<PAGE>
Prudential National Municipals Fund, Inc.
- ---------------------------------------------------------------------------
PROSPECTUS DATED FEBRUARY 28, 1995
- ---------------------------------------------------------------------------
Prudential National Municipals Fund, Inc. (the Fund), is an open-end, di-
versified management investment company whose investment objective is to
seek a high level of current income exempt from federal income taxes. In
attempting to achieve this objective, the Fund intends to invest substan-
tially all of its total assets in carefully selected long-term Municipal
Bonds of medium quality, i.e., obligations of issuers possessing adequate
but not outstanding capacities to service their debt. Subject to the lim-
its described herein, the Fund may also buy and sell financial futures for
the purpose of hedging its securities portfolio. There can be no assurance
that the Fund's investment objective will be achieved. See "How the Fund
is Managed--Investment Objective and Policies." The Fund's address is One
Seaport Plaza, New York, New York 10292, and its telephone number is (800)
225-1852.
This Prospectus sets forth concisely the information about the Fund that a
prospective investor should know before investing. Additional information
about the Fund has been filed with the Securities and Exchange Commission
in a Statement of Additional Information, dated February 28, 1995, which
information is incorporated herein by reference (is legally considered a
part of this Prospectus) and is available without charge upon request to
the Fund at the address or telephone number noted above.
- ---------------------------------------------------------------------------
Investors are advised to read this Prospectus and retain it for future
reference.
- ---------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SE-
CURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
<PAGE>
FUND HIGHLIGHTS
The following summary is intended to highlight certain information
contained in this Prospectus and is qualified in its entirety by the more
detailed information appearing elsewhere herein.
WHAT IS PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.?
Prudential National Municipals Fund, Inc. is a mutual fund. A mutual fund
pools the resources of investors by selling its shares to the public and
investing the proceeds of such sale in a portfolio of securities designed
to achieve its investment objective. Technically, the Fund is an open-end,
diversified management investment company.
WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
The investment objective of the Fund is to seek a high level of current
income exempt from federal income taxes. In attempting to achieve this
objective, under normal circumstances, the Fund intends to invest
substantially all, and in any event at least 80%, of its total assets in
Municipal Bonds and Municipal Notes. There can be no assurance that the
Fund's objective will be achieved. See "How the Fund Invests--Investment
Objective and Policies" at page 8.
RISK FACTORS AND SPECIAL CHARACTERISTICS
The Fund's portfolio will consist primarily of carefully selected long-
term Municipal Bonds of medium quality. While the Fund's investment adviser
will not be limited by the ratings assigned by the rating services, the
Municipal Bonds in which the Fund's portfolio will be principally invested
will be rated A and Baa by Moody's Investors Service (Moody's) and A and
BBB by Standard & Poor's Ratings Group (S&P) or, if not rated, will be, in
the judgment of the investment adviser, of substantially comparable
quality. See "How the Fund Invests--Investment Objective and Policies" at
page 8. The Fund may also engage in various hedging strategies, including
derivatives. See "How the Fund Invests--Hedging Strategies--Risks of
Hedging Strategies" at page 13.
WHO MANAGES THE FUND?
Prudential Mutual Fund Management, Inc. (PMF or the Manager) is the
Manager of the Fund and is compensated for its services at an annual rate
of .50 of 1% of the Fund's average daily net assets up to and including
$250 million, .475 of 1% of the next $250 million, .45 of 1% of the next
$500 million, .425 of 1% of the next $250 million, .40 of 1% of the next
$250 million and .375 of 1% of the Fund's average daily net assets in
excess of $1.5 billion. As of January 31, 1995, PMF served as manager or
administrator to 69 investment companies, including 39 mutual funds, with
aggregate assets of approximately $45 billion. The Prudential Investment
Corporation (PIC or the Subadviser) furnishes investment advisory services
in connection with the management of the Fund under a Subadvisory Agreement
with PMF. See "How the Fund is Managed--Manager" at page 15.
WHO DISTRIBUTES THE FUND'S SHARES?
Prudential Mutual Fund Distributors, Inc. (PMFD) acts as the Distributor
of the Fund's Class A shares and is paid an annual distribution and service
fee which is currently being charged at the rate of .10 of 1% of the
average daily net assets of the Class A shares.
Prudential Securities Incorporated (Prudential Securities or PSI), a
major securities underwriter and securities and commodities broker, acts as
the Distributor of the Fund's Class B and Class C shares and is paid an
annual distribution and service fee at the rate of .50 of 1% of the average
daily net assets of the Class B shares and is currently paid for its
services at an annual rate of .75 of 1% of the average daily net assets of
the Class C shares.
See "How the Fund is Managed--Distributor" at page 16.
2
<PAGE>
WHAT IS THE MINIMUM INVESTMENT?
The minimum initial investment for Class A and Class B shares is $1,000 per
class and $5,000 for Class C shares. The minimum subsequent investment is $100
for all classes. There is no minimum investment requirement for certain
employee savings plans. For purchases made through the Automatic Savings
Accumulation Plan, the minimum initial and subsequent investment is $50. See
"Shareholder Guide--How to Buy Shares of the Fund" at page 23 and "Shareholder
Guide--Shareholder Services" at page 31.
HOW DO I PURCHASE SHARES?
You may purchase shares of the Fund through Prudential Securities
Incorporated (Prudential Securities or PSI), Pruco Securities Corporation
(Prusec) or directly from the Fund, through its transfer agent, Prudential
Mutual Fund Services, Inc. (PMFS or the Transfer Agent), at the net asset value
per share (NAV) next determined after receipt of your purchase order by the
Transfer Agent or Prudential Securities plus a sales charge which may be
imposed either (i) at the time of purchase (Class A shares) or (ii) on a
deferred basis (Class B or Class C shares). See "How the Fund Values its
Shares" at page 19 and "Shareholder Guide--How to Buy Shares of the Fund" at
page 23.
WHAT ARE MY PURCHASE ALTERNATIVES?
The Fund offers three classes of shares:
. Class A Shares: Sold with an initial sales charge of up to 3% of the offering
price.
. Class B Shares: Sold without an initial sales charge but are subject to a
contingent deferred sales charge or CDSC (declining from 5%
to zero of the lower of the amount invested or the redemption
proceeds) which will be imposed on certain redemptions made
within six years of purchase. Although Class B shares are
subject to higher ongoing distribution-related expenses than
Class A shares, Class B shares will automatically convert to
Class A shares (which are subject to lower ongoing
distribution-related expenses) approximately seven years
after purchase.
. Class C Shares: Sold without an initial sales charge and, for one year after
purchase, are subject to a 1% CDSC on redemptions. Like Class
B shares, Class C shares are subject to higher ongoing
distribution-related expenses than Class A shares but do not
convert to another class.
See "Shareholder Guide--Alternative Purchase Plan" at page 24.
HOW DO I SELL MY SHARES?
You may redeem shares of the Fund at any time at the NAV next determined
after Prudential Securities or the Transfer Agent receives your sell order.
However, the proceeds of redemptions of Class B and Class C shares may be
subject to a CDSC. See "Shareholder Guide--How to Sell Your Shares" at page 27.
HOW ARE DIVIDENDS AND DISTRIBUTIONS PAID?
The Fund expects to declare daily and pay monthly dividends of net investment
income and make distributions of net capital gains, if any, at least annually.
Dividends and distributions will be automatically reinvested in additional
shares of the Fund at NAV without a sales charge unless you request that they
be paid to you in cash. See "Taxes, Dividends and Distributions" at page 20.
3
<PAGE>
FUND EXPENSES
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES
-------------- -------------- --------------
<S> <C> <C> <C>
SHAREHOLDER TRANSACTION
EXPENSES+
Maximum Sales Load Imposed
on Purchases
(as a percentage of
offering price)............ 3% None None
Maximum Sales Load or
Deferred Sales Load Imposed
on Reinvested Dividends.... None None None
Deferred Sales Load (as a
percentage of original pur-
chase price or redemption None 5% during the first year, 1% on redemptions
proceeds, whichever is low- decreasing by 1% annually made within one year
er)........................ to 1% in the fifth and sixth of purchase
years and 0% the seventh year*
Redemption Fees............. None None None
Exchange Fees............... None None None
ANNUAL FUND OPERATING EXPENSES
<CAPTION>
(as a percentage of average net assets) CLASS A SHARES CLASS B SHARES CLASS C SHARES**
-------------- -------------- ----------------
<S> <C> <C> <C>
Management Fees............. .47% .47% .47%
12b-1 Fees +................ .10%++ .50% .75++
Other Expenses.............. .20% .20% .20%
--- --- ---
Total Fund Operating Ex- .77% 1.17% 1.42%
penses..................... === ==== ====
</TABLE>
<TABLE>
<CAPTION>
EXAMPLE 1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
You would pay the following expenses on a
$1,000 investment, assuming (1) 5% annual
return and (2) redemption at the end of
each time period:
Class A................................... $38 $54 $72 $123
Class B................................... $62 $67 $74 $115
Class C**................................. $24 $45 $78 $170
You would pay the following expenses on the
same investment assuming no redemption:
Class A................................... $38 $54 $72 $123
Class B................................... $12 $37 $64 $126
Class C**................................. $14 $45 $78 $170
</TABLE>
The above example with respect to Class A and Class B shares is based on
data for the Fund's fiscal year ended December 31, 1994. The above example
with respect to Class C shares is based on expenses expected to have been
incurred if Class C shares had been in existence during the entire fiscal
year ended December 31, 1994. The example should not be considered a repre-
sentation of past or future expenses. Actual expenses may be greater or
less than those shown.
The purpose of this table is to assist investors in understanding the vari-
ous costs and expenses that an investor in the Fund will bear, whether di-
rectly or indirectly. For more complete descriptions of the various costs
and expenses, see "How the Fund Is Managed." "Other Expenses" includes op-
erating expenses of the Fund, such as directors' and professional fees,
registration fees, reports to shareholders, transfer agency and custodian
fees.
--------
* Class B shares will automatically convert to Class A shares
approximately seven years after purchase. See "Shareholder Guide--
Conversion Feature--Class B Shares."
** Estimated based on expenses expected to have been incurred if Class C
shares had been in existence during the entire fiscal year ended
December 31, 1994.
+ Pursuant to rules of the National Association of Securities Dealers,
Inc., the aggregate initial sales charges, deferred sales charges and
asset-based sales charges on shares of the Fund may not exceed 6.25% of
the total gross sales, subject to certain exclusions. This 6.25%
limitation is imposed on the Fund rather than on a per shareholder
basis. Therefore, long-term shareholders of the Fund may pay more in
total sales charges than the economic equivalent of 6.25% of such
shareholders' investment in such shares. See "How the Fund is Managed--
Distributor."
++ Although the Class A and Class C Distribution and Service Plans provide
that the Fund may pay a distribution fee of up to .30 of 1% per annum
and 1% per annum of the average daily net assets of the Class A and
Class C shares, respectively, the Distributor has agreed to limit its
distribution fees with respect to Class A and Class C shares of the Fund
to no more than .10 of 1% and .75 of 1% of the average daily net asset
value of the Class A and Class C shares, respectively, for the year
ending December 31, 1995. Total operating expenses without such
limitations would be .97% and 1.67% for Class A and Class C shares,
respectively. See "How the Fund is Managed--Distributor."
4
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH OF THE PERIODS INDICATED)
(CLASS A SHARES)
The following financial highlights have been audited by Price Waterhouse LLP,
independent accountants, whose report thereon was unqualified. This information
should be read in conjunction with the financial statements and notes thereto,
which appear in the Statement of Additional Information. The following finan-
cial highlights contain selected data for a Class A share of common stock out-
standing, total return, ratios to average net assets and other supplemental
data for each of the periods indicated. The information is based on data con-
tained in the financial statements.
<TABLE>
<CAPTION>
CLASS A
---------------------------------
JANUARY 22,
YEAR ENDED 1990+
DECEMBER 31, THROUGH
--------------------------------- DECEMBER
1994 1993 1992 1991 31, 1990
------- ------- ------ ------ -----------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period......................... $ 16.30 $ 15.94 $16.00 $15.09 $14.98
------- ------- ------ ------ ------
INCOME FROM INVESTMENT OPERATIONS:
- ----------------------------------
Net investment income........... .81 .90 .94 .97 .90
Net realized and unrealized gain
(loss) on investment
transactions................... (1.78) 1.05 .43 .91 .11
------- ------- ------ ------ ------
Total from investment opera-
tions......................... (.97) 1.95 1.37 1.88 1.01
------- ------- ------ ------ ------
LESS DISTRIBUTIONS:
- ------------------
Dividends from net investment
income......................... (.81) (.90) (.94) (.97) (.90)
Distributions from net realized
capital gains.................. (.10) (.69) (.49) -- --
------- ------- ------ ------ ------
Total distributions............. (.91) (1.59) (1.43) (.97) (.90)
------- ------- ------ ------ ------
Net asset value, end of period.. $ 14.42 $ 16.30 $15.94 $16.00 $15.09
======= ======= ====== ====== ======
TOTAL RETURN: ++................ (6.04)% 12.60% 8.88% 12.94% 6.88%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000). $12,721 $14,167 $7,700 $3,819 $1,846
Average net assets (000)........ $14,116 $11,786 $5,401 $2,697 $1,161
Ratios to average net assets:
Expenses, including distribu-
tion fees..................... .77% .69% .72% .75% .75%*
Expenses, excluding distribu-
tion fees..................... .67% .59% .62% .65% .65%*
Net investment income.......... 5.38% 5.49% 5.79% 6.27% 6.43%*
Portfolio turnover.............. 120% 82% 114% 59% 110%
</TABLE>
- --------
* Annualized.
+ Commencement of offering of Class A shares.
++ Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions. Total returns for periods of less than a full year are not
annualized.
5
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH OF THE YEARS INDICATED)
(CLASS B SHARES)
The following financial highlights with respect to each of the five years in
the period ended December 31, 1994, have been audited by Price Waterhouse LLP,
independent accountants, whose report thereon was unqualified. This informa-
tion should be read in conjunction with the financial statements and notes
thereto, which appear in the Statement of Additional Information. The follow-
ing financial highlights contain selected data for a Class B share of common
stock outstanding, total return, ratios to average net assets and other sup-
plemental data for each of the years indicated. The information is based on
data contained in the financial statements.
<TABLE>
<CAPTION>
CLASS B
------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------------------------
1994 1993 1992 1991 1990 1989 1988* 1987 1986 1985
-------- -------- -------- -------- -------- ---------- ---------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE
OPERATING
PERFORMANCE:
Net asset value,
beginning of
year............. $ 16.33 $ 15.97 $ 16.02 $ 15.11 $ 15.15 $ 15.04 $ 14.57 $ 16.18 $ 15.37 $ 13.86
-------- -------- -------- -------- -------- ---------- ---------- ---------- ---------- --------
INCOME FROM
INVESTMENT
OPERATIONS:
-----------
Net investment in-
come ............ .75 .84 .88 .91 .90 .96 1.03 1.05 1.18 1.28
Net realized and
unrealized gain
(loss) on
investment
transactions..... (1.78) 1.05 .44 .91 (.04) .11 .47 (1.55) 1.59 1.52
-------- -------- -------- -------- -------- ---------- ---------- ---------- ---------- --------
Total from
investment
operations...... (1.03) 1.89 1.32 1.82 .86 1.07 1.50 (.50) 2.77 2.80
-------- -------- -------- -------- -------- ---------- ---------- ---------- ---------- --------
LESS DISTRIBUTIONS:
------------------
Dividends from net
investment in-
come............. (.75) (.84) (.88) (.91) (.90) (.96) (1.03) (1.05) (1.18) (1.28)
Distributions from
net realized cap-
ital gains....... (.10) (.69) (.49) -- -- -- -- (.06) (.78) (.01)
-------- -------- -------- -------- -------- ---------- ---------- ---------- ---------- --------
Total distribu-
tions........... (.85) (1.53) (1.37) (.91) (.90) (.96) (1.03) (1.11) (1.96) (1.29)
-------- -------- -------- -------- -------- ---------- ---------- ---------- ---------- --------
Net asset value,
end of year...... $ 14.45 $ 16.33 $ 15.97 $ 16.02 $ 15.11 $ 15.15 $ 15.04 $ 14.57 16.18 $ 15.37
======== ======== ======== ======== ======== ========== ========== ========== ========== ========
TOTAL RETURN: +... (6.39)% 12.15% 8.50% 12.42% 5.96% 7.43% 10.49% (3.14)% 18.78% 21.04%
RATIOS/SUPPLEMENTAL
DATA:
Net assets, end of
year (000) ...... $672,272 $848,299 $828,702 $874,338 $882,212 $1,033,173 $1,066,159 $1,046,293 $1,103,508 $558,662
Average net assets
(000)............ $751,623 $854,919 $829,830 $862,249 $940,215 $1,027,726 $1,081,122 $1,126,394 $ 859,796 $377,053
Ratios to average
net assets:
Expenses, includ-
ing distribution
fees............ 1.17% 1.09% 1.12% 1.15% 1.13% 1.01% 1.02% 1.01% .90% .73%
Expenses, exclud-
ing distribution
fees............ .67% .59% .62% .65% .64% .66% .66% .65% .62% .65%
Net investment
income.......... 4.96% 5.09% 5.39% 5.87% 6.03% 6.45% 6.86% 6.83% 7.13% 8.39%
Portfolio turno-
ver.............. 120% 82% 114% 59% 110% 198% 152% 105% 117% 124%
</TABLE>
- -------
* On May 2, 1988, Prudential Mutual Fund Management, Inc. succeeded The
Prudential Insurance Company of America as investment adviser and since then
has acted as manager of the Fund. See "Manager" in the Statement of
Additional Information.
+ Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions.
6
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
(CLASS C SHARES)
The following financial highlights have been audited by Price Waterhouse LLP,
independent accountants, whose report thereon was unqualified. This information
should be read in conjunction with the financial statements and notes thereto,
which appear in the Statement of Additional Information. The following finan-
cial highlights contain selected data for a Class C share of common stock out-
standing, total return, ratios to average net assets and other supplemental
data for the period indicated. The information is based on data contained in
the financial statements.
<TABLE>
<CAPTION>
CLASS C
-------------
AUGUST 1,
1994*
THROUGH
DECEMBER 31,
1994
-------------
<S> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................. $15.13
------
INCOME FROM INVESTMENT OPERATIONS:
- ---------------------------------
Net investment income................................. .29
Net realized and unrealized loss on
investment transactions.............................. (.69)
------
Total from investment operations..................... (.40)
------
LESS DISTRIBUTIONS:
- ------------------
Dividends from net investment income.................. (.29)
------
Net asset value, end of period........................ $14.44
======
TOTAL RETURN:+........................................ (2.63)%
RATIOS/SUPPLEMENTAL DATA:++
Net assets, end of period (000)....................... $ 141
Average net assets (000).............................. $ 103
Ratios to average net assets:
Expenses, including distribution fees................ 1.51%**
Expenses, excluding distribution fees................ .76%**
Net investment income................................ 4.84%**
Portfolio turnover.................................... 120%
</TABLE>
- --------
* Commencement of offering of Class C shares.
** Annualized.
+ Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions. Total returns for periods of less than a full year are not
annualized.
++ Since the Fund did not commence a public offering of Class C shares until
August 1, 1994, historical expenses and ratios of expenses to average net
assets of Class A or Class B shares are not necessarily indicative of future
expenses and related ratios of Class C shares.
7
<PAGE>
HOW THE FUND INVESTS
INVESTMENT OBJECTIVE AND POLICIES
THE INVESTMENT OBJECTIVE OF THE FUND IS TO SEEK A HIGH LEVEL OF CURRENT IN-
COME EXEMPT FROM FEDERAL INCOME TAXES. IN ATTEMPTING TO ACHIEVE THIS OBJEC-
TIVE, UNDER NORMAL CIRCUMSTANCES THE FUND INTENDS TO INVEST SUBSTANTIALLY ALL,
AND IN ANY EVENT AT LEAST 80%, OF ITS TOTAL ASSETS IN MUNICIPAL BONDS AND MU-
NICIPAL NOTES. THERE CAN BE NO ASSURANCE THAT SUCH OBJECTIVE WILL BE ACHIEVED.
See "Investment Objective and Policies" in the Statement of Additional Infor-
mation.
THE FUND'S INVESTMENT OBJECTIVE IS A FUNDAMENTAL POLICY AND, THEREFORE, MAY
NOT BE CHANGED WITHOUT THE APPROVAL OF THE HOLDERS OF A MAJORITY OF THE FUND'S
OUTSTANDING VOTING SECURITIES AS DEFINED IN THE INVESTMENT COMPANY ACT OF
1940, AS AMENDED (THE INVESTMENT COMPANY ACT). FUND POLICIES THAT ARE NOT FUN-
DAMENTAL MAY BE MODIFIED BY THE BOARD OF DIRECTORS.
THE MUNICIPAL BONDS IN WHICH THE FUND MAY INVEST INCLUDE GENERAL OBLIGATION
AND LIMITED OBLIGATION OR REVENUE BONDS. GENERAL OBLIGATION BONDS ARE SECURED
BY THE ISSUER'S PLEDGE OF ITS FAITH, CREDIT AND TAXING POWER FOR THE PAYMENT
OF PRINCIPAL AND INTEREST, WHEREAS REVENUE BONDS ARE PAYABLE ONLY FROM THE
REVENUES DERIVED FROM A PARTICULAR FACILITY OR CLASS OF FACILITIES OR IN SOME
CASES, FROM THE PROCEEDS OF A SPECIAL EXCISE OR OTHER SPECIFIC REVENUE SOURCE.
THE MUNICIPAL NOTES IN WHICH THE FUND MAY INVEST INCLUDE TAX, REVENUE AND BOND
ANTICIPATION NOTES WHICH ARE ISSUED TO OBTAIN FUNDS FOR VARIOUS PUBLIC PURPOS-
ES.
Interest on certain Municipal Bonds and Municipal Notes may be subject to
the federal alternative minimum tax. From time to time the Fund may purchase
Municipal Bonds and Municipal Notes that are "private activity bonds" (as de-
fined in the Internal Revenue Code), the interest on which is a tax preference
subject to the alternative minimum tax. See "Taxes, Dividends and Distribu-
tions."
THE FUND'S PORTFOLIO WILL CONSIST PRIMARILY OF CAREFULLY SELECTED LONG-TERM
MUNICIPAL BONDS OF MEDIUM QUALITY. WHILE THE FUND'S INVESTMENT ADVISER WILL
NOT BE LIMITED BY THE RATINGS ASSIGNED BY THE RATING SERVICES, THE MUNICIPAL
BONDS IN WHICH THE FUND'S PORTFOLIO WILL BE PRINCIPALLY INVESTED WILL BE RATED
A AND BAA BY MOODY'S INVESTORS SERVICE (MOODY'S) AND A AND BBB BY STANDARD &
POOR'S RATINGS GROUP (S&P) OR, IF NOT RATED, WILL BE, IN THE JUDGMENT OF THE
INVESTMENT ADVISER, OF SUBSTANTIALLY COMPARABLE QUALITY. Bonds rated BBB by
S&P normally exhibit adequate payment protection parameters, but in the event
of adverse market conditions are more likely to lead to a weakened capacity to
pay principal and interest than bonds in the A category. Bonds rated Baa by
Moody's are considered "medium grade" obligations. They are neither highly
protected nor poorly secured. Interest payments and principal security appear
adequate for the present but certain protective elements may be lacking or may
be characteristically unreliable over any great length of time. Such bonds
lack outstanding investment characteristics and in fact have speculative char-
acteristics as well. A more complete description of these and other Municipal
Bond and Note ratings is contained in Appendix A to the Statement of Addi-
tional Information.
8
<PAGE>
As of December 31, 1994, the composition of the Fund's portfolio by rating
category was as follows:
<TABLE>
<CAPTION>
PERCENTAGE OF
RATINGS TOTAL INVESTMENTS
------- -----------------
<S> <C>
AAA/Aaa 43.66%
AA/Aa 15.89%
A/A 22.86%
BBB/Baa 14.28%
B/B --
CCC/Caa --
CC/Ca --
C/C --
Unrated 3.31%
</TABLE>
BECAUSE ISSUERS OF MEDIUM QUALITY MUNICIPAL BONDS MAY CHOOSE NOT TO HAVE
THEIR OBLIGATIONS RATED, IT IS POSSIBLE THAT A SUBSTANTIAL PORTION OF THE
FUND'S PORTFOLIO MAY CONSIST OF OBLIGATIONS WHICH ARE NOT RATED. The market
for rated bonds is usually broader than that for non-rated bonds, which may
result in less flexibility in disposal of such non-rated bonds.
THE FUND MAY ALSO ACQUIRE MUNICIPAL BONDS WHICH HAVE BEEN RATED BELOW MEDIUM
QUALITY BY THE RATING SERVICES IF, IN THE JUDGMENT OF THE FUND'S INVESTMENT
ADVISER, THE BONDS HAVE THE CHARACTERISTICS OF MEDIUM QUALITY OBLIGATIONS. In
determining whether Municipal Bonds which are not rated or which have been
rated below medium quality by the rating services have the characteristics of
rated Municipal Bonds of medium quality, the investment adviser will rely upon
information from various sources, including, if available, reports by the rat-
ing services, research, analysis and appraisals of brokers and dealers and the
views of the Fund's directors and others regarding economic developments and
the creditworthiness of particular issuers.
MUNICIPAL BONDS OF MEDIUM QUALITY ARE SUBJECT TO FLUCTUATION IN VALUE AS A
RESULT OF CHANGING ECONOMIC CIRCUMSTANCES AS WELL AS CHANGES IN INTEREST
RATES. THUS, WHILE MEDIUM QUALITY OBLIGATIONS WILL GENERALLY PROVIDE A HIGHER
YIELD THAN DO HIGH QUALITY MUNICIPAL BONDS OF SIMILAR MATURITIES, THEY ARE
SUBJECT TO A GREATER DEGREE OF MARKET FLUCTUATION WITH LESS CERTAINTY OF THE
ISSUER'S CONTINUING ABILITY TO MEET THE PAYMENTS OF PRINCIPAL AND INTEREST
WHEN DUE AND MAY HAVE SPECULATIVE CHARACTERISTICS NOT PRESENT IN BONDS OF
HIGHER QUALITY. IN ADDITION, OBLIGATIONS WITH LONGER MATURITIES (E.G., 20
YEARS OR MORE) GENERALLY OFFER BOTH HIGHER YIELDS AND GREATER EXPOSURE TO MAR-
KET FLUCTUATION FROM CHANGES IN INTEREST RATES THAN DO THOSE WITH SHORTER MA-
TURITIES. CONSEQUENTLY, SHARES OF THE FUND MAY NOT BE SUITABLE FOR PERSONS WHO
CANNOT ASSUME THE SOMEWHAT GREATER RISKS OF CAPITAL DEPRECIATION INVOLVED IN
SEEKING HIGHER TAX-EXEMPT YIELDS.
In recent years, there has been a narrowing of the yield spreads between
higher and lower quality Municipal Bonds and a reduction in the supply of me-
dium grade Municipal Bonds. As a result of these changing conditions in the
municipal securities markets, the investment adviser has invested a substan-
tial portion of the Fund's assets in higher quality Municipal Bonds. The in-
vestment adviser intends to invest in medium grade Municipal Bonds to the ex-
tent market conditions warrant.
THE INTEREST RATES PAYABLE ON CERTAIN MUNICIPAL BONDS AND NOTES ARE NOT
FIXED AND MAY FLUCTUATE BASED UPON CHANGES IN MARKET RATES. MUNICIPAL BONDS
AND NOTES OF THIS TYPE ARE CALLED "VARIABLE RATE" OBLIGATIONS. The interest
rate payable on a variable rate obligation is adjusted either at predesignated
intervals or whenever there is a change in the market rate of interest on
which the interest rate payable is based. Other features may include the right
whereby the Fund may demand prepayment of the principal amount of the obliga-
tion prior to its stated maturity (a demand feature) and the right of the is-
suer to prepay the principal amount prior to maturity. The principal
9
<PAGE>
benefit of a variable rate obligation is that the interest rate adjustment
minimizes changes in the market value of the obligation. As a result, the pur-
chase of variable rate obligations should enhance the ability of the Fund to
maintain a stable net asset value per share and to sell an obligation prior to
maturity at a price approximating the full principal amount of the obligation.
The payment of principal and interest by issuers of certain Municipal Bonds
and Notes purchased by the Fund may be guaranteed by letters of credit or
other credit facilities offered by banks or other financial institutions. Such
guarantees will be considered in determining whether a Municipal Bond or Note
meets the Fund's investment quality requirements.
THE FUND MAY ALSO INVEST IN INVERSE FLOATERS. An inverse floater is a debt
instrument with a floating or variable interest rate that moves in the oppo-
site direction of the interest rate on another security or the value of an in-
dex. Changes in the interest rate on the other security or index inversely af-
fect the residual interest rate paid on the inverse floater, with the result
that the inverse floater's price will be considerably more volatile than that
of a fixed rate bond. The market for inverse floaters is relatively new.
THE FUND MAY BE ABLE TO REDUCE THE RISK OF FLUCTUATIONS IN ASSET VALUE
CAUSED BY CHANGES IN INTEREST RATES BY HEDGING ITS PORTFOLIO THROUGH THE USE
OF FINANCIAL FUTURES. During or in anticipation of a decline in interest
rates, the Fund may purchase futures contracts to hedge against subsequent
purchases of long-term bonds at higher prices. During or in anticipation of an
increase in interest rates, the Fund may hedge its portfolio securities by
selling futures contracts for the purpose of limiting the exposure of its
portfolio to the resulting decrease in value. There are risks associated with
hedging transactions and there can be no assurance that hedges will have the
intended result. See "Hedging Strategies" below.
ALSO, THE FUND MAY PURCHASE SECONDARY MARKET INSURANCE ON MUNICIPAL BONDS
AND NOTES WHICH IT HOLDS OR ACQUIRES. Although the fee for secondary market
insurance will reduce the yield of the insured Bonds and Notes, such insurance
would be reflected in the market value of the municipal obligation purchased
and may enable the Fund to dispose of a defaulted obligation at a price
similar to that of comparable municipal obligations which are not in default.
Insurance is not a substitute for the basic credit of an issuer, but
supplements the existing credit and provides additional security therefor.
While insurance coverage for the Municipal Bonds and Notes held by the Fund
reduces credit risk by providing that the insurance company will make timely
payment of principal and interest if the issuer defaults on its obligation to
make such payment, it does not afford protection against fluctuation in the
price, i.e., the market value, of the municipal obligations caused by changes
in interest rates and other factors, nor in turn against fluctuations in the
net asset value of the shares of the Fund.
HEDGING STRATEGIES
THE FUND MAY ALSO ENGAGE IN VARIOUS PORTFOLIO STRATEGIES, INCLUDING
DERIVATIVES, TO REDUCE CERTAIN RISKS OF ITS INVESTMENTS. These strategies
currently include the purchase of put or tender options on Municipal Bonds and
Notes and the purchase and sale of financial futures contracts and options
thereon and municipal bond index futures contracts. The Fund's ability to use
these strategies may be limited by market conditions, regulatory limits and
tax considerations and there can be no assurance that any of these strategies
will succeed. See "Investment Objective and Policies--Additional Investment
Policies" in the Statement of Additional Information. New financial products
and risk management techniques continue to be developed and the Fund may use
these new investments and techniques to the extent consistent with its
investment objective and policies.
PUTS
THE FUND MAY PURCHASE AND EXERCISE PUTS OR TENDER OPTIONS ON MUNICIPAL BONDS
AND NOTES. PUTS OR TENDER OPTIONS GIVE THE FUND THE RIGHT TO SELL SECURITIES
HELD IN THE FUND'S PORTFOLIO AT A SPECIFIED EXERCISE
10
<PAGE>
PRICE ON A SPECIFIED DATE. Puts or tender options may be acquired to reduce
the volatility of the market value of securities subject to puts or tender op-
tions compared to the volatility of similar securities not subject to puts.
The acquisition of a put or tender option may involve an additional cost to
the Fund compared to the cost of securities with similar credit ratings,
stated maturities and interest coupons but without applicable puts. Such in-
creased cost may be paid either by way of an initial or periodic premium for
the put or by way of a higher purchase price for securities to which the put
is attached. In addition, there is a credit risk associated with the purchase
of puts or tender options in that the issuer of the put or tender option may
be unable to meet its obligation to purchase the underlying security. Accord-
ingly, the Fund will acquire puts or tender options under the following cir-
cumstances: (1) the put or tender option is written by the issuer of the un-
derlying security and such security is rated within the 4 highest quality
grades as determined by Moody's or S&P; (2) the put or tender option is writ-
ten by a person other than the issuer of the underlying security and such per-
son has securities outstanding which are rated within such 4 highest quality
grades; or (3) the put or tender option is backed by a letter of credit or
similar financial guarantee issued by a person having securities outstanding
which are rated within the 2 highest quality grades of such rating services.
THE FUND ANTICIPATES BEING AS FULLY INVESTED AS PRACTICABLE IN MUNICIPAL
BONDS AND NOTES; HOWEVER, BECAUSE THE FUND DOES NOT INTEND TO INVEST IN TAXA-
BLE OBLIGATIONS, THERE MAY BE OCCASIONS WHEN, AS A RESULT OF MATURITIES OF
PORTFOLIO SECURITIES OR SALES OF FUND SHARES OR IN ORDER TO MEET ANTICIPATED
REDEMPTION REQUESTS, THE FUND MAY HOLD CASH WHICH IS NOT EARNING INCOME. IN
ADDITION, THERE MAY BE OCCASIONS WHEN, IN ORDER TO RAISE CASH TO MEET
REDEMPTIONS, THE FUND MIGHT BE REQUIRED TO SELL SECURITIES AT A LOSS.
Unlike many issues of common and preferred stock and corporate bonds which
are traded between brokers acting as agent for their customers on securities
exchanges, Municipal Bonds and Notes are customarily purchased from or sold to
dealers who are selling or buying for their own account. There are no require-
ments that most Municipal Bonds and Notes be registered with or qualified for
sale by federal or state securities regulators. Since there are large numbers
of Municipal Bond and Note issues of many different issuers, most issues do
not trade on any single day. On the other hand, most issues are always market-
able, since a major dealer will normally, on request, bid for any issue, other
than obscure ones. Regional municipal securities dealers are frequently more
willing to bid on issues of municipalities in their geographic area.
ALTHOUGH ALMOST ALL MUNICIPAL BONDS AND NOTES ARE MARKETABLE, THE STRUCTURE
OF THE MARKET INTRODUCES ITS OWN ELEMENT OF RISK; A SELLER MAY FIND, ON OCCA-
SION, THAT DEALERS ARE UNWILLING TO MAKE BIDS FOR CERTAIN ISSUES THAT THE
SELLER CONSIDERS REASONABLE. IF THE SELLER IS FORCED TO SELL, HE OR SHE MAY
REALIZE A CAPITAL LOSS THAT WOULD NOT HAVE BEEN NECESSARY IN DIFFERENT CIRCUM-
STANCES. BECAUSE THE NET ASSET VALUE OF THE FUND'S SHARES REFLECTS THE DEGREE
OF WILLINGNESS OF DEALERS TO BID FOR MUNICIPAL BONDS AND NOTES, THE PRICE OF
THE FUND'S SHARES MAY BE SUBJECT TO GREATER FLUCTUATION THAN SHARES OF OTHER
INVESTMENT COMPANIES WITH DIFFERENT INVESTMENT POLICIES. SEE "NET ASSET VALUE"
IN THE STATEMENT OF ADDITIONAL INFORMATION.
The ratings of Moody's and S&P represent each service's opinion as to the
quality of the Municipal Bonds or Notes rated. It should be emphasized that
ratings are general and are not absolute standards of quality or guarantees as
to the creditworthiness of an issuer. Subsequent to its purchase by the Fund,
an issue of Municipal Bonds or Notes may cease to be rated, or its ratings may
be reduced. Neither event requires the elimination of that obligation from the
Fund's portfolio, but will be a factor in determining whether the Fund should
continue to hold that issue in its portfolio.
FROM TIME TO TIME, PROPOSALS HAVE BEEN INTRODUCED BEFORE CONGRESS FOR THE
PURPOSE OF RESTRICTING OR ELIMINATING THE FEDERAL INCOME TAX EXEMPTION FOR IN-
TEREST ON MUNICIPAL BONDS AND NOTES AND FOR PROVIDING STATE AND LOCAL GOVERN-
MENTS WITH FEDERAL CREDIT ASSISTANCE. REEVALUATION OF THE FUND'S INVESTMENT
OBJECTIVES AND STRUCTURE MIGHT BE NECESSARY IN THE FUTURE DUE TO MARKET CONDI-
TIONS WHICH MAY RESULT FROM FUTURE CHANGES IN THE TAX LAWS.
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<PAGE>
FUTURES CONTRACTS AND OPTIONS THEREON
THE FUND MAY ATTEMPT TO REDUCE THE RISK OF FLUCTUATIONS IN THE VALUE OF ITS
ASSETS CAUSED BY INTEREST RATE CHANGES BY HEDGING ITS PORTFOLIO THROUGH THE
USE OF FINANCIAL FUTURES AND OPTIONS THEREON TRADED ON A COMMODITIES EXCHANGE
OR BOARD OF TRADE. Financial futures are commodities contracts which obligate
the buyer to take and the seller to make delivery at a future date of a speci-
fied quantity of a financial instrument or the cash value of a securities in-
dex. Presently, futures contracts are available in several types of fixed in-
come securities, including U.S. Treasury Bonds and Notes, Government National
Mortgage Association modified pass-through mortgage-backed securities, three-
month U.S. Treasury Bills and bank certificates of deposit. Futures contracts
are also available on a municipal bond index as described below.
When a futures contract is entered into, each party deposits with a broker
or in a segregated custodial account a good faith deposit of approximately 1
1/2-2% of the contract amount, called the "initial margin." Additionally, dur-
ing the term of the contract, the amount of the deposit is adjusted daily
based on the current value of the futures contract by payments of "variation
margin" to or from the broker or segregated account.
Although most interest rate futures contracts call for making or taking de-
livery of the underlying securities, these obligations are typically cancelled
or closed out before the scheduled settlement date. The closing is accom-
plished by purchasing (or selling) an identical futures contract to offset a
short (or long) position. Such an offsetting transaction cancels the contrac-
tual obligations established by the original futures transaction. Other finan-
cial futures contracts call for cash settlements rather than delivery of secu-
rities. If the price of the offsetting futures transaction varies from the
price of the original futures transaction, the hedger will realize a gain or
loss corresponding to the difference. That gain or loss will tend to offset
the unrealized loss or gain on the hedged securities position, but may not al-
ways or completely do so.
THE FUND INTENDS TO ENGAGE IN TRANSACTIONS IN FUTURES CONTRACTS AND OPTIONS
ON FUTURES CONTRACTS AS A HEDGE AGAINST CHANGES, RESULTING FROM MARKET CONDI-
TIONS, IN THE VALUE OF SECURITIES WHICH ARE HELD IN THE FUND'S PORTFOLIO OR
WHICH THE FUND INTENDS TO PURCHASE. THE FUND WILL NOT ENTER INTO ANY FINANCIAL
FUTURES CONTRACT OR PURCHASE RELATED OPTIONS (AS DEFINED IN THE COMMODITY
FUTURES TRADING COMMISSION REGULATIONS) IF IMMEDIATELY THEREAFTER THE SUM OF
INITIAL AND NET CUMULATIVE VARIATION MARGINS ON ITS OUTSTANDING FUTURES CON-
TRACTS, TOGETHER WITH PREMIUMS PAID ON OPTIONS THEREON WOULD EXCEED 20% OF ITS
TOTAL ASSETS. See "Investment Objective and Policies--Financial Futures Con-
tracts--Limitations on Purchase and Sale" in the Statement of Additional In-
formation.
MUNICIPAL BOND INDEX FUTURES CONTRACTS
A futures contract on a municipal bond index began trading on the Chicago
Board of Trade in 1985. The contract, which provides for cash settlement
rather than delivery of securities, is based on the Bond Buyer Municipal Bond
Index, an index of 40 actively traded municipal bonds. To make the index as
representative as possible of price trends in the municipal securities market,
twice a month new issues are added to the index and an equal number of the
least actively traded issues are dropped from the index. Each bond in the in-
dex is priced daily by a group of six brokers.
THE MUNICIPAL BOND INDEX CONTRACT IS DESIGNED TO PROVIDE A WAY TO HEDGE MU-
NICIPAL BOND PORTFOLIOS, SINCE PRICES OF EXISTING FUTURES ON TAXABLE SECURI-
TIES DO NOT ALWAYS CORRELATE WELL WITH MUNICIPAL BOND PRICES. Because the mu-
nicipal bond index contract should correlate better with the Fund's price
changes than the Treasury Bond futures contract, the Fund's investment adviser
expects to do most of the Fund's hedging using the municipal bond index con-
tract. However, there may be times when the adviser believes that the Treasury
Bond contract corresponds well with municipal bond prices and trades at a
price that makes hedging with this contract less expensive than hedging with
the municipal contract. Accordingly, the Fund intends to use both the Treasury
Bond and the municipal bond index contracts for hedging purposes.
12
<PAGE>
RISKS OF HEDGING STRATEGIES
PARTICIPATION IN THE OPTIONS AND FUTURES MARKETS INVOLVES INVESTMENT RISKS
AND TRANSACTION COSTS TO WHICH THE FUND WOULD NOT BE SUBJECT TO ABSENT THE USE
OF THESE STRATEGIES. The Fund's successful use of financial futures contracts
and options on futures contracts depends upon the ability of its investment
adviser to predict movements in the direction of interest rates and other
factors affecting markets for securities. For example, if the Fund has hedged
against the possibility of an increase in interest rates which would adversely
affect the price of securities in its portfolio and prices of such securities
increase instead, the Fund will lose part or all of the benefit of the
increased value of its securities because it will have offsetting losses in
its futures positions. In addition, in such situations, if the Fund has
insufficient cash to meet daily variation margin requirements, it may have to
sell securities to meet such requirements. Such sales of securities may be,
but will not necessarily be, at increased prices which reflect the rising
market. The Fund may have to sell securities at a time when it is
disadvantageous to do so. Where futures are purchased to hedge against a
possible increase in the price of securities before the Fund is able to invest
its cash in an orderly fashion, it is possible that the market may decline
instead; if the Fund then concludes not to invest in securities at that time
because of concern as to possible future market decline or for other reasons,
the Fund will realize a loss on the futures contract that is not offset by a
reduction in the price of the securities purchased. For a further discussion
of the risks associated with the use of futures contracts for hedging
purposes, see "Investment Objective and Policies--Financial Futures
Contracts--Risks of Financial Futures Transactions" in the Statement of
Additional Information.
OTHER INVESTMENTS AND POLICIES
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES
The Fund may purchase municipal obligations on a "when-issued" or "delayed
delivery" basis, in each case without limit. When municipal obligations are
offered on a when-issued or delayed delivery basis, the price and coupon rate
are fixed at the time the commitment to purchase is made, but delivery and
payment for such securities take place at a later date. During the period be-
tween purchase and settlement, no interest accrues to the purchaser. In the
case of purchases by the Fund, the price that the Fund is required to pay on
the settlement date may be in excess of the market value of the municipal ob-
ligations on that date. While securities may be sold prior to the settlement
date, the Fund intends to purchase these securities with the purpose of actu-
ally acquiring them unless a sale would be desirable for investment reasons.
At the time the Fund makes the commitment to purchase a municipal obligation
on a when-issued or delayed delivery basis, it will record the transaction and
reflect the value of the obligation, each day, in determining its net asset
value. This value may fluctuate from day to day in the same manner as values
of municipal obligations otherwise held by the Fund. If the seller defaults in
the sale, the Fund could fail to realize the appreciation, if any, that had
occurred. The Fund will establish a segregated account with its Custodian in
which it will maintain cash and liquid, high-grade debt obligations equal in
value to its commitments for when-issued or delayed delivery securities.
The Fund may also purchase municipal forward contracts. A municipal forward
contract is a municipal security which is purchased on a when-issued basis
with delivery taking place up to five years from the date of purchase. No in-
terest will accrue on the security prior to the delivery date. The investment
adviser will monitor the liquidity, value, credit quality and delivery of the
security under the supervision of the Board of Directors.
MUNICIPAL LEASE OBLIGATIONS
THE FUND MAY ALSO INVEST IN MUNICIPAL LEASE OBLIGATIONS. A MUNICIPAL LEASE
OBLIGATION IS A MUNICIPAL SECURITY THE INTEREST ON AND PRINCIPAL OF WHICH IS
PAYABLE OUT OF LEASE PAYMENTS MADE BY THE PARTY LEASING
13
<PAGE>
THE FACILITIES FINANCED BY THE ISSUE. Typically, municipal lease obligations
are issued by a state or municipal financing authority to provide funds for
the construction of facilities (e.g., schools, dormitories, office buildings
or prisons). The facilities are typically used by the state or municipality
pursuant to a lease with a financing authority. Certain municipal lease obli-
gations may trade infrequently. Accordingly, the investment adviser will moni-
tor the liquidity of municipal lease obligations under the supervision of the
Board of Directors. Municipal lease obligations will not be considered
illiquid for purposes of the Fund's 15% limitation on illiquid securities pro-
vided the investment adviser determines that there is a readily available mar-
ket for such securities. See "Illiquid Securities" below and "Investment Ob-
jective and Policies--Illiquid Securities" in the Statement of Additional In-
formation.
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in illiquid securities,
including repurchase agreements which have a maturity of longer than seven
days, securities with legal or contractual restrictions on resale (restricted
securities) and securities that are not readily marketable. Securities,
including municipal lease obligations, that have a readily available market
are not considered illiquid for the purposes of this limitation. The
investment adviser will monitor the liquidity of such restricted securities
under the supervision of the Directors. See "Investment Objectives and
Policies--Illiquid Securities" in the Statement of Additional Information.
Repurchase agreements subject to demand as deemed to have a maturity equal to
the notice period.
BORROWING
The Fund may borrow an amount equal to no more than 20% of the value of its
total assets (calculated when the loan is made) from banks for temporary, ex-
traordinary or emergency purposes or for the clearance of transactions. The
Fund may pledge up to 20% of its total assets to secure these borrowings. How-
ever, the Fund will not purchase portfolio securities when borrowings exceed
5% of the value of the Fund's total assets.
PORTFOLIO MANAGEMENT TECHNIQUES
In seeking to achieve the Fund's investment objective, the Fund's investment
adviser will cause the Fund to purchase securities which it believes represent
the best values then currently available in the marketplace. Such values are a
function of yield, maturity, issue classification and quality characteristics,
coupled with expectations regarding the economy, movements in the general
level and term structure of interest rates, political developments and varia-
tions in the supply of funds available for investment in the tax-exempt market
relative to the demand for funds placed upon it. The following are some of the
more important management techniques which will be utilized by the Fund's in-
vestment adviser.
ADJUSTMENT OF MATURITIES
The investment adviser will seek to anticipate movements in interest rates
and will adjust the maturity distribution of the portfolio accordingly. Longer
term securities have ordinarily yielded more than shorter term securities.
From time to time, however, the normal yield relationships between longer and
shorter term securities have been reversed. In addition, longer term securi-
ties have historically been subject to greater and more rapid price fluctua-
tion. The investment adviser will be free to take advantage of price volatil-
ity in order to attempt to increase the Fund's net asset value by making ap-
propriate sales and purchases of portfolio securities.
ISSUE AND QUALITY CLASSIFICATION
Securities with the same general quality rating and maturity characteris-
tics, but which vary according to the purpose for which they were issued, of-
ten tend to trade at different yields. Similarly, securities issued for simi-
lar
14
<PAGE>
purposes and with the same general maturity characteristics, but which vary
according to the creditworthiness of their respective issuers, tend to trade
at different yields. These yield differentials tend to fluctuate in response
to political and economic developments as well as temporary imbalances in nor-
mal supply and demand relationships. The investment adviser monitors these
fluctuations closely, and will adjust portfolio positions in various issue and
quality classifications according to the value disparities brought about by
these yield relationship fluctuations.
INVESTMENT RESTRICTIONS
The Fund is subject to certain investment restrictions which, like its in-
vestment objective, constitute fundamental policies. Fundamental policies can-
not be changed without the approval of the holders of a majority of the Fund's
outstanding voting securities, as defined in the Investment Company Act. See
"Investment Restrictions" in the Statement of Additional Information.
HOW THE FUND IS MANAGED
THE FUND HAS A BOARD OF DIRECTORS WHICH, IN ADDITION TO OVERSEEING THE AC-
TIONS OF THE FUND'S MANAGER, SUBADVISER AND DISTRIBUTOR, AS SET FORTH BELOW,
DECIDES UPON MATTERS OF GENERAL POLICY. THE FUND'S MANAGER CONDUCTS AND SUPER-
VISES THE DAILY BUSINESS OPERATIONS OF THE FUND. THE FUND'S SUBADVISER FUR-
NISHES DAILY INVESTMENT ADVISORY SERVICES.
For the year ended December 31, 1994, the Fund's total expenses as a per-
centage of average net assets for the Fund's Class A, Class B and Class C
shares were .77%, 1.17% and 1.51% (annualized), respectively. See "Financial
Highlights."
MANAGER
PRUDENTIAL MUTUAL FUND MANAGEMENT, INC. (PMF OR THE MANAGER), ONE SEAPORT
PLAZA, NEW YORK, NEW YORK 10292, IS THE MANAGER OF THE FUND AND IS COMPENSATED
FOR ITS SERVICES AT AN ANNUAL RATE OF .50 OF 1% OF THE FUND'S AVERAGE DAILY
NET ASSETS UP TO AND INCLUDING $250 MILLION, .475 OF 1% OF THE NEXT $250 MIL-
LION, .45 OF 1% OF THE NEXT $500 MILLION, .425 OF 1% OF THE NEXT $250 MILLION,
.40 OF 1% OF THE NEXT $250 MILLION AND .375 OF 1% OF THE FUND'S AVERAGE DAILY
NET ASSETS IN EXCESS OF $1.5 BILLION. It was incorporated in May 1987 under
the laws of the State of Delaware. For the fiscal year ended December 31,
1994, the Fund paid management fees to PMF of .47% of the Fund's average daily
net assets. See "Manager" in the Statement of Additional Information.
As of January 31, 1995, PMF served as the manager to 39 open-end investment
companies, constituting all of the Prudential Mutual Funds, and as manager or
administrator to 30 closed-end investment companies with aggregate assets of
approximately $45 billion.
UNDER THE MANAGEMENT AGREEMENT WITH THE FUND, PMF MANAGES THE INVESTMENT OP-
ERATIONS OF THE FUND AND ALSO ADMINISTERS THE FUND'S CORPORATE AFFAIRS. See
"Manager" in the Statement of Additional Information.
UNDER A SUBADVISORY AGREEMENT BETWEEN PMF AND THE PRUDENTIAL INVESTMENT
CORPORATION (PIC OR THE SUBADVISER), PIC FURNISHES INVESTMENT ADVISORY
SERVICES IN CONNECTION WITH THE MANAGEMENT OF THE FUND AND IS REIMBURSED BY
PMF FOR ITS REASONABLE COSTS AND EXPENSES INCURRED IN PROVIDING SUCH SERVICES.
Under
15
<PAGE>
the Management Agreement, PMF continues to have responsibility for all
investment advisory services and supervises PIC's performance of such
services.
The current portfolio manager of the Fund is Patricia Dolan, a Managing
Director of Prudential Investment Advisors, a unit of PIC. Ms. Dolan has
responsibility for the day-to-day management of the Fund's portfolio. Ms.
Dolan has managed the Fund's portfolio since she joined PIC in October 1991.
She was formerly a Vice President and Portfolio Manager in the Municipal Trust
Department of Citibank Private Banking Division where she was employed from
1981 to 1991. Ms. Dolan also serves as the portfolio manager of Prudential
Municipal Bond Fund-Insured Series.
PMF and PIC are wholly-owned subsidiaries of The Prudential Insurance
Company of America (Prudential), a major diversified insurance and financial
services company.
FEE WAIVER AND SUBSIDY
Effective January 1, 1995, PMF voluntarily agreed to waive .05 of 1% of its
management fee. After the waiver, the management fee is .45 of 1% of the
Fund's average daily net assets up to and including $250 million, .425 of 1%
of the next $250 million, .40 of 1% of the next $500 million, .375 of 1% of
the next $250 million, .35 of 1% of the next $250 million and .325 of 1% of
the Fund's average daily net assets in excess of $1.5 billion. PMF may
hereafter agree, from time to time, to further waive or modify any waiver of
its management fee and subsidize certain operating expenses of the Fund. The
Fund is not required to reimburse PMF for such management fee waiver or
expense subsidy. Fee waivers and expense subsidies will increase the Fund's
yield and total return. See "Fund Expenses."
DISTRIBUTOR
PRUDENTIAL MUTUAL FUND DISTRIBUTORS, INC. (PMFD), ONE SEAPORT PLAZA, NEW
YORK, NEW YORK 10292, IS A CORPORATION ORGANIZED UNDER THE LAWS OF THE STATE
OF DELAWARE AND SERVES AS THE DISTRIBUTOR OF THE CLASS A SHARES OF THE FUND.
IT IS A WHOLLY-OWNED SUBSIDIARY OF PMF.
PRUDENTIAL SECURITIES INCORPORATED (PRUDENTIAL SECURITIES OR PSI), ONE
SEAPORT PLAZA, NEW YORK, NEW YORK 10292 (PRUDENTIAL SECURITIES OR PSI), IS A
CORPORATION ORGANIZED UNDER THE LAWS OF THE STATE OF DELAWARE AND SERVES AS
THE DISTRIBUTOR OF THE CLASS B AND CLASS C SHARES OF THE FUND. IT IS AN
INDIRECT, WHOLLY-OWNED SUBSIDIARY OF PRUDENTIAL.
UNDER SEPARATE DISTRIBUTION AND SERVICE PLANS (THE CLASS A PLAN, THE CLASS B
PLAN AND THE CLASS C PLAN, COLLECTIVELY, THE PLANS) ADOPTED BY THE FUND UNDER
RULE 12B-1 UNDER THE INVESTMENT COMPANY ACT AND SEPARATE DISTRIBUTION
AGREEMENTS (THE DISTRIBUTION AGREEMENTS), PMFD AND PRUDENTIAL SECURITIES
(COLLECTIVELY, THE DISTRIBUTOR) INCUR THE EXPENSES OF DISTRIBUTING THE FUND'S
CLASS A, CLASS B AND CLASS C SHARES. These expenses include commissions and
account servicing fees paid to, or on account of, financial advisers of
Prudential Securities and representatives of Pruco Securities Corporation
(Prusec), an affiliated broker-dealer, commissions and account servicing fees
paid to, or on account of, other broker-dealers or financial institutions
(other than national banks) which have entered into agreements with the
Distributor, advertising expenses, the cost of printing and mailing
prospectuses to potential investors and indirect and overhead costs of
Prudential Securities and Prusec associated with the sale of Fund shares,
including lease, utility, communications and sales promotion expenses. The
State of Texas requires that shares of the Fund may be sold in that state only
by dealers or other financial institutions which are registered there as
broker-dealers.
16
<PAGE>
Under the Plans, the Fund is obligated to pay distribution and/or service
fees to the Distributor as compensation for its distribution and service
activities, not as reimbursement for specific expenses incurred. If the
Distributor's expenses exceed its distribution and service fees, the Fund will
not be obligated to pay any additional expenses. If the Distributor's expenses
are less than such distribution and service fees, it will retain its full fees
and realize a profit.
UNDER THE CLASS A PLAN, THE FUND MAY PAY PMFD FOR ITS DISTRIBUTION-RELATED
ACTIVITIES WITH RESPECT TO CLASS A SHARES AT AN ANNUAL RATE OF UP TO .30 OF 1%
OF THE AVERAGE DAILY NET ASSET VALUE OF THE CLASS A SHARES. The Class A Plan
provides that (i) up to .25 of 1% of the average daily net assets of the Class
A shares may be used to pay for personal service and/or the maintenance of
shareholder accounts (service fee) and (ii) total distribution fees (including
the service fee of .25 of 1%) may not exceed .30 of 1% of the average daily
net assets of the Class A shares. It is expected that in the case of Class A
shares, proceeds from the distribution fee will be used primarily to pay
account servicing fees to financial advisers. PMFD has agreed to limit its
distribution-related fees payable under the Class A Plan to .10 of 1% of the
average daily net assets of the Class A shares for the fiscal year ending
December 31, 1995.
For the fiscal year ended December 31, 1994, PMFD received payments of
$14,116 under the Class A Plan. This amount was primarily expended for payment
of account servicing fees to financial advisers and other persons who sell
Class A shares. For the fiscal year ended December 31, 1994. PMFD also
received approximately $92,500 in initial sales charges.
UNDER THE CLASS B AND CLASS C PLANS, THE FUND MAY PAY PRUDENTIAL SECURITIES
FOR ITS DISTRIBUTION-RELATED ACTIVITIES WITH RESPECT TO CLASS B AND CLASS C
SHARES AT AN ANNUAL RATE OF UP TO .50 OF 1% AND UP TO 1% OF THE AVERAGE DAILY
NET ASSETS OF THE CLASS B AND CLASS C SHARES, RESPECTIVELY. The Class B Plan
provides for the payment to Prudential Securities of (i) an asset-based sales
charge of up to .50 of 1% of the average daily net assets of the Class B
shares, and (ii) a service fee of up to .25 of 1% of the average daily net
assets of the Class B shares; provided that the total distribution-related fee
does not exceed .50 of 1%. The Class C Plan provides for the payment to
Prudential Securities of (i) an asset-based sales charge of up to .75 of 1% of
the average daily net assets of the Class C shares, and (ii) a service fee of
up to .25 of 1% of the average daily net assets of the Class C shares. The
service fee is used to pay for personal service and/or the maintenance of
shareholder accounts. Prudential Securities has agreed to limit its
distribution-related fees payable under the Class C Plan to .75 of 1% of the
average daily net assets of the Class C shares for the fiscal year ending
December 31, 1995. Prudential Securities also receives contingent deferred
sales charges from certain redeeming shareholders. See "Shareholder Guide--How
to Sell Your Shares--Contingent Deferred Sales Charge."
For the fiscal year ended December 31, 1994, Prudential Securities incurred
distribution expenses of approximately $2,592,900 under the Class B Plan and
received $3,758,114 from the Fund under the Class B Plan. In addition,
Prudential Securities received approximately $976,100 in contingent deferred
sales charges from redemptions of Class B shares during this period. For the
period August 1 through December 31, 1994, Prudential Securities incurred
distribution expenses of approximately $900 under the Class C Plan and
received $321 from the Fund under the Class C Plan. Prudential Securities did
not receive any contingent deferred sales charges from redemptions of Class C
shares during this period.
For the fiscal year ended December 31, 1994, the Fund paid distribution
expenses of .10%, .50% and .75% of the average net assets of the Class A,
Class B and Class C shares, respectively. The Fund records all payments made
under the Plans as expenses in the calculation of net investment income. Prior
to the date of this Prospectus, the Class A and Class B Plans operated as
"reimbursement type" plans and, in the case of Class B, provided for the
reimbursement of distribution expenses incurred in current and prior years.
See "Distributor" in the Statement of Additional Information.
17
<PAGE>
Distribution expenses attributable to the sale of shares of the Fund will be
allocated to each class based upon the ratio of sales of each class to the
sales of all shares of the Fund other than expenses allowable to a particular
class. The distribution fee and sales charge of one class will not be used to
subsidize the sale of another class.
Each Plan provides that it shall continue in effect from year to year
provided that a majority of the Board of Directors of the Fund, including a
majority of the Directors who are not "interested persons" of the Fund (as
defined in the Investment Company Act) and who have no direct or indirect
financial interest in the operation of the Plan or any agreement related to
the Plan (the Rule 12b-1 Directors), vote annually to continue the Plan. Each
Plan may be terminated at any time by vote of a majority of the Rule 12b-1
Directors or of a majority of the outstanding shares of the applicable class
of the Fund. The Fund will not be obligated to pay expenses incurred under any
plan if it is terminated or not continued.
In addition to distribution and service fees paid by the Fund under the
Class A, Class B and Class C Plans, the Manager (or one of its affiliates) may
make payments out of its own resources to dealers and other persons who
distribute shares of the Fund. Such payments may be calculated by reference to
the net asset value of shares sold by such persons or otherwise.
The Distributor is subject to the rules of the National Association of
Securities Dealers, Inc. (NASD) governing maximum sales charges. See
"Distributor" in the Statement of Additional Information.
On October 21, 1993, PSI entered into an omnibus settlement with the SEC,
state securities regulators (with the exception of the Texas Securities
Commissioner who joined the settlement on January 18, 1994) and the NASD to
resolve allegations that from 1980 through 1990 PSI sold certain limited
partnership interests in violation of securities laws to persons for whom such
securities were not suitable and misrepresented the safety, potential returns
and liquidity of these investments. Without admitting or denying the
allegations asserted against it, PSI consented to the entry of an SEC
Administrative Order which stated that PSI's conduct violated the federal
securities laws, directed PSI to cease and desist from violating the federal
securities laws, pay civil penalties, and adopt certain remedial measures to
address the violations.
Pursuant to the terms of the SEC settlement, PSI agreed to the imposition of
a $10,000,000 civil penalty, established a settlement fund in the amount of
$330,000,000 and procedures to resolve legitimate claims for compensatory
damages by purchasers of the partnership interests. PSI has agreed to provide
additional funds, if necessary, for the purpose of the settlement fund. PSI's
settlement with the state securities regulators included an agreement to pay a
penalty of $500,000 per jurisdiction. PSI consented to a censure and to the
payment of a $5,000,000 fine in settling the NASD action.
In October 1994, a criminal complaint was filed with the United States
Magistrate for the Southern District of New York alleging that PSI committed
fraud in connection with the sale of certain limited partnership interests in
violation of federal securities laws. An agreement was simultaneously filed to
defer prosecution of these charges for a period of three years from the
signing of the agreement, provided that PSI complies with the terms of the
agreement. If, upon the completion of the three year period, PSI has complied
with the terms of the agreement, no prosecution will be instituted by the
United States for the offenses charged in the complaint. If on the other hand,
during the course of the three year period, PSI violates the terms of the
agreement, the U.S. Attorney can then elect to pursue these charges. Under the
terms of the agreement, PSI agreed, among other things, to pay an additional
$330,000,000 into the fund established by the SEC to pay restitution to
investors who purchased certain PSI limited partnership interests.
For more detailed information concerning the foregoing matters, see
"Distributor" in the Statement of Additional Information, a copy of which may
be obtained at no cost by calling 1-800-225-1852.
18
<PAGE>
The Fund is not affected by PSI's financial condition and is an entirely
separate legal entity from PSI, which has no beneficial ownership therein and
the Fund's assets which are held by State Street Bank and Trust Company, an
independent custodian, are separate and distinct from PSI.
PORTFOLIO TRANSACTIONS
Prudential Securities may also act as a broker or futures commission
merchant for the Fund, provided that the commissions, fees or other
remuneration it receives are fair and reasonable. See "Portfolio Transactions
and Brokerage" in the Statement of Additional Information.
CUSTODIAN AND TRANSFER AND DIVIDEND DISBURSING AGENT
State Street Bank and Trust Company (State Street or the Custodian), One
Heritage Drive, North Quincy, Massachusetts 02171, serves as Custodian for the
Fund's portfolio securities and cash and, in that capacity, maintains certain
financial and accounting books and records pursuant to an agreement with the
Fund. Its mailing address is P.O. Box 1713, Boston, Massachusetts 02105.
Prudential Mutual Fund Services, Inc. (PMFS or the Transfer Agent), Raritan
Plaza One, Edison, New Jersey 08837, serves as Transfer Agent and Dividend
Disbursing Agent and in those capacities maintains certain books and records
for the Fund. Its mailing address is P.O. Box 15005, New Brunswick, New Jersey
08906-5005. PMFS is a wholly-owned subsidiary of PMF.
HOW THE FUND VALUES ITS SHARES
THE FUND'S NET ASSET VALUE PER SHARE OR NAV IS DETERMINED BY SUBTRACTING ITS
LIABILITIES FROM ITS ASSETS AND DIVIDING THE REMAINDER BY THE NUMBER OF
OUTSTANDING SHARES. NAV IS CALCULATED SEPARATELY FOR EACH CLASS. THE BOARD OF
DIRECTORS HAS FIXED THE SPECIFIC TIME OF DAY FOR THE COMPUTATION OF THE FUND'S
NAV TO BE AS OF 4:15 P.M., NEW YORK TIME.
Portfolio securities are valued based on market quotations or, if not readily
available, at fair value as determined in good faith under procedures
established by the Fund's Board of Directors. See "Net Asset Value" in the
Statement of Additional Information.
The Fund will compute its NAV once daily on days that the New York Stock
Exchange is open for trading except on days on which no orders to purchase,
sell or redeem shares have been received by the Fund or days on which changes
in the value of the Fund's portfolio securities do not materially affect the
NAV. The New York Stock Exchange is closed on the following holidays: New
Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day and Christmas Day.
Although the legal rights of each class of shares are substantially identi-
cal, the different expenses borne by each class may result in different NAVs
and dividends. As long as the Fund declares dividends daily, the NAV of Class
A, Class B and Class C shares will generally be the same. It is expected, how-
ever, that the Fund's dividends will differ by approximately the amount of the
distribution-related expense accrual among the classes.
19
<PAGE>
HOW THE FUND CALCULATES PERFORMANCE
FROM TIME TO TIME THE FUND MAY ADVERTISE ITS "YIELD," "TAX EQUIVALENT
YIELD," AND "TOTAL RETURN" (INCLUDING "AVERAGE ANNUAL" TOTAL RETURN AND
"AGGREGATE" TOTAL RETURN) IN ADVERTISEMENTS OR SALES LITERATURE. YIELD, TAX
EQUIVALENT YIELD, AND TOTAL RETURN ARE CALCULATED SEPARATELY FOR CLASS A,
CLASS B AND CLASS C SHARES. These figures are based on historical earnings and
are not intended to indicate future performance. The "yield" refers to the
income generated by an investment in the Fund over a 30-day period. This
income is then "annualized"; that is, the amount of income generated by the
investment during that 30-day period is assumed to be generated each 30-day
period for twelve periods and is shown as a percentage of the investment. The
income earned on the investment is also assumed to be reinvested at the end of
the sixth 30-day period. The "tax equivalent yield" is calculated similarly to
the "yield," except that the yield is increased using a stated income tax rate
to demonstrate the taxable yield necessary to produce an after-tax yield
equivalent to the Fund. The "total return" shows what an investment in the
Fund would have earned over a specified period of time (i.e., one, five or ten
years or since inception of the Fund) assuming that all distributions and
dividends by the Fund were reinvested on the reinvestment dates during the
period and less all recurring fees. The "aggregate" total return reflects
actual performance over a stated period of time. "Average annual" total return
is a hypothetical rate of return that, if achieved annually, would have
produced the same aggregate total return if performance had been constant over
the entire period. Average annual total return smooths out variations in
performance and takes into account any applicable initial or contingent
deferred sales charges. Neither "average annual" total return nor "aggregate"
total return takes into account any federal or state income taxes which may be
payable upon redemption. The Fund also may include comparative performance
information in advertising or marketing the Fund's shares. Such performance
information may include data from Lipper Analytical Services, Inc.,
Morningstar Publications, Inc., other industry publications, business
periodicals, and market indices. See "Performance Information" in the
Statement of Additional Information. The Fund will include performance data
for each class of shares of the Fund in any advertisement or information
including performance data of the Fund. Further performance information is
contained in the Fund's annual and semi-annual reports to shareholders, which
may be obtained without charge. See "Shareholder Guide--Shareholder Services--
Reports to Shareholders."
TAXES, DIVIDENDS AND DISTRIBUTIONS
TAXATION OF THE FUND
THE FUND HAS ELECTED TO QUALIFY AND INTENDS TO REMAIN QUALIFIED AS A
REGULATED INVESTMENT COMPANY UNDER THE INTERNAL REVENUE CODE. ACCORDINGLY, THE
FUND WILL NOT BE SUBJECT TO FEDERAL INCOME TAXES ON ITS NET INVESTMENT INCOME
AND CAPITAL GAINS, IF ANY, THAT IT DISTRIBUTES TO ITS SHAREHOLDERS. SEE
"TAXES, DIVIDENDS AND DISTRIBUTIONS" IN THE STATEMENT OF ADDITIONAL
INFORMATION.
Gain or loss realized by the Fund from the sale of securities generally will
be treated as capital gain or loss; however, gain from the sale of certain
securities (including municipal obligations) will be treated as ordinary
income to the extent of any "market discount." Market discount generally is
the difference, if any, between the price paid by the Fund for the security
and the principal amount of the security (or, in the case of a security issued
at an original issue discount, the revised issued price of the security). The
market discount rule does not apply to any security that was acquired by the
Fund at its original issue price.
20
<PAGE>
TAXATION OF SHAREHOLDERS
Distributions out of net investment income, to the extent attributable to
interest received on tax-exempt securities, are exempt from federal income tax
when paid to shareholders. Distributions of other net investment income and
net short-term capital gains in excess of net long-term capital losses will be
taxable as ordinary income to the shareholder whether or not reinvested. Any
net long-term capital gains (i.e., the excess of net long-term capital gains
over net short-term capital losses) distributed to shareholders will be
taxable as such to the shareholders, whether or not reinvested and regardless
of the length of time a shareholder has owned his or her shares. The maximum
long-term capital gains rate for individuals is currently 28%. The maximum
long-term capital gains rate for corporate shareholders is currently the same
as the maximum tax rate for ordinary income.
Interest on certain "private activity" tax-exempt obligations issued on or
after August 8, 1986, is a preference item for purposes of the alternative
minimum tax for both individual and corporate shareholders. In the event that
the Fund invests in such obligations, the portion of an exempt-interest
dividend of the Fund that is allocable to such municipal obligations will be
treated as a preference item to shareholders for purposes of the alternative
minimum tax. In addition, a portion of the exempt-interest dividends received
by corporate shareholders with respect to interest on tax-exempt obligations,
whether or not private activity bonds, will be taken into account in computing
the alternative minimum tax. See "Taxes, Dividends and Distributions" in the
Statement of Additional Information.
Any gain or loss realized upon a sale of shares of the Fund by a shareholder
who is not a dealer in securities will be treated as a long-term capital gain
or loss if the shares have been held for more than one year, and otherwise as
a short-term capital gain or loss. However, any loss realized by a shareholder
upon the sale of shares of the Fund held by the shareholder for six months or
less will be disallowed to the extent of any distribution of tax exempt
interest received by the shareholder with respect to the shares.
The Fund has obtained opinions of counsel to the effect that neither (i) the
conversion of Class B shares into Class A shares nor (ii) the exchange of
Class B or Class C shares for Class A shares constitutes a taxable event for
federal income tax purposes. However, such opinions are not binding on the
Internal Revenue Service.
Net tax-exempt interest distributed by the Fund to shareholders may not be
exempt from state or local taxation. Shareholders are advised to consult their
own tax advisers regarding specific questions as to federal, state or local
taxes. See "Taxes, Dividends and Distributions" in the Statement of Additional
Information.
WITHHOLDING TAXES
Under the Internal Revenue Code, the Fund is generally required to withhold
and remit to the U.S. Treasury 31% of taxable dividends, capital gain
distributions and redemption proceeds payable to individuals and certain
noncorporate shareholders who fail to furnish correct tax identification
numbers on IRS Form W-9 (or IRS Form W-8 in the case of certain foreign
shareholders). Withholding at this rate is also required from dividends and
capital gain distributions (but not redemption proceeds) payable to
shareholders who are otherwise subject to backup withholding. Dividends from
taxable net investment income and net short-term capital gains paid to a
foreign shareholder will generally be subject to U.S. withholding tax at the
rate of 30% (or lower treaty rate).
DIVIDENDS AND DISTRIBUTIONS
THE FUND EXPECTS TO DECLARE DAILY AND PAY MONTHLY DIVIDENDS OF NET
INVESTMENT INCOME AND MAKE DISTRIBUTIONS OF NET CAPITAL GAINS, IF ANY, AT
LEAST ANNUALLY. Dividends paid by the Fund with respect to each class of
shares, to the extent any dividends are paid, will be calculated in the same
manner, at the same time, on the same day and will be in the same amount
except that each class will bear its own distribution expenses, generally
21
<PAGE>
resulting in lower dividends for Class B and Class C shares. Distributions of
net capital gains, if any, will be paid in the same amount for each class of
shares. See "How the Fund Values its Shares."
DIVIDENDS AND DISTRIBUTIONS WILL BE PAID IN ADDITIONAL FUND SHARES BASED ON
THE NET ASSET VALUE OF EACH CLASS OF FUND SHARES ON THE PAYMENT DATE OR SUCH
OTHER DATE AS THE BOARD OF DIRECTORS MAY DETERMINE, UNLESS THE SHAREHOLDER
ELECTS IN WRITING NOT LESS THAN FIVE BUSINESS DAYS PRIOR TO THE RECORD DATE TO
RECEIVE SUCH DIVIDENDS AND DISTRIBUTIONS IN CASH. Such election should be sub-
mitted to Prudential Mutual Fund Services, Inc., Attention: Account Mainte-
nance, P.O. Box 15015, New Brunswick, New Jersey 08906-5015. The Fund will no-
tify each shareholder after the close of the Fund's taxable year both of the
dollar amount and the taxable status of that year's dividends and distribu-
tions on a per share basis. If you hold shares through Prudential Securities,
you should contact your financial adviser to elect to receive dividends and
distributions in cash.
In determining the amount of capital gains to be distributed, any capital
loss carryovers from prior years will be offset against capital gains. The
Fund intends to invest its assets so that dividends paid from net tax-exempt
interest earned from Municipal Bonds and Notes will qualify as exempt-interest
dividends and be excluded from the shareholder's gross income under the
Internal Revenue Code.
Any distributions of net capital gains paid shortly after a purchase by an
investor will have the effect of reducing the per share net asset value of the
investor's shares by the per share amount of the distributions. Such
distributions, although in effect a return of invested principal, are subject
to federal income taxes. Accordingly, prior to purchasing shares of the Fund,
an investor should carefully consider the impact of capital gains
distributions which are expected to be or have been announced.
As of December 31, 1994 the Fund had a capital loss carryforward for federal
income tax purposes of $19,372,500. Accordingly, no capital gains distribution
is expected to be paid to shareholders until net gains have been realized in
excess of such carryforward amount.
GENERAL INFORMATION
DESCRIPTION OF COMMON STOCK
THE FUND WAS INCORPORATED IN MARYLAND ON JANUARY 9, 1980. THE FUND IS
AUTHORIZED TO ISSUE 750 MILLION SHARES OF COMMON STOCK, $.01 PAR VALUE PER
SHARE, DIVIDED INTO THREE CLASSES, DESIGNATED CLASS A, CLASS B AND CLASS C
COMMON STOCK, EACH OF WHICH CONSISTS OF 250 MILLION AUTHORIZED SHARES. Each
class of common stock represents an interest in the same assets of the Fund
and is identical in all respects except that (i) each class bears different
distribution expenses, (ii) each class has exclusive voting rights with
respect to its distribution and service plan (except that the Fund has agreed
with the SEC in connection with the offering of a conversion feature on Class
B shares to submit any amendment of the Class A Plan to both Class A and Class
B shareholders), (iii) each class has a different exchange privilege and (iv)
only Class B shares have a conversion feature. See "How the Fund is Managed--
Distributor." The Fund has received an order from the Securities and Exchange
Commission (SEC) permitting the issuance and sale of multiple classes of
common stock. Currently, the Fund is offering only three classes designated
Class A, Class B and Class C shares. Pursuant to the Fund's Articles of
Incorporation, the Board of Directors may authorize the creation of additional
series of common stock and classes within such series, with such preferences,
privileges, limitations and voting and dividend rights as the Board may
determine.
The Board of Directors may increase or decrease the number of authorized
shares without approval by the shareholders. Shares of the Fund, when issued,
are fully paid, nonassessable, fully transferable and redeemable at
22
<PAGE>
the option of the holder. Shares are also redeemable at the option of the Fund
under certain circumstances as described under "Shareholder Guide--How to Sell
Your Shares." Each share of each class of common stock is equal as to
earnings, assets and voting privileges, except as noted above, and each class
bears the expenses related to the distribution of its shares. Except for the
conversion feature applicable to the Class B shares, there are no conversion,
preemptive or other subscription rights. In the event of liquidation, each
share of common stock of the Fund is entitled to its portion of all of the
Fund's assets after all debt and expenses of the Fund have been paid. Since
Class B and Class C shares generally bear higher distribution expenses than
Class A shares, the liquidation proceeds to shareholders of those classes are
likely to be lower than to Class A shareholders. The Fund's shares do not have
cumulative voting rights for the election of Directors.
THE FUND DOES NOT INTEND TO HOLD ANNUAL MEETINGS OF SHAREHOLDERS UNLESS
OTHERWISE REQUIRED BY LAW. THE FUND WILL NOT BE REQUIRED TO HOLD MEETINGS OF
SHAREHOLDERS UNLESS, FOR EXAMPLE, THE ELECTION OF DIRECTORS IS REQUIRED TO BE
ACTED ON BY SHAREHOLDERS UNDER THE INVESTMENT COMPANY ACT. SHAREHOLDERS HAVE
CERTAIN RIGHTS, INCLUDING THE RIGHT TO CALL A MEETING UPON A VOTE OF 10% OF
THE FUND'S OUTSTANDING SHARES FOR THE PURPOSE OF VOTING ON THE REMOVAL OF ONE
OR MORE DIRECTORS OR TO TRANSACT ANY OTHER BUSINESS.
ADDITIONAL INFORMATION
This Prospectus, including the Statement of Additional Information which has
been incorporated by reference herein, does not contain all the information
set forth in the Registration Statement filed by the Fund with the SEC under
the Securities Act of 1933. Copies of the Registration Statement may be
obtained at a reasonable charge from the SEC or may be examined, without
charge, at the office of the SEC in Washington, D.C.
SHAREHOLDER GUIDE
HOW TO BUY SHARES OF THE FUND
YOU MAY PURCHASE SHARES OF THE FUND THROUGH PRUDENTIAL SECURITIES, PRUSEC OR
DIRECTLY FROM THE FUND THROUGH ITS TRANSFER AGENT, PRUDENTIAL MUTUAL FUND
SERVICES, INC., ATTENTION: INVESTMENT SERVICES, P.O. BOX 15020, NEW BRUNSWICK,
NEW JERSEY 08906-5020. The minimum initial investment for Class A and Class B
shares is $1,000 per class and $5,000 for Class C shares. The minimum
subsequent investment is $100 for all classes. All minimum investment
requirements are waived for certain employee savings plans. For purchases
through the Automatic Savings Accumulation Plan, the minimum initial and
subsequent investment is $50. The minimum initial investment requirement is
waived for purchases of Class A shares effected through an exchange of Class B
shares of The BlackRock Government Income Trust. See "Shareholder Services"
below.
An investment in the Fund may not be appropriate for tax-exempt or tax-
deferred investors. Such investors should consult their own tax advisers.
THE PURCHASE PRICE IS THE NET ASSET VALUE PER SHARE NEXT DETERMINED
FOLLOWING RECEIPT OF AN ORDER BY THE TRANSFER AGENT OR PRUDENTIAL SECURITIES
PLUS A SALES CHARGE WHICH, AT YOUR OPTION, MAY BE IMPOSED EITHER (I) AT THE
TIME OF PURCHASE (CLASS A SHARES) OR (II) ON A DEFERRED BASIS (CLASS B OR
CLASS C SHARES). SEE "ALTERNATIVE PURCHASE PLAN" BELOW. SEE ALSO, "HOW THE
FUND VALUES ITS SHARES."
Application forms can be obtained from PMFS, Prudential Securities or
Prusec. If a stock certificate is desired, it must be requested in writing for
each transaction. Certificates are issued only for full shares. Shareholders
who hold their shares through Prudential Securities will not receive stock
certificates.
23
<PAGE>
The Fund reserves the right to reject any purchase order (including an
exchange into the Fund) or to suspend or modify the continuous offering of its
shares. See "How to Sell Your Shares" below.
Your dealer is responsible for forwarding payment promptly to the Fund. The
Distributor reserves the right to cancel any purchase order for which payment
has not been received by the fifth business day following the investment.
Transactions in Fund shares may be subject to postage and handling charges
imposed by your dealer.
PURCHASE BY WIRE. For an initial purchase of shares of the Fund by wire, you
must first telephone PMFS to receive an account number at (800) 225-1852
(toll-free). The following information will be requested: your name, address,
tax identification number, class election, dividend distribution election,
amount being wired and wiring bank. Instructions should then be given by you
to your bank to transfer funds by wire to State Street Bank and Trust Company,
Boston, Massachusetts, Custody and Shareholder Services Division, Attention:
Prudential National Municipals Fund, Inc., specifying on the wire the account
number assigned by PMFS and your name and identifying the sales charge
alternative (Class A, Class B or Class C shares).
If you arrange for receipt by State Street of Federal Funds prior to 4:15
P.M., New York time, on a business day, you may purchase shares of the Fund as
of that day.
In making a subsequent purchase order by wire, you should wire State Street
directly and should be sure that the wire specifies Prudential National
Municipals Fund, Inc., Class A, Class B or Class C shares and your name and
individual account number. It is not necessary to call PMFS to make subsequent
purchase orders utilizing Federal Funds. The minimum amount which may be
invested by wire is $1,000.
ALTERNATIVE PURCHASE PLAN
THE FUND OFFERS THREE CLASSES OF SHARES (CLASS A, CLASS B AND CLASS C
SHARES) WHICH ALLOWS YOU TO CHOOSE THE MOST BENEFICIAL SALES CHARGE STRUCTURE
FOR YOUR INDIVIDUAL CIRCUMSTANCES GIVEN THE AMOUNT OF THE PURCHASE, THE LENGTH
OF TIME YOU EXPECT TO HOLD THE SHARES AND OTHER RELEVANT CIRCUMSTANCES
(ALTERNATIVE PURCHASE PLAN).
<TABLE>
<CAPTION>
ANNUAL 12B-1 FEES
(AS A % OF AVERAGE
SALES CHARGE DAILY NET ASSETS) OTHER INFORMATION
------------------------ ------------------------------- ------------------------
<C> <S> <C> <C>
Class A Maximum initial sales .30 of 1% (Currently being Initial sales charge
charge of 3% of the charged at a rate of .10 of 1%) waived or reduced for
public offering price certain purchases
Class B Maximum contingent .50 of 1% Shares convert to Class
deferred sales charge or A shares approximately
CDSC of 5% of the lesser seven years after
of the amount invested purchase
or the redemption
proceeds; declines to
zero after six years
Class C Maximum CDSC of 1% of 1% (Currently being charged Shares do not convert to
the lesser of the amount at a rate of .75 of 1%) another class
invested or the
redemption proceeds on
redemptions made within
one year of purchase
</TABLE>
24
<PAGE>
The three classes of shares represent an interest in the same portfolio of
investments of the Fund and have the same rights, except that (i) each class
bears the separate expenses of its Rule 12b-1 distribution and service plan,
(ii) each class has exclusive voting rights with respect to its plan (except
as noted under the heading "General Information--Description of Common
Stock"), and (iii) only Class B shares have a conversion feature. The three
classes also have separate exchange privileges. See "How to Exchange Your
Shares" below. The income attributable to each class and the dividends payable
on the shares of each class will be reduced by the amount of the distribution
fee of each class. Class B and Class C shares bear the expenses of a higher
distribution fee which will generally cause them to have higher expense ratios
and to pay lower dividends than the Class A shares.
Financial advisers and other sales agents who sell shares of the Fund will
receive different compensation for selling Class A, Class B and Class C shares
and will generally receive more compensation initially for selling Class A and
Class B shares than for selling Class C shares.
IN SELECTING A PURCHASE ALTERNATIVE, YOU SHOULD CONSIDER, AMONG OTHER
THINGS, (1) the length of time you expect to hold your investment, (2) the
amount of any applicable sales charge (whether imposed at the time of purchase
or redemption) and distribution-related fees, as noted above, (3) whether you
qualify for any reduction or waiver of any applicable sales charge, (4) the
various exchange privileges among the different classes of shares (see "How to
Exchange Your Shares" below) and (5) the fact that Class B shares
automatically convert to Class A shares approximately seven years after
purchase (see "Conversion Feature--Class B Shares" below).
The following is provided to assist you in determining which method of
purchase best suits your individual circumstances and is based on current fees
and expenses being charged to the Fund:
If you intend to hold your investment in the Fund for less than 5 years and
do not qualify for a reduced sales charge on Class A shares, since Class A
shares are subject to a maximum initial sales charge of 3% and Class B shares
are subject to a CDSC of 5% which declines to zero over a 6 year period, you
should consider purchasing Class C shares over either Class A or Class B
shares.
If you intend to hold your investment for more than 5 years and do not
qualify for a reduced sales charge on Class A shares, since Class B shares
convert to Class A shares approximately 7 years after purchase and because all
of your money would be invested initially in the case of Class B shares, you
should consider purchasing Class B shares over either Class A or Class C
shares.
If you qualify for a reduced sales charge on Class A shares, it may be more
advantageous for you to purchase Class A shares over either Class B or Class C
shares regardless of how long you intend to hold your investment. However,
unlike Class B and Class C shares, you would not have all of your money
invested initially because the sales charge on Class A shares is deducted at
the time of purchase.
If you do not qualify for a reduced sales charge on Class A shares and you
purchase Class C shares, you would have to hold your investment for more than
4 years for the higher cumulative annual distribution-related fee on Class C
shares to exceed the initial sales charge plus cumulative annual distribution-
related fees on Class A shares. This does not take into account the time value
of money, which further reduces the impact of the higher Class C distribution-
related fee on the investment, fluctuations in net asset value, the effect of
the return on the investment over this period of time or redemptions during
which the CDSC is applicable.
ALL PURCHASES OF $1 MILLION OR MORE, EITHER AS PART OF A SINGLE INVESTMENT
OR UNDER RIGHTS OF ACCUMULATION OR LETTERS OF INTENT, MUST BE FOR CLASS A
SHARES. SEE "REDUCTION AND WAIVER OF INITIAL SALES CHARGES" BELOW.
25
<PAGE>
CLASS A SHARES
The offering price of Class A shares for investors choosing the initial
sales charge alternative is the next determined NAV plus a sales charge (ex-
pressed as a percentage of the offering price and of the amount invested) as
shown in the following table:
<TABLE>
<CAPTION>
SALES CHARGE AS SALES CHARGE AS DEALER CONCESSION
PERCENTAGE OF PERCENTAGE OF AS PERCENTAGE OF
AMOUNT OF PURCHASE OFFERING PRICE AMOUNT INVESTED OFFERING PRICE
------------------ --------------- --------------- -----------------
<S> <C> <C> <C>
Less than $99,999.......... 3.00% 3.09% 3.00%
$100,000 to $249,999....... 2.50% 2.56% 2.50%
$250,000 to $499,999....... 1.50% 1.52% 1.50%
$500,000 to $999,999....... 1.00% 1.01% 1.00%
$1,000,000 and above....... None None None
</TABLE>
Selling dealers may be deemed to be underwriters, as that term is defined in
the Securities Act.
REDUCTION AND WAIVER OF INITIAL SALES CHARGES. Reduced sales charges are
available through Rights of Accumulation and Letters of Intent. Shares of the
Fund and shares of other Prudential Mutual Funds (excluding money market funds
other than those acquired pursuant to the exchange privilege) may be
aggregated to determine the applicable reduction. See "Purchase and Redemption
of Fund Shares--Reduction and Waiver of Initial Sales Charges--Class A Shares"
in the Statement of Additional Information.
Class A shares may be purchased at NAV, through Prudential Securities or the
Transfer Agent, by the following persons: (a) Directors and officers of the
Fund and other Prudential Mutual Funds, (b) employees of Prudential Securities
and PMF and their subsidiaries and members of the families of such persons who
maintain an "employee related" account at Prudential Securities or the
Transfer Agent, (c) employees and special agents of Prudential and its
subsidiaries and all persons who have retired directly from active service
with Prudential or one of its subsidiaries, (d) registered representatives and
employees of dealers who have entered into a selected dealer agreement with
Prudential Securities provided that purchases at NAV are permitted by such
person's employer and (e) investors who have a business relationship with a
financial adviser who joined Prudential Securities from another investment
firm, provided that (i) the purchase is made within 90 days of the
commencement of the financial adviser's employment at Prudential Securities,
(ii) the purchase is made with proceeds of a redemption of shares of any open-
end, non-money market fund sponsored by the financial adviser's previous
employer (other than a fund which imposes a distribution or service fee of .25
of 1% or less) and (iii) the financial adviser served as the client's broker
on the previous purchases.
You must notify the Fund's Transfer Agent either directly or through
Prudential Securities or Prusec that you are entitled to the reduction or
waiver of the sales charge. The reduction or waiver will be granted subject to
confirmation of your entitlement. No initial sales charges are imposed upon
Class A shares purchased upon the reinvestment of dividends and distributions.
See "Purchase and Redemption of Fund Shares--Reduction and Waiver of Initial
Sales Charges--Class A Shares" in the Statement of Additional Information.
CLASS B AND CLASS C SHARES
The offering price of Class B and Class C shares for investors choosing one
of the deferred sales charge alternatives is the NAV next determined following
receipt of an order by the Transfer Agent or Prudential Securities. Although
there is no sales charge imposed at the time of purchase, redemptions of Class
B and Class C shares may be subject to a CDSC. See "How to Sell Your Shares--
Contingent Deferred Sales Charges."
26
<PAGE>
HOW TO SELL YOUR SHARES
YOU MAY REDEEM YOUR SHARES AT ANY TIME FOR CASH AT THE NAV NEXT DETERMINED
AFTER THE REDEMPTION REQUEST IS RECEIVED IN PROPER FORM BY THE TRANSFER AGENT
OR PRUDENTIAL SECURITIES. SEE "HOW THE FUND VALUES ITS SHARES." In certain
cases, however, redemption proceeds from the Class B shares will be reduced by
the amount of any applicable contingent deferred sales charge, as described
below. See "Contingent Deferred Sales Charges" below.
IF YOU HOLD SHARES OF THE FUND THROUGH PRUDENTIAL SECURITIES, YOU MUST
REDEEM YOUR SHARES BY CONTACTING YOUR PRUDENTIAL SECURITIES FINANCIAL ADVISER.
IF YOU HOLD SHARES IN NON-CERTIFICATE FORM, A WRITTEN REQUEST FOR REDEMPTION
SIGNED BY YOU EXACTLY AS THE ACCOUNT IS REGISTERED IS REQUIRED. IF YOU HOLD
CERTIFICATES, THE CERTIFICATES, SIGNED IN THE NAME(S) SHOWN ON THE FACE OF THE
CERTIFICATES, MUST BE RECEIVED BY THE TRANSFER AGENT IN ORDER FOR THE
REDEMPTION REQUEST TO BE PROCESSED. IF REDEMPTION IS REQUESTED BY A
CORPORATION, PARTNERSHIP, TRUST OR FIDUCIARY, WRITTEN EVIDENCE OF AUTHORITY
ACCEPTABLE TO THE TRANSFER AGENT MUST BE SUBMITTED BEFORE SUCH REQUEST WILL BE
ACCEPTED. All correspondence and documents concerning redemptions should be
sent to the Fund in care of its Transfer Agent, Prudential Mutual Fund
Services, Inc., Attention: Redemption Services, P.O. Box 15010, New Brunswick,
New Jersey 08906-5010.
If the proceeds of the redemption (a) exceed $50,000, (b) are to be paid to
a person other than the record owner, (c) are to be sent to an address other
than the address on the Transfer Agent's records, or (d) are to be paid to a
corporation, partnership, trust or fiduciary, the signature(s) on the
redemption request and on the certificates, if any, or stock power, must be
guaranteed by an "eligible guarantor institution." An "eligible guarantor
institution" includes any bank, broker, dealer or credit union. The Transfer
Agent reserves the right to request additional information from, and make
reasonable inquiries of, any eligible guarantor institution. For clients of
Prusec, a signature guarantee may be obtained from the agency or office
manager of most Prudential Insurance and Financial Services or Preferred
Services offices.
PAYMENT FOR SHARES PRESENTED FOR REDEMPTION WILL BE MADE BY CHECK WITHIN
SEVEN DAYS AFTER RECEIPT BY THE TRANSFER AGENT OF THE CERTIFICATE AND/OR
WRITTEN REQUEST EXCEPT AS INDICATED BELOW. IF YOU HOLD SHARES THROUGH
PRUDENTIAL SECURITIES, PAYMENT FOR SHARES PRESENTED FOR REDEMPTION WILL BE
CREDITED TO YOUR PRUDENTIAL SECURITIES ACCOUNT, UNLESS YOU INDICATE OTHERWISE.
Such payment may be postponed or the right of redemption suspended at times
(a) when the New York Stock Exchange is closed for other than customary
weekends and holidays, (b) when trading on such Exchange is restricted, (c)
when an emergency exists as a result of which disposal by the Fund of
securities owned by it is not reasonably practicable or it is not reasonably
practicable for the Fund fairly to determine the value of its net assets, or
(d) during any other period when the SEC, by order, so permits;
provided that applicable rules and regulations of the SEC shall govern as to
whether the conditions prescribed in (b), (c) or (d) exist.
PAYMENT FOR REDEMPTION OF RECENTLY PURCHASED SHARES WILL BE DELAYED UNTIL
THE FUND OR ITS TRANSFER AGENT HAS BEEN ADVISED THAT THE PURCHASE CHECK HAS
BEEN HONORED, UP TO 10 CALENDAR DAYS FROM THE TIME OF RECEIPT OF THE PURCHASE
CHECK BY THE TRANSFER AGENT. SUCH DELAY MAY BE AVOIDED BY PURCHASING SHARES BY
WIRE OR BY CERTIFIED OR OFFICIAL BANK CHECK.
REDEMPTION IN KIND. If the Board of Directors determines that it would be
detrimental to the best interests of the remaining shareholders of the Fund to
make payment wholly or partly in cash, the Fund may pay the redemption price
in whole or in part by a distribution in kind of securities from the
investment portfolio of the Fund, in lieu of cash, in conformity with
applicable rules of the SEC. Securities will be readily marketable and will be
valued in the same manner as in regular redemption. See "How the Fund Values
its Shares." If your shares are redeemed in kind, you would incur transaction
costs in converting the assets into cash. The Fund, however, has elected to be
27
<PAGE>
governed by Rule 18f-1 under the Investment Company Act, under which the Fund
is obligated to redeem shares solely in cash up to the lesser of $250,000 or
1% of the net asset value of the Fund during any 90-day period for any one
shareholder.
INVOLUNTARY REDEMPTION. In order to reduce expenses of the Fund, the Board
of Directors may redeem all of the shares of any shareholder, other than a
shareholder which is an IRA or other tax-deferred retirement plan, whose
account has a net asset value of less than $500 due to a redemption. The Fund
will give such shareholders 60 days' prior written notice in which to purchase
sufficient additional shares to avoid such redemption. No contingent deferred
sales charges will be imposed on any involuntary redemption.
90-DAY REPURCHASE PRIVILEGE. If you redeem shares and have not previously
exercised the repurchase privilege, you may reinvest any portion or all of the
proceeds of such redemption in shares of the Fund at the NAV next determined
after the order is received, which must be within 90 days after the date of
the redemption. No sales charge will apply to such repurchases. You will
receive pro rata credit for any contingent deferred sales charge paid in
connection with the redemption of Class B or Class C shares. You must notify
the Fund's Transfer Agent, either directly or through Prudential Securities or
Prusec, at the time the repurchase privilege is exercised that you are
entitled to credit for the contingent deferred sales charge previously paid.
Exercise of the repurchase privilege will generally not affect federal income
tax treatment of any gain realized upon redemption. If the redemption resulted
in a loss, some or all of the loss, depending on the amount reinvested, will
generally not be allowed for federal income tax purposes.
CONTINGENT DEFERRED SALES CHARGES
Redemptions of Class B shares will be subject to a contingent deferred sales
charge or CDSC declining from 5% to zero over a six-year period. Class C
shares redeemed within one year of purchase will be subject to a 1% CDSC. The
CDSC will be deducted from the redemption proceeds and reduce the amount paid
to you. The CDSC will be imposed on any redemption by you which reduces the
current value of your Class B or Class C shares to an amount which is lower
than the amount of all payments by you for shares during the preceding six
years, in the case of Class B shares, and one year, in the case of Class C
shares. A CDSC will be applied on the lesser of the original purchase price or
the current value of the shares being redeemed. Increases in the value of your
shares or shares acquired through reinvestment of dividends or distributions
are not subject to a CDSC. The amount of any CDSC will be paid to and retained
by the Distributor. See "How the Fund is Managed--Distributor" and "Waiver of
the Contingent Deferred Sales Charges--Class B Shares" below.
The amount of the CDSC, if any, will vary depending on the number of years
from the time of payment for the purchase of shares until the time of redemp-
tion of such shares. Solely for purposes of determining the number of years
from the time of any payment for the purchase of shares, all payments during a
month will be aggregated and deemed to have been made on the last day of the
month. The CDSC will be calculated from the first day of the month after the
initial purchase, excluding the time shares were held in a money market fund.
See "How to Exchange Your Shares." The following table sets forth the rates of
the CDSC applicable to redemptions of Class B shares:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED SALES
YEAR SINCE CHARGE AS A PERCENTAGE
PURCHASE OF DOLLARS INVESTED OR
PAYMENT MADE REDEMPTION PROCEEDS
------------ -------------------------
<S> <C>
First........................................ 5.0%
Second....................................... 4.0%
Third........................................ 3.0%
Fourth....................................... 2.0%
Fifth........................................ 1.0%
Sixth........................................ 1.0%
Seventh...................................... None
</TABLE>
28
<PAGE>
In determining whether a CDSC is applicable to a redemption, the calculation
will be made in a manner that results in the lowest possible rate. It will be
assumed that the redemption is made first of amounts representing shares
acquired pursuant to the reinvestment of dividends and distributions; then of
amounts representing the increase in net asset value above the total amount of
payments for the purchase of Fund shares made during the preceding six years
(five years for shares purchased prior to January 22, 1990); then of amounts
representing the cost of shares held beyond the applicable CDSC period; then
of amounts representing the cost of shares acquired prior to July 1, 1985; and
finally, of amounts representing the cost of shares held for the longest
period of time within the applicable CDSC period.
For example, assume you purchased 100 Class B shares at $10 per share for a
cost of $1,000. Subsequently, you acquired 5 additional Class B shares through
dividend reinvestment. During the second year after the purchase you decided
to redeem $500 of your investment. Assuming at the time of the redemption the
net asset value had appreciated to $12 per share, the value of your Class B
shares would be $1,260 (105 shares at $12 per share). The CDSC would not be
applied to the value of the reinvested dividend shares and the amount which
represents appreciation ($260). Therefore, $240 of the $500 redemption
proceeds ($500 minus $260) would be charged at a rate of 4% (the applicable
rate in the second year after purchase) for a total CDSC of $9.60.
For federal income tax purposes, the amount of the CDSC will reduce the gain
or increase the loss, as the case may be, on the amount recognized on the
redemption of shares.
WAIVER OF THE CONTINGENT DEFERRED SALES CHARGES--CLASS B SHARES. The CDSC
will be waived in the case of a redemption following the death or disability
of a shareholder or, in the case of a trust, following the death or disability
of the grantor. The waiver is available for total or partial redemptions of
shares owned by a person, either individually or in joint tenancy (with rights
of survivorship), at the time of death or initial determination of disability,
provided that the shares were purchased prior to death or disability. In
addition, the CDSC will be waived on redemptions of shares held by a Director
of the Fund.
You must notify the Fund's Transfer Agent either directly or through
Prudential Securities or Prusec, at the time of redemption, that you are
entitled to waiver of the contingent deferred sales charge and provide the
Transfer Agent with such supporting documentation as it may deem appropriate.
The waiver will be granted subject to confirmation of your entitlement. See
"Purchase and Redemption of Fund Shares--Waiver of the Contingent Deferred
Sales Charge--Class B Shares" in the Statement of Additional Information.
A quantity discount may apply to redemptions of Class B shares purchased
prior to August 1, 1994. See "Purchase and Redemption of Fund Shares--Quantity
Discount--Class B Shares Purchased Prior to August 1, 1994," in the Statement
of Additional Information.
CONVERSION FEATURE--CLASS B SHARES
Class B shares will automatically convert to Class A shares on a quarterly
basis approximately seven years after purchase. It is currently anticipated
that conversions will occur during the months of February, May, August and
November. Conversions will be effected at relative net asset value without the
imposition of any additional sales charge. The first conversion of Class B
shares occurred in February 1995, when the conversion feature was first
implemented.
Since the Fund tracks amounts paid rather than the number of shares bought
on each purchase of Class B shares, the number of Class B shares eligible to
convert to Class A shares (excluding shares acquired through the automatic
reinvestment of dividends and other distributions) (the Eligible Shares) will
be determined on each
29
<PAGE>
conversion date in accordance with the following formula: (i) the ratio of (a)
the amounts paid for Class B shares purchased at least seven years prior to
the conversion date to (b) the total amount paid for all Class B shares
purchased and then held in your account (ii) multiplied by the total number of
Class B shares purchased and then held in your account. Each time any Eligible
Shares in your account convert to Class A shares, all shares or amounts
representing Class B shares then in your account that were acquired through
the automatic reinvestment of dividends and other distributions will convert
to Class A shares.
For purposes of determining the number of Eligible Shares, if the Class B
shares in your account on any conversion date are the result of multiple
purchases at different net asset values per share, the number of Eligible
Shares calculated as described above will generally be either more or less
than the number of shares actually purchased approximately seven years before
such conversion date. For example, if 100 shares were initially purchased at
$10 per share (for a total of $1,000) and a second purchase of 100 shares was
subsequently made at $11 per share (for a total of $1,100), 95.24 shares would
convert approximately seven years from the initial purchase (i.e., $1,000
divided by $2,100 (47.62%) multiplied by 200 shares equals 95.24 shares). The
Manager reserves the right to modify the formula for determining the number of
Eligible Shares in the future as it deems appropriate on notice to
shareholders.
Since annual distribution-related fees are lower for Class A shares than
Class B shares, the per share net asset value of the Class A shares may be
higher than that of the Class B shares at the time of conversion. Thus,
although the aggregate dollar value will be the same, you may receive fewer
Class A shares than Class B shares converted. See "How the Fund Values its
Shares."
For purposes of calculating the applicable holding period for conversions,
all payments for Class B shares during a month will be deemed to have been
made on the last day of the month, or for Class B shares acquired through
exchange, or a series of exchanges, on the last day of the month in which the
original payment for purchases of such Class B shares was made. For Class B
shares previously exchanged for shares of a money market fund, the time period
during which such shares were held in the money market fund will be excluded.
For example, Class B shares held in a money market fund for one year will not
convert to Class A shares until approximately eight years from purchase. For
purposes of measuring the time period during which shares are held in a money
market fund, exchanges will be deemed to have been made on the last day of the
month. Class B shares acquired through exchange will convert to Class A shares
after expiration of the conversion period applicable to the original purchase
of such shares.
The conversion feature may be subject to the continuing availability of
opinions of counsel or rulings of the Internal Revenue Service (i) that the
dividends and other distributions paid on Class A, Class B, and Class C shares
will not constitute "preferential dividends" under the Internal Revenue Code
and (ii) that the conversion of shares does not constitute a taxable event.
The conversion of Class B shares into Class A shares may be suspended if such
opinions or rulings are no longer available. If conversions are suspended,
Class B shares of the Fund will continue to be subject, possibly indefinitely,
to their higher annual distribution and service fee.
HOW TO EXCHANGE YOUR SHARES
AS A SHAREHOLDER OF THE FUND, YOU HAVE AN EXCHANGE PRIVILEGE WITH CERTAIN
OTHER PRUDENTIAL MUTUAL FUNDS, INCLUDING ONE OR MORE SPECIFIED MONEY MARKET
FUNDS, SUBJECT TO THE MINIMUM INVESTMENT REQUIREMENTS OF SUCH FUNDS. CLASS A,
CLASS B AND CLASS C SHARES MAY BE EXCHANGED FOR CLASS A, CLASS B AND CLASS C
SHARES, RESPECTIVELY, OF ANOTHER FUND ON THE BASIS OF THE RELATIVE NAV. No
sales charge will be imposed at the time of the exchange. Any applicable CDSC
payable upon the redemption of shares exchanged will be calculated from the
first day of the month after the initial purchase, excluding the time shares
were held in a money market fund. Class B and Class C shares may not be
exchanged into money market funds other than Prudential
30
<PAGE>
Special Money Market Fund. For purposes of calculating the holding period
applicable to the Class B conversion feature, the time period during which
Class B shares were held in a money market fund will be excluded. See
"Conversion Feature--Class B Shares" above. An exchange will be treated as a
redemption and purchase for tax purposes. See "Shareholder Investment
Account--Exchange Privilege" in the Statement of Additional Information.
IN ORDER TO EXCHANGE SHARES BY TELEPHONE, YOU MUST AUTHORIZE TELEPHONE
EXCHANGES ON YOUR INITIAL APPLICATION FORM OR BY WRITTEN NOTICE TO THE
TRANSFER AGENT AND HOLD SHARES IN NON-CERTIFICATE FORM. Thereafter, you may
call the Fund at (800) 225-1852 to execute a telephone exchange of shares, on
weekdays, except holidays, between the hours of 8:00 A.M. and 6:00 P.M., New
York time. For your protection and to prevent fraudulent exchanges, your
telephone call will be recorded and you will be asked to provide your personal
identification number. A written confirmation of the exchange transaction will
be sent to you. NEITHER THE FUND NOR ITS AGENTS WILL BE LIABLE FOR ANY LOSS,
LIABILITY OR COST WHICH RESULTS FROM ACTING UPON INSTRUCTIONS REASONABLY
BELIEVED TO BE GENUINE UNDER THE FOREGOING PROCEDURES. All exchanges will be
made on the basis of the relative NAV of the two funds next determined after
the request is received in good order. The Exchange Privilege is available
only in states where the exchange may legally be made.
IF YOU HOLD SHARES THROUGH PRUDENTIAL SECURITIES, YOU MUST EXCHANGE YOUR
SHARES BY CONTACTING YOUR PRUDENTIAL SECURITIES FINANCIAL ADVISER. IF YOU HOLD
CERTIFICATES, THE CERTIFICATES, SIGNED IN THE NAME(S) SHOWN ON THE FACE OF THE
CERTIFICATES, MUST BE RETURNED IN ORDER FOR THE SHARES TO BE EXCHANGED. SEE
"HOW TO SELL YOUR SHARES" ABOVE.
You may also exchange shares by mail by writing to Prudential Mutual Fund
Services, Inc., Attention: Exchange Processing, P.O. Box 15010, New Brunswick,
New Jersey 08906-5010.
IN PERIODS OF SEVERE MARKET OR ECONOMIC CONDITIONS THE TELEPHONE EXCHANGE OF
SHARES MAY BE DIFFICULT TO IMPLEMENT AND YOU SHOULD MAKE EXCHANGES BY MAIL BY
WRITING TO PRUDENTIAL MUTUAL FUND SERVICES, INC., AT THE ADDRESS NOTED ABOVE.
SPECIAL EXCHANGE PRIVILEGE. A special exchange privilege is available for
shareholders who qualify to purchase Class A shares at NAV. See "Alternative
Purchase Plan--Class A Shares--Reduction and Waiver of Initial Sales Charges"
above. Under this exchange privilege, amounts representing any Class B and
Class C shares (which are not subject to a CDSC) held in such a shareholder's
account will be automatically exchanged for Class A shares on a quarterly
basis, unless the shareholder elects otherwise. It is currently anticipated
that this exchange will occur quarterly in February, May, August and November.
Eligibility for this exchange privilege will be calculated on the business day
prior to the date of the exchange. Amounts representing Class B or Class C
shares which are not subject to a CDSC include the following: (1) amounts
representing Class B or Class C shares acquired pursuant to the automatic
reinvestment of dividends and distributions, (2) amounts representing the
increase in the net asset value above the total amount of payments for the
purchase of Class B or Class C shares and (3) amounts representing Class B or
Class C shares held beyond the applicable CDSC period. Class B and Class C
shareholders must notify the Transfer Agent either directly or through
Prudential Securities or Prusec that they are eligible for this special
exchange privilege.
The Exchange Privilege may be modified or terminated at any time on 60 days'
notice to shareholders.
SHAREHOLDER SERVICES
In addition to the exchange privilege, as a shareholder in the Fund, you can
take advantage of the following additional services and privileges:
31
<PAGE>
. AUTOMATIC REINVESTMENT OF DIVIDENDS AND/OR DISTRIBUTIONS WITHOUT A SALES
CHARGE. For your convenience, all dividends and distributions are
automatically reinvested in full and fractional shares of the Fund at NAV
without a sales charge. You may direct the Transfer Agent in writing not less
than 5 full business days prior to the record date to have subsequent
dividends and/or distributions sent in cash rather than reinvested. If you
hold shares through Prudential Securities, you should contact your financial
adviser.
. AUTOMATIC SAVINGS ACCUMULATION PLAN (ASAP). Under ASAP you may make
regular purchases of the Fund's shares in amounts as little as $50 via an
automatic debit to a bank account or Prudential Securities account (including
a Command Account). For additional information about this service, you may
contact your Prudential Securities financial adviser, Prusec representative or
the Transfer Agent directly.
. SYSTEMATIC WITHDRAWAL PLAN. A systematic withdrawal plan is available to
shareholders which provides for monthly or quarterly checks. Withdrawals of
Class B and Class C shares may be subject to a CDSC. See "How to Sell Your
Shares--Contingent Deferred Sales Charges."
. REPORTS TO SHAREHOLDERS. The Fund will send you annual and semi-annual
reports. The financial statements appearing in annual reports are audited by
independent accountants. In order to reduce duplicate mailing and printing
expenses, the Fund will provide one annual and semi-annual shareholder report
and annual prospectus per household. You may request additional copies of such
reports by calling (800) 225-1852 or by writing to the Fund at One Seaport
Plaza, New York, New York 10292. In addition, monthly unaudited financial data
are available upon request from the Fund.
. SHAREHOLDER INQUIRIES. Inquiries should be addressed to the Fund at One
Seaport Plaza, New York, New York 10292, or by telephone at (800) 225-1852
(toll-free) or, from outside the U.S.A., at (908) 417-7555 (collect).
For additional information regarding the services and privileges described
above, see "Shareholder Investment Account" in the Statement of Additional
Information.
32
<PAGE>
THE PRUDENTIAL MUTUAL FUND FAMILY
Prudential Mutual Fund Management offers a broad range of mutual funds
designed to meet your individual needs. We welcome you to review the
investment options available through our family of funds. For more information
on the Prudential Mutual Funds, including charges and expenses, contact your
Prudential Securities financial adviser or Prusec representative or telephone
the Funds at (800) 225-1852 for a free prospectus. Read the prospectus
carefully before you invest or send money.
TAXABLE BOND FUNDS
Prudential Adjustable Rate Securities Fund, Inc.
Prudential Diversified Bond Fund, Inc.
Prudential GNMA Fund, Inc.
Prudential Government Income Fund, Inc.
Prudential Government Securities Trust
Intermediate Term Series
Prudential High Yield Fund, Inc.
Prudential Structured Maturity Fund, Inc.
Income Portfolio
Prudential U.S. Government Fund
The BlackRock Government Income Trust
TAX-EXEMPT BOND FUNDS
Prudential California Municipal Fund
California Series
California Income Series
Prudential Municipal Bond Fund
High Yield Series
Insured Series
Modified Term Series
Prudential Municipal Series Fund
Arizona Series
Florida Series
Georgia Series
Hawaii Income Series
Maryland Series
Massachusetts Series
Michigan Series
Minnesota Series
New Jersey Series
New York Series
North Carolina Series
Ohio Series
Pennsylvania Series
Prudential National Municipals Fund, Inc.
GLOBAL FUNDS
Prudential Europe Growth Fund, Inc.
Prudential Global Fund, Inc.
Prudential Global Genesis Fund, Inc.
Prudential Global Natural Resources Fund, Inc.
Prudential Intermediate Global Income Fund, Inc.
Prudential Pacific Growth Fund, Inc.
Prudential Short-Term Global Income Fund, Inc.
Global Assets Portfolio
Short-Term Global Income Portfolio
Global Utility Fund, Inc.
EQUITY FUNDS
Prudential Allocation Fund
Conservatively Managed Portfolio
Strategy Portfolio
Prudential Equity Fund, Inc.
Prudential Equity Income Fund
Prudential Growth Opportunity Fund, Inc.
Prudential IncomeVertible(R) Fund, Inc.
Prudential Multi-Sector Fund, Inc.
Prudential Strategist Fund, Inc.
Prudential Utility Fund, Inc.
Nicholas-Applegate Fund, Inc.
Nicholas-Applegate Growth Equity Fund
MONEY MARKET FUNDS
.Taxable Money Market Funds
Prudential Government Securities Trust
Money Market Series
U.S. Treasury Money Market Series
Prudential Special Money Market Fund
Money Market Series
Prudential MoneyMart Assets
.Tax-Free Money Market Funds
Prudential Tax-Free Money Fund
Prudential California Municipal Fund
California Money Market Series
Prudential Municipal Series Fund
Connecticut Money Market Series
Massachusetts Money Market Series
New Jersey Money Market Series
New York Money Market Series
.Command Funds
Command Money Fund
Command Government Fund
Command Tax-Free Fund
.Institutional Money Market Funds
Prudential Institutional Liquidity Portfolio, Inc.
Institutional Money Market Series
A-1
<PAGE>
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<PAGE>
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<PAGE>
No dealer, sales representative or any other person has been authorized to give
any information or to make any representations, other than those contained in
this Prospectus, in connection with the offer contained herein, and, if given
or made, such other information or representations must not be relied upon as
having been authorized by the Fund or the Distributor. This Prospectus does not
constitute an offer by the Fund or by the Distributor to sell or a solicitation
of any offer to buy any of the securities offered hereby in any jurisdiction to
any person to whom it is unlawful to make such offer in such jurisdiction.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FUND HIGHLIGHTS............................................................ 2
Risk Factors and Special Characteristics.................................. 2
FUND EXPENSES.............................................................. 4
FINANCIAL HIGHLIGHTS....................................................... 5
HOW THE FUND INVESTS....................................................... 8
Investment Objective and Policies......................................... 8
Hedging Strategies........................................................ 10
Other Investments and Policies............................................ 13
Portfolio Management Techniques........................................... 14
Investment Restrictions................................................... 15
HOW THE FUND IS MANAGED.................................................... 15
Manager................................................................... 15
Distributor............................................................... 16
Portfolio Transactions.................................................... 19
Custodian and Transfer and
Dividend Disbursing Agent................................................ 19
HOW THE FUND VALUES ITS SHARES............................................. 19
HOW THE FUND CALCULATES PERFORMANCE........................................ 20
TAXES, DIVIDENDS AND DISTRIBUTIONS......................................... 20
GENERAL INFORMATION........................................................ 22
Description of Common Stock............................................... 22
Additional Information.................................................... 23
SHAREHOLDER GUIDE.......................................................... 23
How to Buy Shares of the Fund............................................. 23
Alternative Purchase Plan................................................. 24
How to Sell Your Shares................................................... 27
Conversion Feature--Class B Shares........................................ 29
How to Exchange Your Shares............................................... 30
Shareholder Services...................................................... 31
THE PRUDENTIAL MUTUAL FUND FAMILY.......................................... A-1
</TABLE>
- --------------------------------------------------------------------------------
MF104A 440011L
Class A: 743918 20 3
CUSIP Nos.: Class B: 743918 10 4
Class C: 743918 30 2
Prudential
National Municipals
Fund, Inc.
-------------------
Prudential Mutual Funds LOGO
BUILDING YOUR FUTURE
ON OUR STRENGTH SM
P R O S P E C T U S FEBRUARY 28, 1995
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
Statement of Additional Information
February 28, 1995
Prudential National Municipals Fund, Inc. (the Fund), is an open-end,
diversified management investment company whose investment objective is to
seek a high level of current income exempt from federal income taxes. In
attempting to achieve this objective, the Fund intends to invest substantially
all of its total assets in carefully selected long-term Municipal Bonds of
medium quality, i.e., obligations of issuers possessing adequate but not
outstanding capacities to service their debt. Subject to the limits described
herein, the Fund may also buy and sell financial futures for the purpose of
hedging its securities portfolio. There can be no assurance that the Fund's
investment objective will be achieved. See "Investment Objective and
Policies."
The Fund's address is One Seaport Plaza, New York, New York 10292, and its
telephone number is (800)225-1852.
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Fund's Prospectus, dated February 28, 1995, a
copy of which may be obtained from the Fund upon request at the address or
telephone noted above.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
CROSS-REFERENCE
TO PAGE IN
PAGE PROSPECTUS
---- ---------------
<S> <C> <C>
General Information....................................... B-2 22
Investment Objective and Policies......................... B-2 8
Investment Restrictions................................... B-6 15
Directors and Officers.................................... B-7 15
Manager................................................... B-9 15
Distributor............................................... B-11 16
Portfolio Transactions and Brokerage...................... B-13 19
Purchase and Redemption of Fund Shares.................... B-14 23
Shareholder Investment Account............................ B-17 31
Net Asset Value........................................... B-20 19
Taxes, Dividends and Distributions........................ B-20 20
Performance Information................................... B-22 20
Custodian and Transfer and Dividend Disbursing Agent and
Independent Accountants.................................. B-24 19
Financial Statements...................................... B-25 --
Report of Independent Accountants......................... B-37 --
Appendix A--Description of Tax-Exempt Security Ratings.... A-1 --
</TABLE>
- -------------------------------------------------------------------------------
MF 104B 4440201
<PAGE>
GENERAL INFORMATION
At a special meeting held on July 19, 1994, shareholders approved an
amendment to the Fund's Articles of Incorporation to change the Fund's name
from Prudential-Bache National Municipals Fund, Inc. to Prudential National
Municipals Fund, Inc.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to seek a high level of current
income exempt from federal income taxes. In attempting to achieve this
objective, the Fund intends to invest substantially all, and in any event at
least 80%, of its total assets in Municipal Bonds and Municipal Notes, except
in certain circumstances. From time to time the Fund may invest in Municipal
Bonds and Municipal Notes that are "private activity bonds" (as defined in the
Internal Revenue Code), the interest on which is a tax preference subject to
the alternative minimum tax. See "Taxes, Dividends and Distributions" in the
Prospectus. There can be no assurance that the Fund's investment objective
will be achieved. For a further description of the Fund's investment objective
and policies see "How the Fund Invests--Investment Objective and Policies" in
the Prospectus.
MUNICIPAL NOTES
For liquidity purposes, pending investment in Municipal Bonds, or on a
temporary or defensive basis due to market conditions, the Fund may invest in
tax-exempt short-term debt obligations (maturing in one year or less). These
obligations, known as "Municipal Notes," include tax, revenue and bond
anticipation notes which are issued to obtain funds for various public
purposes. The interest from these Notes is exempt from federal income taxes.
The Fund will limit its investments in Municipal Notes to (1) those which are
rated, at the time of purchase, within the three highest grades assigned by
Moody's Investors Service (Moody's) or the two highest grades assigned by
Standard & Poor's Ratings Group (S&P); (2) those of issuers having, at the
time of purchase, an issue of outstanding Municipal Bonds rated within the
four highest grades of Moody's or S&P; or (3) those which are guaranteed by
the U.S. Government, its agents or instrumentalities.
MUNICIPAL BONDS
Municipal Bonds include debt obligations of a state, a territory, or a
possession of the United States, or any political subdivision thereof (e.g.,
counties, cities, towns, villages, districts, authorities) or the District of
Columbia issued to obtain funds for various purposes, including the
construction of a wide range of public facilities such as airports, bridges,
highways, housing, hospitals, mass transportation, schools, streets and water
and sewer works. Other public purposes for which Municipal Bonds may be issued
include the refunding of outstanding obligations, obtaining funds for general
operating expenses and the obtaining of funds to loan to public or private
institutions for the construction of facilities such as education, hospital
and housing facilities. In addition, certain types of private activity bonds
may be issued by or on behalf of public authorities to obtain funds to provide
privately-operated housing facilities, sports facilities, convention or trade
show facilities, airport, mass transit, port or parking facilities, air or
water pollution control facilities and certain local facilities for water
supply, gas, electricity or sewage or solid waste disposal. Such obligations
are included within the term Municipal Bonds if the interest paid thereon is
at the time of issuance, in the opinion of the issuer's bond counsel, exempt
from federal income tax. The current federal tax laws, however, substantially
limit the amount of such obligations that can be issued in each state. See
"Taxes, Dividends and Distributions."
The two principal classifications of Municipal Bonds are "general
obligation" and limited obligation or "revenue" bonds. General obligation
bonds are secured by the issuer's pledge of its faith, credit and taxing power
for the payment of principal and interest, whereas revenue bonds are payable
only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise or other
specific revenue source. Private activity bonds that are Municipal Bonds are
in most cases revenue bonds and do not generally constitute the pledge of the
credit of the issuer of such bonds. The credit quality of private activity
revenue bonds is usually directly related to the credit standing of the
industrial user involved. There are, in addition, a variety of hybrid and
special types of municipal obligations as well as numerous differences in the
security of Municipal Bonds, both within and between the two principal
classifications described above.
The interest rates payable on certain Municipal Bonds and Municipal Notes
are not fixed and may fluctuate based upon changes in market rates. Municipal
Bonds and Notes of this type are called "variable rate" obligations. The
interest rate payable on a variable rate obligation is adjusted either at
predesignated intervals or whenever there is a change in the market rate of
interest on which the
B-2
<PAGE>
interest rate payable is based. Other features may include the right whereby
the Fund may demand prepayment of the principal amount of the obligation prior
to its stated maturity (a demand feature) and the right of the issuer to
prepay the principal amount prior to maturity. The principal benefit of a
variable rate obligation is that the interest rate adjustment minimizes
changes in the market value of the obligation. As a result, the purchase of
variable rate obligations should enhance the ability of the Fund to maintain a
stable net asset value per share and to sell an obligation prior to maturity
at a price approximating the full principal amount of the obligation. The
payment of principal and interest by issuers of certain Municipal Bonds and
Notes purchased by the Fund may be guaranteed by letters of credit or other
credit facilities offered by banks or other financial institutions. Such
guarantees will be considered in determining whether a Municipal Bond or Note
meets the Fund's investment quality requirements.
PURCHASE AND EXERCISE OF PUTS
Puts give the Fund the right to sell securities held in the Fund's portfolio
at a specified exercise price on a specified date. Puts or tender options may
be acquired to reduce the volatility of the market value of securities subject
to puts or tender options compared to the volatility of similar securities not
subject to puts or tender options. The acquisition of a put or tender option
may involve an additional cost to the Fund, compared to the cost of securities
with similar credit ratings, stated maturities and interest coupons but
without applicable puts or tender options. Such increased cost may be paid
either by way of an initial or periodic premium for the put or tender option
or by way of a higher purchase price for securities to which the put or tender
option is attached. In addition, there is a credit risk associated with the
purchase of puts or tender options in that the issuer of the put or tender
option may be unable to meet its obligation to purchase the underlying
security. Accordingly, the Fund will acquire puts or tender options under the
following circumstances: (1) the put or tender option is written by the issuer
of the underlying security and such security is rated within the four highest
quality grades as determined by Moody's or S&P; (2) the put or tender option
is written by a person other than the issuer of the underlying security and
such person has securities outstanding which are rated within such four
highest quality grades; or (3) the put or tender option is backed by a letter
of credit or similar financial guarantee issued by a person having securities
outstanding which are rated within the two highest quality grades of such
rating services.
PORTFOLIO TURNOVER
Although the Fund does not intend to engage in substantial short-term
trading, it may sell portfolio securities without regard to the length of time
that they have been held in order to take advantage of new investment
opportunities or yield differentials or because the Fund desires to preserve
gains or limit losses due to changing economic conditions or the financial
condition of the issuer. In order to seek a high level of current income, the
investment adviser intends to change the composition of the Fund's portfolio,
adjusting maturities and the quality and type of issue. Accordingly, it is
possible that the Fund's portfolio turnover rate may reach, or even exceed,
150%. A portfolio turnover rate of 150% may exceed that of other investment
companies with similar objectives. The portfolio turnover rate is computed by
dividing the lesser of the amount of the securities purchased or securities
sold (excluding all securities whose maturities at acquisition were one year
or less) by the average monthly value of such securities owned during the
year. A 100% turnover rate would occur, for example, if all of the securities
held in the Fund's portfolio were sold and replaced within one year. However,
when portfolio changes are deemed appropriate due to market or other
conditions, such turnover rate may be greater than anticipated. A higher rate
of turnover results in increased transaction costs to the Fund. For the years
ended December 31, 1993 and 1994 the Fund's portfolio turnover rates were 82%
and 120%, respectively.
FINANCIAL FUTURES CONTRACTS
The Fund will engage in transactions in financial futures contracts as a
hedge against interest rate related fluctuations in the value of securities
which are held in the Fund's portfolio or which the Fund intends to purchase.
The Fund will engage in such transactions consistent with the Fund's
investment objective. A clearing corporation associated with the commodities
exchange on which a futures contract trades assumes responsibility for the
completion of transactions and guarantees that open futures contracts will be
performed. Although interest rate futures contracts call for actual delivery
or acceptance of debt securities, in most cases the contracts are closed out
before the settlement date without the making or taking of delivery.
OPTIONS ON FINANCIAL FUTURES. The Fund may purchase and write put and call
options on futures contracts and enter into closing transactions with respect
to such options to terminate an existing position. The Fund will use options
on futures in connection with hedging strategies.
An option on a futures contract gives the purchaser the right, in return for
the premium paid, to assume a position in a futures contract (a long position
if the option is a call and a short position if the option is a put) at a
specified exercise price at any time during the period of the option. Upon
exercise of the option, the delivery of the futures position by the writer of
the option to the holder of the option will be accompanied by delivery of the
accumulated balance in the writer's futures margin account which
B-3
<PAGE>
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 an option is
exercised on the last trading day prior to the expiration date of the option,
the settlement will be made entirely in cash equal to the difference between
the exercise price of the option and the closing price of the futures contract
on the expiration date. Currently options can be purchased or written with
respect to futures contracts on U.S. Treasury Bonds and the Municipal Bond
Index on the Chicago Board of Trade. As with options on debt securities, the
holder or writer of an option may terminate its position by selling or
purchasing an option of the same series. There is no guaranty that such
closing transactions can be effected.
When the Fund hedges its portfolio by purchasing a put option, or writing a
call option, on a futures contract, it will own a long futures position or an
amount of debt securities corresponding to the open option position. When the
Fund writes a put option on a futures contract, it may, rather than establish
a segregated account, sell the futures contract underlying the put option or
purchase a similar put option. In instances involving the purchase of a call
option on a futures contract, the Fund will deposit in a segregated account
with the Fund's Custodian an amount in cash, cash equivalents or liquid, high-
grade, fixed-income securities equal to the market value of the obligation
underlying the futures contract, less any amount held in the initial and
variation margin accounts.
LIMITATIONS ON PURCHASE AND SALE. Under regulations of the Commodity
Exchange Act, investment companies registered under the Investment Company Act
of 1940 (the Investment Company Act) are exempt from the definition of
"commodity pool operator," subject to compliance with certain conditions. The
Fund will only engage in futures transactions for bona fide hedging purposes
in accordance with the rules of the Commodity Futures Trading Commission and
not for speculation. With respect to long positions assumed by the Fund, the
Fund will segregate with its Custodian an amount of cash, U.S. Government
securities or liquid, high grade debt securities so that the amount so
segregated plus the amount of initial and variation margin held in the account
of its broker equals the market value of the futures contracts, and thereby
insure that the use of futures contracts is unleveraged. The Fund will
continue to invest at least 80% of its total assets in Municipal Bonds and
Municipal Notes except in certain circumstances, as described in the
Prospectus under "How the Fund Invests--Investment Objective and Policies."
The Fund may not enter into futures contracts if, immediately thereafter, the
sum of the amount of initial and net cumulative variation margin on
outstanding futures contracts, together with premiums paid on options thereon,
would exceed 20% of the total assets of the Fund.
RISKS OF FINANCIAL FUTURES TRANSACTIONS. In addition to the risk associated
with predicting movements in the direction of interest rates, discussed in
"How the Fund Invests--Investment Objective and Policies" in the Prospectus,
there are a number of other risks associated with the use of financial futures
for hedging purposes.
Hedging involves the risk of imperfect correlation because changes in the
price of futures contracts only generally parallel but do not necessarily
equal changes in the prices of the securities being hedged. The risk of
imperfect correlation increases as the composition of the Fund's securities
portfolio diverges from the securities that are the subject of the futures
contract, for example, those included in the municipal index. Because the
change in price of the futures contract may be more or less than the change in
prices of the underlying securities, even a correct forecast of interest rate
changes may not result in a successful hedging transaction.
The Fund intends to purchase and sell futures contracts only on exchanges
where there appears to be a market in such futures sufficiently active to
accommodate the volume of its trading activity. There can be no assurance that
a liquid market will always exist for any particular contract at any
particular time. Accordingly, there can be no assurance that it will always be
possible to close a futures position when such closing is desired; and in the
event of adverse price movements, the Fund would continue to be required to
make daily cash payments of variation margin. However, in the event futures
contracts have been sold to hedge portfolio securities, such securities will
not be sold until the offsetting futures contracts can be executed. Similarly,
in the event futures have been bought to hedge anticipated securities
purchases, such purchases will not be executed until the offsetting futures
contracts can be sold.
The hours of trading of interest rate futures contracts may not conform to
the hours during which the Fund may trade Municipal Bonds. To the extent that
the futures markets close before the municipal bond market, significant price
and rate movements can take place that cannot be reflected in the futures
markets on a day-to-day basis.
RISKS OF TRANSACTIONS IN OPTIONS ON FINANCIAL FUTURES. In addition to the
risks which apply to all options transactions, there are several special risks
relating to options on futures. The ability to establish and close out
positions on such options will be subject to the maintenance of a liquid
secondary market. Compared to the sale of financial futures, the purchase of
put options on financial futures involves less potential risk to the Fund
because the maximum amount at risk is the premium paid for the options (plus
transaction costs). However, there may be circumstances when the purchase of a
put option on a financial future would result in a loss to the Fund when the
sale of a financial future would not, such as when there is no movement in the
price of debt securities.
B-4
<PAGE>
An option position may be closed out only on an exchange which provides a
secondary market for an option of the same series. Although the Fund generally
will purchase only those options for which there appears to be an active
secondary market, there is no assurance that a liquid secondary market on an
exchange will exist for any particular option, or at any particular time, and
for some options, no secondary market on an exchange may exist. In such event,
it might not be possible to effect closing transactions in particular options,
with the result that the Fund would have to exercise its options in order to
realize any profit and would incur transaction costs upon the sale of
underlying securities pursuant to the exercise of put options.
Reasons for the absence of a liquid secondary market on an exchange include
the following: (i) there may be insufficient trading interest in certain
options; (ii) restrictions may be imposed by an exchange on opening
transactions or closing transactions or both; (iii) trading halts, suspensions
or other restrictions may be imposed with respect to particular classes or
series of options or underlying securities; (iv) unusual or unforeseen
circumstances may interrupt normal operations on an exchange; (v) the
facilities of an exchange or the Options Clearing Corporation may not at all
times be adequate to handle current trading volume; or (vi) one or more
exchanges could, for economic or other reasons, decide or be compelled at some
future date to discontinue the trading of options (or a particular class or
series of options), in which event the secondary market on that exchange (or
in that class or series of options) would cease to exist, although outstanding
options on that exchange that had been issued by the Options Clearing
Corporation as a result of trades on that exchange could continue to be
exercisable in accordance with their terms.
There is no assurance that higher than anticipated trading activity or other
unforeseen events might not, at times, render certain of the facilities of the
Options Clearing Corporation inadequate, and thereby result in the institution
by an exchange of special procedures which may interfere with the timely
execution of customers' orders.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES
The Fund may purchase or sell Municipal Bonds or Notes on a when-issued or
delayed delivery basis. When-issued or delayed delivery transactions arise
when securities are purchased or sold by the Fund with payment and delivery
taking place 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. When-issued and delayed delivery transactions may not settle for
up to one year or more from the time of entering into such transactions. The
Fund bears the credit risk of the counter-party to the transaction until
settlement. Therefore, the credit quality and suitability of the issuer is
examined carefully prior to entering into such when-issued and delayed
delivery transactions. The Fund's Custodian will maintain, in a segregated
account of the Fund, cash, U.S. Government securities or other liquid high-
grade debt obligations having a value equal to or greater than the Fund's
purchase commitments; the Custodian will likewise segregate securities sold on
a delayed delivery basis.
ILLIQUID SECURITIES
The Fund may not invest more than 15% of its net assets in repurchase
agreements which have a maturity of longer than seven days or in other
illiquid securities, including securities that are illiquid by virtue of the
absence of a readily available market or contractual restrictions on resale.
Repurchase agreements subject to demand are deemed to have a maturity equal to
the notice period. Mutual funds do not typically hold a significant amount of
illiquid securities because of the potential for delays on resale and
uncertainty in valuation. Limitations on resale may have an adverse effect on
the marketability of portfolio securities and a mutual fund might be unable to
dispose of illiquid securities promptly or at reasonable prices and might
thereby experience difficulty satisfying redemptions within seven days.
Municipal lease obligations will not be considered illiquid for purposes of
the Fund's 15% limitation on illiquid securities provided the investment
adviser determines that there is a readily available market for such
securities. In reaching liquidity decisions, the investment adviser will
consider, inter alia, the following factors: (1) the frequency of trades and
quotes for the security; (2) the number of dealers wishing to purchase or sell
the security and the number of other potential purchasers; (3) dealer
undertakings to make a market in the security; and (4) the nature of the
security and the nature of the marketplace trades (e.g., the time needed to
dispose of the security, the method of soliciting offers and the mechanics of
the transfer). With respect to municipal lease obligations, the investment
adviser also considers: (1) the willingness of the municipality to continue,
annually or biannually, to appropriate funds for payment of the lease; (2) the
general credit quality of the municipality and the essentiality to the
municipality of the property covered by the lease; (3) in the case of unrated
municipal lease obligations, an analysis of factors similar to that performed
by nationally recognized statistical rating organizations in evaluating the
credit quality of a municipal lease obligation, including (i) whether the
lease can be cancelled; (ii) if applicable, what assurance there is that the
assets represented by the lease can be sold; (iii) the strength of the
lessee's general credit (e.g., its debt, administrative, economic and
financial characteristics); (iv) the likelihood that the municipality will
discontinue appropriating funding for the leased property because the property
is no longer deemed essential to the
B-5
<PAGE>
operations of the municipality (e.g., the potential for an event of
nonappropriation); (v) the legal recourse in the event of failure to
appropriate; and (4) any other factors unique to municipal lease obligations
as determined by the investment adviser.
INVESTMENT RESTRICTIONS
The following restrictions are fundamental policies. Fundamental policies
are those which cannot be changed without the approval of the holders of a
majority of the Fund's outstanding voting securities. A "majority of the
Fund's outstanding voting securities," when used in this Statement of
Additional Information, means the lesser of (i) 67% of the voting shares
represented at a meeting at which more than 50% of the outstanding voting
shares are present in person or represented by proxy or (ii) more than 50% of
the outstanding voting shares.
The Fund may not:
(1) Invest in securities other than Municipal Bonds and Notes (including
when-issued and delayed delivery purchases, and rights to resell Municipal
Bonds and Notes and financial futures contracts and options thereon) as
described under "Investment Objective and Policies" in the Prospectus and this
Statement of Additional Information.
(2) With respect to 75% of its total assets, invest more than 5% of the
market or other fair value of its total assets in the securities of any one
issuer (other than obligations of, or guaranteed by, the U.S. Government, its
agencies or instrumentalities). It is the current policy (but not a
fundamental policy) of the Fund not to invest more than 5% of the market or
other fair value of its total assets in the securities of any one issuer.
(3) Make short sales of securities.
(4) Purchase securities on margin, except for such short-term credits as are
necessary for the clearance of purchases and sales of portfolio securities and
margin payments in connection with transactions in financial futures
contracts.
(5) Issue senior securities, borrow money or pledge its assets, except that
the Fund may borrow up to 20% of the value of its total assets (calculated
when the loan is made) for temporary, extraordinary or emergency purposes or
for the clearance of transactions. The Fund may pledge up to 20% of the value
of its total assets to secure such borrowings. Secured borrowings may take the
form of reverse repurchase agreements, pursuant to which the Fund would sell
portfolio securities for cash and simultaneously agree to repurchase them at a
specified date for the same amount of cash plus an interest component. The
Fund would maintain, in a segregated account with its Custodian, liquid assets
equal in value to the amount owed. For purposes of this restriction,
obligations of the Fund to Directors pursuant to deferred compensation
arrangements, the purchase and sale of securities on a when-issued or delayed
delivery basis, the purchase and sale of financial futures contracts and
options and collateral arrangements with respect to margins for financial
futures contracts and with respect to options are not deemed to be the
issuance of a senior security or a pledge of assets.
(6) Engage in the underwriting of securities or purchase any securities as
to which registration under the Securities Act of 1933 would be required for
resale of such securities to the public.
(7) Purchase or sell real estate or real estate mortgage loans, although it
may purchase Municipal Bonds or Notes secured by interests in real estate.
(8) Make loans of money or securities. The purchase of a portion of an issue
of publicly distributed debt securities is not considered the making of a
loan.
(9) Purchase securities of other investment companies, except in connection
with a merger, consolidation, reorganization or acquisition of assets.
(10) Invest for the purpose of exercising control or management of another
company.
(11) Purchase or sell puts, calls, or combinations thereof, except that it
may obtain rights to resell Municipal Bonds and Notes and it may purchase and
sell puts and options on futures contracts as set forth under "Investment
Objective and Policies" in the Prospectus and this Statement of Additional
Information.
B-6
<PAGE>
(12) Purchase industrial revenue bonds if, as a result of such purchase,
more than 5% of total Fund assets would be invested in industrial revenue
bonds where payment of principal and interest are the responsibility of
companies with less than three years of operating history.
(13) Purchase or sell commodities or commodities futures contracts except
financial futures contracts and options thereon as described under "Investment
Objective and Policies" in the Prospectus and this Statement of Additional
Information.
(14) Invest more than 25% of the value of its total assets in securities
whose issuers are located in any one state.
Whenever any fundamental investment policy or investment restriction states
a maximum percentage of the Fund's assets, it is intended that if the
percentage limitation is met at the time the investment is made, a later
change in percentage resulting from changing total or net asset values will
not be considered a violation of such policy. However, in the event that the
Fund's asset coverage for borrowings falls below 300%, the Fund will take
prompt action to reduce its borrowings, as required by applicable law.
In order to comply with certain state "blue sky" restrictions, the Fund will
not as a matter of operating policy:
1. Purchase warrants if as a result the Fund would then have more than 5% of
its net assets (determined at the time of investment) invested in warrants.
Warrants will be valued at the lower of cost or market and investment in
warrants which are not listed on the New York Stock Exchange or American Stock
Exchange will be limited to 2% of the Fund's net assets (determined at the
time of investment). For the purpose of this limitation, warrants acquired in
units or attached to securities are deemed to be without value.
2. Invest in oil, gas and mineral leases.
3. Purchase the securities of any one issuer if, to the knowledge of the
Fund, any officer or director of the Fund or the Manager or Subadviser owns
more than 1/2 of 1% of the outstanding securities of such issuer, and such
officers and directors who own more than 1/2 of 1% own in the aggregate more
than 5% of the outstanding securities of such issuer.
4. Invest in securities of companies having a record, together with
predecessors, of less than three years of continuous operation, or securities
of issuers which are restricted as to disposition, if more than 15% of its
total assets would be invested in such securities. This restriction shall not
apply to mortgage-backed securities, asset-backed securities or obligations
issued or guaranteed by the U.S. Government, its agencies or
instrumentalities.
DIRECTORS AND OFFICERS
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATIONS
NAME, ADDRESS AND AGE POSITION WITH FUND DURING PAST 5 YEARS
- --------------------- ------------------ ---------------------
<S> <C> <C>
Delayne Dedrick Gold Director Marketing and Management Consultant.
(56)
c/o Prudential Mutual
Fund Management, Inc.
One Seaport Plaza
New York, New York
Arthur Hauspurg (69) Director Trustee and former President, Chief Executive Officer
c/o Prudential Mutual and Chairman of the Board of Consolidated Edison Com-
Fund Management, Inc. pany of New York, Inc.; Director of COMSAT Corp.
One Seaport Plaza
New York, New York
*Harry A. Jacobs, Jr. Director Senior Director (since January 1986) of Prudential Secu-
(73) rities Incorporated (Prudential Securities); formerly
One Seaport Plaza Interim Chairman and Chief Executive Officer of Pruden-
New York, New York tial Mutual Fund Management, Inc. (PMF) (June-September
1993); Chairman of the Board of Prudential Securities
(1982-1985) and Chairman of the Board and Chief Execu-
tive Officer of Bache Group Inc. (1977-1982); Trustee
of the Trudeau Institute; Director of the Center for
National Policy, The First Australia Fund, Inc., The
First Australia Prime Income Fund, Inc., The Global
Government Plus Fund, Inc. and The Global Total Return
Fund, Inc.
</TABLE>
B-7
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATIONS
NAME, ADDRESS AND AGE POSITION WITH FUND DURING PAST 5 YEARS
- --------------------- ------------------ ---------------------
<S> <C> <C>
*Lawrence C. McQuade President and Vice Chairman of PMF (since 1988); Managing Director,
(67) Director Investment Banking, Prudential Securities (1988-1991);
One Seaport Plaza Director of Quixote Corporation (since February 1992)
New York, New York and BUNZL, PLC (since June 1991); formerly, Director of
Crazy Eddie Inc. (1987-1990) and Kaiser Tech. Ltd.,
Kaiser Aluminum and Chemical Corp. (March 1987-November
1988); formerly Executive Vice President and Director
of WR Grace & Company; President and Director of The
Global Government Plus Fund, Inc., The Global Total Re-
turn Fund, Inc., and The High Yield Income Fund, Inc.
Stephen P. Munn (52) Director Chairman (since January 1994), Director and President
101 So. Salina St. (since 1988) and Chief Executive Officer (1988-December
Syracuse, New York 1993) of Carlisle Companies Incorporated.
*Richard A. Redeker (51) Director President, Chief Executive Officer and Director (since
One Seaport Plaza October 1993), Prudential Mutual Fund Management, Inc.
New York, New York (PMF); Executive Vice President, Director and Member of
the Operating Committee (since October 1993), Pruden-
tial Securities; Director (since October 1993) of Pru-
dential Securities Group, Inc.; Executive Vice Presi-
dent, The Prudential Investment Corporation (since July
1994); Director (since January 1994) of Prudential Mu-
tual Fund Distributors, Inc. (PMFD) and Prudential Mu-
tual Fund Services, Inc. (PMFS); formerly Senior Execu-
tive Vice President and Director of Kemper Financial
Services, Inc. (September 1978-September 1993); Direc-
tor of The Global Government Plus Fund, Inc., The
Global Total Return Fund, Inc. and The High Yield In-
come Fund, Inc.
Louis A. Weil, III (53) Director Publisher and Chief Executive Officer, Phoenix Newspa-
120 E. Van Buren pers, Inc. (since August 1991); Director of Central
Phoenix, Arizona Newspapers, Inc. (since September 1991); prior thereto,
Publisher of Time Magazine (May 1989-March 1991); for-
merly President, Publisher and Chief Executive Officer
of The Detroit News (February 1986-August 1989); for-
merly member of the Advisory Board, Chase Manhattan
Bank-Westchester; Director of The Global Government
Plus Fund, Inc.
David W. Drasnin (58) Vice President Vice President and Branch Manager of Prudential Securi-
39 Public Square ties.
Suite 500
Wilkes-Barre, Pennsylva-
nia
Robert F. Gunia (48) Vice President Chief Administrative Officer (since July 1990), Director
One Seaport Plaza (since January 1989), Executive Vice President, Trea-
New York, New York surer and Chief Financial Officer (since June 1987) of
PMF; Senior Vice President (since March 1987) of Pru-
dential Securities; Executive Vice President, Treasurer
and Comptroller (since March 1991) of PMFD and Director
(since June 1987) of PMFS; Vice President and Director
of The Asia Pacific Fund, Inc. (since May 1989).
Grace Torres (35) Treasurer and First Vice President (since March 1994) of PMF; First
One Seaport Plaza Principal Financial and Vice President (since March 1994) of PSI. Prior there-
New York, New York Accounting Officer to, Vice President, Bankers Trust
Company.
S. Jane Rose (49) Secretary Senior Vice President (since January 1991), Senior Coun-
One Seaport Plaza sel (since June 1987) and First Vice President (June
New York, New York 1987-December 1990) of PMF; Senior Vice President and
Senior Counsel of Prudential Securities (since July
1992); formerly Vice President and Associate General
Counsel of Prudential Securities.
Ronald Amblard (36) Assistant First Vice President (since January 1994) and Associate
One Seaport Plaza Secretary General Counsel (since January 1992) of PMF; Vice Pres-
New York, New York ident and Associate General Counsel of Prudential Secu-
rities (since January 1992); formerly, Assistant Gen-
eral Counsel (August 1988-December 1991), Associate
Vice President (January 1989-December 1990) and Vice
President (January 1991-December 1993) of PMF.
</TABLE>
- ---------
* "Interested" director, as defined in the Investment Company Act, by reason of
his affiliation with Prudential Securities or PMF.
B-8
<PAGE>
Directors and officers of the Fund are also trustees, Directors and officers
of some or all of the other investment companies distributed by Prudential
Securities Incorporated or Prudential Mutual Fund Distributors, Inc.
The officers conduct and supervise the daily business operations of the
Fund, while the directors, in addition to their functions set forth under
"Manager" and "Distributor," review such actions and decide on general policy.
The Fund pays each of its Directors who is not an affiliated person of PMF
or The Prudential Investment Corporation (PIC) annual compensation of $7,500,
in addition to certain out-of-pocket expenses. The Chairman of the Audit
Committee receives an additional $200 per year.
Directors may receive their Director's fee pursuant to a deferred fee
agreement with the Fund. Under the terms of the agreement, the Fund accrues
daily the amount of such Director's fee which accrue interest at a rate
equivalent to the prevailing rate applicable to 90-day U.S. Treasury Bills at
the beginning of each calendar quarter or, pursuant to an exemptive order of
the Securities and Exchange Commission (SEC), at the daily rate of return of
the Fund (the Fund rate). Payment of the interest so accrued is also deferred
and accruals become payable at the option of the Director. The Fund's
obligation to make payments of deferred Directors' fees, together with
interest thereon, is a general obligation of the Fund.
Pursuant to the Management Agreement with the Fund, the Manager pays all
compensation of officers and employees of the Fund as well as the fees and
expenses of all Directors of the Fund who are affiliated persons of the
Manager.
The following table sets forth the aggregate compensation paid by the Fund
for the fiscal year ended December 31, 1994 to the Directors who are not
affiliated with the Manager and the aggregate compensation paid to such
Directors for service on the Fund's board and that of all other funds managed
by Prudential Mutual Fund Management, Inc. (Fund Complex) for the calendar
year ended December 31, 1994.
COMPENSATION TABLE
<TABLE>
<CAPTION>
TOTAL
COMPENSATION
PENSION OR FROM FUND
RETIREMENT ESTIMATED AND FUND
AGGREGATE BENEFITS ACCRUED ANNUAL COMPLEX PAID
COMPENSATION AS PART OF FUND BENEFITS UPON TO DIRECTORS
NAME AND POSITION FROM FUND EXPENSES RETIREMENT
- ----------------------- ------------ ---------------- ------------- ------------
<S> <C> <C> <C> <C>
Delayne Dedrick Gold --
Director $7,700 None N/A $185,000(24)*
Arthur Hauspurg -- Di-
rector $7,500 None N/A $ 37,500(5)*
Stephen P. Munn -- Di-
rector $7,500 None N/A $ 40,000(6)*
Louis A. Weil, III --
Director $7,500 None N/A $ 97,500(12)*
</TABLE>
- ---------
* Indicated number of funds in Fund Complex (including the Fund) to which
aggregate compensation relates.
As of February 3, 1995, the Directors and officers of the Fund, as a group,
owned less than 1% of the outstanding common stock of the Fund.
As of February 3, 1995, the beneficial owners, directly or indirectly, of
more than 5% of the outstanding shares of any class of beneficial interest
were: Glenn A. Capalbo & Paula J. Evans & Susan M. Capalbo, 7A Eagle Run, East
Greenwich, RI, who held 2,725 Class C shares (27%), Temple Street Associates
2, 555 Long Wharf Drive, New Haven, CT, who held 4,716 Class C shares (48%),
Stephen W. Mullins & Deborah L. Mullins, 1132 Mulberry Circle, Charleston, WV,
who held 539 Class C shares (5%) and Ray Behrman & Carol Behrman, 8361 W.
Clubhouse Ln, Boise, ID, who held 1,609 (16%) Class C shares.
As of February 3, 1995, Prudential Securities was the record holder for
other beneficial owners of 10,851,364 Class A shares (or 33% of the
outstanding Class A shares) and 5,227,921 Class B shares (or 37% of the
outstanding Class B shares) and 7,448 Class C shares (or 75% of the
outstanding Class C shares) of the Fund. In the event of any meeting of
shareholders, Prudential Securities will forward, or cause the forwarding of,
proxy materials to the beneficial owners for which it is the record holder.
MANAGER
The manager of the Fund is Prudential Mutual Fund Management, Inc. (PMF or
the Manager), One Seaport Plaza, New York, New York 10292. PMF serves as
manager to substantially all of the other investment companies that, together
with the Fund, comprise the "Prudential Mutual Funds." See "How the Fund is
Managed" in the Prospectus. As of January 31, 1995, PMF managed and/or
administered open-end and closed-end management investment companies with
assets of approximately $45 billion. According to the Investment Company
Institute, as of April 30, 1994, the Prudential Mutual Funds were the 12th
largest family of mutual funds in the United States.
Pursuant to the Management Agreement with the Fund (the Management
Agreement), PMF, subject to the supervision of the Fund's Board of Directors
and in conformity with the stated policies of the Fund, manages both the
investment operations of the Fund and the composition of the Fund's portfolio,
including the purchase, retention, disposition and loan of securities. In
connection therewith, PMF is obligated to keep certain books and records of
the Fund. PMF also administers the Fund's corporate affairs and, in
B-9
<PAGE>
connection therewith, furnishes the Fund with office facilities, together with
those ordinary clerical and bookkeeping services which are not being furnished
by State Street Bank and Trust Company, the Fund's Custodian, and Prudential
Mutual Fund Services, Inc. (PMFS or the Transfer Agent), the Fund's transfer
and dividend disbursing agent. The management services of PMF for the Fund are
not exclusive under the terms of the Management Agreement and PMF is free to,
and does, render management services to others.
For its services, PMF receives, pursuant to the Management Agreement, a fee
at an annual rate of .50 of 1% of the Fund's average daily net assets up to
and including $250 million, .475 of 1% of the next $250 million, .45 of 1% of
the next $500 million, .425 of 1% of the next $250 million, .40 of 1% of the
next $250 million and .375 of 1% of the Fund's average daily net assets in
excess of $1.5 billion. The fee is computed daily and payable monthly. The
Management Agreement also provides that, in the event the expenses of the Fund
(including the fees of PMF, but excluding interest, taxes, brokerage
commissions, distribution fees and litigation and indemnification expenses and
other extraordinary expenses not incurred in the ordinary course of the Fund's
business) for any fiscal year exceed the lowest applicable annual expense
limitation established and enforced pursuant to the statutes or regulations of
any jurisdiction in which the Fund's shares are qualified for offer and sale,
the compensation due to PMF will be reduced by the amount of such excess.
Reductions in excess of the total compensation payable to PMF will be paid by
PMF to the Fund. No such reductions were required during the fiscal year ended
December 31, 1994. Currently, the Fund believes that the most restrictive
expense limitation of state securities commissions is 2 1/2% of the Fund's
average daily net assets up to $30 million, 2% of the next $70 million of such
assets and 1 1/2% of such assets in excess of $100 million.
In connection with its management of the corporate affairs of the Fund, PMF
bears the following expenses:
(a) the salaries and expenses of all of its and the Fund's personnel except
the fees and expenses of Directors who are not affiliated persons of PMF or
the Fund's investment adviser;
(b) all expenses incurred by PMF or by the Fund in connection with managing
the ordinary course of the Fund's business, other than those assumed by the
Fund as described below; and
(c) the costs and expenses payable to The Prudential Investment Corporation
(PIC) pursuant to the subadvisory agreement between PMF and PIC (the
Subadvisory Agreement).
Under the terms of the Management Agreement, the Fund is responsible for the
payment of the following expenses: (a) the fees payable to the Manager, (b)
the fees and expenses of Directors who are not affiliated persons of the
Manager or the Fund's investment adviser, (c) the fees and certain expenses of
the Custodian and Transfer and Dividend Disbursing Agent, including the cost
of providing records to the Manager in connection with its obligation of
maintaining required records of the Fund and of pricing the Fund's shares, (d)
the charges and expenses of legal counsel and independent accountants for the
Fund, (e) brokerage commissions and any issue or transfer taxes chargeable to
the Fund in connection with its securities transactions, (f) all taxes and
corporate fees payable by the Fund to governmental agencies, (g) the fees of
any trade associations of which the Fund may be a member, (h) the cost of
stock certificates representing shares of the Fund, (i) the cost of fidelity
and liability insurance, (j) the fees and expenses involved in registering and
maintaining registration of the Fund and of its shares with the Securities and
Exchange Commission, registering the Fund and qualifying its shares under
state securities laws, including the preparation and printing of the Fund's
registration statements and prospectuses for such purposes, (k) allocable
communications expenses with respect to investor services and all expenses of
shareholders' and Directors' meetings and of preparing, printing and mailing
reports, proxy statements and prospectuses to shareholders in the amount
necessary for distribution to the shareholders, (l) litigation and
indemnification expenses and other extraordinary expenses not incurred in the
ordinary course of the Fund's business and (m) distribution fees.
The Management Agreement provides that PMF will not be liable for any error
of judgment or for any loss suffered by the Fund in connection with the
matters to which the Management Agreement relates, except a loss resulting
from willful misfeasance, bad faith, gross negligence or reckless disregard of
duty. The Management Agreement provides that it will terminate automatically
if assigned, and that it may be terminated without penalty by either party
upon not more than 60 days' nor less than 30 days' written notice. The
Management Agreement will continue in effect for a period of more than two
years from the date of execution only so long as such continuance is
specifically approved at least annually in conformity with the Investment
Company Act. The Management Agreement was last approved by the Board of
Directors of the Fund, including a majority of the Directors who are not
parties to the contract or interested persons of any such party as defined in
the Investment Company Act on May 2, 1994 and by shareholders of the Fund on
April 28, 1988.
For the fiscal years ended December 31, 1994, 1993 and 1992, the Fund paid
PMF management fees of $3,633,518, $4,087,672 and $3,946,039, respectively.
B-10
<PAGE>
PMF has entered into the Subadvisory Agreement with PIC (the Subadviser), a
wholly-owned subsidiary of The Prudential Insurance Company of America
(Prudential). The Subadvisory Agreement provides that PIC will furnish
investment advisory services in connection with the management of the Fund. In
connection therewith, PIC is obligated to keep certain books and records of
the Fund. PMF continues to have responsibility for all investment advisory
services pursuant to the Management Agreement and supervises PIC's performance
of such services. PIC is reimbursed by PMF for the reasonable costs and
expenses incurred by PIC in furnishing those services.
The Subadvisory Agreement was last approved by the Board of Directors,
including a majority of the Directors who are not parties to such contracts or
interested persons of such parties as defined in the Investment Company Act,
on May 2, 1994, and by shareholders of the Fund on April 28, 1988.
The Subadvisory Agreement provides that it will terminate in the event of
its assignment (as defined in the Investment Company Act) or upon the
termination of the Management Agreement. The Subadvisory Agreement may be
terminated by the Fund, PMF or PIC upon not more than 60 days', nor less than
30 days', written notice. The Subadvisory Agreement provides that it will
continue in effect for a period of more than two years from its execution only
so long as such continuance is specifically approved at least annually in
accordance with the requirements of the Investment Company Act.
The Manager and the Subadviser are subsidiaries of Prudential which, as of
December 31, 1993, was one of the largest financial institutions in the world
and the largest insurance company in North America. Prudential has been
engaged in the insurance business since 1875. In July 1994, Institutional
Investor ranked Prudential the second largest institutional money manager of
the 300 largest money management organizations in the United States as of
December 31, 1993.
DISTRIBUTOR
Prudential Mutual Fund Distributors, Inc. (PMFD), One Seaport Plaza, New
York, New York 10292, acts as the distributor of the Class A shares of the
Fund. Prudential Securities Incorporated, One Seaport Plaza, New York, New
York 10292 (Prudential Securities or PSI), acts as the distributor of the
Class B and Class C shares of the Fund.
Pursuant to separate Distribution and Service Plans (the Class A Plan, the
Class B Plan and the Class C Plan, collectively the Plans) adopted by the Fund
under Rule 12b-1 under the Investment Company Act and separate distribution
agreements (the Distribution Agreements), PMFD and Prudential Securities
(collectively the Distributor) incur the expenses of distributing the Fund's
Class A, Class B and Class C shares, respectively. See "How the Fund is
Managed--Distributor" in the Prospectus.
Prior to January 22, 1990, the Fund offered only one class of shares (the
then existing Class B shares). On October 6, 1989, the Board of Directors,
including a majority of the Directors who are not interested persons of the
Fund and who have no direct or indirect financial interest in the operation of
the Class A or Class B Plan or in any agreement related to either Plan (the
Rule 12b-1 Directors), at a meeting called for the purpose of voting on each
Plan, adopted a new plan of distribution for the Class A shares of the Fund
(the Class A Plan) and approved an amended and restated plan of distribution
with respect to the Class B shares of the Fund (the Class B Plan). On February
8, 1993, the Board of Directors, including a majority of the Rule 12b-1
Directors, at a meeting called for the purpose of voting on each Plan,
approved modifications to the Fund's Class A and Class B Plans and
Distribution Agreements to conform them to recent amendments to the National
Association of Securities Dealers, Inc. (NASD) maximum sales charge rule
described below. As so modified, the Class A Plan provides that (i) up to .25
of 1% of the average daily net assets of the Class A shares may be used to pay
for personal service and the maintenance of shareholder accounts (service fee)
and (ii) total distribution fees (including the service fee of .25 of 1%) may
not exceed .30 of 1%. As so modified, the Class B Plan provides that (i) up to
.25 of 1% of the average daily net assets of the Class B shares may be paid as
a service fee and (ii) up to .50 of 1% (including the service fee) of the
average daily net assets of the Class B shares (asset-based sales charge) may
be used as reimbursement for distribution-related expenses with respect to the
Class B shares. On May 3, 1993, the Board of Directors, including a majority
of the Rule 12b-1 Directors, at a meeting called for the purpose of voting on
each Plan, adopted a plan of distribution for the Class C shares of the Fund
and approved further amendments to the plans of distribution for the Fund's
Class A and Class B shares changing them from reimbursement type plans to
compensation type plans. The Plans were last approved by the Board of
Directors, including a majority of the Rule 12b-1 Directors, on May 2, 1994.
The Class A Plan, as amended, was approved by the Class A and Class B
shareholders and the Class B Plan, as amended, was approved by Class B
shareholders on July 19, 1994. The Class C Plan was approved by the sole
shareholder of Class C shares on August 1, 1994.
CLASS A PLAN. For the fiscal year ended December 31, 1994, PMFD received
payments of approximately $14,116 under the Class A Plan. This amount was
primarily expended on commission credits to Prudential Securities and Prusec
for payment of account
B-11
<PAGE>
servicing fees to financial advisers and other persons who sell Class A
shares. For the fiscal year ended December 31, 1994,PMFD also received
approximately $92,500 in initial sales charges.
CLASS B PLAN. For the fiscal year ended December 31, 1994, Prudential
Securities received $3,758,114 from the Fund under the Plan. It is estimated
that the Distributor spent approximately $2,592,900 in distributing the Fund's
Class B shares, on behalf of the Fund during the year ended December 31, 1994.
It is estimated that of this amount approximately $3,400 (0.1%) was spent on
printing and mailing of prospectuses to other than current shareholders;
$930,300 (35.9%) on compensation to Prusec, an affiliated broker-dealer, for
commissions to its representatives and other expenses, including an allocation
of overhead and other branch office distribution-related expenses, incurred by
it for distribution of Fund shares; $422,200 (16.3%) on interest and/or
carrying costs; and $1,237,000 (47.7%) on the aggregate of (i) payments of
commissions to financial advisers ($923,900 or 35.6%) and (ii) an allocation
on account of overhead and other branch office distribution-related expenses
($313,100 or 12.1%). The term "overhead and other branch office distribution-
related expenses" represents (a) the expenses of operating the Prudential
Securities' branch offices in connection with the sale of Fund shares,
including lease costs, the salaries and employee benefits of operations and
sales support personnel, utility costs, communications costs and the costs of
stationery and supplies, (b) the costs of client sales seminars, (c) expenses
of mutual fund sales coordinators to promote the sale of Fund shares and (d)
other incidental expenses relating to branch promotion of Fund sales.
Prudential Securities also receives the proceeds of contingent deferred
sales charges paid by holders of Class B shares upon certain redemptions of
Class B shares. See "Shareholder Guide--How to Sell Your Shares--Contingent
Deferred Sales Charge " in the Prospectus. The amount of distribution expenses
reimbursable by the Class B shares of the Fund is reduced by the amount of
such contingent deferred sales charges. For the fiscal year ended December 31,
1994, Prudential Securities received approximately $976,100 in contingent
deferred sales charges.
CLASS C PLAN. Prudential Securities receives the proceeds of contingent
deferred sales charges paid by investors upon certain redemptions of Class C
shares. See "Shareholder Guide--How to Sell Your Shares--Contingent Deferred
Sales Charges" in the Prospectus. For the period August 1, 1994 (inception of
Class C shares) through December 31, 1994, Prudential Securities did not
receive any contingent deferred sales charges.
The Class A, Class B and Class C Plans continue in effect from year to year,
provided that each such continuance is approved at least annually by a vote of
the Board of Directors, including a majority vote of the Rule 12b-1 Directors,
cast in person at a meeting called for the purpose of voting on such
continuance. The Plans may each be terminated at any time, without penalty, by
the vote of a majority of the Rule 12b-1 Directors or by the vote of the
holders of a majority of the outstanding shares of the applicable class on not
more than 60 days' written notice to any other party to the Plans. Neither
Plan may be amended to increase materially the amounts to be spent for the
services described therein without approval by the shareholders of the
applicable class (by both Class A and Class B shareholders, voting separately,
in the case of material amendments to the Class A Plan), and all material
amendments are required to be approved by the Board of Directors in the manner
described above. Each Plan will automatically terminate in the event of its
assignment. The Fund will not be contractually obligated to pay expenses
incurred under any Plan if it is terminated or not continued.
Pursuant to each Plan, the Board of Directors will review at least quarterly
a written report of the distribution expenses incurred on behalf of each class
of shares of the Fund by the Distributor. The report will include an
itemization of the distribution expenses and the purposes of such
expenditures. In addition, as long as the Plans remain in effect, the
selection and nomination of the Rule 12b-1 Directors shall be committed to the
Rule 12b-1 Directors.
Pursuant to each Distribution Agreement, the Fund has agreed to indemnify
PMFD and Prudential Securities to the extent permitted by applicable law
against certain liabilities under the Securities Act of 1933, as amended. Each
Distribution Agreement was last approved by the Board of Directors, including
a majority of the Rule 12b-1 Directors, on May 2, 1994.
NASD MAXIMUM SALES CHARGE RULE. Pursuant to rules of the NASD, the
Distributor is required to limit aggregate initial sales charges, deferred
sales charges and asset-based sales charges to 6.25% of total gross sales of
each class of shares. Interest charges on unreimbursed distribution expenses
equal to the prime rate plus one percent per annum may be added to the 6.25%
limitation. Sales from the reinvestment of dividends and distributions are not
included in the calculation of the 6.25% limitation. The annual asset-based
sales charge on shares of the Fund may not exceed .75 of 1% per class. The
6.25% limitation applies to the Fund rather than on a per shareholder basis.
If aggregate sales charges were to exceed 6.25% of total gross sales of any
class, all sales charges on shares of that class would be suspended.
On October 21, 1993, PSI entered into an omnibus settlement with the SEC,
state securities regulators in 51 jurisdictions and the NASD to resolve
allegations that PSI sold interests in more than 700 limited partnerships (and
a limited number of other types of
B-12
<PAGE>
securities) from January 1, 1980 through December 31, 1990, in violation of
securities laws to persons for whom such securities were not suitable in light
of the individuals' financial condition or investment objectives. It was also
alleged that the safety, potential returns and liquidity of the investments
had been misrepresented. The limited partnerships principally involved real
estate, oil and gas producing properties and aircraft leasing ventures. The
SEC Order (i) included findings that PSI's conduct violated the federal
securities laws and that an order issued by the SEC in 1986 requiring PSI to
adopt, implement and maintain certain supervisory procedures had not been
complied with; (ii) directed PSI to cease and desist from violating the
federal securities laws and imposed a $10 million civil penalty; and (iii)
required PSI to adopt certain remedial measures including the establishment of
a Compliance Committee of its Board of Directors. Pursuant to the terms of the
SEC settlement, PSI established a settlement fund in the amount of
$330,000,000 and procedures, overseen by a court approved Claims
Administrator, to resolve legitimate claims for compensatory damages by
purchasers of the partnership interests. PSI has agreed to provide additional
funds, if necessary, for that purpose. PSI's settlement with the state
securities regulators included an agreement to pay a penalty of $500,000 per
jurisdiction. PSI consented to a censure and to the payment of a $5,000,000
fine in settling the NASD action. In settling the above referenced matters,
PSI neither admitted nor denied the allegations asserted against it.
On January 18, 1994, PSI agreed to the entry of a Final Consent Order and a
Parallel Consent Order by the Texas Securities Commissioner. The firm also
entered into a related agreement with the Texas Securities Commissioner. The
allegations were that the firm had engaged in improper sales practices and
other improper conduct resulting in pecuniary losses and other harm to
investors residing in Texas with respect to purchases and sales of limited
partnership interests during the period of January 1, 1980 through December
31, 1990. Without admitting or denying the allegations, PSI consented to a
reprimand, agreed to cease and desist from future violations, and to provide
voluntary donations to the State of Texas in the aggregate amount of
$1,500,000. The firm agreed to suspend the creation of new customer accounts,
the general solicitation of new accounts, and the offer for sale of securities
in or from PSI's North Dallas office to new customers during a period of
twenty consecutive business days, and agreed that its other Texas offices
would be subject to the same restrictions for a period of five consecutive
business days. PSI also agreed to institute training programs for its
securities salesmen in Texas.
On October 27, 1994, Prudential Securities Group, Inc. and PSI entered into
agreements with the United States Attorney deferring prosecution (provided PSI
complies with the terms of the agreement for three years) for any alleged
criminal activity related to the sale of certain limited partnership programs
from 1983 to 1990. In connection with these agreements, PSI agreed to add the
sum of $330,000,000 to the Fund established by the SEC and executed a
stipulation providing for a reversion of such funds to the United States
Postal Inspection Service. PSI further agreed to obtain a mutually acceptable
outside director to sit on the Board of Directors of PSG and the Compliance
Committee of PSI. The new director will also serve as an independent
"ombudsman" whom PSI employees can call anonymously with complaints about
ethics and compliance. Prudential Securities shall report any allegations or
instances of criminal conduct and material improprieties to the new director.
The new director will submit compliance reports which shall identify all such
allegations or instances of criminal conduct and material improprieties every
three months for a three-year period.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Manager is responsible for decisions to buy and sell securities and
futures contracts for the Fund, the selection of brokers, dealers and futures
commission merchants to effect the transactions and the negotiation of
brokerage commissions, if any. The term "Manager" as used in this section
includes the "Subadviser." Fixed-income securities are generally traded on a
"net" basis with dealers acting as principal for their own accounts without a
stated commission, although the price of the security usually includes a
profit to the dealer. In underwritten offerings, securities are purchased at a
fixed price which includes an amount of compensation to the underwriter,
generally referred to as the underwriter's concession or discount. The Fund
will not deal with Prudential Securities in any transaction in which
Prudential Securities acts as principal. Purchases and sales of securities on
a securities exchange, while infrequent, and purchases and sales of futures on
a commodities exchange or board of trade will be effected through brokers who
charge a commission for their services. Orders may be directed to any broker
including, to the extent and in the manner permitted by applicable law,
Prudential Securities and its affiliates.
In placing orders for portfolio securities of the Fund, the Manager is
required to give primary consideration to obtaining the most favorable price
and efficient execution. This means that the Manager will seek to execute each
transaction at a price and commission, if any, which provide the most
favorable total cost or proceeds reasonably attainable in the circumstances.
While the Manager generally seeks reasonably competitive spreads or
commissions, the Fund will not necessarily be paying the lowest spread or
commission available. Within the framework of the policy of obtaining most
favorable price and efficient execution, the Manager will consider research
and investment services provided by brokers or dealers who effect or are
parties to portfolio transactions of the Fund, the Manager or the Manager's
other clients. Such research and investment services are those which brokerage
houses
B-13
<PAGE>
customarily provide to institutional investors and include statistical and
economic data and research reports on particular companies and industries.
Such services are used by the Manager in connection with all of its investment
activities, and some of such services obtained in connection with the
execution of transactions for the Fund may be used in managing other
investment accounts. Conversely, brokers furnishing such services may be
selected for the execution of transactions of such other accounts, whose
aggregate assets are larger than the Fund, and the services furnished by such
brokers may be used by the Manager in providing investment management for the
Fund. Commission rates are established pursuant to negotiations with the
broker based on the quality and quantity of execution services provided by the
broker in light of generally prevailing rates. The Manager's policy is to pay
higher commissions to brokers, other than Prudential Securities, for
particular transactions than might be charged if a different broker had been
selected, on occasions when, in the Manager's opinion, this policy furthers
the objective of obtaining best price and execution. In addition, the Manager
is authorized to pay higher commissions on brokerage transactions for the Fund
to brokers other than Prudential Securities in order to secure research and
investment services described above, subject to the primary consideration of
obtaining the most favorable price and efficient execution in the
circumstances and subject to review by the Fund's Board of Directors from time
to time as to the extent and continuation of this practice. The allocation of
orders among brokers and the commission rates paid are reviewed periodically
by the Board of Directors. Portfolio securities may not be purchased from any
underwriting or selling syndicate of which Prudential Securities (or any
affiliate), during the existence of the syndicate, is a principal underwriter
(as defined in the Investment Company Act), except in accordance with rules of
the SEC. This limitation, in the opinion of the Fund, will not significantly
affect the Fund's ability to pursue its present investment objective. However,
in the future in other circumstances, the Fund may be at a disadvantage
because of this limitation in comparison to other funds with similar
objectives but not subject to such limitations.
Subject to the above considerations, the Manager may use Prudential
Securities as a broker or futures commission merchant for the Fund. In order
for Prudential Securities (or any affiliate) to effect any portfolio
transactions for the Fund on an exchange or board of trade, the commissions,
fees or other remuneration received by Prudential Securities (or any
affiliate) must be reasonable and fair compared to the commissions, fees or
other remuneration paid to other brokers or futures commission merchants in
connection with comparable transactions involving similar securities or
futures contracts being purchased or sold on a securities exchange or board of
trade during a comparable period of time. This standard would allow Prudential
Securities (or any affiliate) to receive no more than the remuneration which
would be expected to be received by an unaffiliated broker or futures
commission merchant in a commensurate arm's-length transaction. Furthermore,
the Board of Directors of the Fund, including a majority of the noninterested
Directors has adopted procedures which are reasonably designed to provide that
any commissions, fees or other remuneration paid to Prudential Securities (or
any affiliate) are consistent with the foregoing standard. In accordance with
Section 11(a) of the Securities Exchange Act of 1934, Prudential Securities
may not retain compensation for effecting transactions on a national
securities exchange for the Fund unless the Fund has expressly authorized the
retention of such compensation. Prudential Securities must furnish to the Fund
at least annually a statement setting forth the total amount of all
compensation retained by Prudential Securities from transactions effected for
the Fund during the applicable period. Brokerage transactions with Prudential
Securities (or any affiliate) are also subject to such fiduciary standards as
may be imposed upon Prudential Securities (or such affiliate) by applicable
law.
The Fund paid no brokerage commissions to Prudential Securities for the
fiscal years ended December 31, 1992, 1993 and 1994.
PURCHASE AND REDEMPTION OF FUND SHARES
Shares of the Fund may be purchased at a price equal to the next determined
net asset value per share plus a sales charge which, at the election of the
investor, may be imposed either (i) at the time of purchase (Class A shares)
or (ii) on a deferred basis (Class B or Class C shares). See "Shareholder
Guide" in the Prospectus.
Each class of shares represents an interest in the same portfolio of
investments of the Fund and has the same rights, except that (i) each class
bears the separate expenses of its Rule 12b-1 distribution and service plan,
(ii) each class has exclusive voting rights with respect to its plan (except
that the Fund has agreed with the SEC in connection with the offering of a
conversion feature on Class B shares to submit any amendment of the Class A
distribution and service plan to both Class A and Class B shareholders) and
(iii) only Class B shares have a conversion feature. See "Distributor." Each
class also has separate exchange privileges. See "Shareholder Investment
Account--Exchange Privilege."
B-14
<PAGE>
SPECIMEN PRICE MAKE-UP
Under the current distribution arrangements between the Fund and the
Distributor, Class A shares of the Fund are sold at a maximum sales charge of
3% and Class B* and Class C* shares of the Fund are sold at net asset value.*
Using the Fund's net asset value at December 31, 1994, the maximum offering
price of the Fund's shares is as follows:
<TABLE>
<CAPTION>
CLASS A
<S> <C>
Net asset value and redemption price per Class A share............ $14.42
------
Maximum sales charge (3% of offering price)....................... .45
------
Offering price to public.......................................... $14.87
======
<CAPTION>
CLASS B
<S> <C>
Net asset value, offering price and redemption price per Class B
share*........................................................... $14.45
======
<CAPTION>
CLASS C
<S> <C>
Net asset value, offering price and redemption price per Class C
share*........................................................... $14.44
======
</TABLE>
---------
*Class B and Class C shares are subject to a contingent
deferred sales charge on certain redemptions. See
"Shareholder Guide--How to Sell Your Shares--Contingent
Deferred Sales Charges" in the Prospectus.
REDUCTION AND WAIVER OF INITIAL SALES CHARGES--CLASS A SHARES
COMBINED PURCHASE AND CUMULATIVE PURCHASE PRIVILEGE. If an investor or
eligible group of related investors purchases Class A shares of the Fund
concurrently with Class A shares of other Prudential Mutual Funds, the
purchases may be combined to take advantage of the reduced sales charges
applicable to larger purchases. See the table of breakpoints under
"Shareholder Guide--Alternative Purchase Plan" in the Prospectus.
An eligible group of related Fund investors includes any combination of the
following:
(a) an individual;
(b) the individual's spouse, their children and their parents;
(c) the individual's and spouse's Individual Retirement Account (IRA);
(d) any company controlled by the individual (a person, entity or group that
holds 25% or more of the outstanding voting securities of a company will be
deemed to control the company, and a partnership will be deemed to be
controlled by each of its general partners);
(e) a trust created by the individual, the beneficiaries of which are the
individual, his or her spouse, parents or children;
(f) a Uniform Gifts to Minors Act/Uniform Transfers to Minors Act account
created by the individual or the individual's spouse; and
(g) one or more employee benefit plans of a company controlled by an
individual.
In addition, an eligible group of related Fund investors may include an
employer (or group of related employers) and one or more qualified retirement
plans of such employer or employers (an employer controlling, controlled by or
under common control with another employer is deemed related to that
employer).
The Distributor must be notified at the time of purchase that the investor
is entitled to a reduced sales charge. The reduced sales charges will be
granted subject to confirmation of the investor's holdings. The Combined
Purchase and Cumulative Purchase Privilege does not apply to individual
participants in any retirement or group plans.
RIGHTS OF ACCUMULATION. Reduced sales charges are also available through
Rights of Accumulation, under which an investor or an eligible group of
related investors, as described above under "Combined Purchase and Cumulative
Purchase Privilege," may aggregate the value of their existing holdings of the
Class A shares of the Fund and Class A shares of other Prudential Mutual Funds
(excluding money market funds other than those acquired pursuant to the
exchange privilege) to determine the reduced sales charge. However, the value
of shares held directly with the Transfer Agent and through Prudential
Securities will not be aggregated to
B-15
<PAGE>
determine the reduced sales charge. All shares must be held either directly
with the Transfer Agent or through Prudential Securities. The value of
existing holdings for purposes of determining the reduced sales charge is
calculated using the maximum offering price (net asset value plus maximum
sales charge) as of the previous business day. See "How the Fund Values its
Shares" in the Prospectus. The Distributor must be notified at the time of
purchase that the investor is entitled to a reduced sales charge. The reduced
sales charges will be granted subject to confirmation of the investor's
holdings. Rights of Accumulation are not available to individual participants
in any retirement or group plans.
LETTERS OF INTENT. Reduced sales charges are also available to investors (or
an eligible group of related investors) who enter into a written Letter of
Intent providing for the purchase, within a thirteen-month period, of shares
of the Fund and shares of other Prudential Mutual Funds. All shares of the
Fund and shares of other Prudential Mutual Funds (excluding money market funds
other than those acquired pursuant to the exchange privilege) which were
previously purchased and are still owned are also included in determining the
applicable reduction. However, the value of shares held directly with the
Transfer Agent and through Prudential Securities will not be aggregated to
determine the reduced sales charge. All shares must be held either directly
with the Transfer Agent or through Prudential Securities. The Distributor must
be notified at the time of purchase that the investor is entitled to a reduced
sales charge. The reduced sales charges will be granted subject to
confirmation of the investor's holdings. Letters of Intent are not available
to individual participants in any retirement or group plans.
A Letter of Intent permits a purchaser to establish a total investment goal
to be achieved by any number of investments over a thirteen-month period. Each
investment made during the period will receive the reduced sales charge
applicable to the amount represented by the goal, as if it were a single
investment. Escrowed Class A shares totaling 5% of the dollar amount of the
Letter of Intent will be held by the Transfer Agent in the name of the
purchaser. The effective date of a Letter of Intent may be back-dated up to 90
days, in order that any investments made during this 90-day period, valued at
the purchaser's cost, can be applied to the fulfillment of the Letter of
Intent goal.
The Letter of Intent does not obligate the investor to purchase, nor the
Fund to sell, the indicated amount. In the event the Letter of Intent goal is
not achieved within the thirteen-month period, the purchaser is required to
pay the difference between the sales charge otherwise applicable to the
purchases made during this period and sales charges actually paid. Such
payment may be made directly to the Distributor or, if not paid, the
Distributor will liquidate sufficient escrowed shares to obtain such
difference. Investors electing to purchase Class A shares of the Fund pursuant
to a Letter of Intent should carefully read such Letter of Intent.
WAIVER OF THE CONTINGENT DEFERRED SALES CHARGE--CLASS B SHARES
The Contingent Deferred Sales Charge is waived under circumstances described
in the Prospectus. See "Shareholder Guide--How to Sell Your Shares--Waiver of
Contingent Deferred Sales Charges--Class B Shares" in the Prospectus. In
connection with these waivers, the Transfer Agent will require you to submit
the supporting documentation set forth below.
<TABLE>
<CAPTION>
CATEGORY OF WAIVER REQUIRED DOCUMENTATION
- ------------------ ----------------------
<S> <C>
Death A copy of the shareholder's death certifi-
cate or, in the case of a trust, a copy of
the grantor's death certificate, plus a
copy of the trust agreement identifying the
grantor.
Disability--An individual will be A copy of the Social Security Administra-
considered disabled if he or she tion award letter or a letter from a physi-
is unable to engage in any sub- cian on the physician's letterhead stating
stantial gainful activity by that the shareholder (or, in the case of a
reason of any medically determin- trust, the grantor) is permanently disa-
able physical or mental impairment bled. The letter must also indicate the
which can be expected to result in date of disability.
death or to be of long-continued
and indefinite duration.
</TABLE>
The Transfer Agent reserves the right to request such additional documents
as it may deem appropriate.
QUANTITY DISCOUNT--CLASS B SHARES PURCHASED PRIOR TO AUGUST 1, 1994
The CDSC is reduced on redemptions of Class B shares of the Fund purchased
prior to August 1, 1994 if immediately after a purchase of such shares, the
aggregate cost of all Class B shares of the Fund owned by you in a single
account exceeded $500,000. For example, if you purchased $100,000 of Class B
shares of the Fund and the following year purchase an additional $450,000 of
Class B shares with the result that the aggregate cost of your Class B shares
of the Fund following the second purchase was $550,000, the quantity discount
would be available for the second purchase of $450,000 but not for the first
purchase of $100,000.
B-16
<PAGE>
The quantity discount will be imposed at the following rates depending on
whether the aggregate value exceeded $500,000 or $1 million:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED SALES CHARGE
AS A PERCENTAGE OF DOLLARS INVESTED
OR REDEMPTION PROCESS
--------------------------------------
YEAR SINCE PURCHASE
PAYMENT MADE $500,001 TO $1 MILLION OVER $1 MILLION
------------------- ---------------------- ---------------
<S> <C> <C>
First................................. 3.0% 2.0%
Second................................ 2.0% 1.0%
Third................................. 1.0% 0%
Fourth and thereafter................. 0% 0%
</TABLE>
You must notify the Fund's Transfer Agent either directly or through
Prudential Securities or Prusec, at the time of redemption, that you are
entitled to the reduced CDSC. The reduced CDSC will be granted subject to
confirmation of your holdings.
SHAREHOLDER INVESTMENT ACCOUNT
Upon the initial purchase of Fund shares, a Shareholder Investment Account
is established for each investor under which a record of the shares held is
maintained by the Transfer Agent. If a share certificate is desired, it must
be requested in writing for each transaction. Certificates are issued only for
full shares and may be redeposited in the Account at any time. There is no
charge to the investor for issuance of a certificate. The Fund makes available
to the shareholders the following privileges and plans.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND/OR DISTRIBUTIONS
For the convenience of investors, all dividends and distributions are
automatically reinvested in full and fractional shares of the Fund at net
asset value per share. An investor may direct the Transfer Agent in writing
not less than five full business days prior to the record date to have
subsequent dividends and/or distributions sent to him or her in cash rather
than reinvested. In the case of recently purchased shares for which
registration instructions have not been received on the record date, cash
payment will be made directly to the dealer. Any shareholder who receives a
cash payment representing a dividend or distribution may reinvest such
distribution at net asset value by returning the check or the proceeds to the
Transfer Agent within 30 days after the payment date. Such investment will be
made at the net asset value per share next determined after receipt of the
check or proceeds by the Transfer Agent. Such shareholder will receive credit
for any contingent deferred sales charge paid in connection with the amount of
proceeds being reinvested.
EXCHANGE PRIVILEGE
The Fund makes available to its shareholders the privilege of exchanging
their shares of the Fund for shares of certain other Prudential Mutual Funds,
including one or more specified money market funds, subject in each case to
the minimum investment requirements of such funds. Shares of such other
Prudential Mutual Funds may also be exchanged for shares, respectively, of the
Fund. All exchanges are made on the basis of relative net asset value next
determined after receipt of an order in proper form. An exchange will be
treated as a redemption and purchase for tax purposes. Shares may be exchanged
for shares of another fund only if shares of such fund may legally be sold
under applicable state laws.
It is contemplated that the exchange privilege may be applicable to new
mutual funds whose shares may be distributed by the Distributor.
CLASS A. Shareholders of the Fund may exchange their Class A shares for
Class A shares of certain other Prudential Mutual Funds, shares of Prudential
Structured Maturity Fund and Prudential Government Securities Trust
(Intermediate Term Series) and shares of the money market funds specified
below. No fee or sales load will be imposed upon the exchange. Shareholders of
money market funds who acquired such shares upon exchange of Class A shares
may use the Exchange Privilege only to acquire Class A shares of the
Prudential Mutual Funds participating in the Exchange Privilege.
B-17
<PAGE>
The following money market funds participate in the Class A Exchange
Privilege:
Prudential California Municipal Fund
(California Money Market Series)
Prudential Government Securities Trust
(Money Market Series)
(U.S. Treasury Money Market Series)
Prudential Municipal Series Fund
(Connecticut Money Market Series)
(Massachusetts Money Market Series)
(New Jersey Money Market Series)
(New York Money Market Series)
Prudential MoneyMart Assets
Prudential Tax-Free Money Fund
CLASS B AND CLASS C. Shareholders of the Fund may exchange their Class B and
Class C shares for Class B and Class C shares, respectively, of certain other
Prudential Mutual Funds and shares of Prudential Special Money Market Fund, a
money market fund. If Class B shares of the Fund are exchanged for Class B
shares of other Prudential Mutual Funds, no CDSC will be payable upon such
exchange of Class B and Class C shares, but a CDSC will be payable upon the
redemption of Class B shares acquired as a result of the exchange. The
applicable sales charge will be that imposed by the fund in which shares were
initially purchased and the purchase date will be deemed to be the first day
of the month after the initial purchase, rather than the date of the exchange.
Class B and Class C shares of the Fund may also be exchanged for shares of
Prudential Special Money Market Fund without imposition of any CDSC at the
time of exchange. Upon subsequent redemption from such money market fund or
after re-exchange into the Fund, such shares may be subject to the CDSC
calculated by excluding the time such shares were held in the money market
fund. In order to minimize the period of time in which shares are subject to a
CDSC, shares exchanged out of the money market fund will be exchanged on the
basis of their remaining holding periods, with the longest remaining holding
periods being transferred first. In measuring the time period shares are held
in a money market fund and "tolled" for purposes of calculating the CDSC
holding period, exchanges are deemed to have been made on the last day of the
month. Thus, if shares are exchanged into the Fund from a money market fund
during the month (and are held in the Fund at the end of the month), the
entire month will be included in the CDSC holding period. Conversely, if
shares are exchanged into a money market fund prior to the last day of the
month (and are held in the money market fund on the last day of the month),
the entire month will be excluded from the CDSC holding period. For purposes
of calculating the seven year holding period applicable to the Class B
conversion feature, the time period during which Class B shares were held in a
money market account will be excluded.
At any time after acquiring shares of other funds participating in the Class
B or Class C exchange privilege the shareholder may again exchange those
shares (and any reinvested dividends and distributions) for Class B or Class C
shares of the Fund without subjecting such shares to any CDSC. Shares of any
fund participating in the Class B or Class C exchange privilege that were
acquired through reinvestment of dividends or distributions may be exchanged
for Class B or Class C shares of other funds, respectively, without being
subject to any CDSC.
Additional details about the Exchange Privilege and prospectuses for each of
the Prudential Mutual Funds are available from the Fund's Transfer Agent,
Prudential Securities or Prusec. The Exchange Privilege may be modified,
terminated or suspended on sixty days' notice, and any fund, including the
Fund, or the Distributor, has the right to reject any exchange application
relating to such fund's shares.
DOLLAR COST AVERAGING
Dollar cost averaging is a method of accumulating shares by investing a
fixed amount of dollars in shares at set intervals. An investor buys more
shares when the price is low and fewer shares when the price is high. The
average cost per share is lower than it would be if a constant number of
shares were bought at set intervals.
Dollar cost averaging may be used, for example, to plan for retirement, to
save for a major expenditure, such as the purchase of a home, or to finance a
college education. The cost of a year's education at a four-year college today
averages around $14,000 at a private college and around $4,800 at a public
university. Assuming these costs increase at a rate of 7% a year, as has been
projected,
B-18
<PAGE>
for the freshman class of 2007, the cost of four years at a private college
could reach $163,000 and over $97,000 at a public university./1/
The following chart shows how much you would need in monthly investments to
achieve specified lump sums to finance your investment goals/2/.
<TABLE>
<CAPTION>
PERIOD OF MONTHLY INVESTMENTS: $100,000 $150,000 $200,000 $250,000
------------------------------ -------- -------- -------- --------
<S> <C> <C> <C> <C>
25 Years............................. $ 110 $ 165 $ 220 $ 275
20 Years............................. 176 264 352 440
15 Years............................. 296 444 592 740
10 Years............................. 555 833 1,110 1,388
5 Years............................. 1,371 2,057 2,742 3,428
</TABLE>
See "Automatic Savings Accumulation Plan."
- ---------
/1/Source information concerning the costs of education at public
universities is available from The College Board Annual Survey of Colleges,
1992. Information about the costs of private colleges is from the Digest of
Education Statistics, 1992; The National Center for Educational Statistics;
and the U.S. Department of Education. Average costs for private institutions
include tuition, fees, room and board.
/2/The chart assumes an effective rate of return of 8% (assuming monthly
compounding). This example is for illustrative purposes only and is not
intended to reflect the performance of an investment in shares of the Fund.
The investment return and principal value of an investment will fluctuate so
that an investor's shares when redeemed may be worth more or less than their
original cost.
AUTOMATIC SAVINGS ACCUMULATION PLAN (ASAP)
Under ASAP, an investor may arrange to have a fixed amount automatically
invested in shares of the Fund monthly by authorizing his or her bank account
or Prudential Securities account (including a Command Account) to be debited
to invest specified dollar amounts in shares of the Fund. The investor's bank
must be a member of the Automatic Clearing House System. Share certificates
are not issued to ASAP participants.
Further information about this program and an application form can be
obtained from the Transfer Agent, Prudential Securities or Prusec.
SYSTEMATIC WITHDRAWAL PLAN
A systematic withdrawal plan is available to shareholders having shares of
the Fund held through Prudential Securities or the Transfer Agent. Such
withdrawal plan provides for monthly or quarterly checks in any amount, except
as provided below, up to the value of the shares in the shareholder's account.
Withdrawals of Class B or Class C shares may be subject to a CDSC. See
"Shareholder Guide--How to Sell Your Shares--Contingent Deferred Sales
Charges" in the Prospectus.
In the case of shares held through the Transfer Agent (i) a $10,000 minimum
account value applies, (ii) withdrawals may not be for less than $100 and
(iii) the shareholder must elect to have all dividends and/or distributions
automatically reinvested in additional full and fractional shares at net asset
value on shares held under this plan. See "Shareholder Investment Account--
Automatic Reinvestment of Dividends and/or Distributions."
Prudential Securities and the Transfer Agent act as agents for the
shareholder in redeeming sufficient full and fractional shares to provide the
amount of the periodic withdrawal payment. The systematic withdrawal plan may
be terminated at any time, and the Distributor reserves the right to initiate
a fee of up to $5 per withdrawal, upon 30 days' written notice to the
shareholder.
Withdrawal payments should not be considered as dividends, yield, or income.
If periodic withdrawals continuously exceed reinvested dividends and
distributions, the shareholder's original investment will be correspondingly
reduced and ultimately exhausted.
Furthermore, each withdrawal constitutes a redemption of shares, and any
gain or loss realized generally must be recognized for federal income tax
purposes. In addition, withdrawals made concurrently with purchases of
additional shares are inadvisable because of the sales charge applicable to
(i) the purchase of Class A shares and (ii) the withdrawal of Class B and
Class C shares. Each shareholder should consult his or her own tax adviser
with regard to the tax consequences of the systematic withdrawal plan.
B-19
<PAGE>
NET ASSET VALUE
The net asset value per share is the net worth of the Fund (assets,
including securities at value, minus liabilities) divided by the number of
shares outstanding. Net asset value is calculated separately for each class.
The Fund will compute its net asset value once daily at 4:15 P.M., New York
time, on each day the New York Stock Exchange is open for trading except on
days on which no orders to purchase, sell or redeem Fund shares have been
received or days on which changes in the value of the Fund's portfolio
securities do not affect the net asset value. The New York Stock Exchange is
closed on the following holidays: New Year's Day, Washington's Birthday, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day. In the event the New York Stock Exchange closes early on any
business day, the net asset value of the Fund's shares shall be determined at
a time between such closing and 4:15 P.M., New York time.
Portfolio securities for which market quotations are readily available are
valued at their bid quotations. When market quotations are not readily
available, such securities and other assets are valued at fair value in
accordance with procedures adopted by the Board of Directors. Under these
procedures, the Fund values municipal securities on the basis of valuations
provided by a pricing service which uses information with respect to
transactions in bonds, quotations from bond dealers, market transactions in
comparable securities and various relationships between securities in
determining value. This service is expected to be furnished by J. J. Kenny
Information Systems Inc. Short-term securities maturing within 60 days of the
valuation date are valued at amortized cost, if their original maturity was 60
days or less, or by amortizing their value on the 61st day prior to maturity,
if their original term to maturity exceeded 60 days, unless such valuation is
determined not to represent fair value by the Board of Directors.
TAXES, DIVIDENDS AND DISTRIBUTIONS
The Fund will declare a dividend immediately prior to 4:15 P.M. on each day
that net asset value per share of the Fund is determined of all of the daily
net income of the Fund to shareholders of record of the Fund as of 4:15 P.M.,
New York time, of the preceding business day. The amount of the dividend may
fluctuate from day to day. Unless otherwise requested by the shareholder,
dividends are automatically reinvested monthly in additional full or
fractional shares of the Fund at net asset value per share. The dividend
payment date is on or about the 25th day of each month, although the Fund
reserves the right to change this date without further notice to shareholders.
Shareholders may receive cash payments from the Fund equal to the dividends
earned during the month by completing the appropriate section on the
Application Form or by notifying Prudential Mutual Fund Services, Inc. (PMFS),
the Fund's Transfer and Dividend Disbursing Agent, at least five business days
prior to the payable date. Cash distributions are paid by check within five
business days after the dividend payment date.
The Fund intends to distribute to shareholders of record monthly dividends
consisting of all of the net investment income of the Fund. Net capital gains
of the Fund will be distributed at least annually. For federal income tax
purposes, the Fund had a capital loss carryforward as of December 31, 1994 of
approximately $19,372,500 which expires in 2002. Accordingly, no capital gains
distribution is expected to be paid until net gains have been realized in
excess of such amount. The Fund will elect to treat net capital losses of
approximately $3,999,200 incurred in the two month period ended December 31,
1994 as having been incurred in the following fiscal year.
The per share dividends on Class B and Class C shares will be lower than the
per share dividends on Class A shares as a result of the higher distribution-
related fee to which Class B and Class C shares are subject. The per share
distributions of net capital gains, if any, will be paid in the same amount
for Class A, Class B and Class C shares. See "Net Asset Value."
The Fund has qualified and intends to remain qualified as a regulated
investment company under the Internal Revenue Code of 1986, as amended
(Internal Revenue Code). Under the Internal Revenue Code, the Fund is not
subject to federal income taxes on the taxable income that it distributes to
shareholders, provided that at least 90% of its net investment income and net
short-term capital gains in excess of net long-term capital losses in each
taxable year is so distributed. Qualification as a regulated investment
company under the Internal Revenue Code requires, among other things, that the
Fund (a) derive at least 90% of its annual gross income (without offset for
losses from the sale or other disposition of securities or foreign currencies)
from interest, payments with respect to securities loans, dividends and gains
from the sale or other disposition of securities or foreign currencies and
certain financial futures, options and forward contracts; (b) derive less than
30% of its gross income from gains from the sale or other disposition of
securities or options thereon held for less than three months; and (c)
diversify its holdings so that, at the end of each quarter of the taxable
year, (i) at least 50% of the market value of the Fund's assets is represented
by cash, U.S. Government securities and other securities limited in respect of
any one issuer to an amount not greater than 5% of the market value of the
Fund's assets and 10% of the outstanding voting securities of such issuer, and
(ii) not more than 25% of the value of its assets is invested in the
securities of any one issuer (other than U.S. Government securities). The Fund
intends to comply with the provisions of the Internal Revenue Code that
require at least 50% of the value of its total assets at the close of each
quarter of its taxable year to consist of obligations the interest on which is
exempt from federal income tax in order to pass through tax-exempt income to
its shareholders.
B-20
<PAGE>
The Fund generally will be subject to a nondeductible excise tax of 4% to
the extent that it does not meet certain minimum distribution requirements as
of the end of each calendar year. The Fund intends to make timely
distributions of the Fund's income in compliance with these requirements. As a
result, it is anticipated that the Fund will not be subject to the excise tax.
Gains or losses on sales of securities by the Fund will be treated as long-
term capital gains or losses if the securities have been held by it for more
than one year except in certain cases where the Fund acquires a put. Other
gains or losses on the sale of securities will be short-term capital gains or
losses. Certain financial futures contracts held by the Fund will be required
to be "marked to market" for federal income tax purposes, that is, treated as
having been sold at their fair market value on the last day of the Fund's
taxable year. Any gain or loss recognized on actual or deemed sales of these
financial futures contracts will be treated 60% as long-term capital gain or
loss and 40% as short-term capital gain or loss. The Fund may be required to
defer the recognition of losses on financial futures contracts to the extent
of any unrecognized gains on related positions held by the Fund.
The Fund's gains and losses on the sale, lapse, or other termination of call
options it holds on financial futures contracts will generally be treated as
gains and losses from the sale of financial futures contracts. If call options
written by the Fund expire unexercised, the premiums received by the Fund give
rise to short-term capital gains at the time of expiration. The Fund may also
have short-term gains and losses associated with closing transactions with
respect to call options written by the Fund. If call options written by the
Fund are exercised, the selling price of the financial futures contract is
increased by the amount of the premium received by the Fund, and the capital
gain or loss on the sale of the futures contract is long-term or short-term,
depending on the contract's holding period.
Upon the exercise of a put held by the Fund, the premium initially paid for
the put is offset against the amount received for the futures contract, bond
or note sold pursuant to the put thereby decreasing any gain (or increasing
any loss) realized on the sale. Generally, such gain or loss is short-term or
long-term capital gain or loss, depending on the holding period of the futures
contract, bond or note. However, in certain cases in which the put is not
acquired on the same day as the underlying securities identified to be used in
the put's exercise, gain on the exercise, sale or disposition of the put is
short-term capital gain. If a put is sold prior to exercise, any gain or loss
recognized by the Fund would be short-term or long-term capital gain or loss,
depending on the holding period of the put. If a put expires unexercised, the
Fund would realize short-term or long-term capital loss, depending on the
holding period of the put, in an amount equal to the premium paid for the put.
In certain cases in which the put and securities identified to be used in its
exercise are acquired on the same day, however, the premium paid for the
unexercised put is added to the basis of the identified securities. In certain
cases, a put may affect the holding period of the underlying security for
purposes of the 30% of gross income test described above, and accordingly, the
Fund's ability to utilize puts or dispose of securities with respect to which
it has held a put may be limited.
Interest on indebtedness incurred or continued by a shareholder, whether a
corporation or an individual, to purchase or carry shares of the Fund is not
deductible to the extent that distributions from the Fund are exempt from
Federal income tax. The Treasury has the authority to issue regulations which
would disallow the interest deduction if incurred to purchase or carry shares
of the Fund owned by the taxpayer's spouse, minor child or an entity
controlled by the taxpayer. Shareholders who have held their shares for six
months or less may be subject to a disallowance of losses from the sale or
exchange of those shares to the extent of any dividends received by the
shareholders on such shares and, if such losses are not disallowed, they will
be treated as long-term capital losses to the extent of any distribution of
long-term capital gains received by the shareholders with respect to such
shares. Entities or persons who are "substantial users" (or related persons)
of facilities financed by private activity bonds should consult their tax
advisers before purchasing shares of the Fund.
Any loss realized on a sale, redemption or exchange of shares of the Fund by
a shareholder will be disallowed to the extent the shares are replaced within
a 61-day period (beginning 30 days before the disposition of shares). Shares
purchased pursuant to the reinvestment of a dividend will constitute a
replacement of shares. In such a case, the basis of the shares acquired will
be adjusted to reflect the disallowed loss.
A shareholder who acquires shares of the Fund and sells or otherwise
disposes of such shares within 90 days of acquisition may not be allowed to
include certain sales charges incurred in acquiring such shares for purposes
of calculating gain or loss realized upon a sale or exchange of shares of the
Fund.
Exempt-interest dividends attributable to interest on certain "private
activity" tax-exempt obligations is a preference item for purposes of
computing the alternative minimum tax for both individuals and corporations.
Moreover, exempt-interest dividends, whether or not on private activity bonds,
that are held by corporations will be taken into account (i) in determining
the alternative minimum tax imposed on 75% of the excess of adjusted current
earnings over alternative minimum taxable income, (ii) in calculating the
environmental tax equal to 0.12 percent of a corporation's modified
alternative minimum taxable income in excess of $2 million,
B-21
<PAGE>
and (iii) in determining the foreign branch profits tax imposed on the
effectively connected earnings and profits (with adjustments) of United States
branches of foreign corporations. The Fund plans to avoid to the extent
possible investing in private activity tax-exempt obligations.
PENNSYLVANIA PERSONAL PROPERTY TAX. The Fund has obtained a written letter
of determination from the Pennsylvania Department of Revenue that the Fund is
subject to the Pennsylvania foreign franchise tax upon initiating its intended
business activities in Pennsylvania. Accordingly, Fund shares are believed to
be exempt from Pennsylvania personal property taxes. The Fund anticipates that
it will continue such business activities but reserves the right to suspend
them at any time, resulting in the termination of the personal property tax
exemption.
The Fund may be subject to state or local tax in certain other states where
it is deemed to be doing business. Further, in those states which have income
tax laws, the tax treatment of the Fund and of shareholders of the Fund with
respect to distributions by the Fund may differ from federal tax treatment.
The exemption of interest income for federal income tax purposes may not
result in similar exemption under the laws of a particular state or local
taxing authority. The Fund will report annually to its shareholders the
percentage and source, on a state-by-state basis, of interest income on
Municipal Bonds received by the Fund during the preceding year and on other
aspects of the federal income tax status of distributions made by the Fund.
Shareholders are urged to consult their own tax advisers regarding specific
questions as to federal, state or local taxes.
PERFORMANCE INFORMATION
YIELD. The Fund may from time to time advertise its yield as calculated over
a 30-day period. Yield is determined separately for Class A, Class B and Class
C shares. The yield will be computed by dividing the Fund's net investment
income per share earned during this 30-day period by the net asset value per
share on the last day of this period. During this period, no Class C shares
were outstanding.
Yield is calculated according to the following formula:
a - b
YIELD = 2 [ ( ----- +1)to the sixth power - 1]
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during the period
that were entitled to receive dividends.
d = the maximum offering price per share on the last day of the period.
The yield for the 30-day period ended December 31, 1994 for the Fund's Class
A, Class B and Class C shares was 5.69%, 5.47% and 5.23%, respectively.
Yield fluctuates and an annualized yield quotation is not a representation
by the Fund as to what an investment in the Fund will actually yield for any
given period. Yield for the Fund will vary based on a number of factors
including change in net asset value, market conditions, the level of interest
rates and the level of Fund income and expenses.
TAX EQUIVALENT YIELD. The Fund may also calculate the tax equivalent yield
over a 30-day period. The tax equivalent yield is determined separately for
Class A, Class B and Class C shares. The tax equivalent yield will be
determined by first computing the yield as discussed above. The Fund will then
Determine what portion of the yield is attributable to securities, the income
of which is exempt for federal income tax purposes. This portion of the yield
will then be divided by one minus 39.6% (the assumed maximum tax rate for
individual taxpayers not subject to Alternative Minimum Tax) and then added to
the portion of the yield that is attributable to other securities.
Tax equivalent yield is calculated according to the following formula:
TAX EQUIVALENT YIELD = Yield
-------
1-.396
The tax equivalent yield for the 30-day period ended December 31, 1994 for
the Fund's Class A, Class B and Class C shares was 9.42%, 9.06% and 8.66,
respectively.
B-22
<PAGE>
AVERAGE ANNUAL TOTAL RETURN. The Fund may also from time to time advertise
its average annual total return. Average annual total return is determined
separately for Class A, Class B and Class C shares. See "How the Fund
Calculates Performance" in the Prospectus.
Average annual total return is computed according to the following formula:
P(1+T)to the nth power=ERV
Where: P = a hypothetical initial payment of $1000.
T = average annual total return.
n = number of years.
ERV = Ending Redeemable Value at the end of the 1, 5 or 10 year periods
(or fractional portion thereof) of a hypothetical $1000 payment made
at the beginning of the 1, 5 or 10 year periods.
Average annual total return takes into account any applicable initial or
contingent deferred sales charges but does not take into account any federal
or state income taxes that may be payable upon redemption.
The average annual total return with respect to the Class A shares for the
one year and since inception periods ended December 31, 1994 was -8.86% and
6.25%, respectively. The average annual total return with respect to the Class
B shares of the Fund for the one, five, and ten year periods ended on December
31, 1994 was -11.39%, 6.13% and 8.41%, respectively. The average annual total
return for Class C shares for the since inception period ended December 31,
1994 was -3.63%.
AGGREGATE TOTAL RETURN. The Fund may from time to time advertise its
aggregate total return. Aggregate total return is determined separately for
Class A, Class B and Class C shares. See "How the Fund Calculates Performance"
in the Prospectus.
Aggregate total return represents the cumulative change in the value of an
investment in the Fund and is computed by the following formula:
ERV - P
-------
P
Where: P = a hypothetical initial payment of $1000.
ERV = Ending Redeemable Value at the end of the 1, 5, or 10 year periods
(or fractional portion thereof) of a hypothetical $1000 investment
made at the beginning of the 1, 5 or 10 year periods.
Aggregate total return does not take into account any federal or state
income taxes that may be payable upon redemption or any applicable initial or
contingent deferred sales charges.
The aggregate total return with respect to the Class A shares for the one
year and since inception periods ended December 31, 1994 was -6.04% and
39.04%, respectively. The aggregate total return with respect to the Class B
shares of the Fund for the one, five and ten-year periods ended on December
31, 1994 was -6.39%, 35.65% and 124.24%, respectively. See "How the Fund
Calculates Performance" in the Prospectus. The aggregate total return for
Class C shares for the since inception period ended December 31, 1994 was
- -2.63%.
B-23
<PAGE>
From time to time, the performance of the Fund may be measured against
various indices. Set forth below is a chart which compares the performance of
different types of investments over the long-term and the rate of
inflation./1/
[CHART]
/1/Source: Ibbotson-Associates, "Stocks, Bonds, Bills and Inflation--1993
Yearbook" (annually updates the work of Roger G. Ibbotson and Rex A.
Sinquefield). Common stock returns are based on the Standard & Poor's 500
Stock Index, a market-weighted, unmanaged index of 500 common stocks in a
variety of industry sectors. It is a commonly used indicator of broad stock
price movements. This chart is for illustrative purposes only, and is not
intended to represent the performance of any particular investment or fund.
CUSTODIAN AND TRANSFER AND DIVIDEND
DISBURSING AGENT AND INDEPENDENT ACCOUNTANTS
State Street Bank and Trust Company, One Heritage Drive, North Quincy,
Massachusetts 02171, serves as Custodian for the Fund's portfolio securities
and cash and, in that capacity, maintains certain financial and accounting
books and records pursuant to an agreement with the Fund.
Prudential Mutual Fund Services, Inc. (PMFS), Raritan Plaza One, Edison, New
Jersey 08837, serves as the Transfer and Dividend Disbursing Agent of the
Fund. It is a wholly-owned subsidiary of PMF. PMFS provides customary transfer
agency services to the Fund, including the handling of shareholder
communications, the processing of shareholder transactions, the maintenance of
shareholder account records, payment of dividends and distributions, and
related functions. For these services, PMFS receives an annual fee per
shareholder account, a new account set-up fee for each manually-established
account and a monthly inactive zero balance account fee per shareholder
account. PMFS is also reimbursed for its out-of-pocket expenses, including but
not limited to postage, stationery, printing, allocable communications
expenses and other costs. For the fiscal year ended December 31, 1994, the
Fund incurred fees of $457,600 for the services of PMFS.
Price Waterhouse LLP, 1177 Avenue of the Americas, New York, New York 10036,
serves as the Fund's independent accountants and, in that capacity, audits the
Fund's annual financial statements.
B-24
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. Portfolio of Investments
December 31, 1994
<TABLE>
<CAPTION>
Moody's Principal
Rating Amount Value
(Unaudited) (000) Description (a) (Note 1)
<C> <C> <S> <C>
LONG-TERM INVESTMENTS--88.6%
Alabama--0.9%
Courtland Ind. Dev. Brd.
Rev.,
Champion Int'l. Corp.,
Baa1 $ 6,000 7.20%, 12/1/13, Ser.
A..................... $ 5,890,260
------------
Alaska--0.8%
North Slope Boro.,
Capital Appre., Ser. B,
C.G.I.C.,
Aaa 11,000 Zero Coupon, 6/30/05.... 5,646,190
------------
Arizona--1.8%
Mesa Ind. Dev. Auth.,
Hlth. Care Facs. Rev.,
Aaa 3,540 7.50%, 1/1/04, B.I.G.... 3,782,242
Pima Cnty. Unified Sch.
Dist.,
No. 1, Tucson, F.G.I.C.,
Aaa 3,000 7.50%, 7/1/10........... 3,321,360
Salt River Proj., Elec.
Sys.
Rev., Agricultural
Imp. & Pwr. Dist.,
Aa 6,000 5.25%, 1/1/11, Ser. B... 5,169,720
------------
12,273,322
------------
California--5.5%
California St. Pub. Wks.
Brd.
Lease Rev., Dept. of
Corrections,
A.M.B.A.C.,
Aaa 6,500 5.25%, 12/1/13.......... 5,472,545
Culver City Redev. Fin.
Auth.
Tax Alloc. Rev.,
A.M.B.A.C.,
Aaa 9,225 5.50%, 11/1/14.......... 7,928,334
Riverside Elec. Rev.,
Aa 3,000 6.00%, 10/1/15.......... 2,728,590
San Jose Redev. Proj.,
Tax Alloc., M.B.I.A.,
Aaa $ 5,000 6.00%, 8/1/11........... $ 4,767,600
Santa Margarita/Dana
Point Auth. Rev.,
M.B.I.A.,
Aaa 2,000 7.25%, 8/1/09........... 2,167,380
Aaa 2,450 7.25%, 8/1/10........... 2,653,252
Aaa 1,750 7.25%, 8/1/11........... 1,893,027
Aaa 2,000 7.25%, 8/1/14........... 2,169,320
South Orange Cnty. Pub.
Fin. Auth.,
Foothill Area Proj.,
F.G.I.C.,
Aaa 2,000 6.50%, 8/15/10.......... 1,961,400
Special Tax Rev.,
F.G.I.C.,
Aaa 3,650 8.00%, 8/15/09.......... 4,080,335
West Contra Costa School
Dist., Cert. of Part.,
Ba 1,600 7.125%, 1/1/24.......... 1,478,288
------------
37,300,071
------------
Colorado--1.6%
Colorado Springs Arpt.
Rev.,
BBB* 3,700 6.90%, 1/1/12, Ser. A... 3,498,757
BBB* 7,960 7.00%, 1/1/22, Ser. A... 7,372,552
------------
10,871,309
------------
Connecticut--0.3%
Connecticut St. Spec.
Tax
Oblig. Rev.,
Trans. Infrastructure,
A1 2,000 7.125%, 6/1/10, Ser.
A..................... 2,130,540
------------
Florida--2.4%
Broward Cnty. Res. Rec.
Rev., Broward Waste
Energy, L.P. South,
A 13,645 7.95%, 12/1/08.......... 14,709,856
Florida St. Brd. Ed.
Cap. Outlay,
Aaa 195 9.125%, 6/1/14,
E.T.M................. 245,429
Aa 1,260 9.125%, 6/1/14.......... 1,605,366
------------
16,560,651
------------
</TABLE>
B-25 See Notes to Financial Statements.
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
<TABLE>
<CAPTION>
Moody's Principal
Rating Amount Value
(Unaudited) (000) Description (a) (Note 1)
<C> <C> <S> <C>
Georgia--3.6%
Atlanta Urban Res. Fin.
Auth., Clark Atlanta
Univ. Dorm. Proj.,
NR $ 4,755D 9.25%, 6/1/10........... $ 5,568,628
Atlanta Wtr. & Swr.
Rev.,
Aa 4,410 6.00%, 1/1/11........... 4,230,689
Georgia St. Gen. Oblig.,
Aaa 8,000 6.50%, 12/1/09, Ser.
F..................... 8,278,160
Georgia St. Res. Fin.
Auth.,
Sngl. Fam. Insured
Mtge., Ser. C-C1,
Aa 6,550 8.00%, 12/1/16.......... 6,809,184
------------
24,886,661
------------
Illinois--0.7%
Illinois Dev. Fin.
Auth., Poll.
Ctrl. Rev.,
Commonwealth Edison
Co. Proj., Ser. D,
Aaa 5,000 6.75%, 3/1/15,
A.M.B.A.C............. 4,977,500
------------
Kentucky--3.1%
Kentucky St. Prpty. &
Bldgs. Comm. Rev.,
Aaa 19,100 6.25%, 9/1/07,
M.B.I.A............... 19,197,219
Perry Cnty., Solid Waste
Disp. Res.,
T.J. Int'l. Proj.,
NR 2,250 7.00%, 6/1/24........... 2,025,540
------------
21,222,759
------------
Louisiana--4.9%
Louisiana St. Offshore
Term. Auth.,
Deepwater Port Rev.,
A3 3,000 7.45%, 9/1/04, Ser. E... 3,202,590
New Orleans, Cap. Appr.,
A.M.B.A.C.,
Aaa 13,500 Zero Coupon, 9/1/09..... 5,208,570
Orleans Parish, Sch.
Brd.,
Aaa 5,780 8.90%, 2/1/07, M.B.I.A.,
E.T.M................. 7,065,125
Regl. Louisiana Trans.
Auth. Rev.,
Aaa 3,700 8.00%, 12/1/08,
F.G.I.C............... 4,003,844
St. Charles Parish,
Poll. Ctrl. Rev.,
Louisiana Pwr. & Lt.
Co.,
NR $ 4,000 8.25%, 6/1/14........... $ 4,222,080
Baa3 5,000 8.00%, 12/1/14, Ser.
1989.................. 5,225,250
West Feliciana Parish
Poll.
Ctrl. Rev.,Gulf States
Util.,
Baa3 5,000@ 7.00%, 11/1/15.......... 4,801,200
------------
33,728,659
------------
Maryland--1.1%
Maryland St. Hlth. &
Higher
Ed. Facs., Auth. Rev.,
Doctor's Comm. Hosp.,
Baa 4,000 5.50%, 7/1/24........... 2,961,920
Northeast Waste Disp.
Auth.,
Baltimore City Sludge
Proj.,
NR 4,591 7.25%, 7/1/07........... 4,453,775
------------
7,415,695
------------
Michigan--1.7%
Holland Sch. Dist.,
A.M.B.A.C.,
Aaa 4,000 Zero Coupon, 5/1/12..... 1,286,360
Michigan St. Hsg. Dev.
Auth.
Rev., Rental Hsg.,
A+* 1,000 7.55%, 4/1/23, Ser. B... 1,026,000
Sngl. Fam. Mtge.,
AA+* 5,185 7.50%, 6/1/15, Ser. A... 5,378,090
AA+* 3,130 7.75%, 12/1/19, Ser.
D..................... 3,262,837
Okemos Pub. Sch. Dist.,
Cnty. of Ingham,
M.B.I.A.,
Aaa 1,100 Zero Coupon, 5/1/12..... 353,749
Aaa 1,700 Zero Coupon, 5/1/13..... 506,039
------------
11,813,075
------------
Minnesota--0.5%
Southern Minnesota Mun.
Pwr. Agcy. Pwr. Supply
Sys. Rev.,
A 3,880 5.00%, 1/1/12, Ser. A... 3,199,448
------------
Mississippi--0.7%
Mississippi St., Highway
Bd.,
Aaa 5,000 6.20%, 2/1/08, E.T.M.... 4,964,250
------------
</TABLE>
B-26 See Notes to Financial Statements.
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
<TABLE>
<CAPTION>
Moody's Principal
Rating Amount Value
(Unaudited) (000) Description (a) (Note 1)
<C> <C> <S> <C>
New Jersey--9.3%
Bergen Cnty. Util.
Auth.,
Wtr. Poll. Ctrl. Rev.,
Ser. B, F.G.I.C.,
Aaa $ 7,640 Zero Coupon, 12/15/07... $ 3,442,049
Aaa 4,695 Zero Coupon, 12/15/09... 1,848,656
Camden Cnty. Poll. Ctrl.
Fin.
Auth., Solid Waste
Res. Rec. Rev.,
Baa1 1,180 7.125%, 12/1/01, Ser.
C..................... 1,156,329
Baa1 5,100 7.50%, 12/1/09, Ser.
B..................... 4,983,414
Hudson Cnty. Impvt.
Auth.,
Solid Waste Sys.,
BBB-* 12,000 7.10%, 1/1/20........... 11,396,760
New Jersey Econ. Dist.
Heating & Cool.,
Trigen Trenton Proj.,
BBB-* 1,400 6.20%, 12/1/10.......... 1,292,144
Mkt. Transition Fac.
Rev.,
Sr. Lien, M.B.I.A.,
Aaa 3,875 5.80%, 7/1/09........... 3,671,408
New Jersey Hlth. Care
Facs.
Fin. Auth. Rev.,
A.M.B.A.C.,
Jersey Shore Med.
Ctr.,
Aaa 2,585 6.10%, 7/1/10........... 2,482,505
Aaa 2,775 6.125%, 7/1/11.......... 2,670,604
Aaa 1,435 6.125%, 7/1/12.......... 1,367,713
Aaa 2,000 6.25%, 7/1/16........... 1,902,600
New Jersey Sports &
Exposition Auth.,
Convention Ctr. Luxury
Tax Rev.,
Aaa 5,500 6.00%, 7/1/13,
M.B.I.A............... 5,251,950
New Jersey St. Hsg. &
Mtge. Fin. Agcy.,
Aaa 3,435 7.70%, 10/1/29,
M.B.I.A............... 3,524,963
New Jersey St. Tpke.
Auth. Rev.,
A 3,000 6.75%, 1/1/08, Ser. A... 3,074,310
A 8,000 6.50%, 1/1/16, Ser. C... 7,887,440
New Jersey Waste
Wtr.Treat.,
Trust Loan Rev.,
Aa 2,000 6.875%, 6/15/09......... 2,064,880
Union Cnty. Utils.
Auth.,
Solid Waste Rev.,
A-* 5,500 7.10%, 6/15/06, Ser.
A..................... 5,499,670
------------
63,517,395
------------
New York--13.4%
New York City, Gen.
Oblig.,
Baa1 $ 5,000 8.25%, 11/15/02, Ser.
F..................... $ 5,467,500
Baa1 3,500 8.00%, 8/1/03, Ser. D... 3,794,070
Baa1 1,500 8.00%, 8/1/04, Ser. D... 1,602,000
Baa1 2,000 7.75%, 8/15/04, Ser.
A..................... 2,110,220
Baa1 1,500 8.25%, 6/1/06, Ser. B... 1,664,325
Baa1 5,000 7.65%, 2/1/07, Ser. D... 5,266,750
New York City, Mun. Wtr.
Fin. Auth.,
Wtr. & Swr. Sys. Rev.,
Aaa 21,250 6.75%, 6/15/16,
F.G.I.C............... 21,397,263
New York St. Dorm. Auth.
Rev., Court Facs.,
Baa1 6,070 5.20%, 5/15/05, Ser.
A..................... 5,338,565
Baa1 5,000 5.625%, 5/15/13, Ser.
A..................... 4,258,100
New York St.
Environmental
Facs. Corp., Poll.
Ctrl. Rev.,
Aa 5,000 5.75%, 6/15/12.......... 4,534,300
New York St. Med. Care
Facs. Fin. Auth. Rev.,
Mental Hlth. Svcs.,
Ser. F, F.S.A.,
Aaa 5,000 5.25%, 8/15/08.......... 4,419,650
Aaa 13,350 5.25%, 2/15/19.......... 11,048,861
New York Hosp., Ser. A,
Aaa 4,000# 6.50%, 8/15/29,
A.M.B.A.C............. 3,840,520
New York St. Urban Dev.
Corp. Rev. Corr.
Facs., F.S.A.,
Aaa 2,955 5.45%, 1/1/07........... 2,710,710
Aaa 3,000 6.50%, 1/1/09........... 3,044,100
Aaa 3,000 5.50%, 1/1/14........... 2,616,300
Triborough Bridge &
Tunl. Auth.,
Aa 8,500 6.625%, 1/1/12, Ser.
X..................... 8,608,290
------------
91,721,524
------------
Ohio--1.2%
Cleveland Pub. Pwr.
Sys.,
Rev. First Mgte., Ser.
A,
M.B.I.A.,
Aaa 2,685 Zero Coupon, 11/15/10... 957,417
Columbus Wtr. Sys. Rev.,
Ctrl. Rev. Detroit
Ed.,
A1 2,000 6.375%, 11/1/10......... 1,985,020
</TABLE>
B-27 See Notes to Financial Statements.
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
<TABLE>
<CAPTION>
Moody's Principal
Rating Amount Value
(Unaudited) (000) Description (a) (Note 1)
<C> <C> <S> <C>
Ohio (cont'd.)
Ohio St. Pub. Facs.,
Comm. of Higher Ed.,
A1 $ 5,000 7.25%, 5/1/04........... $ 5,425,900
------------
8,368,337
------------
Oklahoma--2.6%
Tulsa Mun. Arpt. Trust
Rev.,
American Airlines, Inc.,
Baa2 19,000 7.375%, 12/1/20......... 17,708,000
------------
Pennsylvania--2.7%
Allegheny Cnty. Arpt.
Rev.,
Greater Pittsburgh
Int'l. Arpt.,
M.B.I.A.,
Aaa 8,535 8.25%, 1/1/16, Ser. C... 9,171,284
Pennsylvania St Univ., Gen. Oblig.,
A1 6,000 5.50%, 8/15/16.......... 5,189,400
Philadelphia Wtr. &
Waste
Auth. Rev., C.G.I.C.,
Aaa 4,500 5.50%, 6/15/15.......... 3,845,295
------------
18,205,979
------------
Puerto Rico--9.3%
Puerto Rico Comnwlth.,
Aaa 6,000 7.50%, 7/1/04,
M.B.I.A............... 6,741,660
Aaa 5,000 5.50%, 7/1/13,
M.B.I.A............... 4,481,150
Aaa 5,000 5.25%, 7/1/18,
M.B.I.A............... 4,204,850
Puerto Rico Elec. Pwr.
Auth., Pwr. Rev.,
Baa1 2,500 7.00%, 7/1/07, Ser. S... 2,605,825
Baa1 2,550 6.125%, 7/1/08, Ser.
S..................... 2,475,999
Puerto Rico Hwy. & Trans. Auth. Rev.,
Baa1 8,405 6.375%, 7/1/08, Ser.
V..................... 8,326,245
Baa1 4,000 6.625%, 7/1/12, Ser.
V..................... 3,961,200
Baa1 4,460 6.625%, 7/1/12, Ser.
T..................... 4,394,260
Baa1 4,000 5.25%, 7/1/21, Ser. X... 3,212,160
Puerto Rico Public Bldgs. Auth. Rev.,
Baa1 5,000 5.60%, 7/1/08........... 4,470,450
Aaa 5,065 5.75%, 7/1/10, F.S.A.... 4,767,988
Puerto Rico Tel. Auth.
Rev.,
Ser. I, M.B.I.A.,
Aaa 8,200 5.25%, 1/25/07.......... 7,531,946
Aaa 7,600 5.449%, 1/16/15......... 6,651,444
------------
63,825,177
------------
South Carolina--1.4%
Charleston Waterworks &
Swr. Rev.,
Aaa $ 7,415 10.375%, 1/1/10,
E.T.M................. $ 9,520,786
------------
Tennessee--1.0%
Metropolitan Gov't.
Nashville & Davidson
Cnty., Wtr. & Swr.
Rev.,
A1 6,575 7.30%, 1/1/08........... 6,839,907
------------
Texas--9.5%
Alliance Arpt. Auth.
Inc.,
Spec. Facs. Rev.,
American Airlines
Proj.,
Baa2 4,500 7.50%, 12/1/29.......... 4,246,425
Austin Combined Util.
Sys.
Rev., Ser. B88,
A 5,400 7.75%, 11/15/08......... 5,759,208
Dallas Ft. Worth, Regl.
Arpt.
Rev., Ser. A, F.G.I.C.,
Aaa 3,500 7.375%, 11/1/08......... 3,778,950
Aaa 3,500 7.375%, 11/1/09......... 3,762,815
Harris Cnty. Hlth. Facs.
Dev. Corp., Spec. Facs.
Rev., Texas Med. Ctr.
Hosp.,
Aaa 4,100 7.25%, 5/15/07,
M.B.I.A............... 4,328,862
Harris Cnty., Toll Rd.,
Aaa 3,000 5.00%, 8/15/16,
F.G.I.C............... 2,407,020
Keller Cnty. Indep. Sch.
Dist.,
Aaa 7,000 5.50%, 8/15/13.......... 6,215,090
Northwest Indpt. Sch.
Dist.,
Cap. Apprec.,
A.M.B.A.C.,
Aaa 4,890 Zero Coupon, 8/15/12.... 1,530,863
San. Antonio Texas Elec.
& Gas Rev., Ser. A,
Aa1 4,055 5.00%, 2/1/16........... 3,247,325
Texas Mun. Pwr. Agcy.
Rev.,
Aaa 9,980 Zero Coupon, 9/1/14,
M.B.I.A............... 2,709,770
Texas Pub. Fin. Auth.,
Aa 10,000 5.50%, 10/1/13, Ser.
A..................... 8,776,700
Texas Wtr. Res. Fin.
Auth. Rev.,
A 11,970@ 7.625%, 8/15/08......... 12,586,335
</TABLE>
B-28 See Notes to Financial Statements.
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
<TABLE>
<CAPTION>
Moody's Principal
Rating Amount Value
(Unaudited) (000) Description (a) (Note 1)
<C> <C> <S> <C>
Texas (cont'd.)
Univ. Texas Univ. Rev.,
Fin. Sys.,
Aa1 $ 2,500 7.00%, 8/15/07, Ser.
A..................... $ 2,624,950
Aa1 3,000 6.75%, 8/15/13, Ser.
B..................... 3,021,090
------------
64,995,403
------------
U. S. Virgin Islands--0.6%
Virgin Islands Pub. Fin.
Auth. Rev.,
Matching Fund Loan
Notes,
NR 3,900 7.25%, 10/1/18, Ser.
A..................... 3,800,355
------------
Virginia--4.9%
Henrico Cnty. Ind. Dev.
Auth. Rev., Secours
Hlth. Sys., St. Mary's
Proj.,
A1 10,100 7.50%, 9/1/07, Ser. B... 10,688,426
Prince William County
Va. Park Auth. Rev.,
A 4,570 7.50%, 7/15/20.......... 4,715,280
Roanoke Cnty., Gen.
Oblig.,
Aa 3,000 5.50%, 6/1/13........... 2,607,810
Virginia St. Pub. Sch.
Auth.,
Aa 5,640 6.125%, 8/1/11, Ser.
A..................... 5,410,283
Aa 5,635 6.125%, 8/1/12, Ser.
A..................... 5,369,704
West Point Ind. Dev.,
Chesapeake Corp.,
Baa3 5,750 6.25%, 3/1/19........... 4,986,918
------------
33,778,421
------------
Washington--3.1%
Tacoma Dept. Pub. Util.
&
Lt. Div., Lt. & Pwr.
Rev.,
A 4,450 9.375%, 1/1/15.......... 4,715,576
Washington St. Pub. Pwr.
Supply Sys. Rev.,
Nuclear Proj. No. 1,
Aa 4,000 7.00%, 7/1/08, Ser. A... 4,105,520
Aa 5,000 7.25%, 7/1/09, Ser. B... 5,181,950
Nuclear Proj. No. 2,
Aa 2,000 7.25%, 7/1/06, Ser. A... 2,120,180
Zero Coupon, 7/1/06,
M.B.I.A., Ser. A...... 2,880,120
Aaa 6,000
Washington St. Pub. Pwr.
Supply Sys. Rev.,
Nuclear Proj. No. 3,
Zero Coupon, 7/1/06,
Aaa $ 5,000 F.G.I.C., Ser. B...... $ 2,400,100
------------
21,403,446
------------
Total long-term
investments
(cost $611,914,906)..... 606,565,120
------------
SHORT-TERM INVESTMENTS--10.2%
California--5.7%
State of California,
R.A.W.,
F.R.W.D.S.,
5.73%, 1/5/95, Ser.
SP-1* 10,157 94C-10................ 10,157,426
Los Angeles Int'l.
Arpt.,
LAX Two Proj., F.R.D.D.,
VMIG-2 28,900 6.00%, 1/3/95........... 28,900,000
------------
39,057,426
------------
Florida--0.6%
Manatee Cnty. Hsg. Fin.
Auth.,
Sngl. Fam. Mtge. Rev.,
A.M.T.,
VMIG1 4,100 4.11%, 1/16/95,
F.R.M.D., Ser. 94..... 4,100,000
------------
Georgia--0.7%
Burke Cnty. Dev. Auth.,
Poll.
Adj. Ctrl. Rev., Pwr.
Co. Vogtle, Ser. 94A,
VMIG1 5,100 6.25%, 1/3/95,
F.R.D.D............... 5,100,000
------------
Illinois--0.1%
Chicago O'Hare Int'l.
Arpt.,
American Airlines Inc.,
F.R.D.D.,
P-2 700 6.00%, 1/3/95, Ser.
83B................... 700,000
------------
Louisiana--0.7%
Louisiana St, Gen.
Oblig.,
J.P.M. Putters, Ser. 29,
F.R.W.D.S.,
VMIG1 5,000 5.75%, 1/5/95........... 5,000,000
------------
North Carolina--0.7%
North Carolina Eastern
Mun. Pwr. Agcy.,
NR 5,000 3.85%, 1/30/95,
T.E.C.P............... 5,000,000
------------
</TABLE>
B-29 See Notes to Financial Statements.
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
<TABLE>
<CAPTION>
Moody's Principal
Rating Amount Value
(Unaudited) (000) Description (a) (Note 1)
<C> <C> <S> <C>
Tennessee--0.5%
Shelby Cnty. Hlth. Ed. &
Hsg. Fac., Brd. Hosp.
Rev.,
Meth. Hlth., F.R.S.D.,
VMIG1 $ 3,240 4.20%, 8/1/95, Ser.
85C................... $ 3,240,000
------------
Texas--0.5%
Brazos River Harbor
Nav. Dist., Dow
Chemical
Co. Proj., T.E.C.P.,
P-1 3,400 4.95%, 3/15/95, Ser.
91.................... 3,400,000
------------
Virginia--0.7%
York Cnty. Ind. Dev.
Auth.,
Mun. Elec. & Pwr. Co.,
VMIG1 4,500 5.15%, 1/5/95,
T.E.C.P............... 4,500,000
------------
Total short-term
investments
(cost $70,097,426)...... 70,097,426
------------
Total Investments--98.8%
(cost $682,012,332; Note
4).................... 676,662,546
Other assets in excess
of
liabilities--1.2%..... 8,471,349
------------
Net Assets--100%........ $685,133,895
------------
------------
</TABLE>
(a) The following abbreviations are used in portfolio
descriptions:
A.M.B.A.C.--American Municipal Bond Assurance Corporation
A.M.T.--Alternative Minimum Tax
B.I.G.--Bond Investors Guaranty Insurance Company
C.G.I.C.--Capital Guaranty Insurance Corporation
E.T.M.--Escrowed to Maturity
F.G.I.C.--Financial Guaranty Insurance Company
F.R.D.D.--Floating Rate Daily Demand Note
F.R.M.D.--Floating Rate Monthly Demand Note
F.R.S.D.--Floating Rate Semi-Annual Demand Note
F.R.W.D.--Floating Rate Weekly Demand Note
F.R.W.D.S.--Floating Rate Weekly Demand Note Synthetic
F.S.A.--Financial Security Assurance
M.B.I.A.--Municipal Bond Insurance Association
R.A.W.--Revenue Anticipation Warrants
T.E.C.P.--Tax Exempt Commercial Paper
# Represents when-issued security.
D Prerefunded issues are secured by escrowed cash
and
direct U.S. guaranteed obligations.
* Standard and Poor's Rating.
@ Pledged as initial margin on financial futures
contract.
NR--Not Rated by Moody's or Standard & Poor's.
The Fund's current Statement of Additional Information
contains a description of Moody's and Standard &
Poor's ratings.
B-30 See Notes to Financial Statements.
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
Statement of Assets and Liabilities
<TABLE>
<CAPTION>
Assets December 31, 1994
-----------------
<S> <C>
Investments, at value (cost $682,012,332)......................... $ 676,662,546
Cash.............................................................. 3,342
Interest receivable............................................... 12,558,652
Receivable for Fund shares sold................................... 2,378,893
Receivable for investments sold................................... 363,069
Due from broker - variation margin................................ 24,374
Other assets...................................................... 19,910
-------------
Total assets.................................................. 692,010,786
-------------
Liabilities
Payable for investments purchased................................. 3,789,611
Payable for Fund shares reacquired................................ 1,995,201
Dividends payable................................................. 419,733
Management fee payable............................................ 243,777
Distribution fee payable.......................................... 286,275
Accrued expenses.................................................. 142,294
-------------
Total liabilities............................................. 6,876,891
-------------
Net Assets........................................................ $ 685,133,895
-------------
-------------
Net assets were comprised of:
Common stock, at par............................................ $ 474,315
Paid-in capital in excess of par................................ 713,644,111
-------------
714,118,426
Accumulated net realized loss on investments.................... (23,680,276)
Net unrealized depreciation on investments...................... (5,304,255)
-------------
Net assets, December 31, 1994................................... $ 685,133,895
=============
Class A:
Net asset value and redemption price per share ($12,720,790 /
881,875 shares of common stock issued and outstanding)......... $14.42
Maximum sales charge (3.0% of offering price).................... .45
-------------
Maximum offering price to public................................. $14.87
=============
Class B:
Net asset value, offering price and redemption price per share
($672,271,575 / 46,539,855 shares of common stock issued and
outstanding)................................................... $14.45
=============
Class C:
Net asset value, offer price and redemption price per share
($141,530 / 9,798 shares of common stock issued and outstanding) $14.44
=============
</TABLE>
See Notes to Financial Statements.
B-31
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
Statement of Operations
<TABLE>
<CAPTION>
Year Ended
December 31,
Net Investment Income 1994
------------
<S> <C>
Income
Interest.............................. $ 47,004,859
------------
Expenses
Distribution fee--Class A............. 14,116
Distribution fee--Class B............. 3,758,114
Distribution fee--Class C............. 321
Management fee........................ 3,633,518
Transfer agent's fees and expenses.... 649,000
Tax expense........................... 251,000
Reports to shareholders............... 237,000
Custodian's fees and expenses......... 127,000
Registration fees..................... 93,500
Legal fees............................ 61,000
Audit fee............................. 51,000
Trustees' fees........................ 37,700
Insurance expense..................... 19,200
Miscellaneous......................... 618
------------
Total expenses...................... 8,933,087
------------
Net investment income................... 38,071,772
------------
Realized and Unrealized
Gain (Loss) on Investments
Net realized gain (loss) on:
Investment transactions............... (27,537,466)
Financial futures contracts........... 3,847,102
------------
(23,690,364)
------------
Net change in unrealized appreciation
/depreciation of:
Investments........................... (68,112,297)
Financial futures contracts........... 45,531
------------
(68,066,766)
------------
Net loss on investments................. (91,757,130)
------------
Net Decrease in Net Assets
Resulting from Operations............... $(53,685,358)
------------
------------
</TABLE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
Statement of Changes in Net Assets
<TABLE>
<CAPTION>
Year Ended December 31,
Increase (Decrease) ------------------------------
in Net Assets 1994 1993
------------- -------------
<S> <C> <C>
Operations
Net investment income.... $ 38,071,772 $ 44,152,405
Net realized gain (loss)
on investment
transactions........... (23,690,364) 38,512,754
Net change in unrealized
appreciation
(depreciation) of
investments............ (68,066,766) 16,778,159
------------- -------------
Net increase (decrease)
in net assets resulting
from operations........ (53,685,358) 99,443,318
------------- -------------
Dividends and distributions
(Note 1)
Dividends from net
investment income
Class A................ (758,853) (645,048)
Class B................ (37,310,847) (43,507,357)
Class C................ (2,072) --
------------- -------------
(38,071,772) (44,152,405)
------------- -------------
Distributions from net
realized gains
Class A................ (95,056) (563,957)
Class B................ (5,131,497) (34,572,412)
------------- -------------
(5,226,553) (35,136,369)
------------- -------------
Fund share transactions
(Note 5)
Net proceeds from shares
issued................. 86,309,362 201,764,486
Net asset value of shares
issued in reinvestment
of dividends and
distributions.......... 27,093,049 50,661,082
Cost of shares
reacquired............. (193,751,516) (246,514,570)
------------- -------------
Increase (decrease) in
net assets from Fund
share transactions..... (80,349,105) 5,910,998
------------- -------------
Total increase
(decrease)............... (177,332,788) 26,065,542
------------- -------------
Net Assets
Beginning of year.......... 862,466,683 836,401,141
------------- -------------
End of year................ $ 685,133,895 $ 862,466,683
------------- -------------
------------- -------------
</TABLE>
See Notes to Financial Statements. See Notes to Financial Statements.
B-32
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
Notes to Financial Statements
Prudential National Municipals Fund, Inc. (the ``Fund''), is registered under
the Investment Company Act of 1940 as a diversified, open-end management
investment company. The investment objective of the Fund is to seek a high level
of current income exempt from federal income taxes by investing substantially
all of its total assets in carefully selected long-term municipal bonds of
medium quality. The ability of the issuers of debt securities held by the Fund
to meet their obligations may be affected by economic or political developments
in a specific state, industry or region.
Note 1. Accounting The following is a summary
Policies of significant accounting poli-
cies followed by the Fund in the preparation of
its financial statements.
Securities Valuations: The Fund values municipal securities (including
commitments to purchase such securities on a ``when-issued'' basis) on the basis
of prices provided by a pricing service which uses information with respect to
transactions in bonds, quotations from bond dealers, market transactions in
comparable securities and various relationships between securities in
determining values. If market quotations are not readily available from such
pricing service, a security is valued at its fair value as determined under
procedures established by the Directors.
Short-term securities which mature in more than 60 days are valued at current
market quotations. Short-term securities which mature in 60 days or less are
valued at amortized cost which approximates market value.
Financial Futures Contracts: A financial futures contract is an agreement to
purchase (long) or sell (short) an agreed amount of securities at a set price
for delivery on a future date. Upon entering into a financial futures contract,
the Fund is required to pledge to the broker an amount of cash and/or other
assets equal to a certain percentage of the contract amount. This amount is
known as the ``initial margin''. Subsequent payments, known as ``variation
margin'', are made or received by the Fund each day, depending on the daily
fluctuations in the value of the underlying security. Such variation margin is
recorded for financial statement purposes on a daily basis as unrealized gain or
loss. When the contract expires or is closed, the gain or loss is realized and
is presented in the statement of operations as net realized gain(loss) on
financial futures contracts.
The Fund invests in financial futures contracts in order to hedge its
existing portfolio securities, or securities the Fund intends to purchase,
against fluctuations in value caused by changes in prevailing 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.
Securities Transactions and Investment Income: Securities transactions are
recorded on the trade date. Realized gains and losses on sales of portfolio
securities are calculated on an identified cost basis. Interest income is
recorded on an accrual basis. The Fund amortizes premiums and accretes original
issue discount on portfolio securities as adjustments to interest income.
Net investment income (other than distribution fees) and unrealized and
realized gains or losses are allocated daily to each class of shares based upon
the relative proportion of net assets of each class at the beginning of the day.
Federal Income Taxes: It is the intent of the Fund to continue to meet the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute all of its net income to its shareholders. For this
reason and because substantially all of the Fund's gross income consists of
tax-exempt interest, no federal income tax provision is required.
Dividends and Distributions: Dividends from net investment income are declared
daily and paid monthly. The Fund will distribute at least annually any net
capital gains. Dividends and distributions are recorded on the ex-dividend date.
Income distributions and capital gain distributions are determined in
accordance with income tax regulations which may differ from generally accepted
accounting principles.
Note 2. Agreements The Fund has a management
agreement with Prudential Mutual Fund Management,
Inc. (``PMF''). Pursuant to this agreement, PMF has responsibility for all
investment advisory services and supervises the subadviser's performance of such
services. PMF has entered into a subadvisory agreement with The Prudential
Investment Corporation (``PIC''); PIC furnishes investment advisory services in
connection with the management of the Fund. PMF pays for the cost of the
subadviser's services, the compensation of officers of the Fund, occupancy and
certain clerical and bookkeeping costs of the Fund. The Fund bears all other
costs and expenses.
The management fee paid PMF is computed daily and payable monthly at an
annual rate of .50% of the Fund's
B-33
<PAGE>
average daily net assets up to and including $250 million, .475% of the next
$250 million, .45% of the next $500 million, .425% of the next $250 million,
.40% of the next $250 million and .375% of the Fund's average daily net assets
in excess of $1.5 billion. Effective January 1, 1995, PMF has agreed to waive a
portion (.05 of 1% of the Fund's average daily net assets) of its management
fee. The Fund is not required to reimburse PMF for such waiver.
The Fund has distribution agreements with Prudential Mutual Fund
Distributors, Inc. (``PMFD''), which acts as the distributor of the Class A
shares of the Fund, and with Prudential Securities Incorporated (``PSI''), which
acts as distributor of the Class B and Class C shares of the Fund (collectively
the ``Distributors''). The Fund compensates the Distributors for distributing
and servicing the Fund's Class A, Class B and Class C shares, pursuant to plans
of distribution (the ``Class A, B and C Plans''), regardless of expenses
actually incurred by them. The distribution fees are accrued daily and payable
monthly.
On July 19, 1994, shareholders of the Fund approved amendments to the Class A
and Class B distribution plans under which the distribution plans became
compensation plans, effective August 1, 1994. Prior thereto, the distribution
plans were reimbursement plans, under which PMFD and PSI were reimbursed for
expenses actually incurred by them up to the amount permitted under the Class A
and Class B Plans, respectively. The Fund is not obligated to pay prior or
future excess distribution costs (costs incurred by the Distributors in excess
of distribution fees paid by the Fund or contingent deferred sales charges
received by the Distributors). The rate of the distribution fees charged to
Class A and Class B shares of the Fund did not change under the amended plans of
distribution. The Fund began offering Class C shares on August 1, 1994.
Pursuant to the Class A, B and C Plans, the Fund compensates the Distributors
for distribution-related activities at an annual rate of up to .30 of 1%, .50 of
1% and 1%, of the average daily net assets of the Class A, B and C shares,
respectively. Such expenses under the Plans were .10 of 1%, .50 of 1% and .75 of
1% of the average daily net assets of the Class A, B and C shares, respectively,
for the fiscal year ended December 31, 1994.
PMFD has advised the Fund that it has received approximately $92,500 in
front-end sales charges resulting from sales of Class A shares during the fiscal
year ended December 31, 1994. From these fees, PMFD paid such sales charges to
PSI and Pruco Securities Corporation, affiliated broker-dealers, which in turn
paid commissions to salespersons and incurred other distribution costs.
PSI has advised the Fund that for the fiscal year ended December 31, 1994, it
received approximately $976,100 in contingent deferred sales charges imposed
upon certain redemptions by Class B shareholders.
PMFD is a wholly-owned subsidiary of PMF; PSI, PMF and PIC are indirect,
wholly-owned subsidiaries of The Prudential Insurance Company of America.
Note 3. Other Prudential Mutual Fund Ser-
Transactions vices, Inc. (``PMFS''), a
with Affiliates wholly-owned subsidiary of
PMF, serves as the Fund's transfer agent and
during the fiscal year ended December 31, 1994, the Fund incurred fees of
approximately $457,600 for the services of PMFS. As of December 31, 1994,
$36,000 of such fees were due to PMFS. Transfer agent fees and expenses in the
Statement of Operations include certain out-of-pocket expenses paid to
non-affiliates.
Note 4. Portfolio Purchases and sales of invest-
Securities ment securities, other than
short-term investments, for the fiscal year ended
December 31, 1994, were $852,772,280 and $995,815,438, respectively.
At December 31, 1994, the Fund sold 78 financial futures contracts on the
Municipal Bond Index which expire in March 1995. The value at disposition of
such contracts is $7,779,719. The value of such contracts on December 31, 1994
was $7,734,188, thereby resulting in an unrealized gain of $45,531. The Fund has
pledged $11,970,000 principal amount of Texas Wtr. Res. Fin. Auth. Rev. Bonds
and $5,000,000 principal amount of West Feliciana Parish Poll. Ctrl. Rev. Bonds
as initial margin on such contracts.
The federal income tax basis of the Portfolio's investments at December 31,
1994 was $682,417,893 and, accordingly, net unrealized depreciation for federal
income tax purposes was $5,755,347 (gross unrealized appreciation--$11,820,207
gross unrealized depreciation--$17,575,554).
For federal income tax purposes, the Fund has a capital loss carryforward as
of December 31, 1994 of approximately $19,372,500 which expires in 2002.
Accordingly, no capital gains distribution is expected to be paid until net
gains have been realized in excess of such amount.
The Fund will elect to treat net capital losses of approximately $3,999,200
incurred in the two month period ended December 31, 1994 as having been incurred
in the following fiscal year.
Note 5. Capital The Fund offers Class A,
Class B and Class C shares. Class A shares are
sold with a front-end sales charge of up to
B-34
<PAGE>
3.0%. Class B shares are sold with a contingent deferred sales charge which
declines from 5% to zero depending on the period of time the shares are held.
Class C shares are sold with a contingent deferred sales charge of 1% during the
first year. Class B shares will automatically convert to Class A shares on a
quarterly basis approximately seven years after purchase commencing in or about
February 1995.
There are 750 million shares of common stock, $.01 par value, per share,
divided into three classes, designated Class A, Class B and Class C common
stock, each of which consists of 250 million authorized shares.
Transactions in shares of common stock were as follows:
<TABLE>
<CAPTION>
Class A Shares Amount
- ---------------------------- ----------- -------------
<S> <C> <C>
Year ended December 31,
1994:
Shares sold................. 2,875,693 $ 42,583,262
Shares issued in
reinvestment of dividends
and distributions......... 37,934 573,468
Shares reacquired........... (2,900,866) (42,851,546)
----------- -------------
Net increase in shares
outstanding............... 12,761 $ 305,184
----------- -------------
----------- -------------
Year ended December 31,
1993:
Shares sold................. 801,949 $ 13,267,418
Shares issued in
reinvestment of dividends
and distributions......... 52,588 854,996
Shares reacquired........... (468,357) (7,812,061)
----------- -------------
Net increase in shares
outstanding............... 386,180 $ 6,310,353
----------- -------------
----------- -------------
<CAPTION>
Class B Shares Amount
- ---------------------------- ----------- -------------
<S> <C> <C>
Year ended December 31,
1994:
Shares sold................. 2,885,324 $ 43,581,881
Shares issued in
reinvestment of dividends
and distributions......... 1,749,682 26,518,677
Shares reacquired........... (10,042,966) (150,899,970)
----------- -------------
Net decrease in shares
outstanding............... (5,407,960) $ (80,799,412)
----------- -------------
----------- -------------
Year ended December 31,
1993:
Shares sold................. 11,392,790 $ 188,497,068
Shares issued in
reinvestment of dividends
and distributions......... 3,054,242 49,806,086
Shares reacquired........... (14,390,713) (238,702,509)
----------- -------------
Net increase in shares
outstanding............... 56,319 $ (399,355)
----------- -------------
----------- -------------
<CAPTION>
Class C
- ----------------------------
<S> <C> <C>
August 1, 1994* through
December 31, 1994:
Shares sold................. 9,735 $ 144,219
Shares issued in
reinvestment of
dividends................. 63 904
----------- -------------
Net increase in shares
outstanding............... 9,798 $ 145,123
----------- -------------
----------- -------------
</TABLE>
- ---------------
* Commencement of offering of Class C shares.
B-35
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
Financial Highlights
<TABLE>
<CAPTION>
Class A Class B Class C
PER -------------------------------------------------- ---------------------------------------------------- ------------
SHARE January 22, August 1,
OPERATING 1990D 1994DD
PERFOR- Year Ended December 31, through Year Ended December 31, through
MANCE: ----------------------------------- December 31, ---------------------------------------------------- December 31,
1994 1993 1992 1991 1990 1994 1993 1992 1991 1990 1994
------- ------- ------ ------ ------------ -------- -------- -------- -------- -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net
asset
value,
beginning
of
period $ 16.30 $ 15.94 $16.00 $15.09 $14.98 $ 16.33 $ 15.97 $ 16.02 $ 15.11 $ 15.15 $15.13
------- ------- ------ ------ ------ -------- -------- -------- -------- -------- ------
Income
from
investment
operations
Net
investment
income... .81 .90 .94 .97 .90 .75 .84 .88 .91 .90 .29
Net
realized
and
unrealized
gain
(loss)
on
investment
trans-
actions..(1.78) 1.05 .43 .91 .11 (1.78) 1.05 .44 .91 (.04) (.69)
------- ------- ------ ------ ------ -------- -------- -------- -------- -------- ------
Total
from
investment
opera-
tions.. (.97) 1.95 1.37 1.88 1.01 (1.03) 1.89 1.32 1.82 .86 (.40)
------- ------- ------ ------ ------ -------- -------- -------- -------- -------- ------
Less
distributions
Dividends
from
net
investment
income... (.81) (.90) (.94) (.97) (.90) (.75) (.84) (.88) (.91) (.90) (.29)
Distributions
from net
realized
gains.. (.10) (.69) (.49) -- -- (.10) (.69) (.49) -- -- --
------- ------- ------ ------ ------ -------- -------- -------- -------- -------- ------
Total
distri-
butions. (.91) (1.59) (1.43) (.97) (.90) (.85) (1.53) (1.37) (.91) (.90) (.29)
------- ------- ------ ------ ------ -------- -------- -------- -------- -------- ------
Net
asset
value,
end
of
period $ 14.42 $ 16.30 $15.94 $16.00 $15.09 $ 14.45 $ 16.33 $ 15.97 $ 16.02 $ 15.11 $14.44
------- ------- ------ ------ ------ -------- -------- -------- -------- -------- ------
------- ------- ------ ------ ------ -------- -------- -------- -------- -------- ------
TOTAL
RETURN#:...(6.04)% 12.60% 8.88% 12.94% 6.88% (6.39)% 12.15% 8.50% 12.42% 5.96% (2.63)%
RATIOS/SUPPLEMENTAL
DATA:
Net
assets,
end
of
period
(000)...$12,721 $14,167 $7,700 $3,819 $1,846 $672,272 $848,299 $828,702 $874,338 $882,212 $ 141
Average
net
assets
(000).. $14,116 $11,786 $5,401 $2,697 $1,161 $751,623 $854,919 $829,830 $862,249 $940,215 $ 103
Ratios
to
average
net
assets:##
Expenses,
including
distribution
fees... .77% .69% .72% .75% .75%* 1.17% 1.09% 1.12% 1.15% 1.13% 1.51%*
Expenses,
excluding
distribution
fees... .67% .59% .62% .65% .65%* .67% .59% .62% .65% .64% .76%*
Net
investment
income.. 5.38% 5.49% 5.79% 6.27% 6.43%* 4.96% 5.09% 5.39% 5.87% 6.03% 4.84%*
Portfolio
turnover
rate... 120% 82% 114% 59% 110% 120% 82% 114% 59% 110% 120%
<FN>
- ---------------
* Annualized.
D Commencement of offering of Class A shares.
DD Commencement of offering of Class C shares.
# Total return does not consider the effects of sales loads. Total return is calculated assuming a purchase of shares on
the first day and a sale on the last day of each period reported and includes reinvestment of dividends and
distributions. Total returns for periods of less than a full year are not annualized.
## Because of the event referred to in DD and the timing of such, the ratios for the Class C shares are not necessarily
comparable to that of Class A or B shares and are not necessarily indicative of future ratios.
</TABLE>
See Notes to Financial Statements.
B-36
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Prudential National Municipals Fund, Inc.
In our opinion, the accompanying statement of assets and liabilities, including
the portfolio of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Prudential National Municipals
Fund, Inc. (the ``Fund'') at December 31, 1994, the results of its operations
for the year then ended, the changes in its net assets for each of the two years
in the period then ended and the financial highlights for each of the five years
in the period then ended, in conformity with generally accepted accounting
principles. These financial statements and financial highlights (hereafter
referred to as ``financial statements'') are the responsibility of the Fund's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities at December 31, 1994 by correspondence with the
custodian and brokers, provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
1177 Avenue of the Americas
New York, New York
February 21, 1995
B-37
<PAGE>
APPENDIX A
DESCRIPTION OF TAX-EXEMPT SECURITY RATINGS
CORPORATE AND TAX-EXEMPT BOND RATINGS
The four highest ratings of Moody's Investors Service ("Moody's") for tax-
exempt and corporate bonds are Aaa, Aa, A and Baa. Bonds rated Aaa are judged
to be of the "best quality." The rating of Aa is assigned to bonds which are
of "high quality by all standards," but as to which margins of protection or
other elements make long-term risks appear somewhat larger than Aaa rated
bonds. The Aaa and Aa rated bonds comprise what are generally known as "high
grade bonds." Bonds which are rated A by Moody's possess many favorable
investment attributes and are considered "upper medium grade obligations."
Factors giving security to principal and interest of A rated bonds are
considered adequate, but elements may be present which suggest a
susceptibility to impairment sometime in the future. Bonds rated Baa are
considered as "medium grade" obligations. They are neither highly protected
nor poorly secured. Interest payments and principal security appear adequate
for the present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such bonds lack
outstanding investment characteristics and in fact have speculative
characteristics as well. Moody's applies numerical modifiers "1", "2", and "3"
in each generic rating classification from Aa through B in its corporate bond
rating system. The modifier "1" indicates that the security ranks in the
higher end of its generic rating category; the modifier "2" indicates a mid-
range ranking; and the modifier "3" indicates that the issue ranks in the
lower end of its generic rating category. The forgoing ratings for tax-exempt
bonds are sometimes presented in parentheses preceded with a "con" indicating
the bonds are rated conditionally. Bonds for which the security depends upon
the completion of some act or the fulfillment of some condition are rated
conditionally. These are bonds secured by (a) earnings of projects under
construction, (b) earnings of projects unseasoned in operation experience, (c)
rentals which begin when facilities are completed or (d) payments to which
some other limiting condition attaches. Such parenthetical rating denotes the
probable credit stature upon completion of construction or elimination of the
basis of the condition.
The four highest ratings of Standard & Poor's Ratings Group ("Standard &
Poor's") for tax-exempt and corporate bonds are AAA, AA, A and BBB. Bonds
rated AAA bear the highest rating assigned by Standard & Poor's to a debt
obligation and indicate an extremely strong capacity to pay principal and
interest. Bonds rated AA also qualify as high-quality debt obligations.
Capacity to pay principal and interest is very strong, and in the majority of
instances they differ from AAA issues only in small degree. Bonds rated A have
a strong capacity to pay principal and interest, although they are somewhat
more susceptible to the adverse effects of changes in circumstances and
economic conditions. The BBB rating, which is the lowest "investment grade"
security rating by Standard & Poor's, indicates an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds
in this category than for bonds in the A category. The foregoing ratings are
sometimes followed by a "p" indicating that the rating is provisional. A
provisional rating assumes the successful completion of the project being
financed by the bonds being rated and indicates that payment of debt service
requirements is largely and entirely dependent upon the successful and timely
completion of the project. This rating, however, while addressing credit
quality subsequent to completion of the project, makes no comment on the
likelihood of, or the risk of default upon failure of, such completion.
TAX-EXEMPT NOTE RATINGS
The ratings of Moody's for tax-exempt notes are MIG 1, MIG 2, MIG 3 and MIG
4. Notes bearing the designation MIG 1 are judged to be of the best quality,
enjoying strong protection from established cash flows of funds for their
servicing or from established and broad-based access to the market for
refinancing, or both. Notes bearing the designation MIG 2 are judged to be of
high quality, with margins of protection ample although not so large as in the
preceding group. Notes bearing the designation MIG 3 are judged to be of
favorable quality, with all security elements accounted for but lacking the
undeniable strength of the preceding grades. Market access for refinancing, in
particular, is likely to be less well established. Notes bearing the
designation MIG 4 are judged to be of adequate quality, carrying specific risk
but having protection commonly regarded as required of an investment security
and not distinctly or predominantly speculative.
The ratings of Standard & Poor's for municipal notes issued on or after July
29, 1984 are "SP-1" "SP-2" and "SP-3". Prior to July 29, 1984, municipal notes
carried the same symbols as municipal bonds. The designation "SP-1" indicates
a very strong capacity to pay principal and interest. A "+" is added for those
issues determined to possess overwhelming safety characteristics. An "SP-2"
designation indicates a satisfactory capacity to pay principal and interest
while an "SP-3" designation indicates speculative capacity to pay principal
and interest.
CORPORATE AND TAX-EXEMPT COMMERCIAL PAPER RATINGS
Moody's and Standard & Poor's rating grades for commercial paper, set forth
below, are applied to Municipal Commercial Paper as well as taxable commercial
paper.
A-1
<PAGE>
Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rate issuers: Prime-1, superior capacity; Prime-2, strong capacity; and Prime-
3, acceptable capacity.
Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more
than 365 days. Ratings are graded into four categories, ranging from "A" for
the highest quality obligations to "D" for the lowest. Issues assigned A
ratings are regarded as having the greatest capacity for timely payment.
Issues in this category are further refined with the designation 1, 2 and 3 to
indicate the relative degree of safety. The "A-1" designation indicates the
degree of safety regarding timely payment is very strong. A "+" designation is
applied to those issues rated "A-1" which possess an overwhelming degree of
safety. The "A-2" designation indicates that capacity for timely payment is
strong. However, the relative degree of safety is not as overwhelming as for
issues designated "A-1." The "A-3" designation indicates that the capacity for
timely payment is satisfactory. Such issues, however, are somewhat more
vulnerable to the adverse effects of changes in circumstances than obligations
carrying the higher designations. Issues rated "B" are regarded as having only
an adequate capacity for timely payment and such capacity may be impaired by
changing conditions or short-term adversities.
A-2
