
non-fixed income equity securities which are not attached to or included in a
unit with fixed income securities, such as equity securities of financially
troubled or bankrupt companies (financially troubled issuers) and in equity
securities of companies that in the view of the Subadviser are currently
undervalued, out-of-favor or price depressed relative to their long-term
potential for growth and income (operationally troubled issuers) (collectively
referred to as `distressed securities`). Equity securities include common
stocks, preferred stocks and warrants.
The Board has adopted a non-fundamental policy that the Fund initially will
limit its investment in such securities to no more than 10% of its total assets.
To the extent the Fund invests in equity securities, there will be a diminution
in the Fund's overall yield.
Distressed securities involve a high degree of credit and market risk and
are subject to greater credit and market risk and price volatility than the
securities in which the Fund generally invests. Although the Fund would invest
in select companies which in the view of the investment adviser have the
potential over the long term for capital growth, there can be no assurance that
such financially or operationally troubled companies can be successfully
transformed into profitable operating companies. There is a possibility that the
Fund may incur substantial or total losses on its investments. During economic
downturn or recession, securities of financially troubled issuers are more
likely to go into default than securities of other issuers. In addition, it may
be difficult to obtain information about financially and operationally troubled
issuers.
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Securities of financially troubled issuers are less liquid and more volatile
than securities of companies not experiencing financial difficulties. The market
prices of such securities are subject to erratic and abrupt market movements and
the spread between bid and asked prices may be greater than normally expected.
In addition, it is anticipated that many of the Fund's portfolio investments may
not be widely traded and that the Fund's position in such securities may be
substantial relative to the market for such securities. As a result, the Fund
may experience delays and incur losses and other costs in connection with the
sale of its portfolio securities.
Distressed securities which the Fund may purchase may also include
securities of companies involved in bankruptcy proceedings, reorganizations and
financial restructurings. To the extent the Fund invests in such
securities, it may have a more active participation in the affairs of issuers
than is generally assumed by an investor. This may subject the Fund to
litigation risks or prevent the Fund from disposing of securities.
Futures Contracts and Options Thereon
The Fund's investment restrictions have been modified to permit the Fund to
engage in futures transactions and related options for hedging, risk management
and return enhancement purposes.
Future Contracts
The Fund may enter into futures contracts for the purchase or sale of debt
securities and financial indices (collectively, interest rate futures contracts)
in accordance with the Fund's investment objective. A `purchase` of a futures
contract (or a `long` futures position) means the assumption of a contractual
obligation to acquire a specified quantity of the securities underlying the
contract at a specified price at a specified future date. A `sale` of a futures
contract (or a `short` futures position) means the assumption of a contractual
obligation to deliver a specified quantity of the securities underlying the
contract at a specified price at a specified future date. At the time a futures
contract is purchased or sold, the Fund is required to deposit cash or
securities with a futures commission merchant or in a segregated custodial
account representing between approximately 1-1/2% to 5% of the contract amount,
called `initial margin.` Thereafter, the futures contract will be valued daily
and the payment in cash of `maintenance` or `variation margin` may be required,
resulting in the Fund paying or receiving cash that reflects any decline or
increase in the contract's value, a process known as `mark-to-the-market`.
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Some futures contracts by their terms may call for the actual delivery or
acquisition of the underlying assets and other futures contracts must be `cash
settled`. In most cases the contractual obligation is extinguished before the
expiration of the contract by buying (to offset an earlier sale) or selling (to
offset an earlier purchase) an identical futures contract calling for delivery
or acquisition in the same month. The purchase (or sale) of an offsetting
futures contract is referred to as a `closing transaction`.
Limitations on the Purchase and Sale of Futures Contracts and Related Options
CFTC Limits. In accordance with Commodity Futures Trading Commission (CFTC)
regulations, the Fund is not permitted to purchase or sell interest rate futures
contracts or options thereon for return enhancement or risk management purposes
if immediately thereafter the sum of the amounts of initial margin deposits on a
Fund's existing futures and premiums paid for options on futures exceed 5% of
the liquidation value of such Fund's total assets (the `5% CFTC limit`). This
restriction does not apply to the purchase and sale of interest rate futures
contracts and options thereon for bona fide hedging purposes.
Segregation Requirements. To the extent the Fund enters into futures
contracts, it is required by the SEC to maintain a segregated asset account with
its custodian sufficient to cover the Fund's obligations with respect to such
futures contracts, which will consist of cash or liquid securities from their
portfolios in an amount equal to the difference between the fluctuating market
value of such futures contracts and the aggregate value of the initial margin
deposited by the Fund with its custodian with respect to such futures contracts.
Offsetting the contract by another identical contract eliminates the segregation
requirement.
With respect to options on futures, there are no segregation requirements
for options that are purchased and owned by the Fund. However, written options,
since they involve potential obligations of the Fund, may require segregation of
Fund assets if the options are not `covered` as described below under `Options
on Futures Contracts.` If the Fund writes a call option that is not `covered`,
it must segregate and maintain with the custodian for the term of the option
cash or liquid securities equal to the fluctuating value of the optioned
futures. If the Fund writes a put option that is not `covered`, the segregated
amount would have to be at all times equal in value to the exercise price of
the put (less any initial margin deposited by the Fund with its custodian with
respect to such option).
Use of Interest Rate Futures Contracts
Interest rate futures contracts will be used for bona fide hedging, risk
management and return enhancement purposes.
Position Hedging. The Fund might sell interest rate futures contracts to
protect the Fund against a rise in interest rates which would be expected to
decrease the value of debt securities which the Fund holds. This would be
considered a bona fide hedge and, therefore, is not subject to the 5% CFTC
limit. For example, if interest rates are expected to increase, the Fund might
sell futures contracts on debt securities, the values of which historically have
closely correlated or are expected to closely correlate to the values of the
Fund's portfolio securities. Such a sale would have an effect similar to selling
an equivalent value of the Fund's portfolio securities. If interest rates
increase, the value of the Fund's portfolio securities will decline, but the
value of the futures contracts to the Fund will increase at approximately an
equivalent rate thereby keeping the net asset value of the Fund from declining
as much as it otherwise would have. The Fund could accomplish similar results by
selling debt securities with longer maturities and investing in debt securities
with shorter maturities when interest rates are expected to increase. However,
since the futures market may be more liquid than the cash market, the use of
futures contracts as a hedging technique would allow the Fund to maintain a
defensive position without having to sell portfolio securities. If in fact
interest rates decline rather than rise, the value of the futures contract will
fall but the value of the bonds should rise and should offset all or part of the
loss. If futures contracts are used to hedge 100% of the bond position and
correlate precisely with the bond positions, there should be no loss or gain
with a rise (or fall) in interest rates. However, if only 50% of the bond
position is hedged with futures, then the value of the remaining 50% of the bond
position would be subject to change because of interest rate fluctuations.
Whether the bond positions and futures contracts correlate is a significant risk
factor.
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Anticipatory Position Hedging. Similarly, when it is expected that interest
rates may decline and the Fund intends to acquire debt securities, the Fund
might purchase interest rate futures contracts. The purchase of futures
contracts for this purpose would constitute an anticipatory hedge against
increases in the price of debt securities (caused by declining interest rates)
which the Fund subsequently acquires and would normally quality as a bona fide
hedge not subject to the 5% CFTC limit. Since fluctuations in the value of
appropriately selected futures contracts should approximate that of the debt
securities that would be purchased, the Fund could take advantage of the
anticipated rise in the cost of the debt securities without actually buying
them. Subsequently, the Fund could make the intended purchases of the debt
securities in the cash market and concurrently liquidate the futures positions.
Risk Management and Return Enhancement. The Fund might sell interest rate
futures contracts covering bonds. This has the same effect as selling bonds in
the portfolio and holding cash and reduces the duration of the portfolio.
(Duration measures the price sensitivity of the portfolio to interest rates. The
longer the duration, the greater the impact of interest rate changes on the
portfolio's price.) This should lessen the risks associated with a rise in
interest rates. In some circumstances, this may serve as a hedge against a loss
of principal, but is usually referred to as an aspect of risk management.
The Fund might buy interest rate futures contracts covering bonds with a
longer maturity than its portfolio average. This would tend to increase the
duration and should increase the gain in the overall portfolio if interest rates
fall. This is often referred to as risk management rather than hedging but, if
it works as intended, has the effect of increasing principal value. If it does
not work as intended because interest rates rise instead of fall, the loss will
be greater than would otherwise have been the case. Futures contracts used for
these purposes are not considered bona fide hedges and, therefore, are subject
to the 5% CFTC limit.
Options on Futures Contracts
The Fund may enter into options on futures contracts for certain bona fide
hedging, risk management and return enhancement purposes. This includes the
ability to purchase put and call options and write (i.e., sell) `covered` put
and call options on futures contracts that are traded on commodity and futures
exchanges.
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If the Fund purchased an option on a futures contract, it has the right but
not the obligation, in return for the premium paid, to assume a position in a
futures contract (a long position if the option is a call or a short position if
the option is a put) at a specified exercise price at any time during the option
exercise period.
Unlike purchasing an option, which is similar to purchasing insurance to
protect against a possible rise or fall of security prices or currency values,
the writer or seller of an option undertakes an obligation upon exercise of the
option to either buy or sell the underlying futures contract at the exercise
price. A writer of a call option has the obligation upon exercise to assume a
short futures position and a writer of a put option has the obligation to assume
a long futures position. Upon exercise of the option, the assumption of
offsetting futures positions by the writer and holder of the option will be
accompanied by delivery of the accumulated cash balance in the writer's futures
margin account which represents the amount by which the market price of the
futures contract at exercise exceeds (in the case of a call) or is less than (in
the case of a put) the exercise price of the option on the futures contract. If
there is no balance in the writer's margin account, the option is `out of the
money` and will not be exercised. The Fund, as the writer, has income in the
amount it was paid for the option. If there is a margin balance, the Fund will
have a loss in the amount of the balance less the premium it was paid for
writing the option.
When the Fund writes a put or call option on futures contracts, the option
must either be `covered` or, to the extent not `covered`, will be subject to
segregation requirements. The Fund will be considered `covered` with respect to
a call option it writes on a futures contract if the Fund owns the securities or
currency which is deliverable under the futures contract or an option to
purchase that futures contract having a strike price equal to or less than the
strike price of the `covered` option. A Fund will be considered `covered` with
respect to a put option it writes on a futures contract if it owns an option to
sell that futures contract having a strike price equal to or greater than the
strike price of the `covered` option.
To the extent the Fund is not `covered` as described above with respect to
written options, it will segregate and maintain with its custodian for the term
of the option cash or liquid securities as described above under `Segregation
Requirements`.
Use of Options on Futures Contracts
Options on interest rate futures contracts would be used for bona fide
hedging, risk management and return enhancement purposes.
Position Hedging. The Fund may purchase put options on interest rate or
currency futures contracts to hedge its portfolio against the risk of a decline
in the value of the debt securities it owns as a result of rising interest
rates.
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Anticipatory Hedging. The Fund may also purchase call options on futures
contracts as a hedge against an increase in the value of securities the Fund
might intend to acquire as a result of declining interest rates.
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Writing a put option on a futures contract may serve as a partial
anticipatory hedge against an increase in the value of debt securities the Fund
might intend to acquire. If the futures price at expiration of the option is
above the exercise price, the Fund retains the full amount of the option premium
which provides a partial hedge against any increase that may have occurred in
the price of the debt securities the Fund intended to acquire. If the market
price of the underlying futures contract is below the exercise price when the
option is exercised, the Fund would incur a loss, which may be wholly or
partially offset by the decrease in the value of the securities the Fund might
intend to acquire.
Whether options on interest rate futures contracts are subject to or exempt
from the 5% CFTC limit depends on whether the purposes of the options
constitutes a bona fide hedge.
Risk Management and Return Enhancement. Writing a put option that does not
relate to securities the Fund intends to acquire would be a return enhancement
strategy which would result in a loss if interest rates rise.
Similarly, writing a covered call option on a futures contract is also a
return enhancement strategy. If the market price of the underlying futures
contract at expiration of a written call option is below the exercise price, the
Fund would retain the full amount of the option premium increasing the income of
the Fund. If the futures price when the option is exercised is above the
exercise price, however, the Fund would sell the underlying securities which was
the `cover` for the contract and incur a gain or loss depending on the cost
basis for the underlying asset.
Writing a covered call option as in any return enhancement strategy can also
be considered a partial hedge against a decrease in the value of a Fund's
portfolio securities. The amount of the premium received acts as a partial hedge
against any decline that may have occurred in the Fund's debt securities.
Risks Relating to Transactions in Futures Contracts and Options Thereon
The Fund's ability to establish and close out positions in futures contracts
and options on futures contracts would be impacted by the liquidity of these
markets. Although the Fund generally would purchase or sell only those futures
contracts and options thereon for which there appeared to be a liquid market,
there is no assurance that a liquid market on an exchange will exist for any
particular futures contract or option at any particular time. In the event no
liquid market exists for a particular futures contract or option thereon in
which the Fund maintains a position, it would not be possible to effect a
closing transaction in that contract or to do so at a satisfactory price and the
Fund would have to either make or take delivery under the futures contract or,
in the case of a written call option, wait to sell the underlying securities
until the option expired or was exercised, or, in the case of a purchased
option, exercise the option. In the case of a futures contract or an option on a
futures contract which the Fund had written and which the Fund was unable to
close, the Fund would be required to maintain margin deposits on the futures
contract or option and to make variation margin payments until the contract is
closed.
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Risks inherent in the use of these strategies include (1) dependence on the
investment adviser's ability to predict correctly movements in the direction of
interest rates, securities prices and markets; (2) imperfect correlation between
the price of futures contracts and options thereon and movement in the prices of
the securities being hedged; (3) the fact that the skills needed to use these
strategies are different from those needed to select portfolio securities; (4)
the possible absence of a liquid secondary market for any particular instrument
at any time; (5) the possible need to defer closing out certain hedged positions
to avoid adverse tax consequences; and (6) the possible inability of the Fund to
sell a portfolio security at a time that otherwise would be favorable for it to
do so. In the event it did sell the security and eliminated its `cover,` it
would have to replace its `cover` with an appropriate futures contract or option
or segregate securities with the required value, as described under `Segregation
Requirements`.
Although futures prices themselves have the potential to be extremely
volatile, in the case of any strategy involving interest rate futures contracts
and options thereon when the Subadviser's expectations are not met, assuming
proper adherence to the segregation requirement, the volatility of the Fund as a
whole should be no greater than if the same strategy had been pursued in the
cash market.
Exchanges on which futures and related options trade may impose limits on
the positions that the Fund may take in certain circumstances. In addition, the
hours of trading of financial futures contracts and options thereon may not
conform to the hours during which the Fund may trade the underlying securities.
To the extent the futures markets close before the securities markets,
significant price and rate movements can take place in the securities markets
that cannot be reflected in the futures markets.
Pursuant to the requirements of the Commodity Exchange Act, as amended (the
Commodity Exchange Act), all futures contracts and options thereon must be
traded on an exchange. Since a clearing corporation effectively acts as the
counterparty on every futures contract and option thereon, the counter party
risk depends on the strength of the clearing or settlement corporation
associated with the exchange. Additionally, although the exchanges provide a
means of closing out a position previously established, there can be no
assurance that a liquid market will exist for a particular contract at a
particular time. In the case of options on futures, if such a market does not
exist, the Fund, as the holder of an option on futures contracts, would have to
exercise the option and comply with the margin requirements for the underlying
futures contract to realize any profit, and if the Fund were the writer of the
option, its obligation would not terminate until the option expired or the Fund
was assigned an exercise notice.
There can be no assurance that the Fund's use of futures contracts and
related options will be successful and the Fund may incur losses in connection
with its purchase and sale of future contracts and related options.
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The following information supplements `How the Fund Invests--Other
Investments and Policies.`
When-Issued and Delayed Delivery Securities
The Fund may purchase securities on a when-issued or delayed basis.
When-issued or delayed delivery transactions arise when securities are purchased
by the Fund with payment and delivery taking place a month or more in the future
in order to secure what is considered to be an advantageous price and yield to
the Fund at the time of entering into the transaction. While the Fund will only
purchase securities on a when-issued or delayed delivery basis with the
intention of acquiring the securities, the Fund may sell the securities before
the settlement date, if it is deemed advisable. At the time the Fund makes the
commitment to purchase securities on a when-issued or delayed delivery basis,
the Fund will record the transaction and thereafter reflect the value, each day,
of such security in determining the net asset value of the Fund. At the time of
delivery of the securities, the value may be more or less than the purchase
price. The Fund's custodian will maintain, in a segregated account of the Fund,
cash, U.S. Government securities, equity securities or other liquid unencumbered
assets, marked-to-marked daily equal in value to the Fund's purchase
commitments. Subject to this requirement, the Fund may purchase securities on
such basis without limit.
MF110A-1 (11/18/96)
